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Is Italy Committing Economic Suicide?

italy GDP 10 Year Moving Average

The title of this post may sound a little extreme and probably should be Is Italy Being Suicided?, but seeing as suicide is not a verb in English, I’ve erred towards grammatical correctness. If, however, I had been writing this post in Italian, then ‘suicided’ would be a valid word. In Italian, the implication behind ‘suicided’ is that someone is forced to take their own life. Italy’s mafias have been known for causing suicides.

Well, Italy’s governments, at least since 1980 certainly appear to have been suiciding Italy’s economy, though they may not have been doing it intentionally. A wild claim? Take a look at this graph I am using with the kind permission of economist . The downward trend illustrates the gravity of Italy’s economic problems succinctly:

italy GDP 10 Year Moving Average
Italy GDP 10 Year Moving Average – Disaster in Progress

Startling, isn’t it? Well, it startled me when Hugh tweeted it in my direction. Note where Italy’s’ economy is today. Yes, Italy has slipped into recession and if the downward trend continues, Italy’s economy will be in even deeper trouble. Deflation is just over the horizon.

What is also starkly clear from the graph is that that the policies pursued by Italian governments since 1980 have not ended the downward spiral.

Perhaps one way to describe the approach of repeated Italian governments to the management of Italy is ‘spin, delay and pray’. Being slightly more charitable for a moment, successive Italian governments did not act possibly because they did not realise what was happening or believed that traditional economic theory would save the day.

Of concern is that what has been happening has been going on for around 25 years. Surprisingly, none of Italy’s highly paid politicians appears to have understood what was happening and more importantly, why. In part, this could be down to the (lack of) quality of Italy’s administrative classes.

Worthy of note is that the economy of Japan finds itself in a similar boat to that of Italy. Japan is running a much higher level of national debt than Italy and is clinging on, or rather, as Edward Hugh may well argue, is walking a tightrope. Japan may fall off at some point, or the tightrope may be cut. Italy may be able to learn from the Japan situation seeing as both nations suffer from similar demographic ills: ageing workforce and low birthrates.

Blame the Voters!

One could attempt to lay the blame upon the doorsteps of voters for Italy’s economic pickle but that would not be fair. All voting does in Italy is to rubber-stamp the, highly questionable, candidate choices made by Italy’s political parties and leaders like tax evasion convict Silvio Berlusconi.

Democracy in Italy is as dysfunctional as its economy which, of course, is managed by the nation’s politicians and other interest groups. Mix in large doses of corruption, nepotism, and clientelism, add a large glob of tax evasion, and you have all the ingredients for catastrophe. Take another look at the ‘disaster-in-progress’ graph above.

Note how the downward trend continued through the Berlusconi years, yet old Silvio Berlusconi is once again angling for another crack at governing Italy. Obviously either his voters have never seen the graph above or they simply do not comprehend the gravity of the situation. Well, a proportion of his voters are not-so-bright housewives who love his cheesy television offerings, so what can one expect? Most of the rest of Berlusconi’s voters believe corruption, nepotism, clientelism, and tax evasion are perfectly acceptable. A small proportion do exceptionally well out of dysfunctional Italy. Though as you have seen, the long term effects of Italy’s vices on the Boot’s economy have been disastrous.

Not Only Berlusconi

Berlusconi, though, is far from being the only one responsible for the phenomenal, and continuing, decline in Italy’s economic fortunes. The global economic crisis merely exacerbated Italy’s inherent economic weakness. Note the acceleration of the decline in 2008 – while Berlusconi still ruled Italy’s roost.

Then there’s the matter of Italy’s huge, and growing, national debt. Now at 135.6% of GDP Italy’s debt is, arguably, already unsustainable. Italy, like Japan, is well and truly in tightrope territory.

For some of Italy’s members of parliaments, such as economist and member of the political party led by Matteo Renzi Italy’s prime minister,  with whom I have been exchanging a few words via Twitter, the massive level of national debt is not an insurmountable problem. Why? Something known as primary budget surplus.

Primary Budget Surplus

In simple terms, primary budget surplus is the pot of cash governments have after their spending has been deducted from tax and other income. Think of this left-over sum of money as something similar to profit.

Companies invest profits in developing or expanding businesses; governments build roads, schools, hospitals and may, as in Italy’s case, pay their politicians stratospheric sums. This is all well and good when levels of national debt are around 60% of gross domestic product, or so Euro convergence criteria has determined. However, when Italy deducts the interest payments it has to make on its national debt from its primary budget surplus, the surplus becomes a deficit. If Italy were a company, the deficit would be a loss which could bring about bankruptcy.

Keeping bankruptcy, or rather default, at bay, is the existence of a primary budget surplus which indicates that Italy’s government’s income exceeds expenditure. In other words, spending is under control which means countries like heavily in debt Italy, can continue borrowing and the cost of borrowing remains manageable. While this situation continues Italy can keep itself afloat. This seems to be Italy’s strategy. It may work.

Some economists, such as Barry Eichengreen and Ugo Panizza theorise that large primary budget surpluses could solve Europe’s debt problems:

For the debts of European countries to be sustainable, their governments will have to run large primary budget surpluses.

If primary budget surpluses are high enough, then this may allow nations to maintain huge levels of national debt and keep their nations running. ‘High’ in the opinions of Barry Eichengreen and Ugo Panizza means over 5% for a period of 10 years:

For the debts of Europe’s problem countries to be sustainable, absent [of] restructuring, foreign aid or an unanticipated burst of inflation, their governments will have to run large primary budget surpluses, in many cases in excess of 5% of GDP, for periods as long as ten years. History suggests that such behaviour, while not entirely unknown, is exceptional.

