It was always a matter of time. When the euro crisis erupted more than a year ago, the markets started fingering Italy as the weakest of the big nations in the single currency. True, France has its problems, and the Spanish are suffering the after-effects of a massive property bubble. But surely Italy with its long history of chronic financial instability would be where the whole system blew up? For a year, it managed to fly under the radar. This week, the crisis arrived. And it may well prove fatal for the single currency.
In the last week, as the government of president Silvio Berlusconi wobbled, bond yields started to soar. On Monday, they briefly went past 6%, getting close to the crucial 7% level at which the markets judge that a eurozone country is effectively insolvent. There is no turning back now. A rescue of the Italian economy by its neighbours looks a certainty at some point.
One way or another, the Italian story is not going to end happily. The unfolding saga of the euro debt crisis tells us that, once your card is marked, there is no turning back. If the markets get jittery about your debt, it is impossible to restore confidence. From now on, every bond trader is going to be scrutinising the economic and political data coming out of Rome, looking for bad news.
And, let’s be honest, this is Italy we are talking about. There is always going to be political instability. There is about as much chance of Rebekah Brooks getting invited to lunch at Number 10 as there is of Italy getting through the next couple of years without any sudden changes of government. At least the Greeks have managed to survive the last year with the same prime minister, even if he is usually accompanied by riot police. Once the bond market starts scrutinising Italy, there will never be a shortage of things to worry about. Step back from the day-to-day gyrations of the bond markets, however, and it is clear just what a disaster the euro has been for Italy. For much of the post-war period, the Italian economy was very successful. True, the south remained relatively poor, but the north powered ahead. Indeed, north Italy has a lot more in common with Austria and Germany than it does with its Mediterranean neighbours. Its economy is based on lots of niche, design-led engineering and manufacturing companies – very similar to Germany’s Mittelstand, the network of small, mostly family-owned firms, that power its export machine.
It was a model that worked. Despite high inflation, governments that lasted about as long as an ice lolly left out in the sun, and a constantly depreciating currency, Italy grew steadily. In the 1980s, it briefly overtook Britain in GDP per capita. In the early 1990s, it overtook France, becoming the fourth-largest economy in the world. There was nothing to be ashamed of in that record. And yet, since joining the euro, Italy has gone nowhere. At least Spain, Ireland and Greece boomed before they went bust. Italy just ground into stagnation. Its average growth rate since signing up for the single currency has been only 0.6%. Measured on a per capita basis, it has been just 0.1%. And this was the 2000s, remember. The global economy was booming everywhere else. Italy just stopped expanding.
Productivity growth has been terrible. Output per worker has actually fallen since 1999. Wages have continued to grow, however, and at a faster rate than in Germany. The result has been that Italian workers get paid more to make less stuff – it is hardly surprising that Italian businesses are not doing very well. To make up for that, one estimate is that Italian real wages will have to be frozen for three decades to restore competitiveness with Germany. That’s an entire working life with no improvement in living standards.
Looking back, the analysis of the financial and political elite was that Italy was a strong economy with a weak currency. Adopt a hard currency and it would flourish. In fact, it was the other way around. Italy worked pretty well as a weak currency nation. The lira fell from 460 to the dollar in 1973 to 1,400 in 1982, but that wasn’t the problem. Steady devaluation allowed it to compensate for the inefficiencies of its political system and labour markets. A hard currency, by contrast, left it brutally exposed. Some countries just work better with weak currencies. Britain is probably one of them, although not as extreme an example as Italy. The pound has been steadily depreciating for about a century now, with only periodic bursts of strength. The US may well be about to join them. The dollar looks to be emulating the pound’s long-term decline from global reserve currency to bit-part player.
With its combination of brilliant design, flexible small firms, and technical excellence, Italy should be doing well right now. It would be well placed to exploit the demand in the BRIC countries for its high-end engineering, and its fashion houses should be clothing the world’s emerging rich. Its exports should be powering ahead, as they are in Germany. But it made a massive intellectual mistake. Its analysis of its failing was completely wrong and so was the solution. Until it summons up the courage to leave the euro, there is no way out of this mess.