Criticism of Italian Fiscal Policy: Outdated and Unfounded
By Jasper H. van Dijk
Dutch members of parliament like to criticize Italy. The country ought to implement more reforms. However, their arguments are based on persistent misunderstandings. These falsehoods stand in the way of solutions to move Italy and the eurozone forward.
In short
Italy has undertaken major reforms.
Italy does not have a debt problem but a growth problem.
Dutch politicians should focus on the growth problem in Italy and other southern member states.
1. Italy is reforming its economy
Prime Minister Rutte was critical about Italy during a debate in the Dutch parliament last August, as he often is. He accused the country of falling behind on reforms in pensions, the housing market and the labour market. The perception that Italy has been struggling to implement reforms is widespread in the Dutch parliament. For this reason, proposals for joint financing, whereby Dutch money flows to the South, often fail in parliament.
The image Rutte and the parliament have is wrong. Italy has made great strides on pensions. The retirement age has been raised: it is now higher than in the Netherlands. The labor market was thoroughly overhauled by Italy in 2015. It is now easier to hire and fire people. According to the OECD's EPL index, an indicator of the level of worker protection, Italy has a flexible labor market.
When it comes to Rutte’s latest criticism of Italy, its housing market, the problems are bigger in the Netherlands than in Italy. IMF and European Commission policy recommendations to the Netherlands are full of concerns about bubble formation and the inflexibility of the housing market. The institutions advise the Netherlands to abolish mortgage interest relief, tighten mortgage lending requirements and expand the private rental market. Advice that the Netherlands has been receiving for years. This contrasts sharply with the advice the EC and IMF have for Italy. For Italy, the Commission does not have a single housing market policy proposal. The IMF has one proposal: Italy should improve its cadaster to improve tax collection.
This does not mean that Italy has a better functioning labor market or pension system than the Netherlands. Italy lags behind in many areas. But the image of Italy is wrong: Italy is undertaking reforms. Moreover, no country has undertaken so much fiscal consolidation in the pre-euro crisis period as Italy.
2. Italy is frugal, but is suffering from poor economic growth
Italy is more frugal than other member states. The primary balance, the budget balance excluding interest expenditure, is generally higher than in the Netherlands and France. This was especially the case during the euro crisis, when Italy made massive spending cuts to keep its budget deficit from rising too much. In 2015, the OECD rated these austerity efforts as significantly stronger than those of Germany or France.
Yet Italy struggles with high debt levels. It has the second-highest debt in the European Union, currently 150% of GDP. When the euro was introduced, the debt was 109%. Debt is still rising in Italy for two reasons: a) Italy is struggling with high interest charges from the past and b) Italy has a problem with its economic growth.
The high interest charges are a legacy of the 1980s when the Italian central bank raised interest rates in an attempt to attract capital, which doubled the government debt at high interest rates. Italy now has to run a high primary surplus to pay for the high interest.
The second problem, Italy's lack of growth, makes the problems worse. Debt is expressed in terms of the size of the economy and therefore naturally decreases when an economy grows. If a country has poor economic growth, it means it has to make extra big cuts to get its debt down.
The consequence of low growth is clearly visible if we compare Italy to Belgium. Belgium had a higher national debt level than Italy when it joined the euro, but has been able to keep the debt manageable because of relatively high economic growth. If Italy had experienced the same growth as Belgium, Italy's public debt in 2007 would not have been 106% of GDP, but 90% (Baccaro and D'Antoni, 2020).
A major reason for low growth, according to Storm (2019), is the harsh austerity measures the country implemented between 2012 and 2015. It is estimated that Italian GDP declined with an additional 5% during those years as a result of these measures (Fazi, 2018). The austerity measures were probably counterproductive: debt increased rather than decreased (Fatas and Summer 2018). Other reasons for low growth are the overly "expensive" euro for the country affecting exports and the lack of productivity-enhancing investments in the past.
3. Italy needs economic growth
More economic growth will make the Italian debt go down. This also benefits the living conditions of Italians, which have to go up: unemployment is at almost 30 per cent and 1 in 10 Italians live in poverty.
