How are the southern euro area countries doing in tackling their weaknesses?

Overall the experience of southern European euro zone countries has not been good since the euro zone was initiated in 1999 with Portugal, Spain and Italy all founding members and Greece joining two years later. Whether or to what extent this poor performance is due to the supposed structural flaw in the euro zone (an integrated monetary area but not an integrated fiscal or political area) or due to problems in the countries themselves is open to debate. The fact that performance was not very good also in the 1990s compared with previous decades supports the view that the problems lie within the countries themselves although two countries in particular were ultimately hurt by excess borrowing resulting from the mistaken view of markets that the lending within the euro zone was safe. When the 2008-09 financial crisis came from the US to the EU the southern euro zone was hit particularly badly. Initially the worst hit countries were Greece, Portugal and Spain plus Ireland. Ireland was the first to recover while Italy’s problems including those of its banks became worse so the ungainly acronym PIGS remained appropriate swapping Italy for Ireland.

From a societal point of view the biggest problem in all these countries is unemployment, especially youth unemployment. In Greece and until recently Spain youth unemployment is almost 50% (although this does not account for unregistered employment) in Italy and Portugal 40%.

International organisations including the European Commission, the OECD and the IMF constantly call for reform and stipulate a wide range of such reforms. Reforms are also called for by creditor countries notably Germany and the Netherlands and the European Commission has to take account of their views in its own recommendations. The creditors recommendations are inevitably informed by their own self interest. The IMF is also a creditor of Greece and is calling for debt relief but not of its own loans.  Such self-interest is reasonable up to a point. Irresponsible borrowing should not be encouraged. But there comes a point when the pain should be shared. Irresponsible lending which assumes that government loans will always be repaid also should not be encouraged.

The biggest problem with reform recommendations is that they tend to be so wide-ranging as to be telling supposedly sovereign and democratic parliaments how to legislate over a wide range of subjects. This has particularly been the case for the hardest hit country Greece but is also a live issue in the other countries. For this reason I want to focus on those l reforms which I think most important. First are reforms to the labour market, most importantly to modify protections to employees which are perceived by employers as very  burdensome and so discourage taking on employees. The second is the pressing need in several countries to simplify regulations and reduce the cost for starting new businesses and running small businesses.  Thirdly, there is the task of making the rule of law more effective, in terms of independence and impartiality of the judiciary, effectiveness in terms of sanctions and also the time taken to bring about justice. Finally, reforms may be needed to improve the management of public finances, not least in terms of collection of taxes. Decisions about how spending is divided and how much to tax should be left to free democratic choice unless expenditure is bankrupting the country or taxes are utterly crippling economic activity remembering that some countries can be economically successful with high levels of public expenditure.

The most important single reform which can improve the chances that more job opportunities are provided and one which more than most others can be done through a single piece of legislation from central governments is to limit the costs and legal procedures for companies to shed employees. The reason is simply that there is much evidence gathered by a range of organisations like the OECD that, if such costs are reasonable and predictable, companies will be much more willing to take on new employees. The model to be aimed at is one in Scandinavian countries and the Netherlands where redundant employees are given adequate welfare support and crucially access to retraining. However, there has been huge resistance to such reforms in countries like Italy and France from trade unions. Trade unions are a key ingredient in a plural society and should not be lightly over-ridden, but in this instance where they are giving priority to their hold on a diminishing membership at the expense of opportunities for young people, they should be over-ridden. The best example of a country that has reformed its labour market in this way is Spain which began introducing reforms early in the last decade and enacted a major labor market reform in 2012, while in recession.  This reform permitted companies in most cases to dismiss regular contract employees with 20 days severance pay per year worked, compared to up to 48 days previously. There were high levels of job creation in Spain during the boom before the 2008 crash, but during the recession and in the wake of a reform making it easier to fire workers, it went sharply into reverse. From 2014 the economy and employment have been recovering strongly. In Italy Matteo Renzi introduced significant reforms in employment legislation when prime minister between 2014 and 2016. There has been no major impact on job creation so far, though this may be due to the fact that the economy remains weaker than the euro area average.

Such a reform to increase flexibility should not be seen as a complete deregulation of the labour market.  The UK, which has long been one of the most flexible labour markets with high levels of job creation, has kept powerful employment tribunals to protect individuals against discrimination or victimisation, although they are now weakened by cost cutting. However, in Italy a law protecting individual employees was a long cause of controversy with employers accepting paying compensation if found to have dismissed an employee unfairly but arguing that having to take the employee back was disruptive.

