The nightmare known as the Italian debt crisis, which had been simmering on the back burner for a few years, has come back to life at a particularly inopportune time. After all, things have been looking up for the eurozone for the first time since the end of the severe 2008–09 recession. Economic growth, after languishing for years, has finally returned to the 2 per cent range, and the unemployment rate recently dropped below 10 per cent. More importantly, concerns that the European Union (EU) might come apart following Brexit have eased somewhat, after France’s Emmanuel Macron and Germany’s Angela Merkel defeated parties on the far right calling for the end of the euro.
But the EU received a jolt in the spring when the left-wing 5 Star populist party and the right-wing League party won the most votes in Italy’s elections. Both parties want to withdraw from the euro. Radical parties have won seats in many other European legislatures, but have failed to capture most of the votes. Marine Le Pen’s National Front, for instance, hasn’t been able to win more than one-third of the votes in French elections. However, the 5 Star and League parties managed to cobble together a national government in Italy at the beginning of June, a development that plunged the country back into a debt crisis as rattled investors sold off Italian government bonds, which sent yields soaring. The spread between German and Italian bonds had tumbled from 3.5 per cent in 2013 to around 1 per cent by the end of April 2018, but that spread has subsequently shot back above the 2 per cent mark.
To add some perspective, the Hoover Institute’s Josef Joffe notes that the marriage between the League and 5 Star parties in Italy could be compared to an inconceivable coalition between U.S. Senator Bernie Sanders and the Republican-linked Tea Party.1 While both Italian parties have built their popularity on bashing the euro and EU, they have backed away from holding a referendum on euro membership, as most Italians continue to support sticking with the common currency. Each party supports the idea of using IOUs to pay some government suppliers—a development that some economists contend could lead to a parallel currency. The 5 Star party wants to implement a guaranteed income of around $1,000 per month, while the League is pushing for a flat tax of 15 per cent. Italy’s public debt is already above 130 per cent of its GDP, and the spending initiatives of the new coalition government could increase the annual budget deficit by $150 billion. Both the League and 5 Star hope to cut the pension age, which would be harmful in a country with a rapidly shrinking working-age population and one of the lowest fertility rates in Europe. They feel that Italy is entitled to $250 billion in debt forgiveness and have proposed getting rid of sanctions on Russia, which has angered Germany’s Merkel.
None of their policies will address the grim reality facing Italy’s economy. In addition to huge debt levels, real GDP growth remains well below the average growth rate in the eurozone, and Italy is not expected to attain its pre-2008 GDP level until sometime in 2025. The unemployment rate is still at double-digit levels, while the youth unemployment rate is a shocking 35 per cent. Productivity growth remains abysmal, while Italy ranks 50th in terms of the ease of conducting business, according to the World Bank, behind even notable laggards like Serbia and Russia. What the economy really needs are reforms to the inflexible labour markets that act as a disincentive for firms to hire younger workers. However, there remains little support for these necessary reforms in Italy. Former Prime Minister Matteo Renzi, who resigned at the end of 2016 after losing a referendum on much-needed constitutional change, failed in his attempts to reform Italy’s economy. His Save Italy campaign was put on hold when the country’s influential lobby groups, ranging from taxi drivers to pensioners, took to the streets to protest his initiatives.
Should we worry about Italy’s potential disintegration? The Globe and Mail’s Eric Reguly saysthe answer is yes: Italy is the EU’s third-largest economy and second-biggest manufacturer, but more importantly, it oversees the world’s third-largest debt market, with around $3.3 trillion in liabilities.2 It is doubtful that the eurozone could survive if Italy fails. This is a key concern for Canada, which signed a free trade agreement with the EU in 2016. Angela Merkel and Emmanuel Macron won’t be able to go ahead with their plans for a stronger and more integrated EU with the ongoing uncertainty in Italy.
There is, however, still some reason for hope. Italy is simply too big to fail, as many financial institutions in Europe are exposed to Italian debt. The European Central Bank has already taken steps to keep yields on Italian bonds from soaring, and is likely ready to provide interest-free loans to banks. Also, Joffe notes that Italy has had 66 governments since the end of the Second World War, which implies that the current coalition government may not be around long enough to implement its bizarre economic ideas.
Canadian Outlook with the Chief Economist: Unfair Trade
Presented by Pedro Antunes, August 15, 2018, at 2:00 p.m. EDT