Business and literacy rates in Spain compared to the United States

Spain

As of late 2010, rumors in the financial community persist that Spain is going to be the next Eurozone nation to suffer an economic crisis. Spain's high unemployment rate, coupled with a lack of economic recovery and being unable to adjust interest rates due to its participation in the euro, has resulted in a rapid appreciation of interest rates in Spanish sovereign debt in recent weeks amid speculation in the bond markets that Spain will be unable to meet its obligations (Krugman, 2010; Krause, 2010). The Spanish economy, it would seem, has been suffering in recent years and that suffering is not expected to end any time soon.

For a company looking to do business in Spain, the current situation is certainly cause for alarm. The economic fundamentals of the country look troubling, and there are significant structural reasons why Spain will not be a good place in which to invest any time soon. However, in order to truly assess the situation, one must move beyond the headlines and get involved in a deeper analysis of the country and its economic circumstances. This paper will do just that. Spain will be analyzed in terms of both the big picture and its current economic situation. The intimation that Spain is overpriced as a place to invest will be addressed in this analysis, as will a number of other concerns. The perspective for this report will be that of an American firm seeking to invest in Spain. Economic, cultural and political elements of Spain and its society will be considered, so that an American firm looking to invest in Spain will be able to gain the full knowledge required in order to make the right decision for its business. At the core of the report will be a PEST analysis, in which four specific components are analyzed. Each will receive both a historical analysis and an interpretation of the present landscape. The four components of the PEST are the political environment, the economic environment, the social environment and the technological environment. Each of these plays an important role in the decision as to whether or not to invest in Spain at present, so each will be given due consideration.

The components of this paper, in order, are going to be the history of Spain, its government, the current climate, its culture, its employment and labor conditions, education, taxes, foreign investment climate, business practices and freedoms and the corruption climate. Lastly, the paper will bring all of this knowledge and insight together to come to a conclusion with respect to investing in Spain.

History

After emerging from Muslim rule in 1492, the Kingdom of Spain immediately became a colonial power with the Columbus expedition. This period saw Spain as one of the world's leading economic powers, a position it occupied for several hundred years through a series of dynasties, culminating the first republic in the late 19th century. Just before the Second World War, Spain's republic fell and the country became a dictatorship under Francisco Franco. After Franco died, the country began a transition to democracy that ushered in the country's modern age. Spain joined the European Union in 1986 and was one of the founding adopters of the euro in 1999, setting the stage for the country's current economic climate.

Today Spain is one of the largest and most important countries in Europe. The country has 46 million people in total. Of these, 74% are the majority Castilian ethnic group, 17% are Catalan, 7% are Galician and 2% are Basque. Among the Castilians are further breakdowns such as Asturian, Aragonese and Andalusian among others, each with distinct regional culture and dialect (CIA World Factbook, 2010).

Government

The current structure of the Spanish government is as a parliamentary monarchy. The royal family of Spain only has nominal control of the country, for the part it is run by elected officials in a parliamentary system. The country is governed by the National Assembly, which consists of a 264 person Senate, of which 208 are elected, and a 350-seat Congress. The structure of the Congress is unusual in that it costs of 248 representatives elected under a proportional representation system and a further 2 members from each of the fifty provinces, plus a single member each from the African enclaves of Ceuta and Melilla. There are a number of different political parties participating in Spanish government, including a number of regional parties representing Basque Country, Catalonia, the Canary Islands and a number of parties representing the Castillian population along different ends of the political spectrum. There are a significant number of socialist/communist parties represented. The head of state is King Juan Carlos I, but the head of government is Jose Zapatero, a member of the Spanish Socialist Workers' Party (CIA World Factbook, 2010).

Despite having a socialist leader, Spain's political climate in recent years has generally been favorable to investment interests. Spanish law remained unchanged following the election of the Socialists in 2004. Foreign investment is permitted up to 100% equity and capital movements are completely liberalized (Dimireva, 2009). As a result, Spain has seen significant capital inflows and indeed this was in part to blame for the country's current economic situation, as these inflows led to a real estate bubble that has since burst.

