How will Spain fare in a European Union of 25 member states?

• Pages: 206-207

Page 206

Spain has been growing faster than the rest of the EU since the mid- 1990s (see chart). As a result, there has been a significant catching-up in living standards. Spain's per capita income exceeded 85 percent of the EU average in 2002-an increase of roughly 10 percentage points compared to a decade ago-and increased further in 2003. Robust growth has been spurred by prudent macroeconomic policies, with large fiscal deficits in the early 1990s giving way to balanced budgets. And as a founding member of the EU's Economic and Monetary Union, Spain enjoyed a decline in real interest rates, which facilitated private investment. Expenditure control allowed the government to reduce taxes, and reforms in the labor and product markets led to more jobs. Domestic demand was also buoyed by investment in public infrastructure and booming construction. In short, Spain has thrived since joining the EU. But will it continue to do so in the enlarged EU?

EU enlargement will certainly test Spain's ability to preserve the gains of the past two decades. Not only are wages sharply lower in the new member states (EU-10), but workers there are also highly skilled. This has helped the EU-10 capture growing market share in the old member states (EU-15). The EU-10 have also become magnets for foreign direct investment (FDI) from the EU-15: flows have almost doubled in the past five years and have, on average, exceeded investment in Spain by significant margins. Moreover, Spain's real effective exchange rate has appreciated steadily over the past years-in part reflecting the strengthening of the euro against the dollar. Some of the appreciation could be the natural by-product of strong growth, but weak productivity growth suggests otherwise. Also, export profit margins have come under pressure following strong increases in unit labor costs. The economy's ability to cope with a global environment that promises intensified competition will depend on arresting these trends.

The opportunities and challenges Spain faces in the new EU are influenced by fundamental factors that underlie the patterns of trade and investment flows, including geography (physical distance to markets, access to seaports, and a common border) and cultural ties. Accounting for these factors is essential when trying to examine the economic impact of...