Beyond Their Ken?

Spain's economic problems now form part of such a complex web of cause and effect, action and reaction, that it is getting increasingly difficult for laymen, journalists and politicians alike to get to the core of what is actually happening.

“To a herd of rams, the ram the herdsman drives each evening into a special enclosure to feed and that becomes twice as fat as the others must seem to be a genius. And it must appear an astonishing conjunction of genius with a whole series of extraordinary chances that this ram, who instead of getting into the general fold every evening goes into a special enclosure where there are oats- that this very ram, swelling with fat, is killed for meat”. – Tolstoy, ‘War and Peace’.

After so many false dawns, the recent announcement by Spain’s Prime Minister Mariano Rajoy that the government was revising down its 2013 economic forecast hardly caused a blink among a citizenry that is now completely inured to deception and ready to believe the worst about the intentions of any politician willing to come forward with either good or bad news. The long announced recovery has once more been delayed, and will now be noted not in the last three months of this year, but during the first six of 2014. Naturally, a public which is now totally accustomed to such postponements will not be surprised if this one is far from being the last.

In fact, the latest institution to throw a bucket of cold water over the Spanish government’s rose-tinted promises is the IMF. In their latest five-year forecast for Spain they paint a pretty bleak picture of low growth and high unemployment lasting at least all through what is left of the present decade. Mariano Rajoy has already jumped into the fray to take issue with their outlook for 2013, but it is their longer-term forecast which is most interesting and preoccupying. Growth between 2015 and 2018 is now only expected to average around 1.5 percent annually. This would seem to be what the IMF now consider longer-term trend growth to be for Spain, and the most notable thing about the number is that it represents a significant downward revision from their earlier optimism. Even this comparatively low number may still be overly optimistic and may yet come down again – I personally expect NO noticeable recovery as cumulative negative developments more or less cancel out positive ones – but it is certainly much more realistic than anything we have seen from the Fund before. There is no question here of any “V” shaped bounce. That is just a fiction of Finance Minister Cristóbal Montoro’s imagination.

Naturally, the other side of the coin on this is the consequence for unemployment. With growth so low there will be little in the way of job creation (watch out, pension system sustainability) and unemployment will linger over 20 percent for many years to come – indeed the IMF have 2018 unemployment at 22.9 percent, meaning they don’t expect it to fall below 20 percent come 2020.

And there’s another highly interesting detail from the IMF Spain forecast. Even to get that rather low level growth of 1.5 percent a year, the Fund pencil in Spain’s running a fiscal deficit of 5 percent a year all the way through to 2018, with the natural consequence that the debt-to-GDP ratio is expected to reach 110 percent by that point, and that isn’t making allowance for any further bank recapitalisation that will be needed. As I have been arguing since 2008 now, Spain’s sovereign debt simply is not on a sustainable path, and what 1.5-percent growth supported by a 5-percent fiscal deficit means is that there is no structurally adjusted growth going on in the economy at all. As a country you are getting more into debt than any increase in output you generate with the borrowing.

A well-oiled crisis

As I have argued in an earlier post, it may well be that the Spanish contraction machine is now so well-greased that it simply continues winding the economy down and down in such a way that things may never recover, in the classic sense of that term. The only argument which stands in the way of reaching this conclusion is the near religious belief now so often heard in policy circles that, well, “economies always recover, don’t they?”

As it happens, they don’t, as a quick look at what happened in Argentina in the 20th century would confirm. But Argentina is arguably an isolated case, and the current economic malaise (I hesitate to use the word “crisis” due to the duration of what is so evidently an ongoing process) seems to be far more general. What people seem to find hard is asking themselves one simple question, “but what if this time really is different?” Which is strange, since reasons for thinking that things may well not return to what was previously considered “normal” are not in short supply.

Populations in developed economies are all now ageing rapidly, generating a phenomenon never before seen in the entire history of known human societies – systematically falling numbers of under-15s coupled with an ever growing population in the over-80s group. The sheer novelty of this phenomenon, coupled with the manifest feeling of unsustainability it generates about our current welfare arrangements should at least give policy makers food for thought, yet evidence that it actually is doing so is in very short supply. Plough on regardless seems to be the watchword.

