Home > Uncategorized > Italy’s stagnation: the need to share the pain

Italy’s stagnation: the need to share the pain

from Dean Baker

According to the plan designed for Italy by the European Commission, Italy must regain competitiveness with Germany by forcing down wages. A prolonged period of high unemployment is an essential part of this process.

There can be little doubt that the main problem with Italy’s economy is a lack of demand. When the housing bubbles that were driving the euro zone economies burst in 2008, there was nothing to replace this source of demand. Italy joined other countries in the euro zone and around the world in using fiscal stimulus to boost demand, but then was forced to revert to austerity in 2010.

Its economy has been shrinking ever since, as would be predicted by textbook Keynesian economics. GDP in 2014 is projected to be almost 9.0 percent less than the 2007 peak. According to the I.M.F.’s projections, which have consistently been overly optimistic, Italy’s GDP will still be 3.5 percent below the 2007 level in 2019. This would imply twelve years with cumulative negative growth, a performance far worse than any major country saw in the Great Depression.

The shrinkage of the economy has been disastrous for Italy’s workers. The employment rate for prime age workers is down by almost six full percentage points. The employment rate for young people is down by ten percentage points, translating into youth unemployment rates of close to 40 percent.

Of course the pain for workers is the strategy. The plan designed for Italy by the European Commission is have Italy regain competitiveness with Germany by forcing down wages. A prolonged period of high unemployment is an essential part of this process.

As a matter of simple economic logic, Italy has no choice but to regain competitiveness barring a change in policy by the E:U. Commission. Italy can only borrow to the extent allowed by the Commission, and this requires adhering to the fiscal policies they demand. Given these constraints, it would make clear economic sense for Italy to leave the euro zone. This would allow it to quickly restore competitiveness by lowering the value of its currency relative to the euro, however for political reasons this solution does not appear viable.

If Italy cannot pursue a reasonable macro policy within the euro, and it cannot for political reasons leave the euro, then it does not have great prospects. Nonetheless, there are ways of making the best of a bad situation.

Clearly the intention of the EU Commission is to impose the pain of adjustment on Italy’s workers. But the logic of adjustment does not require that workers bear the pain, or least not that they bear the pain alone. Italy must reduce its domestic price level relative to the price level in Germany. The Eurozone authorities would see lower prices come about from lower real wages, but reductions in other costs can also help to lower prices in Italy.

The most obvious non-wage cost would be housing. Italy didn’t have the same sort of housing bubble as the United States or Spain, but house prices did rise rapidly measured against wages, rents, and any other metric. Much of this increase has been reversed, but house prices are still considerably higher relative to income than their average over the last four decades. This suggests the potential for further declines, which could translate into substantial savings to workers in the form of lower rents.

One way to put downward pressure on prices is to tax vacant properties. Housing units that sit empty for more than a limited period (e.g. 3 months) could be subject to a punitive tax. This would both raise revenue in a relatively progressive way and put pressure on property owners to rent or sell their homes, thereby lowering the price of housing. (As an added bonus, some foreign-owned vacation homes may be subject to the tax.)

Such a tax is relatively easy to implement since the government has tax records for property and assessed value already. Furthermore, even efforts to evade the tax have the desired effect since they increase the cost of carrying a vacant unit.

The potential benefits of even modest downward pressure on prices are substantial. If housing accounts for 25 percent of consumption spending, and a vacant property tax can lower average housing costs by just 4 percent, it would be the equivalent of a 1.0 percentage point rise in the real wage. Of course many of the property owners hit by this tax will not be wealthy, but Italy does not have any options that don’t involve hurting some people who are not wealthy. And as a group, there is no doubt that property owners are richer than workers. Certainly this route for reducing the price level has to be better than forcing another 1.0 percentage point decline in the real wage.

Another place to look for price declines is the pharmaceutical industry. According to the OECD, Italy spent 23.1 billion euros, or 1.7 percent of GDP, on pharmaceuticals and other non-durable medical goods in 2012. This is considerably less than in the United States, where drug companies are granted unfettered patent monopolies, but it is still probably more than twice as much what the country would pay if drugs were available at the free market price.

There are limits on how far Italy can go to depress its drug prices, but it certainly should press these limits. Again, the alternative is more downward pressure on real wages. Furthermore, the patent system is an antiquated, inefficient, and corrupt mechanism for financing drug development. If Italy can help to the drive towards developing more efficient alternatives, it will have done the world an enormous service.

In the same vein, Italy spends billions each year in payments for Microsoft’s software, for Hollywood movies, for copyrighted video games, and for recorded music. It has treaty obligations that require it to respect copyrights, but there is enormous room for discretion in enforcement. For example, there is no reason that protection of Disney’s copyright on Mickey Mouse should be a higher law enforcement priority than collecting back taxes from millionaires and billionaires who rip off the Italian people. (This discretion would likely be eroded under the provisions of Trans-Atlantic Trade and Investment Pact.)

This list gives some of the areas where they are substantial rents that could be targeted as a way to bring down prices in Italy. Undoubtedly there are many other areas. Targeting high income rent earners is not a substitute for good macroeconomic policy, but good policy is precluded by the troika and the political realities in Italy. The question then becomes the best path forward given the macroeconomic constraints.

Certainly a policy that seeks to accomplish the deflation prescribed by the Eurozone authorities by reducing these and other rents accruing primarily to high income people is better than accomplishing deflation through wage cuts to ordinary workers. In addition, if Italy’s pain is shared by powerful corporations like Microsoft and Pfizer, it may help get the troika to reconsider the wisdom of its policies.

View article at original source.

