Something to worry about
Italy moved a notch closer to a eurozone crisis on Thursday. The downgrade of the country’s debt by S&P and Fitch was hardly noticed by the markets and will almost certainly be ignored by the politicians. But it reflects a painful reality – without a big change in direction, Italy’s membership of the currency union is doomed.
No, it won’t happen right away. That’s why Italian bond yields rose only 0.02 percentage points on the announcement. S&P ‘s A-plus rating is still three downgrades away from the level that the European Central Bank has indicated would make the country’s debt unacceptable for collateral – a situation that would precipitate a crisis. And no politician, in Italy or elsewhere, really wants to deal with a euro mess.
But Italy’s economic problems are not going away. The workforce is too low-skilled to compete with Northern Europe, but wage levels do not reflect that reality. It will take a revolution in education and business practices to resolve the competitiveness problem. Wage cuts would help restore a trade equilibrium, but they seem to be impossible politically. And a currency devaluation, which would do the same thing, is ruled out as long as the euro remains the national currency.
Nor are there any signs of political relief. The government of Romano Prodi may be better intentioned than its predecessor, but it seems no more capable of taking decisive action. The weakness of the 2007 budget – the deficit is still likely to exceed 3% of GDP , the maximum allowed under the Stability and Growth Pact – caused the ratings downgrades.
Italians often argue that their governments would be even more irresponsible without the pressure of eurozone rules. But that increasingly looks backwards. Eurozone membership shields Italy from the pressure of the financial markets. So the country is allowed to stumble along, piling up deficits and losing economic ground. The eventual crisis will be even harder to deal with.