Research Dept. News
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Monthly Report, num 357 - May 2012
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International review
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IMF forecasts
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IMF forecasts: a slowdown with light at the end of the tunnel
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The IMF predicts global growth of 3.5% for 2012 and 4.1% for 2013 although there is still a risk of actual growth being lower.
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In its World Economic Outlook in April, the International Monetary Fund (IMF) predicts a slowdown in 2012 that should be followed by a weak recovery in 2013. The good performance of the US economy and the implementation of urgent policies in the euro area have lowered the risk of a sudden relapse and mean that the slowdown will be less than had been expected in January. But the recovery is still fragile. While activity is expected to remain solid in emerging economies, the lack of demand in advanced economies means that policies have to be calibrated while taking into account the fact that growth also needs to be boosted.
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The fragile nature of the growth means that policies are still required to boost demand.
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World growth in 2012 slows down to 3.5%, a little above January's forecasts, while an improvement in growth is expected for 2013 of 4.1%. The recovery is uneven. According to the Fund, advanced economies will grow by 1.4% in 2012 and will regain some of their vitality in 2013 with an advance of 2.0%. For their part, emerging economies will grow in 2012 and 2013 by 5.7% and 6.0%, respectively.
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According to the IMF, the euro area crisis will have a considerable effect on the rest of Europe but, as long as it doesn't get any worse, its effect on activity in the rest of the economies will not be huge. The Fund believes that fiscal and monetary policies to boost demand such as the three-year refinancing operations carried out by the European Central Bank and the extension of tax exemptions to salaries and unemployment insurance in the United States have helped to reduce the risk of relapse. Similarly, many advanced economies have made progress in designing and implementing medium-term fiscal consolidation programmes.
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There are still risks of growth being less than predicted. The main risk is of the euro area crisis escalating. Secondly, geopolitical tensions might push up oil prices. Thirdly, the size of the public debt in countries such as the United States and Japan could increase tensions in the bond markets. Regarding the policies to be followed, the Fund estimates that, given the weakness of growth in advanced economies, those countries with some leeway should reconsider the pace of fiscal consolidation, leaving room for policies to boost demand. Similarly, it should be noted that the fiscal consolidation plans in the United States and Japan need to be defined in more detail.
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United States
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The United States: a recovery that has yet to become vigorous
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The standstill in income augurs moderation in the expansion.
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The US economy is enjoying a notably better start to 2012 than had been expected two months ago. At the time of writing this report, the Department of Trade announced that growth in gross domestic product (GDP) for the first quarter of 2012 was 0.5% quarter-on-quarter and 2.1% year-on-year, remaining as strong as it was at the end of 2011. However, although the recovery is solid, it is more modest than these figures might suggest. The private sector has yet to take over from expansionary policies, and growth for the whole of 2012 should not go much beyond 2.0%, while the euro area crisis and oil prices are still factors of uncertainty.
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The reason for this moderate growth can be found in the components that have contributed most to the latest advances: the increase in stock and private consumption. While inventories are variable by nature, the rise in private consumption, a component that accounts for 71.0% of the whole economy, should lose steam and gradually return to growth in the range of 1.5-2.0%.
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This is because the purchasing power of households' disposable income has been at a standstill since January 2011, falling by 0.2% year-on-year in February. The recovery of the labour market in 2012 is also unlikely to lead to any rise in wages that could alleviate this situation and, without an increase in income, the growth in private consumption is not sustainable. Consumption is therefore remaining firm thanks to a lower savings rate that, in February, stood at 3.7% of disposable income, the lowest since August 2009, a rate which should rise over the coming months, obeying the need to reduce household debt. Consumption should therefore fall back towards more moderate growth that would nonetheless be supported by improvements in assets, either via rising stock market values or due to the relatively favourable evolution of the deleveraging process, with household debt that ended 2011 at 112.7% of disposable income, a drop of 17.3 percentage points with regard to the peak in 2009.
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The upswing in consumption is partly due to temporary factors.
