As Remainers try to keep us in as close a relationship with the EU as possible, apparently led by the Prime Minister, ironically a crisis is brewing in Italy that could yet end up with that country leaving the euro.
Admittedly, this would not necessarily imply an Italian exit from the EU and/or an existential crisis for the union. But this could well happen eventually. After all, the euro is the EU’s largest project to date and the whole edifice rests on it. Moreover, Italy is a founder member of both the euro and the EU.
Italy’s difficulties with the euro are a long-running story. But this week sees a crisis point. Today, the government’s plans for the budget deficit, reflecting the introduction of a “citizen’s income” and a flat tax, will be submitted to the European Commission. These plans envisage the budget deficit next year at 2.4pc. This may not sound that much but the commission wants the deficit to be considerably lower in order to reduce the ratio of public debt to GDP. This is understandable. The ratio is running at over 130pc, which is unsustainable.
Yet Italy’s situation is complex. The banks are weak, with inadequate capital, a high level of non-performing loans and large holdings of Italian government debt. Italian government bond yields have recently risen sharply, with the spread on 10-year bonds over their German equivalents rising from 1.2pc in April to 3pc now. The concomitant fall in the price of these bonds inflicts a significant capital loss on Italian banks.
This is the crux of Italy’s financial difficulties. But the underlying economic problem is more important. Not all of it is down to membership of the euro, but some of it is. Since the euro was formed in 1999, the Italian economy has grown by only 9pc, or the equivalent of just 0.4pc per annum. Bear in mind that the euro was supposed to bring prosperity to all its members, while narrowing divergences between them.
By the way, according to the British establishment at the time, led by then prime minister, Tony Blair, not joining the euro was supposed to bring the UK slow growth, if not disaster. Currency fluctuations were the “barriers and trade frictions” of the day.
As Theresa May is apparently now going to propose an extraordinary arrangement with the EU in order to secure “access” and fend off supposed disaster for the UK economy, it is worth reflecting on the outcome of our exclusion from the euro. Since 1999, compared with Italy’s 9pc, France and Germany have grown by 32pc. So not much convergence there. Perhaps most strikingly, the UK has grown by 42pc.
Policies of austerity alone will not reduce the Italian debt ratio. Economic growth needs to be higher. This is fully recognised by the Italian government. It wants to boost the economy through increased spending and lower taxes. This should help somewhat but it is unlikely that the consequent rise in GDP will be enough compared to the increased level of the deficit to reduce the debt-to-GDP ratio. An alternative avenue is to embark on a programme of fundamental reform to make the Italian economy more efficient. Clearly, however, this is much easier said than done. Neither Italy nor the markets can wait long enough for the pay-off.
So we come to the third way, which is to try to reduce Italian relative unit labour costs in order to improve competitiveness and, on the back of this, to secure an export boom. According to the progenitors of the euro project, the way to achieve this is through domestic deflation.
Yet since 1999 Italy has failed to improve its competitiveness in this way. Whereas German unit labour costs have risen by 24pc, the equivalent Italian figure is 51pc.
In these conditions, the obvious way forward is to depreciate the currency, which is exactly what Italy did several times during the post-war period. Of course, depreciation is not the answer to a maiden’s prayer. On its own it cannot deliver fundamental economic improvements. But it can keep a country competitive despite a tendency for domestic costs to lodge themselves at too high a level.
The new Italian government understands this perfectly well. It is prepared, sotto voce, to threaten a course of action that would lead to Italy leaving the euro, and hence bringing on a lower exchange rate. They are too clever openly to advocate such a move but they are also adamant that they will not be bullied by the eurozone authorities in the way that Greece was. And they have a scheme up their sleeve for a parallel currency, which puts them in a stronger position to negotiate with the euro authorities. Both sides are well aware that, compared to Greece, Italy has more clout and more ability to succeed outside the euro. It is also too big to bail out.
On the face of it, there is going to be a car crash. To avoid it, someone is going to have to back down. It would be unwise, though, to expect the issue to be resolved this week. In particular, when faced with such difficulties in the past, the EU has adopted a policy of fudge and delay. Accordingly, things may well continue without a proper resolution for some considerable time. But if so, the underlying problem will only get worse.
If the Italian economy is having difficulty in growing now, imagine how things will be when the next global downturn comes. I cannot see the Italian government being prepared to sit idly by while growth sinks from next to nothing to negative.
This is not one of those quietly amusing, short Italian operas. There is much here that is downright tragic. It feels to me more like Wagner’s epic and exhausting Ring cycle. This mammoth work ends with the destruction of Valhalla and the Twilight of the Gods.
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