Quo Vadis Hispania?

The misery index, the sum of the inflation and unemployment rates, hit 22.4 in March in Spain. This figure is double that of the US and 10 points higher than the EU’s (which of course includes Spain’s outlier). In spite of the widespread misery, life goes on. There is no apparent Government crisis and very few people seem to be concerned.

Prime Minister Pedro Sanchez addresses the manifold crises his Godforsaken country faces with 1970s policy tools such as subsidies for gasoline and diesel and price controls for electricity and rents. The subsidies return to motorists some of the windfall tax receipts resulting from inflation and the price controls are, of course, a euphemism for expropriation of private property. Burying their heads in the sand seems to be working for now, politically. Conveniently, there is very little coverage in the not-so- independent and not-quite-free press. The war in the Ukraine overshadows most other problems.

The day of reckoning is nigh

Yet, soon enough, the day of reckoning will come with the same shocking randomness and sudden violence we saw at the outset of the euro area sovereign and banking crises in 2010. Foreign lenders are not often persuaded by nice words or good intentions. Eventually, they want to see cash. This is especially true when neither of the two largest political parties takes structural reforms seriously. In fact, the ruling coalition is actually trying to undo whatever little progress was made deregulating internal markets in the last decade. Very few developed countries have proven to be as fragile in the face of adversity as Spain. The pandemic brought the largest GDP decline in the OECD. The recovery in 2021 was the slowest of any developed country. Year-on-year inflation in March was a record-breaking 9.8%. We can marvel at the resilience thus far, but the Spanish formula is more fragile than ever.

At the same time, we have been living with an exceptionally indulgent European Central Bank. The ECB’s mandate primary focus should be inflation. But the ECB has more recently taken it upon itself to be the motor of economic growth in Europe, lender of last resort to governments, guarantor of the euro zone. This has gone on for a decade, so we now find ourselves with negative real interest rates of something like 8% or 9% in Europe. This is proving too much even for the ECB’s divided governing council, which all points to the ECB raising rates sharply, soon and fast.

There are very few western countries besides Spain where communists are in the government or where enemies of the state support the government in Parliament. This would be merely anecdotal were it not for the fact that on Friday after the cabinet meeting, the government spokesperson announced that property owners with a portfolio of more than ten dwellings would not be able to increase rents by more than 2%, owing to “the high rate of inflation” of the last three months. This expropriation will fail the constitutionality test but not before producing a lot of damage to the quality of the rule of law in Spain, which already has a weak standing. While we have seen a massive demonstration of farmers in Madrid two weeks ago, the labour movement is silent on the big problems, including falling real wages that afflict their members.

Spain has created a wonderful system where trade unions have no dues paying members but subsist on government handouts. Ditto for political parties. What passes for a business federation is an organization run by a person with not much business experience. This person generally does not speak for the country’s large corporations, who do their own lobbying.

Corporates are long in the tooth

We are not sure there is a better alternative as the business community in Spain is not exactly teeming with talent. Recently, Iberdrola, an electric utility, became the largest company by market capitalization in the country, overtaking Inditex, whose stock has reacted poorly to store closures in Russia and lockdowns in China. It is quite revealing that the top position is held by a company with its roots in 19th century technology as it overtakes a company with a business model that is even older.

You may ask, why are we critical of Spanish management when so many companies and their leaders are showered with international awards and distinctions. Probably because total shareholder return is the metric we value most highly. On this metric – and since Inditex went public in May 2001- only 13 other Spanish public companies have total shareholder returns above 8% CAGR – compound annual growth rate. (Ferrovial, an operator of airports and toll-roads, did not go public until 2004. The stock has returned 11.26% CAGR since.) Five of these companies are electric utilities. The best performer, CIE Automotive, is in the auto-parts business. There is a glass bottle maker, a global leader in sausage casings, a manufacturer of railroad rolling stock, a cement company, an insurance company, and two engineering and construction companies. Most of these companies are long in the tooth, several of them have been around for more than 100 years. This sample is representative of the lack of entrepreneurship and innovation that afflicts the Spanish business landscape.

Given this sorry state of affairs for investors in Spain, management compensation at underperforming companies is an aberration that can only be explained by poor corporate governance. We often question the independence of independent directors. We know full well that most CEOs, or executive Chairs, in Spain value loyalty well above independent thinking or competence, and it shows. Independent thinking is generally thought to be a negative with few exceptions.

Thus, not a single management team ever doubted why they were throwing billions of euros at acquisitions in Latin America. When Banco Santander acquired Banco Rio de la Plata in 1997, we asked what did they know about Argentina that Gregorio Perez Companc did not. We made that obvious observation because, at the time, Mr Perez Companc was the wealthiest person in that country and everything he owned there was up for sale. In 2001, the Argentinian Government abandoned the convertibility of the peso into US dollars, put in place capital controls and the infamous ‘corralito’ and defaulted on its external debt for the sixth time in the country’s short history.

