Volume 45 Number 179,
October - December 2014
The Origin of Macroeconomic Imbalances
in The Spanish Economy
Carlos Carrasco*
Date received: January 24, 2014. Date accepted: April 29, 2014
Abstract

This work studies the origin of macroeconomic imbalances in the Spanish economy in the context of European integration, analyzing some of the major hypotheses found in economic literature as causes of imbalances in current accounts, disparities in competitiveness among member states and the fiscal position of the Spanish government. We emphasize the breaking point of adopting a single currency and how this has affected interest rates, economic growth forecasts and the strong and continuous inflow of capital from countries in the Eurozone core, contributing to the real-estate bubble and leveraging the private sector.

Keywords: Current accounts, competitiveness, exchange rates, monetary policy, European integration.

INTRODUCTION

Since the beginning of the last decade and, to a greater extent since Bernanke's (2005) work was published, global imbalances have been viewed as a source of instability and a potential risk for the world economy. The economic literature has studied various hypotheses regarding the origin of global imbalances. One of the most remarkable says that current account balances and falling long-term interest rates in the United States (US) were a result of flows derived from excess savings in emerging economies, principally in Asia, and oil exporting countries, which the literature on global imbalances has coined the savings glut. This savings glut, together with the difficulties the United States faced in absorbing it, was one of the principal causes of the 2007 financial crisis. With that said, empirical studies have researched various reasons why savings rates in East Asian emerging markets and oil exporting countries have grown, coming to a few conclusions. First, some emerging countries have followed an export-led growth strategy, which requires maintaining a competitive exchange rate and, therefore, accumulating reserves to intervene in the currency exchange market (Catte et al., 2011; King, 2011; Herrerías and Orts, 2010; Rodrik, 2008). Second, a significant portion of savings are a sort of precautionary measure, in response to fear of external shocks and sudden capital flight (Menkhoff, 2013; Porcile et al., 2011; Aizenman et al., 2011; Taguchi, 2011; Calvo and Reinhart, 2002), aging populations and deficient social protection schemes (Horioka and Wan, 2007; Ferrucci and Miralles, 2007), as well as coverage in case the price of exported goods should drop (Bems and Carvalho-Filho, 2011; Kilian et al., 2009; Le and Chang, 2013). Finally, savings have also flowed out of these economies and into advanced economies because their own financial systems are underdeveloped (King, 2011; Ferruci and Miralles, 2007).

More recent works have conceded that although the savings glut from emerging Asian markets and oil exporting countries may have contributed to reducing the yields of the most secure and liquid assets through their entry into the United States market, and therefore may have displaced capital flows coming mainly from Europe for financial innovation products in search of greater returns (Bertaut et al., 2012), it is also true that net flows, like the current accounts balance, are less explanatory. Rather, it is gross flows that are the most important factor in explaining the financial instability we have seen in recent years (Borio and Disyatat, 2011). By considering gross flows, the European flows become more relevant. On the whole, although both the European Union and the Eurozone have had a current accounts balance close to the equilibrium, inflowing and outflowing gross flows may have contributed to the instability of the international financial system.

When it comes to the European Union, in general, and the Eurozone more specifically, its member countries have had extremely divergent external positions (Lane and Milesi-Ferretti, 2007). That is, while countries such as Germany, Holland or Finland have had persistent current account surpluses, Spain, Greece and Portugal have had consistently negative external balances. To that effect, the role of Holland, France and Germany as financial intermediaries for the capital flows of the global market has been notable (Chen et al., 2013; Schmitz and Von Hagen, 2011). In other words, they have been borrowers in the global markets and lenders in the European realm.

Besides the discrepancy of external positions seen among member nations in Europe, certain variables related to the functioning of the monetary union vary widely as well. These include public deficits, productivity, prices and labor costs. The discrepancy among these variables contributed to making peripheral countries in the Eurozone less competitive and caused their external positions and fiscal balances to become unstable and unsustainable.

