Friday, November 28, 2014

Italy’s Downward Spiral

MUNICH – Italy is now in a triple-dip recession. But it didn’t get there by itself. Yes, the economy’s long slide reflects Italian leaders’ failure to confront the country’s loss of competitiveness; but it is a failure that is widely shared in Europe.

When the financial crisis erupted in the fourth quarter of 2007, Italy’s GDP plummeted by 7%, then picked up by 3%, dropped again by 5%, rebounded by a measly 0.1%, and lately, during the first half of this year, shrank again, this time by 0.3%. Altogether, Italian GDP has contracted by 9% during the past seven years.

Industrial production, moreover, has plunged by a staggering 24%. Only thanks to stubbornly persistent inflation has Italy’s nominal GDP managed to remain constant. Overall unemployment has climbed to 12%, while the rate for youth not attending school has soared to 44%.

Italy has tried to counteract the economic contraction by increasing its public debt. With the European Central Bank and intergovernmental rescue operations keeping interest rates low, Italy’s public debt has been able to rise by one-third from the end of 2007 to the spring of 2014.

Italy’s new prime minister, Matteo Renzi, wants to stimulate growth. But what he really intends to do is accumulate even more debt. True, debt spurs demand; but this type of demand is artificial and short-lived. Sustainable growth can be achieved only if Italy’s economy regains its competitiveness, and within the eurozone there is only one way to accomplish this: by reducing the prices of its goods relative to those of its eurozone competitors. What Italy managed in the past by devaluing the lira must now be emulated through so-called real depreciation.

The era of low interest rates that followed the decision in 1995 to introduce the euro inflated a massive credit bubble in southern eurozone countries, which was sustained until the end of 2013. During this time, Italy became 25% more expensive (on the basis of its GDP deflator) than its eurozone trading partners.

Seventeen percentage points of this rise can be accounted for by higher inflation, and eight percentage points through a revaluation of the lira conducted prior to the introduction of the euro. Relative to Germany, Italy became a whopping 42% more expensive. That price differential – and nothing else – is Italy’s problem. There is no other solution for the country than to correct this imbalance by means of real depreciation.

But accomplishing that is easier said than done. Raising prices is almost never a real problem. Lowering them or making them rise more slowly than prices in competing countries is painful and unnerving.

Even if a country’s trade unions enable such a policy through wage moderation, debtors would run into difficulties, because they borrowed on the assumption that high inflation would continue. Many companies and households would go bankrupt. Given that disinflation or deflation leads through a valley of tears before competitiveness improves, there is reason to doubt whether election-minded politicians, with their short-term orientation, are capable of staying the course.

Former Prime Minister Silvio Berlusconi wanted to solve the problem by withdrawing Italy from the eurozone and devaluing the new currency. He conducted exploratory conversations with other eurozone governments in the autumn of 2011, and had sought an agreement with Greek Prime Minister George Papandreou, who proposed a referendum that effectively would have meant choosing between strict austerity and exiting the eurozone.

But both leaders had to resign, only three days apart, in November 2011. Higher political considerations, as well as the interests of the banking system, militated against an exit.

The economist Mario Monti, who followed Berlusconi as Prime Minister, attempted a real depreciation, introducing greater flexibility into the labor market in order to force the unions into wage concessions. But Monti’s efforts came to naught; among other problems, the ECB, with its generous financial help, removed the pressure from both unions and companies.

Enrico Letta, who followed Monti as the head of Italy’s government, lacked a clear concept for reform, and in turn was followed by the charismatic Renzi. But, though Renzi expends much verbal energy on the economy, so far he has given no indication that he understands the nature of Italy’s problem.

Renzi is not alone in this. On the contrary, virtually the entire European political elite, from Brussels to Paris to Berlin, still believes that Europe is suffering from a mere financial and confidence crisis. The underlying loss of competitiveness is not discussed, because that is a problem that discussion alone cannot resolve.

