While the German government and German economists do not even dare seriously thinking about economic stimulus packages (with some rare exceptions – see Ulrich Fritsche’s post), some other European countries are moving quickly ahead.
In most crisis scenarios for European countries with real estate bubbles to burst such as Spain or the Baltics, economists now argue that the downturn will not be overly sharp as these country’s governments have ample room to manouvre. In plain English: These economists expect governments to cut taxes or increase expenditure to soften the fallout from the real estate crisis.
In Spain, the question of economic stimulus has even become a major issue in the campaign prior to the upcoming elections on March 9. Even though the economy grew by a still robust 0.8 percent quarter-on-quarter in Q4 of 2007 and thus twice as fast as the euro area as a whole, Spaniards already feel like being in a recession. Since the summer, unemployment has increased by half a percentage points, retail sales and industrial production run below the level from one year ago. There is ample evidence that real estate prices are already falling. Moreover, inflation has increased to more than 4 percent, annilihiating wage increases. If newspapers write about the current economic situation, they write about “la crisis”.
The conservative opposition is trying to use the situation to gain votes in the upcoming election. They promise tax cuts to stimulate the economy. Income tax is supposed to be scrapped for those earning less than 16,000 € annually. In addition, they want to cut the top marginal income tax rate from 43 to 40 percent.
The socialists in contrast propose a combination of public works programs and tax cuts. Premier minister José Luis Zapatero underlines that with a budget surplus of about 2 percent of GDP, the government has the ammunition to spend itself out of trouble.
So, no matter who is going to win the election, Spain is set to get its stimulus package.
Unfortunately, a stimulus package in Spain risks just to cover up the country’s economic problems without solving them, pretty much as co-blogger Christoph Rosenberg has argued for the Baltic countries in his post.
Unit labour costs in Spain have systematically increased faster than in the rest of EMU. Because of this loss in competitiveness, the current account deficit has reached a whopping 10 percent of GDP (compared to a current account deficit of about 6 percent for the US which often is deemed to be “unsustainable”).
Different from the US, however, Spain cannot correct an overvaluation and its external imbalance by a mere correction of its nominal exchange rate. As the exchange rate is fixed within EMU, the only way out is undercutting the rest of the union by a sub-average unit labour cost growth. All historic evidence with the adjustment in other countries and the Spanish labour market point toward the conclusion that this will only happen if unemployment increases substantially. Exactly this, however, will be prevented by a stimulus package in Spain.
To run an expansionary fiscal policy in Spain today will just push the day of reckoning into the future. Given the exorbitant debt level of the Spanish business and household sector, there is little hope that the economy will by itself start to grow vigorously anytime soon. Even with a budget surplus of 2 percent of GDP, the government does not have the money to get itself out of this problem.
This situation contrasts with that of Germany: The German economy is still gaining competitiveness and its current account surplus is set to widen even from the record 160 bn € (or more than 5 percent) reached in 2007. The German economy has never been as competitive as today.
In addition, the preconditions for a turnaround in consumption are there: Unemployment has fallen strongly, real wages are at least slowly increasing again. What is missing is some impulse which gets consumption growing agian.
Exactly this impulse could be provided by some expansionary fiscal policy now, i.e. by a tax cut.
Such a program from Berlin would have the additional advantage that it could help the Spaniards to regain their competitiveness as it would lead to some faster increase of German wages. This in turn might help prevent Spain following Portugal into what is now called the “Portuguese trap”. In the small country, real per-capita-GDP relative to EMU has been falling for years and unemployment has risen sharply since the beginning of the decade – all without yet making a big dent into the country’s wide current account deficit.
This post has been co-posted at Eurozone Watch.