The Pain in Spain: Recession Hits Hard

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Such rules, says Hilario Albarracín, head of advisory services in Spain for consultancy KPMG, have led to an inflexible, costly workforce that finds it difficult to adapt to the current economic climate.

To boost Spain's competitiveness, analysts say, hard choices must be made. That includes cutting employee benefits, delinking worker salaries from inflation, and outlining inevitable job losses. Already, automakers such as Ford (F), BMW (BMWG.DE), and Citroën (PEUP.PA) have reduced the number of shifts at their Spanish plants, with layoffs expected by the end of the year. KPMG's Albarracín figures many domestic companies will cut wages between 10% and 20% this year, as well as reduce employees' working hours. "People in Spain are prepared to accept lower salaries than had been expected in the past," he says.

Changing Expectations

That was true for Claudia Hervoso, a 29-year-old graphic designer from Madrid, who took an 8% pay cut in January. Faced with falling customer demand at the midsize marketing firm where she works, Hervoso says she was willing to accept a reduced salary if it meant she kept her job. "I have a mortgage to pay and can't afford to be unemployed," she says. "If I have to take a pay cut, so be it."

The other obstacle Spain must overcome, economists say, is the heavy bureaucratic burden placed on business. According to BBVA's Domenech, regulatory disparities among the country's 17 provinces make it expensive for companies to expand domestically. A Catalonia-based company looking to set up shop in Andalucía, for instance, would have to file paperwork in both Barcelona and Seville, adding extra layers of bureaucracy to the process of expanding a business. "The different rules produce competitive barriers within Spain's internal market," he says.

To solve this problem, Domenech believes more coordination between the Spanish regions is needed to reduce companies' administrative costs. Yet while such reforms would certainly boost efficiency, skeptics question whether provinces such as the Basque Country and Catalonia, which jealously guard their independence, would be willing to give up certain powers to boost the nation's overall competitiveness.

Market reforms may be unappetizing to some, but they will become more critical as Spain's unemployment rate continues to climb and the country's GDP goes from bad to worse. During the good times, Spaniards paid little attention to improving their global competitiveness. Now faced with the worst recession in generations, Europe's fifth-largest economy suddenly finds itself being forced to take action.

Scott is a reporter in BusinessWeek's London bureau .