By Belén Carreño
The Socialists led by Pedro Sanchez and the hard-left Unidas Podemos have committed, in a 50-page government agreement, to undo some major reforms carried out by conservative leader Mariano Rajoy under a 2012 deal with euro zone partners in return for a financial bailout.
The labour reform is particularly contentious, and the Spanish strife echoes disputes between right and left-wing politicians across Europe and beyond. Its proponents argue it has transformed Spain into a more competitive market, while critics say the country has become a low-wage economy where jobs are more temporary and precarious.
The new government faces a formidable task to make good on its pledges, given the fragmented and fractious state of Spanish politics, which have been deadlocked for the best part of a year in which there were two inconclusive elections.
Sanchez only narrowly won parliamentary backing on Tuesday for Spain's first coalition government in decades, leaving him reliant on a fragile patchwork of alliances to pass laws.
"The fragility of the new government's mandate raises questions about the pace of future policy reforms, including those aimed at improving the labour market," S&P rating agency said in a note, adding that it did not expect major changes in economic or fiscal policy.
REPEAL OR REVISE?
The agreement between the Socialists and Podemos is also an understanding struck between the parties rather than any wider or legally-binding document. It was not signed up to by the smaller regional parties who were instrumental to Sanchez winning lawmakers' backing on Tuesday - and whose votes the government would need for its plans to be adopted.
Among them, the PNV Basque nationalists, a conservative, market-friendly party, has already complained that it has not been consulted on such plans.
"We haven't said we would vote in favour of what they propose. Before approving anything, they'll need to talk with us," said a source at the party.
The wording of the coalition agreement, however, gives the government some flexibility.
While the two governing parties pledged to repeal the labour reform in its entirety during the election campaigns, the text of their agreement commits only to revoking elements of the law on which action is deemed "urgent".
Their priorities include securing a shift back towards sector-wide collective bargaining agreements, and away from individual company deals, and preventing companies from firing employees because they have been absent from work due to illness for a certain period of time.
However the text does not commit to reversing other major provisions of the law that made it easier for companies to lay off staff.
'FEAR OF THE CRISIS'
The 2012 labour law, introduced by the conservatives when Spain was mired in economic crisis, is the last major structural reform approved in the country before political fragmentation began impeding big policy shifts.
The legislation allowed far greater flexibility in the labour market, making it easier to cut wages and cheaper to lay off workers - changes that some economists credit with buttressing the economy.
"Greater flexibility avoided a five-point increase in the unemployment rate during the second stage of the Great Recession (financial crisis), and has facilitated more intense and dynamic job creation during the recovery", said Rafael Domenech, head of economic analysis at BBVA.
However, wages fell 6-8% on average in 2011-2018 and despite the job market reform, Spain has the most temporary workers in the EU as a proportion of its workforce.
Despite six years of steady growth, the unemployment rate in Spain remains at 14%, the second highest in the EU after Greece. In 2013, when the labour reform was launched the unemployment rate reached a peak at 27%.
Ignacio Conde-Ruiz, professor of economics at the Complutense University, said the labour reform was not the only reason for the drop in wages.
"Part of it comes from the implementation of the reform. But another is from the will of the workers who, for fear of the economic crisis, accepted lower salaries," he added.
Conde-Ruiz said rowing back parts of the labour law could cause problems for Spain should it fall back into recession, but that the economy would not notice it in the short term.
BOND EXPERTS: WHAT PROBLEM?
Many economists say the biggest economic impact - positive or negative - would come from a shift back towards collective bargaining. Rating agency Moody's called it a "key risk".
Pepe Álvarez, leader of the UGT union, Spain's second-largest, said collective bargaining would allow for a redistribution of wealth in Spain.
"I believe that recovering the full power of collective bargaining will allow us to recover wages," he told a news conference on Wednesday.
But many bond analysts appear relatively unruffled by the Spanish hubbub, and see Italy as a far bigger problem.
"Spain has been one of the big performers of the last 3-4 years, when it comes to local GDP growth," said Rabbani Wahhab, senior fixed income portfolio manager at London and Capital, an asset management firm.
"So that's the reason why we still like Spanish bonds and have never really looked upon the political volatility as a reason not to hold them."
(Reporting by Belén Carreño; Additional reporting by Paola Luelmo and Dhara Ranasinghe; Editing by Ingrid Melander and Pravin Char)
By BelÃ©n CarreÃ±o