Policy Research in Macroeconomics

Italy: the (ir)relevance of economic theory for leaving the euro

Image with acknowledgment to  Banca d'Italia  

Image with acknowledgment to Banca d’Italia 

“A European cultural consciousness exists and there exists a series of manifestations by intellectuals and politicians who maintain the need for a European union: it can also be said that the historical process leads towards this union and that there are many material forces that will be able to develop only in this union. If in 10 years’ time this union is achieved the word nationalism will have the same archaeological value as municipalism now has.”  (Antonio Gramsci, 1931)

There is no doubt that the current institutional architecture of the Eurozone and the austerity policies implemented in recent years are absolutely irrational. There are no doubts that such policies have generated very significant increases in unemployment, waves of business failures, a drop in the growth rate and – in contrast to the aim stated – also increases in the public debt/GDP ratio, not only in Italy.

The question that therefore must be answered, since it follows logically from the previous statement, is whether or not it is advantageous for a single country to go back to its own currency and, more generally, whether the debate that has sprung up around the question of whether or not it is advantageous to return to the lira is actually relevant.  

First we have to clear up a misunderstanding: foretelling what may happen in the case of a unilateral exit is absolutely impossible, and while the study of what has happened in past cases of monetary union break-ups can help, it is obviously not set in stone, if only because it is almost impossible to repeat historical regularities. [1]

The main arguments in favour of abandoning the euro can be summed up as follows.

1) Leaving the single currency would enable the new lire to be devalued, with positive effects on exports, and therefore on domestic demand and employment.

This argument comes up against two objections. First of all, devaluation means higher prices on imported goods, with a consequent reduction of real wages. Unless the idea is to return to wage indexation, this would produce a redistribution effect detrimental to workers. In this case, it cannot be excluded that the exit would cause a further worsening of income distribution. Secondly, devaluation does not have (just as, in the years when it was used, it did not have) uniform effects all over the country, since it brings benefits to the areas where exporting firms are located, and may accentuate the regional divide. Further, and above all, the policy of competitive devaluation allows (and has allowed) Italian firms to compete by cutting costs, thus discouraging innovations and contributing to the lowering of the growth rate of labour productivity, which in Italy is already below the Eurozone average. [2]

In addition, as documented in a recent publication by the European Commission, entitled “Labour costs pass-through, profits and rebalancing in vulnerable Member States”, the wage deflation policies implemented in Italy (as policies to replace competitive devaluations) have generally had insignificant effects on the current account trends. Statistics reveal that even when there is a current account surplus, it does not lead to a higher employment rate, demonstrating that there is no automatic mechanism to guarantee that an increase in exports translates into a rise in domestic employment. For Italian exports, what counts most is not price competitiveness, but competitiveness in the quality (real or perceived) of goods sold abroad and – in the luxury goods sector – what counts, a contrario, is the high selling price (the so-called Veblen effect, which says that as the price of luxury goods rise, their sales rise).  

2) It is argued that by logical necessity, the single currency entails the adoption of austerity measures.

One could argue, on the contrary, that the main (obviously not the only) flaw in monetary unification lies in the fact that the debt cannot be monetised. But this too was a strictly political decision, and as such could be changed, on the obvious condition that there is enough support to enable it to be overturned. It is a decision at least partially (and temporarily) overcome by quantitative easing. A further flaw could be the fact that a common fiscal policy is essentially non-existent. However, to say that Italy outside the Monetary Union would adopt expansionary fiscal policies actually means turning a blind eye to the class nature of economic policy decisions. This is in relation to the current balance of power between capital and labour, which will determine if and how any post-euro expansionary fiscal policies are implemented.  

It needs to be clarified that the so-called Italian decline dates back to well before entry into the EMU and can essentially be imputed to the lack of industrial policies and therefore to the progressive productive desertification of our economy [3]. The rhetoric of “small is beautiful” played a major role in preserving the ‘dwarf’ stature of Italian entrepreneurial culture, which is the primary factor explaining the scarce propensity to innovate shown by our firms’. [4]

3) The cost of remaining in the EMU is higher than the cost of leaving.

This argument is totally unproven since, as I said at the outset, no one is capable of predicting the costs that the Italian economy (and Italian workers) will have to bear if we abandon the euro. It is argued by those in favour of leaving the euro that this is the only way to regain monetary sovereignty.  In practice monetary sovereignty was abandoned in 1981, the year of the “divorce” between Treasury and Banca D’Italia was sealed. 

4) It is necessary to prepare a “left-wing” exit, getting ready for free trade within the eurozone to be called into question.

