Abstract
Recent success of the Spanish economy is frequently attributed to the benefits from economic integration into the European Community, which Spain joined in 1986. By contrast, this paper takes the view that, to a large extent, the origins of success may be traced back to earlier years and that the benefits from EC membership are best seen as reinforcing favorable trends already in effect. Exploring Spain’s economic development from a longer-run perspective, with emphasis on interaction of events at home and abroad, the paper assesses the financial and structural policy record for its contributions to success. Most significant are the “orthodox” stabilization and reform program under the auspices of the Fund in 1959, the “heterodox” adjustment program pursued on transition to democracy in 1977 and the differences in the response of policy to the oil crises of the early and late 1970s. On the whole, the approach to financial stabilization was radical, and that to structural reform gradual. The paper concludes that by mid-1980 Spain had largely accomplished the transition to a modern economy and prospects were favorable for sustainable expansion over the medium term. The mutually reinforcing effects of those circumstances and the subsequent process of integration into the EC spurred the further progress of Spain.
Introduction
On the eve of the European single market Spain can look back on a decade of broad improvements in inflation, output, employment, and the external accounts. Its product, labor, and financial markets are substantially reformed and its balance of payments opened up. International reserves have risen to record levels and the peseta has been one of the strong currencies in the ERM from its entry in 1989. Participation in the process of European integration has strengthened policy credibility and, together with structural reform, created an environment conducive to sustainable economic expansion over the medium term. Prospects are favorable for an early adherence of Spain to European Monetary Union and for further progress in raising living standards to levels prevailing in wealthier European partner countries.
Economic practitioners and analysts interested in the reasons for the success of Spain customarily refer to its 1986 accession to the EC. This is seen as having entailed a host of favorable effects, almost automatically, launching the Spanish economy on the path of vigorous and balanced growth on which it now seems embarked. There is much truth in this argument but it is far from providing a full account. Many of the conditions for success were in place prior to accession and the economy had begun to exhibit favorable trends, which were subsequently reinforced. Their origins must be traced to earlier years, to the lessons learned from the mistakes In responding to the 1973 oil crisis, which were applied from the late 1970s and through the second oil crisis. More generally, however, the roots of those trends must be sought in the shift of philosophy and practice from political and economic autarchy to integration with Europe and the international economy at large. The establishment of Spain’s membership in the International Monetary Fund in 1958 and agreement on a policy package with the Fund in mid-1959 mark a watershed in this regard. Yet, what occurred then was the logical result of developments and decisions at home and abroad set in motion more than ten years earlier, in the aftermath of the Second World War and at the end of the first phase of Franco’s rule, which had begun in 1939 following his victory in the Spanish Civil War.
For the observer wanting to find what can be gleaned from the experience of Spain and applied elsewhere to similar effect it is well to be aware of the antecedents of Spain’s present success. This will make clear that there is no magic formula to conjure away pervasive maladjustments and deliver prosperity in a day.
1. Spain in the post-war international order
By the end of the Second World War Franco had shifted his sympathies from the Axis Powers to the victorious Allies. But, still ostracized, he was excluded from membership in the United Nations and the Bretton Woods organizations. The situation changed, however, with the advent of the Cold War which induced the West to adopt a more cooperative attitude toward the Franco regime. A U.S. military mission was dispatched to Spain in 1948; in 1949 it received a loan from City Bank; in 1950 Spain was admitted to the FAO and obtained a loan approved by the U.S. Congress under its economic aid program; in 1951-52 OEEC and IMF documents referred to Spain’s eventual membership and the conditions it would have to meet in terms of financial stability and foreign trade liberalization; in 1953 the United States and Spain signed an Economic Accord.
During the same period, Franco had his own reasons for parting with the hitherto practiced policy of radical autarchy. The policy was proving a failure with inflation in the double digits, despite ubiquitous price controls, and real output stagnant or declining in the first nine years of his rule. The level of per capita income that had prevailed in 1935 was not achieved again before 1952; foreign trade stood at one third of the level registered in 1931. First steps were taken to reduce the regimentation of the economy, including the relaxation of travel restrictions within Spain, greater freedom of industrial prices and industrial imports, reform of the foreign exchange market and abolition of rationing. This led to a relative improvement in economic conditions with freer exercise of property rights, lower costs of transactions and a reduction of the hitherto all encompassing role of the state (Gonzalez, 1990). In addition, there were favorable effects from expectations and investment associated with the improvement in foreign relations and American aid, from the import of industrial raw material and equipment, replacing the policy of extreme import substitution, and from improved export opportunities in rapidly expanding markets. In these circumstances, Franco’s then undertaken industrialization drive, involving large public investment expenditure and a relative price structure favoring industrial production (contrary to industrial prices, agricultural prices remained firmly controlled), met with success. Private investment revived and, in the period 1949-59, the economy grew at an annual average rate of 5 percent. In this, the receipt of substantial foreign aid played an important role, helping keep at bay the external constraint that would otherwise have materialized and that would have forced sustainable output growth to a pace below that actually observed.
