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What ails Italy?
If one reads into the minutiae of last night’s Standard & Poor’s downgrade of Italian debt, it wouldn’t be hard to come away thinking that there was not a whole lot wrong with the eurozone’s third largest economy. It’s a “high-income sovereign with a diversified economy and few external imbalances”, S&P notes.
In addition, private sector debt – which crippled Ireland and Spain, when those debts moved onto government books via bank bail-outs – is low. Left unsaid by S&P (but highlighted by Moody’s when it announced its own review in June) is the fact Italy also has a primary budget surplus, which means it actually brings in more money than it spends, if you don’t count interest payments on debt.
According to S&P, then, what ails Italy is as much political as it is economic.
To be sure, Italy has a stiflingly high debt level – at nearly120 per cent of gross domestic product, it’s behind only Greece in the eurozone. But Japan’s debt levels are much higher, and it has little problem borrowing money at low rates on the financial markets.
In addition, Italy has slow to flat economic growth, which could get even worse if Europe and the US fall back into recession. But as S&P notes, dynamism could easily return to the Italian economy if the government were to liberalise one of Europe’s most complicated and overwhelming systems of red tape.
S&P details the lack of foreign investment in Italy, which stands at 16 per cent of GDP – less than half that of even Spain, which S&P says is at 46 per cent. Non-tariff barriers, like overweening regulations, are to blame, says the rating agency.
At the core of the problem, in S&P’s view, is Italy’s dysfunctional politics.
Our macroeconomic analysis also illustrates Italy’s main credit weakness: Even under pressure, Italian political institutions, incumbent monopolies, public-sector workers, and public- and private-sector unions impede the government’s ability to respond decisively to challenging economic conditions…. With elections due in 2013, and the government’s parliamentary position tenuous, it is unclear what can be done to break the deadlock between these political institutions and the government. As a result, we believe that Italy remains vulnerable to heightened fiscal, economic, and financial downside risks.
The conclusion that what ails Italy is political and not economic is both good news and bad news. The good news is that Italy’s troubles can be fixed, and relatively quickly; the bad news is that Italian leaders have been engulfed in repeated scandals, which hasn’t helped their ability to get those solutions through an already fractious parliament.