International Economics - Elcano Royal Institute empty_context Copyright (c), 2002-2018 Fundación Real Instituto Elcano Lotus Web Content Management <![CDATA[ Living with COVID-19: The thinking behind Spain’s lockdown exit plan ]]> 2020-06-02T12:38:00Z

Spain’s lockdown exit plan is based on four pillars: (1) proper data and healthcare capacities; (2) geographical asymmetry; (3) a two-way street with different speeds; and (4) subsidiarity and co-responsibility.

As COVID-19 started to hit the country hard, on 14 March 2020 the Spanish government declared a state of alarm (Article 116 of the Constitution contemplates three states of response to crises: alarm, emergency and siege, in ascending order) and confined its population . Residents were obliged to stay at home unless they needed to go to a hospital, a supermarket, a pharmacy or work in essential economic sectors. Schools were closed and online work was encouraged in all business activities, while the retail and hospitality sectors were completely closed down and, for the first time ever (something that had not even occurred during the Civil War), bars were shut. Tourism had gone; dystopia was upon us.

Some days later I received a call from the Spanish government and was asked to join a small group whose task would be to design a lockdown exit route. Those were difficult days: on 15 March the death toll was for the first time above 100 per day (in fact, 152), on 24 March the country recorded 500 deaths (at 514) and on 2 April the rate reached a high of 950 deaths. The headlines in the newspapers were frightening: Spain was losing 1,000 people a day; it felt like wartime.

By then our work, carried out in confidentiality and away from the media spotlight, was well under way. Naturally, the team was multidisciplinary , including not only epidemiologists, microbiologists and virologists, but also experts in infectious diseases and public health, and medical statisticians. In addition, there were economists, political scientists, sociologists, diplomats, philosophers, engineers and new technology and law experts. The complexity of the task was immense (it had never been done before), so counting on different perspectives was essential. My own task was to focus on anything related to international and comparative political economy.

Very soon one of the first political-economy questions to arise was precisely how to deal with the tension between the priority of the epidemiologists –to continue with the lockdown until the virus was under control– and that of the economists –to reignite the economy as soon as possible–. After intense debates we agreed that while these two realms could not be seen separately, since, indeed, they are strongly intertwined –the economy cannot function if the population is not healthy, and people cannot be healthy in the long run if the economy collapses–, the epidemiologists should have the primacy.

Where there was a strong consensus between the epidemiologists and the economists, however, was in agreeing that geographical asymmetry would be inevitable in lifting the lockdown.

The course of the epidemic was uneven in different parts of the country, so it made sense to have stricter lockdown and social-distancing measures in the areas that were hardest hit, while they should be started to be eased in those less affected, so that economic activity could resume earlier.

That is why, when the French President Emmanuel Macron announced on 13 April that France would start lifting its lockdown on 11 May, we received the news with scepticism. As one of the medics told us at a discussion, ‘those that speak about dates do not know much about viruses’. But the reality was that very quickly everyone became obsessed with dates. The business community was becoming particularly restless, noting that other countries were already putting dates to their exit strategies. The pressure on the Spanish government was mounting and we felt it.

What was our counter-proposal? First, we realised early on that there was no blueprint for a successful exit. China was the only empirical case that we could study. It had shown that dividing the country into geographical units to choke the spread of COVID-19 was effective. But its units were small (districts) and based on very intrusive ‘neighbourhood patrol teams’ that would be unacceptable in a democracy like Spain. The experiences of ‘testing, tracing and isolating’ in countries such as South Korea, Taiwan and Singapore were far more instructive.

Taking all of this into consideration, after four weeks of comparative studies and analysing the situation of the virus in Spain, and what was needed to combat it, and following numerous debates and meetings with members of the government, we finally came up with a plan based on four pillars: (1) proper data and healthcare capacities; (2) geographical asymmetry; (3) a two-way street with different speeds; and (4) subsidiarity and co-responsibility.

The first pillar is the most important. It hinges on generating the right data. For instance, about when the first symptoms appeared in each patient, his contacts, when he was hospitalised, how many beds were free in his hospital, the saturation level of the ICUs in his particular hospital on entering, and the date of discharge. We realised that the information was not complete and rapidly became aware that this was a problem in other European countries too, including Germany, which was coping with the crisis relatively better (I would like to use this opportunity to express my gratitude to our counterparts in similar task forces during those intense and dramatic weeks: many frustrations were shared and useful information was exchanged).

Hence, the first pillar is based on precisely this: the capacity to test, trace and isolate (potential) cases and to have the strategic healthcare infrastructure to deal with a possible new outbreak. In other words, the minimum number of beds and ICUs empty and ready to be used, but also enough resources and staff in primary care to detect and trace potential cases as soon as possible, and even the use of new technologies like apps, with a pilot project starting soon in the Canary Islands.

The second pillar is geographical asymmetry in lifting the lockdown. Here we agreed that the municipal level was too small. Many people live and work in different municipalities, hence closing them off would be too disruptive. Spain’s Autonomous Communities (regions), on the other hand, were too big. Imagine, for instance, that Almería were to have very few cases and Sevilla many. Why would Almería need to wait to open up until Sevilla improved? So we opted for the province, which is an administrative layer in between the region and the municipality (NUTS3 in the European Commission regional map, see Figure 1) and roughly coincides with the functional urban areas (cities and commuting zones, as identified by Eurostat, see Figures 2 and 3 below), covering 70% of Spain’s population.

Figure 1. NUTS 3 regions in the EU
Figure 1. NUTS 3 regions in the EU


Figure 2. Functional urban areas in Spain
Figure 2. Functional urban areas in Spain


Figure 3. Functional urban areas in Europe
Figure 3. Functional urban areas in Europe

The Spanish Government has broadly applied this scheme, although certain regions have opted for sanitary areas, instead of provinces, to accommodate the diverse geographical idiosyncrasies such as the difference between urban and rural areas, where population density is lower and therefore restrictions can be milder (see Figure 3).

This leads to the third pillar. The lifting of the lockdown has been divided into four phases: one preparation phase and three exit phases. Phase 1 started for half of the country on 11 May, and two weeks later (25 May) this half moved to phase 2, while the rest of the country moved to phase 1 (see Figures 4 and 5 below). Every phase has different restrictions. For example, in the preparation phase, bars and restaurants were closed and there were to be no social gatherings. In phase 1, however, bars can admit customers if they have outside tables, and there can be social gatherings of up to 10 people, while retail shops can open 400 square metres of commercial space. In phase 2 bars and restaurants can open their indoor facilities, social gatherings can rise to 15 people, retail shops have no space restrictions and theatres and cinemas start operating with limited admissions and subject to social distancing.

Of course, this gradual and asymmetric approach has been politically controversial. Every province and every region want to move to the next phase as soon as possible, but it was important to assimilate the notion that the generation of capacities is fundamental and that we need to learn to live with the virus gradually and with precautions. The Region of Valencia first complained that it could not pass from the preparation phase to phase 1 on 11 May and later, after seeing a spike in new cases, it decided to wait to move on to phase 2 for another week in order to have the situation better under control, only progressing to that stage on 1 June (see Figures 4, 5 and 6 below to see the gradual change in the map). Indeed, the plan is designed to move forward, but if the virus again gains strength, certain geographical units might need to move backwards to a previous phase. This is a two-way street, with, it is hoped, most traffic moving forwards, although setbacks may occur and U-turns might be necessary.

Figure 4. Spain’s transition to the new normal: geographical asymmetry in exiting lockdown, as of 11/V/2020
Figure 4. Spain’s transition to the new normal: geographical asymmetry in exiting lockdown, as of 11/V/2020


Figure 5. Spain’s transition to the new normal: geographical asymmetry in exiting lockdown, as of 25/V/2020
Figure 5. Spain’s transition to the new normal: geographical asymmetry in exiting lockdown, as of 25/V/2020


Figure 6. Spain’s transition to the new normal: geographical asymmetry in exiting lockdown, as of 1/VI/2020
Figure 6. Spain’s transition to the new normal: geographical asymmetry in exiting lockdown, as of 1/VI/2020

For all of this to work, however, it is necessary to count on the cooperation of regional and local administrations. The subsidiarity principle is a key factor. For instance, it is not the job of the central government to decide how social distancing should be applied in the country’s 3,000 beaches, since that is the task of local municipalities. The police cannot check whether the maximum number of people (and the two-metre social distancing) is respected in social gatherings at home. That is the responsibility of each citizen. Co-governance and civil discipline are therefore indispensable.

At present, moving between provinces or sanitary areas (in the regions that have applied such a division) is banned. In principle this should last until phase 3 is completed and Spain enters a ‘new normal’. But if the minority government is unable to renew the state of alarm (requiring Spanish parliamentary approval every two weeks) there should be other co-governance and co-responsibility schemes agreed upon by the regions and the central government to maintain the plan’s (sound) logic.

In terms of dates, the initial idea was to move from phase to phase every two weeks, a reasonable time frame to assess the course of the pandemic. This would mean that the geographical units that moved to phase 2 on 25 May would be in the green zone (the new normal) by 22 June and places like Madrid and Barcelona, which have a two-week lag, would be there only on 6 July. But the government has already announced that it wants to open up the country to European tourism on 1 July, so it is likely that opening up might accelerate if the epidemiological situation continues to improve (see Figure 7 below).

Figure 7. Daily number of COVID-19-related deaths in Spain, February to May 2020
Source: Spanish government / RTVE.

Nonetheless, as mentioned above, although the speed might be accelerated because the economic pressure to open up is beginning to be huge, it would be good to keep the plan’s basic framework in mind, even if only in the background, because there may be a few bumps on the road to achieving a treatment, vaccine or herd immunity, and we might have to slow down, stop or even turn back temporarily. Of course, if most people respect social distancing (the widespread use of masks in Spain is encouraging) that is less likely. One can design the best plan, but if people fail to adjust to it, effectiveness will be undermined.

This also means that the plan needs to be flexible. The central government needs to listen to regional and local authorities and to key social actors in business and civil society in order to improve the plan. In this respect, some recent rectifications and improvements are also encouraging. We are in uncharted waters and, as Paul Collier has pointed out , experimentation, trial and error, and best-practices are the best way to fight COVID-19. And this is applicable to both Spain and the rest of Europe. Exit strategies have been different in each EU country and that is not bad per se (it might even be positive, since we can learn from each other) but now is also the time to think how we can cooperate to make them compatible so as to re-start social mobility in the EU in the safest possible way.

Miguel Otero-Iglesias
Senior Analyst at the Elcano Royal Institute, and Professor at the IE School of Global and Public Affairs | @miotei

<![CDATA[ A coordinated, unlimited and flexible insurance policy to respond to the pandemic ]]> 2020-04-08T10:05:28Z

The COVID-19 pandemic requires a coordinated global response. This analysis highlights some of the main components.

Original version in Spanish: Un seguro coordinado, ilimitado y flexible: la respuesta de la política económica a la pandemia.


The COVID-19 pandemic requires a coordinated global response. This analysis highlights some of the main components.


The COVID-19 global pandemic has the potential to trigger a systemic economic crisis. A coordinated and rapid International (and European) response is essential. This analysis details the economic policy objectives that should form part of the response and its toolkit in the areas of monetary, fiscal and trade policy. Governments must be on the front line of this economic battle, working in close alignment with the steps taken by the health system to fight the pandemic, providing a coordinated, unlimited and flexible insurance policy to minimise the economic impact.


It is already clear that the COVID-19 pandemic will cause irreparable damage in terms of human life. However, the situation has deteriorated into a systemic global economic and financial crisis. We face an unprecedented situation: fear and uncertainty have interrupted the normal functioning of the system to such an extent that the failure to take measures to provide a coordinated response to the initial shocks to businesses, households and financial entities will see the economic costs multiply. While comparisons with events over a decade ago are unavoidable, the current threat is of a different nature. This time, things have happened much faster, making the economic policy response much more urgent. Theoretically, we have the advantage of the experience of an even more serious situation and the relative success of a coordinated global response at the time. Following months of delays and mistakes, the measures adopted at the G20 summit on 2 April 2009 prevented a depression from occurring. This time, however, there is no room for errors like those that transformed the Greek debt crisis in 2010 into a protracted episode of self-inflicted instability that, at its height, threatened the survival of European monetary union.

(1) Objectives, the G20 and the European dimension

The bitter experience of the global financial crisis has shown that in a systemic situation, the objective of economic policy must be to provide a credible insurance policy against uncertainty. The origin of the shock we are facing today is of a highly different nature and is accompanied by its own dose of uncertainty (how the pandemic will evolve in each country, the behaviour of the virus in terms of reinfection, lethality and the time taken to find an effective therapy or vaccine). After paralysing the Chinese economy (16% of global GDP at market exchange rates) for over a month (with falls of 13.5% in industrial production and 20.5% in retail sales in January-February), the spread of the epidemic and the measures needed to bring it under control are creating a series of successive macroeconomic shocks in the main developed economies and the rest of the world. However, what makes the pandemic a systemic crisis is its generation of two associated negative shocks.

The first has been the panic in the financial markets. Since the end of February, the price of financial risk assets has plummeted, accompanied by a spike in volatility and the symptoms of a dislocation of the private and even public debt markets (the US Treasury bond market has shown signs of a shortage of liquidity that point to major upheaval). From their recent highs, stocks have entered a bear market, falling by over 20% in record time. In a situation where many market segments were characterised by aggressive valuations with respect to their fundamentals, the problem is not the adjustments in prices. The concern is that we have abruptly entered a regime marked by illiquidity, risk aversion and radical uncertainty. The signs of a squeeze in the private debt markets are particularly worrying. It is not merely a matter of widening credit spreads (which remain lower than during the global financial crisis) but of the return to the loss of access to finance by borrowers with the highest level of debt and the sectors most exposed to the economic fallout of the epidemic (tourism, air transport and oil).

With their regional peculiarities, depending on the weight of financing from the market or banking system, the credit markets are the main mechanism for the transmission of financial panic into real economic costs, measured by falls in industrial production or GDP. Bernanke (2018) provides an empirical dissection of the main financial factors that depressed the economy during 2007-09. He concludes that the two key factors were stress in the short-term funding markets (interbank, monetary) and difficulties accessing new financing in the credit markets (measured by spreads in segments such as securitised or high-yield bonds).

The second negative shock from the pandemic is the fear gripping businesses and households. Despite echoes of the crisis 10 years ago, this situation is unprecedented in Europe and the US. The instinctive response is to reduce spending on major consumer goods and investment, cancel any travel and avoid spending that implies being around other people. In many sectors, this sharp drop in demand will continue even after the restrictions on mobility are lifted.

Faced with this sudden and dangerous threat, economic policy must pursue the following objectives:

  • Support the effectiveness of the measures to flatten the epidemic curve.
  • Minimise the loss of income and jobs during the period for which economic activity is interrupted.
  • Stem the panic in financial markets, maintaining liquidity and the orderly functioning of credit markets.
  • Ensure confidence in the V-shaped recovery of the economy and the temporary nature of this disruption.

