Iberia and Italy send contradictory messages to EU policy-makers

 

Portugal cuts to the bone

The Portuguese government’s newly announced cuts of 30,000 government employees designed to replace the cuts in holiday pay and pensions that were disallowed in early April by the Constitutional Tribunal threaten to weaken key services like education, where Portugal is anyway weak, and healthcare, where a relatively well-performing service could be undermined. Portugal like other countries has already endured five years of declining incomes which in the last 12 months have been severely intensified. During this period its long-term external imbalance as measured by the current account deficit has finally been rectified which implies that exports of goods and services now exceed imports of goods and services by a margin sufficient to service the large external debt. But further government cuts threaten to wreak deeper and more permanent damage to the social fabric than has already occurred.

The same is true perhaps even more so with Spain where unemployment has reached a staggering 27% with well over 50% of young people unemployed. If some of these have precarious and low paid jobs in the grey economy such employment hardly provides a basis for their future.

 

Help out of debt-depression spiral is desperately needed

In both Portugal and Spain governments of the centre-right have been implementing harsh austerity policies prescribed by the European Commission and the creditor countries (Germany and the Netherlands being the largest of such countries) and also striving to put in place the kind of structural reforms to labour and product markets which they are being urged to take. Yet even the beginnings of economic recovery remain elusive. Portugal for example has seen a 20% increase in exports outside the EU but with the majority of exports being to an EU in recession this is insufficient to make a noticeable difference. They have a real need for some complementary action by the creditors and European institutions. This commentary does not believe there is any magic answer to the debt-depression spiral but Germany and others could ease fiscal policy a little and allow wages to rise slightly faster so boosting disposable incomes. They could move a little faster to a banking union which would gradually tackle the divided lending markets where businesses in southern Europe have to pay to banks double or more the interest rates charged by German or Dutch banks in their own countries. Germany and its allies in the ECB could take slightly more risks with the distant danger of excessive inflation.

Estimates of the EU budget required to oil monetary union before the actual plans where drawn up in the Maastricht treaty of 1992 were up to 5% of GDP, the actual budget has been held rigidly within a 1% limit. Loans through the European Stability Mechanism or otherwise are not transfers. They do entail the risk of default but such default could be more rather than less likely if southern economies continue their downward trajectory.

On the other hand the German fear, fed by the country’s own experience of massive transfers since unification to eastern Germany which failed to bring economic convergence, of pouring money into countries which use it to avoid rather than help necessary financial discipline and reform is also understandable. What is being done in Portugal and Spain (and even more so in Greece) should make Germany and its creditor allies see that such fears are now as justified as fearing that an anorexic could become obese by over-eatin.

 

But Italy sends another message

However the message coming to the creditors from Italy is very different from that from Spain, Portugal or Greece. Although Italy has a massive and chronic government debt its private sector has a low level of debt and huge financial assets so overall it is a wealthy country and not heavily indebted externally. It is less far off eliminating its government deficit than the other countries and its failure to do so is a result of politicians who in an effort to be re-elected have not taken feasible and necessary measures.

In November 2011, the financial markets and Italy’s partners (then President Sarkozy as much as Chancellor Merkel) lost confidence in the government of Silvio Berlusconi and the yields being demanded of Italian debt threatened to bring the country to financial collapse. As a result the head of state, President Napolitano who normally kept aloof from the country’s politics, intervened to appoint the academic economist, Mario Monti, as prime minister of a government of non-politicians to “save” Italy. Its first set of measures entitled “Salva-Italia”) included a tax on first homes (second homes were already taxed). Although similar property taxes are common in other countries, this was highly unpopular in Italy, and from late 2012 Mr Berlusconi staged a spectacular recovery from near political oblivion to almost winning the March election, a central theme of which was his promise to abolish this very property tax which had been necessary to convince external creditors including private bondholders that Italy was financially viable.

In view of such events in Italy, Germans would not be completely mistaken if they concluded that an easing of financial pressures on Italy would make it easier for politicians like Mr Berlusconi to return to power and use that power to entrench their privileges rather than make the reforms needed to allow Italy to perform adequately within the monetary union.

 

Italy’s problems are not just a result of the economic downturn

It is true that Italy is also suffering from prolonged recession and is offering its young people poor economic prospects but this predicament is more due to deep flaws in Italian politics and society than to the euro zone crisis. The success of Beppe Grillo’s Five Star Movement (M5S) which came from obscurity to 25% of the votes in the March 2013 election reflected a feeling amongst much of the population that Italy’s political class was self-serving. Unfortunately, though, this message was blurred by the simultaneous recovery of Italy’s most self-serving politician Silvio Berlusconi, helped by his control of much of the country’s television. Other flaws include the notorious organized crime clans which though being combatted seriously in Sicily remains rampant in two large southern regions, Calabria and Campania, where their impact on the wider economy is profound. The justice system includes many brave and dedicated public servants but remains appalling slow and is also over-politicised. Most professions remain encumbered by restrictive practices which makes entry even by well qualified young people difficult.