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Stop reading, start speaking

Stop translating in your head and start speaking Italian for real with the only audio course that prompt you to speak.

Economist-politician Giampaolo Galli disagrees, in part, with the analysis of Eichengreen and Panizza.

Galli is against debt-restructuring, which, he argues, would have a devastating effect on Italy’s economy. The problem is Italy’s economy has already been devastated. Hugh, on the other hand, believes Italy will soon be forced to restructure its national debt. While debt restructuring would further weaken Italy’s economy, it should not affect other economies in Europe, or so Hugh told me.

For the “primary budget surplus solution” to maintain its effect, even Italian politician-economist Galli admits that Italy needs reforms. The trouble is, Italy isn’t getting any and the political will required to institute real, deep, reforms is just not there. Reforms may cost money and this, of course, could eat into, or even extinguish, the hallowed primary budget surplus. If this happens, the tightrope upon which Italy now finds itself will start to wobble. The absence of political will on the reform front can be compared to tightrope walking Italy carrying a sword in one hand. At some point, the sword could cut the rope.

An attempt to keep the primary budget surplus in tact may explain why Italy’s present government is focusing on the reform of Italy’s senate. Although, at the end of the day, senate reform may seem unnecessary, not to mention time-consuming and costly, it may achieve two things: a) allow Italy to play for time so its primary budget surplus grows b) once, complete, the reform will send out the message that government in Italy is stronger and this will (or should) help keep Italy’s borrowing costs under control. If all goes to what is assumed to be the grand plan, with a higher primary budget surplus and reasonable borrowing costs, Italy will have more leeway to introduce and finance reforms.

There is a danger that Italy’s senate reform may never happen, though, and this could cause the tightrope to shudder. In addition to this, the government’s ‘Italy is stable’ message could be scuppered by social unrest. Fears are growing in Italy that the nation is heading in an authoritarian direction. If this leads to the eruption of social unrest then the ‘Italy is stable’ message will have no effect. The tightrope could then snap.

Italy does not have too much time to play with and what little there is left may have run out. Some would say that the tightrope sword-wielding Italy finds now finds itself on is not so much wobbling as swaying violently.

The large primary budget surplus solution favoured by Galli only stands a chance of working if Italy’s surplus is high enough. Remember that Eichengreen and Panizza consider a 5% surplus over a 10 year period to be the way highly indebted nations like Italy could possibly keep themselves afloat. Eichengreen and Panizza admit that they are far from sure that the primary budget surplus solution will work.

What is Italy’s primary budget surplus situation? Answer: Primary budget surplus was 2.2% of GDP in 2013, and in 2012 it was 2.5%. The forecast for 2012 was 3.0% and for 2013, it was 4.0%. Italy’s forecasts were too optimistic and half the level considered necessary by Eichengreen and Panizza. If Italy’s primary budget surplus grows in 2014, this will be a positive sign. But will it hit the 5% threshold favoured by Eichengreen and Panizza? 

Solutions

Nothing will turn Italy’s economy around overnight. Aside from keeping itself on the long unstable tightrope, what Italy has to do is to implement real reforms to encourage genuine economic growth. Current attempts at reform are merely half-hearted tinkering while Italy’s politicians stick to their traditional, ‘spin, delay and pray’, er, strategy for managing Italy. As I have written, though, there maybe some method in the perceived madness. Reforms designed to promote growth are supposed to be on the table but whether they will be concrete enough to have an effect is an unknown.

In my opinion, one much needed reform is to allow Italians to elect their politicians directly; not via dreadful party lists which promulgate damaging corruption, nepotism, and clientelism. Such a reform would potentially enable Italians to select more capable leaders and thus avoid future tightropes, and swords.

What would also give Italy’s economy a real boost in this Italy watcher’s opinion would be a co-ordinated focus on increasing exports. While results would not be immediate, by encouraging exports by, for example, making the export process quicker, Italy could return to growth. Once again, though, to achieve real growth on the exports front, Italy needs to reform and this is just not happening.

Tourism is another area where Italy could do much better and some regions of Italy, such as Le Marche, are showing that a coordinated approach to tourism promotion can be of great benefit to the local economy. Taxes paid by successful businesses end up in central government coffers.

By the way, European Central Bank boss Mario Draghi is not at all happy with Italy’s lack of progress on the reform front. Italy’s Prime Minister Matteo Renzi, while acknowledging that reforms are needed, says he won’t be told what to do by the ECB or, for that matter, by the rest of the Trioka.

Renzi?

Does current Prime Minister Matteo Renzi offer any hope? Some, though in common with his predecessors since 1980, Renzi’s approach tends towards that of ‘spinning, praying and delaying’, in other words, the same old, same old.

On a more optimistic note, some believe Italy’s economic recovery is just around the corner. Just which corner is not at all clear though and reforms are needed to reach that elusive corner.

So there you have it: Sword carrying Italy is walking a wobbly tightrope in a dark tunnel hoping to find a corner around which the light lies.

Care to place a bet on when Italy’s recovery will materialise? Even if you dare to place it, I’m willing to bet that the sum you bet won’t be that high.

Edward Hugh and myself will keep an eye on the Italy situation and provide an update in a year’s time.

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