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Thursday, September 28, 2006

The Battle Is About To Commence

The FT this morning has a piece about the looming battle over next years budget:

Romano Prodi, Italy's prime minister, struggled on Wednesday to keep intact his planned deficit-cutting 2007 budget as moderates and leftwingers in his ruling coalition fought each other over his proposals to slash public spending.

Communists and other radicals insisted they would not endorse cuts in expenditure on schools and local government, while centrists voiced concern that the budget was drifting in the direction of higher taxes rather than spending cuts.


Bloomberg also covers the story.

As the FT also points out:

Italy's budget, due for cabinet approval on Friday, is the country's most important since it joined the eurozone in 1999, because the nation's public finances and international competitiveness have significantly deteriorated over the past eight years.

So 2007 is going to be a very hard road for Italy to travel. In some ways the moment of truth time is coming. Again the FT:

"Italy remains at risk of seeing its sovereign debt downgraded by credit rating agencies if its forthcoming budget is not rigorous enough."

Really it is very hard to just at this stage the importance of this threat. Much more than the credit rating agencies it is the response from the ECB which will be important if Italy fails to keep to the terms of the new version of the Stability and Growth Pact. Last year, we should remember, the ECB asserted that it would not accept government paper (bonds) in the future from any country which has not maintained at least an A- rating from one or more of the principal debt assesment agencies. So the threat may not be a hollow one, since if the ECB stop treating Italian paper at par, then this could easily, in and of itself, send Italy off on a default path.

These are not little issues.

Precisely for this reason I am rather sceptical that the ECB would be in any rush to actually carry out its threat. News from Japan though suggests that the climate may be changing. Japan, as is reasonably well known, also has a rapidly ageing population and a large government debt problem. In principle Japan was programmed to take some important steps (like Germany) to begin to correct the situation. The election of Shinzo Abe as prime minister has begun to put question marks over this process, and Standard and Poors have not been slow in reacting:

Japan may slow the pace of fiscal reforms under its new Prime Minister Shinzo Abe, ratings agency Standard & Poor's said on Wednesday, a day after he formed his new cabinet with a "no growth, no fiscal consolidation" policy.

The ratings agency questioned Abe's preference for growth policies over fiscal consolidation, saying his stance may lead to a deceleration of the pace of fiscal consolidation.

S&P currently has a positive outlook on Japan's rating.

But the direction of the sovereign rating depends largely on Abe's government's ability to pursue public sector reform pushed by his predecessor, the agency said.

"The two biggest constraints on the rating are Japan's fiscal position, which though improving remains weak, and its outstanding debt," said the report.

"Critical factors are therefore the pace of fiscal consolidation, the stability of the Japanese government bond market, and interest rates," it said.

Citing Japan's aim to achieve primary account balance in fiscal 2011 through spending cuts and revenue increases, the agency said how the new government meets the target is a major issue for the future direction of the sovereign rating.


So I would say that the issue of sovereign debt is now well up and over the radar, and that the agencies will be serious about downgrades.

The big problem is that EU institutions cried wolf for so long about the Stability and Growth pact that they have been left with a credibility problem. This has been doubly undesireable since it meant that during the relatively good years of 2002-2006 many countries were running deficits when they should have been aiming for balance or even - god forbid - surplus. Now the headwind may have changed, and may well be about to turn negative. The next two or three years ,may well be much harder than the last two or three.

I know that this view seems to go against the prevailing wisdom, but frankly many of the people making the 'euro growth engine call' simply haven't been thinking about the demographic dynamics of the situation. Claus Vistesen has been admirably covering all this, and a very useful point of entry is this post.

So the real question we are left with is what exactly is to be done? This is a very hard question, and I don't have any simple answers handy in my back pocket to pull out at the appropriate moment. Clearly Italy needs to move onto a sustainable fiscal path. It also needs to attach itself firmly to the EU Lisbon Reform agenda, and generate a consensus among the Italian population that the reforms are needed by getting across to the Italian people just why they are needed.

Naturally the political class in Italy isn't exactly an asset here.

