The Iberian Peninsula: A Micro Scale Look at the EUs Financial Crisis

The European Financial Crisis, which began in late 2009, has been dubbed the most
serious financial crisis since the 1930s1 and is the most important and pressing economic
issue in the world at this time. Throughout the financial crisis the spotlight has been put on
countries that are struggling in the EU such as Spain, Portugal, Italy, Ireland, and Greece; by
limiting my focus and analysis to primarily the economies of Spain and Portugal, I will use
this micro scale approach to allow me to take a closer look at some of the reforms and
restructuring intended to aid the ongoing economic recovery and draw larger conclusions
and discussion on the EUs financial crisis.
Spain and Portugal have been in deep, structurally unfavorable, and crippling
recession since the Financial Crisis began. Both Spain and Portugal have seen huge
decreases in Real Gross Domestic Product growth. Spain experienced a decrease from 4% in
2006 to -.01% in 2010 with periods of large negative growth as well (according to OECD
data), with a similar trend observed in Portugal. This decrease in Real GDP growth is coupled
with large increases in unemployment for both countries, especially among Iberian youth.
As unemployment in both countries continues to rise, former structural intricacies of both
countries economies have been exposed as inefficient, in particular those among their
labour markets.
The response from Spains conservative Popular Party (PP) and the Spanish Prime
Minister Mariano Rajoy has been the cause for numerous recent protests nationwide and is
widely unpopular with social rights activists, left-wing politicians, and Spanish youth.
Without getting into the nitty-gritty details of the differing philosophies of North America
and the countries that constitute the European Union, one view that is very important to

take into account from an economic standpoint is the contrasts between the two sides
views on labour and leisure. The average American works 46.2 weeks a year, while their
French counterparts work 40 weeks a year; also, Americans average 25.1 working hours per
week per person within the working age, but Germans average just 18.6 hours 2. These
statistics are indicative of a palpable Western European view that has been noticeably
growing since the late 1960s: more emphasis placed on social welfare and leisure. Although
many Spaniards view employment benefits, such as pensions, collective bargaining rights,
and job security, as integral and important labor market institutions, the conservative
government, headed by Rajoy, has been enacting the necessary harsh medicine policies in
order to counteract years of structural rigidities that have been anything but helpful for
economic recovery. Throughout Rajoys new policies, the overwhelming theme was to
reform the labour market in order to address the key structural weaknesses of the Spanish
labour market, and more specifically, employment protection and collective bargaining
rights. The reforms which have been passed to accomplish this goal include the following
actions: lowered maximum severance payments (reduced to almost half of its original level)
, decreased collective bargaining rights, and the introduction of longer trial periods of

employment. All of these actions chip away at the structural rigidities that many economists
pointed to as problems within the Spanish labour market by allowing firms to assume less
risk when they take on human capital, while also lowering firms costs through lessened
social benefits to workers. Even though these reforms have been met with huge backlash, as
they allow employers more power over their workers and enable firms to fire workers more
easily and with fewer financial obligations, I firmly believe they are a major step in the right
direction for Spain. These reforms are especially important in light of Spain`s recent steep
increase in unemployment, which has been reported to be a record high 26.6% in the fourth

quarter of 2012. As workers benefits are lessened, this loss (from workers) will be
transferred to producers and in turn help decrease the unemployment rate as labour costs
continue to fall and thus, producers are able to hire more workers.
The Portuguese face problems similar to those within the Spanish labour market, but
also have a pronounced duality the majority of labour contracts are either strictly short
term or long term - within their labour market. This duality needs to be addressed within
the Portuguese labour market because the firms which offer these short term contracts are
less likely to invest in their human capital, while firms with long term contracts are
insufficiently mobile. That (lost) mobility is a very important dynamic within a struggling
economy as firms may hesitate to hire long term workers in this economic climate and thus
human capital investment observes another loss. As the recession continues to linger and
worsen, more creative restructuring may need to be enacted in order to ensure that all is
being done to exit the recession as soon as possible. One such action would be to reform
the bankruptcy procedures in Portugal (or Spain) in an attempt to transfer assets from
insolvent companies which are no longer able to operate/produce to other functioning parts
of the economy in an attempt to maximize resource use and lower costly deadweight losses
during transition periods. Other actions could include streamlining regulations and
increasing the efficiency and speed in which government supervised activities such as the
approval of construction permits are completed.
Another economic issue which goes hand in hand with the labour market is the
unemployment rate. Both Spain and Portugal have seen large increases in the
unemployment rate since the start of the financial crisis, especially youth unemployment.
Spains unemployment rate for citizens aged 15-24 was 46% in 2011, which is dismal

