Crisis in Catalonia Threatens Eurozone Stability

On October 27, 2017, Catalonia, an economically powerful and culturally significant region in northeast Spain, declared its independence. Shortly after, the Spanish parliament invoked Article 155 of the Spanish constitution at the request of Prime Minister Mariano Rajoy. This article, labeled the “nuclear option” by many, gives the government the authority to “suspend some of a region’s autonomy” if that region’s government “fails to fulfill the obligations imposed upon it by the Constitution, or other laws, or acts in a way seriously prejudicing the general interests of Spain.” Invoking this legal authority, the Spanish government has jailed Catalan ministers and independence leaders, charging them with rebellion and sedition. The Catalan President, Carles Puigdemont, has fled to Belgium, hoping to escape charges and rally greater support for Catalan independence.

The conflict between Catalonia and the Spanish central government has developed into a crisis, and observers have begun to ask what political turmoil in Spain could mean for the wider European Union (EU). Some have suggested that the EU’s reputation as a source of stability within the region will inevitably be damaged if it proves incapable of preventing a division of sovereignty within one of its member states. The situation could worsen if Catalan’s success serves as inspiration to other European separatist movements, calling into question the stabilizing effects of Europe’s integration efforts. While these political ramifications are serious, they are not the only cause for concern. It is not only the political stability of the European Union that is threatened by an aggressive showdown over Catalan independence but also the economic stability of the Eurozone.

The Spanish economy has recovered remarkably from the economic crisis it faced in the early 2010s. Indeed, most of the European community seems to have recovered from the Eurozone crisis, in which huge levels of sovereign debt eroded confidence in major European financial institutions and economies and at one point appeared to signal the demise of the European experiment itself. However, the recovered economies of some member states remain fragile, and it is unclear whether a nation like Spain would be seriously harmed by a battle to retain sovereignty over one of its most productive regions. The negative effects of a faltering Spanish economy would reverberate throughout Europe, and a potential rise in the number of crises demanding the attention of Europe’s infrastructure of political and economic integration could further escalate the calamity.

The current political moment in Catalonia reached a critical point during the region’s independence referendum on October 1, 2017, undertaken against the wishes of the staunchly unionist Spanish state. While only 43 percent of Catalonia’s population voted, 90 percent of those voters favored independence. The tremendous rate of approval, combined with the low turnout, can be attributed to the decision made by many of those opposed to Catalan independence to avoid the referendum entirely in protest, as well as to the strong efforts of the Spanish state to obstruct voting. The Catalan government reported that Spanish police were responsible for at least 337 injuries on the day of the referendum and used rubber bullets to subdue voters and activists. Catalan President Carlos Puigdemont stated that “the unjustified, disproportionate, and irresponsible violence of the Spanish state…helped to clarify all the doubts” that had remained among those championing independence. No true popular mandate for Catalan independence has surfaced so far, but it is clear that the pro-independence faction remains large and determined.

Invoking Article 155 of its constitution allowed Spain to assert authority over Catalonia and calm markets, which had reacted strongly to Catalonia’s declaration of independence – Spain’s benchmark index, Ibex 35, had dipped 1.5 percent following the declaration. However, the Spanish state’s forceful actions are likely to provide another rallying point for the independence movement, as Catalonia prepares for the December elections scheduled to fill the positions left open by jailed separatist officials. Public sentiment has already shifted. A recent poll shows that 48.7 percent of Catalans favor independence, a much higher proportion than the 41.1 percent who favored independence in June and the greatest support observed since December 2014. As long as the push for Catalan independence remains alive, it has the potential to stir panic within Spanish markets.

Though Catalonia has a particularly strong regional identity and a sense of relative autonomy within Spain, the push for independence has been largely influenced by economic factors. The region is one of Spain’s most productive, and, according to government statistics, it accounts for about twenty percent of the country’s economic output while holding only sixteen percent of the total population. Catalonia’s GDP per capita is greater than that of Spain in general, closer to the rest of the Eurozone’s GDP per capita than anywhere else in the country. The region also contributes more in taxes to the central Spanish government than it receives back in public spending, a fact that weighs heavily on the minds of separatists. While residents of Catalonia contribute 20 percent of Spain’s tax revenue, only 14 percent of Spain’s spending is directed back towards the region. Pro-independence Catalans believe that their economy would flourish if it did not need to help buoy the rest of the Spanish economy. This belief is partially a result of the disproportionately large role Catalonia played in pushing Spain out of its debt crisis. Under the austerity measures adopted to rein in public debt, Catalonia suffered higher budget cuts than any other Spanish region.

However, there are reasons to be less optimistic about the economic outlook for an independent Catalonia – CaixaBank and Sabadell, Spain’s largest banks, along with more than 2,000 other companies, have already left the region in order to avoid political uncertainty and retain the advantages of a location within the Eurozone. Spain’s Ministry of Employment and Social Security reported that Catalonia lost almost 15,000 jobs in October. Nevertheless, as uncertain as Catalonia’s economic future is, it may still be better than the economic situation Spain would face after losing sovereignty over such a productive region.

