The Italian case and the German strings in Europe and the ECB
Roberto Napoletano, Sole24Ore Editorial Director
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Our and their faults and merits
Since the start of the crisis, Italy has lost a quarter of industrial production, nine points of gross domestic product (GDP), and 15 points of GDP in the south. Italy as we knew it does not exist anymore, it has dissolved. In dramatic words, it has died. The sooner we realize we are living in a different Italy – in a smaller and increasingly unequal country, born poor and become rich and which has continued to live rich beyond its means – the better.
It will be easier for us to understand that our faults come from afar, are serious (in numbers, they translate in €2.157 trillion of public debt) and struggle to leave behind these days of social tension and resurgent terroristic bouts. The vices of old and new politics mingle with crime and the underworld, seriously damaging the most important asset of a country – its reputation.
It will be easier to acknowledge our faults, equally serious, which belong to the sick part of the US financial system and its likewise sick German extension (what were – if not state aid – the hundreds of billion dollars and euros that the US Treasury and the German public budget paid to save their crippled banks?). These faults belong to a bad regulation of global financial markets which survives everything and everybody (where is the new Bretton Woods?). Let alone that German nationalism, often justified with this or that European rule, which prevents us from effectively creating the United States of Europe and implementing that ambitious, mutualistic principles which belonged to the founding fathers and without which the world’s largest region for consumption is doomed to being sidelined.
How is it possible that Germany’s politics and finance (the industry has long been aware of it) do not realize that the US is running again because it has implemented strongly expansive economic and monetary policies and that this is the road to restart domestic demand in Europe?
Italy’s seeds of confidence and the European political logjam
The small, big Italy emerged from two crises, domestically and internationally, is dealing during the Christmas holidays with its tardiness and flaws that affect heavily its social fabric, reducing job opportunities and preventing the seeds of confidence that still exist from growing. Italy also faces a paralyzed European political system (where are the eurobonds and real investments? Will they be excluded from EU pact rules? How much will the plan of EU Commission president Jean-Claude Juncker be worth?) and with a monetary policy (of the European Central Bank) at a delicate turning point (will ECB president Mario Draghi’s bazooka arrive?)
For the first time, the real economy in today’s tormented Italy is in a more difficult situation than it was in November 2011, squeezed between financial markets ready to take the chance to focus on Italian sovereign debt like they did that year (for those who have forgotten, nobody bought Italian paper) and the usual strings that Germany and northern Europe could force the ECB to attach to its Quantitative Easing (QE), the new bazooka, threatening to transform a monetary policy tool in another straitjacket for a country exhausted after years of shortsighted austerity.
The double match of Renzi and Draghi
Will the Renzi government be up to a challenge that shakes one to the bone? Does it have the strength, the human capital, the international stature? Will Mario Draghi be able to demonstrate what’s always been his best quality—that is, the political astuteness to do the right thing at the right time? What will the impact be of the strong strains of populism that try to convince Italians (alas, with some success), that their savings and their jobs will be safer outside of the euro—omitting the banal consideration that Italy’s public debt, as long as it’s linked to Europe, creates fear and incites respect? Alone it would just be ours and no one would care about saving us from the kind of poverty that engulfed Argentina when it defaulted.
Or in addition, that companies like Enel and Telecom, a crucial part of the nation’s industrial plan, and many others that are equally indebted, would go belly up from one day to the next because they would not be able to pay their debts, which would still be in euros, to the holders of their bonds, which are subject to English law?
These are the facts. They require a thoughtful, well-developed and in-depth analysis and, for this reason, we have decided to take advantage of your patience to write a kind of letter that discusses Italy in Italy and Italy in Europe, airing the lesser known facts and hidden corners, with the aim of explaining how things really stand, laying out the weaknesses and strengths of our political classes and of those “fetishist” traits that are guiding the EU today.
