Tag: supply-side reforms

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Don’t bank on Italy’s economy

The Brexit vote has caused shockwaves throughout European economies. But there is a potentially larger economic and political problem facing the EU and the eurozone more specifically. And that is the state of the Italian banking system and the Italian economy.

Italy is the third largest economy in the eurozone after Germany and France. Any serious economic weaknesses could have profound consequences for the rest of the eurozone and beyond.

At 135% of GDP, Italy’s public-sector debt is one the highest in the world; its banks are undercapitalised with a high proportion of bad debt; and it is still struggling to recover from the crisis of 2008–9. The Economist article elaborates:

The adult employment rate is lower than in any EU country bar Greece. The economy has been moribund for years, suffocated by over-regulation and feeble productivity. Amid stagnation and deflation, Italy’s banks are in deep trouble, burdened by some €360 billion of souring loans, the equivalent of a fifth of the country’s GDP. Collectively they have provisioned for only 45% of that amount. At best, Italy’s weak banks will throttle the country’s growth; at worst, some will go bust.

Since 2007, the economy has shrunk by 10%. And potential output has fallen too, as firms have closed. Unemployment is over 11%, with youth unemployment around 40%.

Things seem to be coming to a head. As confidence in the Italian banking system plummets, the Italian government would like to bail out the banks to try to restore confidence and encourage deposits and lending. But under new eurozone rules designed to protect taxpayers, it requires that the first line of support should be from bondholders. Such support is known as a ‘bail-in’.

If bondholders were large institutional investors, this might not be such a problem, but a significant proportion of bank bonds in Italy are held by small investors, encouraged to do so by tax relief. Bailing in the banks by requiring bondholders to bear significant losses in the value of their bonds could undermine the savings of many Italians and cause them severe hardship, especially those who had saved for their retirement.

So what is the solution? Italian banks need recapitalising to restore confidence and prevent a more serious crisis. However, there is limited scope for bailing in, unless small investors can be protected. And eurozone rules provide little scope for government funding for the banks. These rules should be relaxed under extreme circumstances. At the same time, policy needs to focus on making Italian banking more efficient.

Meanwhile, the IMF is forecasting that Italian economic growth will be less than 1% this year and little better in 2017. Part of the problem, claims the IMF, is the Brexit vote. This has heightened financial market volatility and increasead the risks for Italy with its fragile banking system. But the problems of the Italian economy run deeper and will require various supply-side policies to tackle low productivity, corruption, public-sector inefficiency and a financial system not fit for purpose. What the mix of these policies should be – whether market based or interventionist – is not just a question of effectiveness, but of political viability and democratic support.

Articles

The Italian Job The Economist (9/7/16)
IMF warns Italy of two-decade-long recessionThe Guardian, Larry Elliott (11/7/16)
Italy economy: IMF says country has ‘two lost decades’ of growth BBC News (12/7/16)
What’s the problem with Italian banks? BBC News, Andrew Walker (10/7/16)
Why Italy’s banking crisis will shake the eurozone to its core The Telegraph, Tim Wallace Szu Ping Chan (16/8/16)
If You Thought Brexit Was Bad Wait Until The Italian Banks All Go Bust Forbes, Tim Worstall (17/7/16)
In the euro zone’s latest crisis, Italy is torn between saving the banks or saving its people Quartz, Cassie Werber (13/7/16)
Why Italy could be the next European country to face an economic crisis Vox, Timothy B. Lee (8/7/16)
Forget Brexit, Quitaly is Europe’s next worry The Guardian, Larry Elliott (26/7/16)

Report

Italy IMF Country Report No. 16/222 (July 2016)

Data

Economic Outlook OECD (June 2016) (select ‘By country’ from the left-hand panel and then choose ‘Italy’ from the pull-down menu and choose appropriate time series)

Questions

  1. Can changes in aggregate demand have supply-side consequences? Explain.
  2. Explain why there may be a downward spiral of asset sales by banks.
  3. How might the principle of bail-ins for undercapitalised Italian banks be pursued without being at the expense of the small saver?
  4. What lessons are there from Japan’s ‘three arrows’ for Italy? Does being in the eurozone constrain Italy’s ability to adopt any or all of these three categories of policy?
  5. Why may the Brexit vote have more serious consequences for Italy than many other European economies?
  6. Find out what reforms have already been adopted or are being pursued by the Italian government. How successful are they likely to be in increasing Italian growth and productivity?
  7. What external factors are currently (a) favourable, (b) unfavourable to improving Italian growth and productivity?
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When the light at the end of the tunnel is yet another oncoming train: Greece’s woes set to continue

As we saw in several posts on this site, last year was a tumultuous one for the Greek people and their economy. The economy was on the verge of bankruptcy; the Greek people rejected the terms of a bailout in a referendum; exit from the eurozone and having to return to the drachma seemed likely; banks were forced to closed at the height of the crisis; capital controls were imposed, with people restricted to drawing €60 a day or €420 a week – a policy still in force today; unemployment soared and many people suffered severe hardship.

To achieve the bailout, the Syriza government had to ignore the results of the referendum and agree to harsh austerity policies and sweeping market-orientated supply-side policies. This, at least, allowed Greece to stay in the eurozone. It held, and won, another election to seek a further mandate for these policies.

But what are the prospects for 2016? Will it be a year of recovery and growth, with market forces working to increase productivity? Does 2016 mark the beginning of the end and, as prime minister Alexis Tsipras put it, “a final exit from economic crisis”?

Or will the continuing cuts simply push the economy deeper into recession, with further rises in unemployment and more and more cases of real human hardship? Is there a hysteresis effect here, with the past six years having created a demoralised and deskilled people, with cautious investors unable and/or unwilling to rebuild the economy?

The article below looks at the rather gloomy prospects for Greece and at whether there are any encouraging signs. It also looks at the further demands of the troika of creditors – the IMF, the ECB and the European Commission’s European Stability Mechanism (ESM) – and at what the political and economic impact of these might be.

Greece’s economic crisis goes on, like an odyssey without end The Guardian, Helena Smith (4/1/16)

Questions

  1. Construct a timeline of Greece’s debt repayments, both past and scheduled, and of the bailouts given by the troika to prevent Greece defaulting.
  2. What supply-side reforms are being demanded by Greece’s creditors?
  3. What will be the effect of these supply-side reforms in (a) the short run; (b) the long run?
  4. Explain the meaning of hysteresis as it applies to an economy in the aftermath of a recession. How does the concept apply in the Greek situation?
  5. Discuss the alternative policy options open to the Greek government for tackling the persistent recession.
  6. Would it be better for Greece to leave the euro? Explain your arguments.
  7. “I cannot see how this government can survive the reforms. And I cannot see how it can avoid these reforms.” Is there any way out of this apparent impasse for the Greek government?