Italy: Theater of EuroTragedy
Ashoka Mody
Based on EuroTragedy: A Drama in Nine Acts, New York: Oxford University Press, June 2018.
The bottom line: Italy needed—and needs—the crutch of a depreciating currency to offset its abysmal productivity growth The depreciating lira, 1970-1998 US Dollar/Euro exchange rate is back where it (Number of liras for one D-mark) began, 1999-2018 1.6 1400 1.5 1200 1.4 1000 1.3 The 800 euro's 1.2 starting 600 exchange 1.1 value 400 1
200 0.9
0 0.8 197070 74 78 82 86 90 94 98 199999 02 05 08 11 14 17
Italian productivity collapsed while even Italian productivity fell relative to German German fell behind the U.S. (annual average total factor productivity (annual average total factor productivity growth) growth) 2.5 0.8 0.6 2.0 0.4 1.5 0.2
1.0 0.0 2008-08 2009-16 -0.2 0.5 -0.4
0.0 -0.6 1970-79 1980-89 1990-98 -0.8 Italy Germany Italy Germany United States
Source: Top left panel: Banca d'Italia, https://tassidicambio.bancaditalia.it/timeSeries; top right panel: ECB data warehouse https://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=120.EXR.D.USD.EUR.SP00.A&periodSortOrder=ASC; bottom left and right panels: The Conference Board, https://www.conference-board.org/data/economydatabase/index.cfm?id=27762.
Prologue: Italy should never have been in the euro area.
The plague of political corruption • Tony Judt: “Clientelistic system of patronage and favors put in place by Christian Democrats came to characterize Italian politics as a whole.” • Guido Carli: Even Italy’s “miracle growth” from 1950 to 1970 occurred in a corrupt political framework where legal norms were “violated with impunity.”
o “Shell” of the capitalist system but the “pillars of the market economy were hollowed.” • Early and mid- 1990s, mani pulite (“clean hands”) judicial inquiries exposed leading Italian politicians and weakened centralized corruption.
o Corruption spread to regional and municipal governments, continued as a plague. • Italy settled into a “normal” of low expectations.
Mirage of Europe as vincolo esterno [external constraint] • Carli in his memoirs: in Italy, European strictures and appeals counted for virtually nothing • But Carli as finance minister:
o since Italians would no longer have the option to devalue the lira, they would collectively act to modernize their economy • Maastricht negotiations: Draghi as Italy’s chief negotiator
o “In his soul, [he] believed in EMU [European monetary union] as a vincolo esterno.” Kohl’s fateful decisions • Italian promise: debt-to-GDP would decline from 120 of 60 percent by 2009. • No German finance official believed this claim:
o Horst Köhler, German negotiator at Maastricht, wrote unsolicited letter to Kohl: Italy poses “a special risk” to the euro. • In January 1998, James Blitz, Financial Times, wrote, “Pinch yourself. Italy will be a founder member of Europe’s economic and monetary union.” • Kohl pleaded Italian case; Italians would continue “structural reforms,” and overcome their handicaps “in the coming years.”
o Kohl felt the “weight of history. Not without the Italians, please.” o He made that decision, single-handedly, on behalf of all Europeans. • Also promised Bundestag: Germans would not pay bills of other members. • One more time, Kohl reminded the Bundestag that they were voting for peace.
1999-2008: “Creeping Normalcy”
Central and northern Italy become pales shadow of itself [1] Unable to withstand low-wage competition • Production of washing machines and refrigerators plummeted, as China emerged as leading producer. • Italian workers earned €24 an hour, while equally skilled Polish workers received only €7 an hour. • Sweden’s Electrolux, which had acquired the iconic Zanussi in the mid-1980s, cut back on number of employees and hours. • Annarita Licci, a thirty-eight-year- old mother of two, had started working at Electrolux’s Porcia factory in the year 2000 earned €1,400 a month.
Central and northern Italy become pales shadow of itself [II] Unable to upgrade technologically • In early 1980s, Olivetti employed fifty thousand people in Ivrea, near Turin.
o Ivrea was “a European Silicon Valley,” and Olivetti’s workers enjoyed “generous salaries and plush corporate recreational facilities.” • In the 2000s, Olivetti was reduced to “a small machinery company:”
o Its factories, jewels of Italy’s “industrial architecture,” converted into museums. o Olivetti’s workers nearly all gone, company’s tennis courts lay abandoned. • Former employee “Gradually at first and then suddenly, everything fell apart.” • Soon, Ivrea’s main employers: a state-run health service and two call centers, which together employed just 3,100 people. • Town had little work for its thirty year olds; many lived on parents’ pensions.
