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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Spam filtration

Regular commenters may have noticed that a disturbingly large percentage of their comments have been held as spam. This issue should now be resolved. For the information of other Akismet/MT users, the problem was that our spam filter assigned a score of +1 if one’s URL had been previously published, and likewise if one’s required e-mail address had been. With the introduction of Akismet, which we can heartily recommend, a problem developed.

Specifically, the spam filter averages the score across all tests, so a genuine comment might have the +6 from Akismet and +1 from each of the other tests. Hence, an average of +2.67 – unfortunately, the threshold value is +3. This would not have been so much of a problem, had it not been that the filter disregards negative tests before averaging. Therefore, commenters with no track record who passed Akismet would get the full +6 points as their final score, but regulars, although getting a total of +8, would be averaged to +2.67

I have now increased the score for previous publishing, and we haven’t yet had a false positive.

Serbia: That Incredible Shrinking Country

This weekend’s election results in Serbia, and in particular the gridlock state of the political process and the resilience of the vote for the nationalist Serbian Radical Party (as ably explained by Doug in the previous post), pose new, and arguably reasonably urgent questions for all those who are concerned about the future of those European countries who currently find themselves locked outside the frontiers of the European Union. What follows below the fold is a cross-post of an entry I put up earlier this afternoon on the new global economy blog: Global Economy Matters. I don’t normally like cross-posting, since I would prefer to put up original Afoe content, but my time is a bit pressed at the moment, and I feel the issues raised are important enough to merit a separate airing on this site.
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La Febbre

A couple of weeks back I had the pleasure of seeing Alessandro D’Alatri’s recent film La Febbre (Fever). As the reviewer says (Italian link), this is a ‘normal’ (everyday) film, not a great one, even if it does include one or two memorable moments, like the scenes shot along the river bank, which were (and I imagine this is not entirely unintentional) rather reminiscent of some which are to be found in the unforgettable L’Albero Degli Zoccoli from that giant of Italian cinema Ermanno Olmi.

La Febbre è il classico film italiano, che vuol raccontare una storia normale, di tutti i giorni, e che per farlo non trascende dai canoni della buona creanza del plot, e da quel pizzico di amara critica sociale che lo rende molto politically correct.”

(La Febbre (the fever) is a typical Italian film, the kind of film which tries to tell a simple, ‘normal’ story – an everyday one – and which in order to do this stays well within the bounds of what is normally thought to be an acceptable plot structure, and then, following the recipe, there is added just enough social criticism to make the film a highly politically correct one.)

My point of interest in this post, however, is not really the film itself, but rather the film as a reflection of something else: the disenchantment and frustration that many young Italians seem to feel with contemporary Italian society, and the impact that the evident failure of Italian civil society to adjust to Italy’s contemporary social and demographic reality may have on the future evolution of Italian economy and society.
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Hungary: Well That Didn’t Take Long!

It was only just over two weeks ago (two weeks, which following the logic of a historical time which seems far from uniform, now seem like half a lifetime) that guest poster P. O’Neill, said this:

For understandable reasons — the addition of 10, and soon to be 12, new member countries, and the constitutional crisis, the European Union has been preoccupied with foundational questions in recent years. But an older concern is working its way back onto the agenda: how to handle an economic crisis in a member country……However, the risk of the latter type of crisis in a member country is now quite high.

The warning lights are flashing again – this time in eastern Europe, and especially in the recent or imminent member countries of Hungary, Romania, and Bulgaria. Poland is also a source of concern. Some combination of profligate governments, political uncertainty, EU spending booms, and capital inflows have created precarious economic positions for these countries.

Well, well, well, scarcely three weeks later, and here it is, all on the table. Sometimes, in the field of interest of what is sometimes erroneously termed the dismal science, things do indeed move quickly.
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Italy’s Supply Constraint

The OECD estimates the current potential capacity growth rate of the Italian economy at 1.25% a year. Actually I suspect even this very low number is over-optimistic. Growth since 2002 has been as follows: 2003 – 0.1%: 2004 – 0.9%: 2005 – 0.1%. To be sure forecast growth for this year is somewhat higher, at 1.4%, and optimists are expecting this to be more or less repeated next year. But I suspect this outcome is unlikely simply because the global economy now seems to be slowing (and in particular the ever important US economy),so the strongly advantageous situation of 2006 is unlikely to be repeated, while next year the Italian government has promised to introduce an important package of spending reductions which are bound to negatively affect growth, at least in the short term..

But why is potential growth capacity in Italy so low?
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Greg Mankiw Wakes Up: Demography Does Matter

I recently berated Greg Mankiw (and the top ten world economists he pretends top cite) for the folly of suggesting that fertility rates don’t matter to economists. Well today Mankiw seems to be having (an implicit) rethink. Dependency ratios, it seems, do matter.

