Italy is stuck in recession mode through a combination of EU policies and its own internal follies. What are the implications of this to the EU and the world?
May 20, 2019
By: Bobby Casey, Managing Director GWP
Some red flags are going up in the EU, and those flags are coming from Italy. Economic discord plagues that country, and the simple answer is: one camp wants out of the EU, the other does not.
Here are some statistics on Italy’s economy:
- 2.3 Trillion Euros in debt (i.e. 132% of GDP, second highest to Greece)
- 1.74 Trillion Euros GDP
- 2.4% Deficit spending of GDP
Italy is the 3rd largest EU economy with 10.6% unemployment overall and 32.2% unemployment under 25 years old. It hasn’t seen much growth. In fact, what growth it’s seen has been rather anemic at under 1% for the past decade save two times.
The current regime is putting the EU warnings on the back burner, while addressing the more immediate populist needs of greater employment and pensions. This is projected to lead Italy’s deficit more than the EU cap of 3% by 2020.
This is an untenable trajectory.
The Deputy Prime Minister, Mateo Salvini, is part of a strong “eurosceptic” political movement that believes the EU is bad for Europe and bad for Italy. His populist sentiments did no favors for Italy’s bond market when he went on to urge Rome to break the deficit cap rules as well as push the debt up to 140% of GDP.
Investors were shaken.
The EU, with all its misgivings, is not a fan of quantitative easing and the inflation begotten by that. They called for a reduction in Italy’s structural deficit by 0.6%, and Italy in turn snubbed them with a 0.8% increase.
The EU is calling for austerity and threatening fines, Rome is calling for “economic stimulus”.
This isn’t the first of the Eurozone crisis. These issues date back at least a decade when France, Spain, Ireland, and Greece were first instructed by the EU to reduce their deficits.
In that time, Greece has received two bailouts, Cyprus, Spain, Portugal and Ireland received bailouts from the EU. All were reeled in from imminent bankruptcy.
The issues are multi fold. The EU is a mirror of what the US is going through. While austerity measures make sense, cutting spending with restricted trade options doesn’t give the nation’s economies much room to grow.
The heavy centralization and economic costs associated with having such a federation is showing. Each nation must keep their deficits under 3%. The EU must approve each member nation’s budgets, and can impose fines for noncompliance.
You would think this would allow each nation to exercise self-determination in their taxes. Not necessarily true. If they want to tax or increase tax, the EU tends to leave it alone. If they want to reduce taxes or offer loopholes that might encourage foreign investment, the EU quells it.
If you recall, that is precisely what happened with the Double Irish Dutch Sandwich. Brussels contended it was an “unfair” advantage for Ireland to have such a loophole in their tax codes, and closed the door on it.
The EU insists upon that same sort of “fairness” in trade. One of the major gripes England had with the EU is the heavy restrictions on trade. Within the EU, it’s quite simple. There’s a free flow of labor and goods coming and going between member nations.
Granted, standardization mandates and regulations exist determining how products should be produced, not just to trade with member nations, but to sell within the country. It’s one thing for France to say “products imported into France must meet these standards”. It’s another for those standards to be imposed on the exporter.
No EU nation can have independent trade agreements with other countries. They must go through the EU. This can become a bureaucratic nightmare, and quickly becomes cost prohibitive.
This is problematic for member nations who need to cut spending, but also need to stimulate their economies to prompt growth and reduce unemployment.
Countries like Spain, Portugal, and Italy are hurting, but can’t incentivize investment through tax incentives. They can only incentivize through keeping their bond values high. But bond values are directly tied to their economic health.
The Euroskeptic leadership of Italy isn’t wrong in that they are being suffocated economically. They are suffocated not because of calls for austerity, but because they have no way of generating their own revenue without EU approval.
What happened in Greece was a huge blow to the EU. But if the same thing were to happen to the 3rd largest economy in the union, Italy, it could send the entire Eurozone into a tailspin.
Economists and colleagues, John Higgins and Adam Hoyes, at Capital Economics wrote in their research notes:
“The IMF voiced concerns about the country’s [Italy’s] high level of debt and the risk of that triggering another euro-zone sovereign debt crisis. Admittedly, Greece’s government debt as a percentage of GDP is even higher than that of Italy.
“But unlike Italy’s, Greece’s debt-to-GDP ratio is on a downward trajectory and its debt has been restructured under far more favorable terms than Italy’s.
“What’s more, Italy’s debt is much larger in absolute terms and poses a much bigger systemic risk for the euro-zone as a whole.”
While the US federal government has no real say over how each state manages their budgets, it does leverage federal funds to get certain policies pushed through.
Italy is stuck in recession, and some of it is its own doing.
- Italy is lacking technologically and educationally
- Their labor force is shrinking
- Their corporate governance is inefficient and their government is corrupt
- Their labor laws are such that it drives companies out of the country, rather than encourages companies to set up shop
If Italy wants to leave the EU, they would have to pay close to 500 Billion Euro at once upon leaving the EU.
Aside from the dire consequences this has for the Eurozone, there are lessons to be learned for onlooking countries such as the US.
The US is a federation as well. States do not need federal approval for their budgets or their state level taxes. They don’t have to tax at all, in fact. States are free to compete with one another, a freedom the EU member nations do not have.
However, heavy-handed centralized federal governments hurt their member states with protectionist polices on trade. Heavy regulations, onerous labor laws, and high taxes deter foreign investment… or any investment for that matter.
The US should look at the EU as a cautionary tale.
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