Stagnation at home and the wall of courage
Today’s Italy, after accounting for the propaganda (including jinxes) lives in a context of economic stagnation. The likelihood of recovery is tied to the number of people who will be able to be provided with work, to the increase of disposable income, and to the return of investments both public (lacking, at 8 billion euros between 2015 and 2017) and private (of which are companies that, before recommencing their investments, are demanding certainties regarding the actualization of reforms, starting with the fiscal and bureaucratic ones). Let’s be clear from the start: there are companies that ransacked the state and made perverse deals with organized crime, that are absolutely bad, and the business world must be strong enough to recite its mea culpa and cut this tumor at its root. It is equally true, however, that there is a widespread texture of medium sized Italian companies, manufacturing companies (which span from instrumental and precision mechanics, to chemical, to specialized IT, to furniture, to the fashion system and to the agricultural and foodstuffs sectors) that can currently still generate 400 billion euros in exports and 100 billion euros in active balance—making it the only positive chapter in a country that lives on public expenditures and debt. If the goal was to save the healthy portion of Italy’s economy so that is could once again start running, investing, and providing jobs, it was not a good choice to use 10 billion euros for a 80 euro bonus that had no effect on consumption, and managed to subtract a precious tool to announce to the world that the Italian financial shock had finally begun in a transparent and linear manner. Failing to recognize that the 6.5 billion euro cut from the labor component of the IRAP and the reduction of taxes for newly hired employees are a move in the right direction would, however, be a mistake. The point is that during recession and deflation very little can be assumed, while the regret for the cumulative effects of these new interventions made by using the 10 billion euro dowry for the 80 euros would have worked as a multiplier by being a psychological and substantial lever for Italian entrepreneurs and foreign investors, endowing the first non-recessive maneuver to take place in a long time, with a truly expansive character. Too bad.
The web of distortions that needs to be erased and the sickness Italy, its corruption
On the latter issue, of vital importance, the government has started to take some action. A proposal on simplifying taxation procedures has finally been turned into a law, however implementation rules are yet to be approved. The Parliament is currently examining a bill on public sector reform –which touches on all the most important matters for tackling bureaucracy and corruption –but the review process is proving to be slow.
Entrepreneurs wishing to start a new business in Italy are still confronted with a complex bureaucracy that spans from administrative and fiscal regulation to environmental guidelines.
By the time they do manage to navigate their way out of Italy’s complex bureaucracy to get their businesses up and running, entrepreneurs develop such a wealth of knowledge that they might as well consider a career change and become legal consultants.
Each region mandates its own set of rules when it comes to environmental protection and healthcare: in the latter case regulation may vary even vary within the same region, from one local health authority to the next.
If Italy does not manage to simplify such a complex web of overlapping rules, creating jobs –and keeping them going –might prove difficult.
This is the real challenge; anything else is a mere distraction.
Italy’s problem with illegal activities and corruption is one of massive proportion. Just consider the corruption scandals of the last few months: from Venice’s Moses project, to development contracts for the upcoming Expo 2015 in Milan and the most recent scandal that exposed an elaborate web of illicit activities and corruption in Rome (“Mafia Capitale”), hardly a month goes by without a major corruption case in Italy making headlines world-wide. This certainly does not help the country’s reputation –other countries might see their own reputation severely damaged for scandals of much smaller proportions. Yet we still have not learned how to turn the right decisions into legislative decrees –and not just bills.
Attempts to measure how much of Italy’s GDP is lost due to corruption are not always straightforward. But what’s for sure is that the country’s reputation could well benefit from a legal system that guarantees prompt punishment of corruption –rather than the current one which allows for many trails to become extinguished because of an inefficient and lengthy trail process. It would need a legal system with a set of executive laws that allow for adjustments and corrections as trials go on, without the need to start legal processes from scratch –a distortion which eventually shelters offenders from due penalties.
