PERSPECTIVE A Progressive Growth Strategy for Spain EMILIO ONTIVEROS October 2013 The Most Important Economic Challenges The Spanish economy is a good example of the vicious circle in which the economies on the periphery of the Eurozone have been immersed since the start of the crisis in the summer of 2007. This circle consists of three ele­ments: an economy in recession, a vulnerable banking system and a public sector deficit and debt expanding in parallel with the other two elements. The fiscal consoli­dation policies implemented since May 2010 have con­tributed to the further deterioration of economic activity and this in turn damages the quality of bank assets. Besides the commonalities with other economies in the Eurozone, Spain presents specific features that should not be overlooked. These have emerged from the situa­tion that characterized the Spanish economy at the onset of the crisis. It may be useful to recall its main features at the end of 2007:  With the onset of the financial crisis in the United States in the summer of 2007, a long period of growth and job creation ended in the Spanish economy. The average pace of economic growth during the decade previous to the crisis was above 3.5 per cent in annual terms, well above the EU average. In 2007, Spanish GDP growth was 3.6 per cent.  At the end of 2007 the unemployment rate in Spain was equal to the European Union average of 8.5 per cent.  In 2007, Spain did not register a public sector deficit. On the contrary, Spain enjoyed a surplus of just over 2 per cent of GDP, while public debt represented only 36 per cent of GDP. However, alongside these positive indicators the Spanish economy exhibited some significant private-sector im­balances, in particular the very high concentration of economic and financial activity in residential construction and real estate, which accounted for more than 12 per cent of GDP and employment. The main players in this sector had very high levels of indebtedness, and so did households, which had made significant investments in housing. One of the main reasons why the Spanish economy was growing at such a high rate, and with a large concentra­tion in real estate, was the cost of financing – low in historical terms – since the inception of EMU. This factor was also the main reason behind the rise in private debt during the 2000s. That is now Spain’s main problem, and one of the most important constraints on GDP growth. Spanish private debt as a percentage of GDP is one of the largest in the Eurozone and the pace of deleveraging is very slow. It is important to underline the private na­ture of the Spanish economy’s problems when the crisis began. There is a strong correlation between growth in private debt and the fall in private consumption after the crisis. It is also a key factor in the lack of stability in the Spanish banking system. The collapse of economic activity led by residential con­struction led quickly to a very high rate of unemployment and the weakening of domestic demand. Tax collection fell strongly and the fiscal deficit rose. The Spanish bank­ing system began to show solvency problems arising from the erosion of the quality of its assets linked to the real estate sector. Since May 2010, the implementation of fiscal austerity policies has compounded the weakness of domestic de­mand, accelerating the rise in unemployment and rapid