Why the Crisis in Italy is Not Over

Yves here. This Real News Network interview with Heiner Flassbeck discusses the recent rescue of Monte dei Paschi and why Italy’s banking and economic woes are far from solved. However, as much as Flassbeck makes many sound observations, it’s disappointing to see him take up the neolibaral meme of “competitiveness,” since among other things, it presupposes that every country should be a net exporter.

Servaas Storm has been in an extended debate with Flassbeck and others on this issue, and we’ve posted some of Storm’s key papers here. From our overview of one, How the Labor Cost Competitiveness Myth is Making the Eurozone Crisis Worse:

The paper below is comparatively short and well-written, but don’t let that fool you. Its author, Servaas Storm, gave the best talk at last year’s Institute for New Economic Thinking annual plenary, and he continues to do important work. His new article makes a devastating attack on a fundamental belief driving Eurozone policy, that the member economies need to be made more “competitive,” meaning labor needs to be squeezed, for the currency union to achieve more growth. Recall that for Greece, one of the key battles that the ruling coalition lost was over labor “reforms” which were all meant to reduce worker bargaining power.

This article shows, decisively, how wrong-headed this worker-crushing approach is. It shows that labor is a comparatively small percent of the cost of wholesale goods, and in the case of Germany, how the reductions in labor costs (the Haartz reforms) had almost nothing to do with Germany’s growth in exports. Instead, the bigger effect of the wage reduction in Germany was to constrain domestic demand, which led the European Central Bank to set interest rates unduly low, which then set off excessive borrowing and real estate speculation in the periphery countries. That in turn led to banking crises that the bailouts transfigured into sovereign debt crises.

His later articles include:

Why the Neoclassical Story About German Wage “Moderation” Causing the Eurozone Crisis is Wrong

Intra-EMU Divergence Is A Feature Not A Bug

Please also note the rush transcript came from Real News. It is missing apostrophes. I made some corrections but I am sure I didn’t catch all the omissions.

HARMINI PERIES, TRNN: It’s the Real News Network. I’m Sharmini Peries coming to you from Baltimore.

Last week the European Central Bank released its long awaited stress test for Europe’’s largest bank and the world’s oldest bank Monte dei Paschi di Siena, MPS, was the worst performing bank of any bank tested. Since then this bank has been rescued though through a combination of new capital race from investors and a selling off of bad debts. But is the Italian banking crisis over? What happened to the robust Italian economy of years gone by and what will be the spillover effects of the current crisis for the rest of Europe?

Joining me now to discuss all of this is Heiner Flassbeck. He is a director of Flassbeck Economics, a consultancy for global macroeconomic questions, and the editor of Macroscope, an internet magazine. He’s also coauthor of the book, Against the Troika: Crisis and Austerity in the Eurozone, which he co-wrote with Costas Lapavitsas. Heiner thank you so much for joining us today.

HEINER FLASSBECK: Thanks for having me today.

PERIES: So Heiner, if you read the financial press, it would seem that the Italian banking crisis has been resolved. This stress test did not spell as much doom as some expected and the world’s oldest bank, MPS was rescued. Would you agree with that interpretation of things?

FLASSBECK: No, not really. You see the oldest bank has been rescued, that’s right but nobody has really addressed the deep digging–the deeper Italian problems which is problems with the economy. Italy is now on the 5th or even 6th year, however you count, of a very deep recession. And so far it is quite normal that you have bad loans piling up in the bank accounts. That’s absolutely natural. And this problem has not been settled.

They found a solution which is not even a systematic solution because you know, meanwhile they have agreed upon a so called banking union in Europe which produces a thing that is called [Bail-in] where the owners of a bank and the people, the depositors so to say, creditors of the bank should save the bank. But that has not been used in the case of MPS because obviously for political reasons it would’ve been too bad for the prime minister Renzi because MPS is from his home region in Tuscany in Italy and so they found another way. But it is said that the main cause of the crisis is not being taken at all.

PERIES: So let’s look at how Italy got into this problem in the first place in a recent article that you wrote. You suggest that a large part of the problem has to do with the European Union’’s policies that favor Germany’s export orientation. What does that exactly mean and how did Italy get into this situation?

FLASSBECK: Well let me firstly say that Italy in the past was always [inaud.] economy. Although they had normally much higher inflation rates than Germany or France even. So how did they settle the problem Well they solved the problem by devaluing their currency, the lira, the Italian, lira at that time. And then they regained competitiveness and the thing was done.

Now inside the monetary union, Italy is trapped in an overvaluation trap. So to say that having a currency. And the reason for that, the same is true for France but at a lower degree but this all, the reason for that is Germany’s wage [inaud.]. Germany has been moderating, mildly moderating, had put enormous political pressure on wage increases the beginning of the 2000s. And then so from the century a Germany had very low wages and very low unite labor costs and unit labor costs, the important measure for competitiveness of a country.

