Paul Krugman on Spain’s Economic Woes: It Doesn’t Matter Where Capital Is Directed, So Long As There Is Spending!

by Sep 22, 2013Liberty & Economy2 comments

Nothing "structural" at all to see here. Move along. Just keep spending...

Paul Krugman writes that officials “all too often” when assessing what to do about a recession “interpret the slump as ‘structural’, something that can be fixed only through painful reforms (which, when unemployment fails to fall, will be dismissed as just not enough) rather than as a shortfall in demand.”

In other words, the problem isn’t that capital has been misdirected such that now the economy needs to restructure by redirecting capital from those areas where malinvestment has occurred back towards sustainable productive ends. It’s just that people aren’t spending enough money.

He takes Spain as an example, arguing that Spain’s problems aren’t “structural”, there just isn’t enough consumer demand; that is, people just aren’t spending enough. And since people aren’t spending, employers have no reason to hire, so unemployment remains a problem. Now, if the central banks would just print more money and push interest rates down, which would incentivize more borrowing and spending.

He concludes that, “given 2 percent inflation or a bit higher, Spain ought to be able to have an unemployment rate around 15 percent, or 10 percent lower than where it is now. That’s a lot of unnecessary unemployment.”

This made me curious about Spain’s inflation, so I Googled it. Turns out, Spains historic inflation looks like this:


And here’s what it looks like this year:


Notice that in fact, Spain’s inflation has been over 2% for several years. 2010: 2.99%; 2011: 2.38%; 2012: 2.87%; 2013 (so far): 2.04%. So where does that leave Krugman’s argument?

Remember that Spain had its own housing bubble. When Krugman says the resulting unemployment isn’t due to “structural” problems in the economy, but lack of demand, he is saying that it doesn’t matter where capital is directed or how money is spent, just so long as people spend. Now, I don’t know much about Spain’s economy, but I took 15 seconds to Google Spain’s housing bubble, found and found this, which linked to this from earlier this year (pictures included, as they’re worth 1,000 words):


Spanish Banks Cut Developers as Zombies Dying: Mortgages

Spain’s zombie developers are finally about to die.

Spanish banks are pulling the plug on thousands of builders kept alive during the past five years even as they built almost nothing, said Mikel Echavarren, chief executive officer of Irea, a Madrid-based consulting firm that has advised on 22 billion euros ($28.5 billion) of refinancing. The banks, forced by the government last year to set aside provisions for the developers, have no incentive to keep funding them.

“Banks have taken the hit, so extend and pretend is over,” said Echavarren. “There’s no motivation to refinance companies that aren’t viable, have no liquidity or possibility of future earnings so we’ll see a tsunami of developer bankruptcies in the next two years.


The final collapse of an industry that accounted for as much as 18 percent of Spain’s growth amid the country’s decade-long real estate boom will add to unemployment, already at a record 26 percent, depress consumer spending needed to turn around the economy and push down the value of residential real estate that’s already dropped more than 30 percent since 2007, said Raj Badiani, an economist at IHS Global Insight in London.

While job losses in the construction industry continued in recent quarters, “they’ve been less severe than expected, given the scale of the real estate slump,” said Badiani. “With banks cutting financial life support to many developers living on borrowed time, we can expect an accelerated downward adjustment in employment levels.” Badiani estimates the jobless rate could climb to more than 27 percent this year and house prices will fall at least 50 percent from the peak by 2015.

Zombie Developers

More than half of the country’s 67,000 developers can be categorized as “zombies,” with liabilities that exceed their assets and only enough income to repay the interest on their loans, according to R.R. de Acuna & Asociados, a real-estate consulting firm….

Spanish lenders, ordered last year to set aside provisions of 84 billion euros to cover anticipated real estate losses, have no incentive to keep unviable builders afloat after they’ve accounted for losses from 280 billion euros of their loans, according to Irea.

Only developers with sufficient rental income from commercial property to repay debt or those still building homes in areas where they can be sold at a profit will survive, said Echavarren, who estimates that between 5 percent and 10 percent of Spanish developers fall into those categories.

Since 2008, more than 19,000 real estate and construction companies, or 14 percent of the total, have gone out of business, according to Iberinform, a unit of credit insurer Credito y Caucion….

Spain built 675,000 homes a year from 1997 to 2006, according to a report by a unit of Spanish savings bank Cajamar. That’s more than France, Germany and the U.K. combined. The frenzy resulted in a surplus of about 2 million empty homes that will take between seven and 13 years to absorb, according to Madrid-based property research firm R.R. de Acuna & Asociados….