More economic growth in Italy is also in the interest of the Netherlands. A sluggish Italy means a smaller sales market for the Dutch export sector. In addition, high debt and low growth in Italy significantly increases the likelihood of a euro crisis.
There is however more at stake. An ailing Italy puts the euro project itself at risk. If the average Italian sees no improvement in his or her living conditions after yet another round of austerity, while Northern member states continue to demand more spending cuts, he or she will wonder whether a future outside the euro might not be better. This aversion already seems to be emerging. After the euro crisis aversion towards the euro increased sharply. And recent election results show that eurosceptic parties are gaining in popularity.
“An ailing Italy puts the euro project itself at risk”
The eurosceptics in Italy have some ground to be critical of the euro project. Studies that try to figure out how different countries benefitted from the introduction of the euro show negative results for Italy. The CEP (2019), a German think tank, calculated that between 1997 and 2017, the average Italian missed out on 73,000 euros because of the introduction of the euro. The average Dutchman became 21,000 euros richer. The calculation, based on very rough assumptions, can be disputed. But when looking at economic growth since the start of the euro, it is also clear that Italy has benefitted little from the currency: only Greece has experienced less economic growth since the introduction of the euro.
So how can Italy grow again? First and foremost, although Italy is intensively undertaking reforms to its economy, there are still significant unresolved problems: bureaucracy is widespread and corruption is persistent. For example, nowhere in Europe does a court case take as long as in Italy.
4. The role of the Netherlands
The Netherlands and other member states have a role to play in the addressing Italy's fiscal problem. To start, they should stop constantly blaming the Italians for the financial problems they are facing. This also helps the Netherlands on the international stage; diplomatic blunders, like the one of Dutch minister of finance, Wopke Hoekstra, can be avoided. At the start of the coronavirus pandemic in 2020, Hoekstra tried to block a new European fund that intended to direct a relatively large portion of its money to Italy. According to Hoekstra, Italy, which suffered badly from the corona crisis, had to solve the funding problem on its own.
Hoekstra argued that Italy should have undertaken to reduce its debt before the pandemic. As we saw, Italy tried to do so, but the lack of growth made this an almost impossible task. Hoekstra's remarks, not surprisingly, were received poorly in Italy. But there was also much opposition towards the Dutch standpoint outside of Italy. This left the Netherlands being sidelined in the remainder of the European discussion. The fund Hoekstra did not want was eventually established at the firm insistence of France and Germany.
Furthermore, Dutch politicians need to think about solutions to Italy's growth problem itself. One approach for a solution lies within the European fiscal rules, which standardize how much debt and deficit member states are allowed to have, and which are to be reformed upcoming year. The current rules mainly call for austerity in times of economic downturn. This reduces economic growth, which can make austerity counterproductive: debts get higher instead of lower (Fatas and Summer, 2018). Another problem is that the current rules are unrealistic. If Italy sticks to the debt rule, it will have to turn over 4% of its GDP, as much as the country now spends in total on education. Needless to say, this would be unfeasible politically. .
We proposed a reform of the budget rules last month to make them more realistic, effective and simple.
Furthermore, there is a need to consider how growth investments can be stimulated. These investments lead to higher growth and can thus "pay for themselves". One solution is to leave this type of investment outside the European fiscal rules, the so-called Golden Rule.
“Let us direct our precious time towards developing solutions together”
Another solution is to finance these investments from a European fund. Countries that desperately need growth investments, such as Italy, could then make a claim to this fund. The European fund that Hoekstra blocked did this during the coronavirus pandemic and will expire soon. The current Dutch minister of Finance Sigrid Kaag praises this recovery and resilience facility. A big plus is that member states can only claim money if there are reforms in return.
Hence, there are plenty of ideas to help Italy. Let us direct our precious time towards developing these solutions together, rather than accusing Italy of flawed reforms based on false assumptions. Solutions can be inspired by our sense of European solidarity; a way to help Italy get rid of its high poverty and youth unemployment. And if that is not enough, we can always have our own interests at heart. The Netherlands, wealthy because of its export sector, also benefits from an economically strong Italy.
