German Chancellor Angela Merkel advocates higher interest rates to cool the German economy while Spanish unemployment has hit 6.2 million – 27 out of 100 people able and willing to work  simply cannot. As Figure 1 shows, unemployment has reached a new peak and in parts of the media austerity gets the blame for this devastating labour market situation. But are public spending cuts really the root of the problem?

 

Figure 1: Spain unemployment rate

Source: Spain National Statistics Institute, Eurostat

 

Since its peak in early 2011, government consumption has declined by 6.7% in real terms. That is substantial, but as a share of GDP it amounts to a reduction of just 1.0%. Investment spending from the public sector is declining alongside other expenditures, but residential construction has had a much bigger impact. Its share in total construction has fallen, but at 66% over the past year of available data it remains dominant. From a labour market perspective, it’s this fall in construction that has led to significant layoffs. Figure 2 compares the amount of floor space that permits were issued as well as the number of people employed in the construction sector. At the height of Spain’s real estate bubble in 2007, for each member of the population permits for 3.4 sq mtrs were issued during a twelve-month period. That fell to just 0.4 sq mtrs in the year to Q3 2012 and the number of jobs has been mimicking the decline.

 

Figure 2: Employment in the construction sector (left hand side) and one-year total of square meters of construction permits (right hand side)

Source: Spain National Statistics Institute, Spain Ministry of Development

 

The number of direct job losses in the construction sector amounts to 43% of the total fall in employment between Q3 2007 and Q1 2013. However, it should be noted that construction has a high employment multiplier, meaning that a job lost in construction itself causes significant additional in other parts of the economy such as manufacturing (e.g. building materials) and services (e.g. real estate services).

 

Taking the estimated UK construction multiplier of around 2.8, we would expect the 1.7 million directly lost jobs in construction to cause another 3.0 million job losses along the value chain and from the overall reduction in economic activity associated with falling sector employment. In sum, we estimate that 4.7 million jobs were lost due to the collapse of Spain’s building industry, under the assumption that the economic impact of jobs in the sector is similar to that in the UK. This is a rough estimate and the actual impact may diverge for a number of reasons, but more accurate figures would probably show a similar picture.

 

The bottom line is that the ruin of Spain’s outsized construction industry alone can explain much of the surge in Spain’s unemployment. Certainly, a reduction in domestic demand due to austerity further undermines an economy weakened by the crumbling of one of its major pillars. However, the underlying cause for Spain’s malaise is the building boom that distorted the economy. More government spending may help the transition of idle human resources into more productive sectors. But like in the US, Spain’s labour market will probably only revive when building recommences.

 

Figure 3: Change in employment in aggregate and in the construction sector between Q3 2007 and Q1 2013

Source: Spain National Statistics Institute, Cebr