Italexit? A bad dream

Italexit? A bad dream - Massimiliano Marzo

The current debate about the merits of the European Union is coming to a cornerstone, at least within the Italian and (to some extent) European public opinion. Forecasts about 2017 GDP project a growth rate of around 0.9/1 percent, one of the lowest rates among EU countries. Advocates of Italexit (i.e. the exit of Italy out of the EU) focus on the historical correlation that exists between Italian productivity and the exchange rate of the Italian Lira (the currency existing before Italy joined the Euro). Historically, a more depreciated exchange rate has been associated with a higher level of productivity. Supporting this obvious principle does not acknowledge the fact that the real problem in the Italian economy is endemically low productivity. Thus, a key aspect missing from this debate is that productivity is considered gross or net of labor taxes. As pointed out by McGrattan and Prescott (2010, 2012), too often there are measurement problems delivering a productivity measure gross of taxation, which makes it quite complicated to ascertain the truth. Certainly the level of fiscal burden (especially on labor) in Italy is severely distorting measures of productivity and efficiency. Resorting to devaluation represents a simple rebranding of the problem. On the other hand, the challenges for Italy are evident: low growth is associated with a future path of increasing nominal interest rates, making the management of the huge Italian public debt (forecasted to be about 133.1 percent of GDP by EC by the end of 2017) costlier. At the same time, both a prolonged recession and weak economic recovery are two of the key reasons for the troubled state of the Italian banking system, for which the Italian government has set out a 20 billion fund to cover potential losses on Non-Performing Loans. The ECB has already announced a reduction in their quantitative easing program, which will likely be followed by an increase of short-term policy rates, given the increased inflationary expectations. 

With such a difficult situation at hand, many advocate to get out of ‘EU-jail’, by returning to the ‘good old times’ with a competitive devaluation scheme. The argument pro-exit is based on the very generous assumption that currency devaluation (post-exit) would reach only 30 percent versus the Euro. In this way, the cost of the exit almost balances with the cost of remaining in the Union (mainly due to the fiscal restraint expected to be put in place to control the increase of public debt). However, this might not come true, because of the increased level of international trade competitiveness. On the other hand, it is also true that the current rules of EU policy making are too restrictive to allow for serious restructuring of the Italian fiscal policy. A possible solution would be to allow for asset swaps, by replacing costly short-term debt with longer-term debt issued at lower interest rates. This is quite easy, given that more than 70 percent of Italian public debt is in the hands of Italian entities (households and private sector, broadly defined). Unfortunately, this approach is not allowed under current rules. An alternative proposal (close, at least in spirit to what has been proposed by Andritzky et al., 2016), would be to allow different degrees of subordination on public debt issued by the same state: for example up to 60 percent of public debt to GDP bonds have an higher degree of seniority with respect to bonds exceeding, for example, a 100 percent ratio. Another solution would be to make any debt restructuring initiatives contingent to serious structural reforms upon fiscal revenue collection and other crucial aspects which have an impact on trade competitiveness. In any case, such reforms have certain and quantifiable costs. The redenomination of public debt into another currency (the old Lira), implies that the Italian exit out of the EU comes with high and uncertain costs. To reduce uncertainty about this issue, it would be better to start by solving some of the deep structural problems of the Italian economy and promoting a different set of rules to manage surpluses and deficits within the Euro Area. Without a clear signal on this issue (one that should indeed come from all EU members), it will be difficult to curb the current uncertainty. 

Massimiliano Marzo is an adjunct professor of International Economics at SAIS Europe and an associate professor of Economics at the University of Bologna. He combines academic activities with active consultancy jobs. He is a risk management consultant for several banks and financial intermediaries. Moreover, he is often involved as a consultant in trials with financial murders (insider trading, market manipulations, excessive risk taking). Currently he is a board member of several companies and investment funds, as independent board member: Simgest SIM, Finorefici SIM, FactorCoop, CNS, Lugo Immobiliare, Unifortune Asset Management (where he serves as Chairman of the Board), CPL Concordia (where he is Chaiman of the Risk and Control Committee). 

Professor Marzo is a commenter on economic themes for Corriere di Bologna, the local edition of Corriere della Sera. He is often requested to discuss future economic scenarios during interviews and public speaking engagements.