Spain's Success

No longer a Latin laggard, the country's economy is fast becoming one of Europe's healthiest

Meta4's name isn't the only clever thing about the seven-year-old software startup. Most of its 550 employees are whiz-kid programmers in their late 20s. Sales at the $23.5 million company doubled last year, and 20% of them are exports. Founder Juan Moran, 39, has banned paper communication at Meta4, insisting on E-mail for speed and efficiency. And he recruits new talent for his fast-growing workforce over the Internet. "In a knowledge-based economy, we can compete very well," says Moran, who has introduced stock options for employees and may take his company public to fund future growth.

The latest high-tech success story in Silicon Valley or Seattle? No, Meta4 is just outside Madrid--and a prime example of how Spain is racing ahead of European neighbors that are used to thinking of it mainly as a vacation mecca. Spain's factories are among the most productive on the Continent, its banks among the most profitable. A tier of midsize industrial companies is gaining global muscle, stealing business from other European suppliers. Government-led labor reforms are creating a flexible workforce. And a new generation of managers is promoting innovation and developing intellectual capital.

In fact, Spain's corporate pioneers are pushing Europe's fifth-largest economy into the 21st century at breakneck speed. Isolated and backward just 20 years ago, Spain is emerging as a maverick in the Continent's transformation into a more effective economic competitor. It is in the front ranks of countries revamping the role of the state, slashing taxes, overhauling labor markets, and nurturing entrepreneurs long frustrated by interventionist regimes. Such moves are positioning Spain to be a winner in a single-currency Europe, whose nations will have to compete for jobs and capital more ferociously than ever before.

Perhaps most dramatically, Spain has a new self-image. Powered by a fierce desire to change its poor-country status, successive governments have embraced free-market reforms with greater zeal than their counterparts in France or Germany. Indeed, the Spanish no longer look up to France as their economic model. Instead, with growth approaching 4% and with inflation at just half that rate, they benchmark themselves against the U.S. and Britain. In the past two years, the country has brewed up 691,000 jobs, more than half of all new jobs in the European Union. "Right now, Spain is the shining light of the European Union," says Ken Wattret, senior economist at Banque Paribas in London.

Spain is reaping the benefits of long-term economic reforms that started hesitantly and gained conviction in 1986, when it joined the EU. In 1995, corporate tax rates were slashed from 40% to 35%--a big draw for new investment. And in the past two years, bold moves by the government of Prime Minister Jose Maria Aznar, elected in March, 1996, have accelerated the momentum for change. Aznar has pushed through $1.3 billion in government spending cuts, a flat capital-gains tax of 20%, and a freeze on the hiring of civil servants.

His government has also opened key sectors of the economy to competition, including telecommunications, oil, and gas, and sold off its remaining stakes in telecom giant Telefonica, fast-growing bank Argentaria, and energy group Repsol. Total revenues from privatizations since 1996 have topped $28 billion, which has helped lower government debt. Last year, in a critical labor reform, the government made it less costly for companies to lay off workers on so-called permanent contracts.

STILL SUBSIDIZED. If the progress has been impressive, so are the challenges that remain. Overall unemployment, at around 19%, compares with 11.2% in Germany, and the official jobless rate tops 28% in depressed areas such as Andalusia. Wealth distribution remains wildly uneven, with the fastest growth concentrated around Barcelona and Madrid. Despite the government's progress in reducing public spending, Spain still needs to shrink the state sector. Its fast-depleting public pension system is still in crying need of reform. And it must wean itself from generous EU subsidies that contribute 1.7% of its gross domestic product.

But Spain has laid the foundations for a more competitive economy and is now nurturing a growing middle class. Mutual-fund investments are soaring, and consumer demand for new cars is so strong that buyers wait six months for upscale models. Spain's economic base has shifted from agriculture and old-line industries, such as steel and coal, to a mix of increasingly competitive industries and services, including autos, components, chemicals, pharmaceuticals, industrial ceramics, wine, and technology.

Now, although the Spanish economy is only one-fourth as big as Germany's, its car industry is No.3 in Europe--behind Germany and France. It is ahead of Britain and Italy, exporting some 80% of the 2.5 million autos it produces annually. Agriculture has fallen to 4% of GDP--which, at $584 billion, is about the size of Canada's--while financial services account for 15% of output.

SHUTTLE. The transformation has stunned many who doubted that Spain could cast off its free-spending habits and qualify for the new single currency in 1999. Spain easily made the cut this May. Its budget deficit is at 2.6% of GDP--well below the 3% Maastricht Treaty limit. And with the deficit forecast to fall to 2.4% in 1998, Spain fiscally outclasses many of its neighbors to the north.

Lured by labor costs that are less than half of Germany's, foreign multinationals have been a powerful force in Spain's coming of age, spending billions on factories that now rank among the most productive worldwide. They also played a key role in transplanting skills to Spain. For example, German auto maker Opel spent more than $6 million on airfare in 1981-82 to shuttle its Spanish workers to its German plants near Cologne for training. Now, Opel, which has invested a total of $4 billion in its Spanish operations, trains workers on site and exports more than 90% of its Spanish production of Corsas and Tigra coupes. "We were the last train in Europe. That was hard on our pride," says Javier Oraa, board member and general manager at Opel Espana. "Now, we are in one of the leading positions. We want to stay there."

