Nacho Álvarez – Spain: Pedro Sánchez and the trilemma of political will

Spain’s social democratic party (PSOE) led by Pedro Sánchez and the left-wing alliance Podemos Unidos, led by Pablo Iglesias, are seeking a common policy. That could be more difficult than it appears at first, explains Nacho Álvarez.

Nacho Álvarez is associate professor at the Autonomous University of Madrid and responsible for Podemos’s economic team (@nachoalvarez)

Translated and edited by BRAVE NEW EUROPE

In the 1960s, economists Robert Mundell and Marcus Fleming developed a hypothesis that would quickly become the cornerstone of open macroeconomics: an economy cannot simultaneously maintain fixed exchange rates, free movement of capital, and an autonomous monetary policy. This “impossible trinity” indicated that it was unfeasible to achieve all three objectives at the same time, and one had to be discarded.

Years later Dani Rodrik, the well-known Harvard economist, used this metaphor again to refer to the “trilemma of globalisation”. One cannot opt at the same time for economic globalisation, national sovereignty, and political democracy. So the simultaneous quest for the three alternatives necessarily leads to the weakening of some of them.

According to Mr Rodrik, maintaining high levels of national sovereignty and internal democracy requires selective and partial integration into globalisation. Conversely, a country fully integrated into economic globalisation will have to sacrifice crucial elements of its sovereignty or, even worse, its democracy.

Some authors try to use this trilemma to explain the crisis that social democracy has been going through for several decades. And they are partially right: the forces unleashed by global capital and free financial mobility have hindered the advance, and even the continuity, of social-democratic policies.

However, understanding the crisis that social democracy is going through today requires awareness of another trilemma: the trilemma of political will. This could perhaps be formulated – in terms of International Political Economy – in the following way: in the peripheral countries of the euro zone it is not feasible to satisfy the demands of the citizens, the demands of the national elites and the demands of international finance (crystallized in the Brussels rules) all at the same time. At least one, if not two, of these three requirements has to be jettisoned.

In nations with weak fiscal regimes, such as the euro zone’s peripheral countries, a fiscal expansion that allows for the reconstruction of the entitlements that austerity policies have destroyed, and the introduction of new ones, must be financed with a certain public deficit – anathema for Brussels – or with a tax reform – which must necessarily tap into the country’s elites, given that in this area the middle and working classes already bear a large part of the tax burden.

Clash with national elites, or with international elites. Or crash with everyone.. There will be those who rightly raise the need for a new fiscal policy, which puts an end to austerity and makes it possible to rebuild and extend the welfare state, to be developed on two pillars: tax reform against national elites and the requirement for European fiscal rules to be made more flexible against Brussels technocrats, by treating the public deficit in a way that is more functional in keeping with other macroeconomic objectives. This has always been the proposal of Unidos Podemos.

However, it should be borne in mind that the various governments of southern Europe will have enormous incentives – because they cannot meet all three demands – to aim for at least two of them. Spain and Italy are two interesting cases in this sense.

In Spain, the government of Pedro Sánchez and his social democratic party PSOE have reached an agreement with Unidos Podemos whereby it commits to reverse the cuts that were applied by the Partido Popular in education, health and welfare. The framework of the agreement also establishes a crucial roadmap for the recovery of lost rights and the extension of new ones, promoting a vector that deepens democracy in our country.

Fulfilling this agreement will require the Sanchez government to confront either the technocracy of Brussels or the Spanish economic and business elites. Either these measures are financed by a loosening of the EU deficit target, or they are financed by a tax reform. Or, in the third case, citizens’ expectations are disappointed and the agreement remains as a worthless piece of paper.

Sánchez’s government has already made clear its willingness to “comply with the demands” of the European Commission. This means adopting an economic target that is really not necessary: the drastic reduction of the public deficit. This reduction should be more gradual, less aggressive, and conditioned to other problems being solved previously,  such as unemployment, inequality or wage poverty. However, Sánchez’s government wanted to send a clear message to the international financial markets: the reconstruction of the welfare state in Spain must be done without increasing the public deficit.