The Spanish economy is one of the great success stories of the Eurozone crisis. After suffering from a private sector economic shock in 2008, the Spanish government had no option but to accept a massive bailout of $125 billion from European finance ministers, which Prime Minister Rajoy called “a loan to recapitalize Spain’s weakest banks.” Five years later, official calculations showed that the country’s economic output has returned to pre-crisis levels.

While this growth is promising, it is clear to some that this recovery is not yet complete, as evidenced by an unemployment rate that remains at 18.6 percent, significantly higher than pre-crisis levels and about double the average Eurozone rate. Unemployment, which peaked during the crisis at 26 percent, is even greater among young workers, for whom it is around 39 percent. Another result of the crisis and the need to accept foreign funds to bailout Spanish banks was a rise in government debt, which was 40 percent of GDP before the crisis but which now stands as high as 100 percent of GDP. While Spain’s economy has rebounded strongly from its crisis, there have been lasting effects that continue to malign Spain and leave it vulnerable to future shocks.

If Catalonia achieves independence, Spain’s potential losses could be devastating. Though the country’s debt level is already quite high, an economist at the Centre for Economics and Business Research has calculated that, in the event of a relatively peaceful Catalan exit, the debt would surge to 116.4 percent of GDP and Spain’s annual deficit would jump from 4.5 percent to 7.8 percent of GDP. Forecasters predict that, if independence is achieved, demand for Catalan and Spanish debt could collapse, seriously increasing the cost of government financing and potentially causing a Spanish recession that could spread throughout Europe. The most pessimistic forecasts thus fear a resurgent Eurozone crisis.

It is important to note that Spain’s recovery has occurred in conjunction with an aggressive bond-buying program from the European Central Bank (ECB), which is beginning to signal a change in its policies. The ECB will be likely to gradually phase out the practices it adopted in response to the Eurozone crisis, meaning there will be less bond purchases and higher interest rates. It is unclear how the Spanish economy will react to such measures, but this shift becomes even more concerning when one considers the potential loss of Catalonia, whose productivity has played a significant role in driving Spain’s growth. If the Spanish economy does falter as a result of the crisis in Catalonia, this will likely discourage the ECB from halting its bond-buying program, preventing measures aimed at further stabilizing the Eurozone.

A successful Catalan independence movement could be destabilizing in another way: by causing a domino effect throughout Europe. One region managing to break away from the sovereignty of a European Union member state could encourage other regions across Europe to seek independence from their sovereigns. President of the European Commission Jean-Claude Junker has stated that, “if Catalonia is to become independent, other people will do the same,” and expressed dismay at the prospect of “a euro in 15 years that will be 100 different states.” Aside from the obvious threat to the political stability of the European Union, this sort of fragmentation would likely cause economic trouble within the Eurozone.

In Italy, for example, two wealthy Northern regions, Veneto and Lombardy, have recently conducted referenda seeking greater autonomy from the central government. It is not difficult to imagine these regions ramping up their independence efforts should Catalonia secure a successful departure from Spain. The same can be said of separatist movements in South Tyrol and Sicily. It should be noted that Italy continues to hold large public debt and has not recovered from the Eurozone crisis nearly as well as Spain has. The International Monetary Fund (IMF) forecasted earlier this year that another decade will pass before Italy’s economic growth returns to pre-crisis levels. If pessimistic observers suggest that Catalan independence could potentially push the Eurozone back into crisis, what might be the results of Italy’s larger economy, which has recovered at a much slower rate, attempting to withstand several separatist movements simultaneously?

Italy is also seen as at risk, as it the most vulnerable of the Eurozone states after Spain, and there is no reason that think that Corsican or Flemish separatists will be any less emboldened by Catalan independence. There would certainly be immediate economic consequences of a Catalan separation from Spain that would likely trouble the Eurozone, but the potential for wider political fragmentation in Europe poses an even greater threat, one which the countries of the Eurozone are more prepared to handle now than they were in 2010 but a threat nonetheless.

President Puigdemont is currently in Belgium facing an international arrest warrant, charged by the Spanish government with rebellion, sedition, misuse of public funds, and breach of trust. He will remain in Belgium through the December 21st elections, wherein he will appear on the ballot along with several members of his party currently detained in Spain. In the wake of Catalonia’s political turmoil, Spain has adjusted its 2018 growth forecast from 2.6 percent to 2.3 percent. Prime Minister Rajoy has said that, if pro-union officials are elected, GDP could grow between 2.8 and 3.0 percent and be accompanied by the creation of 500,000 jobs. As of now, separatist and unionist support remain at very close levels, but those favoring independence retain a slight edge. Eurozone leaders will be following the election closely and with an eye towards their own economic futures.