Why Spain should take the money and (as soon as it’s economically prudent) run

As my colleague Uri Friedman discussed in today’s Morning Brief, the Spanish government has unveiled tough new austerity measures to reduce its deficits after securing a nearly $37 billion bailout from the European Union. The measures, part of the conditionalities attached to the bailout money, include cuts to unemployment benefits, the elimination of Christmas bonuses for civil servants and a rise in the value-added-tax. 

The government is already facing a backlash, including protests by miners over subsidy cuts, but data on past interactions between governments and international financial institutions suggests that Prime Minister Mariano Rajoy’s government is actually in the safest period of the crisis. When economic conditions improve is when he will have to worry about his government’s political prospects.

A paper recently published in the journal International Organization seeks to answer the question of whether IMF and World Bank interventions induce political crises. The authors, Axel Dreher of Heidelberg University and Martin Gassebner of the Swiss Economic Institute, began their research before the recent round of European bailouts but in an interview with Foreign Policy, Dreher said he sees similar dynamics at work in the recent crises.

The paper examines more than 90 developing countries between 1970 and 2002 and finds that intervention by one of the two international financial institutions significantly increases the likelihood of political crisis. These crises can be anything from coups and assassinations to mass demonstrations and general strikes.

An illustrative example discussed in the paper is the political turmoil which struck Bolivia in 2003, when more than 100 people were killed in political protests spurred by governments moves to raise taxes and increase natural gas exports. This followed 15 years of IMF-imposed structural adjustment program. The violent clashes led to the resignation of President of Gonzalo Sanchez de Lozada and, three years later, the rise of populist President Evo Morales.

The paper’s other significant finding is that the likelihood of a political crisis actually increases as economic prospects improve under assistance from an international financial institution. When times are really tough, the Dreher argues, the "government’s leeway is increased due to the availability of additional loans." Governments are able to blame unpopular programs on the necessity of cooperating with the outside institution and voters are unable to tell is the government is merely incompetent of if its hand are tied by the conditions of the loan.

"If the government remains under an arrangement while the economy performs better, this signals that the government is more incompetent because a really competent government would no longer need the help of the international organizations," Dreher says.

Countries like Spain, Italy and Greece may have more robust democratic institutions than developing countries like Bolivia, but they are no less susceptible to moral hazard.

"You can see that [European governments] are able to implement certain conditions by using the troika — the EU, the ECB and the IMF — by way of a scapegoat," he says. "They say, we don’t want to implement these conditions, we think they are too harsh, but we need the support of these organizations to stay in the Euro."

This is essentially the case Spanish Prime Minister Mariano Rajoy made to voters today, according to the New York Times, telling the public, "I know these are not pleasant measures but they are necessary."

But Dreher suggests that this kind of excuse won’t work forever.  "If the situation becomes better and the government remains in these partnerships with the conditions that come with the money, probably voters would turn against the government," he says."

Dreher and Gassebner’s research suggests that if governments like Greece and Spain want to stay in power, "they would have to try to get out of these programs as soon as the situation becomes better."

Of course, given the scale of the economic woes these governments are currently facing, that’s probably a problem they wouldn’t mind having right now.