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The latest consumer spending indicators also point towards this pattern of vigorous growth with a tendency to moderate. Retail sales, without cars or petrol, rose by 5.7% year-on-year, with a first quarter posting a rise of 1.2% quarter-on-quarter in real terms, in line with the robust performance by the national accounts. However, a significant part of this improvement was due to a particularly benign winter, which may be offset slightly over the coming months. The Conference Board Consumer Confidence index is also pointing in the same direction, falling slightly in March to the level of 70.2 points, calling a halt in its rise when it is still clearly below its historical average.
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Within a more upward context, business sentiment is in line with higher growth, in the order of 3% and, in 2012, production capital investment should remain as strong as last year, although the trend in March was uneven. The activity index of the Institute for Supply Management (ISM) for manufacturers provided the positive note, rising to 53.4 points. However, the services index, which accounts for 86.2% of jobs and two thirds of private consumption, was more negative with a drop from 57.3 to 56.0 points.
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Entrepreneurs are still more optimistic than consumers.
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The labour market provides a reliable image of the state of the recovery. There are improvements but these are slow and not enough. Job creation continues to advance, with the addition of 120,000 net jobs in March, a relatively modest figure that may have been affected by the excessive rises seen in January and February. The unemployment rate fell again in March, standing at 8.2%, one tenth of a percentage point below the figure for February. A large part of this decrease is due to a reduction in the labour force as the number of discouraged workers increases. Nevertheless, the improvement in the labour market is real, as the number of underemployed people, those working part-time involuntarily, fell from 9.1 to 7.6 million between September 2011 and March 2012 and the hours worked per week are close to their historical average.
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Unemployment falls to 8.2% but improvements in the labour market are too slow.
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The problem is that this improvement is slow. In two years, the United States has recovered 40.7% of the jobs lost during the crisis so that, should this current rate continue, three years would be needed for the counter to get back to zero. This slowness has two undesirable consequences. Firstly, it delays the recovery in wages, which usually arrives after contracts and hours worked have increased. Without a recovery in wages, incomes cannot rise and culminate in the private sector taking over from public stimuli. Secondly, a context-related problem of poor demand runs the risk of becoming structural, given the high proportion of long-term unemployed, which are the most difficult to relocate.
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The CPI rises by 2.7% and core inflation by 2.3% but the trend in 2012 is still one of moderation.
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Given this situation, the Federal Reserve has remained cautious. The main scenario is that the current monetary policy will be kept up, with minimal interest rates. But we mustn't rule out the possibility of further quantitative expansions should the labour market show signs of weakening. On the plus side, inflation is still moderate and, at the current levels, allows the Fed room to manoeuvre. March's consumer price index (CPI) rose by 2.7% year-on-year (2.9% in February) and, if oil prices remain at their current level, it should continue to moderate, coming close to 2.2% by the end of year. For its part, the core CPI, which excludes energy and food prices, rose by 2.3% year-on-year (2.2% in February), momentarily delaying the expected moderation in prices.
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House prices continue to nearly touch bottom but there won't be a recovery until the end of 2013.
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The recovery in the housing market is also taking its time, affected by the persistent surplus supply, which could continue until well into 2013. Prices are still falling, albeit less and less. In January, the Case-Shiller index for second-hand housing had accumulated a drop of 7.5% compared with June 2010, when it started its downward slide again. With regard to activity, reasonable prices compared with the average household income and mortgage foreclosures due to default are leading to spikes in prices that are nonetheless irregular. Construction is more indicative of a general trend and fell slightly in March, with 654,000 new homes started, in annual terms, perpetuating a level that is very far from the average of 1.5 million during the period of 1995-2000, prior to the bubble. The fact is that 12 million households whose mortgage debt is higher than the value of their home are a heavy burden. Given the insufficiency of the government scheme to modify mortgages, which attempted to extend repayment periods and reduce or delay interest payments, the Federal Housing Finance Board plans to extend this with effective reductions in the mortgage debt still outstanding for these homes. A change that is supported by the IMF, in its World Economic Outlook in April.
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The trade deficit falls temporarily due to the drop in Chinese imports.
