SPAIN: THE ECONOMIC SLOWDOWN
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Confidential
Confidential
EUR 84-10232
December 1984
Directorate of
Intelligence
CCCCCC ' a? PL`
Spain:
The Economic Slowdown
327
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Directorate of
Intelligence
Spain:
The Economic Slowdown
This paper was prepared by
are welcome and may be directed to the Chief
Iberia-Aegean Division
Confidential
EUR 84-10232
December 1984
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Spain:
The Economic Slowdown 25X1
Key Judgments Spain's real economic growth sank from an average annual rate of 7
Information available percent during the "miracle" years, 1960-74, to 1.6 percent during 1975-
as of 21 November 1984 83. The slowdown was due to a variety of factors, including skyrocketing
was used in this report.
real labor costs, the 1973/74 and 1979/80 oil price shocks and ensuing
worldwide recessions, structural problems, some wrong-headed government
policies, and demographic trends. Put simply, the external environment
deteriorated drastically, and Spanish policymakers-distracted by the
difficult task of building a new democracy-made a bad situation worse.
The result was a collapse of investment spending, the main engine of
growth during the boom years.
Adverse worldwide industrial trends hit Spain at an extremely inopportune
time in the mid-1970s. The Franco regime had concentrated its develop-
ment planning and spending on the very industries most affected by the
global economic slowdown-steel, textiles, and shipbuilding, in particular.
Post-Franco governments compounded this mistake by sinking more money
into the wrong industries and boosting social welfare programs and wages
to catch up with northern European countries. Many Spanish institutions
and major portions of the economy, however, were still only semideveloped
and in some respects proved as fragile as the business cycle itself.
Prime Minister Felipe Gonzalez's Socialist government appears deter-
mined to carry out an ambitious and painful adjustment aimed at trimming
inflation and the budget deficit and making Spanish industry more
competitive. The program includes a deal worked out with the Socialist
General Union of Workers (UGT) trade union to curb wage gains during
1985-86 and aims to rationalize overstaffed and debt-ridden firms, return
some of the major money-losing public-sector enterprises to the private
sector, and promote investment in new industries.
Progress has thus far been limited. The Socialists trimmed the current
account deficit to $2.5 billion and brought inflation down to 12 percent last
year. They no longer publicly maintain that their policies have begun to
foster the job creation promised during the 1982 election campaign and
admit that the unemployment rate will not decline from its current 20
percent until next year at the earliest. Real wage losses and layoffs at
inefficient plants will cost the Socialist government some support from
workers and may lead to sporadic strikes. However, Gonzalez's popularity,
a large underground economy, and the UGT's desire to cooperate and
negotiate with a Socialist-led administration suggest that serious social
disruptions remain unlikely.
Confidential
EUR 84-10232
December 1984
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Reflecting the effects of Socialist policies, the economy should post at least
a 2.5-percent growth rate this year, an improvement over its 1975-83
performance. Exports will be the source of most of the growth, increasing
by over 10 percent in volume; on the other hand, real investment and
private consumption probably will fall. Soft domestic demand should help
cut 3 percentage points off the inflation rate and turn last year's current
account deficit into a surplus.
Over the longer run, we believe that an appreciable improvement over the
record of the last decade is reasonably certain, but a return to the miracle
years can be ruled out. Because Spain directs over half its exports to
northern European countries, its average annual growth rate through 1990
probably will not be much better than 3 percent if, as we expect, West Eu-
ropean average annual growth is held to less than 2.5 percent. Moreover,
we anticipate that, if Spain joins the EC in 1986, it will face a somewhat
bumpy transition period as it lowers its tariffs to EC levels and exposes its
highly protected domestic industries to greater competition from more
efficient multinationals.
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Key Judgments
Intensifying Foreign Competition 5
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Spain:
The Economic Slowdown
Spain has gone through two distinct economic periods
in the last 25 years. The efforts of the authoritarian
Franco regime to develop the country's industrial base
led to a period of rapid growth during 1960-74-the
so-called miracle years. This has been followed by a
prolonged recession beginning in 1975 and coinciding
with the restoration of democracy. This paper will
explore the international and national economic
trends behind the turnaround. It also will assess the
difficulties facing the Socialist government of Prime
Minister Gonzalez as it tries to cure Spain's deep-
rooted problems and put the country on a higher
growth path
The Spanish economy, weakened by the postwar
international isolation of the Franco regime and its
efforts to promote autarchy, did not really take off
until 1960. During 1960-74, however, it grew an
average 7.3 percent per year in real terms-a rate
exceeded only by Japan within the OECD (see figure
1). The boom was led by industrial production, which
expanded at an average annual pace of 11.3 percent.
This rapid economic growth fueled a remarkable rise
in living standards, as per capita real GNP rose at a
6.2-percent annual rate. In terms of constant 1980
prices and exchange rates, per capita GNP grew from
$2,325 in 1960 to $5,389 in 1974-from 32 percent of
the US level to 52 percent.
Spain's remarkable economic performance was fueled
primarily by the Franco regime's decision in 1959 to
relax trade and investment controls and to implement
a major devaluation of the peseta. Until then, high
tariffs, import restrictions, and an overvalued ex-
change rate had strangled domestic production and
constrained exports, in part because of Spain's
dependence on imports of capital goods and raw
materials. With the loosening of controls, imports of
capital goods and machinery soared, as did foreign
Figure 1
Spain: Comparative Real GDP Growth
Rates, 1960-83
-2 1960 65 70
investment, helping to push real investment up by an
average annual rate of 10.5 percent during 1960-74
and raising its share of GDP from 17.9 percent to 24.7
percent (see figure 2). In our judgment, this growth of
investment was the major driving force behind the
economic boom. Exports probably were the second
most important engine of growth. After a 50-percent 25X1
leap in 1960 in response to the sharp devaluation of
the peseta, export volume expanded at an average
annual pace of 11.9 percent during 1961-74-the
third-highest rate in the OECD (see figure 3).~ 25X1
Spain
- Industrial
countries
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Figure 2
Spain: Real Investment Growth, 1960-83
Figure 3
Spain: Export volume, 1960-83
-101960
Rapid economic growth enabled Spain to cope with
some dramatic structural shifts, notably the displace-
ment of 1.8 million farmworkers. Between 1960 and
1974, the proportion of workers employed in the
agricultural sector fell from 41 percent to 23 percent
as rising farm wages and government incentive pro-
grams prompted landowners to introduce labor-saving
devices. Meanwhile, the total labor force increased by
about 1.5 million, with women accounting for about
two-thirds of this gain as the female labor force
participation rate rose from 26 percent to 33 percent,
and the male participation rate declined. Unemploy-
ment stayed below 4 percent, however, as the services
and industrial sectors each generated about 1.5 mil-
lion new jobs. A substantial net outflow of workers-
mainly to northern Europe-also helped to hold down
unemployment.
