Italy on the Economic Brink
Can Italy be saved from financial ruin? Are its finances as dire as Greece’s? How high can Italian interest rates go before a bailout is needed to prevent financial collapse? Does the European Union or any group of governments have the resources to mount a rescue?
Investors everywhere are asking these questions this week, trying to anticipate what comes next. There are some reassuring answers, but they won’t help explain the sudden onset of this crisis or the true nature of Italy’s problems, because the questions are the wrong ones.
Unlike the Greek government, which will run out of money in weeks without EU lending, relatively little of Italy’s foreign debt is short-term. And it’s not hemorrhaging like Greece, which is running a budget deficit this year at 9.1% of its output, or even like Britain, at 8.8%. Italy’s 2011 deficit is only 3.7% of gross domestic product.
Even after interest rates jumped to 7.5% this week, Italy was able to complete a scheduled bond sale. Those rates were unsustainable for Spain and Ireland, smaller nations with bigger short-term problems, but so far they are sustainable for Italy, the world’s eighth-largest economy.
While euro zone countries don’t have the money to bail out Italy as they have Greece, there are many less-costly steps before that last resort. So far, the European Central Bank has been able to calm markets by buying small amounts of Italian debt strategically, as it did this week.
But Italy’s problems aren’t acute. They’re chronic. The virulence of this crisis does not represent some recent deterioration of Italy’s finances. The country’s problems have been in plain sight for years, and will be much tougher to overcome.
Yes, its yearly budget deficit is relatively low. It isn’t piling up debt as quickly as other euro zone countries, which should be reassuring to investors. But it starts in a much deeper hole. Unlike France or Germany, which kept debt under control in good times, Italy has always tolerated high debt, which has now reached 120% of its yearly output. Except for Japan, that’s the highest of any sizable economy.
Until now, investors have rarely expressed doubt about Italy’s capacity to service that debt, happy to buy it and get yields a few percentage points above the rock-bottom rates of the United States and Germany. That made Italy the third-largest issuer of debt — a highly liquid asset in strong demand.
One reason why that liquidity is drying up and driving up interest rates: Italy’s chronically ill economy. Over the last 10 years, while its neighbors were posting solid growth, Italy’s GDP growth averaged 0.25% a year. As The Economist has noted, only Haiti and Zimbabwe did worse. Investors have for years ignored the reality that Italy has stopped growing and is in no position to gain control over its crushing debt burden.
The problems start with demographics. Italy has very low birth and immigration rates. Over the last decade, its population growth was among the lowest in the world. It also has proportionally more old people than almost anywhere; only Japan and Monaco are older. With generous income and health care guarantees to retirees — many quit working well before 60 — Italy’s entitlement time bomb is thermonuclear.
At the same time, it’s a terrible place to do business, ranking with Third World countries instead of its modern euro zone neighbors. According to the World Economic Forum’s Global Competitiveness Report, it is ranked 140th out of 142 nations due to its “burden of government regulation” and 133rd for “efficiency of legal framework for settling disputes.”
Prime Minister Silvio Berlusconi will soon leave, but his legacy will be a profoundly dysfunctional government. Italy ranks 127th in “public trust of politicians,” below Nigeria. It ranks 135th in “transparency of government policy making” and 132nd in “organized crime,” far below Russia.
An important consequence is a tax system in shambles. Reliable estimates are that one-quarter to one-third of its economic output is untaxed, compared with 8% in the United States. An absurdly large share of Italy’s taxpayers report income of less than $10,000 a year, even though estimates of per capita income rival those of its euro zone neighbors. One reason businesses avoid taxes: excessively high rates. Italy is ranked 132nd for the competitiveness of its corporate tax rate.
As a result of all this, Italy is the only industrialized nation that has seen labor productivity decline over the last decade, an ominous warning of its long-term decline.
There is little prospect of solving these deeply ingrained problems anytime soon. Even at the lip of an economic abyss, its government seems unable to take concerted action. Red tape, tax evasion and an unproductive workforce are tied up in an Italian culture that seems highly resistant to change.
The only mystery is why investors ignored this reality for so long. Now there they’re not. This crisis might abate, but Italy will remain at the brink.