Spain’s EC membership dates back to January 1986. Since then, it has implemented important structural and financial reforms to open up its economy in accordance with EC directives and to meet the challenges associated with the establishment of the single European market in 1993 and the European economic and monetary union (EMU) by the end of the century. These initiatives, as well as the implementation of structural reforms to speed up the development of a free market economy, follow a long liberalization process that started in the 1960s and was amplified in the subsequent decades in response partly to the impact of the oil crises.
Transition to an Open Economy, 1950–85
Spain’s economic transition may be conveniently split into three main phases: (1) the autarkic phase, from 1950 to 1959, (2) the progressive opening up of the economy, from 1960 to 1973, and (3) the transition to democracy and structural reforms in response to the oil crises, from 1973 to 1985.
Autarky
During the 1950s, the Spanish economy registered a profound industrial change with real growth averaging 5 percent a year. The value of industrial output doubled by the end of the decade. The main factors driving the transformation were (1) the easing of foreign exchange controls, (2) a significantly larger flow of foreign financial aid, as the ostracism of the Franco regime subsided, and (3) reduced price controls on industrial goods, while maintaining tight control on agricultural prices. These developments fueled a sustained private investment boom in the industrial sector.1 By the end of the 1950s, however, Spain was still a relatively closed economy—the sum of exports and imports of goods and services represented less than 8 percent of gross domestic product (GDP)—and still had an important agricultural sector with output representing some 15 percent of total production. Inefficiencies in agriculture and industry combined with large wage increases and price controls gave rise to inflationary pressure that was fueled by a lenient monetary policy, which provided nearly automatic financing for budget deficits. In 1959, a balance of payments crisis led to a three-year IMF stabilization plan.2 Consequently, restrictive financial policies were combined with the progressive elimination of the discretionary system of import licenses and the introduction of a general tariff that aimed at equalizing domestic and international prices. The peseta was devalued by 43 percent against the U.S. dollar, the multiple exchange rate system was dismantled, and restrictions on foreign inward direct investments were significantly alleviated.3
Economic Transition, 1960–73
The implementation of the stabilization plan quickly restored macroeconomic equilibrium and set the conditions for a more sustainable long-term growth. After a short recession induced by the stabilization phase, real output expanded by an average of 7.0 percent a year over the period 1960–73. This was the best performance among industrial countries, barring Japan, and nearly 3 percentage points higher than during the previous decade. The sustained growth was accompanied by a further shift in the composition of output. The share of agriculture in total output declined by 10 percent, while that of the service sector increased by the same percentage. Foreign investment lured by low labor costs provided a significant contribution to the economic expansion. Gross capital inflows increased by 20 percent a year during the period and in 1973 amounted to 13 percent of gross fixed investment. The buoyant activity, concentrated in the construction, industrial, and tourism sectors, did not permit a lasting improvement in inflation. To dampen inflationary pressures, severe price and wage controls were temporarily reintroduced in 1967 and 1968, as financial market rigidities blunted the effectiveness of restrictive financial policies. Over the 1960–73 period, the GDP deflator increased on average by 7 percent a year, a high inflation rate by international standards in the 1960s. With the progressive liberalization of trade flows, the sum of exports and imports of goods and services reached the equivalent of 14 percent of GDP at the beginning of the 1970s. Meanwhile, the current account balance moved from a deficit of 2.7 percent of GDP in 1960 to a surplus close to 2 percent of GDP in the years preceding the first oil crisis (Chart 1). This was helped by a renewed 17 percent depreciation of the peseta against the U.S. dollar in 1967, the preservation of an important effective tariff protection in spite of the decline of the average nominal tariff (Table 1), and the signing of a landmark Preferential Trade Agreement with the EC in 1970.4
Growth, Inflation, External Current Account, and Unemployment Rate
Source: Bank of Spain.Tariffs and Indirect Taxes on Imports
(In percent)
Indirect border adjustment taxation up to 1985 and value-added tax thereafter.
Tariffs and Indirect Taxes on Imports
(In percent)
| Year | Average Tariff |
Indirect Tax1 | Total | Year | Average Tariff | Indirect Tax1 | Total |
|---|---|---|---|---|---|---|---|
| 1961 | 12.71 | 6.0 | 18.71 | 1975 | 5.32 | 6.18 | 11.49 |
| 1962 | 11.9 | 6.24 | 18.13 | 1976 | 5.15 | 6.03 | 11.17 |
| 1963 | 11.84 | 6.23 | 17.73 | 1977 | 6.23 | 6.78 | 13.02 |
| 1964 | 11.61 | 7.31 | 18.91 | 1978 | 5.15 | 6.86 | 12.02 |
| 1965 | 8.82 | 9.14 | 17.94 | 1979 | 4.59 | 6.41 | 11.02 |
| 1966 | 9.97 | 9.39 | 19.28 | 1980 | 3.82 | 6.08 | 9.90 |
| 1967 | 9.62 | 9.22 | 18.43 | 1981 | 3.56 | 4.97 | 8.53 |
| 1968 | 7.97 | 8.05 | 15.19 | 1982 | 3.77 | 5.45 | 9.22 |
| 1969 | 7.80 | 8.39 | 16.19 | 1983 | 3.85 | 5.40 | 9.25 |
| 1970 | 7.29 | 8.15 | 15.44 | 1984 | 3.65 | 5.36 | 9.01 |
| 1971 | 7.60 | 8.17 | 15.77 | 1985 | 3.88 | 5.56 | 9.44 |
| 1972 | 7.86 | 8.43 | 16.29 | 1986 | 4.95 | 10.51 | 15.46 |
| 1973 | 7.51 | 8.52 | 16.02 | 1987 | 4.96 | 11.94 | 16.90 |
| 1974 | 5.21 | 6.67 | 11.88 | 1988 | 4.32 | 11.76 | 16.08 |
Indirect border adjustment taxation up to 1985 and value-added tax thereafter.