Spain's remarkable growth performance was achieved
without creating major economic disequilibrium. The
current account remained relatively stable up to 1974
due to strong foreign demand for Spanish exports,
tourism revenues, and worker remittances. Until the
-10 1960
first oil price shock, the occasional current account
deficit never exceeded $600 million. Price increases
were something of a problem, as Spain's average
inflation rate ran at 7.5 percent annually-3 percent-
age points above the OECD average. However,-with
wage hikes based on productivity and the peseta
depreciating against competitors' currencies, the re-
gime kept relative unit labor costs fairly steady, thus
protecting export competitiveness
Spain's economic performance slid dramatically dur-
ing 1975-83. Average annual real GDP growth
dropped to 1.6 percent, and Spain's growth ranking
within the OECD fell from second to 16th. Moreover,
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Figure 4
Spain: Unemployment Rate, 1960-83
T 1 1 1 1 1 1_ 1 1 1 1 1 1 1' 1 1 1 1 1 1 1
1960 65 70 75 80
Spain's external accounts deteriorated sharply, and
severe inflationary pressures built up in the mid-1970s
(see table 1 and figure 5). The quadrupling of world
oil prices in 1973/74 was a major blow, causing a
swing from a current account surplus of $560 million
in 1973 to a deficit of $3.2 billion in 1974. World
recession and uncertainties about Spain's political
future caused a drop in tourism and worker remit-
tances that widened the deficit to $4.3 billion in 1976,
equivalent to 4 percent of GDP.
Although the current account returned to surplus in
1978 and 1979, the second round of OPEC price hikes
triggered another series of deficits, peaking at $5.2
billion in 1980. Post-Franco Spain has also been
plagued with a persistently high rate of inflation. In
1976 and 1977, consumer price inflation was 17
percent and 24 percent, respectively-nearly three
times the average for Spain's major trading partners.
Tighter economic policies have gradually slowed in-
flation-to 12 percent in 1983-but it is still running
at roughly double the pace in other industrial coun-
tries.
the 5.7-percentage-point decline in the growth rate
from the 1960-74 period was the sharpest drop re-
corded in any OECD country. On the whole, domestic
demand nearly stagnated, mirroring a slowdown in
the growth of private consumption and an average
annual decline of 2 percent in real investment. Manu-
facturing output grew only about 1 percent annually
on average-barely one-tenth of its earlier pace-
while construction activity declined by a total of 20
percent
In contrast with the record of steady job creation and
low unemployment during the boom years, the last 10
years have seen a loss of jobs and a sixfold increase in
unemployment (see figure 4). The jobless rate stood at
20 percent in mid-1984-the highest rate of unem-
ployment in Western Europe except for Turkey. More
than 2 million jobs have been lost-about equally
divided between industry and agriculture-and fewer
people are employed now than in 1952. The problem
of unemployment is particularly acute for young
people. At the end of last year, 38 percent of those in
the 20-to-24 age bracket could not find a job, and the
teenage unemployment rate was even higher.
The one bright spot during this period was the rapid
growth of export volume: although down by one-
fourth from the earlier period, the average annual
growth rate of 9.1 percent was still the second best in
the OECD. Even this had its dark side, however.
Many of the export gains simply reflected the collapse
of the domestic market and were achieved only by
slashing profit margins
There is neither a simple nor a single explanation for
the change in Spain's economic fortunes. Spain suf-
fered along with other industrial countries from the
1973/74 and 1979/80 oil price shocks and ensuing
worldwide recessions, and it too was hit by intensify-
ing competition from the newly industrializing coun-
tries (NICs). There were also structural problems at
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Table 1
Spain: Balance of Payments
Current account
balance
557
-3,244
-3,488
-4,299
-2,450
1,574
1,109
-5,188
-4,980
-4,217
-2,533
Trade balance
-3,545
-7,069
-7,386
-7,327
-6,221
-4,083
-5,687
-11,725
-10,115
-9,181
-7,402
Exports, f.o.b.
5,402
7,265
7,807
8,990
10,611
13,480
18,352
20,581
20,971
21,332
20,832
Imports, f.o.b.
8,947
14,334
15,193
16,317
16,832
17,563
24,039
32,306
31,086
30,513
28,234
Services, net
2,688
2,679
2,755
1,886
2,620
4,001
5,014
4,489
3,443
3,383
3,698
Of which:
Tourism
2,872
2,869
3,096
2,690
3,486
4,917
5,558
5,720
5,709
6,122
5,942
Transfers, net
1,414
1,146
1,143
1,142
1,151
1,656
1,782
2,048
1,692
1,581
1,171
Long-term
capital, net
765
1,669
1,803
1,920
3,219
1,898
3,216
4,252
4,294
1,827
3,089
Short-term capital,
errors, and omissions
1,299
843
1,465
1,579
home, notably the fact that the earlier investment
boom had peaked just as the global economic down-
turn was beginning and had concentrated heavily in
basic products whose markets were to fare poorly in
the post-1973 world.
