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Executive summary.

The 14 year-long period of strong expansion has come to an end, as residential construction has begun adjusting towards a sustainable level of activity and the highly indebted household sector is curbing spending in response to tighter financial conditions, while external demand is weakening as global financial turbulence worsens. The downturn is still at an early stage. Nonetheless, it has already resulted in a marked increase in unemployment, hitting workers in low-skill occupations, including immigrants, particularly hard. Moreover, some of the driving forces of past strong performance are also likely to lose momentum beyond the current downturn: immigration flows may slow, the potential for further gains in women's labour force participation is diminishing, and the expansionary impact of low real interest rates and strong credit growth following euro area entry on investment has ended. At the same time, even if there has been some improvement in productivity outcomes in recent years, the underlying trend still appears weak. Finally, the number of youths leaving full-time education with poor skills is high, while there are few workers with intermediate vocational skills, which offer high returns.

On the other hand the Spanish economy can count on two notable strengths to help it emerge from the deep slowdown: while the international financial crisis and the large exposure of domestic banks to the residential construction sector create a challenging context, the financial sector is overall comparatively well placed to withstand the foreseeable domestic contraction of activity, and the rapid expansion of tertiary education over the past 20 years provides a vast potential for future increases in economic welfare. While the short-term fiscal stimulus that was provided was appropriate so as to reduce risks of mutually reinforcing employment and activity losses, the scope for further discretionary stimulus is limited. In addition, government revenue growth is set to weaken markedly beyond the current downturn, requiring much tighter priority setting in spending.

The overarching policy challenge is to implement structural reforms that will more fully exploit existing potential and tap new sources of growth. Some of these would also do away with the need to offset market distortions with subsidy programmes, helping to lower government spending pressures.

* Improve the matching of workers to jobs. Better activation of the unemployed would make a significant contribution to mitigating the impact of the downturn on the labour market. Reform of stringent employment protection for existing long-term contracts would lower the substantial barriers for young qualified workers to obtain jobs commensurate with their skills, as would focusing housing market reforms more squarely on removing barriers to geographic mobility.

* Exploit the contribution the education system can make to raising long-term economic performance. The very large number of school drop-outs needs to be reduced and vocational training made more attractive. Education outcomes could be raised through improved accountability and autonomy of schools. Better funding arrangements in tertiary education could further boost the contribution of high tertiary attainment to improving living standards.

* Enhance the role product market competition can play in boosting productivity growth. While past reforms in the regulation of some network industries have shown some good results, lack of independence and accountability of some sector regulators still deters entry of new firms. Reforms to heighten competition in transport, postal and professional services would have behests throughout the economy owing to their use as intermediate inputs.
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Publication:OECD Economic Surveys - Spain
Date:Nov 1, 2008
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