Competitiveness of the Spanish Economy. Before and After the Crisis (V). Improvements in Competitiveness through Prices 

04/03/2015

So far, we have seen how inadequate investment in productive capital, technological backwardness and the limited organizational changes that have characterized the Spanish economy have marked its lag in productivity and its losses in competitiveness. In addition, a productive structure based on labour-intensive sectors, coupled with the diversity of employment contracts in our country and labour market regulations, too overprotective of permanent workers, have pushed companies to choose temporary employment, the redundancy costs of which are, for the employer, much lower.

However, this high temporality (around 30%), well above that present in other neighbouring countries, not only aggravates the cyclical behaviour of the labour market, but also reduces labour productivity, because temporary workers in companies receive less training than permanent workers, plus the fact that businesses in expansive periods strongly tend to replace productive capital with temporary labour. It is precisely this fact that has marked, throughout the whole expansive period, the growth of wages that we talked about in the fourth instalment, but it has also helped to generate a restructuring of productive sectors and wage moderation during the current crisis. Both facts, together with the labour reform passed by the government, have helped recover some productivity. And while the latter is important to maintain competitiveness in the long-term, the fact is that it is only one of the factors which can explain this improvement, so we must ask ourselves, what are the other factors?

To answer this question we will essentially focus on three features. Firstly, inflation differentials between Spain and some of our trading partners, mainly eurozone countries. Secondly, the factors that have influenced this price behaviour, with special reference to wage moderation. And finally, the consequences all this could have had on the behaviour of the real exchange rate.

As far as inflation is concerned, we will show the differential between the inflation rate in Spain and that of our major trading partners. In particular, the countries of the eurozone to which we must add, as trading partners, some countries which do not have the euro as their currency, including the UK, US and China, as well as countries in Latin America (Mexico and Brazil) and Africa (Algeria and Morocco).

In the graph below, where the inflation rate in Spain and the eurozone-12 is shown, we can see how the growth of prices in Spain has been higher than in the other countries of the region, at least during the expansive period, when the loss of competitiveness of our country marked a growing trade deficit. However, the trend changed when the crisis started. It is from this point on that the periods in which the differential is positive alternate with those in which the differential is negative. It is in these latter periods where Spain manages to recover some of the lost competitiveness and, as we saw in previous instalments, improve the balance of trade.

 

Year-on-year inflation rate in Spain and the eurozone-12 excluding Spain (1997-2014)


Source: Own calculations based on Eurostat (2015)

 

Now then, the question is whether inflation differentials observed between Spain and the eurozone-12 take place in other trading partners as well, as Spain's commercial recovery cannot be justified just by the possible improvement of competitiveness with the eurozone-12, but also by gains in competitiveness with other trading partners. On this issue we should note, as shown in the graph below, that just as it happens in the Eurozone-12, a loss of competitiveness with other trading partners is also observed during the period of expansion, being our inflation rate higher than that in China, the US and the UK.

 

Inflation differential between Spain and some trading partners (1997-2014)

Source: Own calculations based on OECD (2015)

 

Similarly, competitiveness is recovered during the crisis, particularly as compared to the United Kingdom and China, because in the case of the United States, except for the years 2002, 2003 and 2014, inflation differentials take very low values. In the first two years, Spanish inflation exceeds the US in 1.94 and 0.78 percentage points respectively, while in 2014 it is the US that records a higher inflation rate than the Spanish one by 1.84 percentage points.

In light of this first approach, it appears that the behaviour of prices has partly supported the recovery of competitiveness. The reason is none other than the direct effect that the different behaviour of inflation has on the real exchange rate, something we will deal with in subsequent instalments.

On the other hand, and before going further into the factors that have influenced the behaviour of prices, we must check whether the price disparities are exclusively observed in the CPI, or if they can also be seen in the core inflation. If disparities are greater in the latter case, their structural nature will enable the gains in competitiveness to be maintained over time. With regard to this fact, it should be noted, as shown in the two tables below, that although during the period of expansion Spain's differential as compared to the eurozone was similar, both in terms of the CPI and in terms of core inflation, during the crisis the negative differential in favour of Spain is greater when we remove from the calculation of inflation the goods with a higher price fluctuation (unprocessed food and energy products). This is reproduced in other countries such as Greece and Portugal.

 

Inflation differential with the eurozone-12 (1197-2008 and 2009-2014)

 

                  

 

The greater stability of core inflation, and the fact that the inflation differential measured by this indicator has not only been negative during the crisis, but has even grown as the crisis advanced, suggests that the recovery of competitiveness will not be a fad, but that through the implementation of the appropriate measures by the government, it is possible that it will remain that way and that the foreign sector will benefit from it. However, knowing which reasons are behind this price behaviour can be very enlightening when understanding what measures could support the sustainability of gains in competitiveness via prices, something that we will deal with in the next instalment.