The Corner

Italy: Drowning not Wading

In a post the other day, I mentioned how Greece was (yet again) sliding towards another crisis in its relationship with its creditors.

This was despite the euro zone crisis being, you know, over.

I concluded that post in this way:

And then there’s Italy….

In a lengthy piece for the London School of Economics, Roberto Orsi takes a look at the situation there and doesn’t like what he sees.

It’s all worth reading, but here are some extracts:

Italy’s economy is not going to grow much faster than 1% per year in the foreseeable future in the best possible scenario. This comes after roughly twenty years of stagnation-depression. If Italy can only record a 0.9% growth in 2016, a year when numerous external circumstances were massively in its favour (a weak euro, ultra-low interest rates, quantitative easing from the ECB [European Central Bank], low oil prices, growing trade partners), what will happen when this exceptional alignment of propitious planets dissolves?

A series of financial cracks have started to appear: not only the well-known story of MPS bank, but the banking sector in general is under pressure, with numerous institutions facing serious trouble. Unicredit, the largest bank in Italy, has closed 2016 with a loss of €8 billion, and it is now trying to raise an unprecedented €13 billion in new capital. Furthermore, it emerged recently that INPS, the largest state-owned pension fund and one of the largest in Europe, runs a deficit of over €12 billion/year and during 2016 has crossed the boundary into negative equity.

Italy has a debt/GDP ratio of well over 130%. With an economy which cannot grow in real terms, it can only reduce its debt burden by means of inflation. However, on the one hand the ECB has to keep inflation within limits in the interest of the Eurozone at large, and on the other higher inflation would push interests in the Italian debt higher, with a heavier interest burden which Italy cannot afford (if not financially, then certainly in political terms). After 2011-2012, when it became clear that markets were pushing Italy towards insolvency, the ECB has engineered a protection net to prop-up the national debt, thereby gaining time. However, this came as a consequence of a political agreement within the EU, according to which Italy received (indirect, but massive) financial aid in exchange for deep reforms of its economic system: from labour market laws to pensions, from spending cuts to governance changes. The German/EU idea was that Italy could be put back on the tracks of economic-financial sustainability through those reforms, which were even listed in all detail in a famous letter from the ECB in summer 2011.

After more than five years and three governments (Monti, Letta, Renzi) in which the technocrats of the economic ministries and the Bank of Italy have played an important role, it is clear that Italy is fundamentally unable to reform itself and therefore it will not regain the aforementioned economic and financial sustainability. In all frankness, the German/EU plan was hyper-optimistic at best, bordering on delusion…

Against this backdrop, the question for the EU is whether it will accept to prop-up the finances of Italy and Greece almost unconditionally in the future. In other words, whether the Eurozone will become a veritable and practically irreversible transfer union, where money is channelled, directly or indirectly (the latter is already happening), from sounder fiscal systems to cover the deficits of Rome and Athens….The European partners may accept to do so, out of political, geopolitical, or even humanitarian considerations. Indeed given that Italy and Greece will probably never be back on a sustainable track, the only real alternative to a transfer union is them leaving the Eurozone. This would entail a further, massive political blow to the European project, as well as a wave of acute financial instability (Italy’s national debt is well above the €2.2 trillion mark)…

On the other hand, however, instituting a transfer union would go against the EU treaties (arguably, although that may somehow be circumvented by creative jurisprudential interpretation), the constitutions of numerous member states, particularly Germany, the will of many in the EU elite, and certainly of electorates.

For my part, I suspect that quite a few in the EU elite would welcome a transfer union: ‘Ever closer union’ means what it says.  How voters in the better-run EU states would react—if they are given a say—to the prospect of subsidizing the eurozone’s  poorer countries indefinitely might be a different matter, however.  And, yes, thanks to the continuing effect of the vampire currency on its weaker members, it would be indefinitely.


At a deeper level, the Eurozone and the EU in general is rapidly turning into the opposite of what it was supposed to be at its inception a quarter of century ago. From a club of advanced economies and well-run states governed by the principles of Ordnungspolitik, fiscal integrity, and market oriented competition, it has turned into a redistribution system which accepts the failure of modernisation for vast areas of the continent, accommodates clientelistic if not kleptocratic elites in the South, and openly accepts economic parasitism, until the exhaustion of the relatively few, still productive economic centres in the North.

As was always reasonably likely to be the case for the euro zone, at least, and as (if not in quite such dramatic terms) Germany’s Chancellor Kohl, the statesman who effectively greenlighted the euro, was warned before the currency’s birth.


The question of the transfer union is a real and quite imminent crossroads for the EU. If the EU gives up on its core idea of modernisation, the euro-project can kick the can for another generation or so, at the price of being held together almost exclusively by negative forces, namely the fears of a complete break-up and the unwillingness to face its costs, and accepting the defection of several smaller economies in the North. Otherwise, no transfer union will mean the break-up of the Eurozone: initially involving Italy and Greece, with an extremely uncertain future for both countries, and almost certainly the successive disintegration of the rest (France’s trajectory is in the long-run unsustainable, too).

We shall see. My guess is that those running the euro zone will indeed choose to kick the can even further down the road, and I’d be surprised (particularly in the present geopolitical climate) if any of those smaller Northern countries will be prepared to abandon this voyage of the damned.