Tide is turning for Spain after decade in sun

Jul 2 2008 by Andrew Miller, The Journal

FOR most of the past decade, Spain was one of Europe’s star performers, fuelled by a booming housing market – as any visitor to the Spanish coast will have seen from the abundance of cranes and construction sites.

Yet the tide has turned of late, and decisively so. Worse, there is no easy resolution in sight. Most likely, Spain has entered a slump which could last several years.

Of course, Spain isn’t the only European country to have seen a housing boom. But the size of the Spanish construction bubble has been exceptional. House prices rose by more than double the level of the rest of the eurozone for each of the past 10 years. More recently, though, Spanish house prices have started to fall – the market shrank by 39% in March.

Over the past decade, house prices triggered a huge expansion in the Spanish building trade. Construction and housing-related employment made up 13% of all private-sector jobs at the end of 2007. In recent years, Spain built more new houses than Britain, France and Germany put together.

Until recently, this was a positive for the rest of the Spanish economy. Unemployment, for example, had fallen sharply. In 1994, the jobless rate was at nearly 20%, among the highest in Europe, but by late 2005 it was at the European average of 8.7% -– despite high immigration. But now the tide is turning. Since early 2007, unemployment has risen by around 1.5%, despite falling elsewhere in the eurozone.

Another problem is Spain’s antiquated wage framework. Spanish contractual wages are still linked to inflation, so that rising inflation due to the food and energy shock pushes up labour costs for employers. This makes it even harder for firms to hire new workers. Structural reforms are urgently needed; but these will take time, by which point the damage will already have been done.

Yet Spain’s problems do not end here. High debt is another issue. The country’s growth over the past years was increasingly financed by borrowing from the rest of the world. Its current account deficit is now the second-largest in the world in US dollar terms, accounting for around 10% of GDP.

If Spain still had its own currency, this would arguably already have led to a currency crisis. In this respect, euro membership has been a boon for Spain; only current account surpluses in other eurozone countries like Germany have kept it stable. But this does not mean a correction is not still required. Painful balance sheet restructuring will have to ensue, for both non-financial firms and private households.

Spain’s re-elected government now faces a tough task after the country’s decade in the sun. President Jose Zapatero must rebalance the economy away from construction; ask workers to tighten their belts and reform the wage bargaining system and reduce borrowing. None of these battles will be easy.

Andrew Miller is head of the Newcastle office of Barclays Wealth.