Lost in Deflation: Why Italy’s Woes Are a Warning to the Whole Eurozone

Abstract

Using macroeconomic data for 1960-2018, this article analyzes the origins of the crisis of the "post-Maastricht Treaty order of Italian capitalism." After 1992, Italy did more than most other Eurozone members to satisfy EMU conditions in terms of self-imposed fiscal consolidation, structural reform, and real wage restraint-and the country was undeniably successful in bringing down inflation, moderating wages, running primary fiscal surpluses, reducing unemployment, and raising the profit share. But its adherence to the EMU rulebook asphyxiated Italy's domestic demand and exports-and resulted not just in economic stagnation and a generalized productivity slowdown but in relative and absolute decline in many major dimensions of economic activity. Italy's chronic shortage of demand has clear sources: (1) perpetual fiscal austerity; (2) permanent real wage restraint; and (3) a lack of technological competitiveness, which in combination with an overvalued euro weakens the ability of Italian firms to maintain their global market shares in the face of increasing competition of low-wage countries. These three causes lower capacity utilization; reduce firm profitability; and hurt investment, innovation, and diversification. The EMU rulebook thus locks the Italian economy into economic decline and impoverishment. The analysis points to the need to end austerity and devise public investment and industrial policies to improve Italy's "technological competitiveness" and stop the structural divergence between the Italian economy and that of France/Germany. The issue is not just to revive demand in the short run (which is easy) but to create a self-reinforcing process of investment-led and innovationdriven process of long-run growth (which is difficult).

A Rejoinder

“…The best example is the use of mechanical fiscal policy rules, biased toward austerity and based on a narrow supply-side interpretation of output gaps, which have de facto led to the destruction of production capacity and a decline in potential growth. Capaldo uses the Italian macroeconomic experience to illustrate this pointwith which I am, of course, in strong agreement (Storm 2019). His discussion of the fiscal multipliers used in two recent DSGE model studies for the Italian economy offers a stark illustration of the disconnect between the pompous rhetoric, emphasizing micro-foundations and deep parameters, and the praxis of deliberately choosing lower fiscal multipliers (from a budget-neutral exercise) to assess the macro impacts of a fiscal stimulus involving years of budget deficits.…”

Local David Versus Global Goliath: Populist Parties and the Decline of Progressive Politics in Italy

“…The history of Italian economic stagnation is open to debate and starts well before the 2008-2009 economic crisis. As Storm (2019) shows, much of the economic slowdown that Italy has been experiencing is rooted in policies that actually were adopted some decades earlier, as Italian governments of different political leanings sought to transform the Belpaese into the Eurozone's poster child, shifting blame to the EU and external constraints for decisions taken in Rome rather than in Brussels. Italy in fact ran a budget surplus in each year following the signature of the Maastricht Treaty, with the exception of 2009 budget.…”

“…Cuts were particularly concentrated on social protection: according to Pavolini et al (2015), after 2009 social expenditures decreased by 0.9%, compared to a decrease of 0.6% at the EU level. As such, while in 2008 per-capita expenditures on social protection were at 80% of the EU-4 average, they were just 72% of the EU-4 average in 2018 (Storm 2019). As the crisis hit, austerity thus actually accelerated.…”

Innovation drivers of external competitiveness in the great recession

“…With specific reference to the Italian case,Storm (2019) highlighted how the contraction of domestic demand contributed to prolong and exacerbate the impact of the 2008 crisis.…”