Why Spain needs to moderate wages

Rafael Pampillón. Professor. IE Business School

1 November 2016

While public deficit and unemployment figures are still high Spain needs to avoid a big rise in wage levels, which will only serve to make unemployment levels worse. 

Wages is the subject that causes the most controversy among economists and which is the most sensitive in terms of public opinion. Spain’s National Institute for Statistics recently published its quarterly survey of the cost of labor and the Harmonized Labor Cost Index, which measures the variation in the cost of labor per hour worked. Both sets of statistics point to the same trend. Non-salary labor costs are going down due to fewer social security payments, while salaries are going up, albeit at a very moderate pace. During the second quarter of this year, compared to the same period in 2015, wages went up by 1%, after adjustment for seasonal and calendar effects.

If to this growth in wages we add a fall of 1% during this period in the prices of consumer goods, it can be concluded that on average the increase in purchasing power of workers over the last 12 months is that of 2%. This rise in real wages, coupled with employment, is fueling consumption and, therefore, prices. Hence underlying inflation, which is what measures the variation in prices of the most stable goods and services (prepared food, non-energy industrial goods and services) has kept rising gently since the beginning of 2015.

The slight rise in wage costs is compatible with maintaining the levels of competiveness of the Spanish economy. The variation in the Harmonized Consumer Price Index, which is the indicator used to compare inflation in different EMU countries,  shows that Spain’s inflation differential with the EMU (our main client) average, continues to be negative, which favors the competitiveness of Spanish firms. This differential has been playing in our favor for the last three years. That is what has enabled us to increase exports faster than our partner countries. These increased sales are in turn generating more production and more demand for workers, and that is why salaries are rising.  

Exiting the crisis

It is a good idea to remember that in 2008, at the beginning of this crisis, most economists claimed that real salaries were too high compared to the level of productivity. This was due to the fact that during the last wave of expansion, labor costs per unit produced were some 20% above the average for the eurozone. What effects did such high wages have on the open economy? Firstly, a rise in costs, which caused an increase in prices, which in turn reduced the number of Spanish exports. Secondly, imports grew, which led to a high foreign deficit and, in turn, high levels of debt to the rest of the world.

The crisis, which has been going on for just over eight years, caused a fall in production, and, therefore, a rise in the difference between supply of and demand for employment, or, in other words, an extremely high level of unemployment. The rate of unemployment in Spain rose to 27% (over 6 million people).  

Given that Spain did not have the capacity to devaluate its currency, it had to effect an internal devaluation in order to tackle the crisis, and said devaluation had to entail a reduction in business costs (including labor), and the breaking down of the resistance that has always existed against reducing salaries. And it brought positive results, because rigidity in the face of reducing wage levels is one of the causes that makes it so difficult to reduce unemployment levels. A flexible salary policy, on the other hand, favors work and economic recovery, which continue to be priorities. Unemployment in Spain has dropped from a peak of 6.3 million down to 4.6 million people.

Continuing with reforms  

In short, thanks to labor reform coupled with other structure reforms, three years ago the Spanish economy started out on the road to recovery which it needs to continue along if it wants companies to keep demanding labor. Exports continue to provide essential support for this growth, but they are not the only thing that helps. For several quarters now, the speed at which investment and private consumerism has risen has been surprising. Nevertheless, given that the reform program is not yet complete, and neither are adjustments in the labor, housing and public sector  markets, the economy is still vulnerable, which jeopardizes  balanced economic growth in the long term.  

The situation could have been worse if a populist government had got in at the upcoming Spanish elections. Such a government would have abolished labor reform and once again fixed salaries through sector and province-specific agreement. This would have eroded competitiveness, which would have damaged the business fabric along with levels of employment. In this hard reality that we find ourselves in, it is important to avoid a disproportionate rise in wages, because the only thing it would achieve is to raise an already high level of employment.  

It is also worth remembering that Spain is still in debt, and that we will only be able to reduce that debt if we are able to export to the rest of the world. It is from the perspective of raising the number of exports, and from that of employment, that we are able to justify moderating wage levels. Workers and public opinion have to be aware that the reductions in wages applied in previous years have only served to offset the rises that occurred during the expansive phase of the cycle, rises that were far higher than increases in productivity. In other words, this is about trying to trace back steps taken along the wrong path during those crazy years. Fortunately, the market adjustment process is moving forward and wages have now started to go up.

An uncertain future

Will wages keep going up? Will exports keep moving in the right direction, along with the dynamic family consumption and productive investment? It is difficult to know, but we cannot let our guard down, because the world economic environment is still weak. This is the fifth year that global growth is below its average long-term trend. This could have a negative impact on Spanish exports. If we add to this a rise in uncertainty about Spain’s political future, we could conclude that the trend is going to be one of less growth in terms of the economy and employment.

Recently published data, like the Industrial Production Index, and that of the number of people making social security payments, signal that the economy is slowing down. Investors and entrepreneurs are starting to show a certain lack of confidence in what kind of laws a new Spanish government might promote, which would lead to a drop in investment and fewer expansion plans. This could mean that forecasts for economic growth and employment in Spain in 2017 could be set to lower levels.

Hence, in short, while unemployment and public deficit figures are still high, moderating wage levels (both in the public and private sectors) should still be a priority for labor relations. 

 

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