Inspiring confidence and credibility

Patricia Gabaldón. Professor. IE Business School

14 February 2012

Economic reactivation is the best way to eradicate unemployment, get the deficit under control and get credit moving again. In order to achieve this, the government first has to inspire confidence.

There are three key reasons for Spain’s economic situation, namely the risk premium of Spanish bonds compared to those of Germany is out of control; 20% of its active population is unemployed; and it is having difficulties keeping the promise that it would control debt and public deficit. Mariano Rajoy’s government faces the enormous challenge of inspiring confidence and belief in the Spanish economy. It’s as simple and as complicated as that.

The main battle he will have to fight with his new executive will be over unemployment. The rate of unemployment stood at 21.5% in the third quarter of 2011 and looks set to grow over the next few months, being predicted to reach around 23%. And the problem does not only lie in the number of jobless, but rather in the fact that almost half of them have are long-term unemployed, making for further social problems and placing significant burden on public coffers. The problem can only be solved in two ways, which are not mutually exclusive: by promoting the growth of businesses and making the work market more flexible. It is not just a question of there being more businesses, it is about encouraging these businesses to take on more workers.

Entrepreneurship should be incentivized by the state, improving the business climate and access to funding, but also reducing taxes for new businesses, particularly those created in high value-added or technology-intensive sectors. Labor market reform should include a reduction in the cost of laying off workers, which would make firms less wary of contracting new employees. And the minimum social security payments need to be reduced to encourage part-time jobs.

The second problem the Spanish economy faces is the public deficit, and, by extension, public debt. The Spanish government aims to keep public deficit at below 6% of gross domestic product at the end of 2012, but that means making significant cuts in current spending levels. The situation in Spain is a complex one and achieving these deficit and debt targets is essential in order to be able to stem potential rises in the cost of risk premiums in comparison to the German bond. Although it may seem complicated, if the government wants to avoid touching the main parts of spending (pensions, unemployment benefits, etc.), all it can do is improve income. The simplest way to improve state income would be a rise in VAT.

Spain has one of the lowest rates of VAT in the EU. But the last VAT rise is still fresh in Spaniards’ minds, and it could slow down consumption among families, so perhaps it’s not the right moment to do it. One alternative would be to crack down on fraud, but that would not fill the state’s coffers in the short-term. In the face of this dilemma, perhaps the best course of action is to cut back as far as possible and streamline money collection mechanisms, especially where regional authorities and local governments are concerned. In any case, obviously the best way to improve state revenues is to reactivate the economy.

The third problem is the restructuring of the finance system. It is essential that the reform of Spanish savings banks be brought to a definite close in order for them to work efficiently. In spite of the mergers that have taken place in this sector over the last year, the Spanish finance system still needs to strengthen its capital in order to address possible losses derived from the European sovereign debt portfolio, which could continue to prevent access to credit, one of the key engines for business activity and economic growth. However, the lack of faith in the Spanish banking system does not only stem from a lack of capital, but also from the large number of buildings held by Spanish banks and savings banks, yet another of the problems that can only be solved with an improvement in the economic climate.

We could say that the three big problems with the economy are interrelated, or even that they are both a result of and a catalyst for the lack of confidence and credibility that is paralyzing the Spanish economy. Nevertheless, the first thing the new government should do is to be efficient, coherent and to honor their proposals and promises. It is the only way that they will revive the market’s flagging confidence.

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