Europe’s Leaders Are Aiding Italy’s Populists
The fact that Italy’s public debt has a lower credit rating than private debt is a reflection not of public debt’s intrinsic inferiority but of a political choice made by European leaders. And, by bolstering an authoritarian politician, that choice is now blowing back on them.
ATHENS – Italy is now the frontline in the battle of the euro. Deputy Prime Minister Matteo Salvini is being propelled by a political tailwind that may, after the European Parliament elections in May, enhance his capacity to inflict serious damage on the European Union. What is both fascinating and disconcerting is that the xenophobia underpinning Salvini’s ever-increasing authority is being generated by the eurozone’s faulty architecture and the ensuing political blame game.
In its recent report on the economic imbalances afflicting each EU member state, the European Commission blames the Italian government for its failure to rein in debt, which, it says, results in tepid income growth. According to the Commission, the government’s reluctance to cut its budget deficit has spooked the bond markets, pushed interest rates up, and thus shrunk investment.
Salvini could not be more pleased. The report presents a splendid opportunity to blame the Commission itself for Italy’s travails, by arguing that it was actually the EU’s fiscal austerity policies which constricted growth, pushed the economy to the brink of a new recession, and led to the election of the populist government now dominated by Salvini. And, as if that were not enough, it was the Commission’s threats of penalizing Italy unless it imposed even greater austerity that unnerved bond traders and pushed interest rates up.
Italy’s tragedy is that the Commission and Salvini are both right – and also both wrong. It is correct that Salvini’s announcement that the government would rescind its promise to impose pre-agreed levels of austerity alarmed investors, made Italian debt less viable, and caused capital flight. But it is also correct that the Commission’s fiscal rules, were they to be implemented fully, would have caused a recession that would have made Italian debt less viable anyway.
When two clashing explanations of the same phenomenon are both correct, they must be incomplete, even if they capture different aspects of observed reality. In such cases, it is useful to adopt a new vantage point from which to take a fresh look at the problem. When it comes to the Brussels-Rome clash, I believe, that vantage point is on the other side of the world: Tokyo.
Italy is, in an important sense, Europe’s Japan. Both economies are typified by a strong export-oriented industrial sector, a current-account surplus, similar terms of trade, terrible demographics, and, following years of imprudent lending, zombie-like banks. Moreover, they are also alike in the composition of their financial liabilities, featuring relatively low private debt and very high public debt.
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Unlike Italy, Japan’s political center is still holding because median incomes have risen a little as the economy was being stabilized by a central bank that printed money as if there were no tomorrow and governments that implemented one fiscal stimulus after another. Had Japan’s government labored under the type of restrictions imposed on Italy by the EU treaties and the eurozone’s fiscal and monetary rules, Japanese society would now be in tumult.
Indeed, if financing for Japan’s economy and banking system had been provided by an external central bank bent on enforcing fiscal austerity by threatening to withhold liquidity, then a doom loop of insolvent banks, rising bond yields, and recessionary forces would have been inevitable. Politically toxic populism would not lag far behind, occasioning the same kind of clashing-though-compatible narratives that we now hear from the European Commission and Italy’s government.
An intra-European comparison sheds additional light on the conundrum facing Italy and the eurozone. Spain and Italy have almost identical debt-to-GDP ratios (298.3% and 301%, respectively). So, why is everyone talking about Italy’s debt and not Spain’s? The answer is that 67% of Spain’s debt is private, whereas 64% of Italian debt is public.
In theory (and in law), the European Central Bank is not allowed to monetize any debt, public or private. In practice, however, the ECB has been able and willing to monetize private debt fully, simply by accepting as collateral private debt not even worth the paper it is printed on (for example, stressed Italian mortgages and Greek banks’ IOUs). In contrast, the ECB spent years refusing to buy government debt and, when it did, chose to exclude large swaths of bonds from its asset-purchase program. Put simply, any country whose debt was tilted toward the private sector, like Ireland and Spain, did much better than a country like Italy.
The eurozone’s defenders will reply that it is right that countries are penalized for allowing a high proportion of public debt. The ideological bias against anything public is not limited to the realm of utilities and railways. The credit rating agencies’ readiness to downgrade the bonds of any government that challenges conventional wisdom reinforces the neoliberal assumption that private debt is, by definition, less problematic than public debt.
But even free-market fundamentalists should realize how unsafe this assumption is. If the 2008 financial crisis taught us anything, it is that risks are too endogenous for comfort. Even if no corruption is involved, credit ratings and political choices are co-determined: If the ratings agencies get a whiff that the ECB will choke off Italian liquidity, they have a duty to their customers to downgrade Italian bonds. And if the ECB predicts that Italian bonds will be downgraded, its rules instruct it to diminish liquidity in the Italian banking sector.
When some infrastructure project is to be built, why should it matter whether it is the state or private developers that borrow to fund it? In the eurozone, this matters, because the ECB has much greater leeway to refinance stressed private debt than public debt. But this is a political choice, not an economic reality. The fact that Italy’s public debt has a lower credit rating than private debt is a reflection not of public debt’s intrinsic inferiority but of a political choice by European leaders. And, by bolstering an authoritarian politician, that choice is now blowing back on them.