France And Italy Do Not Want Austerity – But They lack A Credible Growth Strategy Lack of competitiveness, combined with costly welfare, at the root of zero growth

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WASHINGTON – France and Italy want less Brussels-imposed austerity, (spending cuts, higher taxes, fewer benefits for retirees), and more freedom to spend money, (that needs to borrowed, because they do not have it), in order to relaunch their comatose economies. Germany objects, because this would entail breaking rules regarding ceilings to annual deficits, (no more than 3% of GDP), this way encouraging fiscal profligacy.

Austerity cuts demand

Germany has a point. However, it is also true that in frozen economies cutting public spending favors more contraction, making things worse, at least in the short and medium term. So how will France, Italy and other slow-moving economies get out of this swamp?

My guess is that they will not. There is a bad combination of an ideological attachment to bad public policies and lack of basic competitiveness that conspire to keep these countries in constant stagnation, or worse.

Labor market reforms

Much has been said about labor market reforms that would create flexibility, allowing employers the freedom to hire workers when there is growth, and fire them when demand for their products drop.

Italy is slowly getting there. After years of endless debates and polemics, the left of center government led by Prime Minister Matteo Renzi seems to be close to achieving this goal. And this is good.

Italy’s unemployment is at 12.6%

However, an overdue labor market reform, arriving at least 20 years late, will not magically transform what is now a tragic employment picture. Italy has a 12.6% unempoyment rate. Yes, this is double what we have in the US –and do remember that most American economists argue that US unemployment close to 6% is still way too high. Well, in Italy you must also add 40% youth unemployment with peaks up to 60% in the perennially dysfunctional South.

There is no doubt that a more flexible labor market will encourage some Italian firms to hire. And this will translate into more jobs. But this reform, while necessary and welcome, by itself cannot be Italy’s miracle cure. The Italian economy stopped growing years ago. Even with more market-friendly labor laws, in order to hire more people you need to have growth in promising sectors.

Competitiveness

Italy badly needs new competitive sectors. And these are premised on a relentless pursuit of innovation, itself predicated on high quality human capital and significant R&D investments. None of these factors exist in Italy in significant amounts. (In France the picture is better, but not at all inspiring).

Add to the Italian mix a perennially dysfunctional and excessively large public sector, endemic corruption, the cancer of organized crime and a stupendous public debt, now at 136% of GDP, and you get the picture. There are just too many impediments to growth.

As Bill Gross of Janus, (formerly the creator and boss of Pacific Investment Management, PIMCO, the giant bond trader), put it recently, global economic growth is held back and will be held back by too much debt. Debt depresses growth. If it is true that any further expansion of the comparatively more vigorous US economy will be hindered by lack of demand in sluggish, high debt countries, imagine the situation inside a high debt country.

A way out?

Is there a way out for Italy, France, Greece and other weak economies? Of course there is. But any serious growth strategy would require gigantic cultural and psychological changes and a great deal of patience. Real, sustainable growth is predicated on real competitiveness, itself founded on high quality human capital, the natural outcome of good to excellent education.

Therefore, whatever can be done in the short-term, it is imperative to invest in quality public education now, keeping in mind that with luck you will see some results in at least 15 to 20 years. In the meantime, you have to create enough social cohesion to withstand lean times.

Politicians want to mitigate pain

But this is almost impossible, because most politicians are tempted to keep the public spending spigots open as short-term remedies against weak economic conditions. And this means that scarce public funds are spent to finance welfare measures, or unproductive new public employment. They are not invested in education or R&D.

To put it simply, despite a bad economy and high debt, the political pressures favor more and not less public spending to subsidize an unaffordable standard of living. As a result, the deficit keeps growing and the national debt gets bigger, adding long-term pressure on already exhausted economies.

Change is possible

As I said, change is possible. It always is. But meaningful change  would entail ditching bad public policy models and deeply entrenched bad habits.

I somehow doubt that, even when clearly faced with terminal decline, the ruling elites of so many Western countries will have the courage to change course.

 

 

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