The pendulum effect

Fernando Fernández. Professor. IE Business School

2 February 2010

As the decline of macroeconomic indicators finally starts to ease, some can now see light at the end of a tunnel. But we are not out of the woods yet.

January has not brought much new information or many original comments. Except, perhaps, the fact that the international press is becoming increasingly critical, to the point of irony, of Spain’s economic policy. And of course we also have Spain’s European presidency which, while Spain continues to systematically breach Community policies (e.g. the sanctions for the takeover of Endesa or resignation in the face of the sanctions that will come as a result of transposing the services directive), is actually daring to ask for a more effective sanctions system. And this despite the years it takes to earn a good reputation in Brussels.

Elsewhere, the main indicators continue their downhill trend (this week we have had inflation, unemployment and industrial production), even if the fall is being cushioned. For some, it is a sign of the end of the crisis; for others, it is a sign of the continued destruction of employment and the industrial fabric. Perhaps the best summary has come from the Secretary of State for the Economy: we will not return to the levels of employment we had before the crisis in the next five years. Nor will we see previous levels of economic activity or consumption or retail sales for some time. And we will have to wait even longer to return to previous levels of tax collected because the flexibility of public revenue has fallen dramatically.

It is also an optimistic scenario and one that implies an automatic pendulum effect. But that effect is an illusion. It does not exist. The economy does not bounce back automatically. For example, the public deficit will not correct itself and the government will have to choose between continuing into further debt with the risk of entering into an explosive situation on markets that are becoming increasingly concerned with the public debt, or seeing sense and proposing a serious plan for fiscal consolidation.

The same will happen with the real estate sector: either prices fall by at least 30% or the excess supply will take many years to be absorbed by a population whose available income is falling as interest rates rise. If we continue to deny the problem and try to save the sector with state-subsidised housing and bookkeeping protection mechanisms, the crisis will last 10 years. Not to mention the financial sector, which is in urgent need of adjustment. Not only does it have problems with stocks, failed assets related to the real estate bubble and the over-eagerness with which certain corporate transactions were financed, but it also has a serious cash flow problem.

Even in the optimistic macroeconomic scenario described above, revenue will fall and costs will increase, a large number of banks will file losses and need injections of capital. Mergers are one way of dealing with the problem, but only if they imply significant reductions of installed capacity and running costs, and a reduction in political meddling in management processes, which is the opposite of what is happening with the consent of the competent authority.

But the worst thing for the future is the potential fall in the GDP, which is the result of a reduction in the working population by a further two million people since the beginning of the crisis. Many economists think that the Spanish miracle was basically due to the incorporation of six million workers. If we lose two million forever, we can only resign ourselves to growing on a smaller scale in the future, knowing that the aforementioned problem will get even worse. The only alternative left now is that of implementing a labour reform to make hiring workers an attractive proposition again.

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