Matteo Renzi: Should You Believe The Hype?

The Italian prime minister Matteo Renzi has recently been making headlines in the European and international press for his anti-austerity stance. ‘If Europe does not change course there will be no growth’, Renzi recently said in a speech to parliament, warning the ‘high priests and prophets of austerity’ that ‘there can be no stability if there is no growth’.

It’s phrases like these that have made him somewhat of a hero in the eyes of those that are desperately in search of a mainstream political leader willing to challenge the continent’s ‘austerity regime’ and stand up to the self-appointed guardians of fiscal rigour – first and foremost, the German political and monetary establishment.

The Financial Times, for example, has been running of late a rather explicit pro-Renzi campaign – sporting bombastic titles such as ‘Merkel versus Renzi for the future of the eurozone’ –, in which the Italian PM is depicted as being engaged in an epic battle over austerity with his German counterpart. On the surface, he certainly seems to have the physique du role. After the Bundesbank’s president criticised Italy for wanting to loosen the EU’s budget rules and for not reforming fast enough, Renzi swiftly hit back at him, accusing him of improperly intervening in Italian politics. ‘The Bundesbank does not have among its tasks to take part in the Italian political debate’, Renzi said. ‘Europe belongs to European citizens, not to bankers, neither Italian nor German bankers’. Statements of this kind signal a welcome shift in narrative and should be praised. But is all the hype over the Italian PM justified?

Many commentators have described the recent European Council meeting of June 26-27 as a success for Renzi, who supposedly got Angela Merkel to agree to a more ‘flexible’ interpretation of EU fiscal rules. ‘We achieved what we wanted: ample margins of manoeuvre’, stated the Italian undersecretary for European Affairs Sandro Gozi following the summit. But what exactly does this hard-fought ‘flexibility’ consist of? The Council’s conclusions speak of ‘making the best use of the flexibility that is built into the existing Stability and Growth Pact rules’. As is well known, the Stability and Growth Pact (SPG) was initially approved in 1997 with the aim of strengthening the budget rules outlined in the Maastricht Treaty. Among other things, it introduced a series of preventive and corrective measures (most notably the dreaded ‘excessive deficit procedure’ or EDP) for those countries in violation of the infamous 3 per cent deficit-to-GDP limit.

In the years that followed the introduction of the euro, though, the European Council repeatedly proved unable to implement sanctions against the EU’s major players. Between 2000 and 2006, for example, Germany constantly registered a deficit above 3 per cent but didn’t incur any sanctions. The same goes for a number of other countries. Interestingly, following the financial crash of 2008, it was Merkel and Sarkozy who proposed a loosening of the Maastricht rules to allow member states to pursue the necessary stimulus policies (a fact which Paul Krugman credits as ‘probably the most important reason we didn’t have a full replay of the Great Depression’). In the end, no formal exception to the 3 per cent deficit limit was introduced into the Pact, but both the Commission and the Council accepted to close an eye towards the inevitable explosion of budget deficits across the euro area as a result of the crisis (and to a large degree the massive bank bail-outs handed out by many governments to their country’s financial institutions). Hence, the official ‘margins’ of the Pact – which Renzi has repeatedly appealed to in recent months, stating that Italy’s current 2.6 per cent deficit offered the country some leeway – remained unchanged at 3 per cent, below which member states were allowed to decide their budgetary policies in relative autonomy.

What Concessions Did Matteo Renzi Achieve?

Are we thus to assume that the ‘flexibility’ supposedly granted by the Council to Italy is that of increasing its budget deficit up to the 3 per cent limit envisioned by the SGP? If this were the case, while a far cry from the remedies needed by Italy to stem its economic and social crisis, it would certainly offer the government some much-needed breathing room to engage in an emergency stimulus programme. Regrettably, this is not the case. The reason is simple: with the introduction of the Fiscal Compact, in 2012 – which requires member states to reach a ‘structural balanced budget’ (on the very debatable ways in which the Commission estimates the so-called ‘structural balance’ see here) by 2015 and to reduce the public debt in excess of 60 per cent of GDP at a rate of 1/20^th a year – the already limited margins afforded by the Maastricht Treaty and the SGP (namely, the 3 per cent deficit threshold) have been all but eliminated, and replaced by a much stricter budgetary framework, which effectively amounts to the indefinite institutionalisation of austerity on a European scale. In this sense, the simple fact that Renzi would choose to frame the debate in terms of the 3 per cent limit appears somewhat surreal.

In the simplest possible terms, having a balanced budget means that member states have to achieve a primary surplus (i.e. excluding interest payments) equivalent to or higher than what they spend on servicing their debt. While such a provision is in itself highly problematic for its intrinsic counter-cyclical nature, since it deprives governments of the necessary fiscal means to fight recessions (here’s how five American Nobel Laureates reacted to a proposal, subsequently rejected, to introduce a balanced budget amendment in the US constitution), it becomes pure folly if implemented in the absence of a federal government and a central bank capable of acting as lender of last resort and intervening in sovereign bond markets on a normal basis to keep borrowing costs down (and not as an emergency measure and in exchange for austerity, as the ECB’s OMT programme prescribes).

