Eurozone Problems Intensify as Italy Rejects ‘Austerity Cage’

The recent Italian elections saw the majority lower house vote go to Pier Luigi Bersani, leader of the centre-left bloc.

The lack of the requisite majority in the upper house has left the election outcome uncertain. However it is clear that Bersani’s promise to end the crush of austerity in Italy in order to get the Italian economy back on track has resonated with the Italian voter.[1]  Should Bersani emerge as Prime Minister, Italy will be set for a collision course with Germany and the European Central Bank. 

Following the announcements of the election results, Bersani vowed to get Italy out of the austerity cage.

”A change of course is absolutely necessary given that five years of austerity and attacks on workers have pushed up public debt levels across Europe.

The vicious circle between belt-tightening and recession is putting representative government at risk and making it impossible to govern,” Mr Bersani said.

A rejection of austerity measures by Italy will have significant ramifications for how the Eurozone is able to manage the problem of the PIIGS (Portugal, Italy, Ireland, Greece and Spain). These are the economies that emerged from the financial crisis most severely indebted and have had to rely on successive bailouts from the Eurozone, with stringent conditions attached.

As we have seen from the last three years in Eurozone, there is no such thing as a sure thing in economics and finance. Add some fiery international politics in the mix, and we’re not even sure if member states will be part of the union anymore, let alone repay their debts.

The main issue for most Eurosceptics, is that fiscal policies in the PIIGS stifle growth, rather than foster it. Can the Europeans band together to collectively overcome this crisis? To answer this question, we must go back to the inception of this troubled currency.

Firstly, it is important to clarify a common misconception surrounding this issue. The European Union is different to the Eurozone. The former is a 27-member political union which was forged in the aftermath of WWII, which devastated and divided the continent in an unprecedented way. The latter consists of 17 of those countries.

The Eurozone’s monetary policy is overseen by the European Central Bank. However, each country’s government retains control over their own respective fiscal policy. The phenomenon of control over fiscal policy but not monetary policy has led to the bizarre scenario which we now observe, where interest rates in countries like Greece are moderately high, as they are set to cater for the entire European economy, whilst taxes are at an all-time high. Thus, consumers in Greece and more broadly, in every PIIGS country, face debilitating income and property tax rates, coupled with a disincentive to borrow and spend. This worsens the already ailing GDP figures of those countries.

Moreover the PIIGS governments cannot allow the currency to inflate, which would at least relieve pressure on meeting their debt repayments, because they are tied to the stronger European economies. In all, the structure in which the Euro has been set up, has failed.

To say, however, that the crisis is completely down to the way the Eurozone was designed would be a delusion. It takes two to tango. Greece herself should have never really been allowed into the Eurozone, as the economic figures which they submitted in their bid to join the Euro were ‘cooked’ in order to make it seem like they conformed with the Euro’s requirements. Tax evasion and rampant corruption has led to reliance on loans. Tying such an inefficient economy to an economy such as Germany’s makes no practical sense. Spain, Italy and Portugal all had similar structural issues in their economies which were largely overlooked.

Perhaps the only way that such an experiment could have worked would have been complete integration – effectively making Europe a federal entity. Such a concept was obviously too controversial in 1992 (the United Kingdom and 9 other EU countries refrained from entering the Eurozone as it were), and remains so.

However, European leaders are starting to realise that it is impractical to have individual governments taking on copious amounts of debt, when the risk of default affects the entire union. If the Euro was to succeed, a European Treasury should have been created, along with the ECB, which would have controlled tax rates for the entire region, and the issuing of bonds would have been made by this treasury. This way, debt financing would have been uniform throughout the entire Eurozone.

This seems a far-fetched proposal, but we need only look at the federation of Australia to see the success of this approach. No-one in this country, is worried about Tasmania, for example, defaulting on loans, as much as they are Greece. This is because Tasmania is a discrete member of the Commonwealth, whereby the federal government controls taxes (largely via the grants power and the income tax cases), interest rates, and issuing of large treasury notes. Tasmania has very little control over the strength of the Australian dollar, and little control over the payment of income and pensions and tax. This is due to the Commonwealth’s dominance over both monetary and fiscal policy of the AUD.

A gradual transition to a federal-style Europe, or “more Europe” as Angela Merkel puts it, seems to be the most practical long-term solution, to avert crises like this in the future. The ECB and Mario Draghi have done a fantastic job in handling the crisis thus far, but they need some unity amongst European politicians.[2] More bickering amongst the member states equates to less investor confidence, which is half the challenge in overcoming these extraordinary deficits.

A more quick-fix and growingly popular alternative would be to smash the Euro up into smithereens, implying that all countries would revert to their former currencies. The pain would remain, but at least governments could regain monetary policy to boost their economies and start paying down their debt more slowly. With voters in the most hard hit economies increasingly favouring leaders campaigning on a platform of slamming austerity, we have arrived at this fork in the road now. The path the Europeans choose will soon be made clear.