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Cablegate: The Economy's Impact On the Elections

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RR RUEHLA
DE RUEHMD #0171/01 0461158
ZNR UUUUU ZZH
R 151158Z FEB 08
FM AMEMBASSY MADRID
TO RUEHC/SECSTATE WASHDC 4268
INFO RUEHLA/AMCONSUL BARCELONA 3293

UNCLAS SECTION 01 OF 07 MADRID 000171

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: ECON PGOV SP
SUBJECT: THE ECONOMY'S IMPACT ON THE ELECTIONS

REF: (A) MADRID 02306 (B) MADRID 00043

1. (U) This message is sensitive but unclassified and not for
internet distribution.

2. (SBU) Summary: Growing concern about the economy is
getting a lot of attention as a possible factor in the March
9 elections. It would only require a shift of two or three
points to move the election one way or the other. Weak
economic numbers and a very volatile stock exchange provide
plenty of ammunition for the opposition conservative Partido
Popular (PP). Clearly the weakening economy is not good news
for the Zapatero government. Yet, it is not clear that the
economy will prove to be a decisive election winning issue
for the conservatives. The PP is certainly trying make it so
though. The opposition is playing offense on the economy,
especially through the recruitment of prominent businessman
Manuel Pizarro to run in the number two spot on the PP's
Madrid parliamentary list behind party leader Mariano Rajoy.
The two parties' economic platforms are similar, and this
election will not be fought over proposals for drastic
change. Instead, the issues are whether the bad economic
news will lead voters to punish the PSOE government. or
whether the PP can make the case that it is better equipped
to manage the coming economic turbulence. Our sense is that
the economy alone will not likely be decisive. However,
there is one issue related to the economy - immigration -
where the PP, if it does not overplay its hand, might gain
significant traction. The upcoming TV debate between Manuel
Pizarro and Second Vice President and Finance Minister Pedro
Solbes could also be significant. End Summary

SOME RECENT ECONOMIC/POLITICAL HISTORY
--------------------------------------

3. (SBU) Spain has had a magnificent economic run over the
last ten years. There really is no other way to put it.
Since 1998, GDP growth has averaged 3.7%. From being a
chronically underperforming economy with very high inflation
and unemployment rates, Spain has now almost converged in
terms of GDP per capita with the EU-15. The PP's 1996-2004
two governments get a lot of credit from Spaniards (even many
socialists) for good economic management. But the
socialists, while they may be considered dangerously
left-wing by Spanish conservatives on foreign policy, social,
regional autonomy, and Basque terrorism issues, are no
wild-eyed radicals when it comes to the economy. After all,
it was Felipe Gonzalez's government that got Spain into the
EU in 1986. Membership in the EU forced a modernization of
many Spanish institions and provided access to EU development
funds that have been used well by both socialist and
conservative governments. Indeed, Spain will continue to be
a net recipient of EU monies until 2013. Spanish socialists
do not use soak-the-rich rhetoric and are committed to fiscal
stability. The economy started supercharging with euro
membership in 2002. The resulting arrival of what by Spanish
standards were historically low European Central Bank
interest rates allowed Spanish companies and households to
borrow unprecedented amounts of money. One result has been
that real estate prices have almost tripled in Spain since
membership in the euro. Since Zapatero took power in 2004,
Spanish economic growth continued to be higher than average
eurozone growth, with rates of over three percent a year. In
fact, in 2007, the Spanish economy grew by 3.8%. In December
last year, the EU's data compiler, Eurostat, reported that
Spaniards were richer per capita than Italians. What this
means is that while Spain is clearly on the cusp of more
turbulent economic times, most Spaniards know that the last
ten years or so have been among the most prosperous they have
ever enjoyed. Yes, some house prices have stagnated,
particularly in important markets like Madrid and Barcelona.
However, most homeowners still have considerable equity in
their properties. Moreover, mortgage collateral requirements
are high so widespread defaults are unlikely. Spaniards do
complain about rising consumer prices; inflation remains
stubbornly above the eurozone average. There are those who
have not shared in Spain's economic progress. Wages are low
for many people. But, by and large, most Spaniards are still
doing quite well after ten years of rapid economic growth.