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    1. CommentedPierino Postacchini


      The Italian government debt is 140% of GDP and this is not growing since 2007. The ECB’s monetary policy is German centric with a strong focus only on the price stability and not also on the growth.

      The Italian PM Renzi, also President of the European Council for this semester, and the Finance Minister Padoan should remind to the ECB what is written in the its Statute, art. 2 and 3. The ECB has to respect all what is written in its Statute and not focus only on the stability price. This objective was self-tasking because there is no a strong political balance in Europe for a surveillance on the ECB’s actions, so, during this semester, the Italian Government should be able to ask ECB to respect its Statute.
      Everybody understood that if we have a monetary union we need also a fiscal union (the flexibility of the salaries and labour market was not an effective measure for an economic equilibrium, this financial crisis established the failure of the endogenous Optimum Currency Area. If a State loses its trust in the financial market, investors sell their bond and the interest rate consequently grows. Because the banks are the principal investors in government bonds, a growth of the interest rate produces losses in their balance sheets. This means that banks will have a financing problem, a reduction of their liquidity and this way the crisis on the government bonds propagates to the banking system and from this to the economic sector, with the so called “credit crunch”. The companies don’t receive loans and they reduce their liquidity, so they can’t pay back their old loans and consequently the balance sheets of the banks are getting worse.
      In this scenario, the banks lends only to very virtuous companies.
      This is the situation in Italy, there are only few virtuous companies and the rest, the majority, has to finance themselves with not paying taxes and contributions, and undertake insolvency proceedings.
      The measures announced by the ECB such as the TLTROs are not the solutions, because no loans are going to the companies. The good instrument is the Quantitative Easing from the ECB, which allows the Central Bank to buy government bonds from banks and so clean up their balance sheets. This way, they can start to lend again to companies which are the real engine of the economic system.
      The Italian government should make easier the access to the financial markets for companies through a public assurance for the half of their revenues and companies not in an insolvency situation to keep their workforce stable for at least three years. For the companies in an insolvency situation, the Government should start a lease back operation with the Cassa Depositi e Prestiti for restructuring companies in big difficulties.
      In Italy we have one of the highest tax rate and one of the lowest productivity of the Public Administration in the European Union, we need to cut 10% of the public expenditure and to cut the corporate tax and the social charges on the labour. This objective could be realized with a strong spending review of our public expenditure.
      Our Government is focused on the Constitutional reform and on the labour market reform, which are necessary but not sufficient for the economic system that needs a strong European action for helping companies which are the real engine of our economy.
      If the ECB respects its role, the ESM has no reasons to exist. This funds could help to build European Infrastructures in all countries by issuing Eurobond.
      If the Italian Government doesn’t succeed in changing the monetary police of the ECB as it is written in the Statute, the European Members of Parliament has the power to set up a temporary Committee of Inquiry to investigate, without prejudice to the powers conferred by the Treaties on other institutions or bodies, the ECB operations (art. 226 of the Treaty on European Union and the Treaty on the functioning of the European Union).

    2. CommentedPaul Peters

      Italy's problem is the extremes became more extreme while the connecting tissue lost its elasticity. Nationalistic tendencies fueling protectionism which resuling a lack of "social mobility" is key.. Italy fails to address this.. the figures are abysmal. Smallscale "hot" money that usually fuels investment has escaped to invest in real estate in bubbletowns like London, Berlin, Paris and any of the cheapo' businesses has fled to Romania to make use of EU subsidies and try revamp an otherwise bankrupt business model. But because they often used to work in a mutually errorcorrective local clusters with highly versatile and allround employees, they fail to address the growing overhead needed with such a move into a new territory.
      Social renewal is near absent. Foreigners are not welcomed, apart from feeding the tourism industry. Of the 5-6 million immigrants here, they are primarily here for gardening, nursing, housecleaning, factory work and other jobs where they get to work 6 days a week, 10-12 hours a day, for 600 to 800 euro per month.. while the top layer here earns on average 750 euro per HOUR. These people aren't just squeezed a little, they are crushed and stamped upon... The social stagnation has started hollowing out the country and selling pink Ferrari's and fancy real estate for ten times the price to oligarches from the Ukraine and elsewhere doesn't solve the massive problem that nearly two-thirds of Italy's riches is in real estate and when the next generation is not capable or willing to buy this.. What is the marketvalue of a house that nobody wants? We're talking about another devaluation of some 25% of Italy's wealth. What's going to happen then? When that little extra which makes a rich country rich evaporates and there is not enough to even cover the basic costs of living.
      Everyone knows, but words don't translate into action. I live in a country where civilization is dying. i can't escape and noone wants to solve anything. i do not wish this upon anybody else. It hurts.

