Banking & Finance, Economic Development, and Manufacturing

Experts monitor Italy’s fiscal state

GVSU analysts say worsening debt crisis could damage Europe, potentially impacting the U.S.

October 19, 2018
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As Italy hovers on the edge of a financial crisis, local observers say its potential impacts on Europe could spill over into the U.S. and West Michigan.

Italy has the third-largest economy of the 19 countries in the eurozone, which is a bloc of the European Union’s 28 member states that have adopted the euro as an exclusive currency system. The first- and second-largest eurozone economies are Germany and France.

According to Brian Long, director of supply management research at Grand Valley State University, years of bad debt and political instability have contributed to Italy’s troubled economy.

Earlier this year, a new populist coalition government took power that pledged tax cuts, increased pensions and welfare, and a “universal basic income” — all of which would cost between 65 billion and 125 billion euros if enacted in the country’s 2019 budget, according to Italian newspaper Il Post.

“They’re trying to come up with political solutions to economic problems,” Long said. “They promise and promise and promise. … The problem doesn’t sound like it will go away anytime soon.”

Italy’s current budget proposal, which was under review as of Oct. 16, projects a budget deficit of 2.4 percent of the country’s GDP for 2019, up from the 1.8 percent politicians promised before the March elections and encroaching on the European Commission’s limit for deficits of no more than 3 percent of a country’s GDP, according to a CNBC article.

Italy’s current debt-to-GDP ratio is 12.7 percent, CNBC reports, with a deficit of more than $2.4 trillion, according to the Italian government. The country is second only to Greece when it comes to public debt among eurozone countries, according to Eurostat, which publishes government finance statistics.

What does all of this mean for West Michigan? Long said effects would be felt indirectly via Italy’s potentially hampered ability to do business with the European Union, which is the second-largest economy in the world by purchasing power.

“If all of Europe starts to slide, the world economy starts to slide,” Long said. “It is a big risk. ‘The contagion’ as they call it, it could spill over into Spain and Portugal, the weaker economies in the eurozone with more debt.”

Italy’s major industries include tourism, machinery, iron and steel, chemicals, food processing, textiles, high-end motor vehicles, and clothing and footwear.

Long said since West Michigan’s top industry is manufacturing, an economic slide and hampered trade with Italy could affect the manufacturers that currently import Italian machinery, raw materials and other industrial goods, although he couldn’t say for sure what percentage that would be.

Paul Isely, an economist and associate dean for undergraduate programs in the Seidman College of Business at GVSU, said it’s hard to predict the likelihood of a worldwide domino effect because a lot depends on investor sentiment.

“The real issue is how does it affect people’s willingness to believe the nationalist trend is going to hurt the euro?” Isely said, referring to the coalition government’s political philosophy.

“If you think back to a few years ago when Greece was imploding, and they were having lots of debt problems and Italy, Spain and Lisbon were, too, the end result of that was individuals were worried about the euro collapsing. That ended up being, in many ways, good news to U.S. consumers. People moved those savings they were putting into government bonds from the eurozone to the U.S. It actually helped hold down interest rates in the U.S.”

Isely said a factor that could tip the scales in the opposite direction is whether Italy’s fiscal problems and resulting impact on Europe “will create a contagion in other parts of the world.”

“Certainly, within the developed world, we’re worried about this,” Isely said. “We’re worried this could cause a ‘Lehman Brothers moment,’ where (the global financial services firm) was so integral to the world economy that when it failed, it dragged down a lot more economies than we expected.

“The question is, ‘Is the Italian market interrelated in such a way that it could create systemic problems in the rest of the world?’”

Isely said when Greece plunged into a debt crisis in 2010, it ended up only affecting Europe and not the global economy. But Italy’s GDP is 10 times the size of Greece’s.

“It’s a much larger economy and is integrated into industry, heavy machinery, travel, tourism and wine, so it’s a broader-based economy and has greater risk potential for us,” he said.

Italy’s troubled fiscal state has long been known on the world stage, Isely said. The scale of its impact will partly depend on how banks and governments have been behaving when it comes to lending to Italy.

“This is a well-known issue,” he said. “The real question is does that result in banks and governments limiting their exposure to risk? As in, ‘Yes, we lent to Italy, but we only did so at a certain percentage.’ The better known a problem, the more likely we hedge bets. That’s the question we don’t know the answer to is how far banks have done that. Certainly, we saw that a few years ago with Portugal, Italy, Greece and Spain.”

Isely said he believes banks have greater capacity now to withstand losses than they did in 2010 when the world still was climbing out of the Great Recession.

“We have a larger circuit breaker than we did 10 years ago,” he said. “The short answer is we don’t know until it trips. The uncertainty can mean we have systems in place. We know this will slow down the eurozone. The question is will it cause it to do more than that?”

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