International Economics - Elcano Royal Institute empty_context Copyright (c), 2002-2018 Fundación Real Instituto Elcano Lotus Web Content Management <![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

<![CDATA[ Juncker and Trump end the trade war and revive a watered-down version of TTIP ]]> 2018-10-02T05:32:58Z

It is good news that Trump treated Juncker as an equal and has understood that the EU is the key trade partner of the US.

Original version in Spanish: Juncker y Trump frenan la guerra comercial y resucitan el TTIP, en versión descafeinada

The US and the EU have decided to end their trade war, at least for the moment. After a meeting in Washington on 25 July, the President of the European Commission, Jean-Claude Juncker, and the US President, Donald Trump, committed themselves to working together to create a transatlantic free-trade zone that would have no tariffs, subsidies or non-tariff barriers (although it would exclude the automobile sector). To begin with –although it is not at all clear how this will be achieved– the US will export more liquified natural gas to the EU (which would lower EU energy dependence on Russia) and the EU countries will buy more US agricultural produce (especially soy bean products). They will also begin to back away from the mutual tariff escalation that began a few months ago when the US imposed tariffs on European steel and aluminium imports, alleging (absurdly) reasons of national security and provoking a proportional response of reprisal tariffs from the EU. Therefore, while the negotiations remain underway, no new tariffs will be established (the US had promised to impose new tariffs on EU automobiles) and the two sides will work to eliminate the tariffs that have recently been approved. Finally, both powers will study together a possible reform of the World Trade Organisation (WTO) that would allow it to once again play an arbiter’s role in the governance of globalisation that, in recent years, it had been denied by the US.

“If Trump’s aim is to eliminate transatlantic tariffs he could have avoided this last year of rising trade tension”

In short, after months of playing a game of ‘who blinks first’ –which turned into a dangerous tariff escalation with no end in sight and that, in addition, undermined the confidence of both sides–, the US and the EU have decided to wind down the tension and search for a negotiated solution. This is good news for everyone. So, neither ‘trade wars are good and easy to win’ nor ‘tariffs are great’ (according to Trump via Twitter). The global economy had much to lose if the situation was not resolved soon. Although the trade war would not have generated a recession by itself (and its effects would have been fully felt only over the medium to long terms), escalation of the conflict dangerously threatened to destroy the WTO’s multilateral system of rules that has underpinned the liberal international order and a large part of the prosperity generated in recent decades (even if its distribution has remained overly unequal). Furthermore, the dynamic of confrontation also threatened to generate an irreversible breach in the transatlantic relationship, clearly visible both at the latest G7 Summit in Canada and at the summit meeting of the Atlantic Alliance in Brussels.

Nevertheless, things have not returned to normal. First, Trump continues to be an unpredictable nationalist whose word is worth very little. To the extent that this decision allows him to sell to his electorate the notion that he has forced the EU to bend to his will with his impressive negotiating skills, then Trump will be true to his word. But if that does not work, or becomes unnecessary, he could easily change his mind, especially when he sees that the US current account deficit does not decline (and it will not as long as the country continues to reduce taxes and undermine the national saving rate) or that German exports to the US remain strong due to the Americans’ inclination to continue buying top-of-the-range German cars.

Secondly, what has really happened with all this is that we have simply returned to the negotiation agenda of the forgotten TTIP, the trade and investment treaty between the US and the EU (under negotiation since 2013 but abandoned by the Trump Administration in 2017). If Trump’s aim is to eliminate transatlantic tariffs he could have avoided this last year of rising trade tension. The TTIP already incorporated a negotiated reduction of practically all manufactured goods tariffs between the US and the EU. The negotiations had also agreed upon an increase in the LNG trade as well as a deeper convergence between transatlantic regulatory standards. On the other hand, the TTIP had already got bogged down over the harmonisation or mutual recognition of the rules governing both markets (essential for facilitating transatlantic trade in services). The treaty had also run into substantial resistance generated by the different regulatory traditions in respect to the precautionary principle, consumer protection, food security and financial regulation, among other areas. The TTIP had also been strongly opposed both by Europe’s citizens (because it would establish an investment arbitration mechanism championed by the US) and by the US authorities (who have not countenanced the idea of opening their lucrative public procurement markets to European companies). Given that neither of these stumbling blocks will be resolved soon (in fact, the opposition to Trump in Europe will make an ambitious transatlantic trade accord that much more difficult to achieve), the best case scenario might produce a light TTIP (focused on the full elimination of tariffs), the benefits of which we could already have been enjoying for the past two years if we had wanted that version of the treaty. But because Trump likes to seem the great negotiator who resolves problems he must first generate a false conflict where none existed before so that later he can give the impression that he has resolved it, when actually he has done nothing more than pull back his position, and always with an intimidating attitude and a disdain for the rules which allow international affairs to be something more than a minefield.

Beyond the need to bring the current trade war to an end, it is now paramount for the US and the EU to work with Japan and other like-minded powers to adapt the international trade rules of the WTO to the current economic reality in a way that can integrate China within the governance of globalisation without having to fight a trade war with it. This is the major challenge that we face and the most difficult. But it is good news that Trump treated Juncker as an equal and has understood that the EU is the key trade partner of the US.

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

<![CDATA[ Portugal versus Spain: an Iberian economic saga ]]> 2018-08-06T07:29:31Z

This paper aims to compare the socio-economic trends of Spain and Portugal. Eventually the goal is to determine the alleged soundness of Portugal’s performance.


This paper aims to compare the socio-economic trends of Spain and Portugal. Eventually the goal is to determine the alleged soundness of Portugal’s performance.


Spain and Portugal have been the focus of international attention due to their respective economic recoveries in recent years, coming from very difficult economic times. Both were, along with Greece and Italy, among the EU nations most affected by the 2008 crisis, suffering from economic contraction, high levels of unemployment, internal and external indebtedness, wide public deficits and, in the case of Spain, a gigantic real-estate bubble. Nevertheless, and despite the countries’ achievements in sorting out their economic woes, Portugal’s improvement is seen as miraculous, while Spanish achievements are somewhat undervalued. The question now is to elucidate if these arguments are well substantiated and analyse the demographic and economic foundations of both countries. As John Adams wrote in 1770, ‘facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passions, they cannot alter the state of facts and evidence’. So let us find out.


A long time has passed since Portugal and Spain, the two neighbours of the Iberian Peninsula, stood out along with Greece and Ireland as the worst performers of the EU, the so-called PIGS –a nasty, derogatory acronym to describe the economies of these countries during the financial crisis–. Things have changed notably since then.