The current round of cuts to health and education spending are described as “painful but necessary” in order to facilitate a return to growth which will make further adjustments in the future unnecessary. Unfortunately nothing could be farther from the truth. The credit ratings agency Standard & Poor’s, which has been one of the global leaders in highlighting the likely impact of “first world” demographic changes, argues in its latest report on the subject that despite some recent progress, without ongoing and continuous changes in provision entitlement, deficits and debt in developed economies will spiral out of control as the century advances.

I think everyone who stops and thinks for five minutes about the situation will recognize the obviousness of this point, yet scarcely a single politician is willing to come out from behind the curtain and explain to voters the longer-term implications of having shrinking and ageing workforces at the same time as the size of retirement age populations explodes.

Ignoring the obvious

By the middle of this century, and without policy changes, average deficits for developed countries will rise to 15.1 percent of GDP as the interest cost of the increasing debt burden exacerbates the budgetary impact of demographic spending. Median general government NET (not gross) debt (as a percentage of GDP) is expected to increase to 71 percent by the mid-2020s (from around 40 percent today) – and would then accelerate to 216 percent of GDP by 2050. Government spending would rise to about 57 percent of GDP in 2050, from some 49 percent today.

Naturally, these numbers are just very rough and ready estimates, and such levels are unlikely to be reached since markets will surely not fund them, and policy changes will happen. The problem is that many policy makers are still stuck in denial about the need to make them, and where they are willing to do so it is largely linen washing conducted in private and not in the public space provided by election manifestos. Spain’s leaders, for example, continue to insist that no major changes in either pension contributions or entitlement are in the offing even though the need for one or the other is evident, as the structural deficit in the system continues to grow.

Worse, the more frequently they say in public that there is nothing to worry about and all is well, the lower their credibility falls, since few people continue to believe them. At the same time they insist and insist that the current level of health provision will be maintained no matter what, when obviously this is something the country simply cannot afford to do.

But more than the simple impact on government spending possibilities, it is the impact of these demographic changes on growth which seems to be the least widely appreciated part of the story. This is not an oversight of which Standard and Poor’s is guilty. According to the agency:

For several sovereigns in the Eurozone (European Economic and Monetary Union), the financial strains caused by shifting demographics are being compounded by the current economic and financial troubles, which are both strangling growth and increasing the need for social safety net spending. This environment can result in tighter financing conditions amid private-sector deleveraging, plus cuts in public investment leading to a reduction in total investment and consequently the stock of capital. At the same time, the decline in investment activity will likely hurt total factor productivity (a measure of an economy’s technological innovation). Adding to these adverse trends, low employment and net emigration from several sovereigns implies a smaller contribution of labor to future economic growth, a continuing threat if unemployment becomes structurally high.

As can be seen, Standard and Poor’s mention a number of other factors which contribute to what they call the current “strangling” of economic growth in countries like Spain (tighter financial conditions, private sector deleveraging, cutbacks in public sector infrastructure spending, net emigration).

They could also have cited the mere existence of the euro. It is evident that participation in the common currency has had the perfectly foreseeable effect on Spain of making it simple to get into trouble and a lot harder to get out of it. Borrowing was cheap and easy of access during the boom years, now lending to Spain’s banks has all but dried up, and what there is available remains burdensomely expensive.

Divergences in interest rates paid by businesses on bank loans across the Eurozone have recently reached record highs, despite ECB attempts to achieve the opposite result. While the spread between yields on Spanish 10-year bonds and their German equivalent has narrowed significantly the Goldman Sachs interest rate divergence indicator – a measure of cross-border variations in rates charged by Eurozone banks on a selection of business loans – has once more risen and reached 3.7 percentage points in January. This means that companies in southern Europe continue to pay significantly higher interest rates than their northern rivals, leading to the conclusion that while ECB measures may well have been effective in avoiding short term Eurozone break-up, they have still failed to address the problem posed by such inhibitive credit conditions along the southern periphery.

The lessons learned from inaction

So not only does Spain have uncompetitive productivity levels, and a damaged brand image, it also has a high cost of new capital making investment in the country’s economy both unattractive and prohibitively expensive. With unemployment at over 26 percent, non-performing bank loans remain on their upward path, meaning that more companies are facing potential insolvency. The recent bankruptcy of food multi-national Pescanova has renewed rumours in financial circles that the Bank of Spain is preparing another round of provisioning increases – this time for loans to large corporates and small and medium companies – is an indication of how severely the crisis is now hitting the entire business sector. The Spanish problem is now no longer simply one of a construction collapse, since the ensuing impact on overall economic activity has now spread right across the board. A stitch in time saves nine, as the saying goes, but in the Spanish case there was no stitch (since according to policymakers there was no deep-seated issue to address) and the garment simply unravelled. Lesson – it is a lot easier to make things worse by inaction than it is to make them better using the same approach.

