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Alternatives to austerity

The inevitable "structural reforms" Italy faces won't drag the eurozone's third-largest economy out

Silvio Berlusconi's last few days as Prime Minister find him overseeing the introduction of extraordinary austerity measures, passed through the Italian Parliament yesterday on the back of wheedling promises made to EU leaders. Berlusconi's exit will doubtless come as a blessed relief to many millions of Italians. The clown is to be replaced - without, naturally, recourse to elections - by a European Commissioner, Mario Monti, hastily sworn in as senator-for-life. A new government of technocrats will oversee implementation of austerity, assisted by the IMF officials now taking up residence in Italy's finance ministry. Those austerity measures, in turn, will be backed up by the usual demands for "structural reforms" - deregulation and privatisation chief amongst them.

This will not end the crisis in Italy - and, with that failure, the prospect of a global slump is opened. Austerity across Europe has already driven economies deeper into the mire, Ireland and Greece chief amongst them. The mechanism is widely known: as government spending falls, it drags demand down still further. As demand falls, firms cut wages and make redundancies. A vicious circle kicks in. With Italian consumers and businesses keeping their wallets closed, and no real hope of a recovery in export markets, it is spending by government that could sustain economic activity. Yet the scorched-earth economics of austerity are now being forced onto Italy.

Deregulation and the loosening up of labour markets are the second leg of the EU and IMF plans. The hope is that by freeing capital to operate as it sees fit, it will recover its dynamism. But "structural reforms" have taken place in Italy over the last decade or more. On OECD measures, Italy's product and labour markets are now as deregulated as Germany. In conditions of stagnant demand, the chances of further assaults on employment and consumer protection prompting growth are slim.

Italy's economic malaise runs deeper. The rot set in decades ago. A post-war miracle, with growth rates averaging over 5 per cent from 1951-73, halted with sharp recession in the early 1970s. Growth never truly recovered, and for the last 15 years has averaged less than one per cent a year. Businesses and government acted in concert to casualise labour, promoting labour-intensive export industries at the expense of capital investment. Economic activity became increasingly concentrated in the centre and the north, leaving the south lagging still further. Rising public debt initially helped cover the costs of wider stagnation.

Recent governments have targeted that debt, at the expense of public spending - and those without Berlusconi at the helm most successfully. The burden fell from 120 per cent of GDP in 1996 to around 100 per cent by 2007. But the financial crisis of 2007-8 led to a sharp rebound. A decade of debt reduction was wiped out in two years. The combination of a seriously weak economy and sharply rising indebtedness is what has now panicked markets into pushing Italy's current borrowing costs above 7 per cent.

If there is a hope of recovery in the eurozone's third-largest economy, it cannot come through the standard IMF package of austerity measures and market-led reforms. Nor will it come through the erosion of democracy. Quite the opposite is required: supporting public expenditure to sustain demand; industrial transformation, led by public intervention; and an expansion of democracy against the rule of finance - including, ultimately, a recognition that odious and unpayable sovereign debts need not be honoured.

James Meadway is a senior economist at the New Economics Foundation