But the new Spain is more than a low-cost producer for foreign giants. At its economic core are 15,000 midsize, mostly family-owned companies that have followed their customers into global markets and are beating the competition. Take Barcelona's Ficosa International. A $305 million auto-parts supplier, with factories throughout Europe and Latin America, it ranks among the top three in Europe for components from brake systems to door locks. Sales to General Motors, Volkswagen, and Ford Motor make up 60% of revenues, and the company recently clinched a major contract with Japan's Nissan Motor Co.

Today's economic success bears little resemblance to the boom of the late 1980s, which led to a resounding bust in 1992. In a growth spurt fueled by government spending and an overvalued peseta, the public deficit soared, inflation hovered between 12% and 13%, and interest rates topped 14%. "The boom-bust cycle of the 1980s was a wake-up call," says Paul Mylonas, an economist at the Organization for Economic Co-operation & Development (OECD) in Paris.

Spain heeded the call. Spending cuts, restructuring of ailing state industries, deregulation, and privatization have dominated the government's agenda since 1993. The result: When it comes to public-sector reform, Spain is at the head of the EU class. The state plans to be out of everything except coal mines by 2001. If it meets that goal, Spain will have outpaced both Germany and France in privatizing state industry.

FLYING LEAP. The wave of privatization has given rise to Spain's first true multinationals. Spain is the world's No.1 investor in Latin America and, for the first time last year, a net exporter of capital. Telefonica, fully privatized in 1997, has invested $5.7 billion in Latin America since 1990 and is the region's No.1 telephone operator. Energy giant Endesa, which was fully privatized in June, also is staking new claims in international markets, making $2.5 billion worth of foreign investments last year.

The dramatic leap in the competitiveness of Spanish industry is helping fuel a tidal wave of equity investment in Spain. In 1997, private equity funds raised some $453 million, more than eight times as much as the year before. And the market has accelerated in the first six months of 1998.

The stock market has more than kept pace. Buoyed by strong economic growth and a flush of initial public offerings, the Madrid bourse has doubled in value since December, 1996, and is up 49% so far this year. From 1995 to 1997, trading volume tripled. To be sure, Spain's financial markets still are underdeveloped compared with those in France, Germany, or the Netherlands. Spain has seen only 76 IPOs since January, 1997.

Yet Spain's ability to stay on the fast-growth track will hinge largely on channeling capital to competitive, high-tech startups. Already, signs of 21st century industry are sprouting around Barcelona and Madrid. Many believe Spain will develop competitive software, telecom, Internet, and media service companies over the next 10 years. "There is a level of innovation bubbling away that nobody knows about," says David N. Bendel, vice-president at Excel Partners, a Madrid venture fund that has more than $200 million under management.

In banking and finance, Spain has already gained a global edge. The collapse of giant Banco Banesto in 1994 focused regulators' attention on a sector where balance sheets were weak, capital ratios low, bad loans numerous, and accounts opaque. In the wake of the debacle, the central bank introduced new capital requirements and international accounting standards and forced banks to write off nonperforming loans.

JOBLESS RANKS. The moves turned a cluster of domestic banking midgets into a handful of powerful financial groups. Banco Santander, with $173 billion in assets, ranks 19th in Europe, while rival Banco Bilbao Vizcaya (BBV), with $141 billion, is No.23. Pretax returns on capital are 18% and 22%, respectively--among the highest in Continental Europe. And their clout is growing. "We now have size. We are able to make big investments," says BBV Chairman Emilio Ibarra y Churruca, who is bidding on banks in Brazil, Chile, and Italy.

But Spain has plenty of unfinished business. Its economic leap has thrown 3 million people out of work--largely in agriculture--and doubled unemployment in the past 10 years. Although down from 24.1% in 1994, the jobless rate remains stubbornly high, largely because firing workers is still more expensive than anywhere else in Europe. The average cost of laying off employees on permanent contracts--who account for two-thirds of the work force--is two years of full salary.

The previous government had injected flexibility into the Spanish labor market by allowing temporary contracts, ranging from six months to two years. Now, such workers account for a full 25% of the labor force and have given Aznar's government leverage in negotiating lower benefits for those on permanent contracts. In April, 1997, it won agreement from unions for lower severance payments and lower payroll taxes. But industry leaders say the government has to do more. "The pressure is on the government to accelerate labor reforms," says Paribas economist Wattret.

NO ANGLOPHOBIA. Spain also carries the legacy of a heavy public sector. Despite the privatizations, civil servants still make up 17.5% of the workforce. As in France, salaries grow fastest in the public sector, where union power is concentrated. In 1997, the average public-sector salary was $28,667 a year, compared with $22,000 in the private sector.

But the mood in the private sector could prove infectious. The 30- and 40-year-olds now ruling corporate suites are bent on leaving a stagnant France in the dust and absorbing the lessons of the U.S. "We are not influenced by the Anglophobia of the French," says Jose Juan Ruiz, an economist at Banco Santander.

Spain's progressive attitude could be a big advantage when the European Monetary Union takes hold. With lower taxes and labor costs still running 10% below the EU average, Spain is poised to attract even more investment. "EU companies will invest more in Spain because now they are protected against the exchange-rate risk," says Stephane Garelli, an economics professor at management school IMD in Lausanne.

Spain also has gone the furthest in distributing economic decision-making authority to local governments such as Catalonia to shape their own future. As Europe's borders fade and regions grow more powerful, that decentralization could give Spain added economic kick. For Spain's young generation, staying among the frontrunners in the new Europe is everything. "The feeling is this time we can't be left out," says Javier Loizaga Jimenez, a partner at Madrid's Mercapital Financial Services. The smart money is betting they won't be.

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