IB Economics- Macroeconomics Commentary

IB Economics – Internal assessment summary portfolio cover sheet School code 002223

Name of school The Sultan’s School

Candidate number 0028

Candidate name Momina Amjad

Candidate name

Momina Amjad

Candidate number

002223-0028

Teacher

Paul Bird

Title of the article

Spain unemployment hits record high on recession fears

Source of article

Huffington Post Business

Date the article was published

25th April 2013

Date the commentary was written

14th December 2013

Word count (750 words maximum)

747

Section of the syllabus Please tick the one that is most relevant

 Section 1: Microeconomics  Section 2: Macroeconomics  Section 3: International economics  Section 4: Development economics

http://www.huffingtonpost.com/2013/04/25/spain-unemployment-hits-record-high_n_3153508.html Date Accessed: 14th Dec 2013

Spain Unemployment Hits Record High On Recession Fears Reuters | By Paul Day Posted: 04/25/2013 7:50 am EDT | Updated: 04/26/2013 10:12 am EDT

* Unemployment hits 27.2 percent in Q1 * Worse than expected figure highlights market decoupling * Reforms aimed at boosting economy due on Friday

Jobseekers stand in line outside an employment office before opening in Madrid, Spain, on Wednesday, April 3, 2013. Spain's government is waiting for the result of negotiations with the European Union on its budget deficit goals before deciding on its tax policy for 2014. Photographer: Angel Navarrete/Bloomberg via Getty Images

MADRID, April 24 (Reuters) - More than six million Spaniards were out of work in the first quarter of this year, raising the jobless rate in the euro zone's fourth biggest economy to 27.2 percent, the highest since records began in the 1970s. The huge sums poured into the global financial system by major central banks have eased bond market pressure on Spain, but the cuts Madrid has made in spending to regain investors' confidence have left it deep in recession. Unemployment - 6.2 million in the first quarter - has been rising for seven quarters and the latest numbers will fuel a growing debate on whether to ease off on the budget austerity which has dominated Europe's response to the debt crisis. "These figures are worse than expected and highlight the serious situation of the Spanish economy as well as the shocking decoupling between the real and the financial economy," strategist at Citi in Madrid Jose Luis Martinez said.

http://www.huffingtonpost.com/2013/04/25/spain-unemployment-hits-record-high_n_3153508.html Date Accessed: 14th Dec 2013

The collapse of a property boom driven by cheap credit has seen millions in the construction sector laid off since 2009 and private service sector, worth almost half gross domestic product, has followed as Spaniards tightened purse strings and investment plummeted. The malaise has been made worse by billions of euros in state spending cuts and tax hikes to reduce one of the euro zone's highest deficits and convince nervous markets Spain can control its finances. Spain and Italy's costs of borrowing hit their lowest in more than two years this week and EU officials have begun to talk openly of easing up on deficit targets. Prime Minister Mariano Rajoy said earlier this week that a new reform plan, to be announced on Friday, would not include more austerity measures in an effort to calm increasingly desperate Spaniards and reassure investors the country will soon be able to grow. Protests have become commonplace across the country and thousands of police have been drafted in to Madrid to handle a march on Parliament on Thursday. But few believe the government's plans will be ambitious enough to restart the ailing economy and create jobs. The International Monetary Fund sees Spanish unemployment at 26.5 percent next year.

Macroeconomics IA

Candidate Number: 002223-0028

The article is about rising Spanish unemployment which hit a record high of 27.2% or 6.2 million people in the first quarter of 2013. This means 27.2% of Spanish people of working age are looking for work yet they cannot find it. This carries many social and economic costs; society suffers from increased poverty, homelessness and higher rates of crime, and economically, Spain is at a point within its production possibility curve due to loss of output. It is important to consider the source of Spain’s unemployment to suggest any possible solutions for it. According to the article, there is a growing debate about “budget austerity” which was the EU’s response to the 2008 financial crisis. Austerity measures involve spending cuts and tax increases; i.e. a contractionary fiscal policy aimed at reducing aggregate demand (AD). It is evident that one of the chief causes of Spanish unemployment is decreased demand; leading to demand-deficient or cyclical unemployment. Tax increases cause consumers to spend less on goods and services, triggering the firms to cut production and thus require less workers. Furthermore, there might be reduced investment due to higher corporate taxes resulting in further fall in the demand of labor. The diagram below illustrates demand-deficient unemployment: Spanish labor market

