Economic Implications Of The Spanish Elections

As expected, the center-right PP won most votes in Sunday’s Spanish elections and the center-left PSOE came in second (see figure 1). The election result translates into 136 seats for the PP (up from 89) and 122 seats for the PSOE (up from 120), out of a total of 350. Importantly, while the PP won the most seats, it is far from having a majority. It would also fail to achieve an absolute majority if it joined forces with the ultra-right Vox party which finished third with 33 seats, 19 less than in 2019.

To be precise, PP and Vox together are 7 seats short of an absolute majority. While this doesn’t sound like a lot, it will be a nearly impossible task to obtain the support of 7 opposition deputies needed to govern. The PP and especially Vox are hostile towards regional parties aiming for both more financing and autonomy for their respective regions. In fact, Vox wishes to get rid of the system of regional autonomies altogether.

Note that in the first investiture vote, a government would need to be voted in with an absolute majority, which is certainly out of the question. In the second investiture vote, a simple majority would suffice, which could be obtained if 13 opposition deputies abstained. Yet again, based on the division of seats, even the latter seems impossible at the current juncture.

Not surprisingly, PM Pedro Sánchez of the center-left PSOE also claimed a victory. Both because there seems to be no chance of a right-wing government and because the PSOE managed to slightly increase its number of seats. That said, a repetition of a left-wing coalition government with the silent support of regional parties is far from certain either, due to the electoral decline of parties that have supported or at least condoned the current legislature.

After the 2019 elections, Sánchez won the second investiture vote (with the Basque PNV voting in favor, Basque EH Bildu and Catalan ERC abstaining and Carles Puigdemont’s Catalan Junts voting against). This time he would need the outright support of three out of four of the regional parties, with the fourth abstaining rather than voting against him. Both Junts and ERC have already made clear that their support won’t come free. At the same time, however, a failure to install a left-wing government that has in fact been rather friendly and accommodative toward the regions would very likely lead to new elections, which could then go either way: they could lead to more support for either left or right, with the regional parties clearly being worse off if things shift to the right. So the stakes are high both for Sánchez and the regional parties.

We can expect weeks if not months of negotiations and hence a lame-duck government for the time being. Whereas the new parliament must be installed before 17 August, there is no time limit set for the negotiations and the first investiture vote. The King will most likely let the PP’s Feijóo try first to cobble together sufficient support. If he fails, Sánchez will be allowed to try. If both fail, new elections will have to be called within two months after the first investiture vote.

Policy Inertia Amid Major Challenges

If the formation proves to be lengthy, we expect a lame-duck government with few policy changes. The short-term economic impact of such a scenario is likely small and should not be overstated. After two buoyant years economic growth is already likely to slow going forward as the post-pandemic recovery boost fades and higher interest rates start to bite. That said, looking beyond the short term, policy inertia could in fact prove damaging as there are some major challenges to be dealt with. Without being complete, three major challenges are worth mentioning.

The first is heat and droughts whose victims include: farmers who must ration water and limit irrigations to the detriment of crops; households who must deal with scarce water supplies to their home; biodiversity.

The second is very high structural and youth unemployment (around 10% and 28%, respectively - see figure 2). This can at least partly be traced back to a sizeable mismatch in the labor market with respect to skills and knowledge. Vocational training is often cited as a weak spot. Successive governments have recognized this major challenge, but ongoing attention and, more importantly, action are required to address it. This will become increasingly important as Spain's population ages, with the decline in working-age population expected to begin this year, according to UN data.

The third challenge worth mentioning is Spain’s large budget deficit and debt, as already described in a note last week. Obviously, some of this can be traced back to the pandemic and energy crisis, and some of it will be resolved 'automatically' as time passes. Nonetheless, with interest rates having risen, economic and revenue growth slowing, and European budget rules resuming next year, discretionary policy is required to avoid more painful measures in the future.

The impact of a lengthy formation may also be felt in Europe, as Spain holds the EU presidency until the end of this year. Spain's politicians may be forced to devote more time to domestic rather than EU policy issues, potentially slowing and frustrating current negotiations on European budget rules.

In a piece published last week we zoomed in on the implications of a right-wing government. Importantly, we argued that it would have little impact on the economic outlook in the short term, and the same holds for a renewal of a left-wing pact. The economy is projected to grow by around 2% per year in the coming years.

Right-wing government

However, a PP-Vox coalition would lead to a different society than a PSOE-led society, with implications for the future further ahead. The former would imply a more conservative family policy, less fiscal progressivity and lower social spending. The PP would prefer to not drastically cut public services, however, and to continue the dialogue with social partners and businesses on setting an adequate minimum wage and keep a sharp eye on debt sustainability. Regarding climate policies, energy security – including the use of nuclear – would probably be prioritized over emission reduction, fighting climate change and the environment.

Left-wing government

In contrast a left-wing coalition including the PSOE and Sumar would likely put the fight against climate change and the energy transition at the center of policymaking. It would also continue with strict water policies in dry areas, limiting water use by farmers for irrigation. Its economic policy would likely also be largely a continuation of current policy, with a strong emphasis on the vulnerable, public services and low-income households. Both have promised to revalue pensions in line with inflation, whatever the costs, to raise minimum wages, and to offer financial help to students. The government will then likely try to cover the costs by raising taxes on the wealthy and high-income households and large companies. For example, it could make the temporary tax on large wealth introduced this year permanent and try to raise the effective tax rate paid by companies. In general, it seems that a left-wing government would be less business-friendly than a right-wing government. Quite how unfriendly will largely depend on whether the PSOE can follow its own ideology or will have to adhere to that of Sumar who clearly is less concerned about creating a business-friendly climate.

Finally, even though the PSOE mentions the public debt challenges Spain faces in passing, a left-wing government that must court both regional independentist governments and the far-left will have a difficult time tightening the belt. And as mentioned, a more restrictive fiscal policy will be necessary to both fulfil European budget rules that will be reinstated next year and prevent the debt ratio from rising in the second half of this decade.