Spain's Election is Set to Worsen the Crisis in Europe

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Snapshot

The Greek Haircut and Europe's Shared Responsibility

Abraham Newman

The euro crisis is not a simple story of Greek sinners and German saints. In fact, imposing austerity on the eurozone's periphery alone will accomplish little. To save the continent, its richer countries and private investors must share in the sacrifice.

November 21 Update: As opinion polls predicted, the center-right Popular Party (PP), led by Mariano Rajoy, swept Spain’s parliamentary elections on Sunday. Despite running a deliberately vague campaign that mainly played to the electorate’s desire for change, Rajoy overwhelmingly defeated the socialist candidate, Alfredo Pérez Rubalcaba, winning an absolute majority:186 of the 350 seats in the lower chamber of Parliament. Celebrations, however, are not expected to last. Although they do not officially take office until the end of December, Rajoy and the PP are already under pressure to stabilize the market for Spanish bonds, to appease calls for austerity from Frankfurt and Berlin, to decrease Spain’s soaring unemployment, and, ultimately, to save the country from economic recession and default.

For Europe, it turns out that November is the cruelest month: The debt crisis will claim at least three eurozone governments before it is over. Yet, unlike in Greece, where Prime Minister George Papandreou resigned last week, and in Italy, where Prime Minister Silvio Berlusconi stepped down over the weekend, the political crisis upending Spain is toppling the government in slow motion. Facing dwindling public support, an unemployment rate of more than 20 percent, and the increasing cost of Spanish debt, the country's Socialist Prime Minister José Luis Rodríguez Zapatero threw in the towel last July and called for early elections to be held on November 20, four months ahead of schedule.

By all accounts, the election is expected to be a landslide. The current deputy prime minister of the Spanish Socialist Workers' Party (PSOE), Alfredo Pérez Rubalcaba, will face the seemingly perennial candidate of the conservative Popular Party (PP), Mariano Rajoy. Rajoy has lost twice before, but opinion polls suggest that the PP will win big this weekend, securing an absolute majority, its first in more than a decade. This is a so-called punishment vote against the ruling PSOE for presiding over Spain's decade-long boom and, now, its bust.

Those punished, however, will actually be the Spanish people and, more so, the rest of the eurozone. Madrid faces critical economic problems, and the policies of the new government will only make the situation worse. In fact, due to huge private debt, a less than fully deflated real estate bubble, and astonishingly high unemployment, Spain's financial crisis is as bad, if not worse, than Italy's. So despite the PP's good intentions, implementing severe austerity measures in the name of "fiscal responsibility" and "restoring market confidence" -- as Germany, the European Central Bank (ECB), and global investors are urging -- would sink the Spanish economy and push Europe's experiment with a common currency closer to its end. 

This is not the standard prognosis. According to most observers, Spain appears to be on the mend. The country's current debt-to-GDP ratio is only slightly more than 60 percent, the maximum debt threshold established under the Maastricht criteria. Italy's is 118 percent. Moreover, the outgoing Spanish government has worked hard to lower the general deficit from just more than 11 percent of GDP in 2009 to some six percent today. Italy's has been increasing (yet is currently up to only 3.2 percent). And in contrast to Berlusconi's two years of dithering on cuts, the Spanish parliament passed a modest round of austerity measures -- including a decrease in public wages, pension reductions, and an increase of the retirement age from 65 to 67 -- back in 2010. Spanish banks even appear secure, receiving praise from many economists for their overall conservative portfolios and high capital provisions. So from the sovereign debt perspective, Madrid looks pretty good.

The problem, however, is not public debt. The problem is Spain's private debt. Years of historically low interest rates allowed individuals and corporations to borrow too much and invest it poorly. The average level of Spanish household debt tripled in less than a decade, raising the median ratio of indebtedness to income to 130 percent today. Corporate borrowing has soared as well. Its private debt is close to 200 percent of GDP, whereas Italy's and Greece's are around 110 percent. According to a 2010 report from the McKinsey Global Institute, among the 20 most developed countries in the world, Spain has the third-highest level of total debt (government, business, and household), after Japan and the United Kingdom. In total, Spain's debt-to-GDP ratio is 366 percent.

Where exactly did all that money go? Some of it clearly went to good use, producing the eurozone's largest bank, Santander, the world's largest fashion retailer, Inditex, and the global leader in wind energy, Iberdrola. However, much of the money was ill spent on construction and real estate.