Italy’s Economic and Fiscal Troubles
What was the source of the economic standoff between the Italian government and the EU
The Italian government and the European Commission recently endured a spat over the budget that Italy proposed. But to understand the reasons behind the dispute, we must first briefly discuss the recent history of the Italian economy and Italian politics.
Figure 1 – Debt-to-GDP for PIIGS (Source: OECD)
Ever since the European sovereign debt crisis of 2010-2011, the economies of the Eurozone have been experiencing sluggish growth, averaging 1.3% since 2010. This was compounded by the high levels of sovereign debt that many of the countries in Europe’s periphery held. Those countries, which became known as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain), entered into austerity programs designed to slash government spending, lower public debt, and engage in structural reforms of their economies. While most of these countries have since finally begun to grow again, their levels of GDP are still below their pre-crisis levels, their levels of unemployment remain highly elevated (averaging 11.3% among the PIIGS according data from the OECD), and they are still quite some way from reducing their debt levels to ones acceptable by the EU (average debt levels for the 5 countries was 121% of GDP in 2017). Particularly, in the rules set out in the Growth and Stability Pact (which is based on parts of the Treaty on the Functioning of the European Union), the budget deficit of each EU country should not exceed 3% of GDP. Furthermore, the public debt-to-GDP ratio should be less than 60%. (Dendrinou, 2019) As such, the PIIGS are still expected to continue reducing their debts and are advised by the European Commission to engage in structural reforms of their economies and labour markets that would help in improving their potential long-term growth. The European Commission disapproves of policies perceived to move them away from this path.
Figure 2 – Unemployment Rates for PIIGS (Source: OECD)
Understandably, the austerity programs have been extremely unpopular and have led to the rise of populist and Euroskeptic parties and movements in countries around the EU. In Italy, that led to the ousting of the ruling Democratic Party and the rise of two populist parties: the far-right ‘Lega’ (League) party, and the anti-establishment ‘Movimento 5 Stelle’ (5 Star Movement, or M5S). These two parties have formed a coalition government aimed at enacting policies despite any opposition by the European Commission.
The policies that the M5S-Lega coalition are enacting are aimed at reversing some of the austerity measures that were enacted under the previous centre-left government. League campaigned on reducing taxes, a policy especially popular in its stronghold in northern Italy that many small and medium-size business owners call home. M5S, on the other hand, has proposed reducing the retirement pension age back down to 62 years old from the recently enacted 68 years old. That means that welfare spending would swell as a larger population would be eligible for pensions (Jones, 2019). Both parties have also campaigned on introducing a citizens’ income—a basic income policy aimed at alleviating poverty. With Italy having one of the highest rates of poverty in Europe, the populist government hopes that this is the way to improve living conditions for Italians. Opponents of the measure have criticised its selective nature, allowing access to the program to only citizens while those on a work permit are barred (Girardi, 2019).
This is where the reasons for the standoff become clear. In order to enact the policies that both of these parties have campaigned on, the Italian government proposed a budget that the European Commission deemed unwise. Particularly, despite the fact that the budget deficit proposed is 2.4% (which is below the 3% maximum), its projected effect of raising the debt levels by increasing government spending would only move Italy further away from the target maximum level of debt that, according to the Commission, it should be targeting instead.
The conflict carries broader implications for Europe. Given the Euroskeptic bent of M5S-Lega, it is not just a spat over economic policy but a symbolic conflict over which trends will take hold of EU countries in the future. A victory for M5S-Lega will embolden populists around the country bloc and possibly allow them further freedom to pursue policies that will appeal to their base. These might include anti-immigrant policies that Lega and other far-right parties have been advocating for. For example, Lega is advocating the turning back of illegal immigrants that enter the country. Luigi Di Maio, leader of M5S and Deputy Prime Minister, met with leaders of the ‘Gilets Jaunes’ or “yellow vests” protestors in France in a symbol of anti-establishment alliance. A victory for one anti-establishment force is a victory for all, it seems (Toubeau, 2019).
For the moment, the European Commission has decided to allow Italy to proceed with its budget, but this sets up the question of what it will do if Italy continues to increase its debt-to-GDP levels. Already the second-highest in all of Europe, Italy can ill afford an economic misstep. Given its weak productivity, unhealthy financial sector, and large size, economic trouble in Italy could mean economic trouble for all of Europe.
