Why Italy’s economy is stagnating

Leading economists tell the FT why the government’s budget is not the solution

Why is Italy’s economy so sickly and has the country’s new government found the cure for its economic ills? 

As Rome locks horns with Brussels over a draft Italian budget that the European Commission has rejected for breaching EU rules, the Financial Times has consulted leading economists, academics and industrialists about the root causes of the country’s sluggish growth. 

The experts’ answers, ranging from corporate culture to public debt, provide little backing for the Italian government’s case that its plans to increase the fiscal deficit to up to 2.4 per cent of gross domestic product will kick-start growth after years of poor performance. 

THE DEPTHS OF ITALY’S PROBLEM 

The challenge facing the Italian government is to get Italy out of the slow or no-growth trap it has been caught in throughout this century. 

Growth has stalled, leaving the country’s economic output still 5 per cent below its pre-crisis peak of 2008. 

Italy and Greece are now the only EU countries that have failed to recover to the levels of 10 years ago. 

But Rome’s problems go even deeper than this: 

GDP per capita is today, when adjusted for inflation, less than in 2000. 

The data highlight the country’s mediocre economic performance since the introduction of the euro in 1999-2002. 

Eurosceptics, some of whom are close to Italy’s populist coalition government, often blame the single currency for the economy’s ills, arguing that devaluation could kick-start exports. 

But the broad consensus among economists is that the country’s problems are due to structural weaknesses, rather than the euro. 

So why has economic performance been so poor? 

Here are the findings of the experts consulted by the FT, beginning with the most frequently mentioned possible causes.

INDUSTRIAL MODERNISATION — OR LACK OF IT 

Italy’s economic model is very dependent on family-owned companies that are typically smaller and less productive than their equivalents elsewhere. 

This problem has grown worse in recent decades. “In the 1970s and early 1980s, the Italian business model of small and medium-sized enterprises drove growth,” Silvia Ardagna, economist at Goldman Sachs, said. 

But, she added, many of those companies “did not invest in R&D and lacked the management capabilities and human capital to allow them to compete on a global scale”. 

According to the European Commission’s SME tracker, 95 per cent of Italy’s businesses have fewer than 10 employees. 

OECD data show Italian companies of that size have lower levels of labour productivity than their peers.

Bigger companies also fail to innovate, whether because of traditional, change-resistant, family ownership or difficulty obtaining credit. 

The latest OECD economic survey of Italy showed that contrary to the experience of most of the organisation’s member states, productivity among the most efficient companies in Italy is declining even faster than among the least productive ones. 

Despite a government initiative in 2016 to encourage companies to increase their digital presence, fewer than one in 10 non-financial businesses in Italy sells online. 

This is the third-lowest share in the EU after Romania and Bulgaria, according to Eurostat, the bloc’s statistical agency. 

The Italian government’s draft budget allocates very limited resources for dealing with such issues, planning no increase in the funds available to help companies with digital transformation for 2019 and only a minimal rise in 2020.  

POOR EDUCATION SYSTEM 

The experts cited Italy’s dysfunctional educational system as second only to the problems with business culture and industrial modernisation. 

“The highly centralised and unionised educational system delivers poor results in terms of actual skills,” said Massimo Bassetti, an economist at FocusEconomics.  

Fewer than one in three 25-34-year-old Italians has a university degree, well below the 44 per cent OECD average. 

Italian 15-year-olds have lower maths, science and reading performances than most of their peers, according to the OECD PISA report. 

Italy also has one of the highest student dropout rates in the OECD, and about one in four Italians aged 15-34 are neither in work nor education, the largest proportion in the EU. 

Italy’s budget plan contains reforms such as expanding pre-school education, changing teacher recruitment and reducing dropouts from school, but they are not among measures receiving significant additional funds.

UNFRIENDLY BUSINESS ENVIRONMENT 

Italy scores poorly on most measures of government efficiency and satisfaction with public services.  

The country ranks 111th out of 190 countries globally for ease of enforcing contracts, according to the World Bank ease-of-doing-business index. 

Italy scores just as poorly on bureaucracy for resolving insolvencies, paying taxes and dealing with construction permits. 

The country’s civil justice system is also ranked second to last among 35 high-income countries as measured by the World Justice Project.

“In Italy it takes far longer than in other developed countries to conclude civil and criminal trials,” with consequence for the business environment, said Mauro Pisu, senior economist at the OECD. 