But backtracking a bit, the euro makes correcting Spain’s present situation difficult due to the absence of a national central bank able to conduct a full range of monetary policy operations, a limited access to fiscal policy and the fact the country has no currency of its own to devalue. But that does not mean, as Wolfgang Munchau recently suggested, that it is becoming more and more rational to think about euro exit as the cost-of-leaving threshold gets lower and lower. Countries may well one day leave the euro, but if they do it will be because the cost of trying to hold it together has driven them all but mad, not because they have made some back-of-the-envelope calculation showing that the benefits outweigh the costs. Leaving the euro would be a huge leap into the unknown, leaving one side of the calculation sheet simply beyond our ken. As I argued in a post for the CNN blog, the currency bares an uncanny resemblance to Dr Strangelove’s doomsday machine, designed so that one day it would almost inevitably blow up the global financial system, but constructed so that any attempt to dismantle it would also produce the same outcome.

Yet, despite the risks, as Gideon Rachman puts it in the Financial Times, in today’s Spain people are slowly but surely losing their faith in both national and EU institutions, and are slowly being driven towards ever more radical “solutions” which far from being rational bear a pretty strong resemblance to the exact opposite:

The “European dream” that Spaniards embraced promised a middle-class lifestyle for most people. But with little prospect of secure jobs for the young and a threat to the future of the welfare state, the fear now is that the Spain of the future will look more like Argentina than Germany. An Argentine future would involve the constant fear of financial crises – and a widening gap between the social classes, as many continue to enjoy a first-world lifestyle, while a growing underclass becomes detached from prosperity. Above all, Argentine public life is characterised by deep cynicism about national institutions and leaders.

Leaving the euro would be an incredibly costly decision for Spain, and becoming yet another Argentina would surely be no panacea, but that doesn’’t mean it won’t happen.

Following in the Footsteps of Japan?

Meanwhile Mariano Rajoy struggles on. Since it is quite obvious that the current policy mix isn’t working, and with one eye on the growing number of “platforms” out there desperately seeking his scalp (those affected by the mortgage crisis, those affected by the preference share haircut) he is desperately thrashing around for a fig leaf policy to stop the nightmare. Last week he found one – in Japan. “I think in Europe we must all ask ourselves whether the ECB should have the same powers as other central banks around the world,” he told a press conference. In particular he seemed to be thinking about what he described as the “very important” shift in monetary stance that had just been undertaken by the Bank of Japan. Now here is not the place to go into the background to the Japan crisis (see my arguments here if you are really interested), but one thing I am sure about is that neither Rajoy nor his main policy advisers have any real idea about what lies behind Japan’s long lingering deflation problem. What he does know is that Japan is able to run a 10-percent fiscal deficit and a 235-percent government debt-to-GDP level with what Nobel economist Paul Krugman calls “no evident ill-effects”. Sounds good to Rajoy. Will it work in the long run? “No idea”, could be his response. In the long run, as is well known, we are all dead, and “anyway I won’t be in the Moncloa” might easily be his reply.

In fact, as billionaire investor George Soros recently warned, systematically debasing a currency (ie not just conducting a one-off devaluation) is an extraordinarily dangerous move. The Bank of Japan has, in Krugman’s words, committed itself “to credibly promise to be irresponsible”. What this “irresponsibility” means is devaluing the currency sufficiently every year to generate sufficient price rises to comply with the central bank’s recently announced 2 percent annual inflation target. This is one promise it will be hard for the bank to keep since Japan’s deflation is being caused not by a poor adjustment in the economic system by structural demand deficiencies produced by the country’s ageing and shrinking population.

The best case scenario would be that the country’s policy makers realize in time that the experiment won’t work, and come to recognize that they have to learn to live with deflation – in which case the only big headache they will have will be what to do with all that debt (you know, the debt that many thought presented no evident problem). Far worse would be success, since if the Bank of Japan succeed in changing expectations (not in the why, but in the how) and lead people to believe that the currency will be debased every year ad infinitum (even assuming the rest of the G20 could ever agree to this), just to guarantee that 2-percent inflation, then they may well end up forgetting their supposedly innate “home bias” and start converting as many yen as they can get their hands on into dollars or some other convenient monetary unit, in the process creating a run on the currency which will make what happened in Argentina look like child’s play.

