Abstract

After a fall in real terms over 1983–84, domestic demand strengthened in the course of 1985 increasing for the year as a whole by 2½ percent, the first significant expansion since 1980. Private consumption grew on average by 1.8 percent, supported by the recovery of employment (after several years of persistent deterioration), the growth of labor and other incomes, and by a marked increase in social transfers, all of which resulted in an expansion of real disposable income of around l½ percent. The reduction in early 1985 in the withholding rates for the personal income tax is also thought to have provided a special boost to consumption expenditure.

Output and Employment

After a fall in real terms over 1983–84, domestic demand strengthened in the course of 1985 increasing for the year as a whole by 2½ percent, the first significant expansion since 1980. Private consumption grew on average by 1.8 percent, supported by the recovery of employment (after several years of persistent deterioration), the growth of labor and other incomes, and by a marked increase in social transfers, all of which resulted in an expansion of real disposable income of around l½ percent. The reduction in early 1985 in the withholding rates for the personal income tax is also thought to have provided a special boost to consumption expenditure.

Nearly equally important, in terms of its relative contribution to GDP growth, and more important on account of its poor performance over the previous four-year period, was the recovery of fixed investment. After falling by a cumulative 10 percent in real terms between 1981 and 1984, investment expenditure rose by 4 percent during 1985. This expansion was supported by the marked improvement in the profit position of enterprises, the introduction of new fiscal incentives,40 and a fall in interest rates, which increased the attractiveness of real assets relative to financial ones, as well as the improved outlook for demand. A 7 percent rise in investment in equipment goods and, after several years of decline, some recovery of construction-related investment provided a special boost to this component of domestic demand. Real GDP is estimated to have grown by about 4 percent in the second half of 1985, underscoring the fact that the Spanish economy appeared then to have entered a period of sustained expansion.

The growth of domestic activity accelerated significantly in 1986. Supported by the favorable impact of a large (over 16 percent) gain in the terms of trade and the relative easing of financial policies since 1985, domestic demand rose by 6.3 percent in real terms. The rate of growth of fixed capital formation accelerated to 10.8 percent, reflecting the continued improvement in the profit position of enterprises and in the demand outlook, as well as a substantial increase in the inflows of foreign direct investment41 and the desire on the part of Spanish entrepreneurs to modernize the industrial structure so as better to face increased competition within the EC. Underlying this remarkable expansion of investment were a 17 percent real rate of growth for investment in equipment goods and a 7 percent rise in investment in construction. Private consumption grew by 4 percent, reflecting the continued recovery of employment—nonagricultural employment rose by 5 percent with respect to 1985–and the full year impact of the stimulative fiscal measures introduced in 1985. Real GDP grew by 3.3 percent in 1986, reflecting the negative contribution to GDP growth made by the foreign balance. Shifts in Spain’s relative cyclical position, some import penetration as a result of EC accession, and some loss in the competitiveness of the peseta resulted in a negative contribution by the external sector of nearly 3 percentage points.

Although real GDP is estimated to have grown by about 4½ percent in 1987, the composition of growth was not significantly different from that registered in 1986. The further deterioration in the real trade balance was offset by the continued buoyancy of domestic demand, particularly private consumption, but also fixed capital formation, which expanded by 14 percent in real terms—the highest growth rate over the past decade and a half—and contributed 2½ percentage points to overall GDP growth. This acceleration in the pace of economic activity was supported, inter alia, by the continued recovery of employment, the improved profit position of enterprises, and a sharp increase in the inflows of foreign direct investment, reflecting both the strengthening of commercial ties with EC partners and renewed confidence abroad in the underlying strength of the Spanish economy.

The recovery of domestic activity and particularly the beneficial effects of a number of legal measures taken to reduce rigidities in the labor market contributed to the continued recovery of employment throughout 1986 and 1987. Total employment between the last quarter of 1985 and the second quarter of 1987 increased by 6.6 percent, with a particularly pronounced recovery in the services sector, where employment grew by 10.1 percent. An increase in participation rates, however, permitted only a small reduction in the rate of unemployment to 20½ percent.

Inflation

Spain’s inflation performance throughout the 1970s and early 1980s compares unfavorably with that of most of its industrial trading partners. The average annual rates of growth for the Spanish consumer price index and those for the Federal Republic of Germany, France, the United Kingdom, and Italy, Spain’s four most important European trade partners,42 are presented in Table 14. Not only have Spain’s consumer prices risen relatively more rapidly, but their evolution over time has not always reflected prevailing international patterns. Such departures with respect to the observed price behavior of other industrial countries may be interpreted in terms of a number of interrelated factors.

Table 14.

Selected CPI Growth Rates, 1971–87

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Sources: International Monetrary Fund, International Financial Statistics; and European Community, Eurostatistics.

Twelve-month rates of growth for October.