“Inefficient public administration effectively acts as an additional cost on businesses, holding back investment and growth,” said Ms Ardagna. “Italy’s complex tax code, Byzantine regulation and inefficient public administration” are a “handicap”, said Mr Bassetti. 

They also prevent foreign companies from investing in Italy, said Andrea Colli, professor of business history at Bocconi University. Italy is a larger economy than Spain but has received less than half the level of foreign greenfield investment since 2003, according to fDi Markets.

In his letter to Brussels, Giovanni Tria, Italy’s minister of finance, wrote that future structural reforms, including the reform of the Civil Code, would “stimulate economic growth, ensuring the long-term sustainability of Italy’s public finances”.  

HIGH PUBLIC DEBT 

Italy’s coalition government argues that its spending plans will help fuel growth. 

But many of the experts consulted by the FT argue the contrary: that high debt levels already crowd out growth by attracting funds for government paper that would otherwise go towards more productive investments. 

“High public debt has limited the resources that have been devoted to the productive sector of the economy,” said Ms Ardagna.  

With the EU’s second-highest debt-to-GDP ratio, Italy spent 3.7 per cent of its GDP on debt interest, double the average of the EU. 

The European Commission’s latest forecast expects this to rise to 3.9 per cent by 2020 as a result of higher bond yields and interest rates.  

“Italy’s debt burden absorbs substantial financing resources, reducing funds for infrastructure investment and crowding out business investment,” said Mr Bassetti. 

While under the draft budget Italy will allocate additional funding of 0.2 per cent of GDP to public investment in 2019 and 0.3 per cent in 2020, analysts are not expecting significant improvement in its overall structural weaknesses. 

“Our baseline scenario remains that the new government won’t give the economy the needed reform push to jolt productivity,” Nicola Nobile, economist at Oxford Economics, said.

Fonte: qui

Italy Declares War On Merkel And The EU

If there were ever any doubts that the leaders of the Euroskeptic coalition that now runs Italy has a plan to defy the European Union its proposed budget should quell them. Both Deputy Prime Ministers, Luigi Di Maio of Five Star Movement and Matteo Salvini of The League, were adamant about locking horns with European Union leadership over all issues of sovereignty between now and May’s European Parliamentary elections.

Their budget proposal which included both tax cuts and universal income blew past the EU budget limit of 2.0% of GDP, coming in at 2.4%. It has put their Finance Minister, Giovanni Tria, in a difficult position because Tria doesn’t want to negotiate this budget with Brussels, preferring a less confrontational, read more pro-EU, approach.

Salvini and Di Maio, however, have other plans. And since I began covering this story last year on my blog, I’ve said that it was imperative that Salvini force the issue of the Troika’s demands – the EU, European Central Bank and the International Monetary Fund – back down their throats on debt restructuring/forgiveness.

What I meant then, and I was focused on Salvini’s emergence as the leader of this fight, was that Salvini and Italy, because they are more than technically insolvent, have all the leverage in the negotiations. The size of their outstanding debt and the liabilities existent on the balance sheets of banks across Europe, most notably the nearly $1 trillion in TARGET 2 liabilities, are something Juncker, Draghi, Merkel and Christine LaGarde at the IMF simply cannot ignore.

But, to do this Salvini and now Di Maio have to make a good faith effort to negotiate a good deal for Italy with Brussels, Berlin and the IMF. This is why the budget squeaked past the 2.0% limit and then they walked it back to 2.0% but with provisions they knew would anger the EU finance ministers.

The point of this is to push Brussels and paint them as the bad guys to shift public sentiment back towards an Italeave position. Italy’s problems are not solvable with Germany holding the purse strings for all the EU countries.

So, the first prong of their assault on the power structure of the EU is this, challenge them on their budget while making strong statements to the rest of Europe that they are not looking to exit the euro. If they do, it will be Germany forcing that situation.

The other prong of the assault is to remake the EU from within, which Salvini has openly stated is one of his goals.

It started more than a month ago when he met with Hungarian President Viktor Orban who agreed on a strategy of creating a ‘League of Leagues’ to unite the opposition to the current technocratic rule on the European Commission.

They were clear then that the goal was to wrest control of the European Commission Presidency from the coalition backing current President Jean-Claude Juncker.

With the rise in the polls of Euroskeptic parties across Europe, Salvini and Orban can drive real change in the structure of the parties within the European Parliament. The European People’s Party, which Orban’s Fidesz party is a member of, is vulnerable to losing its senior position in any coalition because of the huge change in Italy’s electoral make-up along with that in Austria with the less radical Sebastian Kurz.

