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Friday, August 08, 2008

Italy's Economy Contracts Again in Q2 2008

According to preliminary data from national statistics office ISTAT this morning Italy's GDP fell 0.3 percent in the second quarter compared with the first three months of the year and was unchanged year-on-year (ie zero percent annual growth). Final data and a detailed breakdown for the second quarter will be released on Sept. 10. In the first quarter, GDP rose 0.5 percent quarter-on-quarter and increased 0.3 percent year-on-year.




European Central Bank President Jean-Claude Trichet yesterday said economic growth will be "particularly weak" through the third quarter after policy makers left borrowing costs at 4.25 percent, so it is not unreasonable to anticipate a second consecutive quarter of negative growth in Q3, and hence in all probability Italy is now in recession.



Italian consumer confidence in July slumped to the lowest since 1993, when the country was also - we should note - in a recession following abandonment of the EMS. The Isae Institute index fell to 95.8 from 99.9 in June. In November 1993, the 26-year-old index hit a record low of 95.4.




Italy's manufacturing sector contracted for the fifth straight month in July, posting its weakest performance in over six-and-a-half years, according to the results of the latest Markit/ADACI PMI survey. The Markit Purchasing Managers Index dropped to 45.3 from June's 46.9, sinking further below the 50 divide between growth and contraction.



If we look at the seasonally adjusted output index we can see that Italian industrial output has been dropping almost continually since the November/December 2006 peak, and we might well ask ourselves the question, with energy prices up where they are when will this index ever rise again abover the late 2006 peak?





The Italian services sector purchasing managers' index also in fell in July, to a seasonally adjusted 45.6 in July from 48.5 in June. So the contraction continues, and even accelerates into the third quarter of the year.





And Italian retail sales declined in July for the 17th month in a row. The seasonally adjusted PMI for retail sales was at 38.2, up slightly from the 36.3 shocker registed in June.



Public Spending Cutback?

Earlier this week Italian Prime Minister Silvio Berlusconi survived a confidence vote in parliament over plans to raise taxes on oil companies and reduce salaries for mayors and public employees in a bid to balance the budget by 2011. Italy currently has a debt to GDP ratio of around 105% - way above the official EU limit of 60%. Italy is commited to at least achieving the common target of a balanced budget by 2011, but this looks to be fraught with difficulty to me, given Italy's very poor economic performance and all the negative headwinds going forward.

Berlusconi managed to clear this particular hurdle this time round without too much difficulty, since his allies in the lower house of parliament voted 312 to 239 to approve the necessary amendments to current legislation, and then passed the entire package 314 to 230.

The budget increases the corporate income-tax bracket for energy companies to 33 percent from 27.5 percent and raises taxes on oil and gas inventories. Banks and insurance companies also will pay more. Finance Minister Giulio Tremonti has called the measures ``Robin Hood'' taxes.

On the spending front, the government plans to cut city, town mayor and local administrator salaries by 20%. It is not clear how much of this is serious and how much "window dressing", but since the government estimates that budget cuts at ministries will generate savings of 9 billion euros ($13.9 billion) next year, the salaries of more than a few mayors and public dignataries must be involved.

The broader economic policy outlined in the budget aims at boosting revenue and cutting spending by 36 billion euros over the next three years. And even with these cuts the deficit is expected to widen to 2.5 percent of gross domestic product this year from 1.9 percent last year, largely as a result, of course, of the current recession.

Now, if the Italian government are serious about this, and we will need to watch and wait to know since past performance is far from reassuring, then it will leave us with the clear possibility going forward of seeing an Italy with negative GDP growth in full years 2008, 2009 and 2010. Since the little average underlying net growth that Italy manages to achieve these days will largely be undermined by cut backs in government spending and the impact of continuing high energy prices on headline GDP growth.




So the big question is: are the Italian people ready for three consecutive years of falling living standards and cuts in everything, or is Berlusconi going to have trouble holding his coalition together?

9 comments:

Piazza Armerina said...

