Spain’s new Prime Minister, Mariano Rajoy, will be responsible for re-shaping the country’s image within Europe, as the bleak financial situation continues to engulf the continent.

He will be forced to work with the recently appointed Italian PM, Mario Monti, to raise Spain’s credibility within the search for solving Europe’s current economic meltdown. “The markets know and believe Monti, which could refocus their attention on Spain. Mariano Rajoy is going to have to do a lot more than Monti”, says Charles Grant, a British political scientist.

We know that Greece was unable to control its spending, and outrageously lied about its borrowing.

Rajoy is relatively unknown among the European Union Bloc, which will not put him in good stead. Rajoy does, however, have support from France and Germany as both recognise that Spain’s recovery is essential to the re-establishment of normality.

Spain’s descent into economic abyss is important because it does not fit the narrative. Its case has served to exemplify that the Continent’s issues run deeper than the problem of excessive borrowing by irresponsible governments. We have, until now, found it increasingly easy to place blame on our Southern European counterparts. We know that Greece was unable to control its spending, and outrageously lied about its borrowing. The Portuguese over-borrowed and over-spent. Italy’s debt is skyrocketing; and undoubtedly a legacy of its ill-political situation dating back to the 1970s.  Spain, however, has proved to be a model European.

Hence, the country underwent what at the time seemed like a stable boom…

The saviour

When the use of a unified European currency was first conceived in the 1990s, Germany adamantly insisted on the need for a stability pact, to ensure that Eurozone governments would keep their finances in order. Accordingly, each entrant promised that their total borrowing would be kept below 3% of their total GDP. When Spain first joined in 1999, its government was open about their breach of the rule but continued to run a balanced budget. As the Spanish economy experienced rapid growth, its debt ratio decreased to merely 36% of GDP by 2007. Germany’s, on the other hand, continued to increase. This begs the following question: why are markets now telling us that Spain may be unable to repay its debts, while they believe that Germany’s debts are the safest bet within the Eurozone?

It does not seem fair. The reason is that Spain is faced with an almost impossible economic dilemma. When Spain first entered into the Eurozone, interest rates fell to much lower levels than what were typically seen in Germany. The Spanish government resisted the temptation of cheap loans, but most ordinary Spaniards were not as disciplined. Hence, the country underwent what at the time seemed like a stable boom, underpinned with the irresponsible housing bubble and the consequent undertaking of bigger and bigger mortgages, resulting in a house price increase of 44% from 2004 to 2008.

This will undoubtedly stimulate the demand for Spanish output and boost economic growth…

As expected, Spaniards earned more and spent more, which enabled the increase of Spanish wages to uncompetitive, unmaintainable levels. As a result, Spain’s economy went bust; its construction sector collapsed, households have cut back on their spending and unemployment accounts for 21.5% of the workforce. 

The dilemma facing the incoming Spanish government is this: in order to get out of this economic hell, workers need to be competitive again. This will undoubtedly stimulate the demand for Spanish output and boost economic growth, enabling Spain to support its mountain of debt. For this to happen, Spanish workers would need to agree to further wage cuts and would thus face enormous difficulties to pay their mortgages. 

Rajoy is now left with the difficult decision of whether Spain should leave the euro and devalue a newly recreated peseta. This would indeed lead to the decrease in Spanish wages, but also to the decrease in debt, and it would also eradicate the risk of the Spanish government running out of money, allowing the Spanish Central Bank to bail the government out, something which the ECB has adamantly refused. 

Image courtesy of Mariano Rajoy

 

About The Author

A Modern History and Politics graduate, currently working for a production agency. Interested in all things bright and colourful.

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