A shot in the arm for Spain
In the previous blog, we suggested some modest political reform in Spain which might deliver a fairer representation of the electorate in parliament and more accountability from elected officials and public servants. Accountability may be the biggest weakness in governance in Spain, both in the public and private sectors. The most sought-after positions in the country are those that provide generous pay, control over large budgets, and discretion over the compensation of as many people as possible. However, all this magnificent authority must come without any of the usual strictures seen in other parts, such as reporting or accountability. The masters of the Peninsula have it all!
One of Spain’s largest insurance companies allegedly spends €2 million annually sponsoring a professional tennis tournament in Madrid. This magnanimous contribution affords top management access to VIP boxes, presumably for client entertainment. The issue here is that this mutual insurance company’s main line of business is auto insurance and therefore the company likely has a much smaller percentage or total revenues coming from corporate clients than its peers. In any case, this expense is close to 5% of earnings, which is perhaps excessive for such a low-profitability insurer. At just below 6%, its return on equity is well below that of its peers.
Unlike in other major football leagues in Europe, the two largest football clubs in Spain are still “owned” by their members. This leads to total opacity around strategy, the day-to-day management, or the financial health of the clubs. Is it then surprising that the boards of so many public companies try to emulate these arrangements with varying degrees of success?
Corporate flight and lax governance
There was some debate a few weeks ago when Ferrovial, the most successful infrastructures, engineering, and construction company in the country, announced a change of domicile to the Netherlands. Unbeknownst to a clueless economy minister, the question is not why Ferrovial would abandon ship, but rather why many more Spanish companies do not follow suit. Arguably, Amsterdam is fast replacing London as the stock market capital of the EU. In addition, that country’s AAA Sovereign credit rating cannot hurt anybody, nor do its credentials for financial and legal stability.
The answer may be partly that other companies’ boards would not work well in a more open society. Many Spanish companies would not want any more scrutiny than they currently face, nor would they want to part with the protection afforded to management by a very inefficient market for corporate control, which, until the end of 2023, includes the Spanish Government’s veto power over takeovers of Spanish companies. Where else would a transaction such as the recently completed merger of BFE-MediaforEurope and Mediaset Espana, which valued the target at less than 2x earnings, not raise any criticism from institutional shareholders (or trigger the Government’s veto power)?
Living a life of illusion under Sánchez
Pedro Sánchez has presided over one of one of the worst, if not the worst, peace time economies in Spanish history. Yet, such is this Government’s hold over the media that you would never know that from reading the domestic or foreign press.
As has been the case for decades, Spain has one of the highest unemployment rates in the world today. At 13%, the unemployment rate it is more than double the EU’s 6% rate. Worse yet are the fates of women and children with this progressive government. 15% of women are unemployed vs. 6% in the EU and the youth unemployment rate is still a staggering 30% vs. 14% in the EU. Raising the minimum wage nearly 50% in the current legislature has likely contributed to this awful employment market.
High unemployment hurts economic activity. GDP has yet to recover its pre-pandemic level in real terms. Spain is the EU member with the lowest GDP growth rate since 2018, 0.4% vs. 1.3%. It is also the only country in the EU where per capita GDP is lower today than five years ago, decreasing 1.2% vs. a 4.3% growth on average in the EU. This statistic is even worse in Purchasing Power Parity (PPP) terms, which records a loss of 7%. As a result, GDP per capita has decreased from 90% to 85% of the EU’s average. Spain now ranks 13th out 27 EU countries on that metric. We have moved from expecting a “sorpasso” of Italy to being overtaken by Malta and Cyprus.
While progressives would want you to think that the tax burden is low in Spain because they point to Government spending-to-GDP, they fail to see that the tax burden on earned income is one of the highest in the world. It is currently 5 percentage points higher than the OECD average and it will keep rising if the Social Security reform passed in this legislature is implemented. This confiscatory taxation naturally results in higher unemployment and lower investment. Gross fixed capital formation as a percentage of GDP has declined from averaging 25% to just below 20%. The follies of the communist cabinet members do have a real cost.
No growth + high taxes + large fiscal deficits = higher inflation + higher unemployment!