The relatively large weight of labor costs in the determination of overall costs for the economy43 and the wage explosion which took place over the period 1975–79 go a long way toward explaining the differences in inflation performance vis-à-vis other trade partners referred to above. The unusually large share of labor costs in total costs is in turn related to the relative closeness of the Spanish economy. The ratio of Spanish imports (and exports) to GDP is the lowest in the EC and one of the lowest in the OECD, Spain’s great dependence on imported energy notwithstanding (Table 12). Furthermore, although the share of goods in the consumer price index (CPI) basket subject to some form of control or administration has fallen in recent years,44 refined petroleum products are still included in this group. In time this has resulted in an overall price level that has not always reflected immediately or fully changes in energy prices abroad and that may have been partly responsible, over the 1973–81 period, for one of the highest cumulative rates of growth in the OECD for net petroleum imports (Table 1).

Over 1981–84, prices in Spain exhibited a slowly decelerating trend, which was most pronounced over the 1983–84 period. The tighter stance of financial policies adopted in 1983 resulted in a significant fall in the rate of growth of total liquidity and promoted a degree of moderation in wage settlements that contributed to a deceleration of inflation. The concomitant deceleration in the prices of imported goods, particularly oil products, also played an important role in slowing down inflation. The rate of inflation continued to fall in 1985; the average for the year was 8.8 percent, or 2½ percentage points below the corresponding rate for 1984. Energy prices made an important contribution to moderating the rise in consumer prices, rising by 4½ percent, compared with 10½ percent in 1984 and an annual average of 20 percent over the three-year period ending in 1983. Inflation differentials vis-à-vis the OECD and the EC had narrowed, by end-1985, to 3.6 and 3.2 percentage points, respectively, the lowest since 1980 (Table 15).

Table 15.

Spain: Price and Cost Developments, 1982–87

(Annual percentage change)

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Source: Ministry of Economics and Finance.

Provisional.

Staff estimates.

Twelve-month rate for October.

October.

Including social security contributions.

Price developments in 1986 were affected by a number of factors. The introduction of the value-added tax on January 1 as part of Spain’s accession to the EC is estimated to have added about 2 percentage points to the overall price level. Although the impact of the VAT appears to have been largely limited to a one-time jump in the consumer price index, the decline in the price of imported petroleum and other primary products, the effective appreciation of the peseta45—particularly vis-à-vis the U.S. dollar—and the onset of the process of tariff reductions implied by EC accession, are all thought to have affected significantly the evolution of prices over the year. In the event, prices decelerated only marginally through May and actually rose rapidly through September while the inflation differential vis-à-vis the OECD and the EC widened to about 6 percentage points by the end of the year.

A number of factors help explain these price developments. The authorities’ decision not to pass on fully to consumers the reduction in oil prices and thus provide a windfall to the budget with a view to reducing the deficit was certainly important. To the extent that reductions in energy prices are not passed through to users, the deceleration in the rate of inflation is less pronounced, at least in the short run. The marked increase in the CPI in the third quarter, totaling nearly 3½ percentage points, can largely be attributed to its food component (mainly fresh fruits and vegetables), traditionally the most volatile in the CPI basket. More important, wages showed an upward trend throughout 1986. Data show both an accelaration in the rate of growth of nominal wages per person and contractual wage increases stemming from collective agreements with respect to 1985. The acceleration in the rate of growth of nominal wages together with a significant reduction in productivity (directly related to the improvement in the employment situation) led to an increase in the rate of growth of unit labor costs from 5.7 percent in 1985 to 8.3 percent in 1986.

Largely as a result of the renewed acceleration of consumer prices and the associated implications for then impending wage negotiations for 1987, the Spanish authorities implemented a series of measures in the latter part of 1986 with the aim of preventing too large a departure from the official inflation target. Fuel prices for industrial use were reduced by close to 20 percent, and a number of restrictions against food imports, particularly from the EC, were lifted. Prices, especially the food component, actually fell in November, and the outturn for the annual rate of inflation was 8.8 percent. Because the CPI had captured throughout 1986 the impact of the VAT introduced in January of that year, the 12-month rate of inflation decelerated markedly in early 1987; by October it had fallen to 4.6 percent.46 The rate of inflation in 1987 is estimated to have fallen to 5¼ percent on average, partly reflecting the once-and-for-all impact associated with the introduction of the VAT and the moderation of import and food prices. The inflation differential vis-à-vis the EC was projected to be reduced from 6.1 percent at the end of December 1986 to about l½ percent by the end of 1987, underscoring the substantial progress made in the course of the year (see Chart 8).

Chart 8.
Chart 8.

Inflation, Domestic Demand, and Output in Spain and Other Industrial Countries, 1980–86

(Annual percentage change; unless otherwise noted)

Sources: Bank of Spain; and International Monetary Fund, Research Department.