RECENT ECONOMIC NUMBERS NOT SO GOOD THOUGH
------------------------------------------

4. (U) In terms of growth, 2007 was another strong year for
Spain with 3.8% growth. But, starting in the fall, signs of
weakness started to emerge.

5. (U) GROWTH: Although the widely forecast end of the
housing construction boom had begun earlier in the year,
discussions about possible economic growth numbers in 2008
started in earnest in the fall when the effects of the U.S.
sub-prime crisis started to be felt by French and German

MADRID 00000171 002 OF 007


banks. The IMF began revising global 2008 growth projections
downwards, including its projection for Spain. The IMF now
estimates that 2008 Spanish growth will be 2.7%; the OECD
estimates 2.5%. The Spanish government's original 2008
growth projection was 3.3%. Then it revised the projection
downwards in December, 2007 to 3.1%. Subsequently the
government has hinted it might be something between 2.8% and
3.1%. The conservative El Mundo newspaper reported on 2/6/08
that the GOS is considering revising the 2008 growth
projection down to 2.6%. Growth of 2.6% would still be
higher than average expected eurozone economic growth, and
this would not necessarily put Spain in a recession (defined
as two consecutive quarters of negative growth). According
to a Bloomberg/World Bank forecast, in 2008 Spain will grow
by 2.8% and the eurozone by 2.0%. So, on the face of it this
would not be so bad. But, for reasons explained below, a lot
of people are still likely to feel some economic pain over
the coming year or so.

6. (U) INFLATION: In recent years, the inflation rate has
typically been about a percentage point or more higher than
the eurozone average. More and more stories started showing
up in the press about six months ago about higher prices,
particularly for basic foodstuffs and certain services like,
for instance a cup of coffee in a bar or restaurant.
President Zapatero himself has not been particularly
sensitive on this issue. When asked on a popular TV program
what the price of a cup of coffee was, he replied about 80
cents when in reality most Madrid establishments charge a
euro or more. Second Vice President and Finance Minister
Pedro Solbes has not demonstrated great sensitivity on this
topic either. He suggested recently that one reason
inflation was so relatively high in Spain was that Spaniards
had not quite internalized the true value of a euro. Hence
they often tipped a euro for two coffees costing a euro each,
driving prices upwards. This sounds trivial, but in a
culture that puts a premium on going out, the fact that
Zapatero and Solbes seemed so out of touch with everyday life
got a lot of media play. The full-year 2007 inflation number
was 4.2%, which also generated a lot of media interest and
solidified a widespread sense that goods and services are
getting more expensive and wages are not keeping up. The
conservatives are using this for all it is worth and noting
that inflation tends to hurt the less well off the most. For
instance, the PP's Social Affairs spokesperson, Ana Pastor,
noted in a speech earlier this month that fixed-income
retirees are particularly vulnerable to price rises in basic
foodstuffs, and that these items had risen the most recently.

7. (U) UNEMPLOYMENT: Unemployment is inching upwards as well.
Fourth quarter 2007 unemployment was 8.6%, up from 8.3%
earlier. In January 2008, registered unemployment went up
by 132,000 people, the biggest monthly jump since 1986.
While some socialist-leaning analysts suggested that the
number may be artificially inflated due to one-time factors,
even the socialist government's Labor Minister, Jesus
Caldera, says the number is "bad, very bad". Employment or
lack thereof is an important issue, especially as there are
memories from the seventies and eighties of unemployment
rates of 16% or more. For Spain though, an unemployment rate
of 8.5% of so is historically good, particularly given the
fact that over the last seven years, the Spanish population
has increased from about 40 million to 45 million with the
increase entirely attributable to immigration. The
immigrants have tended to be in prime working age as well.
Many of them found jobs in Spain's construction and tourist
sectors. The former sector is going through a slowdown, at
least with respect to residential construction. Immigrants
do not vote in as great numbers as native born Spaniards
(some have not naturalized yet of course) so it is not clear
what impact leaner economic times will have on their vote.
The Secretary General of Spain's largest trade union (which
has similar views to the PSOE), Candido Mendez, said in a
2/11/08 El Pais interview that the unemployment numbers would
have a "limited" impact on the election result because
unemployment was still low by historical Spanish standards
and many more Spanish workers were eligible for unemployment
compensation than had been eligible during previous increases
in unemployment. Nonetheless, even if most Spaniards still
have a job, the higher unemployment figures contribute to an
overall sense that the long economic expansion is exhausting
itself.