Such details are doubtless lost on Mr Rajoy and his advisers, which is just my point. The current crisis – which is arguably no longer a crisis but rather a way of life – has all now gotten so complex that the issues involved are almost certainly, and in principle, “beyond their ken.” Spain’s economy will continue to march boldly forward towards what now seems almost guaranteed to be long term decline, while from within the captain’s tower, far from an acceptance that what is happening really is happening, we will continue to hear yet one more crazy and implausible story after another telling us “if only this”, or “if only that” even as representatives of the Plataforma de afectados por las hipotecas (or equivalents) start to assemble outside the local version of the winter palace looking for their hides.

Postscript

I have recently established a dedicated Facebook page to campaign for the EU to take the issue of the Euro Area accelerating population imbalances more seriously, in particular by insisting member states measure movements of their own national populations more adequately and also by having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometimes great things from little seeds to grow.

This is a revised version of an article which originally appeared on the Iberosphere website.

Does Emigration Put Spain’s Health and Pensions System At Risk?

According to the Economist’s Buttonwood, “desperate times require desperate measures”. I am sure this is right, times in Spain are certainly getting desperate and many of the measures being implemented in Brussels, far from representing radical and innovative solutions look much more like continually closing the barn door after the horse has bolted.

The issue Buttonwood draws our attention to in the blog post which accompanies this statement is that of migration trends within the Euro Area and the impact these have on trend GDP growth and structural budget deficits in the various member countries. This is an important issue indeed, since such movements seem to be an unforeseen and largely unmeasured by-product of the current monetary and fiscal policy mix being pursued by the EU and the ECB, yet the consequences they have shape the long term future of the whole Eurozone, and with it the sustainability or otherwise of the component states.

As I said in my last Spain post

One of the less commented features of Spain’s boom during the early years of this century is the way the arrival of economic migrants fuelled a significant part of GDP growth. The country’s population grew by more than six million (from 40 to 46 million) in the first eight years of the century, raising employment levels in both the formal and the informal economies. Migrants are still arriving, but the balance has now turned negative. According to data from the National Statistics Office, as of last June the net outflow was 20,000 a month and accelerating. That is to say a quarter of a million a year, or a million every four years. And the final numbers will almost certainly be much larger.

So a country which already doesn’t have enough people working to pay for its pension system now faces having less and less as time goes by, while the number of pensioners looking to claim will only grow and grow. In part that is the end result of sitting back and watching a 1.3-child-per-woman fertility rate for over 30 years. But to this grave underlying problem is now being added a new and potentially more deadly one. Those leaving are not only migrants who came earlier. Increasingly, young, educated, Spanish people are upping and leaving, and unlike in earlier periods many who go now will never return. Not only is there a massive human capital loss involved here, trend GDP growth is evidently being reduced as the workforce steadily shrinks, while all those unsellable surplus-to-requirement houses become even less sellable.

The motivation for the Buttonwood post was a research report published at the end of last week by the European Financial Economist at Jefferies International, Marchel Alexandrovich. Ostensibly his concern is about optimal currency area theory as applied to the Eurozone, but underlying this concern is a further one: that Mario Draghi and his governing council at the ECB may not be living up to their promise. That is to say they may not be doing enough to hold the Euro together. The Outright Market Transactions (OMT) policy was intended to try to remove break-up risk in the capital markets. Despite the fact that the programme has not been made operational, it has worked reasonably well in that capital flight has been brought to a halt and even reversed, the bank deposit base in most countries on the periphery is now rising, and the break-up risk component in national bond spreads has been virtually removed.

But as often happens in economic matters, solutions to one problem may inadvertently lead to the creation of another. Avoiding radical debt restructuring on the periphery, and going for a "slowly slowly" correction doesn’t necessarily mean that all other things remain equal. Take the labour market, for example (I have already touched on this whole topic in my recent post on Bulgaria). As Alexandrovich points out one of the pre-conditions for the existence of an optimal currency area is the existence of cross frontier labour mobility, and the workings of the  Eurozone have often been criticized on precisely these grounds. Buttonwood puts it like this:

“A SINGLE market works best when its workers are mobile; Americans have shifted to the south and west over the years, for example, as jobs in the rust belt have disappeared. Europeans have the right to work anywhere in the EU and have been doing so for decades; a British series about Geordie builders in Germany (Auf Wiedersehen, Pet) appeared all the way back in 1983. But language barriers mean it is more difficult in practice for Europeans to move than for their American counterparts”.

