Spain’s macroeconomic performance has remained remarkable: the country has experienced a 13th consecutive year of strong growth. This economic vitality has had the effect of narrowing the gap in per capita GDP with the euro area average from 20% to under 12% over the past decade and has also contributed to improved fiscal outturns. It has continued to be underpinned by buoyant domestic demand and spectacular employment growth based on substantial immigration, increased female labour force participation and a marked drop in unemployment.

Spanish economic growth, sustained by sharply rising domestic demand and employment, has remained strong in recent times, and the differential in per capita GDP with the euro area average fell to an estimated 12% in 2005. Nevertheless, the imbalances that have been accompanying the expansion for some years now raise persistent questions as to whether the expansion can last: i) the still high inflation differential with the euro area average is eroding competitiveness and helping to widen the external deficit, which has now reached a historic high; ii) developments in the housing market, where real prices have doubled since 1998, and mounting household debt remain disturbing; and iii) productivity growth is still extremely low. Moreover, from a longer-term standpoint, the currently sound position of public finances could be threatened, given the expected consequences of population ageing. There is broad consensus on this assessment of the Spanish economy and the need to find remedies for these difficulties, prompting the authorities to continue to implement their 2005 National Reform Programme. However, in some cases there are questions about the pace and ambition of the measures introduced thus far for meeting these challenges.

Spain’s recent economic performance has been remarkable, with 2006 marking its 13th consecutive year of growth, one of the longest periods of sustained growth in its recent history. However, there are persistent signs of imbalances that threaten to derail the strong performance, although recent data suggest some improvement. The inflation differential with the rest of the euro zone remains significant, undermining international competitiveness. Driven by vigorous growth of private consumption and residential construction, domestic demand pressures have intensified, contributing to the worsening current account deficit. Addressing these imbalances is crucial in order to maintain the good recent performance. This section examines the recent behaviour of the economy, provides a short-term projection and identifies the main risks surrounding it. It analyzes in more detail the possible overvaluation of the housing market and the behaviour of the inflation differential and ends by providing a set of policy recommendations to help tackle these problems.

Budget outcomes have steadily improved in the last decade, as Spain has continued its fiscal consolidation process. Several forces could make it more difficult to maintain the current prudent medium-term fiscal policy, which is needed both to provide room to manoeuvre in case of an economic downturn and to prepare for the budgetary effects of the predictable sharp deterioration in the age structure of the population that will take place in the coming decades. Against this background, the authorities have signalled their commitment to maintain a sound fiscal policy. They have also adopted a series of reforms that aim to increase public-sector efficiency and prepare for the long-term fiscal effects of the ageing process and the resulting rise in demand for health and dependency care. This chapter aims to analyse the forces acting on both the revenue and expenditure sides of the budget in the longer term and the authorities’ strategy to address them. It also provides some advice, in light of the previous analysis, to ensure that the medium- and longer-term fiscal objectives are jointly consistent.

Strengthening technological innovation and using new technologies are some of the key components of Spain’s policy for stimulating productivity growth and guaranteeing the persistence of its medium-term economic convergence with the most advanced OECD countries. This chapter examines the different factors responsible for the economy’s poor technological innovation performance. It looks in turn at the main features of innovation policy, the performance of the education system – especially at the university level – and the framework conditions for innovation – in particular the functioning of the labour market, competition policy and financing of start-ups, including venture capital – various areas in which the government has recently launched a set of reforms. The objective is to assess the main measures proposed and to suggest additional ways of strengthening the innovation performance of the country.

As part of their efforts to establish conditions conducive to increased productivity growth, the Spanish authorities have made improving the functioning of the goods and services markets one of their priorities. Efficient organisation of these markets is one of the essential ingredients of a dynamic economy, helping as it does to stimulate efficient static resource allocation, reduce costs and encourage innovation. In Spain, there is indeed a great deal of room to enhance competition. This chapter looks at the main shortcomings of the product markets and analyses the reforms introduced in recent years. These reforms are designed first of all to modernise the general competition policy framework, but they also concern numerous sectoral aspects such as the regulation of certain network industries, in particular electricity and the distributive trades sector, as well as questions relating to corporate governance. The main economic policy recommendations deriving from this analysis are summarized at the end of the chapter.