Quotes of the Day
The Polos are a typical Spanish family — unfortunately for them and for the European economy. Jesús, 59, has worked as an accountant at an electrical-parts supplier for 20 years. His job is protected by the extensive rights awarded to the Spanish permanent employee. By his estimate, his employer would have to shell out as much as $120,000 in mandated severance payments to lay him off, a prohibitive expense that likely gives him a job for life. Jesús' daughter María, on the other hand, has a less happy situation. María, 28, once held a regular job in Madrid as a hotel receptionist but gave it up to pursue a career as a flight attendant. When that didn't work out, she returned to the hotel industry — but not to her old job. For the past 18 months, María has floated from temporary contract to temporary contract, some of which have lasted as few as six days. When each one expires, she can be sent off with next to nothing.
And that's the point. Though she usually works a full week for the same hotel chain, María says her employer has told her outright that it would be too costly to offer her a contract similar to her father's. "You live day to day. You always think that you're going to get fired," María says. "I feel unstable because my daughter is unstable," Jesús says. "The young people will replace us as builders of the economy, but right now they are always scared. And when they are 40, they'll feel the same."
The travails of families like the Polos are symbolic of Spain's broken economy. Much of the recent investor concern about the nation has focused on its hefty debt and yawning fiscal deficit — and the potential drag on an already anemic recovery that might be caused if they were reduced. The International Monetary Fund (IMF) forecasts that Spain's economy will contract again this year, by 0.4%, after a steep 3.6% drop in 2009. But those woes are merely symptoms of much deeper, potentially even more intractable problems at the very core of the Spanish economy: a distorted labor market, weak competitiveness and high costs. In a gloomy assessment of the Spanish economy issued in May, the IMF warned that the country required "far-reaching and comprehensive reforms" if it was to avoid stagnation and persistent unemployment, which at 20% is the highest among industrialized economies. "Time is of the essence," the IMF insisted.
The same can be said of pretty much the entire European Union. As the global economy slowly emerges from the Great Recession, Europe appears more and more to be its biggest headache. Not only is the region lagging in the global rebound — the IMF predicts growth in the euro zone to reach only 1% in 2010, compared with 3.1% in the U.S. — it is also facing daunting long-term challenges. The promise of a strong, confident Europe, united by a common market and a single currency, the euro, has been stymied by political divisions, income gaps and continued economic rivalries. Europe's leaders have serious concerns about their ability to provide good jobs for the region's children and care for its growing population of elderly. As the emerging nations of Asia become industrial titans, Europe's high-cost economies need to adapt if they are to grow. Whether or not Europe can resolve these problems matters to everyone, whether they live in Europe or not. With the largest collection of rich consumers in the world, Europe is vital to the prospects of every company from Detroit to Dalian, China.
To reverse its current course, Europe needs to change. The crisis in Europe may have been sparked by fears that tiny Greece might default on its mountain of debt, but solving it will take much more than the proposed bailout of the Hellenic state. Like Spain, the entire euro zone requires fundamental reform. A decade ago, Europe's leaders signed on to the Lisbon Process, aimed at making Europe the most competitive region in the world, and in 2009, after years of haggling, the E.U.'s members finalized a treaty that was supposed to strengthen the union's cohesion. Neither goal has been achieved. A May report by the E.U.'s Reflection Group, an advisory panel, recommended bolstering E.U.-wide economic-policy coordination, improving education, encouraging greater mobility of workers, boosting investment in research and development and a host of other reforms — the same endless list that has been recommended many times before. "Europe is currently at a turning point in its history," the group said. "If Europe does not want to be among the losers, it needs to look outwards and embark on an ambitious long-term reform program for the next 20 years." At stake, says Jesús Banegas Núñez, vice president of the Spanish Confederation of Employers' Organizations (CEOE) in Madrid, is the entire European economic system itself. Without reform, "Europe will not be able to maintain its welfare state," he warns.
Investors are far from convinced Europe can pull itself together. Many remain doubtful that Greece and possibly other euro-zone members — especially Portugal, Ireland, Italy and Spain, which with Greece make up the so-called PIIGS — can undertake the drastic fiscal adjustments necessary to avoid defaults or debt restructurings. Besides, in a classic conundrum, the austerity measures already being imposed in many countries to narrow deficits could further suppress growth and reduce employment. The euro has taken a pounding, losing 18% of its value against the dollar since a recent high in November. Many financial analysts believe the euro may continue its descent, perhaps to parity with the dollar, which would represent a further depreciation of nearly 20%.