Immigration undoubtedly forms another part of the picture, but this immigration (which is largely unskilled) needs to be coupled with an expanison of the high value services and new technology business sectors, so that a labour market environment can be created where the best of Italy's young talent can find work appropriate to their abilities, and thus help pull Italy out of this mess.

Over the summer I saw a film from the Italian director Paolo Virzì entitled Caterina va in città. The plot is summarised as follows:

When her father, Giancarlo (Sergio Castellitto) is transferred to Rome from the small country town of Montaldo Di Castro, Caterina (Alice Teghil), a 12 years old girl, discovers her new classmates, a totally new world, an ambient extremely divided politically. She starts developing her friendship with the "left side", represented by Margherita(Carolina Iaquaniello), and the right, Daniela (Federica Sbrenna) side of her class. She will lose herself, without knowing who she really is.

This is the problem I think, an ambient which is extremely divided politically where young Italians do not know 'who they really are'.

23 comments:

Edward Hugh said...

Test

Paris ib said...

Look spreads may widen, if and when your scenario plays out and IT's a BIG IF, to bring up the "default" idea is misleading and IRRESPONSIBLE. Italy, in the past, was paying up to 16 percent on its Government Debt, which was held entirely domestically. The idea that Italy could or would default is rubbish. Sorry but it is. It has been touted around before, usually by financial institutions holding large short positions in Italian Government Debt futures and/or in the Lira. However, since Italy doesn't rely on foreign savings and NEVER HAS, the idea that Italians would stop rocking up to the quarterly refunding programme on the say-so of some foreign ratings agency (which most Italians have never heard about) or even on the say-so of the (very new and very untried) ECB is laughable. Try and stay within the realms of reality or at least stick to what you know.

Edward Hugh said...

Hello Paris,

I think the important point to recognise is that everyone here is entitled to their own opinion. You have yours and I have mine.

In order to take a position on all this one needs to have a pretty comprehensive understanding of the whole global situation, and also get to grips with the problems posed by ageing populations.

Italy, as many poiny out had, in the early 90s, a large public debt to GDP ratio. The important point about that situation was that the porblem was to some extent resolved because Italy was able to significantly devalue the currency, and use inflation to monetise the debt.

Now at this point neither of these options are open, since the currency value is determined elsewhere, and while the euro may well ease back considerably - I certainly don't buy the dollar decline scenario, quite simply it can't fall too far for structural reasons like inherent weakness in the euro and the yen - Italy isn't going to get anything like the devaluation it needs over the time horizon in which it needs it.

On the inflation side we live in a disinflationary environment (rising energy costs notwithstanding), and this may well turn outright deflationary during the next recession (Germany and Italy are particularly vulnerable). This would be the the worst of all worlds for Italy as the real value of the debt would start to rise.

On top of this we have the ageing population problem, and the fact that stucturally the liabilities of the Italian government are set to rise continuously over the next decade. This is again very different from the 90s.

So the default question (or the euro exit one, the two are inextricably linked) is inevitably going to arise if Italy isn't able to change course. Amd it won't simply arise because I say it will, it will arise since the debt agencies will have no alternative but to downgrade the rating, and then the hot potato will be in the ECBs pan.

I'm sure you don't take any of this lightly, well please accept that neither do I. Which is the most irresponsible thing to say is a mute point here. The 'consensus' story is so far from the underlying reality here that you have to worry about what will happen when this becomes obvious. Far from steering expectations in a relistic direction what we appear to have are pipe dreams being peddled (the German 'recovery', the Japanese 'recovery'). How are people going to react when finally the truth breaks in?

On another front, which is not unrelated to Italy, Greece has just 'upvalued' its GDP by some 25%. This may well be a much more realistic estimate of Greek GDP. I don't know, I am waiting to see what EUROSTAT say. But in the Greek case this shoots the debt down overnight to something like 87% of GDP. Italy could make some sort of similar move, but to do this it would need to make official the substantial part of the economy which is currently 'unofficial'. This would certainly make the position on paper look a lot better, but the underlying problem would remain, since the underlying issue is the structural unsustainability of Italian government spending and borrowing, and the structural capacity of the Italian economy to grow. Basically I am not convinced that the economic and political dynamics of what we have now can work.

Edward Hugh said...

