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Will the free market win in Italy?

    As Italy approaches its crucial general election on the 4th of March, it seems the only certainty Italians – and the wider EU – are confronted with is the promise of more chaos and confusion.

    The outcome of the election may decide a new direction for Italy’s troubled economy, which despite being predicted to grow 1.5% this year, boasts a youth unemployment rate of 33% and a government debt to GDP ratio of 133%. This is all compounded by the country’s recent emergence from a banking crisis requiring almost £15bn in bailouts of taxpayer money.  

    Other issues facing an incoming government are high levels of corruption, barriers to innovation and expansion, and prolonged suffering from a lack of restructuring of production.

    The nation’s next government will presumably be a coalition – although the combination of parties who will form the required 40% majority remains unclear. On the left, the ruling Democratic Party could form an alliance with the anti-establishment 5-Star Movement (M5S). The M5S themselves, however, have not ruled out the idea of forming a coalition with a centre-right alliance between Silvio Berlusconi’s Forza Italia and the nationalist Northern League.

    Italy’s long term economic outlook remains bleak, and some of the extravagant election promises of Italy’s four major parties are unlikely to provide any relief. In fact, Italian President Sergio Mattarella called for more realistic policies from Italy’s major parties in a speech over the New Year.

    So how damaging would another term of centre left policies be on Italy, and how might its economy be transformed under a party with an anti-establishment mantra?

    Under Prime Minister Paolo Gentiloni, the ruling Democratic Party plans to negotiate with Italy’s partners to abolish the EU’s Fiscal Compact, which imposes steep budget cuts on high-debt countries. The party wishes to raise the budget deficit to 3 percent of GDP for five years, in order to cut taxes and increase public spending. It also seeks to introduce a minimum wage equivalent to around £8.80 per hour, a move which would affect almost 15% of the nation’s workforce.

    Gentiloni should be presenting policies to bring this debt under control, rather than consciously making it bigger still. The European Central Bank has begun to scale back purchases of bonds, and this stimulus is set to end in September. After that, Italy’s borrowing costs are likely to rise, meaning that steps must be urgently taken to decrease these extraordinary levels of public debt. Furthermore, the introduction of the minimum wage in a country facing Europe’s third largest youth unemployment crisis is another misguided policy, as young, low skilled workers become at greater risk of being priced out of the job market.

    The anti-establishment stance of M5S yields a wide spectrum of policies – ranging from a universal basic income for all citizens, to promises to cut red tape and bureaucracy. They also plan to break the fiscal compact and raise the budget deficit above 3 percent of GDP to increase public spending.

    The party is looking to implement a “citizen’s income”, which would offer monthly support payments of £685 for low earners, in order to tackle poverty particularly in the economically ravaged regions of southern Italy.  The program would amount to a total cost of £15bn per year. But even ignoring Italy’s debt woes, a recent study by the OECD found that the introduction of a basic income in Italy would have no impact on reducing overall poverty rates. Although the party’s promise to cut red tape by abolishing over 400 laws will be welcomed by any free market advocate, issues again arise around the party’s policy to increase the budget deficit to fund more reckless public spending.

     

    Source: OECD – Basic Income as a Policy Option

    So how could the Italian economy be saved by the free market? And could this be achieved under a centre-right coalition?

    Unfortunately, the policies of Berlusconi’s Forza Italia and the Northern League range from the obscure to the downright reckless. Both are pushing for the introduction of a currency for domestic use to boost the economy while keeping the euro for international trade and use by tourists. They also wish to implement a flat tax at around 20 percent for individuals and firms. Moreover, Forza Italia are proposing tax cuts to on everything from inheritance to pet ownership, and strongly advocating for a monthly universal income of £875.

    The concept of a parallel currency has been disparaged by mainstream economists, yet it could prove a viable exit route for Italy from the euro. The currency’s success would be dependent on whether Italian households and firms embrace the new currency, but its backing by the government would provide both credibility and presence, especially given that the Italian government’s spending was measured at 49.6 percent of GDP in 2016. A flat tax is an ambitious proposal which would spur major restructuring a system that is currently in desperate need of reform. Intended to be used in tandem with the basic income, it would simplify the Italian system and reduce the overall tax burden – but would create massive shortfall in revenue. In a time where Italy’s public finances are already strained with more than €2tn of debt, the plan would require radical reductions in fiscal expenditure to be successful.

    More worryingly, not only is there ambiguity surrounding the effectiveness of a basic income in Italy, but Berlusconi’s citizen’s income is even more dear than M5S’s and is yet to be costed by Forza Italia. Moreover, many argue Forza Italia’s basic income is so generous that it will discourage the search for work, further stunting the economy.

    There are no certainties for the upcoming election, but what needs be made clear is that more reckless government spending as proposed by all the major parties is not the answer to Italy’s sovereign debt crisis. No single party has presented any policies which can reduce debt and tackle poverty simultaneously. The most straightforward solution appears to be radical reform to not only the public sector, but also the woefully inefficient private sector.

    Italy currently ranks 46th on the OECD’s Ease of Doing Business Index, and as such cuts to fiscal spending must be supported by a government which cuts red tape and reforms existing tax structures to allow the private sector to flourish. Greater competition would drive business innovation, decrease unemployment and raise living standards in Italy’s poorer southern regions. Private investment in education and training for young Italians also needs to be incentivised by the government in order to address youth unemployment, as well as widespread consolidation and recapitalisation of Italy’s banking sector, which will restore investor confidence.

    It seems idiotic that Italy’s leaders continue to preach further expenditure as a remedy to the crisis the nation faces when it is itself caused by problematic over spending.

    Put simply, policymakers should cut public spending and let the free market thrive in Italy, or the country will continue to remain on the verge of catastrophe. 

    DISCLAIMER: The views set out in this blog post are those of the individual authors only and should not be taken to represent a corporate view of the Centre for Policy Studies

    Josh Adamson is a CPS Economic Research Intern from Perth, Western Australia. He joins us through the Mannkal Economic Education Foundation, which offers international scholarships to students with a passion for free markets. Josh studies economics, and aims to work in the financial services sector.  

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