TheMarketForIdeas

Although part of the euro sovereign debt crisis that triggered a double-dip Eurozone recession in 2012 and turned control of public spending – or austerity – into a reverse-keynesian precept for calming the market’s animal spirits, Italy’s conundrum is quite different from that of Greece, Spain, Ireland or Portugal with which the country is often grouped together by financial analysts.

All of these other countries are basically in the position of Eurozone emergent economies, which experience high capital inflows during booms and high capital flight during busts, pretty much the way things happened with Central and Eastern European economies not in the single currency. While Italy definitely shares some characteristics with these peripheral countries, as they are known, when it comes to internal development disparities and somewhat weak institutions, Italy is nevertheless one of the world’s richest, biggest and most developed economies. And the problems it now faces, daunting as they are, prove this. 

“Latin blood”, “Mediterranean cuisine” 

Although part of the euro sovereign debt crisis that triggered a double-dip Eurozone recession in 2012 and turned control of public spending – or austerity – into a reverse-keynesian precept for calming the market’s animal spirits, Italy’s conundrum is quite different from that of Greece, Spain, Ireland or Portugal with which the country is often grouped together by financial analysts.

First of all, Italy did not experience the same surge in public debt with the onset of crisis, because of a stop in capital inflow and covert capital flight, as has happened in Spain, in particular, but also in other Southern or peripheral euro-countries, especially Portugal and Ireland. Although Italy is a very nice place to invest in a retirement villa and a big tourist destination, Spain succeeded in attracting a much bigger real-estate bubble. Its public debt grew 2.5 times since 2008 as a result, for instance, as opposed to only 30% in Italy, where it even began to fall slightly in 2017. The Italian public debt ratio was already the second highest in the Eurozone after that of Greece and the prolonged recession, bank bailouts and low growth recovery increased it, but not considerably – at least the public debt that is officially on the books. In fact, Italy now has a current account surplus, a primary budget surplus and most of its debt is internally owned, fixed interest rate and not indexed to inflation, which makes it less sensitive to fickle investors. Size and some well-placed nationals, like “do whatever it takes” Mario Draghi at the ECB, also constitute an often unrecognized hidden asset in the present crisis, making markets and rating agencies think three or four times before they quote interest rates on Italian debt. Being too large a sovereign debtor to be bailed out has its advantages with markets: if they push up bond yields too much, bond holders might get nothing in return.

Compared to bubble-burst Spain, Italy’s present economic woes therefore seem mostly the product of accumulated structural and long-term weaknesses, which the recession only moderately amplified. These weaknesses are, in turn, the result of a combination of internal market rigidities, wasteful public spending and unreformed welfare and entitlement systems (tackled by the Mario Monti post-crisis government, but criticized by the current left-wing populist coalition partner), which have led to a low-growth/high public spending under-competitive equilibrium. The euro, and the Eurozone imbalances and misalignments it produced since the 2000s, absent exchange rate adjustment, are only partly to blame for the economic turmoil in the case of Italy.

Moreover, it is unlike Greece, which was bailed out beginning with 2010 (when the manipulation of public debt statistics was also discovered), precisely in order to prevent a Eurozone sovereign debt contagion in Southern European countries. Italy is the kind of Eurozone founding Member State one basically just cannot throw out or threaten to throw out of the euro unless it actually wants to get out of the euro – and this gives it an enormous bargaining power within the governance structures of this currency area, a fact which the populist left-right coalition is vaguely aware of and uses to its advantage. 

Vox populi(sm) stays loud and (un)clear 

The two populist Italian parties, Lega Nord and Movimento Cinque Stelle, whose electoral ascent in the March election and subsequent government sharing coalition has triggered a spike in Italian bond yields and renewed worries on the financial markets, represent a micro-cosmos of the post-2008 European populism.

Italy now has a current account surplus, a primary budget surplus and most of its debt is internally owned, fixed interest rate and not indexed to inflation, which makes it less sensitive to fickle investors. Size and some well-placed nationals, like “do whatever it takes” Mario Draghi at the ECB, also constitute an often unrecognized hidden asset in the present crisis.