 

New prime minister Letta has to square the circle

Enrico Letta, deputy leader of the Democratic Party (PD) which just emerged as the largest party in the March election, but performed much less well than seemed likely at the start of the campaign, leads a new grand coalition between the PD and Berlusconi’s People of Liberty (PdL) having failed to persuade Grillo to enter constructive discussions. The government states that it wants to ease austerity but sis committed to maintaining the budget projections of the Monti government including a 2.9% of GDP deficit in 2013, but will have to remove the property tax if it is to retain the support of Berlusconi. It will somehow have to find expenditure cuts or other tax increases to meet this commitment. Neither are likely to be possible without taking on entrenched interest groups linked to one or other of the two parties in the coalition. Hard-nosed German and Dutch policy-makers will be watching.

 

 

Is Italy governable?

The result of the Italian election on February 24-25th has caused widespread shock bordering on despair over the future of democracy in Italy. Both the German opposition candidate to be chancellor in the September 2013 German election, Peer Steinbruck, and the British Economist, said that the majority of the Italian electorate had voted for “two clowns”, namely Silvio Berlusconi, the media entrepreneur who has dominated Italian politics for 20 years, whose party and allies won 29.1% of the vote to the lower house, and Beppe Grillo, a political satirist with a hirsute appearance like the Scottish comedian Billy Connolly, whose Five Star Movement won 25.6%, an effect that Grillo described as that of a tsunami. The left of centre alliance led by Pierluigi Bersani, who has supported the austerity measures necessary to avoid bankruptcy imposed by the outgoing prime minister, Mario Monti, scraped in as the largest grouping, with 29.5%, which gives it according to Italy’s current bizarre election system a majority in the lower house. However, he had lost millions of votes compared with opinion polls at the beginning of the campaign. Moreover, together with Mr Monti’s Civil Choice (10.6%), those voting for policy continuity were in a minority, an outcome which also had not been predicted in the opinion polls.

Does this make Italy ungovernable, as many inside and outside the country have said? Not necessarily.

The Berlusconi alliance, which brought Italy to the edge of bankruptcy in 2011 and whose voters succumbed to the offer of having a property tax repaid out of money which Italy does not have and many of whose members of parliament have been like Berlusconi himself convicted or are being tried for fraud or other financial crimes, has nothing worthwhile to offer.

Grillo was himself convicted of manslaughter for causing the death of three people in a road accident 30 years ago and for that reason did not stand for parliament. Those elected under his banner are free of any conviction or current prosecution. They are also free of any political experience, before being selected as parliamentary candidates via an Internet process in the last few months. They include job-seekers, housewives, pensioners and people with every kind of profession or business activity. Apart from the fact that 88% have degrees and the average age is a relatively low 37 they could be described as not dissimilar from those selected randomly to serve in juries in the UK or US.

The pronouncements of Grillo himself consist mainly of negative attacks on the previous ly existing political order rather than developing a coherent programme (although M5S has an admirably short manifesto consisting of a range of specific demands, under seven headings, State and Citizens, Information Technology, Energy, Transport, Economy, Health and Education). Immediately after having been swept by the election “tsunami” into a position of responsibility and now a part of the detested political order, he showed no sign of changing his approach when he unleashed a renewed invective against Bersani who, though the only person in a position to try to form a government, he described as a “dead man talking”. However, after Italy’s president Giorgio Napolitano refused, on a trip to Berlin, to meet Steinbruck who had described as noted above described him as a clown, he gave fulsome praise in his blog to Napolitano.

More important is the fact that the disparate representatives M5S are now elected members of parliament and have the right to vote as they wish. During the campaign Grillo expelled one person from M5S for attacking his own autocratic style but he would be shooting himself in the foot if he expelled from his movement elected members of parliament for thinking for themselves and acting in a  responsible way to show that the success of M5S does not make Italy ungovernable. There is thus a reasonable possibility that M5S members of parliament will allow a government formed by Bersani to win votes of confidence in both houses of parliament–as it must do to take office–and then to pass legislation to reform the Italian political system, while not reversing the measures taken by Monti to avert bankruptcy.

