Blog Post

Italian populism calls for hard choices

The economic agenda of Italian populists is likely to exacerbate rather than alleviate Italy’s longstanding problems. But the piecemeal, small-step approach followed by European and national ruling elites, while perhaps tolerable for countries under normal economic conditions, is insufficient for an Italy stuck in a low-growth-high-debt equilibrium. If defenders of the European project want to regain popularity, they will need to present a clear functioning alternative to setting the house on fire.

By: Date: May 31, 2018 Topic: Macroeconomic policy

Prompted by an unfolding political crisis and financial-market sell-offs, several international observers have only just tuned in to Italy’s current situation. Often, they have been shocked by the strength of support in an EU founder-country for parties embracing such inflammatory, populist and illiberal rhetoric.

In the best case, many have jumped to simplistic explanations, the most frequent of which argues that The League voters just seek lower taxes, while Five-Star Movement supporters – largely located in the poorer south – want easy money through a universal basic income. In the worst cases there have been arrogant explanations posited, along the lines of: “People don’t understand, they are irrational, or daft.”

Looking at the economics of Italian populism, most of the proposals appear to be superficial, unbacked by evidence or careful reasoning, and likely to augment rather than alleviate Italy’s longstanding problems – including poor competitiveness, shaky public finances, high spending on retirees and low spending on youth, and rising inequality. However, some of their premises are far from farfetched. In particular, they are rightfully calling out national and European ruling classes, who have prevaricated over long-known problems and inconsistencies, because they required hard choices.

In the Italian case, the orthodox toolkit does not hold bright hopes. The 1980s and 1990s were characterised by large-scale privatisations, which might have had a positive one-off impact but hardly set debt on a downward trajectory.

Though the list could be longer, two cases in point particularly apply to Italy. The first relates to public debt[1]. As is widely known, Italy has the fourth-highest debt-to-GDP ratio in the world, roughly 135%, and by now the government spends more annually on interest payments than on public investment[2]. Reinhart et al (2015) have shown how the debt levels we observe nowadays are unprecedented in advanced economies in non-war periods. They go on to show that the menu of solutions to reduce it can be divided between “orthodox” (fostering growth, privatisation, primary surpluses) and “unorthodox” (e.g. financial repression, inflation, restructuring, etc).

In the Italian case, the orthodox toolkit does not hold bright hopes. The 1980s and 1990s were characterised by large-scale privatisations, which might have had a positive one-off impact but hardly set debt on a downward trajectory. Running large primary surpluses is the official approach enshrined in the EU’s Fiscal Compact. However, Italy has run a primary surplus in nearly every year since the early 1990s. While some will claim that these should have been larger, Eichengreen and Panizza (2014) showed how the primary surpluses required to reduce debt significantly are rare birds in recent economic history and as such are unlikely to do the job for Italy[3].

The most favoured option is fostering growth, which usually comes as a recommendation to implement wide-reaching structural reforms. While this is a safe call[4], we know that reform waves have a heterogeneous impact and only occasionally yield the significant positive boost of the kind that Italy would need to break out of the current low-growth-high-debt equilibrium (Marrazzo and Terzi 2017; Peruzzi and Terzi 2018). In advanced economies, this has generally happened in post-military-conflict periods (Reinhart et al. 2015).

Unorthodox measures – though more frequently used in the past than we are often led to believe, even in advanced economies – are, however, generally against current EU treaties, or they cross red lines of other Member States.

Stuck between a rock and a hard place, the approach at national and European level has been to focus on the short term, employing a combination of the orthodox options, keeping fiscal accounts broadly under control, trying to reduce debt at the margin in good times, and hoping for a supportive external environment.

Unorthodox measures – though more frequently used in the past than we are often led to believe, even in advanced economies – are, however, generally against current EU treaties, or they cross red lines of other Member States.

The second case in point relates to the euro-zone architecture more broadly. By now, it is widely accepted that economic and monetary union (EMU) as it stands is incomplete and dysfunctional, leading for example to harsher drops in GDP during bust cycles (Martin and Philippon 2017). While individual solutions to this problem differ, most economists agree that without a political union the whole euro construct cannot hold together long-term[5]. Having concluded that this is politically unfeasible, the approach has been to focus on short-term patches and hope that a crisis as large as 2008 will not hit any time soon.

This piecemeal, small-step approach might be tolerable for euro-area member states under normal economic conditions. However, in a country that underwent 20 years of real GDP stagnation, and with no clear path to exiting this negative equilibrium in the near term, radical changes are more likely to be sought rather than small tweaks around the status quo.

As Harvard economist Dani Rodrik recently remarked, at least Italian populists are clear about how to solve his famous trilemma[6], which in a euro setting states that it is impossible to simultaneously have a functioning EMU, national sovereignty, and democratic politics. National and European ruling classes are yet to provide a clear answer. If defenders of the European project want to regain popularity, they can no longer hope to brush problems under the carpet and will need to present a clear functioning alternative to setting the house on fire. The current populist agenda might well lead to a poorer Italy; however, simply highlighting the sharp costs of dismantling the status quo will soon no longer suffice.

