Italy: When hope is a strategy

June 25, 2014 15:15
Matteo Renzi, Italy's youngest prime minister, brings hope of reform to his country. Photo: Bloomberg

Let’s look this week at what I uncovered in Italy, which rather surprised me, and think through some of the implications that the new developments suggest for the ultimate outcome of the euro project.

What surprised me about Italy was the emergence of something that felt like speranza, which I am told is the Italian word for hope.

On my previous visits to Italy over the years, I have seen frustration, anger, and resignation – generally, there was a feeling that there was very little anyone could do to really change things.

Government was slow and inept and bureaucratic; it took years or decades to get anything through the courts.

But something different seems to be happening now. In February, the 39-year-old Matteo Renzi became Italy’s youngest prime minister.

So where is the hope coming from?

Renzi is not just going after the economic troubles. He seems to be attacking the very deep structural issues in a novel way. He is seeking serious constitutional reform in a country that has seen no constitutional changes for 30 years.

Changing the constitution is difficult and requires a super-majority, which Renzi does not have. But when you meet with parliament members and ministers from Renzi’s party, there is an optimism that is almost catching. Somehow or another, Renzi has convinced a lot of people in the Italian political system that reform is possible.

In particular, he wants to do away with the upper house (their senate) and streamline the decision-making process in the remaining house of parliament, with different rules for creating majorities.

Further, he is looking to reform the judicial process in a way that will allow court cases to actually be resolved in a realistic timeframe, removing the “justice delayed is justice denied” issue. Of course, labor reform is also on the docket.

Meeting with ministers and government leaders who are involved in developing the budget, I found acknowledgment that the only way they can get out of their current situation is to grow their economy.

They admitted they needed 2 percent real GDP growth, 2 percent inflation, and a 4 percent “primary surplus” (more on that later).

They candidly acknowledged that this outcome is possible but only with significant outside foreign direct investment, substantial growth in exports and a drop in the unemployment rate. “We have to unleash Italian industry and business.”

The current system discourages foreign direct investment and is actually chasing Italian businesses from Italy. The recognition that things need to change if there’s going to be any progress in the economy is widespread across the spectrum of political views.

Most of the political types we talked to were a little unusual from my perspective.

Some very senior positions were not held by the usual career politicians but rather by former businessmen and bankers who had recently joined the government (in some cases returning to Italy to do so) in order to help bring about change.

Something about Renzi just made them want to get involved. These guys were very successful in their former endeavors and brought a level of competency to their current projects.

Frankly, the odds of pulling off the significant constitutional changes that are necessary are quite daunting.

When we would go over the process with various ministers and bureaucrats, there was an acknowledgment that it would not be easy, but there does seem to be a sense of urgency in the air.

And I think that urgency is driven by the serious unemployment problems facing Italy. And so now it’s time to look at the economic realities.

Let’s begin with the saddest of the facts. Youth unemployment is the third highest in the European Union at 43 percent, almost double the EU average of 22 percent.

General unemployment in Italy is at 12.6 percent, and it has been rising since the beginning of the Great Recession.

There has been no recovery in Italy. If you count the underemployed and those employed part-time for non-economic reasons, unemployment in Italy rises to 25 percent

Italy is still in a recession and has been for more than 2½ years. Prior to that time, growth was anemic at best.

While the deficit is down, Italy still had to borrow €75 billion (US$103 billion) last year. The debt-to-GDP ratio is now at 133 percent. Today it takes 5.3 percent of the entire GDP of Italy just to pay the interest on its debt.

How do you get out of this debt trap? The easy answer is that you have to grow your way out. If you get 2 percent real GDP growth and can get the primary surplus well above 3 percent, you can very slowly make headway.

But is a 2 percent growth rate achievable?

For the past 54 years, Italy has averaged just 0.6 percent GDP growth a year. How do you get to a primary surplus of 4 percent You have to do a lot more cost-cutting and your tax receipts have to rise. But tax receipt growth in Italy has been negative for the past few years.

Today interest rates for Italian debt are at their lowest in a very long time, but if rates were to rise just 1 percent, let alone 2 percent orr 3 percent at 140 percent debt-to-GDP, interest costs would quickly spiral out of control.

My conclusion is, the current Italian leadership has decided to deal with their problems. They’re going to try to restructure their system to the best of their ability to create opportunities for growth.

They’re going to remove every obstacle they possibly can. They are going to be – or at least attempt to be – at the very forefront of a movement that will be necessary all across Europe to reform the bureaucracy and labor markets.

If everything goes perfectly, they will get their deficit and debt under control and begin to grow their way out of the problem.

The writer is an author, a commentator and publisher of the Thoughts from the Frontline newsletter.

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A noted financial expert, a New York Times best-selling author, an online commentator, and the publisher of investment newsletter Thoughts from the Frontline