IE Focus - The time has come for an arsenalJanuary 2009 | By Gayle Allard, Professor at IE Business School

Exceptional times require exceptional measures, such as deploying an arsenal of fiscal measures. Itâ??s the only way to combat the current economic crisis.

The tax incentive of 1.1% of the GDP approved today by the Cabinet of Ministers might be considered irresponsible at any other time; however, in the unsettled waters of today´s global economy, it is an appropriate move. What are missing are measures for correcting the structural problems that will make this crisis such a serious one for Spain.

The government is facing domestic recession and the almost certain first global recession since 1982. The monetary policy has made its move and the response has not been encouraging. Given this scenario, the European Commission has requested tax incentive packages and Zapateroâ??s government has responded by announcing new expenditure totalling â?¬11,000 million in 2009: â?¬8000 on public works through local authorities and smaller amounts for the car industry, the environment, R&D, the Dependence Act, the refurbishment of buildings and tourism. According to the president, the move will create around 300,000 jobs.

First of all, this package is necessary. At the present time, we should not waste time discussing its effect on the deficit before we proceed. The recession looks to be worse than any known by most of us and normal solutions would be particularly shy. Furthermore, the resources open to the monetary policy are running out. As Bernanke, the president of the Fed, commented on the monetary policy, “you can´t push on a piece of string”. In other words, if the string is loose because markets are at a standstill due to a lack of trust, lowering interest rates will not encourage spending. It may not have any effect at all: that was the case in the 1930s and during the long Japanese crisis. The European Central Bank can still lower rates, and indeed it should, but the move has come so late that it may not have any effect.

Therefore, the only weapon left in the short-term arsenal of economic policies is taxation and it needs to be used. If the incentive of 1.1% of the GDP is excessive and takes us back to inflation (improbable at a time when the ghost of deflation is on the horizon), we can always use the monetary policy to control it; you can pull on a piece of string.

What´s more, fortunately Spain has room to move in its tax policy. Unlike the USA and major European countries, Spain has reached the crisis with relatively healthy public accounts thanks to the efforts made at the end of the 1990s and it can “afford” a greater deficit.

The 1.1% of the GDP may even be too little. We don´t know what the final figures of the Spanish recession will be, but the latest employment figures suggest that they will be significant. If we are looking at a reduction of 2% or more of the GDP, this package is not enough.

What does need to be questioned is whether or not these measures are sufficient to create 300,000 jobs. The Spanish employment market is at a standstill for fear of what might happen and entrepreneurs are reluctant to take on employees because they know that dismissing workers with open-ended contracts is an expensive affair. An avalanche of money channelled through local authorities may create temporary employment, but businesses will take their time before they trust the situation enough to hire workers in a stable way.

However, the most important criticism is that the package does not move towards a reform that could put Spain in a position where it is more capable of reacting to economic difficulties. An inflexible employment market, a production system that is not very effective and based on a low level of technology and an innovative spirit that is not particularly developed mean that Spain is not very competitive in Europe and much less so internationally. The Spanish current account deficit is currently among the largest in the world; it is almost twice the size of the American deficit. To come through a crisis like this, these problems need to be dealt with and a reform needs to be put in place to make the economy more flexible so that it can react faster; education needs to teach how to think and social services need to meet their objectives at a lower cost. Let´s hope that the working party promised by the president goes beyond an exchange of political opinions and proposes viable solutions for the Spanish economy´s problems, which will continue when the current crisis becomes part of the past.