8. (U) HOUSING (see ref A): Spaniards of widely varying
socioeconomic backgrounds obsess about housing. Roughly 80%
of Spanish households are homeowners. Very often, marriage
is delayed until the couple can afford to buy a property.
For several years in a row, Spain has built more houses than
the UK, France and Italy combined. Prices have tripled in
the last six or seven years. But, finally, the long
residential construction boom is cooling down. Sales of both
new and used homes decreased steadily in 2007 with 232,358
registered sales in the first quarter and only 188,256 in the

MADRID 00000171 003 OF 007


third quarter. Housing starts in August 2007 were reportedly
down 40% compared with August 2006. There are now even signs
the prices are starting to come down. A January 2008 survey
showed that used home prices in Madrid and Barcelona were
down 0.3% and 2% respectively. So far, the slowdown in
housing has not led to widespread defaults. Most Spaniards
can still meet their variable interest rate mortgage
payments, even if it means cutting consumption elsewhere
(which of course has wider economic implications). Younger
first-time home purchasers might be grateful for prices to
level out for a while. But, less residential real estate
construction has significant employment effects. Housing
Minister Carme Chacon recently speculated that 250,000 fewer
homes would likely be built in 2008. One industry
representative calculated that this would lead to the
disappearance of about 300,000 jobs. Again though, more
pertinent to the March elections, is that most Spaniards
still have considerable equity in their properties, although
they know real estate is probably in for a fairly lengthy
correction.

9. (U) THE STOCK MARKET: The Madrid stock market, the Ibex-35
(a blue chip index of the 35 of the most highly traded stocks
in Spain) has lost considerable value and has been highly
volatile. At its height late last year, the market reached
16040,4. At its lowest last month, the market plunged below
12,000, a loss of over a fouth of its value in just a few
months. As of 2/6/08, the Ibex-35 traded at 13,037.30. In
recent weeks, volatility has been exceptionally high. For
instance, during the week of January 21, on one day the
market went down by a little over 7%. Two days later it
surged upward by almost 7%. There is nothing particularly
special about how the Spanish stock market has behaved.
Arguably, the Spanish stock market has simply mirrored the
volatility from around the world. Besides, unlike Americans,
most Spaniards do not invest directly in the stock market.
Company-sponsored 401 (k) equivalents are not common so the
proverbial man or woman on the street typically does not
check stock quotes frequently as, for instance, so many
Americans did towards the end of the tech boom. Nonetheless,
after years of steady gains, the market's gyrations have been
cause for a lot of media attention, and the market's woes
contribute to a general sense of economic malaise. Moreover,
the mere fact that the Spanish stock market is acting like
markets elsewhere is unsettling because Spain has enjoyed
better than average economic performance for about ten years.


10. (U) ECONOMIC CONFIDENCE: During the December 18-27, 2007
period, the Center for Sociological Research (CIS) conducted
a poll showing that almost 36% of the respondents think that
the economy is "bad" or "very bad". About 44% think it is
moderately bad (the Spanish word is "regular", which has
slightly negative connotation). Only 18% of the respondents
think it is "very good". The CIS reports that its economic
confidence indicator is the lowest in 12 years. Moreover, in
its November barometer, economics appeared as one of the top
three issues to the respondents, a first in many years.
Almost a third of the polled individuals believe the economy
will be worse in a year. Anecdotally, the difference in
expectations over the last six months is palpable.

PP STARTS FOCUSING ON ECONOMY
AND LAUNCHES MANUEL PIZARRO
-----------------------------

11. (SBU) During the last four years, the opposition has
focused its criticism of the Zapatero government on Basque
terrorism, regional autonomy matters, and social issues.
Economics only started to get more PP attention in the last
six months or so after expectations for 2008 began to
deteriorate. The opposition started by highlighting
inflationary pressures on the Spanish economy and then
emphasized other bad numbers as they have started to come in.
For instance, on 2/6/08, opposition leader Mariano Rajoy
sounded the alarm by characterizing the increase in
unemployment registrations in January as un "autentico
drama". The government's immediate and predictable rejoinder
was that unemployment was 11.5% in 2004 when it took over
from the PP so the 8.6% rate in 2007's fourth quarter was not
so bad. Besides specific electoral proposals, the PP's
biggest initiative in terms of trying get traction on the
economy was the 1/15/08 announcement that former CEO of
Spanish electricity giant Endesa, Manuel Pizarro, would run
just below Mariano Rajoy in the number two spot of the PP's
Madrid parliamentary list (ref B). The PP did not get quite
the bump it wanted from the recruitment of this prestigious,
if controversial, businessman because the exclusion of Madrid
Mayor Alberto Ruiz Gallardon from the list overshadowed the
launching of Pizarro. However, the Pizarro appointment did
serve to highlight the PP's renewed attention to economic
matters. Since Pizarro's formal incorporation into politics,
he has made a few speeches and issued a couple of statements.

