US embassy cable - 04MADRID2250

UNCLAS SECTION 01 OF 02 MADRID 002250 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, SP 
SUBJECT: ECONOMISTS OFFER MIXED OUTLOOK ON GOS ECONOMIC 
REFORMS 
 
 1. Summary: In a breakfast with the Ambassador, leading 
Spanish economists offered mixed views on the ability of Vice 
President and Minister of Economy and Finance Pedro Solbes to 
hold the line on sound economic policies in a heavily 
political cabinet.  The economists cited as major policy 
challenges for the new government: reining in the budgets of 
the autonomous regions; reducing high housing costs without 
producing a collapse in the booming real estate sector; and 
carrying out labor reform to increase the productivity of the 
Spanish economy.  The economists presented a healthy 
skepticism of the Socialist government's ability to seriously 
address these economic challenges.  End Summary. 
 
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Solbes and the Economic Team v. the Government 
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2. On June 9, Ambassador Argyros hosted a breakfast for 
Spanish economists.  The guests seemed to empathize with Vice 
President and Minister of Economy and Finance Pedro Solbes' 
unenviable position.   The recently elected Socialist 
government ran a campaign calling for increases in education, 
R&D, the minimum wage, and transfer payments, while promoting 
a flat income tax and maintaining responsible fiscal 
policies.  Some of these proposals, such as increased 
education spending and tax changes were modified, as the 
reality of the costs associated with implementing them proved 
difficult in light of the government's promise to maintain 
fiscal restraint. 
 
3.  The economists offered only praise for Solbes' "economic 
dream team".  They noted that this team-up was no accident. 
Socialist leaders realize that the Popular Party (PP) 
government handled the economy well, and that the PP did not 
lose the election on economic issues.  Therefore, Vice 
President Solbes intends to maintain the fiscal balance he 
inherited from the previous government as long as possible. 
The main challenge will be what one economist described as a 
slow bleeding effect on the budget.  Socialist ministers will 
propose spending increases that are opposed by the economic 
team.  The resulting compromises between the spenders and the 
budget guardians will yield a small increase in minimum wage 
here or a new social benefit there.  The cumulative changes 
could derail the government's good reform intentions as 
aggregate spending slowly rises.  The economists emphasized 
that Solbes and his team will need to remain vigilant. 
 
4. The group agreed the Vice President needed Zapatero's 
political support to succeed.  One economist stated, "it 
wasn't Rato who held the line on the Popular Party's 
budget--President Aznar inquired about the bottom line every 
day."  However, no one knows what Zapatero really thinks 
about economic policy.  Our guests noted a recent Zapatero 
statement contradicting Vice President Solbes, claim that 
the capital gains tax would not be raised by the Socialist 
government.  They applauded Solbes' tough talk, but predicted 
that without Moncloa's (the Spanish White House) support, the 
economic team would have a difficult time resisting demands 
of ministers who carry more political weight in the cabinet. 
 
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Center-Regional Budget Issues 
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5. The group noted another challenge for the economic team 
will be reigning in the current deficit spending by some of 
Spain's autonomous regions.  Some regional governments have 
called for greater budgeting power to augment increasing 
political powers.  In light of Solbes' possible 
reconsideration of the 2001 Balanced Budget Law, which 
constrains regional budgets, the economists noted that some 
regional leaders, such as Catalonia's Pascual Maragall, may 
make budget negotiations with the regions very difficult. 
 
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Housing 
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6. The economists expected a soft landing for housing prices 
unless interest rates rise by more than 2%-3%; due to 
economic weakness in Germany, they do not expect this to 
happen.  Such a change could lead to economic displacement, 
but an economist from one of the largest banks noted that 
Spain's banks would adjust mortgage terms if necessary to 
prevent widespread loan defaults.  Another guest noted that a 
negative change in the housing market would harm heavily 
invested developers far more than the average home owner; 
however, a drop in consumer spending and a slow-down in the 
construction industry could cause a negative wealth effect in 
the economy. 
 
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Labor Reform and Productivity 
----------------------------- 
 
7. The economists mentioned labor reform as one of the most 
anticipated changes by the new government to increase 
productivity in Spain.  The group agreed that high labor 
rigidity and inflexibility are major problems.  However, no 
one has been able to divine what the government actually 
plans to do.  Some union leaders are close to President 
Zapatero, but no one could predict whether this will 
facilitate or complicate necessary reforms. 
 
8. One guest posited a litmus test for commitment to reform: 
the debate over commercial and retail regulation.  Minister 
of Industry Montilla is proposing a reduction in retail 
hours.  Solbes has been pushing to keep the current liberal 
regime.  This is only one aspect of a deeper question:  Will 
national policies be put in place to stop the encroachment of 
large wholesale retailers?  Currently in Catalonia 
(Montilla's native region), local regulation requires large 
retailers to submit a business plan before developing a piece 
of property.  This level of regulation makes it virtually 
impossible for large international retailers to enter the 
local market.  It will be telling to see how this plays out. 
 
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Spain Still Good for U.S. Business 
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9. We noted concerns raised by some U.S. businesses that 
Socialist policies combined with anti-American election 
rhetoric could deter U.S. investment.  The economists 
downplayed these fears, noting that Spain is still open for 
business.  They agreed that Spain is and will remain a good 
place to invest and do business for U.S. companies. 
 
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Comment 
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10. In the first few months of the new Socialist government, 
few predictions can be made about the government's commitment 
to carrying out economic reforms or dealing with economic 
challenges.  Our group of economists expressed uncertainty at 
Vice President Solbes, ability to maintain fiscal discipline 
without the full support of President Zapatero--still an 
unknown.  The discussion led to a considerable list of 
concerns and worries about the government's (beyond the 
economic team) commitment to manage economic reforms. 
Whether the issue is maintaining balanced budgets, housing or 
labor reform, the economists presented a scrambled picture. 
ARGYROS