Throughout those years, financial policy involved a fiscal stance subordinated to the Government’s program of economic expansion and an accommodating monetary policy (Rojo and Perez, 1977). Interest rates were fully administered and kept at low levels and budget deficits were financed by the Bank of Spain or by banks on which direct investment coefficients were imposed. The result was a rapidly expanding supply of money and, after a temporary decline at the beginning of the 1950s, a reacceleration of inflation further spurred by government-decreed large wage increases (Chart 1; for charts referred to in this paper, see Statistical Appendix). In the process, the rigidity and unwieldiness of a system of fixed, multiple, exchange rates could not prevent the build-up of unsustainable external Imbalances, despite foreign aid. As the attendant financial crisis worsened, and Spain was on the verge of running out of foreign reserves, an agreement was reached with the International Monetary Fund in the summer of 1959 on a stabilization plan, less than one year after Spain had become a member of the Fund.
SPAIN: MONEY AND CONSUMER PRICES, 1950-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
Fund membership was but a further natural step in the process of Spain’s integration with the international economy, apart from the reasons associated with the immediate crisis. It would have been difficult and costly, in both political and economic terms, to reverse that process of integration. Politically, this would have driven Spain back into isolation, eroding its status at home and abroad. Economically, the benefits of foreign financial assistance and trade would have been lost and the country would have reverted to autarchy and tighter regimentation. Public opinion looked for change in the opposite direction. The old model had proven a failure and the future place of Spain was that of a full member in the international community and participant in its evident progress (by end-1958 the European Payments Union was dissolved and the convertibility of main European currencies secured, paving the way for the European Monetary Accord).
2. From stabilization to the first oil crisis
The 1959 stabilization plan expressed the commitment of the Spanish authorities to restore internal and external balance as well a to open up and modernize the economy over the medium term. Fund approval of the plan enhanced its status and credibility at home and abroad, securing membership in the OEEC and participation in the European Monetary Agreement, combined with access to Fund resources and the associated substantial foreign official and private financing. The plan was ambitious in its targets, broad-based, and complex in its details (International Monetary Fund, internal documents, various issues and Guitián, 1976). It intended to curb excess demand and inflation, driven by public investment outlays directly or indirectly financed by the central bank. Demand restraint, together with a devaluation of the peseta and inducements to capital inflows, was to spur adjustment of the balance of payments. In the fiscal area, total expenditure of the enlarged public sector in 1959 was limited to a fixed absolute amount, consistent with broad stability in real terms, involving reductions in the expenditures of autonomous public agencies and enterprises. Revenue buoyancy was to be enhanced by specified increases in selected taxes and by improvements in tax administration. In the process, the enlarged public sector deficit was to narrow to Ptas 13.5 billion in 1959 from Ptas 18.3 billion in 1958. Limits were placed on the domestic monetary financing of the Government, which was to decline substantially in 1959 and cease altogether in 1960. Money and credit expansion were further restrained by ceilings on private sector credit, which was allowed to rise by Ptas 11 billion in 1959 compared with Ptas 21.4 billion in 1958, by limits on central bank rediscount operations and by increases in the discount and other interest rates. In addition, new issues of government securities could not, unlike earlier issues, be used as collateral against commercial bank credit from the central bank. And an advance import deposit requirement was temporarily introduced, payable at the central bank, targeted to restrain both liquidity and imports.
The balance of payments policies set forth in the stabilization plan included agreement with the Fund on a par value of Ptas 60 per U.S. dollar in the context of a unification of the exchange rate system. The par value was set at a level close to that prevailing in the free foreign exchange market and involved an effective peseta devaluation of around 20 percent in terms of total trade. The price effect of the devaluation was dampened by temporary price subsidies on specific import items, including foodstuffs, while export proceeds were taxed. Concrete steps were taken, complemented by commitments to further action in the future, to liberalize the trade and payments system, diminish price controls, open the economy to more foreign investment, free repatriation of profits and foreign capital, and encourage the return of flight capital. In addition, the Spanish authorities acknowledged that sustained productivity growth required the adoption of still further structural measures aimed at reducing rigidities in the goods and labor markets, including rigidities linked to restrictive business practices and labor legislation. In all, and on a general level, the 1959 stabilization plan looks with hindsight like a blueprint of developments that have since taken place. Not least, this is true also for the realization at the time that the conduct of financial policy would be helped if the monetary authorities, then completely under government control, were given the power to use conventional instruments of monetary and credit control in the sole interest of currency stability.
