The wrong menu

With the publication of Monti’s ‘nation saving’ budget in Italy (here in Italian) and news that Frau Merkel and Sarko have agreed a ‘fiscal compact’ to save the Euro we can see the shape of a week that may postpone Italy’s exit from the Euro but which will surely make it yet more likely in the long run.

First, Monti’s budget looks like a classic Italian serving of pointless, bureaucratic complexity. There’s another expensive-to-collect tax on yachts, and one one private aircraft, which will doubtless raise a net of about 8 euros. There is the return of property tax on first homes, but at a pretty low level and with various possible exemptions. Note that there is no attempt at simplification of different house-related taxes by, say, merging the new levy with the tax on rubbish disposal (known by the acronym TARSU), and sacking half the people who collect these taxes. Monti, may be a technocrat in theory, but this looks like the standard, tried-and-failed fare of the left-of-centre parties. On that note, the Welfare Minister cried while announcing pension cuts (perhaps troubled by the enormity of her own salary).

Why not do tax like Italy does its food? Simple, digestible and to the point. And then apply the tax. You never get to leave a restaurant without paying.

Meanwhile Frau Merkel and Sarko are coming up with a scheme to sanction countries like Italy that don’t stick to budget targets. This plays to German political opinion, but completely misses the point.

It treats Italy as a debt problem. But it isn’t. Italy is a growth problem that can only be resolved with legal system, bureaucratic and labour market reforms that make growth possible. Italy needs to be made to work institutionally.

All this Merkel-Sarko deal is likely to do is to keep the fiscal squeeze on Italy and provide a temporary respite for the Euro. But if Italy cannot grow it will never be able to pay its debts, even at 5% interest.

What we are likely to get this week will be the worst possible outcome. There won’t be pressure for pro-growth reforms from Merkel. And Mario’s budget performance suggests he can’t produce institutional change either.

The Italian economy will just shrink away faster than cuts can be made and taxes levied.

More:

The FT (sub needed) on Merkel and Sarko’s agreement.

IMF headlines you thought you’d never see

The FT (sub needed) today has an article headlined ‘IMF raises alarm on capital flows’. I kid you not.

It is about a new IMF report highlighting cross-border risks from uncontrolled capital flows. This from the agency which helped global banks rape half the world by campaigning for the premature lifting of capital controls in Latin America and Asia in the 1970s and 80s. (You will remember that the IMF was trying to make the abolition of all capital controls an objective in its Articles of Association in the midst of the Asian financial crisis in 1997.)

The FT is apparently unaware of the ironies inherent in an article of this nature. One era just segues into another.

 

Rich and miserable, by graphs

Krugman highlighted a great site on his blog this week. And it is a great site, so here’s the link if you haven’t seen it.

The World Top Incomes Database has income distribution data for 22 countries, with more being added, over long periods of time. Go to the graphics page and you can call up series for different shares of the population for your favourite countries.

I went for the top 5 percent of tax payers in the UK, US and Denmark since 1900. The top 5 percent of earners in the US and UK have gobbled 25-30 percent of national personal incomes in recent years. In Denmark — the country which consistently tops out the rankings in European ‘happiness’ surveys — the percentage is consistently under 15 percent. (UK and US shares were of course lower until the well-known inflection point in the 1970s).

Unfortunately I can’t reproduce the graph here. But you can make your own.

The gentle breeze of British hypocrisy

The Economist has published its sixth, and presumably final, cover story on Silvio Berlusconi. The headline – ‘That’s all folks’ – is supposed to evoke the cartoon quality of his premiership. But coupled with a backdrop of Sil set in a painting of end-of-Empire Roman lassitude, it is too busy. Far more visually effective was the June 2011 cover with a simple photo of Sil and the line ‘The man who screwed an entire country’.

I haven’t been the biggest fan of The Economist’s coverage of Italy because it has focused so overwhelmingly on Sil — rather than on a the malaise of an entire professional class which he symbolises. What sets Italy apart is that, relative to its level of economic development, it has the most backward, self-serving professional class and professional institutions of any state in the world. This includes, but is far from limited to, its political and legal and fiscal institutions.

There is also a very English undercurrent of hypocrisy in the manner in which the British elite discusses the Italian crisis with a told-you-so attitude. The Economist is particularly guilty of this, putting the boot in to the German response to the crisis on a weekly basis.

