Is 2008 Make Or Break Year For Italy’s Economy?

As Italians head to the polls this weekend in order to pick what will be their 62nd government in 65 years (in an election which is being held three years early to boot, due to the collapse of Romano Prodi’s outgoing administration) one odd detail seems to stand out and sum up the multitude of political and economic woes which confront Italy at the present time: we still don’t have economic growth figures for the last quarter of 2007. Now this situation may well be an entirely fortuitous one – Italy’s national statistics office ISTAT are in the process of introducing a new methodology to bring their data into line with current EU standards as employed in other countries (Italy yet one more time is at the end of the line here, but let’s not get bogged down on this detail) – but there does seem to be something deeply symbolic about all this, especially since Italy may well currently be in recession, and may well be the first eurozone country to have fallen into recession since the outbreak of the global financial turmoil of August 2007.

Perhaps the other salient detail on this election weekend is the news this (Saturday) morning that “national champion” airline Alitalia is near to collapse and may have its license to fly revoked, at least this is the view of Vito Riggio, president of Italy’s civil aviation authority, as reported in Corriere della Sera.

“If something isn’t done soon, everyone must realize that Alitalia is on its last legs…. The authority will have no choice but to revoke the airline’s license “in two, maximum three weeks if it can’t show it can find cash to stay in business”

And – as if to add insult to injury – only this week the IMF revised down yet one more time their 2008 forecast for Italian GDP growth, on this occasion to a mere 0.3% , and (as we will see below) a steadily accumulating body of data now clearly suggest that Italy is already in recession, and may well have entered recession sometime during the last quarter of 2007. If confirmed this will mean that Italy will have been in-and-out of four recessions in last five years. So the real question we should be asking ourselves is not be whether Italy is in a recession, but when in fact she entered it, and even more to the point, when will she leave? Continue reading

Italy’s Economic Problems Under The Spotlight

As Manuel points out in the accompanying post, Romano Prodi’s resignation as Italy’s Prime Minister is a rather sudden and dramatic, but scarcely unexpected, development. The immediate political crisis may be resolved as rapidly as it appeared, but again as Manuel indicates it may only serve as a prelude for further things to come, and the fragility of any government coalition which may be put together only underlines the difficulties Italy will almost certainly have in addressing what are important ongoing economic problems. The present post will simply attempt to outline some of the main economic problems Italy faces, in order to contextualize the political problem a little.
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The Economics of the German VAT Hike

I am very happy to be back here at AFOE, if not only, for a brief one-stop guest post about the economics of the German VAT hike and more specifically how market commentators and analists might just be reading the German economy somewhat falsely at the moment in the sense that they are not taking into account the implications of the sustained and evolving process of ageing in the German society. Indeed as Edward noted just a few days ago here at AFOE we might actually be talking about a clash of paradigms or at least a clash between two ways of looking at and interpreting the economic data coming out of Germany and indeed of the entire Eurozone. There are consequently many venues on which this diagreement is fielded and an important one of these is the German economy and more specifically the significance of the VAT hike and below the fold I will give my view on this topic.
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Eurozone Economy: When Paradigms Collide

When scientific paradigms collide everyone should duck, at least that is the best advice I can offer at the present moment. The provisional German retail sales for January are now in, and they don’t make especially pleasant reading:

European retail sales dropped for the first time in 10 months in January as spending in Germany slumped, adding to signs economic growth is slowing, the Bloomberg purchasing managers index showed…..German retail sales had the biggest drop in two-and-a-half years, with its index declining to 43.9 from 55.2 in December

Now for those who have been following the German economy in recent months none of this should be particularly surprising, since as is reasonably well known Angela Merkel’s government has just upped VAT from 16% to 19% in an attempt to address the ongoing federal deficit problems. And of course, one months data never offer a complete picture. But this decline in retail consumption in Germany forms part of a much longer ongoing weakness in domestic consumption (and here), one which many were arguing had finally come to an end in 2006. Some of us, however, seriously doubted that this was the case, and hence the initial significance of today’s reading. In particular what we may be faced with are changing structural characteristics of economies as median population ages rise. In particular – and following the well-known life cycle pattern of saving and consumption – more elderly economies may have a higher rate of saving and a lower rate of consumption increase than their younger counterparts.

Some more evidence to back this point of view comes from Japan, where today we learn that household spending in December declined for a 12th straight month, dropping 1.9 percent from a year ago. Yet the Japanese economy is not in recession, and output is actually rising. As Bloomberg say:

Japan’s factory production rose to a record and household spending fell, underscoring the central bank’s concern that growth has bypassed consumers and left the economy dependent on exports.