R&D rates: low in 1997, stayed low in 2007 (R&D as a percentage of GDP, 2007 versus 1997)
3.7
Finland 3.2 Sweden
2.7 Denmark United States Germany 2.2 Austria France Belgium 1.7 Netherlands
R&D/GDP ratio (percent) in 2007 in (percent) ratio R&D/GDP United Kingdom Spain 1.2 Ireland Portugal Italy
0.7 Greece
0.2 0.2 0.7 1.2 1.7 2.2 2.7 3.2 3.7 R&D/GDP ratio (percent) in 1997
Source: OECD Statistical Database.
Italy’s chaotic banks • More bank branches per capita than any other European country. • As one wit remarked, more bank branches than it has pizzerias. • Even during the years before the global financial crisis, banks struggled to return a profit in a slow- growing economy.
Malaise most stark in Banca Monte dei Paschi di Siena (MPS) • Main shareholder, Fondazione Monte dei Paschi di Siena: • Cash machine for the city of Siena, including funding Palio horse races.
o Siena’s residents: those who received a pension from MPS, those who worked at MPS and expected to draw a pension, and those who aspired to work at MPS so that they too would draw a generous pension. • In November 2007, making losses, MPS began to gamble • Bought Antonveneta for €9 billion, well above market value • Prime Minister Romano Prodi said the purchase be “considered positively.” • In November 2008, Berlusconi government compelled to prop MPS up. • MPS’s exotic derivative deals, “Alexandria,” “Santorini,” and “Nota Italia.” • Banca d’Italia inspectors alerted management—then under Governor Draghi—about “potentially critical” risks embedded in these transactions. The happy vincolo esterno story failed, miserably • Italy in slow economic decay. • Huge banking vulnerabilities. • Government debt-to-GDP ratio around 100 percent in 2008, not near 60 percent, as promised. • Official view on Italy…cautiously optimistic: IMF Staff Report, May 2010
o Strengths: high savings, low private debt, resilient financial sector. o However, elevated public debt, disappointing growth performance; hence Italy vulnerable to future external shocks.
Euro hit hardest—where it hurt the most: Italian pathologies and eurozone policies interact ferociously
Draghi as inflation hawk • European parliament, June 14, 2011 • Draghi: euro “a great success, a success.” • Success because the ECB kept inflation rate at “just under 2 percent.” • Time for the ECB to start planning its “exit from the still very accommodative monetary policy stance”…
o …if necessary, take “preemptive measures” to avoid fight inflation. • Message: he would vote to hike the interest rate. Market panic after July 7 interest-rate hike and farcical bank stress tests. July 7, 2011: ECB raises policy rate to 1.5 percent July 15, 2011: European bank stress-tests are released after markets close 300 100 250 75 200 EURIBOR-OIS spread
150 Target2 balances, billions of euros 50 100 25 US LIBOR-OIS spread (left) 50 0 0 -50 -25 -100
Spread, basis points basis Spread, -50 -150 -75 Italian Target2 balances (right) -200 -100 -250 -300 -125 Spainish Target2 balances (right) November 30, 2011: US Fed -350 announces enhanced dollar December 8, 2011: ECB announces -150 -400 swap lines new long-term liquidity facilities -175 -450 Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul 2011 2012
Sources: US LIBOR-OIS spread: Bloomberg, US0003M Index—USSOC Curncy; EURIBOR-OIS spread: Bloomberg, EUR003M Index—EUSWEC Curncy; Target2 balances are end-of-month position from ECB Statistical Data Warehouse. Note: One hundred basis points equals 1 percentage point. Draghi supports the rate hike, praises Italian banks • Next day, July 8: “Need to end exceptional fiscal and monetary support pro- vided in the last three years is undisputed.”
o Translation: “We do things differently in Europe—our way is better.” • July 13: “Italian banks have shown and continue to show an ability to resist and react in time of difficulty.”