While balance of payments adjustment and financial stability were the priority objectives in the short term, as dictated by circumstances, liberalizing balance of payments transactions and opening up the economy were programmatic commitments that Spain had to undertake as a new member of international financial organizations. Spain moved decisively on the stabilization front, inducing rapid adjustment, while adopting a more deliberate approach in other areas, aimed at gradual adjustment. Apparently, the Spanish authorities felt that, apart from the difficulties in gauging the attendant balance of payments effects, proceeding too rapidly in dismantling trade barriers and price controls would involve excessive costs in terms of output and employment. In the event, imports of raw materials and certain investment goods were liberalized while imports of consumer goods remained tightly controlled and customs duties were temporarily increased.
The stabilization plan was highly successful: performance criteria were easily met, inflation declined to around 3 percent In 1959-60 from well over 10 percent in 1958, and the outturns in the fiscal and, particularly, in the external accounts were markedly better than expected. Foreign exchange reserves, net of US$50 million drawn from the Fund and US$24 million drawn from the European Fund, rose sharply. This made it unnecessary for Spain to draw on the additional US$25 million made available under a Fund stand-by arrangement. And signaling the success of their plan, the Spanish authorities reversed in April 1960 some of the earlier increase in interest rates. On account of the fact that fiscal tightening had begun in anticipation of the stabilization plan, producing significant budgetary improvements in 1958, excess demand was already diminishing at the time and the decline in output and employment in the wake of the implementation of the plan was relatively small. Also, with the large rise in foreign reserves the credit ceilings did not prove as tight a constraint as would otherwise have been the case. Accordingly, in 1960 as a whole GNP fell by no more than 0.5 percent, reflecting a rebound in the second half. As the momentum increased, output marked growth rates of 3.7 percent and 7 percent in 1961 and 1962, respectively. Rapid improvement in the trade balance helped contain the initial fall in output, and the repatriation of capital in the context of the amnesty that was granted contributed to the improvement in the overall balance of payments.
The evident success of stabilization policy was further strengthened over the medium term by continued liberalization, ranging from merchandise imports 1/ to the pricing, production, and marketing of domestic substitutes, as well as by the buoyancy of the international economy. Yet, by 1964 the pace of monetary expansion--now driven by banks and their recourse to central bank financing, rather than by budget deficits as was the case in the 1950s--became again excessive (Chart 1), spurring inflation and putting at risk the balance of payments, already under pressure from the relatively more rapid expansion of demand at home than abroad. The Spanish authorities responded by imposing ceilings on private sector credit, establishing a stop-go pattern of monetary policy. The external current account position was strengthened by the devaluation of the peseta by 17 percent against the U.S. dollar in 1967, although the effective devaluation was much smaller with the peseta merely following suit in the wake of the devaluation of the pound sterling at the time, by a concomitant, temporary, tightening of wage and price controls, and by the maintenance of substantial barriers to imports. Those barriers involved the substitution of taxes for customs tariffs scaled down under a preferential trade agreement with the EC in 1970 that foreshadowed Spain’s eventual EC membership. 3/ The first step in the liberalization of interest rates was made in 1969, setting in motion a process that would be completed by 1988. This was followed in 1970-72 by the extension of the system of bank reserve coefficients, the limitation of rediscount facilities with the central bank and the marketing of government paper geared to liquidity control. The stage was thus set for the modernization of monetary policy instruments and the development of indirect monetary control.
Notwithstanding the erratic behavior of money and inflation, the Spanish economy grew rapidly, with real GDP and per capita output more than doubling in the years 1960-70 (involving a growth rate of 17 percent per annum, Chart 2). Strong impulses to growth came from domestic and foreign investment (Charts 3-4) and, in particular, from tourism and construction. By the early 1970s, the economy was transformed, with the share of agriculture down to around 10 percent compared with 50 percent twenty years earlier, and with the size of the service sector already exceeding that of industry (Chart 5). Unemployment remained at consistently low levels as the buoyancy of foreign labor demand spurred the migration of Spanish workers and helped increase personal incomes (Chart 6).