Paris,

Just one more thing. You are most welcome to comment on this blog. I am sure you are concerned about Italy's future, and I hope you will accept my assurance that I am too.

This is not a political game, this is an attempt to investigate a real problem, one we haven't encountered before (the ageing one). In this sense all views are welcome as we try to find out just where we are.

And since you are in Milan and I am in Barcelona, then maybe later this season we will have the possibility to sort out our differences in the honourable way, on the football pitch :).

Edward Hugh said...

Paris

You also often make the point that Italians save a lot, and this is undoubtedly true.

I have a post on this (linked in the sidebar: Italy Ageing But Saving). But as Mckinsey point out, this savings rate is falling, and will likely continue to fall:

Italian household savings will decline at 1.7 percent annually over the next two decades, causing a sharp slowdown in the growth of household net financial wealth, from the historical rate of 3.4 percent over the 1986-2003 period to 0.9 percent through 2024. By 2024, this slowing growth will cause net financial wealth to fall some 39 percent, or ?1.8 trillion, below what it would have been had the higher 1986-2003 growth rates persisted".

Clearly, in principal and as you suggest, at current saving levels Italians could fund their own government debt, the big question is at what rate of interest? As you again mention yourself before EMU far higher interest rates had to be paid to secure this funding. So if the ECB stepped aside, and European central banks were not to accept Italian bonds, what would happen?

Incidentally Italian's also invest abroad, as this little episode illustrates:

New tack on Argentina debt

However, a new approach is being attempted by Task Force Argentina (TFA), which represents more than 170,000 Italian retail investors holding $5.5bn of debt, which last week took its claim to the World Bank’s International Court for the Settlement of Investment Disputes (ICSID).

If TFA’s ideal scenario is to find a solution through negotiation soon, rather than in a drawn-out arbitration process at ICSID where success is far from guaranteed, it may be disappointed.

Argentina has shown little willingness to negotiate. When Néstor Kirchner, its president, met Romano Prodi, Italy’s prime minister, he said the matter was “finished”. It is thought there is no political will to negotiate with hold-out investors until after presidential elections in October 2007.

Federico Thomsen, an analyst in Buenos Aires, suggests TFA’s move to find a solution through ICSID may have been motivated by a need to show disgruntled Italian bondholders that it was trying to recover funds. The bondholders, in turn, are suing the banks for selling them bonds without being made aware of the risks.

http://www.ft.com/cms/s/d957dd6c-4f17-11db-b600-0000779e2340.html

Paris ib said...

Devaluation was used as a tool to address international competitiveness. It was not used to address the Government debt or deficit. That problem has always been one of internal allocation of resources. You are confusing two very different issues and, although you may be entitled to your opinion, an opinion without the necessary facts is not worth all that much.

We do not live in a deflationary environment. CPI might not register much of a rise (and that is convenient for Governments who pay out CPI related pensions) but the cost of living has risen dramatically in the past five years in Italy and elsewhere. The cost of Housing, which I think you agree is a basic commodity, has more than doubled, and the price of energy (electricity and oil) has more than doubled, food prices have skyrocketed and the cost of clothes has increased ENORMOUSLY. I do not buy the deflationary idea. I think it is a con. In Europe, Italy or France which are two countries which I know well, there is NO DEFLATION. There has been rampant, hidden, undeclared inflation. No matter what the statistics might tell you.

You may have a personal obsession with the impact of an aging population, we all have our foibles, however I'm not sure what the relevancy is here.

As for your belief that the USD will not devalue, well, that's easy let's wait and see. Right now the USD is trading at 1.2700 against the Euro and at 118.00 against the Yen. Let's see where it will be in a year or five from now.

If there is a risk that debt will be come a huge burden on growth that risk is in the United States where debt has been taken on to finance: private consumption a housing bubble and war. None of these generate returns. The USA is closer to repeating the Japanese slowdown than any other country I know. Although all Anglo countries seem to be pretty much in the same boat, except none of them are running a massive trade surplus, quite the reverse.

One thing, I am not in Milan, I live in Beausoleil, France.

Edward Hugh said...

Ok Paris, a lot of interesting points:

"Devaluation was used as a tool to address international competitiveness. It was not used to address the Government debt or deficit."