    3. CommentedM A J Jeyaseelan

      Italian economic crisis is deeply rooted in its extreme dependence on imported oil.

      Unless, Italy is able reduce its dependence on oil, it will need to increase its exports to pay up the oil import bill. So the Italian crisis will remain or aggravate so long as oil prices rule high.

      This is the case with not only Italy but also a few other European countries like Greece and Portugal. They will have to emulate France and Germany and use more of nuclear energy

    4. CommentedClaudio Migliore

      The problem is austerity is a misnomer. The real issue is that some stuff in a country is too expensive relative to other. Readjusting this mismatch of course means belt tightening for some and not so much for others. And this happens anyway, no matter what measures are taken.

    5. CommentedJohn D'Attoma

      This post is nonsense. Why do economists keep promoting the same neoliberal policies that got us into this mess in the first place? For 35 years, economists and political economists having been singing the praises of unfettered markets and competition; and for 35 years we have witnessed deteriorating working and living conditions, climate, wages, and massive increases in inequality. However, the solution according to Hans is more competition, which has clearly resulted in a race-to-the bottom situation. Hans understands this and seems to be promoting it, as well.

      Is it not possible that we have reached a point of capitalist over accumulation as a result of over-competition. This seems more likely to me, than a lack of competition. Once competition reaches a point where capitalists can no longer exploit labor (maybe the case in the developed world) to undercut the prices of its competitors profits begin to fall, resulting in diminishing levels of production. This race to the bottom strangles demand, slowing down investment even further. Considering the demand crisis we are in and the degree of financialization, this seems more relevant than failed neoliberaleralism.

      Just say no to Neoliberalism!

    6. CommentedClaudio Migliore

      I am rendered speechless by the clarity and perfect logic of this post. Maybe that is why there are no other comments. I would point out only one thing where I disagree.
      There is no real choice between strict austerity and alternative measures (exiting the Euro being one). In fact strict austerity in the areas where prices are inflated is inescapable. Those who float this false dilemma hide the real choice, which is 'who' is supposed to suffer the strict austerity and who can escape it. With deflation, debtors and those with low productivity suffer. With devaluation (and exiting the Euro can only mean devaluation) creditors and those on fixed incomes do.

        CommentedJose araujo

        There are options between exiting the EURO and srict austherity, yo just don't wan't to think about them.

        Adds that there are no evidence of inflated prices in Italy, inflation has been low well since entering the euro, the problem is the fixes exchange rate, and I'm sorry but that's not something austherity can correct.

        Austherity is the worst thing that hapened to europe, and quite stupid also to advocate for austherity when we are facing a demand shock.

    7. CommentedGianpiero de Pascalis

      “..the rate of youth not attending school has soared to 44%”. Are Mr. Sinn’s sources dating one century ago? This CLEARLY CANNOT HAPPEN nowadays in a G8 country.
      Perhaps it is also worth to mention that Mario Monti, a guy surely closer to Frankfurt than to the real needs of Italians, during his legislature strongly increased taxation - even to that segment of the population that was, until then, exempted (meaning people earning less than 12k euro per year!). Average tax on wealth and property increased from 10% to 24%. How could people consume and invest in such an environment? The problem, as we should look at the present an not at 1995, is AUSTERITY. If Germans keep on insisting with their diktat on austerity then the best possible solution for Italy and other southern country would be to exit. Union means thinking together while Germans are thinking only for themselves.