Insight Europe does not believe there is any way out of the dire economic financial and fiscal condition of euro zone countries (and non-euro countries, such as the UK) other than years of hard grind to pay down public and private debt (in Italy’s case mainly public debt). A write-off of the debt may be the best answer for a small country like Greece but Italy is too big to fail and, even if they wanted to, its euro zone partners would not be able to prevent disastrous consequences from a default. But that constraint still leaves huge issues for example over how the pain is shared between rich and poor and what can be done in the situation to give opportunities for young people. The diverse group of people elected under M5S, who in their background represent the public much more than professional politicians, have a chance, together with Bersani’s Democratic Party, to change radically the political culture of a major European country. A start would be to insist on putting into effect rapidly M5S’s proposal for a radical cutting of the pay (the highest of any major EU country) of its parliamentarians and their number (also the highest). It is stated in Girl Friend in a Coma, a recent film made by Bill Emmott, former editor of the Economist Newspaper and author of Good Italy, Bad Italy, and Annalisa Piras, an Italian journalist, that the cost of official cars paid for by the Italian taxpayer is more than total government spending in conserving the country’s magnificent  cultural patrimony. The figures can be argued over but Se non e vero e ben trovato: there is huge waste in Italy – in all levels of government—and reforming Italy should begin at the top. After that a new focus has to go into retrieving the vast sums lost by tax evasion.

Budget negotiations are key to future image of EU

On February 5th Herman Van Rompuy put out a video message (http://tvnewsroom.consilium.europa.eu/event/video-messages-of-herman-van-rompuy/eu-budget-negotiations-the-bigger-picture-must-not-get-lost) which made an admirably concise plea for a budget to focus on jobs and particularly jobs for young people and also insisted on moderation, which he surprisingly defined as a real terms cut. This would imply that the demands of the UK, Sweden and the Netherlands in terms of expenditure discipline would be met or even exceeded.

Budget is small in relative terms,but high in absolute terms

As a percentage of national budgets (about 2%) the EU budget is much smaller than implied by the claims of over-centralisation of power. It has remained at around 1% of gross national income (considered a fairer measure than gross domestic product) over the last 20 years well below its allowed maximum of 1.24% of GNI. To have done this during a period when the EU has expanded to include 12 new countries almost all well below the 75% of average income threshold which entitles them to substantial funding to help catch up, and when a monetary union has been created for 17 member states, an embryonic diplomatic service has been set up and effective measures for criminal justice have been put in place is a significant achievement.

The gains in terms of both political stability and prosperity from the single market are not possible to measure but surely hugely outweigh the costs of the EU. Nevertheless when expressed in absolute terms, the amounts are large enough to become politically contentious, at a time when all countries are having to make cuts which are causing large scale public redundancies, closures of hospitals, and other public services like libraries. The UK, France and Italy are currently spending about €16bn (£13bn) in gross terms and €6bn (£5bn) in net terms in contributions to the EU budget.

Some but not all is all is well spent

Some of this money is very well spent. There is huge over-demand for the 11% of the total EU budget spent on boosting collaboration between EU countries (and sometimes also other countries) on scientific research and the development of new technologies. This is money well spent on boosting the EU’s economic potential and ability to thrive in the face of competition from rapidly growing economies like China and India. A strong plea for this spending to be maintained was made on February 5th in a letter to the Financial Times by leading British scientists. Another area of money well spend is co-operation on justice mainly criminal justice, which takes up just 2% of the budget. According to the British Association of Chief Police Officers (ACPO) if, as is being considered, the UK were to opt out of the European Arrest Warrant (EAW) just one of about 20 important EU measures in the field of criminal justice, the result would be “fewer extraditions, longer delays, higher costs, more offenders evading justice and increased risks to public safety”.

Slightly lower in terms of money well spent is the category of administration which absorbs 6%. At 0.06% of national income this is good value for underpinning the benefits of a rules-based single market with a level playing field evened by the enforcement of rules on competition. Yet at a time of austerity the pay and privileges of the upper tiers of the Commission which exceed those of leaders of national governments look excessive.

The largest items of spending are agriculture and regional policy. Agricultural spending, narrowly defined to standard income support for farmers amounts to 27% of spending. If the EU were starting from scratch this might see excessive, but there has been a continuing decline from about 70% when the UK joined the EU in 1973 and most of the spending no longer supports (ie increases) prices as it used to. There is however an additional item called rural development environment and fisheries which absorbs 10% of the total. This is almost as much as is spent on research and innovation and yet its purpose. It includes the very different objectives of environmental conservation or improvement and diversification to non-farming economic activities. It is a category which at least merits careful scrutiny.

Focus of regional spending should be on job creation

But the category which needs most attention is the 37% spent on helping the poorer or most economically troubled regions. This spending has in the past been heavily focused on infrastructure, which does not necessarily bring fundamental economic development. What is most needed is to foster the development and expansion of new micro, small and medium businesses which having already  been responsible for the great majority of job creation across the EU in recent years have the best potential to provide employment opportunities in southern European regions where rates of youth unemployment often exceed 50%.

