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Friday, December 05, 2008

Lessons from Spain and Portugal

While the European Central Bank was busy cutting interest rates by 75 basis points on Thursday - its biggest move ever - our man in Brussels attended a roundtable discussing ten years living with the euro , with particular focus on the experiences of Spain and Portugal.

European Commission economist Carlos Martínez Mongay noted that both Spain and Portugal enjoyed boosts in their GDP before entering the Eurozone in 1999. However Portugal’s substantial growth stopped in 2000, while Spain's continued until last year.

He explained this by pointing to the better fiscal policies (budget surpluses) of Spain - in contrast to Portugal where reforms have been lagging behind for years. Also differences in labour market reforms played an important role. As Mongay showed, after 1999, the Real Effective Exchange Rate of Spain and Portugal was more or less the same.

Both countries experienced an increase of around 10%, but the reasons for the increase were much different. In Spain it was stronger productivity. In Portugal, on the other hand, the increase had its roots in the soaring cost of labour, meaning that the more profound labour market reforms in Spain explain discrepencies in the two otherwise rather similar countries.

What can we learn from this? Well, the obvious: that eurozone membership is by no means a paneca. A county's growth much depends on structural reforms. Or the lack thereof, such as in the case of Portugal. One can therefore not use the economic growth of Spain as an example of the blessings of the Euro.

And one must also look at the disadvantages of sharing a currency and central bank with 15 - soon to be 16 - other countries, some with fundamentally different economic circumstances to one's own. It has been reported, of course, that in Spain and Ireland, the European Central Bank's low interest rates fueled American-style housing bubbles, which now have burst. Spain is currently suffering from a shrinking economy and exponentially rising unemployment. Having your national interest rate set by others is a tricky business indeed.

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