SPAIN: GROWTH, INFLATION, EXTERNAL CURRENT ACCOUNT AND UNEMPLOYMENT RATE, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: DETERMINANTS OF OUTPUT GROWTH, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: DETERMINANTS OF CAPITAL FORMATION, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: DECOMPOSITION OF GDP BY SECTORS, 1970-90 1/
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
1/ National Accounts base 1986.SPAIN: LABOR MARKET, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
Events beginning with the 1973 oil crisis ushered in a more difficult phase of development in the Spanish economy. When the crisis broke it showed up shortcomings that earlier had been masked by the rapid growth of the economy (Garcia Diez, 1990). The focus on heavy industry had raised the energy intensity of output and hence the vulnerability to oil price shocks. The enterprise sector was comprised of 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 the high level of effective import protection. The rigidity of the labor market virtually excluded the possibility of lay-offs and contract flexibility, impeding the adjustment of wages. The capacity to absorb labor released by the rapidly shrinking agricultural sector, and to improve labor productivity, was limited. Full employment, secured in the 1960s, was at risk as foreign employment opportunities waned. The financial system remained regulated and segmented with largely administered interest rates preventing competition and keeping remuneration of savings low. In all, while the share of the public sector in the economy was small, the role of the government was enhanced by broad powers of intervention in economic activity at large.
Believing the crisis to be short-lived, the government determined to offset its output effects and adopted an expansionary stance of financial policies (Chart 1). This coincided with a wage push (Chart 7) 1/ and a rise in labor conflicts as, in the last phase of the Franco regime, rigid controls over trade unions had to be abandoned and their participation in the shaping of policies be redefined. The attendant uncertainties and strains on the economic and political system intensified in the wake of the assassination in December 1973 of Carrero Blanco who had earlier been put in charge of the government. His successors, until the establishment of a democratic regime in 1977, had to contend with social and political ferment as well as with a deteriorating economic situation. The chronic weakness of government at the time made it impossible to adopt suitable remedies.
SPAIN: REAL WAGES AND LABOR PRODUCTIVITY, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
Inflation accelerated to over 20 percent under the impact of rising import prices and unit labor costs, increasing velocity and expansionary financial policies (Charts 8-10). The pace of economic activity slowed in the wake of a worsening drag of the foreign balance and a decline in investment. Profit opportunities and sales prospects deteriorated, reflecting, among other factors, a decline in the profit rate and the lagged impact of a real exchange rate appreciation. The external current account deficit widened, involving losses in the terms of trade and adverse volume effects associated with both the relatively more rapid expansion of domestic demand at home than abroad and worsening competitiveness (Charts 11-13). Conditions became more difficult also in the labor market, with a decline in employment and diminished possibilities of migration leading to a rise in the rate of unemployment from 2.6 percent in 1973 to 4.8 percent in 1976 (Chart 6).
SPAIN: DETERMINANTS OF INFLATION, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: FACTORS CONTRIBUTING TO INFLATION (GDP deflator), 1965-90
(Changes in percent)
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: FISCAL INDICATORS, 1965-90
(In percent of GDP)
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: FLOW OF FUNDS, 1965-90
(In percent of GDP)
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: EXTERNAL ACCOUNT INDICATORS, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
SPAIN: DETERMINANTS OF EXTERNAL PERFOMANCE, 1965-90
Citation: IMF Working Papers 1992, 078; 10.5089/9781451850048.001.A001
3. The new democratic era and the adjustment process
A new democratically elected government came into office in the summer of 1977. Its economic platform emphasized the priority of restoring internal and external balance to the Spanish economy, as well as the need equitably to distribute the costs of adjustment. The policy mix to address those objectives was centered on sustained income restraint supported by measures ranging from exchange rate depreciation and financial tightening to structural reform in the public finances and market liberalization (Garcia de Blas, 1990). The peseta was devalued by 20 percent against the US dollar; fiscal revenues were buoyed by the introduction of a wealth tax, a general personal income tax with marginal rates from 15 percent to 65 percent, and a flat 33 percent corporate income tax; fiscal expenditure was restructured, containing payments of wages and subsidies, while raising those on social security, housing and unemployment compensation; liquidity control by the Bank of Spain was improved, extending the same rules affecting commercial banks also to savings banks, particularly on access to money markets and liquidity-provisioning, with a shift from allocations fixed in terms of own bank capital to an auction system; interest rates were liberalized and compulsory bank investment coefficients lowered according to a predetermined schedule; labor laws were modified, reducing restrictions on layoffs.