Portugal is now often cited as an example of economic resurgence, applauded by international institutions. Most of the praise is based on the good behaviour of its unemployment rate. To put the claim in perspective, as shown in Figure 1, Spain and Portugal had similar unemployment rates at the end of the previous expansive cycle. Since then, the Spanish rate skyrocketed to the historical figure of 26.3% in mid-2013, while Portuguese unemployment rose to 17.5% during the same period. Here, the impact of the Spanish real-estate bubble is evident, as we will see later in this analysis. From 2013 on, both rates followed parallel courses, dropping to 15.9% in Spain (10.4 percentage points down) and to 7.4% in Portugal (down 10.1 pp). The main difference is that Portuguese unemployment levels are currently below those of 2008, whereas Spain’s are still far above them.

Figure 1. Spain and Portugal: comparative unemployment rates, 1995-2018. Source: Eurostat and the authors (@_combarro_).

Both countries are recovering from very hard times. Seven years ago, Portugal needed a bailout of €78 billion (US$92.2 billion) from EU institutions and the International Monetary Fund. After many economic and fiscal reforms, led by a centre-right coalition government under the supervision of the IMF and the EU, Portugal freed itself from international assistance in June 2014. Since then, the Portuguese economy’s pace picked up. The country also managed to exit the eurozone’s ‘excessive deficit procedure’ in 2017.

In Spain things have also substantially improved. Over the past few months, the rating agencies Moody’s, Standard and Poor’s and Fitch have all upgraded Spanish sovereign debt ratings. It appears that the country’s economy is on a robust but more resilient course than in previous expansions. This is reflected in its improved growth forecasts for 2018 and 2019, both from the IMF and the EU Commission. The days of astonishingly painful levels of unemployment (which peaked at 26%) and huge fiscal deficits (topped at 11% of GDP) now seem far behind.

Despite these apparent similarities in both countries’ recent achievements, there seems to be a consensus, especially among progressive media and analysts, to refer to Portugal’s improvement as a kind of ‘miracle’ while somewhat undervaluing Spanish achievements. The current Portuguese socialist government, in power since October 2015 and backed by two far-left parties in parliament, argues that its anti-austerity strategy, which included rolling back pension and salary cuts, is behind the country’s good performance. The popularity achieved due to these measures by its former Finance Minister Mario Centeno, a Harvard-educated economist, helped him to win the race to become President of the Eurogroup, one of the eurozone’s most important policymaking posts.

At this point, some questions come to mind. Are all these claims fair and well substantiated? Is Portuguese economic growth as robust and sustainable as alleged? Moreover, are Portuguese and Spanish socio-economic foundations and models similar? What about their respective weaknesses? Doing a similar exercise as that developed for Italy and Spain, we now aim to compare the socio-economic trends of the two Iberian countries. Eventually our goal is to find out whether Portugal’s performance is structural or merely temporary.


We can undoubtedly affirm that demography is one of the most serious issues in Portugal. As reflected by the British Centre for Policy studies, in recent years EU members have experienced similar demographic trends: a declining fertility rate, an aging population and slowing rates of population growth. But amongst Western European countries, Portugal stands out. Its rate of population growth has dropped quickly in recent years and it currently has one of the fastest declining populations in Europe. Spain, although showing similar overall trends, has a more robust demographic foundation than Portugal thanks to immigration. The Portuguese net migration rate has been negative since 2011 and the country has not benefited from any immigration boom, while Spain ranked second in the list of the top-10 world nations with the highest levels of net migration between 2000 and 2010, according to the UN. Moreover, after a parenthesis of negative net migration rates between 2011 and 2015, Spain has come back to positive population inflows. Figure 2 shows the impact of this phenomenon.

Figure 2. Spain and Portugal: total population and working age population, 1997-2019. Source: European Commission and the authors (@_combarro_).

Although the increase in the population aged over 65 is growing at the same pace in both countries, net migration helped Spain refresh its demographic base with young people, and that also impacted on the overall ageing rate, as shown in Figure 3.

Figure 3. Spain and Portugal: population over 65 and under 15-year-old, plus aging rate, 1997-2019. Source: European Commission and the authors (@_combarro_).

According to the European Commission, the demographic forecasts are not favourable for either countries, but the Portuguese situation is clearly worse. Figure 4 shows how net migration at current levels is unlikely to prevent Portugal from shrinking. In the mid-term, to assure sustainable growth, the country will urgently need to attract and retain new people, which ultimately means new workers, or increase its birth rate or learn to live with a declining population. A challenging task.

Figure 4. Forecasted change of population, 2017-50, with and without migration. Source: The Economist, based on Eurostat.


The Spanish economy, unlike the Portuguese, experienced big structural changes in the job market over the past decade, fueled by the immigration boom of the 2000s and the increasing female labour-force participation rate, which in 2013 practically reached Portuguese levels. That marked the huge difference in the active population shown in Figure 5, which in Spain rose by 40% between 1997 and 2008, compared with a modest 10% in Portugal.

Figure 5. Spain and Portugal: active population and activity rate, 1997-2019. Source: European Commission and the authors (@_combarro_).

During the expansive phase of its economy, up to 2008, and despite its population growth, Spain generated 45% of the additional employment existing in 1997, while in Portugal the increase was only 10%. As shown in Figure 5, the Spanish employment rate gradually converged with the Portuguese, from a 15-percentage point difference to less than 5pp. The big crisis abruptly broke this trend in both countries, most significantly in Spain, due to the bursting of its gigantic real-estate bubble, something that did not occur in Portugal. After a swift deterioration, the gap between the two countries has remained stable.

The number of employed and employment and unemployment rates (Figure 6) provide a good general comparative picture of the respective labour markets. A notable feature is the structural nature of the higher unemployment figures in Spain, as well as its deeper and longer fall in overall employment during the recession. During the recovery, both countries grew steadily, with 2017 being an especially vigorous year for Portugal.

Figure 6. Spain and Portugal: employed, employment rate, unemployment rate and total hours worked, 1997-2019. Source: European Commission and the authors (@_combarro_).

To better understand the labour market differences between the two countries, a sectoral analysis is necessary. Figure 7 shows the abrupt Spanish drop in industry and construction during the crisis, coherent with the bursting of the real-estate bubble. Nevertheless, the key factor that elucidates the extraordinary evolution of employment indicators in Portugal is the growth of hours worked in wholesale and retail trade, transport, accommodation and food service activities, directly linked to tourism, as mentioned in the introduction to this paper. Here, the Portuguese figures rocketed in 2017, compared with a more modest growth in Spain. This also explains that the most dynamic region regarding employment growth is currently the tourist-based Algarve, which has clearly overtaken central Portugal (as shown in Figure 8). Additionally, the female labour force is primarily responsible for the increase.

Figure 7. Spain and Portugal: comparison of hours worked, total and selected sectors, 2008-18. Source: EUROSTAT and the authors (@_combarro_).

In addition, another key structural difference between the Portuguese and Spanish labour markets should not be ignored: the regional setup. Portugal has a homogeneous labour distribution throughout its territory, with similar male and female employment rates in the different regions. On the contrary, in Spain, the regional contrasts are very noticeable. Figure 8 shows a comparison of employment rates between Madrid and Andalusia in Spain, on the one hand, and those of the Algarve and northern Portugal, on the other. Again, it is useful to note the sharp increase of the female employment rate in the Algarve tourist region.