This work studies the origin of imbalances in Spain in an environment of European economic integration. Concretely, it analyzes a few hypotheses found in economic literature as causes of the current account imbalances and disparate competitiveness of member nations. Analyzing the origin of imbalances in the Spanish economy is relevant given that Spain is facing the largest economic crisis of its recent history. Moreover, this work aims to provide useful information and explanatory terms to explore the causes of macroeconomic imbalances in the Spanish economy, their relationship to the financial crisis and sovereign debt, as well as possible economic policy alternatives.

To meet this goal, after the introduction section, the first portion of this work will analyze the economic literature on imbalances between European countries. The second section will look at major hypotheses regarding the origin of these imbalances in the Spanish economy. Finally, this work offers some conclusions. Based on the prior analysis, this text shows that the adoption of the single currency was a breaking point, and that it impacted interest rates, economic growth expectations and the strong and continuous inflow of capital from countries in the nucleus of the Eurozone, helping form the real-estate market bubble and leveraging the private sector.



I. A FEW HYPOTHESES ON THE ORIGIN OF EUROPEAN IMBALANCES

As mentioned earlier, although member countries of the Economic and Monetary Union (EMU) have exhibited, overall, external balances close to equilibrium (measured in terms of the current account balance), the individual positions of each nation are extremely divergent. To describe the situation, we can take as a base the countries that originally adopted the euro in 1999 (Germany, Austria, Belgium, Spain, Finland, France, Holland, Ireland, Italy, Luxembourg, Portugal) and Greece (2001) and separate them into three groups: deficit, surplus and equilibrium (equilibrium countries have a ratio of +/-2%), as defined by the average current account balance as a percentage of GDP since the year in which the euro was adopted until 2012. The surplus country group includes Belgium, Finland, Germany, Luxembourg, and Holland, while the deficit group includes Greece, Portugal and Spain. Finally, countries with relative current account equilibria include Austria, France, Ireland and Italy. Nations with an extreme surplus include Luxembourg (9.27%), Holland (5.68%) and Finland (4.45%), while the countries with the greatest negative balances were Portugal (-9.25%), Greece (-8.44%) and Spain (-5.12%).

A variety of hypotheses have emerged to explain these unbalanced current accounts in EMU countries. The first explanation is based on the convergence of less developed countries towards more developed. That is, given their varied initial endowments, capital would flow from countries with greater capital-labor ratios towards those with lower ratios aiming to obtain higher marginal returns for future growth expectations generated by integration and convergence (sometimes called catching up) (Schmitz and Von Hagen, 2011; Belke and Dreger, 2013; Campa and Gavilán, 2011). The global process of commercial and financial integration, with the EMU as the leader, created a situation in which countries in search of economic convergence1 would take advantage of capital flows now that the currency exchange risks had been eliminated (Lane and Milesi-Ferretti, 2007; Lane, 2013), and this catching up process would increase their economic growth rates. This would have been possible because in the environment of European integration, peripheral countries had relatively developed and homogenous systems as compared to the nucleus, and were embroiled in the very institutional framework of the European Union. In summary, the first explanation relates the current account balance with development levels and European integration.

A first approach is presented in Figure 1, showing the positive relationship between the average of current account balances since the euro was adopted until 2012, with GDP per capita of the country as compared to Germany at the time the euro was adopted. Using the convergence hypothesis and the idea of economic integration, adopting the euro would have meant a significant decrease in interest rates, effectively eliminating currency exchange risks, as capital flows towards peripheral countries would destabilize current accounts, which would be corrected as real convergence was achieved.

Besides the hypothesis of conversion and EMU integration, macroeconomic imbalances among European countries are also linked to the loss of competitiveness in peripheral countries. There are three key points here. The first is related to the German export-led growth strategy instituted after unification, which depressed internal demand by maintaining prices and salaries artificially low and weakening the negotiating power of unions (Schnabl and Freitag, 2012; Brancaccio, 2012). The second is greater relative growth in prices and wages in peripheral countries in the absence of their own nominal exchange rate strategies, which translated into deteriorating competitiveness for these nations. Finally, it has also been said that adopting the euro with nominal exchange rates that were different from long-term values may have contributed to economic cycles becoming unsynchronized (Toribio-Dávila, 2011). If we add to that the implementation of expansive monetary policy, the result is that the economies that entered the Eurozone with a more competitive exchange rate overheated. In an environment of restrictions imposed by the EMU, when there are asymmetrical shocks to demand, monetary policy becomes ineffective and the Stability and Growth Pact (SGP) can become a factor that limits the stimuli that less advantaged members need.



