Editor’s note: This article was first published in July 2012. It was written on 26 July 2012, the day of Mario Draghi’s ‘whatever it takes’ speech. The Spanish bond yields above 7%, the 65 billion euro adjustment and the bank bailout are 2012 data; Spain never requested the full sovereign bailout described.
Today the spectre of a bailout for Spain has receded a little. A few simple words from the ECB were enough to calm the risk premium. Of course, we may only have bought time if we don’t keep taking the right measures. Below we explain what we would have to face in the hypothetical event of a bailout (let’s hope it never comes). How would our way of life change? How would it hurt us?
First of all, let’s explain why a country needs a bailout, even though it is not the best option in Spain’s case.
1. Why does a country get bailed out or taken over?
We live in a monetary union (the European Union), where a member country cannot issue its own currency and the national central banks can no longer act as lenders, which means we cannot monetise our own debt. That is when the country has to turn to the markets for financing.
When there are doubts about a country’s growth and its ability to meet its payments, the price it has to pay to place its debt with investors (the markets) goes up. That rising cost shows up in the famous “risk premium”. The greater the risk of default, the higher the yield needed to place the debt.
Spain’s specific problem is that it is already paying interest above 7%, at one point reaching 7.60%, and paying that interest is unsustainable for the Spanish economy. If the markets keep up the pressure, the country would have to ask for another kind of financial aid at a lower interest rate, because the markets would end up refusing to buy any more Spanish debt, knowing it could not be repaid.
So the loan Spain needs would have to be large enough for it not to need the markets for 1 or 2 years, and that loan is basically what is called a full-blown bailout.
2. Why doesn’t the ECB step in and buy Spanish debt?
The ECB could calm the markets and put an end to speculation simply by buying debt. The dilemma is that if the ECB buys debt, it cannot have a say in how Spain is run, so the prime minister could keep governing and designing whatever measures he sees fit. If, on the other hand, Spain formally requests a bailout, it does so by signing a set of conditions that, however they dress them up, basically mean the prime minister can no longer apply his own measures, only those imposed by the supervisors. Call them the Troika or the “men in black” (as the Spanish press nicknamed the inspectors).
At that point, Spain would receive orders that its government would have to follow without straying from the script in the slightest.
3. What would the day after the bailout look like?
We could say there are two kinds of bailout: the hard bailout and the soft bailout.
We have already seen the soft bailout: the financial aid for the banks, which came with cuts and tax rises. And by the way, the €65 billion they wanted to raise with these adjustments will have to be paid anyway in interest, because the risk premium went up when they were announced, but that’s another story.
A full bailout (a sovereign bailout) would be the hard bailout, estimated at around €300 billion, and it would come with new mandatory measures, whether the prime minister likes them or not. At that point the Spanish government would have no say in anything, although they would still get paid, of course 🙂 The measures imposed would be:
- More tax rises: It wouldn’t matter that VAT has already gone up; they would raise it again, especially on products with a reduced VAT rate (basic necessities).
- Laying off civil servants: Once the Troika came in, they wouldn’t just take away civil servants’ Christmas bonus (the extra month’s pay Spanish public employees receive in December); they would carry out a thorough clear-out of public employees or, failing that, a very considerable pay cut. We could be talking about more than 30%. Of course, they could do both (cut pay and lay people off).
- Winding down unviable banks: They would carry out a controlled liquidation of the banks they consider unviable and a drag on the financial system.
- Cuts to unemployment benefits: They would tighten the number of months you need to have worked to claim unemployment benefit, as well as the contributions and even the percentage of salary paid.
- Cuts to regional government spending: Again, this could be a soft cut or a very harsh one, because the Troika knows that Spain’s cancer lies in the autonomous communities as well as in the financial system.
- Pensions: They wouldn’t settle for a freeze, so they would probably cut pensions and raise the retirement age as far as they saw fit.
- Labour reform: They would come in with the theory that “for people not to be afraid of hiring, they mustn’t be afraid of the cost of firing”, so dismissal would become practically free, and there would probably be a pay cut for 90% of Spanish wage earners.
In short: the cost of living would rise and every Spaniard would lose purchasing power.
Would the bailout work?
Some will say that “Spain is Spain, a big economy, and of course it will pull through; if Ireland managed to recover, Spain will have no problem, because Spain is not Greece.”
That sounds very good in theory, but in practice, when Greece and Ireland were bailed out, they didn’t have even half the unemployment we have right now. Without jobs there is no growth, unless Spain becomes a country of emigrants again and we send money home from abroad.
If the Troika comes into Spain and applies its highly inefficient measures, as has already been shown, Spain would be plunged into a crisis from which recovery could take 10 to 15 years at best, with a high probability that the euro would end up disappearing.
I’d like to think that, if that hypothetical moment came, the Troika would at least have learned the lesson that austerity alone gets you nowhere.
Featured image: World Economic Forum, CC BY-SA 2.0, via Wikimedia Commons.
