Why does Catalonia want to quit Spain? It’s the economy, stupid

Catalans blame Madrid for their economic malaise. But the real culprits are in Brussels, Frankfurt, and Berlin. This disconnect is poised to fuel more regional separatism in Europe.

Disunity is in the air across Europe. Catalonia is the flashpoint, but it is not alone. Its illegal, but-clumsily-suppressed, referendum (and its, now overruled, declaration-of-independence) was preceded by the narrowly-lost Scottish referendum on independence from the UK, the successful Brexit referendum, and legal but unenforceable referenda in the Veneto and Lombardy regions that overwhelmingly opted for more autonomy within Italy earlier in October.

Why, and why now? It’s easy to get lost in the mire of local explanations and recent historical factors, and Spain has those in abundance. They matter, and they may explain why Spain is the most confrontational of the struggles between separatist, nationalist and supra-national ambitions on this Continent. But the core forces lie much deeper and are in essence much simpler.

These are that even tiny Catalonia, with its 7.5 million inhabitants, is far larger than the maximum sized society in which humanity evolved, and that larger aggregations can only be held together via either overwhelming force or overwhelming prosperity. The European Union, which was intended to unite Europeans in plenty, was always doomed to fail on that front, as Wynne Godley saw so clearly a quarter of a century ago. So it has fallen back on force as its means of holding itself together.

The maximum number of people who can maintain effective personal bonds with each other is about 150. “Stone Age” societies had about 150 members, and even villages at the time of the William the Conqueror’s Domesday Book numbered about the same. This scale, known as the Dunbar Number, was first hypothesized by the evolutionary biologist Robin Dunbar in the 1980s and was subsequently confirmed by anthropologists.

The logic behind such a small number is simple. We, humans, are a social species, and interacting in a society requires knowing, not only something meaningful about each individual whom you encounter but also something about how each of the others feels about each of the others in that society. You don’t want to set the table for a party and put two people who detest each other together (unless you’re a social sadist, but let’s not go there).

Stronger together?

The number of person-to-person bonds rises rapidly with scale. With ten people, there are 45 person-to-person relationships; with 100, there are 4,950. With 150, there are about 10,000 (the exact number is 11,175; the number scales roughly to the square of the number of people, divided by two), which appears to be the absolute limit for the number of relationships our brains can handle.

Even in Catalonia, there are about 30,000 billion person-to-person relationships. That’s 4,000 times as many relationships as there are people on Earth. There’s no way that anyone can hold that many personal interactions in their head, so instead we invent abstract concepts like “Catalonia,” and “Spain” to which we relate as if they were people.

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These abstract concepts of region, nation, and empire have existed for no more than a few percent of humanity’s time as a species on this planet, and they have always had an uneasy relationship with the tiny bands in which our species evolved. Yet today they are the prism through which we try to understand everything that happens. Thus, it’s no wonder we get things so badly wrong.

The real mystery, therefore, is not why Catalonia might want independence from Spain or Scotland from the UK. It’s how these huge aggregations—even comparatively small ones like Catalonia—came about in the first place, and how they survive against our comfort zone of intimate tribalism.

There the answer is a factor that economists have named, but usually ignore: “economies of scale.” A large group of people can specialize within itself far more than can a group of 150, and with that specialization comes the capacity to apply far more force. A band of hunter-gatherers was no match for an agricultural society, where slaves worked the fields and soldiers maintained and extended its boundaries.

As first city-states and then nation states developed, our ability to project our range for intimate bonding from 150 people to 149 plus the state, led to some strange mental dichotomies. Within the community itself, we expect some recognition of both our individuality and our bonds. But to maintain that community, we accept that those outside it, or those subjugated within it, can be treated as “other,” and effectively de-humanized. So, we demand democracy within our group but condone the use of force outside it.

That tension has been alive since the first days of democracy. We celebrate Athens as the birthplace of democracy, and Aristotle as its foremost philosopher. However, in discussing slavery, Aristotle could opine that “Tyrannical too is the rule of a master over slaves; for it is the advantage of the master that is brought about in it,” and yet follow this immediately with the comment that “Now this seems to be a correct form of government.”

It was “correct” only because slave ownership gave Athens the economic power with which to grant its citizens a comfortable life.

Modern times

Today, no society of 150 would be self-sufficient outside a rainforest, and our small interpersonal communities are inextricably interwoven with mass-produced technologies that could never have been developed had humans stuck within their biological social limits. As a result, we are instead stuck with the tension between community and economies of scale. That tension can only be contained if any larger grouping either brings undeniable economic advantages to the smaller groupings within it or if it suppresses their discontent with force.

The eurozone was supposed to bring undeniable economic advantages to its member states: to bring about a “United States of Europe” with the economic might to match the United States of America. But it has failed, and now that the glue of prosperity has proved illusory, Spain has opted for force to hold itself together.

This wasn’t supposed to happen. Spain is the poster child for the failings of the euro, even more so than Greece, because according to the eurozone’s rules, Spain was doing everything right. Those rules were that government debt should be capped at 60 percent of GDP and that the annual government deficit should be less than 3 percent of GDP, with a preference for running a government surplus over the longer term. If those rules had worked to deliver prosperity, the separatist forces in Catalonia would be dormant, because Spain was the only country in the eurozone to meet those rules before the Global Financial Crisis hit. Spain entered the eurozone with a government debt level of 70 percent of GDP and reduced it steadily to under 40 percent of GDP before the crisis.