Pain in Spain
To understand what ails modern Europe, look at the pain in Spain. The turmoil caused by the debt crisis in Greece would appear a mere tremor in comparison with the damage done to the global economy by a similar meltdown in Spain, the world's ninth largest economy. To some, such fears are overblown. Spain has traditionally been one of the euro zone's more financially responsible countries. According to the Organization for Economic Cooperation and Development, Spain's ratio of government debt to GDP, a main measure of a state's debt burden, was only 63% in 2009, positively modest compared with Greece, at nearly 120%, and Portugal at 87%. Research firm High Frequency Economics declared in a recent report that "reason suggests that funding [Spain's] deficit should be no problem, and that there should not be a crisis."
But Spain is still vulnerable. Its fiscal position deteriorated with alarming speed amid the crisis, and the government deficit jumped to more than 11% of GDP in 2009. Add in private indebtedness and total debt rises to 232% of GDP — higher than Greece's, according to Standard & Poor's. In the past decade, Spain experienced a housing bubble perhaps even more destructive than the one in the U.S. as builders and lenders got caught up in a speculative dance. As many as 800,000 homes remain unsold from the boom years, and the banks are still digging themselves out from the losses.
The nervousness in financial markets is pushing Spain to speed up reform. In late May, parliament passed a slate of measures aimed at a rapid reduction of the fiscal deficit, including cuts in civil-servant pay, state investment and welfare programs. The government intends to bring down the budget deficit to 3% of GDP in 2013. José Manuel Campa Fernández, Secretary of State for Economic Affairs at Spain's Ministry of Economy and Finance, says the government felt the need to show investors it was committed to fixing its finances. The market turmoil "certainly led us to put these measures in place faster than we had originally planned," he says. "Economics is not about fairness."
The Great Divide
Budget cutting is only the beginning of what Spain needs to do and probably not the most important thing. Spain has lagged in making the tough internal reforms it needs to ensure its companies can compete with those in the rest of Europe and the world. That failure has prevented the economy from becoming more productive and creative in ways that would help it match the advanced manufacturing capabilities of Germany and stay ahead of low-wage China.
Spain isn't the only euro-zone nation facing this predicament. One of the major sources of instability within the monetary union is that it has obscured huge differences in the competitiveness of European economies. A recent study by the World Economic Forum (WEF) ranked E.U. nations by their level of competitiveness, looking at everything from quality of education to Internet-penetration rates. It discovered that some members, including Germany and the Netherlands, were more competitive than the U.S., while others, such as Spain, Portugal and Italy, languished behind.
The single currency has facilitated these disparities by allowing the weaker economies, like Greece, to put off reform. Membership in the euro zone — on the same terms as titans like Germany — enabled them to raise debt at lower interest rates than they would have gotten on their own. But there are huge differences between euro-zone economies, and these have shown up in persistent economic imbalances. While Germany runs a giant current-account surplus, other nations, like Spain, post deficits. With so many poor performers in the monetary union, the euro's value and the overall growth of Europe could suffer. "The truth is coming out," says Jennifer Blanke, a senior economist at the WEF in Geneva. "Being a member of the euro zone isn't related to competitiveness. At the end of the day, they need all of the economies making stuff that other countries want to buy."
Getting to that point will require reform throughout the euro zone. The focus so far has mainly been on fixing the PIIGS, but to solve the euro zone's problems, countries in much stronger positions must chip in — and not just with bailout funds. Europe needs even greater integration, which would allow its companies to take advantage of a true single market. For example, the E.U. has tried for years to pry open national gas and power markets to more unionwide competition, which could reduce energy prices for companies, but has faced resistance from member states with large, dominant utilities. In a March report, the European Commission, the executive body of the E.U., called on countries with surpluses, like Germany, to stimulate domestic demand. In doing so, they would import more from their euro-zone neighbors and aid growth in weaker economies, like Spain's. "Divergence of current accounts and competitiveness are a source of potential concern," the commission said. For balanced growth, "the structural weaknesses of domestic demand need to be identified and tackled."
Facing these E.U.-wide problems, the idea of more coordinated policymaking is gaining acceptance. Since the inception of the monetary union in 1999, critics have contended that it needed a matching set of political institutions so that real economies could be coordinated. Without that discipline, it was feared, some nations' profligate ways would endanger the whole European economy — which is just what has happened. But European leaders have been wary of turning over too much sovereignty to the intergovernmental institutions of the E.U. In the wake of the Greek debt crisis, there is renewed talk of forming an "economic government" that would coordinate the national budgets of euro-zone members. That, believes Javier Díaz-Giménez, an economist at IESE Business School in Madrid, is crucial for the survival of the monetary union. "You can't have a single currency without fiscal-policy coordination," he says. "If we don't do this, we won't have a euro."