 

Figure 1. GDP per Capita Relative to Germany in the Year the Euro was Adopted vs. the Average Current Account Balance (% of GDP) Between Year of Adoption and 2012

Source: World Development Indicators – World Bank.

 



Finally, the economic literature has indicated two factors as the cause of these imbalances. The first is related to the varied demographic stages in which each member country of the EMU found itself (Aizenman and Sengupta, 2011; Hassan et al., 2011; Barnes et al., 2010). This hypothesis says that countries like Germany, with a greater ratio of dependent elderly people than in countries like Ireland, may have contributed to higher savings rates in the former that were channeled to countries like the latter. The second and final factor relates the current account balance with the government budget balance, which in the literature is known as twin deficits, although the extent to which these deficits contributed to the external positions of peripheral countries is still unclear (Barnes et al., 2010; Brissimis et al., 2010; Blanchard, 2007).



2. IMBALANCES IN THE SPANISH ECONOMY

Studying European integration in the third stage of the EMU2 begins with an attempt to determine whether the adoption of the euro was a structural breaking point for macroeconomic imbalances in the Spanish economy. To answer this question, we look to three key variables in the financial and economic integration process. First, the current account balance, which reflects the difference between national savings and investment. Second, the nominal interest rate, where the adoption of the euro and the disappearance of currency exchange risk had a positive impact on the risk premium. Finally, the real effective exchange rate, which, in the absence of a nominal exchange rate adjustment mechanism, reveals relative prices among Eurozone economies and is moreover frequently used as a measure of competitiveness.

Two structural breaking point tests were conducted for this analysis. The first was proposed by Perron (1997) and the second by Bai and Perron (1998). Current account and real effective exchange rate data series were used as a reference, the latter based on unit labor costs taken from the International Financial Statistics of the International Monetary Fund (IFS-IMF), as well as the nominal interest rate for ten-year public debt, which was used as a convergence criterion. This last data series was obtained from the National Statistics Institute of Spain. To describe this approach, it must be mentioned that it was difficult to obtain long data series for the same period, which is why the analysis is restricted by their availability. That means that time periods may be different for the variables, although the reference year is always the year in which the euro was adopted. Moreover, we do not include the period up to 2008Q4, because the objective was to analyze how macroeconomic imbalances developed and the idea was to prevent the shock of the international financial crisis from dominating the results. Table 1 displays the results of the structural breaks tests proposed by Perron (1997) and Bai and Perron (1998). Because the former determines a single breaking point previously unknown in the series, it is not very useful when there are multiple breaks. The second test by Bai and Perron (1998) eliminates this problem and proposes an approach using a least ordinary squares (LOS) regression to identify the presence of up to five multiple unknown breaks.

This table shows a series of structural breaks in the current account balance between 1996 and 2003, that is, in the period prior to and in the early years of the adoption of the euro. The 2003Q4 break indicates the point at which the current account balance began to deteriorate more rapidly. The real effective exchange rate based on unit labor costs reveals breaks in 1989, 1993-94 and 2002. It was during the 2002Q1 break when the divergence between the real exchange rate trends in Spain and Germany began to accelerate. Finally, for the interest rate taken as a reference for convergence criteria, there were changes in 1997, 1999, 2002 and 2005. We can see how starting when the single currency was adopted, the reference interest rate for convergence stabilized around record low levels. In other words, financial and economic integration, which intensified in the third stage of the EMU, was an inflection point for the macroeconomic imbalances of the Spanish economy. The positive shock from adopting the euro and the financial integration process during the third phase of the EMU would have been a great incentive for extraordinary capital flows from the nucleus to Southern countries. These flows, along with falling risk premiums due to the elimination of currency exchange risk, would have caused the current account balance to deteriorate.

