Friday, August 31, 2012

How seriously can investors take Draghi’s assurances?

ECB president, Mario Draghi, has repeatedly claimed that the central bank will do everything necessary to save the euro. Nothing has been formally agreed yet, but the ECB is expected to announce a new government bond-buying programme following next week’s meeting of its Governing Council. To have a significant impact on Italian and Spanish borrowing costs, the latest effort must be big enough to dispel the convertibility risk that lies behind the extreme polarisation of government bond yields across the eurozone: investors are loath to hold Spanish and Italian debt because they fear that the two countries’ membership of the currency union might be unsustainable. Unfortunately, the ECB is highly unlikely to do enough to convince investors that membership is unequivocally forever, not least because the Bundesbank opposes any open-ended commitment to cap borrowing costs.

Spain, Italy and the periphery of the eurozone face unprecedentedly high real borrowing costs, which are preventing a recovery in investment and hence economic growth. Without a return to growth, they will fail to dispel investor fears over the sustainability of their public finances and the solvency of their banking sectors. The Italian and Spanish governments argue that their high borrowing costs largely reflect convertibility risks and that the ECB should do as much as necessary to address these fears. The eurozone’s members that currently benefit from exceptionally low borrowing costs – Germany, Austria, Finland, the Netherlands and to a lesser extent France – maintain that very high Italian and Spanish borrowing costs largely reflect these countries’ failure to reform their economies and strengthen their public finances. There is merit in both these positions, but much more to the Spanish and Italian argument than the opposing one.

Opponents of open-ended ECB action argue that Italian and Spanish borrowing costs are not actually that high. Interest rates have just returned to levels seen in the run-up to the introduction of the euro, when investors distinguished properly between the countries that now share the euro. High borrowing costs are needed to focus minds and instil discipline. Were the ECB to take aggressive action to bring down borrowing costs, it would create so-called moral hazard; countries would be free to delay reforms in the knowledge that they will not be punished for it by having to pay high borrowing costs. According to this argument, it is a positive development that investors are now differentiating so strongly between the risks of lending to various governments. After all, the failure to do so in the run-up to the crisis contributed to the under-pricing of risk across the eurozone and reduced pressure on governments to reform their economies.

In nominal terms Italian and Spanish borrowing are indeed comparable to the levels of the late 1990s. But it is real cost of capital (that is, adjusted for inflation), that is crucial, and not the nominal cost. Both countries face much higher real borrowing costs than they did in the run-up to their adoption of the euro. Moreover, it is erroneous to compare the present with the late 1990s. Italy and Spain are at very different points of the economic cycle now than they were then. In the late 1990s both economies were growing, in the Spanish case rapidly, whereas now they face slump and mounting risk of deflation. Countries facing depressions and rapidly weakening inflation typically face very low borrowing costs: investors invest in government bonds for a want of profitable alternatives. This is what we see in the UK and US; borrowing costs remain at all-times low despite the extreme weakness of both countries’ public finances and poor growth prospects. Investors certainly need to differentiate between eurozone governments, in order to ensure that risk is correctly priced. The Italian and Spanish authorities acknowledge this. But the current spread between the yield on German government debt and that of the Italian and Spanish governments wildly exceeds what is required to make sure investors differentiate appropriately.

The polarisation of borrowing costs has politically explosive distributional effects: Germany is borrowing and refinancing its existing debt at artificially low interest rates. According to the German Institute for the World Economy, investor flight from the government debt markets of the eurozone’s struggling members to Germany has already saved the German government almost €70bn. Other countries face ruinously high borrowing costs, which are simultaneously increasing the scale of their reform challenges and narrowing their political scope to make the necessary reforms. The longer Italian and Spanish borrowing costs remain at such elevated levels, the greater the economic damage to those economies will be and the harder it will become for the two countries’ governments to shore up the necessary political support for further reforms.