The combination of these factors probably made a
sharp slowdown in Spanish economic growth inevita-
ble. The fact that Spain has done so much worse than
the other industrial countries, however, is largely
attributable to the policy mistakes of post-Franco
governments. These mistakes have included inappro-
priate fiscal and exchange rate policies, market-
distorting oil price controls, and encouragement of
inefficient public-sector enterprises. Skyrocketing la-
bor costs-in part a product of the new democracy's
efforts to build support-have also been a major
factor adding to the country's problems
It should also be noted that the actual deterioration of
the Spanish economy is probably not quite as bad as
the official statistics suggest because of the existence
of a large underground economy. The underground
sector almost certainly has expanded since 1974 in
response to layoffs and a rising tax burden, thus
generating jobs and output that are not officially
recorded. But even if the underground economy is as
large as one Spanish study suggests (23 percent of
GDP), and even if its absolute size has doubled since
1974, the increment to Spain's official GDP growth
rate would be only 1 percentage point annually. We
suspect that the actual figure is less than this because
the above assumptions probably overstate the size and
growth of the underground economy.
External Causes
The Oil Price Shocks. Spain was marginally more
vulnerable than most other Western countries to the
two rounds of OPEC price hikes because oil account-
ed for 68 percent of its energy consumption in 1973,
compared with 61 percent for the EC and 60 percent
for Western Europe as a whole. Spain was particular-
ly ill prepared for the second shock because in 1980 it
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Figure 5
Spain: Comparative Inflation. Rates,
1960-83
I I I I I I I I I I I I I I I I I I I I 1 1
65 70 75 80
Industrial
countries
Figure 6
Spain: Migration Flows, 1960-83
I I I I I I I I I I I I I I I I I I !
1960 65 70 75
Emigration
Return flow
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was still covering 68 percent of its energy needs with
oil while the EC and Western Europe as a whole had
cut their oil dependence to 52 percent and 53 percent,
respectively.
The combination of rising oil consumption and sharp-
ly higher oil prices quadrupled Spain's oil import bill
from $1.1 billion in 1973 to $4.5 billion in 1976. This
accounted for about 70 percent of the deterioration in
the current account during these years. The second
round of oil price hikes in 1980 more than doubled the
cost of oil imports again, to $11.2 billion, and brought
another sharp deterioration in the current account. As
elsewhere, this sudden outflow of purchasing power
exerted a substantial contractionary effect.
World Recessions. The world recessions triggered by
the two oil price shocks dealt a hard blow to foreign
demand for Spanish goods. Average annual real GDP
growth for the industrial OECD countries-which
account for approximately two-thirds of Spain's ex-
ports-fell from 4.6 percent during 1960-74 to 2.2
percent during 1975-83. Perhaps even more impor-
tant, the West European slump hurt Spain's earnings
from tourism and worker remittances. As West Euro-
pean governments began to limit the number of
incoming foreigners and to encourage guest workers
to go home, the social safety valve of emigration was
lost; in 1975-80 only 105,000 Spanish workers emi-
grated, whereas approximately 360,000 emigrants
returned (see figure 6). Although Madrid estimates
that net outflows are once again occurring, the aver-
age rate for the last three years is put at only 23,000.
The recession abroad-probably abetted by Spain's
worsening price competitiveness-has also cut into
earnings from tourism and other services. Net earn-
ings from services and transfers covered only 17
percent of Spanish imports in 1983, down from 46
percent a decade earlier.
Intensifying Foreign Competition. Intense competi-
tion from developing countries in traditional export
sectors like footwear, textiles, steel, shipbuilding, and
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leather has hurt Spains export earnings. Spanish
firms boosted production of traditional products in the
1970s-at precisely the time of a major export push
by the newly industrializing countries-Brazil, Mexi-
co, Singapore, Hong Kong, South Korea, and Taiwan.
Handicapped by higher labor costs and a strong
peseta, Spanish exporters could not afford to lower
their prices enough to compete with the NICs. While
the NICs' share of OECD imports of these commod-
ities quadrupled from 1970 to 1982, Spain's market
share rose only 2 percentage points from 1970 to
1978, fell for a few years, and then began rising again
in 1982 as the peseta depreciated.
Deteriorating Terms of Trade. Partly because of the
factors mentioned above, Spain's terms of trade (ex-
port prices relative to import prices) have deteriorated
sharply since 1973. Although all oil-importing coun-
tries faced this problem to some degree, the deteriora-
tion for Spain-about 33 percent between 1973 and
1980-was roughly twice that experienced by the
OECD industrial countries as a group. This reflected
Spain's above-average dependence on oil imports and
its export concentration in basic products whose prices
have not kept up with inflation. It should be noted,
however, that the sharp relative deterioration in
Spain's terms of trade (compared with the other
industrial countries) actually began in 1968. Thus,
while it undoubtedly added to Spain's problems after
1974, it clearly was only one of several causes.
Internal Causes
Rising Labor Costs. Soaring real labor costs were, in
our judgment, a major component of Spain's post-
1974 economic problems (see figure 7). In addition to
hurting export competitiveness, the higher costs
slashed business profits and deterred hiring and in-
vestment. From 1970 to 1983, total real labor costs
jumped 124 percent, nearly double the average in the
four major West European countries and close to 10
times the increase in the United States. A large part
of the increase can be traced to politically motivated
concessions to the trade unions in the final days of the
Franco regime and during the transition period. Dur-
ing 1975-79 real per-worker costs soared over 8
percent annually, with rising social security charges
Figure 7
Spain: Index of Real Unit Labor
Costs, 1964-83a
90 1964 65 70 75 80
o The Spanish Government did not collect data for labor costs or
productivity prior to 1964.
Note: Real unit labor costs were measured by deflating the
industrial labor cost index by the wholesale price index and
dividing by the industrial productivity index.
accounting for about half of this figure. Productivity,
meanwhile, grew at an average annual rate of only 1
percent. Firms consequently saw their real unit labor
costs-which had been steady during the previous
decade-surge 50 percent in five years.