“Mortgage lending and demand for homes will never recover to the highs we saw,” said Juan Villen, head of mortgages for, Spain’s largest property website. “A few years ago an influx of immigrants and buoyant employment among Spaniards fuelled home sales, now everyone is leaving Spain and those left are unemployed or scared that they might become so.”

…The ruling PP Party, which took over in December 2011, passed a decree in February 2012 requiring banks to speed up recognition of losses on real estate by boosting provisions set aside for land to 80 percent from 31 percent and for unfinished developments to 65 percent from 27 percent. A second decree in May forced lenders to set aside more money for real estate loans classed as healthy.

Etcetera. But remember, according to Krugman, the problem isn’t that capital was misdirected into areas where it shouldn’t have been, such as by artificially low interest rates or government interference like forcing banks to continue lending for real estate development, presumably in an attempt to reflate the housing bubble, when there had already been fare more homes built during the bubble than there were people interested in living in them!

Nothing “structural” at all to see here. Move along. Just keep spending…

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  1. Miguel

    This shows a stunning ignorance about the Spanish housing bubble, or recent housing bubbles in general.

    What we’ve seen in Spain was a classic speculative mania, fueled by irrational market expectations about the future. Houses were bought as an ‘investment’, at prices far, far higher than their true value, and the banks went along with it. The fault here lies squarely in private hands.

    ‘[…] according to Krugman, the problem isn’t that capital was misdirected into areas where it shouldn’t have been, such as by artificially low interest rates or government interference like forcing banks to continue lending for real estate development […]’

    This government interference did not cause the housing bubble because, among other things, it was created *after* the bubble had popped. Its goal was to stop unemployment from growing much too rapidly; in other words, it was purely palliative. It may seem meaningless from an Austrian optic, but in the real world real people suffer if they get fired… I mean, suffer a ‘capital reallocation’, overnight.

    Again, this bubble was a classic speculative mania, created by the market. Any political spectator will tell you that, if anything, the political climate (conservative) in Spain those manic years tended far towards deregulation, specially building regulations, land use legislation — massively deregulated, destroying the Spanish landscape — and tax breaks. ‘España va bien’. Spain went well, indeed.

    Blaming it on the interest rate is… questionable, to put it mildly. If the interest rate is too low, that means that I, as a banker, make less of a profit out of totally safe loans to the government — that is what the interest rate means. But if I then go and lend money to some doofus who wants to pave over the entire Costa del Sol, and lose money horribly on the deal, it’s *my* fault.

    In other words, it’s not a duty for the government to guarantee me, as a bank, a 4% profit per year. If the Central Bank decides that my guaranteed profit is 2%, and then I go insane and bet all my money on the roulette because I want a 4% profit, then if I fail it’s my fault, not the governments. Do we agree?

    Actually I, like Keynes, support a 0% interest rate, because I find nothing so repugnant, nothing so parasitical, as rich people living off the interest from zero-risk Treasury bills. But that’s just me.

    • Jeremy R. Hammond

      “This shows a stunning ignorance about the Spanish housing bubble, or recent housing bubbles in general.”

      What does, Miguel? What Paul Krugman wrote about it? Or when I wrote, “This made me curious about Spain’s inflation, so I Googled it…. Now, I don’t know much about Spain’s economy, but I took 15 seconds to Google Spain’s housing bubble…”? Or the articles I cited?

      You assert that the housing bubble in Spain was “fueled by irrational market expectations”, “a classic speculative mania, created by the market”, for which “fault … lies squarely in private hands”. You thus deny that the government and central banking had anything at all to do with it. This would suggest to me that you are the one who is stunningly ignorant about the business cycle. The statement that there was no government interference in the market until after the bubble popped reinforces this conclusion. So there was no central banking system exercising an inflationary monetary policy before the bubble popped? Interest rates were not pushed by this (supposedly nonexistent) monetary policy below where they otherwise have been prior to the bursting of the bubble? This is laughable.

      Interest rates are a price. When government engages in price fixing rather than it being determined by the market, it results in distortions in the economy; specifically, it causes the business cycle. Please read this post for what one commenter just called “the best “cliff notes” explanation of the Austrian Theory of the Business Cycle that I have come across”. In it, I briefly explain in simple terms how artificially low interest rates cause bubbles.


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