The express concern with equity in the government economic program helped foster a broad consensus in support of incomes policy based mainly on wage moderation. Policy implementation involved a series of government directives or agreements among representatives of organized political and economic forces, with the objective of securing consistency of wage developments with substantially normative government projections of inflation. The Moncloa Accord of November 25, 1977, signed by the government and the political parties and subsequently ratified by parliament, put a limit of 20-22 percent on the increase in the 1978 wage bill; tax penalties were to deter non-compliance. A series of similar incomes policy pacts, or directives, were to follow in the years through 1984 (Coricelli, 1990 and Espina, 1991). In December 1978 the government issued a decree imposing limits of 11-14 percent on 1979 wage increases. The following January, representatives of employer and union federations agreed corresponding limits of 13-16 percent and of 11-15 percent for the years 1980 and 1981, respectively. On those occasions, wage limits were determined with reference to government inflation projections subject to review. The same parties formally concurred in two subsequent agreements that real wages should decline in 1982 and in 1983 (for 1982, wages were set to rise by 9-11 percent, with the mid- point of the band 2 1/2 percentage points below the initial inflation projection, subject to review at midyear; for 1983, a wage band of 9 1/2-12 1/2 percent compared to a 12 percent; inflation projection). As to developments for 1984, there was no formal agreement, or government decree, but incomes policies continued to be applied with undiminished emphasis, not least in connection with the program of industrial reconversion that was then initiated. In particular, the government targeted a 1/2 percent real wage decline in the context of an ambitious inflation target. Unions and the employers, while unable to agree on a common position, were not far apart in their assessments of the need for real wage restraint. Eventually, they did come to terms and, in an agreement signed in October 1984, committed themselves to further real wage cuts in 1985-86 (wage bands were set at 5 1/2-7 1/2 percent through the year for 1985 and at 5 1/2-6 1/2 percent for 1986 with mid-points in each instance below inflation projections of 7 percent and 6 percent, respectively). The flexibility provided in the wage arrangements proved useful in 1986 when the review process allowed for additional wage adjustments to match the price effect (2 1/2 percentage points) resulting from the introduction of a VAT system. In the years following, no agreement was reached among social partners on the reference peg for collective wage negotiations. Yet, in conditions of rapidly worsening unemployment, real wage restraint continued, at least up to 1989 (Chart 7). In all, despite initial shortfalls from target, the Moncloa Accord had helped usher in more than a decade marked by the redistribution of value added in favor of profits (Chart 4) and a pronounced trend decline in labor conflicts.
Success on the incomes policy front was accompanied by success in other rears targeted by the government. There were immediate improvements in nflation and in the external accounts, with monetary developments marked by a deceleration in the expansion of liquidity as well as a reversal of the previously rising trend in velocity, reflecting the strengthening of real interest rates and expectations (Charts 1, 8 and 13). In the circumstances, the downward flexibility of real wages helped translate the devaluation of the peseta into a recovery of competitiveness which, together with the greater buoyancy of demand abroad than at home, moved the external current account into surplus and boosted reserves. The adjustment of the economy was not without cost, at least in the short term. The main concern was the continuing decline in employment and corresponding rise in unemployment (Chart 6). There was also a widening of the government deficit, but it must be remembered that fiscal commitments undertaken by the government were the counterpart of the acceptance of wage restraint.
This stabilization strategy was then a heterodox combination of incomes policy, an accommodating fiscal policy and a tightening monetary stance (Charts 7, 8 and 10). The resulting rise in real interest rates tended to offset the positive effects of lower labor costs on business-profits and investment during a period of industrial restructuring. But it also contributed to dampening demand pressures, with net saving of the private sector offsetting public sector dissaving. On balance, and in view of the political and social conditions at the time, the results of adjustment were clearly favorable and, prior to the outbreak of the second oil crisis, the Spanish economy appeared to be poised for an early recovery.