 

Italy general election gives chance for political renewal

Most important event in eurozone in early 2013

The Italian election on February 24-25th is the most important event in the euro zone countries in early 2013. It is potentially the most important election in Italy since 1994 since it gives the country the chance to move on from the bipolar political system–with one pole led by Silvio Berlusconi and the left around the former communists–that in 1994 replaced system which had from 1948 until 1992 seen Italy governed by a coalition in which the Christian Democrats were always the largest party. The bipolar system did provide the Italian electorate which a choice of governments which they had effectively been previously denied but suffered from the fact that the right-of-centre pole was led by man whose series of convictions (subject to appeal) for tax evasion, false accounting and bribery, ongoing conflict with much of the judiciary and use of parliament to change the law to further his own interests greatly weakened the principle of the rule of law in which all are equal that is a key principle of a constitutional democracy. The left wing pole was also something of a disappointment since although the former communists allowed themselves for much of the period since 1994 to be led by a former Christian Democrat economics professor, Romano Prodi, its early reforming motivation was weakened by the need to form an alliance with the far left which blocked many reforms as well as by factional politics within the former communist party (now the Partito Democratico, PD).

The hope that Berlusconi would keep to an earlier declaration that he would not return to frontline politics has been disappointed. He presided over a deterioration of prospects for Italy’s finances to the point where he had to resign in November 2011 because investors had lost faith in the ability of Italy under his leadership to put its house in order. Since then he has swung between supporting the replacement government of Mario Monti for implementing measures necessary to restore confidence of investors and condemning the same measures as a capitulation to German demands. Nevertheless, there is according to recent polls nearly 30% of the electorate still sufficiently gullible to vote for Berlusconi’s Partito della Liberta (PdL) and parties associated with it including the Lega Nord, itself hit by a major corruption scandal. This represents a comeback for Berlusconi.

Even so, there is a chance that the election will bring about a significant renewal. Pier Luigi Bersani, the leader of the PD, which is likely to be the leading party in the next government, was subjected to an open process of re-election through a primary election of the PD and associated parties in November following televised debates in which he fought off a strong challenge by the much younger and radically reformist mayor of Florence, Matteo Renzi. Bersani had been a consistent supporter of the Monti government until its resignation in December 2012 and is open minded about reforms although if he were willing to propose reforms that affected the interests of trade unions he would be opposed by left-wingers in the PD and Nichi Vendola. Vendola is a successful president of the southern Apulia region, whose party, Sinistra Ecologia Liberta (SEL), which is allied with the PD, has strongly opposed labour market reform. Nevertheless the PD is taking measures to renew itself including having also run primary elections for many of its parliamentary candidates (albeit with a low turnout) and welcoming in outside personalities such as the anti-Mafia prosecutor Pietro Grassi. It also tried to bring in the well known political and social commentator, Beppe Servignini, as a leader candidate, although he has turned down the offer.

Monti enters political fray

The second potentially important development is the entry into politics at the beginning of this year of the prime minister from November 2011 to December 2012 and current caretaker, Mario Monti, hitherto without political allegiance, as leader of a centrist grouping based on two existing parties and a new movement promoted by business leaders. At present polls suggest that this grouping would win about 15% of votes. Its challenge is to increase this proportion during the campaign by appealing to voters who are undecided or inclined to vote for the Berlusconi camp or Movimento Cinque Stelle (Five Star Movement)  led by the comedian Beppe Grillo, who wants to take Italy out of the euro. Votes from the PD would inevitably be from its reformist wing and would be a poor reward for the support given by the PD to the Monti government and its unpopular austerity measures.

Mr Monti’s decision to enter the political fray–which took time and cannot have been easy–has drawbacks such as putting him in competition with Bersani who had supported him in government. The decision is a brave one. It is too early to say whether the risk will be rewarded, but it is a risk worth taking. In the Italian context Monti had a degree of legitimacy through parliamentary support for 12 months from November 2011 but only for a limited time. After the election, if he can muster a respectable vote he will have continued legitimacy as an influential person although he is very unlikely to again be prime minister and may well not be in government.

The president of the republic, Giorgio Napolitano, strongly urged the political parties to reform the existing voting system but they failed to do so. Under the system, if the PD and allies receive the support indicated in current polls they should win an overall majority in the Chamber of Deputies because the winning party is given a bonus. However, in the Senate, the bonus applies on a regional basis and therefore the PD and electoral allies will probably not have an overall majority. Such an outturn might seem to give Monti’s centrists some leverage but that leverage would have little chance of enabling them to push through any reforms that are opposed by the left. Nevertheless they could at least try to provide a constructive and realistic critique, which is probably not going to come from the PdL or the Five Star Movement. Beppe Grillo. Assuming that, as opinion polls now suggest, the PD and electoral allies emerge from the election with more than twice the representation of the centrists, there is risk that a coalition government between the PD would be too weighted to the PD group to allow the participation of the centrists to be sufficiently influential. Although  Bersani has said that he would be open to an arrangement with Monti, unless Bersani was able to give a Monti a powerful role in such an arrangement, he would be likely to be able to make a better contribution as a constructive and responsible opposition.