MADRID 00000171 004 OF 007


Importantly, he also traveled to Catalonia in a public
attempt to mend fences with the Catalan business coummunity,
sectors that are still angry at his strong opposition to
Barcelona-based Gas Natural's takeover bid for Endesa.
However, it is not yet clear to what extent he will have an
impact. A lot will depend on the planned TV debate between
himself and Second Vice President and Finance Minister Pedro
Solbes. At least in public, Solbes seem to relish the
upcoming debate. Solbes points out that while Pizarro may be
a successful businessman (a double edged compliment given
that many people think that his pay packages have been a
little too rich in recent years, at least by Spanish
standards), he has no real experience managing and/or
formulating macroeconomic policy. During a 2/10/08 PSOE
rally, Solbes noted that he has thirty years of working for
Spanish citizens, not shareholders. This points to a
weakness for the PP. Many people within the conservative
camp would have liked to convince former IMF Chairman and
former Finance Minister Rodrigo Rato to return to active
politics. Getting him to return to Spanish politics would
have been a much more significant coup for the conservatives.
He would have given the PP's statements on macroeconomic
policy immediate credibility. However, Rato has chosen to
sit out this election (some people think he wants the top PP
job if Rajoy leads the party to defeat next month) and take
lucrative positions with Lazard Freres and Banco Santander.

PSOE AND PP ECONOMIC PROPOSALS
------------------------------

12. (U) The main contours of the parties' proposals are quite
well known, and they focus on tax cuts. There follow below
the main PSOE and PP proposals.

13. (U) PSOE Economic Proposals

Tax Policy
----------

-- 400 euro rebate for those deriving income from work or
pensions

-- reduction of income taxes (undefined)

-- elimination of wealth taxes

-- exemption of estate taxes for all estates worth less than
euros 60,000

-- reductions in corporate taxes (undefined)

Social Policy and Pensions
--------------------------

-- creation of 300,000 day care spots for children up to
three years old

-- extension of paternity leave from two to four weeks

-- extension of maternity leave from 16 to 18 weeks for the
birth of a
second child to single parent homes; 20 weeks for the
third child

-- parents of children up to 12 have a right to part-time
work (not clear how this would work
in practice)

-- schools will be open from 7:30 AM to 8:00 PM Monday to
Friday, 11 months of the year

-- increase of euros 200 in monthly minimum wage by the end
of the government's term in 2012

Employment
----------

-- creation in two years of two million jobs

-- reduce unemployment rate to 7%

-- reduce part-time wage contracts by 25%

-- increase minimum wage to euros 800

14. (U) PP Economic Proposals

Tax Policy
----------

-- people earning less than euros 16,000 per year would be
exempt from income taxes (that would mean about
7 million people would no longer pay income taxes)

MADRID 00000171 005 OF 007

-- women would get a euro 1,000 tax cut

-- there would be 3, as opposed to 4, income tax rates: 20%,
30% and 40% (rates are currently 24%, 28%, 37%,
and 43%)

-- corporate taxes would come down to 25% from 30%; SME's
would pay 20%, down from 25%

-- elimination of estate tax

Social Policy and Pensions
--------------------------

-- creation of 400,000 day care places for children up to
three years old

-- increase per child tax deductions by 40%

-- obtain a 3% of GDP budget surplus; create monitoring
bodies to fight inflation

-- increase minimum pensions by 150 euros

Employment
----------

-- creation of 2.2 million new jobs

-- increase female labor force particpation rate to 68%

WHAT WOULD THESE PROPOSALS COST?

