Italy must face the truth

10.06.12 Publication:

President Giorgio Napolitano was right when he said, last November when the new Monti government was being installed, that it was a time to tell, and face, the truth. Unfortunately, few people seem to have listened. And that includes among the euro-zone’s leading governments, where there is an even bigger need to face up to the truth.

The need to face up to the euro-zone truth is the most urgent; the failure in Italy to acknowledge the truth could ultimately prove even more tragic, if it continues.

The truth about the euro-zone begins the its current situation. This is that ever since the sovereign-debt crisis began, about two years ago, the policies led by Germany and France and followed by the rest of the zone have consisted of attempts to postpone the issue, to buy time. The hope was that in the time bought, the small problem country, Greece, would stabilize its public finances, and the big problem countries, Italy and Spain, would get their debts under control too, while also reforming their labour markets and boosting competitiveness.

This policy succeeded in buying time, but that time has now run out, for the policy has become counter-productive. The southern European countries are trapped in a downward economic spiral, a death spiral: budget cuts weaken their economies, a process that deters companies from borrowing or spending money, weakening economies further.

The result in Spain and Italy is that two European countries that in 2008-10 could boast that their banking systems had been well-regulated and were sound now both have weak and fragile banking systems. Spain’s property market keeps turning more and more debts bad as the economy declines, which is why the Spanish government has had to ask for international funds to recapitalize its banks. Italy’s banks hold too many Italian government bonds the value of which markets now question, and their customers are also getting weaker.

Fiscal discipline, according the rules of the fiscal inter-governmental treaty launched last December, is the main big idea from the euro-zone to deal with these problems. Some call this “a fiscal union”. But the truth is that this is not a fiscal union at all, which would involve a common finance ministry setting a fiscal policy in Brussels that reflected the economic situations in the 17 euro-zone states. Instead, the treaty just sets a common set of fiscal rules, which are to be applied almost regardless of the economic situation in each country.

It is possible that more time will soon be bought: perhaps by Greek voters not electing an anti-austerity government, but instead one that still backs the current course; and perhaps, even this weekend, by an agreement to support Spain’s banks, which would remove one of the biggest fears about what could happen if Greeks vote in the extreme-left Syriza party and end up defaulting on their debts. At least Spain would not then collapse.

Yet the downward spiral would still continue. Why is nothing done to stop it? It is not because German or French politicians or others do not understand the situation. It is because they have so far failed to face up to the truth about the euro itself.

That truth is that in 1999 the single currency was born in a flag of solidarity but in a reality of separate national responsibility. The flag of solidarity meant that the macro-economic rules that had been laid down in the 1992 Maastricht treaty were immediately destroyed, since they should have led to Italy being forbidden to join in 1999 and Greece being forbidden in 2001. The reality of national responsibility—each has to deal with its own debts and own banking system—meant that the solidarity was fake.

The superficial truth about this is that Germans want responsibility to remain national, as do the Dutch and some others, and that the French want truer solidarity. A surprising point about euro-zone bond markets during the two years of crisis—that they have not truly been boycotted by worried investors—is explained by the fact that enough investors seem to have believed that, in the end, Germany would yield and accept solidarity.

This may be the case. But we are running out of time to find out. And meanwhile the problem may well be that the taste for solidarity in France and other euro-zone countries, including possibly Italy, is itself declining. National politics in many countries is drifting against the euro and its austerity rules. A nightmare scenario could be that the Germans finally come to accept solidarity, just when other big countries are forced in the opposite direction by their angry electorates.

In the short-term, a solution based on some form of solidarity looks unavoidable: an international rescue for Spanish banks; ideally some fiscal stimulus in northern European surplus countries; a limited form of collectively guaranteed bonds, either dedicated to infrastructure investment or to replacing the top slice of Italian, Irish, Portuguese and Spanish debts, say.

Still, it is important to listen to Chancellor Angela Merkel carefully. She says that Europe must have deeper political and economic integration. That suggests that she sees collective controls, a relinquishing of sovereignty, as a pre-condition for solidarity. If so, that could slow things down, as well as testing whether euro-zone electorates are really willing to see more autonomy disappear. That doesn’t seem to be the view of Beppe Grillo, at any rate.

For in Italy, it does not seem to this British observer that the truth has been accepted. The Monti government has been in office for half a year, which could prove to be almost two-thirds of its period in office, if political parties insist on early elections in October. Yet how much has really changed?

The Monti government’s main achievement has been its initial one: budgetary restraint. This was a big achievement, making Italy the only euro-zone country truly to meet the fiscal rules. But it has not been accompanied by any substantial market liberalization, nor yet the much-argued-over labour law reforms. Interest groups of all kinds, from trade unions to businesses to political parties themselves, have blocked change.

Perhaps that is no surprise to weary Italians. But to foreign observers this looks like a tragedy. A tragedy that Italy, already vulnerable thanks to its huge public debts, could end this year of technical government with little substantial reform, and an economy and a society no better prepared to face up to whatever storms may come in from the rest of Europe.