- Italy has gone into recession.
- The EU forced Italy’s elected government to reduce its spending plans, roiling its bond market.
- Austerity budgeting does not work, according to two recent studies.
- The subversion of Italian democracy by the unelected European Commission hurt economic growth in Italy.
- The Dutch prime minister should keep his nose out of this fight.
To the surprise of no one, Italy has gone into a recession – two consecutive quarters of declining GDP growth. Europe’s fourth-largest economy contracted by 0.2% in Q4 2018 after a 0.1% drop in Q3, according to the Italian National Institute of Statistics (Istat).
- Italian GDP growth goes into recession:
- Q3 2018 GDP growth: -0.1%
- Q4 2018 GDP growth: -0.2%
The question this prompts is, did the subversion of Italian democracy by the European Union play a role?
For the last six months, the new Italian government has been locked in a dispute with the European Commission over the size of its government’s spending budget. EU rules require all member states to keep the deficit on their fiscal spending below 3% of GDP. The purpose is to restrict governments from taking on excessive debts to fund government spending, which might in the long-run destabilize the euro area.
However, Italy’s pre-existing debts were already so large that the EU got an agreement from the previous Italian government that deficit spending would be restricted to 0.8% of GDP.
Italy elects a government and the EU says “no”
But the Italians held a new national election in March 2018, electing a populist coalition led by Prime Minister Giuseppe Conte, supported by the right-wing League party and the populist Five Star Movement.
Immediately, the government prepared to implement the policies it had promised in the campaign: a reduction in taxes and an increase in certain types of welfare spending, including a basic income experiment. They proposed a fiscal plan that would increase the spending deficit to 2.4% of GDP.
The EU said no.
The European Commission – the executive branch of the EU government whose officers are appointed, not elected – wanted the limit to remain at 0.8%.
Finally, the Conte government successfully persuaded the EC to approve a 2.0% fiscal spending deficit. But that approval didn’t happen until December 2018 – nine months after the new government was elected.
- Italy’s fiscal fight with the European Union
- European Commission limit on fiscal deficit spending: 3% of GDP
- Previous Italian government limit: 0.8%
- New Italian government proposal: 2.4%
- Compromise finally accepted by the EC: 2.0%
In those nine months, the Italian economy came to a standstill and its bond market was trashed as investors decided Italian credit was too risky. (The preponderance of bad loans inside Italy’s financial sector did not help either, of course.) Money fled the country.
Now, certainly, the difference between 2.4% and 2.0% isn’t big.The reduction in spending is about €10 billion ($US11 billion). Fiscal accounting is fraught with slippage and contrivance. Italy may yet sneak its spending plans into existence.
Why should the Dutch prime minister have a say over the Italian budget?
But there is an important principle at stake:
Italy’s voters elected a government with a plan. (It does not matter whether you agree with the plan – that’s democracy.) And the plan was thwarted by the unelected commissioners of the EU.
To give you an idea of just how undemocratic this is, consider that Netherlands Prime Minister Mark Rutte made headlines in Davos by complaining about the deal Italy got: “People start to ask me questions – if Italy, and in the past France, can get away with not implementing what they have collectively agreed, why should we?” He also said he’s “fairly angry” about the “lack of trust” between north and south Europe.
The idea that the Dutch government should have a say on government budgets in Italy is about as infuriating as the idea that the Italians should have a role in setting the budget for the Rijkswaterstaat, the Dutch government agency that runs Holland’s vast flood control program. (And why not, an Italian may ask? The Rijkswaterstaat’s annual budget is €4.5 billion – half that of the fiscal reduction imposed upon Italy.)
The EU is probably wrong about how budget spending works anyway
Now add the fact that the EU is probably wrong in its fundamental assumption that tackling government deficits and debt leads to prosperity. Since 2008, the macro data has shown that fiscal “austerity” – reining in spending to keep budgets balanced and decrease debt – has reduced economic growth, not increased it. Two separate studies have shown as much, one by the IIF and one by Oxford Economics.
Italy has paid a price for this.
If its current government had been allowed to proceed immediately with its spending, its economic situation would be different. The bond market would have stabilised more quickly. There would be more government money swilling around in Italy. While we cannot say that the EU caused the recession in Italy, we can definitely say that derailing the elected government made the situation worse.