In 1979-1980, the increase in the oil price, involving an estimated output loss of 2 percent of GDP compared with 3 percent on the occasion of the earlier oil crisis, set back the prospects of recovery. Yet, in contrast to the response of policy in 1973, the Spanish authorities now remained committed to the adjustment path on which they were embarked. As is evident from the charts, monetary policy remained tight, 1/ curtailing expansion of the money supply, and velocity continued on its decline. Pressures from unit labor costs subsided in the context of the incomes policy agreements, with income distribution in favor of profits. After an initial worsening as a result of the direct impact of the oil shock, the external current account strengthened in the wake of relatively weaker domestic demand at home and the depreciation of the peseta both in nominal and real terms. By 1984 inflation was below 10 percent, the current account was again in surplus, and the fall in the investment ratio had bottomed out following improvements in capital productivity and a recovery of the profit rate. The growth of GDP which had come to a halt in 1981 had since then resumed and was about to gather additional momentum. Progress was made also on structural reform, including further fiscal and financial reforms, greater flexibility in labor legislation and further liberalization of prices, trade and exchange market transactions.
Some of the most incisive reforms involved the restructuring of industry. The Industrial Reconversion Act of 1981 and the Law on Reconversion and Industrialization of 1984 constituted the first comprehensive plan to integrate previous sectoral programs and their financial support through the budget. The plan, which covered mainly the steel, shipbuilding and textile sectors, affected close to 800 enterprises, calling for a reduction of about 26 percent of their employment (Lopez-Claros, 1988). Three quarters of the target were met by end-1985 and 92 percent by 1989 (Ministerio de Industria a Energia, 1989). Of the workers laid off, 25 percent took early retirement and 35 percent enrolled in training programs. The financial cost of the plan was estimated at Ptas 1.1 trillion (4.4 percent of GDP).
Despite temporary restraint, public expenditure rose rapidly in relation to GDP reflecting commitments on social services, the assumption of some of the costs related to industrial restructuring, the need for infrastructures and rising costs of debt service in line with more market conform interest rates. As a result, and on account of the adverse revenue effects from sluggish activity, at least through 1981, the budget deficit continued to widen, reaching around 7 percent of GDP by 1985. Yet, fiscal expansion could not prevent further declines in employment, attributable in large measure to industrial restructuring (Bentolila and Blanchard, 1990), and unemployment rose to over 20 percent.
4. From EC accession to participation in the ERM
In the second half of the 1980s the Spanish economy entered on a virtuous circle combining high output and employment growth with declining inflation. The previously rising trend of unemployment was reversed despite a continued increase In labor force participation. Sustained improvements in the profit rate and sales prospects spurred investment (Chart 4), and by the end of the decade the bulk of the capital stock was less than five years old. Liquidity expansion, velocity and the momentum of unit labor costs all remained on a declining trend. Except for interruptions associated with the introduction of a VAT system in 1986, disinflation continued through 1988. At the time, the movement of the external current account into deficit was not a sign of maladjustment, given that it was associated with a rise in productive investment by the private sector, with a consistently narrowing budget deficit, involving a primary surplus, and with massive inflows of nondebt capital and a build up of foreign reserves.
On the domestic policy front, high real interest rates and a strong peseta complemented fiscal and wage restraint. In the circumstances, the 1986 accession to the EC, and the terms of trade gains associated with the fall in oil prices and the U.S. dollar in the same year, had particularly favorable synergetic effects. EC membership made more visible Spain’s commitment to liberalization and to improvements in supply in preparation for the single European market. The economy was opening up rapidly as Spain adopted the common EC tariff, and the attendant surge of imports, 1/ accentuated by the stance of exchange rate policy, helped modernize production, spur competition and attract foreign investment (Vinals and alii, 1990). Export performance, after an initial setback associated with the elimination of export subsidies and shift to new markets, proved buoyant as the quality of exports improved and their product mix changed. Finally, there was the considerable net inflow of EC structural funds and foreign investment in the context of financial liberalization. 2/ The external constraint was virtually nonexistent, allowing demand and output to grow at a markedly faster pace in Spain than in partner countries (during 1986-90 the differentials in demand and GDP growth vis-à-vis the four large European countries stood at average annual levels of 3.7 and 1.7 percentage points, respectively). Also, in the second half of the 1980s, gains in employment, spurred by recourse to fixed term contracts, were relatively more pronounced than in earlier periods of rapid economic growth.
In 1989 Spain entered the ERM, availing itself of the broad-band option. Subsequently, the peseta remained in the upper half of its band, reflecting significantly positive interest rate differentials vis-à-vis other currencies. The credibility effects associated with participation in the ERM, and the wide interest rate differentials, tended to induce a flood of capital inflows, exerting downward pressure on domestic interest rates at a time of still significantly higher inflation in Spain than in key partner countries. Tensions arose in the process, pointing to inconsistencies in a monetary policy stance attempting to reconcile independent domestic and exchange rate objectives. In the event, reconciliation was effected through the imposition of temporary credit ceilings and the tightening of capital controls. The effectiveness of these measures was soon eroded, hastening their abolition (all capital controls were removed ahead of the schedule agreed in the EC).