Italy in existential crisis: vicious sovereign-bank “doom” loop
Italy Spain 8.0 Financial sector performance (right, 1 8 Financial sector performance 1.2 index) (right, index) 7.5 7.5 1 1.1 7.0 7
6.5 1.0 1 6.5 6.0 6 0 0.9 5.5 5.5 5.0 0 0.8 5 4.5 Government bond yield (left, Government bond yield percent) (left, percent) 4.0 0 4.5 0.7 Jul Sep 11 Dec 11 Mar 12 Jun 12 Jul Sep 11 Dec 11 Mar 12 Jun 12 2011 2011
Threat of euro break up
Draghi-Merkel alliance to save the euro Draghi’s July 2012 makes “whatever it takes” announcement Crucial assist from Merkel, who overruled her Bundesbank chief Jens Weidman
Merkel was unwilling to let the euro collapse, but did not want to burden German taxpayer. Outright Monetary Transactions (OMTs) approved in September 2012.
OMTs provided only partial help
• OMTs only partially undid the ECB’s July 2011 error. • German and other “northern” Governing Council members held ECB back from aggressive monetary stimulus through end-2014:
o Italian real interest rates remained high, between 2 and 3 percent. • Long-Term Refinancing Operations (LTROs) do not count: passive monetary policy, ease credit supply; do not put money in people’s pockets (do not create demand); o Hence, funds used by banks to buy sovereign debt, aggravating the sovereign-bank “doom loop.” Italy began slide into debt-deflation cycle.
Property price deflation in Italy Government debt rises much faster (Price Index in 2010=100) than expected (Debt-to-GDP ratio, percent) 125 135 Germany
115 April 130 2014
105 125 April 2013 95 120 April Italy 2012 85 115
September 2011 75 110 2007 09 11 13 15 2010 11 12 13 14 15 16 17
Sources: Left panel: OECD, Real House Price Index (2010 = 100). Right panel: International Monetary Fund, World Economic Outlook Database, various editions, http://www.imf.org/external/ns/cs.aspx?id=28.
Note: Dashed lines refer to projections at the time.
Matteo Renzi: The search for a savior
Renzi promises to transform Italy • Became prime minister through old-fashioned Italian political infighting. • But portrayed himself to the world as a modernizer. • Ran marathons, rode his bicycle around Florence, wore black leather jackets • Denounced the Democratic Party’s national leaders as “dinosaurs.” • On Twitter, used the hashtag #rottamare:
o A boast that he would consign to the scrap-heap Italy’s aging and corrupt. • “Tonight we are young, so let us set the world on fire,” he often exclaimed, using the words of the American pop group Fun.
International admirers Domestic critics • “Projects hope of wrenching Italy • Accused him of being “all style and out of its long decline.” no substance.” • His “radical reform agenda” was the • He focused on “communication Italy’s best hope.” rather than content.” • “A rare moment of hope for Italy— • “Makes a nice show at first and then and indeed for Europe.” wilts.” • Financial Times, so much hope is • As Florence mayor, “allotted much invested in Matteo Renzi.” Few more time for his Facebook updates days later added, he had “rekindled than he did for serious discussion on fresh hope for reform.” the city’s budget.”
In late 2014, a disappointed FT wrote, “That didn’t last long.” Flamed out in December 2016 referendum, joining the anti-European mood
The single monetary policy—as predicted by Nicholas Kaldor (1971) and Alan Walters (1986)—causes divergence
The great divergence in euro-area incomes and employment. Per capita incomes Unemployment rates (In thousands of US dollars, corrected (Percent) for purchasing power parity)
50 13 12 Italy 48 Germany 46 11 France 10 44 9 42 France 8 40 7 38 6 Italy Germany 36 5 34 4 2003 05 07 09 11 13 15 2003 05 07 09 11 13 15
Sources: Conference Board, “Total Economy Database (Adjusted Version),” http://www.conference- board.org/data/economydatabase/; IMF, World Economic Outlook Database, https://www.imf.org/external/pubs/ft/weo/2017/01/weodata/index.aspx.
Another perspective: Italy in the mirror of Japan’s lost decade. (Per capita GDP, corrected for purchasing power parity, Japan 1991=100, Italy 2008=100)
120 aa
115 Japan
110
105
100
95 Italy 90
85 1991 92 93 94 95 96 97 98 99 2000 01 02
2008 09 10 11 12 13 14 15 16 17 18aa 19
Japan (years on top x-axis) Italy (years on bottom x-axis)
Source: Conference Board, “Total Economy Database (Adjusted Version),” http://www.conference-board.org/data/economydatabase/.
