Italian tragedy

Anyone with an interest in government finances and public spending must, by now, have developed a morbid fascination with Italy.

The country slid into recession again this month, wiping out not only its post-recession growth but much of its growth since it joined the Euro.

Screen Shot 2014-08-17 at 13.48.54 Chart via Matt O’Brien at the Washington Post.

The pattern of Italy’s GDP growth has become detached from that of the rest of the G7. Since the crash, all the other major economies have grown, albeit at different rates. Italy, though, is on a severe downward slide.


Chart via Ben Chu.

Some people blame the Euro for this but Italy was in trouble before it joined the single currency. Both Italy and the UK crashed out of the ERM in 1992. For the UK, this was the start of a decade of high growth but Italy’s economy stalled in the years after and grew much more slowly for the rest of the decade. Briefly, in 1991, Italy overtook Britain and France to become the world’s 4th largest economy. Since then, though, it has been a tale of slow decline.

The Italian government had borrowed heavily during the boom years and the slowdown saw its debt-to-GDP levels steadily rise.

g7-debt-historyChart via Paul Krugman

This excellent piece by Economics Help explains the story in detail. The upshot, though, was that by the start of the recession, Italy’s debt was way ahead of most of the other major economies.

Major Economies Debt

Source: IMF World Economic Outlook 2014

But here’s the twist. Italy reduced its deficits drastically in the 1990s. For many years now, it has run a primary surplus. This means that, before debt interest, its government revenue is higher than its public spending. Unlike many other countries, including Britain and the USA, it is not borrowing to fund public services and social security.

Screen Shot 2014-08-17 at 16.02.45

Chart via Igor Di Giovanni

It is, however, having to borrow to fund the debt repayments on its historic borrowing which is why, despite its primary surplus, it is still running a deficit and its debt is still going up.

This OECD chart illustrates the problem.

3.2 General government primary balance and interest spending as a percentage of GDP (2011)

OECD deficit 2011

Source: OECD Government at a Glance

Even though it is running a primary surplus, Italy’s debt repayments are higher than those of most other countries. It is running a deficit simply to pay the interest on its debt.

It gets worse, though, because Italy’s borrowing costs are relatively high. This is not just because of its high level of debt. As I’ve said before, credit ratings and borrowing costs are based on a number of factors. As this Business Insider chart shows, there is little relationship between a country’s debt level and the amount of interest it has to pay.

Screen Shot 2014-08-18 at 12.28.00

Japan, with a humongous debt-to-GDP ratio, can borrow more cheaply than most other countries because it borrows in its own currency, its economy is growing, most of its debt is held by locals and it has a very stable political and social system. Despite its high debt, it is seen as very unlikely to default.

None of these is true of Italy. Its economy has been slowing down over decades and it is notorious for political instability. It can’t use its own central bank to buy government bonds because it no longer has one. Consequently, its 10-year borrowing costs soared after the recession, hitting 7 percent at one point in 2011 and rising close to 5 percent after its election stalemate last year. By comparison, the US and UK 10-year costs are around 2.4 percent and Germany’s just over 1 percent. It took intervention by the European Central Bank to bring Italian borrowing costs back down.

The result of all this is that Italy is increasing its debt just to service its ever increasing debt. It doesn’t take much imagination to see where this will lead. As we know, despite what politicians say, governments very rarely reduce their debts, they just rely on inflation and economic growth to reduce the relative size of their debts. Take away the growth, then, and you’re in real trouble.

As Edward Hugh says:

The problem is that Italy has an appallingly low trend GDP growth rate – possibly negative at this point – and nothing which has happened since the financial crisis ended suggests it is going to to improve radically anytime soon, in fact there are good reasons to think that growth could even deteriorate further.

And don’t expect much help from the private sector. That’s collapsing too, says Roberto Orsi:

The situation of the Italian economy is simply dramatic. Recently, a study has appeared which reveals how the current crisis (2007-2013) is in many ways much worse than the 1929-1934 contraction. In the present crisis, investments have collapsed by 27.6% in the five year period, against 12.8% in the interwar depression. GDP has declined by 6.9% against 5.1%. Italy, with the second largest manufacturing sector in Europe after Germany, has lost about 24% of its industrial production, going back to the 1980s level. No data is currently showing any sign of recovery. From the beginning of this year, the country has lost over 31,000 companies. Every day 167 retail units are lost, signalling an authentic disintegration of the retail sector. The automotive sector, a crucially important one for the Italian economy, has been constantly contracting: from about 2.5 million cars sold in 2007, sales in 2012 reached only the 1.4 million mark (the 1979 level) and they are still contracting this year. Construction, the other pillar of the national economy, is in rout: the 14% slump in 2012 is only the last in a series of difficult years. Home sales have dropped by 29% in 2012 against the already miserable 2011, to the 1985 level of 444,000 units, about half the number of 2006. Of course, the consequences of this economic disaster in terms of loss of employment are dire: unemployment is now at almost 12% and growing fast.

