Italy: the ticking time-bomb at the heart of Europe

So that's the economy sorted, then. 

Jobs, growth, investment, exports – all on the up! Of course, the usual caveats apply, all that stuff about long-term challenges, underlying weaknesses and so on. Still, the next two years are looking good – and for shallow political types, that’s all that really matters.

There is one cloud on the horizon, though – the remnant of a storm that most people think has blown itself out. Simon Johnson, writing for Bloomberg is not so sure:

• “It has become fashionable not to worry about Europe and the euro area...
• “Optimists argue that Europe is on the mend. The central bank is maintaining stimulus, Germany’s export potential remains large, and France will continue to be a haven for investors. Struggling countries such as Greece and Portugal represent less than a 10th of the euro area’s economic output and population.”

What could possibly go wrong? The answer to that is Italy:

• “...the third-largest economy in the euro area, with a population of more than 60 million and gross domestic product of more than $2 trillion. The government’s debt burden, at about 1.3 times GDP, is among the largest in the world.” 

Does all that debt really matter? As Johnson reminds us, other “countries have grown their way out of even larger debt burdens.”

Unfortunately, the Italians have a long-standing problem with growth as well as debt:

• “During the 1990s, the country’s economy expanded at an average annual inflation-adjusted rate of just 1.2 percent, compared with the euro area’s 1.8 percent. From there, it only got worse: Italy’s average growth rate since 2000 has been 0.4 percent, compared with 1.3 percent for the euro area.”

This looks like a fundamental weakness, one that started well before the financial crisis and which will continue long after it:

• “The main obstacle to growth in Italy is the government itself. As Daniel Gros, a leading European economist, put it in 2011: ‘The only factors that have deteriorated absolutely and relative to the core of the Eurozone are indicators of governance – such as corruption and rule of law.’ On some measures of governance, Italy does worse than even Greece.”

A lot of this is down to regional variations within Italy:

• “A recent report from the World Bank, for example, found that a municipal building permit takes six months to obtain in Palermo, compared with just one month in Milan.”

The implication is that deep-down cultural change is required, of the sort that could take a generation or more – which means no quick fix for Italian debt:

• “Even if interest rates stay low for a long time, just keeping the debt burden stable as a percentage of GDP will require impressive spending restraint. At any point, the market could lose faith in Italy’s ability to handle its financial challenges.”

And if interest rates don’t stay low for a long time? Right now, the Eurozone is in a strange situation where low interest rates suit all member states. But there are signs that the healthier economies will be back on their feet soon – at which point they’ll be needing higher interest rates.

Thus it could be recovery, not recession, that tears the Eurozone apart.