The Italian Job: not so “mini” anymore
After the recent summit in Brussels, markets responded positively as stocks, bonds and the Euro all rose in response to the approval of an emergency economic plan. The measures approved were also aimed at supporting the weaker areas of the Eurozone, none more so than Italy. Fears that it too will soon be engulfed by the crisis have been paralysing markets for months and last week’s measures were explicitly aimed at reducing the likelihood of this occurring.
After Greece, Italy is the second most indebted country in the Eurozone, its debt weighing 118% of GDP, but thanks to peculiarities endogenous to its system, the country has escaped the fate of other, less heavily indebted countries in Europe. Moreover, except in 2009, Italy’s debt has been above 100% of GDP since 1991. Surprisingly to most economists, Italy had managed to remain solvent, since majority of its debt are relatively liquid, easily exchangeable for cash and therefore a low-risk investment, Moreover, Italians have a culture of being risk-averse: household debt is relatively limited, and government expenditure has been below income every year since 1992, except in 2009.
That being said, Italy’s finances are very weak. Its economy is one of the slowest growing in the world, and its long-term instabilities and defects are now threatening to engulf itself. Mr. Berlusconi has long been a source of concern for his international counterparts, and widespread lack of faith in his government culminated this summer, when squabbling, particularly within the leading coalition, lead to the approval of a watered-down version of the austerity plan first proposed by Italy’s finance minister, Giulio Tremonti.
The plan was immediately criticised as unfair, ineffective and inadequate. Most of the spending cuts it included were delayed until 2013 and the rise in taxes contained within the fiscal policy it outlined appeared mostly damaging to low-income households. Furthermore, the plan appeared to do little to address the problem of tax evasion, a fundamental cause of economic weakness in Italy.
To make matters worse, Mr. Berlusconi attempted to make personal use of the plan by slipping in a clause which would enable him to postpone the payment of an indemnity of 750 million euro to a business rival, who recently won the right to compensation after Berlusconi’s lawyers were found to have bribed a judge in a previous legal battle between the two.
Unsurprisingly, this failed to impress investors and Eurozone leaders alike. Investor pessimism peaked and Italy was downgraded first by Standard & Poor’s and by Moody’s, two of the most important rating agencies in the world. This in turn prompted the spread (the difference in interest rates on sovereign debt) between German and Italian bonds to reach historic highs over the summer, sparking further ineffectual panic within the government. In the end, the European Central Bank intervened, hurriedly buying up Italian bonds, but at a price: the formulation of a new austerity plan to include a new, more stringent budget.
Eventually, a final version was presented at the European summit last week, but not before Mr. Berlusconi was chided once more by his French, British and German counterparts, sparking noisy resentment in the leading coalition.
The root of Italy’s economic malaise is clearly political. A prime example of this was the markets’ reaction to an incident in July which saw the finance minister, Giulio Tremonti, implicated in a scandal involving a close friend being accused of corruption. As soon as the scandal emerged, markets reacted sending Italian bonds soaring and bringing the whole economy to the brink of disaster. This is because, in a state system which appears increasingly corrupt and volatile, Mr. Tremonti was viewed as a safeguarding influence, having been widely praised for his role in steering the country through the recent financial crisis. When his reliability and integrity came under scrutiny, so did his ability to hold the economic fort.
The problems that plague Italy are endogenous. Profits from organised crime are thought to comprise up to around 7% of GDP. Tax evasion is widely tolerated, and is in fact publicly endorsed by Mr. Berlusconi himself. Corruption is a feature of government that the population is sadly beginning to see as a necessary part of politics, and Italy is now at a point where tough decisions will prove inescapable. Unfortunately for Italy, its future rests once again in the hands of corrupt giants and political mice.