News Column

Spain: New Government, New Terrorism Threat

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Two and a half years after the Sept. 11, 2001, terrorist attacks in the U.S., Spain is now mourning 190 people who died in one of the largest terrorist attacks ever on European soil. Beyond the human dimensions of the tragedy, the outrage shook up Spain's March 14 general elections, held three days after the bombs exploded on trains in and around Madrid. Contrary to all predictions, the Socialist Party (PSOE) snatched control of the government away from the conservative Popular Party (PP). The abrupt turnabout and continued fears of new terrorist episodes raise all sorts of questions: What will happen to the Spanish economy? What are the main goals of Spain's new chief executive? What repercussions will the terrorist attacks have outside of Spain?

The Facts
None of the passengers traveling toward Atocha station in Madrid on the morning of March 11 could have imagined that 13 knapsacks filled with Tytadine were on their trains. At 7:39, 10 bombs exploded almost simultaneously in four suburban trains and explosives experts detonated another three. The latest official count: 190 dead and 1,430 wounded.

Instinctively, everyone – including the government and practically all public opinion pollsters – assumed that the massacre was the work of ETA, the [Basque] terrorist group which has already been held responsible for killing more than 800 people in Spain. Last Christmas Eve it attempted a similar attack in another downtown train station. Moreover, barely two weeks before March 11, the Spanish police detained two ETA terrorists who were on their way to Madrid loaded with more than 1,100 pounds of explosives.

Then within hours of the massacre, a van was discovered containing seven detonators and a tape with Arabic verses from the Koran, and officials began to wonder whether the crimes were committed by an Al Qaeda-sponsored Islamic terrorist group. The answer would have major political implications and a significant impact on the general elections scheduled to take place in just three days.

The Popular Party government had been harshly criticized by many for its support of America's war in Iraq. Voters appeared ready to deprive the PP of its absolute majority and force it to make compromises if it wanted to stay in office. However, if ETA were held responsible for the attacks, it would help the PP at the polls because of the party's traditional hard line in the struggle against Basque terrorists. Meanwhile, the main opposition Socialists party had always opposed the Iraq war and felt that many others, including, voters, agreed with that position. Yet it seemed impossible that they could wind up the winners in the election. All that changed when Al Qaeda was held responsible for the attacks and the idea gained momentum that getting involved in Iraq was a huge mistake for Spain.

On Friday, March 12, 11 million Spaniards took part in demonstrations against terrorism. On March 13, the day before the general elections, the first arrests took place, conclusively linking the attacks to the Islamic group. On March 14, the Socialists won the election despite all predictions to the contrary. Experts attributed the electoral upset to an erosion of support for the government's backing of the Iraq war.

It did not take long for markets around the world to react. In Spain, the IBEX-35 index suffered a 4 percent loss. The New York Stock Exchange closed with a drop of about 1.5 percent. In Germany, the Dax Xetra lost 3.46 percent. The Euro Stoxx 50 fell 3 percent and France's Cac 40 fell 2.97 percent. Overall, the trading sessions of "11-M" [March 11] were the worst in almost 10 months.

The Future
Spain's stock market is now struggling with two elements of uncertainty – the terrorist attacks and the unexpected victory of the Socialists. Among equities, Endesa, the electric company, which declined 12.1 percent, and Amadeus, the travel reservation company, which fell 11.2 percent, felt the most damage. Endesa dropped because the Socialists want to base Spain's Kyoto Protocol compliance on expanded use of renewable energy. Amadeus dropped because of fears that terrorist attacks will adversely affect tourism.

Each year Spain plays host to some 50 million visitors and derives 12 percent of its Gross Domestic Product from tourism. Carlos Mulas-Granados, professor of applied economics at the Complutense University of Madrid, argues that the attacks "can have a negative impact on tourism, but we foresee the same number of visitors [in Spain] this year." Most foreigners who come to Spain have a second residence there, he says, and are thus less affected by recent events.

The economic impact of the attacks extends beyond the borders of Spain. According to a report by Goldman Sachs, the impact will be felt throughout the rest of the euro zone and will slow down the entire zone's economic recovery. This is especially likely if the Madrid massacre turns out to be the start of a pan-European campaign [by Al Qaeda], not an isolated attack. The same report predicts that there will be "rapid normalization of Spain's economy and political life." Its authors are confident that "the positive economic results will continue after an early period of instability that will affect consumer spending at home and business investment."