Tariffs and Indirect Taxes on Imports
(In percent)
| Year | Average Tariff |
Indirect Tax1 | Total | Year | Average Tariff | Indirect Tax1 | Total |
|---|---|---|---|---|---|---|---|
| 1961 | 12.71 | 6.0 | 18.71 | 1975 | 5.32 | 6.18 | 11.49 |
| 1962 | 11.9 | 6.24 | 18.13 | 1976 | 5.15 | 6.03 | 11.17 |
| 1963 | 11.84 | 6.23 | 17.73 | 1977 | 6.23 | 6.78 | 13.02 |
| 1964 | 11.61 | 7.31 | 18.91 | 1978 | 5.15 | 6.86 | 12.02 |
| 1965 | 8.82 | 9.14 | 17.94 | 1979 | 4.59 | 6.41 | 11.02 |
| 1966 | 9.97 | 9.39 | 19.28 | 1980 | 3.82 | 6.08 | 9.90 |
| 1967 | 9.62 | 9.22 | 18.43 | 1981 | 3.56 | 4.97 | 8.53 |
| 1968 | 7.97 | 8.05 | 15.19 | 1982 | 3.77 | 5.45 | 9.22 |
| 1969 | 7.80 | 8.39 | 16.19 | 1983 | 3.85 | 5.40 | 9.25 |
| 1970 | 7.29 | 8.15 | 15.44 | 1984 | 3.65 | 5.36 | 9.01 |
| 1971 | 7.60 | 8.17 | 15.77 | 1985 | 3.88 | 5.56 | 9.44 |
| 1972 | 7.86 | 8.43 | 16.29 | 1986 | 4.95 | 10.51 | 15.46 |
| 1973 | 7.51 | 8.52 | 16.02 | 1987 | 4.96 | 11.94 | 16.90 |
| 1974 | 5.21 | 6.67 | 11.88 | 1988 | 4.32 | 11.76 | 16.08 |
Indirect border adjustment taxation up to 1985 and value-added tax thereafter.
Oil Crises Spur Transition to Democracy and Structural Reform
The outstanding performance of the Spanish economy at the beginning of the 1970s masked important weaknesses that were exposed by the two subsequent oil crises. The industrial sector comprised small to medium-sized firms with weak financial, economic, and technological structures. It was protected from domestic and foreign competition by the remaining price controls, cartelization, and a highly effective import protection. Industrial firms had limited ability to absorb the labor supply in the face of the rapidly shrinking agricultural sector and efforts to improve labor productivity in the industry. Spain’s ability to maintain an unemployment rate below 1.0 percent during the 1960s reflected rigid labor laws, a structurally low level in the female participation rate due to social and cultural factors, and persistent emigration to neighboring countries.
As for the financial system, it was dominated by banking intermediation that was highly regulated and segmented with largely administered interest rates preventing competition between banks and providing low remuneration of savings. The public sector’s share in the economy was small but the Government nevertheless maintained a tight grip on the economy through financial policies and overwhelming intervention in all economic sectors. Yet, the ability of restrictive financial policies to check inflationary pressures was impaired by the largely administered characteristics of the economy. The openness of the economy was still limited—14 percent of GDP, or hardly half the EC average—in spite of the improvement of the 1960s. The external sector remained quite protected by trade and foreign exchange regulations, and the switch from coal to oil in the production of energy during the industrialization phase made the economy highly dependent on imported energy.
The First Oil Crisis
The first oil crisis at the end of 1973 put these weaknesses in sharper focus as the Spanish authorities, convinced of the short duration of the crisis and satisfied by a still comfortable current account surplus, attempted to counter the real shock induced by the doubled oil prices by relaxing financial policies. Fiscal measures implemented to weather the depressive impact of the oil shock on the domestic economy were partly effective5 and allowed Spain to maintain a GDP real growth rate of 3.3 percent, against 2.2 percent in the countries of the Organization for Economic Cooperation and Development (OECD), over the period 1974–77. This, however, was bought at a high price in terms of budget deficit and external imbalance and inflation. The budget balance moved steadily from a surplus of 0.7 percent of GDP in 1973 to a deficit of 1 percent of GDP in 1977 (Chart 2). The substantial current account surplus registered at the beginning of the 1970s was wiped out under the combined effects of oil price increases, adverse relative domestic demand pressures, and appreciation of the real effective exchange rate and turned into a deficit averaging 3 percent of GDP over the period 1974–77. The inflation rate increased from 11.4 percent in 1973 to 24.5 percent in 1977, fueling the demand for high wage increases allowed by an initially tight labor market and a largely accommodating monetary policy. The renewed and various attempts made to rein in price and wage increases by decree over the period 1973–76 met with little success. Wage settlements continued to be determined mainly on the basis of past labor productivity and past inflation. The growth of the average nominal wage went from 18 percent in 1973 to 27 percent in 1977, and the real wage grew on average 1 percent faster than labor productivity over the same period. The high increase in labor costs and oil prices combined to reduce the return on capital and to induce the obsolescence of industrial capacities relying heavily on imported energy, in particular shipbuilding, steel manufacturing industries, and textiles.