The loss of monetary autonomy in the presence of an exchange rate target and free capital movements has put pressure on the Spanish authorities to change their policy mix. In the pursuit of domestic objectives this requires a shift of emphasis in the direction of fiscal and structural adjustment. To meet the objective of inflation convergence vis-à-vis key partner countries, the budget deficit will have to be reined in and impediments to competition be phased out (wage rates do not respond adequately to cyclical conditions; collusion and other imperfections impair competition in the non-traded goods sector).
Conclusions
Spain should be able to make a relatively early transition to EMU. Its inflation and fiscal records, despite recent weakening, appear within reach of the convergence criteria specified in the Maastricht Treaty. Inflation in 1991 was about 2 1/2 percentage points higher than in the low inflation countries of the EC, or 1 point higher than ultimately required for participation in EMU. Similarly, the budget deficit in relation to GDP was about 1 1/2 percentage points larger than the reference 3 percent target envisaged in the treaty. Meeting the convergence criteria, at a relatively early date, should not therefore, exceed Spain’s scope for adjustment. Nor should Spain find it difficult to avoid monetary financing of government deficits, having passed a law giving the Bank of Spain complete independence.
This is not to say that Spain is without problems. It will have to contain the widening fiscal deficits of the regions, acting on recent agreements, improve tax administration and continue to enhance control over the finances of the social welfare system. It will have to narrow the external current account deficit which is not indefinitely sustainable at the current level. It will have to spur the supply response of the economy with the aim of making lasting inroads against unemployment. In view of the proven adjustment record of the Spanish authorities, these are problems that should be amenable to successful resolution.
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Statistical Appendix
Notes on Charts
| Chart 1. | Average annual changes in consumer prices and changes in year-end narrow money, lagged one period. |
| Chart 2. | Output growth and inflation refer to annual changes in real GDP and in the GDP deflator; the external current account is the current account in the balance of payments; unemployment rate in percent of labor force. |
| Chart 3. | Investment ratio is the ratio of total fixed investment to GDP, lagged one period; marginal productivity of capital refers to the inverse of the incremental capital-output ratio (ICOR) measured by the ratio of the change in GDP to total fixed investment. |
| Chart 4. | Capital stock is measured by cumulative volume of gross fixed investment adjusted for an annual depreciation rate of 4 percent (for the initial year 1965 an estimate of the capital stock was obtained from a capital-output ratio equal to 3, consistent with a steady state ratio associated with an investment ratio of 27 percent, a depreciation rate of 4 percent and GDP growth of 5 percent). The return on capital, or profit rate, refers to the ratio of gross operating surplus to the capital stock. |
| Chart 5. | Shares of services, industry and agriculture in nominal GDP. |
| Chart 6. | Unemployment rate in percent of labor force; labor force; employment |
| Chart 7. | Real product (consumer) wage is the average annual wage (national accounts basis) divided by the GDP (private consumption) deflator; labor productivity is measured by the ratio of GDP in volume to total employment. |
| Chart 8. | Unit labor costs are expressed as the average annual wage divided by labor productivity; import prices refer to import unit values; inflation refers to CPI inflation; ALP is broad money, including M3 plus Treasury bills and commercial paper held by the nonfinancial sectors; velocity is measured by the ratio of nominal GDP to the centered stock of ALP. |
| Chart 9. | Inflation is expressed in terms of the GDP deflator; labor costs, profits and indirect taxes (net of subsidies) are expressed in terms of their contributions to the increase in the GDP deflator. |
| Chart 10. | Decomposition of the general government balance into expenditure, revenue, interest payments and primary balance. |
| Chart 11. | Flow of funds, national accounts basis. |
| Chart 12. | Foreign reserves are official net foreign assets, including gold; the current account is the external current account in the balance of payments; the effective exchange rate of the Peseta is a weighted average of main industrial countries’ bilateral peseta rates. |
| Chart 13. | Export market shares refer to the ratio of non-oil Spanish exports to the weighted average of partner countries’ non-oil imports, in volume terms. Relative demand is the ratio of partner country demand to demand in Spain, in volume terms; the current account is the external account in the balance of payments. The real effective exchange rate is the nominal effective rate adjusted for the corresponding CPI inflation differential (an increase denotes an appreciation). |
| Chart 1. | Average annual changes in consumer prices and changes in year-end narrow money, lagged one period. |
