Abstract

This paper has examined the impact of the adjustment program undertaken by the Spanish Government during 1982–86. Implemented in response to the serious deterioration of the economic situation that took place in the late 1970s and early 1980s, the program sought to redress the imbalances affecting the Spanish economy through a combination of demand management policies and structural reforms. Whether viewed in terms of a simple before-and-after comparison of various economic and financial indicators or in terms of its impact upon resource allocation, the adjustment effort was successful in a number of important areas.

This paper has examined the impact of the adjustment program undertaken by the Spanish Government during 1982–86. Implemented in response to the serious deterioration of the economic situation that took place in the late 1970s and early 1980s, the program sought to redress the imbalances affecting the Spanish economy through a combination of demand management policies and structural reforms. Whether viewed in terms of a simple before-and-after comparison of various economic and financial indicators or in terms of its impact upon resource allocation, the adjustment effort was successful in a number of important areas.

In the decade and a half ending in 1974, Spain had grown faster than any other country in Europe. This growth had been led by the industrial sector, notably through the development of energy-intensive industries. The effects of the terms of trade loss brought about by the first oil price rise were compounded by the rapid increase in real wages after 1974 at rates far in excess of those warranted by productivity gains. At the same time, a rapid expansion of credit contributed to inflationary pressures and, in conjunction with an exchange rate policy that sought to offset the impact of the higher oil prices, led to a substantial erosion of external competitiveness. Increasing transfers of financial resources to ailing enterprises and rising social security expenditures resulted in a steady deterioration of public finances. The lack of an effective adjustment to the first oil crisis left the Spanish economy vulnerable to the new round of oil-price increases registered over 1979–80. In conjunction with the widening fiscal imbalances, this further terms-of-trade loss led to current-account deficits over 1980–82 in excess of 2 percent of GDP and a substantial increase in external indebtedness. Over the same period the average rate of growth of GDP fell below 1 percent a year.

The main elements of the adjustment program were an initial depreciation of the peseta in conjunction with a nonaccommodating stance of financial policies. This policy stance was supported by a number of structural reforms aimed at improving resource allocation.

Monetary policy played a key role in the adjustment effort. In late 1982, against a backdrop of accelerating inflation and growing fiscal and external imbalances, the authorities significantly tightened the stance of monetary policy. The rate of growth of total liquidity fell, interest rates rose sharply, and credit to the private sector slowed down. This tighter stance contributed to a deceleration in the rate of inflation and nominal wages. Together with the 12 percent real depreciation of the peseta over 1983 and a marked expansion in the rate of growth of non-oil imports in Spain’s partner countries, it led to a turnaround in the external position as the current account of the balance of payments registered a surplus of US$2 billion (1.3 percent of GDP) during 1984. In the next two years, as the external situation continued to improve and with the aim of promoting a recovery of domestic demand, particularly investment, the monetary policy stance was relaxed. Liquidity growth decelerated less rapidly, interest rates fell, and credit to the private sector recovered. Although nominal wages began to exhibit an upward trend, rising by about 2 percent in real terms in 1986, by mid-1987 inflation had fallen below 5 percent, the lowest rate over the previous 17-year period.

The progress in the fiscal area would appear to have been less satisfactory when viewed in terms of the size of the nonfinancial deficit, which over the period 1982–86 hovered around 5½ percent of GDP. A closer look at the various components of the general government’s operations, however, and an assessment of the likely impact of a number of policies implemented in the latter part of the adjustment period, with potentially important fiscal implications, suggest that the groundwork may have been laid for further progress in the fiscal area in the medium term. The introduction of the value-added tax in early 1986 is a measure with important implications over the medium term. The elimination of a plethora of inefficient indirect taxes, applied and collected at all levels of government, and the substantial widening of the tax base implied by the VAT already had a beneficial impact on 1986 revenues. Although a number of issues need to be addressed in the medium term concerning the financing of the social security system,48 the reform of the pension system in 1985 did lead to a deceleration in the rate of growth of beneficiaries and an increase in the level of contributions. Privatization and industrial restructuring, two areas in which significant structural reforms were implemented, together with the emergence of more efficient management, contributed to a marked improvement in the financial position of public enterprises.

