The Spanish economy: outlook and challenges
Third Economic-Insurance Meeting: "Economic future and insurance industry
trends"
Pablo Hernández de Cos
Governor
Ladies and gentlemen, good morning.
I should like to start by thanking the president of the Lawyers' Mutual Society, Enrique Sanz,
for his kind invitation to deliver the closing address to this third economic-insurance
meeting. It is an honour and a pleasure to participate in this event and to share with you
some reflections on the economic outlook for the immediate future and, especially, on the
main medium and long-term challenges facing the Spanish economy. The degree of
vulnerability of the Spanish economy to possible shocks and, ultimately, the well-being of
the Spanish people will largely depend on how the economy's main structural problems are
addressed.
The economic situation
The global economic expansion in weakening against the background of the downturn in international trade...
The international economic environment in which the Spanish economy operates has
become more unfavourable over the past year, with a slowdown in growth and, in particular,
in international trade. Global GDP growth continued to moderate, to a rate of 2.8%
year-onyear in the second quarter of 2018, down more than one percentage point (pp) from a year
earlier. In addition, growth projections have been revised downwards in most economies in
recent quarters. Indeed, global GDP growth is projected this year to be at its lowest level
since the international financial crisis.
...
and high geopolitical uncertainty
The contraction in world trade, meanwhile, appears to have intensified, against a
background of persistent uncertainty surrounding US and Chinese trade policy and
intensifying geopolitical risks. Although the deterioration in activity has been particularly
intense in manufacturing, the slowdown in recent months in the global services output PMI,
which remains in expansionary territory, is indicative of an increased risk of a steeper
slowdown in global activity.
Given its degree of openness, and the confluence of certain idiosyncratic elements, the euro
area economy has been affected more than most by these international trade developments.
Specifically, the euro area slowed significantly from the beginning of 2018, mainly due to
the sharp moderation in exports. As a result, GDP grew at an average rate of 1.9% last year,
down 0.7 pp from 2017, and year-on-year growth since end-2018 has fallen to around 1%.
On the latest information available, euro area GDP growth was only 0.2% quarter-on-quarter
in Q2, down from 0.4% in Q1, weighed down by weak exports and slack investment. By
contrast, private consumption continued to grow, driven by the relative relatively robust
labour market. On the supply side, industrial activity contracted in this period, while services
behaved more positively. By country, the decline in activity in the German economy and the
stagnation in Italy were notable.
Moreover, the indicators available suggest that euro area economic activity remained weak
in Q3. Thus, the trade and industrial activity indicators signalled continuation of the
deterioration. Also, some qualitative indicators of services activity and employment showed
a decrease, which may indicate that the weakness is beginning to spread to these activities.
The slowdown in employment, along with the gradual decline in consumer confidence in
Q3, points to more modest growth of private consumption, until now the main driver of
growth.
Against this background, in September, the European Central Bank (ECB) revised its
macroeconomic forecasts for the euro area as a whole. Expected GDP growth was revised
downwards, especially for 2020. Specifically, growth of rates of 1.1% and 1.2% are now
projected for 2019 and 2020, respectively, in both cases below the rates projected In June.
In the medium term, activity is expected to recover, underpinned by favourable financial
conditions and a slightly expansionary fiscal policy, in the event of a gradual disappearance
of political and trade uncertainty.
Despite this downward revision to macroeconomic forecasts, the ECB's Governing Council
emphasised the existence of significant downside risks to the baseline scenario, arising
mainly from a possible escalation of trade tensions. It should be taken into account, as I
have just stressed, that the baseline scenario of the ECB's macroeconomic projections, like
those of the Banco de España, which I will refer to below, are based on the assumption that
there will be a Brexit agreement and trade tensions will dissipate.
Inflation in the euro area, meanwhile, remains low. In Q3, inflation developments were
marked by the downward dynamic of energy prices and the persistence of moderate rates
for services. The 12-month rate of change of the harmonised index of consumer prices
(HICP) fell by 0.8% in September, and underlying inflation, which excludes energy and food
prices, stood at 1%. In fact, since 2013, average euro area inflation has also been 1%, less
than half the rate observed during the first 10 years of EMU (2.1%).
