EC should learn from Spanish lessons

Looking at the Spanish economy, you might have thought that this was an election it would have been wiser to lose. Just why that should be carries two interesting messages for the whole of the European Community, not least Britain.

The financial markets yesterday responded to the narrow win by Prime Minister Felipe Gonzales by marking the peseta sharply up. But that was only because they had assumed that the balance of probability was that the Partido Popular would form the next government and that it would, after a decent interval, devalue the peseta yet again. The rise was therefore not a vote of confidence in the currency; merely a sign that the market had got its book the wrong way round.

Spain's economy has two messages for the rest of the EC. First, relatively low wages are not of themselves an adequate protection against unemployment. Second, even for a medium-sized economy like Spain's, the freedom to follow independent macro-economic policies is very limited, and any improvement in economic performance will depend on getting structural policies right.

Spain is in the unhappy position of having the highest unemployment in the EC, which itself has far higher levels than the US, Japan or the non-EC Western European countries. Registered unemployment, as defined by those claiming benefit, is 16.5 per cent, while stated unemployment, measured by a sample survey which estimates the number of people who claim they are out of work, was nearly 22 per cent in the first quarter of this year. By the end of this year it is forecast to reach 25 per cent.

That is an astonishingly high figure, but do not expect it to come down swiftly. The rolling European recession strikes Spain this year: after a 1992 in which growth edged upwards by 1 per cent, this year GDP will decline by about the same amount. Unemployment will climb through this year, and depending on the policy response, maybe into 1994 too.

This is particularly cruel because the country perceived itself as an economic success. So too did foreign investors, as anyone driving past the glitzy offices of the multinationals that flank the road from the airport into Madrid can see.

Why the unemployment? The answer lies in the rigidity of Spain's labour market, as a new study of the economy by Morgan Grenfell points out. First, it costs up to two years' salary to dismiss a permanent worker. The has predictable effects. As far as possible, firms hire temporary workers instead; but permanent workers are able to bid up wages. The problem is made worse by the cost of relocating employees, which allows regional unemployment differences to persist. And relatively high unemployment relief encourages people not to accept low-paid jobs.

At some stage Spanish employment legislation will be reformed, and ahead of the election both of the main parties had plans to do so. But this is unlikely to take place under a weak government, so very high unemployment will persist.

The second lesson, the limited policy options available to Spain, is equally stark. Despite the weak economic performance inflation also persists. Headline inflation is down to 4.6 per cent, but the underlying inflation rate is around 6 per cent, while service sector inflation is over 8 per cent. With the successive devaluations of the peseta since the autumn Spain has recovered the competitive position the peseta had when it joined the exchange rate mechanism. But with inflation stuck at these levels and the economy so weak, another devaluation is inevitable. The only two issues are the timing, and whether it would be wiser to follow the UK and Italy and suspend membership.

But just as Spain has to tackle the rigidities in its labour market, it also has to tackle rigidities in its distribution system, the main reason for the high service sector inflation. With services accounting for more than 60 per cent of GDP, holding down prices in manufacturing is not enough.

So while Spain could give itself a little more leeway on interest rates by leaving the ERM, and will give itself some competitive advantage by devaluing, neither of these macro-economic actions does more than buy time. The achievement of the Spanish economy during the 1980s was impressive, for it sustained the fastest growth of any large European economy. But that achievement disguised the need for structural reform.

These are issues for the rest of the EC, too. What are the structural reforms that are needed elsewhere, in the labour market and in the service sector? It cannot be right that the EC has far higher unemployment than the rest of the industrial world. And are Europe's service industries as efficient as those of North America? Spain's problems are Europe's problems, just writ a little larger.