Making life easy for people to start and run small businesses should not be controversial but is less easy in practice than might be expected. Two reasons may be postulated. One is that registration usually involves local governments, which are rightly autonomous. Secondly, some parts of southern Europe have a long established culture of non-co-operation and even antagonism between the private and public sectors. Private companies regard government as just a hindrance and don’t like paying taxes while government regards private companies as out to cheat. The resulting behavior of one side reinforces that of the other. Nevertheless there have been significant improvements according to the OECD in most OECD countries over the last eight years. In 2016 an OECD survey found that Scandinavian countries, the UK, Ireland and France were below average for both time and cost required to start a new business. Amongst southern European countries, Portugal seemed the best with well below average time and just slightly above average cost (just over 2% of income per capita). Italy was average for time but high for cost.

Another survey on overall Barriers to Entrepreneurship affecting small and medium enterprises also published by the OECD shows that both Italy and Portugal moved from being amongst the countries with the most burdensome regulations to being third and seventh best in terms of least restrictive legislation between 2008 and 2013. Spain, however, which has as noted done most to reform labour market legislation, retained in 2013 the second most burdensome other restrictions on entrepreneurship, having seen no improvement over the previous five years. Greece did improve but still scored only a little better than Spain.

It may of interest that Italy according to the OECD had just over 3.5m enterprises in 2013 more in absolute not just relative terms than any other country apart from the US (and not much less than the US). A generation ago Italy’s local networks of enterprises both cooperating and competing were seen as a model. They have been less dynamic than hoped in the intervening period but remain resilient. In particular Italy is a (possibly the) world leader in design, particularly but not only clothing, and there has been a moderate return of clothes making to Italy for those willing to pay a little more.

On the general question of good government, a very interesting and still relevant book called Making Democracy Work: Civic Traditions in Modern Italy by Robert Putnam was published in 1993.  It takes as its starting point the major devolution of government reform which took place in 1970 following 100 years since unification of centralized government. It compared various survey measures of good government seen through the eyes of both individual citizens and businesses and measures of civic participation (partly actual participation in social groups and partly attitudes). It found that regions with a higher degree of “civicness” correlated surprisingly closely with better government performance both through objective tests and as seen by citizens. The higher degree of civicness itself was found to be linked to the history of the regions – ones that had been city states or with local autonomy hundreds of years ago showing much higher levels of civic participation than those that had been under autocracies – most notably in the south. But the book did not find that as a cause for fatalism. Both southerners and northerners were positive about the impact of devolution and improvements on the quality of government could be seen in the south as well as north between 1970 and the early 1990s. While the south remains poorer than the centre and north and with higher unemployment, its standard of living, which had remained very low during 100 years of centralised government, has increased hugely in the decades after 1970. The book is not only relevant to Italy. The differences between regions within a country are perhaps particularly strong in Italy but also exist in most other countries and should be a warning against sweeping generalisations.

Often taking for granted when it operates well, the effectiveness of a country’s legal system including the objectivity and independence of the judiciary, is essential to a good environment for businesses of all sizes to operate and so to economic development. Companies need to be able to enforce contracts and be able to operate without fear of criminals particular mafia-type organisations which have in southern Italy particularly conducted widespread extortion.  In Spain and Italy the judiciary is independent and has been a thorn in the side of allegedly corrupt politicians in both countries, including members of the governing Popular Party in Spain. On the other hand, the system can be very slow, especially in Italy. As is well known Sicily and southern Italy are where the word mafia originated and particularly in Sicily, Calabria and around Naples has had a vice-look grip on parts of the economy. Due to the dedication and bravery of police, public prosecutors and judges, and also the co-operation of businesses in resisting extortion, the power of the mafias especially in Sicily have been reduced though they remain a major challenge and have indeed spread into the north.

In overall terms, I think the four countries I have discussed are all making changes for the better albeit slowly and unevenly and subject to the normal political shenanigans of any democratic country. The devolution of power in Italy has been very beneficial, although inevitably it means differences in quality of government between the regions. It has also overall been beneficial in Spain, despite some bad examples of corruption associated with speculative building in some regions. Outright independence for any region would be a step backwards. Although independence is favoured by many in Catalonia, a geographically small but economically important autonomous community in Spain, I don’t think the majority exists to bring it about.

The issues here discussed are in my opinion more important for the countries’ future than whether or not they remain members of the euro zone, though leaving would cause a lot of disruption and no significant benefit. Criticisms made of euro area policies towards countries dependent on the backing of creditors and of the European Central Bank are mostly valid but their claim that a softer policy would have enormous benefits is exaggerated. Once country Greece is being unjustly treated by Germany and the Netherlands taken into account how much pain it has suffered in the last nine years, the fact that it finds itself host to more refugees relative to its population than any other EU member and the fact that lenders and EU decision makers acted just as irresponsibly as Greek governments, but even in this case the answers to Greece’s economic travails lie more inside Greece than outside.