But now, suddenly, in the wake of the current crisis things are changing. While “the political process to evolve the euro area toward an optimal currency area is slow,” says Alexandrovich, “the migration data suggest that there are rapid changes made in terms of the labour mobility dimension”.

The question is, is this good news? Obviously in one sense it is, if this is needed to make the Euro work it has to happen. But there is a downside, one which Alexandrovich points to: changes in the political process are lagging well behind developments in other areas, and especially in the migration one. It has been clear since the Euro debt crisis that a common treasury was a necessity for the good functioning of the currency union, yet progress in this direction has been painfully slow, and full of bitter recrimination. The migration problem might be just about to bring this simmering issue right to a head.

As Alexandrovich points out, migration trends have recently reversed in some key Euro states. While Spain had rapidly growing population due to large scale immigration during the first decade of the century, migration into Germany was falling steadily, and at one point even went negative. Now all that has changed, people, on aggregate, are moving into Germany and moving out of Spain.

In fact a similar situation exists in Portugal, Ireland and Greece (see my last piece on Portugal), while the UK, for example, has steadily been receiving economic migrants.

These migration patterns affect working age population growth, and with this the rate of underlying potential GDP growth, the number of people paying taxes and social security contributions, the rate of new family formation and demand for new housing, etc etc. As Alexandrovich notes, movements in population momentum are an important economic indicator, and the degree of uncertainty about what individual national population dynamics  are is rising.

One of the interesting details within the latest European Commission Winter economic forecasts for instance is the downward revision to Spanish population estimates, with the country’s population now expected to shrink in size by 0.2% in both 2013 and 2014 – the previous forecast from only a few months previously was a 0.1% annual fall (see table below). This may not seem particularly significant, but these are obviously just first estimates and as the economy goes through another tough year this years outcome could be much worse than expected with the drop potentially extending for years into the future.

In fact the negative movement in Spain’s population is accelerating and no one really knows how far this acceleration will go, or how long it will continue. What we do know is that the likelihood of Spain’s unemployment rate falling below 20% by 2020 is small (it is currently over 26%), and with such high unemployment the pressure to move will continue to be strong.

Now, if we look back over Spain’s “good” economic years, it is clear that even though growth between 1999 and 2006 was normally in the 3% to 4% range, most of this growth came from population increase, which was extraordinarily rapid, while productivity growth was miniscule, and even in the best of cases less than 1%.

Spain’s population had been virtually stationary in the second half of the 1990s, and the subsequent rise was almost entirely due to immigration, the overwhelming majority of which was of working age population, as can be seen in the chart below from the Spanish national statistics office.

Now why, if this was the case you might ask, did Spaniards feel so much better off during these years, since GDP growth per capita, and especially per working age person was not exactly stellar. Well, the next chart tells us why.

Basically Spain as a country was getting into debt, by borrowing abroad through the European interbank market, and consuming a lot of products which were produced elsewhere. Naturally, with house prices going up each year, homeowners felt increasingly well off. Now, of course, house prices are going down each year, and exports are being increased to help pay down all the accumulated debt. So we getting the “continually feeling worse” effect.

Not unsurprisingly, IMF growth forecasts for Spain are being steadily revised downwards to reflect the new reality. And naturally if the current working age population dynamics continue they will be revised down further and further. This is what makes listening to that continuing string of speeches from Spanish politicians just so tiresome. They continually talk about recovery being just around the corner, but in reality they have no idea what recovery will mean in Spain, or even of what they are talking about.

And there’s yet another nasty twist here. Spain’s employment legislation effectively protects older workers at the expense of younger ones. That is why while the overall unemployment rate is 26% the rate for 15 to 24 year olds is 55%. This “older worker bias” also has implications for productivity, as a recent report by Deutsche Bank’s Gilles Moec indicates:

"The dualism of the labour market in many European countries means that, on average, workers under the age of 25, since the beginning of the crisis, have contributed 4 times as much to the contraction in employment as their actual share in total employment (see Focus Europe 9 November 2012). Young workers often are the vehicle of innovation in companies and any labour market adjustment which is skewed towards young workers will ultimately reduce aggregate productivity.