  1. November 15, 2014 at 2:11 pm

    Quote from Dean Baker:

    <>

    There is a solution that does not assume euro exit, but at the same time gives a national eurozone government the necessary fiscal tool to get the economy going: introduce a national parallel currency in crisis-ridden eurozone countries.

    This should be done fast and in a simple and very cheap way by letting this parallel currency be purely electronic, no bills and coins. Everyone gets a current account directly at the national central bank. The government spends this currency into the economy together with euros, and taxes both currencies back in the same proportion. The proportion could be 75% euros and 25% electronic national currency. Wages and pensions are paid in the same proportion. And firms will adjust and set prices and wages in similar proportions. Firms which do not accept the electronic national currency in purchases will be outcompeted by those which do accept such a share.

    The proposal is described in detail in a paper in this report, page 14: http://www.itk.ntnu.no/ansatte/Andresen_Trond/articles/sammelpublikation_parallelw%C3%A4hrung.pdf

  2. November 15, 2014 at 2:12 pm

    Sorry, the quote disappeared.Here it is:

    “it would make clear economic sense for Italy to leave the euro zone. This would allow it to quickly restore competitiveness by lowering the value of its currency relative to the euro, however for political reasons this solution does not appear viable.

    If Italy cannot pursue a reasonable macro policy within the euro, and it cannot for political reasons leave the euro, then it does not have great prospects.”

  3. Nell
    November 16, 2014 at 1:13 pm

    I don’t see how Dean Bakers proffered solutions are any less problematic that leaving the Euro. Both require the political will to challenge those who are in power, internally or externally. There is a good reason that the preferred choice is to depress wages. It is because those earning a wage have no power.

  4. Paolo Leon
    November 16, 2014 at 3:54 pm

    Revert to the original plans: European public works financed by the ECB, and europization of the extra 60% of GDP of public debt. Unfortunately, the Commission is working on 300 billion euro to divide among 28 countries, while maintaining all austerity measures: even f financing this amount is left to member countries, and not with the ECB. The mystery is why the Germans behave that way, knowing that it will be no good, even for them. Perhaps, it is a historic psychic complex: they always refused Keynes, because they had Shacht, a pre-Keynesian, as Hitler’s helper. Or is it simply nationalistic mercantilism?

  5. Macrocompassion
    November 17, 2014 at 9:11 am

    The lack of demand is due to prices being too high compared to wages. By raising wages all that happens is that the produces find they need to raise prices, because it now costs more to produce. This feed-back (or viscous circle) has no solution and it avoids our understanding of the basic problem by introducing a separate situation, without explaining why the wage/price ratio is so low to start with. This attitude is one that the monopolists actually subsidize in our centers for teaching macroeconomics!

    Production costs depend on the 3 Smithian returns for use of the 3 factors of production, land, labour and durable capital goods (tools, buildings, transports, etc.) The above discussion deals only with the last two. But what about the land? Landlords and their supporters the banks find that they can speculate in the prices of the land by investing in some that is likely to be developed (often on the outskirts of towns) and then waiting for demand for its use and the resulting price to rise.

    This is what caused the 2007 economic crisis, when the speculators in land for housing found that their bubble-like inflating prices would no longer hold. But during this expansion time, the production costs also rose due to the greater amounts of ground-rent that the tenant farmers, manufacturers, industrialists and entrepreneurs had to pay for access to the land. Many of them went broke before the bubble burst and after this the banks felt it as mortgages became toxic. According to Georgist theory this situation then repeats and roughly every 18 years there is a new failure. Thus it is speculation in land values which is the cause of investment failures, unemployment and the lack of steady macroeconomic progress along with the high prices and low demand.

    By taxing land values instead of incomes, purchases and capital investment this problem can be eliminated, but to do this we first have to show landlords that their selfish behaviour is throttling the progress of the working population. Their craving for greater amounts of ground-rent and land prices creates a socially tense situation which opposes natural growth.

    TAX LAND NOT PEOPLE; TAX TAKINGS NOT MAKINGS!

  6. November 18, 2014 at 12:03 pm

    (… Continuing from my initial comments:)

    Euro claims and savings will remain with the same safety as today. The whole point of a national parallel currency (from now on “NPC”) is that it allows a financially non-dramatic injection of demand in a depressed economy that has a lot of spare capacity. You don’t even need to have much of a market for euro/NPC exchange. Since the NPC can be used to settle tax obligations, there counting on a level with euros, they will not fall much below par, say to 0.95 or close to that. That is not a big problem.

    There is an elegant twist you can make to this system: asssume that a government declares a general euro:NPC ratio, say 75:25. This ratio (from now on called the “ENR”) is fairly fixed but can be changed incrementally just like the Central Bank adjusts the interest rate. This ratio is then an indicative parameter for how to set many of the economic relations in the economy. Govt employees and pensioners are paid in the ENR, with one NPC counting as one euro. Govt pays providers in the ENR. Providers who don’t accept that don’t get any sales. But providers and other firms will of course try to use the ENR when they pay their employees. But firms may have the freedom to offer employment at another ENR, higher or lower.

    For non-govt business, firms may sell their goods/services at the ENR, or a somewhat different ratio. Instead of only competing on price, they can use a lower ENR to attract customers. Firms can be obliged by law to announce their ENR along with the price (where 1 NPC counts on a par with 1 euro). If firms insist on a high ENR they will lose out to competitors. This will adjust itself. The private sector will probably – on the average – converge to an ENR close to the value declared and practiced by the government, both for sales and wages.

    With NPCs only mediated via mobile phone, the typical payment situation will be bills and coins (euros), and a mobile message sent with NPCs. That means a small, but no big delay at the checkout.

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