So Italy fell behind more and more and after 6-7 years of the monetary union, Germany had gained a huge, not a comparative advantage but an absolute advantage in terms of competitiveness. So it was undervalued by 20-25% against Italy and Italy was overvalued but Italy didn’t have a currency anymore so it couldn’t solve the problem. And this leads to first the deflation in the whole of Europe and it leads to the situation in Italy where Italy is absolutely in-able to tackle, as I said, the longest recession that nay big major country in the world has since the 30th of the last century.

PERIES: Now Heiner, one of the things that you referred to is the fact that most nation states abilities in terms of their own macroeconomic policies here, their hands are tied and they’re unable to act. How does that effect what’s going on now? What could they be doing?

FLASSBECK: Well the only way out you see, the situation is rather simple and all the countries surrounding Germany or the deficit countries so those countries that have a deficit due to current accounts. Italy has now a surplus in the current account but it doesn’t mean very much. It’s just a reflex of the long recession.

So all the countries with problems of competitiveness vis-a-vis Germany, have only one means to stimulate and that is deficit spending. Government deficit spending. But this exactly is forbidden. See. This is the bizarre or absurd situation that European monetary union has created and Germany’s [inaud.] and fiscal affairs has created, you know everybody call it the crisis that came up in the Eurozone.

After the big financial crisis, everybody called the it the government debt crisis which is plain nonsense. It had nothing to do with the government debt crisis. It was a crisis as I said of diverging competitiveness. So but with the name government debt crisis, everybody obviously said now we have to cut public expenditures.

But if you are in a situation where you cannot get positive effects from the rest of the world as Germany does but you cannot because you’re not competitive vis-a-vis the rest of the world and Germany. And you have to put pressure on your wages. So the wages in the country cannot increase so your consumption will be flat and investment will obviously be flat if consumption will be flat. So what are you doing?

So the only way logically, just pure logic, the only way to stimulate such an economy is by the spending of the government. Do whatever you want. All the other things, structural reforms is all ridiculous because it doesn’t give an impulse. What you need is certain moment in the economy and this momentum can only come from the demand side. It cannot come from the supply side. Oh this is sad. Just pure ideology. People who say you do structural reforms and then you grow. Nobody grows just by structural reforms but only by stimulating demand side. And this exactly is not allowed.

PERIES: Now this constrained in terms of having a deficit as a part of the EU. Now Spain and Portugal recently as I guess as well as Greece, have gone into debt or created a deficit in these countries and it was reported that, El Pais for example, reported that Germany has decided to force Spain and Portugal to pay a fine for violating the EU agreement. And then they retracted that position and decided not to do that particularly give how unpopular the EU is becoming all over Europe, especially following the Brexit. So what do you make of this reverse decision and do you think that will be how things will be for Italy for example?

FLASSBECK: Yeah, you see you described it very well. You can only call it [observe t deterrent]. It’’s the kind of [observe t deterrent] that you replace with itself. In the first round, the EuroGroup, the ministers of finance decide that Spain and Portugal should be punished and should pay fees because their deficits are still too high. On the other hand, France’s deficit is also too high but nobody wanted to punish France for political reasons. Italy’s deficit is still rather high but nobody wanted to punish Italy. Italy should have gone through the new banking union regulation with Monte dei Paschi as we discussed already. But it hasn’t done for political reasons.

So if you fine a small country like Greece or Cyprus or Spain or Portugal then you can punish it and you punish it and you show that you are sticking to the rules of the game. Which is really absurd. Then they retreated from that because obviously they got a warning from the conservatives to a conservative majority in Spain then they would have difficulties to form a new government. Which they already have.

But it would be more difficult to form a government if this process would go through so [inaud.] that no, no we don’t punish them. So it’s observed to see that they have a contract which is called stability and growth pact. This stability and growth pact is beyond any macroeconomic logic because it just focuses on the government. It says, if you a government deficit, you have to cut at any price. Nobody cares what the rest of the economy has but we all know and I’ve shown it in this article about Italy.

We all know there’’s strong relationships between the savings of private households. The saving of what we have in most countries of the company sector and the government sector, the government deficit, and the current accounts. So you cannot cut one part out and say, you have to cut public deficit, whatever happens in the other sectors. It’s just absurd.

PERIES: So what does this all tell us about the strength of the European Union and then of course the spillover effect this might have in other so called trouble economies, especially Spain, Portugal, and Greece?

FLASSBECK: Yeah, it’’s not only southern Europe, it’s even Eastern Europe. As you look at Eastern Europe there’s a lot of frustration with the whole European Union, with the whole European Monetary Union because all these countries are blocked in one way or another. Being a member of the monetary union and up, they’re all blocked so that all of Europe is in a stalemate in a stagnated mode that does not change. Even Germany–that’s even true for Germany if you hear about growth figures in Germany some statistic say something goes up.

But if you look at the real hard facts like industrial production and incoming orders you see nothing for 5 years. The Germany economy is stagnating. So yeah, the result is that we have and we discussed it formally in our last interview already. We have a move to the right everywhere.

So people are frustrated with Europe. People are absolutely shocked about the inability of Europe to solve a problem like getting out of recession you see. The United States even has managed to get out of recession so, let me say that.