 

[1] A useful reference for this is “A New Start for the Eurozone: Dealing with Debt” by Corsetti et al (2015)

[2] See “Clouds are forming over Italy’s elections” by Terzi (2018)

[3] In their words, “The point estimates do not provide much encouragement for the view that a country like Italy will be able to run a primary budget surplus as large and persistent as officially projected”.

[4] On this point, it is worth remembering a quote of the World Bank chief economist: “Structural reform is safe advice. No one knows what it means. If economy grows: I told you. If it stalls: You didn’t do structural reform.”

[5] See “Does Europe Really Need Fiscal and Political Union?” by Rodrik (2017)

[6] https://twitter.com/rodrikdani/status/1000849241160540161

 

Bibliography

Eichengreen, B., & Panizza, U. (2014). A surplus of ambition: can Europe rely on large primary surpluses to solve its debt problem? NBER Working Paper, 20316.

Marrazzo, P. M., & Terzi, A. (2017). Structural reform waves and economic growth. ECB Working Paper Series, (2111).

Martin, P., & Philippon, T. (2017). Inspecting the mechanism: Leverage and the great recession in the eurozone. American Economic Review, 107(7), 1904–1937. doi:10.1257/aer.20150630

Peruzzi, M., & Terzi, A. (2018). Growth acceleration strategies. Harvard CID Working Paper SeriesCID Working Paper, (91).

Reinhart, C. M., Reinhart, V., & Rogoff, K. (2015). Dealing with debt. Journal of International Economics, 96(S1), S43–S55. doi:10.1016/j.jinteco.2014.11.001


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Past Event

Past Event

What is in store for Euro area economies?

ECB Executive Board Member Philip Lane discusses the outlook for Euro area economies.

Speakers: Maria Demertzis and Philip Lane Topic: European governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 5, 2022
Read article Download PDF More on this topic
 

Policy Contribution

Inclusive growth

Better pensions for the European Union’s self-employed

What is the current state of pensions policy in Europe and how are independent workers treated compared with their traditionally employed counterparts?

By: Rebecca Christie, Monika Grzegorczyk and Diane Mulcahy Topic: Inclusive growth Date: March 24, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article Download PDF More on this topic More by this author
 

External Publication

Book notes: Monetary policy in times of crisis

Review of 'Monetary policy in times of crisis: a tale of two decades of the European Central Bank' published in the Central Banking.

By: Francesco Papadia Topic: Macroeconomic policy Date: February 17, 2022
Read article More on this topic
 

External Publication

The Euro in 2022

An annual review of the euro published jointly by Fundación ICO and Fundación de Estudios Financieros to expand knowledge, raise awareness of the single currency, and suggest ideas and proposals for strengthening its acceptance and sustainability.

By: Grégory Claeys, Maria Demertzis and Fernando Fernández Topic: Macroeconomic policy Date: February 17, 2022
Read about event More on this topic
 

Past Event

Past Event

A debate on fiscal rules and the new monetary strategy

Presentation of the Yearbook of the Euro 2022.

Speakers: Maria Demertzis, Fernando Fernández, Gonzalo García Andrés, José Carlos García de Quevedo, Pablo Hernández de Cos and Jorge Yzaguirre Topic: European governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 17, 2022
Read article More on this topic
 

Blog Post

Who is suffering most from rising inflation?

The lowest income households are suffering disproportionally from the current inflation increase, with rising energy prices the main culprit.

By: Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: Macroeconomic policy Date: February 1, 2022
Read about event
 

Past Event

Past Event

Nonperforming Loans in Asia and Europe—Causes, Impacts, and Resolution Strategies

What can we learn from the experiences of Asia and Europe with regard to NPLs during the financial crisis to help us weather the current and future ones?

Speakers: Rebecca Christie, Luis de Guindos, Alexander Lehmann, Cyn-Young Park, John Fell and Santiago Fernández de Lis Topic: Banking and capital markets, Global economy and trade Date: January 20, 2022
Read article More by this author
 

Opinion

European governance

The euro comes of age

A well-functioning euro reflects a degree of unity that allows the EU to credibly claim a position at the global table and therefore help shape the policies that will deal with global problems. That is a decisive success.

By: Maria Demertzis Topic: European governance, Macroeconomic policy Date: January 13, 2022
Read article More by this author
 

Podcast

Podcast

The European economy in 2022

What are the economic priorities for the new year?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: January 5, 2022
Read article More by this author
 

Opinion

European governance

The Euro at 20

The euro’s advocates hoped that the single currency would deliver economic and financial integration, policy convergence, political amalgamation, and global influence. While these predictions were often wide of the mark, the euro has arguably proven to be a wise investment.

By: Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: January 3, 2022
Read article
 

Blog Post

European governance

Policy coordination failures in the euro area: not just an outcome, but by design

Discussions on the fiscal framework should aim to correct its procyclical nature with a view to promoting more cooperative outcomes.

By: Maria Demertzis and Nicola Viegi Topic: European governance, Macroeconomic policy Date: December 20, 2021
Load more posts