No, but it did have the consequence of 'sweating-off' the deficit. Devaluation produces inflation, and inflation favours borrowers to the disadvantage of savers, that is why it is such an undersirable thing.

Although being somewhat influenced by Keynes in this sense, I do think a little inflation is a *lesser evil* (see How To Pay For The War) in comparison to deflation, which is a *big* headache (as we are about to see).

So when I say they were able to 'monetise' the debt, what I mean is that they were able to leverage the inflation produced by the slide in the currency to transfer wealth from savers to borrowers, with the principal borrowing beneficiary being the Italian exchequer.


"We do not live in a deflationary environment."

I'm sorry, Italy now does. This is the consequence of the Prodi 2007 budget and the high value of the euro. With the currency fixed and fiscal tightening Italy is using deflation as a policy tool to restore competitiveness.

But the issue is a much more general one. Global labour arbitrage means that the real value of unskilled labour - of which Italy has plenty - is falling, and as we enter the next recession there will be important global overcapacity - following several years of investment-driven growth in Germany, China and Japan - which is bound to exert a downward pressure on prices. You just wait and see.

"but the cost of living has risen dramatically in the past five years in Italy"

Oh yes, I'm sure, and with a strong currency this is now a tremendous headache for your government. And since they now can't devalue, they will have to cut wages and prices to get you back into line. You have very low growth and above average eurozone inflation, the 'perfect storm' stagflation combination.

"You may have a personal obsession with the impact of an aging population"

I sure do. Ever heard of the 'marginal propensity to consume'. Well as well as being income related, this is also age related, as that excellent Italian economist Franco Modigliani drew to all our attention.

"however I'm not sure what the relevancy is here."

Unfortunately at this point very few people do. If they did a tragedy which is about to happen could be averted.

"As for your belief that the USD will not devalue"

Oh this is impossible, do you understand, impossible. I am not saying it doesn't need to fall, of course it is overvalued, the US cannot export to pay its way, but given the reserve currency status and given the long term weaknesses in the eurozone and Japan, there is just no way the dollar can fall at this point.

The next move for the dollar is up as we move towards the next recession.

Of course one day the yuan and the rupee will be able to do the heavy lifting and all this will come to an end, possibly quite dramatically. Maybe after the next recession after the next one (ie up around the 2015 mark).

"If there is a risk that debt will be come a huge burden on growth that risk is in the United States"

This is the Roubini line, although curiously he also thinks that Italy will default. Of course, if you *are* right (which I actually doubt) you had better start trembling, since the knock-on effects in Japan, China and Germany (which all depend on the US consumer, or on each other) will be the next best thing to devastating.

Paris ib said...

You seem to have a lot of certainties which are not backed up by facts.

Certainty number one: Italy will have to cut wages and prices. How so? Italy is not running a trade deficit, so it does not need to cut prices to compete internationally. Wages are one area which have not seen rises in line with real inflation. They don't need to be cut. You may have noted that your friend Paola's earning capacity post-degree was the meagre sum of Euro 600 a month. You think that needs to be cut? You can't have it both ways. You seem to believe that Italy "needs to catch up" with whom, why, in what way?

Italy's problem is Government Debt. That has not worsened in recent times, it has improved. As part of the Euro Zone lower domestic interest rates have increased the likelihood that this improvement will continue.

Certainty number two: the USD will not devalue. He-llo? Obviously you don't have a lot of financial market experience. This statement is based on nothing at all, except your personal conviction, which doesn't seem to be backed up by much. The USD is not appreciating, it is down some 40% against the Euro since it reached its high point against that currency in 2001. That's a fact. And 40% is a lot. Even if you don't think so.

Certainty number three: there is a deflationary environment in Italy. There is not. Quite the reverse. You do not live in Italy, you don't know the situation on the ground.

As for the "tragedy that is about to happen", please, get a life. What is this your English origin coming out. Ennio Flaiano once commented that the English imagine the future that reflects their sad/depressed character. Have you ever read Flaiano? You should.

I don't understand why you have started a blog on the Italian economy. You don't live there, you have (as far as I am aware) no understanding of how the Italian economy works on the ground, you have not studied in Italy, you are not an Italian economist, you don't seem to have a grip on the Italian culture and I don't think you speak Italian. Why the interest in Italy? Perhaps you should comment on something you know. Spain? England? Then your comments would add value.