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No significant contributions to growth are expected from the foreign sector, given the situation of global demand. However, the trade balance for goods and services in February noticeably improved, falling to 46.03 billion dollars, a drop of 6.5 billion that can be explained almost entirely by the reduction in imports from China, which might be due to stoppages for the Chinese New Year. For their part, exports remained the same as in January, evidence of the little room for improvement in the current situation. Nevertheless, oil prices still pose a threat, no longer for the foreign sector but for the economy as a whole, due to the effect they might have on households' disposable income. What has changed in March is the fact that the risk is now symmetrical, as we cannot rule out Saudi Arabia's increased production pushing down oil prices, which would boost growth in the United States.
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Japan
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Japan: reconstruction against deflation
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Japan expects an expansionary first quarter.
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The Japanese economy expects a relatively robust first quarter in 2012, after having ended 2011 poorly. The growth forecast for the whole of 2012 is 1.7%. The recent initiative by the Bank of Japan to establish an explicit inflation target of 1%, accompanied by a round of quantitative easing totalling 10 trillion yen (2.1% of GDP), could be helping the yen to depreciate (which has lost 6.8% against the dollar since last September) and to strengthen economic recovery.
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At the same time as these expectations of growth, industrial production has also improved over the last few months, in spite of the slight decline in February. The general index is 4.2% below the level of February 2011, prior to the earthquake and tsunami, after having lost a total of 16.2%. The industrial production of consumer goods has posted even better figures, now back at the level of February 2011. Business sentiment is still one of caution, however, with a Tankan index for large manufacturing firms repeating a level below 4.0 points in the first quarter, corresponding to low growth.
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Industrial production picks up and comes close to levels prior to the tsunami.
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But the real task yet to be tackled by the Japanese economy is to put an end to deflation, as consumers have now become accustomed to ever-decreasing prices. However, the global rise in energy prices, exacerbated by attempts to denuclearize the country, are pushing up industrial costs, which are being passed on to consumer prices. February's CPI increased by 0.3% year-on-year, the largest since December 2008. Similarly, the core CPI, the general index without energy or food, posted its second month-on-month rise, reducing its year-on-year rate of decline to 0.5%.
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Prices rise for the first time since 2008, while the trade deficit hits another peak.
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The reconstruction work, higher energy bills and the slowdown in world demand have ensured the continuity of the trade deficit which, in the last 12 months up to March, reached a record high of 4.7 trillion yen. March's 1.2% growth year-on-year in exports contrasts with the 6.3% rise in imports.
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China
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China: a slowdown of little concern
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China moderates its advance with 8.1% growth year-on-year in the first quarter of 2012.
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The GDP of the world's second economy grew by 8.1% year-on-year in the first quarter of the year, less than the 8.9% of the previous quarter and consensus forecasts. The moderation in foreign demand due to the weakness of advanced economies, particularly Europe, is the main reason for this slowdown in China. In particular, exports grew by a very moderate 7.7% year-on-year in current terms in the first quarter of 2012, compared with 14.3% in the last quarter of 2011.
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Nevertheless, our main scenario is still of a soft landing for China. The trajectory of domestic demand will allow it to maintain a high growth rate, with an advance of close to 8% in 2012, although there is the risk this might be lower. A greater slowdown than expected in Europe (the destination of 21% of the goods exported) would have a significant impact on the country's rate of growth.
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The rise in industrial production and retail sales in the month of March reinforces our scenario of a soft landing. Industrial production grew by 11.9% in March, higher than the 11.4% of the first two months. Retail sales were up 15.2% year-on-year in current terms, also higher than the 14.8% two-monthly figure. On the other hand, fixed capital investment grew by 20.9% in the first three months of the year, 0.6 points below the cumulative figure up to February.
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Industrial production and retail sales push forward in March.
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Although it is still too early to make any definitive judgement, the trends in these activity indicators, together with the decline in the foreign sector, are a small sign, albeit welcome, that the Chinese economy might be rebalancing its growth pattern towards private consumption and away from exports and infrastructure investment.