"...So the big question is: are the Italian people ready for three consecutive years of falling living standards and cuts in everything, or is Berlusconi going to have trouble holding his coalition together?..."

Of course the people are ready. The Italian people share much of the blame for this situation, and it will be getting worse.

This is only the beginning. Hello downsizing.

Meanwhile, Italians with money are very active here in Miami buying up real estate, opening restaurants, and working offshore investments. These are the smart ones. Sure, Miami is in a "recession" - but for Italians it is an investment paradise. It all depends on perspective.

Of course, most Italians would not enjoy it here - too much work for them. They already did their work a few hundred years ago, time to relax now.

Demo said...

Ed, Italy has simply no choice than cut back expenses.

Country GDP won't grow anyway given the low productivity of its workforce and anti-business legal framework.
Foreign investors have better expectations in Burundi than Italy.
Aging population will further worse public budgets. Political system is re-active not pro-active, without considerations on policies that rather goes for populism than any serious step to improve country deteriorated R&D and business environment.

As Zackaria said in its recent editorial (newsweek), in the new world economic order, Italy is most likely to step back into a kind of middle income (or third world) country within the next 10 yrs.

Callum said...

There is no way Italy is going to become a third world country in the next ten years, even if it is perhaps the most likely developed country to do so. Despite 15 years of economic malaise italy's living standards are still on a par with most European countries. Meanwhile, cutting government debt (if indeed they succeed) is a positive move overall. Credit ratings go up, and less money is spent servicing the debt, meaning more money can be diverted into improving peoples living condition. I also think that as the dollar strengthens, and the effects of the credit crunch wear off (18months down the line admittedly) demand for Italian goods should compensate for the cut in spending. I can't forsee 3 years of negative growth - growth in Q2 even wasn't negative annualised, and that was in the middle of soaring energy prices and a general slump.

Piazza Armerina said...

"...As Zackaria said in its recent editorial (newsweek), in the new world economic order, Italy is most likely to step back into a kind of middle income (or third world) country within the next 10 yrs..."

I agree with Callum - despite my criticism of Italy (I am a citizen of that country), I find 10 years a bit too soon for Italy to reach "middle income status" in terms of development. Even Argentina, which was one of the wealthiest countries at the turn of the 20th century still has even today an abundance of evidence of a history of a well-developed economy.

Furthermore, I have read some of Zackaria's other writings, and I was not impressed. I put more stock into what Edward Hugh says over Zackaria any day.

Speaking of Mr. Hugh, demography will influence a lot, and while 10 years seems too soon, I would think by 2030 Italy will be safely in a middle-income type of bracket.

By the way, "Third World" is such an outdated term, and in no way good enough to be able to generalize the complications of today's global economy and interactions thereof. There is no longer a true "Second World" as it was originally defined. Anyone who uses the notion of a "Third World" loses credibility in my eyes - and seems amateurish (maybe old)

Italy, however, will certainly "downsize" as a nation over the next 20-30 years, so it is natural that its output will substantially decrease relative to rapidly growing middle-income countries. The trick will be the evolution of an educated middle class in Italy to keep the GDP/head at competitive levels.

Edward Hugh said...

Hello Callum

"There is no way Italy is going to become a third world country in the next ten years, even if it is perhaps the most likely developed country to do so. Despite 15 years of economic malaise italy's living standards are still on a par with most European countries."

I basically agree with you, but do note what piazza armerina has to say. I mean over the longer term Italy could follow the path already trodden by Argentina in the 20th century. And of course Italy may not be the only one to do this. What is it the song says: "everything that lives was born to die".

There is nothing permanent and "god given" here. If you want a high standard of living you have to find the wherewithall to maintain it.

Basically I don't really know what the term "third world" means any more.

I mean we can talk about emerging markets and less developed countries. The former are accelerating rapidly, and some of the better positioned ones in Eastern Europe can overtake some of the worst poitioned ones in Southern Europe - namely Portugal - pretty soon now.

The problem is ALL the Eastern European emerging economies have their own ageing population and low fertility problems - as do Vietnam and China.

