Founded in 2016, Ceteris Paribus is A student-led economics and finance publication at Davidson College.

Spain-Catalonia Conflict

by Sean Wright

 

 (Photo via KLM)

(Photo via KLM)

Barcelona, situated on the eastern coast of Spain, has long been recognized around the world for its delicious food, awe-inspiring architecture, and Mediterranean beaches. But recently the city has become a hotbed of political conflict, spurred by the disagreement between Catalonia, one of Spain’s 17 autonomous communities, and the central government of Spain. Autonomous communities are essentially the Spanish version of states or provinces. These communities have varying degrees of political authority and autonomy, with Catalonia being one of the most independent. However, centuries of conflict between the Spanish central government (located in Madrid) and the Catalan regional government (Barcelona), coupled with recent economic problems, have caused simmering tensions to boil over. Catalonia is demanding independence from Spain, and the central government is adamantly refusing.

 

 (Map via SomTribute)

(Map via SomTribute)

The Catalan calls for independence led to a regional referendum on October 1, which was quickly declared illegal by the central government. When Catalans arrived at the polls to vote, they were met by officers from the Guardia Civil, Spain’s paramilitary force, who had dispatched to polling places to stop voters from participating in the referendum. Naturally, the angry Catalan voters did not like this, and violent clashes broke out between prospective voters and Guardia Civil officers. By the end of the day, graphic images of these violent encounters were circulating around social media. The forceful intervention of the government, coupled with the results of the referendum (90% of voters cast ballots in favor of independence), became a rallying cry for the angry Catalan secessionists.

 

 An image from the October 1 referendum. (Photo via CNN)

An image from the October 1 referendum. (Photo via CNN)

Although these results seem to indicate overwhelming support for independence, these numbers are extremely skewed. Due to the illegality of the vote, the large majority of Catalans in favor of staying with Spain abstained from voting. Furthermore, since the vote was not sanctioned by Madrid, many separatists were able to cast multiple votes in favor of independence, distorting the results even more. The ambiguous and violent outcome of the referendum further heightened tensions between the two parties. On October 27, the Catalan regional government declared its independence from Spain. Their declaration, however, was not recognized as legitimate by any other countries. In response, Mariano Rajoy, the Prime Minister of Spain, fired the entire regional government.

At an initial glance, Catalonia seems to have an economic case for secession. Its population of 7.5 million people makes up 15% of the Spanish population. However, the region provides about 20% of Spain’s gross domestic product. Additionally, Spanish GDP per capita is €24,000, while Catalonia’s is €28,600. In the eyes of the Catalan separatists, these figures demonstrate that Catalonia is in better economic shape than Spain, and that the autonomous community would be better off on its own.

Like most countries around the world, the Spanish economy was badly damaged by the 2008 financial crisis. However, few countries were hit as hard as the home of flamenco dancing, paella, and Picasso. According to the OECD, Spain suffered the second-largest reduction in economic output of all countries, behind only Ireland. Although Spain’s GDP has begun to recover, the country is still dealing with the fallout from the crisis, with an unemployment rate of 17.1% and the largest budget deficit in the European Union. Among people aged 25-29, the unemployment rate is an appalling 25.6%. Statistics like these are part of the reason that the Catalan independence movement has so many young supporters--they see the Spanish government as having failed them, so why not take the risk of seceding if it could offer them a better future? However, upon analyzing the economic consequences of a Catalan secession, one realizes that the negative consequences far outweigh the potential benefits of such a split.

The first and most visible consequence of an independent Catalonia would be an exodus of prominent corporations from the region. In fact, due to the state of political uncertainty, this has already begun. The two biggest Catalan banks, Banco Sabadell and CaixaBank, announced shortly after the October 1 referendum that they would be moving their headquarters elsewhere in Spain. To make matters worse, within the next few weeks, large multinational companies like Cellnex (telecommunications), Abertis (toll road operator), Inmobilaria Colonial (real estate), Gas Natural Fenosa (energy), and Oryzon (pharmaceuticals) all moved their headquarters to Madrid. Additionally, tech giants like Amazon, Airbnb, and WeWork have offices in Barcelona, and would be candidates to leave in the case of an actual separation.

Screen Shot 2018-02-08 at 1.00.09 PM.png

 

Why are companies so eager to leave a potentially independent Catalonia? One reason is the effect of the political uncertainty on their stock prices. As publicly-traded corporations, these companies are beholden to their shareholders, and a mandate to create value for them. By staying in Catalonia, these companies would have been subject to months of violent stock price fluctuations, all due to the political uncertainty in the region. Shareholders tend to be intolerant of prolonged stock price volatility, and staying in Catalonia while the conflict played out would have been a surefire way to ensure this kind of price unpredictability. If an actual split were to occur, there would be further uncertainty for companies in Catalonia, as the new country would need time to establish itself and its institutions.

