Adios Austerity, But Debt Will Still Limit Spain’s Growth Measures

Spain’s 32-month experiment with austerity-at-all-costs, as devised by Angela Merkel’s budget ultras, is drawing to a close.

Prime Minister Mariano Rajoy oversaw 62 billion euros of tax hikes and spending cuts, 851,000 job losses and three different deficit targets, all in his first year in office. Now European Union budget enforcer Olli Rehn is ready to ease up on the beleaguered premier.

“If there has been a serious deterioration in the economy, we can propose an extension of a country’s adjustment path,” said Rehn, the EU’s economic and monetary affairs commissioner, as he sat alongside Spanish Economy Minister Luis de Guindos on Jan. 28.

Thirty-eight hours later the National Statistics Institute duly confirmed that Spain was indeed suffering a serious deterioration in the economy. The pace of economic contraction more than doubled in the fourth quarter, when the tax hikes Rajoy had delayed to try and win power in the south region of Andalucia finally kicked in. Unemployment hit a record 26 percent.

The shift reflects a changing consensus among policy makers, which has seen the IMF join economists including Nobel laureate Paul Krugman in arguing that too much austerity is self-defeating. It damages economic activity, reduces tax revenues and tips economies into the vicious cycle of deeper spending cuts and falling output that the Greeks have been suffering since 2010.

Officials from the Washington-based fund pressed Rehn on the issue at the IMF’s October meeting in Tokyo, and in January Chief Economist Olivier Blanchard published a paper showing that European austerity programs damaged economic output more than twice as much as Rehn’s analysts had expected.

For Spain, though, what comes next is a trickier issue.

When the first-wave of the global financial crisis tipped Spain into its slump five years ago, then Prime Minister Jose Luis Rodriguez Zapatero applied his sometime adviser Krugman’s recipe of deficit spending for two years.

“We should learn the lesson of the Great Depression,” Zapatero told the New York Times in a July 2009 interview. “When an economy enters a deep recession, the only way we can come out of it is from a big push from the public sector.”

That approach, it turned out, was like revving the engine of your SUV as it careered off a cliff. In May 2010, with the deficit soaring beyond 11 percent, Zapatero was forced into the volte-face that ultimately cost him his job.

Today Spain is 180 billion euros of toxic banking assets closer to reaching a point of equilibrium, but its public finances have been shredded. Government debt reached about 85 percent of GDP at the end of last year from 36 percent in 2007, limiting the scope for any return to fiscal stimulus.

That is the circle the EU officials have to square when they update the Spanish program on Feb. 22.

Over to you Mr. Rehn.

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