WPI: Italy and the EU - An Even Bigger Mess Than Brexit?

World Economics - November 2018


A familiar Greek drama is now playing in Rome.

Italian GDP has never recovered from the 2007-2008 financial crisis. According to the CEIC database, GDP per capita remains an astonishing 20% below its 2008 level. Others put the fall in GDP/capita at somewhat less. But whatever data source is used, there is little doubt that Italians are significantly poorer today than they were a decade ago. 

The richer northern European countries are highly averse to propping up or otherwise providing relief for Italian debts (as was the case for Greece). Many politicians persist in labelling the Italian state as spendthrift. But this is not the case. Since it entered the Eurozone, Italy has been remarkably frugal. Its high indebtedness stems from pre-Eurozone days. Unlike almost all other Eurozone countries (except Germany) Italy has achieved a primary budget surplus for most years of its Eurozone years, and in recent years a current account surplus.

What Italy has, that mirrors the Greek problem, is a very high burden of historic debt deriving from Governments of many years ago, fiscal austerity implemented to reduce debt, coupled with an attempt at structural reform, and the elephantine problem of a perpetually overvalued currency through its tie to the Euro. Together these problems have resulted in a shrinking economy less and less able to service, let alone pay off, its debts. Italy needs debt relief in some form, and structural reform. These are in essence political problems. But the economic growth desperately needed to provide jobs, taxes and ultimately a means of paying off debt, may be severely restricted by the Euro tie. 

The chart below shows World Price Index Purchasing Power Parity data for Italy and Germany. 


As can be seen, the Italian Euro (in PPP terms) has been continuously overvalued in comparison with the German Euro. Where once, in times of economic distress, the Greeks and the Italians could have devalued their currencies to reduce indebtedness and increase competitiveness, within the Eurozone they have not this card to play.

As The Economist wrote recently “The fate of the Euro was always going to depend on Italy ... Italy ...poses a challenge to the single currency that Europe seems unable to manage but cannot avoid". 

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