Why have government borrowing costs across the eurozone diverged so much? The principal reason for the size of the spread between the periphery and Germany is convertibility risk. Investors believe that there is a chance that Italy and Spain will ultimately be forced out of the currency union and are thus demanding a hefty premium to insure against this eventuality. This feeds the convertibility risk by weakening countries’ fiscal positions and raising private sector borrowing costs (government bond yields set the cost of capital for the private sector). With private and public consumption in both Italy and Spain set to remain depressed for years to come, economic recovery requires stronger investment and exports. But borrowing costs are crippling and credit scarce. In a vicious cycle, the steep fall in the value of Italian and Spanish banks’ holding of government debt, combined with mounting bad debts as a result of recessions made worse by punitive borrowing costs, are forcing the banks to further rein in business lending. 

The ECB’s latest programme of bond purchases will be big enough to ensure that Mario Draghi does not lose face. But it will not be big enough to dispel convertibility risk and hence demonstrate its credibility as a lender of last resort. And it is this credibility problem, rather than the relative ‘credibility’ or otherwise of member-states policies, that is the principal reason for the unsustainably high borrowing costs faced by Italy and Spain.

Simon Tilford is chief economist at the Centre for European Reform.

Wednesday, August 29, 2012

Will a new German constitution save the euro?

If the Social Democrats win next year’s general election in Germany, they will ask voters to adopt a new constitution in a referendum. The new document, so they plan, would remove the legal fetters that currently prevent Chancellor Angela Merkel agreeing to eurobonds or joint deposit guarantees. Not only the Social Democratic Party (SPD), also politicians from Merkel’s ruling coalition are now speaking out in favour of a referendum. Some analysts are rejoicing that Berlin is finally preparing the ground for the fiscal union that will save the euro. But this is Germany, where policymaking is complex and slow. The debate about a new constitution might sap political energies without contributing much to the stability of the single currency.

German politicians mean different things when they talk about a euro-related referendum. Sigmar Gabriel and his fellow leaders of the SPD say they want voters’ consent to a eurozone fiscal union that involves not only debt mutualisation but also joint budget-planning, harmonised tax rates and tough financial regulation. Some pro-European MPs in Merkel’s own Christian Democratic Union (CDU) agree on the need for a new constitution. But many others insist that the current document leaves enough leeway for euro rescue measures. Some CDU politicians use talk about a referendum mainly as a warning shot to the constitutional court: if you judges continue constraining Merkel’s euro policies, a new constitution will restore power to elected politicians. Finance Minister Wolfgang Schäuble predicts that a constitutional referendum will happen “quicker than I would have expected a couple of months ago”. But he does not say what it would entail.

Horst Seehofer, leader of the traditionally euro-wary Christian Social Union (CSU), the CDU’s smaller Bavarian sister party, wants a referendum each time the EU assumes new powers, bails out a struggling member or admits new countries. And he probably hopes voters will say no to these. Foreign Minister Guido Westerwelle from the Free Democratic Party (FDP, another coalition member), contemplates not a German but a Europe-wide referendum on euro rescue measures. All parties are spooked by the recent successes of the Pirate party which campaigns for more country-wide referendums.

Even if Germany’s politicians could agree on a referendum strategy, this would not be a quick fix to save the euro.

Germans are having this debate right now because the constitutional court has indicated that EU integration could not go much further on the basis of the current constitution. Stricter budgetary oversight from Brussels, as envisaged by the fiscal compact, could be problematic. Eurobonds or any other kind of unlimited liability involved in a fiscal or banking union would be incompatible with the constitution. These would undermine Germany’s statehood and democracy by constraining parliament. If politicians cannot promise different fiscal policies, voters are deprived of a real choice and democracy suffers.

These constraints cannot be removed easily because the German constitution contains an ‘eternity clause’ (Article 79) that sets in stone certain principles, notably democracy, federalism and the market economy. No parliamentary majority and no referendum can alter these principles. Hence, the only way for Germany to accede to a fiscal union is to convene a constitutional assembly, work out a new constitution and put it to a referendum.

Some lawyers say this could be done quickly: only the eternity clause and the one detailing how Germany transfers powers to international organisations (Article 23) need to be tweaked. But more likely the constitutional assembly would be inundated with calls for more extensive social rights, a reform of federalism and a new voting system, to name but a few. “This would be an extremely long process”, predicts a constitutional expert.

