Posted by: Dirk | November 21, 2011

‘Austeridad’ in Spain – more of the same?

The general elections is Spain have brought the Partido Popular to power, as voters ousted the socialist (really, social democrat) government. The problem of Spain is, of course, inflation. Just kidding, it is unemployment, which stands at 22%. El Pais has understood the dynamics of the European Union and reports that the incoming presidente Mariano Rajoy has received the crucial call from Mrs Merkel.

Let me just outline the state of the Spanish economy. After the burst of the housing bubble, Spaniards are now struggling to repay debt. Consumption has fallen, since households are increasing their savings. Monetary policy did not help much to stop the fall in consumption, since the lower nominal interest rate did not lead to increase in Spanish investment. Since the main channel works via real estate, that is perhaps not surprising. Fiscal policy is not available, because of the 3% rule of the stabilization and growth pact. Spain cannot break it, since the country has no central bank that could finance deficit spending of the government. A devaluation is no option either, since Spain is member of the euro area.

To summarize the position of Spain: the country is left with no instruments to influence its economic fate, except for leaving the euro zone and/or defaulting on some of its debt, public or private, internal or external. If these instruments are neglected for political reasons, than Spain’s fate is not in her hand anymore. Growth can only come through an increase in consumption, investment, government expenditure or net exports. Austerity rules out consumption and government expenditure, investment is rules out by the deleveraging going on. Nobody wants to borrow more, never mind the interest rate. Net exports depend on the price level, but so does real debt. A lower price level would increase the quantity of exports, but not necessarily the export earnings. At the same time, euro-denominated debt increase in real terms after wages have fallen.

The Spanish government is between a rock and a hard place. It is clearly a lack of demand that is causing the economic troubles. Since Spain cannot tell other countries to spend more, it is trapped in a position where it can only regain control by leaving the euro zone. Else, it will be like a leave on a river.

After government by the left has failed, a failure of government by the right would leave the next general elections up for some extremist party of either left or right. It would be the failure of the elites of both left and right to understand the functioning of a modern economy that would open the door to extremist parties of the future. Therefore, the hopes of the Spanish democracy now rest on Mariano Rajoy. The report from Bloomberg do not generate much hope, as some paragraphs from that source show:

Rajoy, who studied law and worked as a land registrar before getting into politics in his mid-20s, is better known for self-restraint, for listening carefully to advisors and for preaching patience than for taking strong initiatives or inspiring his followers.

The son of a judge, Rajoy has the impenetrable demeanor typical of his native Galicia in northern Spain, where people are famed for their reserve and for answering a question with a question.

Rajoy, who has little international experience and limited English, is expected to name a heavyweight economy minister to deepen painful austerity measures at home and travel abroad to persuade investors that Spain has its accounts in order.

Schooled by Roman Catholic nuns, he laments the decline of Latin studies in Spanish schools. His stable provincial family background appears to make it difficult for him to relate to young Spaniards frustrated with a youth jobless rate of more than 40 percent.

He is dismissive of the “Indignados” (or Indignant) movement that took over public squares in May to protest against the political status quo and inspired the Occupy Wall Street movement worldwide.

The picture painted here is one of a conservative, who is called ‘cautious’ in the Bloomberg headline. The part about austerity shows that Rajoy belongs to the confidence fairy movement and not attack the underlying problem of a demand failure. Throwing out one government for the lack of ability to tackle the economic problems and voting in a new government which is showing the same lack of ability already seems like a strange thing to happen.

The austerity theorem (“deepen painful austerity measures at home”) a.k.a. the confidence fairy (“persuade investors that Spain has its accounts in order”) have been discarded as theories long ago – very, very long ago. Keynes in his 1936 opus magnum cites Malthus (1766-1834) on this issue:

We see in almost every part of the world vast powers of production which are not put into action, and I explain this phenomenon by saying that from the want of a proper distribution of the actual produce adequate motives are not furnished to continued production. … I distinctly maintain that an attempt to accumulate very rapidly, which necessarily implies a considerable diminution of unproductive consumption, by greatly impairing the usual motives to production must prematurely check the progress of wealth. … But if it be true that an attempt to accumulate very rapidly will occasion such a division between labour and profits as almost to destroy both the motive and the power of future accumulation and consequently the power of maintaining and employing an increasing population, must it not be acknowledged that such an attempt to accumulate, or that saving too much, may be really prejudicial to a country? [36]

The question is whether this stagnation of capital, and subsequent stagnation in the demand for labour arising from increased production without an adequate proportion of unproductive consumption on the part of the landlords and capitalists, could take place without prejudice to the country, without occasioning a less degree both of happiness and wealth than would have occurred if the unproductive consumption of the landlords and capitalists had been so proportioned to the natural surplus of the society as to have continued uninterrupted the motives to production, and prevented first an unnatural demand for labour and then a necessary and sudden diminution of such demand. But if this be so, how can it be said with truth that parsimony, though it may be prejudicial to the producers, cannot be prejudicial to the state; or that an increase of unproductive consumption among landlords and capitalists may not sometimes be the proper remedy for a state of things in which the motives to production fails?[37]

Adam Smith has stated that capitals are increased by parsimony, that every frugal man is a public benefactor, and that the increase of wealth depends upon the balance of produce above consumption. That these propositions are true to a great extent is perfectly unquestionable. … But it is quite obvious that they are not true to an indefinite extent, and that the principles of saving, pushed to excess, would destroy the motive to production. If every person were satisfied with the simplest food, the poorest clothing and the meanest houses, it is certain that no other sort of food, clothing, and lodging would be in existence. … The two extremes are obvious; and it follows that there must be some intermediate point, though the resources of political economy may not be able to ascertain it, where, taking into consideration both the power to produce and the will to consume, the encouragement to the increase of wealth is the greatest.[38]

Of all the opinions advanced by able and ingenious men, which I have ever met with, the opinion of M. Say, which states that: un product consommé ou détruit est un débouché fermé (I. i. ch. 15), appears to me to be the most directly opposed to just theory, and the most uniformly contradicted by experience. Yet it directly follows from the new doctrine, that commodities are to be considered only in their relation to each other, — not to the consumers. What, I would ask, would become of the demand for commodities, if all consumption except bread and water were suspended for the next half-year? What an accumulation of commodities! Quels débouchés! What a prodigious market would this event occasion![39]

Anyone promising growth by austerity should have to prove his or her case before implementing any policy. Since all evidence goes against it, and models predict depression by austerity, I can only hope that Mr Rajoy listens to his advisors, and that these advisors know their trade.



  1. […] very likely lead to higher incomes in Spain, not lower incomes like suggested by Sala-i-Martin. Mr Rajoy, who in autumn 2011 was member of the confidence fairy club, seems to have changed his opinion about economic models. […]

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