Pension Reform and the Prodi Coalition

Well despite the fact that Wolfgang Munchau seems to feel that the Prodi coalition is shaky, but not about to collapse, I continue to have my worries, and here's why:

A dispute about pensions reform erupted in Italy’s government at the weekend immediately after Romano Prodi, prime minister, extracted pledges of loyalty to his leadership from the squabbling parties in his centre-left coalition.

Mr Prodi said all nine parties in his government had agreed to start discussions next January on overhauling Italy’s state pensions system, but two communist parties that hold the balance of power in parliament contradicted him.


The problem is that Prodi is very much between a rock and a hard place. The deficit cannot be brought back under control without substantial health and pension reforms, and some of the members of his coalition are unlikely to ever vote for real and meaningful reforms since they are in denial that these are necessary. So we seem rather destined to wobble forward until we eventually fall over, caught as he is between the ratings agencies on the one side and his ex-communist allies on the other. Trying to stay in the middle here just will not work. Really, to make any sort of economic prognosis about Italy you need to factor-in this problem.

On other matters Prodi is apparently forecasting economic growth of 3%, this is a very attractive idea, but if you look at Italys growth trajectory over the last 5 decades, this is now, quite simply, to live in cloud cuckoo land. I have, it seems, to agree with his political opponent:

(Prodi)..said his government had set its sights on boosting Italy’s annual gross domestic product growth rate to 3 per cent, far in excess of the 1.3 per cent that, according to the Paris-based Organisation for Economic Co-operation and Development, is Italy’s present rate.

“Prodi has had a mid-autumn night’s dream, talking about staying in power for five years and increasing GDP growth to 3 per cent a year,” said Fabrizio Cicchitto, an opposition legislator, said on Sunday.

Also, and in conclusion, don't miss this, it gives an indication of the scale of the problem:

Pensions expenditure accounts for 14.7 per cent of Italy’s GDP, the highest in the 15 countries that made up the European Union before its expansion to 25 member-states in 2004.

The burden constrains Italy’s ability to reduce its public debt, forecast this year to be 107.6 per cent of GDP, and cramps much-needed investment in education and infrastructure.

Under a law passed by the government of Silvio Berlusconi, the former centre-right premier, the retirement age for many Italians will rise to 60 from 57 in January 2008.


Update

There is a reasonably intelligent analysis of all this by Tony Barber in the FT. Obviously, and in particular, I notice this:

Unlike some non-Italians, practically no Italian expert questions the country’s ability to remain in Europe’s monetary union. Nonetheless, few hide their worries about the chronic lack of economic reform and the political paralysis that partly accounts for it.

“The divergence between the growth in labour cost per unit produced in Italy and in the rest of the euro area is not sustainable,” Lorenzo Bini Smaghi, Italy’s member of the European Central Bank’s executive board, said in August. “In the next 10 years, it is absolutely necessary that salaries rise in line with productivity growth, if not at a slower rate.”

Obviously Lorenzo Bini Smaghi does not share Eric Chaney's optimistic reading of the situation (I will have more to say on all this in another moment). Also there is this:

“We have a country that is too slow in taking decisions and has too many competing power centres,” Luca Cordero di Montezemolo, head of Confindustria, Italy’s employers’ association, told the Financial Times this month. “A parliamentary system with 23 parties cannot function efficiently. Without a strong bipartisan reform of the state, including electoral reform, our country is destined not to grow. Ten years from now, we will be paying for the non-choices of today.”

Absolutely to the point I think. As is his observation on the plight of the DS and Margherita:

For the parties that have most to lose from Mr Prodi’s dwindling credibility as a reformer are the Democrats of the Left (DS) and the Margherita, the two largest in his coalition........the electoral success of the DS and Margherita depends on their ability to persuade voters that they can be intelligent managers of Italy’s capitalist system and will not “punish the middle classes”.

