Capitalisn’t: Worse than Brexit

Speaker 1: The market is getting very spooked by what’s going on in Italy, and we know that-

Luigi: Hi. I’m Luigi Zingales at the University of Chicago.

Kate: And this is Kate Waldock from Georgetown University. You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Speaker 4: Italy officially becoming the next European country to deliver huge victories to far-right populist parties.

Speaker 5: The two biggest winners, the populist Five Star movement and the right-wing League, earned better than 50 percent of the vote.

Speaker 6: Some have said, in recent months, that the wave of populism is over, but it seems to be cresting again, at least in Italy.

Kate: On today’s episode, we’re going to be talking about Italy, its role in Europe, and the most recent Italian elections—whether we should be concerned about it here in the US. We really scratched our heads as to who we could have on the show to be an Italian expert. I think after some time, we realized that we’ve got our own expert right here. Also, what did you have for breakfast this morning?

Luigi: Avocado and grapes.

Kate: No prosciutto today?

Luigi: No prosciutto today.

Kate: Almost every time I talk to Luigi, he’s had grapes and prosciutto, which I think qualifies him to talk about all things Italy.

So, Luigi said something a couple weeks ago which really struck me.

Luigi: Yeah. I said for the European Union, the Italian elections were worse than Brexit.

Kate: That’s pretty crazy to me, because at least over here in the US, there was a ton of hype about Brexit when it was going on, and we’ve heard a lot less about the recent Italian elections. So, why is it so bad for the EU?

Luigi: There are two things that, in my view, can be worse than Brexit. The first one is this is an indication that a country that was super pro-Europe has turned around and become anti-Europe or Euro-skeptic. So you have to realize the that United Kingdom was always a marginal partner, at least in spirit, to the European Union. They joined relatively late, in 1973, and if you look at polls, the polls were always 50-50, 40-60 in favor of the European Union. So there wasn’t a sense that the European Union was really popular in the United Kingdom. Italy was a founding member of the European community that later led into the European Union. This was started in 1957 actually in Rome. The Treaty of Rome is the founding treaty of the European community. For the greater part of the last century and the beginning of this one, the support for the European Union in Italy was enormous. Like 80 percent of the people thought they benefit from being part of the European Union. This support, starting in the early 2000s, started to drift down. Recent polls are more like 50-50, and the vote gave a majority of the votes to parties that are anti-Europe. Not necessarily anti-Europe, but they are, let’s say, Euro-skeptic, if not anti-Europe.

The second is, this election could lead to what I prefer to call Quitaly, where Italy might leave the euro. By the way, according to the treaty, leaving the euro implies also leaving the European Union. So it will be similar to a Brexit but much more disruptive than the Brexit because it might involve the breakup of a common currency.

Kate: Right. This is a distinction that still confuses me, I’m a little embarrassed to say. Could you walk us through what you mentioned just now, the Treaty of Rome in 1957, but also how that led to the formation of the EU, as well as the eurozone and what the differences are between those things?

Luigi: Immediately after World War II, there was a very strong push to try to make France and Germany be allied to avoid what happened twice in the century, i.e. a major world war about the tension between France and Germany. The nutshell of what is now the European community started as a commercial deal, mostly between France and Germany, to make accessible to France some of the coal and steel in Germany, to make it more difficult for Germany to become powerful again militarily and start another world war.

That original agreement was formed by France, Germany, and then surrounding countries: Netherlands, Belgium, Luxembourg, and Italy. One of the big changes between the European community and the European Union was that when it became a European Union in 1992, it introduced also the free movement of people within the union. If you are an Italian, you can freely go and work in Belgium, and if you are from Poland, you can freely go and work in France. In the process, a lot more countries were admitted to this union, starting with Austria, that used to be a neutral country, and so on and so forth. Then, around that time also, some of the core countries signed a treaty called the Treaty of Maastricht to create a common currency.

Kate: So, to be clear, where the eurozone is the group of countries that adopt the euro, a single currency, whereas the European Union was just a broader set of countries with a centralized governing body that mostly oversaw ... What? Commercial deals? Trade agreements?

Luigi: The centralized part is very weak. We do have a European parliament, but it’s not very powerful. Basically, think about there is a commercial union that is called European Union, and then there is a common currency that is called eurozone. However, and this is important, in principle, the idea is that every country that belongs to the European Union eventually should belong to the euro. And, this is crucial for the discussion we’re going to have today, there is no way to exit the euro without exiting the European Union. So the two things, at least on the way out, they are connected.