Inexplicably, despite the undeniably global nature of this threat, the G20 remains almost absent. The Saudi presidency convened a videoconference of G20 leaders, but the statement was full of platitudes and short on concrete commitments. The epidemic has spread very fast and is now hitting the whole world. Emerging economies are already suffering the consequences in terms of currency depreciations and capital flight. There would be a need for a carefully prepared summit to follow in the footsteps of the successful meeting in April 2009, which prevented the destructive spiral between the financial system and the real economy that threatened to plunge the world into a depression.

After years marked by a lack of tangible achievements, it is once again time for the G20 to provide a robust, coordinated and full response to a global health, economic and financial emergency. While each country must determine the measures it adopts depending on its needs, it is nonetheless possible to provide an outline of the programme to respond to COVID-19.

The eurozone once again faces a critical juncture, without having been able to fully heal the wounds of the 2010-12 crisis or build the full institutional framework required for optimal functioning. The fact that Italy and Spain are the two countries most affected by the epidemic increases the scale of the challenge for authorities in the area. This time, however, any errors or delays may prove much more costly. The survival of monetary union may once again be on the line.

The uncertainty at this moment is extremely high. We have some idea of the lethality of the virus and the epidemic curves in China and other Asian countries. However, it is not yet clear how these variables will play out in Italy, Spain, France, Germany and the US (and much less in other major economies like India and Brazil). Nor do we know the full extent of the negative impact on GDP for 2020 and how long it will affect the potential for growth. In principle, the shock is temporary in nature. However, its impact on production and employment will depend on the effectiveness of the measures adopted. Macroeconomic uncertainty is inseparable from financial uncertainty: if investors fear an intense and protracted recession (as reflected by interest rates for public debt), they will take flight from the stock markets and private debt. If banks face uncertainty accessing funding or the risk of lending to businesses and families, they will once again withdraw, tightening access to credit.

In short, the economic policy response must provide an insurance policy in the face of these uncertainties. If the policy is credible, the agents will reduce the probability of catastrophic outcomes and the market will continue to function (albeit with significant price adjustments). The policy must be coordinated to internalise all the externalities that the situation generates among countries. It must also be unlimited, because we do not know how long the phase to flatten the epidemic curve will last or how much it will cost. The idea of ‘whatever it takes’ exemplifies this unlimited character: it is not a matter of numbers, which will be as high as they need to be. Recall that Mario Draghi’s statement in 2012 was backed by an unlimited programme whose ultimate cost was zero because it was so credible in never had to be used. It must also be flexible, adapting to the institutional characteristics of individual countries (the strength of their automatic stabilisers, exposure to the hardest-hit sectors) and the evolution of the situation.

The following sections offer some guidelines on the measures that should form part of this economic policy programme, which, fortunately, are already being developed by the authorities in various countries affected by the pandemic.

(2) The short-term insurance policy for businesses and homes

Even before the number of cases in a country begins to rise, the pandemic already has a negative sectoral economic impact due to the fall in demand for services related to tourism, transport and public gatherings. When countries reach the steepest part of the curve and activate measures to limit movement and ensure social distancing, the economy suffers an abrupt paralysis, affecting both supply and demand.

GDP and employment will inevitably fall during this period but there are four types of measures that can ameliorate the contraction and must support the operation of automatic stabilisers:

  1. Paid leave. Workers who contract the virus or who are unable to continue working as a result of confinement measures or childcare must still be paid. The specific forms will depend on the starting point of individual countries but the State should cover part or all of the cost. In the US, where paid leave is not widespread, this measure has been one of the biggest innovations in the first relief bill to respond to the economic consequences of the virusThe faster and more generous its application, the easier it will be for social distancing to limit damage. Specific attention must be paid to small businesses and self-employed workers.
  2. Subsidies and flexibility for temporary adjustments to employment. Many businesses had recorded temporary losses even before falls in sales or the impossibility of maintaining output. To minimise the number of people losing their jobs as a result of this situation, the State should subsidise and ensure the flexibility of temporary mechanisms to reduce working hours or allow part of the workforce to stay at home. A good example is the Kurzarbeit scheme in Germany to facilitate the temporary reduction of employment without job losses. The measures announced on Friday 13 March reduce the requirements for companies to make use of this option and extend it to temporary workers.
  3. Temporary relief from tax obligations and social security. Many countries, including Spain, have already announced measures to allow the deferral of tax payments for SMEs and self-employed workers. Social security payments can also be temporarily reduced to incentivise companies to retain staff. These measures were used in 2009 and aim to provide businesses with temporary liquidity. However, given that those who are most affected will not generate income for a period of time, they must be combined with other measures to provide access to liquidity.
  4. Finance for businesses. Many businesses and self-employed workers will face a period of limited activity and suppressed revenue, which could threaten those without sufficient financial resources. To avoid the destruction of the fabric of production, it will be necessary to adopt a series of measures that will make it possible to ensure continued financing flows for businesses. On the one hand, this will involve channelling funds to banks to allow them to provide these loans and avoid excessive tightening of credit conditions from increased risk. The Bank of England and European Central Bank (ECB) have already done this with their liquidity programmes linked to new credit. On the other hand, the existing programmes of public financial entities must be scaled up and complemented with guarantee programmes in which the State assumes credit risk and liability for losses. This measure has already been announced by the German government on 13 March, with the unlimited provision of liquidity for SMEs. In Europe, the European Investment Bank (EIB) is moving forward to complement these measures by providing financing and above all by taking on risk through the European Investment Fund.

The design and application of these measures must seek to ensure the active involvement of companies, trade unions and banks. This catastrophe requires us all to participate in the search for formulas adapted to the needs of individual countries and sectors to prevent the inevitable economic damage multiplying. Depending on how long the shutdown continues, it may also be necessary to extend these measures with extraordinary steps to support specific sectors and businesses (the European Commission has already announced flexibility in the application of its State aid rules).

(3) Stabilising the financial system

Central banks have already provided a robust response to the growing signs of dislocation. However, the response needs to be sustained, cutting off any sign of escalation that can amplify the economic costs of the pandemic at the root. Despite the spectacular losses in the stock markets, the success of measures depends on keeping them focused on liquidity and the credit markets.

The measures taken by the ECB (immediate general liquidity through long-term operations, incentivised and broader liquidity to provide credit for planned long-term operations and an €870 billion increase in the asset purchase programme until the end of the year) will provide the banking system with security and reinforcement to prevent a disorderly increase in credit spreads that could jeopardise both businesses and the fiscal response capacity of the countries affected by the pandemic. In the banking sector, there is also a willingness to use macroprudential measures to temporarily reduce capital requirements and prevent them from becoming a barrier to the availability of credit. In terms of the debt markets, the ECB can make temporary adjustments to the distribution of purchases from individual countries if the circumstances of the markets require. As its chief economist Philip Lane has remarked, the ECB must increase its presence in the debt market during this period of volatility. To do so unhindered, it has already relaxed some of the current limits on purchases, especially for sovereign debt.

The Federal Reserve has cut rates to zero, reactivated its quantitative easing programme through asset purchases and has taken various steps to maintain liquidity, for both the domestic market and dollar funding outside the US, through coordinated action with other central banks.

Banks are better prepared than they were 10 years ago in terms of capital and liquidity. However, at least in Europe, the profitability of their business model is low and there is scarce room to absorb a negative shock in terms of credit risk while maintaining services for businesses and families. Following the sharp drop in the share prices of many banks and their increased credit spread risk, the authorities must pay careful attention and be ready to intervene over the coming weeks and months if there are signs of faltering confidence in the banking system. The extensive experience of the previous crisis will support the swift adoption of the appropriate measures, including capital injections, which should be centralised for the eurozone.

Ensuring financial stability will also require the financial safety net to be strengthened to ensure emerging economies are not dragged down by aversion to risk and the depreciation of their currencies. There are already signs of capital flight and economies with high volumes of dollar-denominated debt may experience a tightening of financial conditions that could exacerbate macroeconomic weakness. The G20 should adopt similar measures to those that helped stem the spread of the systemic crisis from developed countries to developing economies in April 2009. These include issuing and allocating Special Drawing Rights (the virtual currency of the IMF) to States to strengthen foreign exchange liquidity and increase the financing capacity of the IMF, the World Bank and other regional development banks.

(4) The insurance policy against macroeconomic uncertainty and rolling back the trade war

The pandemic struck just when the global economy was starting to recover from the trade war, which meant growth in 2019 was the slowest it had been since the financial crisis. The structural supply surplus once again became clear, together with the difficulty of sustaining growth in aggregate demand at the pace required to maintain full employment. Beyond the fiscal and financial measures of the immediate response, the G20 and the eurozone should commit to boosting aggregate demand in 2020 and 2021. Otherwise, the hysteresis of permanent losses, manifest in unemployment and lower investment, will act as a drag on growth for various quarters, perhaps even years.

A credible programme is required to convince businesses, families and the financial system that this is a temporary crisis from which we will emerge strong, investing, consuming and creating jobs. All G20 economies will need to choose the best combination of macroeconomic policies to coordinate this programme to reactivate the economy, which must include shock measures for the most affected sectors. In many emerging countries, there is still enough room for manoeuvre in monetary policy to respond effectively and, given the pandemic’s deflationary potential, this may prove a useful and flexible instrument. This time, however, the bulk of the response must necessarily be fiscal.

In the US and the eurozone, the stimulus from low interest rates and even the resumption of nonconventional measures is much more limited. Some experts believe the time has come for monetised fiscal expansion (so-called ‘helicopter money’). While this may be the case, we must remain practical: there is no time to engage in doctrinal battles or prepare the necessary legal and institutional framework. It suffices to design a coordinated programme of fiscal and monetary expansion, which is now inevitable. Furthermore, it would be dangerous to lend credence to the idea that macroeconomic policy is nearly exhausted in developed countries. This would weaken all credibility of the insurance the economic policy programme seeks to provide and it is simply false. It is a matter of political willpower: despite the level of interest rates and the high volume of public debt, States still have the capacity to provide stability through their budgets and the balance sheet of central banks. As shown by the historic minimum returns on public debt assets, the demand for risk-free or low-risk assets is extremely high in the current climate and is able to absorb a significant increase in supply. As Mankiw (2020) remarks, now is not the time to worry about public debt.

The choice facing the eurozone is stark: the ECB’s interest rates are already in negative territory and there are numerous countries with limited fiscal capacity. The Council has activated the general escape clause for fiscal rules to facilitate coordinated fiscal expansion. While the ECB maintains an active and flexible presence in the debt markets, this temporary increase in deficits must not create financial stress for the most indebted States. Gourinchas (2020) proposes that the European Stability Mechanism issues eurobonds to finance part of the response. There is no doubt that if the eurozone already had a shared fiscal capacity, this would be the right way to proceed. However, this is not the case and this is no time to fight protracted political battles. We must take advantage of the fact that the German government has stated on this occasion that it has the financial firepower to respond and is willing to use them. Yet, the Euro Area fiscal support falls short by at least three percentage points of GDP, so there is a need to add a European layer, financed with joint debt as an exceptional and temporary measure.

Beyond classic macroeconomic policy, China and the US have a powerful instrument that can jump-start confidence in the global economy. Despite the agreement reached in December to halt the trade war, with China making commitments in various areas and the US agreeing not to implement its final wave of tariffs, the trade barriers between the two major economies are much higher than they were a year and a half ago. The two powers could accelerate phase two negotiations and either fully or partially rollback with immediate effect the tariff increases imposed in recent months. The pandemic clearly shows that interdependence generates threats that are extremely unpredictable and hard to manage. Protectionism is a political obstacle that impoverishes us and has no place in a world like ours as we confront the coronavirus.

These measures can also be supported by a commitment to reduce barriers to trade for medical supplies needed to fight the pandemic and provide proper treatment for the most vulnerable people who contract the virus. As Bown (2020) notes, the US has introduced temporary exemptions from tariffs on certain key products from China required for the health response to the coronavirus. Many other health products remain subject to high tariffs. However, this problem is not exclusive to China and the US. France, Germany and South Korea have all announced restrictions on the export of medical equipment. In the case of the two European countries, this decision is cause for concern and goes against the Commission’s call to uphold the single market. After various meetings at which the US has avoided adopting a clear position in favour of an open trade system, the G20 now has the opportunity to reach an agreement that uses the power of trade to ensure that the countries that do not produce the required equipment can also treat the most vulnerable patients affected by the pandemic.


The economic authorities are accelerating the pace and ambition of the adoption of measures to respond to the pandemic. There will be a lot of bad news over the coming weeks and the sense of anxiety and fear will only get worse. Following the measures taken by central banks, governments and the European Commission, we must keep up the momentum to respond adequately to the threat. Measures must be implemented swiftly to ensure they take effect as soon as possible and there is an urgent need for international coordination in the response. However, the G7 is not the right forum. Instead, leadership by the G20 would show the world that we will tackle the pandemic using all possible resources, with everyone working in unison. For the eurozone, the following weeks will be decisive: we will use its instruments and institutions to their full potential in a spirit of cohesion and unity in the face of adversity.

Governments must be on the front line of this economic battle, working in close alignment with the steps taken by the health system to fight the pandemic. However, we can only win if all of us –businesses, workers and banks, supported by the insurance policy provided by the State– behave responsibly and play an active role in overcoming the crisis.

Gonzalo García Andrés
Head of Economics at Analistas Financieros Internacionales @gongarand


Benassy-Quéré, A., R. Marimón, J. Pisani-Ferry, D. Schoenmaker, L. Reichlin & B. Weder di Mauro (2020), ‘COVID-19: Europe needs a catastrophe relief plan’, 11/III/2020.

Bown, Chad P. (2020), ‘Trump’s trade policy is hampering the US fight against COVID-19’, 13/III/2020.

Demertzis, M., A. Sapir, A. Tagliapietra & G. Wolff (2020), ‘An effective economic response to the Coronavirus in Europe’, Bruegel Policy Contribution, nr 6.

Gourinchas, Pierre Olivier (2020), ‘Flattening the pandemic and recession curves’.

Guttenberg, Lucas, & Johannes Hemker (2020), ‘Corona: a European safety net for the fiscal response’, Hertie School Policy Brief, 13/III/2020.

Mankiw (2020), ‘Thoughts on the pandemic’.

OECD (2020), Economic Outlook, March.

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Steinberg, Federico (2020), ‘Coronavirus: economic threat, political response and implications’, ARI 35/2020, Elcano Royal Institute.

<![CDATA[ Coronavirus: economic threat, political response and implications ]]> 2020-04-03T02:10:31Z

What will be the economic impact of the coronavirus and what economic policy responses are required by this unprecedented situation?

Original version in Spanish: Coronavirus: amenaza económica, respuesta política e implicaciones.


What will be the economic impact of the coronavirus and what economic policy responses are required by this unprecedented situation?


This paper analyses the impact of the coronavirus. It explains why we are facing radical uncertainty that makes it impossible to anticipate the impact of the pandemic, outlines economic policy options to address the crisis and identifies potential lessons to be learned.