To the dismay of DS and Margherita strategists, opinion polls suggest large numbers of Italians think Mr Prodi’s budget falls short on both counts. Not surprisingly, Piero Fassino and Francesco Rutelli, the parties’ leaders, are insisting to Mr Prodi that the government waste no more time in launching economic reforms.

They call it the government’s “phase two” – and they may not have been happy to hear Mr Prodi describe this phrase last Wednesday as “a term I don’t know and don’t use”.

Centre-left politicians dismiss as “nonsense” the rumours in Rome that a plot is afoot to oust Mr Prodi. Yet no one has forgotten how Mr Prodi’s 1996-98 premiership ended: he was overthrown in a parliamentary revolt led by communists but exploited by other politicians to replace him with Massimo D’Alema, now foreign minister.

Publicly, almost everyone on the centre-left says that, if Mr Prodi’s government were to fall, perhaps because of a lost confidence vote in the Senate, Italy would hold a snap general election. But matters may not be so simple.


Silvio Berlusconi, the opposition leader, wants an election because, at the age of 70, it is his best hope of holding the premiership one more time. But not all his centre-right colleagues are thrilled at this prospect. For example, Pier Ferdinando Casini, a Christian Democrat often tipped as a future premier, says he sees no need to hold an election. Rather, a new government based on Italy’s moderate parties of left and right could take over.

This kind of realignment would halt Italy’s never entirely convincing progression since the early 1990s towards a system that clearly distinguishes left from right.

Some respected figures such as Mario Monti, the former European commissioner, favour it because it would deny power to extremists in both coalitions – communists on the left, the rabble-rousing Northern League and some elements in the National Alliance on the right. It might even boost the prospects for economic reform.

However, it would undoubtedly revive memories of the years from 1948 to 1994, when the former Christian Democratic party dominated a political system increasingly discredited by corruption, economic incompetence, political violence and organised crime.

Whether Italy is ready for such a political upheaval remains to be seen, but the present system – reinforced by the re-introduction last December of full proportional representation in general elections – appears to have an inbuilt tendency to block reform.

Given his hair’s-breadth election victory, Mr Prodi’s window of opportunity was always going to be narrow. But the pressure on him is intense because, in five years of power, Mr Berlusconi introduced few notable reforms. In spite of holding a parliamentary majority stronger than any government had enjoyed since the collapse of fascism, the former prime minister achieved little except some modest changes to the pension system and labour market.

Italy’s budget deficit climbed above 4 per cent of GDP under Mr Berlusconi. It is forecast this year to reach 107.6 per cent of GDP (the European Union’s treaties stipulate that countries joining the eurozone should have debts of 60 per cent of GDP or less). Excluding debt interest payments, Italy’s budget balance needs to be about 2 per cent of GDP in surplus to prevent the debt stock from increasing. In the last years of the Berlusconi government, this surplus shrank so much that the public debt rose for the first time in a decade.

With deficit and debt reduction a priority, Mr Prodi’s government published a four-year outlook in July that promised deep and permanent spending cuts in public sector employment, healthcare, welfare and local government. Equally welcome were measures to open some of Italy’s notoriously protected professions and product markets to competition. Lawyers, notaries, pharmacists, taxi drivers and others with privileges more suited to the Middle Ages than a modern economy would no longer be able to keep prices high and exclude outsiders.

Since August, the flame of reformist zeal has burned less brightly. Although the 2007 budget aims to cut Italy’s deficit to below 3 per cent, it does so mainly by raising taxes and cracking down on tax evasion, rather than making the spending cuts promised in July. On October 19 Standard & Poor’s and Fitch Ratings, the credit ratings agencies, criticised the budget and downgraded Italy’s government debt.

Mr Montezemolo says: “We have to get out of the vicious circle of ‘more taxes, more spending and therefore still more taxes’. We can do it. It may not be popular, but we need cuts, cuts and more cuts.”

This month, internal government disputes have caused the budget to undergo continual revision, a process that Tommaso Padoa-Schioppa, finance minister, defends as entirely normal.

