Italy back in Europe

Together, Roberto Gualtieri and Paolo Gentiloni can help Italy understand that deficit spending is not a budget. Reforms and open dialogue with the EU are solutions

With its double act Roberto Gualtieri-Paolo Gentiloni, Italy should be spared the dramatic developments it has experienced for the past five years over the decimal points required to comply with the Stability and Growth Pact and the threats of excessive debt procedures linked to its excessive deficit that had become dramatically tangible during the Conte 1 government run by the Five Star Movement and Matteo Salvini‘s League. The Minister for the Economy of the Conte 2 government is the Italian political figure who has the best understanding of all the highroads and byroads of the complicated European Union budget regulations, mainly thanks to his experience as president of the Economic Affairs Commission of the Euro-Parliament and one of the “sherpas” engaged in the negotiations with member states on the reforms to the Stability and Growth Pact. The future European Commissioner for Economics is a refined politician, capable of finding the right balance between orthodoxy and flexibility on public accounts and he will be in a position to use his clout as a former prime minister not just during the internal negotiations within Ursula von der Leyen’s commission, but will also have the opportunity to rely on a certain amount of ‘moral suasion’ towards Euro-zone capitals. The Gualtieri-Gentiloni team can also help make the Stability and Growth Pact more favourable towards investments, as we approach the discussion to be held in the coming months on how it should be simplified. But we mustn’t kid ourselves that the two of them are capable of bring about a major reform of European tax laws that might allow Italy to run up much more deficit spending. It would also be wrong to imagine that the two Economics ministers in Europe can hope to solve the structural problems of the Italian economy seeing as Rome doesn’t have the political will or courage to tackle them.

The first Update Note to the Economic Planning Document, on which Gualtieri has based his budget for 2020, is indicative of the new minister’s intentions: no confrontational attitudes towards the Commission, but a very painstaking exploitation of all the flexibilities afforded by the internal rules to avoid a significant increase in tax pressure or politically unsustainable tax cuts that are difficult to put into practice. The coverage to avoid increasing VAT is largely missing, which means more deficit than expected. The discrepancy compared to the structural reduction objectives is significant, but it falls within the flexibility implicit in the Stability and Growth Pact rules (more than 0.5% of GDP) thanks to an explicit request for flexibility for infrastructures and providing land risk mitigation (0.2% of GDP). The Commission could have something to say about the excessive revenue expected from the battle against tax evasion and the Italian Treasury’s calculations of its output gap.

Furthermore, a few of the budget’s measures work against the EU’s own recommendations. But none of this is in any way comparable to the Conte 1 government’s budget for 2019, which blatantly contradicted the rules of the Stability and Growth Pact. Gentiloni should therefore behave with Gualtieri exactly as his predecessor, Pierre Moscovici, did with the French Minister for Economics during his mandate: use the privileged communication channels to adjust the budget provisions in order to narrowly avoid the risk of any procedures by the Commission.

For Gentiloni it is essential that Gualtieri avoid stretching the rules or making outrageous requests with regard to flexibility. If he makes to many concessions to Italy, Gentiloni would be in trouble within the Commission (the deputy president responsible for the Economy, Valdis Dombrovskis, is considered a hardliner) and in the cross-hairs of the Eurozone governments that insist on an orthodox approach to the Stability and Growth Pact (Holland being the frontrunner here). If he isn’t in a position to provide Gualtieri with the flexibility he requires, Gentiloni risks being fingered as a traitor even by his own party. After all, during his confirmatory audition in front of the Euro-parliament, his first opportunity to outline his vision of the Stability and Growth Pact, the Italian commissioner advisedly chose the middle road. “I will use flexibilities whenever they are necessary to (…) enable the fiscal policy to play a stabilizing role and promote investments”, were Gentiloni’s words, but he immediately added that high levels of debt have a “potentially destabilizing impact when times are tough” and as a result, in applying the rules he will focus on their “reduction”.

