A fall in economic output of 0.7% from quarter to quarter is a huge drop, 2.8% on an annualized basis. Spain is caught in the classic debt trap where attempts to cut debt paradoxically create more debt. Budget cuts are decreasing GDP while tax increases sap the spending power of consumers.
Rajoy is in a tenuous political position. He must continue austerity to appease his Eurozone and ECB overlords, but at the same time he must be responsive to his constituents so that he may retain power.
In an attempt to balance the conflicting demands of these groups, he has crafted a stimulus plan. The unemployed are a very important constituency because they comprise over 26% of the electorate. To garner their support, the plan includes a provision to extend long-term benefits until the unemployment rate falls under 20%.
Auto manufacturing is the largest industry in Spain. All of the major European automakers have operations in Spain, and they have increased production in Spanish plants to take advantage of cheaper labor costs. To ensure that they continue to do so, Rajoy offers financial assistance for new car purchases. This is also a giveaway to the rich who are the only people who can afford to purchase new cars.
Youth unemployment has reached stratospheric levels, so it is important that Rajoy at least give the perception that he is doing something about it. The third element of the stimulus plan allows people under 30 to pay only €50 a month for social security, a savings of €200 from the minimum contribution.
The first portion of this package is a good idea. People have paid social security contributions for all of their working lives, and it is important that these benefits are delivered during this time of severe economic distress.
The next two parts of the plans are window-dressing and pork. Subsidies for new car purchases merely give those who were planning on buying a car anyway a taxpayer funded discount. This is exactly what happened during the American cash for clunkers program. Purchases were brought forward causing a spike in sales followed by the inevitable crash.
The last part of the plan made me chuckle and shows why Spain needs to drastically reform its economy if it is to have any hope of leaving its depression. If you start a new business in Spain, you have to pay €250 a month in social security taxes whether or not the business in making any money. In addition to start up costs and supporting yourself, there is an additional €3000 ($4000) a year in taxes courtesy of the Kingdom of Spain.
Certainly, cutting this tax is a step in the right direction, but eliminating it entirely would spur more people to open new businesses. Could you imagine what the state of Silicon Valley would be if we charged Americans $4k a year to be entreprenuers?
While Spain slowly suffocates, it seems like it is politics as usual. One of these days, one of these politicians will offer an alternative, which will include leaving the Eurozone, and the people will start listening. In the meantime, expect more perception plays and more austerity.