Spain’s Economic Woes Could Be Worse Than Currently Projected: Its GDP Could Fall by 20% This Year

In a recent report, the IMF predicted Spain’s GDP could contract by 8% in 2020; the Bank of Spain estimates this year’s decline could reach 12.4% if the lockdown lasts 12 weeks (for now, the lockdown is expected to last at least eight weeks). These predictions, while grim, appear to assume a V shape recovery that starts in the second half of 2020 and continues throughout 2021. A sharp rebound makes sense (from here, the only direction is upwards).  I don’t like to be the bearer of bad news. However, considering Spain’s economic structure – including its high dependence on tourism and high unemployment even before the Corona outbreak – and considering its lockdown is still ongoing, and so far, has been among the longest (in Europe, second to Italy), strictest and could partly continue in the coming months a full recovery this year or by early next year doesn’t seem likely. Therefore, I’m concerned that these outlooks of Spain’s economic growth rate appear too optimistic. My guesstimate and I hope I’m wrong, is that at the current political and economic circumstances, the GDP could contract by as much as 20%.

Let’s consider the following back of the envelope calculation: Tourism – roughly 12% of GDP – is still likely to remain subdued this year with foreigners unwilling to return (or Spain won’t be eager to open its borders as it will fear, from the second wave of infections). Since a large portion of tourists tends to arrive during the summer (more than a third), this industry alone may bring down Spain’s GDP by eight percentage points (assuming tourism will only be 25% of its normal level).

Other industries are likely to keep suffering even when the lockdown, as local spending is still likely to be weak. In general, economic activity could remain anywhere from 10% to 50% below normal levels depending on the recovery for the rest of the year (hard to see events, restaurants, shops opening with strong demand). Even if economic activity in the second half of 2020 remains, let’s say, only 10% below normal, GDP could fall by 10% this year due to the weak services sector: Services account for two-thirds of GDP. Since tourism is 12 percentage points (assuming all is in services), services (sans tourism) are roughly 55% of GDP. Assuming services declined by half from March to May, and 10% from June, and assuming the monthly distribution is equal (I know, very unlikely but let’s keep it simple). Each month contributes around 4.6 pp to GDP, so this comes to roughly 7 pp drop in March-May, and 3.2 pp for the second half of the year or a total of 10.2 pp fall in GDP.

Even after the economy fully reopens, Spaniards are not used to work from home – the rate of people who telecommute is one of the lowest in the Euro Area at 7.5% (the EU average is 15%). Thus, it will be harder for Spain to restart operations compared to other countries whose share of workers work from home.

Moreover, the consumer in Spain, unlike in Germany or the U.S., hasn’t benefited from rising wages or low unemployed – wages grew by less than 2% in Q4 2019 (YoY), and unemployed was close to 14% – so consumer spending could be less robust than in other countries.

If the industry sector, which accounts for 20% of GDP, also decreases by only 10% on account of weaker local and global demand – this could mean another 2% fall in GDP.

Putting all these simple calculations together (tourism 8%, services 10% and industry 2%) Spain’s GDP could decline by 20% in 2020.     

Another way to look at it is to consider that if GDP were to fall by 20% this year, it means, based on Okun’s law, and assuming a coefficient of 0.8  (the number quoted in the literature), the unemployment should rise by at least 16% to reach 30%. Back during the Euro debt crisis, Spain’s unemployment rose to over 25% (it started less than 10% before the Great Recession of 2009). This recession is likely to be more severe with a higher starting point (and less of a boost from tourism this time even if local prices were to fall), so unemployment reaching similar levels seems possible, which could reaffirm a drop in GDP of 20%.  So far, the number of unemployed rose by 480 thousand since March, which brings the number of unemployed to 3.7 million or 15.8% — a two percentage point rise. As the global recession advances, this number is likely also to grow.        

As for government “stimulus” (it’s more of disaster relief than stimulus), it has been small relative to other countries as it accounts for only 1.2% of GDP (even Germany’s stimulus is set at 4.4% of GDP). Spain’s high debt is hindering its political leaders from taking more steps. The government is also on shaky grounds as it’s a minority government, which makes it even harder to pass stimulus bills.

For now, the Germans still seem reluctant to allow issuing Euro bonds (corona bonds) so that Spain and Italy won’t be able to expand their fiscal stimulus.

A lot of this analysis shows a grim outlook; however, the purpose of this crude outlook is to motivate the ECB and European governments to take action in easing the damage that will unfold from the Covid19 recession.

This projection didn’t even account for a possible second wave of infections in the winter or even longer lockdowns or political uncertainty, Europe’s fragility, just to name a few. A sizable and timely disaster relief (fiscal and monetary stimulus) could reduce the damage to the economy. Just how bad it could be will fall on the shoulders of Spain’s government, the ECB, and the rest of European Union governments.