Average real wage rate

AS

We

a

b c

W1

ADL1 0

Q1

Qe

ADL

Number of workers

Here, aggregate demand has fallen from ADL to ADL1. The previous equilibrium b shifts to the new equilibrium c. This should mean that the real wage should fall from We to W1, but in reality that doesn’t happen. Average real wages in Spain and elsewhere are “sticky downwards”- real wage may increase after some time but it’s very unlikely that it will decrease because firms don’t want to demotivate workers. Moreover, there is significant trade union power in Spain1 that tries to ensure that real wage doesn’t drop. So the end result is that unemployment a-b is created. Since wages don’t drop, firms employ less people and workers are laid off.

1

Köhler, Holm-Detlev and José Pablo Calleja Jiménez. Trade Unions in Spain: Organization, Environment, Challenges. 2013. 17. E-book.

1

Macroeconomics IA

Candidate Number: 002223-0028

Spain also suffers from other types of unemployment. The article mentions “millions in the construction sector laid off since 2009” due to the collapse of the property boom. This signifies structural unemployment in Spain; there is a permanent fall in the demand for construction workers. This becomes problematic when workers don’t have skills to do the jobs that are required in the economy and lack occupational mobility. Prolonged demand-deficient unemployment, as is the case in Spain, also leads to structural unemployment. Often new forms of labor are required when the economy picks up for the changing economic climate. Although not stated in the article, Spain also suffers from significant seasonal unemployment due to its tourism sector being most active during the summer, after which many young people become unemployed2. The solutions to Spain’s unemployment are diverse and complex due to there being various unemployment types. Demand-deficient unemployment can be solved by increasing aggregate demand via expansionary fiscal and monetary policies. Lower taxes and lower interest rates would urge consumers to spend more and save less, thereby increasing consumption; it would also promote investment, both increasing the aggregate demand level. However, this demand side policy is only a short term solution and is not necessarily guaranteed to work due to low consumer or business confidence in a difficult economic climate. Structural and seasonal unemployment require reshaping of the entire labor market, which is much harder to achieve. This is a long term supply-side solution wherein the LRAS curve shifts to the right or the production possibility curve moves outwards. This involves training the workforce to be more occupationally flexible so that workers can change jobs easily. Apprenticeship programs that train the youth to adapt to changing economic conditions are required. Retraining programs for adults that reskill them in jobs other than construction are also important because it decreases Spain’s dependence on the construction sector. The government can also subsidize firms that provide training for their workers. However, all of these policies have a high opportunity cost- Spain has to forego spending in other areas to be able to afford these strategies, and they are only effective in the long run. The public may get impatient if it doesn’t see rapid results. In conclusion, Spain suffers from demand-deficient, structural and seasonal unemployment and their solutions lie in expansionary fiscal and monetary policies and supply-side policies respectively. Although the solutions might initiate new issues, if Spain does not tackle its unemployment problem in time, there will be political unrest- as the growing protests in the article indicate- which will become very problematic for Spain. Word Count: 747 2

Burgen, Stephen. "Spain youth unemployment reaches record 56.1%." the Guardian, 2013. Web. 14 Dec 2013. http://www.theguardian.com/business/2013/aug/30/spain-youth-unemployment-record-high

2

Bibliography Burgen, Stephen. "Spain youth unemployment reaches record 56.1%." the Guardian, 2013. Web. 14 Dec 2013. http://www.theguardian.com/business/2013/aug/30/spain-youthunemployment-record-high Köhler, Holm-Detlev and José Pablo Calleja Jiménez. Trade Unions in Spain: Organization, Environment, Challenges. 2013. 17. E-book.