15. (U) There are no clear-cut estimates of what these ideas
might cost, and what impact their adoption might have towards
meeting both political parties' goal of continuing to run
budget surpluses. El Pais reports that the government
estimates that the euro 400 tax rebate would cost euros 5
billion. El Pais reports that it talked to a number of PP
economic policymakers off the record who suggested that their
tax cut proposals might, at least initially, cost up to three
times as much as the PSOE's proposals. The PP is less
willing to speculate regarding what its ideas might cost for
two reasons. There are presumably those in the party that
believe in the dynamic effects of tax cuts, particularly the
cut in the top marginal income tax rate, but they are
unwilling to estimate publicly how much extra revenue might
accrue to the treasury as a result of supply-side effects.
The more traditional fiscal hawks suggest they might be able
to pay for some of the income tax cuts by increasing indirect
taxes, but they are certainly not going to advertise that
idea before the elections.

WHAT DO THESE PROPOSALS SAY
ABOUT THE POLITICAL PARTIES?

16. (SBU) Up to a point, the two parties' proposals compete
for whom can lower taxes more or promise to create more jobs.
One PSOE contact ridiculed the fact that after the PSOE said
it would try to create 2 million new jobs, the PP countered
with 2.2 million. Ditto with respect to day care places.
The PSOE offered 300,000 and the PP 400,000. But the
parties' proposals do say something about their thinking.
The traditionally leftist PSOE offers tax cuts, including the
elimination of the wealth tax. The socialists also offer
more spending, but the party's tax cut ideas have
overshadowed the spending plans, not typical for a
center-left party. Indeed, the successor to the Spanish
communist party, Izquierda Unida (IU), has criticized the
PSOE for engaging in a tax cut competition with the PP,
thereby in IU's view undervaluing the role of the public
sector. The PP offered a modest supply-side tax reduction
that would lower the top rate to 40% from 43%. However, its
proposals to eliminate income taxes for those earning less
than euros 16,000 have gained more prominence than the
marginal income tax rate reduction proposal. (Note: Former
Presidency Economic Office Director and former Madrid mayoral
candidate Miguel Sebastian recently told DCM that the
socialists have deliberately not criticized the PP proposal
as a gift to the rich, presumably because the socialists do
not want to be perceived as a traditional soak the rich
left-wing party.) And for a party that says it wants reduce
the role of government, the PP's spending proposals are not
cheap. What does this all say? At least with respect to
economic policy (not social issues like gay marriage or
constitutional issues such as the powers of the regions),
both political parties look to the center. There certainly
are some differences. For example, the PSOE promises less
with respect to both tax cuts and spending, perhaps a
reflection of the fact that it thinks it has a somewhat
better than even chance of remaining in office. The PP
offers somewhat more to the better-off. But the truth is

MADRID 00000171 006 OF 007


that both political parties' ideas on the economy are so
similar that the differences tend to get blurred. There will
be a debate as to which party is better in terms of managing
the economy in tougher times, but it is difficult to believe
that the parties' substantive economic proposals will tip the
balance one way or another.


PUNDITS AND POLLS INCONCLUSIVE
REGARDING THE IMPACT OF THE
ECONOMY ON THE ELECTIONS
------------------------------

17. (SBU) DCM hosted a lunch recently for major newspaper
editors of all major political persuasions. They all had a
lot to say about the economy, but none of them thought that
the economy per se would have a major impact on the election
result. DCM also hosted a lunch last week for six major
economic pundits, some who support the PP and others the
PSOE. They engaged in a very lively debate about the
economy. There were occasionally heated exchanges, for
instance on whether the latest unemployment statistics really
reflected what was going on in the economy or not. But the
pundits were very reluctant to hazard a guess as to whether
the economy would make the difference in the election result.
One PP oriented economist said yes, the economy will be a
critical issue because the PP was more trusted to handle an
economic crisis in his opinion. But subsequently he would
not hazard a guess as to which side would win. Former
Director of the Presidency Economic Office and failed Madrid
mayoral candidate Miguel Sebastian contrasted the PP's
comments about the economy in 1996 with their comments today.
In 1996 the PP expected to win, Sebastian said, and
therefore had optimistic things to say about the economy
because they did not want to damage public expectations.
This year, he said, the PP expects to lose and therefore sees
no downside to spreading doom and gloom about the economy, as
it will not have to manage the fallout. This acerbic comment
from Sebastian capped a somewhat bitter exchange regarding
whether pessimistic comments about the economy could in the
end precipitate unnecessary damage on the economy. The
socialists have accused the conservatives of a lack of
"economic patriotism" in this context. The conservatives
attack the socialists for a lack of realism. In recent
weeks, the Embassy has sent political officers to Andalucia,
the Basque Country, Valencia and Navarra to talk to people in
widely different positions and from widely different
political persuasions about the elections. The Embassy
officers asked whether the economy would make a significant
difference in the election results. Most people thought that
the latest economic numbers certainly do not help the
socialists. However, the prevailing opinion seems to be that
the more adverse economic circumstances will not have
affected a sufficiently large number of people by March 9 to
prompt many people to change their votes.