Current Climate

The bursting of that real estate bubble has led to considerable difficulty in the current Spanish economic climate. Unemployment at present stands at 18.1%, in 2009, up from 11.4% in 2008. Spain has the worst unemployment rate in the EU by far and the second-worst in Europe after Bosnia-Herzegovina. To put Spain's unemployment rate in perspective, it ranks in between Kyrgyzstan and Sudan, two landlocked third-world nations with considerable civil strife (CIA World Factbook, 2010). The Spanish GDP has declined 3.7% in 2009 and appears to have continued to decline this year.

There is intense speculation that the European Union is going to need to bail out the Spanish economy. Such a bailout could cost upwards of $1 trillion, severely depleting Europe's contingency reserves. This is turn could cause a crisis in the euro. Any reduction of the value of the euro would have a twice effect on Spain. On one hand it would make Spanish exports more competitive, but it would also serve to increase the value of Spain's sovereign debt. The overall impact of such a situation is expected to be negative.

At present, Spain is not yet in crisis, but interest rates on its sovereign debt have increased significantly in recent weeks. While this is largely speculative, it has real consequences for the cost of Spanish debt, making such actions a self-fulfilling prophecy of sorts. Spain is currently considered to be the second-riskiest country in Europe after Portugal, so depending on the reaction of major EU powers to the crisis Spain's situation could either stabilize or worsen dramatically over the course of the next couple of weeks (Faiola, 2010).

At the heart of this crisis was Spain's real estate bubble. When the euro was formed, it enabled money from around the continent to flow more freely, and this encouraged investment in what were then marginal economies like Ireland, Portugal and Spain. As early as 2004, there were signs that Spain was experiencing a real estate bubble that was prone to bursting, and the OECD warned of the likelihood of such at the time, with real estate prices growing at 17% at the time. A number of perverse incentives in the economy fueled the real estate boom, but when global credit markets began to dry up the bubble burst. This crippled Spain's GDP and through millions of Spaniards out of work. Whatever measures are undertaken in terms of Spanish government response and European bailout of the situation, there is little in the fundamentals of Spain's economy to indicate that demand will be restored any time soon, so the bleak outlook will continue for the foreseeable future (Knowledge @ Wharton, 2004).

Working in Spain's favor thus far has been its relative reluctance to engage in austerity measures, having passed a small package by only a single vote and taken its time in implementing that (Dowsett, 2010).. Austerity measures, which have been entirely worthless with respect to aiding Ireland's economy or lowering its cost of debt, essentially cripple any hope of economic recovery and cause dramatic civil unrest. If Spain was to implement tougher austerity measures, its economic situation would deteriorate, so it is hoped that the country's current strategy is sufficient to pull the country through the current crisis.

One of the most important considerations of the current crisis is that it is unlikely that any measures can be undertaken to restore the country's economic health in the near-term. In essence, the real estate bubble left Spain with an overpriced economy, characterized by price and wages that were higher than the equilibrium level. This problem persists, so Spain is in general a high-priced country right now, to an uncompetitive level. The primary skill set in the country is in construction, an industry that is dormant. Spain's solvency issues mean that it is not in a good position to provide fiscal stimulus to aid its economy. Worse, it cannot devalue its currency as a means to bring real prices and wages down. Without the devaluation option, and with no hope of either fiscal or monetary stimulus, Spain faces a long and painful period of deflation in order to bring the economy back to equilibrium, and during this process internal devaluation only makes the country's debt problems worse (Krugman, 2010).

Beyond the crisis, Spain's current rate of inflation is -0.3%. While deflation is generally negative in that it increases the cost of debt, it also is required in the Spanish economy to bring prices into equilibrium. The deflationary environment, therefore, is expected to continue, especially with respect to wages and real estate. This implies that any investment in Spain should be delayed, as it will be cheaper in the future than it is today, should the internal disinflation hold.