External Accounts

The remarkable improvement in the external accounts over the 1982–86 period is one of the highlights of the adjustment program undertaken by the Spanish authorities (see Chart 9). The current account of the balance of payments moved from a deficit of 2½ percent of GDP in 1982 to a surplus of 2 percent of GDP in 1986. International reserves, which had reached a five-year low at the end of 1982, recovered sharply and stood at US$17.3 billion at the end of 1986, the highest end-of-year level (see Chart 10 and Table 16). The stock of external debt, which had risen rapidly from US$19.5 billion in 1979 (10 percent of GDP) to US$28.8 billion in 1982 (16.2 percent of GDP) had fallen below US$24.5 billion (10.7 percent of GDP) by 1986, as the authorities embarked upon a program of anticipated repayment of external debt. The 1986 ratios of debt-service payments to GDP and to exports of goods and services net of anticipated amortizations stood at 2.1 and 11.9 percent, respectively, low by international standards.

Chart 9.
Chart 9.

Spain: Balance of Payments, 1978–861

(In billion of U.S. dollars)

Sources: Bank of Spain, Secretariat of State for Commerce; and Fund staff estimates.1Transactions basis
Chart 10.
Chart 10.

Spain: Indebtedness, 1977–87

Source: Bank of Spain, Statistical Bulletin, various issues.1End-of-period figures.2Defined as the difference between official reserves and the outstanding stock of external debt.
Table 16.

Spain: Official International Reserves, 1982–87

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Sources: Bank of Spain, Statistical Bulletin; and International Monetary Fund, International Financial Statistics.

In December 1981, gold was revalued in Spanish statistics to US$251 per ounce. Subsequent adjustments have been based on the following rule: (1) if the accounting price is greater than 80 percent of the market price it is to be revised downward until it is equal to the latter, these adjustments are to be made on a monthly basis; (2) if the market price is over 50 percent higher than the accounting price, the latter is to be adjusted upward, with the change being equal to the percentage increase in excess of 50, these adjustments are to be made on an annual basis.

Imports of goods during the corresponding calendar year.

Much of the improvement in the current account that took place over the adjustment period can be imputed to developments in the trade account. On a transactions basis the trade deficit fell from 5.1 percent of GDP in 1982 to 2 percent in 1986 with the bulk of the adjustment taking place in 1984, when exports grew in volume terms by 17 percent under the impetus of the 12 percent real effective depreciation of the peseta registered over the previous year and a sharp recovery of foreign demand. At the same time there was a substantial deceleration in the rate of growth of the import bill, much of which could be attributed to a reduction in the dollar value of energy imports stemming from both lower prices and cutbacks in the volumes imported as part of the Government’s policy of reducing dependence on foreign sources of energy.

Invisible receipts have also played a role in the recovery of the current account. With an average of 43 million tourists a year over the period 1982–86—in excess of the total Spanish population of some 38 million—tourist receipts have continued to be an important source of foreign exchange (US$12 billion in 1986) and the dominant factor in the invisibles account. At the same time, the reduction in the stock of external debt and an easing of international interest rates contributed to a reduction of investment income outflows, which fell from about 1½ percent of GDP in 1983 to 0.9 percent of GDP in 1986.

The rapid growth of domestic demand, both in the latter part of 1986 and throughout the first half of 1987, and the further reduction in tariff protection stemming from Spain’s accession to the EC (tariffs on industrial imports from EC countries were reduced by a further 12½ percent on January 1, 1987) fueled a sharp expansion of imports; in the first ten months of 1987 non-energy imports grew by 27 percent in volume terms as the trade deficit rose to nearly US$8.7 billion, more than twice the level registered in the corresponding period of 1986. The better-than-expected performance of tourism—over 50 million tourist arrivals and gross receipts of nearly US$16 billion—and a 7 percent rise in the volume of merchandise exports prevented, however, a more pronounced deterioration of the current account. The authorities’ present estimates for the current account of the balance of payments for 1987 project a surplus of about US$ 1½ billion (0.4 percent of GDP), less than half the level registered in 1986, but still at a comfortable level. Underlying this forecast is a negative contribution to GDP growth from the external sector of about 2 percentage points.

As regards developments in the capital account, in both 1985 and 1986 there was a significant transfer of resources to the rest of the world. The authorities’ stance on the prepayment of foreign credits resulted in net long-term capital outflows of about US$1.5 billion in both years. Public sector capital outflows exceeded US$2 billion in 1986, the largest such outflow ever. Long-term capital outflows would have been much larger but for a sizable increase in foreign direct investment, which rose by 83 percent in dollar terms with respect to 1985. Private foreign long-term investment inflows in the first ten months of 1987 exceeded US$8.7 billion, reflecting dramatic rises in direct and portfolio investment. Taken together these grew by nearly 100 percent in dollar terms with respect to the corresponding period of 1986. There remarkable increases reflect the substantial liberalization of the regulations governing foreign direct investments introduced in mid-1985 as well as Spain’s entry into the EC, which has led a number of firms from other EC countries to increase their participation in Spanish enterprises with a view to a more active role in the domestic market.47 By the end of October 1987 official international reserves exceeded US$28 billion (Table 16).

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    Inflation, Domestic Demand, and Output in Spain and Other Industrial Countries, 1980–86

    (Annual percentage change; unless otherwise noted)

  • View in gallery

    Spain: Balance of Payments, 1978–861

    (In billion of U.S. dollars)

  • View in gallery

    Spain: Indebtedness, 1977–87