Will the Italian economy recover?

Simona Piattoni | 17 March 2021

The Next Generation EU superfoods are on their way. Can they save a starving Italian patient?

Photo: Mauro Scrobogna/LaPresse via AP/NTB

Italy entered the Covid-19 crisis enfeebled by years of anaemic growth, stagnant public and private investment, high unemployment, a heavy debt load and tendentially feverish interest rates. Hopes for its recovery were pinned on the Eurozone’s standard recipe of spending cuts, labour market flexibilization, product market liberalization, and trade surpluses all aimed at reducing the debt to GDP ratio.

Unfortunately, the diet made the patient even weaker and further aggravated its recovery potential. The diagnosis of the liberal doctors was that only a lean and trim patient could hope to absorb shocks and return to health, even as the cure made her economy demand-depressed and starved of investment.

Socioeconomic disparities were boosted by many of the reforms, such as various rounds of labour market flexibilization. Moreover, repeated spending reviews induced cuts to public health – a condition that aggravated the lethality of the Covid-19 pandemic, making it into a veritable syndemic.

Change with the pandemic

The pandemic, however, has prompted a change in the recommended treatment. As stated by the General Secretariat of the Council:

[H]ow quickly Member States’ economies will recover from the crisis … depends on the fiscal space Member States have available to take measures to mitigate the social and economic impact of the crisis, and on the resilience of their economies. Reforms and investments to address structural weaknesses of the economies and strengthen their resilience will therefore be essential to set the economies back on a sustainable recovery path and avoid further widening of the divergences in the Union.

Large doses of analeptics and tonics in the guise of deficit spending to sustain ailing companies and furloughed workers were administered by Italian authorities. The precious stimulants were allowed by the European Commission which temporarily suspended the Stability and Growth Pact (SGP) provisions.

The Italian public debt thus spiralled to roughly €2,700 billion. Its debt to GDP ratio soared, further debilitating an already sickly economy, whose GDP has dipped by some 6,7% in 2020 after having declined by 5% between 2009 and 2019. At the end of 2020, the debt to GDP ratio reached the figure of 158% (Banca d’Italia 2021).

Next Generation EU superfoods

The current narrative has it that the Next Generation EU (NGEU) superfoods are on their way. In the guise of investment funds in digital and green technology, education, innovation and research, the nutritious Covid-19 recovery fund vitamins aim for economic, social and territorial cohesion and greater gender equality.

It is impossible to be against such a program, to be achieved through an increase in public and private investment and a few structural reforms.

The Council made interesting references to “diversifying key supply chains [and] thereby strengthening its [the EU’s] strategic autonomy.” In other words, recognizing the need to sustain an internal demand that does not depend on foreign imports for fundamental health and technological supplies.

Perhaps this signals a turn towards a more demand-driven economic model rather than a purely export-driven one. Apparently, for the first time since the Maastricht Treaty, direct financial support to Member States does not simply aim at rebalancing territorial inequalities, but at making the regional economy of the EU more independent from foreign demand.

The extra boost to public and private investment is coming from a dedicated tool, the Recovery and Resilience Facility (RFF). The Facility is partially financed out of the European budget and partially through the issuance of Euro-bonds drawn by Members States, hence adding to their public debt, but guaranteed by the European Central Bank and therefore priming lower interest rates.

Moreover, part of the support from the RRF is “non-repayable”, which means that it takes the form of one-off transfers of resources from the EU budget to the Member States. Some states will receive more and some less than what they contribute to the EU budget, which should manifest solidarity among Member States and particularly towards the weaker ones.

Building resilience

This policy change has been hailed as a veritable transformation in the EU economic discourse. Some of the old approach, however, can still be gleaned beneath the surface.

Let’s start from the notion of resilience. In engineering, resilience is the capacity of materials to withstand shocks and resume their original form once the pressure is released. In economic thinking, as can be surmised from the Council’s documents, it means being able to resume the original growth path once the crisis is withstood.

Unfortunately, the Eurozone has been suffering from secular stagnation in the last decade (2009-2019) so that “resuming the original growth path” does not look like a very promising prospect.

After the storm

A more scathing criticism comes from those who note that the single market structurally favours stronger economies. Accordingly, any form of compensation to weaker economies for their structural disadvantage is really destined to perpetuate disparities and breed continuing suspicion and resentment between the two.

The question then is whether this resolve to show solidarity and build resilience will continue after the Covid-19 syndemic, given that the Commission wants to maintain “the consistency of the proposed recovery and resilience plan with the relevant country-specific challenges and priorities identified in the context of the European Semester, including fiscal aspects thereof, and, where relevant, those identified in the context of the macroeconomic imbalances procedure” [emphasis added].

In other words, the measures financed under the RRF will eventually have to be compatible with the usual reinforced Stability and Growth Pact constraints and do not imply any relenting of the usual budgetary constraints.

More internal, less external

While unlikely, it seems that the only real hope lies in a veritable change of the economic growth model that has been pursued so far. Stronger emphasis should be placed on a model that puts a premium on the support of an internal EU demand – both in investment and in consumption – rather than the exclusive focus on an export-driven, external competitiveness-seeking growth model that has prevailed so far.

For further studies, please see Simona Piattoni and Ton Notermans’ special issue of German Politics: Italy and Germany: Incompatible Varieties of Europe?