This absence of inflationary pressures and the weakness of demand, along with the
deteriorating global environment, led to a further downward revision to the Eurosystem
inflation projections, to 1.2% in 2019 and 1% in 2020. In 2021, inflation is forecast to stand
at 1.5%, clearly below the monetary policy objective. In turn, the long-term inflation
expectations derived from financial markets are at historic lows.
In short, the euro area macroeconomic setting is characterised, first, by a downward revision
to growth forecasts that were already relatively weak and remain subject to downside risks,
owing to the persistence of trade tensions and other geopolitical uncertainties, such as
those relating to the final Brexit outcome, and which in some countries of the area, such as
Germany, even point to a risk of imminent recession; and, second, by medium-term inflation
projections that have also been revised downwards and are well below levels that could be
considered compatible with the ECB's price stability mandate.
This is the background to the measures adopted by the Governing Council of the ECB at its
September meeting. In particular, and in accordance with previous communications, the
Governing Council acted - with a package of expansionary measures - in response to
inflation rates, both observed and projected for the next few years, that have remained
persistently below the ECB's objective, in line with its commitment to symmetry in relation
to this aim. In this context, symmetry means that the ECB undertakes to act with the same
determination whether inflation is persistently above or below 2%.1
In particular, the Governing Council of the ECB took the decision to decrease the interest
rate on the deposit facility by 10 basis points (bp) to -0.50% and reinforced its forward
guidance on interest rates by indicating that they will remain at their present or lower levels
until the inflation outlook is seen to be robustly converging on a level sufficiently close to,
but below, 2%. Such convergence should also be consistently reflected in the observed
behaviour of inflation.
The ECB also agreed to restart net purchases under its asset purchase programme (APP)
at a monthly pace of €20 billion as from 1 November and without a defined time limit. In
order to preserve favourable bank lending conditions, the modalities of the new series of
quarterly targeted longer-term refinancing operations (TLTRO III) were also changed,
eliminating the 10 bp spread established on the interest rates applied to them and extending
their maturity from two to three years. Finally, in order to support the bank-based
transmission of monetary policy, a two-tier system for reserve remuneration was
announced, such that part of banks' holdings of excess liquidity will be exempt from the
negative deposit facility rate.
These decisions aim to counter the worsening growth and inflation outlook by means of a
package of measures that complement one another, easing financial conditions by a
different route. The resumption of net purchases, without a defined time limit, also has an
important signalling effect with respect to the Governing Council's commitment to meet its
inflation aim, which is particularly relevant in the current context of inflation expectations at
risk of becoming de-anchored.
In addition, the period of time over which the net asset purchases and the reinvestment of
existing assets will continue is anchored to the normalisation of interest rates, thus
enhancing the consistency and complementarity of the different measures and their
dynamic adjustment to inflation. In a setting of heightened uncertainty, this automatic
adjustment of the expectations about the future path of monetary policy in the face of
potential changes in the macroeconomic environment is particularly desirable.
Monetary policy measures have contributed to the increase in activity and in inflation
Economic research shows that these measures have been effective in the recent past, in
terms of easing financial conditions and encouraging lending. Bearing this in mind, the new
package of measures will boost economic activity in the euro area against a background of
high uncertainty and will help to bring about the convergence of inflation to levels in line with
the ECB's mandate.
As regards negative interest rates, although there is no conclusive evidence to date that
they have adversely affected the supply of bank credit, we cannot rule out that maintaining
rates at very low levels for an additional, potentially extended, period of time, could
ultimately have some negative consequences for the bank-based transmission of monetary
policy. In this regard, the mitigating measures adopted by the ECB, consisting of a tiered
system for remunerating excess liquidity holdings, are intended to soften the negative
impact on bank profitability of the new reduction in reserve remuneration, and thus ensure
the expansionary effect on activity and inflation of the interest rate cuts in the current setting.
Prolongation of the current expansionary cycle, albeit at a more moderate rate than in previous years
In relation to the Spanish economy, the latest economic data point to a gradual weakening
of activity. First, the indicators that measure agents' confidence have tended to gradually
deteriorate since the beginning of 2018, albeit less so than in the euro area as a whole.