Despite these positive developments, a number of fiscal weaknesses remain. Foremost among these is the underlying structure of public expenditure, which may have prevented a more rapid reduction of the deficit. Numerous expenditure commitments entered into by the Government over the previous two decades, frequently in response to conjunctural sectoral needs, have in time limited severely the authorities’ room for maneuver and may have had an adverse impact on such specific areas as public investment in infrastructure. There is evidence that, in an effort to keep the deficit within manageable levels, the authorities have frequently opted for reductions in public investment expenditure. Quite aside from the implications which such a policy may have on the provision of important services, such as roads, a distortion is introduced in the pattern of public expenditure as investment projects are no longer judged on the strength of their merits but rather on the extent to which they might contribute, in the short run, to a widening of the growing deficit.49 An additional policy option open to the authorities, at least in principle, might be to raise taxes. If, however, the growing public sector requirements stem from rising expenditures rather than faltering revenues, it could be argued that a viable solution to the fiscal imbalances in the medium term must come largely through the expenditure side. It must also be pointed out that the sensitivity of the interest component of public expenditure to fluctuations in interest rates may also impose additional constraints on the exercise of monetary policy and may lead to attempts by the authorities to put a ceiling on interest rates on government paper merely on the grounds that not to do so would prove a threat to the budget. This higher degree of intervention in the financial markets may come at a time, as was the case in early 1987, when the authorities’ own stated policy as regards financial regulation is a move toward freer, less-regulated markets. Thus the need to evaluate the cost of all expenditure commitments and to examine periodically their economic justification, particularly within the context of a rapidly changing economic environment brought about by EC accession, emerges as one of the most important tasks ahead if Spain is to respond effectively to the competitive pressures implicit in EC membership. In this regard, a recent study undertaken by the Bank of Spain, which examines the costs to the budget of Government intervention in the private sector, underscores the existing wide scope for efficiency gains in the allocation of public financial resources and suggests that this may well be an area for the implementation of further reforms in the medium term.

Progress, albeit on a more limited scale, was also made in the labor market. In 1984–85 the Spanish authorities enacted a number of measures to foster greater labor market flexibility, such as the liberalization of fixed-term contracts and part-time employment, the reduction of employers’ social security contributions, and the granting of fiscal incentives for the hiring of the young through apprenticeship and training contracts. The remarkable recovery of employment in the second half of 1985, throughout 1986, and the first half of 1987 suggests that the institutional framework for a sustained expansion of employment has begun to be put in place. The estimated real rate of growth for the Spanish economy in 1987 (4½ percent) made an important contribution to this expansion. Nevertheless, employment prospects would be enhanced by increased labor market flexibility as the nation’s productive apparatus undergoes further restructuring in order to meet effectively the challenges and opportunities afforded by EC membership. Efforts should continue therefore to remove remaining legal and administrative impediments to geographic and functional mobility of the labor force and to giving increased weight to productivity considerations in the wage-bargaining process.

The Government’s medium-term economic strategy is to consolidate the recent gains by maintaining the economy on a path of noninflationary growth. Monetary policy is likely to continue to play an active role in this process, as was made clear in early 1987 when the Bank of Spain tightened its stance significantly in response to the buoyancy of domestic demand and the concomitant expansion—well above target—of private sector credit. The recent signing by the Bank of Spain of the Basel Agreement of March 13, 1979, by which the Central Banks of the Nine established the operating procedures for the European Monetary System (EMS), may be taken as an indication of the authorities’ commitment to eventual membership in the system.50 Entry into the EMS is not likely to take place before 1989, but, in the view of the authorities, on account of the various processes of liberalization currently being implemented in Spain, affecting both the current and the capital accounts of the balance of payments, the goal of membership will impose a continued commitment to the maintenance of a stable financial environment.

The implementation of economic policy in Spain in coming years will take place within the context of the prior agreements arrived at with the EC as part of accession. These agreements, dealing with virtually every aspect of economic activity and intended to strengthen the bonds of interdependence between the EC’s member states, will serve as a frame of reference for the conduct of national economic policies and will continue to imply some curtailment of sovereignty in specific areas. The Spanish authorities are of the view that such curtailment is inherent to any process of economic integration and that its costs will be more than offset by the benefits derived from the associated greater degree of consultation and cooperation with Spain’s EC partners. Spain’s phased transition into full membership is scheduled to come to an end in 1992 and coincides with the EC’s projected completion of the so-called internal market.51 The 1987 unanimous ratification by the EC’s member states of the Single European Act, an amendment of the Treaties of Rome, which provides for a significant streamlining of the Community decision-making process, has given a new impetus to the accomplishment of the internal market goal.52 It is therefore expected that within a period of seven years (1986–92) Spain will have become a full partner in a more economically integrated Europe. The continuation of the adjustment effort through the maintenance of financial policies geared toward moderate, noninflationary growth of demand, and through further structural reforms to improve the supply response of the economy, would, if carried out with determination, ensure that Spain’s integration into the EC is fully successful.