    8. CommentedJonathan Lam

      Gamesmith94134: Two model for Europe 12-29-2011
      I think what Mr. Hans-Werner Sinn meant was the outflow were the collateral damage attributed by the Rogue Trader who bidden on the 1.6 instead of 1.3 to a dollar; the hedge fund managers like FM and Goldman Sacks and the fall of Dexia bank and others. Furthermore, the outflow to the Dow Jones was not accidental either at the slow down on the American economy, the stock boomed for sake of the monopoly or ‘get me out of Eurobonds’ made it obvious is upon everyone else guesses, or its disposition is part of the deleverage that Euro is pegged to dollar to promote another delusion of growth scenario. The recent sale on the Italian and Spanish bond held at 7%; and inflation rate edged higher from 2% to 3.4% in America; so, I suspect the Europe is not any lower on the account of the deleverage, rather than the shortage of resources and the questionable status in the Strait of Hermuz. Besides, the next four months in rolling over of the $900 billion Euro bonds may not be sold again at 7%, even with the direct periphery of the loans from Fed, even at the 500 basis points to exchange or 0.25% loan available to the local banks.
      “MUNICH – Interest rates for public debt within the eurozone have spread once again, just as they did before the introduction of the euro. Balance-of-payment disparities are steadily increasing. The sovereign-debt crisis is eating its way from the periphery to the core, and the exodus of capital is accelerating.”
      So, the question is clear for the safety net could be for the $650 net foreign wealth, if the interest rate is being sacrificed to sustain the unity of the Eurobonds? Or, how much is American banker is willing to abstain to bankruptcy if the present 8-15% for the Euros will escalate in the coming three-year-term of the Eurobonds and the exchange rate must sustain at a profitable level after being deleverage?
      Far as the data indicated the unemployment and housing are merely improved the sentiment to the holiday seasons, or Fed is playing with the exchange rate again. And, the yuan went 4% over the year and inflation rate held at 6.5%, China must made its domestic growth program to ease the tension on the manufacturing slowdown. I am not sure how the debtor nations can use its austerity program to sustain the level of certainty for repayment on the next coming restructuring of the debts.
      Shuffling of the 2.7 trillion with lesser growth is hard to do, even if, the investors and banker would turn into rogue trader to hold the line on the exchange rate. However, the inflation rate would certainly change one’s mind quickly if the change of status quo to commodities goods or outbreak of war in Middle East is eminent.
      Perhaps, it is time to choose how the next round for the global finance and the sovereignty debts if Euro stands even it is contagious. There is no escape for most financials if Euro collapses; but EU must sustain a firewall like to create its EU zone policy as well to stop further spread of inequity and insecurity if the Bael II is not working with its banks, or breakup of the north and south under the pressure of the fiscal unity. Then we may consider the financials are separated by the disgusted investors as each develops their doors in shutting of trades by its partners by continents other than EU; if the exchange rate or interest rate becomes irrelevant. So, sovereignty debts must be traded under the scrutiny of sovereignties not bankers since they, the citizens of sovereignty, must repay them. And, capital financing should not be the part of the sovereignty debt that shared with the lower rate; it demands its proof of performance and consequence and not just politicians for promoting propagandas like ClubMed or Green industries, that they plays double jeopardy on WTO.
      Personally, I refer the multi-speed, multi-currencies approaches in various zones that each enjoy their own responsibility for building up their equities; and shared retirement with their assets they earned by leaving the exchange rate and interest rate to the achievement and performance of the states, and not to bankers even for Central banks. Finally, there is no right choice of the model as available, but each must accept the alternatives in changing the model we definitely needed to meet globalization of the finance.
      May the Buddha bless you?
      Gamesmith94134: The Exchange-Rate Delusion
