Italy's Budget Crisis: Fiasco or Fair Fiscal Fight?

Set the scene: a blue 1960s bus precariously hanging off the edge of the road in the Italian Alps. One tilt in the wrong direction and the bus will plunge down into the valley in a spectacular crash. The only positive outcome is survival.

Of course, this is the final scene of the Italian Job, a must watch (https://www.youtube.com/watch?v=HZCaSyid4m0). This Michael Cane classic encapsulates the predicament of the 3rd largest Eurozone economy. Teetering on the edge of collapse with survival as the only tangible route out. We must question how Italy has got itself into this mess and how it could find a solution.
Long term trends of high debt, an ageing population, deindustrialisation and fragmentation between the growing north and declining South highlight the fractured nature of Italy. Though somewhat surprising to outsiders, the formation of an Italian coalition government in May 2018 led by the Five Star Movement is the epitome of the divisions in Italy.

But is it Italy’s fault that the country is on the edge of collapse? The answer is multifaceted and depends completely on who you talk to.

The levels of debt to GDP per capita in Italy are the highest in Europe (excluding our Greek maverick Stravos whose debt has been restructured). Why is this bad though? Japan has had the highest debt to GDP ratio in the world for the last ten years, but it is not complaining about debt, disfunction or degradation. This debt burden is so heavy on Italy, as the Italian economy is tied to the Eurozone. The outperformance of other Eurozone nations such as Germany and France have stressed a weak economy in Italy (and notably other Mediterranean countries, e.g. Greece). Is there a solution to this? For Italy, it needs to either restructure its debt or untie itself for the Eurozone to let the internal strains balance. The possible return to the Italian Lira as its currency would allow turbulent devaluing which the country needs to rebalance the economy. Economically sound, politically disastrous. The Five Start Movement is a populist party so the idea of putting your nation to the sword is rather unpopular, even if it may be a solution.

Chronic underinvestment, especially in the South and public services, has led to unemployment and underemployment, with the unemployment rate at 9.7% (has been pretty constant for the past 6 years) and youth unemployment recovering from 2014 highs of 43% to a current 31% (hardly happy reading). Hence, ending unemployment, ending poverty and improving public services are major political issues in Italy. In the Five Star Movement’s budget to the EU commission, it highlights that increases in spending would help repair these issues. These are fair grievances for the Italian people and, whilst economically dubious, political and social necessities for a functioning state. In the 8th largest economy in the world, on 27th October, 8000 protestors gathered in Rome to complain about the lack of rubbish removal. Other cities such as Naples have gained a reputation for having no dustbin men with the city full of rubbish. Underinvestment has taken a nastier tone in the South, which has become a haven for criminal activity with 80% of Europe’s cocaine traffic flowing through the south of the country. (Another must watch is Simon Reeves’ Mediterranean which highlights this in scary detail). This is the Italy that the Five Star Movement is fighting to improve.

The European commission wants debt managed, to avoid contagion of Italian risk to the remaining parts of the Eurozone. The Italian government wants to appease the anger of its people and increase spending in basic areas of the economy. For the European Commission, Italy is a fiasco with potential risk to cause serious damage to the Eurozone, especially at the height of the Brexit negotiations. For Italy, this is a fair fiscal fight for a country on the verge of collapse.

Hence on 23rd October, the EU commission rejected the Italian budget in an unprecedented move, which highlighted the deepening rifts between the European Commission and the Italian government. Italian leaders said the government would “not give up” on its plans. “We know that, if we were to surrender, we would quickly return to the pro-bank and pro-austerity ‘experts’,” Luigi Di Maio, deputy prime minister and leader of the Five Star Movement, wrote on Facebook. “And so we will not give up. We know that we are on the right track. And so we will not stop.”

Luigi couldn’t have expressed his government’s view better. The explosion of the Italian 10Y bonds to 3.45% from around 2.7% in the last month also couldn’t explain European Commission President Juncker’s position better.
So will the Italian bus fall of the edge? Either way, the story will not have a happy ending.

Written by Benjamin Hughes