The Spanish economy after the elections

Ignacio de la Torre. Professor. IE Business School

1 August 2016

Spain will once again lead economic growth among big Western countries, in spite of those who predict that the opposite will happen. Here’s why.

The story goes that a tribe of Native Americans had to decide how much firewood to prepare for winter. To make the decision they had to predict the harshness of the coming winter. The tribe turned to its chief, given his reputation for wise decisions. He urged them to cut a lot of wood, saying the winter would be very hard. Actually the chief had consulted the local weather forecast agency, which in turn consulted with the national forecaster. 

When the tribe had cut a huge pile of wood they asked the chief if the winter was really going to be so intense, in which case it would be better to cut more wood. The chief urged them to cut more wood, saying the winter would be extremely hard. Again and again they assessed whether to cut more firewood. Again and again the chief consulted the local weather station, which again said the winter would be hard. Eventually, the chief asked the local agency why it was so sure a harsh winter was coming. After consulting with the national agency it responded: "as well as our own forecasts, in the past we have seen how the intensity of winter relates to the amount of wood the local tribes cut, and this year they have cut more wood than ever."

This story illustrates an aspect of financial psychology about how rumors affect the economy. Only a few months ago the weakness of the Chinese economy created negative feeling in the markets, which immediately foresaw the possibility that the United States was headed toward recession, that the European economy was extremely weak, and that the Spanish economy would experience a sharp slowdown. To justify this analysts argued that the political situation in Spain would paralyze foreign and domestic investments, and spoke of "sinking" consumer confidence as a harbinger of this country’s stagnation. Of course, in reality this is just another example of financial psychology’s "self fulfilling prophecy", or in other words, reaching a conclusion and then only remembering the data consistent with our thesis, discarding the rest, allowing us to validate our already formed opinion as a pseudo reality.

As I wrote a few months ago, the United States was never going into recession, and nor has the Spanish economy collapsed. 

In fact, the Spanish economy has been growing for several quarters at 0.8% (3.2% year on year). During the first quarter of this year there was much talk of how political instability would slow growth. The reality is that it grew 0.8%. The doomsayers then turned their attention to the second quarter, and then particularly on the third. To date it appears that the economy will have grown slightly below 0.8% in the second, and 0.8% in the third ... The reasons for this lack of slowdown are as follows:

Firstly, Purchasing Managers’ Indexes (PMI ) are by far the most commonly used indicators by the financial markets to anticipate what is happening in the economy. An indicator above 50 shows acceleration and below that, a slowdown. The second best year in the history of the stock market was in 2009, the year of the Great Recession, why? Because PMI indicators turned around and anticipated exit from recession by the fourth quarter, as indeed happened. The Spanish stock market began to rise in the fourth quarter of 2012 when the PMI hit bottom (43) and began to rise ... 

The reason is that the activity measured by purchasing managers is much closer to economic reality than the predictions economists make. That’s why the market pays less attention to us than it does to the PMI, especially the service sector, the most important in Western economies. Today the Spanish services PMI is at levels of 56, pointing to annual economic growth close to 3%.

Secondly, consumer confidence is less relevant than consumption. Although confidence fell in the first quarter, it stood at historically high levels, which explains the strength of consumption. This pattern is repeated in the second quarter, except that in June consumer confidence has recovered. Seasonally adjusted April retail sales have been good, not so good in May, due to lower spending on food, but the trend of consumption remains very healthy, something consistent with the health of the labor market.

Thirdly, the labor market remains very buoyant, as shown in unemployment data for April, May and June which all point to GDP growth in line with the above. The more jobs are created the more we consume and the more salaries will gradually grow. 

Fourthly, unlike other Western economies, where firms are hardly invested or have even reduced investments, Spanish companies have invested strongly, due to perceived sustainable demand and advantageous financing conditions. Large-scale investment creates jobs, which in turn generates consumption, which in turn leads to more investment. Spain is now in this virtuous circle.

Again, as I explained recently, Spain still faces clear and present risks in the short and medium term. It is in our DNA to ask politicians to do something about growth ... My impression is that they would be best employed managing medium terms risks, as growth in 2016 and 2017 will be healthy and strong.

Spain will once again lead economic growth among the major Western nations.

Despite the apocalyptic prophecies, today we might do well to stop and ask ourselves why those Indians have really cut so much wood. 

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