US embassy cable - 05PARIS781

UNCLAS SECTION 01 OF 02 PARIS 000781 
 
SIPDIS 
 
FROM USOECD PARIS 
 
BRUSSELS FOR USEU 
 
FRANKFURT FOR TREASURY ATTACHE 
 
TREASURY FOR IA -- LESLIE HULL 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, XG, XT, ZM, SP, ECON, EFIN 
SUBJECT:  OECD SURVEY OF SPAIN'S ECONOMY: EROSION OF 
COMPETITIVENESS UNDERMINING CONVERGENCE GOAL 
 
 
CONTAINS REPORT OF OECD MEETING -- NOT FOR INTERNET 
DISTRIBUTION 
 
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SUMMARY AND INTRODUCTION 
------------------------ 
 
1.   The Economic and Development Review Committee of the 
OECD conducted an economic review of Spain on January 31, 
2005.  The last such review was held in February 2003.  Mr. 
Angel Torres, Director General at the Ministry of Economy 
and Finance and Spain's previous EDRC delegate, led the 
Spanish delegation of 18.  Japan and Austria were the lead 
examining countries.  The draft survey notes that Spain's 
economy has been performing well but the government needs to 
accelerate structural reforms in order to reduce inflation, 
boost productivity and increase employment.  Embassy Madrid 
has had an opportunity to see this telegram in draft.  End 
summary. 
 
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LIGHT AND DARK 
-------------- 
 
2.   The draft survey notes that Spain's recent economic 
growth has been higher than the euro area average, although 
the country lags high performers in the OECD such as the 
United States, Australia and the Scandinavian area.  Spain's 
persistent inflation is a problem that could be helped by 
eliminating structural rigidities in the housing market and 
a reform of the wage bargaining system. 
 
3.   Mr. Torres declared the draft survey a very good report 
which shed a lot of light on Spain's problems in the area of 
employment and productivity but, he said, "where there is 
light, there is also shadow".  He said that the Spanish 
government was more optimistic than the OECD for the year 
2005, noting that investment in equipment spending was 
recovering and that there had been a restoration of export 
growth in the fourth quarter of 2004. 
 
4.   The inflation differential with the euro area average 
is a major challenge, he said, but he criticized the OECD 
for minimizing the role of demand pressures in continuing 
inflation.  He said he thought the OECD overemphasized the 
negative aspects of temporary employment contracts and 
minimized the positive.  He noted that many of the OECD 
recommendations to reform the wage bargaining system were 
not feasible and that the report was too optimistic about 
the trade-off between productivity and employment. 
 
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THE VIEW FROM JAPAN, AND ELSEWHERE 
---------------------------------- 
 
5.   The Japanese delegate, who traveled from Tokyo, noted 
that his country's wage bargaining system had been weakened 
in recent years:  the fact that it continues strong in Spain 
is an indicator of weak competition.  He said duality in the 
labor market existed in Japan as well, with full-time 
workers protected by high wages, generous benefits and 
employment protection legislation while part-time or 
temporary workers earned little and enjoyed no social safety 
net, but said that employment protection legislation in 
large companies in Japan was on the decline.  Austria noted 
that another reason for the continuing inflation 
differential in Spain was a lack of competition in the 
retail industry. 
 
6.   The German delegate, who traveled from Berlin, 
criticized the Spanish authorities for not working harder to 
bring their inflation rate more in line with the euro area 
average, and worried that a collapse of the housing bubble 
in Spain might cause problems for the euro.  The Belgian 
delegate, on the other hand, agreed with Spain that doing 
away with wage indexation it is not feasible and added that 
"it may not even make economic sense".  He, and a number of 
others, agreed that temporary contracts had a more positive 
aspect than the OECD gave Spain credit for.  The Australian 
delegate argued against collective wage bargaining in the 
sense that it de-links wage increases from sector or company- 
specific productivity gains. 
 
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THE SECRETARIAT'S LAST WORD 
--------------------------- 
 
7.   Secretariat staff remarked that the Spanish output gap 
was bigger than the euro area average, which is an 
indication that the inflation differential is not demand- 
driven.  In any case, euro membership precludes using 
monetary policy, so the Spanish government should adopt a 
more restrictive fiscal policy if it thinks demand is the 
source of inflation; rather, the OECD is arguing for 
structural reform. 
 
8.   Secretariat staff also made it clear that in 
negotiations over the February 2003 draft survey it had 
allowed itself to be persuaded by the Spanish authorities 
that the inflation differential was a temporary phenomenon 
caused by entering the euro area with an undervalued 
currency and because of productivity differentials between 
the tradable and non-tradable sectors -- the experience of 
persistent inflation for the past two years has proven this 
assertion false. 
 
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PENSIONS AND DECENTRALIZATION 
----------------------------- 
 
9.   The afternoon session was devoted to reforming the 
pension system and to public sector decentralization in 
Spain.  The draft survey made the OECD standard 
recommendation to refrain if possible from offering tax 
incentives for pension saving, since this has been shown in 
other OECD countries to shift savings from one vehicle to 
another but not to increase net savings.  The Spanish 
delegation argued that tax exemption may cause people to 
increase long-term savings, and since the only other long- 
term saving investment for most people was housing, this 
might serve to help cool off the housing market. 
 
10.  On public sector decentralization, the OECD 
recommendations that the national government improve 
financial arrangements for sub-national governments and 
develop systems to make public spending more effective 
were by and large accepted, albeit with resignation. 
Mrs. Silvia Lopez, a Director General in the Ministry 
of Economy and Finance, said pointedly:  "Where there 
is a solution, there is always a problem.  Where there 
is no solution, there is not a problem -- there is a 
fact.  In decentralization, the government of Spain is 
faced with a fact." 
 
MORELLA