So please note: growth appears to have by-passed consumers, and the economy is ever more dependent on exports. The same goes for Germany, and this is why I talk about paradigm collision, since the neo-classical theory of economic growth – with its core conception of ‘steady state’ growth – was never built to handle median age related changes in economic performance and structural characteristics. Something new is clearly needed.

Over the coming weeks I will undoubtedly have more to say about all this, as we get to see more of the 2007 Eurozone data, but for now let me point you in the direction of Claus Vistesen, who has been patiently toiling away trying to work through a hypothesis which, in terms of the data we are now seeing, certainly seems more in keeping with current economic realities than the view we currently see emanating from the ECB. His arguments on Japan can be found in depth here, and his latest piece on the eurozone is reproduced below the fold.
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Of Population Pyramids and Value Chains

It is by now well known that the main hope for developed societies subject to rapid population ageing who wish to maintain their relative standard of living lies in increasing their collective productivity more rapidly than they increase their dependency ratio via-a-vis the older age groups. Now in the comments thread on the recent ‘Reform is a Dirty Word‘ post I ventured to say that I found it obvious that at some stage we would reach a point where the rate of population ageing was going to outstrip the rate of productivity increase (in which case relative income per capita would inevitaby start to fall). David, unsurprisingly, asked me why I thought this to be the case. I was not happy with the response I offered (which was essentially some ‘rigmarole’ about the biology of ageing which is coming in a separate post), and since that time I have been scratching my head trying to find a simple way to get this point across. Perhaps I now have one.

All you need to get to grips with what follows is a basic understanding of geometry and a vague interest in football.
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Garden Of The Forking Paths?

“Global imbalances matter” seems to be the favoured warcry over at Brad Setser’s blog these days (I’m not sure anyone really disagrees with the idea that they matter, all the arguing seems to be about how much and why). Recently however Brad seems to be drawing support from a rather unexpected quarter: “one part of the Economist” (well, one part is definitely better than none), the part which believes that despite what happened in 2005, 2006 will be the year of the “great dollar decline”: And why would this be? Because, of course, global imbalances do (here read the US CA deficit), in fact, matter.

Now there is another view available on this.

However this issue is more interesting, since the part of the Economist which believes that the US CA deficit will prove decisive in 2006, also seems to believe that global ageing isn’t in fact a terribly important phenomenon (and here).

The Economist seems to take the view – as Claus Vistesen puts it – that “Rich countries’ populations are shrinking … not to worry though“?

In fact Claus seems much nearer the mark than the part of the Economist which seems to be arguing that ageing doesn’t matter too much when he says:

I agree with the zest of their arguments, namely that the new realities mean that there will be fewer people in the workforce to support more old people in the future. In a global perpspective I also believe that the world would benefit from having fewer people on the whole. However, the point that escapes The Economist in the midst of their optimism is that some countries will have a hell of a lot more difficulties adapting than others, and as such these demographic trends might have a real negative effect, at least some places in the world.

Yes, I would say that this is just the point that escapes the ‘ageing doesn’t matter so much’ part of the Economist, who seem to believe that population meltdown in Japan wouldn’t be a problem since “the last Japanese will (only) die as soon as 2800.” (Actually the article on Japan is near to scandalous, since it only focuses on the legal minimum pensionable age, and misses entirely the important point that most Japanese already continue working after 65, and even by the age of 75 25% of the population are still working).

I have already posted extensively on the population turning point in Japan (and here). So now I would simply make two points. Firstly it is the age structure of the population which matters, not its size, and secondly, it is curious how all those people who seem to want to argue that the US current account deficit is the most important determinant of today’s global economy also feel themselves impelled to downplay (if not actually try to ridicule) the idea that changing global demography (from Bolivia, to Vietnam, to Turkey, to China, to France, to Germany, to Japan) has any important role to play in helping us understand current economic phenomena. I think there is a choice here: two world-views are colliding, and the paths are forking.

Getting Older, Or Getting Younger?

Warren Sanderson & Sergei Scherbov had a very interesting article in Nature earlier this year (you can find the full article reproduced here on page 5). The article title really tells the story in itself: average remaining lifetimes can increase as human populations age. Put differently, we may be facing the interesting enigma that the longer we live, the longer we have left to live.

But, riddles aside, what Sanderson and Scherbov actually propose is a new metric: the median age of the population standardized for expected remaining years of life. Now why would that be interesting?
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On Un-Common Ground

Now just remember, you read about it first on Afoe. Bertrand Benoit and David Pilling have an excellent article in the FT today:

Question: Which of the world’s biggest economies is holding an early election this month dominated by debate over radical economic reforms?

