Overcoming the political-institutional tensions that have characterized Italy in the last fourteen months opens up new prospects for economic growth and cooperative relations with the European authorities. In this regard, the recent attribution of the Economy to the designated Italian member – Paolo Gentiloni – for the new European Commission is an important signal. However, these promising prospects will not automatically translate into real progress. For example: the perimeter of the Economics portfolio assigned to Gentiloni is different from that for Economic Affairs held in the old (and still operational) Commission by Pierre Moscovici; above all, Gentiloni's skills are more limited than those attributed to Valdis Dombrovskis as executive vice-president designated with responsibility for one of the three leading areas (precisely the Economy) which are considered crucial by the new Commission. The fact that Dombrovskis has to carry out a coordination function also – but not only – with respect to Gentiloni's perimeter of action shows how much It is important that Italy does not force the European bonds and that - at the same time - knows how to exploit the many opportunities opened up by the general guidelines of the new Commission. These guidelines are, moreover, well expressed in the program drawn up by the new president of the Commission, Ursula von der Leyen, on the occasion of her appointment by the European Parliament.
Analogous and complementary considerations apply to the action of the Italian government. To strengthen effective Italian economic growth, the new government coalition between the Five Star Movement (M5S) and the Democratic Party will:
- overcome latent internal conflict, thus avoiding reproducing the pre-existing climate of political uncertainty in new forms;
- launch an effective economic maneuver which stimulates sustainable development in the short and medium-long term and which is, at the same time, compatible with European commitments and with a reacquired centrality of Italy in the European Union (EU).
In this Note I will focus on the second point, keeping short-term problems separate from medium-long term ones which, in reality, are also strongly intertwined.
HOW ITALY ARRIVES AT THE BUDGET MANEUVER
Let's start from the short term, referring to the next deadlines for the passing of the Budget Law for 2020.
The adjustments implemented last July by the M5S-Lega government in order to block the European procedure for excessive imbalances of the Italian budget with respect to the public debt (see the related budget adjustment law) had restored the conditions for the public deficit/GDP ratio at the end of 2019 it was around the threshold of 1,9% (according to government estimates) or 2% (according to that of the Commission). In any case, these were values close to those indicated in the Budget Law for 2019 (approved in December 2018). The result appeared to be achievable even in the presence of a growth rate of the Italian GDP of less than 0,5%.
It is very probable that, at the end of the current year, this forecast will prove to be too prudent thanks to two factors which cannot be included in the budget adjustment manoeuvre: the effective use of the two flagship interventions, launched by the previous government (“Basic income"and "100 quota”), is translating to expenses lower than the appropriations for 2019; the income deriving from unrepeatable events and - above all - from indirect taxes (VAT) thanks to the introduction of the electronic invoicing, are marking strong increases. In mid-July 2019, the Parliamentary Budget Office had estimated, on the basis of these dynamics and the trend towards a slowdown in the growth rate, that the public deficit/GDP ratio for 2019 could undergo further decreases, settling at 1,8% of GDP.
Over the summer, expectations of lower government spending and higher revenues strengthened. The most recent estimates predict a decrease in spending of around €5 billion and an increase in revenue of around €2,5-3 billion. It should be added that the same macroeconomic adjustments described above, combined with the results of the European elections at the end of June and with the expected return to very expansive monetary policies by the European Central Bank (ECB), they had already triggered reductions in the structure of interest rates on Italian bonds of public debt last July; this trend underwent a further acceleration with the launch of the new government. It is therefore reasonable to expect that, if the ECB restores unconventional monetary policies to the extent expected by market participants, by the end of 2019 financial charges on servicing the Italian public debt will decrease by around 500 million euros compared to the provisions of the past Budget Law.
Barring sensational changes by the administration Trump on the subject of international trade and of the British government on the subject of Brexit, the last months of 2019 will mark a slowdown in the euro area economies. While considering that - also as a result of this slowdown - the growth rate of Italian GDP for 2019 will be much lower than the forecasts of the past government (it will settle, at most, around 0,1%), the previous considerations lead to support That the public deficit/GDP ratio of our country could reach 1,6% in the current year.