So if you want to look for Emerging Economies that may overtake the ageing laggards in the 2020s you need to look at places with more solid demography, and good growth potential, like Brazil, Chile, Turkey, South India. The thing is, none of these economies will be "third world" by the time we enter the 2020s, so being behind them wouldn't mean you belonged to that group, whatever - as I say - the term may mean. I think it is more a cultural expression used by people in the "first world" who like the comparison since it makes them feel better - rather like the people at the Henley regatta speak about the dreaded "working classes" (as Piazza Armerina says, would that more people in Italy wanted to belong to this group these days) -than any economically significant term.

"Meanwhile, cutting government debt (if indeed they succeed) is a positive move overall."

Of course, we all agree on this, but we do need to understand that this will be growth negative, since we are NOT talking about cutting taxes here - and thus freeing up resources for private consumption - we are talking about a dircet reduction in aggregate (ie public plus private) demand.

"I also think that as the dollar strengthens, and the effects of the credit crunch wear off (18months down the line admittedly) demand for Italian goods should compensate for the cut in spending."

I think this is all very hard to see Callum. This "as the dollar strengthens" is a big as. We really don't know where we are headed here. Clearly as the ECB cuts the dollar will firm vis-a-vis the euro, but therre is a limit as to haow far this can gop without putting abig break on US exports, which are likely to be an important driver of headline GDP growth in the next couple of years.

I don't think anyoine is going to be happy to see the US CA deficit start ticking upwards here, so I think we need to bide our time a bit and see what actually happens. We are also back to places like Brazil, Turkey and India towing global growth out of the mire in the shorter term I think, and energy prices remaining high and OECD consumers remaining under pressure.

"and the effects of the credit crunch wear off (18months down the line admittedly)"

well, again we need to distinguish two components in this "crunch". One is the financial difficulties the banks are having. These I would agree may well be over in the US (although not in Spain) in 18 months or so, but you also have to think about the "easy lending" credit driven consumer growth. I think that second part of the credit crunch is going to last for a good deal more than 18 months, which is why I think the US will need to have a more permanently competitively priced dollar and go fort exports - which I imagine the US is going to be rather better at than Italy is.

"I can't forsee 3 years of negative growth - growth in Q2 even wasn't negative annualised, and that was in the middle of soaring energy prices and a general slump."

This isn't quite how I see it. I think the worst is yet to come here in Europe. The Eurozone may be entering recession now, or it may enter later this year.I think we are now entering several years of stagflation, since remember as soon as growth starts to pick up again energy prices are going to also shoot back up, so we have a permanent constraint here, and I reckon this one could be in place for many years yet to come.

Now Italy had trend growth of only between 0.5 and 1% before all this broke out (I think this is the point, not the "third world" stuff, but ther ever weakening trend GDP growth) and this was with around 3% budget deficit. In the new conditions Italian trend growth is going to be struggly to get over the zero percent mark, and then you have to subtract the lack of fiscal stimulus. At best Italy is going to hover round zero between now and 2011, and there is what they call "downside risk".

Cheers,

Edward

Piazza Armerina said...

The only way that Italy's living standards are on par with other European countries is when I compare it to Romania, Hungary and the Czech Republic. Italy will be lucky to stay close to Portugal. To say that Italy is even close to Scandinavia, UK, Benelux, France and Germany is quite laughable.

Now, if we use food, wine, sunshine, beaches, mountains, and beautiful women as yardsticks for measuring standard of living, well then maybe Italy is on par...with Venezuela! Maybe even Colombia or Brazil (albeit with a more civilized form of corruption). The main difference is that those economies are dynamic and growing.

Now onto the assertion that a US dollar gain will save Italy from prolonged recession: Despite everything you hear about interest rate differentials, current account deficits, and technical analysis from experts, much of the dollar weakness can be attributed to political weakness. Once a new administration is in place and optimism returns to the States, then I believe we will see a major dollar strengthing. Abundant international investment to the US will offset the dollar gains and help to finance the CA to a certain extent. Don't write off the States just yet. It is very dynamic and ever-changing (unlike Italy).

