Why Spanish Economy Needs to Return to 2000 Wages and Prices

When it comes to the housing meltdowns in the richest economies, the US has been matched only by Spain, Ireland and the UK. All four countries have seen spectacular losses of wealth in the housing sector over the last two years.

The response by all four governments was to apply as much stimulus as they reasonably could to prevent their economies from descending into free fall. This has opened up gaping holes in each country's government accounts. However, in contrast to the United States or the UK, both Spain and Ireland have the Euro as an external constraint which limits their policy choices. This has resulted in credit downgrades for the sovereign debt in Ireland and Spain.

Looking at Spain, there was massive over-building in the property sector, which attracted a lot of labor to Spain. Now that these jobs have been vaporized, the unemployment rate has soared to near 18%. The problem is quite acute and there are few policy solutions. Reinforcing this point for me was a discussion I had with Spain-expert Edward Hugh, who writes at the blogs Global Economy Matters and A Fistful of Euros, in the wake of some downbeat comments by Paul Krugman about the country.

Edward wrote:

The problem is Spain can only create jobs through exports. The problem is, with Brussels prices we cannot attract investment to build new factories to create high volume unskilled employment. At this stage in the game we are not in competition with Brussels, but with Bratislava. That may not be a pleasant truth, but it is simply like that. We have attracted a large quantity of people here to work in unskilled low-value employment. The industry that gave them work just permanently disappeared out of sight. We need, urgently to find alternatives since we cannot pay them all 420 euros a month for ever. This is more than a simple academic exercise, it is now a question of life and death for the Spanish economy.

Basically we need to go back to 2000 wages and prices and start again. Maybe you don’t like this idea, but can you point me to anyone who has an alternative?

Obviously, a huge cut in nominal wages is never going to fly in any country because wage prices are sticky. Call it “money illusion” or call it a desire to maintain a decent standard of living, across-the-board nominal wage cuts are a political non-starter. But, this is what is needed in Spain.

Edward does address the standard-of-living problem this presents:

This is not simply about bringing down wages. It is about simulating a devaluation by bringing down prices AND wages together. So you as an employee should be in the same situation as before. The only realistic way to do this is through a pact between employers, unions and political parties, everyone.

The only real problem is with the debts, since they will also need adjusting down, but see another thread here on this.

But OK, I’m not saying this is going to be easy, just that we have no alternative. We shouldn’t have inflated the housing bubble in the first place.

Of course, being able to devalue the currency is one way to achieve this. But, Spain does not have that option. These are the very real policy cul-de-sacs faced in the aftermath of a debt-fueled asset bubble. And since another one seems to be inflating right now, I reckon the U.S. and the U.K. will be joining Ireland and Spain on this dead-end street in due course whether their currencies are weak or not.

Comments

[Michael Clark:]

Can anyone believe that the Spain Index has rallied right along with other indexes during this last rally? Is that insane? Water lifts all the botas equally I guess.

Nov 01 07:48 AM

[Old Trader:]

I caught the piece on the Fistful of Euros blog the other day, and it made for a most edifying read. I found it interesting that there's a fairly large variance in the condition of the various economies that comprise the EU. Somewhat surprisingly (to me, at least) is that France seems to be the best of the lot, at least at the moment. Even Italy (the perennial "weak sister") is doing better than Spain!!!

Nov 01 08:37 AM

[mdmrjsds:]

This is another way of reporting on the flaw in world financial systems. When money is created out of thin air because there is 'demand' for it, people treat that money as if it was real (represented value). But it doesn't. So when the house of cards collapses, someone has to pay for that assumption. That is the person left holding the bag. In the article above, the debt.

Adjusting wages and prices can't fix this, there is a real loss. It is much clearer if looked at from the perspective of money as energy / thermodynamics. It is obvious then why there has been a collapse.

In the US, Goldman-Sachs seem to understand this dynamic. So they got out of the markets they created that were ready to fail and left others holding the bag. From a certain perspective, this looks much like fraud, and from another perspective, savvy investing.

Cutting all wages and leaving prices the same is a solution that makes everyone pay for the excesses of the few. Cutting both wages and prices does nothing, and cutting prices in fact is impossible because they are determined externally, by the world market.

The central banks have decided to take the course of cutting all wages. They have decided to do it under the table by inflating all currencies in unison, so that nominal wages don't decline, but actual purchasing power does. Note that, because of the way financial systems are designed, this solution rewards the financial institutions that destroyed the system. What a world!

I haven't yet decided if the political class are complicit in this or are just ignorant.

Nov 01 03:17 PM

[Formyx:]

Spaniards already compete for slave wages with illegal immigrants. Spain may be the first to face social unrest because of EUs tolerance to illegal trafficking during the boom years. Frontex is already patrolling EU borders to crack down on illegal immigration. Unlike the US, European nations are still largely ethnocentric with low assimilation rates of the newcomers. It is a very dangerous cocktail.

Nov 01 08:27 PM