Spain Economy and the Situation in the United States - Essay Example

Spain Economy Introduction The regime of General Franco left an essentially fascist economy to Spain which is characterized by lack of economic freedom. The economy is dominated by large public institutions controlling all sectors and monopoly was prevalent. However, the accession of the country in the European Union during 1986 necessitated Spain to "open its economy, modernize its industrial base, improve infrastructure, and revise economic legislation to conform to EU guidelines." These huge developments in the country's policies and structure irrefutable introduced changes in its economy. The immediate years following the country's ascent to the EU marked Spain's economic boom. It should be noted that from 1986-1990, Spain saw substantial mount in Gross Domestic Product (GDP), reduced the ratio of public debt to GDP, decreased unemployment from 23% to 10%, and curb inflation to under 3%. By the end of 1990, GDP reached more than 50 trillion pesetas while the annual per capita income amounted to 1.1 million pesetas (Zaldivar, et al 1992). However, this economic boom was followed by a recession in the mid-1992 to 1994 which was the most severe economic depression since the international oil crisis. Spain faced huge challenges which greatly affected its financial system and international relations. The first part of the paper will determine the factors which prompted the devaluation of the peseta in 1994 as well as its economic implications. The second part will review the effects of the lower trade barriers brought about by the country's integration with other nations in EU. The Depreciation of Peseta-Origin and Consequences The figure below shows the US dollar-peseta exchange rate from 1990 to 2004. What is very notable in the graph is the plunging of exchange rate in the early 1990s, reaching a minimum in 1992.1 The dollar-peseta exchange rate plummeted at 0.77 implying a depreciation of 3.75. Source: Euromonitor PLC, 2006 The depreciation of Spain's currency in early 1990s is only a repercussion of the collapse of the fixed exchange rate regime across the members of European Union also known as the Exchange Rate Mechanism (ERM). Members of the ERM which were also adversely affected by the ERM crisis were Belgium, Denmark, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain and United Kingdom. The ERM is essentially a managed float exchange rate regime where the currencies of the participating countries are allowed to float at a specific band. Most of the currencies of participating countries are allowed with a fluctuation band of 2.25% against a central rate while the Portuguese escudo and the Spanish peseta were allowed a broader band of 6%. Constant intervention of the participating countries' central banks became prevalent to control exchange rate. As the German mark is the most stable currency of the group, it became the yardstick or the central rate with which all the other currencies are measured. The mark has become the unofficial reserve currency, meaning that if Spain was intervening to buy pesetas it would be selling marks in exchange for pesetas (Weerapana, 2004). The reunification of East and West Germany commenced the collapse of the ERM in 1992. It is important to note that the reunification necessitated the transfers of huge amounts from the large rich economy of the West Germany to the smaller, poorer East. These huge transfers which accounts for 50% of the West Germany's savings created a budget deficit which reached 13.2% from the original 5%. As the German government is becoming nervous on the prospects of high inflation, it started pursuing contractionary monetary policy. However, the combination of the expansionary fiscal policy (transfers to East Germany) and contractionary monetary policy yield to a surge in German interest rate (Weerapana, 2004). As inflation raged through Germany, the world interest also rose. Due to these, there was an outflow of money from European countries thereby causing the devaluation of ERM currencies like peseta. The dramatic depreciation of peseta in the mid-1992 left huge impacts in the Spanish economy. The Gross Domestic Product (GDP) in 1993 declined which triggered a drop in inflation. The country's inflation dropped to a 4.57 low registering a 23% fall relative to the 2002 level. The depreciation of peseta affected the external and trade relations of Spain among other economies, specifically in servicing its external debt and exchange of goods and services. The plunge in the value of peseta led into the ballooning of its interest obligation to its foreign creditors. This was reflected in the 50% increase in budget deficit during 1993, wherewith a significant portion of the budget was allocated to service a larger interest payable. The country's foreign debt posted double-digit growth in 1992 worsening in 1993 where budget deficit doubled to 57, 005 million. The depreciation of peseta also meant that its goods became more attractively and competitively priced in the foreign market, as generally the price of its exported commodities fall. Conversely, this will be detrimental for Spanish importers because more pesetas are needed to acquire foreign goods and services. This has been true in the case of Spain. The first three quarters of 1992 registered net