EU recovery fund: can Spain transform its economy?

It was as if events took place in reverse. In March, Spain’s prime minister Pedro Sánchez and King Felipe VI visited the carmaker Seat, near Barcelona, to mark their support for the electrical vehicle project the country hopes will modernise and preserve its vital automobile industry.

The project is the showpiece of Spain’s plans to spend €70bn of grants from the EU’s coronavirus recovery fund. The visit felt like an inauguration. But it was only four months later that the government issued its formal approval for the scheme. Even now the rules for the consortium behind it have yet to be issued. The tender will not begin until the end of this year and the funds will only be disbursed in 2022.

Spain is in a hurry to spend the money. But the delays to the electric vehicle project — and the lack of clarity about its rules — are one of several question marks hanging over what Sánchez says is the “most ambitious” economic transformation programme in the country’s modern history and the biggest opportunity since it joined the European Community 35 years ago.

The Spanish plan is also a litmus test for the EU’s overall €800bn recovery programme — a gamble to modernise the European economy and deepen integration whose execution represents perhaps the biggest challenge the bloc now faces.

The Spanish government says its national plan, involving 110 investments and 102 reforms, will create 800,000 jobs during the next three years through spending on green technology, digitalisation, education and training.

“It is essential that we receive these amounts at this moment,” says María Jesús Montero, Spain’s budget minister, adding that the country is still coping with the “hangover” from the savage 11 per cent contraction in gross domestic product in 2020.

But she adds: “For us the European funds are a fundamental help not just to accelerate the economic recovery . . . but to achieve a programme of transformation. We have agreed with Europe that these resources will allow us to carry out change.”

In theory, the big benefits will come over the longer term and they hinge more on economic reforms than investment. Reforms in areas such as labour markets, taxation and pensions could boost the economy by 8-10 per cent over 20 years, according to rough estimates by the Spanish government and European Commission.

There is much at stake for the EU too. Spain’s plan is the second biggest in the EU after Italy, amounting to €140bn, including €70bn in loans which Madrid is expected to request at some point in the next two years.

If the €800bn recovery fund — which is financed by common EU debt issuance — is seen as a success, it could pave the way to a more closely integrated and stable eurozone, with a permanent facility to borrow in times of crisis and a banking union. If it is a failure, the forward march of the EU could come to a definitive halt. Spain is a crucial test case.

Some critics are already warning that the country may be about to miss its historic opportunity because of politicised spending plans and halfhearted reforms. They charge that Spain is using the money to turbo-charge the recovery ahead of elections due in 2023 rather than finance long overdue reforms to raise productivity.

“We need a reform plan and instead we are seeing a counter-reform plan,” Mariano Rajoy, the country’s former centre-right prime minister, said last month.

‘We can’t wait’

Against the commission’s initial advice, Spain intends to front-load the funds, spending 77 per cent of its grants over the next three years.

“We are trying to balance the long-term investment plans and transforming the economy with the bread and butter of today,” says Manuel de la Rocha, Sánchez’s main economic adviser, who oversaw the plan’s submission to Brussels. “We can’t wait so many years to spend the money, because people need jobs now.”

While most of the resources will not begin to reach recipients until next year, the main spending priorities have already been outlined. They include €3bn in public funds for the electric car initiative, a €7bn programme to increase the energy efficiency of buildings, and €3.5bn on helping as many as 1m small and medium sized businesses go online.

“The tenders are being launched and are on track,” says Nadia Calviño, deputy prime minister for the economy. “My assessment is that we have made enormous progress when one thinks that it was [only] in July last year that the [EU] leaders agreed to create the plan . . . in terms of historical timelines this is really remarkable.”

She argues that the fundamental goal of the plan is to “undertake a transformative modernisation process” that boosts growth and increases its resilience over the medium and longer term, adding that the programme will “reach cruise speed next year”.

But, in contrast with Italy, where the national unity government has forged a consensus around its plans, Spain’s hyper-partisan political debate means there is no national agreement on the use of the funds.

Pablo Casado, the leader of the main centre right People’s party, has argued that the prime minister’s control over the resources could lead to “clientelism . . . that ends in corruption”. In an interview with the FT this year, he added: “Businesses are taking unprofitable projects out of the drawer — and the government is saying: ‘Give me projects so I can justify the European funds’ . . . It’s irresponsible.”

The country’s regions will spend some €22bn of the €70bn in grants, but Javier Fernández Lasquetty, the PP politician who is the chief economics official for the 6.6m strong Madrid region, complains that his hands are tied right down to the smallest of programmes.

In Madrid’s case these include €2m the central government has allocated for spending on becoming an “audiovisual hub” and €600,000 on the environmental and digital transformation of the agricultural and fishing system of the landlocked region.

But while critics complain that allocation of the fund has been placed under the government’s direct control with little input from the opposition parties or Spain’s 17 regional administrations, the government and commission both maintain it will be subject to tough external controls.

