1.
The Elephant
in the Room
Italy in Europe: missed
economic adjustment and
political nemesis.
Silvia Merler
Head of Research
Algebris Policy & ResearchForum
1

2.
“Italy is now the
centre of the
political universe”
Steve Bannon
Sept. 2018
2
A political outlier, an economic idiosyncrasis.
How did we get here, and where are we headed?

3.
• Rank countriesin the 50th ’most virtuous’ vs. ’least virtuous’ percentile
of the distribution for the indicatorsused in the EU Commission’s
Macroeconomic Imbalance Procedure (MIP).
• Over the 2000-2008 period,thisyieldsthe ’usual suspects’
• Over a longer horizon,positionsare in flux.The ‘South’ has adjusted.
Source: own work based on AMECO, Eurostat
– A macroeconomic
imbalance-based
classification of EZ
economies
Who is ‘North’,
who is ‘South’?

4.
Different growth
models…
• 1999-2007: demand-driven
growth in theSouth
• 2007-2012: demanddrops
more thanGDP duringcrisis
• 2012-2017: demandgrowth
below pre-crisisrates
Source: own work based onAMECO data

5.
…have shifted.
• Pre-crisis, tradecontributed
negativelyto GDP growth in
South.
• Post-crisis,net exports are
keydriverof growth inthe
South; consumption more
importantin the North
• Italy lags behindespecially
onGFC formation
Source: own work based onAMECO

6.
North /South:
Crisis and Reversal
• Pre-crisis:low real rates
drewK inflowsto South.
Private creditboomed.
• Post-crisis:relativereal rates
haveinvertedpositions;
sizeable deleveraging
• In Italy, real ratesarehigher
(idiosyncraticpolitical risk)
Source: own work based on BIS; ECB

7.
North /South:
Crisis and Reversal
• Capital inflows mirrorin large
current account imbalances
• Flow adjustmenttodayis
complete, legacy of external
debt remains
• Italy neverhad anexternal
debt problem…
Source: own work based onAMECO

8.
The Elephant
• …but Italy continues to have
an internaldebtproblem
• Massivepost-crisisadjustment
of fiscal deficitin theSouth,
much less in Italy…
Source: own work based onAMECO

9.
The missed
adjustment
• …despite interestexpenditure
at its lowest since1995…
• …current expenditure
(excludinginterest)in Italy has
not declined
Source: own work based onAMECO

10.
The missed
adjustment
• Adjustmentin the Italian
bankingsector hasbeen much
slower thanin theSouth
• Italian bankshaveremained
uncompetitive andunprofitable
for longer (seeSpain)
Source: own work based on ECB

11.
Elusive growth
• Standardsofliving have
reboundedstrongly inSouth
• In Italy, real p. c. GDP is at
the level of 2 decadesago
Source: own work based on Eurostat

12.
Lack of rebalancing
• South’s competitive position
deterioratedin2000-2009
• Massiveimprovementsince:
today North/South areequal
• Italy remainsanexception
• Index in1998 => it is not
about thecurrency !!
Source: own work based onAMECO

13.
Unfit for
the future?
• Production in high-tech
manufacturingindustrieshas
stagnated(unliketheSouth)
• The averageage of equipment
is almost back to pre-1950s
Source: own work based on Eurostat and (Bergeaud, Cette and Lecat, 2016)

14.
Unfit for
the future?
• Italy has a low shareof
population with tertiary
education(2nd lowest inOECD)
• Studying doesnot pay off: low
InternalRateof Returnfrom
pursuing tertiaryeducation
Source: own work based onOECD

15.
Broken Ladder
• Itergenerationalmobility
acrosseducational levels is
especially low inItaly
• Only 6% of Italians reach
tertiaryeducationif neither
parentsattainedupper
secondary
• Compareswith 17% in the
North, almost 20% in theSouth
Source: own work based onOECD

16.
16
• Inequality spikedin theSouth,
during the crisis.Sincethen,it
hasbeen decreasing
• Not so in Italy
Inequality
Source: own work based onOECD

17.
The social legacy
• Unemploymentandyouth
unemployment skyrocketed
• Youth unemployment at 50%
in 2014, downbut still high
• In Italy, declinein youth
unemployment is slowerand
shareof NEET is highest
Source: own work based on Eurostat

18.
The social legacy
• ...andItaly is ’special’also
because almost 50%of youth
unemployment is long-term
• In the restof South, duration
of youth unemployment
today is below 1997 levels
• In Italy skills gets destroyed,
growth potential impaired

