To Hell and Back: Spain’s Grotesque Recession and Its Surprising New Economy

By Steven Hill, The Atlantic, October 18, 2013

A not-so-short history of the Spanish economy: The half-century housing bubble, the excruciating recession, the grisly unemployment, and, finally, a glimmer of hope. 

MADRID – It’s been more than a rocky few years for Spain. It’s been a rocky half-century.

Run by a military dictator until the 1970s, Spain emerged in the early 2000s as a model of social democracy and the poster child for the European Union. Then the global economy collapsed in 2008, and suddenly Spain was suffering from Depression-era levels of unemployment and an economy melting down like a surreal Dali horrorscape. In a few years it had gone from budget surpluses, a growing middle class, and generous social supports to wrenching austerity policies and collapsing wages, triggered by the massive failure of Spanish banks. 

When the global crisis struck in 2008, Spain was headed by the Socialist government of Prime Minister José Luis Rodríguez Zapatero. Unlike Greece, it was not a chronic over-spender. Its debt was merely 36% of its GDP in 2007, about half the debt burden of the U.S. and Germany at the time. The Socialist Party wasn’t stocked with bank industry shills, or slavish admirers of greedy capitalism, but their reaction to the crisis devastated their own constituents just as Spain’s decades-long economic model was coming undone. There are lessons for Americans in understanding what happened to Spain.

The Spanish Model: Home Is Where the Economy Is

In a way, Spain’s bubble lasted for the entire second half of the 20th century.

Its economy had been heavily dependent on real estate and construction since General Francisco Franco’s dictatorship in the 1950s. This was an anomaly from the rest of western Europe, which enjoyed a post-war boom in manufacturing growth. Still, the emphasis on housing continued after Franco’s death in 1975 under the first Socialist government with Felipe González. As researchers Isidro López and Emmanuel Rodríguez noted, Spain’s ongoing property bubble, aided by an expanding European financial industry, was its domestic motor for economic expansion. López and Rodríguez called it “asset-price Keynesianism.”

For years, the strategy worked. Spain had high unemployment throughout the 1980s and 90s – often over 20 percent of the work force – but in less than three decades it rose from being a poor, backward country run by a dictator to a modern, wealthy, technologically-advanced European social democracy. In the 1990s, the Spanish bull economy grew at nearly 4 percent a year, much faster than most of Europe or the U.S. Job creation soared and by the mid-2000s the unemployment rate was in single digits for the first time in modern history. Once again, houses were the heart of it: in 2007 the levels of private home ownership topped off at 87 percent, one of the highest rates in the the world (it’s never been above 70 percent in the U.S.).

The Spanish middle class had arrived. But just as the American middle class would discover, housing prices always rise—until they don’t.

The global economic collapse of 2008, the most destructive since the Great Depression in the 1930s, started in the housing markets of the U.S., fanning out around the world, and slamming Spain, Ireland and the United Kingdom. Suddenly the sector that for decades had driven the Spanish economy crashed. For-sale signs are so abundant that one source told me they had become “Spain’s national tree.”

From Stimulus, to Austerity, to Depression

Like its US and European allies, the Zapatero government initially used stimulus to dull the recession. The Socialists launched the largest stimulus package in the European Union, as a share of the economy. But despite this intervention, the Spanish economy was still stagnant by 2010 and the deficits were staggering. Regional banks and governments, which political parties had historically used to reward their cronies with construction projects (e.g.: sports stadiums and “airports to nowhere”), began to fail en masse. It fell to the national government to take on their debts

Practically overnight, Spain’s debt burden doubled. As Greece’s own crisis raised fears of its default, European leaders envisioned a domino effect that could engulf Spain, Portugal, Ireland and even Italy, and threaten the stability of the Euro currency itself. European leaders were looking into an abyss and fearing an imminent collapse of the entire post-World War II project. The Zapatero government—without enough tax revenue to pay for its elevated spending and facing high and rising interest rates to borrow the difference—came under immense pressure from both its European allies and the bond markets to cut its spending.

If Spain controlled its own currency, like the U.S. does, it might have printed money and risked inflation to pay off its debt. Instead, Spain is tethered to the euro and has little control over monetary policy. Zapatero felt he had no choice but to cut spending and raise taxes to win back trust of Spain’s investors. His plans included a 5-percent salary cut and a salary freeze for public employees, a cost-of-living freeze for pensions, a higher retirement age, the elimination of “kiddie stipends” (the widespread European practice of providing several hundred dollars per month per child to families), an increase in the value-added tax, and modest cuts in health spending.

These cuts weren’t merely painful. They were particularly painful to public employees and pensioners—the heart of the Socialists’ core constituency. Austerity, which had destroyed hundreds of thousands of jobs, would inevitably destroy the Socialists, themselves.