 Priorities for the next government: opportunities for the young and legal reform

Apart from the painstaking business of continuing to put Italy’s fiscal affairs in order, there should be two priorities for the next government. The first should be to increase opportunities for young people through education reforms and trying to increase job opportunities. There is however very unlikely to be the necessary political backing for any further overarching labour market legislation following that of the Monti government in June 2012 (see Can labour market reform boost plight of young people without jobs, July 31st, 2012 http://insighteu.com/?cat=7 ). So the challenge will be to try to make the new law work and put pressure on unions and employers to work together rather than antagonistically. The PD economics spokesperson, Stafano Fassina, has also indicated that a left-of-centre government would pursue reforms to increase competition in professions and trades such as law and pharmacies which could reduce the present power of incumbents to make new providers’ entry into the markets very difficult.

A second key priority is reform of the legal system. The slowness of the legal system, including excessive delays during appeals, means that it is often ineffective. An effective legal system is an essential part of a strategy to improve Italy’s currently low ranked business environment and more broadly is a key part of a well-funcitioning democracy.

Is unelected ECB likely to be too powerful?

Two major steps

Two developments are likely enormously to increase the role of the European Central Bank (ECB) in the euro zone. First it has announced its intention by a large majority on its board of governors, though against one of the two German members of the board, Jens Weidman, to be prepared to purchase unlimited amounts of the bonds of governments of up to three years duration, whose interest rate spreads against those of other euro zone countries are unacceptably high, but on the condition that the governments of such countries accept what they see as the humiliating need to subject themselves to agreed programmes monitored by a troika of the ECB itself, the IMF and the European Commission as has been the case for Greece, Ireland and Portugal.

Secondly, plans being developed for a “banking union” of euro zone countries envisage a single prudential regulatory authority, namely the ECB, banks in all the participating countries.

Does this mean democratic deficit will increasee?

In both cases, the stability and prosperity of the euro zone is at stake and it makes good sense from a practical point of view to give these powerful roles to a body which has established its independence, brings together representatives of all euro zone countries and can draw on a deep well of economic and financial expertise. On the other hand, the ECB board is not elected which means that the existing democratic deficit of the euro zone will be increased. The moves can be justified by the fact that popular opinion in most countries favours keeping the euro zone together rather than a return to national currencies and given the risks that the latter could happen unintentionally, the best policies available should be used to hold the currency together. Nevertheless, the consequences for democratic accountability need to be debated, taking heed of concerns expressed by bodies like the German constitutional court, which on September 12 gave the go-ahead to a new permanent European Stability Mechanism to take over from the temporary European Financial Stability Facility (EFSF) but emphasised the need for the German parliament to remain involved and agree only after proper debate to any further commitments. The constitutional court had previously expressed its opinion that the European Parliament does not have a high enough profile to replace the need for the involvement of national parliaments in the development of the euro zone. One conclusion should be that efforts should be made to enhance the oversight role of the European Parliament but another is that there is no foreseeable prospect that this will replace the need for oversight of key euro zone policy developments by national parliaments, despite the difficulty of making a coherent policy out of 17 different parliaments.

The role of the troika

The ECB has been right to insist that it will only intervene from now on in government bond markets if the country concerned has agreed to a programme monitored by the troika since that ensures that the decision is shared. Although the IMF has no effective democratic accountability, the Commission can be thrown out by the European Parliament and does have to take account of the views of the elected governments of participants. Moreover the programmes are monitored and debated by national parliaments and the press in creditor countries. There is inevitably going to be conflict between the democratically expressed wishes of debtor and creditor countries, as is continuing in an acute form in the case of Greece. It can be argued that Spain and Italy are already trying to implement very severe austerity programmes and that any more austerity might well be counter-productive by depressing the economies and their tax-raising capacities. However, it cannot be predicted  what will happen if and when current governments lose power. The Spanish government is relatively new but is still vulnerable as a result of disenchantment and tensions with regional nationalities, Catalonia and the Basque Country, while the government of Mario Monti in Italy cannot last beyond the next election due in April 2013. On this issue therefore the ECB chaired by Mario Draghi (but the ECB decisions are collective) has given a coherent and balanced lead which is as far as possible compatible with democratic criteria but it will have many future challenges.