The situation has improved since 1979 when the
recession began to encourage a new spirit of coopera-
tion between labor and management. In particular,
the National Bargaining Agreement in 1980 has
slowed real wage growth to an average of only 1
percent per year in the early 1980s. Although indus-
trial growth has stagnated, productivity has risen by 5
percent annually on average since 1980 because of the
large numbers of layoffs. Despite these recent reduc-
tions in real unit labor costs, they still stood about 26
percent higher at the end of 1983 than a decade
earlier.
' Real labor costs are defined as total wage and nonwage a ments,
including contributions to social security
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Structural Problems. A large part of Spain's prob-
lems grew out of the Franco regime's efforts to
industrialize the country. To their credit, the develop-
ment programs reduced the share of agriculture in
GDP from 27 percent in 1960 to 12 percent in 1970
and increased the share of industry from 34 percent to
close to 40 percent. The programs had been targeted,
however, at mining and lower technology sectors.
Thus, at the start of the 1970s, steel, shipbuilding,
textiles, clothing, and leather accounted for 28 per-
cent of Spain's industrial production.' In the four
major West European countries, on the other hand,
these "sunset" sectors accounted for between 14 and
22 percent of industrial production. These were the
very sectors where worldwide surplus capacity and
stiff competition from newly industrializing countries
emerged later in the 1970s~
Mistimed Investment Surge. Spain's 1960-74 invest-
ment boom unfortunately peaked just as Spain's
major markets were plunging into recession. During
1972-74, real investment in machinery and equipment
soared almost 60 percent-an expansion that was
rivaled only by Turkey within the OECD during this
period. Such a growth rate could not have been
sustained in any event, but in this case the new
capacity was coming on line just as world demand was
falling. Spanish firms thus found themselves saddled
with excess capacity and high fixed costs-undermin-
ing both their incentive and their ability to carry out
further investment.
Demographic Developments. In our judgment,
changes in demographic trends can account for only a
small part of the worsening of Spanish unemployment
since 1974. Partly because of the turnaround in net
emigration, the growth of the working-age population
accelerated from 0.8 percent annually during 1960-74
to 1.2 percent annually during 1975-82. If the earlier
growth rate had been maintained, the labor force in
1983 would have been about 300,000 to 400,000
smaller than it actually was, and unemployment
presumably would have been reduced by a similar
amount.
' Wood, cork, paper, rubber products, and processed foods repre-
sented another 24 percent of industrial production; the remaining
half was distributed between mining, energy, chemicals, and equip-
Labor force growth actually slowed during 1975-83,
however, as the higher population growth was more
than offset by a decline in labor force participation
rates. The decline was due largely to discouraged
workers withdrawing from the labor market, although
part of it may represent people finding jobs in the
underground economy. In any event, the participation
rate for men plunged an average of 1.5 percentage
points a year between 1974 and 1982, about twice the
rate of decline recorded during 1960-74. The female
participation rate, meanwhile, showed no change be-
tween 1974 and 1982, in contrast to its 7-percentage-
point rise during the earlier period. If the previous
male and female participation rate trends had contin-
ued through 1982, the labor force would have been
larger than the actually reported figure by some 1.2-
1.3 million people, and the official jobless total would
have been correspondingly higher.
Government Policies. Social Security Taxes. Post-
Franco Spain has relied heavily on corporate taxes to
fund sharply expanded welfare benefits. Employers'
contributions made up 77 percent of total social
security revenues in 1975, and large and medium-
sized corporations, which could not easily evade taxes,
have borne most of the burden. Subsequent govern-
ments have recognized the damaging impact on indus-
trial profits and competitiveness and have attempted
to shift the expense toward the state and employees.
Budgetary restrictions and growing unemployment,
however, have limited progress; employers' contribu-
tions were still 62 percent of total revenues in 1983.
Labor Laws. Paternalistic labor laws inherited from
the Franco era have limited the ability of firms to lay
off or release workers. Although intended to protect
jobs, such laws ultimately reduce employment by
discouraging employers from taking on new workers.
Attempts to reform labor regulations have been belat-
ed and sometimes counterproductive. It was not until
1980 that Parliament passed the Workers Statute;
this legislation made layoffs slightly less difficult, but
it provided also for high separation payments and
stipulated that employers could be forced to pay an
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indemnity of three and a half years of basic pay if
labor authorities found dismissals unjust.' In addition,
until 1981, firms could not legally hire temporary
workers, and even now the number of such workers is
limited by law to a small percentage of the permanent
work force. The intention of this restriction was to
encourage full-time hiring, but the regulations gov-
erning working hours made it cheaper to pay over-
time.
The introduction of collective bargaining has made
wage settlements more rigid. Agreements reached at
the national level between the unions and the employ-
ers' association establish a narrow band within which
wage settlements must be negotiated at the company
level. Wage increases are no longer tied to productivi-
ty, as in Franco's day. This, along with the uniformity
of wage hikes across sectors and companies, has
particularly hurt small firms operating on the mar in
and in the less dynamic sectors.
Weak Public-Sector Enterprises. Madrid. has com-
pounded structural problems with misguided invest-
ment projects and efforts to shore up ailing state
firms. In continuing to subsidize dying industries, the
government failed to allocate its resources to produc-
tive investment and taxed more efficient industries, at
an appreciable cost to economic growth. Management
mistakes and slowness in adjusting to both domestic
and worldwide economic conditions in other sectors
sent total losses in public-sector enterprises up from
$150 million in 1975 to $2.5 billion in 1983, about 2
percent of GDP. Publicly owned companies-which
account for 85 percent of shipbuilding production and
42 percent of steel production-have been major
losers since the collapse of these markets in the mid-
1970s. As late as 1979, however, Spain was still
opening up new facilities to build oil tankers when
other industrial countries had already begun -recon-
version programs in their shipbuilding industries. In
the steel industry, public and private Spanish produc-
ers, assuming a domestic market of 20 million tons of
steel per year, boosted steel production by 18 percent
from 1975 to 1983. Domestic consumption, however,
sank about 20 percent to 8 million tons by the end of
last year.
