This weekend, I was invited at a conference on the global and European economic situation in nothern Italy. Many scientists of very high caliber as well as high ranking policy-makers (from the EU and the ECB) attended (you can visit the website here and here is one of the interviews that I gave (in Italian)).

It is was discomforting to see and hear once again how many misconceptions are still alive about the European crisis and how difficult it is – scientifically and even more politically – to find a solution to it or at least conceive a strategy that points towards it. I want to highlight once again the most important misunderstandings. I will especially comment on Italy and make some simple points that are difficult to refute, but, as the discussions showed, also not easy to communicate.

Some of the crisis countries are successful!

This still haunts the imagination of many, but here the desire is the father of the thought. It is the argument that the crisis countries have caught up, that this is proof positive that the ‚structural reforms‘ are working and that it would be a major political mistake to not push them through any further. However, as we show in almost every cyclical analysis that we publish (see here and here for the latest one) this is incorrect for sourthern europe. The hard statistical data do not show a turnaraund. GDP calculations by the statistical offices that come up with 0.5 or 0.8 percent growth are constantly being cited to prove that the turn has been made, that the crisis countries returned to grow, first and foremost Italy (economically speaking the most important crisis country). A simple lack of understanding lies behind it. The numbers prove absolutely nothing. The growth that is being reported may be due to chance or, as we always warn against, the rosy figures may result from the obedience and the ideological orientation of the statistical offices  They will sweep up everything that can be sweeped up if it raises their growth figures. We use several, well chosen parameters for our cyclical analyses: we look at the evolution of new orders and at construction, retail sales, price evolution, inflation and the rate of employment. On the basis of these data, it can be said with confidence that there has been no or almost no recovery in southern Europe.

But Ireland is growing again!

This has become very typical. At every conference, someone from Ireland will give a highly detailed overview of the policy measures that have been implemented in Ireland and how successful they have been. This gives many people the impression that the Irish case is interesting and that we can learn from it. What is usually forgotten (but as we have often said, for example here in our detailed examination of the so-called program countries), is the simple but essential fact that Ireland cannot be compared to any other country. Its economic structure is unique and very peculiar: Ireland has an export share of more than hundred per cent of GDP. I pointed out this weekend during a discussion that Italy and other southern European countries have an export ratio of 25 percent of GDP.  This should end the discussion immediately. The Irish case cannot be generalised. However, I bet that this fact is not being mentioned in ninety per cent of all conferences and therefore Ireland continues to be used as proof that the ‚reforms‘ are working. If economists would act like scientists, it would be unnecessary to have to repeat the same point over and over again. Everyone would accept it because it is irrefutble. But economics has become extremely politicised. People are not looking for the truth.

All Europeans must become competitive!

You will not believe it, but this argument is still being made with great and even renewed force. That Europe is a large and almost closed economy which also has a freely floating exchange rate against the rest of the world should constitute the main basic economic insights from which all else has to follow. It seems impossible to get it into policy-makers‘ heads. The fact that the exchange rate has the function of compensating for differences in competitiveness between economies and that, therefore, any attempt of a competition between nations under such conditions is senseless, is going against their wish that there should be such a thing as a competition between nations which would presumably be ‚better.‘

There is even a much worse mistake: all Europeans need to try to achieve to the same thing simultaneously, they all need to become more competitive. This goal, which is of course impossible, is being announced unscrupulously, as if it is evident. Again, it only takes two minutes to save the world from such a disastrous purpose – at least for the moment. How and why is it that economists are not sounding the alarm every day and that they do not correct any politician who is propagating this nonsense?

What Italy and others are doing goes in the right direction!

Even most of those who understand what has happened in the European Monetary Union believe that one can solve the crisis with gradual adjustments, with small but permanent ‚structural reforms.‘ The Italian problem is its competitive disadvantage to Germany, as we have repeated said. Since the beginning o the monetary union, labour unit costs in Italy have risen by thirty per cent more than in Germany.

Italy is proud of what it has accomplished in the meantime in terms of reforms of the political system (see for example the two articles by Guiseppe Vandai last week on our German site here and here). It also reformed its labour market. The latter is all about the so-called flexibilisation, decreasing employment protection and greater wage flexibility. Every interview an Italian journalist starts with the same question: what we are doing now in the labour market is correct, or is it not?

Italian policy-makers of course believe that if you go into the right direction, you  have already done the right thing. This is wrong. I will and cannot asses in detail whether what is happening in the Italian labour market is right or justified. But I can say very clearly and unequivocally that these labour market reforms will not solve the Italian problem within the EMU, not even if these measures are going in the right direction. Suppose that, in the wake of such measures, it would be possible to squeeze Italian wages and unit labour costs by one percent from now on every year (as Italian productivity is currently not growing, the fall in nominal wages by one percent would thus also mean a decline in unit labour costs by one percent). The Italian economy could, if wages and labour unit costs would rise in Germany and the other major trading partners regain its competitiveness in this way over many years (ten or twenty, it is not relevant).

This would mean nothing else than that the Italian domestic market from now on and every following year would be shrinking and that deflation would increase – and that for the next ten or twenty years. For many successive years, wage reductions and higher competitiveness would still show no positive effect, because the absolute gap with Germany would remain large and no market share could be recovered. In reality, for Italy this would therefore mean another five to ten years of recession on top of the current recession which lasted for five years already. There would be rising unemployment and increasing despair among the population. This is simply out of the question. Politically speaking, it cannot be done. Democracy will be not able to withstand the forces against it. Every pro European government will be outsed and nationalism will celebrate its victory with a vengeance.

I gave in Cernobbio a simple but astonishing message. It probably shocked the Italian public. The message is that Italy can decide whether it wants to die slowly or whether it want to die quickly. It will die slowly when it moves in small steps or if it does not progress at all. It can also die quickly, if it tries, as Greece, Spain or Portugal tried, to reduce wages in a very short by something like twenty or thirty per cent. The point is easy to understand, but mainstream economics refuses to come to terms with what is glaringly evident: the general level of wages in a country like Italy (or France) cannot be reduced with so much without triggering an economic catastrophe. The mainstream economists talk about this and that, but they never address the essential point, the issue that really matters.