But it is unclear how far European leaders are willing to go. Germany, for example, has brushed off pressure to reduce its current-account surplus. The German leadership sees its strong economy as the result of years of hard reform and frugality and hasn't been willing to sacrifice its position to help euro-zone neighbors that the public perceives as irresponsible. German Finance Minister Wolfgang Schäuble recently dismissed criticism of its surplus as tantamount to "praise" for German industrial prowess. Meanwhile, the E.U. governing bodies lack the sticks required to keep members in line. The E.U. "needs to go after the countries that don't reform," says the WEF's Blanke. But "they might not have the political oomph to do that." Thus troubled countries like Spain may be left to solve their own problems. Investors "want to see the basics for sustainable growth in the future," says Campa of Spain's Economy Ministry. "They would like to see some structural reforms that lead in that direction."
Laboring over Labor
The response to the crisis in Europe so far has focused on cutting budget deficits, but no single reform might be more important than fixing the distorted labor market. In Spain, the strict laws have increased the costs of hiring to the point where companies are reluctant to take on new staff in permanent positions, thus perpetuating joblessness. That's why employers like María Polo's hire on short-term contracts. Not only has that left about a third of the salaried workforce with little job security and few benefits, it also weakens Spain's corporate sector. With almost no hope of receiving permanent positions — a mere 5% of those on temporary contracts are "promoted" into regular jobs — there is little incentive for the employee or employer to invest in job training. That inhibits the development of new, high-tech industries. The laws have created something of a generational conflict, with older workers in jobs for life while youngsters, as new entrants to the workforce, exist as a giant underclass of underpaid, poorly trained peons. "It's a very divisive system," says Juan José Dolado, a labor economist at Carlos III University of Madrid. "It's parents against kids, men against women." If the labor market isn't fixed, "we are looking at a big crisis, a road to destruction," he says.
Patricio Rodríguez Carmona couldn't agree more. The 40-year-old entrepreneur is founder of the Tie Gallery, a retailer of ties, cuff links and other accessories. Amid Spain's crushing recession, Rodríguez was forced to close six of his 10 outlets over the past two years, laying off 12 full-time employees, which cost him $90,000 in severance payments. After that experience, Rodríguez says he's reluctant to open new shops or hire more workers until he's certain the recovery is irreversible. "It's too expensive to invest in people," he says. "That doesn't make any sense." The labor laws, Rodríguez complains, are representative of a highly regulated business environment that creates endless hurdles for small businessmen like himself. Getting a government license to open a new retail store, he says, can take as long as two years. He also has to contend with conflicting layers of regulation between the city, regional and national governments. "It is very difficult to be an entrepreneur in this country," Rodríguez says. "If we don't change that, we will always be behind our partners in Europe. It will be difficult for us to be competitive."
With pressure mounting, the government decided to act. In June, Prime Minister José Luis Rodríguez Zapatero approved a slate of labor reforms aimed at encouraging companies to hire, including a reduction in severance payments for most newly hired employees and restrictions on the use of temporary contracts. Critics attacked the plan from all sides. Employers lamented that the reforms don't go far enough, while union leaders called a general strike for September to protest them. "This decree is very negative," says Javier Doz Orrit, international secretary at Comisiones Obreras, the country's biggest union. "It is based on a false assumption, that in order to reactivate the economy, labor reform has to be done."
Zapatero, however, will face only more such politically dangerous decisions. Spain finds itself in the most difficult of positions — pressured to reform in order to start growing again but lacking the very growth that will help the economy adjust to reform. "We have a problem that requires time to be solved, but we're not being given time," says José Manuel Entrecanales Domecq, CEO of infrastructure and energy giant Acciona in Madrid. "We don't have growth as a medicine. We are treating this patient with shock treatment, and the patient is pretty sick. That's what worries me the most." Yet if Spain fails in its reforms, it could face a protracted period of stagnation, with low growth and sustained high unemployment. "The weight of responsibility on the government is enormous," says the CEOE's Banegas. "I cannot accept that we are not able to do the things we need to do." He'd better be right.
— With reporting by Cristina Mateo-Yanguas / Madrid
- Michael Schuman / Madrid
- Fixing Europe's economic problems will require difficult choices and painful change. But is it too late to avoid failure?