About the Update note to the Economics and Finance Document (NADEF) that the new Italian government will have to present to the European Commission by the end of this month of September, this report should be sufficient to fulfill the commitments undertaken for 2019 towards the EU. Furthermore, if it were possible to reason with the legislation unchanged, the consequent "drag effects" should also guarantee the realization of that 0,6% reduction in the structural deficit/GDP ratio for 2020 which was requested by the European Commission for Italy's gradual approach to its medium-term objective (MTO) and which is part of the commitments undertaken by the past government towards the EU last July. Furthermore, the plausible prediction of a further fall in interest rates on Italian public debt securities of various maturities and of a positive - albeit moderate - growth rate of GDP for the new year (0,4% in forecasts of the Parliamentary Budget Office) should allow the setting in Italy of a public deficit/GDP ratio for 2020 - with unchanged legislation - of around 1,2%.
3. HOW THE NUMBERS WILL CHANGE
This framework of apparent fiscal rebalancing is, however, unrealistico. First of all, even if it were implemented in the terms set out above, it would be partial because it would 'forget' the problem of the Italian public debt. Furthermore, it is de facto unfeasible because it should be based on passive and restrictive tax policies (full increase in VAT rates without stimulus for the exit from the current situation of stagnation) which would have a short-term recessionary impact on the Italian economy and which, in any case, would not be compatible with the new government's arrangements.
Therefore, it is a question of redefining the framework outlined by introducing at least three further factors:
- The decrease in the public deficit/GDP ratio in 2019 will not lead to a corresponding fall in the Italian public debt/GDP ratio, since the 18 billion euros envisaged in the Budget Law for 2019 as a result of the sale of public shares will be missing movable property (17 billion) and real estate (1 billion); having suffered twice the opening of an infringement procedure for excessive public debt (November 2018 and June 2019), Italy will be forced to design a credible strategy for the gradual reduction of the public debt/GDP ratio in its 2020 budget law, without resorting to distorting expedients (transfers of shares owned by public companies from the Ministry of Economy and Finance – MEF – to Cassa Depositi e Prestiti, which is controlled by the MEF).
- Since the NADEF and, even more so, in the Draft of the Budget Law for 2020 (to be presented to the European Commission by mid-October 2019), the new Italian government will have to specify the alternative coverage to the use of the safeguard clauses which, for 2020, they predict increases in VAT rates and some excise duties for more than 23 billion euros; one of the qualifying points of the economic program of both the old and the new government excludes, in fact (in our opinion, too stringently), the activation, even partial, of these clauses.
- Even if still generic, the other qualifying points of the economic program of the new Italian government draw interventions to support economic growth (reduction of the 'tax wedge', relaunch of public investments, stronger incentives for innovation and education) and social cohesion (minimum wage, poverty reduction) which will lead, in 2020, to decreases in revenues and increases in public expenditure for an estimated amount of at least 15 billion euro; it should be noted, in this regard, that a large part of the coverage for public investments has found other uses in past financial years and should therefore be reinstated.
Faced with a tendential reduction in the public deficit/GDP ratio of around 1,2% for 2020 (see above), Italy therefore risks having to face an overall burden on its budget balances of more than two percentage points of GDP. In 2020, as well as in subsequent years, an increase in the public deficit/GDP ratio that exceeds (or even stands around) the 3% threshold would, however, be incompatible with the agreements made with the EU. Above all, this increase would have even more significant effects on the public debt/GDP ratio: given the failure to reduce the aforementioned ratio in 2019, in the absence of ad hoc adjustments, its growing dynamics would be confirmed and aggravated also in the following years and would expose the Italy to new tensions due to excess public debt (with the concrete risk of frustrating the reduction of financial charges on this same debt). Which would call into question the medium-term sustainability of the Italian public budget.
4. INVESTING IN INNOVATION AND IN THE SOCIAL STATE
The realistic short-term picture is, therefore, much more problematic than the hypothetical analysis with the legislation unchanged would suggest. It is therefore inevitable that, without falling into the habit of indiscriminately zeroing out what the previous government did, the new coalition will reduce public budget imbalances for 2020 and subsequent years scaling back, as much as possible, the most inefficient spending increases or tax cuts implemented in 2019 (“Quota 100”; 'flat' rate for a part of self-employed workers below given income thresholds; and so on).
However, the problems to be addressed take on even greater importance if the short-term framework, which has just been outlined and focused on the presentation of the Budget Law for 2020 and its preparatory stages, is linked to the medium-long term prospects.