Figure 8. Comparison of employment rates, men and women, selected regions, 1999-2017. Source: EUROSTAT and the authors (@_combarro_).

In summary, the sharp rise in Portuguese employment and its activity rate during 2017 was sustained by tourist areas and by increased female participation. Nevertheless, this noticeable job creation (3.3%) was only partially reflected in the overall GDP (2.7%), which means a negative apparent productivity of labour (Figure 9). This implies that despite wage moderation, unit labour costs in Portugal are rising and it could involve a gradual loss of competitiveness, at least relative to Spain and to other members of the common currency area. The data also indicate the exceptionality of the country’s employment figures in 2017, something already pointed out by the European Commission in its 2018 and 2019 forecasts.

Figure 9. Spain and Portugal: evolution in apparent labour productivity, 2011-17 (annual %). Source: EUROSTAT and the authors (@_combarro_).

GDP and growth

The eurozone grew at its fastest rate in a decade in 2017, with a gross domestic product expansion of 2.3%. Both Spain and Portugal stood out in this area. Spanish GDP growth remained strong in 2017, at 3.1%, above the euro area average for the third year running. For its part, Portuguese economic growth picked up to 2.7% in 2017, as mentioned above. Nevertheless, the size and structure of both economies are notably different.

Spain is, according to the most recent FMI estimates, the 15th largest world economy (in PPP terms), with Portugal 55th. In terms of per capita GDP (PPP) the gap is smaller, with Spain ranking 32nd and its neighbour 43rd. If we go beyond the GDP for comparison, using the Human Development Index, Spain and Portugal are placed 27th and 41st, respectively. Figure 10 shows the comparative evolution of the main growth indicators, reflecting the Spanish boom of the 2000s and the deeper impact of its crisis. After the recovery, both countries are growing above their potential GDPs, outperforming expectations.

Figure 10. Spain and Portugal: evolution of growth indicators, 1997-2019. Source: European Commission and the authors (@_combarro_).

Figure 11 helps to better compare the differences in GDP growth and the contributions in each country. Private consumption, net investment and sound exports have been the main drivers of the Spanish economic growth model these past years, also with an important role for the public sector, which is now starting to grow. Portugal has a less diversified economy, something that the new progressive government wants to improve through a pragmatic approach. In fact, it has followed many of the economic guidelines set by its conservative predecessor, setting up an intensive National Reform Programme to have a more dynamic economy that is attractive to investment and starting to show its effects. Domestic demand (supported by job creation, wage growth and favourable financing conditions) is strong and tourism remains a major driver, as explained above (accounting for 11% of Portuguese GDP and 8% of employment). Investment growth rose thanks to an upturn in construction and equipment. A recent capacity expansion in the automotive sector is projected to provide a more robust framework.

Figure 11. Spain and Portugal: contribution to GDP growth, 2010-18. Source: EUROSTAT and the authors (@_combarro_).

Figure 12 summarises the accumulated growth in active population, employment and real GDP from 2008 to 2017, as well as the resulting growth in the apparent productivity of labour. The large decline in Portugal’s active population has been a key contributor to the reduction in the country’s unemployment rate. Moreover, the overall growth in the apparent productivity of labour was significantly lower in Portugal than in Spain. Both indicators (lower active population growth plus lower productivity) will have negative effects for Portugal in the mid-term, even though in the short term they apparently favour a reduction in the unemployment rate.

Figure 12. Comparative selected indicators related to growth, 2008-17.Source: the authors.

Finally, focusing only on the past two years, despite Portugal’s exceptional achievements, its economic growth has been lower than Spain’s, as shown in Figure 13.

Figure 13. Spain and Portugal: comparative quarterly GDP evolution, 2012-18 (annual rate). Source: EUROSTAT and the authors (@_combarro_).

Wage, salaries and productivity

At this stage, mention should be made of the severe adjustments undertaken in the Portuguese public sector as a result of the reformist agenda that accompanied the country’s bailout. Public financial management has been substantially improved, the receipts from an ambitious privatisation agenda exceeded the initial Programme target, a significant reduction in public administration staff numbers was achieved, including through early retirement and mutually-agreed contract termination, while several attempts by the government to reduce public-sector wages were mostly ruled unconstitutional. These adjustments in the public sector are shown in Figure 14. Wages are projected to gradually grow over 2018-19 along with the unfreezing of career advancement in the public sector.

Figure 14. Spain and Portugal: wage and salary growth, selected sectors, 2008-18. Source: EUROSTAT and the authors (@_combarro_).

Regarding productivity, as shown in Figure 15, there is a clear divergence between Portugal and both Spain and the euro area average. The trend is even clearer if considering Portuguese productivity in reference to the entire EU, which has been consistently declining since 2013. Portugal is experiencing a greater slowdown in productivity growth than in advanced economies. The rising and deeper integration of the Portuguese economy in global markets in recent years was expected to lead to a convergence in productivity, but this is not occurring. A very interesting paper by Ricardo Pinheiro Alves, of the Gabinete de Estratégia e Estudos of the Portuguese Ministry of Economy, concludes that the increasing misallocation of capital, labour and skills both at a sectoral and business level are behind this productivity issue. Additionally, we believe that the rapid growth in employment in the tourist sector, as well as the relative importance of agriculture in Portugal, also weigh on these poor results.

In contrast, Spanish productivity has increased steadily over the crisis. Most of the adjustment from 2008 to 2011 came from job destruction, but since then there are two factors that have contributed to productivity growth: (1) the strong recovery in exports, with a fair product diversification; and (2) the effects of labour market reform. On the other hand, there are still elements that prevent productivity from growing more markedly: the overreliance on temporary workers (much more pronounced in Spain than in Portugal); persistent rigidities in the wage setting system; a high concentration of export firms, leading to a lack of competition; and the small size (and consequently, low productivity) of Spanish companies, which account for a large part of employment and output. The latter is also a Portuguese feature.

Figure 15. Spain, Portugal and the euro area: productivity per hour worked, 2008-18. Source: the authors (@_combarro_).


According to the World Trade Statistical Review 2017, Spain ranks 16th in the world ranking of merchandise exporters and 11th in commercial services, while Portugal is 47th and 35th, respectively.

Figure 16. Spain and Portugal: total exports (current and volume) and share of exports in global trade, 1997-2019. Source: European Commission and the authors (@_combarro_).