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Within this context of moderating activity, March's inflation rose to 3.6%, slightly above February's figure of 3.2%, due to volatile food prices, which make up more than a third of the general price index. Nonetheless, this figure is below the 4% target set by the government and is expected to continue easing throughout the year. This has allowed monetary policy to be relaxed. At the beginning of year, the reserve ratio was lowered and we expect interest rates to be reduced by 50 basis points throughout 2012, which will boost growth in credit and domestic demand. Fiscal policy will continue to be active along the same line of supporting growth. The economy's moderate debt, even taking into account the debt of local governments, should help to reinforce the network of social benefits and continue with an acceptable level of investment in infrastructures.
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The central bank widens the daily renminbi trading band against the dollar.
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Lastly, in mid-April, the central bank widened the daily renminbi trading band allowed against the dollar from ±0.5% to ±1%. However, given the slowdown in foreign demand, we do not expect the rate of appreciation of the Chinese currency against the dollar to exceed 3% in 2012.
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In short, and in spite of a possible greater deterioration in advanced economies, China's slight moderation does not seem alarming and, moreover, some indicators seem to point to a shift towards a greater role being played by private consumption. We will have to wait and see how these indicators develop over the next few months.
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Brazil
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Brazil: stimuli... and yet more stimuli
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Brazil's authorities are using stimuli to put a stop to the slowdown.
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After the disappointing growth figures for the second half of 2011 and given the accumulation of signs that the first quarter of 2012 will not be much better, Brazil's economic authorities have opted to turn the tap of stimuli full on. At the beginning of April, the government announced a new package of measures aimed at encouraging domestic expenditure and including tax discounts, credit facilities and a series of instruments to boost an industrial sector that is still failing to consolidate a pattern of strong growth. Similarly, trade policy has adopted a clearly more protectionist slant, even considering the possibility of introducing new custom duties to protect those sectors most exposed to competition from China, particularly textiles.
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Brazil's central bank cuts the official interest rate again by a further 75 basis points, leaving it at 9%.
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For its part, the central bank of Brazil lowered the SELIC rate by a further 75 basis points and, surprisingly, left the door open to further reductions depending on the economic situation. Its decision, which has put the discount rate at 9%, almost its lowest level in fifteen years (8.75%), was based on a progressive moderation in the rise in prices (inflation continued to fall in February, down to 5.85%), the aforementioned slowdown in the pace of activity and the threats still hovering over global economic growth. In any case, and although no excessive inflationary pressures are expected in the short term, the country's high degree of wage indexation, the rigidity in services and the more aggressively expansionary turn taken by economic policies will keep inflation above the middle point in the target range for 2012 (4.5%). This, and the expected upswing in activity in the second half of the year, suggests that the end to cuts in the official interest rate is not far off.
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Although this new arsenal of stimuli, in addition to those that have been introduced since mid-2011, might provide industry with a blast of oxygen, their impact is expected to be marginal and temporary as they don't tackle the root of the problem. In addition to an excessively overvalued real, Brazil's industry is also suffering from a series of structural inefficiencies that result in high production costs and low competitiveness. And, unfortunately, for the time being, neither Dilma Rousseff nor her government team seem concerned about undertaking the necessary reforms to put an end to these inefficiencies.
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Mexico
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Mexico: the calm before the election
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The Mexican economy is facing a relatively comfortable economic outlook.
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The latest macroeconomic indicators suggest a relatively comfortable outlook for the Mexican economy. Consumer and producer sentiment is increasingly optimistic; industrial production posted strong growth in February (5.9% year- on-year, compared with 4.3% in January) and purchasing manager indices point to the manufacturing cycle becoming stronger. This reflects the better tone, on the one hand, in domestic demand, which continues to pick up speed thanks to improved credit, remittances and employment; additionally, foreign demand has been boosted by the gradual recovery in its neighbour to the north.
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The central bank has yet to make a move but its governor advocates far-reaching structural reforms.