Employment and Labor Conditions

Spain has the highest unemployment rate in the European Union, and there is little hope that this rate will come down any time soon, a function of being in the Eurozone. However, if any benefit can be seen in this it is that for a company looking to invest in Spain there is an ample supply of workers, and they can be had at relatively low prices. Indeed, lower wages are required to bring Spain's costs back into equilibrium. However, Spain lacks significant breadth of skills in its workforce. The country's workforce just over 23 million people, which means that there are around 4.1 unemployed workers. The labor force is heavily oriented towards the service sector (71.7%). A large portion of the unemployed are laborers without the skills to create their own work -- they risk become structurally unemployed in that they will spend so much time without work that they will be unemployable. Worse, in Spain there are no personal bankruptcy laws, so unemployed workers will be in a negative financial situation even if they find work or can sell some of their assets. The crisis for Spain's laborers is severe (Saunders, 2010).

For a company investing in Spain, the country's labor laws have historically favored the worker, a function of the country's history of socialist governance. Observers have noted that reform of Spanish labor laws is one of the keys to any economic recovery the country might enjoy, as such reform would remove a barrier to investment. Part of the government's plan to spur economic recovery has been to propose labor law reform, but this has met with strong opposition from the country's left-wing parties and its unions (Dowsett, 2010, 2).

Education

Spaniards are largely a well-educated people. The literacy rate is slightly low for a Western nation at 97.9% and the average Spaniard spends 16 years in school which equates to some sort of post-secondary education. The education figures compare with the U.S., but the literacy rate is lower. Spain spends 4.4% of its GDP on education, a relatively low level for the developed world, below U.S. levels but on par with Germany and head of Italy (CIA World Factbook, 2010). For a country considering investment in Spain, the workers are well-educated and given the high unemployment rates, it should not be too difficult to find quality workers.

Taxes

The corporate tax regime in Spain is as follows. For small companies with a profit up to €120,202 the marginal tax rate is 25% and above that amount the marginal tax rate is 30%, a rate that has been reduced over time. There are a number of exemptions available to corporations. Some highlights, from the Confederation Fiscale Europeene, are a research and development deduction of 30%; "fostering technological innovation activities" deduction of 15%; export deduction of 25% on foreign investments; and 10% of company contributions to pension plans (Gola, no date).

Businesses and individuals in Spain are also subject to a consumption tax, the VAT. The VAT rate in Spain has been increased to 18% this past year as part of the country's austerity measures. By contrast the U.S. has no VAT. This increase was made as a revenue generating move for the country and as part of these measures Spain also increased taxes on new real estate sales and processed foods and catering services (Xinhua, 2010).

Foreign Investment

Spain attracts the 7th highest amount of foreign direct investment in the world and even with the recession, this amount increased in 2009. Part of the attractiveness of foreign direct investment in Spain is the stability offered by the Euro, but the downside is that this created a bubble in the real estate sector that has led to the current crisis. Spain's current investment climate is tainted by the euro, as asset prices and wages are generally above equilibrium levels, which should discourage FDI to a certain amount.

That said, Spain's laws with respect to foreign direct investment are liberal. As a member of the European Union, Spain has an open economy and capital inflows are encouraged by government as a means of growing the economy. It is expected that over the coming years, FDI laws will be liberalized further in order to encourage a return of investors to the Spanish economy.

Foreign Exchange

Spain is on the euro, which is one of the contributing factors to its current economic malaise. The euro is the currency for a number of European countries, and its value is ultimately dominated by the financial fortunes of its largest constituents -- Germany, France, Italy and Spain. The euro has fluctuated in the past year largely on the basis of the ongoing European debt crisis. At present, the euro is trading towards the low end of its range, and if Spain requires a bailout the euro will go lower.

A lower euro would make Spain more attractive from a price point-of-view, even if it would ultimately hurt the country by increasing the value of its debt. However, the euro tends to fluctuate more significantly during fits of speculation, so the actual value of the euro is probably between $1.40 and $1.50, unless there are significant structural changes in the way the Eurozone functions.

