July 18, 2011
Italian politics have been best known in recent years for the farce they have become. Italian Prime Minister Silvio Berlusconi’s womanizing, “bunga bunga” parties, and legal troubles dominated headlines. It was all very dramatic and entertaining; it was all very Italian. And no one in Europe seemed to take any of it very seriously.
All that changed last week. Investors, already weary of debt-ridden European states like Greece and Ireland, began to panic over Italy’s ability to raise money through bond auctions, its high level of existing debt and its stagnant economy. The political turmoil surrounding Berlusconi, combined with concerns about the debt crisis spreading from Greece to Italy, only added to investor uncertainty about Italy’s long-term prospects. Some were worried that Europe’s third-largest economy could be on the brink of collapse.
A successful bond auction last Thursday, in which Italy raised $8 billion, and a massive austerity bill cutting $57 billion in spending, calmed market concerns about Italy and – at least for now – bolstered confidence about Rome’s ability to get its finances under control. But troubles in Italy are far from over. Underlying political and economic problems persist.
Official unemployment is 8.5 percent, although many Italians have simply stopped looking for work. A thriving illegal, cash-in-hand economy allows many Italians to evade taxes. The economy has grown only 2.5 percent in real terms in the last decade, while the population has doubled. Exports, the driver of the Italian economy in the 20th Century, are down, as is worker productivity. The problems in Italy are complex and structural: the old solutions and playbook used to bailout Greece, Ireland and Portugal, where the problem was straight forward and easily defined, will not work in Italy, according to experts.
“Italians have been complacent about the fiscal situation because the banks are strong, but the complacency was unjustified,” said Erik Jones, professor of European Studies at the SAIS Bologna Center of the Johns Hopkins University. “Tax revenues are below what they should be and government accounts are moving into the red. Further consolidation is required.”
These revenues are so low that in a recent interview, Italian politician and economist Antonio Martino said taxes in Italy make up only 14.6 percent of GDP. By comparison, taxes account for 39 percent of GDP in Germany, according to Eurostat.
Politicians Fight While Economic Growth Sputters
Last week’s panic stemmed in part from infighting between Berlusconi and his finance minister, Giulio Tremonti, a respected academic whose interests lie more with tax policy than parties and women . In what has become a typical episode in Italian politics, Tremonti was recently caught on tape calling a Berlusconi deputy a “cretin.” Berlusconi responded by telling an Italian newspaper: “You know, [Tremonti] thinks he's a genius and that everyone else is stupid. I put up with him because I've known him for a long time and one has to accept the way he is. But he's the only one who is not a team player." Rumors that Tremonti was being pushed aside swirled through Rome.
The fight and rumors spooked investors, who worried that without the pragmatic Tremonti, austerity measures would not pass. Few believed Berlusconi had the political capital to force through difficult changes at a time when endless scandals have rendered him essentially powerless. Investors fled Italian debt, and the panic began.
“People are now waking up to the complicated reality of Italian politics. A very competent economics minister is being pushed aside, while even a small rise in interest rates would push the Italian government into the red,” Jones said.
Meanwhile, Italian economic growth has stagnated In the 1950s and 1960s annual growth of 10 percent was normal. Italy’s GDP hasn’t grown more than 2 percent since 2001. Unemployment is high, while exports are down. Productivity increased only 0.1 percent from 2001 and 2005, and shrank by 0.8% a year from 2006 to 2009. Italian government spending has increased steadily over the same period. According to the Organisation for Economic Co-operation and Development, Italian spending has exceeded revenues every year since 1995. The combination was unsustainable.
Bailout Unlikely, But Not Impossible
Despite Italy’s troubles, Ansgar Belke, research director for international economics at the German Institute for Economic Research in Berlin, said that a bailout along the lines of Greece or Ireland likely would not be needed. Italian private citizens and institutions hold the majority of Italian debt. This lessens exposure to the whims of foreign investors, whose flight from Greek and Irish bonds sparked their crises.
Still, with a debt-to-GDP ratio of 119 percent (compared to 62 percent in the U.S. in 2010) and unpredictable politics, additional action might be needed to support Italy. Where this help will come from is no longer certain: newly installed International Monetary Fund chief Christine Lagarde has expressed frustration over the slow pace of austerity reforms. German Chancellor Angela Merkel has made clear that Berlin’s patience with its European neighbors is waning. If Italy fails to make necessary reforms, it could be without economic allies.
“The Italian economy is eight times larger than the Greek economy,” Belke said. “A bailout would exceed the capacity of what’s even thinkable. Germany would not bear this burden. Only the European Central Bank could try to save the euro from a breakdown.”