Spanish officials are all too aware of the resentment caused in Greece by the “men in black” — the EU and IMF officials who oversaw Athens’ austerity programme in the aftermath of the financial crisis. They add that they have resisted pressure from Brussels to micromanage the use of the funds.

But they argue that the conditionality imposed by the EU is unprecedented all the same — “stripping governments naked”, in the words of one.

Overall, the plan has 416 milestones and targets agreed with Brussels, three quarters of them in the period up to 2023. The key condition for the funds to keep flowing is for Spain to keep its word on carrying out reforms — particularly in some of the most sensitive parts of the economy.

The Spanish plan was among the first to receive official approval from Brussels. Ursula von der Leyen, commission president, has hailed it as “ambitious [and] far-sighted”. Sceptics worry that the conditionality of the EU programme — which will include €70bn of loans in 2024-26 after the equivalent amount of grants for the first three years — will be weaker than expected.

The EU’s northern member states, which initially tried to scale down the size of the recovery fund arguing grants would be wasted, are watching closely.

Adriaan Schout, a senior researcher at the Netherlands Institute for International Relations and a former adviser to the Dutch government, says Spain’s plan compares unfavourably to Italy’s under prime minister Mario Draghi.

“Spain impressed a decade ago with the way its banks were restructured. However, that was a decade and a crisis ago. Italy has now picked up speed under Draghi and the national reform plan is more concrete when it comes to milestones.”

Zsolt Darvas, of the Bruegel think-tank in Brussels, says Spain will only receive disbursements of EU money if it meets the milestones for labour, pensions and other reforms which have been set in conjunction with the commission.

“What will be really crucial will be to look into the details of reforms and investments to see whether they are doing what they are really supposed to do or whether they are just meeting the milestones,” Darvas says. “How transformative it is going to be is more difficult to assess than whether they meet the milestones.”

Spain could face the risk of higher borrowing costs next year if investors perceive that the government has made little progress with reforms and is struggling to reduce its public deficit just at the moment when the ECB begins to pare back its purchases of eurozone government debt. Such a punishing scenario is his “worst nightmare”, one senior Spanish figure tells the FT.

“This is the big risk the country faces,” the person says. “And if things go badly, the risk not just to Spain but to the European project could be considerable.” 

‘Sweeties before spinach’

One big challenge has already been deferred to next year. With government debt that jumped from 95 to 120 per cent of GDP during the crisis, Spain will only take measures to put public finances on a more sustainable footing after a group of experts has prepared a report on the issue which is not due until February.

But the commission has demanded progress on the two other showpiece reforms — pensions and labour rules — by the end of this year, while noting that changes the government has committed to so far, such as indexing pensions, “would increase pension expenditure in the medium to long term unless their impact is sufficiently offset”.

“The government is giving out sweeties before serving up the spinach; they have got the order of the reforms wrong,” says Toni Roldán, a former centrist MP now at the Esade business school.

The leftwing coalition responds that it is seeking agreement with business, unions and other political parties on increasing the effective retirement age through incentives, as well as alterations to how final pensions are calculated.

“Pensions were a lifesaver for many families during the pandemic,” says Montero. “Any change has to be the result of a broad consensus; we cannot have a policy on pensions that changes with the political cycle, it has to last one or two decades to be credible.”

Still more difficult is the biggest structural flaw of Spain’s economy: its dysfunctional labour market, which is plagued by sky-high unemployment, particularly among the young, and a two-tier system in which more than a fifth of the workforce ekes out a precarious existence on temporary contracts.

The government is committed to rolling back 2012 reforms by the previous conservative administration, which watered down some protections for people on permanent contracts. But critics who argue that the 2012 reforms helped Spain recover from the financial crisis by keeping down wage costs say such a move will make the country’s labour markets more, not less, inflexible.

The issue is causing a deepening rift within the government: Sánchez’s coalition partners in the radical left Podemos grouping are stepping up calls for the wholesale repeal of the 2012 legislation — pitting them against the prime minister’s Socialists, who favour more modest changes.

“We should achieve a balanced reform that encourages job creation but also improves the quality of those jobs,” says Calviño. “We need to Europeanise the Spanish labour market, to provide flexibility but also end abuses and precariousness of contracts, which have increased inequality in Spain since the financial crisis.” 

She, like other ministers, emphasises the potential for change in other aspects of the recovery plan, such as training the 43 per cent of the population that lack basic digital skills, spending €4.5bn on renewable energy and, perhaps most important of all, revamping education and training regimes that have underperformed for decades.

“The educational system is for us one of the big questions we have to push for the future, and so is everything connected to training,” says Montero.

The scope of the plan’s ambitions is momentous, even though the timetable for both the spending and reforms have been contracted into a few short years. The coming months will do much to decide whether it will really transform Spain, and bolster Europe, or instead go down as a wasted opportunity.

“The funds are going to be very significant,” Pablo Hernández de Cos, Spain’s central bank governor, has said. “But the big challenge is for the programme to change the country.”