ROME – Global policy trends heavy fiscal stimulus, led by the US, faces test cases in Southern Europe.
Italy, Greece and Spain, which were hit hard in the European sovereign debt crisis a decade ago, are once again running large budget deficits and planning to spend on a large scale to improve their economies.
Italian Prime Minister Mario Draghi and other leaders in the region are betting that ambitious investment can provide a lasting growth boost. If the stakes don’t work out, these countries will be saddled with some of the highest debt ratios in the world, potentially destabilizing the eurozone.
After years of running tight budgets with little room for transformative investments, they now see a once-in-a-generation opportunity to revitalize their economies.
Mr Draghi, presenting his plan to the Italian Parliament, said that it contained not only a list of public works but also “the destiny of the country.”
Many developed countries have accepted President Biden’s belief that aggressive fiscal stimulus and public works can not only repair the economic damage caused by the Covid-19 pandemic but also boost growth in the coming years.
The massive loan plan, exploiting historically low interest rates and central bank support, stands in stark contrast to Western countries’ tilt for austerity after 2010, when many governments cited Greece’s debt crisis as a warning about where excessive deficits could lead.
The European Union, which for years promoted a balanced budget even when it required painful austerity measures, is taking part in borrowing. The middle part is The European Union’s recovery fund is worth 750 billion euros, the equivalent of $ 900 billion, is officially known as the Next Generation European Union. The mix of grants and low-cost loans will be financed by general EU bonds and aim to support investment and improvements that increase productivity and long-term growth.
European Economic Struggle
“This is a clear change in the economic paradigm. Taking debt to finance growth, doing it on a large scale, and on top of the already high existing debt, is something we’ve never seen before, “said Enzo Moavero Milanesi, Italy’s former foreign minister.
Mr. Draghi, who is president of the European Central Bank played a major role in taming The near euro terminal debt crisis of 2012, now has a unique opportunity to destabilize Italy’s struggling economy.
Since the 1990s, Italian leaders have tried to overhaul the country’s sclerotic economy while also running a tight budget. Mr Draghi is the first in decades that can use massive fiscal weapons to help.
The Italian economy has rarely grown by more than 1% annually for the past quarter century. The economy has never fully recovered from the global financial crisis and the subsequent eurozone crisis, and is slumping another 9% in 2020 amid the pandemic and tight lockdowns.
Germany, France and other EU countries supported the recovery fund primarily out of concern Italy and Southern Europe could be caught in another deep economic slump that is once again testing the cohesion and viability of the eurozone.
“I think there is broad agreement at the moment that we need economic growth rather than fiscal tightening to emerge from the crisis and shore up massive public debt,” said Federico Santi, analyst at risk consulting firm Eurasia Group.
Italy will be the largest recipient of EU funding with around € 190 billion, of which € 70 billion is in grants. The country will add nearly € 60 billion from its own coffers to fund investment plans.
Italy’s debt has reached 156% of gross domestic product, mainly due to the pandemic. Greece has increased to 206%, the highest ratio in developed countries after Japan.
Most of Greece’s debt is in the form of bailout loans from other eurozone, without repayment for years, making another Greek debt crisis unlikely for long.
Europe’s main long-term risk on debt sustainability relates to the much larger Italian economy. The future of the euro may once again depend on Mr Draghi’s performance.
“The big risk is that these investments will not increase a country’s ability to grow, which means that they will only stimulate GDP for a few years. The effect of higher demand will then decrease, growth will be lower again but debt will be much higher, ”said Lorenzo Codogno, a London-based consultant and former economist at the Italian Ministry of Finance.
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Financial markets are relaxed about risk, for now, with the expectation the ECB will resume large-scale government bond purchases, keeping sovereign borrowing costs low.
“I think the ECB will maintain an accommodative monetary stance for two to three years no matter what. I hope this provides all the support possible in this phase, ”said Francesco Daveri, an economist at Milan’s Bocconi University.
However, financial market pressures could start to emerge in the long term if economic growth is sluggish again, debt remains high and the ECB tightens its monetary policy, economists say.
While the thinking behind the US and European fiscal packages is partly parallel, the scale is much bigger in the US, which has so far introduced fiscal measures worth around 26% of its GDP, far outpacing all stimulus efforts in Europe.
European spending plans are not aimed at increasing household spending but rather at increasing the productive side of the economy, through investment in digital and physical infrastructure, education, environmental efficiency and other long-term needs.
Mr Draghi also aims to improve Italy’s inefficient public administration training and technology, as well as streamline the notoriously indolent justice system.
If the efforts of Mr Draghi and his Greek and Spanish counterparts do not bear fruit, the experience is likely to lead to renewed pressure for fiscal discipline from Europe’s financially conservative north. But if the return to big loans pays off, it will reinforce calls for a European fiscal union to use the EU’s collective power to invest in weaker economies.
“If Bidenomics works in the US, President Biden will go down in history as the new Roosevelt,” said Moavero. “In Europe, the effects may set a precedent that will be difficult not to repeat.”
Write to Giovanni Legorano at [email protected]
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