Austerity did not help Italy

Austerity did not help Italy

A ridiculously ferocious attack on Italy's mildly pro-growth fiscal policies in next year's budget are firing up market panic and an unedifying spectacle of chronically mismanaged intra-European relations. As EuObserver writes in an article "Austerity did not help Italy - maybe spending will?", deprived of an independent monetary policy and flexible exchange rate to manage demand and employment, Italy has slightly reversed its restrictive fiscal stance to provide some support to economic activity and prevent what clearly looks like a cyclical downturn in 2019 and 2020.

The country's economic growth is sluggish. Italian GDP is expected to grow 1.1 percent in 2018 and 1.2 percent in 2020 - almost twice as slow as the eurozone and five times slower than Poland. Apart from exports, all major demand components look weak. Household consumption - nearly two-thirds of GDP - is held back by high unemployment and no real income gains owing to stagnant real wages and the third-largest (after Greece and Spain) unemployment rate in the euro area.

10.7 percent of Italy's labour force is out of work and almost every third of youth. On top of that, there are 6.5 million Italians, more than a tenth of the population, living below the poverty line. Italy's government is in a standoff with the European Commission. Rather than reducing the public deficit, as the previous government had promised, the new government plans to increase it significantly, mostly to allow higher social spending.

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Because Italy's debt is high—over 130 percent of GDP—and its structural (cyclically adjusted) fiscal balance still in deficit, the proposed budget violates EU fiscal rules. But Italy is not the only one having a public debt over 60 percent of GDP, so does Belgium, Germany, Ireland, France, Cyprus, Austria, Portugal, Slovenia and Finland among others.

The previous government was ousted out of office and so was their miracle plan of austerity, which did not work. Following two years of fiscal loosening, leading to a rise in the structural deficit of 1.3 percent GDP in 2018, the government programme envisaged a modest fiscal tightening in 2018, followed by further tightening on the order of 0.6 percent in 2019 and 0.5 percent in 2020.

This tightening would have reduced Italy's fiscal deficit to around zero by 2021 for the first time since 1926. Is such a fiscal goal worth the potential cost? The electorate did not think so and so might the economy. The current government is proposing a mix of lower taxes for self-employed and a basic income of €780 to all adults residing in Italy for the last five years as a "top up" for pensioners or the working poor and as a conditional benefit for the unemployed. They also want to free up the labour market and increase chances for early retirement and increase infrastructure spending.

Italy has experienced two lost decades in the eurozone, and, according to the EU commission, the proper way of dealing with its problems is more austerity. Even with the increased spending Italy is comfortably within the euro area budget rule. Its projected budget deficit of 2.4 percent of GDP for the next fiscal year is below the three-percent-deficit limit in the monetary union.

Why all the fuss?

So, why all the fuss? Why is it that nobody seems to be objecting to the fact that France and Spain will have larger deficits than Italy? You might not like their political views but let the Italian government implement some pro-growth reforms because austerity did not work in jumpstarting their economy. Now they are trying a different route to support their economic activity, boost consumption and employment. Both the EU and global markets need a new narrative, because demanding from Italy to continue the wrong lessons of the past will only produce lesser growth and more debt.

In the European debate, some voices supporting the Italian stance were heard, including from Polish prime minister Mateusz Morawiecki. It might be sensible for Italy to focus on fixing its tax system to improve the health of public finances and generate additional revenue for pro-business and pro-social reforms as it did Poland in the last three years. Polish economic results have been praised by many European and global rankings. Maybe this road is a way forward for Italy is to bridge the expectorations of its society with decreasing the loopholes in taxes as Poland did in the last few years. This a better recommendation than simple austerity.

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