In addition to the financial integration explanation, deteriorating current account balances are related to future growth expectations for the Spanish economy associated with convergence (catching up) towards the nucleus economies of the Eurozone. Empirical works have shown that growth expectations for convergence economies in the Eurozone were biased with respect to their macroeconomic foundation (Ca'Zorzi et al., 2012; Gibson et al., 2012; Beirne and Frantzscher, 2013), which shows that economic agents overreacted both to the positive effects of integration on convergence economies as well as the real negative impact of the recent financial crisis.

The question now is to analyze the why competitiveness fell in the years following the adoption of the euro, and what role the fiscal position of the Spanish government played in Spanish imbalances.

Figure 2 compares the performance of the real exchange rate for various Eurozone member countries in the years following the adoption of the euro. For reasons of space, the countries known as PIIGS (Portugal, Ireland, Italy, Greece and Spain) and the German economy were used as a reference. Based on Figure 2, and starting in the year in which the euro was adopted, we see a discrepancy in the real effective exchange rate index between Germany and the PIIGS. The difference is greatest for Ireland, Spain and Greece.

A key part of this analysis is studying the relationship between the growing labor costs and productivity. Figure 3 shows how the growth rates of nominal unit labor costs have evolved in this group of countries. Three facts stand out in this Figure 3. First, unit labor costs rose constantly in the PIIGS countries following the introduction of the euro. Second, we can see a sudden drop in labor costs following the start of the financial crisis in 2007, made worse by the European sovereign debt crisis starting in 2010. On this point, it should be said that in Ireland, costs fell, a place where the labor market has been considered highly flexible. Finally, in Germany, until right before the crisis, unit labor costs were relatively stagnant. This would have contributed to the loss of competitiveness seen in peripheral countries as compared to the German economy, whose export-led growth strategy has been characterized by weakened domestic demand.3



 

Figure 2. Real Effective Exchange Rate (1999=100)

Source: World Development Indicators – World Bank.

 

Figure 3. Unit Labor Costs for the Overall Economy 1995-2012 (Annual Growth Rates)

Source: OECD database.

 



Figure 4 compares the evolution of unit labor cost indices, productivity per labor unit employed and consumer prices for the period 1999-2012. The series reveal that in Spain, Ireland, Italy and Portugal, unit labor costs grew consistently and more strongly than productivity. Looking at the Greek economy, there is a positive correlation, in which productivity growth was greater than unit labor cost growth until before the crisis. Finally, in the German economy, unit labor costs were relatively stable while productivity grew significantly. In the Spanish economy, there was a strong and sustained increase of consumer prices, while the German economy saw consumer price growth below that of productivity in the period before the crisis.



 


Figure 4. Comparative Evolution of Unit Labor Cost Indices, Productivity per Unit of Labor Employed
and Consumer Prices, 1999-2012 (1999=100)

Source: Prepared by the author based on OECD data.

 



In summary, the combination of strong price growth and labor costs in the Spanish economy with respect to productivity, relative price and unit labor cost stagnation, simultaneous to strong productivity growth in the Germany economy, meant that the Spanish economy became less competitive as compared to Germany. First, the German export-led growth strategy would have contributed to its relative increase in competitiveness by maintaining the aggregate domestic demand depressed. Second, external flows reaching Spain would have pressured demand, which is reflected in the prices and salary costs of its economy. However, labor costs in both the German and Spanish economies grew at different rates depending on the sectors involved.

Table 2 offers sector-based information on unit labor costs in the Spanish and German economies. In the former, unit labor costs for manufacturing, industry, construction, commerce, transportation and communications, financial and business services, market services and the business sector grew. However, it was the construction sector that saw unit labor costs grow significantly faster than other economic sectors between the start of the third phase of the EMU and the beginning of the crisis. Similarly, the construction sector was most drastically affected after the crisis began. Looking at the German economy, an analysis by sectors reveals no constant trends. Similarly to the Spanish economy, construction saw greater increases in unit labor costs, although to a lesser extent. The strong increase in unit labor costs in the Spanish construction sector can be explained primarily by the real-estate bubble that grew in the first half of the past decade. Falling nominal interest rates, as a result of decreased transaction costs associated with integration and the elimination of currency exchange risks, in addition to high growth expectations for the Spanish economy, led to a boom in resources, which, through the Spanish financial sector, mainly their savings banks, translated into constant investment in housing, in light of the high yields of this sector and the assumption that real-estate prices would not fall.