ECB could have done much more to oversee national banking systems

On the question of bank supervision more reservations are in order. It is important that the ECB be held accountable and it has not been very effectively held to account to date. It is true that it did not have the same degree of authority over financial stability as it is to be given but it clearly should have been a concern to the ECB while many of the national banks, part of the European System of Central Banks (ESCB) with the ECB, did have responsibility for bank supervision. The ECB did point to the dangers posed by government deficits and but failed to point to the equal dangers posed by banking imbalances, particularly in Spain and Ireland. In fact it did not consider it important to examine what was happening in individual countries, believing instead that the euro zone could be treated as a single economy. That was a position that it had to take with regard to setting interest rates but is not appropriate for seeing signs of financial instability. A good first move would be to publish comparative statistics for the different countries rather that just euro zone wide statistics as it has done so far, in contrast for example to the IMF and OECD. The ECB if it is to live up to its new role needs to learn lesson from its past failings and should be made to explain why it failed by the European Parliament. The result would not be likely to be that the task of supervising banks is passed to other institution since none that would have been likely to have been more prescient exists but it would help the cause of democratic accountability in the euro zone. The European Parliament is a parliament for the whole EU but what happens in the euro zone and what the ECB does is a matter of importance also for non-euro zone EU countries.

 

 

 

 

Can labour market reforms boost plight of young people without jobs?

The euro zone’s southern countries fiscal and banking problems have exacerbated an underlying social challenge, one facing all countries, but most acutely those of southern Europe, namely that of providing job opportunities for young people. Even when their economies were performing better, Italy and Spain had developed dual labour markets, in which a large number of established employees enjoyed a high degree of job security, together with relatively good wages, while most young job-seekers could only obtain a succession of short-term jobs which provided little or no training. Now that these countries are in the second part of a double-dip recession, the opportunities for young people are even worse: half of those not in education under 25 in Spain, and a third in Italy, are unable to find a job at least other than completely unregistered jobs in the shadow economy.

Labour market reform is therefore rightly high on the agenda of these countries. Many economists and other commentators believe that, if job security were reduced, employment would increase, pointing to Denmark and the Netherlands, two countries which have achieved not only low levels of unemployment but high rates of participation by bringing into the labour force those, especially women, who in southern Europe do not seek jobs. These countries models are described as “flexicurity” since those who lose jobs have both relatively good unemployment benefits and a labour market which provides opportunities for re-employment. Unfortunately there are huge obstacles towards moving to this model. Allowing the easier dismissal of existing workers would certainly increase redundancies, but despite the evidence from countries like Denmark and the Netherlands that it would increase opportunities for new jobs, this cannot be proved and, from the perspective of trade union members remains a  matter of speculation, and under existing economic circumstances the prospects do not look very good. Moreover, it has to be pointed out that Spain and Italy already do have a large section (the second tier) of their labour markets which are highly flexible – some would say excessively so—and although this second tier has led in Italy at least to the creation of jobs which were not there before, they have by no means produced north European levels of employment even when economic conditions were better.  An obstacle particular to Italy is that this country at present only provides an adequate cushion of unemployment benefits to a limited group of the work force through the so called Cassa Integrazione. Those not covered by this fund receive negligible benefits. Efforts are being made to fill this gap in the social security system but these are limited the need to bring the public finances into surplus so as to begin to reduce the 120% of GDP public debt.

More fundamentally, the functioning of labour markets is dependent not just on the legal framework but on patterns of industrial and social relations which have developed over generations. The experience of countries with well-functioning labour markets should be given prominence and lessons should be learned but applying those lessons is not as easy as just tearing up excessive regulation. Labour markets are highly political and it is not easily possible to impose common euro zone rules that over-ride domestic politics on top of the increasing severity of fiscal rules needed to address the sovereign debt crisis.

Nevertheless Spain has brought about a significant reform which should limit dismissal costs for standard contract employees to a month’s pay for every year worked, ending the uncertainty over costs which had been such a disincentive previously, although this applies only to newly taken on employees. Those already employed before the reform retain existing rights. The reform has not yet resulted in any beneficial effects on job creation but this is likely to have to wait till the elusive economic recovery takes place.

Negotiations over a bill to reform labour markets in Italy put forward by Mario Monti’s employment and pensions minister, Elsa Fornero, was the major domestic policy preoccupation between March 2012 and the end of June when, after amendments by parliament, the bill was passed into law. It has been severely attacked by the employers’ organization, Confindustria, and by some Italian commentators. On one of the government’s objectives, the simplification of legislation, it certainly fails, running to nearly 100 pages of dense text. However it does make some significant changes, which should be for the better. With regard to the highly contentious Article 18 of the 1970 Workers’ Statute, regarding individual dismissals, it makes these considerably easier if they are for economic reasons. Protection against dismissal for disciplinary reasons can rightly still be contested in the courts. If the employee is vindicated he or she has a right to compensation but will no longer have an automatic right to be re-instated, the latter now is dependent on the judge.

Controversially, the new law makes some changes, which increase the rights of employees on short-term contracts. The law also increases the obligations of employers towards the training of apprentices, an aspect where the ministry claims to have the support of both sides of industry.