It is still too early to know the final economic impact of the COVID-19 global pandemic. The impact will depend on whether the virus can be brought under control in the second quarter of the year or whether its effects will be longer lasting, accompanied by further economic complications, particularly in the financial sector. The first scenario will result in a softer V-shaped impact, which would only see global production fall by a few tenths of a percentage point. However, the impact under the second scenario could be much more complex, as anticipated by the OECD, which notes that global growth for 2020 could be halved, falling to 1.5%. It now seems increasingly likely that this figure will be revised downwards.

So far, economic news on the virus has remained focused on the spectacular fall in stock markets and the urgent analysis of the macroeconomic impact, which will necessarily be highly speculative in light of the current radical uncertainty. On this point, there is little more to add: financial markets exhibit herd behaviour and fear drives cascading sell-offs and the flight to safe-haven assets such as gold and US Treasuries, accompanied by a strengthening dollar and falling prices of oil and other commodities. However, if we can prevent these effects from spreading or take measures to bolster confidence, we may see movements in the opposite direction, all of which means we should prepare for high levels of volatility over the coming weeks. Regarding the negative impact on growth, unfortunately it is already clear that even a V-shaped recovery (in contrast to a U-shaped one) will have profound and lasting effects. Any future rebound will not fully compensate for the fall in activity we are seeing and it is becoming increasingly clear that the most critical phase will last longer than initially envisaged.

Unsurprisingly, the slowdown will first be felt in China –the origin of the epidemic– and will be strong, given the Asian giant’s enormous influence on its neighbours (and beyond), which stems from the key role it plays as a supplier of intermediate and final goods throughout the world (China is the source of 12% of global exports, a four-fold increase over the last 15 years). It is likely that the economic impact on the EU, the US and other countries will be uneven and felt later, in the second and third quarters of 2020. It is probable that Italy (and perhaps Germany) will enter into recession, while the impact on economies like Spain, which were growing faster but are more dependent on tourism (a sector that will be badly hit), remains to be seen. The final economic outcome will depend on the effectiveness of confinement measures (quarantines, social distancing and the closure or cancellation of public gatherings and events), the challenge of managing fear among the public and the effects of the fiscal and monetary measures that are being taken. It will be especially important to avoid serious problems for financial stability and business solvency, particularly restrictions on business loans and increases in sovereign borrowing, similar to those experienced during the euro crisis and the various crises in emerging countries in recent decades. Finally, cooperation and responsible behaviour by the public will help reduce the impact of the pandemic and the cost of failing to take it seriously (as has been the case with the Trump Administration) will be high.

The difficulties of reacting to a black swan event

Under normal conditions, economies have cycles, which are often smoothed by countercyclical monetary and fiscal policy. This means that short-term macroeconomic forecasts are generally reliable (give or take a tenth of a percentage point), since they indicate a trend. At the start of 2020, the global economy was experiencing a mild slowdown and many of the risks to growth that marked 2019, such as the trade war and the risk of a disorderly Brexit, appeared to have subsided. This resulted in a broad consensus among macroeconomic analysts that 2020 would be a year of growth, albeit at a slower pace than in previous years.

However, when faced with a black swan event, forecasting models often break down. As Nicholas Taleb explains in his seminal book in 2007, black swan events are extremely hard to anticipate and have a major impact, meaning they cause us to rethink the forecasts of our predictive models. The fall of the Berlin Wall and the Soviet bloc in 1989, the September 11 attacks in 2001, the financial crisis of 2008 and the impact of the current COVID-19 pandemic are all examples of black swan events (although it can be argued that the risk of a global pandemic is always present, it is impossible to predict when such an event will occur). None of these risks were foreseen, not even with a low probability, but they have all changed the course of history in one way or another. This is not to say that we should abandon predictive models but we must remember that they are always subject to uncertainty and on occasions like the present, need to be placed in quarantine.

The greatest difficulty is knowing when the current phase of radical uncertainty will end and when it will once again be possible to trust macroeconomic models. For example, the September 11 terrorist attacks resulted in relatively short-lived episodes of panic and uncertainty, causing a minor economic shock, despite major geopolitical implications, such as the ‘war on terrorism’. In contrast, the macroeconomic impact of the 2008 financial crisis was much greater. Once the uncertainty surrounding the potential collapse of the global financial system had subsided, the real economy fell into a protracted recession, which almost claimed the European single currency among its victims and left deep scars of unemployment and inequality in southern Europe.

The problem lies in anticipating how long the phase of radical uncertainty will last and the damage it will do to the system. It is clear that, at some point, the COVID-19 epidemic will be brought under control at the global level. At this point, economic activity will cease to fall, international trade and the prices of financial assets will rebound and there will be some sort of recovery. However, the fact that the disruption is in an area as sensitive as public health significantly increases the difficulty of designing an effective strategy to minimise its duration. It also increases the probability of making mistakes in the response and complicates European and international coordination, which is essential to bring the problem under control and avoid additional tension and distrust among countries. Moreover, the longer it takes to bring the health situation under control, the more likely it is that there will be additional effects on the economy, such as protracted slowdowns in investment (reducing the potential for growth and causing a collapse in international trade) and even more serious financial problems with unforeseeable consequences.

How to respond: political leadership, coordination, liquidity and stimulus

We are facing an extremely complex situation. Panic in the financial markets and the fear of paralysed consumers require strong political responses and leadership, since technical solutions alone will not be sufficient to restore confidence. Nonetheless, the technical judgement of doctors and epidemiologists is essential (and sometimes more important than political judgement) in responding adequately to the pandemic. It is imperative for public institutions to send a message that ‘somebody is in control’ of the economic response (as was the case in September 2008, with the collapse of Lehman Brothers). However, this message may not be sufficient on its own, given the uncertainty of the public health outlook. In short, we need strong leadership that is able to incorporate the criteria of specialists and coordinate an economic response to minimise the damage of COVID-19 in all areas. In contexts such as the Eurozone –an incomplete monetary union with the risk of each country acting alone– a coordinated response by the different member states and European institutions is especially important, a feat we know is not easy to achieve.

Economic policy will have to respond first to a supply-side shock, followed by a shock to demand. Both are cause for concern and require different responses. Firstly, there is the disruption caused by the closure of factories (beginning with China and gradually followed by other countries), supply problems and complex disruption to supply chains, which have also become much more intense compared to the SARS epidemic (Severe Acute Respiratory Syndrome) in 2003. The Chinese economy is now four times larger and companies throughout the world are even more dependent on Chinese components and intermediate inputs, above all in the automotive, electronics and chemicals sectors. However, this shock to supply, which recalls the shortages of the 1970s oil crises and which may return to normal in the second quarter of 2020, is complemented by a fall in demand, which primarily affects the transport, tourism, trade fairs and events sector and means an extremely high level of uncertainty that will slow consumption and paralyse activity. To reduce this fear, which is understandable but sometimes exaggerated and irrational, it is essential to inform the public correctly, avoiding exaggeration and sensationalism, and put in place adequate contingency plans. As Keynes famously remarked ‘markets can remain irrational for longer than you can remain solvent’ and herein lies the greatest risk: the panic results in a fall in activity that inflicts damage on the economy from which it will be hard to recover.

Cushioning the impact of this double shock will require imaginative economic policy. As has been the case in China and more recently in Europe, the payment of certain taxes and social security contributions can be deferred and the debts and lines of credit of businesses suffering a temporary drop in sales can be refinanced. However, the commitment of the financial system to refinancing must be accompanied by extraordinary injections of liquidity by central banks to avoid credit crunches. It is important to ensure that any instances in which liquidity dries up –whose greatest effects will be on small and medium businesses– do not give rise to insolvency (which increases unemployment), all of which means providing liquidity to the system, ensuring banks refinance the debts of customers facing difficulties in making payments.

A monetary policy response based on lowering interest rates is unhelpful, since rates are already at record lows and such a course of action is unlikely to incentivise the public to increase consumption if people are worried about the future. As such, well-defined and carefully targeted support is essential. The surprise rate cuts of half a percentage point by the US Federal Reserve and the Bank of England at the start of March, which aimed to shore up confidence, do not seem to have worked. Moreover, they have the potential to result in a currency war if other countries perceive them as a form of devaluation. A coordinated response by the world’s main central banks (European Central Bank, Federal Reserve, Central Bank of China, Bank of Japan and Bank of England) would almost certainly have been more effective. Concerted action would have sent a much more powerful signal that political authorities are willing to provide a strong response, avoiding competitive devaluations and helping prevent global deflation caused by the collapse in demand, which would be extremely dangerous given the high levels of debt.

It remains to be seen if the communiqué by the G7 leaders in March to bolster confidence will be matched by coordinated policies in the coming months. One of the best outcomes would be for the G20 to design a fiscal stimulus package like the one used to fight the Great Recession in 2009. However, this seems unlikely while the Trump Administration continues to downplay the full scale of the pandemic. If fiscal expansion is designed to allow money to quickly reach the real economy (which would require increased spending and not tax cuts), it could cushion the blow to GDP over the coming months. However, it is advisable for countries with higher fiscal margins to spend more to prevent increased debt undermining the sustainability of public accounts in countries facing difficulties, as was the case during the financial crisis. Regardless, given the need to include fiscal policy in the response to the pandemic, there is justification for the EU to launch an emergency catastrophe plan with resources from the European budget. The €37 billion announced must be genuine additional funds, over and above existing budgets, and must be invested at a federal European level, coming from projects by the European Investment Bank (EIB) and private financing from the European Stability Mechanism (ESM), which could use their precautionary lines of credit or be used imaginatively (which may require modifications to their regulations) to generate pooled resources. All this means we will need to rethink certain elements of the fiscal rules of the Stability and Growth Pact, which are already being revised to address their excessive complexity and tendency to incentivise pro-cyclical policies. At the national level, it is necessary to ensure there are is no reluctance to use public funds to purchase medical equipment and recruit health workers due to fears of reprimands from Brussels, although it is even more important to design a coordinated European response based on solidarity. Just as Brexit has finally come to pass, the EU has the opportunity to show it can step up to the mark. Perhaps this crisis will give new impetus to European monetary union.

Long-term outlook

Beyond the immediate economic impact, there will be a number of lessons for the future of globalisation and its governance as a result of the COVID-19 crisis. First, it leaves no room for doubt that in a highly interdependent world, in addition to being ineffective, unilateral action is often counter-productive. Multilateral cooperation, coordinated responses and trust in institutions with knowledge and experience (in this case the World Health Organisation) are essential, making the isolationist tendencies and improvisation that have characterised the Trump Administration especially dangerous.

Secondly, we must reflect on whether the advance of globalisation and the deepening of global supply chains have occurred in a disorderly fashion, leaving European countries exposed to intermediate medical supplies from China. It may be time to increase the geographic diversity of sources of supplies and take advantage of 3D printing to give a new impetus to domestic industrial production. This is not to deny the advantages of international specialisation and division of labour. Instead, it means taking advantage of lower costs from new technology to reduce our dependence and increase our autonomy without reducing our capacity for consumption and well-being.

Third, the EU (especially the Eurozone) risks a rerun of its lack of coordination and slow reaction to the global financial crisis in 2008 and the euro crisis in 2013. Moreover, in a context of growing international geopolitical rivalry and the crisis of multilateralism and cooperation, the EU is more necessary than ever at a time when critical situations have the potential to exacerbate divisions. In such an environment, it is imperative to refrain from unilateral action (eg, the restrictions on the exports of medical material announced by Germany, France and Austria) that can open up divisions that can be exploited by external powers to weaken the EU. Moreover, as mentioned, crises of this nature show the need to make progress in integration, both in terms of economic and monetary union and issues related to migration policy, security and the support for European champions in strategic sectors, avoiding Franco-German hegemony.

Fourth, the pandemic will have major geopolitical implications that are still largely unforeseen. We do not know if COVID-19 will strengthen or weaken China. Its apparently effective response to the pandemic (still to be confirmed) may provide a boost for its government. However, if the economy falters or its management of the crisis proves to be less successful, the opposite may occur. The Chinese economy is set to contract in the first quarter of 2020 for the first time since the Cultural Revolution in 1968.

Moreover, the economic crisis triggered by the pandemic may jeopardise the sustainability of public and private debt in some emerging countries, which are experiencing significant capital outflows and weakening currencies, with the associated political and social impacts. Finally, oil prices remain low due to the fall in demand, there will be a significant transfer of revenues from producer countries to consumer countries (including Spain), in addition to major economic issues from the increased vulnerability of exporting countries.

Fifth, and on a positive note, the crisis may have important lessons for the potential and effectiveness of remote working, allowing us to test many of the tools offered by new technology. Learning to harness their full potential will help reduce journeys in cities, reducing greenhouse gas emissions and supporting the fight against climate change. However, this will require leadership and determination from the authorities once the crisis has passed.


Governments face a difficult choice between halting economic activity and stopping the pandemic. The sooner strict measures are imposed to halt the spread of the virus and the more drastic they are, the greater the short-term economic impact, although the pandemic will be contained faster. Measures to contain the spread of the virus, such as restrictions on mobility and confinement must be imposed regardless (in the worst case when the health system collapses but ideally before).

The economic impact for Europe in the second quarter of 2020 will be severe. However, a relatively swift recovery is still possible if the shutdown is restricted to a few months, requiring a strong economic policy response at both the fiscal and monetary levels and sufficient leadership and coordination to control panic among the general public. More cohesive and civic societies are better placed to tackle the threat, since an excess of individualism over the coming months could lead to disaster.

Finally, this crisis highlights some of the risks of hyper-globalisation, incomplete economic and monetary union and an EU that lacks sufficient political integration. All of this makes it another wake-up call for Europeans.

Federico Steinberg
Senior Analyst at the Elcano Royal Institute and Economics Professor at the Universidad Autónoma de Madrid | @Steinbergf

<![CDATA[ The main economic challenges confronting Spain’s next government ]]> 2019-06-24T12:26:29Z

Spain’s next government faces major economic challenges and to overcome them it needs to regain the reformist momentum that used to characterise the country before political uncertainty set in.


Spain’s next government faces major economic challenges and to overcome them it needs to regain the reformist momentum that used to characterise the country before political uncertainty set in.


The economy has rebounded from a long recession, and the focus now needs to be on a series of challenges on the fiscal front, a pensions system that is unsustainable, unemployment that is still very high, productivity that is low and an education system not providing what Spain needs. Resolving these issues will determine the shape of the economy in the future.



The fragmentation of the political system, with three general elections in the last three and a half years (the same number as between 2004 and 2015), has weakened Spain’s capacity to carry out economic reforms. The country is still living with the 2018 budget as the previous minority Socialist government of Pedro Sánchez was unable in February to garner enough support in parliament for its 2019 budget, as a result of which a snap election was held in April.

The Socialists were the most voted party in that election, but without an absolute majority. Two months on Spain does not have a new government, although Sánchez is expected to be able to form one in July by the skin of his teeth. Whether that government will last the full term of four years is an open question. What is not in doubt is that Spain needs a stable and lasting government, able to implement structural reforms.

The continued political uncertainty comes at a time the economy is slowing down, as it is past the peak in the cycle of growth that began in 2014, following the extended double-dip recession in 2008-13 (see Figure 1). The pre-crisis GDP level was not restored until 2017.

