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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French protests : it’s the politics, stupid!

There are some offers you can’t refuse. An invitation to join the permanent roster of Afoe is one of them. Let me first say, then, that I was initially happy and thrilled and grateful to be part of this wonderful blog. All the more so since it means that I’ll be ineligible for the Afoe Awards next year, and thus spared the humiliation of a third crushing defeat in a row. (For those of you who are scratching their head and wondering “who the hell is this guy?”, check this post)

If is say “initially”, it’s because, as the French guy of the team, I now have the daunting task of trying to explain clearly our current social row over the Contrat première embauche (First job contract) to a mainly non-native readership. As it happens, the BBC has already done a quite decent Q&A on the topic. So go read it to get the basics. And then come back here if you want my long and -I hope- not too muddled thoughts on what it all means.
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The Booming Czech Republic

The Czech Republic is booming apparently. Both per-capita GDP and fertility are definitely on an upswing, although surprisingly perhaps, for once I am not going to try and suggest that these are connected:

The Czech republic has joined Slovenia among new member states with higher levels of wealth per capita than old member Portugal, according to European Commission statistics.

This raises interesting questions which I just touch on in this AFEM post here. (Incidentally, you can find a one-page set of economic statistics for the Czech Republic from the OECD here).

What is perhaps most interesting about the Prague Post article is the way they explicitly link the increase in preganancy to a recent reform in maternity provision (due to come into effect in April), and to the fact that the ‘postponement phenomenon‘ often leads to a spike in births as women who have postponed reach the new ‘childbearing age’.

“The Labor and Social Affairs Ministry recently launched its own reforms aimed at encouraging couples to have children. The reforms provide generous benefit packages and require companies to hold the jobs of employees on leave for up to four years, and, as of April, women will begin receiving a state subsidy of 17,500 Kč ($725) for each newborn child — more than double the current amount.”
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Germany To Exceed Deficit Limit Till 2010

The IMF has just published Chapter One of the autumn 2005 edition of the World Economic Outlook. The key section on the eurozone economies can be found between pages 25 and 29 (including the interesting Box 1.3). The Table where you can find the information on German debt projections is on page 15, and there you will see that the government deficit is projected to remain over 3% at least until 2010. In addition the level of indebtedness is projected to rise from just under 60% of GDP in 2002 to nearly 75% in 2010. (Italy incidentally is seen as quietly suffering from melt-up at 115% of GDP come 2010).

The reasons for this trend:

Unsustainable medium-term fiscal positions remain a key risk. Among the major industrial countries, fiscal deficits are expected to decline only modestly over the medium term (outside Canada, which remains in surplus), with rising
public debt ratios in Japan, Italy, and Germany of particular concern. In most countries, despite past reforms, fiscal pressures from aging populations remain a serious concern, especially for health care.

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CDU: Screwing up on purpose?

Ok, now that Edward has already mentioned it, I might as well explain in a little more detail what I meant by saying that “on some level, the CDU might be afraid to win.”

Last Saturday evening, strolling through Stockholm’s Gamla Stan, Edward asked me about my gut feeling concerning the outcome of the German election next week. I told him that, while it was rather entertaining, this campaign has also been confusing – and confused – in many ways, particularly when looking at the CDU. And I believe the confused and confusing campaign the CDU is conducting is even more an expression of the way the German establishment is puzzled about the way ahead than the fact that Schröder “called” the elections a year too early, too early for any of his reforms to have any perceptible impact on the economy, not even in the West.
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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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The Euro and Structural Reform

New Economist has a useful post one the euro and the reform process. He picks up on the point that as much as interest rate cuts, what the eurozone needs are the Lisbon Reforms. He also points to the fact that having cheap money in the southern part of Europe may be impeding and not facilitating reform. What can I say, I agree:

Nonetheless, I hope the ECB eventually do cut rates. Even if the stimulus to growth proves to be modest, it can’t hurt (likewise a weaker Euro). But of course what’s really needed in Europe is structural reform of product and labour markets, greater competition and the extension of the single market to services.

This makes the findings of new research by OECD economists Romain Duval and Jorgen Elmeskov, delievered at a recent ECB conference, all the more disturbing. Their paper, The effects of EMU on structural reforms in labour and product markets (PDF), points to:

…the apparent slowdown in the reform process after the formal advent of the euro and by the limited ability of EMU countries ? with the exception of few small ones and of reforms to retirement schemes ? to carry out needed reforms in areas where political resistance is normally strong.

This is consistent with their finding that:

…the absence of monetary policy autonomy seems to be associated with lower structural reform activity in large, more closed economies.

…Obviously these simple findings should not be exaggerated. However, if additional testing suggests that they are robust it would point to a potentially problematic aspect of EMU. In particular, an effect of EMU in the direction of weakening the incentives for structural reform in the larger member countries would be a cause for concern.

Ankara Steps Up To The Plate

This is a very intelligent move:

Between the rock of the French and Dutch referenda and the hard place of the looming early elections in Germany, Turkey has reiterated its determination to seek full EU membership. Ankara has also named its chief EU negotiator.

Turkey’s 38-year-old chief EU negotiator Ali Babacan is a founding member of the ruling Justice and Development Party (AKP) who believes that there is no slowdown in Ankara’s reforms, notwithstanding that “political reforms, unlike economic reforms, do need some adjustment time to change the mental framework of the people”. In an interview with Reuters a few days prior to his appointment on 24 May, Babacan said that Turkey had no reason to fear from the referendum in France provided that Ankara stayed calm, pursued its own reform agenda and met all EU conditions for opening accession negotiations on 3 October 2005. He has said that he had “no solid reason” to believe that the scheduled 3 October launch of accession talks would be in jeopardy.

Handling matters this way throws all the pressure back on the EU. “We are ready to negotiate, now lets get on with it”.