Renzi’s government has established an anti-corruption entity (Autorità Nazionale anticorruzione, National anti-corruption authority, translator’s note) and its newly appointed president, Raffaele Cantone, is certainly doing a good job. But in order to really eradicate the sickness from the system –a sickness that spurs from the complex interaction of bad politics, bad bureaucracy and organized crime –Italy must start taking serious action. Words of disdain will not be enough. Why haven’t they taken down, as demanded by Carlo Cottarelli (former commissioner for the national public spending review) those inefficient or bankrupt companies that still benefit from municipal funding?
Why are we not tackling the bureaucratic jungle that arises out of overlapping regulation across different levels of local government? Do we really need to compromise on the reform of Italy’s “Provinces” (sub-regional government entities that Renzi’s government had initially considered to call off entirely, translator’s note). What has happened to Italy’s spending review?
The Jobs Act is a step forward but Italy must avoid further complications
Economic data from the last quarter indicates that consumption is still falling. The peak in consumer spending usually registered during the holiday season is counterbalanced by end-of-the year taxes and property taxes (old and new ones). Some positive signals are being registered in automotive sales, however disposable incomes of Italian households remains low. It is true that families can still rely on a good level of savings –that have dropped since the crisis anyway –but consumers confidence must be higher in order for families to decide to spend their savings.
Consumer confidence can’t improve simply by making small government contributions (such as the €80.00 bonus for low-income families introduced by Renzi, translator’s note) to families’ incomes, which are eroded by heavy taxation anyway.
Confidence needs to be instilled from the labor market: we need to create jobs.
In order to create jobs, we need investment, which in turns needs fiscal reform, a simplified bureaucracy, private sector integrity and a modernization of labor unions.
So we go back to the labor market. Renzi’s Jobs Act is certainly moving things forward, but its implementation rules will need to make sure that further legal complications are avoided.
The Jobs Act has managed to introduce a higher degree of flexibility for those quitting a job and to introduce choice for incremental job-protection –which should mark the end of cycles of temporary work contracts that affected many workers up until now.
However, the government did not go as far as into make new rules effective for current contracts, over and above new ones.
Change is always fueled by brave choices. But taking on smaller challenges first is definitely a good starting point, especially if they had never been tackled before.
We need a “Di Vittorio” policy line in order to prepare for the jobs of the future
The bravery shown by Di Vittorio (a former head of Italy’s labor unions known for its openness to change and rejection of violent protests, translators’ note) during postwar era is the kind of bravery that labor unions need to show today.
This kind of bravery is needed in order for the country to address cyclical and structural problems. It is needed in order to understand the nature of new jobs to come –and the kind of value that they will be able to generate. It is needed in order to understand that many of today’s jobs will soon be gone –but will replaced by new ones in emerging sectors such as e-commerce logistics (especially for popular e-commerce goods such as food products).
Businesses will need to resist the temptation of substituting their retiring workforce with low-cost replacements. We need to invest in knowledge and to support our youth –this is really what the many small multinational companies that make Italy’s economic backbone need to do. Freezing investment on research and development would prove to be a huge mistake, as it would be ceasing to develop our best talent.
Even doctors now see their jobs at risk due to new protocols and to product standardization.
But society will always be in need of specialized and competent doctors and teachers. It is precisely in these sectors –healthcare, education –that the true strength of the government’s reform agenda can be measured. So far the government has verbally committed to push for change in those sectors, but we need for words to be followed by action in order to assess the real effectiveness of reforms.
We have started to build grounds for “normality”, but there are still mistakes that need to be corrected
The government has covered significant ground in terms of institutional reform.
It introduce a new electoral law and reformed the Senate, two issues of major importance but perhaps not as urgent as reforms of the fiscal system, public administration and corruption –three areas that have a real weight on Italy’s economy.
In order to gain back “normality”, the government has correctly started its process by creating institutions that can allow for the country to be actually governed. So that next time we go for elections, we will be able on the very next day to look at election results and clearly understand who will be heading the new government (something that could not be assured to happen given the previous electoral law, translator’s note).