We know of only one instance when a director was not slated for renewal by the controlling shareholder of a listed company because during his tenure he had not once opposed any point of debate in board meetings. This state of affairs may be about to change, as just this morning we read press reports that Blackrock will oppose top management’s compensation at Telefonica. This is doubly interesting as they are currently the company’s single largest shareholder, with a 5.1% stake.

Fathers and sons (and daughters)

Nepotism is the other silent killer of initiative in Spain. When Ana Botin posted on Twitter that she had to overcome tremendous difficulties when she started her finance career because the senior people around her were old white men, she did not do herself any favours. As far as most people can tell, her main qualification to hold her current position is to have been her father’s daughter. This is also the case with Marta Ortega, the brand new chair at Inditex, Marta Alvarez at El Corte Inglés, and Sol Daurella at Coca Cola Europacific Partners. What is interesting about their nominations is that, in some cases, some of these candidates were chosen over their male siblings, which is good news perhaps for gender equality, but not for curing nepotism. Thus for many Spaniards the HBO series ‘Succession’ is art imitating life. Nepotism defeats any attempt at fairness or equality of opportunity. It also discourages entrepreneurship as the scant domestic capital pools are generally earmarked to family endeavours.

Rote, rote, rote your boat

Some of the lack of entrepreneurship is a result of labour and corporate legislation that punishes failure unduly. The rest may be attributed in equal parts to education and culture. Education in Spain is pernicious. As a friend of mine described brilliantly, the best schools in the country take on B+ students and turn them into B- students. The first problem is a national curriculum that is both mandatory and heavily politicised. There is – or there used to be before the pandemic resulted in everybody passing irrespectively of grades – much emphasis on rote learning and very little on oral and written communication skills, critical thinking, or working in teams, as occurs in the workplace. Spaniards are still in awe of candidates who become State Lawyers or Notaries Public because of their talent for memorizing thousands of pages of information and regurgitating them without fault in an oral exam. How this prepares these mandarins for the difficult task of making policy decisions is unclear.

We recently listened to a very interesting interview in the ‘Invest like the Best’ podcast with David Rubenstein, a co-founder of the Carlyle Group. He was very concerned about the 14% of Americans who are functionally illiterate; i.e. people who cannot read at the 4th grade level (9 to 10 year olds).

We are afraid we do not even want to ask that question for Spain. Spanish culture is rich in tradition and folklore. Yet when it comes to reading, most people in Spain prefer to get their news from TV or the radio. Newspaper and magazine sales have declined precipitously. Book sales have always been low relative to household income. In fact, even though surveys suggest that Spaniards read on average 5 hours and 48 minutes per week – just ahead of Germans, Canadians or Italians – the fact is that you can count the number of people reading a book in public transportation or on a packed beach with the fingers of one hand. Most people pay lip service to the value of a good education but very few people actually get one.

No pain and no gain

In general, Spaniards are risk averse. Many educated people prefer a government job to the vagaries of the private sector, and many of them get one. The public sector was once again the fastest growing employer in 2021. Partly because of the increase slice of the public sector in the labour market, productivity has not grown very much lately.

The median household income has not grown very much either since 2009, as wages have generally not kept up with inflation and other sources of income have declined, especially returns on savings because of falling interest rates and higher taxes. Only 5% of Spanish households have a disposable income above $100,000 vs 11.7% in France. 51.2% of households have a disposable income above $35,000 vs. 72.5% in France.

Governance of government a blemish

The governance of government is also poor. A Council of Europe report published last week states that Spain has not fully complied with any of the 19 recommendations on corruption the Council made in 2019. Obviously, the Council of Europe knows a lot about corruption since some of the most corrupt countries in the world – such as Russia, Belarus, Moldavia and Ukraine – are among its members. Nonetheless, it is another blot on the landscape.

This is not good PR when you have as large an external debt as Spain does. Aldi Nord, the German supermarket chain announced it is raising prices on 400 food items by between 20% and 50% as of today; we shall soon see how German officials react to the public outcry that may ensue.

Sanchez is likely to set price caps on food items as well. This will lead to kilos that weigh just 750 grams, or scarcity, or both. If the playbook for this new crisis in Spain is to continue to follow the tools used by Peronist Governments in Argentina, we may soon see capital controls and a corralito here as well. If you think this is far-fetched, you should remember that this is what happened in Cyprus and Greece.

This entry was posted in Reports from the Field. Bookmark the permalink.

Leave a Reply