The American Interest
Policy, Politics & Culture
The Achilles Heel within the Boot
Published on January 9, 2013
Good Italy, Bad Italy: Why Italy Must Conquer Its Demons to Face the Future

by Bill Emmott

Yale University Press, 2012, 304 pp., $30

Italy is a large and prosperous country but one that has never sat comfortably among the great powers. During the 1950s, it was home to Europe’s strongest communist party—a party that, but for a doctrinal anticlericalism, would have had a government in the heart of Europe. During the 1970s, Italy looked on the verge of tearing itself apart in a terrorist war that culminated in the kidnapping and assassination of Prime Minister Aldo Moro. Not many years later, Italy taught the world a new word, tangentopoli (graftville), and most recently it has given us the spectacle that is Silvio Berlusconi. The condition of the country’s economy is captured in the World Bank’s rankings of ease of doing business: Italy is 84th, one place ahead of Tanzania and one behind Mongolia.

Nonetheless, Italy is the Eurozone’s third-largest economy, behind only Germany and France. It produces in a month what Greece produces in a year. It has long been one of the world’s larger exporters of textiles and machine tools, and it has one of the larger manufacturing sectors among the world’s high-income countries, not far behind Germany as a share of GDP. In 2008, when the financial follies ran out of juice, Italy’s reliance upon things you hold in your hand looked to be its salvation. It suffered no real estate collapse because its prices had never inflated. Its banks didn’t find their vaults strewn with worthless paper because they had watched the securitization derby from the sidelines. Indeed, throughout 2009 and much of 2010, Italy looked like a model of moderation. Its debt spreads were manageable, and while a recession of some magnitude was unavoidable, Italy looked like a survivor.

About half way through 2010, however, word spread that Italy was in a debt trap. This term refers to a country whose national debt exceeds its GDP and whose GDP grows at a rate below the interest rate it pays on debt service. Once a country falls into this state, it must either run a surplus in its other accounts that is large enough to cover interest obligations, or its debt service will eventually consume all national income. This is not a matter of economics; it’s just arithmetic. Few countries remain in this condition long before defaulting.

As realization of this condition spread, Italy endured a textbook financial crisis. The market for its national debt all but shut down, interest rates in all private credit markets rose by 2–5 percentage points, and credit ceased to flow. By August of 2011, Italy’s equity prices had fallen back below their recession lows of March 2009. Unemployment was heading into double digits, and, most alarming, money began to leave the country. Italians, observing the trials of Greece and now experiencing a crisis at home, began to doubt the longevity of the euro and were moving savings to a safe haven. The Swiss franc rose to new highs against the euro, and in Europe’s Target II clearance system the Bundesbank accumulated an uncomfortable exposure to the Bank of Italy. Moreover, a cloud of pessimism settled over the Italian nation. Educated Italians, once Europhile, now talk of having their children learn English to facilitate their exodus from the country.

Bill Emmott’s Good Italy, Bad Italy picks up the Italian narrative in the early 1990s, just after the Mani Pulite trials, and quickly brings its readers through the heart of the financial crisis and its aftermath. Drawing upon his years as editor-in-chief of the Economist, Emmott has produced a book that is longer on anecdote than analysis, but one that nonetheless comes to the right conclusion. The Italian republic faces an unavoidable decision: either accept uncomfortable institutional changes or leave the euro currency area. There seems to be no third way. Emmott wisely avoids predicting which choice the country will make.

Good Italy, Bad Italy is organized along the lines of Dante’s Divine Comedy. Political Italy is an Inferno, and economic Italy a Purgatorio. There is no Paradiso. The politics of Italy resemble those of a failed state, led ever lower by Silvio Berlusconi, whom Emmott depicts as an evil political genius motivated alternately by venality and lust. Berlusconi, it seems, achieved high office using old- and new-fashioned techniques. He bought his way in and then used his television monopoly to shout down the voices of his rivals. The peculiarities of the Italian electoral system let him pack the parliament with sycophants and to devote more energy toward holding power than to confronting Italy’s problems. Reading Emmott, Italian politics has a protean quality that would be humorous were its results not so tragic. The number of politicians, and the ease with which they reconfigure themselves into new parties, is little short of dazzling. The results, however, are always the same: motion without direction.

