July 7, 2010
Real Instituto Elcano

The Economic Observer: Can you give us a short introduction to the Real Instituto Elcano and what your role within the think tank is?

Fredrico Steinberg: Sure, I'm the chief economist of the institute. We're an international relations think thank, focusing broadly on international strategic studies, so our economic team is quite small - basically just me and one other person. We don't really do short-term forecasting - like banks and other institutions might, it's more about geostrategic elements of economics and international political economy and banking governance, that kind of thing.

The Economic Observer: How long has the institute been established for?

Fredrico Steinberg: It's been around for 8 years. We're the best-known think tank in Spain - at least that's what the figures say

The Economic Observer: Does the institute have a department that is particularly focused on China?

Fredrico Steinberg: We have an Asia Pacific Analyst - Pablo, and he just published a book called Chindia. I also deal with China to an extent with my work on the impact of China and other emerging markets on the world economy.

The Economic Observer: Let's start by looking at the details of the Spanish economic situation. Despite the public debt situation in Spain being nowhere near as severe as in Greece and a lot of other European countries, it appears that Spain has been "attacked" by the market. How do you think Spain has handled the crisis over recent years?

Fredrico Steinberg: Well, I don't think Spain has been "attacked" by bad investors who are trying to overthrow the government - it's a bit more complicated than that, but it is true that Spain has a lot of long-term challenges in terms of structural reforms, but the short-term prospects are not enough to justify the recent attacks.
So basically, if Greece has never existed, and the people who work on financial markets had not tried to make uninformed parallels between the two economies, than probably, we would have been ok in terms of having a normal recession. But the problem is - "normal growth" in Spain is going to be much lower than in the past.
This is due to a back log of structural reforms that we need to undertake. Those are:
- Labor market reform
- Financial reform
- Pension reform
- Education reform
- Competition policy reform
To wrap it up - the contagion from Greece has precipitated all this (the recent doubts about public debt etc), but I think it will pass and then we'll have to face the questions that we already had to face 5 years ago in relation to structural reform.

The Economic Observer: Returning to the list of structural reforms you mentioned earlier - in relation to labor market reforms, doesn't the recent announcement by the government indicate a willingness to push ahead with these reforms?

Fredrico Steinberg: Yes, basically, the government has put a proposal on the table, it's something - before they didn't want to do anything. It [the proposal] addresses the issue of contracts and makes it cheaper for companies to lay people off, which is a prerequisite for them to be willing to hire them. Otherwise, companies will be reluctant to hire if they think it will be hard or expensive to fire someone in the future. But they haven't touched the issue of collective bargaining. In Spain, one of our problems is a low-level of productivity, the current negotiating system for setting wages is very poor at recognizing and rewarding productivity growth.

The Economic Observer: On the question of the need for labor market reforms, can you tell us why Spain has had such persistent levels of high unemployment that have hovered at twice the European average for over a decade and are now at 20%?

Fredrico Steinberg: First, it is the system - and the fact that there is a two-tier system - which means that although 2/3 of contracts make it difficult for employees to fire people, the remaining 1/3 or contracts are temporary contracts - with zero firing costs. So when the crisis hit the construction sector, the companies fired all these workers on temporary contracts, so that can help to explain the recent spike in unemployment. The second thing to say is that the real unemployment rate in Spain is probably much less than what is officially recorded. It's not that the statistics are wrong, but due to the presence of the underground or black-market economy (estimated to be about 20% of official GDP), many jobs are not being counted. There are a lot of people doing things on the black market; it's true they're not paying taxes, but at least they have something to do, so this means that we don't have 4.5 million people sitting on their arses.

Another point to make is the high-levels of official unemployment not leading to widespread social unrest has much to do with the number of people working in the informal sector, but also has to do with the strength of social and family networks in Spain which are more solid than in the Anglo-Saxon world where there is a more individualistic approach. 80% of the population in Spain owns their own house (the highest level in Europe) this means that if you own your own house and you can pick up some odd jobs to get some cash; you can survive.

The Economic Observer: Sticking with the labor market, in terms of migrants, what percentage of these migrants were temporary workers?

Fredrico Steinberg: Basically, I don't have the figures, but a large proportion of those who lost their jobs very quickly were migrants, and here's the thing, some of them are returning to their home countries...

The Economic Observer: There's a policy, right? That encourages then to return...

Fredrico Steinberg: Yes, all the unemployment benefits that they would be entitled to on a monthly basis if they stayed, are offered to them in a one-off payment if they leave. But from what I've heard, many are leaving anyway. They've saved a lot. The other thing is that migrants have the geographical mobility that Spaniards don't (they're willing to travel for work). So if you have full employment in Valencia and 20% unemployment in Catalonia, you wouldn't see people move for jobs, but migrants do move. So migrant labor has helped to lessen the problems related to mobility and regional unemployment. It's a general European phenomenon.

The Economic Observer: Turning now to the financial system, you mentioned the small savings bank...

Fredrico Steinberg: Basically in these past 10 years, a lot of over capacity has been put into the system. So you have a lot of over capacity, some of the branches are losing money, the banks are indebted to foreigners - they borrowed cheaply from German banks in order to finance real estate initiatives - so they have a lot of debt. So, basically, what you need is to consolidate all these small banks into fewer large banks that have more financial muscle and are able to go out and get financing if they need it.

The Economic Observer: To what extent was overcapacity in the banking system a problem of poor regulation?

Fredrico Steinberg: I actually think it was more the banks, because what happened was Spanish regulation of the financial system is up there with Australia and Canada - we had no toxic assets, and no balance sheet operations. So basically, the problem was caused by the under-perception of risk by private institutions. Credit was so cheap for so many years and the business of banking was so profitable, that they were offering 40 or 50 year mortgages. And it's not the government's role to step in here. I should emphasise that it was only some banks, others did well. I wouldn't blame the central bank, they did a good job.

The Economic Observer: Turning to one of the other reforms you mentioned earlier - what needs to change about the pension system?

Fredrico Steinberg: I'm not really an expert here, but basically, like in most European countries, we are witnessing changing demographics. So there should be a move to encourage people to work longer and to lift retirement ages. This is a challenge that faced us before the crisis, maybe this is a good chance to push through reform, but if not it could wait another 5 years.

The Economic Observer: What makes it difficult to break into markets at the moment?

Fredrico Steinberg: It's about powerful interest groups. In the "Doing Business" survey conducted by the World Bank, Spain usually appears as a country with a lot of red tape, a lot of bureaucracy.

The Economic Observer: Does Spain look to emerging markets?

Fredrico Steinberg: Spain is doing very well in Latin America. This has to do with history, etc. Brazil and Mexico are huge export markets for Spain and we're not as good in China. But in China, aside from the huge, established multinational coroporation like Telefonica, we have less small and medium-sized enterprises exporting to China.

The Economic Observer: How do you see the relationship between China and Europe?

Fredrico Steinberg: The relationship is interesting; Europe has more trade ties with China than the US, but we don't make so much noise about the exchange rate.

But the other thing is we don't seem to have a common strategic approach to China. We need to know what we want to have with China. That in part is because it's difficult to get the individual member states to agree. For example, as Germany exports a lot to China, it doesn't have a problem with the exchange rate, while other countries want to see a faster appreciation.

In Spain, we're basically out of the debate because we don't have enough trade connections with China. But yes, Europe in general would like to see a revaluation of the RMB, but not so desperately. We would like to see China become a more responsible global partner in relation to climate change and the Doha round and all that. But in a way - we know that the big fight is between the U.S and China. We're out, so why spend political capital fighting with them? It's much better to trade, be quiet and not take sides.