Why Spain suffers from much higher inflation than the large countries of Europe

The resurrection of inflation is a phenomenon that is affecting practically everyone (even so, there are some exceptions). However, although the trigger for this price rise is global, some countries are experiencing much higher inflation rates than others, which may have negative consequences for the competitiveness of the most affected countries and for the most vulnerable households. Spain is among the economies that suffer a higher rate of inflation, especially when compared to the rest of the great powers of the Eurozone. What is the explanation for this ‘anomaly’ in the Spanish economy?

This week, the National Institute of Statistics published that inflation in Spain stood at 9.8% year-on-year in March, the highest figure since 1985. Meanwhile, in France the CPI is at 5.1%, in Portugal at 5.3%, in Italy at 7%, in Germany at 7.6% and in the euro zone at 7.5%. A combination of peculiarities is generating this inflation gap between Spain and the large economies of the euro zone.

The Moody’s agency has published an analysis this week that analyzes the differential between inflation in Spain and the great powers of the Eurozone: “The effects of the rise in energy prices have been more pronounced in Spain than in the rest of the Europe because the electricity bill is closely linked to the evolution of wholesale gas prices For example, in February, energy prices in Spain had increased by 43.7% compared to February 2021, compared to 32% in the Eurozone”.

This fact is, therefore, related to the high price paid in Spain for electricity and to the controversial methodology used by the INE to calculate the CPI, which does not include consumers with free market contracts, although the 60% of households have this type of rate, which has less volatile prices and is not linked in real time to wholesale markets.

CaixaBank Research economists published a note in which they highlighted the distortions generated by this calculation. According to the analysts of the Catalan bank, if the prices of the free market were incorporated and not only those of the regulated market, Spain would have closed the year 2021 with a general inflation of 4.7% instead of the official 6.5% and with a annual average in 2021 of 2.2% compared to the official 3.1%. Not only the methodology, but also the operation of this market is key to understanding why Portugal has much lower inflation than Spain despite the fact that both countries share an electricity market.

For all of the above and some other peculiarity, the gap is enormous: electricity in Spain has risen 80% in the last year, compared to 33.4% in the euro zone. There is part truth here and part methodological distortion. Another European economy with an electricity system closely linked to the volatility of the wholesale market is the Netherlands, where inflation has been above 11%, driven by a 94% increase in the price of electricity.

However, the proposal of the Government of Spain and Portugal to cap the price of gas, if it goes ahead, will have a significant downward impact on inflation. The gasoline bonus will also have a notable impact. The Dutch government is also taking steps to quell the situation.

On the other hand, Moody’s points out that it is also necessary to take into account the higher participation of energy in the price index (11.7%) of Spain compared to the Eurozone average (10.9%). This is no coincidence, since these weights are made according to the intensity with which the economies use each component (consumers and companies). In order to produce a unit of GDP, Spain probably needs to consume more energy than other economies with more efficient production in this sense (according to the latest data from the World Bank). So if the price of energy goods rises, this affects the Spanish economy and its production system to a greater extent.

gasoline and taxes

Experts also highlight the lower weight in Spain of fixed taxes on fuels. This low relative taxation allows Spain to have one of the cheapest final prices for gasoline and diesel in the euro zone, however when the raw material becomes more expensive, the price rise is higher in percentage compared to countries that have taxes higher in fuels. This would partly explain why the price of fuel in Spain has risen by more than 52% compared to last year, while in the average of the euro zone the increase has been 42%.

Analyzing the bulletin on fuel published monthly by the Government of Spain, it can be seen that the price of a liter of gasoline in Spain (1.58 euros) it was 47.3% tax, compared to 54% in the euro zone (1.77 euros). In the case of diesel, 43.2% of the final price were taxes in Spain and in the euro zone this percentage rose to 52%. A good part of these taxes are fixed (special taxes), whose weight is reduced as the raw material (oil) rises, thus lowering the percentage of taxes. Although Spain continues to have cheaper gasoline than the euro zone average, its price has risen much faster in recent months.

The latest definitive data on inflation in Spain is still for the month of February (the figure for March is preliminary), when the CPI rate was 7.62% per year. Of those 7.62 points, 4.75 points were due to increases in energy prices (electricity, fuels…). However, it is also true that little by little the rest of the components are beginning to show worrying growth rates, proof of which is that core inflation reached 3.4% in March.

Other explanations for the gap

On the other hand, there may also be other explanations whose demonstration is practically impossible in the short term. For example, an economy in which competition is relatively low tends to absorb more quickly and directly the increase in costs that come from abroad. Companies that do not face a competitive market (many similar companies fighting for the same public) have more control over prices and more chances to maintain your margins without losing market share.

Compared to past periods in which labor costs were the cause of the highest Spanish inflation, it can now be concluded that almost the entire inflation differential between Spain and the large countries of the euro zone due to the energetic componentproduct of an electricity market whose prices are more volatile, an incomplete CPI methodology, a greater weighting of energy in the index, the lower taxation of fuels and, probably, other residual factors that it is impossible to decipher right now.