Now since dependency ratios are really a function of three factors – fertility, life expectancy and net migration – it is hard to deny the obvious: that fertility is important.

Mankiw also cites approvingly the opinion of US economist Jeremy Siegel to the effect that the “way to finance the baby boomers’ retirement is persistent capital inflows and trade deficits with developing countries”. Now Siegel doesn’t quite have this right here. The way to finance a high old-age dependency ratio, is through a high level of saving, and running persistent capital *outflows* and trade *surpluses*. This, of course, is precisely what Germany and Japan are now doing, (and also, incidentally, steering the currency down to reduce deflationary pressure, which is again what has been happening in Japan) and this is one of the reasons I give so much importance to this phenomenon. It is also one of the reasons why I discount the likelihood of domestic-demand-driven growth in these countries.

So all I can say is, well, well, well, welcome onboard Greg. As is well known both time consistency and cognitive dissonance are phenomena which constitute important problems for economic theory, but normally not in the sense that we can see them at work here.

A topic whose time has finally come? We will see. To quote the evolutionary biologist Linda Partridge (in another context) “there is much to do”. Would that economists were as aware of this as theoretical biologists seem to be.

Update: the problem is more perplexing than I initially imagined, since I now discover that on July 20th Greg approvingly cites a paper by Nir Jaimovich and Henry Siu. The title of the paper is The Young, the Old, and the Restless: Demographics and Business Cycle Volatility , and the extract he cites is this one:

changes in the age composition of the labor force account for a significant fraction of the variation in business cycle volatility observed in the US and other G7 economies“.

Greg says that this was the most intriguing hypothesis he had heard all day (he was at the NBER Summer Institute), which is fair enough, and I don’t expect him to agree with the hypothesis simply because he finds it intriguing, but I *am* stumped to understand how he can then go on on August 26 to describe the idea that low fertility posed a serious economic problem as one of the most wrong headed ideas he had heard recently, since, obviously, it is fertility levels which in part determine age structures which in part influence volatility in business cycles (according to the intriguing hypothesis). So come on Greg, which is it, wrong-headed or intriguing?

Seriously though, my point here is not to have a go at Greg Mankiw (although I have rather done that haven’t I?). My point is to draw attention to all the confusion which is knocking about on this topic. Material not unrelated to all of this is to be found in a recent article in the FT by John Kay. Kay asks hijmself why it is that Eureka moments seldom happen to economists. Basically he suggests that the reason is down to the difference between the natural and the social sciences. I don’t buy that, and I think that we social scientists sell ourselves too cheap if we succumb to it. But by the by Kay touches on another point, and it is one which brings us back to the struggle Greg Mankiw is having with the recalcitrant phenomena, since:

“It will rarely, if ever, be the case in economics that an old account of the world will be shown to be simply wrong, like the medieval account of planetary motion, or the phlogiston theory of heat.”

Well sorry John, but we have just found one that is: the neo classical account of steady state growth, there is no real factual basis for this theory, and theoretically it isn’t hard to see that it must be flawed, if, that is, the ‘intriguing hypothesis’ which Greg was scratching his head about is a valid one, and thus, since age structures constantly change, so must rates of economic growth. In which case both steady state growth and convergence theory go quietly west, off into the sunset. The intriguing question is then of course what exactly it is which modulates the changes in age structure. This is, of course, just the kind of problem that Archimedes was toiling away with in the relatively unturbulent waters of his bathtub. Aha, now I know why it is economists seldom have Eureka moments: they all take showers.

Now just let me step outside a moment, what is going on out there, is that the sun going round the earth, or could it just be that somehow or another the earth – unbeknownst to me – is actually turning round the sun.

Italy and the Eurozone

John Kay had an article in the Financial Times earlier in the week, and this seems to have caused quite a ripple around the blogsphere (Eurozone Watch, Economonitor, Claus Vistesen at Alpha Sources). The article was about whether or not it was technically possible for Italy to leave the Eurozone. (Update: Sebastian has a fresh post over at Eurozone Watch Blog continuing the discussion).

John Kay’s conclusion, and it is supported by a very reasoned commentary by Sebastien Dullien at Eurozone Watch Blog (welcome Sebastain and Daniela), is that there is no in-principle technical difficulty in exit. The most authoritative piece of work on this topic that I know of comes from Harvard International financial law specialist Hal Scott. The paper was written back in 1998, and was provocatively entitled “When the Euro Falls Apart“. Despite the title the paper is a tightly reasoned piece of work whose main conclusion is that not only is euro-exit technically perfectly feasibe, in fact the mechanisms which would make this possible were incorporated from the start (in particular keeping independent central banks with their own reserves). I think those who were able to think clearly back then – and were able to use some emotional intelligence – were always aware that there were question marks over Italy’s ability to go the distance.

