Euro Crisis: After Greece, Italy?

Secret denunciations against anyone who will c...Image via Wikipedia
The G20 meeting in Cannes was rocked by the Greek Prime Minister's antics - first a  referendum on the proposed European bailout then a quick withdrawal. 

But the real concern was Italy. 

Is Italy the equivalent of Lehman Brothers whose failure on 15 September 2008 threatened Wall Street with collapse or is it bigger still, like AIG, "too big to fail"?

Italy is of course much larger than Greece. It is the third economy on the continent after Germany and France. Whether it really is the third in Europe is a matter of debate: there has always been a rivalry between the UK and Italy for that position.  What is certain is that Italy is actually a lot bigger than the official statistics would allow - probably some twenty percent larger because of its "economia sommersa", the hidden part of the economy that escapes all taxation and does not show up in national statistics. 

What it means to have an economia sommersa.

Anyone who lives in Italy (as I do) is instantly aware of the situation when at the restaurant you're asked whether you want a bill ("fattura") or whether the cash ticket (the "scontrino fiscale")  will be enough. With a bill,  the tax (IVA) is fully counted in, with the ticket it's not. In other words, most restaurants never fully pay the government the taxes they owe - just a part of it. And that's only the tip of the iceberg. Tax evasion in Italy is massive and affects just about every economic activity. As it is massive in Greece of course.

And tax evasion is not considered immoral by most Italians. On the contrary. The government is the one viewed as immoral: services are bad, trains are always late, the roads are full of potholes, whole towns in the South go without water in summer, hospitals are overcrowded, the bureaucracy is bloated, slow and inefficient. It is the direct result of clientelismo, the Italian version of pork barrel. Everybody knows that politicians win over votes with lavish distribution of  favors. Careers are made on "raccomandazioni". Meritocracy is not a word in the Italian lexicon.

Berlusconi's empty promises.

When Berlusconi came to power in 1995, he promised reform and never delivered on any of his promises. Yet Italians had hoped to see change: here at last was an entrepreneur, not a professional politician. Here was someone so rich that he wouldn't be open to corruption. 

Unfortunately, that was not counting on the skeletons in his closet: throughout his mandate, the Law has been after him. He's faced charges ranging from tax fraud to sex with an underage prostitute.  Instead of pushing for reforms he has only defended his own interests. As a result, under his stewardship, the situation that was bad got worse.

But then, what could one expect from a leader with such a tarnished profile? Nothing but more and more corruption. The fish always starts rotting from the head. For example, Berlusconi had promised a big infrastructure plan: some 189 projects to overhaul the Italian highway system etc. Out of these, over the last decade, only 40 came to fruition! Berlusconi had made a big fuss of building a bridge over the strait of Messina to link Sicily to the continent, but of course nothing came out of it (and whether such a bridge is at all needed is a good question).

Now Italy is faced with continued slow growth and a locked political situation.

Berlusconi, to save his majority in Parliament, has allowed himself to be highjacked by Bossi, the head of the Lega Nord, the northern secessionist party whose avowed aim is to get Northern Italy to break away from Rome. Not something the Left or the Center relishes, and neither does Napolitano, the Italian President. Meanwhile the public debt has grown to 120% of gross domestic product, some two trillion Euros, threatening the survival of the Euro.

Everybody in Italy knows what the reforms should do: streamline the bureaucracy and get rid of excess fat, liberalize the labor market with a special effort to include new entrants (the young with unemployment nearing 40% are especially affected), introduce measures for growth to cut red tape and support business innovation and entrepreneurship. 

In August the European Central Bank sent Berlusconi a letter detailing all the needed measures, plus an appeal to sell the "crown jewels", i.e. government property to pay for the debt (I'm not sure that's a good idea, but I'll get to that in another post).

The letter went unheeded, Berlusconi didn't even show it to his cabinet.  However a minimal series of "austerity measures" were passed in the summer aiming to balance the budget by 2013 but application has been slow and erratic - except for an immediate rise in the IVA tax (although as we all know this is a widely evaded tax).

Meanwhile rating agencies got in the act and started the process of downgrading Italy's debt ranking (for example, one month ago Fitch downgraded Italy from A+ to A--). And it is becoming increasingly expensive for the Italian government to raise money on the bond markets: the spread with Germany is now averaging over 4 percent - an unsustainable amount.