Thisgives rise to two critical observations. Firstly, the Italian productive structure mainly consists of small firms with little innovation, are not highly export-oriented  (especially in the South), and are located in mature sectors of production (agro-food, tourism, luxury goods). Essentially, these arguments do not seem to take into account that before being problems of public finance, the problems of the Italian economy are problems related to the industrial desertification of our economy, and that in the final analysis they derive from political choices made in a period prior to the adoption of the single currency: first and foremost, the failure to implement industrial policies. 

It might also be added that any implementation of protectionist measures would further weaken Italy’s fragile production sector, which already has trouble becoming part of the “value chains” of the Eurozone [5]. Secondly, German capital does not have much to lose from the adoption of protectionist measures in a new Europe of small nations, since a considerable proportion of German exports already go elsewhere: German exports inside the EU, in fact, have fallen in recent years, moving on to other areas, China above all. In this scenario, it is reasonable to think that the survival of the Union largely depends on the ability of German industry to further increase its exports to extra-EU countries, and that, if anything, it is Germany, not Italy, that would gain most from giving up the euro. [6]

Transitional and political problems

Those who argue in favour of the benefits of abandoning the euro recognize that returning to the lira would generate a significant increase in interest rates on government bonds. On this point, it might be remembered that interest rates on public sector debt instruments fell following the adoption of the single currency. The spread between Italian and German bonds, at the end of the 1990s, was on average around 500 points, reaching an all-time peak (575 points on short-term securities) in 2012, to then steadily decline (thanks to the “protection” of the ECB).  

Basically, for the operation to be successful, one has to imagine the following events occurring: a return to the lira; reinstatement of wage indexation; the possibility of monetizing debt; expansionary fiscal policies; adoption of protectionist measures; absence of speculative attacks. 

Even assuming that nothing else happens, which political force will manage the transition following these procedures?  In that case, economic theory has very little to say on the costs and benefits of an exit, since it is an intrinsically political matter, involving class relations, inter-capitalist conflicts, and the structural weakness of the Italian economy. 

Guglielmo Forges Davanzati is Professor in Political Economy at the University of Salento, Italy


[1] For a thorough reconstruction of cases of monetary union failure, see E. Brancaccio and N.Garbellini (2015). Currency regime crises, real wages, functional income distribution, “European Journal of Economics and Economic Policies – Intervention”, vol.12, n.3. In my opinion, it is an extremely interesting research study from the historical standpoint, but not very useful in interpreting the dynamics of the European Monetary Union, since i) the cases examined concern monetary unions that cannot be compared to the European situation, because of both the GDP of the member countries and their political importance; ii) given its specificity, the EMU is truly unique in the history of monetary unifications and also for this reason not to be compared with any other case. Furthermore, as has been pointed out, “Historical examples lead us to the conclusion that monetary integration, which involves total loss of monetary sovereignty, once established is unlikely to be questioned by the single member states, insofar as change is perceived as a leap in the dark, of which the costs are considered to be far higher than the benefits. The collective psychology in monetary questions is dominated by inertia” R. Patalano, Una ‘escape clause’ per la zona euro, Micromega on-line, 8.12.2013. 

[2]  V.A.Graziani, L’economia italiana dal ’45 a oggi, Il Mulino, Bologna, 2000. 

[3]  As Augusto Graziani wrote, “Growing territorial imbalances and risks of industry sliding backwards in the technology field are therefore the dangers threatening the Italian economic structure. And here it is inappropriate the blame the Maastricht treaty’s public spending constraints or the loss of monetary control due to the European monetary union, since what is needed is a design for industrial policy, accompanied by a policy of territorial rebalancing”. A.Graziani, La moneta al governo, “La Rivista del Manifesto”, luglio-agosto 2002. 

[4] G.Forges Davanzati (2016). Alle origini del declino economico italiano. Domanda aggregata, dimensioni d’impresa e sottofinanziamento dell’Università, “Itinerari di ricerca storica”, XXX, n.1, pp.149-160.  

[5]  V. A. Simonazzi, A. Ginzburg and Nocella, G. (2013). Economic relations between Germany and Southern Europe, “Cambridge Journal of Economics”, 37 (3), pp. 653-675; R. Bellofiore, F. Garibaldo and M. Mortagua, (2015). A credit-money and structural perspective on the European crisis: why exiting the euro is the answer to the wrong question, “Review of Keynesian Economics”, vol.3, n.4, Winter, pp.471-490. 

[6] On this, remember the well-known argument of George Soros, for whom Europe would be better off if Germany abandoned the euro, and Germany itself would benefit considerably.  

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