Nor is it assured that Germans would vote yes in the ensuing referendum. Eurosceptics will argue that the new constitution will lead Germany into the dreaded transfer union, characterised by permanent money flows from Germany to the eurozone’s South. And even if a new constitution was adopted, who says there would be a political majority for eurobonds? Most Germans are against debt mutualisation even if it comes with tough budgetary oversight, according to a recent Emnid poll. Even among SPD voters, less than 40 per cent are in favour. “It’s not that if we had a new constitutional clause we would just wave through debt mutualisation”, says one CDU advisor.

And there is a last hurdle: Germany might adopt a plan for fiscal union only to be blocked by Austria, Finland or the Netherlands. After all, this is not really a debate about the German constitution but the future shape of Europe.

Nevertheless, the constitutional debate will continue because it suits both the opposition and the government. The SPD seeks to sharpen its political profile ahead of the 2013 election. It has so far loyally supported Merkel’s euro policies in parliament. Now many voters complain that they no longer know what the SDP stands for. The SDP is trying to change that, not by blocking Merkel’s policies but by going beyond them.

The CDU also gains from the constitutional debate. The opposition accuses Merkel of lacking a blueprint for the euro, of reacting to market panics, and of recklessly putting taxpayers’ money at risk without delivering more European integration. By talking about a new pro-European constitution, the government looks like it has a plan while it can put off hard decisions until after the 2013 election.

Now all eyes are on the constitutional court again. On September 12th the judges will issue a preliminary verdict on the European Stability Mechanism and the fiscal compact. They are unlikely to strike them down. But they will define conditions for making the ESM and the compact compatible with the constitution.

Some constitutional experts expect that the court will use the occasion to pronounce on what a process of constitutional renewal might look like. Others think that the court will shy away from encouraging such a process and instead widen the government’s room for manoeuvre within the current basic law.

Whatever the court does, the debate about a new, pro-European constitution will hot up this autumn. But do not be fooled: Germany is still a very long way from agreeing to eurobonds.

 Katinka Barysch is deputy director of the Centre for European Reform.

Thursday, August 23, 2012

Burma: An EU foreign policy success

Disunity is bad but pluralism is good. The story of EU policy on Burma illustrates this point. Disunity is normal: sovereign states with varied histories and traditions might be expected to disagree. The remarkable thing is that in the end, on Burma as on much else, the EU manages to achieve a common policy. The policy may even be better for being the product of disagreement and debate. Unfortunately the EU tends to do its disagreeing in public but when it reaches a sensible consensus often conceals the fact.

On Burma the disagreements start with the name. EU documents refer to Burma/Myanmar. Can one really have a policy on a country when one cannot agree on the name?

This disagreement is in fact not so unreasonable. On one side is the argument that if the UN, its neighbours and some people in the country call it Myanmar, the EU should follow suit.  But the argument on the other side is also strong: an early act of the State Law and Order Restoration Council (SLORC), one of the nastier manifestations of the military in its 50-year term of office, was to change the official name in English to Myanmar. The SLORC claimed that this name had the advantage of including minorities not from the predominant Bamar (or Burman) ethnic group. But this argument is largely false since ‘Burma’ is in fact a colloquial form of ‘Myanmar’ and the one the British rulers opted for. Furthermore, Aung San Suu Kyi and her supporters gave the name political significance by refusing to follow the SLORC’s decree. The lady now uses Myanmar when speaking the Burmese (or Myanmar) language, thereby offending some of her supporters, but insists on using Burma in English, thereby offending some generals. Too much energy has been wasted on this rather unimportant issue.

On the more critical issue of sanctions there are respectable cases to be made both for and against. Let us leave aside the EU’s visa bans and asset freezes on members of the regime, which have certainly discomforted those targeted. The arguments against broad sanctions are that they corrupt and distort an economy; they impoverish people; they often create illegal trade from which the primary beneficiaries are those in power; and they provide a convenient alibi for the government’s own economic mismanagement. If sanctions bite, the intention is that they will hurt people and thus encourage them to overthrow the government through elections or revolution.  That makes them particularly ineffective when dealing with military regimes. Besides, it is contact, not isolation that brings about change. Trade leads to more extensive relations with other countries; it opens countries up, eventually creating the middle class that is essential for democracy.