Edward Hugh said...

"I don't understand why you have started a blog on the Italian economy."

Ah, I'll deal with this first.

Basically as a young man I was very influenced by the ideas of Karl Poppper about how you go about distinguishing between science and mere ideology. Basically the issue turns on the assymetry between verification and falsification. Basically you can falsify but you can never confirm.

So, for Popper good scientific theories distinguish themselves from the rest of the pack by being able to make unlikely predictions and then try to falsify them.

So when I came up with this new demographic theory - which I hope will one day rival for being the principal macro economic paradigm - I thought now what is likely to happen here which most people will consider to be improbable. And of course I hit upon Italy.

If I can read this situation in Italy from day one going forward then this is good confirnation, for me, that the theory works.

Basically three countries are first through the door here - with median ages in the 44 range and rising - Germany, Japan and Italy.

Italy for its governance issues, its lack of international competitivity and its low profile in the value chain is easily the weakest, so I deduce, it is hear that the problem will start.

So what I am saying is that when Italian finaces go bust, the world will wake up. It is going to have to since this will send a big shock wave round all the financial markets. The world will wake up to the fact that population ageing presents special issues that need to be addressed if the transition to 'elderly' societies is to be handled without breaking the links of inter-generational solidaity.

Since so many people like you seem to be saying that there is no probem, then this unfortunately only makes it more likely to happen.

I repeat this is going to be a tragedy, a tragedy which is avoidable, but unfortunately one which few seem to have much appetite for avoiding.

Edward Hugh said...

"Italy will have to cut wages and prices. How so?"

Well you explained this yourself:

"the cost of living has risen dramatically in the past five years in Italy and elsewhere. The cost of Housing, which I think you agree is a basic commodity, has more than doubled, and the price of energy (electricity and oil) has more than doubled, food prices have skyrocketed and the cost of clothes has increased ENORMOUSLY."

Now there are basically two ways to handle this kind of scandalous inflation, devalue the currency, or operate deflation. Since the former isn't open, then unfortately it will have to be the latter. This is where you are going next year.

"Italy is not running a trade deficit,"

Sorry but it is, and it has been since the end of 2004.
http://www.oecd.org/dataoecd/7/5/20209190.pdf

Possibly most of this is due to energy, and this can correct, but you need - like Germany and Japan - to run a trade surplus. Since you are in denial that ageing is a problem you don't get this.

The thing is that internal demand is flat, it has been for years, this is why even with a 4% public sector deficit you are still only able to average 1% growth. Now if your health and pensions system are to be sustainable as your pyramid becomes ever more top heavy you need to grow much faster than this. Since with the propensity to spend of your aged population this is not going to be consumer driven internally you need to drive it with exportas. It's as simple as that.

"You may have noted that your friend Paola's earning capacity post-degree was the meagre sum of Euro 600 a month. You think that needs to be cut?"

No, these have already been slashed, it is futher up the age system you need to look, to where the 'insiders' are. I am not saying they should be cut (NB) I'm saying they are going to be. This is the price to be paid for trying to stay in the euro. Basically I see poor old Prodi as a bit like De la Rua in this moment, he is going to have to force hard medicine down people's throats, and unfortunately even then it probably won't work.

"Certainty number three: there is a deflationary environment in Italy."

No. I didn't say there was deflation in Italy, I said that the policy which was coming was a defationary one. The deflationary environment is outside Italy, in the product areas in which Italy competes. Just look at the problems your shoe nad T-shirt manufacturers are having with Chinese imports.

"Certainty number two: the USD will not devalue."

Yes I am saying that. The dollar now has bottomed out, the next way is up as the euro drifts down.

"This statement is based on nothing at all, except your personal conviction,"

Well that and a whole corpus of theory whioch I have to support it.

"The USD is not appreciating, it is down some 40% against the Euro since it reached its high point against that currency in 2001. That's a fact."

Well good, here is somethging we agree on, the dollar has fallen, but I am talking about what happens next.

