IMF advises Spain to cut wages by 10 percent

The International Monetary Fund (IMF) on Friday called on Spain’s unions and employers to work together to find solutions - including cutting workers’ wages - to tackle unemployment and stimulate growth so that more jobs can be created.

In its latest report on Spain, the IMF said government reforms need to go further to increase companies’ “internal flexibility” and “enhance employment opportunities for the unemployed.”

While lauding the government’s labor reform, IMF officials said the government should consider reducing taxes on companies that focus on hiring certain groups, such as the young and low-skilled.

“A social agreement should be explored to bring forward the employment gains from structural reforms,” states the report. The accord could include a deal between employers, who would commit themselves to “significant employment increases,” and the unions, who would agree “to significant further wage moderation and some fiscal incentives.”

“The risks, however, are significant and any agreement should not stall the reform process,” the IMF said.

IMF technicians undertook a study to look at the effects of a 10-percent wage cut over two years accompanied by a reduction in social security contributions by one and two-thirds of a percent. It also examined broadening the base of the value-added tax (VAT) in two years, passing the now-reduced products, which have an 11-percent rate, into the general 21-percent category.

“The results, while subject to inherent limitations of the model, suggest the wage reduction, and associated fall in prices, would have a significant positive impact on economic growth and support the fiscal adjustment,” according to the study.

“The wage/price decline would result in a real depreciation of around five percent over three years, boosting exports and slowing imports. Importantly, a credible social agreement would also have a large positive impact on investment given the lower production costs and improved outlook.”

The IMF also called on Spanish banks to play their part by “promptly recognizing” losses and selling distressed assets quickly “to avoid tying up resources.”

The report goes on to state that financial institutions should continue to reinforce the quality and quantity of capital, remove supply constraints, and implement “rigorous and regular forward-looking scenario exercises on bank resilience to guide supervisory action.”

“The government has a large majority, no general elections until late 2015, and has faced only limited social unrest. But the economic context has reduced the popularity of the two main parties, which could make public support for new difficult reforms more challenging,” the report said. “There is a risk that regional-center tensions could also increase and political fragmentation yield inconclusive elections in the future.”