These constant inflows led to negative real interest rates, which pushed real-estate prices up. Moreover, the construction boom attracted workers from other economic sectors because of the high salaries it offered. One of the features of the Spanish economy, due to the marked duality of its labor market, is that in times of boom, it creates lots of jobs, while in times of recession, it destroys them just as quickly. This can be explained by the fact that job creation in times of boom is buoyed by temporary contracts, which strongly limit productivity growth, not to mention that they contain provisions for easy firing and often fail to offer the social benefits of indefinite contracts.

Figure 5 displays approximate real interest rate data estimated for the various nominal interest rates minus the GDP deflator for the Spanish economy for the time period 1995-2012. The series shown are for the interest rate of the Euribor inter-banking market for one year terms, the weighted average of the mortgage market interest rate for three-year or longer loans for all financial entities and the interest rate for ten-year public debt used as convergence criteria.

Starting at the beginning of that time period, the real interest rate fell and even in the years immediately prior to the start of the third phase of the EMU, real rates were negative. This would have encouraged the real-estate bubble to develop and would have increased private indebtedness. To this effect, Toribio-Dávila (2011) wrote that the adoption of the euro at a nominal exchange rate different from the long-term equilibrium may have desynchronized economic cycles among Eurozone countries, as some of them entered with a relatively competitive exchange rate and others had competitiveness issues. Based on this assumption, active monetary policy would become ineffective in addressing asymmetrical demand shocks, because it would overheat the group of countries with competitive exchange rates. In terms of the European economy, this would explain part of the demand side pressures that impacted economic growth in Southern economies and led to a substantial increase in prices and wages.

The constant entry of foreign flows in combination with the housing market boom and real negative interest rates would have caused household savings rates to fall drastically. Overall, the boom in private consumption and historically low interest rates were an incentive for the Spanish private sector to take on growing amounts of debt. Non-financial corporations were involved in leveraging linked to the boom of the decade prior. Figure 7 shows the ratio of net debt to income after taxes for non-financial corporations in Germany, Ireland, Spain, Italy, Portugal and the Eurozone. It reveals a notable increase in leveraging in Spain and Portugal. The increase in Italy was rather more moderate, while the ratio was relatively stable in the rest of the countries.



 


Figure 5. Nominal Interest Rate Minus the GDP Deflator (1995-2012)

Source: Nominal interest rate data obtained from the National Statistics Institute of Spain and the GDP deflator from the World Development Indicators.

 





 


Figure 6. Spanish Household Savings Rate as a Percentage of Available Income

Source: Annual Macroeconomic Database (AMECO).

 



Although the Spanish case has recently been described principally as a public debt issue, which would indicate the need for fiscal consolidation to return debt levels to the limits imposed by the SGP, its origin is actually a combination of private debt, economic policy errors prior to the crisis (undermining the capacity for economic officials to respond to problems) and the financial aid system. The left axis in Figure 8 shows data for the evolution of public debt as a percentage of GDP for a select group of countries including the Eurozone (the group of 17), while the right axis shows public deficit/surplus data for the Spanish economy. Because public debt as a percentage of GDP is exclusively focused on the Spanish economy, we can see that starting at the beginning of the third phase of the EMU, when the Spanish economy had a sustained economic growth rate, the ratio of public debt to GDP fell continuously until 2007, reaching some of the lowest levels seen among developed nations. By way of comparison, up until before the outbreak of the crisis, the Spanish economy had a public debt to GDP ratio far below that of Germany, France, Italy, Greece and the average of the Eurozone (the group of 17). France and Germany have performed better than SGP requirements – which stipulate a maximum debt to GDP ratio of 60% – since 2002/2003. Meanwhile, Greece and Italy have also faced debt problems with respect to the limits imposed by the SGP during the period under study, reaching record highs above 170% in Greece and 130% in Italy.

