We showed in the first part that the Italian economy is doing very poorly and we explained that this can only in part be attributed to specific Italian circumstances and policies. We now need to answer the question how the economy can be turned around and why this does not happen. The crucial turning point in recent Italian economic history was the global financial crisis of 2008/2009. As we showed in the first part, Italy ended up in a deep recession. Until today it has not recovered. The evolution of investment is very interesting (see figure 1). Unlike France and Germany, where investment more or less stagnated after a slight recovery after the Great Recession, Italy witnessed a brutal crash.

Figure 1

The evolution of the rate of investment tells the same story (see figure 2). The rate of investment fell from quite satisfactorily levels to below 17% of GDP. The comparison with France and Germany shows it bad this really is. This is not to say that Germany and France’s investment rate should be evaluated positively, but it is far better than what happened in Italy.

Figure 2

How can this brutal decline in investment be explained? It certainly has to do with the inability of Italian exporters to regain their position on the international markets after the recession. But this factor alone is insufficient as an explanation. The weak export position went together with a blatant weakness on the domestic market. Furthermore, in 2012, after the outbreak of the crisis in the European Monetary Union, there was, in addition an extremely strong decline in already weak private domestic consumption (see figure 3), also a marked decline in government spending (see figure 5).

Figure 3

The slump in private consumption, which quantitatively speaking is of major importance for Italy (it is ca. 60 percent of GDP), coincides with a huge increase in unemployment from 8% before the crisis to a new high of 12% (see figure 4). It is absolutely clear that consumer uncertainty, which was in turn driven by the inactivity of economic policy-makers, caused the crisis to intensify.

Figure 4

An additional factor was that the state – which is after all responsible for one third of private consumption – also significantly reduced its spending.

Figure 5

On the other hand, change in real wages was not a important determinant of the decline in private consumption (see figure 6). In 2010, real wage per hour stood in Ital on an almost equal foot with Germany and in the meantime it only stagnated.

Figure 6

The stagnation of real wages in Italy is due to its weak productivity growth – this is one of the main factors distinguishing the Italian economy from the economies of Germany and France (see figure 7).

Figure 7.

In fact, productivity growth in Italy was already very weak before the acute lack of investment took hold. The country had succeeded, without major internal conflicts, to keep real wage development in sinc with productivity gains. In principle, this should have been sufficient to ensure price stability as well as the stability of real demand of households. The fact that Germany – Italy‘s most important trading partner – had committed itself to a completely different policy, which would turn out be very counterproductive to Italy had not been anticipated by Italian policy-makers and they responded to it much too late.

Which economic policies need to be followed?

Given these conditions, it is clear to anyone with common sense that the solution must come from the state. The fiscal balances of the three domestic sectors and from abroad (see figure 8 ) leave no room for doubt.

Figure 8

Households that had traditionally a very high savings rate and a high positive net balance landed since the start of monetary union at a very modest level. It even tended towards zero during the global financial crisis. After that, the savings rate of households somewhat recovered, but it remains very low even today. The big problem in Italy, as in many other countries, are the companies.

The cards are stacked against Italy. Only government intervention can guarantee success of the various adjustment processes, but the state is being forced by the EMU, and in particular by the euro group under German leadership, to implement exactly the wrong policies.

To explain this in a bit more detail: the positive foreign balance has no meaning because it is only a reflection of a long and severe recession. It is not, as I explained in the first part, a sign that competitiveness is improving. Italy’s competitiveness cannot improve without an absolute wage cut, but such a wage cut would once again decrease domestic demand, so this is not possible. A move in which the state pushes households to spend their already low savings at a zero interest rates is pointless as well as risky. This is not the way to stimulate consumption.

As I said, the crucial problem in Italy are the companies. No one has tried to make companies, of which the financial balances are positive, to go into debt and invest in productive infrastructure. It is certainly more risky than to force households into more consumption. To put it bluntly: there is no well thought-out mechanism which has proved to work that the state can rely upon to force companies back into their crucial function in a market economy, namely to be the bearers of leveraged investment.

Consequently, the Italian state lacks the macroeconomic ability to act. Only government can, regardless of the level of government budget deficits and absolute levels of debt, create the impetus necessary to reboot the economy. But this is exactly what European economic governance outlaws.

The result of this is, as anyone can see, pure genius. During the 1970s, the neoliberal counterrevolution redefined the role of the state. It had to pamper companies, give them tax breaks, cheap labour and other advantages. The profits of companies improved without them seeing the necessity to go into debt and invest. At the same time, the neoliberals forbid government to go into debt itself. In Europe, this is against the law. There is however a solution. We all need to go for the ‚German solution:‘ the budget of all countries must be positive! This is possible, in principle, as soon as we start trading with other planets.

Figure 9