Figure 1. Main indicators of the Spanish economy, 2014-18
  2014 2015 2016 2017 2018
Gross domestic product (a) 1.4 3.6 3.2 3.0 2.6
Private consumption (a) 1.5 3.0 2.9 2.5 2.3
Government consumption (a) -0.3 2.0 1.0 1.9 2.1
Exports of goods and services (a) 4.3 4.2 5.2 5.2 2.3
Imports of goods and services (a) 6.6 5.4 2.9 5.6 3.5
Contribution of domestic demand to GDP growth (pp) (a) 1.9 3.9 2.4 2.9 2.9
Contribution of net external demand to GDP growth (pp) (a) -0.5 -0.3 0.8 0.1 -0.3
Unemployment rate (b) 24.4 22.1 19.6 17.2 15.3
Unit labour costs (c) -0.2 0.5 -0.6 0.2 0.8
Consumer price index (end of period) (c) -1.0 0.0 1.6 1.1 1.2
General government fiscal balance (d) -6.0 -5.3 -4.5 -3.1 -2.5
Net international investment position (d) -98.8 -89.5 -85.3 -83.5 -77.1
General government gross debt (d) 100.4 99.3 99.0 98.1 97.1
(a) Annual rate of change.
(b) % of labour force.
(c) Rate of change.
(d) % of GDP.
Source: Bank of Spain.

On the surface, Spain looks to be doing quite well. GDP growth will still be more than 2% this year, higher than the Eurozone average (1.2%) for the fifth year in a row, the unemployment rate is down to below 15% from 26.9% in the first quarter of 2013, the current account has been in surplus since that year, partly due to record exports, inflation has remained at below 2% and the country received US$44 billion of direct foreign investment last year, double that in 2017 and the third-highest amount in the EU. Last year Spain, to the surprise of many, was the largest single contributor to Eurozone growth, ahead of Germany, the bloc’s traditional locomotive.

But there are imbalances that threaten the sustainability of growth, and ones that make Spain vulnerable in the event of another global economic crisis. The next government faces challenges on the fiscal front, in the ailing pensions system, an unemployment rate that is still very high, particularly for young adults, productivity that is low and an economic model that is still disproportionately based on tourism and construction, a sector that is regaining dynamism, a decade after the bursting of a spectacular property bubble, but far from the previous boom due to much reduced public works.

The fiscal challenge

The most immediate issue for the next government is to approve a budget for 2019. Spain was finally released in June from the European Commission’s tutelage (the excessive deficit procedure), as last year’s fiscal deficit came in, for the first time in a decade, at below the EU threshold of 3% of GDP (see Figure 2). The deficit peaked at a whopping 11% in 2009 (surplus of 1.9% in 2007, at the height of the boom). Brussels is keeping a watchful eye on the situation.

Figure 2. Spain’s budget balance, 2013-18 (% of GDP)
2013 2014 2015 2016 2017 2018
-7.0 -6.0 -5.3 -4.5 -3.1 -2.5
Source: Bank of Spain.

Initially, Spain was going to cut the deficit to 1.3% of GDP this year and 0.5% in 2020. The Commission forecasts deficits of 2.3% and 2%, respectively. After years of austerity, the pressure to spend more is growing. The previous Socialist government extended the 2018 budget and adopted new spending and revenue measures by royal decree. On the expenditure side, the measures include some additional pension increases and a number of social policy measures. Some measures adopted in the 2018 budget law approved by the previous Popular Party government, such as a pay hike for public sector workers, restoring annual inflation-linked rises in pensions and the tax cut for low-income earners, will have a budgetary impact this year. The capacity for spending more is very limited unless there is a substantial rise in government revenue, due to growth effects and tax increases. Tax cuts are out of the question.

Spain’s government revenue last year accounted for 38.9% of GDP, according to Eurostat, compared with a Eurozone average of 45%, while government spending was 41.3% (45.6% average). Effective tax rates are much lower than nominal ones due to a number of loopholes, but judging by the amounts of unpaid taxes recovered every year, Spain also has a substantial tax fraud and evasion problem. The Tax Agency netted €15 billion last year (see Figure 3). Spain’s tax revenue as a percentage of GDP (33.7%) is well below the EU average of close to 40%, but among the 36 OECD countries it is almost in line with the average (see Figure 4).

Figure 3. Revenue recovered from tax fraud and evasion, 2009-18 (€ billion)
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
8.1 10.0 10.5 11.5 10.9 12.3 15.7 14.9 14.8 15.0
Source: Tax Agency.
Figure 4. Tax revenues as % of GDP, 2017 and 2000
  2017 2000
France 46.2 43.4
Germany 37.5 36.2
Italy 42.4 40.6
Spain 33.7 33.2
UK 33.3 32.9
US 27.1 28.2
OECD average 34.2 33.8
Source: OECD Revenue Statistics.

As well as grappling with a fiscal deficit over the past decade, public debt has also soared –from 36.3% of GDP in 2007 to 97% in 2018–. The debt has hardly declined since 2014 when it stood at 100%. Servicing the debt accounts for a significant chunk of spending and its size makes Spain vulnerable to international interest-rate hikes. Excluding the interest paid on the debt, the State ran a small primary surplus last year equivalent to 0.72% of GDP.

An unsustainable pensions system

There is no shortage of warnings from within Spain (Bank of Spain) and outside (IMF and OECD) that the country’s pensions system is headed toward a crisis unless measures are taken in time to restore its sustainability. In essence, a toxic mix of the retirement of the 1960s baby boomers, high and rising life expectancy (one of the highest in the world at 83 years) and one of the world’s lowest fertility rates (1.25) is making pension reform a pressing issue. The number of deaths has outstripped births since 2015, a major demographic change. Last year there were 56,262 more deaths than births, the highest figure on record. Political parties under the so-called Toledo Pact failed earlier this year to agree any measures on pensions after three years of negotiations.

The reforms approved in 2011 and 2013 made some adjustments that countered the impact of ageing on public spending on pensions, but measures included in last year’s budget delayed the application of a sustainability factor and reintroduced the annual inflation-based revaluation of pensions (eliminated as of 2014 when the annual rise was set at 0.25%, well below inflation, unless the system could afford more). The reform to allow for rising life expectancy in calculating pensions was put back from 2019 to 2023.

In the current context of an ailing social security system, restoring the inflation indexation is largely viewed as an irresponsible and populist measure. The decision was taken by the minority Popular Party government in order to secure support from the Basque Nationalist Party (EAJ/PNV) for its 2018 budget. Increasing pensions every year in line with inflation might seem just, but in the context of Spain’s ailing system it adds a significant amount to the pensions bill.

The proportion of the over-66s compared with those aged 16-66 is forecast to double between 2018 and 2050 (see Figure 5). In other words, there will be fewer people of working age to support those who have retired in the pay-as-you-go system. For each person over 66, there will only be two persons aged 16-66. By 2050, Spain will have 15 million pensioners, up from 8.7 million today.

Figure 5.
  1950 1975 2000 2015 2025 2050
France 19.5 24.5 27.3 33.3 40.9 52.3
Germany 16.2 26.5 26.5 34.8 41.4 59.2
Italy 14.3 21.6 29.2 37.8 45.6 72.4
Japan 9.9 12.7 27.3 46.2 54.4


Poland 9.4 17.1 20.1 24.3 36.4 60.8
Spain 12.8 19.0 26.9 30.6 38.6 77.5
UK 17.9 25.5 27.0 31.0 35.9 48.0
OECD 13.9 19.5 22.5 27.9 35.2 53.2
(1) The old-age dependency ratio is defined as the number of individuals aged 65 and over per 100 people of working age defined as those aged between 20 and 64.
Source: United Nations Population Division.

The social security system has been in deficit for a decade and is the main reason for the general government deficit (in 2018 it was 1.41% of GDP, more than half the total deficit). Social security contributions collapsed as a result of the crisis after 2008, when unemployment soared and wages declined in real terms, while pension expenditure, which is much less linked to economic fluctuations, maintained its growth in real terms.

The gap between revenue from contributions and spending on pensions was largely covered until 2016 by running down a special reserve set up in 2000 during Spain’s economic boom. That fund peaked at €66.8 billion in 2011. In 2017 and 2018 the gap was covered by recourse to state loans (€10.2 billion and €13.8 billion, respectively).

The Court of Accounts criticised this method in May 2019 for ‘negatively affecting’ the solvency of the social security system and called for the pensions deficit to be covered by taxes.

Action needs to be taken on the revenue and spending side. The Bank of Spain points out that even if the employment rate grows significantly, in order to maintain the present benefit ratio there would have to be a huge increase in revenue from social security contributions. The number of contributors has been growing but is still around one million below the peak of 20.7 million in 2007.

The first steps to increase the retirement age, a significant aspect of the sustainability of the pension system, were taken in 2011, and will be completed in 2027 when it will be 67 (for workers with less than 38.5 years’ contributions). The age at which people are currently retiring is 63, below the statutory retirement age of 65.5, and there is no clearly upward pattern.

The government needs to implement other measures to reinforce the pensions system, such as making plans taken out by individuals more attractive (the amount that is tax deductible was reduced from €12,000 to €8,000 in 2015). Saving for a rainy day, however, is beyond the means of a large swathe of the working population who barely get by as it is. The household saving rate was at a historically low rate of 4.9% of gross disposable income in 2018, well below the peak of 13.4% in 2009.

There are also severe disincentives to combine work and a full pension. Spain is one of only seven OECD countries that applies limits to the earnings above which combined pension benefits are reduced. The pensions of those who continue working are reduced by 50%, apart from self-employed workers earning less than the minimum wage or hiring at least one worker. Furthermore, workers still in employment and receiving a pension do not earn additional pension entitlements although they pay a special ‘solidarity’ contribution of 8%, which does not apply to those continuing to work and deferring the pension.

Making the pensions system sustainable is a complex and highly important challenge that requires all levels of society to be made fully aware of the problem (not the yet the case) and for sacrifices to be made so that the system does not crack.

The persistently high unemployment rate

Spain’s job creation in the last five years has been one of the most robust in the EU. Close to 3 million jobs were created, but that still left 3.3 million without work in the first quarter of this year. The unemployment rate dropped from a staggering 26.1% in 2013 to 14.7% in the first quarter of this year, double the EU average and the second highest after Greece (see Figure 6).

Figure 6. Seasonally adjusted unemployment rates, April 2019 (%)
Greece 18.5
Spain 13.8
Italy 10.2
EU average 6.4
France 8.7
UK 3.7
Germany 3.2
Source: Eurostat.

Unemployment for those aged between 15 and 24 is particularly acute at more than 30%, and most of these people who do have jobs are on temporary contracts. Overall, around 25% of jobholders are on temporary and thus precarious contracts. The dual system of ‘outsiders’ (those on temporary contracts) and ‘insiders’ (those on permanent contracts) is one of the hallmarks of Spain’s dysfunctional labour market.

Temporary workers were the first to lose their jobs when the financial crisis hit as of 2008, particularly in the construction sector, which shed 1.3 million jobs between 2008 and 2018. The number of housing starts plummeted from a peak of 865,561 in 2006 to around 100,000 last year, underscoring the depth of the shaky foundations upon which the economy was roaring along.

High levels of unemployment by the standards of other developed countries, even when the economy is growing at a brisk pace over a sustained period, have characterised Spain in the last 40 years. Comparisons with the last decade of the Franco regime (1939-75) are not fair because the virtually full employment during the last decade of the dictatorship was made possible by considerable pluriempleo (holding two or more jobs) in order to make ends meet, very low female participation in the labour market and massive emigration for economic reasons (2.75 million between the 1950s and 1973). Apart from the real-estate bubble period (2002-08), Spain’s jobless rate has been at least five percentage points above that in Germany, France, Italy, the UK and the US, 10 points higher in the early 1990s and 15 points in 2013 and 2014. Even in 2007, at the height of the economic boom, Spain’s unemployment rate was a ‘historically low’ 8% (the average rate in the Eurozone), a high level for countries such as Germany and the UK.

Companies complained they could not find qualified workers to fill posts, which led some economists to put Spain’s structural unemployment rate at 8%, regardless of the economic cycle and particularly among women and young people.

Workers emerged from the Franco regime with ironclad job security, and those protections remained. Democracy brought class-based political trade unions but the paternalistic labour legislation was seen as a ‘worker conquest’ and political freedom gave the unions the muscle to exploit Franco’s labour regulations (ordenanzas).

All governments in the past 40 years have adopted labour-market reforms of one sort or another (52 between 1980 and 2015), but the problem of high unemployment has not gone away. The first Socialist government introduced temporary contracts in 1984 as an exceptional measure in order to make the labour market less rigid and more flexible and bring the market’s functioning more into line with the European norm (Spain joined the then EEC in 1986). As this system was maintained, employers were quick to use and abuse these contracts, creating the two-tier system that persists today. In 2012, the Popular Party’s reforms, the deepest so far, allowed companies to opt out of collective pay-setting agreements within industries and to make their own deals with workers. They also gave companies greater discretionary powers to adopt internal measures to limit job losses. Dismissal regulations were also modified, redefining the conditions for fair dismissal. Severance payments in the case of unfair dismissal for those on permanent contracts were reduced from 45 days per year-worked with a maximum of 42 months to 33 days per year with a maximum of 24 months and the requirement of administrative authorisation in the case of collective redundancies eliminated. Compensation for permanent contract termination in the case of redundancies for objective reasons was set at 20 days per year-worked with a maximum of 12 months.

These reforms softened employment protection legislation, though severance pay for permanent workers in relative terms remains among the highest in OECD countries. The reforms, however, have lowered the GDP growth rate needed to create employment, spurring the job creation over the last five years.

Spain’s economic model, heavily based on labour-intensive construction and tourism and not very productive, is also part of the unemployment problem as it does not provide jobs on a sustained basis. Spain has a very high number of small companies: fewer than 1% have more than 50 workers (compared with 3% in Germany). Firms need to be bigger so they have economies of scale, which would enable them to export more successfully, among other things. Tourism, which generates 12% of GDP, is a particularly seasonal industry. The Canary Islands, for example, received 15.6 million tourists in 2018 (seven times the islands’ population) and its unemployment rate was 21% in the first quarter of this year.

The country is also at a greater risk from automation, which would compound the unemployment problem. One quarter of middle-income jobs are at risk compared with an OECD average of one sixth (see Figure 7).

Figure 7. Percentage of workers in occupations at high risk of automation, by income class
  Lower income Middle income Upper income
Spain 29 24 15
OECD average 22 18 11
Source: OECD (2019), ‘Under pressure, the squeezed middle class’.

More focus on human capital and less on infrastructure

Spain’s motorways, train services (the high-speed train network is the longest in Europe and the second in the world) and other infrastructure such as the fibre-optic network for high-speed data transmission (it covers three-quarters of the population) are world class. But the same cannot be said for its education system. Too much emphasis has been placed on physical infrastructure and not enough on human capital.