With regard to bringing young people into the labour force, an example that southern countries could benefit from looking at is that of Germany. Its latest youth unemployment rate in May 2012 was 7.9% compared to 37% in Italy and 50% in Spain. Of course the recent overall performance of the German economy has been much better than those of Italy and Spain, which clearly provides a more favourable background to taking on young people. But the German youth unemployment rate has throughout the cycle kept much closer to the overall rate—youth unemployment peaked at just over 15% in 2005. A likely reason for Germany’s better performance is the longstanding priority in German business culture to apprenticeships, backed up by a system of days released for external vocational education. Apprenticeship programmes are supervised and monitored by local chambers of commerce. Although the German system is an old one it has adapted to changed needs by introducing 43 (out of total of 344) new types of apprenticeship in the last ten years and changing many others. In other countries, employers often complain about the quality of school education, but results for German 15 year olds in the OECD’s comparative studies known as PISA have not compared favourably with other EU countries which reinforces the likelihood that low German youth unemployment is linked to the apprenticeship system.

The German labour market also benefits from reforms introduced in the mid-2000s under the heading Agenda 2010, although the reforms were incremental rather than consisting of a radical sweeping away of regulations.  Indeed in some ways it increased regulation. For example, employees serving notice now have a right to time off to seek new employment. An important change was a radical reform of the federal labour market agency, incorporating elements of a private job agency and integrating its work with the provision of benefits.

Arguably more important than government-driven reforms has been a decentralization of bargaining over wages and conditions, which has taken place over the last decade. This has increased the role of existing works councils, which have long been provided for by German law and have gradually come to be seen as a valuable tool by company management and owners for concerted approaches to competitive challenges. They have allowed greatly increased flexibility within companies for tackling changes in demand and between companies depending on the performance of companies.

Italy and Spain should likewise strive to increase the say of employees at company and local level, where large national trade unions cannot be expected to know the conditions. National agreements may continue but, as is the case now in Germany, they should be increasingly open to adaptation at company and local levels. However this does require central union organisations to be willing to devolve some of the powers.

Follow-up to summit undoes its good work

Euro zone policy makers have failed to follow up the small successes of June summit 29th with a consistent message which could inspire investors’ confidence. There were three main specific policy moves of significance and potential benefit that the summit agreed on: first that the European Stability Mechanism (ESM), when it comes existence as it is supposed to in the coming months, should be able to buy government debt of Italy and Spain without the same arrangements involving wide-ranging programmes of the type applied to Greece, Ireland and Portugal which are monitored by the troika of the European Commission (although there would still have to be policy commitments by the governments). Secondly, such debt if bought by the ESM should not become senior to other debt, which would have taken away any realistic chance that it could actually support the private sector market. And finally that, once the ECB has been given regulatory supervision over the euro zone banks, the ESM can provide capital to support troubled banks without that capital being underwritten by the government of the country in which those banks are based, so avoiding an sovereign debt burden that would weaken confidence in the ability of the country to manage its debt.

All three were significant moves and all should have had a beneficial impact on what at present appears the most intractable problem affecting the euro zone’s prospects, namely the threat that lack of market confidence in the solvency of Italy and Spain becomes self fulfilling by charging interest rates in those countries debts that becomes unaffordable. They did have such a beneficial impact but this was very short-lived and in little more than a weak the spreads between Italian/Spanish and German government debt had risen to even higher than they had been before the summit. This partly reflects the fact that though the agreements should have been helpful none will be decisive. Assuming the ESM comes into existence, it will have a lending power of €500bn against a Spanish government debt of €800bn and an Italian one of almost €2,000bn.

Given this gap, it is possible that there is nothing that can be done to prevent the gradual deterioration of the situation unless or until there is a massive underwriting of the weaker countries’ debt by the euro zone as a whole either through euro bonds or the ECB. This possibility has become more likely as a result of the follow-up from the summit. It is in the interests of the creditor nations to try to prevent this.

A lesson that should be learned is that it is not only important to reach agreements on policy but also to agree on how what has been decided is presented. If each country tries to interpret it in a way most favourable to its own domestic political situation, as has happened, the effect will be to undo any beneficial impact of the agreements on the financial markets.

Some criticism can be made against the governments of Spain and Italy. They both said that they were more favourably treated than Greece, Ireland or Portugal in that they had not agreed to the same Memorandums of Understanding and detailed monitoring. They needed on the contrary to tell markets they are doing just as much as these countries to correct their finances and reform their economies. However, both these countries have, following the summit, introduced swingeing further expenditure cuts on top of those previously put into effect. Given that such measures will intensify and prolong the second recession they are experiencing, it is hard to see how they can be expected to do more.

