In the last few weeks, Makroskop published a number of contributions about political developments in Italy (see for example here). I thought that it would be a good idea to complete the picture by presenting a thorough macroeconomic analysis of the country and compare it to its main competitors, Italy and France. The article is in two parts. Part 1 deals with the loss of Italian competitiveness and export due to German wage moderation. Part 2 explains how the crisis of the Italian export sector affects the economy in globo and diminishes the capacity of the Italian state to react.

There is, in all likelihood, no other European that many Germans are more prejudiced against than Italy. The picture of the good life which prevails most of the time and the dolce vita cannot be removed from German heads, not even when one presents them with a serious number of impressive past Italian economic performances. And so the widespread prejudices persist. Italy remains the country, which once had the chronically weak Lira. It high public debt was just not manageable. The European Monetary Union (EMU) brought this to the surface for everyone to see.

The popular conception of Italy’s economy is false

These popular beliefs are all wrong. It was wrong in the past and it is wrong now, just as the current dominant German diagnosis of the Italian patient is wrong. To realize how bad it all is, one only needs to read what the FAZ (Frankfurter Allgemeine Zeitung) correspondent for Italy manages to write up with monotonous regularity (see here for his latest contribution). Tobias Piller reports with indignation that, at the moment, in Italy an “adventurous” (read: irresponsible) discussion is taking place in which Germany’s policy in the monetary union is being castigated for Italy’s problems. In the same newspaper the world economy editor, Thomas Mayer, writes that there is no denying that ‘for 18 years now, Italy has failed to assert itself economically in the monetary union,’ (see here).

The ‘best-selling’ authors Friedrich and Weik have nothing to mention than to repeat Hans-Olaf Henkel’s senseless conclusion that ‘The politically motivated currency experiment (was) just too stringent for Italy’ (see here). None of this has anything to do with economic reality. These are nothing but cheap diversionary tactics. It is always the same: journalists – and not only them – will go at great lengths to discuss the role of the deficit countries. The surplus countries are not the problem, it is the deficit countries which are dysfunctional. Currently, Italy no longer has a current account deficit, but it continues to suffer from the disease that the deficit would increase substantially if the economic situation would return to normal.

When using GDP figures, it is true that the overall economic development of Italy shows a frightening picture when it is being compared to Germany and France (see figure 1). Italy did keep pace with Germany until 2007, but in 2008 its total economic output collapsed and since then it has practically not recovered. Italy has been in a severe recession since 2011. In contrast, France reacted very well to the financial crisis of 2008/2009, much better than Germany, but, after the crisis, for the last couple of years it has been incapable of keeping up with Germany.

Figure 1.

The drama of this failed development becomes even clearer if, instead of looking at the evolution of the GDP, we examine the evolution of manufacturing output (see figure 2). Here, the development of France and Italy is almost uniform since the early 2000s, but it is especially so since 2004. Both countries are lagging behind German development. The difference is that industrial production in France, in contradistinction to Italy, did not plummet in and after 2011.

Figure 2.

 

Competitiveness in the EMU

Nothing else explains these major differences than the massive divergence in unit labour costs which started to concretise in Europe with the start of the Monetary Union (see figure 3). I do not want to comment on this again here. The facts are there for anyone to see. By 2006, the gap between Italy and Germany – where labour costs did not increase during the first years of the EMU – had already grown to 20 percent.

Figure 3.

No reasonable person can have any doubt that such a gap in labour unit costs between countries leads to a skewed economic development that has, at one point, to evolve into violent rupture. Today, it is largely forgotten that, well into the 1990s, Italy was one of the Germany’s main competitors in engineering – the industrial sector pas excellence.

Even if the country had a relatively weak currency in the past (older  ‘experts’ still like to poke fun of the chronically weak Lira), this has in fact nothing – and I mean absolutely nothing – to do with the Italian ability or inability to produce competitive products. The Lira was a weak currency, mainly because inflation in Italy was relatively high, especially compared to Germany. But this did not in any way affect the production of some of the best products that one can imagine – this is, anyway not as long as the country was capable to depreciate its currency when circumstances demanded it.

The real effective exchange rate of the three countries (i.e. their global competitiveness) shows exactly the same picture (see figure 4). Italy greatly appreciated with the launch of the monetary union. France also appreciated, but less strongly. Germany massively depreciated and in doing so it greatly increased its European and global competitiveness because of its wage moderation policies.

Figure 4.

Once Italy was in the EMU, it got stuck in a real appreciation – its products became more expensive because of higher labour costs. It rapidly lost its ability to remain competitive and boost its export. Figure 5 shows the evolution of Italian exports.

Figure 5.

Win one, lose two

It happened, at the latest, in 2004. France and Italy decoupled completely from the exorbitant German development. Since then the gap only became larger, year after year. After the global financial crisis, the German export industry increased its pace. German politicians decided to go for German mercantilism as never before. Germany managed to build up a stable cost advantage of at last 15 per cent with France and well over 20 per cent with Italy. These advantages made it possible for German export to displace their European competitors from European and global markets.

Germany also leads in imports, although imports are well below the level of its exports. France, on the contrary, imports almost as much as Germany, but its export are nowhere close to Germany’s (see figure 6). In Italy, imports collapsed following the deep recession. Today, they are below the level of 2007.

Figure 6.

Whenever the Italian export position slightly improved, the Italian current account improved of course with it and even showed a surplus in 2012. But this has no bearing on the fundamental underlying problem. The decline in imports is probably completely attributable to the deep recession. In the meantime, Italian international competitiveness did not improve (see figure 3).

Figure 7 cannot be beaten for clarity. It depicts how the development of the divergence of unit labour costs reflects itself in the accounts. It takes a lot of ignorance or ideological misconception to not understand or not want to understand this.

Figure 7.

The loss of competitiveness compared to Germany sealed the fate of the Italian patient. Within the constellation of the monetary union, there is no easy out. There is also no way out that would, politically speaking, be easy to manage in a democracy.
You can read the in second part how the crisis in the export sector affects the Italian economy as whole and how it diminished the ability of the Italian government to solve these urgent economic problems.