It has become fashionable since Spain's economy began to decline to make comparisons to Germany, which is rebounding strongly. The idea is that the Germans went through their restructuring, got organized labor under control, and thereby made their economy more competitive. According to this narrative, this is the key to their economic success – so Spain should do the same if the Spanish economy is to recover.
This fits well with various stereotypes of Germans as disciplined and hard working, willing to do what is necessary to be competitive in the global economy, while their counterparts in Europe's periphery are seen as undisciplined and indulgent. However, the story does not fit the economic facts very well.
Spain's problems are mostly associated with the euro, combined with some bad economic policy decisions that have nothing to do with "labor inflexibility," the strength of unions, or government spending. And its recovery is being delayed as a result of decisions made by the European authorities: the European Commission, the European Central Bank, and the International Monetary Fund (IMF).
When Spain joined the euro in 1999, its level of productivity in manufacturing was about 63.6 percent of Germany's. Over the next 10 years, productivity grew at about the same rate in both countries, so that by 2009 the ratio was about the same: 63 percent. Hourly wages in manufacturing also increased by about the same amount in both countries, so Germany kept its large, productivity-based cost advantage over Spain. Of course, this arrangement has worked out much better for Germany – during the upswing from 2002-2007, more than 120 percent of Germany's growth was due to exports – with most of these exports going to other Eurozone countries.
This is the basic problem when a country decides to adopt a common currency with other countries that have much higher levels of productivity. They can't really be competitive in tradable goods – which includes not only exports but industries that compete with imports. If Spain had its own currency, it could let the value of its currency fall to a level that would make the country's tradable goods sectors competitive. In a situation where the economy is in recession or is weak – Spain's economy shrank by 0.2 percent in 2010 – the increased exports and reduced imports from such a devaluation would also help get the economy growing again.
Instead, the European authorities have prescribed what is called an "internal devaluation" – shrink the economy and raise unemployment enough so that the country can become competitive, through lower prices and wages, without changing the exchange rate (i.e. keeping the euro). Unemployment in Spain is now 20 percent, and although exports have picked up some over the last year or so, it is not nearly enough to pull the economy out of its slump. Spain needs expansionary fiscal and monetary policy to boost the economy. But monetary policy is controlled by the European Central Bank – which just last week announced that it may raise interest rates, despite Europe's anemic recovery and crushing unemployment in the Eurozone's weakest economies (Spain, Ireland, Portugal).
Expansionary fiscal policy is prohibited by pressure from the European authorities – who are actually pushing Spain to do the opposite, i.e. cut spending and raise taxes — and the fact that, not having its own monetary policy, Spain cannot engage in "quantitative easing," as the US has done recently, or Japan has done for decades, to finance government spending without adding to the country's net debt burden.
Now back to Spain's decade of experience with the euro. The adoption of the euro opened up a period of bubble growth, with big capital inflows from other European countries, and the country experienced a vast run-up in the stock market and a huge housing bubble. Spain's economy grew by a third between 1999 and 2007, and its net debt fell to just 26.5 percent of GDP in 2007. But it was bubble-driven growth: the stock market peaked at 125 percent of GDP in November 2007 and dropped to 54 percent of GDP a year later. A housing bubble increased construction from 7.5 percent to 10.8 percent of GDP (2000-2006), and housing starts dropped by 87 percent when the bubble burst.
It was the bursting of these bubbles, and not any lax spending policies by the government, that crashed Spain's economy and caused its budget troubles. And it is Spain's subordination to the European authorities, which prohibits it from using any of the three most important macroeconomic policies – fiscal, monetary, and exchange rate – to get out of its slump. Furthermore, although it was theoretically possible for Spain to have narrowed the productivity gap with Germany – since it was starting out at a much lower level of productivity – the bubble-driven growth of the last decade, spurred by the adoption of the euro and large capital inflows, is not the kind of growth that drives up manufacturing productivity.
So the neoliberals have it backwards: it is the neoliberal macroeconomic policies, locked in with the euro, that are the source of both its recession and continuing troubles. Spain should refuse to accept any policies that prolong its slump and prevent it from reducing unemployment. If that means restructuring its debt or even leaving the euro, then these options should be on the table in any negotiations with the European authorities. These choices would better than suffering through many more years of sluggish growth and high unemployment.