John Bruton

Opinions & Ideas

Category: Italian Economy

ITALY

 

Despite the 11th hour agreement to form a new government in Rome, Italy still has the potential to send Europe into depression, if the costly promises made in the election campaign are kept, and long overdue and difficult reforms further postponed.

The Italian government debt is 130% of GDP. If the financial markets lost confidence in an Italian government’s ability or willingness to service and roll over this debt, there could be a rapid series of events leading to Italy’s exit from the euro, and widespread loss of confidence in the bonds of indebted countries.

What could trigger this?

The parties in the new Italian coalition government, 5 Star and the Lega, promised during the election

  • to reverse a recent VAT increase ( cost €12.5billion),
  • to introduce a flat tax (€50 billion),
  • to introduce a basic income(€17 billion) and
  • to scrap a recent pension reform( €8 billion).

These measures could bring the budget deficit from its present 1.9% of GDP to a staggering 7% of GDP. That would certainly create a financial crisis. It would break EU rules too.

It would also impoverish Italian voters, especially older Italians with savings . Despite years of low growth, the average Italian household still has more net wealth than the average German household. But a lot of that wealth is tied up with the Italian banks and their bonds.

Overall, two thirds of Italian government bonds are owned by Italian residents, including Italian banks, so many Italian households would be suddenly impoverished if these bonds were devalued. A sudden rise in interest rates in Italy would devalue bonds that had been issued at a lower rate of interest. Of course leaving the euro would devalue them even more.

48% of the bonds of the Italian government are held by Italian banks themselves. A loss of confidence in Italian bonds could destroy the capital base of some Italian banks. That could lead to a run on the banks, like the Northern Rock situation.

The European Central Bank (ECB) could step in to stop such a crisis. It has power to buy Italian government bonds, under its OMT programme. But the OMT programme can only be brought into operation if the Italian government has first applied for help, and has signed up to a tight austerity programme. The present Italian government would have difficulty agreeing as this would go against its election promises.

But the ECB would have to insist on the austerity measures. Otherwise, it would be simply sending good money after bad, something that would not appeal to European taxpayers who are the ultimate owners of the ECB.

For the last 10 years, Italian politicians, including the parties who lost the recent Italian General Election as well as those who won, have been blaming the constraints of euro membership, and the disciplines supposedly imposed by Brussels and Germany, for the sluggish performance of the Italian economy, and for the fact that Italian wages are still far below what they were in 2007.

But, as a recent IMF study of the Italian economy shows, the reasons for stagnant incomes in Italy are to be found in Italy itself, not in Brussels.

Since 2000, the total factor productivity of the Italian economy has fallen by 6 %, whereas productivity in Spain has risen by 2% and in France by 4%.

Since 2000, investment has risen by 10% in Spain and by 20% in France, while it has fallen by 15% in Italy.

France and Spain are in the euro too, so euro membership does not explain Italy’s under performance.

Italy’s problems derive from a number of factors.

One is the big increase in its spending and debt levels that took place in the 1980’s.

Another is the fact that its administrative and legal systems have inhibited the reallocation of Italian talent, money, and effort from less productive to more productive activities.

The arteries of the Italian economy are blocked by a sluggish parliamentary and courts system, by out of date insolvency laws, and by an over large public sector. Wages are set centrally with little regard to the profitability of individual firms. A lot of capital is tied up in zombie businesses, many state owned.

Reforms have been made by previous governments to liberalize the labour market and the professions, but these will take time to yield results, and are insufficient on their own.

Italy is a rapidly ageing society, so the proposed reversal of the recent pension reforms by the new government would worsen the situation.

On the other hand, the new government’s flat tax and basic income proposals could, if combined with radical measures to combat tax evasion, remove tax shelters and  improve work incentives, improve the overall efficiency of Italy.

Euro membership has prevented Italy from using the devaluation to restore competitiveness at the price of higher inflation. Older Italians have benefitted from this. Italian savers (mainly older people) have been protected from the devaluation of their savings, through inflation. that took place before the euro.

But the failure to free up the arteries of the Italian economy through structural reform has meant that job seekers (mainly younger people) have suffered. Many talented young Italians have emigrated, some to Ireland.

The new Italian government could tilt the balance in favour of young Italy, and attract those young people home, if it combined its popular tax and welfare plans with, much less popular but equally urgent, reforms to administration, the courts, wage setting,  insolvency and pensions.