19.
The social legacy
• EmigrationfromSouth to
North as anexit route. Loss
of talent (braindrain)
• Migrationfrom Italy has
pickedup from 2012 andit is
at a 5-decades-high
Source: own work based onWEF; OECD

20.
The political nemesis
After the crisis,Europeansin North and South associate the EU with ’economic
prosperity’more than with ’unemployment’.In Italy,the opposite istrue
• Social malaisehas major
consequencesfor political
dynamicsathome andvis-à-
vis the EU
Source: own work based on Eurobarometer

21.
The political nemesis
• Those who migrate(movers)
become seeEurope asan
escapedoor andbecome
more pro-European
• Those who stayare stuck in
an economically andsocially
impoverishedenvironment
• The result is radicalization
andEuroscepticism
0
5
10
15
20
25
2007 2012 2017
The EU means ... Economic Prosperity
(% mentioning)
Stayers Movers
0
5
10
15
20
25
2007 2012 2017
The EU means ... Unemployment
(% mentioning)
Stayers Movers
0
5
10
15
20
25
30
2007 2012 2017
The EU means ... Democracy
(% mentioning)
Stayers Movers
0
5
10
15
20
25
2007 2012 2017
The EU means ... Social Protection
(% mentioning)
Stayers Movers

22.
A Bad Romance ?
22
68% of Europeans think their country benefits from EU membership; only
30% believes the future would be better outside. UK and Italy outliers.
0
10
20
30
40
50
60
EU EAST NORDICS UK BALTICS
0
10
20
30
40
50
60
EZ12 Core IT Programme
«Better outside of the EU fuori dallaUE» (%)
Fonte: APRF su dati Eurobarometro

23.
Input Legitimacy
23
Fonte: APRF su dati Eurobarometro
0
10
20
30
40
50
60
70
80
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
My voice counts in the EU (% agree)
EU EAST NORDICS UK BALTICS
0
10
20
30
40
50
60
70
80
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
My voice counts in the EU (% agree)
EZ12 Core IT Programme
Europeans do not see the EU as undemocratic, but many feel they lack a “voice”
In Italy, perceived input legitimacy input is particularly low.

24.
24
Fonte: APRF su dati Eurobarometro
This sense of disenfranchisement is more pronounced among those:
• At the bottom of the skills distribution or outside the labour market;
• In countries that have undergone a severe macroeconomic adjustment
(Greece) or a prolonged stagnationin the standard of living (Italy)
Input Legitimacy

25.
Output Legitimacy
25
Fonte: APRF su dati Eurobarometro
Europeans are thorn between economic anxiety and a sense of insecurity
Italy has the highest economic anxiety; has seen largest increase in insecurity

26.
26Fonte: APRF su dati Eurobarometro
In theface of economic anxiety and insecuirty, what does the EUmean to people?
It used to beseen as an opportunity(for peace, democracy, prosperity..) beforethe crisis. It
became a threat (ofunemployment, loss of identity…).Today,neutralassessment. But not in
Italy and UK.
Output Legitimacy

27.
Where are we
headed?
The EPelections
• Debt legacyon one hand, and socialstrains on the other raise a
potent (although not lethal) threat of Euroscepticism
• The 2019 EP electionswill not be ’the end of Europe as we
know it’ but need to be a wakeup call.
• A Union that no longerrepresents an unequivocalopportunity
to counter economicanxietyand insecurity, is not sustainable.
• Today, “North” and “South” are closer than ever, in terms of
economicperformance.Adjustmenthas been unilateral.
• it is possiblythe best time to have an honest and open
discussionabout EU (and especiallyEZ) solidarity…

28.
Where are we
headed?
Italy
…but Italy is an obstacleto that discussion.
Italy stands out from the crowd:
• especially high public debt burden and no fiscal adjustment
• lagging behind in terms of competitiveness adjustment
• uniquely rising long-term nominal and real rates
• stubbornly high long-term youth unemployment
• stagnating standard of livings, rising inequality
• low intergenerational mobility, sizeablebrain-drain
• loss of faith in the ’meaning’ of the EU as a prosperity project

29.
Where are we
headed?
Italy
Italy is a caseof missed adjustment (before and during crisis).
This explainswhy its recent economicpolicychoiceshavenot
won Italy any ‘friends’ in either the North or the South.
Lookingat Italy back in 1978, Posnerwrote that historically,in
interactingwith the internationalpoliticaleconomy:
”one of [Italy’s] main bargaining devices has been that its creditors
could not affordto see it go bankrupt”.
But is this still true today?