'The Workers Statute also granted laborers the right to strike. The
resulting increases in lost man-hours were an additional factor that
Oil Price Controls. Partly out of fear of exacerbating
inflation, Madrid did not raise domestic petroleum
prices or enact a national energy plan until almost six
years after the 1973 OPEC price hikes. As a result,
the country had the poorest oil conservation record
within the OECD during the period between the two
oil crises, increasing its vulnerability to the second
crisis. Between 1973 and 1980, Spanish oil consump-
tion rose 34 percent, while overall energy consumption
rose 32 percent; both increases were the second
highest in the OECD. More significantly, the ratio of
oil consumption per unit of real GDP rose 13 percent
during this period. Only one other OECD country-
Portugal-recorded an increase in this index during
this period; most countries had large decreases (see
table 2). If Spain had been able to reduce its oil/GDP
ratio by 10 percent during 1973-80-which would
still have been the sixth-poorest performance among
OECD countries-its 1980 oil import bill would have
been about $2.3 billion lower and the 1980 current
account deficit would have been cut almost in half.
Spain's energy situation began to improve when Ma-
drid passed a national energy plan and raised oil
prices in 1979. The main objectives of the plan were
to dampen demand; reduce dependence on oil imports;
and diversify sources of energy by eliminating oil
price subsidies, investing in nuclear facilities, and
encouraging coal production. From 1980 to 1983 oil
consumption fell 9 percent, while oil use per unit of
GDP declined 12 percent-returning it to the 1973
level. The decline in oil consumption, coupled with the
weakening of world oil prices, enabled Spain to reduce
its oil import bill by over $3 billion during this period.
Exchange Rate Policy. By our estimates, the Spanish
exchange rate has tended to be overvalued, in varying
degrees, throughout the postoil crisis period (see fig-
ure 8). A competitive exchange rate was an important
prop of the 1960-74 boom; when inflation in the mid-
1960s began to erode the impact of the huge 1959
devaluation, another devaluation in 1967 helped to
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Table 2
OECD: Trends in Real GDP and Oil Consumption
Real GDP
Oil Consumption
1980
1983
1980
1983
1980
1983
Denmark
112.5
118.2
76.0
58.1
67.6
49.2
Japan
130.0
143.9
88.3
76.5
67.9
53.2
Ireland
134.8
141.8
109.3
77.8
81.1
54.9
France
121.4
125.1
86.3
70.1
71.1
56.0
Belgium/Luxembourg
119.1
119.5
84.4
67.3
70.9
56.3
United Kingdom
106.4
111.5
71.4
64.0
67.1
57.4
Netherlands
122.7
121.0
93.2
70.5
76.0
58.3
Sweden
113.0
115.3
85.0
68.0
75.2
59.0
Finland
121.8
131.1
96.2
78.2
79.0
59.6
Norway
139.0
146.0
91.9
88.4
66.1
60.5
Iceland
123.9
117.2
80.9
72.1
65.3
61.5
West Germany
117.7
117.4
87.6
73.3
74.4
62.4
Canada
122.2
124.3
104.7
79.5
85.7
64.0
Austria
122.6
126.1
103.4
84.7
84.3
67.2
United States
117.6
122.3
97.1
85.6
82.6
70.0
Italy
121.2
119.4
94.5
85.6
78.0
71.7
New Zealand
107.2
113.6
105.6
92.9
98.5
81.8
Switzerland
102.2
102.3
87.1
83.7
85.2
81.8
Australia
118.3
125.3
110.3
111.9
93.2
89.3
Turkey
131.7
148.2
119.4
134.7
90.7
90.9
Greece
126.6
126.3
124.0
115.0
97.9
91.1
Spain
117.8
122.3
133.5
121.7
113.3
99.5
Portugal
124.3
134.9
134.9
149.2
108.5
110.6
Source: The BP Statistical Review of World Energy. The calcula-
tion of oil consumption includes bunkers.
restore it. Our index of Spanish competitiveness' was
already beginning to slip again in 1973, and the
OPEC price hikes that year added to the need for a
downward exchange rate adjustment to help Spain
cope with its oil bill. Madrid refused to devalue,
however, and a surge of inflation worsened the situa-
tion further; by the end of 1975, the competitiveness
index was above the level that had prompted the 1967
devaluation. A devaluation was finally implemented
in 1977, but it restored competitiveness only to the
1973 level; moreover, soaring inflation rapidly wiped
out its impact. By the middle of 1979, Spanish
competitiveness, according to our index, was even
worse than it had been before the 1959 devaluation.
Exchange rate adjustments since then-particularly
in 1982-have improved the situation considerably,
although competitiveness is not quite back to the 1973
level.
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Figure 8
Spain: Index of Competitiveness, 1959-83,
by Quarter a
70 1959 60 65 70 75 80
a The ratio of Spanish consumer price inflation to a trade-weighted
average of inflation in competitor countries, adjusted for exchange rate
fluctuations. A decrease in the index indicates an improvement in
competitiveness.
Efforts by Earlier Governments
Madrid was slow to respond to the worsening econo-
my in the early 1970s, probably because the leader-
ship was preoccupied by the effort to establish democ-
racy. Indeed, we believe government policy generally
was making things worse during this period. In re-
sponse to growing current account deficits in the
middle 1970s, the centrist government led by Adolfo
Suarez launched the Moncloa Pact-an austerity
plan in 1977 to which all the major political parties
subscribed-and agreed upon additional measures
with the IMF in 1978 in exchange for a $185 million
standby loan. The stabilization program involved tight
monetary policy, a slight decrease in the budget
deficit, wage ceilings for public-sector employees, and
wage guidelines for the private sector. Austerity
measures led to a momentary improvement in the
current account in 1978-79, but domestic demand
stagnated. Spanish authorities then eased their poli-
cies in 1979 to stimulate GDP, but the second round
of oil price hikes forced an immediate change of
tactics. Madrid tried to support economic growth and
simultaneously narrow its current account deficit with
an expansionary fiscal policy and a somewhat restric-
tive monetary policy in 1980-82. The policies were not
compatible-although the government allowed the
budget deficit to nearly quadruple to 6 percent of
GDP, it did not permit sufficient monetary growth to
satisfy the borrowing needs of both the government
and the private sector. As a result, interest rates rose,
contributing to a fall in investment.
