Italy is in recession. There is nothing extraordinary about this, as Donald Rumsfeld notoriously said 'stuff happens', and economies do have their ups and downs. But this recession is a little different, since it is structural and not cyclical. For the Italian economy to return to a better trajectory something has to be done, but what? Morgan Stanley's Vicenzo Guzzo offers two alternatives: devaluation, or deflation (actually the way he puts the alternatives it sounds to me more like a case of: "with which instrument would you prefer I cut your throat sir, the stanley knife or the chain saw"?).
"If Italy intended to restore the pre-1999 competitiveness level, it would have to experience a 25% currency depreciation. While the euro is now down over 5% from the start of the year, such a large correction appears unlikely at this stage. In addition, the economy has steadily lost ground also vis-?-vis its euro area trading partners, as the breakdown of the trade data suggests. Euro depreciation would provide no oxygen on that front. In order to return to pre-1999 competitiveness levels, Italy would have to abandon the current exchange arrangements. To put it bluntly, it would have to drop out of EMU. A 25% devaluation is equivalent to what the economy experienced between 1991 and 1995. Exports scored double-digit gains in the aftermath of the realignment, but domestic demand fell heavily and debt services costs hit 12.5% of GDP. In a replay of those years, Italy would either default on its debt or run toxically tight fiscal policy. This is simply not an option, in my view."
So Italy is caught. To devalue it would have to leave EMU. But then even if it could and did, it would go bust. So, on Guzzo's reading, the only remedy left is substantial deflation, that is an ongoing reduction of wages and prices which would enable competitiveness to be restored. This sounds very much like the 1930's and an Italy stuck with a modern version of the gold standard. It also sounds like going through a recession which could turning out lasting for a number of years, even if this was politically feasible it would be extraordinarily painful for many of those most immediately affected.
This, of course, is a question which is widely treated in the textbooks. So would anyone like to suggest a rival 'escape strategy'?
Italy Economy Real Time Data Charts
Edward Hugh is only able to update this blog from time to time, but he does run a lively Twitter account with plenty of Italy related comment. He also maintains a collection of constantly updated Italy economy charts together with short text updates on a Storify dedicated page Italy - Lost in Stagnation?
3 comments:
As Berlusconi is singularly implicated in this economic debacle, perhaps the incoming Prodi government could start by confiscating the entire value of the "balding one's" media empire and then (politely) request other similarly wealthy individuals who have benefited from some of scams perpetrated by the previous administration to also contribute (albeit on a more optional basis).
This fund might help to soften the blow for Italian citizens screwed by Berlusconi and his fellow crooks!
An Increase in labor productivity would increase the competitiveness of the italian economy without the need for devaluation. Recent german experiances provide an excellent example of labor market reforms helping an economy--even when bound by the EMU.
Hi there,
"An Increase in labor productivity would increase the competitiveness of the italian economy without the need for devaluation."
Of course, the question is given the demographic profile Italy has, and the rising median age of the population, it is far from clear that this will be possible. The human capital stock is also changing negatively as young educated Italians leave to be replaced by lower eductaed immigrants.
Don't misunderstand me , I'm not against immigration, au contraire, Italy needs migrants to make up for the missing births, but we need to think about a lot of factors here. Stopping the outward flow of graduates would be a good first move, but you need to be able to create well paid positions before the age of 30 to do this. This means a big change in corporate mentality. Otherwise people just up for the US, Canada, the UK, Australia or whatever, where they can start earning reasonably well from 25/26. The simplistic story on labour market reform does not address this issue.
Then you need to think about the demand side, since to get sufficient GDP growth to finance the deficit you need to have internal demand growth, and this is just where the elderly societies - Germany, Japan, and Italy - are experiencing greatest difficulty. So while Germany has gotten the productivity gains you mention, it has also become totally dependent on exports (ditto Japan) and still will have difficulty getting ternd growth of over 1%, and like this Italy undoubtedly goes bust at some point.
The consumer demand issue is really the key one, and needs to be grasped in its entirety. Claus Vistesen has a first pass at Japan here, and at Germany and the Eurozone here.
Anyway, thanks for passing by and taking the trouble to leave a comment.
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