But there are also valid arguments on the other side. The damage done to the Burmese economy by EU sanctions has always been small compared with the damage inflicted by the military government. Spending on health and education has been minimal, while the defence budget as a proportion of GDP – officially 4.9 per cent, though the true figure is certainly much higher – surpasses that of any other country in the Association of South-East Asia Nations (Indonesia and the Philippines both spend 1 per cent, Malaysia and Thailand 1.5 per cent, Vietnam 2.5 per cent and Singapore 3.6 per cent, according to the International Institute for Strategic Studies). 

The sanctions did have one powerful effect, namely, to signal to European companies that the Burmese regime was unacceptable, and that they should stay away. Almost universally, they took this advice. The sanctions also gave moral support to the opposition, thousands of whose members have been beaten and locked up.
The arguments of those who opposed sanctions nevertheless had an impact on what the EU did. Its sanctions were designed to limit direct damage to the livelihoods of ordinary Burmese. They were selective and targeted on the extractive industries – mainly timber and gem stones – where the military and their cronies are dominant (though the sanctions’ effectiveness was impaired by some of these goods being rebadged and exported via Thailand).
The EU matched sanctions with a commitment to provide humanitarian support, not just at the time of cyclone Nargis in 2008, but on a continuing basis, with an emphasis on health and rural poverty. The US chose a very different path, applying an enormous and complex web of sanctions to Burma, similar to those in force against Iran. The US blocked World Bank lending and cut off Burmese banks from the international financial system. Congressional restrictions obliged the Global Fund (which ran programmes to fight malaria, tuberculosis and AIDS) to pull out of Burma in 2005. The EU led a consortium to replace the work of the Global Fund. In sympathy with those who argued against having anything to do with the Burmese regime, the EU ran all its programmes through NGOs.
Western sanctions were probably not the main cause of the thaw in Burma. When authoritarian regimes decide upon profound reform, foreign pressure may be a factor but is often less important than the ambitions of key leaders. Mikhail Gorbachev pursued glasnost and perestroika because he was a communist patriot.  In South Africa, F W de Klerk saw that his country had no future with apartheid. U Thein Sein, who became Burma’s president in March 2011, appears to be a man who wants the best for his country, and who knows that he cannot tackle poverty and under-development without first engaging in political reform and reconnecting Burma to the world.

Perhaps change would have happened without sanctions. But if so it would have happened differently. It is hard to imagine that representatives of the National League for Democracy (the NLD, the party led by Aung San Suu Kyi) would have spent hours in the Ministry of the Interior going through lists of political prisoners if their release had not been one of the conditions for suspending sanctions. And would the NLD have even been there at all? It was always an EU demand that all political forces should participate in the political process. That was code for Aung San Suu Kyi and the NLD, as well as Burma’s too-often forgotten ethnic minorities.

Then there is the China factor. Burma’s leaders were becoming worried about not only their economic dependency on China – a major trading partner and source of investment – but also their reliance on its diplomatic protection in international organisations. They wanted to balance the ties to Beijing with closer ties to the West, and that required reforms that would persuade the EU and the US to remove sanctions.

As it turns out, Western sanctions provided not only the opposition with a card it could play, but also reformists within the government. A government trying to reform cannot easily show benefits to sceptical conservatives, at least in the early stages. But greater respect from foreign powers – Hillary Clinton, David Cameron and Catherine Ashton have been among the recent visitors – and the removal of sanctions are visible rewards that a government can point to when it is fighting difficult internal battles.

In the case of Burma the opposition has been a cause worth supporting. Not only Aung San Suu Kyi herself, but also her supporters are fully committed to democracy and the rule of law. She has shown that she is ready to compromise – contrary to the propaganda persistently put about by the regime. Her approach to the government, the constitution and the parliament has involved many compromises. And on the question of sanctions, she and her party have, understandably, been somewhat ambiguous. She believes that Burma has a long way to go before it is free and democratic, and she has not called for the US to end all sanctions. But she has gone along with the EU’s suspension of sanctions and favours responsible foreign investment to create jobs.

On certain points, such as corruption and the fair conduct of elections, Aung San Suu Kyi remains immovable. This should be welcome; too many countries in Asia have become accustomed to a kind of semi-democracy, in which elections are held but are not particularly fair, in which the rule of law functions but not in quite the same way if you have friends in high places, and in which corruption is a part of the system. It is good that for once that a senior political figure in Asia is supporting high standards. If the Burmese are lucky, eventually she will prevail – and hopefully set an example to other Asian countries.

