Italy Needs Expansionary Fiscal Policy to Escape Six-Year Recession
Further cuts in government expenditure to compensate for the bailout will worsen the situation, says economist Heiner Flassbeck
KIM BROWN: Welcome to The Real News Network. I’m Kim Brown in Baltimore.
The government of Italy is about to nationalize the world’s oldest bank, the Monte dei Paschi di Siena, which was founded in the 15th century. This bank is also Italy’s third largest bank and represents only part of Italy’s troubled banking sector, which some say needs at least $50 billion worth of bailout funds in order to stave off a collapse. Italy’s Parliament agreed to a $20 billion rescue package on Wednesday but is it enough? And what does this mean for the economies of Italy and Europe as a whole?
Joining us to discuss this from Geneva, Switzerland is Heiner Flassbeck. Heiner is the Director of Flassbeck Economics which is a consultancy for global macro-economic questions and the Editor of Macroscope which is an Internet magazine. He’s also co-author of the book, titled Against the Troika: Crisis and Austerity in the Eurozone. He joins us today, as I mentioned, from Geneva. Heiner, thank you for being here.
HEINER FLASSBECK: Thank you for inviting me.
KIM BROWN: Well, the bailout of the world’s oldest bank may not be so important if it were not for the fact that this is happening in the context of a relatively fragile European economy. Italy, after all, is the world’s third most indebted country and in terms of its debt-to-GDP ratio. Now the bailout may not add that much to Italy’s overall debt, but how dangerous is the situation of Italy’s banking sector for the Italian economy? And what does this bailout mean?
HEINER FLASSBECK: Well, first of all, let me say the situation of the Italian banks, in general, is the result of the very bad economic situation in Italy. You have to take into account and to consider that Italy is in a recession for six years now. It is really in a recession for six years. So, unemployment is above 10%, production has been falling all the time — industrial production, construction production is below the level of 2009. So, that shows what is the, so to say, root cause of the trouble of the banking system. Imagine in the United States, you would have had six years recession, well, many banks would have non-performing loans, no doubt about it, and many banks would go onto their knees because this is an absolutely untenable situation.
KIM BROWN: So, when Europe’s financial crisis shook the global economy five or six years ago, it was always assumed that Italy and Spain would be the next domino to fall after Greece. So, is the financial crisis that actually began in the US in 2008 now threatening to bury Italy?
HEINER FLASSBECK: Well, you see, we have two different crises: one was the financial crisis but we have a different, our own crisis, so to say. We have a Euro-crisis, which was triggered by the financial crisis, but is not a direct outcome of the financial crisis — it’s a crisis of gap in competitiveness. Germany, on the one hand, that undershot the target that everybody set for the monetary union by wage dumping. Italy overshot the target, the inflation target, with wage increases.
So, there is a huge gap in competitiveness between Italy and Germany, in particular, but also between Germany and France. And this is, so to say, bringing about the stagnation and the recession in the other countries because the other countries cannot escape. The only way to escape the recession and stagnation would be expansionary fiscal policy, because monetary policy in Europe has done what the Fed has done in the United States. They have stimulated the economy as much as possible and they’re still… they continue to stimulate but it is obviously not enough. You need fiscal policy to do it, to stimulate demand, to give momentum to domestic demand — and this is absolutely lacking because of, yeah, let me say clearly, silly rules that the European countries have given themselves under the pressure of Germany. No doubt about it, Germany was the, so to say, spiritual leader of that.
But Germany is, as I said, due to its position, external position, in a much better situation than all the other countries. All the other countries cannot escape that situation without expansion and fiscal policy. And now, this is forbidden. It is also forbidden, so to say, to rescue your own banks. You see, Europe has decided about a banking union some time ago. It was officially decided, it is ratified — this banking union says explicitly you should not bailout banks. You should bail in, so to say, the owners of the bank, the stockholders of the bank. But the case of Italy now, shows even in the first case, where this banking union should happen, it doesn’t work.
KIM BROWN: So, will the bailout of the Italian banking sector, Heiner, in your opinion, will it solve the crisis, or are they merely shifting the crisis elsewhere by transferring even more debt onto the Italian government? So, in other words, is this the best solution? Or is there more of something else that could or should be done?
HEINER FLASSBECK: No. It’s clearly not solving the crisis. That is, as I said, the non-performing loans, the huge amount of non-performing loans in the Italian banking sector is the result of the crisis, is the result of the Italian recession. So, it can only… the recession will continue. There’s no change.
It depends very much on what the government does. If the government goes for further cuts in government expenditures to compensate for the $20 billion that they are using for the bailout, well, then the situation will definitely worsen. Otherwise, it will not change the situation very much. Italy has very high government debt in relation to GDP. You mentioned it. And this is not, so to say, a problem in itself that would kill the Italian economy. Japan has a much higher debt and in the US debt is also very high. So this is… debt is not such a break to recovery and a better economic development.
KIM BROWN: So, is there a fear of economic contagion? I mean, does this latest Italian crisis have implications for Europe as a whole, in your opinion? I mean, could the crisis expand to the rest of Europe?
HEINER FLASSBECK: Definitely. Definitely. We have seen that the situation politically is very fragile in Italy and the contagion is more on the political side, which means that if the people in Italy realize how much more pain this will put on them, through cuts in government expenditures, for example, then they will go on and the resistance to the euro will increase. And this may spread over to other countries. Or it may even bring about the collapse of the new government in Italy which is anyway very weak, because this government is just a successor to the former government.
The former government lost a very important referendum at the beginning of December, so the situation is extremely fragile — and this fragility may indeed spread over to other countries. France has general elections this year. The Netherlands have general elections. Germany has general elections. So, what we have ahead of us is definitely quite a long period — another long period, I have to say — another long period of a lot of turbulence and insecurity all around Europe.
KIM BROWN: So, what steps need to be taken? I mean, exactly what needs to happen to stabilize the financial situation in Europe, more generally, Heiner?
HEINER FLASSBECK: Yeah, the situation is rather simple. So, far, in one country I mentioned already, my country, Germany — Germany is in a very simple and fine situation. Germany has a huge current account surplus of 9% GDP which brings about the simple fact that Germany can, and has, reduced its government debt in the last two years. The actual recurring government deficit — there is no current deficit in the budget of the government in Germany overall, which means they have a surplus and they are in a very comfortable situation.
But, so Germany could be the locomotive of the European economy and stimulate European economy by investment, public investment, for example. In Germany, if Germany would, say, spend something like $100 billion a year on public infrastructure in its own country, the spillover effect, the positive spillover effects would definitely be very large and that would help the other countries very much.
Otherwise, what you have to do definitely is to relax the stupid regulations that in the middle of the crisis, in the middle of the recession, governments have to go for austerity, have to try to cut — it doesn’t work. But have to try to cut government deficits, to whatever rule, 3% or whatever it is. It is never reasonable. It is never reasonable in the middle of a recession. You can only cut government deficits when others are investing, when others take on debt, and that can only be the private sector. But this is not the case at this moment in Europe and in so far, the government has to play an active role.
KIM BROWN: We’ve been joined by Heiner Flassbeck. Heiner is the Director of Flassbeck Economics which is a consultancy for global macro-economic questions. He’s also the Editor of Macroscope. We’ve been discussing the troubled Italian financial and banking sector and whether or not a bailout would be enough to rescue that country from economic instability. Heiner, we appreciate you joining us. Thank you very much.
HEINER FLASSBECK: Thank you for having me. Bye-bye.
KIM BROWN: And thanks for watching The Real News Network.