Cablegate: Economists Offer Mixed Outlook On Gos Economic

This record is a partial extract of the original cable. The full text of the original cable is not available.



E.O. 12958: N/A

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.

--------------------------------------------- -
Solbes and the Economic Team v. the Government
--------------------------------------------- -

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.

Center-Regional Budget Issues

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.


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.

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.

Spain Still Good for U.S. Business

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.


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.

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