Three years ago, the pulse of Spain’s population was taken at the polls. On March 14, 2004, the Spanish Socialist Worker Party (PSOE) snatched power away from the Popular Party (PP), which has Christian Democratic roots, in the general elections. Since that time, the two main parties in Spain have not had the chance to face off, but on May 27, voters went to the polls to reconfirm their support for the current government. However, the elections in municipalities and autonomous regions have resulted in a turnaround, and the PP has won by a slight advantage. When it comes to the economy, however, what is the current situation facing Spain?


Despite its overall good condition, there is a certain bittersweet quality to the Spanish economy. Most of the statistics show a high growth rate that exceeds the average in Europe. Along with strong job generation, investment in capital equipment is recovering, and inflation has been moderate because of a decline in energy prices in recent months. Since 1996, the average growth rate of the Spanish economy has been 3.5%, and that figure has varied only slightly. Spain’s standard of living has practically reached the average within Europe.


“Growth is above 4% (according to recent data), revealing that economy is experiencing an outstanding growth cycle,” states Juan Carlos Martínez Lázaro, economics professor at the Instituto de Empresa business school. “You have to remember that Spain has a public-sector surplus unlike other periods in the history of our country. Day by day, this is the largest asset that the Spanish economy has.”


Experts have no doubt that the Spanish economy is doing well. “It is one of the best periods in our history, not only because there is growth but because that growth is accompanied by a reduction in some of the imbalances in the Spanish economy,” notes Martínez Lázaro. Agustí Ulied, a professor at Esade [business school] in Barcelona, says that “the stable growth shows that the Spanish economy is doing well.”


Construction, Immigration and Real Estate


Spain’s recent growth has been based on a strong surge in domestic demand, especially consumption and residential construction, driven by two factors: The accumulation of debt on the part of families and corporations, as well as increased immigration. Short-term, these processes generate a lot of jobs and accelerate tax revenues. However, in the medium term, they lead to imbalances, especially a loss of competitiveness that comes from differential inflation. Beyond that, the strong growth of the immigrant population limits the degree to which per capita income can grow. The general perception is also growing that the price of real estate is too high, and that there will be an adjustment [in prices]. In the best case scenario, the price adjustment will be smooth.


According to Martínez Lázaro, construction and immigration are now the two engines of the Spanish economy. “Construction comprises approximately 16% of the Spanish GDP,” he says. “And without the immigrant population, we would not have the growth rates that we have today.” Ulied notes that immigrant workers bring their families to work in Spain. “We would not be able to attract workers if not for these immigrant workers.” At the moment, Ulied adds, “I do not believe that there is any risk that immigration will have any sort of negative effect on the Spanish economy.”


The year 2006 will be remembered in Spain as the time when the real estate sector began to suffer a slowdown in home prices, following eight years of uninterrupted price rises. Real estate developers and construction companies have made changes in their previous forecasts, which turned out to be a bit too optimistic. Little by little, all of the big companies began last year to diversify their business into foreign markets. Spain’s real estate sector escaped into the tertiary sector, consisting basically of office buildings, industrial sites and shopping centers.


In recent years, the driving forces behind Spain’s growth have changed. Rising interest rates have dampened consumption and residential construction is showing signs of a slowdown. Meanwhile, banks and savings banks are making it harder for people to get loans because the volume of loans, already at high levels, could not continue to grow at the same pace. “Not considering construction, which is the sector that supports the growth of the Spanish economy, one of our strong points is the financial and banking sector. Another strong point is tourism, which is enjoying stupendous health,” notes Ulied.


Almost all of the experts say that the slowing rate of [real estate] price rises that began three years ago will continue in 2007. The latest numbers confirm that view: The average price of housing increased by 9.1% last year, which was 3.5 percentage points lower than [they rose] in 2005 and 8.3 points lower than [they rose] in 2004. Weeks after she assumed her post in 2003, María Antonia Trujillo, minister of housing, explained that she would try to achieve a gradual adjustment in the cost of housing and bring it closer to the rate of inflation.


So far, that trend is confirmed by the latest data. During the first quarter of 2007, housing prices were growing at a rate of 7.2% on a year-to-year basis. Although the eventual goal is to achieve price rises that are fully in line with the Consumer Price Index (CPI), the cost of housing is still growing at more than double the rate of inflation. “The cost of housing has grown by 17% in recent years. Now, it is below 10%,” says Martinez Lazaro. “Everything makes us think that they will be able to fulfill their forecasts. We will begin to notice a slowdown in prices over the next few years.”


Nevertheless, the high cost of real estate is the biggest concern for Spaniards. “Loan volume has increased because of the cost of acquiring real estate. However, so has the net worth of Spanish families. The problem is not the high debt, but whether people have enough liquid assets to pay it,” notes Martínez Lázaro. The average family’s debt continues to grow, moving well beyond the 100% of [annual] disposable income.


How much longer will Spaniards be able to support this pace? “That depends on how the economy grows. At the moment, Spain has four million immigrants and the lowest unemployment rate in its history. That shows that unemployment doesn’t have to grow just because there are a growing number of immigrants living in Spain,” says Martínez Lázaro. “The key in Spain is what is going to happen with the price of money; if interest rates continue to rise, consumption will decline.” Ulied says that the current pace of growth will continue as long as “interest rates permit.”


The biggest competitive advantage of the Spanish economy is that its fiscal surplus will enable it to temporarily pay for part of the deceleration of domestic demand by increasing public spending, even if that policy has a negative impact on the country’s public accounts in the medium term.


Alleviating The Trade Deficit


Any change in growth cannot come only from investment in capital goods because companies have already made a significant effort in that direction, and have accumulated a high level of indebtedness. The most obvious substitute should be exports, especially within the context of the European economic recovery. The latest data show that activity within the 13 [countries of the old E.U.] grew by 3.1% during the first quarter of 2007 and by 3.2% within the current 27 countries, according to Eurostat.


Clearly, Spain has to make adjustments to its excesses, and correct its accumulated imbalances. “There is an effort to alleviate the big trade deficit and to control inflation,” notes Martínez Lázaro. Although Ulied worries about that, he says “there are signs of improvement because European economies are recovering.” For his part, Ulied says that improving the country’s rate of productivity is one of the obligations of Spain’s executive branch.


The same opinion was voiced in March by Jean-Claude Trichet, president of the European Central Bank, who said then that the level of labor productivity in Spain is “very unsatisfactory.” He recommended numerous structural reforms for Spain, as well as for the rest of Europe, to avoid getting left behind by the United States when it comes to competitiveness. According to the National Institute of Statistics (INE), labor productivity in Spain grew by only 0.8% in 2006. Some sectors, such as services and construction, registered negative growth because of widespread hiring of workers who were not well qualified.


Some experts say Spain’s current structural problems are in the textile and footwear sector, which is threatened by imports from China. Martínez Lázaro does not consider that a major problem, but he says some industries are very exposed to competition from Chinese products. “This means that [Spanish] manufacturers must lower their production costs and focus on contributing added value; the [competitive] difference comes from [strong] design and branding.” Ulied says that this process is not threatening, but Spanish companies will have to make improvements in “innovation and in all those activities related to the knowledge economy.”