Can Berlusconi get away with it this time

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Last updated: April 21, 2019

Italy has a diversified industrial economy with roughly the same total and per capita output as France and the UK. The Italian economy is divided into a developed industrial north, dominated by private companies, and a less developed, welfare-dependent agricultural south. Most raw materials needed by industry and more than 75% of energy requirements are imported. Over the last ten years Italy has tried to maintain a strict fiscal policy in order to meet the requirements of the Economic and Monetary Unions.

The European Monetary Union is built on strong fiscal discipline foundations. The budgetary autonomy of EMU’s members is subject to the constraints of the Maastricht Treaty and the Stability and Growth Pact. The Maastricht, and later Amsterdam, Treaty sets rules with regards to, among others, budget deficits, public debt and inflation as requirements for joining the euro as single currency.The current government of Silvio Berlusconi has initiated numerous short-term reforms trying to meet the Treaty requirements and improve competitiveness and long-term growth. Italy has moved slowly on implementing needed structural reforms, such as lightening the high tax burden and overhauling Italy’s rigid labor market and over-generous pension system, because of the current economic slowdown and opposition from labor unions.

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Silvio’s government made several promises to the public. It promised to strengthen Italy’s economy by: 1) Cutting taxes, 2) Increasing pensions, 3) Creating new jobs, 4) Reducing crime and 5) Launching major infrastructure projects. In this essay we analyze whether Berlusconi can live up to his promises, and what the consequences of his policy decisions are for the country as a whole. What are the consequences regarding budget deficit, public debt and inflation? And which alternatives does Berlusconi have?In our opinion, the economy is worse off when Berlusconi executes the measures described above all at the same time.

The country will end up with much more problems than it is already facing. Italy is ready for some more structural reforms and creative thinking when it comes to financing these reforms.Maastricht requirementsThe Maastricht Treaty’s main objective is to provide a set of rules to enhance stability in the area. In order to have a single currency, every country involved must stabilize its economy.

Stability makes the economy predictable, and prevents big movements of money, people or goods from one country to the other.The Treaty requirements relevant for this essay are:* A budget deficit not to exceed 3% of GDP* A public debt not to exceed 60% of GDP* Inflation not to exceed 1,5%The relevance of these criteria is obvious. They show how a country is economically performing. Below we’ll discuss the consequences of Berlusconi’s measures with regard to these criteria. Let’s start with budget deficit.N.B.

In order to be able to analyse the consequences as explained below, we assume that all other relevant factors remain unchanged. This assumption is known as the ‘ceteris paribus’ principle.Budget deficitIt’s all about maintaining a balance between income and expenditures. Following the pattern of two decades we see an increased expenditure after ’92, common to other European countries getting ready for the European Community. Berlusconi’s cabinet finally succeed in maintaining a deficit below the required 3% of GDP. The measures are severe containing a new legislation to strictly control and limit spending, introduced at the end of 2002. It also included a tax amnesty program to reduce the existing sub-economy (black market).

The lost claim equalled to about 0.7 per cent of GDP. Further measurements involved massive reduction op public assets in real state through sales to the private sector. Berlusconi aimed at a deficit of 1.

5 per cent of GDP in 2003, but ended with 3.1. Under the 2002 update to the Stability Programme, the objective for 2004 is a deficit of 0.6 per cent of GDP, based on a GDP growth rate of 2.9 per cent. This is still a long shot performing at a 0.

3% GDP growth rate in 2003.We can put budget deficit in perspective along with other macro indicatives. In comparison we see an anti-cyclical development of the GDP growth line. Government investments are not immediately followed by a boost in growth. A non-steady growth can be explained by the many one-off measures imposed by the different cabinets.

A peak in deficit in 1997 is followed by a decline in the unemployment rate. Redundancy remains constant low and is expected to increase in the next period. We also see a dramatic drop in long-term interest rate, much in the same period as a rise in deficit rate around ’94 – ’96.