compared to the rest of the EUs unemployment rate of 20% and the OECDs 16% (OECD
countries) for the same age group4. The unemployment rate is continuing to rise in Spain,
now at almost 27 percent, and in Portugal as well (increased to 16.9% in the fourth quarter
of 2012)5. With these increases in unemployment and increasing pressure from other EU
countries to reform unfavorable economic and labour policies, both countries need to turn
to more austere unpopular reforms. Spain has recently started to undertake and implement
such reforms, as they will not only lead to more investment in human capital by firms, but
will also help lower the overall unemployment rate and increase the fluidity of their labour
markets.
Portugals population, total size, and economy are smaller than that of Spain and
because of its relatively smaller size, it engages in less international trade than Spain and
has suffered an even worse deficit in its current account than Spain has throughout the
recession. In fact, the Spanish government has recently announced a current account
surplus which, despite being a positive indicator, is partly due to a sharp decrease in imports
due to the prolonged recession. It is because of Portugals worsening current account (and
balance of payments) deficit that Portugal needs to undergo structural reforms which
increase productivity and effectively reorient their economy towards more international
trading. Portuguese markets barriers to entry, which therefore hamper competition, have
been a major talking point concerning low productivity and also the lack of foreign direct
investment. As Portugal continues to reform its private sector and privatize state-owned
assets, as it has been doing, the increase of FDI stemming from that increased privatization,
coupled with the economic growth from the benefits of competition rendered from

decreased barriers to entry in Portuguese markets will help improve the Portuguese current
account and (hopefully) its balance of payments.
The European Financial Crisis took a large toll on the Spanish finance sector and the
measures to correct Spanish banks have not only taken a toll on Spanish companies and
helped amplify the recession, but has also taken a financial toll on other EU countries which
recently gave a thirty-seven billion euro bail out to recapitalize four Spanish banks, in what
is the largest amount given in a series of Spanish bank bailouts since the recession began 6.
Throughout the recapitalization of Spanish banks, the amount of credit availability has been
decreasing as a result of bank deleveraging (which has been a common theme among EU
countries throughout the financial crisis) in order to meet new capital and liquidity
requirements. The resulting decrease in bank lending is predicted to continue to contract
6-7% a year until 20167 which holds severe economic consequences. The Economist reports
on the impact of these financial constraints on Spanish firms: By comparing Spanish firms
that are foreign owned, and therefore have access to other forms of financing, to those that
are domestic, and are therefore reliant on local banks, the [analysts] can see what
uncertainty about financial access did to their decision-making before and after the 2008
crisis. The Spanish-owned firms cut investment by 19% more than the foreign-owned
companies, and reduced employment by 6% more.7 This does not bode well for Spanish
owned firms, and the Spanish economy as a whole, as credit availability and lending are set
to continue to decline and unemployment continues to rise. This also further amplifies the
importance of increased Foreign Direct Investment in Spain as the credit crunch is set to
worsen and financing for Spanish firms will be scarce.

As the need for Foreign Direct Investment in both countries becomes increasingly
significant, another factor in both economies growth and recovery then is the
attractiveness it holds to potential foreign investors. Spain recently continued its barrage of
austerity measures by reforming all levels of government and enacting sweeping
consolidation measures in an attempt to further cut costs and continue to engage in
macroeconomic deleveraging; however, the recent scandals within the Spanish government
(going as high as Prime Minister Rajoy) undermine the attempted rebranding of Spain as
an attractive investment. In addition to the recent scandals there have been multiple street
protests, strike/protests at airports, and growing street resistance, especially among Spains
semi-autonomous regions, all of which undermine the recent improvements Spain has
seen in its current account surplus and its general movement in the right direction. Spain
and Portugal are still not attractive investments as both economies continue to see
increases in unemployment, little to no increase in GDP, and in Portugals case, a negative
current account.
Through Spain and Portugals austerity measures: cuts to social benefits such as
pension, increasing employer power, and decreasing worker rights, these two economies
have moved in the correct direction for eventual economic growth by lowering their total
debt to GDP ratio and fixing some of the many structural problems within both of their
labour markets. Although many economists may agree with these ultra-austere strategies,
there are some stark and worrisome risks associated with the possibility of lower than
expected growth. The lack of growth within the periphery of the EU Portugal, Greece,
Spain, Italy, and Ireland despite the implementation of austere reforms like those of Spain
and Portugal (and in some cases, like Greece, much more severe-austere reforms) is cause

