Posted Monday, April 16, 2012, at 10:34 AM
How screwed is Spain? Very screwed, accurately notes Wolfgang Munchau:
European policy makers have a tendency to treat fiscal policy as a simple accounting exercise, omitting any dynamic effects. The Spanish economist Luis Garicano made a calculation, as reported in El País, in which the reduction in the deficit from 8.5 per cent of GDP to 5.3 per cent would require not a €32bn deficit reduction programme (which is what a correction of 3.2 per cent would nominally imply for a country with a GDP of roughly €1tn), but one of between €53bn and €64bn. So to achieve a fiscal correction of 3.2 per cent, you must plan for one almost twice as large.
For those keeping score at home, that means a combination of tax hikes and budget cuts in the 5.5-6.5 percent of GDP range. But as ever, it's even worse than that because the Eurozone's various problems are all tied in with one another. Any Spanish person of means is going to look at this impossible math, recognize the possibility of a disorderly exit of Spain from the Eurozone, and start moving as many of his euros as possible into German banks. This decapitalization of Spain's banks will further squeeze the Spanish economy. At the same time, the Spanish government really doesn't have the option of simply unilaterally refusing to engage in these austerity measures. All things considered, gaining official support (and money) from the European Central Bank to undertake a more measures fiscal consolidation would be positive-sum, but Germany still wouldn't like it. Which is why Spain's best bet is to hope François Hollande wins the French presidential election and throws the whole situation into chaos. Hollande can't help Spain, but the political hot potato would effectively be tossed to Paris.