Centrist governments experimented with a variety of
largely unsuccessful schemes in the early 1980s to
hold unemployment down. In addition to revising
labor laws in the Workers Statute and absorbing more
of the cost of social security, they introduced tax
incentives and public works projects, reduced permis-
sible overtime, and set a higher minimum working
age. The Suarez government also persuaded trade
unions to accept a cut in real wages under the 1981
National Employment Pact (ANE) in exchange for a
commitment to promote the creation of 350,000 new
jobs. Nevertheless, the unemployment rate had risen
above 16 percent by the time of the 1982 election
campaign.
The government also began drafting an industrial
restructuring program as early as 1977, but no com-
prehensive plan was introduced until 1981. The four-
year program aimed at increasing productivity by
eliminating job redundancies, consolidating firms to
take advantage of economies of scale, promoting
research and development, cutting capacity, and pro-
viding financial assistance to ease the burden of
adjustment. In all, 11 sectors fell under the reconver-
sion scheme, including textiles, footwear, steel, ship-
building, and electrical appliance and components
industries. Implementation of the plan was slow,
however, and when the Socialists took power in 1982,
only 300 of 8,800 target firms had received approvals
for financial assistance under the plan.
Efforts by the Socialist Government
Surprising those who thought it might take the same
expansionary/inflationary route followed by new So-
cialist governments in France and Greece, the Gonza-
lez administration instead concentrated on restoring
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economic stability. It moved quickly to establish and
maintain a more realistic exchange rate, although
perhaps not going far enough in this area. Madrid also
introduced a stringent monetarist policy and reined in
government spending. To date, the Gonzalez adminis-
tration has made considerable progress in reducing
the current account deficit and has brought the
inflation rate and budget deficit down somewhat.
We judge the centerpiece of Socialist longer term
economic strategy to be the industrial reconversion
program, which was picked up from the previous
government and expanded. The Gonzalez government
has vowed to complete the program within three years
and to prune weak industries vigorously. According to
the Socialist plan, 63,500 workers-9.5 percent of the
labor force in the affected sectors-will be laid off.
An additional 135,000 workers will probably lose
their jobs in support industries indirectly affected by
reconversion.
The Socialists particularly want to reallocate re-
sources to industries with a greater growth potential.
They plan to foster investment in auto production,
electronics, food processing, and defense materials
through government subsidies, direct credits, credit
guarantees, tax exemptions, investment incentives,
and labor subsidies. To minimize worker dislocations,
investment will be targeted at the geographic areas
most affected by reconversion. The Gonzalez govern-
ment is also designing retraining programs and pro-
viding unemployment compensation to cushion the
effects of restructuring.
A major goal of the program is to restore the health of
the public-sector enterprises. Of the $7 billion budget-
ed for the reconversion program, 70 percent will go to
state-owned firms to help scale down sick industries,
support investment in new areas, and improve the
companies' debt ratios. In addition, the Gonzalez
government is developing plans to sell to the private
sector the state's stock in some of the major money
losers, which had been taken over by the Franco
regime to protect jobs. Madrid thus hopes to bring
public-sector companies' budgets close to balance by
1986 and reduce the burden to the state over the
longer run. Initially, however, Madrid probably will
have to accept a loss to entice buyers for the firms.
Another key element of Socialist strategy is the new
national energy plan, aimed at reducing Spain's de-
pendence on oil imports by cutting oil's share of total
primary energy consumption to 47 percent by 1992.
To accomplish this, the combined share of hydro-
power and nuclear energy is to climb to 23.1 percent,
up from 11.3 percent in 1982, while the share of
natural gas is to increase from 3.2 percent in 1982 to
4.6 percent. Madrid hopes to reach these targets by
promoting energy conservation through realistic pric-
ing policies and by encouraging substitution through
credits and subsidies. The government also will pro-
vide financial support to boost coal production, keep-
ing coal's share at about 25 percent. The Socialists
project that the plan will cost $7.3 billion and gener-
ate 97,000 jobs from 1984 to 1992. We are skeptical
that Madrid can achieve all these goals, particularly
because the plan requires substantial investments to
convert from oil to gas and to distribute gas
The Socialist record on employment promotion is
mixed. On the positive side, they are not relying on
government programs to create jobs but instead are
trying to boost employment by moderating real wages
and revising labor laws. Madrid has extracted the
Socialist General Union of Workers (UGT) trade
union's agreement to a wage band next year of 5.5 to
7.5 percent, versus the government's 8-percent infla-
tion target. In 1986, wages are set to rise by 90 to 107
percent of the actual 1985 inflation rate. To stimulate
employment, particularly among youth, Madrid has
also eliminated the obligation to pay an indemnity to
laid-off workers. The measure applies only to new
hires; workers brought in under the old regulations
are not affected. Madrid also has put youths under 25
on their parents' social security benefit plan, thus
allowing employers to hire young people without
making social security payments
On the negative side, the Gonzalez administration has
implemented some measures that tend to discourage
hiring. By reducing the number of temporary workers
who can be hired, the maximum length of their
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contracts, and the number of hours in the workweek,
the government has, in our view, reintroduced some
rigidities into the system. Other factors, not under its
control, also have worked against it. With the impact
of lower real wages and labor market reforms expect-
ed to have a lag of about a year, the Socialists have
been obliged to watch the unemployment rate reach
20 percent.
The Short-Term Outlook
Spain appears to be on the road to a modest recovery.