Using data collected at the firm level in Belgium (which in our view is a good proxy for the Euro area in general), Lallemand and Rycx estimated the impact of a change in the age structure of staff on productivity, by adding to a canonical model of productivity based on firms’ characteristics (such as sectoral specialization and educational attainment of workforce) the share of three age groups (below 30, 30 to 49, above 50) in firms’ workforce, as explanatory variables. To provide an illustrative order of magnitude of the negative impact of the recent change in the age structure of companies on aggregate labour productivity in the peripherals, we applied the coefficients estimated by Lallemand and Rycx on the actual changes observed in Spain and Italy between 2007 and 2012 (see Figure 1). This effect is actually quite sizeable, with an adverse shock on the level of aggregate productivity of around 2% in both countries".

So really the whole current situation is most lamentable, since Spain’s ongoing loss of young talent means that the country may well be losing growth potential just as fast as the implementation of structural reforms is recovering it.

But, to go back to the start, and Buttonwood’s point that “desperate times require desperate measures,” these are just what Marchel Alexandrovich at Jefferies is calling for, serious and substantial political measures to shore up the Euro fiscal system, to enable people to move without making the instability in health and pensions systems, and the difficulty of carrying through national level fiscal adjustments, even worse. Spain’s pension system shortfall added at least 1% to the 2012 deficit, and the situation is only deteriorating as fewer people contribute to the social security system with each passing month  while ever more people retire and claim benefits.

Alexandrovich is not, however, as Buttonwood appears to suggest, advocating “a fiscal union where tax revenues is distributed to the smaller countries to allow people to stay put”. This is what happened to the Spanish system of inter-regional solidarity following the 1970s transition  and has now become part of the problem in Spain’s labour market. No, he is arguing for automatic health and pension fund stabilisers to be put in place, so that workers can move freely around without worrying about the implications for their parents or grandparents back home. Otherwise we really will have winners and losers coming out of this crisis, with some countries shoring themselves up, while others are (unknowingly) melting themselves down.

But first, we need to take more determined steps to really measure what is happening. At the moment our knowledge about these flows and their implications is woefully limited. As the European President of the Migration Policy Institute Demetrios Papademetriou put it recently: “The current knowledge base on the economic and social impacts of free movement is slim — in part because its evolving, flexible nature is difficult to capture in official data sources — but it must be improved, to afford a greater understanding of the effects on communities, local workers, and the public purse.”

In conclusion, I leave the last word to Mr Alexandrovich:

"And so we have gone full circle back to the idea of an optimal currency area. The way that a banking union tries to mitigate the effects of a potential bank run, similarly one could help mitigate the effect of Spanish or Greek workers going to work in Germany by having a union where tax revenues get redistributed between the various countries. Otherwise, debt needs to be serviced by fewer taxpayers which then need to be squeezed even harder to keep the whole thing ticking over. So on various levels arguably the euro project remains incomplete and migration data simply help shine a light on some of its further shortcomings, where some countries get isolated and left even further behind".

Postscript

I have established a dedicated Facebook page to campaign for the EU to take this issue more seriously, in particular by insisting member states measure the problem more adequately and having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometime great things from little seeds to grow.

This is a revised version of an article which originally appeared on the Iberosphere website.

Has Spain’s Economic Contraction Now Become Self Perpetuating?

Spain’s political leaders are in cheerful, almost jubilant, mood at the moment. Economy minister Luis de Guindos, speaking in Davos, declared the tide had turned, and forecast that the Spanish economy would return to growth in the second half of 2013.

“The perception of the Spanish economy has improved and will continue to do so over the coming weeks and months,” he told his audience at the World Economic Forum. In similar vein, he told Spanish journalists in Moscow last weekend that Spain's economy no longer being a key theme at G20 meetings was another welcoming sign of the times.

As ever, Spain's economy sage is hedging his bets - earth shattering the growth will not be, but grow the economy will, this is his mantra. Put another way, the bottom in Spain's economic collapse has now been passed. From here on in the road may be winding, but it will be up. Perhaps, he suggested, the economy will be stationary in the third quarter, and then we will see growth, albeit ever so slight, in the fourth one. And quite possibly he is right. The core of the issue is not whether the country could see one, or even two, quarters of positive performance, but whether any faltering recovery will be sustained out into the future, through 2014 and beyond. It is here that all the old doubts really emerge.