It is an axiom that educational attainment tends to increase employment prospects, and yet almost one in every five people in Spain last year had completed at most a lower secondary education and were not in further education and training, the largest rate in the EU, but down from close to one in three in 2006 when students dropped out of school in droves for a job that was easy to find, particularly in construction. When the massive property bubble burst and unemployment soared many more students had no option but to stay on at school. But Spain’s progress has been nowhere near as stunning as Portugal’s –from 44% in 2000 to 11.8% (see Figure 8)–.

Figure 8. Early leavers from education and training, 2018 and 2006 (% of population aged 18-24)
  2018 2006
Spain 17.9 30.3
Portugal 11.8 38.5
Italy 14.5 20.4
UK 10.7 11.3
EU-28 10.6 15.3
Germany 10.3 13.7
France 8.9 12.4
Source: Eurostat.

Spain has made considerable progress in attainment in the last 40 years and has done better than many other European countries as regards educational mobility: around 40% of adults have a higher level of education than their parents. It also leads in the area of early childhood enrolment rates: 96% of three-year-olds are in education compared with the OECD average of 76%. But, generally speaking, the country is not producing the skills it needs or will need.

Skill demands are more polarised in Spain than in many other OECD countries, with a big share of jobs requiring either very low levels of education or very high levels. The share of all jobs requiring only a primary education is higher in Spain (25%) than in any other OECD country; however, the supply of low-educated workers exceeds demand. At the other end of the labour force, Spain faces high over-qualification and field-of-study mismatch. ‘Rising educational attainment has created a large supply of highly-qualified adults, but many of them are working in jobs for which they are over-qualified’, the OECD noted in a recent report on Spain.

Among the problems of Spain’s education system are endless reforms, which in practice have changed little, learning based excessively on memorisation as opposed to critical thinking, students having to repeat a year if they fail a certain number of subjects (which then demotivates them and leads them to drop out of school at 16), the university entrance requirement to take the teaching course is too low, which means that not always the best quality people become teachers, and a shortage of support personnel and a lack of autonomy for teachers, including the capacity to involve and interact with parents, compared with that, for example, in countries such as Finland and Singapore, among the top countries in the OECD’s PISA tests, which evaluate education systems worldwide by testing the skills and knowledge of 15-year-old students who are nearing the end of their compulsory education.

Teachers in Spain are paid relatively well (above the OECD average) and the average number of students per class is among the lowest (13 compared with 21 in the UK and 22 in France), but the number of support staff per teacher is one of the lowest (one per 11 teachers compared with one for every two teachers in the UK).


The next government has a lot on its plate. Many of the reforms require cross-party support, which in the current climate of minority governments and a parliament fragmented among five main parties (two until 2015) is no easy task. Parties need to put aside their differences for the good of the country.

Bibliographical references

Alain Cuenca & Santiago Lago Peñas (co-directors) (2019), El sector público español: reformas pendientes, Funcas, RIFDE & University of Alcalá.

Economy Ministry (2019), La agenda del cambio: hacia una economía inclusiva y sostenible.

Finance Ministry (2019), Stability Programme Update 2019-2022.

<![CDATA[ From trade diplomacy to economic warfare: the international economic policy of the Trump Administration ]]> 2019-05-31T12:23:59Z

This paper is an analysis of the discursive practices of the international economic policy of the Administration of President Donald Trump, writ large. Within this conceptual context it offers an empirical case study of the US-China relationship across the spectrum.


(1) The global context
(2) Concepts and theories
(2.1) Discursive practices: from securitisation to economic warfare
(2.2) Economic theory and international economic relations: the rise and fall and rise of economic statecraft and mercantilism
(3) The securitisation and weaponisation of US economic policy: the Trump agenda
(4) The US-China relationship: towards economic warfare?
Conclusion: assessing a Trumpian strategy of political (economic) warfare
The record
Donald Trump and the changing nature of geopolitics


This paper is an analysis of the discursive practices of the international economic policy of the Administration of President Donald Trump, writ large. Within this conceptual context it offers an empirical case study of the US-China relationship across the spectrum, from tariff conflict through to the growing struggle for control of the 21st century high-technology industries. The argument is that the Trump Administration utilises the discursive practices of what some scholars call ‘securitisation’ (Buzan et al., 1998) through to what might more appropriately be described as a discourse of ‘economic warfare’.

The paper is in four parts. Part 1 provides a brief discussion of the changing historical and international context of the study. Part 2 provides a conceptual discussion of the discursive practices of securitisation, economic statecraft and economic warfare on the one hand and the theory of international trade captured in the idea of the rise and fall of mercantilism and its re-emergence in the international economic agenda of the Trump Administration on the other. Part 3 looks at these concepts as they pertain to current US international economic policy. Part 4 concentrates on US policy towards China particularly. The paper concludes with some reflections on the success or otherwise of contemporary US policy.

(1) The global context

The cooperation that developed during the period of US ‘self-binding’ hegemonic control (Martin, 2004) over a liberal international order had been under strain in the US since the 1980s when the bilateral deficits with Japan became a major political issue. But it has been since the financial crisis of 2008 that the order has really begun to unravel. The Japan challenge was not sustained but great power competition from both China and Russia has grown. Always fragile, the popular consensus in support of a global liberal order –which was only ever partially liberal and partially global (see Acharya, 2017)– has further dissipated as strong ideological populist challenges have fuelled nationalist politics with attendant practical implications for economic globalisation and international relations in the post 2008 era (see Higgott & Proud, 2017).

This unravelling and great power competition pre-dates Donald Trump becoming President of the US. But it has been exacerbated by his economic nationalist counter-agenda to globalism; an agenda voiced not only by President Trump but also by subordinates in his close policy community –initially by Steve Bannon, but also others such as US Trade Representative Robert Lighthizer, Commerce Secretary Wilbur Ross, Treasury Secretary Steven Mnuchin and Special Economic Adviser Peter Navarro–.2

As this paper will argue, the challenges faced in a search for a new, post-liberal global equilibrium are reflected in both the conceptualisation and practice of economic securitisation and warfare as an instrument of US policy. The contours of any new order will be a highly contested with an increasing interdependence of the two key issues areas –economics and security– and increasing competition between the two principal combatants –the US and China. What might have started as a fairly traditional recourse to a protectionist trade agenda is steadily, and rapidly, morphing into a wider battle between the US and China across the whole spectrum of relations, and especially the battle for technological ascendency in the 21st century. We are witnessing not simply a rhetorical securitisation of US economic policy discourse but a more intense economic and political response to economic globalism in general, and the ascendency of China as a rival global economic power in particular.

For much of the post-World War II era, the relevant government agencies in the US (especially the US Treasury, abetted by the USTR) and the many interested trade and commerce lobbies and pressure groups had sought to treat international economic policy in general, and trade policy in particular, in a manner different to the normal rules of foreign and security policy. Trade policy was seen as a quasi-preserved domain with its own epistemic discourse. This has changed in the current era, where expert knowledge, when not directly rejected or increasingly belittled, is less valued (see Nicholls, 2017).

We are now in an era in which international trade policy, underpinned by a belief in the welfare-enhancing nature of trade openness is under challenge (see Irwin, 2017). This should not lead us into thinking that the globalisation of the international economy as a set of sinews, networks, activities and practices that developed over the last 40 years are somehow coming undone. This is clearly not the case (see Slaughter, 2018; and Baldwin, 2018). Rather, US policy has undergone a major change. An open liberal economic system has been characterised as a licence for others to cheat in their economic relationship with the US.

(2) Concepts and theories

(2.1) Discursive practices: from securitisation to economic warfare

Following 9/11 it became fashionable in some academic and policy quarters to talk about the ‘securitisation’ of US international economic policy. In academic language, securitisation (following the work of the Copenhagen School) was defined as a set of socially constructed and contextual speech acts and processes in which ‘… an issue is framed as a security problem’ (Waever, 1995, p. 75; and Buzan et al., 1998). Evidence of the securitisation of economic globalisation in US policy can be traced far back: from the time of the Raegan Administration and its introduction of the use of VRAs and VERs against the Japanese in iron and steel, machine tools and cars in the 1980s (Reich, 1989) through the to the Bush Administration. It was 9/11 that (perhaps unsurprisingly) firmed up the trend as the Administration proved unable to resist the siren calls to link the narratives of foreign economic and security policy.

For the Bush Administration, globalisation became not only an economic issue but also a ‘security’ problem. As a consequence, the discourse and practice of the securitisation of foreign economic policy developed accordingly. This trend was particularly acute in trade policy where, to illustrate, the granting of the bilateral Free Trade Agreements (FTAs) under negotiation at the time to those who supported the US Gulf War Two initiative (Australia and Singapore) contrasted with the explicit withholding of them from those who refused to join the Gulf War coalition (New Zealand and Chile) (see Higgott, 2004).

The earlier discourse of securitisation did not operationalise the concept of economic statecraft, let alone economic ‘warfare’ –concepts largely applied to non-liberal regimes, notably Russia and China. This study will demonstrate a step change between the Bush era and the contemporary era of the Trump Administration. It will demonstrate that contextual global change and the empirical narrative of international economic policy in general, and trade policy in particular, under the current Trump Administration requires a recognition of both the similarities and differences in the securitisation-economic warfare dialogue not required in the age of George W. Bush. Current US policy is taking us beyond both the securitisation problematic of the Copenhagen School and the traditional understanding of economic statecraft restated recently by Blackwill & Harris (2016). Rather, current US international economic policy should be interpreted through the discursive lenses of an aggressive and pro-active –as opposed to the earlier defensive and reactive– economic warfare.

Current US strategy in trade policy under the Trump Administration offers a counter-veiling argument to the notion that democracies will invariably prefer, à la Joseph Nye, (2004) a soft power diplomatic approach to more atavistic approaches. The preference is now to challenge longstanding commitments to multilateral collective action in the global trade regime with a preference for a strategy based as much on threat as on reward. A comparative analysis of the Bush and Trump Administrations suggests two major differences:

  1. The securitisation strategy of the Bush Administration after 9/11 was underwritten by assumptions of ‘existential threat’ but still with a significant commitment to multilateral institutionalism. By contrast in the Trump Administration’s strategy, without formally articulating it, it is clear that President Trump has a longstanding belief in a mercantilist view of trade with little or no commitment to multilateral institutionalism.
  2. The impact of the communication and technological revolutions on how the dissemination of a securitised trade policy under the current US Administration is practiced, when compared to the tools at the disposal of the Bush Administration, is both more intense and more sophisticated. George Bush did not have the populist communicative skills of Donald Trump nor the weaponry of digital social media, especially Twitter. The message of economic warfare is much easier to disseminate today.

Current strategy and policy harness the discursive instruments, tools and practices short of war to secure the enhancement of national objectives over those of adversaries. If we use the language of security studies we are seeing what Mahnken et al. call ‘… the coercive use of non military instruments to alter adversary behaviour’ (2018, p. 3). This allows us to demonstrate the degree to which our understanding of the discursive practices of trade war can be extended in two ways:

  1. To include allies as well as adversaries as targets.
  2. To extend our focus beyond Russia and China, to the discursive practices of econo-political warfare beyond the traditional understandings of US economic statecraft in recent years (see Blackwill & Harris, 2016).

This comparison of language and practice in US international economic policy is not of courses to suggest any wider similarity between the US on the one hand and China and Russia on the other. The US, for all its current problems, remains a robust democracy while Russia and China are both strongly authoritarian states. But comparative discursive narratives can be identified. In their case study on Russia, Mahnken et al. (2018, p. 10) identify what they see as key themes in the post revolution Bolshevik narrative. Four of the six they identify –(a) ‘we are special’; (b) the ‘country is threatened’; (c) there is a ‘sacred mission’; and (d) ‘victory is assured’– do warrant comparison and find resonance in the Trumpian international economic playbook that stresses:

  1. The residual myth of American ‘exceptionalism’ (‘we are special’).
  2. That the US is disadvantaged by the cheating and free riding behaviour of its major trading partners (‘the country is threatened’).
  3. The presidential mission is to ‘Make America Great Again’ (MAGA as ‘a sacred mission’).
  4. In the economic domain, this has meant a turn to aggressive and unilateral protectionist measures addressed to competitors and allies alike and based on the premise that, in Trump’s own words, ‘trade wars are easy’ (‘victory is assured’).

The analogy permits two further discursive comparisons. First, Vladimir Putin believes Russia was betrayed by the West after the Cold War with its support for the ‘colour’ revolutions in regional neighbours and the eastward expansion of NATO. Similarly, this sense of betrayal is mirrored in the US President’s belief that European allies have been free-riders on US largesse in both the security domain (NATO) and the economic domain (trade imbalances). If his resentments reflect core elements of Trump’s world view, then they lend themselves to explaining his policy responses: bilateralism, transactionalism, aggressive competition, and punishment and retaliation rather than cooperation and multilateralism. In addition, the observation of Trump’s attitudes towards the US’s European allies (for example, his position on Brexit and suggestions to President Macron that France leave the EU) also suggests a willingness to sow division amongst allies where possible. Secondly, the MAGA discourse mirrors Xi Jingping’s emphasis on enhancing respect for China globally after years of humiliation. This theme –that the US must be respected– is to be found in much presidential rhetoric about the lack of deference paid to the US by ungrateful allies.

Richard Higgott, PhD, FRSA, FAcSS
Emeritus Professor of International Political Economy, University of Warwick
Research Professor, Institute of European Studies and Distinguished Professor of Diplomacy, Vesalius College of Global Affairs, Vrije Universiteit Brussel

1 The author is grateful to Luis Simon, Patrick Low, Simon Reich, Jaihong Chen, John Hart, Anthony Milner and Uli Penzkofer for their helpful comments.

2 See Navarros’s documentary, Death by China

<![CDATA[ India in 2024: Narendra Modi once more, but to what end? ]]> 2019-05-21T11:00:14Z

This analysis argues that Narendra Modi will have to deliver much bolder reforms in his second term in order to allow India to reach its potential turning its rising working age population into a demographic dividend.


This analysis argues that Narendra Modi will have to deliver much bolder reforms in his second term in order to allow India to reach its potential turning its rising working age population into a demographic dividend.


  Prime Minister Modi shows a mix record in fulfilling his promises on economic reform during his first term.  He has made some progress in attracting capital and reforming the banking sector, but, much of the work is left unfinished as India still does not attract enough FDI in manufacturing to absorb its labor force. Moreover, India needs to also increase its savings rate to boost infrastructure investment. Both require Modi to deliver much bolder reforms in his second term that is certainly a strong leap from where it is today. That said, India is the only country comparable to that of China and any significant progress in India will be globally consequential.


Official results will not be published until 23 May , but Narendra Modi and his incumbent coalition government are set to retain power as suggested by a few exit polls after India concluded the final phase of its six-week ballot. The projections indicate that the BJP-led National Democratic Alliance (NDA) will secure most seats in the Lok Sabha –the lower house of India’s parliament–. Meanwhile, exit polls are divided as to whether the BJP can win a parliamentary majority on its own, with several predicting that it will lose seats compared with its 2014 landslide victory.

