The Spanish reversal

Contrary to what you may believe when reading Paul Krugman and many others on Spain, Spain has actually had a relatively moderate drop in output during the latest crisis. Of the four other major Western European economies, only one (France) has had a smaller drop in output, while the other three (Germany, Italy, the U.K.) have had bigger drops in output.

While the drop in domestic demand has been bigger than elsewhere, this has been largely compensated for by a big drop in the Spanish trade deficit.

Yet if you look at unemployment, Spain has fared worse than other Western European countries, much worse in most cases in fact. It has the highest unemployment rate in Western Europe and has also seen the biggest increase (in percentage points).

How can this discrepancy be explained? While it is possible that there might be some statistical error (with either the Spanish drop in output being underestimated or the Spanish drop in employment being overestimated, or both), the main cause is that productivity has increased faster than elsewhere.

But haven't we often been told that Spain has a problem with productivity? Yes, we have, and while that was true in the past, it hasn't been true recently.

If you look at the more detailed national account numbers released today, you can see that nominal GDP has dropped 2.8% (nominal domestic demand is down 7.6%, the difference being of course the result of a big drop in the trade deficit) in the latest 2 years, while the domestic demand price deflator is down 1.5%, implying a cumulative 1.3% drop in the real value of output.

Yet employment has dropped as much as 9.1% in two years, with the job losses being particularly dramatic in the construction sector, where employment has dropped as much as 34.5%.

This implies a productivity increase of more than 8% in 2 years. Meanwhile, compensation per employee increased more than 10% in real terms, the difference being accounted for by stagnating profits and a sharp drop in net taxes on production and imports. So, while employment has dropped dramatically in Spain, average real wages for those that have been able to hold on to their jobs have soared.

The current story of rapid increases in productivity and rapid drops in employment contrasts with the opposite story during the boom years when employment grew rapidly, while productivity dropped.

The most likely explanation for this is that during the boom, labor supply increased rapidly due to massive immigration (and to a lesser extent an increasing number of women entering the work force). However, since the new workers had lower productivity than the male native born Spanish workers, output increased a lot less than employment.

With the bust, that hit the construction sector (where low productive foreign workers were over represented) disprortionately hard, causing unemployment to increase. While employment of native born Spanish workers dropped 5.1% in the latest year, employment of foreign workers dropped 11.75%. The unemployment rate of foreigners have now reached nearly 30% (compared with 16.8% for Spaniards). Because job prospects remained dismal in their countries of origin, few have wanted to return.

So, Spain had for years a boom with particular emphasis on low productive foreign workers in the construction sector, causing it to have higher growth in employment than in GDP, but now the current bust partially reverses this, as these low productive workers disproportionately loses their jobs, causing employment to drop more than output.

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