Both the Portuguese and Spanish foreign sectors have been gaining importance in recent years. Between 2005 and 2017 Portuguese exports increased their share of GDP by 16 percentage points in nominal terms, and now account for more than 40% of GDP. Exports have, along with tourism, been the key element in the recovery of the Portuguese economy. The dependence of Portuguese exports on European countries has decreased from 80.3% of total exports of goods in 2005 to 73% in 2017, bringing more robustness and diversification. Exports outside the EU increased their share from 19.7% in 2005 to 26.8% in 2017, with the US being Portugal’s biggest non-European trading partner. Brazil and Angola, as former Portuguese colonies, are also important destinations. According to Caixabank Research, part of the increase in Portugal’s trading volume in recent years can be explained by its greater participation in global production chains, with an increasing demand for Portuguese products in the countries of the ASEAN bloc, China and India.

Regarding Spain, as explained in the Elcano Expert Comment 16/2018, Spain’s exporting strength continued in 2017 when sales of goods abroad increased for the eighth consecutive year and reached a new record of €277.1 billion, close to one quarter of GDP. External demand has been largely responsible for Spain’s recovery. Spanish exports are less dependent on the country’s EU partners than Portugal (65.7% of the total). The increased geographical diversification of exports has helped to boost sales in relatively new markets such as China and Turkey. The leading export sectors were capital goods (20.3% of the total and up 9.2%), food, drinks and tobacco (16.5% and 6.3%, respectively) and the motor industry (16.3% and 0.1%). Spanish exports are expected to grow strongly in 2018 and 2019, as Spain continues to register small gains in market share despite the projected appreciation of the euro.

When it comes to bilateral trade, Spain has been increasing its share in Portuguese imports (from 27% in 2012 to 33% in 2016), whereas the Portuguese share of the Spanish market remained relatively stable at around 3.9%-4%. According to the latest official statistics, figures on bilateral trade between January and December 2017 show a year-on-year increase in Spanish exports to Portugal of 10.1% (€19.844 million). Spanish imports from Portugal amounted to €11.001 million, a year-on-year increase of 0.9%.

Debt and deficit

High gross public debt-to-GDP ratios have been one of the main economic Portuguese woes during the crisis, but after falling by 4.2 pp to 125.7% in 2017, they are forecasted to decline further to 122.5% in 2018 and 119.5% in 2019, mainly due to fiscal adjustments and economic growth (Figure 17). By contrast, the Spanish public-debt ratio recently stabilised at around 100% of GDP and is also experiencing a reduction.

Figure 17. Spain and Portugal: public debt and financing conditions, 1997-2019. Source: European Commission and the authors (@_combarro_).

Regarding private debt, Portugal still has to deal with a high level of bad loans in the banking system (16.7%, while the figure is 4.8% in Spain) and substantial consolidated private sector debt (163.5%, compared with 139.2% in Spain, according to Eurostat). In this regard, Portugal remains more vulnerable to macroeconomic downturns than its neighbour. Here it is important to highlight that both countries benefit greatly from the favourable financing conditions set by the European Central Bank’s monetary policy in recent years.

Net international investment position

The comparison in this area shows similar patterns but still a significant difference between the two countries. Portugal is more indebted to the world than Spain. Since the introduction of the euro, both countries’ net foreign assets declined, but Spain has finally managed to reduce its large current-account deficit to a greater extent than Portugal and has recently shifted to external surpluses, which has been sufficient to stabilise and slowly reduce its net external indebtedness. The recovery in Portugal appears clearly weaker in this area.

Figure 18. Spain and Portugal: net international investment positions, 1997-2017 (% of GDP). Source: EUROSTAT and the authors (@_combarro_).


The facts and figures analysed so far speak for themselves. Our key findings shows that:

  1. Portugal has a much severe demographic problem than Spain, with no sign of improvement. This weighs heavily on its economic future, as the country needs to reduce emigration and at the same time encourage the growth of businesses with limited resources. Lowering the barriers for the immigration of non-EU workers and investing in human capital will be the only viable ways to improve.

  2. The apparent productivity of labour in Portugal is much lower than in Spain and has been declining over time. This implies a gradual lose of competitiveness, both relative to Spain and to other members of the eurozone.

  3. The main driver of Portuguese employment growth is tourism. The tourism boom has made the industry one of the biggest contributors to the national economy and is now its largest employer, with female labour-force participation playing a key role in the take-off. Spain’s labour framework remains more diversified.

  4. The three factors above, although fostering a rapid improvement in the Portuguese economy, are not sustainable over time, reducing the country’s growth prospects in the mid-term.

  5. Despite its very noticeable economic developments, both public and external debt place the Portuguese economy in a more vulnerable situation than Spain’s.

In summary, even though Portugal has achieved substantinal progress over the past few years, returning to economic growth and budgetary stability (thanks to a severe, partially imposed, plan of reforms), which has been enthusiasticaly called ‘the Portuguese miracle’, seems to have been mainly the result of a temporary rise in tourism but resting on a very negative demographic base combined with low productivity. This reduces the apparent unemployment rate but makes mid-term economic expectations worse. Such a lack of sustainability, along with public and private debt issues, are a cause of reasonable concern.

Spain, on the other hand, shows a better macroeconomic position overall and its macroeconomic improvements deserve greater recognition, although this should not lead in any case to self infulgence and conformism. Further changes are needed in the labour market, fiscal system and regional financing. The sustained growth and employment recovery of recent years should be reflected in increasing wages in the private sector and better opportunities for both young people and the more disadvantaged social groups. In this regard, and due to its territorial configuration, Spain lacks Portugal’s market and administrative uniformity, making the implementation of reforms more difficult and increasing regional disparities. Figure 19 perfectly summarises the situation. In a country where territorial administrations manage around 50% of public expenditure and account for 77% of public employees, administrative standardisation, coordination and simplification are essential to prosper and compete in the global arena.

Figure 19. Spain and Portugal: regional employment rate, 2017
Figure 19. Spain and Portugal: regional employment rate, 2017. Source: EUROSTAT and the authors (@_combarro_).
Source: EUROSTATS and the authors (@_combarro_).

Sebastián Puig
Analyst, European External Action Service | @Lentejitas

Ángel Sánchez
Professor of Macroeconomics, UNED

<![CDATA[ Renminbi internationalisation: stuck in mid-river – for now ]]> 2018-07-04T11:57:45Z

This paper looks at the internationalisation of the renminbi in May 2018, why it has stagnated since 2015 and what its possible future course might be.


This paper looks at the internationalisation of the renminbi in May 2018, why it has stagnated since 2015 and what its possible future course might be.


A Chinese proverb suggests that one should always be cautious and cross a river by testing the stepping-stones. It can be said that the Chinese authorities progressed fairly quickly in internationalising the renminbi between 2010 and 2015 remaining in fairly shallow waters close to the shore, but once they ventured into deeper and choppier waters (ie, the stock market turbulences of 2015) they realised their foreign exchange reserves were swiftly haemorrhaging and they decided to go back to a more active intervention in foreign exchange markets and to tighter capital controls. This slowed down the internationalisation process. The question now is whether the Chinese authorities will give up and withdraw or forge ahead. If the latter, conventional wisdom would suggest they follow a liberal course of action. But perhaps there is an illiberal option more suited to China’s state-led capitalism: in this alternative track the Belt and Road Initiative (BRI) can have the potential to provide the necessary stable footing to complete the endeavour the Chinese way. But it would be advisable not to wait with bated breath.