Italy’s case is paradigmatic: with an interest expenditure amounting to 5 per cent of GDP (equivalent to a staggering 80 billion euros a year), the country would have to achieve an almost equivalent primary surplus in order to adhere to the requirements of the Fiscal Compact – and for decades to come. Not only would this prove to be utterly self-defeating from an economic standpoint, due to severely recessionary effects on GDP; it would also be politically and socially unsustainable, given the budget cuts and tax hikes that it would require. Yet, this is precisely the path outlined in the budget for the 2015-2017 period recently approved by the Renzi administration, which aims to reach a balanced budget by 2016 by increasing the country’s primary balance – already the highest in the eurozone, as it has been since the early 1990s – from today’s 2.2 per cent of GDP to 4.2 per cent in 2016 and ultimately 5 per cent by 2018. A policy which obviously can only be achieved through a severe deepening of austerity – and this in a country that has already lost about 9 per cent of GDP from pre-crisis levels and registers record-high unemployment, poverty and corporate insolvency rates.

The conclusions are obvious: excluding a revision of the EU’s budgetary rules – something which undersecretary Gozi has categorically ruled out by stating that in the course of the semester Italy ‘won’t ask for a change of rule but for a change of priorities’ (despite the IMF itself calling for a revision of the SGP) – any talk of ‘flexibility’ is necessarily limited to the very narrow (and almost non-existent) margins afforded by the Fiscal Compact. Which is exactly what has been going on behind the scenes. In mid-April the Italian government wrote to the Commission to say that it expected its budget balance to be -0.1 per cent in 2015 – a tiny notch below the 0 per cent objective set out by the Commission – and that it needed an extra year to reach a fully balanced budget. Apparently, the usually more-inflexible-than-thou Commission responded positively.

Surprisingly, though, a document penned and signed by all governments (including, of course, the Italian one) at the recent European Council meeting – in which Renzi supposedly won his battle over ‘flexibility’ – states the exact opposite: i.e. that Italy must achieve a balanced budgetary position by next year and that ‘additional efforts, including in 2014, are needed to be in compliance with the requirements of the Stability and Growth Pact’. This is rather unusual, since Council meetings are usually used by governments to dilute, not to further tighten, the Commission’s recommendations. Even though we are talking of just a few decimals of a percentage point, if Italy isn’t able to obtain even this small margin of manoeuvre – which it doesn’t seem to be doing too much to obtain – it would mean that the government would have to implement already this year a draconian adjustment of around 25 billion euros that would further depress aggregate demand and kill any hopes of achieving even the very modest growth rates estimated by the Commission (not to mention the grossly over-optimistic estimates of the government). And besides, even if the government somehow succeeded in buying some extra time, the austerity shock would simply be postponed to next year.

Where Is the Room For Manoeuvre?

In light of all this, it appears unclear what exactly the ‘ample margins of manoeuvre’ supposedly negotiated by the Italian government at the Council meeting amount to. A clarification in this sense came from the German finance minister, Wolfgang Schäuble, who recently stated in an interview with the Financial Times that ‘I haven’t heard [a demand for more flexibility] either from the Italian prime minister or from anyone else’.

So what is going on? Could it be that obtaining a more flexible approach to the EU’s budget rules – let alone changing course with regard to austerity, despite all the talk about giving Europe ‘a fresh start’ during the Italian presidency – was never really a part of Renzi’s plans? And that the young Italian PM’s political vision is actually closer to that of his supposed arch-enemies – Merkel and Schäuble – than most of the commentaries would have us believe? One needn’t look further for an answer than the recent article co-authored by the Italian economy minister Pier Carlo Padoan and his German counterpart Schäuble in the Wall Street Journal, in which the two ministers state clearly that ‘Berlin and Rome agree on what Europe’s economic agenda should be’. Namely: ‘a pro-business, pro-growth agenda’, which ‘can be achieved by applying in full the existing fiscal framework’ – i.e. through austerity – as long as this is counterbalanced by more integration, an investment boost and, more importantly, a scaling-up of structural reforms.

What we are witnessing is clearly an attempt to salvage the increasingly delegitimised austerity agenda, in the face of its self-evident failure, by saying that the problem isn’t that we’ve had too much austerity (though they concede that it can be applied a bit more ‘flexibly’) but that we haven’t had enough growth. This, though, doesn’t depend on more expansionary monetary and fiscal policies – and thus on a radical reversal of austerity – but on a stepping-up of structural reforms (liberalisation of labour markets, reduction of labour costs, privatisation of state assets, etc.). In other words, we are told that the solution to the crisis lies is a deepening of the neoliberal agenda that is at the root of the crisis. This is clearly stated in the programme for Italian presidency of the European Union, which reads that ‘the focus on structural reforms is the cornerstone of the new vision underpinning the Presidency’s policy agenda’, since these ‘are the major driver of growth’.

Will this means business-as-usual for Europe? It’s too early to say so (though it certainly looks likely, especially given Juncker’s latest statements – notwithstanding the fact that a lot will depend on the response of the anti-austerity left). What we do know is that there is a struggle even within the elite with regard to austerity, between those who want to stick to the path of fiscal hyper-rigidity (the German government, the Commission, etc.) and those who consider the current path a threat to the stability of the system itself. And that if Renzi truly wanted to spearhead a rethinking of Europe’s flawed architecture he could likely count on the all-out support of the latter group, which includes the French President Hollande, the Financial Times, the IMF, etc. The question thus is: does he want to?