Spain gives austerity another shot. But why?

Spain’s in brutal shape, and its economic woes are hauling down the rest of Europe. Just to review: The country’s in a messy recession, unemployment is hovering at 25 percent, local banks are going bust and need a bailout, and the government faces the daunting prospect of borrowing at least $42 billion this year from skeptical lenders just to stay afloat.


Spanish austerity measures, like Spanish bulls, are unstoppable. (Daniel Ochoa de Olza/Associated Press)

So what’s the remedy? For starters, the rest of euro zone has agreed to help bail out Spain’s banks. But in exchange, Spanish Prime Minister Mariano Rajoy announced Wednesday that he’d push through fresh austerity measures, cutting $79 billion from the deficit through tax hikes and spending cuts:

The conservative leader announced a 3-point hike in the main rate of Value Added Tax on goods and services to 21 percent and cuts in unemployment benefits and civil service pay and perks in a speech interrupted by jeers and boos from the opposition.

“These measures are not pleasant, but they are necessary. Our public spending exceeds our income by tens of billions of euros,” Rajoy told parliament.

Analysts said the draconian savings plan, tearing up several of Rajoy’s campaign promises, showed Madrid was already under de facto supervision from Brussels even though it has not requested a sovereign bailout and retains access to bond markets.

Spain’s new austerity program is somewhat less drastic than it was originally scheduled to be. Last year, the country’s budget deficit widened to 8.9 percent of GDP. Thanks to a reprieve from EU. finance ministers, Spain only has to whittle that down to 6.3 percent of GDP by the end of this year, rather than the original 5.3 percent target that was laid out in March.

The problem, according to many economists, is that more austerity may not do much to help the deficit situation so long as Spain is mired in recession. Higher taxes on goods and services, as well as reduced incomes for the unemployed, will hurt the economy. As the University of Wisconsin’s Menzie Chinn recently noted, citing research by the IMF and Deutsche Bank, austerity is particularly harmful to euro zone economies right now. And if the hit to Spain’s economy is big enough, that could make the deficit situation worse, not better.

So why would Spain do this? Over at the Economist, Ryan Avent suggests that the goal of Spanish belt-tightening isn’t really to improve the deficit picture. Rather, it’s to convince Germany to take more actions to salvage the euro zone, like agreeing to banking unions or fiscal unions or any of the other ideas bandied about:

[T]his is best understood as another bank shot move toward a crisis solution. The aim is to demonstrate a willingness to suffer great enough to convince Germany you’re worth sharing risks with. So far the Spanish are game. But a quarter of Spanish workers are unemployed, a number that has risen 4 percentage points over the past year. One wonders how much more they’ll stand.

It’s a good question. The initial reception to Rajoy’s austerity measures hasn’t been warm and cuddly: "More than 70 people were injured in clashes in Madrid on Wednesday as Spanish police used rubber bullets and batons to disperse anti-austerity protesters."

By the way, for those wondering if Europe has any other options besides austerity, here’s our write-up of an earlier ING report that outlined five alternatives to what they called “Austeria.” The report outlined a variety of scenarios, from more central-bank inflation to closer European integration. The ING analysts noted that, by and large, relying solely on austerity was the least likely to prove effective. It’s just that all the other measures are considerably more tricky from a political standpoint.

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Suzy Khimm · July 11, 2012