The different exchange rate would subject the company to transaction and translation risk. One of the benefits of the euro is that transaction risk can easily be hedged by investing in growth not just in Spain but anywhere in the euro zone. Even without an operating hedge, the company can hedge the euro easily as dollar-euro exchange is one of the most liquid in the world and subject to highly liquid futures markets as well. Translation risk cannot be hedged.

Banking System

Spain's banks are largely private, and the country has moderate regulations. Spanish banks were major underwriters of the country's real estate boom. Their health is roughly akin to those of major British banks, which is to say they will survive, but have required substantial bailouts in order to continue functioning as usual. Expect the Spanish banking sector to remain private but be subject to stricter lending controls going forward.

Accounting Standards

European accounting standards are governed by International Financial Reporting Standards (IFRS). There are substantial differences between IFRS and GAAP. In recent years, the two bodies have been working towards convergence, but significant difference remain in a number of areas. An accountant familiar with IFRS will need to work on the financial statements for any subsidiary. In addition, the figures from any Spanish subsidiary will need to be translated back to GAAP for domestic reporting purposes, requiring experienced accountants. Governance is less strict in Europe, however, than it is under Sarbanes-Oxley.

Regulation and Business Freedoms

Aside for the traditionally stringent labor laws, there are few regulations that are worrisome in Spain. The country is an open economy in general. The degree of regulation does differ, however, depending on the sector. It is worth investigating what the specific regulatory environment for the individual industry in question, but in general regulations in Spain are aligned with European standards.

Spain has generally shed all vestiges of its state-run economy from the Franco years. The right-wing Heritage Foundation ranks Spain 36th in the world for economic freedom. The country scores relatively well for business freedom, investment freedom and property rights. However, the country ranks 19th out of 43 European countries on the survey. It takes an average of 47 days to start a business in Spain, compared with a world average of 35 days. It takes less than the world average of 18 procedures to open a business and bankruptcy proceedings are relatively straightforward. All told, Spain ranks between Norway and Slovakia for economic freedom, much lower than the United States (Heritage Foundation, 2010).

Corruption

Non-profit group Transparency International charts corruption in the world's countries. In the 2010 survey, Spain scored 6.1 on the index, a figure that performs poorly in comparison to northern European nations but is above nearly all southern European nations. Spain's score ranks 30th in the world, tied with Israel and in between the UAE and Portugal. This score indicates that Spain does suffer from some corruption issues, but in general the climate is relatively good in terms of corruption in Spain (Transparency International, 2010).

Culture

Spanish culture is similar to what one might expect from Latin or Mediterranean countries. Hofstede's cultural dimensions can explain some of the underlying basis of culture in Spain. Spain has a slightly higher power distance than other European countries, which indicates that the people in Spain are more accepting of differences in class and wealth in society. In the workplace this typically translates to workers being relatively unwilling to take initiative, and more willing to defer to superiors. Managers in Spain are less likely to embrace collaborative tactics, merit hiring and other cooperative elements common in American business culture.

Spain scores relatively low on the individualism dimension. The Spanish view that collective action is more important than individual action. They are more likely to seek consensus on matters, and they are less likely to take initiative. Some examples of how this impacts Spain would be the high rate of unionism and the proclivity for socialist government.

Spain has a moderate score for masculinity. The idea beyond this dimension that that masculinity in a culture rewards aggressiveness and competition. Spain scores lower on that dimension that most European countries, and therefore leans more towards caring values and nurturing rather than competition. It should be noted that this concept does not refer to machismo.

The last dimension is uncertainty avoidance. Spaniards score very high on this dimension, meaning that they hate uncertainty. Spaniards are uncomfortable with situations that are unstructured and therefore they prefer that terms of negotiations be negotiated ahead of time, that there are no surprises. They are also less likely to respond well to significant changes in the external environment (Hofstede, 2009).