Due to the differences in the fiscal positions of these governments, empirical studies have shown that the relationship between current account balances and the government budget balance is neither clear nor homogenous among countries with the greatest macroeconomic imbalances in the European Union (Barnes et al., 2010; Brissimis et al., 2010; Blanchard, 2007). On the other hand, we can see that between 2004-2005 and 2007, the Spanish economy enjoyed a surplus in its public accounts, largely connected to Spanish economic growth. Now, the key question is to determine what made the fiscal position of the government go from having a fiscal surplus and a debt to GDP ratio far below SGP imposed limits to a situation in which its public finances are now apparently unsustainable. When Spain joined the monetary union, it was affected, on the one hand, by the contagion of weaker fiscal positions from other economies and, on the other, the limits that the SGP imposed on the economic policy measures it could take to respond to the strength and duration of the 2007 crisis. In addition, the dynamics of Spanish public debt can also be explained by interventions from public administrations in recapitalizing financial entities,4 including the European Financial Stability Fund, bilateral loans with Greece, the European Stability Mechanism, the Fund for Orderly Bank Restructuring and the Fund for the Acquisition of Financial Assets, as well as financial system aid, such as contingent liabilities, which refer to the volume of operations known as bank guarantees from Spanish public administrations, which was around 17% of GDP at the end of 2012 including backing given to the financial system, the European Financial Stability Fund and the Company for the Management of Assets from the Restructuring of the Banking System (Gordon



 

Figure 7. Ratio of Net Debt to Income (After Taxes) of Non-Financial Corporations

Source: Eurostat.

 


Figure 8. Public Debt (% of GDP)

Source: Eurostat.

 



In recent economic literature, there have been two works notable for their understanding of the economic policy errors that led the Spanish economy into its public debt problems. On the one hand, Serrano (2010) describes a combination of situations and early economic policy errors made by the Spanish government that greatly reduced the margin for fiscal policy to act within SGP limitations and impact economic reactivation.

First, 2007-2008 fiscal policy was biased towards expansion, even when the economy was in the growth phase of its economic cycle due to the proximity of the 2008 general elections. To this we can add the fiscal reforms of 2007, which were somewhat pro-cyclical. Second, the distribution of the 2008-2009 fiscal stimulus – one of the largest in Europe at nearly 9% of GDP – between public income (tax cuts) and public spending was fundamentally different than in the rest of European countries, because tax cuts played a relatively more important role in Spain. Serrano proposes that the effect of the fiscal stimulus depends to a greater extent on its compatibility with monetary policy and multipliers associated with spending and taxes. Because the coefficients of these multipliers are not static, the combination of high indebtedness among families and the uncertainty associated with the shock of the crisis meant that tax cuts were not channeled into consumption, nor did they help aggregate income grow. Rather, they led to a substantial increase in savings (see Figure 6) aiming to prevent future economic catastrophes and reduce private sector leverage. This combination greatly limited fiscal efforts in keeping with SGP limits, and the effects of the fiscal stimulus were minimal.

On the other hand, Ferreiro et al. (2013) focused on the issue of coordinating Spanish governmental fiscal policy and European Central Bank policies, the pro-cyclical slant of fiscal policy before the crisis and the size of the public sector of the Spanish economy, as well as its role as an automatic stabilizer. This author also wrote that the Spanish public sector was too small, with respect to other economies in the Eurozone and the European Union, to really stabilize the economy after the shock of the financial crisis. This work shows a positive relationship between public sector size and economic stabilization. In that sense, a small public sector would further decrease income levels and hurt the fiscal balance.

Finally, the lack of coordination between ECB and Spanish governmental economic policy: this issue limited the effects of the fiscal policy implemented. Briefly, the fiscal position of the government was balanced and sustainable during the cycle of macroeconomic fluctuations, but it was not until the outbreak of the crisis that prior economic policy errors made by the Spanish government, the effects of automatic stabilizers, aid to the financial system and the lack of coordination with ECB monetary policy that the fiscal position of the government became, according to the SGP, unsustainable.