The Burmese government’s announcement this month that it is scrapping press censorship suggests that it is still bent on reform. But in June, violence between the Muslim Rohingya minority and Buddhists in the western province of Rakhine left dozens dead and nearly a hundred thousand homeless. Burma’s leadership continues to ignore the basic rights of Rohingyas. The opposition says too little about their plight – and some of its leaders have even questioned whether the Rohingyas belong in Burma. Several other ethnic conflicts continue to fester in various corners of the country. Further EU development aid should be conditional not only on continuing progress on human rights, but also on the regime seeking to achieve reconciliation with the ethnic groups.

The EU can offer its own expertise – from countries such as Spain – in building political structures that accommodate minorities. The EU should also encourage the army to retreat from political life, while recognising that this process will inevitably be slow. In Turkey the army has spent more than 50 years – with many ups and downs – gradually relaxing its grip on the political system. One suspects that Egypt’s generals will continue to control large swathes of that country’s economy for several years to come.

This year the EU has, to its credit, stepped up aid and opened an office in Rangoon. Its policy on Burma has looked a bit messy: in the past, pursuing sanctions but not across the board, and giving aid but not working with the government; and now, suspending rather than lifting sanctions while not insisting that every single political prisoner should first be released – while continuing to press the case of those who remain. Messy is what you expect when 27 countries debate and compromise. But the common line forged by the EU has helped to change Burma for the better.

Charles Grant is director of the Centre for European Reform.

Wednesday, August 08, 2012

The Commission should stand firm on Iceland’s accession negotiations

Iceland is the world’s longest running democracy. At a time when some member-states are struggling with democracy in the face of economic crisis, and the European institutions are still being criticised for a democratic deficit, Iceland would therefore be a valuable and welcome member of the club. Iceland also has much to teach the EU about energy policy: it generates three quarters of its electricity from hydroelectricity, and the rest from geothermal plants. All of its heat comes from geothermal.  However, the European Commission should remain firm on its negotiating demands on fishing and whaling.

Iceland applied to join the EU in 2009, in the aftermath of its banking crisis. The island saw EU membership as a source of stability and economic recovery. Out of the 35 negotiating chapters, 18 have been opened. Ten of these have been provisionally completed. Enlargement Commissioner Stefan Füle hopes that accession negotiations will be completed in 2013 – though the most difficult chapters, on agriculture, environment and fisheries, have not been negotiated yet.  As a member of the European Economic Area (EEA) and Schengen, Iceland has already adopted two-thirds of the acquis.

Iceland’s accession bid has quite broad support among member-states. The main obstacle to its accession is that Icelanders themselves are likely to reject it. Once negotiations are completed, Icelanders will vote in a referendum on whether or not to join the EU. Polls suggest that only around a quarter support EU membership, with over half against and around a fifth undecided. The level of support for membership has fallen since negotiations began in 2009. This is in part because Iceland’s economy has recovered from the serious 2008 banking and debt crises, and is now growing at over four per cent per year. And EU membership is no longer seen as a source of stability.  But support for membership has also fallen because of the European Commission’s perceived (by Icelanders) unfairness towards Iceland over the Icesave  settlement and the current “mackerel war”. And the totemic issue of whaling remains to be confronted.

Icesave was an online facility run by the Icelandic bank Landsbanki between 2006 and 2008. It gained over 300,000 customers in the UK, and over 125,000 in the Netherlands. But in 2008 Landsbanki was placed into receivership. The British and Dutch governments argue that the Icelandic government is obliged to pay at least €20,000 to each depositor, and that Icelandic and foreign depositors must be treated in the same way. Reykjavik disagrees. It argues that, had the restructured bank been obliged to bear the full cost of the debt, it would have had a negative equity of €2.6 billion, which would have had to be paid by Icelandic taxpayers.

Half the Icesave debt to depositors has now been repaid. The EFTA Court will hear legal argument about the remainder on September 18th.  The time for negotiation over Icesave has passed, since the matter is now before a court. So the key negotiating issues are fishing and whaling. The European Commission should remain firm on these issues. It would be counter-productive to lower existing EU standards to attract a new member. If this firmness leads to Iceland voting no in a referendum, so be it.

