The new Italian prime minister must be a schizophreniac: The one self calls for the end of austerity politics and for a joint growth policy, the other self confirms Italy’s determination to stick to the prescribed consolidation path of the public budget. Which self is stronger, which one dominates – or what is going on here?
Italy’s dismal facts are well known: it has accumulated one of the highest debt ratios in the world (127% of GDP), it had (and still has) massive political problems, unemployment is high and rising, especially for youths, and economic growth Italians know only from looking beyond their borders. The latter is partly due to low productivity, held back by one of the lowest expenditures on R&D, but also to a large extent the result of Italy’s readiness to follow the EU’s prescribed austerity policy. Between 2010 and 2012 Italy has reduced its budget deficit ratio by 3 ½% of GDP, a massive contraction. Its cyclically adjusted (“structural”) deficit is close to zero in this and next year. But the Fiscal Compact forces Italy to reduce its debt ratio further by annually 2% of GDP for the next years and decades. This will require massive – contractionary – primary surpluses (after interest on government debt). It is nearly universal (???) knowledge that this feat is impossible without strong growth. But: further massive cuts in public expenditures or increases in (statutory) tax rates will impede growth, will increase unemployment further, will take any perspective for a better life away from young people. All this will only increase the popular support for the “simplificateurs terribles”, the right-wing populists who promise simple solutions. This will tear the society apart, with all the dismal political and social upheavels this entails.
Letta is in an economic double bind (in addition to his political problems with his coalition “partner” Berlusconi who threatens to leave the coalition and call for new elections any time he does not like what Letta proposes). One the one hand he needs to show the financial markets (which he still needs) and the EU that he is willing to follow their prescriptions (Austerity) and that he will attempt to avoid an EU bail-out at (nearly) all cost. On the other hand, he demands what most sensible economists have been calling for (a growth strategy) as a result of the failure of recent austerity, which has depressed growth and increased unemployment throughout the EU and the Eurozone. Austerity has not even been successful in reaching its intended objective, i.e. a lowering of the very high debt ratios. Letta’s good compliance with the wishes of the financial markets has recently been rewarded by very low interest rates for government bonds.
Letta knows, however, that Italy alone cannot pursue a growth strategy in a sea of austerity-minded EU countries, that for that he needs a joint European growth effort. In this he puts his finger on one of the festering sores of European economic policy: the lack of a truly “European” economic policy, instead of the pursued country-by-country approach. In European economic policy thinking, let along implementation, Europe does not exist as the objective of policy. It is the result of country-by-country prescriptions. Ask any European policy maker whether she knows the fiscal position of the EU or the Eurozone. While he can most likely tell you that of most EU countries, that of the whole Union he will not know. But, how then can the optimal policy mix of fiscal and monetary policy be decided? Right now, all the EU finance ministers’ hopes for growth lie with the European Central Bank, while they themselves are busily running down their deficits (even if recently at slightly slower pace than previously agreed. The upcoming “Pact for Competitiveness” will once more force “structural reforms” on countries, in order to increase their competitiveness vis-à-vis the outside world. But: given an export share of the EU of only 15% of GDP, would it not be advisable to promote and increase the domestic demand, which, after all, accounts for 85% of GDP? It is an illusion to think that the EU (and Eurozone) can “export their way out of the recession”, especially given the slowdown in growth all over the world. We all know that because of high debt levels of households and private enterprise (“Balance sheet recession”) private demand in Europe is stagnating: consumers are not spending, entrepreneurs not investing. In this situation, and given the impossibility for the largest trading block in the world to export its way out of the recession, the only macroeconomically sound policy prescription would be for government to supplement total effective demand, i.e. for governments increasing their deficits, and not cutting them. This is very basic macroeconomics, pursued by Europeans in 2008/09, but now again forgotten and abandoned – in the hope that lower debt levels and “structural reforms” will somehow be “rewarded” with growth. Growth is supposed to fall like manna from heaven, thus economic policy making is being turned into a new religious sect.
Given all this, my initial (amateur) diagnosis of Enrico Letta’s psychiatric illness is wrong. Letta is no schizo, but attempts to serve both his “masters”: the financial markets cum European Commission, as well as his economic conscience. Forza Letta!