 The brunt of the argument which says the country is now about to see a resurgence rests on the idea that Spain’s government have now enacted sufficient reforms to enable the economy to return to a strong growth path. Optimists claim they will, which the skeptics like myself are not convinced at all.

Certainly Mr de Guindos can point to occasions where he has carried the argument. Back in October last year, when he told an audience at the London School of Economics that Spain didn’t need a bailout they simply laughed. Four months later it is looking increasingly unlikely that the country will seek additional EU aid in the short term. “Spain doesn’t need any sort of bailout,” he told Bloomberg TV recently, and this time no one laughed.

Perhaps the key point here hangs on your interpretation of the word “need”. If paying around 5% on your 10 year bonds is considered to be an acceptable cost for financing your country’s debt – Germany, for example is paying around 1.7% - then there is no need to apply to the EU and trigger ECB bond buying via the Outright Monetary Transactions program. If, on the other hand, you think the country could well benefit from lower funding costs, and the kind of pressure for reform which would be exerted from the outside though a Memorandum of Understanding, then clearly a bailout is needed.

Personally I take the latter view, since personally I think the country still has a long way to go in terms of reforms and since it is clear that introducing more measures that bite would be massively unpopular (and especially in the context of all the recent corruption scandals), the shelter provided by a troika driven program would make implementing them a lot easier.

Pension reform is a case in point. With the country’s elderly dependency ratio rising rapidly, and the number of people paying contributions into the pension fund going down by the month, the whole system is badly out of balance and urgently needs some deep structural reform. According to estimates provided by EU economics commissioner Olli Rehn at the last Euro Group finance ministers meeting, shortfalls in the pension system added more than 1% to the fiscal deficit in 2012. And without major changes in the system this problem will only get worse. Yet Spain’s political leaders are apparently incapable of addressing this problem in public.

Another example is the urgent need to restore additional export competitiveness to the economy. Despite all the claims that the recent labor market reforms need time to work it is already evident that what has been done is far too little far too late. Exports have improved considerably, and the current account balance is moving into surplus. Yet despite this sterling performance the economy still contracted by 0.7% in the last three months of last year, and this during a period when the government was running at least a 7% annual fiscal deficit.

Private domestic demand is weak, and weakening. Retail sales, for example, are on a continuing downward course. As salaries fall while prices continue to rise it would be wishful thinking to imagine this dynamic is going to change, especially as consumption patterns are altered by the population ageing process.

High unemployment (currently just over 26% of the workforce is unemployed) and heavy household indebtedness only add to domestic weaknesses, and it is clear that this will continue to be the case for years to come. No one seriously imagines an unemployment rate under 20% come 2020, and household and corporate deleveraging still have a long way to go.

On the other hand whatever deficit target relaxation the EU Commission gives Spain in 2013, fiscal accounts do eventually have to be brought into balance, so we can expect government spending to remain on a downward trend. The conclusion we are forced to draw is that all we have left are exports, if we want to see Mr. de Guindos’s hopes fulfilled and the economy return to sustainable growth that is.

So to cut through the jargon, and the war of statistics and counter statistics, I want to propose a definition – a country suffering from deteriorating demographics (rapid population ageing) and a private debt overhang is sufficiently internationally competitive when its exports grow quickly enough to fuel headline GDP growth sufficient to generate new employment on a sustainable basis.

This is patently not Spain’s case, and it won’t be in the coming years, so more needs to be done. Much more. The employment generating caveat is important, since it is only by starting to generate new employment again that the Spanish economy could enter a positive dynamic, bringing to an end the surge in non-performing loans in the banking system, initiating a recovery in the housing market, and giving some sort of stability to consumer demand.

Thus, despite the fact that the country's current account balance is steadily moving into the black, this doesn't necessarily mean that growth is just around the corner. I recently carried out a study of another economy in the process of adjustment, the Hungarian one, where the current account is now regularly positive, but the economy continually falls back into recession. As I point out in that study:

Surely there are lessons from the Hungarian case for the future outlook on the southern periphery of the Euro Area. Improving goods trade balances are steadily pushing current account balances in countries like Portugal, Spain and Greece back into the black. But far from being like Japan and having a large stock of external net savings these countries are more like Hungary with a large negative net external investment position (again hovering near 100% of GDP in all cases) and consequently a large external debt. What this means is that they are totally unprepared to receive the full impact of the kind of population ageing we have seen in Japan, an impact which is surely now under a decade away.