Fishing has always been a bone of contention between Iceland and other European countries. The Common Fisheries Policy is not included in the EEA, so Iceland can set its own policy. The fishing industry provides 40 per cent of Iceland’s export earnings, and eight per cent of employment on the island.  The current dispute focuses on mackerel. Iceland has increased its annual quota for mackerel catch enormously – from 2,000 tonnes to 146,000 tonnes. Reykjavik argues that this is sustainable because climate change is resulting in more mackerel in its waters. The Commission disagrees, and argues that Iceland’s quota is 36 per cent higher than it should be to be sustainable. Ireland, France, Portugal and Spain are demanding sanctions. The Commission has threatened to block Icelandic ships from unloading mackerel at EU ports.

The EU and Ice­land (plus the Far­oe Islands and Nor­way) will meet in Lon­don in Sep­tem­ber to try to reach agreement.  Some movement by the Commission, to defuse the argument and avoid conflict, would be understandable. But the Commission should not move much. It should continue to base its position on its scientific estimate of a sustainable catch.

On whaling, the Commission should not move at all. In 2006 Iceland resumed commercial whaling of fin whales and minke whales. Thus it joined Norway in defying the international moratorium on commercial whaling.  Iceland has always caught some minke whales for “scientific research”.  So the 2006 decision made little practical difference on minke – it simply represented Iceland becoming more open about its reasons for whaling. But it did represent a restart of fin whale hunting. Fin whales are an endangered species. Iceland maintains that there are enough fin whales in Icelandic waters for a small catch to be sustainable. This may or may not be correct, but is anyway not relevant to EU negotiations. EU law prevents the killing of any whales, even those which (like minke) are relatively numerous.  EU law is based partly on the need to protect biological diversity, but partly also on the need to prevent animal suffering.  Being killed by harpoons is a particularly painful, and often slow, way for an animal to die.

By no means all Icelanders favour whaling. Whale watching is an important part of their tourism industry – and increased tourism is one of the drivers of economic recovery. Yet some Icelanders argue that whaling is an important part of their culture and tradition. Culture is important, and European integration must respect most cultural traditions. But not all, and not those which involve cruelty. Iceland has an impressive culture –and has produced some of the world’s greatest literature. So it ought to be possible, in the twenty-first century, for Icelanders to separate their cultural heritage from whaling. If this is not possible, EU membership should also not be possible.

In any case, the ongoing dispute about Icesave and the Icelandic economic recovery may well result in Iceland voting no to EU membership, whatever concessions the Commission has offered on fish and whales. The EU should not lower its standards whatever the rewards. To lower them and get no reward would be particularly unwise.
Stephen Tindale is an associate fellow at the Centre for European Reform 

Wednesday, August 01, 2012

Can 'good Italy' triumph over 'bad Italy'?