 The stock prices of CaixaBank and Sabadell both experienced volatility in the wake of the referendum. (Graph via Reuters)

The stock prices of CaixaBank and Sabadell both experienced volatility in the wake of the referendum. (Graph via Reuters)

Additionally, companies were also pressured by the international finance community to leave the region. According to Spanish newspaper El Pais, in the wake of the October 1 referendum, Catalan companies “received a deluge of phone calls from international credit rating agencies and investment fund managers, all delivering the same message: Catalonia had become synonymous with uncertainty, and uncertainty is something the markets hate.” Credit rating agencies are responsible for determining the creditworthiness of borrowers, and their analysis of a company’s ability to repay its debts determines the interest rate at which firms can borrow money. If companies stayed in Catalonia, they risked a credit downgrade by the agencies, which would have effectively increased the interest they pay on their debts. Investment fund managers are responsible for allocating the assets of their respective investment funds, which hold sizeable positions in these corporations. Since they possess such substantial amounts of stock, they hold influence over the operations of these companies. If companies were to ignore investment fund calls to move out of Catalonia, these funds could sell their positions, which would likely drive down the company’s stock price. Even worse, an exit by an investment fund would serve as a public rebuke of the company’s management and strategy. As illustrated by these demands from the international finance community, Catalan companies had, and will continue to have, strong incentives to move. Otherwise, they'll face steep consequences in the global capital markets.

Another repercussion of secession for Catalonia would be loss of its European Union membership, which it currently enjoys as an autonomous community of Spain. This would be extremely harmful to both the Catalan government and businesses in the region. Jean-Claude Juncker, President of the European Commission, has made it clear that an independent Catalonia “would find itself outside the European Union.” This means that they would lose all advantages of being in the bloc. Most notably, they would lose access to the EU single market and customs union, as well as the EU regulatory framework.

The removal from the EU single market and customs union would likely be the most devastating. This single market allows countries the free movement of people, goods, services, capital between other members of the bloc as if they are the same country. The loss of this privilege would mean that Catalonia would have to re-negotiate trade agreements between all the countries it currently trades with. In the meantime, higher tariffs would be implemented, putting a severe damper on international trade. How difficult is the process of re-negotiating trade agreements with the bulk of your trading partners? For some indication, one can look to Britain, who is currently going through the arduous and time-consuming process of severing its ties with the European Union. To make matters worse, since Spain is an active member of the EU, they could lobby other member countries to isolate Catalonia and refuse to trade with them.

 

Catalonia would also lose access to the EU regulatory framework, which would prove to be a massive inconvenience for both the government and remaining Catalan businesses. This is due to the wide scope of policy that the EU regulates. These regulations cover thousands of business issues, including: formation, capital, and disclosure; domestic mergers and divisions; multinational business regulations; director and board member regulations; shareholder law; sustainable investment guidelines; and transparency regulations. In the case of a secession, these rules, along with thousands of others, would need to be re-written by the Catalan government. In addition to being an extremely tedious and time-consuming task for the government, this would also leave Catalan businesses in a state of purgatory as they waited for business regulations to be re-written. Since they would be unsure of the content of the new laws, business operations would be severely interrupted while they waited for the new regulations. This regulatory uncertainty would even further incentivize a business exodus out of Catalonia.

Along with all these consequences, Catalonia would also face serious declines in its tourism industry. Catalonia, the most popular region for tourism in Spain, is attractive to both domestic and international visitors. Its coastal location offers beaches and a variety of aquatic activities. Urban centers like Barcelona and Girona are known for their culture, architecture, history, food, and nightlife, among many others attributes. In 2016, there were more than 18 million visitors to the region, representing 25% of all tourism in Spain. Barcelona is the 12th most popular city in the world for tourism. But all these impressive statistics have been threatened by the conflict between Catalonia and Spain. Tourists, spooked by the political unrest in the region, have already slowed down their visits to Catalonia. In the two weeks after the October 1 referendum, Catalan tourism slumped by more than 15%, and some government agencies estimate that it could fall 25-30% by the end of 2018. This drop in tourism will not only cost Catalonia a large chunk of revenue, but it will also threaten the 400,000 jobs the Catalan tourism industry provides.

 (Photo via TripAdvisor)

(Photo via TripAdvisor)

The common theme among all these consequences is uncertainty. Uncertainty is bad for business, and the conditions in an independent Catalonia would leave many businesses little choice but to move at least their headquarters, if not all of their operations, out of the new nation. This outflow of capital and loss of corporate tax revenue would ravage a young Catalonia, and leave them in extremely poor economic condition. There’s no doubt that Catalonia is a particularly strong autonomous community--but that does not mean that it would be economically viable on its own. To put an end to this political standoff, the Catalan government should try to negotiate improvements to their autonomy agreement with Spain, rather than take the desperate, irreversible step of secession.

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