Fiscal Indicators
(In percent of GDP)
Source: Bank of Spain.The political context of the 1973–77 period, marked by the end of the Franco regime and the setting up of democratic institutions in an uncertain environment, restricted the ability of the successive Spanish governments to respond adequately to the first oil crisis. The establishment of democratic institutions enacted in the 1978 constitution law, the transformation of Spain into a federal state comprising 17 regional governments invested with administrative and legislative powers, the election of the first democratic government, and the 1977 October Moncloa agreement signed by the major political parties helped build the social consensus needed to implement a far-reaching adjustment program involving drastic stabilization measures and structural reforms.
The 1977 adjustment measures included (1) a 20 percent devaluation of the peseta against the U.S. dollar, supported by more restrictive financial policies to contain the budget deficit and monetary growth; (2) price and wage controls, including the introduction of price stabilization agreements with enterprises, the stabilization of the real wage in 1978, and the unilateral determination of wage increases by the government on the basis of expected inflation; (3) a relaxation of the restrictive law on layoffs allowing employers to lay off up to 5 percent of their labor force; (4) a fiscal reform to achieve a more neutral and equitable tax system and to simplify the tax structure—adoption of this reform was the sine qua non condition imposed by the signatories to the Moncloa agreement; and (5) a reform of the monetary and financial system to strengthen the role of market forces and reduce government intervention. In particular, these latter reforms broadened the control of the Bank of Spain over bank liquidity by opening the money market to savings banks, and by switching its intervention technique from a fixed rate allocation depending on banks’ own capital to an auction system. Also, efforts were made to develop market mechanisms in credit distribution. Interest rates were to be progressively liberalized, and investment ratios that commercial and savings banks had to fulfill by purchasing government bonds and providing subsidized credits were to be significantly reduced.
These measures succeeded in bringing down inflation and wage increases by nearly 10 and 8 percentage points, respectively, over the two following years. Helped by the buoyant international environment, the current account recorded a remarkable improvement, moving from a deficit of 4 percent of GDP in 1977 to a surplus of about 1 percent over the two following years. With the growth of activity coming to a stand-still, investment and employment deteriorated, in particular in the industrial sector, accelerating the shift in the composition of output in favor of the services sector. The deterioration of the budget deficit was amplified, reflecting both the working of economic stabilizers and the measures implemented to extend and improve the quality of public services and catch up with the main EC countries.
The Second Oil Crisis
The initial recession induced by the 1977 adjustment program was deepened by the impact of the second oil shock. The authorities, however, did not attempt to prevent or limit the pass-through of oil price increases to domestic costs and prices. To contain inflationary pressure, they relied mainly on monetary restraint and incomes policy, while the fiscal stance remained accommodative. Monetary restraint was illustrated by the deceleration of the growth of the money supply from 19 percent in 1979 to 13 percent in 1985, and by an increase in short-term interest rate differentials with the main currencies by some 8 percent between 1980 and 1983. Incomes policy was instrumental in containing wage pressure, as the employees’ unions and employers’ confederation accepted collective settlements over 1980–84 on the basis of previous productivity gains and rather conservative government inflation targets. This policy resulted for some years in a decline of real wages.
The monetary contraction, combined with the accelerated obsolescence of the capital stock induced by the oil price increase, amplified the decrease in capital accumulation in the industrial sector, and led to a massive unemployment increase.6 The unemployment rate jumped from 8.6 percent in 1979 to 21.5 percent in 1985. There is no doubt that such an important slack in the labor market contributed also to wage moderation. To alleviate the social burden induced by the rapid increase in unemployment, to support the restructuring of the industrial sector, and to strengthen the financial system, the authorities adopted the following measures: (1) a more lenient fiscal policy, which propelled the budget deficit from 2.1 percent of GDP in 1979 to 7 percent in 1985 (Chart 2); (2) an industrial reconversion program covering about 30 percent of total industrial activity; and (3) a strategy aiming at consistent reduction of the losses of the nationalized productive sector and a progressive privatization of the profitable firms included in Instituto Nacional de Industria (INI), the largest state holding company. The Industrial Reconversion Act in 1981 and the Law on Reconversion and Industrialization in 1984 constituted the first comprehensive effort to put together previous sectoral industrial programs and integrate their financial support through the budget. The program, which covered mainly the steel, shipbuilding, and textile sectors representing nearly 800 enterprises, called for a reduction of about 26 percent of their employment, or 2.5 percent of industrial employment.7 By the end of 1985 and the end of 1989, the target was achieved by 70 percent and 92 percent, respectively.8 Of the workers laid off, 25 percent had benefited from early retirement, 35 percent had been enrolled in a training program, and the rest had been made redundant. The financial costs of the programs were estimated at Ptas 1.1 trillion, or 4.4 percent of GDP.
Also, the Spanish authorities adopted an energy plan with the objective to reduce the share of imported energy from some 70 percent in the early 1970s to 52 percent by 1992, thanks to the development of domestic sources, namely, nuclear energy and coal output. In addition, efforts were made to restructure the banking system, whose soundness had been severely undermined by the industrial crisis in 1978 as a result of its traditionally important involvement in the industrial sector.9
On the external front, to tackle the bulging current account deficit, the Government adopted a policy of rather benign neglect of the peseta, which depreciated in effective terms by 53 percent over the period 1979–85, and alleviated exchange restrictions on long-term capital inflows in 1983 and on foreign direct investment in 1985.
Over the 1980–85 period, the average growth of GDP was 1.4 percent. Inflation and wage increases declined from 15.6 percent and 17.3 percent in 1980 to 8.8 percent and 8.7 percent in 1985, respectively, reflecting the impact of monetary contraction, changes in wage policy, and rising unemployment. Labor productivity started to grow faster than the real wage after 1979, recording an average growth differential of nearly 2 percent over 1980–85. From then on, labor costs ceased to be the dominant factor in contributing to inflation. The current account, after registering a deficit of about 2.5 percent of GDP a year over the period 1980–83, recovered owing to the depreciation of the real exchange rate of the peseta, the economic slump, and structural reforms.