The motivations behind China’s internationalisation of its currency have become only too obvious in the aftermath of the global financial crisis of 2008-09. They can be summarised thus: (1) China wants a currency to match its economic status, since it is the world’s second biggest economy and the leader in purchasing power parity it wants its currency to be among the top ones; (2) it has realised with the crisis that it is too dependent on the US dollar, as made evident when Lehman Brothers collapsed in the autumn of 2008, when a dollar shortage spread throughout the world and economic activity plunged even in East Asia, the world’s most dynamic region; (3) by having an international currency, Chinese export and import companies can avoid exchange-rate risk, while firms and banks can invest all over the world in their own currency and, due to the demand for Chinese currency, foreign financing can therefore be cheaper; (4) it wants to develop its own financial centres in order to compete with New York and London, and while Hong Kong is already a top financial hub, Shanghai is not there yet and internationalisation will give it the boost it needs; and (5) many in China believe that for the renminbi (RMB) to be successful it will require certain structural, and difficult, reforms for China to continue benefitting from a sustainable growth.2

Since the Chinese government started in earnest to develop a two-track approach towards the RMB’s internationalisation in 2009, the currency has increased its level of foreign usage, with a steady rise from 2010 to 2013 and a substantial acceleration between 2013 and 2015. That year, the RMB even managed to be included in the Special Drawing Rights (SDR) basket of the International Monetary Fund (IMF), a milestone for policymakers in Beijing, especially at the People’s Bank of China (PBoC). However, since the stock market turbulences of 2015 and the depreciation of the RMB they provoked, the Chinese currency’s internationalisation in 2016 and 2017 either stagnated or even declined. In 2011, when first looking at the prospects for the RMB’s internationalisation, I argued that the Beijing authorities were following the traditional cautious Chinese approach of crossing the river by testing the stepping stones beneath the surface.3 In line with the same metaphor, it appears that they are now well into the river but that at the first sign of failing to find a firm footing they have taken a step back (ie, reintroducing capital controls and a more strictly managed exchange-rate regime) and are now wondering whether to continue or to move back.

Measuring the progress so far

Before entering into the question of whether China should continue to pursue its currency’s internationalisation and how it should do so, it is important to determine –as far as possible– what the foreign use of China’s currency is at present. Here it is useful to distinguish between sources, and between hard facts and rhetoric. Certain banks, like Standard Chartered, for instance, which is very active in emerging markets –including China– have an interest in overemphasising the rise of the RMB and underplaying its weaknesses,4 while certain academic authors, at the other extreme, can be too negative regarding the Chinese currency’s potential5. When looking at the data, however, there is a consensus that the internationalisation trend has stagnated since the RMB was included in the SDR. This can be seen graphically when looking at the curve of the Standard Chartered Renminbi Globalisation Index (RGI) (see Figure 1).6 On a more disaggregated level, here I use the usual functions of money as a medium of exchange (settlement, vehicle currency and swap lines), store of value (deposits, bonds and reserves) and unit of account (invoice and pegs) to provide an overall picture.7

Figure 1. Standard Chartered RMB Globalisation Index

Starting with the medium of exchange function, China’s cross-border trade settled in RMB rose from over RMB500 billion in 2012 to RMB2 trillion in 2015 (its peak) to fall back to around RMB1 trillion in the spring of 2018 (see Figure 2). In percentage terms, this means that only 15% of Chinese trade is settled in RMB, and usually this includes trade with Hong Kong, which accounts for 80% of that trade. Thus, including Hong Kong as a national transaction, the share of Chinese trade settled, let along invoiced, in RMB would be very small.8 Where the RMB is regaining ground (almost reaching the levels of 2015) is in the settlement of China’s inward and outward foreign direct investment, and especially in the relatively newly established ‘Cross-border Interbank Payment System’, also known as China’s Interbank Payment System (CIPS), which is the Chinese equivalent of SWIFT and an important milestone in creating the necessary infrastructure to internationalise the RMB.

Figure 2. Cross-border trade settled in RMB

Finally, in this specific function of money there are also the official bilateral currency swap agreements that the PBoC has now signed with more than 30 other central banks (see Figure 3): the latest being Albania (in April 2018) and Nigeria (in May 2018). Here it is important to highlight that the total sum of the swaps has now reached RMB3 trillion and that the largest ones are with Hong Kong (RMB400 billion), South Korea (RMB360 billion) and the Bank of England and the ECB (at RMB350 billion each). However, so far only the Hong Kong Monetary Authority, and perhaps the central bank of Argentina, have used the facility. On the other hand, in 2014 China used its swap line with the central bank of Korea to obtain RMB400 million won for a Chinese commercial bank to provide trade financing for paying imports from Korea.9 Thus, there is a stark dissonance between the long list of swap agreements and their actual use.

Figure 3. Currency swap agreements signed by the People’s Bank of China

In the field of payment and vehicle currencies, the most reliable and quoted data are those provided by SWIFT for international payments, which show that the share of payments in RMB has shrunk from 1.60% in December 2015 to 0.98% in December 2017 (see Figure 4). This is far removed from the US dollar’s 41%, the euro’s 39%, sterling’s 4% and the yen’s 3.5%. As a matter of fact, the Chinese RMB is only in eighth position, after the Canadian dollar, the Swiss franc and the Australian dollar.10 In the foreign exchange markets the pattern is very similar. Here the essential data is the triennial Bank for International Settlements (BIS) survey that, in its latest edition, published at the end of 2016, shows that the US dollar comprises 88% of transactions (out of 200%, because there are always two currencies involved), the euro 31%, the yen 22%, sterling 13% and the Chinese RMB again in eighth position at 4%, in this case following the Australian (7%) and Canadian (5%) dollars and the Swiss franc (5%).11

Figure 4. Currencies used in international payments settled by SWIFT

When it comes to the attribute of store-of-value, the RMB equity held by overseas institutions within China has overcome the slump of 2015 and 2016 and has now reached higher levels (over RMB1 trillion) than before the stock market turbulences of 2015. This shows that China’s stock-market connect initiatives12 are having some positive impact (see Figure 5). This can be said of private and public bonds in general, although here the preference is treasuries.

Figure 5. RMB equity held by foreign institutions within China

In this regard, it is interesting to see that in the RMB Qualified Foreign Institutional Investor (RQFII) quotas the countries that invest the most in China are the US, Korea and Singapore, followed by the UK, France and Germany. On the public side of the store-of-value function, the benchmark is the official foreign reserves disclosed by the IMF (COFER): again, the RMB is far removed from the other four currencies that compose the SDR basket, accounting for only 1% of allocated world reserves, while the US dollar is at 63%, the euro at 20% and both the yen and sterling at 5% (see Figure 6).

