IMF Country Focus Spain: Time to Strengthen Resilience, Promote Inclusive Growth

The difficult structural reforms that Spain undertook in response to the global financial crisis continue to bear fruit. But the economic recovery is maturing and new risks are clouding the medium-term outlook, according to the International Monetary Fund (IMF) IMF’s latest economic health check of the country.

Andrea Schaechter, the IMF’s mission chief for Spain, sat down with the IMF Country Focus to discuss the report. She commended Spain on its strong growth while highlighting the increased urgency to make the economy more resilient and inclusive so it can better withstand future shocks. These are some of her main conclusions:

– The economy in Spain has maintained a strong momentum but has passed its peak. Real GDP growth is projected to moderate to 2.5 percent in 2018 and 2.2 percent in 2019—still above the euro area average. These projections reflect both a less supportive external environment and weakening domestic demand.

As for employment, the labor market has improved but significant challenges remain. While the unemployment rate fell to 14.6 percent—below its long-term average—Spain’s youth unemployment rate, the share of temporary contracts, and involuntary part-time employment remain among the highest in the European Union.

– Demographic change in Spain and many advanced economies means that fewer people of working age are funding more and more pensioners. The important pension reforms of 2011 and 2013 addressed the financial pressure on the pension system. The reforms involved a reduction in the purchasing power of pensions while ensuring that Spanish pensioners continue to receive higher pensions—relative to wages—than most other EU countries.

But since then, the acceptability of those reforms has been questioned by the public. It’s clear that further adjustments to the pension system will be needed. While it is important to look for a transparent, holistic, and fair solution, it is will be very difficult to entirely avoid a reduction in real pension benefits in the future, unless there are fundamental changes to pension contributions and the labor market.

Labour market

Spain’s unemployment rate is still high at 14.6 percent. Also, the split between secure full-time workers and those on short, fixed-term contracts—known as labor market duality—is pervasive as many employees are hired on fixed-term contracts. The duality of the labor market is a problem because it lowers investment in the training of employees under short-term contracts and weakens their productivity. It also aggravates the volatility of employment and increases inequality.

The main reason for the wide-spread use of fixed-term contracts is that there is still a large difference in the cost of hiring workers on fixed-term contracts compared to employees on open-ended contracts. This is not only in relation to severance payments but also legal and other costs.

This gap should be reduced to make hiring of workers on open-ended contracts more attractive for employers. Ongoing efforts to tackle the abuse of fixed-term contracts are important but this alone is unlikely to be enough. At the same time, more coordinated and better-designed active labor market polices have a role to play in helping low-skilled youth and long-term unemployed return to work.

Growth projections

Beyond 2019, real GDP growth is projected to gradually slow to its long-term rate—estimated at around 1.75 percent. Sluggish productivity growth, high structural unemployment, and an aging population weigh on the medium-term prospects.

A new, broad-based structural reform initiative could upgrade that outlook. This would allow Spanish incomes to continue catching up to those of richer EU countries. For example, there should be a focus on fostering innovation. This is particularly relevant given that today the Spanish state and the private sector spend less on research and development (R&D) than European peers, despite several R&D incentives.

Also, strategies that reduce the high school drop-out rate and improve education outcomes are particularly important to upgrade skills and help Spanish youth stay competitive. And finally, the predominance of small and medium-sized enterprises in the Spanish economy acts as a break on innovation and productivity growth. So, it is important to dismantle barriers for firms to grow and strengthen the business environment.

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