Integration into the EC
After six years of negotiations, Spain became a full member of the EC on January 1, 1986, and was granted a transitory period of seven years to align its laws and regulations with the EC Directives. Since then, Spain has signed (1) an addendum to the EC Rome Treaty, the Single European Act in February 1986; (2) the 1978 Basle Act in May 1987, to participate in the European Monetary System; and (3) the Maastricht Treaty in December 1991, defining the two final steps of economic and monetary integration and laying the conditions for joining the European monetary union by 1999.
Overview of Main Macroeconomic Developments
As Spain entered the EC, the fundamental macroeconomic imbalances that had plagued the economy during the previous fifteen years had been eliminated and market mechanisms had largely replaced previously pervasive government interventions. The progressive opening up of the economy and structural reforms had alleviated rigidities in the goods and capital markets and provided for a deep restructuring of the industrial sector and the banking system.
Weaknesses remained, however, in the functioning of the labor, goods, and financial markets. Regulations, public monopolies (energy, transportation, communications), and private cartels continued to thwart competition, while the long-term conditions for a sustained and balanced growth were jeopardized by the plummeting of the economy’s gross saving ratio (from a maximum of 28 percent in 1974 to some 21 percent in 1985), reflecting to a large extent the increase in the budget deficit. These weaknesses were increasing the social cost of anti-inflationary policies and slowing the catching up process with the core EC economies.
By opening up the economy to EC competition, offering a vast market to Spanish producers, buttressing the credibility of Spain’s financial policies by joining the ERM, and keeping up a sustained pace of structural reforms, the authorities expected to overcome these weaknesses. The remarkable macroeconomic results achieved over the period 1986–91 bear witness to the effectiveness of the strategy.
In a favorable international context, at least until 1989, the performance of the Spanish economy was impressive. GDP grew at an average annual rate 4.3 percent over the period 1986–91, or 1.5 percent faster than in main trading partners. This allowed Spain to reduce its real gap with the core EC economies. In real terms and after correction for purchasing power parity changes, the ratio of GDP per capita between Spain and Germany increased from 40.1 percent in 1986 to 52.4 percent in 1990. GDP growth was propelled by soaring investment and buoyant consumption. Instrumental in the recovery of investment were the successive improvements of the return on capital starting 1984–85 after nearly ten years of consecutive deterioration and a huge inflow of direct foreign investment fueled in part by the prospects offered by the incoming single European market. At a sectoral level, the persistent decline of the industrial sector’s share in total output, observed since 1973, was arrested partly as an outcome of the Industrial Reconversion Program. The sustained growth of activity, a more flexible labor market10 and, a more subdued growth of the real wage boosted employment growth. The average annual increase in Spanish employment reached 3.1 percent over the period 1986–90 compared with 1.4 percent and 1.6 percent in the EC and the OECD, respectively, over the same period. This achievement reduced the unemployment rate from an average of 21.4 percent in 1985 to 15.8 percent in 1991. The buoyant activity did not impede significant progress in inflation despite persistent high pressure in the nontraded goods sector. Inflation declined from 8.8 percent to 4.8 percent in 1987, rising thereafter to 6.7 percent in 1990, and eventually slowing to 5.9 percent in 1991; underlying inflation continued to hover around 6.4 percent. Overall, the inflation convergence with the core ERM economies improved significantly (Chart 3).
Inflation
Source: International Monetary Fund.Financial policies were set to spur the nominal convergence process. The budget deficit was reduced from 7 percent of GDP in 1985 to 2.7 percent in 1989 but deteriorated somewhat thereafter owing, in part, to the working of economic stabilizers and, in part, to the entrenched development of the fiscal decentralization process.11 In subsequent years, most of the burden fell on monetary policy. The conjunction of a restrictive monetary policy with a more lenient fiscal stance induced a substantial increase in the nominal and real interest rate of the peseta and resulted in a persistent appreciation of its exchange rate, to the extent allowed by the ERM constraints after June 1989. The current account deteriorated, from a surplus of 1.6 percent of GDP in 1985 to a deficit of 2.9 percent in 1991, as a reflection of the differential in demand pressures between Spain and its main trading partners, the appreciation of the real exchange rate of the peseta, and large endogenous capital inflows attracted by high expected returns.
Impact on Trade and Capital Flows
Spain’s participation in the EC Rome Treaty and the Single European Act had the following implications: a progressive and reciprocal phasing out of all commercial protection (Table 2) between Spain and EC members’ by the end of 1992 for industrial and some agricultural products and by the end of 1995 for Mediterranean agricultural products; the adoption of the Common External Tariff rate vis-à-vis non-EC countries and the need to obtain the EC Commission agreement to introduce specific restrictive trade practices vis-à-vis non-EC members; the elimination of tax rebates on exports; and the phasing out of all capital controls by the end of 1992.
