At the end of Madrid’s Gran Via, the 25-storey Edificio España is a stark reminder of the tough economic times facing Spain. Once a symbol of opulence and prosperity, the neo-baroque high-rise is now boarded up. Plans to convert the building into luxury apartments have ground to a halt. With derelict edifices like these and the violent protests seen in recent months, it is no wonder that outsiders are quick to draw gloomy conclusions about the city’s economy.

A walk through Madrid’s weaving labyrinth of smaller streets tells a different story. If the past decade was characterised by grandiose infrastructure projects, the city is now undergoing a different type of makeover and the sound of construction now echoes from countless new shops, bars and restaurants springing up across the inner city.

Today the activity is largely grass roots. After losing their jobs and facing a dismal job market, many young, educated and increasingly frustrated Madrileños are looking elsewhere. With unemployment at a staggering 25.1 per cent, some job seekers are opting to open small businesses to survive. Buoyed by reduced rental prices and often backed with finance from family, this new generation of business owners is inadvertently transforming Madrid. City council figures reveal that 11,262 businesses were created in 2011, with 2012 numbers showing a gradual upward trend toward pre-crisis levels. Madrid mayor Ana Botella is resolute.

“Entrepreneurs hold the key and the Madrid city council will therefore do all it can to advocate their central role in both society and on the political agenda,” she says. Many of these entrepreneurs have flocked to the hospitality sector. Antonio Santiago, 30, opened his bar and restaurant Circo de las Tapas two years ago. With a background in advertising, he is new to the industry but judging by the constant crowds here, his risk seems to have paid off. Antonio inspected 60 venues before settling on the run-down street and since opening has witnessed the area flourish, with at least five similar new businesses opening. “There has been an explosion of creativity from young Spanish people since the crisis and small theatre spaces, modern restaurants and clothing stores are regenerating entire neighbourhoods,” he says.

Silvana Cordobés, also from the advertising world, opened café-delicatessen Motha, together with her partner and Argentine chef Daniel Golinelli. With a focus on organic food, the couple run a thriving catering wing and eco-friendly cooking workshops. Cordobés exemplifies a growing trend in the city – Madrileños who once enjoyed stable salaries have been cut loose and propelled to go solo. With them they are revitalising outdated ideas about customer service and opening hours.

Cordobés is quick to highlight the difficulties though, with bureaucratic delays and local government regulations. A provisional licence has been hanging on the wall since June and she has no indication of when it will become permanent. The city council introduced temporary “express” licences this year in an attempt to streamline the tedious bureaucracy. Privatising the registration process has also reduced waiting periods from one year to about three months but further improvement is needed.

Madrid’s municipal leaders have sought to reset the business culture in the city. One of their first moves was to create Madrid Emprende – the city’s network of small business incubators. Designed and built with public money, they are managed by private companies and business schools. With strained public budgets, government subsidies are receiving heightened scrutiny and Madrid Emprende is under pressure to perform. Their principle challenge: striking the right balance between public and private.

“The government wants to see results – namely job creation. They have the resources but don’t necessarily have the knowledge,” says Katelyn Melan from Tetuan Valley Startup School, which works with Madrid Emprende. “One of the positive sides of the crisis is that they have been forced to become leaner, more transparent, and more open to new ideas.”

The government is slowly taking a step back. Madrid Emprende’s centres have been allowed to evolve organically with a renewed focus on shared workspaces and providing services such as marketing advice and access points for local government services. “You can have an idea or a model in the beginning but you have to allow it to adapt to the reality,” says Miguel Ángel Villanueva, Madrid’s deputy mayor. “Our role as a city council has also changed and we need to respond to the job-creation challenge with horizontal collaboration rather than implementing a top-down approach.”

The company uSpeak has created a smartphone app that provides custom-made language classes and now boasts a team of 14. They reside in the city council’s International Lab, and he is quick to tout the centre’s strengths. “The best thing is that their content is not politicised,” he says. “Investors have complete freedom to move their money around and there’s a real effort to optimise the system, creating the right framework for budding entrepreneurs.”

After €23m of initial public investment, the centres now generate two euros for every public euro spent, and neighbouring cities such as Lisbon and Barcelona are looking at creating their own networks based on the Madrid model.

Back on the streets, there are also glimmers of hope in a fledgling manufacturing base. “Spain had always been a country of artisans but it lost this during the get-rich-quick property boom in the 1980s and 1990s,” laments Pablo del Barrio, a former economist turned leather goods maker. “With so much disenfranchised youth, people have begun doing things with their hands again.”

Sharing his workshop with a mechanic of recycled bicycles and former lawyer David Iglesias Resina, both men saw their professional careers end during the downturn. However, their shop Dale Pedales has doubled in size since it reopened a year and a half ago, and is looking to expand even further. Rising public transport prices and cost pressures have energised a nascent cycling culture.

Resina claims the principal problem facing young Spanish entrepreneurs lies in the banks’ unwillingness to grant loans. However, with €5,000 of personal liquidity and no debt, he was able to expand once more. “We don’t want to get too big though. The desire to get rich is what created this mess in the first place,” he says, shaking his head.

This desire to survive and succeed is also echoed by Rocio Muñoz. Her online retail venture Real Fábrica Española is throwing a lifeline to a struggling manufacturing sector by offering Spanish crafts, food and cosmetics. She happily discusses her growing customer base in the UK and Japan but turns serious when talking about Spain’s economy.

“There’s a general sense of pessimism undermining the morale of the young. Even people with jobs are being affected,” she says. “People worry when they see the EU asking Greece to adopt a six-day working week but I’ve been working seven days a week for two years now, and in tough economic times more people need to do the same.”

David Castro agrees. His artisan beer label La Cibeles is already exporting to Japan, the US, Sweden and Norway after just a year and a half. “We’re the backbone of the economic recovery in Spain,” he says. The small brewery now sells over 150,000 litres a year, giving the brand a potent voice in local corridors of power. “My voice was hoarse from asking for government help but because of the crisis the local administration is finally beginning to listen.”

Madrid’s city council is starting to acknowledge the potential of small businesses. Mayor Botella recently unveiled the Zona Franca icc initiative, which will waive local government taxes for new creative businesses. “This is our way of telling the world that Madrid is open to talent and we want to welcome artistic people to establish their projects here,” she says.

The policy is the culmination of a public and private collaboration between the local government and the neighbourhood association in El Barrio de Las Letras (bdll). Andrés Culebras started the association in 2004, believing that the area needed a voice based on co-operation rather than confrontation. In the years since – despite the crisis – the Las Letras district has rapidly transformed itself into a dynamic area, with more businesses opening than closing this year. Similar neighbourhood organisations in the city are beginning to emulate the bdll example; with businesses banding together to lobby the city council more effectively. “We have managed to establish a direct line to the city council and we often bring politicians here to show them what’s working and, more importantly, what isn’t,” says Andrés.

Despite the pain and social strife created by austerity measures and the fiscal crisis, Madrid may be on the cusp of real change – the government is stepping back, creating space for a new partnership between the authorities, businesses and residents. Prescriptive policies are being replaced by flexible ideas based on dialogue. Efforts to eliminate red tape and cultivate new industries will take time but a new generation of forward-thinking business owners already seem to be rising to the challenge. In the process, they are not just altering their own fortunes but transforming their city from the ground up.