The crisis hit Italy hard because, with the exception of Greece, Italy area suffers from the weakest governance and institutions.
Italy 1998 2015
Greece 1998 2015
Spain 1998 2015
France 1998 2015 Better governance Portugal 1998 and institutions 2015
Finland 1998 2015
Austria 1998 2015
Germany 1998 2015
Netherlands 1998 2015 0.0 0.5 1.0 1.5 2.0 2.5
Source: World Bank, Worldwide Governance Indicator. Note: The overall index presented is an average of measures of government effectiveness, regulatory quality, rule of law, and control of corruption. Each individual measure is normally distributed, with a mean of zero, a standard deviation of 1, and an approximate range of –2.5 to 2.5. Larger values indicate better governance.
.
ECB’s lowflation wound ECB’s delayed quantitative easing failed to raise inflation in the manner the ECB anticipated.
The ECB’s balance sheet (left-hand scale, Despite ECB forecasts of rise in inflation, trillion euros) increased rapidly, but the inflation remained at a low level annual inflation rate (right-hand scale) remained low 5.0 3.0 1.8 2014 2015 2013 forecast forecast Inflation expectations forecast 4.5 1.6 (right) 2.5 2016 forecast 4.0 1.4 2.0 2017 3.5 forecast ECB's 1.2 3.0 balance sheet 1.5 (left) 1.0 2.5 Solid line is 1.0 2.0 0.8 the actual Core inflation euro-area (right) core inflation 1.5 0.5 0.6 2011 12 13 14 15 16 17 18 2012 13 14 15 16 17 18 19
Sources: Left panel: ECB Balance Sheet, Bloomberg’s weekly “EBBSTOTA Index” at weekly frequency; inflation expectations are measured by Bloomberg’s daily FWISEU55 index (five-year, five-year inflation swaps); core inflation is the three-month moving average of Eurostat’s annual change in the monthly “HICP—All-items excluding energy, food, alcohol and tobacco” index. Right panel: ECB’s Macroeconomic Projections made in March of the year, https://www.ecb.europa.eu/pub/projections/html/index.en.html. Note: The ECB’s balance sheet and inflation expectations are plotted at weekly frequency; the core inflation rate for the week is the same as the year-on-year monthly inflation during the month in which the week falls. The eurozone problem: single monetary policy causes inflation divergence: Italy’s lowflation problem. (Annual core inflation, three-month moving average, percent)
1.60 Germany 1.40 1.20 1.00 0.80 0.60 0.40 0.20 Italy 0.00
Source: Eurostat. Note: Core inflation is the annual percentage change in the Harmonized Index of Consumer Prices excluding energy, food, alcohol and tobacco.
Hence, with current 10-year government bond yields near just below 3 percent, Italian real interest rate is over 2 percent, with negative productivity growth and potential growth rate below 1 percent. • By early 2014, Annarita Licci’s bosses told her that they would reduce her €1,000-a-month salary by €130. • Once the wage cut went through, Licci said she would not be able to afford her monthly €600 mortgage payment. • “It’s a matter of survival,” she said. • “Why doesn’t Electrolux to do more R&D and product development here and give us better jobs,” she asked. • Because Italy in a low growth trap.
Young college-educated Italians leave Italy in growing numbers.
30 16 Share of 25 to 34 year 14 25-34Share of 25 to 34 25 year-olds among 12 migrants with
20 degrees college with college degrees 10 (right)
15 8 Number of college - olds amongmigrants
- educated migrants older graduates leaving Italy 6 (left) 10 than 25 (thousands) than 4 5 2 Number of college
Number college of Number graduates returning to Italy (left) 0 0 2002 04 06 08 10 12 14 16
Source: Italian National Institute of Statistics. Italy’s low growth trap: poor opportunities, the educated leave, R&D remains weak, and opportunities remain poor. The future does not look any better: Asia surges ahead of Europe in the technology race.
(US patents granted annually to companies in different countries, numbers in thousands)
18 Republic of Korea 16
14
12 Germany 10
8 China 6
4 France
2 Italy
0 1995 97 99 01 03 05 07 09 11 13 15
Source: World Intellectual Property Statistics Database, https://www3.wipo.int/ipstats/index.htm.