The transfer of executive authority in Spain will also have consequences. In the short term, says Carlos Mulas-Granados, "it's logical that markets are going to be affected by these events and by uncertainty created whenever there is a change in government. But once that is accomplished, things will return to normal." The election results, adds Antonio Argandoña, economics professor at the University of Navarre's business school (IESE), "are not going to have any economic impact beyond the normal uncertainties involved in forming a new government and taking the first steps in new policy."

'Quiet Change'
As Spain tries to recover from the attacks, a new government headed by José Luis Rodríguez Zapatero will be taking over. Experts agree that the economy will not be one of the new chief executive's priorities. Other concerns – including security, foreign policy and relations with other political groups in the country – will have greater weight on Zapatero's agenda. Although he is unfamiliar to the public, those who know Spain's new leader characterize him as a conciliator who prefers dialogue. His motto is "quiet change."

Security is now clearly the number-one concern among Spaniards, including families, companies, financial institutions and exporters. In that sense, "the government has no time to lose in clarifying its policy. It can be demanding, but it must also be credible. And it must above all allow for optimism in the business community," says Argandoña.

Starting out, Spain enjoys some advantages because of its recent economic successes. During PP's eight years in power, the country grew at an average rate that exceeded 3 percent. In the process, four million new jobs were created. "The other three big economies of the euro zone [France, Germany and Italy] achieved fewer – and more modest – reforms than Spain did," says Rafael Pampillón, professor at the Instituto de Empresa business school. "As a result, they have been putting up with lower rates of growth [than Spain] for years." However, "maintaining Spain's current growth rate of 3.5 percent, while also stimulating job growth, will be a challenge for the new government."

"Fortunately, there are no urgent economic problems that require emergency measures," says Argandoña. "Nevertheless, while the economic situation is not delicate, it is not overly buoyant either. The mood among executives is not euphoric. Investment growth in capital goods has started to soften. Above all, the crimes of March 11 will have an impact on tourism and on foreign investment."

Mulas-Granados believes that "the main challenges facing Spain's economy will not be different [after March 11]. However, the areas where PSOE (the Socialist party) policy will be spelled out will be housing, productivity, research and development, tax regulations and changes in the labor market.

No Experimenting
The day after the elections Miguel Sebastián, who coordinates economic policy for the PSOE, announced the directions the new government will take, iIncluding an emphasis on a growth model based on productivity. Areas of continuity (with the previous government) include respect for the zero deficit, a balanced budget and rigorous tax regulations. According to Monica Melle, assistant dean at the Complutense University's faculty of business and economic sciences, "Zapatero is not an expert in economics but he knows the basics. Moreover, he is open to learning and figuring out the hidden aspects of the economy." Sebastián hastened to quiet economic markets by noting that "we are not going to do any experiments."

Although the new government takes over at a time of economic peace and quiet, it will not all be smooth sailing. "The economic model that has propelled the Spanish economy in recent years has been exhausted," argues Melle. "It was based on domestic demand and on bricks-and-mortar (housing). The socialist model for sustainable growth is based on a virtuous circle. It involves increased spending on human and technical development, on R&D and on education in order to generate greater productivity."

Argandoña has this advice for the new government: "You will have to define, slowly but surely, the parameters of your fiscal policy. Society does not want to go back to high levels of public sector debt. It must understand the results of any promises to lower taxes, develop R&D, create new infrastructure and so forth."

On the other hand, "a great deal of economic policy is now determined by the European Union," notes Melle. "Decisions about interest rates, exchange rates and so forth, come from Europe. What's most important in Spain's economic program is industrial policy and everything related to training, innovation, budget stability and employment." The economic platform that the PSOE presented at election time highlighted four pillars: Greater productivity, higher savings, quality jobs and greater social cohesion.

High Cost of Housing
Until now, Spanish consumers' rate of saving has been damaged by low interest rates and high inflation. However, investing in real estate has created an alternative source of wealth. Now the danger exists that a fall in real estate prices will have an impact on the "wealth effect" and on consumption by reducing consumers' purchasing power. The Goldman Sachs report notes that Spain's main disadvantage when it comes to growth is "the high level of household debt, largely because housing prices are getting higher and higher."