We must be careful with the Senate tough. We should avoid getting politics at the regional level to have an excessive impact on the Senate.
We should take care of those small enclaves of democracy that have been set by the writers of the Constitution.
In a country doomed by myriads of conflicts of interests, it is of vital importance to defend those democratic values embedded in our Constitution.
It may seem a shaky move to go jump from the democratic principles of the Constitutions to talk about the administrative issues that we face in all of our cities and towns, but I am asking myself: what is still preventing us from taking territorial planning seriously in order to avoid to crack our road network open each and every time we need to carry out works on the electricity, gas or broadband networks? Changing our country will take as long as it will –and this has nothing to do with German nationalism, it is entirely up to us.
“The fetishists” in Brussels, German nationalism and the challenge of ECB
European bureaucracy runs the risk to make us miss the Italian bureaucracy, as it is pervaded by a quasi-religious tendency to see state aid everywhere. For instance, the nonstop pleas for capital increases to Italian banks might wind up being pro-cyclical , insofar as less resources would be devoted to credit for businesses; this happens while investments are still struggling to rise after falling by 25-30% over the last few years. Italy, as it should be understood and rightly interpreted in Brussels, is a country where expenditure – netted out of the interest payments on public debt– grew in the first seven-eight years of the new millennium, and slid over the last four-five years, as a percentage of GDP. Italy’s deficit has been exemplary, growth has been much less so, and the debt/GDP ratio keeps escalating because austerity is undercutting growth and this is a too-long-running vicious cycle, and markets are wondering whether the country will be able to pay interest rates in the long term. Why does not Europe think about the wisdom of achieving a low deficit that in the same breath strangles the economy of a country? Why does not it give up its “religious fetishism” that causes it to think that any loosening of the rules in Italy’s case would lead to the umpteenth squander of money?
The unfair bill that Italian real economy is footing
The truth, to be clear, is that European politics as in Weidmann’s or Schäuble’s versions, is rather nationalistic, and it conceals its nationalism with a cross-eyed “religion of rules.”
Were not the €247 billion that Germany used to plug its banks’ gaps tantamount to state subsidies? Why did not Europe, back then, extend that exception to all the member states? How can the German veto on the “Made in”-branding be justified, in the light of its previous commitments– and how could the Italian reaction be so inadequate? All of this has happened, but was quickly silenced, forgotten, hidden. All that remains are the Italians, who cannot abide by the budget rules and are unable to guarantee transparency and honesty from an ethical and economic point of view.
Italy is criticized for its never-ending electoral cycle (and it is fair criticism), and looked with distrust since its response is always looking for a culprit to blame (banks, the Euro, bureaucracy). As a consequence also who is pursuing a noble goal within Europe must deal with extremist parties in their own countries, and with the shortcomings of a European project that is still a stateless currency area. There are no improvements in cooperation in the fields of public budget and defense, and even the plan for a unified bank crisis-management mechanism is advancing slowly and unconvincingly.
Italy did more than France, but this was not acknowledged
In such circumstances, it can happen that stress tests penalize Italian banks not only because of the country’s GDP and sluggish growth, but even for an hypothetical event foreseen on the basis of projections lending credibility to a scenario that never materialized. If we assume that the state bonds’ interest rate will fall back to the levels of November 2011 (7% for the ten-year bonds) and we impose a prudential increase of capital, this will just take liquidity away from businesses: while there are many speculations about rates hitting 5.9%, in the real world they are still below two percent, and the economy is struggling. To be sure, Germany’s attitude is to blame: the Spanish and the Dutch benefitted from Berlin’s help (rightly so), and right now Italy is alone and with a bad reputation: it is considered an unreliable, corrupt country, which took advantage of past concession on the part of monetary authorities , and which made bad use of the single currency boon: the elimination of the bond-spread helped Italian citizens to get loans on very favorable terms and made the interest rates on our debt fall dramatically. It is true that there is too much corruption in Italy, and therefore it is crucial to act quickly and effectively; but it is also true that Italy made too many sacrifices when compared with its European peers. Italy had to introduce property tax after property tax (first just on houses, now also on lands), it boosts a unique total tax rate, it adopted the pay-as-you-go pension system, it jump-started a program of reforms that , if insufficient, surely amounts to much more than the French have done.