What is forgotten is how the Germans are left to do the political heavy lifting in Europe almost single-handedly. They have a French ‘assistant’, but he is barely worthy of the name.

If Britain had joined the Euro, things would have been different. There would be two big political grown-ups in the Euro-zone instead of one, and that would have made the job of dealing with Italy so much easier.

You cannot argue with Britain’s decision to stay out of the Euro from a selfish, pragmatic perspective, but anyone who supported that decision should limit themselves when yelling from the sidelines about what to do now. How would you like to be Merkel, put in a team with Sarko, and expected to sort out Greece and Italy?

If Britons are honest, they must concede that post-war Germany has done the bulk of the work in creating a stable, prosperous and progressive Europe while the British — famed as people of action — stood around bitching. And when Britain realised it desperately needed to be inside the Common Market in the early 1970s, it needed German support — against French opposition — to get in.

Germany, not Britain, is the moral leader of Europe in the past half century.

Trust

Nouriel Roubini, who lived for 20 years in Italy, has the day’s best post on the evolving Italian crisis. The concluding paragraph is a reasonable summary of what is required by Italy’s Euro partners to keep it in the currency bloc at this point:

‘Only if the ECB became an unlimited lender of last resort and cut policy rates to zero, combined with a fall in the value of the euro to parity with the dollar, plus a fiscal stimulus in Germany and the eurozone core while the periphery implements austerity, could we perhaps stop the upcoming disaster.’

What Roubini does not spell out is why this is unlikely to happen. When all the talking is done, it is a simple matter of trust.

Northern Europe does not trust Italy to push through the reforms that would make the effort and expense worthwhile.

The Matilda problem that I highlighted back in August is coming home to roost.

My own thought for the day is Article 54 of the Italian Constitution:

Those citizens to whom public functions are entrusted have the duty to fulfil such functions with discipline and honour.

It seems the last Euro-era chance to interpret that line in a more mundane and literal fashion may fall to Mario Monti.

Studying the classics

They say you can learn from the classics. So here are my bullet points on the heroic struggles of Europe’s ancients.

 

How Greece did it:

1. Get money from EU in return for reforms.

2. Tell EU/IMF you need to hold referendum in order to get population on board.

3. Abandon referendum when rest of Europe says this is devious and should have been discussed up front.

4. Bicker and look ridiculous.

5. Leave Euro and return to Third World.

(6. Feel really bad when Turkey joins EU and takes commitments seriously.)

 

How Italy could do better.

1. Tell EU you need to hold referendum in order to get population on board.

2. Form government of national unity. Agree comprehensive package of labour market, justice system and fiscal reforms with EU/IMF to be overseen by IMF.

3. Don’t bicker. Hold referendum in January.

4. Implement reforms under IMF oversight.

5. Remain in Euro and begin to be respected member of First World instead of being resident joke member.

(6. Not have to feel bad when Turkey joins EU and takes commitments seriously.)

 

But which option to go for?

Rodin's epic representation of the Italian politician

Oh mamma, can this really be the end? (Nth reprise)

Only in Italy do markets bounce, the currency strengthen, and gold weaken when the leader of political ‘right’ says he will step down (in order, as the traditional Italian formulation has it, to spend more time with his bunga-bunga girls).

Of course Sil hasn’t said when he will go.

As if to remind us that whatever the Greeks can do badly, the Italians can do at least as badly, this limp political comedy will continue.

Meanwhile, the IMF has been invited to Rome, which will give staffers a pre-change-of-government chance to reflect on what actually needs doing to keep Italy in the Euro. Most economists quoted in the press focus on the need to deflate. But this is impractical — Italians couldn’t take the deflation any more than Greeks could. No society can watch its real incomes shrink by a quarter or a third in order to make economists’ graphs look the way they ought to.

The only real way forward for Italy is very serious structural reforms which unlock fairly quick productivity gains and hence growth.

There is no theoretical reason why this cannot happen.

However, the job that will confront the IMF if it is called in to run a programme — which I continue to believe it will be — would exceed anything it has undertaken before.

Not only the labour market and outsize public sector need to be overhauled, but the entire justice system has to be reworked.

Can a foreign agency do such things outside the settlement terms of a catastrophic war? I suspect not. Which leaves two choices. Either give Italy German money and accept the country will not change and will remain a fiscal burden on the centre. Or kick Italy out of the Euro and refocus the group on a more northerly European caucus of states that can actually deliver political, social and fiscal integration.