The Italian economy has been losing momentum for decades. Its purgatorial aspect refers to the regulatory labyrinth within which businesses are required to find their way. Yet, the northern third of the country is home to several respected firms. Many are perhaps smaller than they should be, but they have been competitive for fifty years and remain so today. Together they inhabit a region of some ten million people, who enjoy a living standard on a par with West Germany. Italians with income are nearly pathological savers, which is why Italy’s national savings rate has been for years the highest in Europe. It has fallen some recently, but given the depth of the recession, some decline was in order. Emmott is particularly good at spotting regional successes, both in the north and elsewhere. The city of Turin, for decades an economy built around the Fiat Motor Company, should today be a rust bucket. Worldwide, automobiles have been a declining industry, and Fiat has led on the way down. Turin, however, has managed to survive. In 1992, the city reorganized its politics, elected a succession of competent mayors, and has attracted firms from outside the motor trade. Stories like Turin become scarcer as Emmott moves southward, but even there he find localities, for example, that have organized themselves to resist the predations of the Mafia.

The most difficult part of Emmott’s argument to accept is the degree of responsibility he attributes to Silvio Berlusconi. One senses there must be some deeper trouble than the character flaws of one man. Berlusconi did not undermine the Italian political system. It was dysfunctional when he found it. The actions or inactions of his government did not disable the Italian economy. A few success stories aside, it had been struggling to keep up for years. Italian history suggests that generations of politicians before Berlusconi had grasped the resources of the Italian state and used them to their own ends. They got away with it because they found an institutional structure that all but invited plunder. It didn’t hurt that living standards were rising, and they could bribe the electorate with free medical care and generous public pensions. And, of course, they cut deals with special interest groups as they were needed. In the decades prior to Italy’s joining the euro currency, the money to pay these bills was either borrowed or printed. Italy’s nominal GDP grew by over 8 percent per year in the fifty years prior to 2000, but the national debt grew more than twice as fast, rising to 120 percent of GDP by the year 2000. Berlusconi inherited this debt.

The decision to enter the euro blew the whistle on a fifty-year swindle, and in retrospect was a blunder on the part of Italy’s political cast. Once the country was in the euro, its politicians could neither print money nor resort to periodic devaluation of the currency. Emmott doesn’t pay much attention to currency devaluation, but it was an important part of the story. A devaluation, in effect, allows a country to reset the clock, to take the sum of inefficiencies and violations of economic logic that have crept into the system and to sweep them under the carpet by debasing the currency. It works for a while, and Italy did it often, reducing the lira from two hundred to the German mark in 1960 to more than 1,200 by 2000. The inevitable cost is inflation and a deterioration in the terms of trade. Measured in terms of purchasing power over German goods, for example, nearly half of Italy’s postwar growth is a mirage.

Once Italy had lost the option of devaluation, financial crisis was only a matter of time. After slowing for decades, on the day Italy adopted the euro currency growth stopped. A debt trap was all but unavoidable, even though during the past decade—a large part of it under Berlusconi—Italy’s public finance had been relatively sound. The inherited debt became an insupportable burden because the economy couldn’t grow. As it stands today, Italy is a threat to itself and to hopes for Europe’s integration. No population, once accustomed to steady improvement, will tolerate stagnation for long. Internal dissent eventually will force change, and voices within the country already have identified the euro as the problem. Italy’s share of Europe’s GDP is 13 percent. Were it to leave the Eurozone, others would follow.

The remedies currently on the table in European councils will do little for Italy. One regularly hears that Europe’s problems would be solved if Germany would step up and underwrite the debt of Europe’s weaker governments and insure the value of their bank deposits. Whatever merit this prescription holds, it does not get at Italy’s problems, which are internal and micro-economic. Italy, in many ways, looks like what Daron Acemoglu and James Robinson have called an extractive society, a place where basic property rights are impaired. The analysis of how it got to this condition starts not with the politics of the past few decades but reaches at least as far back as the writing of Italy’s postwar constitution. Its consequence is to give Italy a chronically overvalued currency. Growth will always be a problem, and financial crisis will never be far off.

Italy at the moment has two good things going for it. The Italians call them “i due Mario”— Mario Monti and Mario Draghi. Monti, the technocrat imposed over the electoral system, at least recognizes the nature of Italy’s problem. His program calls for liberalizing markets and dissolving the hold that special interest groups have on the economy. The odds of his success get longer every day. As Emmott correctly observes, institutions of this type change only in crisis. It is worth remembering in this regard that the first Berlusconi government had an agenda not dissimilar to Monti’s. Its architect, a Professor Marco Biagi of the University of Modena, was assassinated walking home from work.

Paul DeRosa has taught economics at Columbia University and ran a hedge fund for three decades.