Italy must reform: It can’t wallow in the mire forever
ITALY is the lumbering hippo of the Eurozone, more notable for its size rather than its speed. Compared to what was going on elsewhere in the run-up to 2008, Italy was not drinking from the cheap credit oasis in the same way as its neighbours. It wasn’t running as fast, with growth averaging 1.5 per cent between 1999 and 2007. Spain was running 2.5 times faster than Italy and Ireland four times faster during the same period. But Italy was bloated, always carrying a triple-digit ratio of government debt to GDP, with modest dieting allowing a fall from 113 per cent to 103 per cent over the same period.
Although everyone knows the risks of obesity, there’s no knowing just quite when, or how, problems may manifest themselves. Italy may have shed some pounds during the good times, but problems were building. As with other peripheral nations, competitiveness was eroded, labour costs rose far faster than in Germany and the current account surplus of the start of European monetary union was slowly replaced by a modest deficit.
It’s been known for years that Italy is facing a population time-bomb greater than most other nations. By 2030, the OECD reckons Italy will have a dependency ratio of one working aged person for each one over the age of 65. Even more frightening is that there is no other major country which is set to see this ratio rise faster. We may struggle to forecast one day to the next in the Eurozone crisis, but when it comes to forecasting the big trends in procreation and deaths, economists tend to have a better track record. The problem isn’t going to go away, whatever government is in power.
Wasn’t the current government meant to be different, though? Soon after Mario Monti’s appointment as Prime Minister in November, yields on Italian bonds plummeted by over 2 per cent to below 5 per cent, helped by the ECB’s injection of funds into the Eurozone’s banking system. Furthermore, yields moved below those of Spain. The going is now proving a lot tougher though, for two main reasons.
Firstly, and not surprisingly, Monti is meeting stiff opposition to his central pillar of labour market reform and is already being forced to compromise on key points. While Ireland has seen labour costs fall 13 per cent from their peak in 2009, they’ve risen 4 per cent in Italy. It’s a long road.
Secondly, as other peripheral nations are drawn ever-closer to the vortex of a possible Eurozone exit, investors become less and less discerning when it comes to investing in anything other than liquid, highly-rated government debt. Just look at US and German yields.
If the hippo is to survive, it needs to lumber – preferably trot – down the road of reform. If nothing is done, by 2030 less than one-third of over 16s will be working, presuming a constant 57 per cent employment rate in the working age population and that the OECD’s aging assumptions turn out to be true.
However, the hippo’s legs will buckle well before then and possibly this year if Greece leaves the euro.
Simon Smith is research director at FxPro.