Criticism can also be directed at the post-summit comments and interpretations  of the creditor member states. The German has been more keen to emphasise what it has not agreed to (euro bonds) that what it has agreed to and Wolfgang Schauble, the German finance minister, has emphasized that the transfer of regulatory authority to the ECB will not happen till next year so that the rescue of the Spanish bank, Bankia, will in the meantime have to be added to Spanish debt. On the other hand the German parliament has given a large majority to legislation providing for the establishment of the ESM. Of great concern has been the apparent attempts of the Netherlands and Finnish governments to pull back from what their prime ministers agreed to at the summit. Both these countries face difficult domestic political situations with populist politicians exploiting voter concerns about the potential costs of participating in the ESM. However, the reality that they should explain to voters is that the whole euro zone is threatened with disastrous financial and economic consequences if major euro zone countries become insolvent. This is likely to be most difficult in the case of Finland. The Netherlands lies at the heart of the euro zone and its banks are heavily exposed to other euro zone countries. Finland is the only Nordic member of the euro zone and the Nordic countries are at present experiencing benign economic conditions. These conditions are still at risk from developments elsewhere in Europe including the euro zone but there is a danger that in order hold back the gains made by the populist and anti-euro True Finns in the 2011 election, the government and parliament will prevaricate in a way which could be highly damaging for the euro zone.  It may be that Finland will have to be treated as a special case able to negotiate special conditions for its contributions, although if other countries were to try to copy Finland the whole exercise could be threatened. But it would be better if Finnish politicians could recognize that Finland’s longer term prospects like other EU countries depend on preventing the euro zone crisis from continuing to deteriorate.

A week to save the euro says Monti, but it is also up to him

Mario Monti has said there is a week to save the euro. He may be right. But saving the euro needs action by both sets of countries: those currently seen as strong by the financial markets, like Germany and those seen as weak, including Italy. There is much that he needs to do back home and, if he is right that the action has to be taken in a week, he has left himself little time. His government came to office in November and over the next two months did not disappoint the hopes that had been put in him and his government. He brought in a series of deficit cutting measures  and the beginnings of an effort to boost growth and employment, notably in a Decree-Law of December 6th, 2011, entitled Urgent Dispositions for Growth, Equity and the Consolidation of Public Accounts.  This was followed by a major pension reform, introducing substantial cuts in entitlements. Although the government should be providing more information and analysis on its fiscal programme, there can be little doubt that the public finance measures, including pension reform, has had an impact and there is still the a reasonable chance that the government deficit should fall this year to under 2% of GDP and of reaching balance in 2013. In annual budget balance terms, this puts Italy in a favourable position compared not only to other vulnerable euro zone countries, like Spain, Ireland and Portugal but also compared with France and the UK. However, such improvement is the minimum necessary because Italy’s public debt is the highest in the EU in absolute terms and the second highest after Greece relative to the size of its economy.

Given Italy’s record in fiscal management, there can be no complacency, but even assuming that expenditure is kept under tight control and tax collection improved, Italy like most of its EU partners other than Germany is in a trap whereby it is required by financial markets, the EU fiscal compact and simple financial prudence to take “pro-cyclical” measures that exacerbate the downturn in demand, leading to recession and rising unemployment. For that reason, the government rightly launched a reform strategy designed to create the conditions for growth and particularly to create opportunities for young people, many of which continue to see better opportunities outside than inside Italy. One of the most innovative was the creation of a legally recognized “Simplified Company with Limited Responsabilities” designed to enable those under the age of 35 to start companies with a minimum capital of one euro and with no need to pay notaries’ fees for bureaucratic requirements. This was part of a package of reforms presented on January 24th, which became law on March 23rd, entitled Cresci-Italia.

However, after its impressive first three months, the Monti government entered a period of drift. Mr Monti has remained active in a European and international context but has no longer exercised the driving force for reform domestically that he did early in his government, nor have other ministers stepped in. What should have been a major element in the reform programme, a wide-ranging reform of the overall labour market, has fallen flat. This in large part reflects a failure of representatives of business and the trade unions to set aside their longstanding differences and work together but it might have been hoped that the government would knock heads together. At present the bill, 130 pages in length, is being debated in parliament. The debate has become weighed down by detail which has caused a loss of focus on the objective of fostering job creation while providing basic legal protections for employees which safeguard rights at a cost which does not inhibit job creation.  The drive to open up access to individual trades and professions where incumbents have set up barriers on new entrants is one to which the government is in principle committed but one which also has lost momentum.

The government urgently needs to reclaim the initiative in driving an agenda for business formation and growth and job creation. Good initiatives such as the one on simple companies established by young people should be followed up, to analyse their success or failure, and the obstacles encountered by those trying to build up small businesses.

Mr Monti is right to argue for more intervention by the European Financial Stability Facility (EFSF) and the new European Stability Mechanism (ESM), which should come into operation in July. But he also has to show that Italy is acting with vigour to boost its economic performance so as to find a way out of the trap of fiscal consolidation exacerbating recession which itself then threatens the success of the process. Italy may be helped by bond purchases by the EFSF or ESM but in the last resort Italy is the country that is too big to save.  It has to save itself. The government cannot revive the economy in a week but it needs to show that it has a plan and the determination to make major progress in the nine months which remains before the next election falls due.