In Spain, as in the euro area, the deterioration in these qualitative indicators has been
comparatively more pronounced in the case of manufacturing than in that of services. The
quantitative indicators, which in principle tend to be more closely related to activity, have
also tended to show less favourable behaviour in manufacturing than in services.
This mixed behaviour across sectors, and developments coinciding with the timing of the
global trade tensions between the United States and China are consistent with the shocks
observed since the beginning of 2018, which appear to have had a more pronounced impact
on manufacturing, being external in origin; from the viewpoint of demand, manufactures are
typically more closely linked to exports than are services.
In addition, the regulatory changes in the car industry sector, which came into force after
the summer of 2018, have also contributed to explaining the weakness of exports and of
manufacturing as a whole, while services, a much smaller proportion of whose value-added
is exported, have shown greater resilience.
One area in which the slowdown in activity has made itself plain is the labour market. This
is a reason for concern, given that the rate of unemployment in the Spanish economy is still
high, something that I shall refer to later in greater detail. In particular, Social Security
registrations have lost significant momentum since the beginning of the year, growing in
September at a year-on-year rate of 2.4%, as against 3.1% at the end of 2018. A similar
conclusion is drawn from the Labour Force Survey data for 2019 Q3 published last week,
which also imply a moderation in the rate of generation of employment, to 1.8%
year-onyear, down 0.6 pp from Q2 and 1.4 pp lower than at the end of 2018. Moreover, the
magnitude of the fall in the rate of unemployment in Q3 - to 13.9% of the labour force - was
more modest than has been typical since the start of the recovery.
Against this background, the latest macroeconomic projections of the Banco de España,
published on 24 September, foresee a moderation in the Spanish economy's growth rate
over the next two years, in response to the loss of momentum of domestic demand, which
has already begun to be observed, in the latest period, and which has affected both private
consumption and private investment. As I have mentioned already, this behaviour appears
to have been fundamentally influenced by the deterioration in the external environment, as
well as by the uncertainty regarding the future outlook.
In any event, under the baseline scenario, which assumes that export markets will gradually
recover (following their recent weakness) and that budgetary policy will acquire a neutral
stance over the projection horizon, the accommodative stance of monetary policy and the
improvement in the financial position of firms and households over the last few years, should
allow the economy to continue to grow at slightly above its potential rate (which according
to our estimates is somewhat less than 1.5%).
However, as in the euro area, this baseline scenario for economic activity is subject to
significant downside risks. In fact, the projected recovery in world trade and activity could
be hampered by factors such as the possible adoption of further protectionist measures,
the worsening of geopolitical tensions and the high level of indebtedness of certain agents
in particular regions of the world. A source of further uncertainty, which has still to be
clarified and has been highly unpredictable, is the process of the United Kingdom's
departure from the European Union and the subsequent negotiation of the future UK/EU
trading relationship.
Lastly, we cannot rule out that the uncertainty surrounding the future course of some
domestic economic policies (such as budgetary policy and the structural reform agenda),
arising from the difficulty in recent years of forming solid parliamentary majorities, or the
recent events in Catalonia, may also, if they persist, have an adverse effect on the spending
decisions of private agents.
Transformations and vulnerabilities of the Spanish economy
In this context, the Spanish economy, despite the improvements made during the recovery,
continues to suffer from significant vulnerabilities. Progress in correcting these is urgently
required, in order to enhance the economy's resilience to possible adverse shocks.
In fact, some positive elements stand out from the evolution of the Spanish economy in
recent years, such as, for example, the ability to continue to run external surpluses during
the upswing, something that was not normal in previous recoveries, and which would
indicate that at least part of the correction of the external imbalance is structural in nature,
and is associated with cumulative improvements in competitiveness and the increase in the
geographical diversification of exports and in the number of firms that regularly export to
the rest of the world. This growing internationalisation of Spanish companies has served, in
turn, to stimulate business investment and employment. Indeed, more than 2.5 million jobs
have been created since the beginning of the recovery.
Also notable in recent years has been the deleveraging carried out by the non-financial
private sector. This has reached a very advanced stage, both in the case of non-financial
firms and households. For example, the debt to GDP ratio of Spanish companies has been
reduced by more than 40 pp from its peak and it is now below the average level in the euro
area.