During his audition before the Europarliament Gentiloni chose the middle ground also on the issue of tax regulation reform within the eurozone. In the weeks before, a level of expectation had built up in Italy for some kind of revision of the Stability and Growth Pact to enable more deficit spending, not least in the address by Italian President Sergio Mattarella at the Ambrosetti Forum in Cenobbio. Gentiloni preferred to stick to what can be achieved: a simplification of the current regulations, based on the proposals made by the European Fiscal Board (a group of experts that assess how the Commission puts the Stability and Growth Pact into practice). No revolution, revision or reform: the European Fiscal Board in September suggested that the criterion for the reduction of structural deficits (subject to constant amendments owing to the uncertainty surrounding output gaps and potential growth) be abandoned and replaced with a cap on net primary expenditure growth rates linked to the nominal growth of GDP. In the meantime, the European Fiscal Board has suggested an innovation with the “introduction of a limited Golden Rule to protect public investment” linked to EU objectives (such as the Green Deal) which would mean ruling out “certain specific expenses promoting growth from the cap set for net primary expenditure”. In this way the Stability and Growth Pact would become more predictable and anti-cyclical, helping Italy and other countries to deal with stagnation or recession. By the same token, it would introduce a new form of flexibility – the limited Golden Rule – that is less subject to political discretion than the current one. The European Fiscal Board’s proposal would allow Italy at most a few more decimal points of deficit spending during a stagnation period like the current one.

In other words, between setting up the 2020 budget and simplifying the Stability and Growth Pact, one can reasonably expect that with the Gualtieri-Gentiloni tandem Italy will get back on the “straight and narrow”. The expression was first coined by Pier Carlo Padoan when referring to the need to get back to reducing debt and, at the same time, providing support for internal demand so as not to depress growth. But is Padoan’s “straight and narrow path” a viable solution for Italy and its economic problems? A large section of the political establishment – including the Democratic Party – has never politically accepted it as a government strategy, because it prefers to consider deficit as the only panacea in the belief that only neo-Keynesian policies can support growth. And even the real growth figures during the Padoan years have highlighted the ineffectiveness of the “narrow path”. The Conte 1 government on the other hand demonstrated the counterproductive effects of an expansive budget in a context where markets are mistrustful. Between 2014 and 2018 Italy grew much less than the rest of the Eurozone because the strategy was focused more on the symptoms (internal demand) than on the sickness (the lack of productivity increases). During the 2018-2019 two year period Italy totally undermined the additional deficit – the expansive budget of the Conte 1 government has become recessive – because it made the sickness worse by using the wrong medicine for the symptoms.

The budget project for 2020 hatched by Gualtieri from this point of view does not bode well. “Quota 100“, the pension counter-reform and the Citizen’s Income, which is designed too badly to work, will be retained. On expenditure cuts and privatisations, nothing significant is foreseen. On the reform side, everything would seem to indicate that the Conte 2 government will just kick the can down the road, postponing every decision to when it’s reason for existence will lapse, meaning after the election of the new Italian President in 2022. Can Italy afford to stick to the “narrow path” on public expenditure and avoid acting on all reform instances for another three years? Will Gentiloni still be flexible if Italy finds itself in a situation matching that of the 2011-2012 two year period due to external factors such as a global financial crisis, a trade war or a military conflict? The answers as to how to deal with the structural sickness affecting Italy can be found in the recommendations that the Commission has forwarded over the last five years. It should shift taxation from work and incomes to consumption and real estate, even if this means increasing VAT and taxing homes. And revise the so called Tax Expenditure, the tax easements of various kinds that have stacked up over the decades and currently amount to 300 million euro. Implement the “Fornero” reform completely to reduce the burden of old-age pensions on the public coffers and create margin for other social expenditure. Reform the public administration and the judicial system from the ground up. Resume the privatisation of the vast plethora of public companies and the liberalisations to remove restrictions on competition. Focus on investments in research and innovation and on quality infrastructure. The most important support Gentiloni can provide Gualtieri is to convince the political establishment and Italian citizens that the solution does not lie in a 3% deficit but in implementing reforms.

@davcarretta

This article is also published in the November/December issue of eastwest.

You can buy the magazine at newsstand or subscribe.