Why Wage Depression is not the Way out for Spain

Manuel de la Rocha-Vázquez es economista en la Fundación Alternativas y miembro de Economistas Frente a la Crisis

December 21th, 2013 will mark the second anniversary of the election of Mariano Rajoy as Spain´s Prime Minister after the parliamentary elections that saw the conservative PP sweeping into power.  Half way through its four year term, it is good time to assess the government economic policies.

In late 2011 the Spanish economy was deep into economic recession and facing serious macroeconomic imbalances. Two years later, things are not much better: economic growth has been negative, 2013 will still end with a negative growth of around -1.7%, while forecasts for the following years are lukewarm. Public debt has continued growing and will reach 100% of GDP, while private debt remains still at 195%. External imbalances have improved, particularly the current account deficit, which peaked at about 12% of GDP and is now almost balanced, thanks to a robust growth of exports, coupled with falling imports and a very good tourism season.

Why wage depression does not help growth

From the onset the government’s main objective was to regain competitiveness lost during the boom years, in order to export the way out of the crisis. To do this, absent the possibility of nominal exchange rate devaluation, the government sought full internal deflation, no matter how painful. Labor market reforms enacted in 2012 went much further than previous ones, and essentially eschewed labor relations in favor of employers, weakened collective bargaining and allowed a free hand to fire and lower salaries. As one could have expected for an economy in recession, the main effect of easing dismissals was massive dismissals: over one million jobs have been lost in the last two years. Unemployment rate has increased from 22.8% in 2011 to 25.9%, temporary contracts remain at 24% of all contracts, but now the large majority of new hires are under temporary contracts –over 90% in November. In one aspect the labor reform has been effective; real wages have fallen between 5 and 10% in the last 2 years. Low earning workers have been much more affected; according to FEDEA Foundation wages have dropped down to 17% in real terms since the beginning of the crisis for those in the lowest decile of the salary scale.

The main flaw with this strategy is that it missed the point about the causes behind competitiveness losses. It was argued that the problem was high growth of wages fueled by trade union´s demands in a rigid labor market. In fact,  real unit labor costs have been falling in Spain since 1986 as a report from the State Consejo Económico y Social[1] showed earlier in the year, with only short periods in which they increased, such as 2007-2009. Overall, workers remunerations as a share of GDP have dropped by 3 percent since 2000, an amount mostly transferred to profit margins. Thus, the real problem lie elsewhere; Spanish prices grew faster than those in the Euro by about 1.5% in average, caused not by high salaries, but by low labor productivity and high profit margins. So although real salaries did not really grow, because of higher inflation nominal labor costs increased faster in Spain than in the Euro area.

Yet, the effect on competitiveness was not so clear-cut. Spain´s share of world exports in industrial products did not fall despite the apparent loss in competitiveness during the boom years, whereas other countries like France or US lost close to 20% and 30% of market share between during the decade up to 2009. So, it does not seem that the loss of competitiveness affected greatly its exports performance. This is probably due to the dual structure of the Spanish economy, with a small number of very large and competitive multinationals that are world leaders in their sectors (infrastructure, renewable energy, construction, biotechnology, etc.) and the bulk of SMEs focusing on the domestic market and very little attention to exports.

Elasticity of consumption to salary levels is much higher than elasticity of exports to labor costs. Thus, deep and sustained falls in real salaries in Spain have depressed domestic consumption, which has been falling consistently every quarter for the last 2 years, far outweighing the competitive gains obtained from the external sector. Exports represent around 22% of GDP, about half the weight of household consumption, so for every percentage point that consumption falls, exports need to grow several times larger in order to sustain output. This is not realistic.

Moreover, most exported products incorporate imported inputs, so that growth of exports also pushes imports up, reducing the contribution of external sector to GDP. Further, salary repression as a way to grow exports is an imperfect channel; given Spain´s chronic lack of competition often labor costs reductions are not passed-through to final export prices. In reality, most firms are profiting from lower wages to reduce their high debt levels not to lower prices. So, ultimately the much needed private deleveraging is taking place on the back of workers purchasing power.

In this context, leaving aside equity considerations which are not insignificant, it is hard to see how growth can pick up with falling domestic demand. But is even harder to imagine how consumption can recover with unemployment rates above 25%, almost all new hires under precarious contracts, higher taxes and a general depression of salaries.

What are the alternatives to wage depression?

Alternative policies to internal devaluation do exist. They involve some rectification to the labor market reform in order to restore collective bargaining; getting credit flowing back to SMEs and households; design and implementation of a robust industrial policy in order to revert the decline of industry in GDP occurred since 2000. The latter should involve increasing expenditure on R&D and innovation, which have been slashed by the Government leaving Spain with lowest R&D in the EU; liberalization of closed sectors that sheltered from competition keep pushing prices up and; negotiation of a grand bargain between the government, unions and employers to moderate wages, alongside prices and profit margins, so that the country can improve competitiveness while not repressing domestic demand.

Above all, the key lies in investing massively in education and active labor policies to retrain and enhance the skills of the millions of workers, especially young ones, left with no jobs and no education by the burst of the construction bubble. In the same vain that in the 90s Spain made huge strides in upgrading its physical infrastructure resulting in one of the world´s best, today all efforts must focus on improving the country´s human capital, which should constitute the backbone of a new productive model based on innovation, technology and high-value sectors.

***

Este artículo se publico en la revista Social Europe.


[1] ¨Informe: Distribución de la Renta en España: desigualdad, cambios estructurales y ciclos¨. Consejo Económico y Social. 03/2013.

Un pensamiento en “Why Wage Depression is not the Way out for Spain

  1. Muchas gracias por el excelente post, que es un resumen muy apropiado de la situación económica. A pesar de estar de acuerdo en la mayoría de los aspectos, me gustaría puntualizar algunas cuestiones. Por ejemplo la contabilización de deuda, aún siendo importante, ceo que es más importante la posición de inversión internacional neta y aún así es conveniente desglosar esta para ver la evolución de su partidas, ya que tampoco todas ellas tienen la misma importancia. Un análisis detallado se puede ver aquí: http://golpedefecto.blogspot.com.es/2013/11/composicion-y-evolucion-de-la-posicion.html . estoy de acuerdo en que la deflación interna plasmada como recorte de salarios no ha sido trasladada a precios hasta hace muy poco en el caso de que esta haya sido la razón de la evolución del IPC. Sin embargo habría que tener en cuenta también la evolución de otros costes como los energéticos o financieros que impedían un recorte del IPC, o simplemente la falta de competencia en múltiples sectores de nuestra economía, como se comenta en el post. Pudiendo estar asociado el incremento de márgenes empresariales a la dificultad de obtener crédito o su coste y por tanto autofinanciarse de esta forma.
    En cuanto a las soluciones propuestas, no puedo estar de acuerdo en la recuperación de la negociación colectiva como estaba antes, sino más bien en la corresponsabilidad común y en el establecimiento de un contrato único con una mochila tipo austriaco. Lo referente a la financiación es cierto decirlo y no tan fácil hacerlo y lo que es indudable es que hay que cambiar el modelo económico a uno más competitivo basado en I+D, comenzando por la educación y no en recorte de salarios.

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