Short-term growth prospects also looking shaky
Euro-area growth marches to the drum of world trade growth, which is slowing. 5
- 1946–1970 Before 1991 4 1920–1929
3 1971–1990
1890–1899 1991–1998 2
1999–2008 1930–1939 area country, percent 1
After 1991 0 -2 0 2 4 6 8 10 Per capita GDP growth rate of themedian euro 2009–2016 -1
Annual average world trade growth, percent
Sources: Real per capita GDP growth rates: Angus Maddison, “Historical Statistics of the World Economy: 1–2008 AD,” http://www.ggdc.net/maddison/oriindex.htm; Penn World Tables 8.0, http://www.rug.nl/ggdc/; International Monetary Fund, World Economic Outlook Database, http://www.imf.org/external/pubs/ft/weo/2014/02/weodata/index.aspx. World trade: League of Nations, Monthly Bulletin of Statistics; CPB Netherlands Bureau for Economic Analysis, World Trade Monitor, https://www.cpb.nl/en/data. Note: Eurozone countries in this chart include Austria, Belgium, Finland, France, Germany, Ireland, Italy, Netherlands, Portugal, and Spain. The periods 1914–1919 and 1940–1945 are missing due to a lack of wartime trade data.
Italy does even worse when world trade slows 7 1946–1970 6 Before 1991
5
4
3 1890–1899 1971–1990 2 1930–1939 1999–2008 1991–1998 1 1920–1929 Per capita GDP growth rate of Italy,percent 0 -2 0 2 4 6 8 10 -1 2009–2016 -2 After 1991
Annual average world trade growth, percent
Sources: Real per capita GDP growth rates: Angus Maddison, “Historical Statistics of the World Economy: 1–2008 AD,” http://www.ggdc.net/maddison/oriindex.htm; Penn World Tables 8.0, http://www.rug.nl/ggdc/; International Monetary Fund, World Economic Outlook Database, http://www.imf.org/external/pubs/ft/weo/2014/02/weodata/index.aspx. World trade: League of Nations, Monthly Bulletin of Statistics; CPB Netherlands Bureau for Economic Analysis, World Trade Monitor, https://www.cpb.nl/en/data. Note: The periods 1914–1919 and 1940–1945 are missing due to a lack of wartime trade data. Cumulative effect of tight money: ECB credibility even lower than BOJ’s in maintaining sustained monetary policy easing.
Depreciation relative to the dollar February 1, 2016 150 Start of quantitative easing January 4, 2013: Bank of Japan July 1, 2016 140 January 22, 2015: ECB Taper talk JPY/USD 130
120 EUR/USD 110 October 24, 2017: ECB begins tapering QE
100 June 14, 2018: ECB announces QE end date as end-2018 90 Taper talk January 1, 2017 September 15, 2017 80 -100 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 Number of days from the quantitative easing announcement
Note: Exchange rate for JPY/USD equals 100 on January 4, 2013 (date of the announcement of quantitative easing by the Bank of Japan) and exchange rate for EUR/USD equals 100 on January 22, 2015 (date of the announcement of quantitative easing by the ECB). Source: For USD and Japanese Yen, https://www.investing.com/currencies, for USD and Euro rates ECB, https://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=120.EXR.D.USD.EUR.SP00.A&periodSortOrder=ASC Italian banks still struggle to collect debts. (Non-performing loans as a percentage of all loans)
20 18 16 14 12 10 8 6 4 2 0 2006 07 08 09 10 11 12 13 14 15 16 17: Q2 Gross bad debts Gross non-performing loans excluding bad debts
Source: Banca d’Italia, “Financial Stability Report,” November 2017, https://www.bancaditalia.it/pubblicazioni/rapporto-stabilita/2017-2/index.html. The complete data series is in: “Data for charts,” Section 2. Financial system risks, Figure 2.11. Non-performing loan ratios, per cent. Note: “Nonperforming loans” are the loans on which scheduled payments are late by more than 90 days. “Bad debts” is a category of nonperforming loans whose full repayment is highly uncertain because the debtors are either legally insolvent or in an essentially similar situation.
“It is true, Italy breaks your heart.” Enrico Letta. • Italy has not invested in its future for two generations. • Today, macro conditions are grim: o High real interest rates, strong euro, slowing world economy. • As the Italian economy slows— possibly goes into a recession—non- performing loans and government’s debt burden will rise rapidly. • These macro conditions will determine budget discussions and performance. • For sure, Italy will continue to break our hearts.