Two clues: The economy, long in the doldrums, is showing signs of life, thanks to improving exports and a restructured private sector. An ageing population is making structural reform an urgent priority.

The answer: Not one, but two countries – Japan and Germany.

Just my point in my earlier post, and the more this connection is recognised the sooner we’ll enter the zone of framing meaningful solutions. As the FT writers suggest, there are many intriguing parallels between next Sunday’s Japanese election and the German ballot one week later.
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Something Worries Me About Peter Bofinger

Really I realise I have been remiss in another important sense. I have long assumed that in fact the decision to reduce deficits was taken due to the coming fiscal pressure from ageing. This certainly was the background to the discussion. However now I look at the details of the SPG this area is not mentioned (as far as I can see) and the other – the free rider and associated – is the principal consideration.

So those who criticize the bureaucratic and infexible nature of the ECB are in the right to this extent. Of course the underlying demographics *should* be part of the pact, but that is another story.

I find myself in a tricky situation, since I am deeply sceptical that the euro can work, and now after the French vote even more so, but since it has been set in motion, the best thing is obviously to try and make it work (even while doubting). So I am thinking about all this. Obviously I should try and write a longer post making this clearer.

The SGP was adopted at the Amsterdam Council 1997. A history of the implementation of the pact, and a summary of the debate over the new pact can be found here. The Stability and Growth Pact was designed as a framework to prevent inflationary processes at the national level. For this purpose it obliges national governments to follow the simple rule of a balanced budget or a slight surplus.

Now if we go back to the origins of the pact, to the communication of the European Commission on 3 September 2004, you will find the following:

“As regards the debt criterion, the revised Stability and Growth Pact could clarify the basis for assessing the “satisfactory pace” of debt reduction provided for in Article 104(2)(b) of the Treaty. In defining this “satisfactory pace”, account should be taken of the need to bring debt levels back down to prudent levels before demographic ageing has an impact on economic and social developments in Member States. Member States’ initial debt levels and their potential growth levels should also be considered. Annual assessments could be made relative to this reference pace of reduction, taking into account country-specific growth conditions.”

Now curiously I have found nothing in Bofingers argument which seems even to vaguely recognise this background.

A good starting point for this topic would be the conference “Economic and Budgetary Implications of Global Ageing held by the Commission in March 2003.

The European Council in Stockholm of March 2001
agreed that ?the Council should regularly review the
long-term sustainability of public finances, including the
expected strains caused by the demographic changes
ahead. This should be done both under the guidelines
(BEPGs) and in the context of the stability and
convergence programmes.?

This document on the history of EU thinking on ageing and sustainability is incredible.
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No Answers Only Questions

One person who could rightly claim to know more about global ageing and its possible consequences than anyone else in the business is the German Director of the Manheim Research Institute for the Economics of Ageing Axel B?rsch-Supan. If there’s a conference being organised, he seems to be there. Actually his comments at both these meet-ups are well worth reading in and of themselves (here, and here).

In a sense B?rsch-Supan is almost uniquely qualified to express opinions on the topic since he has both devoted a large part of his professional career to studying the question, and he lives and works in a society which is already reeling under the impact. As he says:

“Today?s Germany has essentially the demographic structure that the United States will reach in a quarter of a century. The dependency ratio (the ratio of persons aged 65 and over to those aged from 20 to 59) is at 28 percent, and it will reach 75 percent in 2075, if we dare project that far. Almost one-fifth of the German population today are aged 65 and over. One quarter are aged 60 and over, which is relevant because the average retirement age in Germany is 59.5 years. Thus, in this sense the United States is not ?entering largely uncharted territory,? …. Rather, they can look to Europe?in particular to Germany and Italy?to see what will happen in the United States.”

I mention B?rsch-Supan because he serves as a good pretext for going over where we are to date with the issue. As he says himself. watching demography change is rather like watching a glacier melt, on a day-to-day basis it’s hard to see that anything is happening, but over time the impact is important.

One of his recent papers has the intriguing title: “Global Ageing: Issues, Answers, More Questions“. It is a good up-to-date review of the ‘state of the art’, and a quick examination of the points he makes probably serves as a good starting point, since I can’t help thinking, in the case of global ageing, it isn’t so much what we know that matters, it’s what we don’t know.

So here we go, a review of what we “know”, what we think we know, and what we don’t know:
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