The first big test will come in October when a budget has to be presented. That is when the new government’s real  priorities will be revealed.

POLITICS AND DEBT……ITALY NEEDS BRAVE LEADERSHIP

Italy and EU Puzzle Pieces - Italian and European Flag

Italy and EU Puzzle Pieces – Italian and European Flag

Crunch decisions are approaching for Italy and its new Prime Minister Paolo Gentiloni.

The really difficult decisions are not about who gets which Ministry in the new government, or even about the timing of elections, but about how to cope with the problems of some of Italy’s banks.  

On Friday last the European Central Bank rejected a request from Rome to delay a proposed private sector  led rescue of Monte Paschi di Siena (MPS), Italy’s oldest and most troubled bank.

According to the Financial Times, this leaves Italy with little option but trigger a government led bailout of the bank which will involve imposing losses on junior bondholders in the bank, many of whom are small savers rather than anonymous financial institutions. “Burning the bondholders” thus does not have quite the same popular appeal in Italy as it had in Ireland a few years back!

But the burning of bondholders, in a bank that has to be rescued by the taxpayer, is now required by EU rules, and the EU is a rule based institution. The primacy of rules, rather than of raw power, are what distinguishes the EU from other international arrangements, and are among the reasons EU membership is particularly valued by smaller countries, like Ireland.

Avoiding a taxpayer led bailout of MPS, by forcing the other Italian banks, who are better off than MPS, but have troubles of their own, to bail out MPS could infect the  entire Italian banking system and weaken confidence in it.  And all banking, like all money itself, depends on confidence. As it is, Italian banks have only half the capital they need to meet  the required safety standards.

Of course it is true that if the Italian economy was growing more quickly, its banks would not be in such trouble. The Italian economy is expected to grow by only 1% this year, well below the EU average. In fact the Italian economy is the same size as it was in 2007, whereas other countries , which are also subject to the  disciplines of the euro zone, have grown substantially since 2007, France by 20% and Spain by 15%.

This contradicts those who want to blame the euro for all Italy’s problems.

For example, David McWilliams has mistakenly claimed  that “the strictures imposed by the euro have destroyed the Italian economy”. He said that Italy’s economy grew, before it joined the euro. But it was only able to do this because it repeatedly devalued its currency. This gave temporary relief but concealed the underlying problems. Devaluation was an anaesthetic, not a cure.

Once it joined the euro, this had to stop

When  Italy’s  leaders decided to join the euro, and  set the rate of exchange between the old lira and the  new euro, they  knew  that  devaluation was impossible thereafter. This was a freely taken Italian decision.

Unfortunately Italian voters do not see things that way and blame Europe for problems that are actually home grown. For example in a poll last September, only 38% of Italians felt their country had benefitted from being in the EU, whereas 51% felt it had not .

In truth, the problems of the Italian economy predate the decision to join the euro. Government debt levels were increased during the 1980’s and were already  well above the recommended 60% of GDP  when Italy joined the euro.

Italy was already an ageing economy at that stage, with early retirement and historically low birth rates. The ageing of a society inevitably saps its growth potential, as even the Chinese are now beginning to find.

There was the added difficulty, since 2000, that the Italian consumer and fashion goods sector competed directly with goods coming from Asia, and Italy could no longer devalue  to meet this  new competition.

Italy did not adapt to this new reality.

Productivity remains poor in Italy.  For example, since 2007, Spanish productivity per hour increased by 10%, whereas Italian productivity per hour actually DECLINED by 5%. Both Italy and Spain are in the euro, so the euro does not explain this difference in  productivity performance.

The public sector in Italy is expensive and inefficient. The hourly pay rate in the Italian public sector is 40% above that in the private sector, whereas in France and Germany, the hourly rate in the public sector is below that in the private sector.

Incidentally in Ireland, hourly pay in the public sector is 25% above that in the private sector.

In Italy, healthcare and pensions absorb 20% of GDP, as against 12% in Ireland.

There are also severe inefficiencies in Italy’s commercial sector caused by lack of adequate competition. The transport and energy sectors are particularly costly.

There is a lack of competition in the legal system. The Italian courts are the third slowest in the EU. For example it takes 500 days to get a case into court. This means that it is difficult and costly for Italian businesses to enforce contracts and collect debts owing to them. Court delays have also contributed to the increase in non performing loans(NPLs) in the Italian banking system. NPLs are now 18% of all loans, as against 6% in 2007.

