This news today seems to confirm a lot of the points I was arguing in the previous post. It is going to be very hard for Prodi and co to maintain course on deficit reduction if growth in the economy stagnates in 2007 as it looks like it may well do:
Italian industrial production unexpectedly fell in July for the first time in three months as near-record oil prices raised manufacturing costs and weighed on consumer demand.
Output declined 0.3 percent from the previous month when it gained 0.1 percent, the national statistics office Istat said in Rome.....Output dropped 0.2 percent from a year earlier.
The economy of the dozen euro nations is showing signs of losing momentum after expanding at the fastest pace in five years in the second quarter. Crude oil prices reached a record of $78.40 a barrel on July 14. Manufacturers may trim output in coming months as energy cost sap consumer spending and exporters rely on a slowing global economy.
``It looks like there will be a moderation of growth'' in the second half, said Marco Valli, an economist at UniCredit Banca Mobiliare SpA in Milan. ``It remains to be seen by how much but it should be a gradual slowdown.''
French industrial production unexpectedly declined for a second month in July, Paris-based national statistics office Insee said Sept. 11. In Germany, Europe's largest economy, business confidence declined for a second month in August.
The production decline indicates that growth in Europe's fourth-biggest economy continues to lag behind that of its biggest trading partners. The European Commission said Sept. 9 that Italy will expand 1.7 percent in 2006, compared with growth of 2.5 percent in the economy of the dozen euro nations, the fifth year that Italy trails the euro region.
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?
Friday, September 15, 2006
Italy and the Eurozone
John Kay had an article in the Financial Times earlier in the week, and this seems to have caused quite a ripple around the blogsphere (Eurozone Watch, Economonitor, Claus Vistesen at Alpha Sources). The article was about whether or not it was technically possible for Italy to leave the Eurozone. (Update: Sebastian has a fresh post over at Eurozone Watch Blog continuing the discussion).
John Kay's conclusion, and it is supported by a very reasoned commentary by Sebastien Dullien at Eurozone Watch Blog (welcome Sebastain and Daniela), is that there is no in-principle technical difficulty in exit. The most authoritative piece of work on this topic that I know of comes from Harvard International financial law specialist Hal Scott. The paper was written back in 1998, and was provocatively entitled "When the Euro Falls Apart". Despite the title the paper is a tightly reasoned piece of work whose main conclusion is that not only is euro-exit technically perfectly feasibe, in fact the mechanisms which would make this possible were incorporated from the start (in particular keeping independent central banks with their own reserves). I think those who were able to think clearly back then - and were able to use some emotional intelligence - were always aware that there were question marks over Italy's ability to go the distance.
So the problem is not a technical one. But as John Kay indicates it *is* a political one:
"But what of financial and commercial contracts made in euros before A-day but not yet completed?
The simple answer is that an agreement in euros stays in euros. But this is not politically feasible. Italians would not accept that their mortgages and credit-card debts, denominated in euros, would cost them one-third more to repay: and it would be absurd if the bank deposits of Italian residents were revalued by a similar amount.
The relevant principle of international law seems to be that debts are denominated in the currency of the place where they are to be paid. But in the modern world, that question often has no clear answer."
This then is going to be the question *when* Italy leaves (I say *when* since I have no doubt that she will, the demography makes that inevitable, and here, and here, and here). So it is perfectly coherent to argue that Italy can leave. This however is the moment when the debate normally veers off in a southerly direction - towards Argentina - and Argenitina seems, as usual, to generate more heat than light, since the argument tends to move away from Italy and its specific problems, towards a 'what really happened to Argentian debate" (welcome new blogger Felix), which is, of course interesting, but sometimes it is helpful to discuss just one thing at a time. So going round a rather more circuitous route, let's think for a moment about what just happened in Turkey and in Hungary. Two economies which were on an unsustainable external deficit course were brought back sharply into line by a sudden, large drop in the value of the local currency. Judging by posts and comments on this site we seem generally to be agreed that having such flexibility was a good thing, since it enabled these economies to correct and adapt before a big crisis (hard landing) situation built up.