| Chart 2. | Output growth and inflation refer to annual changes in real GDP and in the GDP deflator; the external current account is the current account in the balance of payments; unemployment rate in percent of labor force. |
| Chart 3. | Investment ratio is the ratio of total fixed investment to GDP, lagged one period; marginal productivity of capital refers to the inverse of the incremental capital-output ratio (ICOR) measured by the ratio of the change in GDP to total fixed investment. |
| Chart 4. | Capital stock is measured by cumulative volume of gross fixed investment adjusted for an annual depreciation rate of 4 percent (for the initial year 1965 an estimate of the capital stock was obtained from a capital-output ratio equal to 3, consistent with a steady state ratio associated with an investment ratio of 27 percent, a depreciation rate of 4 percent and GDP growth of 5 percent). The return on capital, or profit rate, refers to the ratio of gross operating surplus to the capital stock. |
| Chart 5. | Shares of services, industry and agriculture in nominal GDP. |
| Chart 6. | Unemployment rate in percent of labor force; labor force; employment |
| Chart 7. | Real product (consumer) wage is the average annual wage (national accounts basis) divided by the GDP (private consumption) deflator; labor productivity is measured by the ratio of GDP in volume to total employment. |
| Chart 8. | Unit labor costs are expressed as the average annual wage divided by labor productivity; import prices refer to import unit values; inflation refers to CPI inflation; ALP is broad money, including M3 plus Treasury bills and commercial paper held by the nonfinancial sectors; velocity is measured by the ratio of nominal GDP to the centered stock of ALP. |
| Chart 9. | Inflation is expressed in terms of the GDP deflator; labor costs, profits and indirect taxes (net of subsidies) are expressed in terms of their contributions to the increase in the GDP deflator. |
| Chart 10. | Decomposition of the general government balance into expenditure, revenue, interest payments and primary balance. |
| Chart 11. | Flow of funds, national accounts basis. |
| Chart 12. | Foreign reserves are official net foreign assets, including gold; the current account is the external current account in the balance of payments; the effective exchange rate of the Peseta is a weighted average of main industrial countries’ bilateral peseta rates. |
| Chart 13. | Export market shares refer to the ratio of non-oil Spanish exports to the weighted average of partner countries’ non-oil imports, in volume terms. Relative demand is the ratio of partner country demand to demand in Spain, in volume terms; the current account is the external account in the balance of payments. The real effective exchange rate is the nominal effective rate adjusted for the corresponding CPI inflation differential (an increase denotes an appreciation). |
The authors gratefully acknowledge comments from Leo Van Houtven, P. R. Narvekar, Jim Prust and Angel Torres.
The central element of the liberalization was the progressive elimination of the discretionary system of import licenses and the introduction of a general tariff which aimed at equalizing domestic and international prices. The share of liberalized imports increased from 40 percent in 1960 to 80 percent in 1973.
The agreement involved reciprocal tariff reductions and removal of nontariff barriers to industrial imports over the period 1970-77. At the same time, however, there was an adverse effect on trade due to distortions in the then prevailing indirect tax system. In compliance with GATT regulations, indirect taxes should have been neutral in its effects on competition, but this was not the case. Until the introduction of VAT in 1986, effective protection of domestic producers was higher than suggested by nominal import tariffs, including border taxes. Of the overall protection, 40 percent was attributable to indirect taxation (Bajo and Torres, 1990, and Gamir, 1990). On the export side, Spanish producers benefitted from the EC preferential tariff and also from tax concessions exceeding indirect tax rebates.
The renewed and various attempts made to rein in price and wage increases by decree over the period 1973-76 met with little success and wage settlements, for the most part, continued to be determined on the basis of past developments in labor productivity and inflation. The growth of the average nominal wage accelerated from 18 percent In 1973 to 27 percent in 1977 and the real wage accelerated on average 1 percent faster than labor productivity over the same period.
The money market rate, following International trends, increased by over 6 percentage points during 1979-1983, with Spanish interest rates among the highest on international financial markets.
This also resulted in significant trade diversion. Plummer (1991) provides evidence that trade liberalization with the EC resulted in an overall net trade diversion representing 1 percent of total imports.
Financial liberalization took place over the period 1986-92, promoting interest rate adjustment as financial and money markets were opened to international competition. The liberalization included various reforms of the money and public debt markets and of the stock exchanges.
