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Letture per il fine settimana 20-3-2010

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Is Italy the real joker in the eurozone pack?

By Mike Dicks

Published: March 16 2010 15:13 | Last updated: March 16 2010 15:13

The news this month of the Greeks’ substantive additional fiscal effort (of about 2 per cent of GDP) to add to the near 4 per cent tightening announced back in December raises significantly the probability that markets will give Greece the benefit of the doubt, and assume that it will avoid a debt default. In other words, there is a general presumption that public debt concerns are behind us, and that, if things do deteriorate further, Greece will not be left high and dry.

We suspect that this is overly optimistic: tightening on this sort of scale normally depresses economic activity by enough to ensure that the debt-to-GDP ratio keeps rising – thanks to a fall in the denominator rather than a rise in the numerator. More importantly, regardless of whether or not Greece’s attempt at ‘financial programming’ fails or not, its convulsions likely represent just a prologue to the main drama. For other members of the euro area have problems of their own to solve that are just as serious, if not worse, than Greece’s.

Before considering who the new, albeit reluctant, actors might be, consider two crucial points, not sufficiently emphasised by most commentators.

First, Greece’s high debt-to-GDP ratio is not really the big issue. When it comes to a potential default situation, what really matters is whether or not the authorities have the capacity to print money – creating inflation and eroding the value of the public debt, as opposed to rescheduling or reneging on debt obligations. In the case of a currency union, that possibility is ruled out for members. So the public debt ought perhaps not be measured against GDP but against exports. Remember, were Greece to leave EMU and introduce a “new drachma”, its existing euro debt would count as foreign currency liabilities.

Second, competitiveness is actually the key issue. Although everyone is focusing on raising taxes and cutting spending, to stop the haemorrhaging of public finances, what really matters is competitiveness. After all, if you lose that – say because your productivity falls or your wages rise – you will diminish your source of foreign revenues.

Taking a look at the numbers, it is apparent that the Greek problems are by no means unique, or indeed as bad as some other eurozone countries. According to OECD estimates, back in 1995 – when Germany’s relative unit labour costs (or “RULCs”) peaked – Greece’s were roughly on a par. By 2009, however, Greece’s were 17 per cent higher. Hardly surprisingly then, that this shift has been accompanied by Greece losing export market share in nine of the past ten years.

OECD data suggest both Italy and Spain have much bigger competitiveness problems. Since 1995, Spain’s RULCs have risen by nearly 30 per cent. And Italy’s are up by a humungous three quarters. Back in 1995, Italian manufacturers benefited from having labour costs per unit of output that were only 60 per cent of Germany’s. Now Italy’s RULCs are 30 per cent higher than Germany’s.

As a check on whether this matters, take a look at German export volumes and compare them to Italy’s. After the millennium, the former rose pre-crisis by about 70 per cent, and look set to return to that level again next year. Italy’s, by contrast, rose by just shy of 20 per cent pre-crisis, and do not look set to get back to their old peak this side of 2013, if even then.

Indeed comparing Italy’s public debt to its exports, instead of to its GDP gives a debt-to-“income” ratio of roughly 4. This is not just a big number, but is more or less spot on what Ken Rogoff and Carmen Reinhart have identified as being a key ‘tipping point’ for identifying when crises occur. (See “This Time is Different”, Princeton University Press, 2009.)

Of course, optimists point to non-export components of GDP as also representing income streams that the authorities can expropriate if they deem it fit to do so. Even if one accepts this argument – looking at the more traditional public-debt-to-GDP ratio as a gauge of the sustainability of public finances – then Italy’s, at 115 per cent of GDP at the end of last year, was still slightly above Greece’s.

The bottom line of all this is that, more likely than not, Europe’s problems are not going to go away. If, for example, the continent double-dips - a real possibility in 2011 - then pressures on the weakest members of the currency union are likely to rise, and the current strategy to ring-fence the Greeks will prove unsuccessful. As for political support to bail out the likes of Italy, that is a really thorny issue. Recently, the German Chancellor, Angela Merkel, asked why Germany might be expected to support Greece, when Greek workers can, and do, retire earlier than their German counterparts. I wonder what she might say if Italy was under the cosh? After all, OECD data show that Italians retire on average at the age of 60.8 years – almost one year earlier, on average, than the Greeks!

Mike Dicks is Chief Economist at Barclays Wealth

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