Kate: So let’s go to Italy after the financial crisis. How has the economy been doing? What’s been going on politically since then? What are other factors that are leading up to the Italian election that just took place?

Luigi: So, the global financial crisis had, as a first-order impact, a strong reduction in international trade. Italy was hit by this much stronger than most countries. Just to give you a sense, German exports dropped by 10 percent. Italian exports dropped by 20 percent. The United States in 2009 had a recession, I go by memory, of 3 or 4 percent. Italy, 5.6 percent. So Italy was hit very, very hard. Then, by the time we’re slowly recovering, we are 2010, 2011, people started to doubt that the Italian government could actually pay its debt. Whenever there is a doubt like this in a country with an independent central bank but a sovereign central bank, the central bank tends to come to the rescue of the government. In the eurozone, this did not happen until late in 2012. In the meantime, Italy experienced a dramatic rise in interest rates, a fiscal crisis, had to cut the budget deficit in a major way, at the time we were just slowly recovering. It’s as if, let’s say, in 2009 the United States, instead of adding a gigantic stimulus package, had to cut their deficit by a huge amount.

That triggered a second recession that had a dramatic impact, also, on the stability of the Italian banks. Over the period 2008 and 2015, 35 percent of the loans to firms got into default.

Kate: That’s crazy.

Luigi: Three major banks basically collapsed, unemployment shot at 12 percent, and youth unemployment shot to 35 percent.

Kate: So what does this feel like for an Italian? Do you have friends and family who are really suffering from these two recessions?

Luigi: Yes. I have my parents. My father passed away in 2015, but at the time, both of them were alive. One of my concerns was, what happens if banks fail and they can’t buy food? One of my concerns was, I want to make sure that they have enough cash at home that if anything happens, they could actually go to the grocery and buy. The possibility of a generalized bank failure was not out of the feasible set. I have a lot of friends who lost their jobs and are unemployed or were unemployed for a long time. I have nephews and nieces who find it very difficult to find a job. I think the typical Italian of the generation of my kids looks forward to expatriating somewhere else. My son, who lives in the United States, got married at age 25, and when he announced this at the family gathering at Christmas, everybody thought he was joking. How could somebody at 25 support himself and actually start a family? In Italy, it’s inconceivable. Generally, you leave your parents’ house when you are 35. It’s not a coincidence that fertility in Italy is one of the lowest in the world. People don’t have kids, because generally, you don’t have kids when you stay in your mother’s house.

Kate: So, did Italy ever recover?

Luigi: Now, Italy is going again, but in 2017, people were celebrating that we grew at 1.5 percent after years of recession or growth below 1 percent. This is not enough, because Italy’s GDP, in real terms, is below what it was in 2007. We still have to recover from the beginning of the Great Recession.

Why the recovery was so slow, a number of things. One is we couldn’t devalue like, for example, the United Kingdom did to recover. The other one, which was quite important, is Italy had a banking crisis due to the fact that when you have 35 percent of your businesses defaulting, basically, it’s very hard for banks to stand. The Italian government found it very difficult to intervene in this banking crisis because there were a bunch of European rules that made this more difficult. That delayed the recovery in a major way. Now, the recovery slowly is taking place, but there is still a huge amount of discontent.

Kate: All right, so now let’s talk about the Italian political system and bring this to the recent election.

Luigi: First of all, it is important to understand Italy is a parliamentary system, not a presidential system, so our president is kind of the Queen of England—decides who to appoint but not much more. I’m exaggerating a bit for simplicity. What decides who rules is basically the set of parties, the coalition, who can get a majority in parliament. Traditionally, you could think about the party being divided into two major blocks. One called, not surprisingly, the Democrats, and very similar to the US Democrats. Another was a coalition of center-right parties, kind of the Republicans, but until very recently, led by Berlusconi, which is not that different from Trump. It’s just a kind of nicer version of Trump.

Kate: Then, more recently, I know that there’s been some turnover in your political system, but Matteo Renzi has been more powerful. He’s more of a Democrat, right? At least, more centrist?

Luigi: Yeah. In 2013, there was some elections in which the Democrat got a majority but not enough to rule. After some internal in-fighting, eventually Matteo Renzi, a young fellow, became the leader of the party and got a coalition with some of the conservatives in order to run the country.

Kate: Can we think of Renzi as like a Macron or a Justin Trudeau in Canada?

