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Spain is in a deep recession as well as most EU countries and OECD member states. While the current worldwide recession affects most industrialised countries it has hit the Spanish economy hard.
Many commentators have asserted that this arises principally from the property market bubble bursting and a rigid protected labour market which has been a permanent drag on competitiveness.
However, I consider the lack of business solvency has had an even more destructive effect, both in the past and the present, on the Spanish economy than realised by many commentators and analysts.
The financial solvency of business goes right to the heart of sustainable economic development and growth. It is no mere coincidence that high unemployment has been a chronic feature in the Spanish economy. Even at the height of the economic and property boom unemployment never dipped below 8% which is still a long way from full employment measured at 4-5%.
Unfortunately, the benefits gained during the economic boom did not address the underlying structural problems affecting business solvency. The result is that many Spanish businesses today are in an even more fragile state compared with the other major economies. This situation, apart from other adverse factors, will result in a slower economic recovery than other EU countries.
The current economic stimulus measures are macroeconomic measures. They will not significantly improve the financial solvency of individual businesses in the short to medium term. Many companies will continue to fail as a result pushing up unemployment through at least 2010.
However, tackling the underlying causes for business solvency can lessen the economic effects of failing businesses and stimulate growth and employment for Spain. It is a huge opportunity to build a more robust economic model.Facts and Figures
In Spain many financial commentators routinely tag excessive expansion in the property sector and a rigid protected labour market as the principal structural problems undermining economic recovery.
Other commentators have highlighted low productivity and high labour costs with some stating unit labour costs have risen by some 30% above Germany in the last decade. Yet Ministry of Finance statistics, based on personal income tax declarations data for 2007, show that more than 60% of salaried workers in Spain earn below €1,100 monthly. This does not appear an expensive labour market.
The labour issue is not a new one as even in the previous boom times it was singled out as a being the major cause, depressing the overall economic results. Despite having one of the highest EU growth rates (2002-2007) and accounting for a third of new jobs created in the EU in that period, there has historically been a high unemployment rate in the Spanish economy. This rate has never got below 8% (2007) even in the good times. So other causes are at work.
The active employees currently stand at 23 millions. However, in the space of 24 months some 2.2 millions were eliminated. The current (June 2009) unemployment rate stands at 4.1 million or 18%, one of the highest in the EU and could reach a high point of 20% by 2010. (OECD estimate).
This does not sound like a rigid protected labour market, to quote an analyst from The Economist Magazine last year.
Nevertheless, some of the major institutions, major analysts and financial commentators continue to call for more structural changes in the Labour market as a necessary precondition to get the economy out of recession. Indeed some have converted this into their holy grail.
However, many of the same institutions and commentators, similar to their counterparts elsewhere, never even saw this global crisis coming. So it is fair to question their opinions on resolving the crisis.
In reality there are multiple issues which affect, to a greater or lesser degree different industry, sectors, businesses and economic activities.
However, there is a common cause which affects all, whether big or small, and that is cash flow. Cash flow is the lifeblood both of a business and an economy. The lack of it causes a severe drain on all economic and commercial activity. It stunts growth, restricts trade and is a major obstacle to competitiveness.
Yet it rarely occupies the centre stage and is usually a subject for discussion in restricted specialist forums and Trade Associations campaigns. This may be because of a lack of understanding by many economic policy makers and commentators, more accustomed to macroeconomic policy debates, of micro-economic principles and their effect on individual businesses.
The lack of cash flow can be caused by many factors but, for most businesses, delays in collecting customer debts are top of the list. A standard indicator is the number of days taken to receive payments. The longer the payment cycle indicates a weaker solvency in a business as meanwhile it has to finance its own commitments from other resources.
No economic or business indicator by itself is all-conclusive. However, the high temperature of a patient suggests something is wrong although it remains to be diagnosed. The delays in payments data are a good benchmark for analysing the situation further.
The Intrum Justitia organisation, a leading European provider of credit management services, publishes a comprehensive annual report on supplier payments across Europe. This annual report is based on data obtained from several thousand companies and has been published over the last 5 years.
A summary of the days' payments outstanding (Data 2008) for 26 European Countries follow;
Private Public Sector Sector
Pan European (average) 57 67
Germany 49 40
The Netherlands 42 49
UK 52 49
France 63 70
Bottom of the List
Italy 88 128
Portugal 87 129
Spain 98 139
Greece 120 165
(Source: European Payment Index 2009 – Intrum Justitia)
The average for Public Sector debt payments in Europe is 67 days. However, the bottom-of-the-list countries, including Spain, stand even further apart from their peers as 19 of the total 26 countries surveyed are even below 50 days payment in the Public Sector.
The payment performance in the Public Sector plays the predominant role in most economies because of its enormous presence. Any slowdown or delay in payments will spill over into the Private Sector as suppliers struggle to meet their commitments to their counterparts.
However, these payment statistics are averages and the situation is often much worse. In Spain delays in payment in the Public Sector of between 200 to 365 days are a common feature and over 120 days in certain areas in the Private Sector.
