"For countries attempting to address these twin imbalances within a currency union, there is a ‘Catch 22’ situation: competitiveness can only be regained via real exchange rate adjustment (i.e., by running lower inflation than the Euro-zone average). However, in order to boost public sector finances, economies need stronger nominal GDP growth and, thus, relatively low inflation (or deflation) has the effect of exacerbating the public-sector deficit problem. In other words, it is difficult to address one imbalance without exacerbating the other, and vice versa".If we simply take this years outlook as an example. Italy, as we have seen, is unlikely to achieve more than 1% real GDP growth (and this a year of strong global expansion), but the country might just get nominal GDP growth of 4%, since inflation is currently running near to 3%. At the same time Germany may have GDP growth nearer 4%, and inflation around 1% lower than Italy. These kind of inflation differentials just don't make sense, when you consider that it is Germany that is booming, and Italy that is near to falling back into recession. Such differences are symptoms of deep economic rigidities in Italy. So what if Italy were to have 1% inflation, and 3% real GDP growth? Well, just how plausible is this? Germany, as we have seen, has only been able to get 1.3% annual growth in productivity over the last decade, and it is hard to see Italy doing better, no matter how deep the structural reforms introduced. Indeed, Italy's long term trend growth has been slipping steadily over the last half century, at the rate of about 1% a decade, according to the Italian economist Francesco Daveri:
"Italy’s per-capita GDP growth was 5.4% in the 1950s, 5.1% in the 1960s, 3.1% in the 1970s, 2.2% in the 1980s and 1.4% in the 1990s. A rough-and-ready extrapolation of this decade-long continued slowdown would lead to expect no more than 0.5% in the 2000s."Since he wrote this in 2006, and growth over the decade was something like an average of 0.6% I would say that his expectation wasn't a bad guess. What puzzles me at all the people who now "guess" that Italy will be able to put in enough a much higher growth rate over the next decade. All Together Now: "I Believe In Structural Reforms" The IMF are expecting real growth of about 1.3% between 2012 and 2015, and the EU forecasts are not substantially different. As average growth rates this seem very optimistic to me, especially given the recent performance. All efforts seem to be directed towards impelling structural reforms, and this in itself is worrying, since what we seem to have is something more akin to blind faith than to sound empirical economic analysis. The most recent IMF Article IV Report concludes that: “only a bold and comprehensive structural reform program will unleash Italy’s growth potential”. But what is the likelihood of such a bold and comprehensive programme being introduced, and anyway, how much do we really know about Italy's real growth potential at this late day in its demographic history? While echoing the "structural reforms" mantra, the OECD is rather more cautious:
Italy’s economy has passed the deep recession triggered by the global crisis and seems set for a gradual recovery. The strength of this recovery is uncertain: it would be wise to plan for no more than the rather sluggish growth seen in the decade prior to the crisis.The problem is, like many on Europe's periphery, after a decade of Euro membership the Italian economy is seriously distorted, and badly in need of devaluation, but of course, as elsewhere there is no currency left to devalue, hence some sort of debt restructuring to reduce the burden of interest payments may be the only alternative while we await the jury's verdict as to whether all these structural reforms work or not. Many, of course, will say that Italy is a lot richer than it seems, since so much economic activity takes places in the informal sector. But this is entirely beside the point, since the informal sector by definition does not pay taxes, and I will believe a promise to reduce the importance of the informal sector when I see the results. In the meantime Italy is, at best, a country which is much richer than it seems where government finances are in danger of spinning off into an unsustainable debt spiral. As Standard & Poor's put it in the statement accompanying their decision last week to put Italian Sovereign Debt on rating watch negative: "In our view Italy's current growth prospects are weak, and the political commitment for productivity-enhancing reforms appears to be faltering. Potential political gridlock could contribute to fiscal slippage. As a result, we believe Italy's prospects for reducing its general government debt have diminished."