Europe’s Champions on Different Economic Paths
Why is Spain starting look a little more robust economically than Britain?
- Since the start of the financial crisis, the British economy has done even slightly worse than Spain, the current focus of the euro crisis.
- While Spain is tackling its problems ever more seriously, British efforts to repair its public finances and reform its supply-side are losing momentum.
Congratulations are in order to Britain. It has staged near-perfect Olympic Games, and its athletes have rewarded their country and themselves with Britain’s best medal tally in more than a century. London 2012 shows the greatness that Britain can achieve with its unique mix of ingenuity, humor and dogged determination.
Britain’s Olympic triumph outshines even the success of Spain, which had won the other great sporting event of the year, the 2012 UEFA European Football Championship.
Unfortunately, Britain’s Olympic prowess does not translate into the mundane matters of economics. Since the start of the financial crisis, the British economy has done even slightly worse than Spain, the current focus of the euro crisis.
Spain and the UK are almost identical twins in terms of economic growth since the beginning of the financial crisis. Since the second half of 2007, Spain’s GDP is down by 3.9%, Britain’s by 4.3%. Both have been in recession for some time.
Off-Peak. Both Spain and the United Kingdom remain well below their peak GDP in 2007. (Data: Eurostat)
The similarities go further than headline GDP figures. Both countries experienced a property and consumption boom in the run-up to the subprime mortgage crisis, and both were running current account deficits. Both countries’ bubbles burst during the crisis and borrowing by both governments rose sharply.
Debt levels in 2011 stood at 68.5% of GDP in Spain and 85.7% in the UK. Spain’s budget deficits was 8.9%, while Britain’s was 8.3%. Both countries experienced a large swing in their trade balances.
There are important differences, too:
Labor market: Britain’s unemployment rate stands at 8.1%. Spain’s is 24.8%. Britain’s flexible labor market and London’s global draw helped to offset some of the adjustment pain, while Spain’s masses of construction workers were unable to find jobs.
Austerity: The UK announced intelligent austerity measures in 2010, combining spending reduction with growth enhancing corporate tax cuts. Spain’s fiscal cuts came later, but were more front-loaded. An ambitious labor market reform in Spain addresses labor market weaknesses.
Like Spain, Britain has to cope with a big real estate bust, overindebted households, runaway government deficits and serious problems with its banks. But while Spain is tackling its problems ever more seriously, British efforts to repair its public finances and reform its supply-side are losing momentum.
Yet Spain’s borrowing cost has reached 7% for 10-year debt, while the UK’s is only 1.6%. A key reason for that is the central bank. While the Bank of England has made clear it will do anything to stop the crisis and promote growth, the European Central Bank has acted hesitantly. The ECB only steps in when the pain is almost unbearable.
For Britain, having its own central bank has one advantage. Through massive bond purchases, the BoE is subsidising the government, allowing Britain to postpone the day of fiscal reckoning into the future. The flip side of the coin is that the economy is now adjusting much faster in Spain than in Britain.
Despite being part of the euro, Spain has managed to turn a huge trade deficit of 10% of GDP in 2007 into a small surplus now. Britain, with its own currency, is still living beyond its means with a net export deficit of around 1%, modestly down from the 3.5% of 2007.
In the near-term, the outlook for Spain is worse. Because Madrid is taking a major fiscal hit now with a hike in the standard value-added tax rate from 18% to 21%, Spain will remain in deep recession until at least early 2013.
But once Spain has finished its frontloaded fiscal repair, it may well outcompete the British reform laggard by a serious margin — unless Britain finally applies the qualities it is demonstrating at the fabulous London Olympics to its own economic policies.