Recent analyzes reaffirm that the Italian economy and, in particular, the manufacturing sector can count on companies of excellence that are located on the international frontiers of innovation and that defend and strengthen our shares in world trade. However, such companies have too few national imitators. Thus, the majority of Italian companies remain uncompetitive also because they are crushed by their very small dimensions, which are ill-suited to the combination of technical innovation and organizational innovation imposed by the new technological trajectories. This explains why our economy is an extreme case of the innovation delays accused by the entire EU and the euro area of China and the United States in terms of artificial intelligence and digital technology. This double Italian delay (with respect to non-European international areas and the EU itself) is the main cause of the stagnant dynamics in our average labor productivity and other forms of productivity, which has now lasted for more than twenty years and which creates a growing rift between the limited subset of internationalized Italian companies and the majority and backward body of national companies. Adding to a negative demographic dynamic (significant aging of the population), the stagnant average labor productivity implies that Italy's lack of economic growth capacity is a structural and not an accidental factor.
It is therefore essential that the new Italian government vary, as soon as possible, a systematic and well-designed set of incentives for innovation. In this regard, the recommendation to the new government is to allocate the available resources efficiently, establishing - for example - close links between the composition of new public investments and the incentives for the dimensional growth of very small and small private companies with innovative potential.
The opening of the Italian economy to innovation, which is an essential condition for restarting medium-long term growth, however has the effect of accentuating – in the short and medium term – the serious social vulnerabilities of our country. Already today the activity rate, i.e. the active presence in the labor market of the (declining) share of the Italian population of working age, is one of the lowest among the economically advanced countries. Despite this, the Italian unemployment rate, i.e. the percentage of those who are active in the labor market but cannot find employment, is structurally above the European average (especially for the weakest groups of workers and, in particular, for young people; and for the more marginal areas, such as the South). Moreover, employed Italians have skills that are ill-suited to innovative productions because they boast levels of education and qualifications lower than the European average and, with the same education, they have specializations further away from frontier technical skills. The result is that Italian companies try to compensate for the low quality of their demand for labor and the related supply, by squeezing money wages, which – moreover – are burdened by a high 'tax wedge', or resorting to short-term solutions which accentuate the structural inefficiencies of our economy (temporary and unprotected jobs). It is not surprising that, in this situation, Italy has not corrected the increases inequalities in the distribution of income occurred in the years in which the central countries of the EU and the euro area began to adopt new innovative technologies (early nineties); and has seen the growth of the phenomenon of 'poor' workers and the incidence of absolute and relative poverty as a result of the further polarization between the highest and lowest income classes in the last twenty years.
In the presence of such vulnerabilities, a pervasive introduction of innovative processes without corrective social policy interventions would have the effect of making a significant part of the current workers even more inefficient or unusable and of aggravating both income polarization and marginalization and the fall into some form of poverty of even larger shares of the working and active age population. It is therefore essential that the new Italian government increase investment in education and training, reduce the 'tax wedge', strengthen the fight against poverty, provides for new protections for the income and integration of the unemployed. If anything, the recommendation to be made is that the new government not limit itself to sporadic interventions but finance a systematic design of welfare state reform. In fact, the traditional idea according to which the welfare state should only intervene ex post to protect and reintegrate the segments of the population most affected by economic changes must be overcome; instead it is a question of intervening also and above all ex ante so as to prepare and/or adapt the population, especially but not only young people, to the transformations taking place in the innovative processes.
5. FLEXIBILITY IS NOT ENOUGH
These considerations have at least two implications. First: they show that, in the long run, the management of the Italian public budget cannot be simple maintenance or ordinary administration. If the objective of making Italy a competitive country capable of sustainable growth within one of the most advanced areas of the international economy (the EU) is pursued, it is necessary to foresee a radical change in the composition of public expenditure and revenue and be prepared to manage its impacts against vested interests. Only in this way will it be possible to build a society open to economic innovations and centered on equity (equality of opportunities in a substantial sense). Second: the same considerations show that, in the short term, the problems of the Italian budget cannot be tackled effectively if the already difficult combination of growth stimuli and balance adjustments is separated from the objectives and related medium-long term interventions. Increases in public spending and/or reductions in taxation must become pieces of a broader plan, which find their complement in socially ineffective and economically inefficient 'cuts' in public spending compared to the more innovative and more equitable society that we mean build in the medium to long term.