While exit polls have a record of being inaccurate in past elections, the huge difference between the NDA’s projected seats versus the United Progressive Alliance (UPA) led by the opposition Congress means that each of the exit polls should be extremely unreliable for the case of an NDA loss. As the election is widely seen as a referendum on Modi’s leadership over the past five years, his victory would indicate that the public is generally willing to give him a second term to complete unfinished tasks, such as reducing the high unemployment rate.

That said, even with the recent economic slowdown, India still boasts Asia’s fastest-growing economy in 2018. But beneath the veneer of impressive GDP expansion, unease about India’s economic model clearly tempers enthusiasm. There is no doubt that the slowdown in the Indian economy casts a shadow over Modi’s second term and whether this time things will be different, for instance as to whether he will finally push through key economic promises to provide India with much-needed investment and jobs.

Growth is particularly important to India not only because of its need to converge on account of its low GDP per capita but also to pressure on employment creation on the back of its rapidly growing population. In fact, India struggles to generate enough formal jobs and lacks capital to invest in infrastructure to absorb its existing excess labour supply.

To assess what is at stake in Modi’s second term, this paper analyses India from two perspectives: (1) the progress the Modi government has so far made on key pillars of his pledges since coming to power in 2014 ; and (2) the scale of reforms that needed for India to reach its potential. For the latter, we use China as a comparison based on similar population size and, possibly, even –in many ways– global ambition.

(1) Modi has made progress but far from enough compared to what India needs

We have analysed Modi’s pledges within the framework of the Solow growth model, which looks at three output/production factors: labour, capital and productivity (soft infrastructure reforms). India does not have a challenge as regards the supply of labour, in contrast to countries in East Asia, since its working-age population is expected to expand rapidly, so much so that it needs to create millions of jobs per year in the next decade to absorb all its incoming labour (see Figure 1). Beyond its employment needs, India struggles in regard to total factor productivity, which requires capital to absorb existing and incoming labour into more productive sectors as well as reforms to reduce red tape. Reforms are required in all three aspects of the Solow growth model to escape from its current low middle-income trap.

India currently has a low labour participation rate, especially compared with China (see Figure 2). Worse still, within its employment population, the vast majority are still stuck in informal sectors, which equates to low total factor productivity. For China, informal employment takes up a significantly lower proportion of total. The situation can only get worse for India unless many more jobs are created.

Figure 1. India: population, 1950-2050 (millions)
Figure 1. India: population, 1950-2050 (millions)
Source: UN Population Statistics.
Figure 2. India: breakdown of the working-age population (%)
Figure 2. India: breakdown of the working-age population (%)
Sources: Natixis, ILO.

These challenges are well understood within India’s academic and political circles and have been sources of how to address the ills of India’s under-performance despite its great demographic potential. Modi and his BJP have made pledges on the country’s key economic challenges.

First, starting with the positive progress Modi has made since 2014, mainly pertaining to capital, while he underperforms on his labour and productivity promises. Capital is obviously important as the infrastructure deficit is a clear bottleneck to create more jobs. Regarding capital, there are two obvious ways to increase it: foreign capital and public investment. As for the former, Modi has tried to liberalise both FDI and portfolio with mixed results. Within his ‘Make in India’ campaign, a few measures to open up some sectors to foreign competition have been taken, which have helped increase FDI into India (see Figures 15 and 6). That said, it is still significantly less than what is really needed to increase demand for workers, particularly in the manufacturing sector, which only comprises a small percentage of GDP even compared to China’s in the early 2000s (Figure 11).

Moreover, Modi has backtracked on some of his reforms, particularly in opening up e-commerce given the backlash from small- and medium-sized retailers who make up a large part of the voting population. For instance, the recently announced e-commerce rule to cap the inventory sourcing of online retailers from a same supplier –many of them being stakeholders of these online retailers– has hurt Amazon to the benefit of domestic players and raised questions about the commitment and consistency of India’s foreign investment policy.

In addition to a relatively timid opening up to inward FDI, his government has also further liberalised portfolio investment. In particular, the quota for foreign investment in Indian government bonds has gradually been lifted. As regards public investment, Modi has tried to increase the tax base by introducing goods and services taxes (GST) that aim to harmonise existing taxes with much more simplified codes. This has resulted in improved ease-of-paying-taxes and ease-of-doing-business rankings for India (Figures 3 and 4).

Figure 3. India: improved ease-of-paying-taxes rankings, 2015-19
Figure 3. India: improved ease-of-paying-taxes rankings, 2015-19
Sources: World Bank, Natixis.
Figure 4. India and China: ease-of-doing-business ranking, 2015-19
Figure 4. India and China: ease-of-doing-business ranking, 2015-19
Sources: World Bank, Natixis.

Regarding management of capital, particularly banking sector reform, the Modi government approved an Insolvency and Bankruptcy Code to provide a clear framework for recovering debts. That said, the non-performing loans (NLP) ratio remains high for public banks. Modi also demonetised the economy in the hope of tracking down and bringing back black money stashed away in foreign banks and offshore accounts. This removed the majority of currency from the system but faced a backlash in that it disproportionately hurt small- and medium-sized enterprises and resulted in job losses. Based on data from the Centre for Monitoring the Indian Economy, both GST and demonetisation caused massive job losses in 2018.

While Modi has made progress on whatever concerns capital as a factor of production, he has clearly fallen short on both labour and productivity reforms. On the labour side, his government has discontinued the collection of meaningful comprehensive labour data, but our estimate is that the Indian economy is far from delivering much-needed jobs for the its massive labour supply. Modi promised 10 million new jobs per year but new payroll records from EPFO point to a huge gap in jobs created in 2018 (Figure 5). Moreover, the ILO estimates for informal labour have worsened over the years as the size of vulnerable employment has risen and that is in addition to half of the working-age population being idle.

Figure 5. India: job creation by sector, 2018 (million). Figure 6. India: FDI by sector, 2010-18 (US$ million)

The weakness of the job scenario is supported by incorporating FDI inflows into the manufacturing sector. The Make in India slogan primarily attracts services and information & communication technology while not enough manufacturing FDI (Figure 6). In other words, it is a mere drop in the bucket of what is needed for India to become self-sufficient in manufacturing, let alone to becoming a manufacturing centre of the world. For example, India exported a comparable volume of manufacturing goods in 2018 as Vietnam, a country significantly smaller in size. It does not help that Modi’s pledge to improve infrastructure is held back by limited public funding and a banking sector saddled with bad loans and dominated by state-owned banks. In fact, the quality of India’s infrastructure has seen little improvement over the past five years (Figure 7). Moreover, India’s infrastructure spending has been stuck in low gear since 2014 too (Figure 8).

Figure 7. India and China: reliability of infrastructure index, 2015-19
Figure 7. India and China: reliability of infrastructure index, 2015-19
Sources: World Bank, Natixis.
Figure 8. India: infrastructure spending to GDP, 2012-18 (%)
Figure 8. India: infrastructure spending to GDP, 2012-18 (%)
Sources: Natixis, CEIC; NB. Infrastructure spending of India is derived from the sum of gross capital formation of railway, road transport, water transport, air transport, strorage, electricity, gas, water Supply & other Utility Services and construction.

One of the key challenges to investment and development in India is its restrictive land and labour laws. Modi had promised to repeal the Amend the Land Acquisition Act of 2013, which is a barrier to investment and development, but on 31 August 2015 Modi decided not to go forward. Modi also promised to review and amend Labour laws, which are onerous, but has not done so. For instance, India requires any firm employing more than 100 workers to seek and receive government permission before dismissing any employee. Employers therefore hire informally to get around the law and, as a result, most of India’s workforce is informal.

In short, while the Modi government has made progress in attracting capital, its pace has been agonisingly slow for what is needed to allow India to turn its rising working-age population into a demographic dividend. The following section discusses what is needed for India to do so.

Figure 9. India: population growth, 1955-2050 (millions)
Figure 9. India: population growth, 1955-2050 (millions)
Sources: UN Projection,Natixis.
Figure 10. India: employment, 1991-2017 (millions)
Figure 10. India: employment, 1991-2017 (millions)
Sources: ILO Estimates, World Bank, Natixis.

(2) What is needed to take India to the next level: savings and investment

The only country comparable to India is China due to their massive sub-continental population and their geographical size. For India, the road forward is clear: it needs to raise its capital stock per worker, but the debate is how to do so. China’s experience in the early 2000s may prove to be an important lesson for India. There are two key differentiating factors between the two countries: (1) the rapid urbanisation of China’s rural population by moving farmers into factories by attracting FDI in manufacturing to capitalise on its comparative advantage in labour; and (2) the rise in China’s savings rate to finance necessary infrastructure projects and to develop sectors needed for industrialisation.

The previous section showed that the key challenges to India are well understood, such as labour and land reforms. That said, the scale of progress needed is not often discussed. Although India is the only country that can absorb the labour-intensive manufacturing that is increasingly uncompetitive in China, it only attracts as much manufacturing FDI as Vietnam, a country a tenth of its size.

India currently attracts small amounts of manufacturing FDI, having remained at the same level over the past eight years. If compared to China when it joined the WTO in 2001, India’s level is too low to attract much-needed capital, particularly the kind of capital that demands large numbers of workers. As a share of fixed asset investment (FAI), manufacturing FDI in India also lagged behind. As an aggregate, India has not done so badly, but, as mentioned, most is not in much-needed manufacturing, with the result that India needs to absorb much more capital from the rest of the world than it currently does to boost labour demand in manufacturing.

Figure 11. Manufacturing FDI as a % of GDP: China (2000-08) and India (2010-18)
Figure 11. Manufacturing FDI as a % of GDP: China (2000-08) and India (2010-18)
Sources: CEIC, Bloomberg, Natixis.
Figure 12. Manufacturing FDI as a % of Investment: China (2000-08) and India (2011-18)
Figure 12. Manufacturing FDI as a % of Investment: China (2000-08) and India (2011-18)
Sources: CEIC, Bloomberg, Natixis.

Beyond using its labour surplus advantage to attract labour-intensive manufacturing, India also needs to increase its savings rate to be able to fund much-needed infrastructure development. Such a gap is particularly noticeable when compared to China in the early 2000s. The country’s persistent current account deficit makes it vulnerable to volatile capital flows, another key reason why it needs to attract more FDI and also raise the savings rate. Because of this capital deficit, the Indian government cannot engage in public-led investment without significantly raising the deficit. The previous administration forced the state-owned bank to lend to infrastructure firms and caused a large increase in NPLs. Since then, investment in infrastructure has declined. Our assessment of India’s significantly lower investment than China means there is much scope to increase.

Figure 13. China and India: Gross Domestic Saving as a % of GDP, 2000-18
Figure 13. China and India: Gross Domestic Saving as a % of GDP, 2000-18
Sources: CEIC, Natixis.
Figure 14. Investment as a % of GDP: China (2000-08) and India (2010-18)
Figure 14. Investment as a % of GDP: China (2000-08) and India (2010-18)
Sources: CEIC, Bloomberg, Natixis.
Figure 15. The Modi government’s progress report
Figure 15. The Modi government’s progress report
Sources: Natixis, ILO, CMIE, EPFO, World Bank, CEIC, Transparency International.


Our analysis of Modi’s progress report shows that he has made some progress in attracting capital and reforming the banking sector. That said, much of the work remains unfinished as India still does not attract enough FDI in manufacturing to absorb its labour force. Indeed, India needs to attract 2% more of GDP than it currently does. This should help it leverage its excess labour supply to absorb much-needed capital from the rest of the world and close the financing gap. Moreover, India also needs to increase its savings rate to boost infrastructure investment. Both require Modi to deliver much bolder reforms in his second term, in what should be a significant leap from where it is today. India is the only country comparable to China and any significant progress it makes will have global consequences.

Alicia García Herrero
Senior Research Fellow, Elcano Royal Institute | @Aligarciaherrer

Trinh Nguyen
Senior Economist Natixis
| @Trinhomics

<![CDATA[ The economic effects of Brexit in the “Campo de Gibraltar”: an econometric approach ]]> 2019-02-26T05:31:28Z

The UK’s exit from the EU has become a political maze. Uncertainties increase and so do the negative economic effects, especially on Britain’s European borders: Northern Ireland and the Campo de Gibraltar in Spain.

Original version in Spanish: Efectos económicos del Brexit en el Campo de Gibraltar: un modelo econométrico.


The UK’s exit from the EU has become a political maze. Uncertainties increase and so do the negative economic effects, especially on Britain’s European borders: Northern Ireland and the Campo de Gibraltar in Spain.


Geographical proximity generates positive economic effects to the inhabitants of the Campo de Gibraltar, the area adjoining Gibraltar, due to cross-border employment (workers with a job in Gibraltar who live in the Campo) and the exchange of goods. This economic impulse is clearly necessary in a region with high levels of unemployment. However, the increasingly likely absence of an agreement is jeopardising these effects: both parties (Gibraltar and the Campo), considering the institutional instability in the UK, are readying themselves for the worst-case scenario.

In this context, the Campo is more than ever marked by the border with Gibraltar: in a hard Brexit (with no deal between the EU and the UK), the flows of goods, capital and labour will no longer be ensured or protected and non-tariff barriers will rise. This will entail remarkably negative consequences for the economy of the region. Losses due to Brexit are inevitable, but they can be reduced if there is an agreement concerning the special status of Gibraltar and its future.

Economic models such as the one presented in this paper can be a useful tool to shed light on a complex phenomenon like Brexit in the context of the Campo de Gibraltar. Predictions have been made under two alternative scenarios which correspond to a higher or lower degree of mobility of production factors. Their results have been compared with a counterfactual scenario, where the UK remains an EU member. All the predictions point to a common result: the Campo de Gibraltar will suffer worse economic effects if there is no deal.


The UK’s exit from the EU has generated significant debate about the future of the European project in every dimension. Debate is growing in complexity and volatility and has been heightened by the division of the ‘Leave’ supporters as well as by the lack of a real alternative,2 with the Labour Party divided between a blurry scepticism and a discrete and reluctant support for a second referendum.

Nonetheless, the complexity of the debate should come as no surprise: the relations between the UK and the EU have never been simple even before the beginning of the European Communities, and they became especially tortuous since the Fontainebleau Summit in 1984, when Margaret Thatcher pronounced her famous ‘I want my money back’. The summit was a milestone in these complicated relations, because it began a sequence of grants and privileges to the UK that might otherwise have abandoned the European project long before 2016.

All these European issues have their consequences at the local level, more specifically on the border that separates the seven municipalities of the Campo from Gibraltar. In this region 10,000 cross-border workers,3 whose earnings impact the entire local economy, depend on the border. Moreover, the business network generated by geographical proximity sees a no-deal scenario with increasing concern.

Sector analysis: economic interaction between Gibraltar and the Campo

The economies of Gibraltar and the Campo are closely linked. Their geographical proximity makes possible a high volume of exchange of production factors between them: around 18.5% of the region’s GDP in 2013 was due to the interaction with Gibraltar and the volume has been increasing over the past few years.4 5

Two types of interaction between the economies have been identified: cross-border employment and the exchange of goods. The first refers to the workers with a job in Gibraltar that reside in the Campo, whereas the second relates to the important volume of trade (not only goods but also services) that takes place between the two areas. The enrichment has been mutual: Gibraltar also benefits from the geographical proximity and, until now, also from the integration process.6

Cross-border employment generates around 11% of the total employment in the Campo7 and it is concentrated mainly in the wholesale and retail sectors, as well as in construction and the hotel industry. Assuming that cross-border workers adopt the same expenditure pattern to the rest of the Campo’s workers,8 their wages are mainly spent on housing, groceries, leisure and transport, generating new cycles of activity.

