My take on the Southern European debt crisis:
The euro’s worst nightmare has come to pass. Its Southern European fringe – often referred to by the dubious acronym PIGS – is creaking under the pressure of a brutal adjustment borne entirely by domestic prices. Latest estimates suggest that Greece requires a deflation so severe than it will take until 2017 to return to its 2008 nominal GDP. Spain’s unemployment rate has hit 20 per cent, and Portugal is also facing brutal reductions in living standards. This bleak outlook is spooking investors, threatening debt financing not only in Greece, but countries across the Eurozone periphery.
So were the opponents of extending the eurozone to the shores of the Mediterranean right? In one respect, yes. Critics argued that the reluctance of political leaders in the Southern countries to embrace structural reforms would hinder adjustment if they ran into competitiveness problems within the monetary straitjacket of EMU. Although euro membership brought inflation, interest rates and fiscal deficits down dramatically, wages still rose ahead of productivity in the Southern eurozone. Old problems such as inefficient public administration, demographically skewed social policies and lack of investment in human capital were addressed only half-heartedly. So when recession struck, the cohesion of the euro area came under immediate threat.
But this narrative tells only half the story. In fact, the countries in direst trouble at present enjoyed buoyant economic growth rates for most of the noughties. Spain in particular won praise for its embrace of economic openness, financial liberalization and fiscal rigour. Its post-euro boom raised living standards and transformed Madrid into a major corporate and banking centre, whilst Spanish companies went on buying sprees in Latin America. In contrast, Italy’s stagnant growth rates were attributed to its refusal to countenance changing its inward-looking, sclerotic form of crony capitalism and addressing its burden of national debt. Aznar and Zapatero were lauded abroad for presiding over Spain’s economic miracle; Prodi and Berlusconi condemned by the Anglo-Saxon financial press as unfit to govern the European Commission and Italy respectively.
In 2010, a very different picture is emerging. Spain’s new economic model is now looking decidedly peaky. It is now apparent that, as in the UK and Ireland, Spain’s impressive growth performance was a function of the Greenspan bubble. Spanish property prices doubled between 1995-2007, even though residential construction was expanding at such a rapid rate that only mass immigration could meet the sudden demand for low skilled labour. A good part of the boom was driven by speculative investments by Northern Europeans generating a trade deficit of around 10 per cent of GDP. The building boom spilled over into the rest of the economy, bringing unemployment down to unprecedented levels. Yet as in any other case of irrational exuberance, investors over-reached themselves, leaving deserted building sites and a million unsold homes, and sawing 4 per cent off Spain’s output in 2009. Despite running fiscal surpluses throughout the boom years, Spain very quickly found itself running deficits of around 10 per cent.
In contrast Italy, which has not run a budget surplus for over quarter of a century, finds itself in a rather less dramatic situation. The current government deficit is, at just over 5 per cent of GDP, within touching distance of the limits imposed by the Stability Pact, and bond prices as yet show little sign of contagious panic. Output has certainly shrunk sharply in this recession and unemployment is rising, yet the Italian press is relaxed enough about the crisis to focus instead on the endless saga of Berlusconi’s encounters with judges and showgirls, and the inevitable government reshuffle as leaders jostle for position after each round of local elections. In short, while Spain faces economic collapse, for Italy it is business as usual. Why?
The answer lies in the perils of financialization. Although the big Spanish banks adopted a conservative approach to capital requirements and remain apparently solvent, Spain’s openness to foreign capital flows imported the Greenspan bubble and stoked a housing boom to match those in America and the British Isles. The sound budgetary position of the Spanish government masked the accumulation of household debt whilst the euro hid the symptoms of an unsustainable trade deficit. The severe imbalances of the Spanish economy were ignored because Spain ticked the correct boxes according to the orthodoxy of the boom years: fiscal probity, openness to financial flows, and an acquisitive and outward looking corporate sector.
Meanwhile Italy was doing everything wrong. Outside capital – whether industrial or financial - was shunned. When Dutch bank ABN-Amro sought to expand into Northern Italy by buying the Venetian Banca Antonveneta, Bank of Italy governor Antonio Fazio pulled out the stops to block the deal. He first used regulatory powers inappropriately, and then mobilized contacts in the Italian financial world to generate an unsuccessful counter-bid, which allegedly used insider-trading to raise the capital for an alternative deal. At the time, the affair seemed symptomatic of everything that was dragging the Italian economy down: regulatory inefficiency, corruption and cronyism. Yet, when the financial crisis hit, ABN-Amro, now owned by the Royal Bank of Scotland in a deal involving the Spanish Banco Santander, found itself forced into the arms of the British taxpayer by insolvency. In an ironic twist, Antonveneta was sold off by Santander back to another Italian bank, Monte dei Paschi di Siena.
The story of Antonveneta is evocative of broader trends in the Italian economy. This protectionist instinct of Italy’s political and economic elites was not limited to finance: Berlusconi’s trashing of a deal, carefully brokered by Prodi’s government, to sell off national carrier Alitalia to Air France-KLM reflects the same logic applied to the industrial sector. Alitalia may not be viable as a global airline, but regulatory manipulation and backdoor subsidies allow it to continue to dominate Italian airspace. This mercantilist style has clear fiscal and efficiency costs. But rejection of open markets, long criticized by outsiders as a drag on growth, proved an asset when the global financial system imploded. Hostility towards foreign investment protected Italy from the direct effects of the crisis, as there were no flows of hot money to dry up. Italian output suffered as a result of the collapse of its export markets, rather than a fall in domestic demand.
The Italian elites’ determination to retain control of their economy by curbing markets was theorized by Giulio Tremonti, Berlusconi’s Treasury Minister, in a book, La Paura e la Speranza, published in early 2008. For Tremonti and his allies on the Italian right, globalization was always seen as a threat rather than an opportunity. The Italian left, ironically, has increasingly embraced a ‘third way’ style of politics which accepts many features of market liberalism, such as flexible labour markets, privatization and the deregulation of professional services. The electoral consequences of this unlikely political division of labour have been clear: Berlusconi consistently trounces the left at election time. Tremonti’s modern-day mercantilism is not an option for the left, since it generates rent-seeking opportunities which have regressive implications for income distribution. But if there is a lesson progressive forces in Europe should learn from the Southern European experience, it is that voters do not like the downside of free markets and crave protection from the volatility of globalized finance.