Figure 6. Currency composition of official foreign exchange reserves (COFER)

In the debt markets, the RMB is still in its infancy compared to the US dollar and the euro. The issue of private and public debt in foreign currency is so dominated by the US currency (60% of the total), with the euro a distant second (slightly more than 20%), that international comparisons usually only list the yen, below 5% and in decline, as is the trend for all other currencies.13 Nonetheless, from a very low base, corporate and sovereign bonds denominated in RMB have also overcome the dip recorded in 2015-16 and are now at record numbers, more so on the corporate side than the public one. Of course, here China and the RMB have enormous potential. Currently, the participation of foreign investors in the Chinese domestic bond market is only 2%, compared with 60% in Mexico and 35% in Brazil. This might change with the gradual opening up of the China Interbank Bond Market (CIBM), a development that international banks and investors are eagerly awaiting.14

On matters related to the unit-of-account function, the data are scant. In the EU, for instance, the data for extra-EU exports and imports of European firms show that roughly 50% of exports are invoiced in euros, around 30% in US dollars, 8% in non-euro European currencies and only 12% in other currencies.15 The Chinese authorities do not appear to provide this type of micro-data. Again, it is important to distinguish between the currency of invoice and that of settlement, which are not necessarily the same and determine exchange-rate risks. SWIFT offers data of RMB usage for commercial payments ending in China and Hong Kong and shows that a very high percentage of the purchases from countries such as the UAE, Korea and Taiwan are effected in RMB, with Korea close to 90%. The countries that use less RMB when purchasing from China are Pakistan and the US, doing so in less than 5% of payments. Countries like the Netherlands and the UK are in the middle, at close to 50% of payments in RMB. But it must be borne in mind that this is settlement and not invoice.

Of course, when it comes to invoice, the pricing of oil is a fundamental issue and in this respect China is making progress with the yuan-denominated crude oil futures contracts listed on the Shanghai Futures Exchange since 2018. If the market develops and, more importantly, if at some point the price of the oil barrel is quoted in RMB in any of the international markets, then this would be a game-changer. None of the other SDR basket currencies has that.

Explaining stagnation

This section aims to explain the reasons that brought the attempt to internationalise the RMB in 2015 and 2016 to a halt. In other words, what prompted the Chinese authorities to check their attempt to cross the river? Obviously, stock market turbulence and the consequent depreciation of the RMB were a watershed. Although there is a general sense that the stock market crash of Summer 2015 was triggered by ultra-loose credit easing, a stock market bubble and the underlying reduction in the pace of GDP growth of the Chinese economy, it is important to analyse more in detail some of the mechanisms that caused the crisis and the reaction of the Chinese authorities to mitigate it, since it was these same actions that impeded the further internationalisation of the RMB.

For this, it is useful to summarise the work of Zhang Ming, one of the most respected economists in China.16 In his view, one cannot understand the crisis, and the evolution of the internationalisation process of the RMB for that matter, without looking at the foreign exchange value of the Chinese currency. During the years 2013 and 2014, the US dollar appreciated considerably. Specifically, the US dollar Index appreciated 13% from the end of 2012 until the end of 2014. At the same time, due to the managed floating exchange rate regime of the RMB its value remained relatively stable vis-à-vis the US currency over the period, appreciating only 2.6%. This meant that the Chinese currency appreciated considerably with respect to other currencies, especially the euro. In fact, Zhang does not consider this, but during the period the value of the European currency was important for several reasons. First, the US dollar Index is heavily determined by the euro, since it accounts for 58% of its value, and, secondly, the Eurozone economy as a whole is roughly the same size as that of China, is a bigger exporter and has a much higher per capita income and therefore a very important systemic impact for China, not least because it is the second largest export market for Chinese products after the US. Hence, a considerable appreciation of the RMB versus the euro has substantial effects and that is precisely what occurred between May 2014, when the ECB, under the command of Mario Draghi, accelerated its dovish monetary policy, and April 2015, just a few months before the stock market crash in China. In this period the RMB appreciated a whopping 25% against the euro (see Figure 7).

Figure 7. RMB-euro exchange rate

This massive appreciation of the RMB led Zhang to argue that the RMB was overvalued over the period according to macroeconomic fundamentals and therefore that at some point the market expectations of an ever appreciating RMB, which drove RMB internationalisation, would have to be reversed, and this happened over the 2014 and 2015 period. Interestingly, for more than a year, from February 2014 until April 2015, the PBoC intervened in the FX market to keep the exchange rate of the RMB stable vis-à-vis the US, but by doing so the value of the Chinese currency was increasing versus the second most international currency: the euro. This was highly problematic and partly explains, alongside the bleeding of reserves that the intervention was generating, why finally the PBoC decided on 11 August 2015 to reform the exchange rate mechanism and let the RMB depreciate more on a daily basis. Actually, Zhang points out that the ‘RMB exchange rate mechanism entered the era of free floating during a short period after the 8/11 reform… (since) the opening price of RMB against the US$ decreased from 6.1162 on 10 August 2015 to 6.4010 on 13 August 2015, depreciating 4.7% in only three days’. In the metaphor employed above, this is the moment when Chinese policymakers, in their journey across the river of internationalisation, realised that they could not see the next stepping stone, and they quickly drew back. They intensified intervention in the foreign exchange market and tightened capital controls.

Overall, in order to stem the crisis, the Chinese authorities applied three strategies that might have been necessary to avoid further instability but all of them were detrimental for the internationalisation of the Chinese currency. First of all, they had to use their massive foreign exchange reserves to keep the value of the RMB stable. This came at a cost. Chinese foreign reserves declined from US$4 trillion in June 2014 to US$3 trillion in January 2017 (see Figure 8), a massive reduction that came very close to what many in China believed would be the optimal level of reserves: according to Zhang’s own calculations, following the IMF matrix, this was US$2.83 trillion by the end of 2016. The massive reduction in reserves dented China’s prestige as a stable economy and therefore discouraged the holding of RMB abroad. In hindsight, however, as in the 1997-98 Asian Financial Crisis, international observers might value the fact that the Chinese authorities kept the exchange rate stable. At that time many in the West feared that China would let its currency drop by 20% and that it would lead to a massive deflationary shock in the world economy and intensify the pending currency wars.