One of the Socialists' most ambitious programs involves housing. A specific electoral promise involves creating a ministry of housing and a public rental agency as well as deregulating property. There is also a firm commitment to "tackle overpricing and speculation in real estate," notes Mulas-Granados. According to Melle, "this sector is undergoing disinflation and it is no longer the motor of growth. To create a market that is once again stable, you need a very careful approach that does not explode the real estate bubble." Melle warns that if the government gets involved in the real estate market, it could be viewed as an insulting form of intervention.

Another key issue is labor reform. "The labor market is crying out for an overhaul of collective bargaining (unions and employer associations both oppose it), and an overhaul of unemployment insurance and the costs involved in [worker] severance," says Argandoña. "The four million new jobs created during the administration of the Popular Party represent a significant achievement," adds Melle. "Now we must undertake a qualitative labor reform that addresses the precarious nature of temporary work. And, as everyone involved agrees, we must reduce the 14 types of [labor] contracts down to four."

According to Mulas-Granados, the goal is "to achieve greater employment flexibility and stability." That is because "business people have no incentives to establish more long-lasting relationships with labor … The reform they want to carry out is not unilateral. They will have to create a consensus in support of the proposal." One goal, according to Pampillón, "is to do away with temporary work. Clearly, in recent years, the rate of temporary jobs, while very high, has continued to decline [from 35 percent of all employed workers in 1995 to 31 percent in 2003]."

In any case, "you can't apply this approach in one day," notes Mulas-Granados. "It has to be achieved step-by-step, gradually." Argandoña concludes that there is no doubt about at least one thing: "The new chief executive won't be getting bored over the next four years."

Predictable Turnabout in Spain's Foreign Policy
"Unlike other countries, Spain has no guidelines for international relations on the national level," points out Sara González, professor at the Complutense University in Madrid. "It is very much influenced by the political party in power. A country cannot change its foreign policy as party positions change. That projects an image of weakness and a failure to take a leading role. A weak position in the international arena isn't helpful to the economy. Spain's interests," she adds, "should be defined and a position should be mapped out."

In what ways has Spain's foreign policy changed? Under Popular Party rule, José María Aznar promoted closer relations between Spain and the United States, which was seeking international support to combat terrorism more effectively. For 30 years, Spain has been paying a social price in its battle against terrorists. Yet the Popular Party ultimately derived no political dividends from its U.S. alliance. On the contrary, the PP fell from power. Moreover, the opposition realized that getting closer to the U.S. would mean getting further away from the European Union.

The Socialists' arrival in power means a predictable turnabout in Spain's foreign policy. One of Zapatero's first announcements was that he would comply with his promise to withdraw Spain's troops from Iraq. Equally predictable is Spain's rapprochement with the Franco-German axis and its determination to end the deadlock regarding the European Constitution.

Miguel Angel Moratinos, a candidate to become Spain's next foreign minister, told the Spanish newspaper Expansion that Spanish policy now "passes through Europe" and relations with the United States "will be managed from Brussels, not from Madrid."

Regarding the European Constitution, Moratinos contends that "it is not necessary to maintain the arrangements made in Nice. Last December, Spain and Poland blocked approval of the first European Constitution because it meant breaking with the terms of power-sharing provisions in the Treaty of Nice. The new terms established a system of a double majority – based on both the number of states and their population. Both Spain and Poland would lose some share of the powers previously outlined for them in the Nice agreement.

Apparently, the new government aims to end the deadlock regarding negotiations for the European Constitution. However, as Gonzalez notes, it still isn't clear how that will be achieved. "Would they give up a share of power in exchange for nothing?" asks González. "No one cedes power to France and Germany for nothing. I don't know what kind of strategy lets those two countries achieve their goals at no cost."

When it comes to foreign policy, the Socialists' challenge is "to connect together all the different isolated proposals (they made during the electoral campaign). If they don't manage to do that, it will be very hard to create a sense of security in the [securities] markets," notes González. "International investors have no political ideology; they don't care about that. The only thing they want is tranquility, stability, and countries that are strong. That's what drives business and investment."

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