So what about Italy? Well Italy as we know cannot go down this road, and Italy has, in fact, used the cheap finance made available by the eurozone not to reform, but to avoid reforming. This, at least, was the conclusion reached by two highly respected European economists (Romain Duval and Jørgen Elmeskov) in a widely quoted paper entitled The effects of EMU on Structural Reforms in Labour and Product Markets
So Italy is unable to correct, and the inbuilt problem is growing. The Italian economist Francesco Daveri (who is a specialist in technological change and ageing) makes the important point in this podcast for Radio Economics that Italian economic growth *peaked* in the 1950's at around 5% per annum. Since that time it has dropped steadily at the rate of about 1% per decade, and in the 1990s was at an annual rate of about 1% per annum. Following this trajectory, and what we already know, it is not unreasonable to imagine that this decade the Italian economy will flatline (an average of 0% growth) and possibly enter negative territory in the next one (say -1% pa 2010-2020). Of course this situation makes a complete nonesense of the neoclassical theory of 'steady state' growth, but that is a problem for that particular theory, it doesn't mean that what is happening isn't hapening (I have a post about this issue in the context of Germany, Japan and Italy on Demography Matters). So the question is, where does that leave the problem of Italian public debt currently running at 105 - 110% of GDP? Unsustainable, that's where it leaves it. And the only way for Italy really to get to grips with the situation is to recognise that it cannot resolve this problem and default. This default is unlikely to be possible inside the eurozone, and hence Italy will leave. This is a question of simple economics, not popularist politicians.
Which brings us to the last point before the last: won't this cause chaos? Well of course it will, this is why it would be better that people come to terms with this rationally rather than making it an emotive topic.
Now for the last point. John Kay rightly laments:
Any international bank or business should contemplate these issues. But the consequences of such contemplation are grave: in financial markets, actions to protect against a contingency make that contingency more likely. That is why a debate on the fragmentation of the eurozone is a debate that no one dares have.
And John Kay is right, debate on this topic will probably make default happen sooner. I remember the heartsearching Paul Krugman went through when it became obvious Argentina was going to default. Such situations pose special problems for those economists who can, to some extent, see what is happening. But my conclusion was in that case, and it remains the same today, that if something is unsustainable it is better to recognise this sooner rather than later: quite simply the damage is less. If Argentina had defaulted one year earlier, then the politics of the default transition would have been much easier. Basically, if you ask people to make a lot of sacrifices for a project that can't work you can hardly blame them if they are not in the mood for another round of sacrifices after it turns out that the earlier sacrifices were in vain. This is as true for the Italy of 2007 as it was for the Argentina of 2000. I think we would all do well to remember that.
John Kay's conclusion, and it is supported by a very reasoned commentary by Sebastien Dullien at Eurozone Watch Blog (welcome Sebastain and Daniela), is that there is no in-principle technical difficulty in exit. The most authoritative piece of work on this topic that I know of comes from Harvard International financial law specialist Hal Scott. The paper was written back in 1998, and was provocatively entitled "When the Euro Falls Apart". Despite the title the paper is a tightly reasoned piece of work whose main conclusion is that not only is euro-exit technically perfectly feasibe, in fact the mechanisms which would make this possible were incorporated from the start (in particular keeping independent central banks with their own reserves). I think those who were able to think clearly back then - and were able to use some emotional intelligence - were always aware that there were question marks over Italy's ability to go the distance.
So the problem is not a technical one. But as John Kay indicates it *is* a political one:
"But what of financial and commercial contracts made in euros before A-day but not yet completed?
The simple answer is that an agreement in euros stays in euros. But this is not politically feasible. Italians would not accept that their mortgages and credit-card debts, denominated in euros, would cost them one-third more to repay: and it would be absurd if the bank deposits of Italian residents were revalued by a similar amount.
The relevant principle of international law seems to be that debts are denominated in the currency of the place where they are to be paid. But in the modern world, that question often has no clear answer."
This then is going to be the question *when* Italy leaves (I say *when* since I have no doubt that she will, the demography makes that inevitable, and here, and here, and here). So it is perfectly coherent to argue that Italy can leave. This however is the moment when the debate normally veers off in a southerly direction - towards Argentina - and Argenitina seems, as usual, to generate more heat than light, since the argument tends to move away from Italy and its specific problems, towards a 'what really happened to Argentian debate" (welcome new blogger Felix), which is, of course interesting, but sometimes it is helpful to discuss just one thing at a time. So going round a rather more circuitous route, let's think for a moment about what just happened in Turkey and in Hungary. Two economies which were on an unsustainable external deficit course were brought back sharply into line by a sudden, large drop in the value of the local currency. Judging by posts and comments on this site we seem generally to be agreed that having such flexibility was a good thing, since it enabled these economies to correct and adapt before a big crisis (hard landing) situation built up.