In the same vein, I would like to highlight the intense process of banking industry
rationalisation, recapitalisation and restructuring. This has led to a more efficient allocation
of capital across firms and sectors, which, as we will see later, has contributed to
productivity growth. In particular, the non-performing loan ratio for lending to the resident
private sector, in business in Spain, stood at 5.3% in June 2019, down 8.7 pp from the high
levels recorded in December 2013. Foreclosed assets, meanwhile, have fallen continuously
during the years of recovery; a total cumulative reduction of 50% from the peak levels
recorded in 2011 had brought them down to below €40 billion by June 2019.
As I was saying, this progress should not cause us to forget that the Spanish economy has
significant imbalances, among which the still high levels of unemployment, government debt
and external debt stand out. Since the start of the recovery progress (of varying intensity)
has been seen on these fronts, but the magnitude of the imbalances built up in terms of the
stocks of these variables means that they still amount to vulnerabilities (to turbulence in
international markets, for example). At the same time, the Spanish economy's growth
capacity continues to be constrained by its very poor productivity dynamics, which is
particularly worrying insofar as it will also be adversely affected by the impact of population
ageing.
Main challenges facing the Spanish economy
Turning to focus on the labour market, as you all know, the Spanish economy's rate of
unemployment remains very high, at around 14%. Also, around 45% of the unemployed
have been seeking work for a year or more, a factor that reduces their likelihood of success.
There thus seems to be a need to improve the employability of this more vulnerable group
notable for the presence of very young and very old workers, as well as individuals with
fewer skills. To do this, it would be desirable to increase the human capital of these workers,
a task which, in particular, would need training tailored to employers' requirements.
Furthermore, it should not be overlooked that the higher inequality in household income
emerging in the crisis was, above all, a consequence of job destruction, which underscores
the need to ensure that these people can get a job as soon as possible.
In addition, the incidence of temporary employment remains very high (nearly 27% in the
third quarter of 2019), which, among other things, makes for high employment volatility and
reduces worker productivity.
Main vulnerabilities of the Spanish economy
A second source of vulnerability originating as a legacy of the crisis is the high government
debt, which in the second quarter of 2019 stood at around 99% of GDP, more than 60 pp
above that in 2007. It is in this terrain where headway has been less satisfactory in the last
few years, as evidenced by the fact that the budget deficit continues to have a high structural
component, estimated by the European Commission at above 2.5 pp of GDP. This figure is
still far from the medium-term structural budgetary balance, convergence to which is
required by the so-called "preventive arm" of the Stability and Growth Pact (SGP) applicable
in Spain since July.
It is therefore a priority to make headway in cleaning up the public finances so as to reduce
this source of vulnerability of the economy and to be able to make full use of national fiscal
policy as an effective macroeconomic stabilisation instrument in the event of a sharper
economic slowdown in the future. In addition, this improvement in the budgetary situation
must be compatible with other challenges which the public finances will have to face in
coming years, including most notably the consequences of population ageing, which I will
discuss later.
A third and final area of vulnerability of the economy to which I would like to refer is the
external debt. Despite the correction achieved to date in the form of current-account
surpluses, much work still remains to be done, as shown by the negative net international
investment position and the gross debt, which stood, respectively, at around 80% and
170% of GDP in the second quarter of 2019.
To continue correcting these two magnitudes, the external surpluses will have to be
sustained over time, which in turn will require further headway in the gains in
competitiveness achieved in the last few years. Having said that, while these gains have so
far been based mainly on the moderation of labour and financial costs, in the future they will
have to come increasingly from genuine increases in productivity.
Long-term growth of the Spanish economy: the challenge of productivity
The productivity challenge
The timid gains in productivity seen in the past recession and subsequent recovery proved
to be insufficient to close the gap separating us from the core European countries. The
limited headway in productivity by the Spanish economy should be a cause for great
concern, since productivity gains are the only mechanism which can generate sustained,
stable growth of per capita income in the long term. The consensus in this respect in
economic circles is practically unanimous, and the repute of the studies in this area is
attested to by the Nobel prizes in economics awarded to Robert Solow and Paul Romer in
1987 and 2018, respectively, for their contributions in the fields of productivity and
longterm economic growth.