We expect real GDP this year to show an increase of
about 2.5 percent, due mostly to a strong export
performance. Gains in competitiveness from the 8-
percent devaluation of the peseta in December 1982
and a narrower inflation differential, together with
the incipient recovery in Western Europe, should
boost export volume by more than 10 percent for the
year as a whole. Private consumption and real invest-
ment, however, are showing signs of weakening. The
government's tight fiscal policy probably will hold the
growth of public consumption to 2.5 percent. Conse-
quently, domestic demand and imports should be up
only slightly, allowing Madrid to turn last year's $2.5
billion current account deficit into a surplus of about
$1 billion. Slack demand, lower import prices, and a
moderation of wage gains should help to shave anoth-
er 3 percentage points off the inflation rate.
Coming close to achieving most of its goals this year
and doing better than expected in the external sector,
the Gonzalez administration apparently believes that
it can afford to relax its monetary stance over the near
term. Madrid has persuaded domestic bankers to
lower interest rates by 1.5 percentage points and has
allowed faster liquidity growth to accommodate this
reduction. The Socialists hope to stimulate investment
in interest-rate-sensitive sectors, such as construction
and consumer durables, and to promote employment.
During negotiations with the UGT and business lead-
ers, the government agreed to expand unemployment
compensation coverage and create 160,000 to 190,000
public-sector jobs but made it clear that it will not
retreat from its intention of reducing the budget
deficit to 4.5 percent of GDP by 1986. Madrid is
increasing taxes, slowing the growth of real public-
sector investment, and cutting public-sector employ-
ees' real wages 1.4 percent next year to achieve its
goal.
Assuming the Socialists do not abandon the objectives
of their austerity program, GDP will probably expand
by close to 3 percent annually in 1985 and 1986.
Higher taxes to keep the budget deficit in line, real
wage losses, and a lagged response to lower interest
rates and labor law reforms probably will limit private
consumption and investment growth. Firms may re-
spond to real wage cuts and greater labor market
flexibility by hiring more workers, but the slow pace
of economic growth and demographic trends suggest
that little or no improvement in the unemployment
rate is likely in the next few years.
We thus expect the unemployment rate-Madrid's
most serious problem-to stay near 20 percent, at
least for the next year or two. In our view, the
economy cannot absorb the 70,000 to 100,000 people
that the Bank of Spain estimates will enter the job
market annually, and only a few will be able to
emigrate to northern Europe. We believe that the
Socialists probably cannot promote the creation of
enough jobs in new industries and in the services
sector to offset job losses resulting from the industrial
reconversion program. In addition, agricultural em-
ployment will undoubtedly continue to fall, albeit less
sharply than in the past because of the aging of the
farm population over the last two decades.
The trade unions' willingness to discuss wage guide-
lines and other labor issues with the government and
the employers' association suggests that high unem-
ployment probably will not lead to serious social
disruptions. We believe union leaders will hesitate to
do anything that could undermine the Gonzalez gov-
ernment as long as the opposition is headed by the
rightwing leader of the Popular Alliance, Manuel
Fraga de Iribarne. Although the Communist-domi-
nated Workers Commissions (CCOO) labor union
would not sign the social pact, it has less support than
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the UGT and little potential for mobilizing nation-
wide strikes. Sporadic demonstrations against the
government's program to cut jobs in weak industries
are likely to continue, but the Socialists will probably
be able to head off an escalation of strike activity by
offering compromises.
The structure of unemployment in Spain should also
keep social tensions down. The fact that more than
one-half of the jobless are youths between 16 and 24,
many of whom still live at home, suggests that the
family support system will continue to ease some of
the pain of unemployment. Among 25- to 54-year-old
men, the actual unemployment rate is probably lower
than the 11.6-percent official estimate because of the
On balance, we believe that it is highly unlikely that
the Gonzalez government will water down its industri-
al reconversion program-a topic that probably will
stay on the political front burner because it directly
affects workers' interests. Government officials proba-
bly recognize that they cannot bring unemployment
below 19 percent by 1986 as promised, even if workers
cooperate and real GDP grows faster than targeted.
With little to be gained from a policy change, we
expect the Socialists to stay on their present course,
mitigating worker unrest by laying more emphasis on
the labor benefits available under the industrial re-
conversion program, giving less publicity to the belt
tightening necessary, and offering compromises to the
UGT that will allow it to keep its followers in line.
hidden economy.
There are downside risks, and our 3-percent annual
growth forecast for 1985-86 could be optimistic. As
the unemployment rolls mount, workers may feel that
they have been asked to carry an unfair share of the
burden of adjustment. Because past worker sacrifices
have not yet led to any tangible benefits, the trade
unions may turn increasingly against the Gonzalez
government's pleas for further sacrifices. If workers
mount stronger opposition to the industrial reconver-
sion program, it could damage the Socialists' plans for
making Spanish industry competitive. Moreover, if
the government fails to bring down public-sector
credit demands, private investment will be crowded
out.
If the economy is still mired in recession as the 1986
election nears, the Gonzalez administration may con-
sider expansionary policies. Under this scenario, Gon-
zalez probably would have to sack Finance Minister
Miguel Boyer, the architect of the austerity program.
We consider this unlikely because of Gonzalez's asser-
tions that he will pursue an adjustment program in
spite of the potential political losses in the next
election and because of his strong support for Boyer.
Moreover, Madrid clearly hopes to avoid making the
same mistakes as President Mitterrand initially did in
France, where the 1981 expansionary program simply
boosted inflation, put the current account deep in the
red, and caused a run on the franc. In any case,
Madrid would have to weigh the short-run political
mileage from relaxing its policies against the proba-
bility of having to apply the brakes again later on.
The Longer Term Outlook
Although longer term forecasts are always shaky, we
feel reasonably certain that the next decade will be
better for the Spanish economy than the last one. In
the first place, the external environment should be
more favorable because it is unlikely that the next 10
years will see a combination of two sharp oil price
hikes and two severe international recessions. In the
second place, Spanish economic policymaking is now
on a sounder footing. Although there are still impor-
tant problems, it does not seem probable that the
major policy errors of the 1970s will be repeated.