for worry. As the implementation of various reforms continues to improve the current
accounts for periphery countries economies within the EU and inspire some (small amount
of) confidence, the lack of real GDP growth and increasing unemployment paints a very
different picture. Firstly, there are inherent risks brought on by the role of exports being a
large contributor to the increase in current accounts surplus (or decrease of deficit) as most
exports from Portugal, Spain, and other periphery countries go to other countries of the EU;
therefore, if demand within the EU decreases (i.e., the EUs financial crisis worsens and
more EU economies begin struggling) projected growth will be much lower and these fragile
economies have the possibility to cycle downwards due to the increased austerity, weak
banking sectors, and high debt to GDP ratios seen in Spain and Portugal. Abebe Aemro
Selassie, the IMF mission chief for Portugal, also mentions possible risks due to fiscal
performance being too low because of higher than expected export performance because
exports generate less tax than domestic economic activities and so revenue performance
has been weak in recent months.8 Mr. Selassie also goes on to mention the unforeseen
risks posed by the higher than expected unemployment. The risk of these (almost) uniform
acts of austerity need to be taken by the EU as whole as the benefits outweigh the risks, but
without the needed GDP growth the gap between the periphery and the rest of the Euro
zone will continue to widen. Closing the fiscal and economic gap between periphery
countries and other EU members is imperative for ending the EUs financial crisis. Austerity
measures can and have been helping to prepare the weakened economies, while structural
reforms can help narrow that GDP gap (eventually) as long as the inherent risks of the
process do not come into play. If this cycle between weak state economies and weak
banking sectors is to be broken however, the real answer may be more in depth EU
economic integration, possibly in the form of a more integrated EU banking union. The

result of that more intense and unified economic integration would be smaller GDP gaps
between countries and hopefully a stronger EU economy as a whole as well it could
benefit the EU`s deepening goals and result in more benefits to member countries.
Within Spain and Portugal the austere reforms intended to lower their total debt to
GDP ratio should be viewed as a step (or steps) in the right direction as they are setting up a
framework within which to grow and thrive without old structural inefficiencies and with
lower costs as well. These measures of austerity should not be handled lightly or be viewed
as a completely foolproof method however, as there are many possible pitfalls along the
way such as lessened availability of capital as a result of a weakened banking sector and the
possibility of decreased exports to the EU and thus an unforeseen drop in GDP coupled with
numerous acts of austerity which could push Spain or Portugal into further recession. Much
work is to be done in the way of reinstituting confidence in the banking sector and local
industries for any sort of measurable increase in GDP to occur within Spain and Portugal.
Although the gap between economies like those of Spain or Portugal and the richer EU
countries such as France or Germany could begin to narrow with the implementation of
structural reforms, the only way to ensure future financial crises like the current EU financial
crisis do no occur again would be to integrate the economies of the EU more tightly and
completely a monetary and fiscal union in the EU would accomplish that needed level of
integration.

Footnotes:
1. https:\\bonds.about.com
2. http://www.nber.org/papers/w11278
3. http://revolting-europe.com/2012/02/10/rajoy-legalises-precarious-employment-withsweeping-labour-reforms/
4. See graph and data attached - http://www.oecd.org/eco/surveys/spain2012.htm
5. http://www.tradingeconomics.com/portugal/unemployment-rate
6. http://www.economist.com/blogs/schumpeter/2012/11/spanish-banks
7. http://www.economist.com/blogs/freeexchange/2013/02/spains-economy
8. http://www.imf.org/external/pubs/ft/survey/so/2012/car071712a.htm

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