Luigi: Actually, the better example is Obama. If I may say, he turned out to be like Obama in that he was better at giving speeches than running the country.

Kate: Yikes. We’ll save that for a different discussion. So, then what happened?

Luigi: Two things happened. First of all, back in 2006 or ’07, a comedian, a professional comedian, started a movement. The first gathering of this comedian was a day that was called Vaffa Day that, I don’t know whether I can say it on air, but basically translated, I’m sorry to say, is ...

Kate: Just say it.

Luigi: Go eff yourself. This was basically a protest movement against the perception, and I will say also reality, of a country that was stuck with old politicians, old businesspeople, most of them corrupt. Just to give you a sense, the leader at the time, Berlusconi, was in his late 70s and had been in politics for more than 20 years. The largest banks were run by people in their 80s. The president of the republic was in his late 80s. It was what we call a gerontocracy. That is a fancy name to say ruled by old people.

Kate: A bunch of geezers.

Luigi: The great feature of this movement is it was appealing to both sides of the political spectrum. One some issues, it was more on the left side, like environment, like anti-corruption. On some issues, it was more right-wing. For example, concern about immigration.

Kate: All right, so I sort of like the idea of this guy. He at least sounds fun to listen to. Was there some expectation that he would actually do well?

Luigi: No, at the beginning, he was considered like a caricature, as you can imagine. He has a degree in accounting, which is something you don’t expect from a comedian.

Kate: From a comedian, yeah.

Luigi: But that puts him better than most politicians. Actually, the right example is like John Oliver. So imagine a John Oliver starts a political system.

Kate: So, what is this Five Star movement?

Luigi: The answer is we don’t know yet, but this is the interesting thing, is the movement, first of all, called itself a movement, not a party, because they try to be post-ideological. If you take away the jargon, they are trying to get people to express their opinions from bottom-up. So they tend to be less strict ideologically than most parties.

Kate: So in addition to Brexit, something that got a lot of attention in the American press was the refugee crisis from Syria, which involved a lot of provocative images of people washing up on beaches, boats full of people immigrating to Europe. To what extent has immigration and potentially anti-immigration sentiment been as strong in Italy as it was in England and Britain?

Luigi: It’s interesting that you mention Syria. You don’t mention Libya. There was a major refugee crisis from Syria that went through Greece and, eventually, to Germany. That was stopped by an agreement between the European Union and Turkey. There’s still an open crisis, actually, through Libya. Italy is at the front line of this crisis, and this is a crisis, you’ll be happy to know, that is not being caused by American interventionism. There was a major attack to Libya that destabilized the Libyan regime, and now, Libya is a failed state that favors illegal immigration to Italy. In case you don’t get your geography right, little Italian islands are very close to the shore of Libya, so there are a lot of people that make money by bringing potential immigrants to the border of the Italian sea border and then dumping them there and Italy rescues them. Then, this is the interesting thing. The European treaties say that if you rescue an illegal immigrant, that illegal immigrant must remain in the country that receives it. It’s as if all the illegal immigrants in the United States went through New Mexico, and New Mexico was responsible, out of the state budget, to pay all the costs of all the immigration. So Italians are mad about the situation, but they are not so mad against the immigrants. They’re mad against Europe.

Kate: Wait, but I thought the whole idea of the EU was that people could move freely between countries.

Luigi: Except if you are an illegal immigrant. The rules say if you’re an illegal immigrant, you have to remain in the country that accepted you. Of course, all this immigration created a huge resentment against the European Union that added up to the economic discontent. I want to be very clear: the economic discontent is not only the responsibility of Europe, but certainly, Europe did play a role. The rest of the role, I think, was played by the Italian establishment. The combination between the two created a perfect mix to have parties that are antiestablishment and anti-Europe to win the election.

Kate: OK, but as of right now, it seems like since no one has the majority, Italy is sort of stuck at a stalemate. Couldn’t this be good for the eurozone, then?

Luigi: Depends what you mean by good. Is it good in the sense that it postpones problems? Absolutely. It’s going to be more calm, and the markets seem to be very calm at the moment. I have to say that even Germany took six months to form a government, so it will not be surprising if it takes six months to form the Italian government. There is a possibility of new elections. So we don’t really know what is going to happen in the near future. The question is, can the eurozone reform itself in a way that makes it more viable for countries like Italy to be there? Or at some point, do we need to conceive a breakup? At some point, I conceive a breakup in which Germany will leave from the top. It’s much easier to leave a currency union from the top rather than to leave from the bottom. If Germany wanted to leave and create a northern euro, that I will label the neuro, it will be a strong currency and will make it much easier for the rest of the union to go along.