"this your English origin"

Not that this, as you would say, is either here or there, but I am not English and never have been. I am British, and these days I feel more Catalan than anything else.

Paris ib said...

Goodness me. So you are trying to make Italy fit your "dismal" science. Malthus was a fool anyway. And he was English. Have you read Eversley? Also English (I think) and considerably less dismal. Great work and goes a long way to destroying some of the most widespread demographic myths. Of which there are quite a number.

It was not so long ago that the real problem, we were told, was the population explosion. Now we are all going to die (well that was always the case) but a narcisstic (self-centred/self-absorbed basically boring) generation wants everyone ELSE to believe that when THEY DIE then the world as we know it will come to an end.

Well it won't. Actually it is my opinion that when this generation of career narcissits shuffle of their mortal coil, the world will be considerably better off. At least we won't have to listen to you guys whine. Or tell us that you have the answer to everything, which you don't. Sex, drugs and rock and roll - what a joke. Superficial answers to questions which are as old as mankind. Of course superficial is what you would expect from your generation. Sorry guys, why are you having such a tough time dealing with reality and why do you want to bum eveyone else out? Grow up and get over it.

Population decline is a good thing. New immigration to Europe is a good thing. There have been bulges and anti-bulges in population before. Like a python digesting they eventually feed out of the data.

Maybe if the English could learn to cook they wouldn't be so pessimistic. What I would like to know is why the English are like this and why do you guys do weird things like save bits of string?

Try more fruit and vegetables. And read Ennio Flaiano.

As suspected your connection with and understanding of Italy is pretty much non-existant.

Paris ib said...

"there are basically two ways to handle this kind of scandalous inflation, devalue the currency, or operate deflation"

Says who?

There are always more than two ways to do anything. With inflation you can let it feed its way through the system and disappear, which I think would be the wisest course of action. Devalue or deflate. Please. Diaster or disaster. Take mineral supplements. It might help.

The world has been through this type of price shock before in the 1970s. Then Central Banks of the world handled the situation rather badly.

I don't know what your qualifications are, or what type of experience you have had, but I don't think you are qualified to offer solutions. And you certainly don't know where things are at in Italy. I think it would be fair to your readers if you were upfront on that score.

Same goes for the non-Italian, non-economist who contributes here. As for the very newly qualified Italian economist who has been unable to find suitable employment in Italy: when she's proven her chops then maybe she can add something. Till then this blog is just a rehash of FT articles (which mostly are poorly conceived when it comes to Italy) and unproven theories.

Edward Hugh said...

"Goodness me. So you are trying to make Italy fit your "dismal" science. Malthus was a fool anyway."

Well we'll leave aside Malthus's intellectual capacity, and go the heart of the matter: this isn't about Malthus. This is about new generation economic research which is finally getting to grips with the importance of demographic changes for economic processes. (There was always some understanding of all this in the work of Italian economist Franco Modigliani and his life cycle theory. Interestingly his last paper before he died was precisely on saving in China).

Can I direct you to this conference which was held in July in Australia and which was centred on Demography and Financial Markets. May I suggest that you would find the papers by David Bloom and Ralph Bryant especially interesting. Despite all your protest to the contrary I suspect that you are interested, and that you are not so closed that you are unwilling to learn.

These are new problems, and new theories will develop to get to grips with them. Science never stands still, it wouldn't be science if it did.

"With inflation you can let it feed its way through the system and disappear "

I think you are missing the main point here, it only 'disappears' if you can devalue it away. Otherwise it stays, as we can see in the lack of competitivity of Italian industry today. That is why I say the choice is a stark one, either deflation or leave the euro. It is precisely because I don't believe that deflation can work (we saw all this in the 1930's) that I feel the second option is really the only realistic way out for Italy. The short term costs will be very high, but in the longer term there will be a future.

The other road is only 2,3,4, 5.... years of pain and suffering only to lead to the same result.

Paris ib said...

Malthus was wrong: populations don't inevitably expand to the point where economic resources are insufficient. In fact the current reduction in birth rates PROVES that. Malthus was a fool and he was WRONG. Eversley examined some of the type of myths propogated by supposed "scientists" and proved them to be misleading.

Economics isn't science it is pseudo-science.

