<B>Competitiveness: the challenge facing the Spanish economy</B>

José María O'Kean. Professor. Instituto de Empresa

21 March 2006

In the past, Spain always had the option of devaluating it currency when it needed to restore competitiveness. But with the euro this is no longer possible. What then, is Spain to do in order to gain a competitive edge over its trading partners?

In the long term, the biggest challenge facing the Spanish economy is how to hitch its wagon to the information society; in the short term, it is how to tackle the trade deficit and boost competitiveness—two shortcomings that today cast a dark shadow over Spain’s prospects for achieving in the future non-inflationary growth, strong job creation and balanced financial accounts.

No single definition of competitiveness exists. A competitive country has a high per capital income and is able to attract both financial and corporate investors. For others, a competitive country enjoys a surplus on both its trade and current account balances—which is a reflection of its success at selling goods and services to consumers, both domestic and foreign.

The Spanish economy is far from competitive. Indeed, its trade deficit widened to 6.3% of gross domestic product in 2004. Not even the receipts from the country’s buoyant tourism industry succeeded at narrowing the deficit of 5.3% of gdp on the current account of the balance of payments. And the gap is expected to widen even further.

The challenge is for Spain to become more competitive than its trading partners. Who these partners are is well known: the European Union accounts for 73% of Spanish exports and 61% of its imports. France, Germany, Italy, the United Kingdom and Portugal are Spain’s biggest partners and competing with them is difficult.

Competitiveness depends on four factors: productivity, costs, prices and the exchange rate. Productivity is the value created per unit of production. Spanish productivity grows at a slower pace than that of its trade partners. What’s more, the economy expands by employing more factors of production but fails to boost productivity.

Spanish labour costs are growing faster than the costs of its trade partners, which also enjoy lower rates of inflation. The country loses competitiveness because it suffers from lower productivity and higher costs and prices than its partners. In the past, when this occurred, Spain devalued its currency to restore competitiveness—a remedy that is no longer possible with its membership of the European monetary union. To finance a chronic current account deficit, a country can resort to financial transfers and increase debt levels or it stands to lose reserves. Though Spain is currently doing all three, the days of receiving European transfers are numbered, while its reserves are limited. The US, with a bigger trade deficit than Spain’s in relative terms, is in a similar situation, but it is fortunate enough to print and operate in the world currency—the dollar.

In the past, a flexible or adjustable exchange rate enabled Spain to correct its current account imbalances and boost exports through currency devaluations. Now that devaluation is no longer an option, the growing appetite of Spanish consumers for foreign goods, coupled with weak foreign demand for Spanish products, leads local companies to close up shop or go abroad in search of lower production costs, higher productivity, lower prices and a more flexible currency.

One solution is for Spanish business to focus on domestic demand, particularly in markets that are sheltered from foreign competition, such as handmade products and personalized services—a very 19th century approach.

Switching trading partners is another option, but Latin America’s market economy hasn’t yet consolidated and Asia has very low production costs. A better solution would be to meet the challenge of honing competitiveness without resorting to devaluations. How? Boosting the competitiveness of the Spanish economy would contribute to reducing the inflation differential with its trade partners. Spain has too many oligopolies--which are more or less collusive--and too many companies that enjoy dominant market positions in strategic and regulated sectors.

The key to Spain’s future lies in boosting productivity, or the value per unit of production, by improving product quality, design, customer service—both during and after sales--and product innovation, etc. It also requires increasing corporate efficiency. In short, greater productivity requires greater talent and wide-spread use of information technology. Boosting competitiveness is the biggest challenge facing our business community today. Meeting that challenge requires becoming part of the information economy. As someone once said, enterprise is software. Talent and software point to the way forward.

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