Bigger than Berlusconi

Up until now the crisis in Europe has involved plenty of Greece, large doses of Portugal and Ireland and a dash of Spain.  But seemingly from nowhere, Italy hit the headlines last week and took the unenvious position of centre stage.  The new focus on Italy changes the extent of the crisis. Greece makes up a mere 2.5% of GDP in the euro zone and Germany’s economy alone is more than 10 times larger.  On the other hand, Italy’s GDP is over 16% of the euro zone, and with government debt approaching 120% of GDP, any help for Italy is going to involve a considerable amount of funds.

A lot of fingers have been pointing at Silvio Berlusconi, the ex-Italian Prime Minister who resigned over the weekend, but Berlusconi was a symptom of a larger problem in Italy.  Italy is a country that is dominated by a range of different interest groups (be they unions, public sector workers, pensioners, Northerners, and so on) which makes the country difficult to govern (as any change to government policy is likely to annoy some group in society).  Berlusconi has made this worse by his own aversion to reform.   The lack of leadership and the control of the interest groups has dulled the dynamism of the economy and saddled Italy with its large debts.  One result of this is a lot of cumbersome regulations, which has Italy ranked 87^th in the World Bank’s ease of doing business ranking (just below Mongolia).

As such, the economy in Italy has languished and others boomed.  Between 2000 and 2008, Italy grew at an average annual rate of 0.8%, the lowest in the Eurozone, compared to the Eurozone average of 1.8% and 3.8% in Greece.  Greece’s problems stemmed from too much debt at low interest rates after having joined the euro fuelling growth that was unsustainable.   But, in Italy, a stagnated economy meant the country missed out on the party in the good years but is still suffering from a hangover. 

Slow growth by itself would not have been a problem had it not been coupled with high levels of debt.  Unlike Greece, government debt has typically been high in Italy and has not been seen as a problem until Greece brought it to the forefront of investors’ minds.  Berlusconi has helped to make the situation worse by backing away from plans to rein in government spending and this is what ultimately prompted already jittery investors to sell off Italian government bonds and cost Berlusconi his job as Prime Minister.

While Berlusconi himself is not the main problem, removing him from power may open up the door to a solution.  But it depends on the governing powers in Italy being bold enough to put in place policies that will not only bring down its debt but also free up its economy and also on voters that recognize that this is necessary.  The markets seemed to have helped highlight the need for change and I think that this will put Italy back on track.