Monti: Europe’s Third Leg

Two legged stools are not very stable and Monti’s ascension to European prominence is a good thing for Italy and for Europe as a whole. While Sarkozy is fighting a difficult battle for re-election and Merkel is trying to manage the ideological concern that post-war Germany has over becoming again Europe’s leading nation, not with guns but with money this time, Mr Monti has used his prestige and his impeccable European record to start changing the European discourse towards growth. This will not be an easy battle since Germany’s aversion to easy money is even older than its fear of leading Europe, but it is a beginning.

As a seasoned economist, and as the prime minister of a nation that has practically stopped growing ten years ago, Monti knows full well that fiscal constraints can only do so much to reduce debt. Having done a lot of work on the nominator, it is now time to work on the denominator. The problem with a growth strategy is that in the past nations have abused the concept and the result has been more debt and not a lot of sustainable growth. Italy is trying to square the circle acting along three axes. The first was the emergency budget approved before the turn of the year, which in effect ensured a current account surplus one year ahead of the Berlusconi-Tremonti plans,  which had already done a lot to keep Italy’s finances in better shape than most other economies. The problem was and is growth, the second driver of the plan. Berlusconi had already insisted on a lot of the liberalisation and flexibility measures advocated now by Monti, but wasn’t able to implement them due to Tremonti and his fragmented coalition. Monti has a better shot at it because of his economic credibility and because Italy has now stared into the abyss and presumably the Italians shouldn’t want to go back there. Growth measures are expensive, and achieving a flexible economy is difficult because of the remaining power of Italy’s unions and the ideological difficulty in getting rid of the famous Art.18, which stipulates that companies with over fifteen employees cannot lay off workers. To pay for growth and to show equanimity, Monti is using the tax axe, directing it mainly against ‘the rich’. With newspaper headlines recounting juicy stories about owners of Ferraris and Lamborghinis being caught by the tax police with reported incomes barely enough to pay for the petrol, Monti is achieving two things: first, he should start raising the taxable basis, as Italians learn that they cannot have sports cars and yachts without a demonstrable income; second, he will be able to tell the unions and the working class who is dead scared about labour flexibility, that ‘also the rich cry’, to paraphrase the name of an old Brazilian soap opera.

While every country has its own history and its own particular dynamics (this is the problem with the one size fit all euro area which hasn’t been solved, and may not be solvable…), Italy’s plans can serve as a template for other countries as well. Greece for example, needs a tectonic change in the mind-set of its citizens that need to understand that you cannot have a welfare state without paying substantial amounts of tax. France, on the other hand, and this is also a lesson that other countries, should understand, should be careful with its tendency to over tax to pay for the generous and efficient welfare state that its citizens have come to expect. The continent wide tendency to increase higher rate taxes to over 50% and sometime up to 75% has been proven in the past to backfire. It may serve as a populist tool, but it doesn’t raise tax revenue.