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Western EuropeApril 4 2004

The show goes on

The Madrid bomb blast may have changed the election outcome but Spain’s strong economic performance is unlikely to be affected. Jules Stewart reports.
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The terrorist bombs that killed more than 200 rail commuters in Madrid on March 11 failed to destabilise the country’s democratic institutions, but the shockwaves threaten to fracture the Iraq alliance in which the Spanish government has played a leading diplomatic role.

Within hours of the blasts government officials were pointing the finger at Eta, the violent Basque separatist group, that had been put on the run during prime minister José María Aznar’s eight years in office. But there now appears to be little doubt that the bombings were the work of al-Qaeda militants taking their revenge for Mr Aznar’s support of the Iraq war effort.

“Al-Qaeda has sent Aznar the bill for his trip to the Azores,” said Madrid daily Expansión, in reference to the Spanish leader’s summit meeting with US President George W Bush and and UK Prime Minister Tony Blair on the Portuguese island earlier this year.

The Islamic extremists confirmed the government’s worst fears by claiming responsibility for what had been the deadliest terrorist attack against a European target in recent history.

The Spanish people, who took to the streets in greater numbers than any other European country last year to demonstrate against the Iraq invasion, went to the polls three days after the Madrid bombings to deliver a resounding electoral upset by voting in the socialist opposition candidate José Luis Rodríguez Zapatero. Before March 11, the pollsters’ only doubt was whether or not Mr Aznar’s conservative Popular Party would be returned with an absolute majority.

Within hours of claiming victory, Mr Zapatero set alarm bells ringing in Washington and London by vowing to withdraw Spain’s 1,300 troops in Iraq by the summer. Marking a dramatic volte-face from his predecessor’s pro-war stance, Mr Zapatero issued a strongly-worded condemnation of the invasion, while he invited Mr Bush and Mr Blair to engage in some reflection and self-criticism. “You cannot organise a war with lies,” he said.

Spain shifted overnight from being one of the staunchest supporters of US policies in the Middle East and Afghanistan, to what Washington may come to perceive as a dangerous maverick threatening to splinter the Iraq war alliance.

There seems to be little doubt that Mr Zapatero will be tempted to capitalise on the wave of anti-American sentiment by seeking to forge closer ties with core European countries such as France and Germany. “There will be a move towards a more European aligned stance,” says Edward Teather, European economist at UBS.

“The new socialist government will also focus more on domestic than international issues. We can say after the election, the outlook is more uncertain. It opened up the boundaries of possibilities, both up and down.”

Coalition politics

Despite winning the election, the socialists failed to gain a clear majority and therefore stand little chance of pushing through radical legislation. The PSOE (Spanish Socialist Workers’ Party) is going to have to engage in some hard horse-trading with regional nationalists such as the Basques and Catalans in order to govern effectively.

“The socialists intend to form coalitions as and when these are required to push through legislation,” says Mr Teather. Mr Zapatero will almost certainly have to be highly communicative with the regions, as he will need to rely on them to achieve his objectives.

“The national political picture will be influenced by demands for greater regional autonomy,” says Mr Teather. “The socialists offer a less centralist stance on the position and power of the regions relative to central government.”

Even though the Madrid bomb was not the work of Eta, the Basque issue is likely to be very much in the foreground from here on. The Basque terrorists enjoy a small but vocal level of popular support in the region and Madrid cannot count on much sympathy from the nationalist government, which has deployed its own plan for more radical devolution.

There is a perceived risk that Mr Zapatero will be forced to devote a lot of his time to issues of regional sovereignty, leaving less time available for tackling the reforms that are needed to boost Spain’s productivity levels.

So far economists are remaining bullish on the prospect for continued Spanish out-performance this year relative to the eurozone. Alejandra Kindelán, chief economist at Santander Central Hispano (SCH), Spain’s biggest bank, forecasts 2.8% GDP growth this year, a healthy gain from 2.4% achieved in 2003. Ms Kindelán cites a rebound in exports as a leading component of this year’s growth, with the recovery of major world economies.

“The external sector will show a more positive performance this year,” she says. “Exports should grow by about 7% this year compared with 4% previously. There is clearly a higher level of demand from our major trading partners.” Private consumption, meanwhile, should turn in a performance similar to last year when it registered 3% growth, moving well ahead of the EU average.

Lack of investment

But while Spain’s competitiveness is not yet a significant handicap for economic growth, Ms Kindelán says it is a problem to watch. “Spain’s export quota in the world has risen significantly since the early 1990s, but it started to deteriorate somewhat in the latter part of the decade,” she says.

“Prices are increasing and there is not nearly enough investment in R&D. If Europe is behind the US in technology development, Spain is clearly behind Europe in this area.

“The EU enlargement will pose a challenge since their export products are similar to ours. We need to move up the scale in offering products with added value. EU structural funds are coming down and it is important for us to be able to continue without them.

“Spain needs to focus on hi-tech sectors in order to differentiate its products from lower cost competitors that are able to boost their own levels of competitiveness faster than Spain and produce at lower cost.

“We have, however, a good starting point, since the concept of a balanced budget is ingrained in our political and social classes.”

Economic threats

Economic issues, as well as politics, will loom large in Mr Zapatero’s dealings with the regions. Ms Kindelán says the new prime minister will have to tackle the problem of land laws that have fuelled the boom in property prices in recent years, posing a potential threat of overheating the economy.

“The way to ensure a slowdown in house price increases is to change the way land is allocated for building,” she says. “This is currently in the hands of regional governments and municipalities, and one of their prime sources on income is the ability to designate land for industrial or residential development.”

Unemployment remains a lingering blight on the economy and one that a nominally socialist party coming to power on a wave of populism cannot afford to ignore.

Susana García-Cervero, economist at Deutsche Bank, says that although the Spanish economy has enjoyed faster growth than the eurozone for nine consecutive years, its unemployment rate, at 11.2%, is still considerably higher than the EU’s 8.8% average, and has been so for 25 years. “There is a high degree of precariousness in labour contracts, as more than 30% of employed workers have a temporary contract,” she says.

The PSOE’s programme, unsurprisingly, places more emphasis on social reforms than was the case under Mr Aznar’s Popular Party (PP). The socialists have pledged to reduce taxes for low and medium income families, simplify the tax regime, increase the minimum wage to e600 per month and cut corporation tax from 35% to 30%, largely to encourage foreign investment.

There is, as UBS’s Mr Teather points out, some uncertainty surrounding fiscal policy under the socialists. He agrees that Mr Zapatero will place the focus on social policies and push for productivity growth by incentivising areas such as R&D and education.

“Fiscal policy is likely to be looser, aiming more for a balanced budget than a surplus, which was the case under the PP which achieved a 0.3% GDP surplus in 2003,” he says.

“There is a risk that the government will not be able to square increased spending and tax cuts without incurring a fiscal deficit. This is reflected in the bond markets, where the spread between German bunds and Spanish government bonds, which normally trade in a very close range, widened after the election.”

Mr Zapatero faces the challenge of avoiding imbalances in the economy that could have a serious impact on employment and growth. The question analysts are looking at is how long robust demand, low interest rates and high housing prices can continue to be major features of the Spanish economy.

The socialists may also be forced to take some unpopular steps to introduce greater flexibility into the labour market. “They have to encourage a freer flow of workers from one sector to another, provide retraining and cut the cost of hiring and firing,” says Mr Teather.

In association with Tesoro Publico

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