Changes in Spain’s Commercial Protection Since EC Membership
Changes in Spain’s Commercial Protection Since EC Membership
| Industrial Products | |||
|
|||
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| March 1 | 1986 | 10.0 percent | reduction |
| January 1 | 1987 | 12.5 percent | reduction |
| January 1 | 1988 | 15.0 percent | reduction |
| January 1 | 1989 | 15.0 percent | reduction |
| January 1 | 1990 | 12.5 percent | reduction |
| January 1 | 1991 | 12.5 percent | reduction |
| January 1 | 1992 | 12.5 percent | reduction |
| January 1 | 1993 | 10.0 percent | reduction |
| Total | 100 percent | reduction | |
| Agricultural Products | |||
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Changes in Spain’s Commercial Protection Since EC Membership
| Industrial Products | |||
|
|||
|
|||
| March 1 | 1986 | 10.0 percent | reduction |
| January 1 | 1987 | 12.5 percent | reduction |
| January 1 | 1988 | 15.0 percent | reduction |
| January 1 | 1989 | 15.0 percent | reduction |
| January 1 | 1990 | 12.5 percent | reduction |
| January 1 | 1991 | 12.5 percent | reduction |
| January 1 | 1992 | 12.5 percent | reduction |
| January 1 | 1993 | 10.0 percent | reduction |
| Total | 100 percent | reduction | |
| Agricultural Products | |||
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Trade liberalization with the EC had three principal effects: (1) it contributed to increase the openness of the Spanish economy from 18.1 percent of GDP in 1985 to 22.6 percent of GDP in 1990 and induced important changes in the geographic distribution of Spain’s trade; (2) it had an overall negative impact on the trade balance in the initial phase of integration; and (3) it favored a convergence of prices between the Spanish and EC traded goods sectors, thus helping to contain overall inflationary pressures in Spain.
Spanish exports to and imports from EC members increased from 50 percent and 33.4 percent, respectively, in 1985 to 71.3 percent and 59.6 percent in 1991. Spain’s revealed comparative advantage—as measured by the imbalance vis-à-vis the EC divided by the total of Spanish exports to and imports from the EC—deteriorated from a surplus of 6.7 percent in 1985 to a maximum deficit of 16.4 percent in 1989, declining thereafter to 13.6 percent in 1991. Instrumental in this deterioration were the selective and progressive removal of import protection on goods where Spain’s comparative advantage was the weakest—industrial goods—and the elimination of export subsidies after the introduction of the value-added tax (VAT) system. Trade liberalization with the EC also altered the allocation of resources both in Spain and in partner countries—EC and non-EC members—inducing various trade creation and trade diversion movements.
These results are also supported by a sectoral analysis carried out by Plummer (1991), on the basis of an econometric model of bilateral trade flows, to measure the efficiency effects of the accession of Spain and Portugal to the EC. The main conclusion of the study is that there was an overall net trade diversion over the period 1986–90 equivalent to 1 percent of total trade due mainly to the agricultural sector and concentrated on cereals and tobacco. The calculation of the revealed comparative advantage on the agricultural balance (agricultural intermediary goods and consumption goods), which moves from a surplus of 4.9 percent in 1985 to a deficit of 3.7 percent in 1991, also confirms this result, which reflects in part the relatively less favorable treatment of agricultural products in relation to industrial goods in the phasing out of tariff protection. Trade liberalization coupled with the stabilization or appreciation of the peseta exerted strong competitive pressures in the Spanish exposed sectors. It contained the annual average price increase in total exports to 0.9 percent over the period 1986–91, a performance comparable with those of the main EC countries: 0.6 percent for Germany, 0 percent for France, 1.9 percent for Italy, and 1.3 percent for the United Kingdom.
Capital liberalization was implemented generally at a faster pace than required by the EC directives. Over the period 1986–92, all the remaining restrictions to capital mobility, applying not only to EC countries but also to non-EC members, were phased out. This resulted in a progressive integration of the Spanish financial market into the international market and ended the segmentation of the domestic and external money markets as suggested by the elimination of any significant spread between their interest rates.
Capital liberalization had two principal effects on the Spanish economy: (1) it helped finance the current account deficit and boosted domestic investment; and (2) it altered the conditions for the implementation of financial policies, in particular, when coupled with exchange rate stabilization.
First, capital liberalization laid the ground for sustained financing of the current account deficit by the foreign private sector. Various motivations accounted for the sustained flow of long-term capital. Portfolio investors were attracted by high interest rates and the stabilization of the peseta. Direct investors were lured by the comparatively low costs of Spanish labor, the stable political and social environment, and the dynamics of the EC integration process. Net foreign direct investments grew at an average annual growth rate of 45 percent over the period 1985–90, increasing their share in gross fixed investment from 3.1 percent in 1985 to 8.8 percent in 1990. After 1987, they were concentrated in the service sectors, mainly financial services. This orientation was motivated by the high profitability of activities largely sheltered from competition as well as by the merger activity prompted by the incoming single European market for financial services as suggested by the increase in the share of EC investment in total direct investment from 40 percent in 1985 to 57 percent in 1990.
Second, the process of capital liberalization coupled with exchange rate stabilization altered the implementation of financial policies and led to important structural reforms in the banking system and financial markets. On the monetary side, the process hastened the abandonment of direct monetary management and led to a progressive loss of monetary independence. Ceilings on credit to the private sector introduced in 1989 were removed at the outset of 1991. Their effectiveness, already blunted by financial disintermediation, had subsequently been eroded by the removal of reserve requirements on foreign borrowing and the phasing out of most other impediments to capital movements. Exchange rate stabilization, especially following the participation of the peseta in the broad band of the ERM in June 1989, reduced further the scope for the implementation of an independent monetary policy, as large capital inflows in excess of the current account deficit forced the Bank of Spain to intervene in the foreign exchange market to contain the appreciation of the peseta in the ERM.12 Also, the increasing credibility attached to the ERM commitment, combined with improved capital mobility and substitutability, fostered a rapid interest rate convergence with core ERM economies.
