Italian Nights: Europe’s New Trench Warfare

Nothing allows a deeper look into the differences between German and Italian views on the euro than a friendly discussion among economists of the two countries, say, over a bottle of wine during a mild Italian summer night. I am providing a shortened transcript of such a recent conversation.

“If we Europeans want to keep the euro as our common currency, you Italians have to clean up your house finally,” demands the German economist of his Italian colleague.

“What you need is an ‘Agenda 2020,’ a program of structural reforms like our own ‘Agenda 2010’ launched by Gerhard Schröder’s government of in 2003.

“Then, the labor markets needs to become more flexible. To get there, your stifling web of regulations needs to be reduced and simplified.

“According to the World Bank, in this area you are at par with some developing countries. And, above all, you have organize your political system and parties in a more efficient manner.”

“These are fair points,” admits the Italian economist, “and we are indeed trying hard. But what do you Germans do in the meantime? Nothing! You are proud of your international competitiveness and brag about being the world champion of exporters.

“But your current account surpluses threaten to destroy the currency union. If you don’t give us a chance to export, we cannot buy imports from you. If we buy them nonetheless on credit, you should not be surprised that, when we are bankrupt in the end, you’ll have to say goodbye to the money you lent us.

“Why can’t you Germans be a bit more relaxed? Why not enjoy higher wages, have more leisure time and, above all, consume more?”

The German is perplexed. “Wages cannot grow by more than labor productivity if the purchasing power of money is to remain stable. We are indeed prepared to let our wages grow along with increases in productivity.

“But you Italians have now to keep your wage growth below productivity growth — if you want to make up for competiveness you lost in the past. Since the beginning of monetary union, Italy’s wage growth has consistently outpaced productivity growth.”

Responds the Italian: “Our productivity growth is so low that we would need nominal wage cuts to regain competiveness against you Germans. But wage cuts are impossible for political reasons.”

“Then raise your productivity by reforming your economy!” retorts the German.”

The Italian takes a deep breath. “This is more easily said than done. First, it takes time, which we do not have any more. Second, our voters don’t see the merits of reform. They don’t believe that growth can be raised through structural reforms.

“What you Germans and lots of international analysts call ‘rigidities’ are finely balanced structures that have emerged in Italy over many years.

“Behind each regulation is a vested interest, which would lose out if the regulation were scrapped. That loss is real and would be felt immediately, while the promised gain in growth comes much later, if at all. On this basis, you cannot win an election in Italy. Just ask Mario Monti.”

The German dares to question this point. “But Monti lost the elections this February because of the tax hikes he imposed during his stint as head of the ‘technocratic’ government.”

“This was not the only reason,’ argues the Italian. But you are right, the tax hikes clearly added to his lack of popularity.

“The bigger point is that we Italians do not trust the state as a matter of principle. That’s why we pay taxes only very reluctantly. But we are prepared to lend to the state.”

“Why do that?” asks the German. “This boosts your debts to gigantic levels!”

“But as long as we Italians fund our state ourselves and don’t borrow from abroad, where’s the problem? You Germans prefer to diligently pay your taxes, we Italians prefer to lend the state our money.”

“If you had your own currency,” counters the German, “we would not have a problem with this Europe-wide. It would be your business when you put the burden of funding your government on future generations.

“But in a currency union, your level of public debt threatens the stability of our common money. If you can’t refinance your government debt in the market, the ECB needs to step in and buy it up to prevent default.”

“What’s wrong with that?” rebuts the Italian. “The Fed, the Bank of Japan or the Bank of England all buy the debt of their governments.

“They help their governments to fund themselves cheaply, they lower interest rates for the private sector and they depress the exchange rate to raise the international competitiveness of their industry. Why should the ECB not do the same for us?”

“Because monetary policy would become much too easy for us Germans and other nations. Our wages and prices would rise.”

“So what? That would only be desirable,” says the Italian.

With the discussion returning to its starting point, both sides pause. Slowly, a certain level of realism and frustration settles in simultaneously.

The good news is that, compared to much more ominous events a century ago, Europe’s new trench warfare is only about the profound incompatibility of economic cultures. But what if those are the modern-day equivalent of armies?