The future of Europe, between the weakness of Italy and the doubts of UK

The world economic growth has overall slowed down, with significant differences among areas:

– The USA appears the only western country on a real recovery path (2.2% in 2012 and is likely to confirm this figure also for 2013)

– Developing economies are still outpacing and outperforming developed ones (Russia +3.4% in 2012 and the forecast is 3.6% for 2013 – India 4% and the forecast is 5.7% for 2013 – China 7.8% in 2012 and the forecast is 8% for 2013).

–  Europe has the lowest growth and as a whole is losing weight on the global scenario. In the ‘90s the EU was generating 20% of world’s growth; its share is now 5.7%. Nowadays there is not a single European country in the world’s top 10 most growing economies.

The response to the new economic “balance of powers and the completion of the European integration are non-reversible processes. Europe seems to be at an important crossroads, paraphrasing the East’s heading: to go further toward a larger integration or scale back the European project. The sovereign debt crisis turned into a European systemic crisis, with markets’ distrust primarily concerning the sustainability of the Single Currency and of its governance. The main reasons of the current sovereign crisis: high public debts, Eurozone, excessive competitiveness gaps between core and peripheral Euro countries which led to huge current-account unbalances between the Eurozone’s members, interdependence between banking and sovereign crisis. These elements are calling Europe for fiscal discipline, growth (through the promotion of competitiveness-enhancing domestic reforms in the southern European countries) and a European framework both for banking supervision and resolution (beyond a simple coordination at national level) in order to cut the vicious circle between banking and sovereign risks that, among other things, entails higher costs of recapitalization and funding, especially for banks based in the EU peripheral countries like Italy. Instead, the economic crisis is automatically resolving the current-account unbalances given the sharp fall of the aggregate demand in the peripheral countries which reduced significantly the import goods.  

Considering these elements, in real terms,now it is time to act the reforms to make Eurozone a single-global palyer:

In the short term we have to reach the “banking union” and to respect the “fiscal compact”, important signals about the will to proceed forward in the project of European integration through further transfer of sovereignty to the European institutions. But in the medium-long term, we have to achieve political and fiscal union in order to reduce uncertainty and cross-border asymmetries. . The Delors Report of 1989 argued that “in all federa­tions, the way fiscal policies are combined have a power­ful effect in terms of shock absorption, reducing sudden surges in economic hardship or prosperity among indi­vidual states”:

–       On the political side, Eurozone will be under 34 elections in the next 3-4 years, confirming potential stages of adjustment to face.

–       On the fiscal side, Bruxelles authorities manage a balance of €145bn (1% of area GDP) and less than a half is spent in policies for economic development (in federal countries –USA, Brazil, Australia- central governments receive on average more than 50% of total tax revenues). $1 decline in income in Texas triggers 40c of extra federal transfers, a 1 Euro decline in income in Spain triggers less than 1c from Bruxelles.

–        If we compare GDP dispersion between the US states’ GDPs and the Eurozone countries GDPs as a coefficient of variation, we see a remarkable rise of the index of dispersion within Europe, where the index grown by more than 2%, while between US states’ falls by almost 1%.

We have to start thinking as a single-global player, in order to leverage on the potential of our economy, the third most populated area of the world (after China and India).  The former Italian Prime Minister and European Commis­sioner Romano Prodi told the Economist magazine in an interview in 2002 that “the monetary union was like an unfinished build­ing that would be completed when conditions were ripe or a crisis imposed its completion”. The lack of strategic vision among European leaders in recent years suggests the correctness of Prodi’s character­ization. But the worst thing is that also in the current crisis some European leaders and national authorities seem scarcely committed in moving further along the European project, supporting short-sighted national interest. An example is the Deutsche Bundesbank behaviour toward the ECB monetary policy (the German Constitutional Court has been called to decide about the legitimacy, under the German law, of the ECB Outright Monetary Transactions).

ITALY

Since the beginning of the sovereign debt crisis, soon turned into the Euro crisis, Italy has often been seen by the international business community and by the international press as a stronghold in the defense of the Economic and Monetary Union. This because Italy is one of the biggest economy of the Eurozone and, in case of default, a bail-out would be not possible: the Italian GDP is about the 17% of the overall GDP of the Eurozone (the Greek one is 2.5%) and the standing stock of public debt is more than 2,000 bn. (e.g. the sum of the ESM and EFSF funds – the two European crisis management instruments – is equal to 750 bn. only).Contrary to other European heavily indebted countries (like Greece or Portugal) the Italian public debt is counterweighted by a very huge private wealth. The Italian households’ net worth is more than 4.5 times the amount of the public debt. The housing component is around 57% (€ 4,950 bn. of the total net worth).  May be, one of the problems about Italian household wealth allocation is that the real estate component has a larger weight, which means that there is relatively less saving available for firms’ funding. 

