Italy Takes a Baby Step on Financial Reform – Baby Steps Won’t do the Job

Actions to Contract the Economy Not Offset by Actions to Expand the Economy

Austerity is all the rage in Europe.  The powers that be think, without the benefit of experience or logic, that if the troubled economies of southern Europe just contract their economies, the economies will expand and the European crisis will be over. Yes, this is ludicrous, but that is what passes for policy in Europe these days.

In Italy the financial markets has lost confidence that the country can bring its high level of national debt under control.  Italy is not running a huge budget deficit, but it has borrowed so much in the past that lenders are unwilling to lend Italy money at rates that the country can sustain.  So Italy must get its budget into surplus and/or it must grow the economy.  And since policy to reduce spending and increase taxes to lower budget deficits is exactly opposite policy to grow the economy, Italy must introduce structural reforms in its society to offset the negative impact of the contractionary fiscal policy.

This is not happening.  The new Italian government is one composed of “technocrats”, supposed financial and economic experts not bound to a particular political philosophy or party. It is lead by Mario Monti. The government is succeeding in some of its fiscal reform.

Despite disagreeing on some measures, the main political parties backed the package of tax increases and spending cuts, which passed with a large majority of 495 votes to 88. The measures will now go to the Senate, which is set to vote them before Christmas.

Now this package of tax increases and cuts in government spending and some other minor stuff will not help the economy grow.  In fact it will cause the economy to shrink, thus driving up the deficits.  So there has to be another piece to the puzzle, and that is fundamental reform of Italy’s business and labor systems.

In addition to austerity measures, heavily indebted countries like Italy and Greece are expected to carry out structural reforms that experts say may eventually make their economies competitive with those in northern Europe, particularly Germany’s. That lack of competitiveness has produced a chronic balance of payments deficit in the southern countries that economists say lies at the heart of the euro zone’s troubles.

Italy, like many other European countries has taken the good idea of protecting employees from arbitrary, capricious and discriminatory acts of employers and made it so extreme that labor markets are unable to function.  Those employed remain employed, those unemployed remain unemployed.  The country has also taken the good idea of having regulations and standards for various professions and made it so extreme that instead of protecting the public the laws protect the professions.

So that offset to the austerity program is supposed to be a freeing up of the economic systems.  That does not look good.

“In Italian society, there is no division between left and right; there’s a division between those who are inside or outside some organized groups,” said Sergio Fabbrini, the director of the School of Government at Luiss Guido Carli University in Rome. “All the main political parties from left to right represent the insiders. The left represents the pensioners, the trade unions. The right represent various insiders: the lawyers’ organizations, notaries.”

The only way for young people and women to be represented “is to have a technical government,” he added, “but of course a technical government will have to pass through the approval of the Parliament. And here again the insiders are well organized.”

So like in Britain, once again there is an economic experiment taking place.  Italy’s economy will be severely damaged if the austerity program is not offset with fundamental reform.  The markets know this, the economists know this, even the Italian people and politicians know this.  But none of that means reform will be implemented.

Mr. Fabbrini said Mr. Monti’s strength is that “there are no alternatives.”

This is not correct.  The alternative is a decades long period of high unemployment, high national debt, continuing lower standards of living, increases in poverty and general political and social unrest.  In other words, Greece.