In a recent contribution, Italy’s Prime Minister Enrico Letta summarised his government’s approach to the country’s, and indeed Europe’s, situation. If Italy’s grand coalition government survives, later next year Mr. Letta will assume the rotating Presidency of the Council of the EU. However, the Italian PM’s views on the eurocrisis matter even more, because Italy’s economic future is largely out of the country’s hands and rather rests on Europe’s overall performance.
As has been repeatedly pointed out, both in this Journal and elsewhere, Europe’s gloomy prospects depend mainly on three issues.
First, the ECB has seen its balance sheet ballooning to a degree comparable to the Fed’s, and yet its monetary policy has been ostensibly less effective in lifting the Continent out of recession. This is evidently a consequence of the limitations in the ECB’s instruments and mandate, as well as of conflicting international views inside its Board.
Second, inadequate regulation of the eurozone, in particular the lack of appropriate international redistribution mechanisms and of schemes to prevent intra-EU fiscal and social dumping, have produced a cumulative divergence between “central” (or creditor) and “periphery” (or debtor) countries.
Third, while the EU common budget is so absurdly small to be even considered here, there is a total lack of coordination of Member States’ economic policies. All countries are mandated to do exactly the same thing (i.e. both private and public sector deleveraging), all at the same time. Europe is like a football team made up of eleven goal keepers: not exactly one’s idea of “coordination”.
The European response to all three issues has been timid and often wrong. Austerity has been repeatedly confirmed, even by Mr. Letta, policy coordination severely lags behind (with the lack of any meaningful progress e.g. in the field of a banking union) and the ECB is confined to Mario Draghi’s “Open Mouth Operations”, the actual efficacy of which depends only on shaky (and possibly unfounded) market expectations.
Firmly stuck among the “guilty” debtor countries, Italy by itself can do very little. Its economy is cannibalised by an enduring credit crunch, and by an austerity drive that is imposed by financial markets (when the interest rate spreads point to finance, the idiot shouts at Ms. Merkel). Truly, Italy’s gargantuan public debt may be considerably reduced, e.g. through a well-engineered one-off property tax to be applied to both real estate and financial assets, which would give the country some room for manoeuvre. But such a move would not return productivity growth to the country: it may temporarily solve its sovereign debt crisis but not its balance of payments problem.
In his contribution, Mr Letta limits himself to humbly begging for some European financial incentives to be linked to the government’s commitment to “structural reforms”. Which reforms are not mentioned, but one can guess they are to be taken from the usual “deregulation and privatisation” basket: a beggar-thy-neighbour policy that is usually ineffective in producing growth if a lot of other conditions are not in place. Secondly, the PM asks for a scheme to insure Member States from asymmetric macroeconomic shocks.
He is unlikely to obtain these nice concessions, because some conservative leaders, such as the mighty Ms. Merkel, have repeatedly clarified that they object to intra-EU international redistribution. Even an “insurance” scheme, such as that proposed by Mr. Letta, would produce structural international redistribution: it cannot be neutral across eurozone countries because it was not idiosyncratic asymmetric shocks that hit Europe, but rather a long-term process of cumulative divergence.
On the contrary, what Italy and the other periphery countries require are: a true banking union, which must also include the handling of legacy assets (starting from the recognition that part of the outstanding debt of the periphery countries is simply impossible to be repaid); and a Continent-wide program of investments to be financed through Eurobonds. The former scheme should be aimed at finally severing the link between the sovereign debt and the banking crises, and thus contributing to ending the credit crunch. The latter measure should be enacted in a way to counterweigh austerity at the Member States’ level, while producing the productivity growth in the periphery countries necessary to address their current accounts deficits.
Contrary to Mr. Letta’s insurance scheme, it was repeatedly shown that Eurobonds may be implemented in a way that does not necessarily imply international transfers of resources. There is thus no need to continue considering them a deal breaker, even from a conservative point of view.
In conclusion, the policy of small steps and policy fine-tuning proposed by Mr. Letta increasingly resembles a resignation to managing the country’s long-term decline. However, while such decline is worrying for Italians, it is certainly not in our European Partner’s interest either. Italy is the third largest economy in the eurozone, a good export market for several European countries and, most of all, it is too big to fail. These are the cards Mr. Letta should throw on the table.
 Since the crisis erupted such imbalances have partly been reduced, mostly because the squeeze in the debtor countries demand has largely reduced their imports. But all signs indicate that an eventual (so far out of sight) economic recovery would immediately return these countries to a current account deficit.
 Productivity in Italy has been stagnating from considerably earlier than the eurocrisis, for both supply-side reasons (e.g. small average firm size, backwards sectoral specialisation, little investment in innovation) and demand-side reasons (since productivity is strongly correlated to the aggregate value of production, anaemic GDP growth since the 1990s has been a major cause of productivity slowdown).
 As Germany’s example shows: http://www.ft.com/intl/cms/s/0/b3faf9b0-2489-11e3-8905-00144feab7de.html
 Such as a depreciation of the currency, etc.: http://krugman.blogs.nytimes.com/2013/03/13/night-of-the-living-alesina/
 For example by De Grauwe, P and W Moesen (2009), “Gains for All: A Proposal for a Common Eurobond”, Intereconomics, May/June.