In the end, it is all politics.

We like dull

Three recent articles make me think how dull and conservative good industrial policy in developing countries needs to be. And how China is proving the point.

The first piece reveals that only 106 plug-in electric cars were bought in the UK in the third quarter of the year. The second indicates that after biding its time, General Electric is making a move into the solar industry (FT sub needed) — but not into the poly-silicon technology that has dominated thus far, instead into the thin film approach that grew out of the US semiconductor business. The third article concerns GE’s third quarter results (FT sub needed), which were none too bad but which were not helped by falling wind turbine prices, a business where GE is already very active.

China has designs on all these green energy businesses. It also has large domestic firms in each sector which are screaming for subsidies. The government could have thrown its money at the most exciting technology — electric vehicles — or at the one where Chinese scientists lead the world — poly-silicon solar. But instead it chose to place its big bets on wind turbines, where the technological path is most established and the cost of green energy lowest, throwing billions of dollars at the construction of Chinese wind farms. It was the boring choice, but it looks like having been the right one — hands down.

As recent press shows, the market for electric vehicles remains tiny. If China had gotten too far ahead of the demand curve, the country could have wasted vast sums on e-vehicle technologies that fizzle. In the solar business, where private Chinese companies dominate global production of poly-silicon cells, there is a real risk that poly-silicon is not going to be the winning long-run technology.

The shape of the evolving wind turbine market, by contrast, is easier to see. It is largely a matter of making the same turbines bigger. In this context, China has created some of the world’s largest wind turbine producers in the space of a few years and there is little chance going forward that they will be ‘technologically disrupted’. They are competing first on price — hence the pressure mentioned by GE in its third quarter results — capturing market share, over-running the entire production value chain so as to ‘own’ the technology, and they will then start to compete on quality and service later.

Sensible industrial policy in a developing country involves plucking low hanging technological fruit. Then you bring cheap capital — human and financial —  to bear.

Shaggy dog

It’s another fudge from Europe. The European Financial Stability Fund has been ‘theoretically’ expanded through approved leverage to perhaps Euro1 trillion. Private holders of Greek bonds will ‘theoretically’ take a 50 percent hair-cut, though no details have really been agreed. Silvio Berlusconi has delivered a letter ripe with fulsome promises of structural reform in Italy, to add to lots of other fulsome promises he made before.

It was clear in recent days the markets were ready to accept some more thin European gruel as ‘good news’. Corporate earnings in the US continue to be strong and the latest US GDP figures suggest the American economy is slowly crawling away from the abyss. The very slow improvement in the US macro numbers is the bigger economic story, albeit less trumpeted in the press.

The European train wreck waiting to happen has been moved back down the line. But not far. In the absence of any substantive structural change in Italy, a train wreck there will be. The base case remains remains an Italian fiscal crisis and IMF intervention in the absence of any EU capacity to address the problem.

In the mean time, Italy’s negotiating position can only be strengthened by the ECB’s continued purchases of its debt (EU debt socialisation by the back door) and by the Greek debt hair-cut (What about us, another ‘young’,  ’peripheral’ European state?). Time to write about something else for a while.

Next day update:

Porco cane! Rome auctions some debt this morning and the market still wants 6 percent (FT sub needed)… In fact the cost of Italian public debt has gone up to a new record. Is it possible that people outside the Italian elite are less stupid than they thought?

Un-modern family

You’ve got a big mummy who hasn’t aged that well but has cash. Your dad is a bit flash but somewhat light-weight and ineffectual. And you are still sponging off your parents despite the fact you are 75 years old.

Sound familiar? That’s right, it’s the Germany-France-Italy relationship.

The sight of Frau Merkel and Sarko-I-can-do-a-serious-face-too chastising Big Baby Silvio Berlusconi is like watching some super-sick sitcom that makes Modern Family seem like straight play.

Sil is going to have an emergency cabinet meeting (FT sub) to talk about really really really doing something to sort out Italy’s structural problems.

I am soooooooo excited.

Betchuartooo.

 

Mum and Dad are questioned about Sil:

Here is the presser where a journalist asks in French if Mummy Merkel and Daddy Sarko find Sil’s promises about what he is going to do convincing. The facial expressions are priceless. There have been a couple of hundred thousand page views already.