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Tension resurfaces

Political agreement on how to escape the crisis would help to overcome suspicion in the markets

Spain’s economy is once again under the microscope of investors and European authorities. This renewed attention is due to growing doubts over the government’s ability to fulfill its budget deficit objectives (5.3 percent of GDP this year having ended 2011 at 8.5 percent). The result is that Spain’s risk premium is up around the 400-basis-point mark after Wednesday’s debt auction, at which the Treasury had difficulties meeting its targets.

The markets do not believe that the government’s austerity program is viable and apply to Spain the same contradictory demands as in the cases of Greece and Portugal: cutbacks in order to boost the credibility of Spanish debt, only to withdraw any signs of confidence when the budgetary contraction prevents economic growth. And all the while, unemployment continues to rise (38,700 more people were registered as out of work in March) and it is considered increasingly likely that the recession will stretch into 2013.

Optimistic voices assure us that those at the head of the European Union are starting to become aware of the seriousness of the problem. The president of the European Central Bank (ECB), Mario Draghi, said on Wednesday that what the markets expect of governments are reforms, and that economic growth must then proceed from those reforms. In theoretical terms, that is all very well, but Draghi — not to mention Germany, France and the European Commission — should be more specific on what these reforms that produce growth are. In no way could they include a budget cutback or labor reform as severe as those put forward by the Spanish government this year. Decisions such as these reduce employment, cut demand and shrink economic activity — at least in the short term.

Yet, it is possible to devise reforms which favor economic growth. A major reform of the public administration, for example, would reduce expenditure, leave state income unchanged and would not damage consumption. But such a reform cannot be carried out in a matter of weeks or even months, so it falls foul of the need for an instant reduction of the deficit.

Draghi is also concerned about the effectiveness of his extraordinary liquidity measures, and he is right to be. Very little of these funds has trickled down into the real economy. It is not even being used to buy sovereign debt. Apart from demanding harsh budgetary cutbacks, the European institutions must coordinate growth strategies so that those countries which are undergoing drastic adjustments could at least count on greater demand from those which are not obligated to follow such policies.

The euro zone needs to create room for maneuver in which to stimulate or at least maintain demand in those countries which are suffering from persistent recession. No one in their right mind can believe that financial reforms are the only way to return to growth, particularly when the preferred reforms lead to a collapse in funding. In the specific case of Spain, it would be helpful if this year’s state budget had broad political support; a possibility which seems as remote as it is necessary.

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