A Competition Bill, which would have helped resolve some of these problems, was watered down in the bargaining between the Senate and the Lower House.

Renzi’s constitutional reforms, which would have reduced the power of the Senate, would have dealt with that problem. Unfortunately they were rejected by the voters.

The Gentiloni government, like that led by Renzi, has a  majority in the Lower House, but will  now face an increased risk of  any reforms it proposes, being bogged down in the  Senate, because the Senate  will feel empowered by the referendum result.

The electoral arithmetic may have changed, but the arithmetic of Italy’s debts has not.

Leaving the euro would actually increase the nominal value of those debts, because the debts would still be owed in euros, but the money to pay them would have to be raised in a new, and probably, less valuable Italian currency.

Resolving Italy’s problems will require statesmanship of a high order in Rome, Brussels, Frankfurt and Berlin. Ireland overcame a similar crisis since 2010, and the willingness here of all sectors of society here to meet the painful challenge quickly , and leave politics aside till later, may provide a model that Italy could follow.

NAPLES

I have just spent an enjoyable day and a half in Naples, capital of the Italian south
It is a beautifully situated city, near Pompeii and the Amalfi coast, and endowed with some of the most remarkable churches in the world.
In one of these I discovered the tomb of an Irishman I had never heard of before, Luke Concannon born in Kilbegnet in Co Roscommon in 1747, and a Dominican priest, who was the first ever Catholic bishop of New York. He died in Naples in 1810, presumably on his way back to New York after a visit to Rome.  
I was struck by how clean and well kept Naples was, contrary to its reputation, and by the number of young people and small children on the crowded streets of the old city.

THE ITALIAN ECONOMY

Italy is facing many economic problems at the moment and I saw signs calling for demonstrations against the policies of the Monti Government.
Economic growth has been lagging in Italy since the 1990’s, and Italy has been hit particularly hard by Chinese competition, particularly in fashion goods. Meanwhile pay has increased far faster than productivity.
 Italy had the same balance of payments situation as Germany in 2000, whereas in 2010 Germany has a large surplus and Italy a large deficit.

THE IMPACT OF CHINA ON THE EURO ZONE HAS BEEN DIFFERENT IN ITALY THAN IT HAS  BEEN IN GERMANY

This is because Germany has been able to export engineering goods to the expanding Chinese market, while Italy has lost market share to China in its speciality, fashion goods.
 In a way, the opening up of China has created unanticipated new imbalances in the euro zone that have arisen since the currency was launched. Some of the German commentary on the euro crisis has ignored this fact.

UNLIKE IRELAND, ITALY ALMOST HAS A PRIMARY SURPLUS

Italy has a big Government debt, but most of this debt dates back to the 1990s, when services expanded while revenues were contracting. Today, Italy almost has a primary surplus on its Government accounts, in other words, it is collecting as much in tax, as it is spending on all Government services apart from interest on past debt. In this regard, it is in a much better situation that the rest of the euro zone.
In contrast, Ireland has a smaller government debt as a proportion of GDP, but has a substantial primary deficit….Ireland’s day to day spending on all services, apart from debt interest, still exceeds its day to day revenue by one of the largest margins in Europe.
Italians have a much lower level of private debt, 130% of GDP, as against 350% in Ireland, and 250% in Spain, Sweden and the Netherlands. There was no property bubble in Italy, in sharp contrast to Spain, something that needs to be explained.
Italy’s problem is that its medium term growth potential is less than that of either Ireland or Spain . This is partly because Italy has an older population, and partly because Ireland has a more modern industrial economy. 
Italy has a large black economy (15% of GDP), and it takes ages to enforce a contract or set up a business in Italy. A judicial process that would take 52 days in the Netherlands, 49 days in the US, or 183 days in Spain, would take 630 days in Italy!

ITALIAN BOYS LOSE OUT

Italy’s educational system is open to criticism.
A large number of students, particularly boys, drop out of school with no qualification at all, and its universities fail to prepare students for the jobs that actually exist. This is strange for a country, so many of whose prominent politicians are university professors! 
Only 15% of men, and 24% of women, in the 30 to 34 age group have a university education. 
As in other countries, the educational system is failing boys more than it is failing girls. Similarly, in Ireland, the unemployment rate among boys is higher than it is for girls.  

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