Nevertheless, the numbers by themselves do not tell the whole story of the enormous business consequences for Spain. Long delays in payment can result in much higher financial and administrative costs, higher bad debt risks, limits on growth, higher risk of business insolvency and lower investments to name a few.
These are serious issues for a company, a sector, an industry and a national economy. The number of days outstanding is only the tip of the iceberg. Delays in payment are the financial stress lines exposing the underlying weakening financial state of a business or entity.
This chronic lack of business solvency is one of the principal competitive disadvantages facing Spanish businesses and its Achilles heel. A business can struggle on with higher labour or other costs, but a lack of solvency can it shut it down overnight.
Yet the mainstream economic commentators and institutions are silent on the matter as I pointed out earlier. I consider that this is because of a lack of understanding of the gravity of the issue and its economic and business consequencesFailed Measures
As long ago as 1997, the European Commission was stating that late payments represent a serious obstacle to a single market.
Following EU initiatives, the law covering Commercial Operations and Payment Terms (3/2004) was approved in Spain. The maximum payment period was set at 60 days with interest on overdue payments to encourage compliance. Nevertheless, this legislation in practise has been ineffectual.
The most glaring example of non-compliance continues to be the Public Sector reported in the payment statistics through 2008. This can be attributed to the following factors.
There is a culture malaise in the Public Sector about supplier payments. Suppliers' bills are processed through their internal systems and paid when their systems decide, irrespective of established payment terms.
Yet the same Public Sector is implacable with suppliers on tender conditions. Suppliers to the Public Sector normally have to demonstrate that they are current with their payments for the principal taxes and social security collections in any public tenders.
The Public Sector in Spain has also gone through a massive decentralisation through the transfer of many of the core services from central government to the 17 regional governments and local city administrations. However, funding these transferred services is still a contentious issue between the various administrations and their ability to pay for them.
Finally, many of these Regional and Local Administrations have also continually overspent their own budgets putting even more stress on their financial resources.
In April 2009, the Central Government threw a € 3 billion lifeline to the Local Governments to pay at least some of their outstanding supplier bills. Yet, subject to final confirmation by the Institute Credito Oficial (ICO), only a minor part of the credit facility has been used so far (Expansion 24-9-2009 M.Tejo).
The blame initially was laid on bureaucratic problems but probably the real issue is that greater fiscal discipline was required from the Local Governments as a counterpart.
Unfortunately, they preferred to continue to sacrifice their suppliers to avoid these fiscal discipline measures.
However, these measures and a similar business insurance scheme are seriously flawed. In reality a supplier is being offered a credit line or business insurance to cover the amount owed by the Public Entity. The supplier ends up with a higher debt level, affecting his capacity also to borrow for other operations, to obtain an advance on his bill. Private supplier financing has not been replaced in these circumstances.
The lack of any real progress in reducing the late payments by the Public Sector directly affects its Private Sector suppliers and their ability to pay. So it was not unusual the major industries in the Private Sector maintained their habitual late payment practises in these circumstances.
Within the Private Sector the Retail Giants continue to lean heavily on their suppliers. While their customers pay in cash or credit cards (30 days) the supplier payment terms stretch from 90 -120 days.
Leading companies and some financial institutions also lean on their suppliers and stretch their payments to the maximum. Early payment discounts are offered but with a steep financial cost.
Therefore despite pressure from Government measures and Trade Associations no significant changes have been achieved in these late payment practises in Spain. As I pointed out above, only a few suppliers have sufficient market strength to negotiate their own more favourable terms.
The alternative of charging interest on delayed payments has also been unworkable. It takes a strong supplier willing to demand interest from some of his principle customers. The real threat of losing the customers' business effectively neutralises these measures.Serious Consequences
This situation is not new and forms a chronic drawback in doing business in Spain. Nevertheless, in more abundant times, businesses could resort to their banks and obtain some financing for their trade receivables.
While this solved the more pressing liquidity needs for a business, it came, of course, with a heavy financial cost. Most businesses accepted this as part of their overall cost structure as there was little choice.
However, having to finance beyond the normal trade credit terms eats into a businesses' competitiveness as it incurs extra costs. It also places it at a serious disadvantage with stronger financial competitors who have greater cash resources.
These excessive late payment terms place Spanish businesses in a more fragile position than their major European counterparts in the current economic downturn. They were already in a weakened financial state before the global recession started
The backbone of all major economies is small businesses (90% of total) even though their value-added in industrial terms is restricted by a limited ability to invest. However, their ability to create employment quickly, especially in the service sectors, in an economic upswing is only matched by their capacity to shed jobs at an even greater rate in an economic downturn.
Small businesses are continually walking a tightrope. They have little cushion to absorb any disruption in getting paid by their customers. It takes only a payment slowdown by some of their principal customers to tip them over the edge into insolvency. As the payment situation gets worse it creates a domino effect as customers drag down their suppliers who drag down their customers in turn.