The strings to be removed on quantitative easing to benefit the whole of Europe
What is clear is that the EU’s current lopsided framework– where austerity is not counterbalanced by growth– may doom peripheral economies to a dead end. This attitude , mostly German but increasingly less so, is becoming widespread even within the European Central Bank. The question, now, is: will the quantitative easing come with
certain restrictions, or without them?
We are in favor of restrictions, as long as it is not allowed to freely buy state bonds that are riskier than others– we are referring to bonds issued by countries whose debt tend to increase as a result of slow growth and low inflation (like Italy itself); this may actually be acceptable, given that the possibility to act flexibly in those same countries is reduced. This holds true especially for Italy, a country that is paying (probably wrongly so) the ransom of a lasting mistrust in the capabilities of its political class to bring about reforms: the fear is that politicians would exploit the additional liquidity to shirk their responsibilities.In this scenario, our interest rates would soar again, and our debt would have a higher price. Paradoxically, Italy might wind up facing the threat of a “tailored quantitative easing” – i.e.: one that would not apply to Italy, and, actually, would be of dubious utility. In that case , for us, even the advantage coming from the dip of oil prices would be offset, as the interplay of debt and deflation would trigger the rise of the real rates to pay. That is why restrictions would mark the end of the single European monetary policy and would be tantamount to acknowledge that we are bracing for the end of the Euro. Two reasons good enough to oppose this possibility.
The double European game that Italy must win
This tragedy must be avoided at all costs. How? Firstly, we need to understand whether Renzi will be able to persuade Brussels and pass the test of the excessive deficit procedure by insisting on the fact that one thing is the flow (deficit) – we are definitely the best at this because we have a primary surplus net of interests between revenues and expenditure – and one thing is the stock (debt) that we pay for our lack of growth. We cannot do miracles without selling cheap.
The road ahead is narrow and we will see whether the prime minister is able to use the influence of its success at the EU election and whether he joins forces with France (although chances are small) or other countries. Otherwise, the problem between flow and stock will always (and wrongfully) be the latter and Italy, because of its high debt, would emerge with its bones broken.
Shouting will not help, but it’s necessary to do things in Italy and act politically outside, making people understand that blocking Italy’s economy is a damage for entire Europe, while freeing EU productive investment.
Renzi seems to understand and therefore moves cautiously, but some past outbursts and the lack of meaningful results during Italy’s EU presidency don’t help him and, on a totally different level, don’t help Draghi in building support to a monetary policy action that Europe really needs, a platform to express the autonomy of the central bank but also a political base towards the United States of Europe.
So far, Draghi has never missed a shot and, as we said, his biggest ability is to seize the right political moment to do, and do well, what is necessary. This time, he faces the opposition of German public opinion. Moreover, Italy faces the verdict in spring of a dogmatic commission dominated by Germany.
The message sent from the Franco-German summit in Deauville was to restructure public debt and save Greece, and that this would not be repeated with high-debt countries. We all know what this produced to the disadvantage of Spain and Italy.
Today, we cannot afford to run the same risk. The markets would make us dance again. The Italian prime minister must show that he has the personal strength and the following to push Europe to make decisive progress in terms of policy. He should rather say things as they are, without declining advice that comes from experience and which could be precious.
The game is not easy, it’s very difficult, but we must win. We know that Italy has the resources to make it and we wish it so, sincerely.
P.S. In all this, the imminent change at the Presidency of the Republic cannot be a testing ground. The path toward normalcy passes through a complicated transition and no distraction is allowed. We need the head and the experience of a president living up to the feat.
AlessandroPedrini Finanza&Mercati 