The problem of this is, seriously, where will France fall? This has always been the dramatic question in the European Union, because France is more like a southern European country than they want to admit, but they want to be in a coalition with Germany in order to avoid another world war. If Germany were to leave the euro from the top, France would be forced to either join the German currency union and basically destroy its economy or be with what they call, with a lot of contempt, the Club Med, and be with the southern European countries. I don’t think that any French president will allow that to happen, because it will touch their national pride.

Kate: It sounds to me, actually, like what happens in Italian elections don’t really matter for the eurozone or for the EU. If Italy is so screwed if you leave because that will trigger bank runs, which will just plunge Italy into another very deep recession, then, in some sense, you’re stuck. So Germany can just treat Italy however it wants, right?

Luigi: I think that we can look at the example of Argentina. Argentina was in a unilateral currency union with the dollar. For many years, the currency union worked very well. Then, there was an increasing problem in Argentina to export and an increasing problem in Argentina to pay the debt. All the governments have promised that they will never exit the currency, and eventually, they did, and they defaulted on the public debt. It took five presidents in two months to do that. It’s extremely politically disruptive, because the person doing it is not going to survive.

There is this famous line that if something is not sustainable, eventually, it will not be sustained. It’s not that deep, but it’s actually quite important in thinking about this thing. Is the euro sustainable for Italy long-term? I have my doubts. In many ways, the last few years have been the best possible world for Italy because interest rates were incredibly low, the euro, until recently, was relatively cheap vis-a-vis the dollar, and oil prices were quite low. The combination of these three, if you have to pick the best variables for Italy’s economy, those are the three variables. With this magic combination, we achieved 1.5 percent GDP growth. The upside, in my view, is limited. The downside is quite serious.

Kate: So, what should the leaders of Europe do, both the leaders of Italy after the most recent election as well as the leaders of the EU and the ECB?

Luigi: I think that in Italy, it’s relatively simple. Simple to say, very difficult to do. You need, really, to turn over the existing establishment. The message was very clear: Get out of the way. I think that, potentially, in terms of votes, the parties that won the election have the force to do that. Now the question is, it’s easier to send home people. It’s not easy to find qualified and competent and better people to replace them in a short period of time. I think that is their first mandate, and they should work on that. The second one is trying to do a good-faith effort in renegotiating the situation in the euro. For example, pushing for a European unemployment insurance, to me, should be a first priority. I think that negotiating hard on this, if they succeed, possibly, the situation is fixed. If they fail, I think they will have a stronger mandate to say, “You know, we can’t continue like this, so maybe we should think seriously about breaking away from the euro.”

The European leaders should pay attention. I think there was a sense in which people thought that you could govern Europe from Frankfurt. The perception was once we control the common currency, we can control the politics on all the European countries. I think the message from Italy is people are sick and tired of this. Part of the aversion toward the euro is that people are starting to see this game. So I think it’s very important for both the political authorities but also the monetary authorities to understand that the game has changed, and they have to change the way they play it.

Kate: So I don’t know if I speak for all Americans when I say this, but at the end of the day, I’m pretty selfish. I care about what happens here. So why should America care about what’s going on in Italy?

Luigi: I think for two reasons. First of all, if Italy were to exit the euro, probably the euro will break up in a major way. This will create economic and political turmoil in Europe with dramatic repercussions in the United States, as well. I think that just for those spillovers, you should care about it. Second, many people, after the 2016 election that brought a lot of populism to victory in the UK and in the United States—2017 sounded like a pretty stable year with Macron winning France and, in the Netherlands, the populist is not gaining too many votes, and in Austria, the right-wing candidate did not win, and so on and so forth. So people thought that was the end of it and things will subside. The Italian election suggests that, no, that people are upset. When they get to vote, they vote very strongly antiestablishment. In the grand scheme of things, the Five Star movement is not the worst thing that can happen, because they are pretty moderate in many policies, except for their anti-European bias. If they were to fail at the government this time, we could have more radical movements. I think that the easy way to manage Western democracy that prevailed for most of the period after World War II, I think is broken and is broken in Western Europe, is broken in the United States.

Kate: All right, well, Luigi Zingales, it was a pleasure having you on the show.

Luigi: Thank you, Kate.