One encouraging sign is the diversification and expan-
sion of Spain's export base. In 1970, agricultural
commodities represented over one-third of total ex-
ports; manufactured goods accounted for only slightly
more than half, and these manufactures were highly
concentrated in a few traditional sectors. By 1982,
food exports had declined to 16 percent of total
exports, and manufactures had risen to 71 percent and
had a somewhat more varied composition. Although
traditional goods remain important, Spain has diversi-
fied its export sector by moving into the production of
automobiles, cement, machinery parts, domestic ap-
pliances, plastics, and chemicals. On the negative side,
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Table 3
Export Specialization a
Spain
European Community
NICs b
1970
1982
1970
1982
1970
1979
Steel
0.3
1.9
1.1
1.0
0.3
0.5
Ships
3.3
1.6
1.0
0.5
0.2
1.4
Textiles
0.8
1.1
1.2
1.2
1.2
1.9
Leather
2.5
4.3
1.7
1.5
0.8
1.0
Footwear
7.3
4.7
1.8
1.3
1.5
3.2
Automobiles
0.2
1.2
1.2
1.0
0
0.1
Trucks
0.3
0.8
0.8
0.8
0.1
0.3
Rubber manufactures
2.3
2.2
1.1
1.1
0.2
0.9
Mineral manufactures c
1.3
4.9
1.3
1.2
0.3
0.7
Domestic appliances
1.2
1.3
1.3
1.2
0.2
1.0
Electric appliances
0.5
0.7
1.1
0.9
0.9
0.5
Chemicals
0.6
0.8
1.0
1.2
0.4
0.3
Plastics
0.2
0.6
1.1
1.3
0.1
0.2
Medicine
0.5
0.7
1.3
1.2
0.9
0.4
Scientific instruments
0.2
0.2
0.9
1.0
0.1
0.3
Heavy industrial machinery
0.6
0.6
1.2
1.0
0.1
0.2
Telecommunications equipment
0.4
0.4
1.0
0.8
0.1
0.7
Machine parts
0.6
1.0
1.3
1.2
0.4
0.3
Business machinery
0.4
0.5
0.9
0.8
0.3
0.6
a This is defined as the proportion of exports of a given sector in
relation to total exports for a country, divided by the proportion of
OECD exports in that sector to total OECD exports. An indicator
greater than 1 indicates "specialization" in that sector, according to
the definition.
As the table shows, Spanish-manufactured exports were highly
concentrated in traditional sectors in 1970. Like the NICs, Spain
has gradually moved into other sectors such as automobiles and
plastics; however, it remains weak in high-technology commodities
like telecommunications equipment. The industrial reconversioin
program should help diversify Spanish exports, but it will be a long
time before they are as evenly distributed as the EC's.
b Newly Industrializing Countries (NICs). The most recent avail-
able data are 1979.
c The major components are construction materials, such as ce-
ment, asbestos, lime, and bricks; glass; and ceramics.
Spain still lags behind the European Community in
the infrastructure needed to export either capital-
intensive goods or high-technology commodities
where world demand has grown rapidly (see table 3).
On the other hand, we think a return to the high
growth rates posted during the miracle years is out of
the question. Madrid still has a long way to go in
solving its economic problems, and we believe this will
hold average growth through 1990 to perhaps 3
percent annually. With the labor force still
expanding at about 1 percent per year, this means
that relatively little progress will be made against
unemployment
With most forecasters expecting Western Europe as a
whole to grow by no more than 2.4 percent annually
for the remainder of the decade, the prospects for
Spanish emigration and 1960s-style export growth are
not bright. Slow progress in industrial reconversion
means that, optimistically, Madrid could not hope to
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be in a strong competitive position before 1987.
Moreover, as a result of early retirements under the
reconversion program and demographic factors, social
security will become an increasing burden. With the
number of pensioners jumping by nearly 30 percent
from 1983 to 1990, Madrid projects social security
expenditures at 14.2 percent of GDP in 1990, versus
12.3 percent last year. Financing benefits for both
pensioners and the army of unemployed will keep
taxes high and drain resources that might otherwise
go into investment
The small size of most Spanish firms could also be a
serious impediment to growth in the increasingly
competitive, high-technology environment of the
1980s. As early as 1959, the Franco government
recognized the problem of undersized firms and
sought to promote mergers. These efforts had little
effect, however, perhaps due to a lack of entrepre-
neurial skill, to complacency, or to bureaucratic red-
tape. In 1975, less than 1 percent of all companies
employed 500 or more workers, the same as in 1958.
The percentage of medium-sized firms actually fell,
reflecting a sharp increase in the number of bankrupt-
cies that probably stemmed from steep labor costs,
slow sales, and liquidity problems. Even today, more
than 90 percent of Spanish companies employ fewer
than 25 people. Equipment in these small firms often
is obsolete, productivity has remained at less than
one-half the EC level, and the product quality is
sometimes poor. In addition, the smaller enterprises
generally sell to the protected domestic market and
thus contribute little to the drive to expand exports.'
Another problem for the longer term is that Madrid
still pursues a comparatively protective trade policy,
which has allowed uncompetitive firms to survive.
Although Madrid lowered tariffs in 1970, trade barri-
ers remain considerably higher than in the EC. The
average Spanish tariff on EC goods, for example, is
13.3 percent, versus an average EC tariff on Spanish
products of only 3.3 percent. Similarly, Madrid's
tariffs on goods from third countries average about 17
percent-more than triple the average common exter-
nal tariff in the EC. Shielded from international
competition, Spanish firms have had less reason to
invest in new equipment or to improve the quality of
their merchandise.
EC accession-which may take place in 1986-thus
may not initially bring many rewards. The transition
years, during which Spain will have to lower its tariffs
to EC levels, seem likely to produce considerable
economic strain. Some inefficient industries, previous- 25X1
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bankrupt with the onslaught of increased competition
from the north. Meanwhile, some of the benefits of
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