Concerning the cross-border exchange of goods, Gibraltar’s imports from Spain9 are concentrated in construction materials, wholesale and retail.10

This sectoral analysis shows that there are synergies between cross-border employment and the exchange of goods between the Campo and Gibraltar: the sectors in which trade is greater are those that employ a higher number of cross-border workers. The productive structures of both economies are complementary; hence the importance of ensuring the flow of productive factors without imposing obstacles at the border.

Theoretical analysis: towards a theory of the economic disintegration?

Brexit also offers an opportunity to revise economic doctrine. Until now, economic theories have studied the rapprochement between different economies as a cumulative and gradual process formed by different stages that acted as a sequence: in the case of the EU, the starting point was a customs union followed by an imperfect single market that would ultimately lead to a still incomplete monetary and economic union.

Generally, economic integration processes begin by a ‘negative’ integration that consists in eliminating obstacles to trade between Member States. As the integration process moves forward it starts to shift towards a ‘positive’ integration defined by the creation of institutions that drive and articulate the process.11 It will need two conditions to be successful: similar initial economic situations of the Member States12 and the existence of a consensus in the formal criteria to be adopted during integration, which can vary between intergovernmental and supranational.

The EU, however, did not comply with any of these two initial conditions: there were not enough economic symmetries between the Member States and there were significant differences between the approach that should be adopted for the European project to be successful. These divergences in the formal criteria slowed down its development since the very beginning, especially in the UK’s case.13 Even so and despite these difficulties, the EU has helped Member States decisively in achieving levels of wealth that would have been unreachable without an integration process.

Brexit, however, disrupts considerably the rules of the game and brings up the need of analysing the costs of re-establishing the barriers that were removed a long time ago. This new field in economic doctrine has been named the ‘theory of economic disintegration’ and it pursues the study of the increasing fragmentation of global value chains. The model presented in this paper uses this approach to reach its conclusions.14

How can Brexit be applied to this new paradigm? There are two key ideas: first, the research carried out so far agrees in that Brexit will have adverse effects for the UK’s economy because it will create new obstacles to trade, immigration and foreign investments. However, studies differ in the magnitude of these effects in the long term and point to uncertainty as the greatest concern in the short and medium terms.15

Secondly, the political momentum of Brexit has brought up an uncomfortable debate about the future of the European project, especially amongst Eurosceptics: is the European project truly compatible with the national sovereignties of Member States? The theory of economic disintegration does not only quantify the price that the UK will have to pay for its withdrawal, but also reflects the direction that the European project itself should take.16 This concern has been laid down by the European Commission in its recent ‘White Book about the Future of Europe’.17

Plausible scenarios after Brexit

The model in this paper analyses the economic effects of Brexit in the Campo de Gibraltar under two alternative scenarios that are compared to a counterfactual. The first scenario (‘optimistic’ in Figure 1 below) consists of a ‘soft’ Brexit, where the UK and the EU are able to reach an agreement that remarkably reduces non-tariff barriers but maintains the obligation of European standards for the products exported to Europe from the UK. The latter has full sovereignty overs migration control and borders. Concerning Gibraltar, the border is open but bureaucratic costs and non-tariff barriers increase compared with the counterfactual scenario.18

Conversely, in the second scenario (‘pessimistic’ in Figure 1 below) there is no agreement between the UK and the EU and the former negotiates its commercial position vis-à-vis the European countries through the World Trade Organisation (WTO). This would increase restrictions on the movement of people, goods and services between Gibraltar and the Campo, resulting in a significant downturn in economic activity.

In the counterfactual scenario the UK remains a Member State in the EU. It retains the four freedoms of the single market and also its obligations. We assume that economic activity between Gibraltar and the Campo does not vary because the model tries to isolate the structural effects of Brexit.


The predictions hereby presented have been made using a data base prepared specifically for this model. The variables have been carefully selected considering the interactions presented in the sectoral analysis: cross-border employment and exchange of goods. Since no disaggregated data for the Campo are available it has been necessary to territorialise it with regional data using a GAV (Gross Added Value)-related distribution key, using the methodology used by the Statistical Institute of Andalucía in similar studies.19

The model’s variables are as follows: income per habitant in the Campo; number of cross-border workers; employment level in the Campo; Gibraltar’s imports from Spain; Gibraltar’s GDP; and household income in the Campo. All of them have been used to create an econometric regression using the Ordinary Least Squares (OLS) technique where income per inhabitant acts as the dependent variable and the rest as regressors. Household income in the Campo has been used as a control variable in order to increase the quality of the results but has no part in the model’s interpretation.

In these predictions we assume that the data estimated for the year 2018 is representative and that it allows us to predict its future values in the ‘t+1’ period, which is taken as the year 2025. According to the different studies carried out so far,20 the initial effects of uncertainty will have dissipated by then and only structural effects will persist. The results are shown in Figure 1.

Figure 1. Predictions by variable under alternative scenarios

Figure 1 shows that predictions point to a negative tendency in every variable that gets worse in the pessimistic scenario. This first result supports the initial hypothesis of this empirical work: the economic effects of Brexit are worse in a scenario where the free movement of production factors is completely restricted.

In any event, the four freedoms (people, services, goods and capital) only take place in the counterfactual because in every other scenario the UK is no longer a Member State of the EU. Therefore, we obtain another result: whatever the Brexit negotiations may be, there will be negative economic effects due to the loss of the four freedoms of the single market, which are beneficial to both economies. The final result will be conditioned by the dynamics of negotiation in the upcoming months, especially in the agreements concerning borders.

Thirdly, the model also verifies another hypothesis. The Campo’s wealth seems to be explained simultaneously by two cumulative effects: cross-border employment and trade. The results show that both of them will be reduced after Brexit and that this will have negative consequences in the Campo’s economy. Figure 1 also shows that the variables linked to cross-border employment (number of cross-border workers and total employment) are more vulnerable to Brexit than those related to trade (imports and Gibraltar’s GDP).

Income per inhabitant in the Campo is the model’s most important variable, as it is the dependent variable in the OLS regression. Thus, its tendency is representative of the individual behaviour of all other variables and a specific analysis of its predicted values becomes significant: a 5% and an 8% fall in the optimistic and pessimistic scenarios respectively. Even if the difference between them may seem small, it can clearly be seen that income is 1.6 times more damaged in the latter.

However, it should also be clarified which of the two effects (employment or trade) has more weight in the total change of income per inhabitant in the two scenarios. All the variables decline in both scenarios, but they differ in each of the effects: while in the ‘employment effect’ the drop is equally distributed between the two variables (cross-border workers and total employment) in the ‘trade effect’ (imports and Gibraltar’s GDP) the change is mainly felt by imports. More specifically, according to the model it is expected that they might drop by 11% in the optimistic and 18% in the pessimistic scenario, whereas the GDP change would remain between 2% and 4%. We can see an additional result here: Brexit’s costs will take place mainly in the exchange of goods and, to a minor extent, in employment levels in the Campo (both cross-border and local).

Finally, these predictions allow us to conclude that Brexit will be detrimental to Gibraltar regardless of the outcome of the negotiations. In the optimistic scenario, Gibraltar would lose 2% of its GDP and, moreover, 11% of its imports from Spain. The latter would be especially harmful for an economy that depends on imports for its survival.


The econometric model presented in this paper allows us to quantify and determine the economic effects of Brexit in the Campo considering the current state of negotiations,21 the contributions of the theory of economic disintegration by Sampson22 and other authors and the specific nature of the interactions between Gibraltar and the Campo.

These interactions explain the wealth generated in the area due to the geographical proximity with Gibraltar through the ‘employment’ and ‘trade’ effects. They both generate positive effects in the economy and complement each other: the sectors where Gibraltar is more dependent in imports are those that employ most cross-border workers.

The mutually beneficial dependence between the two economies allows us to establish clearly that Brexit will be harmful to both parties. There will be increased costs for the mobility of production factors, particularly in imports and also, even if on a smaller scale, in cross-border and local employment.

These negative economic effects will be persistent no matter what the outcome of the present negotiations. However, they will be reduced if effective measures are taken in order to ensure the cross-border mobility of factors. Unilateral proceedings like closing the borders or increasing restrictions will be harmful to both economies. Ancient conflicts must be left behind and innovative solutions are needed to achieve a mutually beneficial solution. This paper shows how costs can rise if the parties fail to reach an agreement.

Luis Galiano Bastarrica
University of Seville, MA European Economic Studies - College of Europe (Bruges)

1 This article is based on a bachelor’s thesis at the University of Seville between January and June 2018. No facts were considered after April 2018 to create the model presented in it. The thesis was supervised by Eva Mª Buitrago Esquinas, Professor of Applied Economics at the University of Seville. This empirical work would have been impossible without her dedication, commitment and support.

3 HM Government of Gibraltar (2015a), ‘Employment survey’.

4 J. Fletcher, Y. Morakabati & K. Male (2015). ‘An economic impact study and analysis of the economies of Gibraltar and the Campo de Gibraltar, update 2015’, The Gibraltar Chamber of Commerce.

5 We do not consider here the economic activity generated by petroleum products.

6 HM Government of Gibraltar (2015b), ‘Abstract of statistics’.

7 HM Government of Gibraltar (2015a), op. cit.

8 Instituto de Estadística de Andalucía (2016), ‘Encuesta de presupuestos familiares’.

9 No disaggregated data were available on Gibraltar’s imports from the Campo.

10 HM Government of Gibraltar (2003), ‘Input-output study of Gibraltar’, (financial products are not considered).

11 E. Buitrago Esquinas & L. Romero Landa (2013), Economía de la Unión Europea, Ed. Pirámide, Madrid.

12 E. Feás (2017), ‘Brexit, Cataluña y la teoría de la desintegración económica’.

13 OECD (2018), ‘Organisation for European Economic Co-operation (OEEC)’.

14 A. Boussie, P. Foley, N. Hill, S. Punhani & G. Zanni (2016), ‘Brexiting the supply chain’.

15 B. Busch & J. Matthes (2016), ‘Brexit – the economic impact: A meta-analysis’, IW Report, 10/2016, p. 1-96.

T. Sampson (2017), ‘Brexit: the economics of international disintegration’, Journal of Economic Perspectives, vol. 31, nr 4, p. 163-184.

17 European Commission (2017), ‘Libro Blanco sobre el futuro de Europa’, Brussels.

18 A. Sentence, J. Hawksworth et al. (2016), ‘Leaving the EU: implications for the UK economy’, PricewaterhouseCoopers LLP, London.

19 I. Enrique Regueira (2009), ‘Estimación municipal del Valor Añadido Bruto en Andalucía’, Documentos de trabajo, nr 1, p. 1-57.

20 Busch & Matthes (2016), op. cit., p. 1-96.

21 Facts were taken into consideration for the empirical work until April 2018.

22 Sampson (2017), op. cit., p. 163-184.

<![CDATA[ Spain’s 20 years in the euro: a beneficial straitjacket ]]> 2019-01-04T12:15:36Z

We will never know with certainty whether Spain would have been better off not joining the euro. What we know is that in real GDP growth terms Spain has performed better than Germany, France and Italy since 1999.

Twenty years ago this month Spain was one of the 11 EU countries that started to use the euro when the common currency was first introduced. Joining the euro and being in the vanguard of a European movement, 13 years after Spain entered the European Economic Community (EEC) and ended a long period of isolation from mainstream Europe, was very much a matter of national pride.

Yet has it been worth it? Euro zone membership deprived Spain of its former capacity to set interest rates and devalue its currency. Interest rates are set by the European Central Bank, not by member state central banks, and euro zone countries cannot devalue. The loss of independence in these areas meant that when the Spanish economy entered a long period of recession as of 2008, as part of the meltdown of the North Atlantic financial system and the subsequent Eurozone debt crisis, it could not use some of the most important macroeconomic tools –monetary policy and exchange rates– to restore competitiveness and perhaps emerge from austerity more quickly and less painfully but not necessarily on a sustained basis. The country had to rely on ‘internal devaluation’, cutting production costs, mainly wages, in order to lower unit labour costs and make the economy more international and competitive.

Preparing the country for the euro, which involved a tough wrench, mainly fell to the conservative Popular Party under José María Aznar. When he took office in 1996, Spain met none of the criteria for joining the Economic and Monetary Union (EMU) as of 1999. Inflation, interest rates, the budget deficit and public debt all breached the convergence requirements enshrined in the Maastricht Treaty of 1992 for setting up the euro zone. Many policymakers and pundits thought Spain would never be fit for the purpose.

“The truth is that Spain’s decade-long boom was a false bonanza, as it was mainly propelled by the debt-fuelled property sector”

The Spanish political establishment was determined to prove them wrong. Civil servants agreed to a wage freeze, public spending was reduced, privatisations began on a larger scale than under the Socialists, and various structural measures were taken. By the spring of 1998, Spain had met the conditions: its budget deficit was less than the maximum allowance of 3% of GDP (6.5% in 1995), public debt as a proportion of GDP was on a downward path and inflation was down to 2% from 4.5% in 1995. With it, interest rates fell. The path was also eased by Spain being the largest net recipient of EEC funds.

The macroeconomic stability required for sustained economic growth as a result of meeting the euro criteria ushered in a virtuous circle of high growth, low inflation and job creation. The country’s per capita income increased from 80% of the average of the 15 EU countries in 1996 to 87% in 2004, and thanks to the creation of 1.8 million new jobs the unemployment rate dropped from 23% to 11.5% during this period. The economy was going so well that José Luis Rodríguez Zapatero, the Socialist Prime Minister between 2004 and 2011, adopted a football metaphor and proclaimed in September 2007 that Spain ‘has joined the Champions League’.

“The euro itself cannot be blamed for banks’ reckless and irresponsible lending practices”

The truth is that Spain’s decade-long boom was a false bonanza, as it was mainly propelled by the debt-fuelled property sector (construction’s share of GDP grew from 7.5% of GDP in 2000 to 10.8% in 2006), creating a massive bubble that burst as of 2008. But was that the euro’s fault? While building and consumption in general was spurred by the sharp drop in interest rates after Spain joined the euro –average short- and long-term rates fell from 13.3% and 11.7%, respectively, in 1992, to 3.0% and 2.2% in 1999 and to 2.2% and 3.4% in 2005, encouraging borrowers to go on a spending binge–, the euro itself cannot be blamed for banks’ reckless and irresponsible lending practices, particularly those of the politically-influenced cajas de ahorros (savings banks). The Bank of Spain did not do enough to discourage the orgy of borrowing, but it deserves credit for introducing macroprudential provisions. When several banks, including Bankia, the fourth-largest lender, were on the verge of collapse in 2012, euro membership enabled Spain to avail itself of the zone’s bailout fund, the European Stability Mechanism (ESM), without which the whole financial system might have gone awry.

