Economic Survey - Spain 2005: Executive summary


The Spanish economy has enjoyed many years of brisk growth and has recovered swiftly from the recent international slowdown. Activity has been boosted by low interest rates and strong job creation, and underpinned by structural reforms and a sound fiscal policy. As a result, the income gap with the euro area steadily narrowed. However, tensions have arisen that could undermine the strong growth performance as inflation is relatively high, eroding competitiveness, while the surge in house prices does not yet show signs of abating. Also productivity gains have remained meagre and unemployment is still high.

Against this background, the new government has embarked on a strategy that aims at boosting productivity performance by raising spending on education and research and development activities, while pursuing a prudent fiscal policy within a more transparent framework. Also a plan has been adopted to alleviate the tensions in the housing market. These measures go in the right direction, but they need to be complemented by additional reforms to accelerate convergence with the best performing countries.

Maintaining macroeconomic stability and competitiveness: narrowing the inflation differential with the euro area is key to avoiding a continuous erosion of competitiveness. Relatively high inflation is fuelled by rigidities in labour, goods and services markets. The wage bargaining system, for instance, leads to nominal wage inertia through catch-up clauses in collective agreements. Moreover, competition needs to be raised in several sheltered sectors. Cooling the housing market is also key for maintaining macroeconomic stability. Reforms should go beyond those already approved and remove the obstacles limiting the supply of building land. Tax incentives for house purchases should be phased out to lower demand pressures and to develop the rental market, which is too narrow.

Combining higher productivity gains with rapid employment growth: productivity growth is hampered by shortcomings in the education system, while R&D activities are low, despite recent progress. Policies that sharpen incentives should accompany the planned spending increases, including greater autonomy for schools, linking the financing of universities to their performance, raising university fees and fostering private R&D spending, mainly by improving framework conditions. Reducing labour market segmentation by lowering employment protection for permanent workers and applying current legal limits to the renewal of temporary contracts is also crucial as segmentation undermines productivity gains by weakening incentives for job training and work effort. Reforming active labour market policies together with unemployment benefits would help to reduce unemployment further.

Preserving sound public finances: aiming at a balanced budget over the business cycle rather than every year, as planned by the authorities, is warranted, but must not undermine fiscal discipline. This will require maintaining a fiscal surveillance system for the regions. The financing system for the regions should be improved by taking better account of the net fiscal effect of demographic developments linked to immigration and ageing, while regional authorities’ incentives to act in a cost-conscious way should be strengthened. Better information systems would favour the adoption of best policy practices by the regions. In the long run, the financial viability of the pension system is threatened. Reforms should focus on revising the parameters for establishing pension rights, which are inconsistent with long-term solvency. The adjustments needed will be less far-reaching insofar as policies designed to boost productivity and employment, particularly for female and old workers, are effective and if the transient social security surpluses expected over the coming years are saved, which would imply a tighter fiscal policy than currently projected.

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