imports to support the projected robust demand from the domestic economy. However, as the peseta depreciated in the mid-1992, there has been a fall in the level of exports and a consequent drop in the gross foreign exchange reserve. The depreciation of peseta also affected the confidence of investors in the economy. While all the components of the GDP expanded in 1992, the level of private investment declined by 3.36% with foreign investment accounting for the bulk of it. Trade Liberalization As discussed above, Spain's accession to the European Union necessitated the opening up of the economy and a more vibrant relationship with other nations. Spain is regarded as one of the most closed economy in the 1980s. Among the 21 countries in the OECD, Spain ranked 17th. However, it is currently considered 8th most open economies among OECD nations. With its accession to the World Trade Organization, the economy is further liberated in terms of trade policies and practices (Deutsch Bank Research, 2005). This section will specifically look at the effects of the establishment of a Single European Market in 1993. The single market is created through the pursuit of the European Union in establishing harmonized standards geared at reaping economic benefits such as the creation of larger, more efficient markets. This was realized by imposing internal policies such as the free trade of goods among member states, establishment of EU competition law which regulates the anti-competitive activities of companies and member states, the Schengen treaty, freedom for citizens to work within EU, free movement of capital within member states, and harmonization of government laws among others. External policies include common external tariff and a common position in international trade negotiations (European Union, 2006). Source: Euromonitor PLC, 2006 The figure above describes the inflow and outflow of merchandise out of Spain from 1990 to 2004 in million. It can be seen that there is a minimal level of merchandise export and imports prior to the membership of Spain in the European Union. There was a notable trough in 1993 where both imports downslide. It should be noted that this is brought about by the huge depreciation of peseta which was discussed above. However, it is worth mentioning that there has been a vibrant trading activity following the Single European Market in 1993. Exports ballooned by 153% reaching 215873 million in 2004 from the 85300 in 1992. Imports on the other hand, expanded at a relatively slower rate of 140.23% during the same period considered (Euromonitor PLC, 2006). Though the Single Market allows for the movement of services across geographical borders, merchandise exports still account for the bulk of trading activities. It is also worth mentioning that the single European market promoted employment, boost investors' confidence, attracted foreign direct investments, and significantly improved the economy of Spain. Conclusion The above discussion clearly illustrates the interdependence of macroeconomic variables. Each of the changes in one area has a corresponding repercussion. The first section of the paper showed how the German mark led to the depreciation of the peseta which in turn spurred the growth in exports and discouraged imports, lowered private investment and created discrepancy in government budgets. Meanwhile, changes in trade policies, specifically lowering trade restrictions facilitate a freer movement of merchandise among Spain and its trading partners, while promoting efficiency in the economy. The situation in the United States in very much different by the economic state of the European Union. Europe is currently considered as the largest economy at the moment while the United States is recognized the largest and one of the most technologically advanced nations. The most striking difference of the two is that US is a more integrated economy with a single law embraced by all states and single economic policy. The European Union on the other hand, is comprised of other countries, which pursues different initiatives patterned after the EU law. As opposed to the United States, EU does not have a single central bank and central government. Though there are also differences in wages in United States, it should be noted that there is a huge income inequality in the European Union among member states. References Deutsch Bank Research. (2005). Opening Economies Succeed. Retrieved 19 March 2006, from http://www.dbresearch.com/PROD/DBR_INTERNET_EN- PROD/PROD0000000000189232.pdf Economy of Europe. Retrieved 19 March 2006, from http://en.wikipedia.org/wiki/Economy_of_Europe#Economic_sectors Economy of US. Retrieved 19 March 2006, from http://en.wikipedia.org/wiki/Economy_of_US#A_mixed_economy:_The_role_of_the_ma rket Organization for Economic Co-operation and Development. (1993). Spain-Developments In Individual OECD Countries. Retrieved 19 March 2006, from http://www.findarticles.com/p/articles/mi_m4456/is_n53/ai_14334863 Weerapana, Akila. (2004). The ERM Crisis of 1992. Retrieved 20 March 2006, from http://www.wellesley.edu/Economics/weerapana/econ213/econ213pdf/lect213-15.pdf World Trade Organization Database, www.wto.org Zaldivar, Carlos Alonzo, et al. (1992). Spain Beyond Myths. Retrieved 15 March 2006, from http://www.sispain.org/english/economy/ecointro.html Read More