High public spending, low interest and increased export are boosting the Italian economy in the early ’90’s.Question remains how shallow this recovery is. Unemployment and public dept are still on a high level. Lowering budget deficit might be just window dressing to the European partners. Berlusconi’s promises to the Italian voters (pan et circense) have different effects on de budget deficit rate. Cutting taxes is without other sources of income bad news to the deficit rate.

We can only expect a growing public dept to keep the current expenditure pattern. Especially when increasing pensions is the next promise in line. To create new jobs a low tax policy to incentive the corporate market is needed. A reformed and simplified tax program has been introduced.

Again, this has an impact on Italy’s treasure box. This has to be compensated otherwise. Both initiatives to reduce crime and to start new major infra projects need to be paid for. Unless the community is willing to trade off, the Italian government will pick the check, again.Public DebtThe major problem with all five promises is that they will increase government expenditure dramatically and worsen the public debt position as % of GDP. Cutting taxes will reduce direct tax income.

Increasing pensions and major infrastructure projects will increase public spending at the same time. Economic growth is low and the population is shrinking. Reducing public debt is difficult due to the cost of high unemployment, the high level of welfare and the comfortable pension schemes. Another factor is that the average age is increasing therefore the public debt is rather increasing then decreasing because of the pension burden. All in all this is making it difficult to reduce the public debt.

Regardless whether the government has to issue new bonds to raise the cash for these reforms, or whether they will create a much larger deficit at the end of the year, both will be added to the total public debt. For a full view on the consequences of his measures regarding public debt we refer to the power point presentation.InflationInflation is the percentage change in the price level from one period to the next. Higher prices have a big influence on the economy. They can result in increasing demand for money and thus higher interest rates. If you get less product for your, purchasing power shifts from the buyer to the seller. And higher prices and interests lead to a decrease in expenditures of interest sensitive goods.

Higher prices make trade with that market unattractive and net export will decrease and as a result unemployment may increase. All in all inflation can have a downward effect on equilibrium GDP. To stabilize the economy it is important to control inflation as much as possible.Berlusconi’s promises are no exception to the rule. All of his measures will either reduce the government’s disposable income or increase government expenses.

For a full view on the consequences of his measures regarding inflation we refer to the power point presentation.What to do than?But if all of these measures turn out to be detrimental to Italy’s economy, what should Berlusconi do?As suggested by authoritative institutions like the OECD, Italy needs further restrictive budgetary measures. It can no longer count on ‘one off’ measures -like the sale of UMTS frequencies which accounted for 1.2% of GDP back in 2000 and the sale of public real estate which accounted for 0,5% of GDP in 2002 1 – to back up its revenues.All of Berlusconi’s measures will, independent from the others, have a negative effect on the economy. Together, all his measures will bring the Italian economy on the verge of bankruptcy.

What Italy needs are structural reforms, and measures that enhance the economic climate. The economic climate consists of several factors, among others the amount of people, their average income, the level of their education and the quality of their living environment. Those factors will influence companies to invest in Italy. Low tax tariffs are also important, but seem to be outweighed by other factors if companies need to decide were to establish their business2. To improve the economic climate Italy needs to invest in infrastructure and for example in education. Berlusconi’s programme takes care of at least part of the needed reforms. But these investments need to be paid for and that is why economic recovery is in contradiction with cutting taxes.

Besides letting go of his promise to cut taxes, Berlusconi should look for more creative solutions. If he would involve the business environment in some of his projects, he could very well save money. A measure that has proven successful in some European countries is the privatisation of infrastructure through concessions.

If a company builds a tunnel and then gets a long-government contract to exploit it, the government need not spend its -full- budget on the tunnel and can reallocate the funds.ConclusionBerlusconi’s measures all executed at the same time will turn out to be disastrous for Italy’s economy. Berlusconi has to invest in a better economic climate and foster creativity to pay for the needed structural reforms. And he has to let go of the idea of cutting taxes. His voters won’t be happy, but it is history revisited.

Remember who else said the famous words: “Read my lips: No higher taxes.” We’re sure Berlusconi can save him self from this treacherous situation. He has proven to be a successful escape artist before.

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