By default, Italy's exports could benefit from this situation - but not enough to achieve a GDP growth past 1% annually over the next 3 years. The Italian character is too permanent to position itself for anything other than mediocrity ...er I mean "relaxation".

Italy has been suffering from low growth for so long that future GDP, even if positive (.5%-1%) will not solve anything. There are so many years to make up for, and Italy needs at the very least 1.5% consistently to make any headway at all.

Since the state has stimulated most of the recent GDP growth - cost cutting will just lower GDP even more. They don't have the luxury of financing consumer stimulus packages.

Over the next decade, as the country downsizes, it seems that the immigrant population will remain in the lower classes due to racism. Therefore, as the Italian middle class dies off, it seems that the only logical replacement would come from a combination of immigrants and from a trickle down of those formally in the upper classes (but they would have to make more kids - and they are not really doing it consistently).

In the end, we'll have a dual society - a very rich class along with an underclass of severely limited financial resources and limited class mobility. And contracting outputs and population.

Sounds like middle-income to me (or 3rd World for those old fashioned people).

I still think that getting out of the Euro would lower asset prices to the extent that it would spur an abundance of foreign investment. Italy could be a thriving global village if it just opened the gates. But they would have to have go on global sale. I know my pocketbook would be open.

But no ... that's too innovative for Italians. That sounds like something that would happen in the US. Italians are way too parochial. It goes against the clan mentality. Let's just go to the beach and eat pizza instead. Little Giovanni is 39, and still lives with Mama.

Callum said...

Italys living standards are still some way above Eastern Europe, and Greece and Portugal...yes they may be below those of Germany/Scandanavia etc but as a whole they are on a par with most European countries. Yes the South may be poor, corrupt...the lot...but every country has its poor areas. The UK is no golden land of economic or social prowess, and having lived in the UK, Italy and now Ireland I have noticed no discernable change in living conditions. And no, I wasn't living in Italy's south, but then the areas I've lived in in the UK and where I live now would not be considered periphiral regions. Thats just what I've found...

Not that has anything to do with the economy but I do think people overstate how behind Italy is in everything. Its not that long ago that Italy had a larger economy than the UK. Of course I'm not saying that Italy isn't starting to fall behind, that much is obvious. As the educated youth emigrate Italys capacity to innovate fades, while birth rates fall further. It is natural that the economy will fall behind somewhat, simply because of the fact that the population is predicted to fall by 5 million by 2050. And whats more that decline will be concentrated among the most productive age group. I personally think that as things get worse (and as anti-immigrant sentiment increases when people look for a scapegoat for their woes) a lot of the immigrants will leave to countries where jobs are plentiful. Italians will no longer be able to snub cleaner jobs etc. But there is no way all the many famous Italian companies will suddenly...disappear. The prospects for a lot of Italian companies are good for the medium term. And Italian luxury will always sell. I do believe that the 'brand' of Italy will prevent any dramatic crash. Regretably I would agree that growth over the next 10...probably 50 years will be less than 1% average P/A. When the decline of the educated workforce really starts to hit home (at best in 2020?) I can even see prolonged recession. Italys current situation has been compared many times to that of the decline of Venice, and unless there is a pronounced policy shift I can see Italy steadily fading into the economic background. I don't think pulling out of the Euro would do Italy any favours though. The EU has kept Italy under some sort of control, making sure the debt is kept beneath a certain level, condemning certain practices. Leaving Italy on its own without any fall back if things go badly wrong (which you wouldn't bet against with people like Berlusconi in charge) would not be a wise idea at all. Also leaving the Eurozone would be tantamount to pulling out of the EU. Surely no one can think that would be a positive move?

