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.