Nor was the building of ‘ghost’ airports and other white-elephant projects scattered around the country the euro’s fault. Spain wasted more than €81 billion on ‘unnecessary, abandoned, under used or poorly planned infrastructure’ between 1995 and 2016, according to a damning report published by the Association of Spanish Geographers last year. Likewise, the euro is not to blame for Spain’s consistently high unemployment (it reached 24% in 1994, five years before the introduction of the euro, and it has never got below 8% since the euro was adopted). Today, the jobless rate stands at 15%, down from a peak of 27% in 2013.

“Spain suffered far more than Italy during the euro crisis, but it has also reformed more and, as a result, enjoyed a much stronger recovery”

The sharp drop in interest rates and in Spain’s risk premium (the yield spread with the German bond fell from 500bps in 1993 to below 50bps) enabled companies to borrow funds much more cheaply in order to expand abroad. The creation of a bevy of multinationals has been one of the most significant economic developments in Spain over the last 20 years (the stock of outward direct investment rose from US$129 billion in 2000 to US$597 billion in 2017). A stable currency (the peseta was devalued many times) has also been good for attracting inward foreign direct investment (it increased from US$156 billion in 2000 to US$644 billion in 2017) and keep relatively high living standards.

The strong euro did not hinder making Spain’s exports of goods and services more competitive (they rose from 26.4% of GDP in 1999 to around 34% in 2018).

Spain suffered far more than Italy during the euro crisis, but it has also reformed more and, as a result, enjoyed a much stronger recovery. The euro ‘straitjacket’ made Spain reform, to its benefit, while Italy resisted. Unlike Italy, Spain’s economic output has been above its pre-crisis peak since the middle of 2017. Italy’s GDP is still some 5% below its prior peak. There was no shortage of misguided predictions after the Spanish economy crashed that Spain might exit the euro. Whereas the populists in Italy’s government have toyed with leaving the common currency, all of Spain’s main parties support staying in.

Close to two-thirds (62%) of Spaniards believe the euro has been good for Spain, slightly down on a year ago, according to the latest Eurobarometer (see Figure 1). More than 20% of the population was not born when the euro came into force and has not known another currency.

Figure 1. Having the euro is a good or a bad thing for your country? (%) (1)
  A good thing A bad thing Can’t decide Don’t know
Euro area 64 (=) 33 (=) 7 (=) 4
Finland 75 (73) 15 (14) 7 (9) 3
France 59 (64) 29 (25) 6 (5) 6
Germany 70 (76) 21 (16) 7 (5) 2
Netherlands 69 (68) 21 (23) 6 (=) 4
Portugal 64 (60) 24 (26) 7 (10) 5
Italy 57 (45) 30 (40) 11 (12) 2
Spain 62 (65) 27 (23) 6 (=) 5

(1) 2017 figures in brackets.

Source: Eurobarometer, December 2018.

Three-quarters of people in the 19 euro zone countries are in favour of the euro, the highest since 2004. But that does not mean that all is well with the single currency, as even its most fervent advocates acknowledge. Its design flaws include the lack of a banking union (recognised but not fully implemented) and a system for making fiscal policy counter-cyclical. When economies are expanding, they need fiscal discipline and when in recession some freedom to borrow. Another omission is the absence of any means to ensure euro countries adopt structural reforms, which only tends to happen in times of crisis and as a last resort. Governance that is better designed for crisis management is also required.

We will never know with certainty whether Spain would have been better off not joining the euro. What we know is that in real GDP growth terms Spain has performed better than Germany, France and Italy since 1999. Were Spain to leave the single currency today and return to the peseta, the move would have huge repercussions, including skyrocketing interest rates and a currency devaluation.

William Chislett
Associate Analyst, Elcano Royal Institute
 | @WilliamChislet3

<![CDATA[ Italy’s budget battle with the European Commission ]]> 2018-11-14T07:02:44Z

The European Commission has rejected Italy’s proposed draft budget because of how seriously it breached prior fiscal commitments, including an increase in the deficit to 2.4% of GDP, three times higher than originally agreed.

The original version in Spanish was published by Agenda Pública

Challenging European institutions seems to be catching on. In September the Commission took Poland to the Court of Justice to force it to preserve the independence of its own Supreme Court. At the end of October, the head of Europe’s Brexit negotiation team, Michel Barnier, repeated for the umpteenth time to Prime Minister Theresa May that her Chequers plan is unworkable and that the Commission’s red lines are not flexible. Finally, the Commission also rejected Italy’s proposed draft budget because of how seriously it breached prior fiscal commitments, including an increase in the deficit to 2.4% of GDP, three times higher than originally agreed. This is the first time in the euro’s history that a draft budget has been rejected.

As a result, political collision seems inevitable. With the odd bedfellows Matteo Salvini –leading the xenophobic far-right Lega– and Luigi Di Maio –head of the 5 Star Movement, originally left-wing and ‘anti-system’ but now hard to categorise– in the Italian government, it is unlikely to be intimidated by Brussels although it could buckle under market pressure, as other Southern European countries did during the euro crisis.

Italy’s draft budget is explosive, combining the Trump-style tax cuts desired by the Lega with the increased spending demanded by the 5 Star Movement, in the form of higher minimum pensions and long-term unemployment subsidies –that could be akin to a minimum basic income–, further aggravated by a reduction in the retirement age that makes Brussels particularly uncomfortable. Nevertheless, the budget should be no surprise. The Italian government promised higher expenditure, a perfectly natural policy for a country that has been economically stagnant for two decades and whose infrastructure is literally collapsing, although it has so far not suggested an increase in revenue to fund a fiscal expansion that might satisfy Brussels. Hence, the President, Sergio Matarella –who could reject the budget as unconstitutional for violating prior Italian commitments to the EU– will very likely raise no objections in order to prevent ‘Europe and the establishment reject Italy’s budget’ from becoming the war cry of the government coalition’s campaign for the European elections next May. According to the latest Eurobarometer only 42% of Italians believe that EU membership is beneficial for Italy, six points less than the British, who are quitting the Union, and 30 points less than the Spanish. Clearly, the anti-Europeanism is a good selling point in Italy.

Figure 1. ‘Generally speaking, do you think that your country’s membership of the EU is…’ (%)
Figure 1. ‘Generally speaking, do you think that your country’s membership of the EU is…’ (%)

For its part, the Commission had no choice but to reject the draft budget, since it deviated so unjustifiably from what had been agreed, unlike the cases of other countries from which explanations were requested like Belgium, France, Spain, Slovenia and Portugal.

Italy should send the Commission an amended budget, although it most likely will not. The gesture of one of the Lega’s MEPs was highly revealing: after Commissioner Pierre Moscovici had presented the Commission’s opinion of the Italian budget he purposefully placed his shoe on top. Everything seems to suggest that Italy will continue challenging the Commission because it is not too concerned about possible sanctions, which would only be imposed in the spring of 2019 and be subject to a long list of conditions: that it is finally agreed that Italy’s debt is not on the right downward trend –since the deficit is below 3% it cannot give rise to sanctions–, that the data published next year support that conclusion, that the Commission proposes sanctions, that the Council approves them and a number of other aspects of the tortuous Stability and Growth Pact that needs reforming to make it simpler and more transparent…

“ (...) the real worry is that if Italy fails to improve its growth potential through the medium of reforms, it will find it increasingly difficult to remain in the euro”.

But the Italian government is aware that it will have to back down if the country’s risk premium shoots up as a result of both the budget and the subsequent confrontation with the Commission. After all, most Italians are dissatisfied with the EU but they do not want to leave the euro (similarly to the Greeks in 2015).

The question is how much market pressure will be required for the government to give way. From statements made the leaders of the government coalition it can be surmised that they will not budge until country risk is above 400 basis points, perhaps because they have done their maths and believe that up to that level the higher cost of debt will still not offset the budget’s fiscal stimulus, although that remains debatable. In any case, the government knows that the markets want growth, the budget is expansive and the country has some structural strengths that are often overlooked –such as a primary fiscal surplus, a current account surplus and a net positive international financial position (something Spain, for instance, lacks), while most of its public debt is held by Italian and not foreign savers–. Furthermore, for the time being the ECB is buying Italian debt via its quantitative easing programme and will continue to do so while credit quality does not decline (in which case it would not serve as collateral). All this suggests that the markets may take some time to react –with an Italian risk premium currently at 320 basis points– and instead wait and see if the situation is resolved before Italy finds itself on the ropes. As a backup, it appears that the Italian government has asked Russia for financial support, as Greece did at one point, although that would be an unlikely solution: Italy, after all, is still a richer country than Russia.

Although the Italian government’s style –especially Salvini’s– runs against the grain of Europe’s habitually suave diplomacy, there is still a window of opportunity for tension to wind down. This could happen if the markets put on more pressure, Italy begins to see the wolf at the door and the government makes minor changes to the budget –as regards, for instance, the age of retirement, certain items of expenditure or a proposal to increase revenue–, leading the Commission to finally approve the budget.

However, there is no guarantee that things will ultimately work out that way. Beyond Italy’s confrontation with the Commission, the real worry is that if Italy fails to improve its growth potential through the medium of reforms, it will find it increasingly difficult to remain in the euro. Since 1999 Italy has lost 20 per capita income points relative to Germany and today its income level is still roughly the same as when the euro was introduced. This is unsustainable over the long term. It is bleak outside the Monetary Union but, for many members, the euro at present is an unhappy marriage whose cost of divorce is simply too high. It must be made to function better.

Federico Steinberg
Professor at the Autonomous University of Madrid and Senior Analyst at the Elcano Royal Institute | @Steinbergf

<![CDATA[ Salvini’s Italy between Greek tragedy and Portuguese fado ]]> 2018-10-19T02:29:57Z

Salvini has struck a heroic pose because he knows it attracts votes in Italy. Conversely, his pugnaciousness makes him many enemies in Brussels and elsewhere. It might not be a bad idea to implement some of the structural improvements recommended by the European Commission.

The original version in Spanish was published by Agenda Pública.

Italy is the chronicle of a conflict foretold. It was evident the government of Giuseppe Conte –directed by his political patrons, Luigi Di Maio (of the Five Star Movement) and Matteo Salvini (leader of the Lega and, for many, Europe’s strongest because most feared politician)– would clash with the European Commission over the deficit levels of the new Italian public budget. Di Maio and Salvini convinced (or more likely compelled) their Minister of Finance, Giovanni Tria, to allow the deficit for 2016 to rise from a planned 1.6% of GDP to 2.4%, which was received in Brussels like a slap in the face. In response, the Commission’s President, Jean-Claude Juncker, was very firm: Italy cannot receive favoured treatment, for ‘if everyone received it, that would be the end of the euro’.

I have just returned from a few days in Italy, where the tension was plain to see. I had the opportunity to attend a meeting of young US and Italian leaders from a variety of sectors, organised by the Italy-US Council. The level of concern amongst the Italian contingent was more than noticeable. Many feared that Salvini would over-estimate his own strength in his battle with Brussels and push the country into an even more acute crisis. The ghost of the Greek tragedy of 2015 was in the air. Nevertheless, many of these young Italian executives and entrepreneurs understand that their current government has a popular mandate. If the politicians who won the elections with such a broad majority have promised a basic subsidy for the long-term unemployed, a minimum pension of €780 and a tax cut for nearly a million workers, naturally the deficit will increase.

“Salvini has struck a heroic pose because he knows it arouses sympathy and attracts votes in Italy. Conversely, his pugnaciousness makes him many enemies in Brussels and elsewhere”

It is possible to feel a certain sympathy for Italy’s increased spending. The country has been stagnating for decades and its public accounts are subject to the iron-fisted control of senior civil servants in the Treasury, who know that Italy’s hefty public debt (over 130% of GDP and €2.3 trillion in volume) does not leave the state much elbow room. In a sense Salvini’s government could do what Antonio Costa’s did in Portugal. When the latter came to power –also on the back of an unprecedented coalition that generated as much mistrust in Brussels as in the markets– many commentators thought his anti-austerity measures reckless. Nearly three years later, however, Portugal is bringing down its debt –despite (or perhaps as a result of) raising the salaries of civil servants–, increasing pensions, cutting unemployment and recording over 2% growth.

And this is precisely Giovanni Tria’s vision. At the last Eurogroup meeting he apparently asked his colleagues for an opportunity: a chance to apply stimulus policies to conjure up the primeval spirit needed to re-launch the economy. If the experiment works, it might even bring down Italy’s debt.

It sounds reasonable, but the snag is more the style than the substance. Were Salvini to go to Brussels singing a mellow Portuguse fado like Costa did, he would raise far greater sympathy. But, to the contrary, the Lega’s leader seems to have chosen drama and Greek tragedy. He has sought confrontation and constantly provoked the Commission and the Union’s northern members. Like Varoufakis in his day, Salvini has struck a heroic pose because he knows it arouses sympathy and attracts votes in Italy. Conversely, his pugnaciousness makes him many enemies in Brussels and elsewhere. The EU is based upon dialogue, alliances and mutual commitment and at present Italy has not a single ally in the Eurogroup, not even Malta. Salvini does not seem to grasp that today it is much more difficult to play the old ‘two-level’ game in the EU. In an ever more integrated and interconnected Europe, ranting at home is heard by the entire neighbourhood. By playing the tough guy in Italy, when in Brussels the legitimate representatives of the other European democracies will have to be tough too, precisely so as not to lose votes at home. That is how democracy works.

Italy is a club member that tends to be underestimated: certainly, it has a large public debt, but it also has a primary surplus and its debt stock has a relatively long average maturity. The country also has an almost structural current account surplus (my visit to Trentino and Alto Adige only confirmed my view of northern Italy’s powerful export strength), while its net international investment position (ie, its net foreign debt) improved from -24% in 2014 to -8% in 2018. It can therefore stand its ground for a few rounds with Brussels (which the Commission knows). However, if confrontation continues unabated, the markets will start to get jittery, the risk premium will shoot up, Italy’s banks will see their Italian public debt holdings lose market value and the country could swiftly descend into a vicious cycle like the one that overwhelmed Greece in 2015, particularly if Salvini starts to play the ‘Italy might leave the euro’ card. This seems unlikely at the moment, but it remains a powerful political weapon especially if Brussels appears before Italian public opinion as the implacable bureaucratic monster.

My advice to Salvini and Di Maio would be not to follow in Varoufakis’ wake. They should choose the Portuguese fado (even if a melancholy acceptance that heroics are something of the past) over Greek tragedy (which always ends in tears). It might not be a bad idea to take the European Commission’s most recent country report on Italy and implement some of the structural improvements it recommends. Commissioner Moscovici and the Eurogroup would then surely be more flexible and a more positive dynamic could be fostered, on balance benefitting Italy. In the final analysis, what Italy needs is more investment and higher productivity, and this cannot be achieved with higher consumption alone. In that too, Portugal can be an apt lesson on what to avoid: its productivity levels remain low.

Miguel Otero-Iglesias
Senior Analyst, Elcano Royal Institute
 | @miotei