Lega Nord is a three decades old right-wing populist party with a fringe history of playing on the dissatisfaction of the richer and more developed Northern part of Italy with the centralized state’s redistributive policies towards its less developed South. Its current political success is the result of the frustration generated by the apparent ineffectiveness of the Rome government to restart the economy among middle-class voters as well as increased anti-immigrant sentiment following the large wave of refugees/migrants facilitated by the Libyan civil war and other MENA flashpoints, which dashed the high hopes many commentators put in the so-called Arab Spring. In short, within the family of European populist parties, the Lega Nord headed by Matteo Salvini currently occupies, all things considered, a place in-between France’s Front National and Germany’s new Alternative für Deutschland.

The Movimento Cinque Stelle, founded by comedian Beppe Grillo and headed by Luigi Di Maio, is a much younger left-populist party, born out of the public discredit of the centrist Italian political class and the high unemployment and economic hardship experienced by the young, working, also middle-class, population, resembling in this regard the Spanish party Podemos. The right-left division between the two equally populist parties is perfectly reflected in their economic programmes. While the Lega has a conservative and neoliberal program of reforming the fiscal system by introducing a flat tax, reducing red-tape bureaucracy and cutting welfare payments, particularly to immigrants and asylum seekers, the M5S, besides its anti-corruption rhetoric, wants, on the contrary, to increase welfare support, primarily by introducing a guaranteed minimum income in Italy, independent of any work related requirements. The implied public spending shortfall that the implementation of the combined governing program of the left-right populist coalition government, headed by Giuseppe Conti – who was confirmed in office on a second try by the Italian president Sergio Matarella, just in time for the Italian national holiday –, is, by all accounts, sure to throw the already highly indebted Italy into a fiscal crisis and consequently threaten the very existence of the Eurozone as it currently stands. This is, in short, the challenge Italy poses to Europe and the international economy.

According to some of the best estimates regarding its fiscal impact, “Il Contratto” – as the antinomical Lega-M5S governing program of large revenue cuts and large increases in spending is called – will triple Italy’s 2.3% of GDP 2017 budget deficit[1]. Whence all of the very unorthodox proposals of the populist coalition to finance such large deficits on top of an accumulated debt that has topped 2.3 trillion euros: making the ECB buy or monetize the Italian debt; reinventing the French Revolution’s assignat by circulating debt certificates as a parallel form of currency; or even exiting the euro, whose stability minded strictures have come to be regarded as a cage and a recipe for the impoverishment of Italy. 

Euro moneymakers vs. Italian spenders 

The implied public spending shortfall that the implementation of the combined governing program of the left-right populist coalition government, headed by Giuseppe Conti, is, by all accounts, sure to throw the already highly indebted Italy into a fiscal crisis and consequently threaten the very existence of the Eurozone as it currently stands.

Currently, the EU’s governing structures of the Eurozone have two mechanisms in place to deal with fiscally weak, endangering countries for this area: the European Commission’s excessive deficit procedure and the rather new ECB outright monetary transactions program. None however suits the new Italian coalition government’s desires, quite the contrary. Respecting the excessive budget deficit procedure, which is a bit stricter for countries with debt ratios of over 60% of GDP such as Italy, is what basically brought the downfall of the previous Partido Democratico government led by Matteo Renzi and initiated the anti-austerity populist backlash. The ECB’s Outright Monetary Transactions Facility set up as a weapon of last resort following the 2012 Eurozone sovereign debt crisis, as a way to circumvent the statutes that forbid it to fiscally assist member governments (to much German and more generally Northern European criticism and anxiety), if activated, comes with a pretty similar set of conditionalities and austerity constraints. Or even worse, since the untested facility is theoretically designed as a sort of central bank-run IMF adjustment program. So, in the confrontation that is expected to ensue with the European institutions and other Eurozone governments (particularly those of the large German and French economies which have already rejected any sort of debt relief), Italy’s left-right populist coalition government’s plans of fiscal expansion will become not only a challenge but – even without the openly anti-euro economist Paolo Savona as minister of European affairs – an ongoing plebiscite regarding the Eurozone’s workings, shape and prospects.

[1] Osservatorio Conti Pubblici Italiani: http://osservatoriocpi.unicatt.it/cpi-elezioni-2018-commenti-ai-programmi-di-finanza-pubblica.