No growth and high taxes have not prevented cumulative price inflation of 16% since February 2021. The food component of that index has risen 25% in that period and 29% since Pedro Sanchez became prime minister. This is likely the case, among other reasons, because Government spending is on a tear. At €612 billion, expenditures are 22% higher than in 2022. Despite this, the percentage of families living in poverty is at its highest since Spain joined the EU in 1986.
Clearly there is something very wrong when the non-accelerating inflation rate of unemployment (NAIRU) is above 10%. Worse yet, Spain’s productivity, measured by GDP per hour worked, is below the EU’s average and well below that of the largest economies in the EU. Labour productivity in France, one of Spain’s largest trading partners, is 70% higher, according to a recently published IMF staff paper.
No pain, no gain
What could be done to fix this mess? Pension and labour market reforms should be a top priority.
These are politically charged reforms that will be met by massive industrial action and street protests, like those we have seen in France. Is it better then to wait until the next crisis brings Spain closer to the precipice of sovereign default at which point these reforms will be imposed by Brussels and the IMF? While this is the politically expedient choice, the cost of waiting may far outweigh the cost of social strife. Not only should the retirement age be raised, but we believe that Government pensions will need to be means-tested at some point unless Spain is ready to face structural unemployment in the 20% region. Who in their right mind would ever hire anybody to manufacture or provide any tradeable goods or services when taxes on labour will continue to rise for decades under the latest pension reform scheme?
When justice means “just us” for companies
In parallel, the Justice system needs to be overhauled. Until such time as it is fixed, important criminal or civil cases may need to be tried elsewhere to ensure a swift process. There is already a deeply entrenched double standard of justice, as most corporate cases are settled in arbitration courts that are unaffordable to ordinary citizens. While many believe that the problem is underfunding, Eurostat data suggest that spending in law courts, police, and other public order and safety areas as a percentage of GDP is above average in the EU. This is most urgent a fix as the economy may not grow at its potential without legal security. This is the main reason why Ferrovial, and many other companies, are moving abroad. This lack of legal security, and previously mentioned governance issues. are reflected in the higher cost of capital that Spanish businesses face relative to other EU firms.
Fix the internal market(s)
Mercifully, there are some quick fixes, including plenty of arbitrary and unnecessary restrictions on commerce. Most internal markets need to be liberalized and homogenised. Tourism is Spain’s largest industry yet only two out of seventeen autonomous regions allow stores to open freely on Sundays year-round. If this were not bad enough, rigid labour laws make it very difficult for most restaurants to open seven days a week. Worse yet, strict limits on the number of hours that employees may work have forced some of the leading restaurants in the world to only open for lunch or limit dinner service to three evenings per week as they cannot find adequately trained staff to serve more meals and the number of hours their staff may work is capped by law.
Regulatory capture in services in general, and in financial services in particular, detracts from consumer choice while keeping prices high relative to other EU markets. Regulators need to be overhauled or, in the case of the banking industry, more decision making should be taken by the EU supervisor as the local regulator seems incapable of preventing mis selling. Competition should be encouraged and yet it is stifled in many regulated industries.
Let’s make a deal
Meanwhile, Spain remains saddled with an antiquated system of sector-wide collective bargaining between unrepresentative labour unions and cartel-like employers’ associations. These collective negotiations do not seem to work very well for the workers the unions profess to represent. This is evidenced in the monotonously declining number of memberships. Only 13.7% of the labour force are union members, a rate well below the OECD’s 16%. It is high time for employers to recognize this reality and stop pretending that they should continue negotiating these agreements with unions who represent very few people. Labour unions in Spain survive thanks to generous taxpayer funding. Why should the 86% of employees who are not union members subsidize these organizations?
The net effect of all these problems is that despite lower real wages, labour productivity is not improving. Add to this one of the most rapidly ageing populations in the world (in 2022 there were more deaths than births), a large net debtor international position, and growing social unrest and one would think that Spain is not a great place to live. Yet, Madrid has become a mecca for many affluent Latin Americans and the tourism industry is recovering fully.
The way forward
A much brighter future might be in store, especially when compared to the stagnation since 2006, should a new Government take some proactive measures, including an improved resident non-domicile tax regime that can compete with those of Italy or Portugal, cutting red tape for new and existing businesses, lowering taxes, especially taxes on labour, liberalising labour markets, removing barriers to commerce, including regulation of opening hours, and tackling the structural public pension system deficit. Perhaps then the relative and absolute decline of the past sixteen years may be reversed.