The two implications mentioned may appear visionary. However, they have at least three very concrete consequences at both national and European level.
At the national level, it follows that the Italian economic and social decline can be arrested only if one admits that, during the extraordinary period of rapid economic development after the Second World War (1952-1979) and - above all - in the following decade, there has been an accumulation and crystallized protected annuity positions that are no longer sustainable today in terms of level and composition of public debt and social cohesion. The non-ordinary management of the public budget must reduce these rents through the implementation of punctual and concrete interventions, which are able to affect the many inefficiencies both public and private.
The two consequences at European level, however, concern the risk of using an easy but distorted way to link short-term and long-term problems: the search for fiscal 'flexibility' instead of stringent agreements with respect to European rules.
The previous analysis clarifies that, for the new Italian government, it would be almost impossible to reconcile the relaunch of sustainable growth in the medium-long term and the gradual adjustments of our public debt without European cooperation which makes it possible to manage, in the short term, a part of the financial charges deriving from efficient public investment programs for the reform - for example - of our educational systems or for the creation - for example - of intangible infrastructure for the innovation of our businesses.
This cooperation can, however, result in two alternative strategies:
- the European institutions grant our country margins of fiscal flexibility, i.e. they loosen the constraints with respect to temporary increases in its public deficit/GDP ratio above the trajectory of convergence towards the medium-term objective (MTO), without any evaluation and any centralized control regarding the allocation of excess expenditure or the reduction of revenues but also without making any commitment of future support in the event of emergency situations in our public budget;
- Italy agrees with the European institutions a multiannual program of reforms and investments and accepts centralized periodic checks on the gradual implementation of this programme, in exchange for obtaining centralized funding which does not weigh entirely on its budget as long as the program is implemented according to the agreements made and in forms consistent with a shared and explicit medium-long term plan.
The first strategy, which tends to be preferred by any national political coalition because it places no restrictions on its fiscal choices, is very dangerous. It translates into the use of flexibility for short-term public commitments which, as happened in Italy in past years, can disregard the implementation of the investments and reforms required by the medium-long term plan without immediate sanctions. The result is that, once the margins granted by the European institutions have been exhausted, the country (in the case of Italy) would find itself with aggravated imbalances in its public budget and - therefore - with even more stringent constraints for relaunching sustainable growth of long term. Strategy (ii), which in the short term appears politically more costly because it involves a transfer (albeit shared and temporary) of national sovereignty, vice versa represents an opportunity to translate the management of the public budget into a set of elements consistent with a design long-term at least partially supported by the European institutions.
The objection, which can be advanced with respect to the conclusion just suggested and which leads us to the second consequence at the European level, is that the first strategy ends up weakening the current and distortive tax rules of the EU and the Euro-area while the second strategy fully accepts and legitimizes these rules. Therefore, fiscal 'flexibility' would have a positive impact not so much due to its short-term effects on national public budgets as because it would act as a lock pick to loosen the rules and strengthen cooperation between countries in the long term.
Such an objection risks producing unintended but serious negative effects. It is true that the European tax rules show significant problems and can be much improved; and indeed it is urgent to start a reflection in this direction. However, the validity of those rules represents the glue that ensures the coexistence between a centralized monetary policy and some form of institutional coordination between decentralized, i.e. national, fiscal policies. A pure and systematic relaxation of fiscal rules would lead to the de-responsibility of the European institutions compared to the fiscal imbalances accumulated at the national level, in the sense that countries with high public debt would find themselves exposed to the volatile valuation and sanction of market investors without any European institutional protection.
This menacing prospect is not theoretical but has already manifested itself in the recent reform of the European Stability Mechanism (ESM). After having long favored stringent European fiscal rules (with the tightening of the Stability and Growth Pact), the more rigorous countries of the Euro-area are now moving towards granting growing margins of fiscal flexibility in favor of the most fragile countries. As emerged in the December 2018 and June 2019 meetings of the Eurogroup and the Eurosummit, however, these countries demand in return a quasi-automatic restructuring rule of sovereign debts for the member states which are then forced to activate European aid programs at the ESM. The new strategy thus consists in placing to the individual member state in difficulty full responsibility and all the burdens deriving from its persistent fiscal imbalances.