Who’s going to provide the investment to grow Italy’s economy again? Its private sector is dominated by small firms who are traditionally reluctant to invest, its state running a primary surplus just to keep up with its debt and its educated people are leaving the country.

It’s difficult to see how Italy will get out of this mess. Some say it should leave the Euro but to do so would be a de facto default with horrendous consequences for the rest of Europe. In any case, the country’s other structural problems would still be there if it left the Eurozone. It could even speed up the brain-drain as rich Italians pick up their Euros and run.

More austerity is unlikely to help either. Italy’s public sector finances have been running a surplus for over a decade. As Edward Hugh says, it would need to run a 6.6 percent surplus for another decade just to get its debt down to 60 percent of GDP. With a shrinking economy, falling tax revenues and a fleeing intelligentsia, this looks improbable.

The speed of Italy’s decline is astonishing. Italians once celebrated displacing Britain and France as the world’s 4th largest economy. Now, a mere twenty or so years later, a knackered state, with hardening arteries and on ECB medication, is trying to outrun a rising tide of debt, and losing. It is a depressing and rather frightening story.

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13 Responses to Italian tragedy

  1. P Hearn says:

    Anyone still think it’s a good idea to let politicians run things?

    • roGER says:

      Yes, me!

      I’d rather have democratically elected politicians rather than kings or queens, holy men or soldiers.

      • P Hearn says:

        Wasn’t proposing any of the above as alternatives.

        • Then why did you bother commenting?

          • P Hearn says:

            Because I was wondering if anyone still thought it a good idea to have a bunch of egomaniac amateurs who are aiming to win a popularity contest every four or five years, running a nation’s finances. roGER apparently does, so currently the “ayes” have it by one vote to nil.

            An alternative might be to try some non-political appointments of people who’ve actually run things successfully and thus have experience and expertise? Having tried politicians for all these years, it hasn’t really succeeded in anything other than ever-rising taxes and public debt. When someone’s job depends on awarding “free” money to some special interest group or other, its’ unlikely to lead to long-term thinking or good governance.

  2. roGER says:

    One thing that may save Italy is the unofficial or ‘black’ economy.

    Based on nothing more than business trips and occasional work assignments, it seems (anecdotally at least) that the whole country is on the fiddle. Backhanders here, tax evasion there, jobs for cash in hand over there. It may mean the economy is quite a bit larger than the offical figures suggest?

    Of course the official figures quoted above may well include an estimate for the black economy too, in which case my point is invalid.

  3. Dave Timoney says:

    The problem with analyses of Italy is that there tends to be too much “morbid fascination” and a susceptibility to hyperbole, such as “tragedy” (this has a long pedigree).

    Though growth has been poor since “il sorpasso” in 1991, Italy enjoyed consistently higher growth than the UK between the 50s and 90s (hence the over-taking), despite the supposed impediments of political instability and corruption. Italy’s poor record since the mid-90s reflects two structural features that were previously strengths: the reliance on small and medium businesses (notably in the North) and a weak services sector (big domestically but a poor contributor to exports outside of tourism).

    The impact of ICT has turned the former into a weakness (i.e. due to inadequate capital investment), while the latter was unable to take sufficient advantage of the EU single market and globalisation (compare and contrast the UK’s service sector export growth and Germany & France’s retooling of their manufacturing and tech sectors). Historically, the Italian state has made up the capex shortfall of business, both through overt public infrastructure investment and covert clientelism (often combined in the South), hence the high levels of public debt (if they’d stopped building autrostrada in Sicily in the 90s and invested in fibre-optic cables nationwide instead, they’d be a lot healthier now).

    The (assumed) solution is big capital, i.e. the consolidation and amalgamation of businesses, along with deregulation of services to encourage the growth of exporters at the expense of current vested interests. Matteo Renzi’s conscious evocation of mid-90s Blair makes a lot of sense domestically.

  4. Any thoughts on potential policy prescriptions?

    The IMF in its most recent Article 4 statement suggested 10 policies to help the economy, including stimulating investment by tax cuts, rebalancing spending away from pensions and on to education, and reforming the judicial system:

    • P Hearn says:

      This blog generally steers clear of suggesting solutions. The articles are researched in great detail, well written and argued, and as the name implies, there are always lot of charts, but its role is really to point out the problems rather than offer solutions.

      That’s what the comments section is for!

      • Rick says:

        If I knew what the solutions were, I wouldn’t have time to blog. I’d be too busy charging governments a shedload of money for advice.

        • P Hearn says:

          Ha ha! Fair point Rick. In fairness, if you can get into advising the government, there’s a good living to be had. Only bettered by a stipend from the EU – that’s the real prize.

  5. yorksranter says:

    You might want this:

    Italian companies underinvest in IT, while Italian banks seem to lend more to subsectors with lower productivity growth. The comparison is with Germany. In Germany there doesn’t seem to be a significant relationship at the detailed sector level, but in Italy there is and it’s negative.

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