Just as we discussed last week, Monti has delivered a tough budget which comprises both tax savings and incentives.
The standard narrative in Italy is that the advent of the Euro saved the Italian economy. Three standard reasons are given: the Lira kept on being targeted by speculators and its peg to the ECU and DM had to be devalued on a semi-regular basis; the conditions for joining the club, which were imposed by the Prodi-Amato administration forced Italian finances to become more virtuous; and finally, the lower cost of borrowing would have allowed the budget deficit and the cost of servicing the stock of debt much lower.
Most of the above benefits did indeed take place for most of the previous decade, which saw record low borrowing rates, primary budget surpluses, and a conservative approach to government spending post the Lehman crisis which meant that Italian finances didn’t appreciably deteriorate after 2008, unlike the United States’ and the UK’s, for example.
However, and counter intuitively, the price paid for these virtues was a transfer of wealth from the productive areas of society which stopped growing as unit labour costs went up in absolute and relative terms and made Italy less competitive, to the ‘rentiers’, which had lower nominal returns on their fixed income portfolios, but enjoyed an incredible appreciation in the value of their real assets. These effects are easily spotted: Italy barely grew in the last decade, as a strong currency made it less competitive vis a vis not only China, but also Germany, but the price of a square meter of prime real estate in Rome and Milan is now in the same league of London and Paris, and certainly higher than Frankfurt and Berlin.
The fair way to deal with this problem, which we understand Mr. Monti ‘gets’, is to reduce taxation on the productive part of the economy, by lowering payroll taxes, and making the labour market more flexible, and at the same time taxing big property wealth and increasing the pensionable age. These measures would have a combined effect of reducing youth unemployment, reducing unit labour costs, increasing consumption, and ensuring a degree of fairness to the fiscal adjustment which will improve the chances of it being accepted by the nation.