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NUTS2

Earlier posts have described Argentina’s fiscal federalism as a real-world picture of what U.S. federalism may look like ten or twenty years hence: escalating federal transfer payments; profligacy and dysfunction at all levels of government; reckless state gambles on federal bailouts; public insolvencies and increasingly desperate central interventions. However, fiscal federalism—that is, central tax authority, coupled with local authority to spend and borrow—is a disaster just about everywhere one looks. Lately, the global bond markets have been looking at Spain.

They do not like what they see. Yields on the country’s 10-year bonds have again risen above 6%, notwithstanding tough austerity talk and ECB interventions.

Spain isn’t Greece. For one thing, it’s a lot bigger. For another thing, its debt-to-GDP ratio (around 70%) remains manageable, even though it has risen fast since 2008. It’s the country’s budget deficit that alarms the markets (as well as the high priests of austerity in Brussels and Frankfurt). And the alarm, in turn, has a lot to do with Spain’s federalism. In the last (2010-2011) budget-and-tussle-with-Brussels cycle, the Spanish government promised to bring public debt down to 6% of GDP. Instead, the number came in at 8.5%. Overwhelmingly, the excess was attributable to Spain’s 17 regions—“autonomous communities” or “NUTS2,” in the European Commission’s nomenclature.

The regions gained a great deal of autonomy after the fall of the Franco regime. (Under the Constitution, some are more autonomous than others.) Over time, they gained additional autonomy and, fatefully, federal transfers. In 1985, their share of public expenditures was 15.8%; it is now over 37%. While some regions have been granted tax autonomy, virtually all of the increase is attributable to increased federal transfers and revenue sharing. The regions spent—sorry, “invested”—the money in the things that also attract our states and their politicians: health care, education, and public bureaucrats. Since 1996, the public workforce has grown from 2.2 million to nearly 3.2 million.

The fiscal federalism splurge was masked by a long investment and real estate boom. And the enthusiasm for decentralization was fueled by a number of factors: a reflex against the centralist Franco regime; a well-meant but unavailing desire to defuse Catalan and Basque nationalism; and, not least, the promptings of the Eurocracy, which pushed and financed regionalism all across the continent on the theory that whatever is bad for the nation-state is good for the European Union. But the boom is long over, and costs of regionalism have hit home.

The Spanish government, now in the hands of Prime Minister Mariano Rajoy’s conservative People’s Party, has promised the EU to make up for last year’s overspending through yet more austerity. And it has enacted measures to crack down on the regions. Neither of these things is going to happen. The new deficit targets (5.3% for 2012, 3% for 2013) imply an absurdly harsh tightening—far harsher than anything contemplated by any other EU country, in a nation with 25% unemployment. The European powerbrokers may insist on the numbers and pretend to believe them, but the markets plainly don’t; that’s why they’re acting up.

As for Spain’s regions, fiscal federalism’s moral hazard is far too deeply engrained to be cured with stern announcements and get-tough enactments. To be sure, the regions are so broke that no one (with the possible exception of some German Landesbank) will be sufficiently stupid to lend to them. Thus excluded from the bond markets, they will have to come to Madrid hat in hand. Senor Rajoy may be able to drive a hard bargain at least with the regions that are under his party’s control. Alas, that excludes two of the largest regions: Andalucia, which is governed by a Socialist-Communist coalition; and Catalonia, governed by we’re-too-big-to-care nationalists. (Think of it as California with a really good soccer team.) Plus, there is more than one way to deal with public debt. Regional governments have dealt with it by not paying their vendors, from cleaning services to pharmaceutical firms. In a well-meant attempt to save Spain’s private economy, Madrid assumed and paid a big chunk of those debts. The regions will reward the intervention by again not paying.

Spain’s federalism differs greatly from ours. As noted, it is “asymmetric” and grants some regions more autonomy than others; it also features not two levels of government but four (national, regional, provincial, and municipal). Admittedly, and alarmingly, we have replicated those features—asymmetry (for California) in the Clean Air Act, a multiplicity of very robust local jurisdictions under state laws and constitutions. Still, Spain has explicitly constitutionalized those institutions. Moreover, it is locked into the EU’s supra-national federalism. In short, Spain’s problem is constitutionalized multi-level lunacy.

It remains true nonetheless that the problem of the regions is a large part of the overall picture. And the central lesson is this: once you’re too far into fiscal federalism’s morass, it becomes very hard to find a way out.

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