CONCLUSIONS

The economic crisis that began in 2007 and has led the Spanish economy to record high unemployment above 25% has made clear that the macroeconomic imbalances that began to appear in the third phase of the EMU were unsustainable. With that said, adopting the single currency reduced costs associated with the exchange rate and encouraged trade relationships between EMU member countries in a common institutional framework that bolstered growth expectations for economies in Southern Europe – as a result of so-called catching up – and was an incentive for strong capital flows towards convergence economies. On the one hand, this exerted pressure on demand for prices and wages and, on the other, significantly reduced nominal interest rates, to the point that there were even negative real interest rates. Moreover, Spanish growth in the years following the adoption of the euro was linked to indebtedness strongly associated with the real-estate market boom. Moreover, during the boom of the last decade, the fiscal position of the government was strong, as it not only had a fiscal surplus for many years, but it also had a substantially low debt to GDP ratio, one of the lowest in the European Union. The shock of the international financial crisis, coupled with private indebtedness, the insolvency of the Spanish banking system and lack of coordination between governmental fiscal policy and ECB policy, has led to a profound Spanish economic recession with unemployment hovering around 26% and poor economic growth prospects.

The crisis made clear that the macroeconomic imbalances that developed in the Spanish economy were unsustainable. However, the policies implemented, both in Spain and in Europe, do not appear to attack the structural problems underlying these imbalances. On the one hand, to emerge from economic stagnation and reduce its high unemployment rate, Spain must turn away from the panacea of austerity and implement measures to drive demand. In this sense, the fairly low competitiveness of Spain as compared to Europe could be addressed by increasing nominal wages in nucleus countries. Moreover, this would drive the demand for exports from convergence countries. The arrival of a coalition government in Germany, which includes the Social Democratic Party, would appear to be a change, as they have announced that a minimum wage will be implemented. On the other hand, Spanish economic growth must rely on sources besides the real-estate market. Spain must diversify growth through targeted stimulus policies oriented towards specific sectors and industries. Finally, all of this will also require a labor policy scheme that incentivizes productivity, which will require a relative decrease in precarious temporary employment and a shift towards greater labor stability.



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* Universidad del País Vasco, Spain. carlosalberto.carrasco@ehu.es

1 Convergence countries, Southern European countries or European peripheral countries are all terms used in the economic literature to describe countries that are relatively less developed in the EMU (Greece, Ireland, Italy, Portugal and Spain). Countries such as Germany, Finland and Holland are known as the nucleus of the union.

2 The EMU was to be constituted in three phases. The first began in July 1990 with the liberalization of capital transactions, greater cooperation between central banks and free use of the European Currency Unit (ECU). The second phase (1994) provided for the creation of the European Monetary Institute, sought greater autonomy for central banks and heightened monetary policy coordination. During the third stage (1999), countries began to share the euro, and therefore common monetary policy.

3 For reasons of space and the goals of this work, we will not analyze competitiveness using nominal unit labor costs. However, there has been criticism of this relationship. For example, Felipe and Utsar (2011) indicate that there is no relationship between growing unit labor costs and the product. Moreover, constructing unit labor costs with aggregate data can lead to errors. In addition, the basket of goods exported varies widely among European countries, which makes it difficult to compare how unit labor costs have evolved. The work by Felipe and Utsar concludes that reducing nominal salaries would not resolve the competitiveness issues faced by some members of the Eurozone. This perspective, together with the fact that the qualitative features of the products should be taken into account, is worthy of further discussion. We would like to thank an anonymous evaluator for this enriching comment.

4 Data on public aid provided to recapitalize the banking system should be read with care. In a publication dated September 2, 2013 on aid for the Spanish financial system, the Banco de España divulged that this information is heterogeneous, disperse and does not include a series of items for which it was allocated, which makes it difficult to use in international comparisons.

5 The real amount of items contingent on the debt of public administrations cannot be precisely known until these schemes mature.

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