A few figures will suffice to illustrate how improvements in a community's standard of living
over the long term depend almost entirely on productivity gains. Thus, for example, 80% of
the increase in US per capita income since 1948 can be attributed to the growth of total
factor productivity (TFP).2 In other words, increases in TFP of around 2% per year have
allowed the average US citizen to enjoy inflation-adjusted annual income which in 2015 was
about US$ 30,000 higher than in 1948.
In Spain, the recent growth of TFP has been notably lower, and was even negative for a
good part of the first decade of the 21st century. Thus, in the past 25 years, TFP in Spain
has grown by approximately 0.2% per year, 0.3 pp below the euro area average, according
to European Commission estimates.
A simple calculation suggests that, if in that period the Spanish TFP had performed the
same as in the euro area, Spain's per capita income would now be nearly 92% of the euro
area average, instead of 87%. Expressed in euro, Spain's per capita income would now be
€28,000 per year, or €2,000 more than the observed value (8% in percentage terms). And if
the TFP had grown at a rate of 2%, in line with the world technological frontier, the annual
income of the average Spanish citizen would be nearly €40,000, or more than €1,000 extra
each month.
There are two intimately related factors which would at least partly explain why productivity
has behaved less dynamically in Spain than in other euro area economies in the past two
decades. The first is that the Spanish business sector consists to a larger extent of small,
less productive firms; the second is that the inefficiency of the resource allocation
mechanisms facilitates the survival and growth of less productive firms.
The determinants of these two factors are many and diverse. Allow me to focus on three
particularly important ones in which the Spanish economy is in a worryingly poorer position
than our European partners: human capital, technological capital and the financing of
innovation.
According to the available evidence, the presence of human and technological capital
shortfalls is the main reason for the low productivity of Spanish firms.3 And the difficulty in
obtaining finance for highly productive business projects has shown itself to be a
determinant of the inefficient allocation of resources to firms.4
The need to correct the human and technological capital shortfalls is particularly urgent
when viewed in the current context of technological change. The advances in digitalisation,
automation and technological development are altering certain crucial aspects of the
economy, such as consumption patterns, production processes or the provision of public
and private services.
Thus, for example, the spread of new technologies has allowed the financial sector to
provide services in more flexible ways not requiring customers to be physically present. As
an example, the percentage of Internet users in Spain reporting that they use electronic
banking services has increased by 30 pp from 2003 to 2018.5 However, all sectors to a
greater or lesser extent are caught up in the so-called "digital revolution".
Human capital
Human capital
Educational policies at all levels are crucially important for fostering innovation and adapting
the labour force to new occupations and, in general, enabling individuals to acquire and
preserve the skills needed to work in an environment characterised by digitalisation,
robotisation and artificial intelligence. Specifically, these phenomena will foreseeably affect
the future labour market, which will be characterised by increased demand for qualified
workers with high technical skills, at the expense of demand for lower skilled workers
engaged in routine tasks.6
Having said that, Spain's starting point to address this challenge of accelerated
technological innovation is not the most favourable one. The low performance of Spanish
students in standard international exams indicates that the quality of the Spanish
educational system leaves room for improvement in comparison with other developed
countries. What is more, Spain's educational system is characterised by high rates of early
school leaving: 18.3% in the population between the age of 18 and 24, compared with
10.6% in the European Union as a whole.
These shortfalls are also apparent in the adult population as a whole. Thus, in the
qualifications obtained in the Programme for the International Assessment of Adult
Competences (PIAAC) for the working age population, relating to mathematical reasoning
and reading comprehension, Spain was ranked last and second last, respectively, among
the OECD countries.
The disadvantageous levels of human capital compared with those in other developed
economies are apparent in both workers and employers. On Eurostat data, in Spain 40.5%
of the self-employed, 35.1% of employers and 32.6% of employees have a low educational
level, compared with much smaller percentages (24.8%, 20.1% and 19.8%, respectively) in
the euro area as a whole.
Spain also has a shortfall in terms of the proportion of the population with profiles related in
some way to disciplines such as engineering or mathematics. For example, 9% of university
graduates in Spain have qualifications in mathematics, science or IT, compared with 14%
in Germany or 11% in the European Union as a whole.
