Newsgroup: it.politica.internazionale
Titolo: Italy’s 'this time it’s different' moment: Reaction to Giavazzi (Ch. Wyplosz)

http://www.voxeu.org/article/italy-s-time-it-s-different-moment-reaction-giavazzi
 
 
Italy’s 'this time it’s different' moment: Reaction to Giavazzi
 
Charles Wyplosz, 15 August 2012
 
The recent article by Francesco Giavazzi is both depressing and déjà vu 
all over again.
 
In early 2010, when the situation started to deteriorate in Greece and 
some eggheads opinionated that an IMF program was unavoidable – the 
Greeks replied "we are not Latin America";
Half a year later, the Irish stated that they were not Greeks;
Then the Portuguese insisted that they were not Ireland;
Just a few months ago, the Spaniards claimed that they were not Portuguese.
Now guess what – the Italians remind us that Italy is not Spain.
 
As Reinhart and Rogoff (2009) have recalled, every country that faces a 
crisis always denies that it is fodder for IMF-style conditionality. In 
fact, you know that the point of no return has been reached the minute 
policymakers – or influential commentators – explain that their country 
is different.
And, yet, they are right. It is true that Italy’s fundamentals are 
clearly different from Spain’s fundamentals, which are different from 
those in Greece, Ireland and Portugal. What these countries have in 
common is that they have lost market access, at least at 'normal' 
interest rates.
 
The underlying economic mechanism is self-fulfilling market 
expectations, a.k.a. multiple equilibria. Rightly or wrongly, once 
markets conclude that a country’ situation is hopeless:
 
Interest spreads start rising;
Debt service becomes explosive; and
The situation eventually becomes hopeless.
Back in 2009, Greece did not have to get into a crisis. Nor did Korea in 
1997, nor Mexico in 1986, nor Chile in 1982. In all these cases, the 
fundamentals were less than rock-solid, but they were not completely 
disastrous either. In each case, once the crisis occurred, hard-nosed 
observers, who had failed to predict what was to happen, went on drawing 
a list of alarming policy failures that fully justified the crisis and 
the harsh treatment imposed on the now-delinquent country.
 
What we know full well, at least since Obstfeld (1986) and Krugman 
(1986), is that a crisis can (but does not have to) occur when a country 
suffers from a vulnerability. We also know that, once a self-fulfilling 
crisis occurs, it tends to spread in a contagious way. Research has 
still to unearth cases when a country that moved into a bad equilibrium 
was able to recover to a good equilibrium.
 
Italy slipped into the bad equilibrium
 
Sometime early this year Italy moved into a bad equilibrium. This could 
have been avoided if there had not been crises in other Eurozone 
countries. Like Korea after the Thai and Indonesian crises, Italy is 
guilty by association. Like these countries, it has a vulnerability and 
thus susceptible to run into trouble (Wyplosz, 2010).
 
Italy’s vulnerability is its public debt. Italians are proud to note 
that their governments have been able to run primary budget surpluses 
since the early 1990s. The problem is that this has just been enough to 
stabilize the public debt, which has hovered around 110% of GDP since 
the early 1990s.
 
Debts that big are crippling; Reinhart and Rogoff (2009) claim that they 
stunt growth. Indeed, Italy’s economy has been stagnant for more than a 
decade.
 
Even before the crisis, Italy was well on its way to emulating Japan’s 
two-decade zero growth performance;
Now that the Eurozone is burning, there are many reasons to conclude 
that this dreadful scenario is no longer the pessimistic outcome – it’s 
the optimistic one.
As the recession spreads, tax revenues fall and the debt starts growing, 
at least in proportion to GDP. Mario Monti’s maiden round of fiscal 
austerity has accelerated the process.
 
Self-defeating austerity
 
As in every other Eurozone country already in crisis, or soon to join 
the fray – France is now a prime candidate - this policy was meant to 
reassure the markets. It has had the exact opposite effect. The markets 
have long concluded that debts will not decline until economic growth is 
back. The more governments tighten, the more likely they are to fall in 
the bad equilibrium. Monti’s limited structural reforms may deliver a 
limited boost, but this will take years to materialize. Meanwhile, the 
debt will grow.
 
The recession is opening up another vulnerability. It inexorability 
deteriorates the ability of past borrowers to pay up. The volume of 
non-performing loans is bound to increase steadily. Sooner or later, 
hitherto healthy banks will need government recapitalization, so the 
public debt will jump up. Those who hold this debt have every reason to 
be worried. This is how Italy is losing market access.
 
True, Italy is not poor. Its citizens and firms hold considerable 
wealth. Could it not be taxed in emergency? We know from the Latin 
American crises that, in times of crisis, wealth holders are prompt to 
move their assets away from the taxman. The Italian government too is 
wealthy, holding profitable state-owned firms and precious land and 
buildings. We know that selling out in the midst of a crisis takes the 
form of fire sales that are economically counter-productive (Krugman, 
1998). While, we Europeans, are not Latin Americans – for whatever it 
means – the principles of economics know no geographical or cultural 
borders.
 
The dreadful inevitable
 
At the end of all this, the conclusion is unmistakable, simply because 
this dreadful process is so well known. In spite of all its admirable 
human and economic assets, Italy has moved to a bad equilibrium from 
which it is most unlikely to escape.
 
True, outrage is perfectly justified when waste of huge proportions is 
about to happen.
True, a few months away from general elections, the timing is 
particularly frustrating.
The temptation to deny and wait a bit more is irresistible. But waiting 
only raises the economic, social and political cost of the eventual 
crisis resolution.
 
Conclusion
 
Our best minds should not fall in this trap. Instead, we should all 
concentrate on how not to further repeat the errors of distant and more 
recent past. In particular, the Troika should imagine radically 
different conditions and the ECB should hasten its recently announced 
determination to do “whatever it takes to preserve the euro” by – in 
effect – acting as lender of last resort of governments and banks.
 
If not, the crisis will not end here. France is not yet there, but not 
that far away. And when that happens? Sorry my German friends, but the 
mast will sink with the ship.
 
References
 
Krugman, Paul (1996) “Are Currency Crises Self-Fulfilling?”, NBER 
Macroeconomics Annual: 345-506.
 
Krugman, Paul (1998) “Fire-sale FDI", prepared for NBER Conference on 
Capital Flows to Emerging Markets, MIT.
 
Obstfeld, Maurice (1986) “Rational and Self-Fulfilling Balance of 
Payments Crises”, American Economic Review 76(1): 72-81.
 
Reinhart, Carmen and Kenneth Rogoff (2009), This Time is Different, 
Princeton University Press.
 
Wyplosz, Charles (2010) "And Now? A Dark Scenario", VoxEU.
-- 
Namib
--
I have examined maps of the city with the greatest care, yet have never 
again found the Rue d'Auseil (HPL)

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