18. (U) Spanish newspapers publish polls regularly. Most of
them need to be interpreted carefully though because the
Spanish press is so partisan. A 1/23/08 Cadena Ser (more
socialist-leaning) poll asked whether the PP or the PSO could
solve better the country's economic problems. Some 40% said
the PSOE and 39.2% said the PP. On the other hand, a 2/3/08
EL Pais (socialist-leaning) poll found that 43% of the
respondents said that the PP was best placed to restart the
economy and 37% said the PSOE. A 2/10/08 El Pais poll found
50% of the respondents think that the economy is bad or very
bad. But, 43% say their personal financial situation is good
or very good. A recent ABC (conservative newspaper) poll
shows that 32% of the respondents think that the PP is best
placed to manage an economic crisis versus 28% for the PSOE.
The poll showed that 56% of the respondents think that the
Spanish economy will perform roughly the same as the rest of
Europe, perhaps suggesting that many people think that
tougher economic are not necessarily "made in Spain". This
is consistent with the government's frequent emphasis in
public statements that the current economic worries result
from the U.S. sub-prime crisis rather than the long-expected
end of the housing boom. Other polls that have come out in
the press have tended to give one or the other of the major
parties an advantage on this issue, but usually the advantage
is within the margin of error.

IMMIGRATION EMERGING AS AN ISSUE
--------------------------------

19. (SBU) The economy has performed so well in recent years
that Spain's absorption of five million immigrants in the
last seven or eight years has so far not had major political
consequences. But that may be beginning to change. Spain's
education and health systems are under pressure to deal with
the newcomers and maintain previously reached standards. On
2/6/08 Mariano Rajoy proposed that immigrants be obliged to
sign a contract "to respect Spanish customs", an initiative

MADRID 00000171 007 OF 007


modeled on French President Sarkozy's ideas on immigration.
The socialists immediately accused the PP of xenophobia.
But, according to a poll conducted by El Pais, 56% of the
respondents support the measure. Most pertinently, 45% of
socialist voters support the proposal. This is an issue
where the PP may be able to make some headway. However, the
conservatives need to be careful not to overplay their hand.
The PP's economics and employment spokesperson, Miguel Arias
Canete, complained on 2/7/08 about the quality of waiters in
Spain nowadays and that an Ecuadorian woman could get a
mammography for free in Spain in 15 minutes, rather than
spend the equivalent of nine months of her salary in Ecuador.
Statements of this kind make it fairly easy for the
socialists to portray the conservatives as callous. After
all, millions of middle class Spaniards depend on immigrants
from Latin America, especially for child care and elder care.
Rajoy has been careful to talk about the benefits of
immigration as well as the need for stricter immigration
controls and an obligation on the part of immigrants to
follow Spanish customs. This suggests that the PP leadership
is aware of the need to straddle a fine line on this issue.


COMMENT
-------

20. (SBU) Economists from both poltical parties recognize
that Spain has two major economic challenges. First, in the
short-term how to deal with effects of slowing growth. With
respect to this challenge, Spain can use fiscal stimuli given
the budget surpluses it has racked up in past years. With
respect to the second challenge, both parties are flush with
proposals. However, there are no major policy differences
reflecting the general consensus in Spanish society on
economic issues. Indeed, Spain's long run of economic
success means that neither party is recommending a
French-style economic "rupture" with the past. Both parties,
however, will make the case that they are better able to
manage the coming economic turbulence. Who the voters
ultimately trust to run the economy could be significant in
this coming election.

2.
AGUIRRE

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