He told the magazine L’Espresso: “Once it was said that the novel is by definition an imperfect literary genre, that it can’t be like a sonnet in which everything is perfect. So it is with the budget. In a novel a woman walks into the room wearing red. Then when she leaves she is described as wearing blue, because the author has forgotten she was in red. Such inconsistencies can also be found in the budget. The parliamentary process is needed to correct them.”

Come December, Italians will know if their government has successfully edited its “imperfect novel”. Meanwhile, the “perfect sonnet” of economic reform is a verse form no Italian government seems capable of mastering.

Business Confidence Indexes

Despite the fact that some would have it that I am given to presenting critical data, whilst ignoring the more positive variants, the real reason I didn't get round to posting on the most recent confidence indexes is that I have been labouring under the effects of a heavy cold. Sometimes the simplest explanation for events is the most accurate one, and we are, as Nietzsche was want to say, 'human, all too human'.

As far as business confidence indexes goes last week largely brought good news, with the readings rising in France and Germany, as well as in Italy.

Business confidence in Germany and France unexpectedly rose in October as lower oil prices and exports to Asia brightened the outlook for economic growth in Europe. Stocks rose to the highest in five years and bonds fell.

The Ifo institute in Munich said today its index climbed to 105.3 from 104.9 in September. Economists expected a decline to 104.5, the median of 39 forecasts in a Bloomberg News survey showed. In France, a gauge of optimism advanced to 108 from 106 in September. Germany and France together account for more than half the euro region's economy.


Italian business confidence remained near a four-month high in October as declining oil prices reduced manufacturing costs and orders increased. The Isae Institute's confidence index fell to 97.1 from 97.3 in September, the state-funded research center said today in Rome.


As we have been seeing, China forms a big part of the story here:

Foreign demand and cheaper oil prices are easing those worries for now. European exports to China jumped 21 percent in the first seven months of this year compared with the same period a year ago, the European Union's statistics office said last week. Confidence among exporters in Germany and France rose in October, today's reports showed.

``Trade between Asia and Europe has grown stronger this year, and that trend will continue,'' said Klaus Herms, chief executive officer of Germany's Kuehne & Nagel International AG, which books space on ships and planes for exporters.

The real question is where we go from here. There is some discussion in the press about the relative weighting of the "current conditions" and the "expectations" components in these indexes, with the suggestion being that the high values being registered are more a reflection of the former. The FT had a good summary last weekof the relative readings on (and variance between) the German Ifo and ZEW surveys.

My feeling is that the outlook moving forward is much more complicated than this months readings suggest. Of course others may chose to differ, and we will soon see who is right.

Italy's business confidence ``probably has pretty much peaked,'' said Perkins at ABN Amro, who says investors have expected French, German and Italian businesses optimism indexes to drop for the past six or seven months.

An index measuring production expectations for the next three months fell to 21, from 22 in September, Isae said. A measure of price expectations for the next quarter rose to 19, the highest in at least three years, from 17 in September.

Confidence in Italy in the coming months may be hurt by the government's efforts to tame the budget deficit next year, which includes 34 billion euros of spending cuts and revenue measures, including tax increases.

Prime Minister Romani Prodi's budget proposal, which needs to pass in parliament by the end of the year, was not enough to stave off downgrades by both Standard & Poor's and Fitch Rating last week. Both S&P and Fitch said the budget didn't do enough to cut spending and relied too much on higher tax revenue to lower the deficit and debt.

Italian consumer confidence fell in October from a four- year high, partly on concern that higher taxes included in the government's budget plan would leave households with less money to spend.

Update

Thanks to Paris for providing a link to the latest industrial data from ISTAT, which is up in October 3.4% y-o-y (I'll put an English language link as and when I find one). This is completely consistent with the current conditions component of the above-mentioned indexes. So there is no doubting the currently favourable environment, the question is where exactly we are in the cycle. My feeling is that we are now at, or near, the top of this cycle. In any event we are soon about to find out.