The key battles for the survival of the euro will be fought in Italy more than anywhere else. Mario Monti’s technocratic government is struggling to push through sufficient reforms to convince financial markets that economic growth will return and thus erode the country’s mountain of public debt. Unless EU institutions intervene in government bond markets to lower the country’s cost of borrowing, Italy may soon be frozen out of those markets. The EU’s bail-out funds may just have enough money to provide Spain’s financing needs for the next few years, but they would then have no spare capacity to save the larger Italian economy. So Italy’s inability to borrow could lead to the euro unravelling – unless the Germans suddenly agree to bigger bail-out funds or the mutualisation of eurozone debt.
When the euro was conceived, more than 20 years ago, many economists thought the Italian economy ill-suited to take part. Then Italy’s reformist governments in the 1990s did just enough to convince the EU’s leading member-states that it should be allowed into the single currency. But after the launch of the euro in 1999, with Silvio Berlusconi prime minister for much of the time, reform more or less stopped.
Bill Emmott’s new book, ‘Good Italy, Bad Italy: why Italy must conquer its demons to face the future’ (Yale University Press), provides an excellent account of what is rotten in the state of Italy. When editor of The Economist, in 2001, Emmott started to run a series of investigative stories that exposed Berlusconi’s questionable financial dealings. One cover proclaimed: “Why Silvio Berlusconi is unfit to lead Italy”. The Italian prime minister, unamused, complained of an “E-Communist plot” against himself, pointed out that Emmott looked like Lenin and launched two libel actions that The Economist fought and won (though one of these is still subject to appeal).
Emmott’s book is particularly good on the sorry story of the Italian economy. Only Haiti and Zimbabwe grew more slowly in the period 2000-10. He describes how archaic labour market rules that prevent employers of more than 15 people from firing workers have kept companies small and thus damaged productivity. The lack of competition in the economy is a major cause of Italy’s service firms being inefficient. As a result, businesses pay more than they should for logistics, information and communications technology, marketing, transport and legal advice. There are 290 lawyers for every 100,000 Italian citizens, compared with just 22 in Britain. Emmott explains how an ageing population, unmeritocratic universities, low levels of foreign direct investment and the high level of public debt (over 120 per cent of GDP) depress the economy. Meanwhile a black economy amounting to 20-25 per cent of GDP weakens the state.
Emmott defines ‘Bad Italy’ as “the urge to seek power in order to use it for self-interested purposes, to amass power to reward friends, family, bag-carriers and sexual partners regardless of merit or ability, and by doing so to build clans and other networks that are beholden to you, and that live by enriching themselves at the expense of others, by closing doors rather than opening them, by excluding rather than including…This sort of selfishness involves a special and even wilfully destructive disregard for a wider community or, especially, national interests, institutions, laws and values.”
The roots of Bad Italy are embedded in the political system and the nature of Italian society. Emmott’s descriptions of these are not as profound as his economic analysis. He does not say a great deal about the centre-left, which held power from 1995-2001 and again from 2006-08 but reformed very little (though its record is somewhat better than that of the centre-right). He might have examined why the Italian centre-left is so weak and fragmented, compared with that in Britain, France or Germany. However, Emmott is good on the nefarious influence of the Catholic Church on politics: for many years it supported Berlusconi because of his stance on gay marriage and in vitro fertilisation – and because he exempted Church property from taxation.
Emmott could have focused more on the many vested interests that profit from the current system and have been so successful in blocking reform. But he implies that they can be overcome because half the book is about ‘Good Italy’, the Italy that draws its strength from civil society, promotes vigorous entrepreneurialism and thinks globally. One of the book’s merits is to point out that Bad Italy is not synonymous with the south of the country, nor Good Italy with the north. Emmott takes the reader on a tour of success stories, to ‘Addiopizzo’, an anti-mafia NGO in Sicily; the Tecnam sports aircraft manufacturer near Naples; the Brunello Cucinelli cashmere clothing company near Perugia; Rainbow, a world-beating maker of animated children’s cartoons near Ancona; the Slow Food movement in Turin; and well-known firms such as Luxottica (sunglasses) in Milan and Ferrero (chocolates) in the Langhe region of Piedmont.
Emmott shows that energetic companies, usually led by brilliant individuals, can beat the system and succeed. He sets out a list of reforms that Mario Monti – or the next prime minister – should seek to achieve, to tilt the system in favour of Good Italy. But he does not attempt to say how a reformist government should seek to overcome the vested interests of Bad Italy, or why Good Italy will ultimately triumph.
Mario Monti, a brilliant economist and the incarnation of the hopes of Good Italy, would surely agree with Emmott’s analysis. But his government is embattled. Within Italy, trade unions, professional associations and other conservative lobbies have diluted many of Monti’s reforms. In democratic countries, the most able governments find it hard to introduce structural economic reforms, even when economies are growing; the losers feel the pain immediately while the benefits take years to emerge. When an economy is shrinking – as is the case in Italy, partly because of excessively tight fiscal policies across the EU – it is almost impossible to implement structural reforms.
Monti’s noble efforts to reform Italy may have come too late. Bad Italy is extraordinarily resilient. Even if Monti’s government survives until the elections that are due in spring 2013, the entrenched power of Bad Italy may yet force Italy out of the euro. And if Italy and the other southerners quit, the EU’s leaders may find it hard to convince financial markets that France – which though a much stronger economy than Italy, suffers from some of the same ailments – can stay in the euro.
Charles Grant is director of the Centre for European Reform.
A similar article appears in the August 2012 edition of the Literary Review.