      Since 92, Emerging nations looked to the consumer of the world like America, and Europe for fueling their industries, the dominant currencies as in Euro-dollars as the leverage to propel growth. In the turn to 2001, the developed nations started to yield their growth by shifting their labor forces off source to the emerging nations because the cost of labor was cheaper and they saw the emerging nations had fully developed in technical and administrative skills in handling production; so, the developed nation like America, and EU can concentrate on R&D, and kept on shifting the manufacturing to emerging nations to cut labor cost. As the imbalance of the payment in trade showed on the developed nations; there is cut of R&D after the displacement of funds shown when deficits advanced. Then, the deficit expanded.
      Perhaps, there is an ideology of balance of payment through monetarism that the rise of the currencies from the emerging market nations would balance the trade deficits if the Euro-dollar can maintain itself at a deflationary level in lesser compensation of interest rate; then, the inflationary EM nation’s currencies can continue in a falling position in creating the balance of payment in cutting deficits. However, the formula of such exchange rate was interrupted by the displacement of investments that transferred to surpluses of the EM nations, as the deficits are even deepened and the cutting on the private or government programs of the developed nations made the situation worsen. The strength of one’s currencies is no longer under the sovereignty’s control when the surpluses are pooled in to the EM nations when austerity program are introduced to the defaulting nations like PIIGS, who suffered in devaluation that cause deflation. At the same time the deleverage of the currencies like Euro, the surpluses from the EM nations used its surplus in hoarding that they can sustain the equivalent exchange to their local currencies, then, we are having the high rate exchange of Euro even after their default.
      Perhaps, when we look into the displacement of investment that the deficit created instead of the change of the exchange rate; or the behavior of the surpluses and interest rate payment of the bonds are used against deflation and inflation. It was not the exchange rate that took the effects after the imbalance, but how it was the control of the exchange rate when it intervene the sovereignty finance like investments or bonds after the effects of inflation or deflation. There is less of the solution of the imbalance of sovereignty payment on bond or development for growth at present since there is lesser of growth and domestic unease arises. I think Mr. Zsolt is right on the attitude of Homeostasis in healing the nations either inflation or deflation hits.
      I personally suggested the multi-speed, and multi-currencies in maintaining the sanity of the financial system; and Euro-dollar may not be the only international reserves only that counts; because they certainly lost count of themselves. Then, Zone must be developed to monitor the flow of currencies and its rates to exchange that participating in the throw weight including the deficits and displacement of investment of the surpluses. In time, we can really control the interest rates to compensate when inflation or deflation would take their effects even assistance to growth and not just valuation to shift in order to maintain gain or loss. In final, I think the exchange rate must apply to the ambience of zone not forsake of profit or loss, and its performance counts not by the value of the currencies it converts. We must give the Sovereignty Bonds another attitude too, if we can use promotion on coupons for import/export to maintain the domestic sanity and privatization of the state owned projects to advance growth that guarantee the balance of payments either domestic or foreign.
      I wish there is a better solution that can prompt to success in solving the default without changing the present, but the use of peseta in Spain inspire me most for another alternative to change.
      May the Buddha bless you?

    9. CommentedJose araujo

      What collection of non-sense..... gosh..

      Euro was introduced in 2000, not 1995 .....

      Real depreciation doesn't exist and it doen't work. We need inflation in Germany but we are getting stagnation.

      So Italy became uncompetitive beacause of the lira apreciation before entering the euro.... WHATTTTTT. What about Italy becoming less competitive because of the EURO, period.

      Massive credit bubble in Southern European Countries, where is the data to prove that? Default rates are normal in most southern european countries, except for SPAIn there wasn't a massive credit bubble, credit was in line ith northern countries.

      I should have already dismissed the STUPID austrian explanation, for god sake, we are living in a DEMAND shortage. ITALY had to endure with not only its austherity but also with NORTHERN EUROPEAN STUPIDITY, who also went into austherity mode.