Spain's per-capita income is currently standing at 95 per cent of the EU average. But declining competitiveness, highlighted by the increasing relocation of multinationals to countries with labour costs lower than Spain’s, and reduced foreign direct investment, is worrying the country’s socialist government. In addition, Spain, the largest net beneficiary of EU aid, faces becoming a net contributor in the coming years.

Inflation is historically low for Spain, at less than three per cent, but is higher than the average of the eurozone countries, with which Spain does most of its trade.The contribution of net exports to GDP growth (Gross Domestic Product) has been negative for five years, partly due to lower competitiveness.

Strong economic growth

Unemployment has declined sharply, thanks to strong economic growth and some labour market reforms, but at 11 per cent, is still well above the EU average. Spain, however, is one of the few EU countries whose general government accounts are in balance and its public sector debt is comparatively low, at just under 50 per cent of GDP. The surge of immigrants into Spain (more than two million since 1998), mainly from North Africa and Latin America, has reversed the decline in the population, which had been shrinking because of Spain’s very low fertility rate. The driving force of the economy is buoyant domestic demand, particularly investment in the construction sector.

Vast public infrastructure projects, such as the high-speed train between Madrid and Barcelona and the building of houses and apartment blocks in virtually every city and town, make Spain look like a giant building site in places. The number of housing projects started in 2005 (600,000) was more than Germany and France combined. Many are for foreigners, for whom Spain is increasingly an attractive option to buy a holiday home, because it uses the euro and thus there is less exchange rate risk than when the peseta was king.

Low interest rates (negative in 2005 because of the soft monetary policy of the European Central Bank and Spain’s higher than average inflation) and a plentiful supply of cheap mortgages have fuelled the housing boom. House prices have surged and created a major crisis for many first-time Spanish buyers, and even more so for immigrants earning little more than the minimum wage. This situation led the socialist government to make housing one of their top priorities when they took office in April 2004. They established a Housing Ministry, for the first time since the 1939-75 dictatorship of General Franco, which is using public sector land to build homes at ‘accessible’ prices.

As well as construction, the other domestic driver and cornerstone of the economy is tourism, which goes from strength to strength. Tourism contributes more than 12 per cent of GDP. Spain has overtaken the US to become the world’s second-largest tourist destination, and is increasingly a favoured option for retirement. Around two million foreigners own homes on the Mediterranean coastline, particularly the Costa del Sol, and some projections suggest up to six million Northern Europeans may retire in Spain over the next decade.

The economy’s foundations give the appearance of being solid, but the construction boom cannot last for ever. The OECD (Organisation for Economic Co-operation and Development) warned Spain in 2004 of a ‘sudden and sharp fall in the medium term’ in house prices, much to the government’s annoyance. Spain’s gross household indebtedness has more than doubled in six years, thought it is still short of that in the UK, and over 80 per cent of it is in mortgages. A property price crash would hit heavily indebted families hard, as they might end up owing more to the banks than their homes are worth (Spain has never experienced a ‘negative equity’ phenomenon).

The cost of success

The strength and high visibility of the construction and tourism sectors hide the underlying problems of ailing competitiveness and low productivity, and at a time when the country is beginning to adjust to the prospect, as of 2007, of receiving much less – or even no aid at all – from the EU. The reduction in funds is the price of Spain’s success, which has enabled Spain to develop its infrastructure (its roads and railway are superior to the UK’s).

At present, regions whose per capita GDP is less than 75 per cent of the EU average (known as ‘Objective 1’ regions) are granted structural funds (70 per cent of Spain’s total EU funds in 2000-06). The EU enlargement sharply reduced the average per capita GDP; as a result of this ‘statistical effect’, the only Spanish regions that might still qualify for aid in 2007 are Andalucía and Extremadura, and perhaps Galicia. Spain would also fail to qualify for the less important cohesion funds, as its national per capita income has already surpassed the threshold of 90 per cent of the EU average needed to qualify for these funds.

Spain slipped seven places down the rankings of the world’s 60 most competitive economies to 38th position in 2005, according to IMD, the influential Swiss business and economics school. Some of the former communist countries that joined the EU are already luring multinationals away from Spain. Productivity growth in Spain (as measured per person employed or per hour worked) has been virtually zero – or even negative – over the past couple of years.

Not only are some multinationals leaving Spain, but foreign direct investment (FDI) in Spain has been declining since 2001. In contrast, foreign investment in real estate has been growing. FDI in 2003 represented 2.4 per cent of GDP, far from the level of 6.7 per cent in 2000, while investment in real estate represented one per cent of GDP. The two main factors behind the jump in this investment are Spain’s entry into the euro and the surge in house prices. In 2003, investment in real estate represented 40 per cent of total FDI.

Regional effects

Spain is one of the most decentralised countries in Europe, with each of the 17 regions enjoying varying degrees of autonomy. The main engines of the economy are Madrid and Catalonia (each generates close to 20 per cent of GDP, and between them they account for around 30 per cent of the population). The regions of  Valencia and Murcia, and the province of Almería in Andalucía, are also playing an increasingly important role, largely due to tourism and construction – sectors that are closely intertwined in those parts of Spain with large and growing foreign populations.
 

ECONOMIC FACTS

• It is predicted that the Spanish economy will have grown by 3% in 2005
• Inflation currently stands at less than 3%
• Unemployment in Spain is above the EU average of 8%, currently standing at 11%
• Foreign investment in real estate represents 1% of Spanish GDP
• Construction generates 18% of the country’s GDP
• In 2005, 600,000 housing projects were begun, mostly for foreigners