Inane in Spain: debate on terms of debt brake begins

As predicted, the debate about exactly what to write into the proposed constitutional amendment to institute a balanced budget/debt brake requirement in Spain has started and promises to be controversial. Underneath the superficial political agreement on the supposed need for such an amendment, major differences are emerging between the socialists and the conservatives on what form it should take. Plus trade unions, the United Left Party and even some Socialists have voiced their opposition.

So far so good.

In fact none of the positions in this inane debate are entirely tenable, although some are much worse than others.

Most obviously wrong-headed are the conservatives who want “a simple zero deficit rule”. This is sheer madness. Avoiding a deficit in any one year implies running perpetual and substantial budget surpluses just in case a recession comes along. Apart from the fact that at some point the public sector would become a net creditor and there would be no Spanish Treasuries for people to hold, for example, in order to save for their retirement, this implies some combination of permanent net borrowing by the Spanish private sector and/or permanent current account surpluses. (This is because of national accounting identities: see here p. 16ff for an explanation). Neither of these things are going to happen in the short-to-medium run and neither are desirable in the longer run. For a country lacking an exchange rate and an independent monetary policy to commit itself to never running government deficits is quite simply stupid, and actually impossible: how could Spain (or any other country) have possibly avoided running a deficit in 2009. This is up there with creationism and the flat-disk earth as the centre of the cosmos.

Meanwhile the Socialists are downplaying the implications of the constitutional amendment and emphasising that flexibility will be retained.

“Our Budget Stability Law states that in the case of normal growth of between two and three percent – the norm in the years prior to the crisis – that the deficit has to be zero,” she [economy minister Elena Salgado] said. “If growth is more than 3 percent than the budget has to show a surplus, and if growth is slightly below 2 percent a small deficit is allowed. The same idea will be included in the Constitution.”

This is sensible as far as it goes. The problem is that this is exactly the fiscal policy that Spain followed during the 2000s. This  did not prevent it being hit by a massive crisis which then caused, among other things, the fiscal train wreck. In other words a debt brake on these lines is useless. The problem in Spain, and in many other countries, with Greece as the only notable exception, was out-of-control private debt and a concomitant huge current account deficit: yes, its those pesky sectoral (im)balances again. This is the elephant in the room that policymakers have not yet addressed but must do. By distracting attention from this, the debt brake plan is much worse than useless.

Opposition to the debt brake plans by the unions and some opposition parties is welcome. It is indeed outrageous to railroad such a potentially far-reaching legislative change (only the second since the end of the Franco era) through parliament in a matter of weeks. One quibble. It is not actually correct to claim that  “With this measure we are witnessing the burial of the welfare state”. That would only be the case if the limit on borrowing were coupled with restrictions on raising taxes or additional revenue side measures. It may well be the case politically (rather than as a matter of logic) that conservative-liberal policymakers will use any constitutional rule as a means to pursue their agenda of shrinking the welfare state. But it could just as well be used to justify, for example, the need for a financial transactions tax.

I don’t see a good outcome here. A hugely damaging rule might be anchored in a hard-to-change constitution. Or the rule might be highly flexible, and thus a useless placebo in the short run, storing up trouble in the longer run, when the inevitable debate starts about where we are in the cycle and how high above trend growth Spain currently is. And/or there could be a prolonged period of political wrangling and possibly social unrest which will spook the markets (rather than calm them down, which appears to be one of the goals) and make it even harder to focus on the real tasks that must be faced to overcome the crisis.

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