Welcome to the World, the Country of Catalonia? by Bill O’Grady, Confluence Investment Management

On November 9, the Catalonia region of Spain is due to hold a referendum for independence. The referendum had previously been approved by the regional government; however, it was ruled unconstitutional by the Spanish Supreme Court. Currently, it is unclear whether the November 9 referendum would result in a different outcome.

This week, we will look at the separatist movement in Catalonia. We will start by giving a brief overview of the region’s history and politics, then look at the roots of the independence movement. We will explore the probability of independence, the potential future relationship between the region and the central government, and the role of the EU and the Eurozone. As always, we will conclude with market ramifications.

The Region of Catalonia

Catalonia, one of the country’s 17 districts, is located in the northeastern region of Spain. The regional capital of Catalonia is Barcelona. Catalonia’s population of 7.5 mm makes up 16% of Spain’s population, while the region accounts for over 18% of the country’s economy. Catalonia has a distinct language and culture from Spain. It is also one of Spain’s richest and most industrialized regions, accounting for almost 20% of Spain’s tax revenues.

Welcome to the World, The New Country of Catalonia?

Prior to the 15th century, when King Ferdinand of Aragon and Queen Isabella of Castile married and formally united Catalonia with Spain, the region was a fully independent country. Even after the two courts merged, Catalonia maintained its own institutions, remaining an effectively independent nation. In 1714, during the war of Spanish secession, the Spanish army formally conquered the region. Catalans are proud to mention that it took the combined Spanish and French armies a full year to conquer Barcelona. The Catalans have never forgotten that they were conquered and merged with Spain, with some pro-independence politicians pointing out that the region never chose to be part of Spain.

Not surprisingly, to this day, Catalans celebrate the day that Barcelona fell in 1714 as the National Day of Catalonia. On this date in 2012, more than two million people marched in support of independence.

When the monarchy was replaced with a democracy in 1931, Catalonia was given broad autonomy, with its own regional president and government that reported to the central government in Madrid.

The Spanish Civil War (1936-1939) and the ensuing dictatorial rule of Francisco Franco was ruthless for all Spaniards, but was especially brutal in Catalonia. The region was a Republican stronghold against Franco’s army, which resulted in heavy bombing of its cities, especially Barcelona. Franco’s ultra-conservative rule revoked any independence that the region had enjoyed. The dictatorship also attempted to suppress the Catalan identity, restricting the public use of its language. Following the death of Franco in 1975 and
the democratization of Spain, Catalonia was granted its own parliament but was still required to send its revenues to the central government in Madrid.

The Call for Independence

The calls for Catalonia’s independence are based on a variety of issues, but the two key disputes are cultural and economic. Culturally, Catalonia has a separate identity and language from Spain. Catalan culture is markedly different from Spanish culture. The population views itself more akin to the Catalan regions of France than to the rest of Spain. As noted above, the region was independent until the 15th century and has sought to return to independence ever since.

Catalans believe that when Spain became democratic in 1931, the central government granted the region certain freedoms that started the process toward full independence. The oppression of Catalan culture and language during Franco’s dictatorial rule only further boosted the aspirations for autonomy. Additionally, when the current central government tries to tighten its control over Catalonia, the regional communal psyche assumes that any central control will be as repressive as Franco’s regime.

As an interesting aside, the recent political discourse between Catalonia and the central government in Spain mimics that of the soccer stadium atmosphere before a Real Madrid vs. FC Barcelona game (Real Madrid is based in Madrid while FC Barcelona is based in Catalonia). The dispute over independence goes back further than the soccer rivalry, but both are highly emotional causes.

Economically, the pro-independence movement has been fueled by the perceived unfavorable tax outflows of Catalonia. Tax revenues from Catalonia have historically been larger than the funding received, subsidizing poorer regions of the country and funding central government spending priorities. Since 1986, an average of 9% of Catalonia’s annual GDP has been redistributed to other regions, according to the separatist movement. Catalans have never been happy about it, but they tolerated it when the Spanish economy was growing; however, now that economic growth remains challenged and the unemployment rate is at 25%, the tax subsidies are becoming a major issue.

Most recently, the pro-independence sentiment was reignited by the hardship caused by the Eurozone crisis. In 2012, Catalonia voted for a pro-independence party during a snap election, which put a separatist coalition in power. The independence ambition was further boosted after Madrid refused to renegotiate a fiscal pact under which Catalonia sought to have more independence over its finances.

The central government’s budget decisions are often criticized by the regional governments as not serving the interests of the regions funding the central budget. One of the most oft-cited examples is the malinvestment in infrastructure spending. Spain is the fifth largest EU member state by population and GDP, but it has more international airports and more miles of motorways than any other continental European country. It has more miles of high-speed rail than any other country in the world except China; however, it has the lowest ridership per mile than any other country in the world. Additionally, more miles of high-speed rail are currently under construction in Spain than all other European countries combined.

Economically, a separate Catalonia would be richer, but more indebted, than the rest of Spain. Based on GDP per capita, Catalonia would rank higher than Italy, while the rest of Spain would rank closer to Greece. The chart below shows GDP per capita of an independent Catalonia, Spain ex-Catalonia, along with various other European nations.

Catalonia

Role of the EU and Eurozone

The EU and the Eurozone govern monetary policy and have become more important in deciding intra-union subsidies than the governments of the individual countries. It is easy to see that it would currently be more beneficial for Catalonia to control its own fiscal policies and have direct representation in the EU.

However, if Catalonia were to secede, it may have to leave the Eurozone, as well as the EU, and reapply for membership as an independent country. The EU has no plan of action for countries that decide to split or even leave the Eurozone. So far, the monetary union has been able to avoid a country or a region leaving the union. If a country were to leave, this would set a precedent and it could mean that other countries might also take the same route. In fact, it is in the Eurozone’s interests to make secession difficult in order

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