To make matters worse the bank finance previously relied on to finance customer receivable has all but dried up since the beginning of the year. While this has also occurred in the other major economies, business solvency was already weaker in Spanish businesses so the blow was even heavier.
Many businesses are closing because they cannot pay their employees, suppliers and other debts. Their lack of solvency is asphyxiating them. It is estimated that some 60% of small and medium-sized businesses are close to insolvency in Spain.
This goes a long way towards explaining why there has been a much higher loss of employment in Spain compared to other EU countries. The loss of some 2 millions of jobs in the last 24 months is not all attributable to the bursting property bubble and rigidity in the labour market.
Other EU economies will undoubtedly recover faster as their businesses were not as overexposed to severe financial insolvency as in Spain. Even the EU countries in a similar situation (Italy, Greece and Portugal) will probably recover earlier as they did not have the added problem of the property bubble. Some analysts are predicting unemployment in Spain to remain at 20 % through 2012.Viable Solutions
The real and imminent threat now to business recovery in the Spanish economy is business insolvency. While economic stimulus plans can fill the gas tank, the engine needs oil to run as well. Cash is the oil that greases the wheels in business and industry.
Macroeconomic measures that do not target business solvency will not revive the business sector in the short or medium term. While cutting public spending will reduce public deficits it does not mean that supplier payment terms improve.
Businesses need cash injections and Public Sector customers paying their bills more promptly is a sure way of achieving this. Failure to react will only provoke more business failures, higher unemployment and more damage to the Private Sector.
Any economic recovery in these circumstances where the Public Sector does not change its funding practises can only be fragile, long-drawn-out and characterised by an inability to achieve its full potential. Suppliers are there to finance normal trade credit terms only; their role is not financing Public Sector deficits through excessive delays in receiving payments
Increased public borrowings will be needed to substitute excessive trade credit in the public sector, which may have downside consequences. The upside is that financially solvent businesses invest, create employment and will pay taxes directly or indirectly to bring down the public debt.
While there are calls for changes for a new economic model to substitute residential construction the solutions proposed so far are few.
Robust economic growth driven mainly by residential construction must be shelved for perhaps the next decade until the current excesses are absorbed by normal market forces.
In those circumstances achieving even the historic low of 8% unemployment is impossible within the next 5–10 years.
Nevertheless, it is worth remembering that full employment (some 3-4%) has never been achieved even with construction booms.
However, I think the economic drivers for sustainable economic growth are already in place. Businesses have gone through an enormous transformation in the last decade. Infrastructural investments in communications, rail and road networks, and the latest technologies have placed Spain in a prime position beyond some of its most immediate competitors who invested less.
The banking sector has survived the worst and gained the grudging respect of many of its detractors in international banking circles. Many companies are staffed with eager, professional and competent executives and staff. The last decade has already seen the growth of authentic Spanish multinationals notably in banking, energy, telecommunications and public works construction.
This pent-up energy, talent and resources needs to be released and allowed to achieve their real potential. Measures to improve business solvency is one of the quickest and effective means to achieve this. It also conforms to open market principles as successful businesses will rise to the challenges and opportunities now within their reach.
Finally what is a current weakness can be turned into an opportunity. Other competing economies and businesses have their own Achilles Heels in areas where Spain has clear advantages. Infrastructural weaknesses and other structural weaknesses are long-term issues which normally need up to a decade to modernise. Good use was made of EU funding in Spain to carry out these already. Measures to improve business solvency can be implemented rapidly and put Spain at the forefront.
Even just halving the current payment situation to bring Spain in line with the Pan- European average of 55 and 65 days would be a huge business stimulus.Conclusions
Of course business solvency is only one issue and there are many other social and economic factors which form a complex situation. Nevertheless, it is businesses which create the wealth, jobs and taxes that are the mainstay support of any economy.
Priorities are many but business solvency cannot be delayed any longer. The Central Government has started several structural reforms but it has failed to drive them home. Negotiations have been long, complicated and difficult with the Regional and Local Administrations. The parking of Local Administration financing until 2011 is an ominous sign.
However, the Central Government has been elected by the voters to govern and empowered to do this. Political compromises and agreement have to be reached with the major political parties despite ideological differences. The current lamentable state of excessive Public Sector funding through suppliers has been provoked by all the parties in one-way or another.
Failure to tackle this by the elected politicians runs the risk of delivering a generation to unemployment, lost opportunities and sickly, lethargic economic performance for at least the next 5 years.
On the other hand, if the politicians have courage to sit down and work this out among themselves they can solve this and place moral and legislative pressure on the Private Sector to follow suit.
Finally, a much more comprehensive and wide-ranging debate is needed on the economic and business issues. Such a debate would be a real driver for change. I believe that too often the focus has been too narrow as headline grabbing and news bulletin reporting has trivialised many serious issues and marginalised others.
Never was there a greater need for clarity, serious non-partisan analysis and responsible debate to grapple with the realities and create viable alternatives.
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