Easy to Fire, Easy to Hire

Spain’s austerity program plunged the country back into a recession, by sucking income and economic activity out of the country. It also exposed a crucial rift at the heart of the economy between job-holders (insiders) and job-seekers (outsiders). Spain’s economy has long afforded strong protections to the insiders, making it harder for the outsiders to break in.

“Insiders, such as labor union members and public employees, strongly prefer employment protection schemes that protect their jobs,” says Professor Mariely Lopez-Santana of George Mason University, who studies Spain’s labor markets. “Outsiders, such as the unemployed or those with temporary employment, favor policies that reduce labor protections to pry open more jobs.”

As the number of outsiders grew during the recession—including swelling numbers of unemployed young people and immigrants—the Zapatero government responded by scaling back some of its employment protections for the insiders. For example, the government made it easier and less costly to lay off workers, and drastically reduced its generous severance pay. It’s cheaper to hire somebody, the government reasoned, if it’s also cheaper to fire them.

Leftist critics cried foul, but many hailed the labor reforms as long overdue. One small business owner with eight employees and collapsing sales told me he would have to pay about $14,000 in severance per worker to lay off just two people. “Please explain to me how my business is to survive,” he asked me, “under the weight of all those employees that I no longer can support. Most of my friends are business owners. The talk when we get together is that we are all struggling to find some way to survive.”

Spain’s strict labor laws have contributed to a black market for jobs, with growing numbers of Spaniards accepting work under-the-table, so that employers can skirt the severance-pay law. In fact, Professor Lopez-Santana said one reason Spain’s unemployment rate is so high—an eye-popping 26 percent—is because so many people work in this “grey economy” and don’t show up in official figures. Some have estimated that this underground market now accounts for 20 percent of GDP.

Meet the New Austerity, Same as the Old Austerity

Labor unions hit the Socialist government with a series of strikes and demonstrations, with allies turned suddenly into adversaries. The Socialists went on to lose both the national and regional elections to the conservative People’s Party — which then enacted even harsher austerity measures. Along with Greece, Spain’s unemployment rate has been, by far, the highest in the developed world.

And yet, on the streets of Madrid and Barcelona, it’s hard to find signs of misery and economic depression. The streets are teeming, the cafés, tapas bars and plazas are full, the public spaces still buzzing with street musicians, sidewalk artists, and dramatic flamenco performances. “In Greece, they go on strike,” one person told me. “In Spain and Portugal, we go to the beach.” Every Spaniard citizens has health care, unlike nearly 50 million Americans, as well as other social supports. The ranks of homeless people and beggars are growing, but there are still far fewer than I see in downtown San Francisco or New York City. The protest movement of young people, known as Indignados, has transformed itself into an effective movement against foreclosures and evictions.

Credit for Spain’s resilience also goes to two other pillars of support: strong families and ongoing social benefits. Even after cutbacks, Spain still has fairly generous unemployment support. And generous families. The unemployment rate for the “principal breadwinner” is about 14% lower than the overall rate. José Ignacio Torreblanca, director of the Madrid office for the European Council on Foreign Relations, explained that involved families are motivated to help each other, especially parents and grandparents assisting their adult children by drawing upon savings.

The Recession: ‘Es Historia’

In September 2013, the government announced a bounty of good news. Exports were up 8 percent–higher than Germany’s–bond yields were down and the economy actually grew for the first time in three years. Prime Minister Mariano Rajoy told La Vanguardia the economic crisis “es historia.” Yet it is still a “by the numbers” recovery that many average people I talk to have failed to experience.

Still, recovery has moved the country away from over-dependency on real estate and construction toward a more German-style economy driven by exports of everything from automobiles to hot tubs, pharmaceuticals, textiles, machinery and software. About 60,000 firms are now exporters, 9% more than last year. Most observers seem to agree that exports have been aided by the reduction in wages that has been wrung from workers, with Spain’s labor costs narrowing the gap with Germany by 5.5 percent.

Looking forward, Spain has many assets, including a highly educated and skilled workforce and a burgeoning green tech industry that has made Spain a leader in solar and wind power. It also has an ideal climate—and a gorgeous landscape for tourists—with outstanding infrastructure and mass transportation (the high speed train I rode from Madrid to Barcelona sped along at over 180 miles an hour). As a Spanish-speaking nation, it benefits from a natural trade simpatico with the fast-developing economies in Latin America.

The last few years have shown Spain the limitations of an old economic model, which relied on speculative asset bubbles and unsustainable private debt. As Europe is slowly emerging from a painful round of austerity, which hurt aggregate demand throughout the continent and increased inequality, it is also trying to set course for a more sustainable economy driven by exports and steady growth rather than fragile bubbles. For Spain, the cold comfort emerging from the last few hellish years is that when you fall this far, up is the only way to go.

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