The relationship of the Spanish social democrats with Brussels – unlike other countries – has always been a “linked” relationship, where uncritical subordination has trumped any independent thinking. And the relationship of Sanchez’s new government with the European Commission is no exception.

This social democratic government has thus (uncritically) adopted the neo-liberal framework of the Stability Pact, fighting to reduce the deficit even though it will be below 3% by the end of 2018. It means that the Italian populist right is the only party left in southern Europe with a strong “anti-austerity” platform.

Now that Spanish social democracy has abandoned efforts to rethink its intellectual (and political) approach to the EU’s Stability Pact, its only option – if they want to pursue fiscal consolidation and a “zero deficit” – requires  simultaneously introducing  a major tax reform. If Sánchez’s government aims to reduce the public deficit rapidly over the next two years, it can only undertake a “balanced budget fiscal expansion”: new expenditure and investment by the Spanish state must be financed by new structural income.

A “balanced budget fiscal expansion” would allow the fulfilment of the agreements reached with Unidos Podemos – restoring public services, restoring lost rights and expanding new ones.

But the fiscal agreement reached with Unidos Podemos, which must see the light of day in the next few weeks, relies on a fundamental assumption: the middle and working classes are those who already provide the bulk of the revenues in our tax system. They cannot therefore be additionally taxed. The fundamental way to finance the reconstruction of our welfare state is to take away the tax privileges and exemptions enjoyed mostly by the upper classes and big business. No one can ignore the fact that this reform, if it has teeth, will entail a certain degree of conflict with the country’s economic and business elites.

This is the trilemma of political will from which the Spanish government cannot escape, if it really wants to recover lost ground, legislate for the social majority, and provide new space for progress with its new parliamentary partners.

The composition of our tax revenues shows that it is possible and necessary to promote a tax reform that begins to dismantle some regressive tax privileges. Take the current state of corporation tax as an example.

This tax collects half as much today as it did in 2007, despite the fact that corporate profits and GDP have already surpassed the level they had before the crisis. Over the last decade, the effective rate has fallen by ten percentage points to just 6% for large companies. These companies benefit from compensation (perennial and non-prescriptive) for their losses from past years, which is certainly abusive. In addition, the extension of double taxation exemptions for dividends – more generous in Spain than in other countries – has reduced these revenues: this exemption, which in 2006 was 16 billion euros, reached 105 billion euros in 2016. A swingeing 85% of this exemption benefits big business groups, not SMEs (Small and Medium-sized Enterprises).

Setting a non-deductible minimum of 15% in corporation tax, and revising some of the exemptions mentioned above – so that, for example, only 95% of income obtained abroad, such as in Germany or France, is exempted – would ensure sufficient revenue to guarantee the indexation of pensions to inflation, and a first phase of universal education from 0 to 3 years. The tax regime that companies and dividends would face in our country after such a reform would be similar to that of other euro-zone countries.

The “Italian variant” is developing along a different path than the Spanish one: the implementation of the Citizenship Income promoted by the Five Star Movement, from the coalition government with the Northern League, may lead to increases in the public deficit that have already been harshly criticized by Brussels. At the same time, the government listens to the demands of the conservatives and employers, and will impose a “flat tax” for businesses and families, which will reduce revenue and widen the deficit. In this case, the government’s action does not clash with the Italian elites, but relies on them. In addition, it is trying to meet some popular demands, such as the Dignity Decree or the aforementioned Citizenship Income.

To govern is to choose, to decide whether – within the framework of the trilemma to which we have referred – the demands of the country’s elites, those of the technocracy in Brussels, or those of the social majority will be met. The Italian government has chosen to clash with Brussels. The weakness of the Spanish government may push it into having a certain degree of conflict with the national conservative elites, if it wants to guarantee the support of Unidos Podemos.

Democratic advances and progressive victories have hardly ever been achieved in the past satisfying all interests symmetrically and simultaneously. The balance always tends to tilt one way or the other. The pendulum of capitalism – a term coined by Belgian economist Paul De Grauwe – oscillates between the free market and public regulation. The challenge we have today in Spain, and in peripheral Europe, is to shift that pendulum in favour of social progress.

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