Even Germany didn’t do as well, according to rules its politicians played the dominant role in setting. Germany entered the euro period with a government debt level of 60 percent, spot on target (just fancy that!). But despite its expectations, and its proclivity for fiscal discipline, it didn’t improve on this level. Instead, the ratio fell slightly from 2000 till 2003, but then rose to 70 percent in 2006, and 64 percent of GDP when the Global Financial Crisis hit. After the GFC, Germany’s government debt level grew as rapidly as Spain’s, but it stopped growing as the global economy recovered, and Germany’s under-priced exports started to rise once more.

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Spain really only did so well on government debt before the GFC because of private debt, which the eurozone’s rules completely ignore, was out of control and the euro undoubtedly played a significant role in unleashing private debt. When Spain had its own currency, private debt rarely exceeded 80 percent of GDP. But just before the euro commenced, private debt started to rise faster than GDP, and it took off with the euro. Private debt almost trebled relative to GDP and fueled an unprecedented Spanish property bubble. It rocketed from 80 percent of GDP when the euro began, to 200 percent by the time the GFC struck, and it maxed out at almost 220 percent in 2010.

This private debt bubble is what caused Spain’s apparent prosperity in the lead-up to the GFC, and its collapse is what has caused Spain’s Second Great Depression since.

As I explain in my short, non-technical book, Can we avoid another financial crisis?, total demand in an economy is the sum of the turnover of existing money plus credit, which is created one-for-one when banks create new debt, and it is normally spent almost immediately by the debtor on assets or goods and services, thus stimulating asset prices and incomes. Mainstream economists deny this link on the basis of a model of banks as intermediaries rather than loan originators which is now being discredited by central banks, including very recently the Bundesbank. The data also screams that mainstream economists are accidental liars, and no more so than in Spain, where the correlation between credit and unemployment since 1986 is a staggering minus 0.94.

Berlin benefits

Germany, in stark contrast to the rest of the OECD, was able to pay down both government and private debt, because the fixed exchange rate it now shared with Europe meant that it could exploit that fixed exchange rate and its lower inflation rate to—let’s be frank here—screw eurozone countries which had higher rates of inflation.

One of the lesser-known magic numbers in the eurozone is a target rate of inflation of two percent per annum. This is the level that central banks around the world used to believe was the “natural rate” of inflation when they also believed that their DSGE models actually described the real world. If every country in the eurozone had hit that target, then the eurozone could have worked, even without fiscal transfers, because competitive parity would have been maintained between its member countries. But predictably, given its anti-inflation fetish after its experience of hyperinflation in the Weimar Republic days, Germany undershot the target, by berating its unions to accept lower wage rises.

Inflation in Spain wasn’t high by historical standards—it averaged just 3.1 percent from the start of the euro till the GFC—but inflation in Germany was substantially lower, at an average 1.4 percent per year.

It’s not much of a gap, but over time it had meant that prices of German goods are now 20 percent lower, when compared to Spanish products, than they were when the euro began. German prices are roughly 15 percent lower than Germany agreed they would be, and Spanish prices are roughly 5 percent higher.

With the euro’s ridiculous fiscal rules, and with the absence of any Euro Treasury to even things out by countervailing tax receipts and government spending, and the inability to devalue, the only way that Spain can restore parity with Germany is via deflation. This is what the austerity imposed by Rajoy’s government at the EU’s behest achieved. Spain’s price level, having been 20 percent above the eurozone target when the GFC began, is now only 5 percent above it.

But this has been to no avail since Germany’s inflation also fell after the GFC. The gap between Spanish and German prices is even bigger now than it was at the time of the GFC.

Exit door

With deflation as the only weapon to restore parity with Germany and an ineffective one at that, Spain’s membership of the eurozone is imposing poverty on its own regions, including the once prosperous Catalonia. This is the primary reason why Catalonia wants out of Spain, but it still wants to be “in” the European Union. It wants to escape the binds of its failing national super-community but doesn’t appear to realize that Spain’s failings are because of its membership of the eurozone.

The EU, meanwhile, is supporting its vassal Spain in its suppression of the Catalonian rebellion. The EU’s behavior here has been almost as ham-fisted as Rajoy’s sending paramilitary forces to bash voters, rather than the alternative of simply ignoring an illegal vote. Now, both the EU and Spain have lost the moral high ground in this contest between community and state.

Because the European Commission’s statement that the referendum was not legal was strictly true, but the failure to amend it to remove the statement that “we trust the leadership of Prime Minister Mariano Rajoy to manage this difficult process in full respect of the Spanish Constitution and of the fundamental rights of citizens enshrined therein” was a huge mistake. It made the EU complicit in the heavy-handed techniques that Rajoy has employed.

What will happen after Rajoy’s weekend decision to impose direct rule is anyone’s guess, but given Spain’s history of using violence to suppress internal dissent, it won’t be pretty. Nor will it end the forces for secession within Europe. The only things that will is either the abandonment of the euro itself or of the stupid rules of the Maastricht and Lisbon Treaties that have made the eurozone a force for poverty rather than prosperity.