José María O´Kean. Professor. IE Business School
1 July 2008
No actually. For years, Trichet could have put the brakes on the real estate bubble by raising interest rates. But Germany and France had other priorities. So what do we do now?
The truth is no, it hasn´t. With certain irony, perhaps, we can imagine how "hurt" Trichet must be by the reprimand given by the President of the Spanish government. The ECB is keeping an eye on inflation and the growth of the UM economy, especially Germany and France, and Germany has grown 6.1 in the last quarter and still maintains a year-on-year rate of 1.8%, with an inflation of 2.4. The Eurozone grows at a year-on-year rate of 2.2, with an inflation of 3.3, which is starting to be too high for the ECB´s targets. Germany´s industrial production grows at 4.6 whereas Spain´s falls by 13.3% and in this context Trichet starts to think that the liquidity required at 4% is very high and sends out a signal to the markets: "We are going to increase the intervention rate" and this has pushed the one-year Euribor up to 5.4% and the income available for Spanish citizens, after paying their mortgages, threatens them with serious problems for coping until the end of the month and perhaps paying their debts. But, what does the ECB care about the Spanish economy?
What is our problem? Our problem is that someone should have avoided the property model. With a considerable increase in the interest rate three or four years ago, this would have been avoided, but then the ECB focused on the German recession and kept the interest rates low. And the Spanish economy created a model that was different from the previous one, similar to the USA model. Instead of the state getting in debt, families got in debt and, more specifically, businesses. The construction sector reached almost 10% of the GDP, when it usually stands at 5%. Local government financed all kinds of equipment and other "needs" and the construction sector absorbed all the unskilled labour that kept our national unemployment rate high. Anyone wanting to ride the wave of the moment became a developer or a constructor and cheap finance pushed consumerism to an all-time high. Party time!
And now we have to tighten our belts. Besides the question of finance, which has detonated the situation, the halt to construction has pushed the aggregate demand down. It has done away with expectations and we are obtaining worse and worse global indicators of the situation. The effect on the accounts of local government and unskilled labour is now significant. Fortunately, we can implement an expansive taxation policy because the public accounts are not too badly off, but unfortunately, if we do that, inflation, which is already very high, will take off and jumping on an inflationist spiral at this point is sheer madness. Our hands and feet are tied.
What can we do? There are three lines of action available. The first is the liberal theory: let the markets adapt themselves. This line proposes an adjustment that is lengthy and hard. Withstanding the increase in raw material prices and the fall in the aggregate demand, waiting for salary moderation and the increase in productivity is a very uphill road.
The second option would consist of "taking the bull by its horns". In the long term, a serious and well-financed productivity improvement plan based on the productive fabric’s incorporation of ICT and investing in productive training as far as we possibly can, enabling open-ended contracting and dismissals, where necessary, for young workers that can assume training in accordance with the improvements to productivity we need.
In the short term, a salary policy with unions and entrepreneurs, offering reduced taxes on production (special taxes, indirect taxes and social security contributions), perhaps on a temporary basis, that have an effect on the aggregate supply, softening the increase in raw material costs. This is the best option, but it requires a great deal of credibility and persuasion from the government, unions that assume the cost with the union elections on the horizon, entrepreneurs who understand that the construction sector must adapt and an opposition party with fewer internal problems...
The third option is "managing the crisis", which is what we are doing at the moment. Saying that things are not so bad, adopting measures that are not incorrect but which convince no-one, waiting for a miracle that improves our competitiveness, praying that Trichet does not increase the interest rates any further, waiting for prices to level out and, when next January comes and things are really bad, trying to implement the salary policy based on negotiations with the unions. In view of how all the indicators continue to worsen and how social unrest increases, politicians are going to have a very hard time from now to the end of the year. It´s a good job the opposition has other problems.
There are many things we can learn from the situation. One of them is that when things are bad, we do not dare deal with the structural changes we all speak of and when they are good, we leave things alone. We never do anything truly important, strategic to change our direction.