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In the area of prices, the bulk of the evidence available suggests that the inflationary upswing at the end of 2011, due to a shock in the food supply and the impact of a weak peso on core inflation, is dying down. Undoubtedly, the cyclical position of the economy, with moderate growth below its potential, has helped to ease the rise in prices.
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This macroeconomic scenario is of great help to the monetary authority which, given the solid but still restrained growth and with the absence of any significant pressures on prices, can allow itself to keep the discount rate unchanged, at 4.5% since July 2009. In any case, its latest announcements continue to show a clear bias towards laxer monetary policy, due undoubtedly to the context of extreme monetary lassitude at a global level.
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This favourable economic situation is also helping to prepare the ground for the electoral campaign to dust off proposals for substantial structural reforms. In this respect, the governor of the central bank, Agustín Carstens, recently and explicitly asked the presidential candidates to think seriously about these reforms. Reforms that, as he ventured, if they are carried out successfully, might take the Mexican economy to growth rates in the region of 5%, double its average growth over the last decade.
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Commodities
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A change of direction for oil?
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Oil falls by 4.7% in one month and goes below its level of a year ago.
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Oil fell slightly between 20 March and 20 April, with a drop of 4.7%, standing at 118.60 dollars per barrel (Brent quality, for one-month deliveries). Crude was therefore 10.7% above its level at the start of 2012 but 4.8% below its level of a year ago, when the Libyan crisis had already reached its peak, which should help to push down the CPI of most economies.
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Oil prices seem to have taken a downward turn. The main factor could be Saudi Arabia, which increased its production to 10 million barrels a day, the highest level in 30 years. In addition, the International Energy Agency predicts conditions of supply and demand that should lead to further price reductions, although this is being hindered by the tensions generated by Iran's nuclear programme. Moreover, the weakness of the euro area is also pushing down demand for crude.
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The change in direction for commodities is confirmed.
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The rest of the commodities joined crude's downward slide. The CRB index fell by 3.0% between 20 March and 20 April, its biggest drop since May 2010. Among metals, aluminium and nickel lost close to 8.0%, while copper was down by 4.3%, affected by the slowdown in China and the revelation that the Asian giant has a larger stock than expected. The exception to these decreases was gold, which only fell by a minimal 0.4%. Falls also predominated among foods, with decreases in the price of wheat, sugar and coffee; rice being the exception, up by 1.9%.
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Companies and productivity: a matter of size
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Spain's business fabric is typically highly fragmented, with a clear predominance of small and micro-enterprises and, on the other hand, a small number of large firms. This distribution might be partly a reflection of obstacles to growth or disadvantages in being large, an issue that is far from irrelevant when it has been proved that larger companies not only tend to be more productive but are also more likely to export. Given the current situation of very weak domestic demand, it is essential for our firms to gain both domestic and foreign market share, and this requires improved productivity and savings in costs. In short, boosting competitiveness and internationalization, two elements that are positively associated with the size of a company. That's why this box advocates a regulatory environment that not only encourages the creation of firms, mostly very small when they start up, but also their growth.
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From an international perspective, the average size of a typical Spanish firm is smaller than that of other countries with a similar degree of development. According to data gathered by the OECD, in Spain in 2007, 3,305 firms were operating with more than 250 workers (considered to be large firms) out of a total of 2,712,397 firms. This figure is slightly lower than its equivalent in Germany, for example, where 8,995 large firms were operating out of a total of 1,818,909 in the same period. On the other hand, Spain stands out as one of the advanced countries with the largest share of micro-enterprises or firms with fewer than 10 employees, accounting for 93% of all companies compared with 83% in Germany, which coincides with the OECD average.(1)
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In terms of employment, small and medium-sized enterprises (fewer than 250 employees) account for 78% of all employment in Spain, while in Germany they employ just 60.4% and, in the United States, 47.3%. Moreover, the distribution of employment also shows a clear bias towards micro-enterprises with 38.3% of the total compared with 19% in Germany and 11% in the United States. Although industrial firms tend to be larger than service firms, Spain's bias towards small-sized companies cannot be put down to the tertiary sector's greater weight. If we look just at the manufacturing branch, SMEs also employ the lion's share with 73% of all workers, while firms with fewer than 20 workers employ double the number of workers as in Germany (29% versus 15%). Large manufacturing firms, however, only employ 27% of the sector's total employment in Spain, compared with 53% in Germany (see the graph above).
