Spain’s economy is finally pulling out of its recession, with growth accelerating from a standstill to a snail’s pace. This is a good sign for a country that has been in recession for nearly two years.
But the official estimates of tepid growth in the formal economy are missing the bigger picture. A new report from the Spanish Inland Revenue Department shows the informal economy is actually thriving. According to the report, Spain’s informal sector now accounts for nearly one-quarter of the entire economy and has grown by almost 7 percent since 2008, compared to a 15 percent drop in gross domestic product during that same period.
This is good news and bad news. The good news is that the economy is likely growing more than people realize (or, maybe, are willing to admit). The bad news is that much of this growth is off the books, a victim of Spain’s poor business climate and onerous welfare state requirements. According to The Guardian, some factors leading to informality include
the punitive social security regime imposed on the self-employed and the lengthy and labyrinthine process of establishing a legal enterprise, both of which discourage entrepreneurship and boost the cash-in-hand economy.
Labor policies also haven’t helped. In 2013, the minimum wage in Spain rose by 0.6 percent despite the Bank of Spain’s request that minimum-wage increases in selected cases be delayed in order to encourage hiring. Although significant steps have been taken since 2012 to liberalize the labor market, more needs to be done to allow small business to hire and fire people in the formal marketplace.
High taxes may also be a root cause as businesses seek shelter in the informal economy to avoid the burdensome tax rates in the formal one. In pursuing an “austerity” program to stimulate growth, the Mariano Rajoy government chose the wrong weapon—tax increases—instead of deep cuts in government spending. These higher taxes have strangled growth. According to Heritage research, countries that raise taxes during a fiscal crisis tend to have slower growth than countries that just cut spending.
All these problems are reflected in Spain’s score in the Index of Economic Freedom, co-published each year by The Heritage Foundation and The Wall Street Journal. Spain’s score in the Index has declined about two points since 2008, in part because of declining business freedom in recent years and deteriorating fiscal freedom.
Although the Rajoy government is to be praised for taking some good steps, the Spanish economy remains in a vulnerable situation and risks becoming less dynamic if more robust economic freedom reform measures are not fully implemented and decisively followed through.
Spanish entrepreneurs, both formal and informal, are helping the economy grow despite the efforts of the government. If Spain’s leaders want to create better incentives for growth, they should remove barriers (such as business licensing requirements and above-market minimum wages) that can make entrepreneurial activities illegal. Only then will they reap the benefits of the economic growth now occurring only in the shadows.