But, the big swing is on the table in Germany. Alternate for Germany (AfD) is now pushing up towards 20% nationally and the next hurdle for its growth is this weekend’s Bavarian state elections. If AfD out polls the Greens and denies the CSU a path to a coalition government without them then that could have spillover effects for Angela Merkel.

The latest polls have AfD averaging around 11% versus a strong push up to 18% by the Greens. The CSU has collapsed to just 35%. How accurate these polls are are anyone’s guess at this point, but given recent history I would not be surprised to see AfD outperform their polling numbers on Sunday.

Figure 1: Source Wahlrecht.de

Because if they do and the CSU/Green total is less than 50%, the CSU may be forced to form a three-headed coalition to freeze out AfD. And this is assuming that the CSU and the Greens could form any workable coalition in the first place.

That would truly upset CSU leaders and the cries to break the Union with Merkel’s CDU would grow louder.

And with Merkel dealing with internal CDU disloyalty the possibility rises quickly that her national coalition could collapse amid external pressure from Salvini and Di Maio over budget and debt issues.

The markets are beginning to wake up to the fact that this political battle is not going to go as smoothly for Germany and the Troika as it did for Greece. Salvini and Di Maio are not Varoufakis and Tsipras and Italy is simply way more important than Greece.

The euro is weakening by the day while Italian bond yields are spiking. Traders do not know what to do as each statement by an official associated with this fight moves Italian debt markets by 20 basis points.

And, I shouldn’t have to say this too many times but 20 basis point moves in sovereign debt markets is the definition of ‘not normal.’

Populist forces within the EU are angry and their power is growing. The technocrats in Brussels still seem to think that the old rules apply but they do not. Scare tactics will not work on these men because they know that the ultimate move is to simply make preparations for a new currency, be it the mini-BOT that has been floated previously by Salvini or a new lira.

My read on the current state of affairs is as follows. Since the ECB is the only marginal buyer of Italian debt, which has been the case for more than a year now, any sharp rise in bond yields is a result of the ECB simply backing off that buying and market forces taking over.

This is the ECB’s biggest weapon. It will try to scare everyone by allowing Italy’s fiscal position to erode quickly making it impossible for them to issue debt at sustainable yields. But, it does so at the expense of the value of the bonds it and other European banks already hold. Because they are dropping in value, undercutting the solvency of those banks.

If the Italian leadership holds the line and refuse to back down, then they call the ECB’s bluff on allowing rates to rise. The ECB has to come back in, begin buying to support the price, and the regroup for the next battle.

That’s what we’ve been seeing for a few months now in the Italian bond market. That’s where this war is being waged as well as the headlines. And Salvini and Di Maio understand it. Because if they didn’t they would have already folded.

Instead they have doubled down on their opposition to Brussels and Berlin and added new vectors to their attacks.

This will not end well.

Authored by Tom Luongo via The Strategic Culture Foundation

Italian Bonds Slide After Italy's New Prime Minister Spooks Markets With "Radical" Plans

The eye of the hurricane may have passed over Italy and the winds are again starting to pick up speed, because shortly after Morgan Stanley laid out what a worse case scenario for Rome could look like (ugly, read here), Italian bonds started selling off again, with 2Y yields rising to session highs following Italian premier Conte's inaugural speech in which the populist premier spooked markets by reiterating that the new populist government will pursue a radical policy program, and highlighting legislative priorities that will be extremely costly - including the right to universal income, minimum wage, overhauling the healthcare system, prioritizing social rights, and so on - all without saying just how these will be paid for (spoiler alert: much more debt).

Conte also said that a new flat tax would be introduced, even if no timeframe has been provided, and there was no mention of avoiding the hike in sales taxes which is currently planned for 2019, or canceling the "Fornero" pension reform.

Amusingly, in the speech Conte also said that he plans on reducing public debt, although in light of the surge in spending which will not be financed with increased revenue, it is not clear how that can be achieved. As Bloomberg economist Stephanie Flanders notes "Italy cannot convincingly cut its public debt as a share of GDP without reasonable growth in nominal GDP (real growth plus inflation). Even the more optimistic forecasts do not point to nominal GDP growing much faster than 2.5% in the foreseeable future. By contrast, the average cost of its public debt is 3.1%."

A much more important chart is the following from Morgan Stanley showing what would happen to Italy's debt/GDP if interest rates rose even modestly from their artificially low levels.

As a result of Italy politely reminding the world that nothing has changed since the start of last week when the world woke up to the reality of a populist government in Europe's 3rd largest economy, Italian 2Y yields have spiked....