"That is why I say the choice is a stark one, either deflation or leave the euro."

The above is a false choice based on nothing but your opinion. And your opinion is not based on knowledge of the Italian economy. We have already established that your understanding of Italy is rudimentary at best. What are your qualifications exactly? And what gives you the authority to comment on these matters?

I will not argue the point here. Because false choices lead us nowhere. Set up another straw man, if you like, in the end what actually transpires will be proof enough.

Edward said...

"Malthus was wrong:"

Oh, yes, I forgot the key point, why Malthus isn't especially relevant here. He was concerned about population *size* which isn't really the point, the big new discovery is that it is age structure that matters for saving, consumption and productivity.

"Economics isn't science it is pseudo-science."

I see, well that explains a lot.

Edward said...

Incidentally, thanks for helping me give the 'Master Class', I think this has been a useful run through of many of the major issues. Perhaps we may now leave it to the readers to decide who is better able to offer advice to Italian policymakers.

Paris ib said...

You actually believe you are offering policy advice to Italian policy makers?

That settles it. Talk about delusional. (Which is, incidentally, part and parcel of the narcissitic personality disorder.)

Edward Hugh said...

Incidentally, Paris, it might be worth clarifying a couple of other points.

Obviously there are more than two simple policy alternatives available. Increased productivity could be an important element in alieviating the uncompetitiveness issue. But here we have 'stocks' and 'flows' issues. Italy has a rather large number of workers over 50 with relatively little education. Getting high productivity (TFPs) out of increasing the participation of this group is going to be difficult. At the same time there are relatively fewer higher educated people, and also, as we have been discussing, the lack of earlier reform makes it difficult for the economy to assimilate even what there is at a rate which can really make a difference. This is why I am not optimistic here.

Also, the euro itself will probably fall back somewhat in value as the eurozone slows, but I doubt this small devaluation will be anything like what Italy truly needs. So again I am not optimistic.

There is of course a third alternative: do nothing. Sperare, to wait and hope, with the kind of fatalistic indifference that the ambivalence in this verb implies. This seems to be really what you are advocating, but I truly think this will produce the worst of all worlds. Of course, the realities of Italy's political divisions may produce, unfortunately, presisely this kind of paralysis.

Paris ib said...

Good grief. Wait and hope. What on earth are you talking about? The Euro was a response to a problem: foreign exchange instabilty which impeded economic growth and integration. It is new (new means that it represents change), it is successful and the EuroZone economy is doing well. Wait and hope for what? That your dismal projections come true. I don't think so. Only the English enjoy that kind of gloom. Meanwhile Europe is moving on.

Viqar Qadir said...

:)
I am enjoying this exchange guys.
I know almost nothing about macro economics so I can truely be awe struck by both of you...please go on!

Edward Hugh said...

Hi Vigar,

Glad to see you enjoyed this. Unfortunately Paris dropped out somewhere along the road, but if you want to up your understanding of macro economics a bit, then please keep following the blog. All of this might be about to get quite interesting.

Edward

Viqar Qadir said...

You think so?
I feel dark clouds taking shape accross the sea getting ready to come Europe's way kind of premonitions?
On the other hand, what do you think about the looming recession everyone keeps talking about? Do you think its happening already? How will it effect Italy? Do you think that the famous Veneto model of small family run businesses will withstand it this time?

Edward Hugh said...

Hi again Viqar,

"I feel dark clouds taking shape accross the sea getting ready to come Europe's way"

In my mind they are already here.

"Do you think its happening already?"

Yes. It is possible growth Q3-Q4 2007 was zero or negative.

"How will it effect Italy?"

They won't be able to meet their commitments on reducing the government debt to GDP ratio, and then who knows what comes next in this credit crunch environment. They are playing with fire here.

"Do you think that the famous Veneto model of small family run businesses will withstand it this time?"

Look, in my mind there is nothing wrong at all with this model, provided it continues to adapt to changing methods and times. Italy's problem, IMHO, is its ageing population and workforce. Unless this is put to the top of the policy agenda and explicitly addressed, then I'm afraid the Italian economy - like Venice itself - is only going to sink ever deeper into the sea, and all the partial engineering works won't be worth a damn.