Thanks to the austerity measures that have been put in place since summer 2011, the process of fiscal consolidation remains broadly on track, despite the weak economic performance. Apart from the “historical” stock of public debt (it was equal to 127% on GDP in 2012), the current fiscal situation in Italy is better than those of other European countries. In fact, Italy’s budget deficit on GDP was -3% in 2012 while, for example, France registered a negative budget balance of -4.8%, Spain -10.6% , Portugal -6,4% and, outside the eurozone, UK in 2012 recorded a deficit on GDP equal to -6.6%. In 2013, Italy should register a budget balance of -3%, with a 0.5% impact coming from the payment of arrears to enterprises by the public administration. Notwithstanding the negative impact on the budget balance, the beginning of the payment of arrears has been a first, important, support to the Italian enterprises that could not be longer postponed.

Among the several cost cutting measures adopted in Italy, it must be mentioned the structural reform of the pension system, carried out by the Monti’s government, which puts Italy’s pension system well ahead of most European and international peers. IMF estimates show that the Net Present Value of pension spending from 2011 to 2050 of Italy will decrease about 34% with respect to the current amount while the majority of western countries will record an increase. For example, for the UK, in the same period, is forecasted a pension spending increase of 13%, +30% for Germany,  +38% USA and +43% Canada.   

However, it’s obvious that – in the current downturn – economic policies based only on austerity may cause a worsening of the situation. Even the IMF has stated that at the beginning was underestimated the recessive impact of austerity measures. This problem is particularly relevant for a country, like Italy, hit by a deep economic recession (Unicredit forecasts indicate a GDP decrease of -1.7% in 2013, which follows a -2.4% recorded in 2012). That is why the new elected government should absolutely undertake effective measures to support the economic growth without loosening the fiscal rigour. Notwithstanding its competitive problems, Italy is the second largest European manufacturing country after Germany with several strong exporting firms, therefore it has still a good growth potential.

In order to support the trade within Europe, we believe that the countries which do not face severe fiscal constraints, like Germany, should allow more expansionary policies, increasing their internal demand. In fact, restrictive policies simultaneously implemented in all the Euro countries risk to bring the all eurozone into a long lasting economic depression.

Together with fiscal discipline, economic growth must become the new European “mot d’ordre”. Actually, just after his appointment as prime minister, in his journey in Berlin, Paris and Bruxelles, Mr. Letta stated that the problem of the crisis was not Europe but, actually, a lack of Europe, in the sense that only a further integrated European Union, committed to maintain fiscal discipline as well as to foster economic growth, is the real solution.

In order to foster a new long-lasting economic growth in Europe, we also do believe that the stabilisation of the European Monetary Union is a precondition, as only a strong Eurozone can serve as a powerhouse of growth for the overall European Union as well as for the global economy.

 UNITED KINGDOM

The historical wariness of the British towards the European Union has been recently reaffirmed by the refuse to sign the binding EU-wide Fiscal Compact, containing the so-called ‘golden rules’ to balancing na­tional budgets and the  announcement of  the Con­servative Party leader and British Prime Min­ister David Cameron  (Jan 2013) that, if Europe should continue down a path that is not in the interests of the United Kingdom, he will hold a referendum to decide whether the coun­try should stay in the EU or not after the gen­eral election in 2015. These moves brought to a widespread anti-British sentiment among the continental European leaders and public opinion, especially in France and Germany. The Cameron’s statement about the referendum has been seen by many opinion leaders as an electoral move to gather votes among the most Eurosceptic conservative electorate and the UKIP supporters. Cameron tried with this move to address British public opinion, including the Labour voters. His view is that Britain should stay, on renegotiated terms. But a plurality of his compatriots disagree, favoring a British exit by 43% to 37% according to a May poll. To some extent, in the current tough crisis period,  the UK has larger degrees of freedom in terms of fiscal and monetary policies, giving the fact that UK is not a Eurozone member. The British economy appears to be less subject to fiscal constrains than countries joining the European Monetary Union. This could be seen by the Britons like a further incentive to set themselves apart.

But, honestly, we have to say that even the current British fiscal situation is not so brilliant (the UK deficit/GDP ratio in 2012 was equal to 6.6% and the forecasts indicate 6.9% for 2013;  the public-debt/GDP ratio was 90% in 2012 and it is estimated to reach 94% in 2013). Therefore, the British government, perhaps, is just putting off the necessary fiscal adjustments. Anyway, at the moment, the risk of UK leaving the EU seems to be very unlikely on the grounds of the believe that Britons get more benefits from staying in the EU than from leaving it. An  example is the role that London stock exchange plays in Europe: it is the financial hub of the European Union. The UK exit from the EU could impair this role, favouring  the development of alternative continental stock markets. IPPR estimates that leaving Europe could cost GDP to permanently be lowered by 2.25% (Source: LSE/EUROPP, 2012). Anyway, if the “tail risk” of an UK exit would occur, then  I do not see large negative impacts on the rest of the EU or on the Eurozone economies, given the historical lower degree of integration of UK (e.g. being out of the Single Currency or of the Schengen area).