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It is now well-known and documented that larger firms are more likely to export.(2) The main reason is simply the presence of fixed costs for breaking into export markets, which a larger company can more readily afford. In Spain, during the period 2001-2007, only 12% of all firms exported some kind of good; however, among large firms, 57% did so compared with just 2.9% of micro-enterprises.(3) Similarly, a recent study concludes that, with the collapse of global trade in 2009, those Spanish companies that gave up exporting the most were generally the smaller firms. The findings also reveal that, in the case of large companies, export volumes were adjusted largely by reducing the intensive margin (in other words, the average value exported) and not so much via the extensive margin (leaving the market), an option that was used more often, however, by the smaller firms.(4)
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(1) See OECD, Entrepreneurship at a Glance, 2011.
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(2) See, for example, Bernard, Jensen, Redding and Schott, «Firms in International Trade», Journal of Economic Perspectives, 2007.
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In addition to being more inclined to export, larger firms also tend to be more productive. The positive association between productivity and company size can be explained, fundamentally, by the presence of increasing economies of scale that help to progressively reduce unit costs as a company grows larger. According to data gathered by the OECD on productivity in the manufacturing sector, large Spanish firms are almost 3 times more productive than micro-enterprises and 1.6 times more productive than the average-sized firm. These differences in productivity due to size are comparable to those observed in other countries, such as Germany (see the graph above).
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These data also reveal a regularity that may be surprising at first glance: when similar-sized companies are compared, the productivity of Spanish firms is not very different from that of their German peers. In fact, large Spanish firms are even more productive than large German firms. On the other hand, micro and small enterprises are somewhat less productive in Spain. This suggests that the difference between the average productivity of German manufacturing firms compared to Spanish (20% higher in Germany) might be due to the lower share of large firms in Spain.
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(3) Source: The Bank of Spain's Boletín Económico, November 2010.
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(4) See the Bank of Spain's Boletín Económico, January 2012.
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In this respect, it is revealing to calculate how the average productivity of Spain's manufacturing sector would change if the distribution of employment among firms of different sizes were the same as in Germany. The findings show that, in this case, Spain's average productivity would be the same as in Germany. If, however, we maintain the current composition by size of Spanish companies but assume that German companies of the same size are equally productive, we find that Spain's average productivity would still be 16% lower than that of Germany. This illustrates that, from a strictly accounting point of view, Spain's lower average productivity compared with Germany can certainly be put down to the composition effect resulting from the excessive fragmentation of Spain's business fabric and its bias, in employment terms, towards small firms, which are less productive not only in Spain but everywhere.
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So why are there so few large firms in Spain? The bulk of the evidence available suggests that Spain's smaller average company size results both from the inflexibility and obstacles in the institutional environment and the market in which firms operate (which makes it difficult for them to grow), as well as from broader social and cultural factors that limit the horizon of many business projects from the start. These limiting factors are explored in more detail in the boxes entitled «To grow or not to grow, that is the problem», «Does labour regulation allow company growth?» and «SME financing in Spain: short-term emergency, long-term challenge» in this issue. The first two examine the institutional environment's influence on company growth, while the third tackles the relationship between access to financing and company size.
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In summary, large Spanish firms are competitive and, in recent years, have demonstrated notable dynamism in exporting. The problem lies in the fact that these firms still make up a very small proportion of the economy. Given that domestic expenditure is likely to be weighed down by adjustments for a long time to come, the best bet for the Spanish economy to get back on the path of growth is to gain market share abroad. This undeniably requires a larger number of our companies to jump on the bandwagon of productivity and internationalization; and it's clear that growing in size will make for a cheaper ride.
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This box was prepared by Marta Noguer
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International Unit, Research Department, "la Caixa"
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