... with the move starting to seep across the Atlantic, sending the dollar to sessions highs...

... and 10Y yields back to lows.

Via Reuters, here are the key excerpts from Conte's speech (link to full speech here), highlights ours:

INTRODUCTION

“Today we come before you to ask for your trust not only in a government team, but also in a project for the change of Italy.”

“I do not think this is simple novelty. The truth is that we have brought with us radical change, of which we are proud.”

“I take on this task with humility, but also with determination, with the awareness of my limits, but also with passion.”

“The political forces that make up this government have been accused of being ‘populist’ and ‘anti-system’ ... If ‘populism’ means the ruling class listens to the needs of the people ... (and) if ‘anti-system’ means to aim to introduce a new system, which removes old privileges and encrusted power, well these political forces deserve both these epithets.”

EUROPE AND PUBLIC FINANCES

“We want to reduce the public debt, but we want to do it by increasing our wealth, not with austerity that, in recent years, has helped to make it (public debt) grow.”

“Italian public debt is fully sustainable today. However, its reduction must be pursued, but with a view to economic growth. Fiscal and public spending policy should be geared towards the pursuit of the objectives set for stable and sustainable growth.

“In Europe, these issues will be strongly pushed forward with the aim of changing its governance, a change already at the centre of reflection and discussion in all EU member states.

“We are optimistic about the outcome of these discussions and confident of our negotiating power, because we are facing a situation in which Italy’s interests ... coincide with the general interests of Europe, with the aim of preventing its possible decline. Europe is our home.”

PENSIONS AND CITIZEN’S WAGE

“The government’s goal is to provide income support for families most affected by socio-economic hardship. The support ... will be conditional on vocational training and job reintegration. We propose, in a first phase, to strengthen the employment centres.”

“We will also take action to help pensioners who do not have enough income to live in a dignified manner.”

“We need to cut the pensions and annuities of parliamentarians, regional councillors and employees of constitutional bodies ... The so-called ‘golden pensions’ are another example of unjustified privilege that must be opposed. We will intervene on pensions that exceed 5,000 euros per month when the sum has not been covered by the contributions paid.”

TAXES

“Our tax burden, combined with an excessive amount of bureaucracy, has a negative effect on the relationship between taxpayers and the state, and on the competitiveness of our country.”

“The goal is the ‘flat tax’, which is a reform with fixed tax brackets and a system of deductions that guarantees the progressiveness of the levy in full harmony with the principles of the constitution. This is the only way to bring about a drastic reduction in tax evasion, which will have benefits in terms of greater tax savings, greater consumer spending and investments, and increasing the tax base.”

IMMIGRATION

“We will end the immigration business, which has grown out of all proportion under the cloak of fake solidarity.”

“We will forcefully seek the overcoming of the Dublin Regulations in order to obtain the effective respect of the principle of equal distribution of the responsibility to set up an automatic system of obligatory re-distribution of asylum seekers.”

“We are not and will never be racists. We want procedures that determine refugee status to be certain and speedy, in order to effectively guarantee their (refugee) rights.”

FOREIGN POLICY

“First of all, we intend to reaffirm our convinced membership of NATO, with the United States of America as a privileged ally.”

“We will support opening up to Russia ... We will push for a review of the sanctions system, starting with those that risk humiliating Russian civil society.”

Fonte: qui

The European Crisis Is Back: Italian, Spanish Bonds Crash Amid Political Chaos

Just when you thought it was all over... the PIIGS chaos rears its ugly head as political crises start to spread across the periphery.

European stock markets are extremely mixed with the core relatively stable as the periphery plunges...

Italian banks stocks - so bloated with Italian sovereign debt - are accelerating lower...

Italian 2Y Yields are now at their highest since 2014...

As the entire BTP curve flattens dramatically...

And Italian sovereign risk is exploding...

Which leaves us wondering...

Is MF Global long Italian 2Y again?

— zerohedge (@zerohedge) May 21, 2018

As if Italy was not enough, Spain is now under pressure as PM Rajoy is under pressure from a potential 'no confidence' vote and Spanish bond yields (and sovereign risk) is blowing out...

The widest spread to Germany in almost 6 months...

Which means only one thing... the PIIGS are coming back to life and there is little that Draghi can do this time...

And all of this is weighing on the euro...

And finally - the scariest chart of all - reflecting the reality of Italy's 'Mini-BoT' parallel currency concerns...

"Get back to work Mr. Draghi..."

Fonte: qui