On the fiscal side, capital liberalization provided a powerful incentive toward fiscal harmonization. This led to the introduction of the VAT at the beginning of 1986 and the progressive adjustment of its standard rate with the EC tax harmonization proposals after 1991, and to an income tax reform in 1991, aligning the taxation of capital income and capital gains of residents with the most liberal rules in EC countries, and removing most of the corresponding taxes imposed hitherto on nonresidents. Capital liberalization reduced also the seigniorage and increased the public debt burden following the reform of the reserve requirement system and the progressive phasing out of privileged financing. The stabilization of the exchange rate also limited further the possibility of seignorage from the inflation tax and provided the macroeconomic conditions for a greater effectiveness of fiscal policy.
Capital liberalization and the need to align Spain’s prudential regulations with those of EC partner countries also prompted important reforms in the banking system and capital market. To preserve the competitiveness of Spanish financial institutions in the integrated European capital market and prevent a major reallocation of financial transactions, the Spanish authorities revised drastically the bank reserve requirement system and accelerated the phasing out of investment coefficients on subsidized credits and treasury bills. These revisions were associated with structural reforms of the banking system and stock exchanges with a view to improving the effectiveness of financial policies.
Impact on Inflation
There is evidence that the policy of exchange rate stabilization brought about some improvement in inflation. Coupled with the opening up of the economy to EC competition and with the progressive implementation of antitrust EC directives, the stabilization of the peseta and its subsequent anchoring in the ERM provided the conditions for price convergence between the Spanish and EC traded goods sectors as indicated above. This helped drive down overall inflation in Spain and contributed to the progressive reduction of its inflation differentials vis-à-vis EC members. The inflation differential with the EC as a whole declined from some 4 percent at the end of 1985 to 0.7 percent at the end of 1991, while reductions vis-à-vis core ERM countries were more moderate.
Inflation gains were achieved, mainly, in the manufactured goods sector where Spanish producers were most directly exposed to their EC competitors. In this sector, consumer and producer prices increased by 4.9 percent and 2.4 percent on average a year, respectively, over 1986–91, which compares with an average increase in the consumer price index (CPI) of 5.9 percent over the same period. In other sectors, foreign and domestic competition remained impaired by regulations, cartel-like behavior, and oligopolistic structures.13 In the agricultural sector, the adjustment of Spanish prices to EC intervention prices imposed by the Common Agricultural Policy induced initially a sustained increase in food prices. This catching up process has now ended, and the elimination of existing positive compensatory amounts—related to the nominal appreciation of the peseta in terms of the European currency unit (ECU)—expected to take place in coming years will dampen price increases in this sector. In the nontraded goods sector, market structures and lower productivity favored the development of significantly and persistently higher price increases than those recorded in the exposed sectors. Average annual inflation in services was 9.1 percent over the period 1986–91. Efforts to improve competition in this sector through implementation of the antitrust law voted in 1988, in accordance with EC directives, have not succeeded so far.
The convergence observed in overall inflation between Spain and the EC was not accompanied by the same trend in nominal wages or unit labor costs, despite pressures exerted on the profit margins of Spanish producers. Wage growth differentials between the Spanish and EC industrial sectors stood at 2.7 percent in 1990, despite a significant reduction since 1986. A comparison based on unit labor costs in the same sector points to a more disturbing trend. The growth differentials of unit labor costs between Spain and the EC increased from 0.7 percent in 1986 to 3.8 percent in 1990. The absence of significant convergence of labor costs can be accounted for mainly by two factors. First, labor mobility in the EC is still hampered by national regulations. Second, the competition in the Spanish labor market was and is still impaired by institutional restrictions (the Ordenanzas Laborales inherited from the Franco regime) and structural mismatches between demand and supply at the sectoral and regional levels, as suggested by the high remaining unemployment level—even by European standards. In this context, one can surmise that Spain’s opening up to the EC put, in fact, upward pressure on nominal wages. It would be so because the liberalization of goods and financial markets in Spain coupled with the decline of real interest rates induced by the faster reduction of interest rate than inflation expectations provided the conditions for a more sustained growth than would have been expected in the absence of EC integration. This may have raised significantly the demand for labor while its supply remained plagued by the important rigidities previously mentioned.
Structural Reforms and EC Integration
To improve the competitiveness of the Spanish industry in the perspective of the single European market, and in light of the removal of remaining nontariff barriers (physical, technical, fiscal) and elimination of subsidies as required by the EC directives, the Government developed various programs over the period 1986–91 to provide financial support and credit to private and public companies. These programs, which also benefited from support of the EC, were associated with efforts to reduce Spain’s dependence on imported energy and to favor a more balanced regional development.
Restructuring and Privatization of Publicly Owned Companies
Spain extended its 1981–84 program of rationalization and restructuring of public enterprises to improve the allocation of resources, help develop market mechanisms, and comply with the EC directives on competition by eliminating or restricting the monopoly power of the public sector. This was combined with privatization to reduce the weight of the public companies in the Spanish economy, even though it was already rather small by European standards.14 Privatization was carried out through outright sales of some thirty companies, and partial privatization by sales of minority holdings on the stock exchange (General Eléctrica Sociedad Anónima (GESA), Empresa Nacional de Celulosas y Papel (ENCE), Empresa Nacional de Electricidad Sociedad Anónima (ENDESA)), and REPSOL, the state enterprise in charge of oil production and distribution. Most recent sales concern enterprises in the industrial sector, the energy sector, the mining industry and telecommunications. In the industrial sector, the Instituto Nacional de Industria (INI) was split in two parts: the Teneo Group or INISA receiving all the profitable or potentially profitable firms, and the Sociedad Estatal del Instituto Nacional de Industria (INISE) the remaining firms. INISA is expected to invest in private sector companies and, in the long run, to open up its own capital to private investors. INI will remain the main shareholder of INISA. Some public enterprises, like the state-owned airline company (IBERIA), might be later included in INISA, after improvement of their financial position. By contrast, INISE will remain strictly a public enterprise. It includes firms in the following sectors: steel industry, mining, weaponry, shipbuilding. The firms included in INISE are likely to require subsidies from the Government for some years to come.