It is also foreseeable that the massive eruption of new technologies will result in greater
importance being afforded to non-cognitive skills (such as a desire to innovate, self-control,
ability to concentrate, or adaptability to a changing environment),7 in which Spain also
performs poorly in the international comparison.
It therefore seems advisable to rethink the institutional design of the educational system,
the content of the curriculum and the learning system itself. In this respect, it is crucial to
treat this project of improving human capital as a collective task. The government will play
a leadership role, evaluating and adjusting the educational system on an ongoing basis at
all levels to attune it to the needs of the business world, but, at the same time, firms must
become involved in the training of their employees, particularly young workers in their first
job.
Technological capital
Technological capital
In the field of technological capital, there is a broad consensus on the positive effect which
research and development and innovation (R&D&I) have on the productivity of firms.8 In this
respect, the available indicators of the degree of intensity of these activities suggest that
Spain ranks poorly in the international comparison. Specifically, according to Eurostat, the
proportion of innovative firms is 33.6% in Spain, compared with 53.4%, 56.1% and 66.9%
in France, Italy and Germany, respectively.
Similarly, the investment in research and development activities in Spain is, in aggregate
terms, still very low in both the public sector (0.54% of GDP in 2017) and the private sector
(0.66% of GDP in 2017), which makes Spain's R&D spending 26% and 54% lower,
respectively, than the European average. It is therefore no surprise that the lack of innovation
and the scant accumulation of technological capital of Spanish firms is a determining factor
in explaining why Spanish firms are less productive than their European counterparts.
This technological capital gap between Spain and its European partners is at least partly
due to structural characteristics which limit firms' innovative capacity, such as the lack of
available human capital referred to above, or a productive structure skewed towards sectors
with a low technological content.
Another basic determinant requiring special attention and which poses major challenges in
the current context of technological change, is the access to finance - whether public or
private - for business projects with a high innovative content.
Financing of innovation
In general, the growth of firms is conditioned by the availability of external finance to
undertake new investment projects. But external finance also plays a particularly vital role
in the success of the innovative projects of small new firms whose characteristics make it
more difficult for them to obtain funds.9
These greater difficulties have their origin in information asymmetries between firms and
financiers and in the comparatively higher inherent risk than that for established companies,
all the more so when the returns will only be received in the long term. These characteristics
contrast with the preferences of capital market financiers, who tend to seek more
shortterm returns and have a certain aversion to risk.10
Evidently these asymmetries apply to any investment project. But they are particularly
important in the case of innovative projects in Spain, where external finance comes mainly
in the form of bank loans, due to the absence of sufficiently developed alternative capital
markets, as evidenced by the fact that bond issues still represent barely 10% of the total
finance received by Spanish non-financial corporations, compared with 40% in the USA.
Financing innovation
The most recent period has seen some growth of non-bank financing in Spain and a certain
improvement in the allocation of bank financing compared with the period immediately
before the crisis, during which the firms receiving credit were characterised by their low
productivity and a high proportion of real estate assets on their balance sheets. This largely
explains the low dynamism of aggregate productivity in that period.11 By contrast, in the
recovery phase funds tended to go to firms with a comparatively more favourable economic
and financial position and which were more productive.12
In any event, this relative improvement in the allocation of bank credit cannot be allowed to
hinder the development of specific financial products to facilitate the financing and growth
of small and/or newly created innovative firms. This is particularly important in a country
such as Spain where the business sector consists basically of small firms, since these firms
generally lack collateral, have highly uncertain future cash flows and do not have credit
ratings allowing investors to get an idea of the risk associated with investing in them.
Furthermore, the high uncertainty surrounding the return on investment in R&D&I and the
long time horizon at which it materialises (above five years)13 are arguments for government
involvement in their financing, particularly in the area of basic research. This is all the more
so in view of the positive - and potentially disruptive - effects which certain investment in
these areas may have on the population as a whole. It should be noted in this respect that
the seed of the Internet was a basic research project for military use undertaken by an
agency of the US Department of Defence, an initiative which would have had little chance
of obtaining finance from the private sector. Moreover, the range of possible government
actions go beyond providing an R&D&I investment budget. For example, they also
encompass the introduction of changes to the researcher promotion and career system so
as to stimulate the entry and development of promis