Figure 8. China’s foreign currency reserves (US$ trillion)

Since the foreign exchange intervention was not very effective, the Chinese authorities had to use more drastic measures to halt the haemorrhage. This they did in the form of tighter capital controls. In particular, Beijing started to worry that much outward foreign direct investment (OFDI) was not really that, but rather capital flight. For that reason it first started to restrict OFDI in foreign currencies (to ensure RMB internationalisation was unaffected) but then also in RMB, which, of course, massively reduced the access to RMB overseas. Zhang reckons that the PBoC strategy was effective. ‘After 11 consecutive quarters of financial account deficit from 2014Q2 to 2016Q4, China began to face 4 consecutive quarters of financial account surplus from 2017Q1 to 2017Q4’. But stopping in mid-river had two major consequences. First, the liberalisation of the capital account, envisioned by the PBoC to reform the country and put it on a more sustainable course of growth, was reversed, and, secondly, that the offshore RMB markets dried up. One thing is clear, if the RMB wants to become an international currency, foreign investors need to get hold of it and this can only happen via a current or capital account deficit: this is a major structural issue that China still needs to overcome.

Most Western (and even Chinese) experts and commentators would also argue that for the RMB to be a fully international currency its price needs to be determined by market forces, as with the US dollar, euro, sterling and almost always for the yen. This is not the case with the RMB, and certainly not since the 11/8 reforms. Free floating was considered a no-go by the Chinese authorities and from the end of 2015 and early 2016 they introduced a series of changes that reduced rather than liberalised the RMB’s market pricing. The first was the introduction of the China Foreign Exchange Trade System (CFETS), which essentially tracks the value of 13 currencies on a weighted basis with the US dollar as its largest component (26%), followed by the euro (21%), the yen (15%) and so forth. The RMB’s price therefore follows two variables, each with a weight of 50%: the closing price of the previous day in the FX market and the CFETS exchange rate. The arrangement was not, however, optimal. When the US dollar index weakened (and hence the dollar depreciated) the RMB vs the US dollar exchange rate remained relatively stable, but when the US dollar index climbed the depreciation pressure on the RMB multiplied, undermining the entire object of the exercise. This led in May 2017 to the introduction of the ‘three-factor pricing mechanism’, which includes the two variables mentioned above and a ‘counter-cyclical adjustment’ factor, which essentially means that the PBoC will intervene whenever it thinks that the price of the RMB is misaligned with macroeconomic fundamentals and follows market irrationality. This is in line with the usual Chinese government tradition of generating ‘administratively managed market equilibria’.17 The ‘three factors pricing mechanism’ has so far worked, but the drawback is that RMB exchange-rate liberalisation was postponed indefinitely.

Overall, it can be concluded, as Zhang & Zhang do in another worthwhile study,18 that between 2010 and 2014 the remarkable success in the RMB’s internationalisation was to a large extent driven by market expectations of an appreciation and the consequent arbitrage the trend gave rise to, rather than on any solid grounding. The Chinese authorities continued to cross the river but at some point they realised their footing was unsure, as suggested by those critical of the inclusion of the RMB in the SDR basket of the IMF.19

The way forward

Now that RMB internationalisation is stuck in mid-river, perhaps many in China are thinking that it was not a good idea to begin to cross in the first place. There is a reason why Germany and Japan, two other large export countries, were always reluctant to internationalise their currencies. It is also true that the timing of internationalisation is a key factor. Japan started the process late and it did not work.20 But in normal circumstances –given its size, untapped potential and growth trajectory– there is no reason to believe that China cannot have an international currency with at least as much international market share as the euro has today. The question is: what steps should it now take? Conventional wisdom is that China needs to further liberalise its economy and financial markets.21 This is the ‘liberal’ approach dominant among Western commentators, and also among renowned economists in China. Zhang & Zhang follow this way of thinking and propose a number of reforms to achieve what they call a ‘more sustainable RMB internationalisation in the future’.

First, they suggest that China needs to continue to generate high and efficient growth, but for that to happen and to overcome the headwinds of aging, a diminishing yield of capital investment and the slowing down of total factor productivity growth, the Chinese authorities need to break up the monopoly of state-owned enterprises (SOEs), promote private entrepreneurship, liberalise domestic factor prices and improve income redistribution. Secondly, they warn that the government needs to develop and apply a more robust counter-cyclical macro-prudential policy framework to avoid a systemic banking crisis. This means that it needs to apply more market-oriented measures to deal with non-performing loans and clean up the balance sheets of banks. Third, the liberalisation of the capital account should only be gradual and once three conditions are met: (1) the full liberalisation of RMB interest rates; (2) the liberalisation of the RMB exchange rate; and (3), most importantly, opening the capital account gradually and only after the vulnerabilities in the financial system are overcome. The fourth reform, a proposal linked to (3) above, is to develop China’s financial markets. In the Zhang’s words, ‘ultimately, the competitiveness of a currency is determined by the development and openness of the domestic financial markets’.22 In particular, they say that China needs to augment its corporate and sovereign bond markets. Finally, they propose that the Chinese authorities should focus their efforts in the region. ‘In the future, more real demand for the RMB would come from Asian countries, not remote European or American countries, considering the current distribution of global production networks’. In other words, before becoming an international currency, the RMB needs to become the regional currency, starting within the ASEAN+323 framework.

This is the logically liberal path to attempt to cross the river; but is it the only one? Other authors, more in the international political economy tradition, have argued that in a less liberal world, and that may well be the case in the coming century, perhaps the main international currencies might not be issued by liberal regimes.24 In this respect, political stability, sought by international investors, might not necessarily be provided by the rule of law, plural democracy and a market economy. A more illiberal, less financial-led socio-economic framework might be equally attractive, as long as the issuing country maintains other key determinants for currency internationalisation such as a large economy, a stable macroeconomic framework and enhanced network externalities. China is already the largest trading partner for a great number of countries, and the long list of currency swap agreements between the PBoC and other central banks shows that there is both interest in and demand for good monetary relationships with the Middle Kingdom. Nonetheless, this does not avoid the structural determinant, which is that China needs to provide the world with RMB either by running a sufficiently large current-account deficit, like the US does today (but something China is reluctant to do), or a financial account deficit, which the Chinese authorities have just shown they are not that keen on either.

It is here where the Belt and Road Initiative (BRI) comes into play. The BRI is certainly the most ambitious and, for many, the most exciting foreign affairs and geopolitical project witnessed over the past few decades. The sheer size of the endeavour, with trillions of dollars to be invested in infrastructure in railroad, ports, roads, pipelines and fibre optic, is mindboggling. Many believe it is over-ambitious because it tries to connect the two ends of the Eurasian supercontinent with regions that are highly unstable. There is also the question whether most of the benefits and contracts will go to Chinese companies and leave many countries over-indebted. But China seems to be serious about the endeavour. The economic corridor in Pakistan and the creation of the Asian Infrastructure Investment Bank (AIIB) are perhaps the two most significant developments in the BRI. It is clear that for its economic size China still has very low OFDI and this will only increase in the future. This is already noted in Europe, where the debate about receiving more Chinese investment has become a hot topic in policymaking circles. Many see a danger in the rise of China, but others see great opportunities.25