What Italy needs is a fresh new Prime minister who will tackle corruption and the mafia once and for all, unite a country bitterly divided by the Lega Nord and their policies of fear, and who won't be afraid of making some bold economic moves. Italy needs a huge shake up, but all the ingredients are there for a strong economy, able to compete on a global scale. One of Italy's strongpoints is a huge diaspora worldwide, many of which (I hope) still care a lot about Italy. If a good leader did rise to power in Italy maybe it could trigger the return of young Italians who have the benefit of being brought up overseas, who will have new ideas, new beliefs... I'd like to point out what has happened to Fiat since Sergio Marchionne (an Italian brought up in Canada) has been CEO. After all when you get down to basics an economy is entirely about people...if enough have the chance to go forward and innovate you have a strong economy.

Unfortunatly none of this seems likely to happen anytime soon but there is still hope for Italy...until then Italy will have to cope with trundling along at .5-1% growth, falling ever behind the pack. Alongside I must say a lot of Southern Europe...

demo said...

piazza and callum comments are more pessimistic than Zackaria...
BTW, with all due respect, I d say south of italy is already (at best) in "middle country" status....
Most italians i know who r getting qualified jobs internationally did study abroad (usually in UK) and won't come bk in their home country with ridiculous petty salaries they get there (public or private sector alike).

...unless they d get a CEO position at fiat.... they won't be bk..

Edward Hugh said...

Very interesting conversation everyone. I will just pick up a few points.

"Once a new administration is in place and optimism returns to the States, then I believe we will see a major dollar strengthing. Abundant international investment to the US will offset the dollar gains and help to finance the CA to a certain extent. Don't write off the States just yet. It is very dynamic and ever-changing (unlike Italy)."

Well this is a bit off-topic in terms of Italy, but I would say I am most certainly not writing of the US at all. As you know I do take a country's demography seriously as one indicator of its potential economic well-being, and the US is still an amazingly young country (median age around 36). So I mean, obviously it still has bags of potential, and plenty of entrepreneurial energy.

The thing is, I do take the stagflation situation rather more seriously. There is a very high level of indebtedness in some parts of the US citizenry, and really the only way this can unwind softly is by having higher than normally desireable inflation for a number of years, together with a lower than optimal interest rate (for fighting inflation, ie monetary accommodation). This seems to be the option Bernanke is going for at the moment. (You also of course need people to line up and offer to lend a savings-lite US the money at the low rates, but the Chinese - among others - do seem to be filling this role at present).

The whole model of construction driven booms as the key factor in developed economies I think also just went out of the window for some years, and the US will now undoubtedly attempt to secure a more balanced growth dynamic with a better trade balance covered by growing exports (and oil remember is probably going to stay expensive, even if it is dropping now as the global economy slows, this current oil decline has got more to do with the slowdown in Europe and Japan and monetary tightening in key emerging economies like India and Brazil than it has to do with the uptick in the US dollar IMHO).

But of course the euro can fall against the dollar, even while both of them fall vis a vis a basket of emerging market currencies, so Italy's exports can, of course, benefit, but she will still be paying for the oil, so how much real growth you are going to get from net trade is a moot point I think.

incidentally:

"Don't write off the States just yet."

Well quite. Weren't we being told here in Europe after last August that the US had serious economic problems, while the rest of the world was going to be just fine? But the US has still to fall into recession, while it wasn't just the Italian economy that contracted in Q2, the German, Fench and Japanese ones did too. Something doesn't quite fit together in this argument, now does it.


Also:


1/ "Over the next decade, as the country downsizes, it seems that the immigrant population will remain in the lower classes due to racism."

2/. "I still think that getting out of the Euro would lower asset prices to the extent that it would spur an abundance of foreign investment. Italy could be a thriving global village if it just opened the gates."

Well, opened the gates and opened the mindset too, and this is what I just don't see happening. (1) could be a strategy (although absolutely fraught with difficulty and probably passing through a sovereign default) but it couldn't possibly hope to achieve anything without a change in the racism you mention in (2). Otherwise the "downsizing" will just become terminal. What we seem to be seeing at the present time, however, is just the opposite, with migrants being made more and more unwelcome.

Callum

"Its not that long ago that Italy had a larger economy than the UK."