So the problem is not a technical one. But as John Kay indicates it *is* a political one:
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Taxi! For Nöel Forgeard

Well, it looks like one of the questions from this post may have been answered indirectly. It now matters little whether or not the Clearstream affair is ever cleared up, as some of the people most responsible for it have anyway been disgraced. Since the last post, the only real news on the Clearstream story is that the allegations by General Rondot (that the government wanted him to investigate Nicolas Sarkozy for partisan reasons) were confirmed, by the top EADS executive Jean-Louis Gergorin, although he continues to deny being the corbeau.

However, the Clearstream story has largely been overtaken by events. One explanation for it was that it began as part of a scheme by a faction at the huge Franco-German aircraft and armaments company in order to prevent the head of Thales (another French defence contractor, specialising in electronics and shipbuilding) from becoming the boss. Their alternative candidate was almost certainly the choice of the French government, being a personal friend and political compadre of Jacques Chirac, one Nöel Forgeard. This chap had a good claim to the job anyway, having run the EADS division that builds the Airbus civilian airliners and culminated his time there by overtaking Boeing in sales for the first time and seeing the A-380, the world’s largest passenger aircraft, to its first flight. He also promised to maintain French primacy of influence, which is important as EADS’s structure gives it two co-chiefs, in practice one French and one German.

Forgeard today resigned in disgrace as chief executive. Like Clearstream, it was an overdetermined event. For a start, there was the lingering scandal-Gergorin being an old pal of his. But there was also trouble at the mill. The A380′s delivery timetable has slipped after problems were discovered with the electrical systems of several airframes, beginning with serial no. 013, and requiring a temporary halt to work at station 40 on the assembly line. This has caused trouble with some of the buyers, who have threatened to invoke penalty clauses.

But that wasn’t the real problem. It flies, after all, and has passed its safety certification (something which escapes those journalists who have been claiming Boeing’s Dreamliner project has overtaken it – the 787 has, I think, yet to fly let alone be type-approved). The real problem was that Forgeard exercised his stock options immediately before the public heard about the cock-up on station 40. He denied vigorously that he knew of the problem, without credibility – the director of production for the A380, Jean-Claude Schoepf, had informed union representatives of the problem as early as the 24th of February. This perceived dishonesty, stacked atop the Clearstream muck, left him shaky, and Jacques Chirac’s response didn’t help. Chirac (and presumably the government) wanted to replace him with the current head of the French railways as a new single chief.

Enter Angela Merkel. The German government wanted, rather than more centralisation, to see more EADS stock in free float. Putting the SNCF in charge, possibly sensible given their reputation, was not going to grip them. But – without a major change in EADS’s charter – sacking Forgeard would require the German co-chief to step down too. It now seems that the Germans are willing to accept the railroad tycoon, Louis Gallois, instead of Forgeard, even at the price of dropping Gustav Humbert – the new head of the Airbus division – in favour of an exec from Saint-Gobain. This means, of course, that there is a need for new German appointments.

The Germans have therefore thrown out the bums, got rid of responsibility for the trouble at Airbus, replaced the French co-CEO with someone apparently competent, and kept their own rights of appointment. Advice: don’t get into an argument with Angie Merkel. It’s like the EU budget all over again, when she essentially pushed Tony Blair out of the presidency chair to close the deal.

Meanwhile, a French government commission on official secrecy is said (by the Canard Enchainé) to have advised the Ministry of National Defence to open the files seized from Rondot on the rest of Clearstream, including the infamous investigation by Gilbert Flam into Chirac’s alleged bank accounts in Japan. It doesn’t end for the General, either. He’s being sued by Carlos “The Jackal” from his prison cell, over his arrest in the Sudan back in 1994. Rondot traced him to a clinic there where he was undergoing medical treatment, had him arrested and flown to Paris in a sack, where he went on trial for various terrorist acts. Now, after Rondot spoke about the – well – very extraordinary rendition in an interview with Le Figaro on his retirement, he’s suing. Cheeky old bugger.

Oh We Are The Champions

Yes we are really, aren’t we. Especially if we are called Arcelor, or Danone, or Endesa, or Eni, or Enel, or Banca Antonveneta or Pekao. And what these champions have in common, and it is this which sets them so much apart from their footballing equivalents, is not the ability to win anything, but rather their capacity to lose, especially in a take-over battle from a foreign pretender. And just for this very reason it is, it seems, ok for you to include the referee in your line-up. Indeed such is the sporting prowess of these ‘champions’ that it is deemed that what they are most in need of is not the cold harsh wind of competition, but rather protection, and indeed protectionism, anything rather than face outright competition from would-be global rivals. A rare breed of champions these.

I think before I go further, I would like to draw attention to one idea which holds us all together here at Afoe:

Purity of race does not exist. Europe is a continent of energetic mongrels. – H.A.L. Fisher
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