To prepare for the November G20 meeting, Berlusconi sent a letter of his own to the European Union. It  was accepted probably because there was no time to discuss it. Rejecting it would have made matters worse at the G20 meeting making Europe look like it couldn't handle one of its major members - although nobody was duped. 

Because Berlusconi's letter was remarkably devoid of any real content. Indeed, Tremonti, his own Minister of the Economy, refused to subscribe to it. Just consider one of the points Berlusconi made, that he would see to pension reform and bring the Italian system in line with the rest of Europe - with pensionable age at 67 years for both women and men (something strenuously opposed by the Italian labor unions). Sounds good but the timetable?  It is not planned to be introduced before 2026...that's15 more years of mismanaged and unsustainable expenditures!

So a lot of pointless letter writing is going on and a lot of wrangling.  Including such hot points of contention as a wealth tax (politicians, all very rich thanks to their super salaries, fight it) and a proposed amnesty (condono) on tax evasion. The condono system is well established in Italy and it recurs regularly: rich people who have built "abusive" houses (i.e. without building permit) are very fond of them. And they inevitably cause the Left to rise up in arms.

No wonder the  budget bill presently in the Senate is getting nowhere. Because nobody agrees on the exact content of the reforms or the timetable. Big business is getting increasingly nervous: both Marcegaglia (head of Confindustria) and Montezemolo (Fiat group) have appealed to the government to do something or step down. That's democracy for you.

The way out? 

First get rid of Berlusconi! His reputation is destroyed, the man is finished. But he's desperately holding on to his seat, as is the rest of the Italian Parliament. No one wants to leave a table with so many goodies on it.

Will an Italian politician rise above the corrupt mass? Berlusconi is losing his supporters (another six just left his party) but more, much more needs to be done for Italy to have a new government capable of reforming the system.

I'm not very optimistic.The timetable promises to be a long one - just like in Greece, by the way, if not worse. People expect Berlusconi's government to collapse at year end or January. Then two or three more months will be needed for elections and to get a new government started.

Even if Italy opts for a coalition government Greek-style, times will be long, reforms can never be actuated overnight. Berlusconi has agreed to let the International Monetary Fund monitor the process, but that won't change much of anything and hardly accelerate the process. The IMF can only monitor - not impose anything.

Times in a democracy are very long, and times on financial markets very short. 

Euro zone leaders thought the G20 meeting in Cannes would help them solve their fundamental problem: how to strengthen the EFSF (European Financial Stability Facility) and make it big enough to protect Italy while it took its time to undertake reforms. 

Europe has enough firepower for Greece, but not for Italy. Europeans knew America could not help. They hoped the BRICS would, but they balked. Even China hummed and hawed. From that point of view, the G20 meeting was a total failure.

Bottom line Europe  has to build up its own firepower

That means either strengthen the EFSF or allow the European Central Bank (ECB) to act as a Central Bank. 

The new head of the ECB, the Italian Draghi who (contrary to his predecessor Trichet) is an economist, knows something needs to be done. He immediately moved in the right direction, lowering the interest rate - and managing to do so with the approval of his whole Council, Germany included. 

Because so far, it's Germany that's been dragging its feet: they don't want to hear about Euro bonds or any other mechanism to defend the sovereign debt of Euro zone members. They want Euro members to "put their house in order" first (read: adopt austerity measures). But with too much austerity you kill the hen and you won't get anymore eggs.

The Greek hen is almost killed and the Italian one is badly wounded (not to mention Ireland, Portugal and Spain). 

How much hen killing will it take to convince Germany to adopt mechanisms that truly defend the sovereign debt of members under speculative attacks? 

Additional firepower is needed to give Euro member countries the time to put their house in order. It's as simple as that.

With a caveat: additional firepower should not be used as a pretext to continue playing the game as before, lavishly spreading about unaffordable salaries, pension benefits and other privileges. European countries need to reform, no question about it.

This said, in the end, something will need to be done to avoid the immediate collapse of the Euro. My own favorite means would be Euro-bonds. It's simple, financially elegant and easy to control (say via the ECB).  And it's a means you could fine tune and use as a whip against member countries that do not toe the line - in other words: you could threaten to withhold the Euro-bond cover if they don't reform.

What's yours?

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