Analysis: Sudden exit is no magic bullet

LAST week, Italy was the focus of the world’s media. But not for its style, wine or food. Most attention was given to the long-running demise of the flamboyant but ineffective Berlusconi.

Even his eccentric behaviour was superseded last Wednesday when Italian bond yields became the focus of the world’s press. They briefly exceeded 7 per cent, the trigger point for recent international bailouts in Ireland and Greece.

To avoid, or at least delay, such a bailout, Berlusconi agreed to step down after an emergency austerity plan was agreed by the Italian parliament. The plan was passed by the senate on Friday before snaking its way through the chamber of deputies yesterday.

The plan bears a strong resemblance to the UK Spending Review. The UK’s debt was around 80 per cent of GDP in 2010. The current value of Italian government debt is 120 per cent of its GDP.

Berlusconi’s departure is an essential component of the solution for Italy. But equally important will be the acceptance by the markets and the Italian public of a viable fiscal solution. What really spooked the markets last week was the perception that the political classes in Italy were unable to act decisively. Last Wednesday, to sell a ten-year bond the Italian government had to promise a 7 per cent return. The UK government, by comparison, needed only to promise 2.25 per cent. This was untenable, and hence the austerity budget.

Attention will now turn to the package itself. In September, Berlusconi announced plans to take the annual budget from a deficit of 4.6 per cent of GDP in 2010 to surplus by 2014. Key elements are: an increase in VAT from 20 per cent to 21 per cent; a freeze on public sector salaries until 2014; cuts in welfare benefits; sales of state assets; measures to reduce tax evasion and a special tax on the energy sector. Together, these are intended to save the Italian government €59.8bn by 2014. This is less severe than the 2010 UK Spending Review, which is meant to save the Treasury the equivalent of €94.6bn by 2015-2016. For the longer term, the budget includes measures to save on pensions. From 2014, the statutory retirement age of women in the private sector will be increased from 60 to 65 to align it with that of men by 2026. Pensions will continue to be an issue, given that Italians have among the higher life expectancies in Europe. On average, they can expect to live more than a year longer than UK citizens.

Will the package provide the fix that Italy, and the Eurozone, desperately need? One positive aspect is that it is not predicated on unrealistic growth forecasts, as has been the case in the UK. The Italian government expects growth to be below 1 per cent until 2014. Clearly austerity could weaken Italy’s already anaemic growth, while further meltdown in the Eurozone outside Italy will weaken its ability to meet its fiscal targets.

If a new technocratic prime minister is put in place, market sentiment may temporarily move in Italy’s favour. But there is a huge risk if the austerity package causes a public backlash against the political class and further uncertainty over Italy’s political direction.

• David Bell is Professor of Economics at the University of Stirling