In the energy sector, the monopoly power of public companies was further curtailed. In the production, transportation, and distribution of oil and natural gas, the public parent company controlling the sector (CAMPSA) was split up. Its subsidiaries were put up for sale, its monopoly on the distribution of fuel and natural gas was phased out in 1992, and restrictions imposed on the location of gas stations were alleviated. CAMPSA received Ptas 33 billion of fiscal exemptions for shedding its gas stations—the proceeds of assets revaluation related to the restructuring of CAMPSA equivalent to Ptas 60 billion were tax exempt. In the mining industry, to reduce unit costs of production, and consistent with EC directives aimed at reducing subsidies, a large restructuring of the coal industry has been initiated. Recent social unrest in some regions is linked to these restructuring efforts. In telecommunications, the monopoly power of Telefonica has been recently curtailed. Nevertheless, it will retain its monopoly on the basic telecommunication network for the next thirty years, in accordance with EC directives.
The Energy Plan
The previous energy plan, which reportedly contributed significantly to the reduction of energy consumption, was renewed in 1991 for the period 1991–2000. The new plan forecasts a relative containment of the final demand of energy and will foster the use of natural gas and renewable resources, expected to increase their share by some 9 percent in the energy balance, mainly at the expense of nuclear energy and oil. To achieve these objectives, the Government will rely on market mechanisms, taxes, and regulation. In the case of oil, trends in domestic prices will strictly reflect those on the international market. Prices of other sources of energy will be controlled with a view to preserving the environment, and maintaining domestically produced coal as a significant source of energy. The restructuring of the energy sector will be accompanied by an increase in the participation of private firms, which are expected to provide up to 10 percent of the production of electricity by the year 2000. This would be achieved in accordance with the EC directives, which call, in particular, for a reduction of subsidies. Energy-saving measures would reduce by 12 percent the ratio of consumption of primary energy to GDP. For the budget, the cost of these measures would be close to Ptas 0.2 billion over the period 1991–2000. With increased efficiency in energy utilization, the long-term growth of final energy and electricity is expected to be contained at 2.4 percent and 3.5 percent a year, respectively, a higher pace than in the past decade. The proportion of the various sources of energy in the final energy balance would change between 1990 and 2000, as indicated in Table 3. Investment expenditures of about Ptas 3 billion are required over the next decade to achieve the energy plan.
Energy Balance
(In percent)
Energy Balance
(In percent)
| 1990 | 2000 | ||
|---|---|---|---|
| Coal | 21.0 | 19.4 | |
| Oil | 52.6 | 50.0 | |
| Natural gas | 5.6 | 12.2 | |
| Nuclear energy | 15.8 | 11.2 | |
| Others | 5.0 | 7.2 | |
| Total | 100.0 | 100.0 | |
Energy Balance
(In percent)
| 1990 | 2000 | ||
|---|---|---|---|
| Coal | 21.0 | 19.4 | |
| Oil | 52.6 | 50.0 | |
| Natural gas | 5.6 | 12.2 | |
| Nuclear energy | 15.8 | 11.2 | |
| Others | 5.0 | 7.2 | |
| Total | 100.0 | 100.0 | |
Regional Development, EC Structural Funds, and Net Transfers from the EC
Financial assistance provided by the EC through the various components of the structural funds—European Social Fund (ESF), European Fund for Regional Development (ERDF), Fund for Agricultural Development (EAGGF)—to reduce regional imbalances in Spain, which had been accentuated as a result of the industrial reconversion program, reached 0.5 percent of GDP in 1990. Over the period 1989–93, Spain is expected to receive the largest share of the ESF, ERDF, and EAGGF funds—20.2 percent, 27 percent, and 21.8 percent, respectively.15 Their effectiveness, as an instrument of regional development, remains, however, uncertain.16 To the extent that these funds are fungible and are targeted to projects that would have been developed anyway, they provide global budgetary and balance of payments assistance benefiting the country as a whole. What matters from this perspective is the overall net transfer received by Spain from the EC, that is, after including receipts from the CAP and deducting expenditures corresponding to the contribution of Spain to the EC budget. In 1990, these net transfers were barely positive and represented 0.3 percent of GDP.
Prospects for Participating in the EMU
The medium-term prospects for Spain are tightly conditioned by the speed of the European economic integration process and, in particular, by the 1991 Maastricht agreement concluded among EC members to set the requirements for joining the EMU scheduled for the end of the century.17 Participating in the EMU at an early stage has thus become the fundamental objective of the Spanish authorities. With monetary autonomy severely curtailed by the ERM commitment, the authorities are left mainly with fiscal adjustment and structural reforms to comply with the following Maastricht convergence criteria: (1) inflation should not be more than 1.5 percent above that of the three best performers of the EC, and the long-term interest rate should not exceed by more than 2 percentage points the average long-term interest rates of these three countries over one year; (2) the budget deficit should not be more than 3 percent and the public debt of GDP ratio not more than 60 percent, or at least declining consistently toward these reference thresholds, while central bank credit to the Government is to be phased out; (3) the independence of the central bank from the Government should be assured by law; (4) the peseta should enter the narrow band at least two years before the beginning of the third stage and the stability of its central rate should be preserved over this period. With inflation and interest rate differentials with core ERM economies currently close to 3 percent and 4 percent, respectively, a budget deficit hovering around 5 percent of GDP, in part for cyclical reasons, and a public debt-to-GDP ratio close to 40 percent, there is no doubt that Spain can meet the Maastricht criteria on schedule.