As noted by a joint cooperation effort by researchers from Chatham House and the Institute of World Economics and Politics (IWEP) at the Chinese Academy of Social Sciences, European and Chinese actors can collaborate in the success of the BRI and the parallel internationalisation of the RMB.26 The example of the management of the AIIB, in which the Europeans are highly involved, can be a small laboratory in this regard. Much of the financing of the BRI, which attempts to be a public-private endeavour, is channelled through financial centres such as London and Frankfurt and Paris by issuing RMB-denominated bonds, for instance. In principle, much of the financing infrastructure needed for BRI to be successful, from bonds to loans to development aid, could be invoiced and settled in RMB. But for this to happen, the Chinese government would need to take the initiative and convince key actors in Asia, Europe and beyond, about the benefits of such a change. Here market inertia provides a strong headwind. Furthermore, if the RMBs gained abroad cannot be invested in China, it will always be difficult for the Chinese currency to be attractive. But the journey is long and China’s interbank payment system (CIPS) is a start in creating the necessary infrastructure for the RMB to be more attractive. However, so far even the China-led AIIB has rejected the idea of operating in RMB. Hence, doubts remain about the next steps to be taken in the RMB’s internationalisation.


From the start, Beijing adopted the traditional and cautious Chinese approach of crossing a river by testing the stepping stones when it came to internationalising the RMB. As in crossing any river, the first few steps were easy. RMB internationalisation, from a very low starting point, progressed exponentially, so much so that there was speculation that China would at some point liberalise interest and exchange rates and fully open up its capital account. But once internationalisation stepped into deeper waters, the currents became stronger and the stepping stones more unsure. After moving towards appreciation alongside the US dollar between 2012 and 2015, market expectations started to change and a market panic broke out in the summer of 2015. After haemorrhaging reserves during a year, the Chinese authorities realised there was no stepping stone underfoot when they let the currency float on 11 August 2015. This was the watershed that let them halt in mid-river and reapply stringent FX interventions and capital controls.

Currency internationalisation comes with benefits, as explained in the introduction, but also with costs and burdens, especially if it is achieved via liberalisation: (1) the Chinese authorities took control over their currency’s capital and exchange rate movements; (2) they relinquished the macroeconomy levers over which they now keep a tight control, especially as regards steering the credit cycle; (3) the Chinese economy was far more at risk of potential foreign speculative attacks; (4) the central bank was under considerable scrutiny to stabilise the financial system without the control it now possesses; and (5) China would need to be a much more active player, with more responsibility, in stabilising and governing the international monetary system. All this can be frightening and some can be tempted to draw back.

Thus, there are now three possible ways forward for the Chinese currency: (1) China can give up on RMB internationalisation and step back; (2) it can follow the liberal course of developing its financial markets, becoming a market economy and liberalising its exchange rate system, thus opening its capital account; or (3) refuse to follow a liberal course and continue on an illiberal footing by keeping its domestic market relatively state-managed and, on the basis of its Belt and Road Initiative, start to actively promote the RMB as the invoice and settlement currency for most transactions. The latter would mean that China would still be in relative control on how and where the RMB flows out (specific projects and loans) and how and where it comes in (what can be sold to China and where it can be invested). Such a state-led international command-and-control framework has not existed since at least the Middle Ages as regards international currencies but, in an ever-changing world in which liberal forces are retreating, the possibility cannot be completely ruled out.

Miguel Otero-Iglesias
Senior Analyst for International Political Economy, Elcano Royal Institute, and Professor, IE School of International Relations
 | @miotei

1 Paper presented at the Forum ‘China’s innovation development and global economy’, organised by the Chinese Academy of Sciences and the Fairbank Center for Chinese Studies at Harvard University and the Lee Kuan Yew School of Public Policy at the National University of Singapore, Beijing, 21-22/V/2018. The author would like to express his gratitude to Elsa Carrasco for her research assistance.

2 Ming Zhang & Bin Zhang (2017), ‘The boom and the bust of the RMB’s internationalization: a perspective from cross border arbitrage’, Asian Economic Policy Review, vol. 12, nr 2, p. 237-53.

3 Miguel Otero-Iglesias (2011), ‘The internationalisation of the renminbi: prospects and risks’, ARI, nr 73/2011, Elcano Royal Institute, 18/IV/2011.

4 Standard Chartered Bank (2017), ‘RMB internationalisation in 2017: change, alignment and maturity’, Hong Kong.

5 J. Benjamin Cohen (2017), ‘Should China be ejected from the SDR?’, Project Syndicate, 30/V/2017.

7 Most of the data is drawn from the very useful Natixis RMB Internationalisation Monitor of May 2018 by Alicia Garcia Herrero and her team.

8 The distinction between invoice and settlement is important because if a Chinese export or import company settles in RMB but invoices in US dollars, it carries the exchange rate risk.

9 There is a very useful interactive webpage on Central Bank Currency Swaps by the Council on Foreign Relations. Updated in February 2018.

10 SWIFT (2018), ‘RMB internationalisation: where we are and what we can expect in 2018’, RMB Tracker, January.

12 ‘Stock Connect’ refers to the link between the stock exchanges of Shanghai and Shenzen with Hong Kong. See Goldman Sachs (2016), ‘What is stock connect’, December.

13 ECB (2017), ‘The international role of the euro’, July.

14 See the 2017 Standard Chartered report on the RMB mentioned above.

16 Ming Zhang (2018), ‘China’s efforts to contain renminbi’s depreciation and the relating impacts’, paper presented at the seminar Chinese Overseas Investment in the Energy Sector: Opportunity and Risk, organised by the Global Development Policy Center of Boston University and the Institute of World Economics and Politics at the Chinese Academy of Social Sciences in Boston, 30/III/2018.

17 Miguel Otero-Iglesias & Mattias Vermeiren (2015), ‘China’s state-permeated market economy and its constraints to the internationalization of the renminbi’, International Politics, vol. 52, nr 6.

18 Zhang & Zhang (2017), op. cit.

19 Miguel Otero-Iglesias (2016), ‘The institutional limits to the internationalisation of the RMB’, Financial Times, 15/I/2016.

20 For a more recent take see N. Saori Katada (2018), ‘Can China internationalize the RMB? Lessons from Japan’, Foreign Affairs, 1/I/2018.

21 For a recent short review, see Barry Eichengreen (2017), ‘The renminbi goes global: the meaning of China’s money’, Foreign Affairs, 13/II/2017.

22 Zhang & Zhang (2017), op. cit., p. 250.

23 ASEAN+3 refers here to the 10 ASEAN countries and China, Japan and Korea.

24 See Jonathan Kirshner (2014), American Power after the Financial Crisis, Cornell University Press, Ithaca; and Christopher A. McNally & Julian Gruin (2017), ‘A novel pathway to power? Contestation and adaptation in China’s internationalization of the RMB’, Review of International Political Economy, vol. 24, nr 4, p. 599-628.

25 John Seaman et al. (2017), ‘Chinese investment in Europe’, ETNC Report.