The Spanish economy has suffered from relatively high unemployment and inflation rates, and has lurched from one industrial crisis to another, for decades. In the 1980s it cleaned up its heavy industries, like shipbuilding, and went big into tourism, turning its Mediterranean coast into a playground for sun-starved northern Europeans. Growth accelerated, but the best was yet to come.
The real party began when Spain joined the euro club in 1999. Interest rates, which historically had been in the mid-teens, plunged. Cheap and easy credit flowed into the economy and Spain went on an epic spending spree, dominated by real estate. At one point in the middle of the last decade, construction spending represented 16 per cent of GDP - two to three times its normal level - and 12 per cent of employment. Speculative projects like those in Sesena were thrown up like tents.
The housing boom - propelled by tax rules that allowed owners to deduct both interest and mortgage payments - allowed Spain to create fully half of all EU jobs in the first half of the decade. Spain sucked in capital from the rest of Europe to finance the breakneck growth in general, and the building bonanza in particular, swelling the country's current account deficit to a fat 10 per cent in 2007 (the figure refers to the difference between the payments Spain received for selling exports and the payments made to purchase imports).
"In 2006, Spain built more homes than France, Italy and Germany combined," said Angel Estrada Garcia, director-general of macroeconomic analysis for Spain's economy and finance ministry.
Spain's finances, meanwhile, began to deteriorate even as growth barrelled ahead. Spending on endless infrastructure projects proved costly. Wages soared, driven by agreements that gave workers covered by collective bargaining agreements pay increases that matched or exceeded the inflation rate. In 2008, the crash year, wages went up 3.9 per cent. By last year, the budget deficit had reached 11.4 per cent of GDP - nearly Greek levels. "Now it's payback time," said Jose Manuel Amor Alameda, a partner at AFI, an independent economic and financial consulting firm in Madrid.
The financial crisis ended the housing boom overnight. Since 2008, a million Spanish workers have lost their jobs, nearly half of them in construction. Spain was slow to grasp the severity of its problems, economists said. The Greek debt crisis changed that in a hurry. Investors dumped the bonds of any EU country with shaky finances, including Portugal and Spain. Spanish bond prices plummeted, sending the interest yield in the opposite direction. "What scared us was the reaction in the debt markets," the finance ministry's Mr. Estrada said.
Fearful of being labelled the next Greece, the socialist government of Prime Minister Jose Luis Rodriquez Zapatero is suddenly in a hurry to clean up Spain's financial act, knowing it cannot rely on currency devaluations to make the economy more competitive. Consumption taxes are rising, the tax-driven housing incentives are disappearing and only one in 10 retiring civil servants will be replaced.
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But the cutbacks may not be enough. Gayle Allard, economics professor and labour expert at Madrid's IE Business School, said "there is no plan for labour reform," suggesting that unemployment rates will remain high because of the lack of job flexibility. AFI's Mr. Amor said the government's recovery plan depends in good part on economic growth forecasts he considers "overly optimistic." He also expects a massive restructuring of the dozens of smaller banks that had pinned their fortunes on an endlessly rising housing market and now face years of zero to low growth.
Will the pain get so intense that Spain will ditch the euro? It's not even under contemplation, according to Mr. Amor, Mr. Estrada and most European economists. But Spain, Mr. Estrada said, will require "discipline" to get its deficits down. So will Greece, Portugal and the other EU debt miscreants, a process that could take many years and possible trigger social turmoil, as it already has in Greece. "The jury is still out, and the euro zone is not out of the woods yet," said Mr. Annunziata, the UniCredit economist.
With files from Brian Milner in Toronto