But Europe is not able to get out of recession, so it’s really bad and people intuitively recognize that this cannot go on, and intuitively what they do is emotionally hit by this wrong guided European idea, they move to the right and vote for nationalist parties. So we’re getting closer to the point of no return where national parties really take over power in big countries, in Italy or France and then the whole European idea is dead.

PERIES: And the relaxation in terms of the EU agreement would go a long way in terms of stimulating the economy. What kind of investments need to be made in order to reboot the economy?

FLASSBECK: Well you have to–everywhere you can do it by public investment and infrastructure and education and ecological sustainability so there’s many, many fields where you could do it. You can also do it through stimulating the private consumption but the obvious way to do it in an environment where we are where the investment ratios are very low and the public investment ratio is extremely low in Germany for example, well the very simple way is to spend money inside the country. And in Germany and in many other countries, even in France, the interest rate is zero.

So if there is a signal coming from the capital markets, the signal is please please take money from me the [inaud.] and spend it because this is the only way to get out of this scenario of zero interest rates forever. But see the dogma, this is the interesting thing politically, the dogma in particularly in Germany is so strong. This dogma which should never have public debt anymore, which is stupid and childish. But this is the dogma and they will not move one millimeter and the old German media are fully behind them. They are supporting this funny position. So it’s–nobody’s touched by anything by the outside world.

PERIES: Alright Heiner, I thank you so much for joining us today and just want to let everyone that Heiner Flassbeck will be doing regular reports with the Real News Network every other week. So I welcome and I look forward to having you back Heiner.

FLASSBECK: Thank you for giving me the opportunity. Bye bye.

PERIES: And thank you for joining us on the Real News Network.

Print Friendly, PDF & Email


  1. paulmeli

    “It shows that labor is a comparatively small percent of the cost of wholesale goods,…”

    That would be true for direct labor but most other costs of production also accrue to labor beyond a businesses employees (vendors, subcontractors, finance).

    Virtually all costs of production distill down to labor of one kind or another plus profits. Raw materials have little relative cost until processed, transported and sold, all of which require labor.

    Labor involved at every turn.

  2. Michel Verbeek

    “it’s disappointing to see him take up the neolibaral meme of “competitiveness,” since among other things, it presupposes that every country should be a net exporter. ”

    Flassbeck does not explain it here (he is not asked), but I can assure you (I read him in German) that he does not in any way support the idea that countries have to compete against each other, definitely not the way that Germany did by lowering wages.

  3. hemeantwell

    Yves, I see your point about a competitiveness fetish. However, while I may be conflating Flassbeck/Lapavitsas and Varoufakis — I read them about the same time — as I recall Flassbeck/Lapavitsas also talked about how the German wage pact suppressed German consumption of goods from other Euro countries. (Perhaps there’s a contradiction there.?) Also, I believe they discussed how “surplus” capital — derived in part from both low wages and the resulting lack of domestic market — ended up being cycled by German banks into foreign real estate, setting up that bubble.

    This was interesting:

    So if there is a signal coming from the capital markets, the signal is please please take money from me the [inaud.] and spend it because this is the only way to get out of this scenario of zero interest rates forever. But see the dogma, this is the interesting thing politically, the dogma in particularly in Germany is so strong

    Are there some factions in German capital that are taking this position? Or does this signal lack any political expression so far?

  4. Synoia

    This article shows, decisively, how wrong-headed this worker-crushing approach is.

    If the goal is to contain China, after admitting China to the WTO and moving jobs there to make it the biggest economy in the world, the demand crushing, and worker crushing, approach seems very logical.

    One needs a theory which fits the facts, and is testable.

    A test it the practice behind the theory is both continuous and maintained in the face of all evidence.

  5. Larry

    Capital has won over reason in Europe, that much is clear. Rules and treaties and currencies are all in place to placate capital. Nothing will reverse this course other than utter chaos and dissarray. The Eurocrats have no flexibility, much like Hoover during the great depression.

  6. Sound of the Suburbs

    “So people are frustrated with Europe. People are absolutely shocked about the inability of Europe to solve a problem like getting out of recession you see. The United States even has managed to get out of recession so, let me say that.”

    Luckily, Janet Yellen and Ben Bernanke read Richard Koo’s book and followed his advice and didn’t impose austerity ensuring the US didn’t go over the fiscal cliff.

    Mario didn’t read Richard Koo’s book and pushed the Club-Med nations over the fiscal cliff with austerity.
    The really harsh austerity on Greece just killed it.

    In a globalised world no one pays any attention to what is going on elsewhere.

    In 1989, Japan had a massive real estate bust that it still hasn’t recovered from.

    No one noticed and everyone has been inflating their housing markets.

    In 2008, the US housing market collapsed with devastating consequences; to make things worse they leveraged it up with derivatives.

    It must be a one off “black swan” event (don’t mention Japan).

    Japan has been in a balance sheet recession for 25 years since 1989 and Richard Koo has been following its progress. Japan was just recovering when 2008 hit.

    Luckily, the FED did look beyond their neoclassical dogma and read Richard Koo’s book.

    The ECB is in neoclassical dogma world and probably will be until the Euro-zone goes down.

    Adios Euro-zone.

Comments are closed.