The path to recovery, though difficult and lengthy, has been relatively clear and specific. First, unit labor costs needed to decline toward productivity levels to restore competitiveness – a painful process without the exchange-rate mechanism. In fact, there has been substantial post-crisis re-convergence toward German levels.
Second, both capital and labor needed to flow to the tradable sector, where demand constraints can be relaxed as relative productivity converges. Like many other southern European countries, however, labor-market and other rigidities dramatically reduced the speed and increased the costs of structural economic adjustment, resulting in lower levels of growth and employment, especially for young people and first-time job-seekers.
But Spanish policymakers and business leaders appeared to grasp the nature of the pre-crisis economic imbalances – and the importance of the tradable sector as a recovery engine. Recognizing that the economy could not benefit from a partial restoration of competitiveness without structural shifts, the government passed a significant labor-market reform in the spring of 2013. It was controversial, because, like all such measures, it rescinded certain kinds of protections for workers. But the ultimate protection is growing employment. With a lag, the reform now appears to be bearing fruit.
Indeed, though domestic investment is constrained by credit availability, major European and Latin American multinationals have begun investing in the Spanish economy, attracted partly by its enhanced competitive posture and structural flexibility, and, on a slightly longer time horizon, by a recovery in domestic demand. Private equity is flowing in as well, not only because the valuations are attractive, but also because potential growth in Spain now seems within reach.