No it isn't. But that just shows you how corrosive 15 years of 1% growth can be on living standards when everyone else has 2 or 2.5%.

"I personally think that as things get worse (and as anti-immigrant sentiment increases when people look for a scapegoat for their woes) a lot of the immigrants will leave to countries where jobs are plentiful."

Well this is definitely a major concern, especially as migrants get Italian nationality and can move. Would you stay in a country where you weren't welcome and they paid you badly to boot!

So the relative laxity in regulations in Italy can turn it into a sort of new version of Ellis Island, a transit point where people spend a given period in quarantine - in this case maybe five years - before moving on to other climes for more permanent settlement.

"But there is no way all the many famous Italian companies will suddenly...disappear. The prospects for a lot of Italian companies are good for the medium term."

I quite agree, but then there is no necessary direct one-to-one mapping between nation and company. As I can see here in Spain, many companies can effectively employ people from 30 to 55, and then let the "nation" think what to do with them for the rest of the time. Companies can effectively become like the mitochondria in a eukaryotic cell, the complementarity of function is necessary to both entities, but they maintain their own quite separate dynamics.

And of course, the brand name is one thing, and the reality another. Just how much of Fiat's manufacturing is now done in Eastern Europe?

"When the decline of the educated workforce really starts to hit home (at best in 2020?) I can even see prolonged recession."

Well quite. It seems we are not so far apart really. Really all of this is such uncharted territory I personally prefer not to say much beyond 2011, since I prefer to see what happens between now and then. That should give us a measure of some sort. In my mind there is no doubting that the present slowdown is a very significant one, not for its magnitude (which is slight) but for what it seems to tell us about the future.

"Also leaving the Eurozone would be tantamount to pulling out of the EU."

First off, I am not advocating that Italy leave the eurozone. I simply consider it a scenario that might come to pass. Basically I don't see how Italy is going to reduce the massive debt without defaulting on at least part of it, since without growth and with mounting age related costs, something really doesn't add up.

But having said that, I think leaving the eurozone doesn't mean leaving the EU - Sweden, denmark and the UK never joined - and it isn't clear how many more of the EU10 will be joining anytime soon.

And again having said that, there may be changes at some point in the eurozone format itself. Some things are evidently not working. Especially - as you yourself note - in the South of Europe. Portugal and Italy have effectively stagnated, while Spain and Greece were sent off on construction driven stellar growth paths. These are now coming to a dead stop, and then people will be asking what the precise advantage was of having a "boom-bust" fuelled by cheap interest rates. Particularly since picking up the pieces afterwards isn't especially pleasant.

So I think over the next 5 years or so a lot of things will be going into the melting pot, and we certainly need changes, and maybe it is better to talk about all this openly, and to some extent be in charge of our own destiny, rather than simply waiting for the inevitable to happen.

But I think a precondition for that kind of process in Italy is some sort of change in mindset, and some sort of consensually grounded desire to change and do things better. Absent that all you will get is a lot of vitriol and a lot of stupid rhetoric, until finally the inevitable does happen - ie government finances go bump in the night.


Hi Demo,

"piazza and callum comments are more pessimistic than Zackaria..."

Possibly, although I guess what makes the difference is that they are avoiding the emotive sounding headline-catching language preferred by Zackaria :).

You and the others raise serious question about the Mezzogiorno though. I can see this in the labour surveys, job creation, unemployment and rates of immigration. So a very big difference is building up between the North and North East one the one hand, and the South on the other. We see something similar in Germany between the North West and the South and then the East. Eastern Germany and Southern Italy are going to have the highest rates of depopulation and age related poverty. Now as Callum notes, such differences are not uncommon in other countries (for example we all saw what was unearthed in the centre of New Orleans when they had to evacuate after Katrina), but what is going to be new in both Germany and Italy is the ongoing fiscal crisis of the state which makes it impossible to adequately redress these growing differences via redistributive policies. Hence the tensions will mount. And again you could well reach a point (I don't know when) that living standards in the South of Italy fall below those in Morocco or Tunisia. I certainly wouldn't discount this possibility.