2008: Expectations and Challenges.

Rafael Pampillón. Professor. IE Business School

4 March 2008

The economic miracle built on construction-fuelled employment and consumerism is over. Construction has fallen, shaking the pillars of the virtuous circle.

The forecast for world growth for 2008 is lower than last year (2007). This is due to the fact that the two main driving forces of the world economy (USA and the euro zone) will continue to cool down. We are also in the middle of a financial crisis with a heavy rationing of credit and a high level of uncertainty regarding the direction to be taken by economies and macroeconomic policies. In this context, the Spanish economy also shows signs of deceleration and future weakening, made evident by the heavy deterioration of the foreign balance, high inflation and lower economic growth, especially in consumer goods and the construction sector.

Indeed, the heavy increase in inflation and high interest rates are having a negative effect on family consumer purchasing power. Moreover, spending on housing will slow down notably and is expected to reach negative growth rates this year. This fall in the growth of consumer goods and construction could bring about a fall in the growth of exports generated by the higher Spanish inflation that is causing some firms to lose competitiveness and, as a result, sooner or later they will suffer a fall in demand for their products, which will prevent them from increasing their production and employment.

Furthermore, employment was acting as the driving force behind our economy. Indeed, the significant increase in employment (especially immigrant employment) generated by the Spanish economy from 1996 to 2007 has led to a significant increase in the salary mass and, therefore, more income, which has led to a greater demand for consumer goods and housing; in other words, a higher production of consumer goods and more construction; in short, more economic growth and employment, which, in turn, increases income, etc. A virtuous circle based largely on the growth of employment in the construction sector. However, what will happen if employment and construction come to a standstill? The virtuous circle of employment could be broken and an inverse circle could begin: a vicious circle.

Accordingly, many analysts doubt the Spanish economy´s capacity for maintaining a growth rate that generates employment once we reach the end of the boom in construction that has nourished our economic expansion during the present cycle. What do the analysts forecast? An overall growth for the year 2008 of around 2.7% and almost 2% during the last quarter. Besides the increase in the number of unemployed, in 2008, we will continue to suffer from another two imbalances. The domestic imbalance shown in the higher rate of inflation in comparison with the countries with which we compete and the heavy external imbalance which generated a current account balance deficit of around 10% of the GDP in 2007. These levels clearly indicate that Spain is losing competitiveness.

What is the main challenge we face? Improving our competitiveness (according to the World Economic Forum, we have fallen 6 positions in three years, from 23rd in the world in 2004 to 29th in 2007). As a result, we need to (a) improve our education (Finnish style), adapting it to the needs of the changing production system; (b) increase our capacity for innovation in both knowledge networks and spending on R&D; (c) stabilise prices, making markets more flexible and dynamic, in other words, making them more competitive; and (d) balance out our balance of payments.

The improvement in competitiveness will allow us to increase our exports, which, although they are growing at a decent rate, are threatened by strong competition from emerging countries. Furthermore, (e) corporate tax needs to be lowered even further so that enterprises can reduce their capital cost and increase options for new, self-financing projects. We must remember that countries such as Ireland and Finland have aimed their economic strategy along the abovestated lines, obtaining very competitive sectors and becoming two of the richest countries in the EU. In short, the idea is for Spain to intensify its efforts to increase the competitiveness and productivity of its production system by extending the use of information technologies and investing in R&D and human capital.

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