The standoff between the Italian government and the European executive continues over the 2019 budget of the peninsula. Brussels expected Rome to revise its plan, but the justifications provided for the expansionary budget were not enough to quell the dispute.
Without resorting to financial sanctions, the European Commission is going to place Italy under a “procedure for excessive deficit”.
Italians are not doing themselves any favors by significantly increasing their deficit, worrying the markets, risking higher borrowing costs to distribute income that the economy does not generate, challenging pension reforms, and delaying a planned VAT increase.
A substantial investment strategy to renovate the productive system and refurbish decrepit infrastructure would at least have the merit of raising potential growth, making it more difficult for Brussels to sanction an aggravated deficit.
After vociferously proclaiming its hostility to so-called austerity imposed by Brussels, the Italian government announced that to finance a series of reforms including the promised universal income for disadvantaged southern populations, the flat tax promised to small northern entrepreneurs, and a more generous pension, they decided to revise upward the deficit forecasts for the coming years (2.4% in 2019, 2.2% in 2020, and 2% in 2021 compared to 1.7% in 2018 and an initial deficit forecast for 2019 and beyond of 0.8%!).
For Rome, such a choice does not worsen the public finances situation as long as the expected growth (1.6% in 2019 then 1.7%) materializes.
Such an approach immediately provoked the ire of the markets and Brussels, reminding Rome that it cannot disregard commitments with impunity, increase the structural deficit, and risk breaching the 3% threshold when growth is sluggish (1% in H1 2018 and 1.1% in 2019 according to the Commission).
The budget: a political power struggle
For a country whose debt represents 132% of GDP, a debt with an average maturity of 7 years and an average cost today of 2.8%, a rise in rates would be fatal. Let us recall that in 2011 the 10-year bond rate hit 7%, and it was at 3.44% last September 27th! More daunting than Brussels’ potential sanctioning power is the de facto oversight of Rome’s fiscal policy by the markets.
Moreover, it is essential to consider the elements of the Italian macroeconomy. Since 2006, growth in Germany has been 18%, 9% in Spain, and -3% in Italy. GDP per employee has increased by 5% in Germany and decreased by 4.5% in Italy. Only France has done worse since 2006 in terms of net exports, with a 7-point GDP gap in favor of Italy, which still suffers a 7-point GDP gap disadvantage compared to Germany (source Candriam). The explanation lies in the inflation of industrial wage costs, higher than those of Germany and equivalent to those of France since 1999 (index 100), in productivity (VA/Employee) which is falling (France, Spain, Germany around 150 against 115 for Italy) and thus in unit wage costs that have soared since entering the eurozone.
What can be concluded about the political sequence that comes to a close with the presentation of the 2019 budget draft?
- Heated by economic stagnation, the erosion of purchasing power, and public impotence in the face of the migratory wave, Italians have entrusted the keys of government to populists, and nothing suggests they would do otherwise today if given the chance.
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The mistrust towards the EU and, more generally, Euroscepticism is gaining popularity in a founding club member country that feels unfairly treated.
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The Euro, on the contrary, gains adherence, and the mere prospect of a potential exit provoked a public outcry, indicating it has entrenched itself in the landscape, perceived as a safeguard against the economic excesses of populists.
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The structural reforms advocated by Europhiles to strengthen participation in the Euro remain thus suspended.
The problem posed to Italy remains unanswered: how to restore competitiveness without devaluation? How to overcome economic stagnation, investment shortfalls, and market share erosion without internal or external devaluation?