So what about Italy? Well Italy as we know cannot go down this road, and Italy has, in fact, used the cheap finance made available by the eurozone not to reform, but to avoid reforming. This, at least, was the conclusion reached by two highly respected European economists (Romain Duval and Jørgen Elmeskov) in a widely quoted paper entitled The effects of EMU on Structural Reforms in Labour and Product Markets
So Italy is unable to correct, and the inbuilt problem is growing. The Italian economist Francesco Daveri (who is a specialist in technological change and ageing) makes the important point in this podcast for Radio Economics that Italian economic growth *peaked* in the 1950's at around 5% per annum. Since that time it has dropped steadily at the rate of about 1% per decade, and in the 1990s was at an annual rate of about 1% per annum. Following this trajectory, and what we already know, it is not unreasonable to imagine that this decade the Italian economy will flatline (an average of 0% growth) and possibly enter negative territory in the next one (say -1% pa 2010-2020). Of course this situation makes a complete nonesense of the neoclassical theory of 'steady state' growth, but that is a problem for that particular theory, it doesn't mean that what is happening isn't hapening (I have a post about this issue in the context of Germany, Japan and Italy on Demography Matters). So the question is, where does that leave the problem of Italian public debt currently running at 105 - 110% of GDP? Unsustainable, that's where it leaves it. And the only way for Italy really to get to grips with the situation is to recognise that it cannot resolve this problem and default. This default is unlikely to be possible inside the eurozone, and hence Italy will leave. This is a question of simple economics, not popularist politicians.
Which brings us to the last point before the last: won't this cause chaos? Well of course it will, this is why it would be better that people come to terms with this rationally rather than making it an emotive topic.
Now for the last point. John Kay rightly laments:
Any international bank or business should contemplate these issues. But the consequences of such contemplation are grave: in financial markets, actions to protect against a contingency make that contingency more likely. That is why a debate on the fragmentation of the eurozone is a debate that no one dares have.
And John Kay is right, debate on this topic will probably make default happen sooner. I remember the heartsearching Paul Krugman went through when it became obvious Argentina was going to default. Such situations pose special problems for those economists who can, to some extent, see what is happening. But my conclusion was in that case, and it remains the same today, that if something is unsustainable it is better to recognise this sooner rather than later: quite simply the damage is less. If Argentina had defaulted one year earlier, then the politics of the default transition would have been much easier. Basically, if you ask people to make a lot of sacrifices for a project that can't work you can hardly blame them if they are not in the mood for another round of sacrifices after it turns out that the earlier sacrifices were in vain. This is as true for the Italy of 2007 as it was for the Argentina of 2000. I think we would all do well to remember that.
Sunday, September 10, 2006
Hanging In The Balance
OK, this blog is about to ramp up again after the extra-long sleepy summer. Actually I have been quite busy, but with non-Italy issues. Hence the silence here. Of course there won't be a post everyday. Maybe once a fortnight.
Things do seem to be starting to move again after the fairly brief honeymoon:
Prodi defends reform plans against rising discontent
Romano Prodi, Italy's prime minister, on Monday sought to calm growing unrest in trade unions and on the left wing of his ruling coalition over plans for budget cuts and pension reform.
The confrontations were a sign that, less than four months after he took office, Mr Prodi may soon face as much trouble from his nominal allies on the Italian left as he does from the centre-right opposition led by Silvio Berlusconi, the former premier.
Unions are preparing massive disruption to Italy's transport systems this month, with a strike on Thursday in the air sector to be followed by shutdowns of municipal public transport on September 15 and the national railway network on September 27.
The planned protests highlight Mr Prodi's difficulties as he tries to restore order to Italy's public finances and introduce long overdue structural reforms in the economy.
While international financial markets and the European Commission regard such measures as essential, Mr Prodi must take care not to lose the support of the leftist elements in his coalition on which he depends for his slim parliamentary majority.
This was always going to be the big issue. This year is still one of 'grace' for the Italian government, and the Italian economy. Of course it is a boom one. Next year is going to be much tougher, as the global economy slows, and the fiscal cuts take effect. And we will be hear on the Italian Economy Watch to follow this through.
Things do seem to be starting to move again after the fairly brief honeymoon:
Prodi defends reform plans against rising discontent
Romano Prodi, Italy's prime minister, on Monday sought to calm growing unrest in trade unions and on the left wing of his ruling coalition over plans for budget cuts and pension reform.
The confrontations were a sign that, less than four months after he took office, Mr Prodi may soon face as much trouble from his nominal allies on the Italian left as he does from the centre-right opposition led by Silvio Berlusconi, the former premier.
Unions are preparing massive disruption to Italy's transport systems this month, with a strike on Thursday in the air sector to be followed by shutdowns of municipal public transport on September 15 and the national railway network on September 27.
The planned protests highlight Mr Prodi's difficulties as he tries to restore order to Italy's public finances and introduce long overdue structural reforms in the economy.
While international financial markets and the European Commission regard such measures as essential, Mr Prodi must take care not to lose the support of the leftist elements in his coalition on which he depends for his slim parliamentary majority.
This was always going to be the big issue. This year is still one of 'grace' for the Italian government, and the Italian economy. Of course it is a boom one. Next year is going to be much tougher, as the global economy slows, and the fiscal cuts take effect. And we will be hear on the Italian Economy Watch to follow this through.
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