In the meantime, establishing the macroeconomic conditions for catching up with the per capita income of the core ERM economies might be more difficult to achieve, as the fiscal consolidation required to dampen inflation is likely to slow economic growth significantly over the next three to four years. The Spanish Convergence Plan, presented in June 1992 to the EC Commission, which targets a budget deficit of 1 percent of GDP for 1996 and an inflation of 3 percent, aspires nevertheless to preserve an average economic growth close to potential, thanks to sweeping structural reforms expected to improve competition in the product and labor markets.
One cannot, however, discount the risks attached to a persistent real appreciation of the exchange rate and to possible reduction of real interest rates. This could happen if expected inflation adjusts gradually, while the peseta is stabilized in the ERM and its interest rate declines swiftly, reflecting the credibility of the exchange rate commitment. These developments could spur the growth of consumer demand and slow the nominal convergence process, while further reduction in the profitability and competitiveness of Spanish firms will affect investment and exports. Under such circumstances, a tighter fiscal consolidation might be called for and the ambitious growth objective of the Convergence Plan might not be feasible.
A significant improvement in labor mobility within European countries could also jeopardize economic growth. Greater labor mobility could translate into progressive alignment of Spanish wages with those of the richest countries of the EC, fuel inflationary pressures, reduce the profitability of investment, and exert a depressive impact on output and employment in Spain. Emigration could prevent an increase in Spanish unemployment and improve the allocation of resources in the EC countries. For social and cultural reasons, however, this may be deemed a long-term process un-likely to have a significant influence over the present decade.
Conclusion
During the last five years, Spain recorded impressive growth, which allowed significant improvement in labor market conditions, reduced inflationary pressures, increased opening of the economy, maintained its external account imbalance at a level consistent with private capital inflows, and reduced significantly market rigidities. There is no doubt that membership in the EC, since 1986, has played a significant role in these achievements. Monetary authorities have gained credibility in their fight against inflation by participating in the ERM and anchoring the peseta near the top of the broad band. Their determination, in this regard, coupled with the appreciation of the nominal and real effective exchange rates of the peseta have helped drive down inflationary expectations. Spain has recorded an important shift in the geographic composition of its trade in favor of the EC countries. While this shift had some negative effects in the initial phase, significant improvements in the imbalance vis-à-vis EC countries are emerging. The opening up, spurred by the implementation of EC directives, has also improved competition in the traded goods sector, contributing to reduce further inflationary tensions. The opening up and the prospect of the establishment of the single market have lured foreign investors who have provided an important impetus in the development of investment and output growth—through financial resources and technological transfers—and fostered an important movement of mergers, at the domestic and EC levels, likely to strengthen the Spanish productive and financial sectors.
These achievements would not have been possible without the social consensus that emerged after 1975, and the successive adjustment programs and structural reforms of the 1960s and 1970s—in particular, the elimination of most price and wage controls, the fiscal reforms, the restructuring of the industrial sector and banking system, the efforts to increase the efficiency of the nationalized productive sector, and the incipient privatization of the most profitable public companies. These reforms, accompanied by an important shift in the composition of output, helped the Spanish economy move from an administered to a market-oriented economy at the eve of its entry into the EC.
Over the 1990s, the implementation of structural reforms should be accelerated to preserve the momentum of the catching up process observed since 1986, while financial policies should be geared toward the attainment of the Maastricht targets, namely, through an increase in public sector net savings to restore the domestic saving ratio at a level consistent with a more long-term balanced growth.
For a detailed description of the various macroeconomic adjustment programs implemented by Spain between 1939–90, see Spitaller and Galy (1992).
In 1959, a liberalization decree opened most Spanish industries and financial services to foreign investors. Only investments in excess of 50 percent of the capital of domestic firms were to be authorized. These authorizations were provided quite liberally (De La Dehesa, Ruiz, and Torres 1989).
The EC Preferential Trade Agreement can be considered as the prelude to the entry of Spain into the EC. The agreement consisted of reciprocal tariff reductions and removal of nontariff barriers for industrial products scheduled to take place between 1970–77.
The depressive impact was estimated at 3 percent of GDP. Two thirds of the impact is estimated to have been offset by the more expansionary fiscal stance (Garcia (1990)).
Ministerio de Industria y Energía (1989).
The improved flexibility of the labor market—in quantity if not in prices—was induced by the rapid development of fixed term labor contracts following the implementation of the 1984 law on the reorm of “El Estatuto de los Trabajadores.” The lower costs of normal termination or of firing fixed term labor contracts compared with those of indefinite duration contributed to their success. Temporary labor contracts, nearly nonexistent in 1985, represented more than 30 percent of total employment at the end of 1991.
For details on fiscal decentralization in Spain, see Section VI.
For details on recent experience with central bank intervention in foreign exchange markets in Spain, see Section IV.
In the energy, telecommunication, and transportation sectors and in some segments of financial services, prices are still regulated. In the rent market, 75 percent of the leases are still under control with rent increases targeted on those of the CPI. In the agricultural sector, minimum prices imposed by the EC Common Agricultural Policy have introduced a downward rigidity in prices.
Shares of Spanish public companies in total employment and gross fixed investment of 4.5 percent and 15.9 percent, respectively, in 1985 compare with average corresponding shares of 12.3 percent and 27.7 percent in the fourth biggest EC countries (Gonzalez-Paramo (1989)).
For a description of the agreement see International Monetary Fund (1992), pp. 52–55.
