The negotiations between Spain and her Eurozone partners continue.
Prime Minister Mariano Rajoy agreed to new austerity measures, released on Wednesday, as a means of avoiding a full state bailout and the loss of control to the EU’s supervisory institutions that this would entail. In total, the moves would cut Spain’s budget deficit by €65 billion.
The value-added (i.e. sales) tax would be raised by 3 points to 21 percent—a questionable move that would dampen already weak consumer demand during a deep recession—and there would be cuts to unemployment benefits and pay and benefits to state workers. Also on the table was the subject of pensions, though no cuts were announced at this time. Rajoy promised to consult with the opposition Socialists before pushing through any reforms to Spain’s generous retirement system.
Though it was not announced as such, the moves appear to be part of a quid pro quo. In return for the austerity moves, Spain will be given more time to get its budget deficit in check and it would avoid the humiliation and loss of control that come with a full state bailout.
Investors seemed to take the news well. Spanish stocks (iShares MSCI Spain—$EWP) were up big today (one of the few countries not in the red), and Spanish 10-year bond yields eased under the psychologically-important 7% level.
There is an obvious question raised here: Why does Spain appear to be getting special treatment that the rest of the problem countries do not?
To this, I have two simple answers. First: size matters.
Spain is the fourth-largest economy in the Eurozone (after Germany, France and Italy), and with size comes power. If Ireland or Greece blows up, it really doesn’t matter. All of the fretting about Greece in recent years was not over the failure of Greece itself. Frankly, no one cares about Greece. If the country broke off of the European continent and sank into the Aegean Sea, it wouldn’t make a lick of difference to the global economy.
The fears over Greece were that failure would lead to contagion—to Spain and Italy. When Greece demands that its bailout be renegotiated, Germany’s Angela Merkel has the luxury of flicking them away with her index finger as if they were a buzzing gnat. Spain is a different story. Spain knows that it is big enough and important enough to the health of the Eurozone to negotiate. And the rest of Europe knows that too. If Spain or Italy sinks, so does Europe.
The second reason that Spain gets special treatment is that Spain’s crisis is very different from that of Greece. In the case of Greece, the Greek government borrowed and spent funds it could never hope to repay and went so far as to lie about it. This has left little room for sympathy among Greece’s Eurozone peers.
But in the case of Spain, government debt was actually lower than that of Germany prior to the onset of the 2008 crisis, and its budget enjoyed a modest surplus. It was the collapse of the Spanish property market and banking system that sank the economy, and the gaping budget deficits were the result of the deep recession that followed. So Spain has a certain “good faith” element that Greece clearly does not.
What all of this mean for the rest of the EU countries receiving bailouts?
It means different things for different countries. Ireland’s crisis is very similar to that of Spain—driven by a collapse of the property and banking sectors—and the Irish have endured austerity with remarkable grit. The EU is renegotiating parts of its bailout, and in the end Ireland may get a deal that looks closer to Spain’s. Specifically, it appears that some of Ireland’s debt will be shifted to its banks and off the sovereign balance sheet.
Greece should expect no such concessions for the reasons outlined above.
But what about Italy? Under the technocratic government of Mario Monti, Italy has largely done with the EU has asked of it and has made needed reforms. But should Italy fall off the wagon and revert to its old ways, the EU will have a difficult choice. Do you punish bad behavior? Or do you recognize that Italy, like Spain, is too big to be allowed to fail?
So long as Italy more or less toes the austerity line, I don’t see any major confrontations with the EU. But if Italy’s political parties start the siren song of populism or—worse—if a non-credible leader like Silvio Berlusconi wins the premiership again, I would expect a showdown.
At that point, it becomes a question of who blinks first.
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