Euro Zone Crisis: If Austerity in Spain Isn't Eased Up, There Will Be Terrifying Instability

On April 25, 2013, the Spanish National Institute for Statistics (INE) made a disconcerting yet unsurprising announcement as it released the latest unemployment statistics in Spain. The unemployment rate is now at an all-time high, with 27.16% of the labor force, more than 6 million Spaniards, unable to find a job. Most affected are young people below the age of 25, a group which is reaching 55.7% unemployment. Even more alarming is the duration of unemployment. According to Eurostat, the rate of long-term unemployment (over 12 months) was at 11% of the Spanish labor force in 2012, second only to Greece (14.4%).

The very next day, Brussels approved Madrid's plan to delay the budget deficit reduction by two years in order to ease unprecedented austerity measures that were prompted by a sharp economic slowdown since 2007. The initial budget deficit target set by Brussels was 4.5% in 2013, which is still above the EU limit of 3%.

Annual GDP growth (%, 2003-2011):Source: The World Bank Indicators. Data last viewed on April 27, 2013.

It was expected that Spain's staggering unemployment rate, the contraction of its GDP by 1.8% in 2012, and the massive popular protests against tough austerity measures would lead Brussels to accept Madrid's plan to delay the reduction of the budget deficit. It is still hard to understand how Spain is supposed bring the deficit from 10.6% down to 4.5% by 2016, but this softer target will ease political tensions in Spain and within the EU, at least in the short term. 

Spain's Prime Minister Rajoy can use this compromise with Brussels as leverage with the Spanish autonomous regions, especially Catalonia. Indeed, Catalonia used pressure from Madrid to cut its deficit by 4.8 billion euros ($6.3 billion) as a reason to re-affirm its independence claims. Now that the EU granted Spain a softer public deficit target, Madrid will, as announced, pass it on to the autonomous regions. For Rajoy, that could mean weakening the independence claims in Catalonia by exploiting the political divisions among its ruling political coalition. Indeed, since the September 2012 Catalonian parliamentary elections, the winning party Convergence and Union (center-right) was forced to form a coalition with the Republican Left, who also happen to be the main sponsor for Catalonian independence. On the contrary, Convergence and Union considers Catalonia as a nation within Spain.

Still, Madrid is now forced to implement a new financing system for its autonomous regions, whereby they can keep a greater share of collected taxes. While such measures will appease independence claims, it will also reduce Madrid's fiscal resources and consequently its control over the regions.

On a European level, the compromise with Madrid to ease the budget deficit will help sooth tensions created by the Cypriot bailout. Indeed, too much rigidity from Brussels towards ailing countries could aggravate the already strong divisions within the Union. Brussels knows that if Spain is pushed too far, it could experience the same political crisis as Greece and Italy: the rise of anti-establishment and anti-EU parties like New Democracy and the Five-Star Movement. 

Nevertheless, on a longer term, any concession made by Brussels to one member state will almost certainly encourage other countries to ask for similar compromises. Of course, this comes at the cost of weakening Germany's austerity approach.

For Spain and the EU, the difficulties that compromise on the budget deficit will bring in the medium to longer run seem to outweigh its short-term benefits.

The financial crisis that started in 2008 became a sovereign debt crisis in Europe. A similar crisis in China or the USA would be and currently is treated on a strictly technical, economic, and fiscal level: how to reduce the debt on a sustainable manner, where to cut. In Europe, it is has become a political problem and no fiscal or economic solution would solve the sovereign debt problem and prevent the euro zone from collapsing.