Spain and UK: Prickly Comparison for Cameron

“The euro does not work, the UK is so much better off with its independent economic policies.” We have heard this refrain over and over again for the last five years. But to what extent do the facts back that up?

Spain and the UK share some remarkable similarities: Both countries are formally monarchies. Both countries have long coast lines (to add a special twist, these coast lines are beloved by many Britons in either case). And both countries face separatist challenges on their fringes.

Both countries were also among the fastest-growing “old” EU members in the run-up to the great financial crisis. Both countries’ economies were artificially boosted by a credit-fuelled boom in the housing market.

In both countries, the bubbles burst in 2007. Both then plunged into a deep adjustment recession thereafter. Both had to back up their banking systems with major amounts of taxpayer money. Both started to recover over the course of 2009.

The long-term view

In a 15-year perspective, the economic performance of the UK is actually quite similar to that of Spain.

That means that Britain’s ability to run an independent national monetary policy and to occasionally devalue its currency does not give the country a long-term advantage.

Using the exchange rate to boost manufacturing exports can have a modest impact short-term. But it does not create a genuine competitive advantage.

Temporary divergence

Spain and the UK parted company when the euro crisis escalated in 2011. In the UK, the Bank of England supported demand by massive bond purchases. In the Eurozone, the ECB held back.

As a result, Spain fell back into recession – but not because of an inherent flaw of the euro, that is, the notion that a “one size fits all” monetary policy did not suit Spain. Instead, the reason was that the ECB ran a restrictive monetary policy for the Eurozone as a whole. It was even too restrictive for Germany, which suffered virtual stagnation from mid 2011 to early 2013.

Spain’s catch-up

The ECB’s reluctance to act is now history. The still-young central bank has learned its lesson, albeit in stages. With Mario Draghi’s promise to “do what it takes” of July 2012, the ECB ended the systemic euro crisis, starting a Eurozone recovery.

With its January 2015 decision to buy €60 billion of bonds per month, the ECB is now adding momentum to the recovery in demand across the Eurozone.

Rebounding from its double-dip recession and reaping the rewards of its 2012 labor market reforms, Spain has actually enjoyed stronger quarterly growth than the UK in late 2014 and early 2015, even slightly surpassing the UK’s annual growth rate in the first quarter of 2015.

Fiscal challenges

Both countries still face serious fiscal challenges, posting excessive and virtually identical budget deficits in 2014 (5.7% of GDP in the UK, 5.8% in Spain).

But the Spanish deficit data for 2014 still reflect Spain’s slower rate of growth early that year. With Spain now growing faster than last year, while the UK economy has lost a little momentum, Spain may find it easier than the UK to reduce its fiscal shortfall in the future.

Receding risk of Brexit

With the Eurozone out of the doldrums and the Spanish recovery proving that countries can easily thrive within the euro, chances are that we will see fewer headlines linking “Europe” to “crisis” in the next few years despite the occasional headlines about the isolated case of Greece.

As Europe is working more normally again, I am confident that a potential UK referendum in 2017, probably coming after some modest EU reforms, will result in a clear vote for Europe.