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Cut the debt, cut growth?

Italy has just passed yet another austerity measure, enduring another batch of strikes and protests. Given the failure of the preceding cuts, Italians are asking whether these measures are actually preventing growth, rather than encouraging it.
Giulio D’Eramo
23 September 2011

Italy's latest austerity package was passed a week ago. It is the third economic measure taken by Berlusconi's government in the past year. On the same day, Italy's state bonds were sold at 5.6% interest, up 0.7% from the end of July. A week later, S&P downgraded the Italian debt to A/Negative. As the debt is now 120% of our GDP, 5% of our GDP goes to repay interests on the debt: A massive obstacle for growth.

Unlike what happened during the previous two measures taken, the government has made it clear that more are to come, such as cuts to pensions and/or a fiscal shield that would allow the state to gather at least part of the huge tax evasion cake. This announcement has 2 main objectives.

The first is to reassure the markets, and the shaky European Union, that there is still room for savings capable of ensuring the financial stability of Italy as well as that of the Eurozone.

The second is to reassure Italian entrepreneurs; just like the previous two measures, this bill does not contemplate any substantial incentive for growth. The head of the Confindustria, Emma Marcegaglia, has been very unyielding on the subject, stating; “of course it is a depressive measure, it is only made up of tax-increases”.

Different analysts estimate that increased taxes make up between 66% and 86% of the bill, thought to be able to bring in some 4.6 billion euros in 2012 and 2013.

The main points of the package include:

1) VAT raised from 20 to 21%. This is widely criticized as damaging to consumer consumption, especially by consumers' associations.

2) Mayors to sell-off city assets and cut spending. Nine thousand mayors from across the political spectrum went on “strike” on Friday, shutting down their city halls as a protest against the cuts, which they claim will force them to lay off services and increase local taxes. On the bright side, the bill imposes limits to the number of representatives local government and cities can have.

3) A 5 to 10% tax rise for electricity and gas providers. As they are usually monopolies, many fear that the price hike will be paid for by the end-users, even though this is expressly forbidden by the bill.

4) A welcome criminalization – 5 to 8 years of prison - for underpaid, illegal work. Everybody agrees on this, although it is unlikely it will produce income for the state.

5) More taxes on petrol (already up 17% from last year) and cigarettes. The petrol tax is yet another measure regarded as having negative effects on growth. The retail price is now 8.6 USD per gallon.

6) Small measures to appeal to the public, like a solidarity tax of 3% for those earning more than 300,000 euros per year, becoming 5 to 10% for elected representatives above 90,000 euros (at the moment the highest paid in Europe), and the reduction or abolition of some state funded associations regarded as useless. This part was the flagship of the bill, but its impact has been greatly reduced.

While the austerity package was being passed by a parliament surrounded by protesters, students were staging protests all over Italy on the first school day of the year. Were they protesting against cuts envisaged by the austerity package? No, the cuts to the school system came a few months ago, as many other cuts to social and cultural services have been passed in the last two years, after ten years of stagnation in which successive governments have failed to stimulate growth. This is to point out that there is an international feeling that society has already paid for the ruthless mismanagement of public money by our elected representatives - as in Italy - or for the reckless, rampant greed of the banking industry – as in the UK.

Recent governments, both right and left-wing, have failed to act (perhaps willingly) against the waste of public money inherited from the 50 year reign of the Christian Democrats (DC), and according to many the situation has actually worsened. The malfunctioning bureaucracy and its massive frittering of funds has weighed heavily on Italy's growth, causing stagnation.

Just like the present measure, in the past 20 years nothing structural has really been done to make things more efficient, either in the private or in the public sector – with the exception of a small package of liberalizations approved by the 2006 centre-left government.

In fact it can easily be argued that for both coalitions the way to cut expenditures is to slash the salary of public servants like teachers (from 2001 to 2009 teachers' wages fell 1%, while in the rest of the OSCE countries it was up 7% in the same period), without tackling any of the major wastes produced by mismanagement of public assets and a too high cost of both the political and the administrative structures.

On top of that, Berlusconi's governments have been completely unable to take any measures capable of stimulating growth (Italy did not have to inject money into the banking system), and have an appalling record in the “fight” against tax evasion, which is considered to float at around 120 billion euros per year. In fact, we could argue that if the first act of the 2008 Berlusconi government had not been that of erasing the 55 anti-evasion measures approved by the centre-left in 2006, measures that brought over 20 billion euros in 2 years, we would not need these measures now.

The government actually reinstated all these measures in the past year, and is now shouting aloud that countering evasion is a budget priority.

The contradiction is evident, but it becomes even more so when we see that one of the next measures envisaged is another fiscal “shield”. This is a one-time measure that is meant to bring in a large amount of money in a short time. Berlusconi governments are very keen on these, having already used them 3 times and counting. Twice it was a real estate shield, once the infamous 2008 fiscal “shield” which allowed capital smuggled out of the country to return to Italy with only a 5% tax (while the average Italian employee pays between 30 and 43% of taxes).

So instead of trying to make it easier for honest tax payers and home-owners to respect the law, we prized those who had the boldness to break the law and evade taxation in the first place.

The centre-left has also used similar short-term measures, however. Instead of Berlusconi's “shields”, the centre left has often opted for urgent sell-offs of state assets, which is ethically better, but practically worse than Berlusconi's “shields” as these assets are sold for less than their value. Opposition leader P. Bersani has listed 30 billion euros profit through sell-offs among his proposals.

If our fundamental weaknesses are tax evasion, public waste and a non-competitive labour market, a look at our underdeveloped strengths could easily raise our hopes, if we could have just a little more confidence in our ruling class. Apart from obvious assets such as tourism, Italy is the second largest manufacturer and exporter in Europe - after Germany.

Like the US Republicans, our Prime Minister has never been very concerned about the debt, maybe because an increased expenditure led to more votes in the short term, at the same time as it paved the way for massive privatization in the long run. A win-win strategy for the right, and also for the secessionist Northern league, which has allied itself with the government: “if Italy goes down, Padania (the rich north) goes up” said its leader at a recent party-gathering.

And despite his spicy legal problems, and thus the fragility of his government, Berlusconi is likely to stay in charge until 2013 as his allies still depend on his media empire. So a change of direction is unlikely. The economic proposals of the opposition do not sound too promising either. But it is not too late to turn Italy’s economy around.

 

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