In light of the standoff, how are the economies of Italy and the EU performing and what does their near future look like
There are several risks to the EU economy at the moment that might derail its growth and spell disaster. For one, even without uncertainty in Italy, the broader Eurozone economy has slowed down. Italy experienced a 1% growth in 2018 while the IMF estimates even that will slow down to 0.6% in 2019. Germany has experienced a slowdown at the end of 2018, partially as the result of Germany’s auto sector adjusting to new emissions requirements for its new automobiles. But it is also the result of the deterioration of the global economy particularly the weak growth of the Chinese economy, as well as the trade war between China and the US. While the IMF estimates that the economy grew by 1.5% in 2018, estimates also show that the German economy contracted for the second quarter in 4Q2018, triggering a technical recession. Growth is likely to be subdued at 1.3% in 2019 as well. In France, while the economy is performing better than expected, it still faces headwinds of the yellow vests protests, and growth in 2018 comes in at 1.5%, with IMF forecasts for 2019 to continue at that level. It’s not all doom and gloom in Europe though. Spain is experiencing strong growth compared to the EU, expanding 2.4% compared to a bloc-wide 0.2%. However, unemployment levels around the EU remain quite elevated, with average unemployment sitting at 7.9%. Even strong performer Spain still suffers a problem of low employment, where the unemployment rate is 14.5%. The EU might not be in disaster mode, but it is far from healthy.
Debt levels are also still a problem. The PIIGS (save Ireland) still maintain a high level of public debt that could be very detrimental to their long-term growth potential. With the ECB ending its quantitative easing program, it is expected that borrowing costs will only go up from here. Rolling over debt will just make it more difficult for these economies to grow. Furthermore, high public debt implies high debt servicing costs which take away resources from possible investment into infrastructure, government services, or investment into policies that contribute to labour productivity such as education and healthcare. Austerity has not proven to be effective in bringing those levels down, and so the pressure to find ways to improve growth prospects is higher than ever. Economic reforms are the best way to do so, as the PIGS, especially Italy, suffer from structural problems that lower their growth outlook. Italy suffers from several problems that have led it to anaemic growth.
Figure 3 – Productivity for PIIGS (Source: OECD)
For one, Italy’s productivity lags behind that of other countries. Part of this is a result of the business environment in the country—more than 95% of all firms in the country are small with less than ten employees. Smaller firms have lower productivity than their larger counterparts, and that leads to lower overall productivity in the country. But even when compared to their European counterparts, small Italian firms show low productivity. Italian firms overall also find it difficult to innovate to gain a competitive advantage, whether due to resistance to change, family ownership, or difficulty borrowing money to finance investments (Romei, 2018). Combined, these factors contribute to weak productivity which hurts economic growth potential.
Experts also cite Italy’s weak education system as a reason for the lack of productivity. Italian students underperform their OECD peers—they are thus less productive in the workforce which is, of course, detrimental to the economy. Reforms to the education system are in the government’s plans, but they have not received significant focus. Finally, the business environment in Italy contributes to stifling growth. The country scores poorly on measures of government efficiency, and it ranks 111th out of 190 countries in ease of enforcing contracts according to the World Bank. This reduces the incentive for businesses to invest and grow, dampening any possible growth potential (Romei, 2018).
Together, these issues lead to long-term stagnation in Italy, and they must be resolved if the country is to reach its full potential. Doing so would ease pressure on the government as growth allows it to reduce its debt levels (as urged by the European Commission) and help increase living standards for its citizens (easing internal pressure). While government spending to alleviate poverty is a welcome measure, it must also be the beginning not the final step in government policy to ensure the well-being of its citizens. Rather, the government must use its resources to address Italy’s long-term structural problems (Romei, 2018).
Dendrinou, V., 2019. How Italy Sparked a Standoff Over EU’s Budget Rules. [Online]
Available at: https://www.bloomberg.com/news/articles/2018-11-21/how-italy-sparked-a-standoff-over-eu-s-budget-rules-quicktake
[Accessed 21 February 2019].
Girardi, A., 2019. The Italian Citizens’ Income Reform Part 1: The Measure Against Poverty And The Welfare In The EU. [Online]
Available at: https://www.forbes.com/sites/annalisagirardi/2019/02/07/the-italian-citizens-income-reform-part-1-the-measure-against-poverty-and-the-welfare-in-the-eu/#5789b6d36f77
[Accessed 21 February 2019].
Jones, G., 2019. Factbox: Italian early-retirement option rolls back 2011 pension reform. [Online]
Available at: https://www.reuters.com/article/us-italy-politics-pensions-factbox/factbox-italian-early-retirement-option-rolls-back-2011-pension-reform-idUSKCN1PB2KD
[Accessed 21 February 2019].
Romei, V., 2018. Why Italy’s Economy is Stagnating. [Online]
Available at: https://www.ft.com/content/b3c85b34-e10a-11e8-a6e5-792428919cee
[Accessed 30 January 2019].
Toubeau, S., 2019. A feud between France and Italy sums up the deep rift over Europe. [Online]
Available at: https://qz.com/1548392/a-feud-between-france-and-italy-sums-up-the-deep-rift-over-europe/
[Accessed 21 February 2019].
Source from: MERatings