The Hungarian lesson is that exports can do well, very well, and the current account can correct, but the economy can still languish permanently on the verge of recession unable to generate sufficient growth to break out into a sustainable growth dynamic.

Spain, like Hungary, has a very high negative net external investment position - around 90% of GDP - which means the country is extremely ill-prepared for the full impact of an elderly population.

 Financial Economy - Real Economy Split

What is beyond doubt is that conditions in the financial economy have improved greatly. The government has opened a market for its debt, the banks have a solid capital base for 2013 and are able to access European wholesale funding markets – even if this is still at a considerable price in terms of interest paid. This is why Mr. de Guindos thinks the need for a bailout is receding. But of course conditions in the real economy continue to deteriorate. Most estimates for 2013 are for a larger contraction than that estimated by the government (something which has become habitual), and many observers continue to expect the negative growth trend to continue in 2014. Unemployment was already over 26% as 2012 drew to a close, which makes 27.5% next December a virtual certainty and a number over 28% entering 2014 horrifyingly possible.

So despite all the positive “talking up” that Spain’s economy is receiving from well-wishers at the international level, the disconnect between the financial economy and the real one has now become markedly pronounced, and the clearest evidence for this is that what are now, at least for the time being, well capitalized banks are still unable to provide systematic credit to the deteriorating private sector.

And if the private sector doesn’t improve, then the banking system will surely need more capital further along down the line. Even the relaxation of deficit targets comes at a price – next year (2014) government debt will almost certainly slip through that psychological 100% of GDP level, and still be heading upwards. Meaning that at some point a sovereign debt restructuring in Spain certainly can’t be ruled out.

Perhaps the worst of all assumptions that policymakers seem to be making is the one that “economies always recover”, an assumption which seems to be based on some sort of quasi-religious version of the “hidden hand” theory. Indeed, all that is necessary to makes this a less than universal generalization is one counter example, and unfortunately the real world is populated by several of them. Argentina in the 20th century would be one, the country started out among the richest globally, and look how it ended the century. Twentieth century Japan would be another, and once you start to look you can surely find more (try Ukraine, or Hungary). So recovery isn’t automatic, and something has to happen for recovery to occur. That something isn’t present in Spain at the moment, and indeed the danger is that as conditions deteriorate the contraction becomes self-perpetuating.

One of the less well commented features of Spain’s boom during the early years of this century is the way the arrival of economic migrants fueled a significant part of GDP growth. The country’s population grew by more than 6 million (from 40 to 46 million) in the first eight years of the century, raising employment levels in both the formal and the informal economies.

 Migrants are still arriving, but the balance has now turned negative. According to data from the National Statistics Office, as of last September the net outflow was around 20,000 a month and accelerating. That is to say a quarter of a million a year, or a million every four years. And the final numbers will almost certainly be much larger.

So a country which already doesn’t have enough people working to pay for its pension system, now faces having less and less as time goes by, while the number of pensioners looking to claim will only grow and grow. In part that is the end result of sitting back and watching a 1.3 child per woman fertility rate for over 30 years.

But to this grave underlying problem is now being added a new and potentially more deadly one. Those leaving are not only migrants who came earlier. Increasingly young educated Spanish people are upping and leaving, and unlike in earlier periods many who go now will never return. Not only is there a massive human capital loss involved here, trend GDP growth is evidently being reduced as the workforce steadily shrinks, while all those unsellable surplus-to-requirement houses become even less sellable. And so we may go on in what has all the hallmarks of a non too virtuous circle. So next time Luis de Guindos proudly proclaims that economic conditions are improving, he might care to consider stopping for a moment to reflect on the possibility, nay the almost certain reality, that Spain’s economic contraction now feeds on itself.

The country is no longer waiting, as the New York Times' Landon Thomas so aptly put it, for Mr Rajoy.  Indeed, Mr Rajoy himself has now turned his famous indecision into a virtue. "Sometimes the best decision is not to take any decision, and that itself is a decision," he told enthusiastic supporters in his Partido Popular parliamentary group last week. Or as one PP supporter put it to me last week, it now looks like Mariano Rajoy took a very intelligent decision last autumn, saying he would ask for a bond buying programme if the country needed it and doing nothing. Only time will tell if this was such a good decision as it seems. In the meantime far from waiting for Mr Rajoy, many young Spaniards are now only waiting to see who will be the last to leave so they can ask them to turn the lights out.

This is a revised version of an article which originally appeared on the Iberosphere website.