Dysfunction in Italy has deep roots

Public administration and judicial reforms would support investment and raise productivity growth

Tony Barber

Earlier this month, Italy’s national statistics agency estimated that 1.8m households were living in “absolute poverty”. These families accounted for about 5m people, or 8.4 per cent of the population.

One can quibble about how European definitions of poverty compare with those used in less prosperous parts of the world. But Italy is a country where average wages are stagnant, some public services are crumbling and per capita income slips year after year behind that of its western European neighbours.

Next to this unhappy picture is another, more dynamic side to Italy. It helps to explain why, despite routine predictions that Italy will fall into extreme crisis, the country never actually slides over the edge.

Net of energy, of which Italy is a large importer, the national trade surplus rose last year to 4.6 per cent of annual economic output from 1.4 per cent in 2010. The trade figures mainly reflect the exporting prowess of northern Italian industry. This part of the economy boasts world-class companies and delivers, for the most part, a high quality of life for the region’s inhabitants.

Yet even this success story cannot suppress rising apprehensiveness in financial markets, EU capitals and Italian circles critical of the unconventional, populist coalition government that took power just over a year ago. The primary focus of concern is Matteo Salvini, deputy prime minister and leader of the hard-right, anti-immigration League, which after its victory in the European Parliament elections is indisputably Italy’s dominant political party.

Mr Salvini delights in cocking a snook at Brussels. He scorns the eurozone’s budget deficit rules and vows repeatedly to ignore or overturn them. He refuses to drop the League’s interest in small-denomination bonds called mini-BoTs which, if ever they were introduced, might look suspiciously like an attempt to prepare Italy’s exit from Europe’s currency union.

But just as Italy repeatedly defies forecasts of imminent doom, so Mr Salvini is unlikely to turn into the demon of the EU’s nightmares. In any case, Italy’s problems have such deep roots, culturally and institutionally, that it is misleading to concentrate on the policies and pronouncements, no matter how provocative, of one politician.

Tommaso Padoa-Schioppa, the late central banker and economist, had some excellent insights on this second point. He once remarked that, to overcome its woes, Italy might wish to adopt either free-market Thatcherism or the state-directed economic policies associated with Jean-Baptiste Colbert, Louis XIV’s finance minister. But Thatcherism was ruled out because Italian politicians lacked the courage to carry out such policies against bitter opposition. Colbertism was ruled out because the Italian state was too inefficient.

Since the return of democracy after the second world war, the weakness of the Italian state has taken some bizarre forms. Tax collection in Sicily was rarely more efficient than in the period up to 1984 when it was run by a firm controlled by the Salvo cousins, members of a mafia family. They took a 10 per cent commission and paid bribes to politicians to keep the contract. Eventually they were brought to account, but Sicilian tax revenues collapsed after the state resumed control.

Under a charitable interpretation, Mr Salvini has not held power long enough to be judged on whether he is capable of improving the state’s efficiency. But as with all Italian politicians, there are grounds for doubt. In its latest economic survey of Italy, the OECD urged reforms of the public administration and justice system, saying these would have the greatest impact of all its proposals because they would strengthen the rule of law, support investment and raise productivity growth.

The evidence of Mr Salvini’s year in office suggests that his priorities lie elsewhere, in consolidating his mastery of the right wing of the Italian political spectrum and in maximising his influence on the EU stage. To achieve the first end, he needs to complete the task of driving a stake into the heart of Forza Italia, the once all-conquering party of former premier Silvio Berlusconi.

To fulfil his second goal, Mr Salvini needs to earn a certain respectability in the EU’s halls of power. This may seem an outlandish prospect, but there is a precedent. Gianfranco Fini, Mr Berlusconi’s deputy prime minister, led a party with neo-fascist roots, but he moved decisively to the centre right under the influence of moderate European politicians he met in Brussels.

The possibility that Mr Salvini will travel the same road may be one reason why the European Commission, guardian of the eurozone’s fiscal rules, is signalling its reluctance to pick a fight with Rome over Italy’s debt. It calculates that, as happened last year, financial markets can exert the discipline needed to keep the populist government’s fiscal stance in check. Before the League and the anti-establishment Five Star took office, Italy’s borrowing costs were similar to Spain’s but the spread on 10-year government bonds has widened.

Italy’s difficulties are a slow-burning fuse, set alight decades ago, rather than an act of arson by its present rulers.

Encouraged in a pragmatic direction by Brussels and by the League’s northern Italian business allies, Mr Salvini may turn out to be less threatening to the EU political and economic order than his rhetoric suggests.

Army dreamers

Xi Jinping wants China’s armed forces to be “world-class” by 2050

He has done more to achieve this than any of his predecessors

OVER THE past decade, the People’s Liberation Army (PLA) has been lavished with money and arms. China’s military spending rose by 83% in real terms between 2009 and 2018, by far the largest growth spurt in any big country. The splurge has enabled China to deploy precision missiles and anti-satellite weapons that challenge American supremacy in the western Pacific.

China’s leader, Xi Jinping, says his “Chinese dream” includes a “dream of a strong armed forces”. That, he says, involves “modernising” the PLA by 2035 and making it “world-class”—in other words, America-beating—by mid-century. He has been making a lot of progress.

Organisational reforms may be less eye-catching than missiles that fly at Mach 5, unmanned cargo planes and electromagnetically powered superguns (all of which China has tested in the past year). Yet Mr Xi has realised that there is little point in grafting fancy weapons onto an old-fashioned force. During the cold war the PLA evolved to repel the Soviet Union and America in big land wars on Chinese soil. Massed infantry would grind down the enemy in attritional battles.

In the 1990s Chinese leaders, alarmed by American prowess in the Gulf war of 1991, decided to focus on enhancing the PLA’s ability to fight “local wars under high-technology conditions”. They were thinking of short, sharp conflicts on China’s periphery, such as over Taiwan, in which air and naval power would be as important as ground forces. Mr Xi decided that winning such wars required changing the armed forces’ structure. He has done more in the past three years to reform the PLA than any leader since Deng Xiaoping.

Mr Xi’s principal aim is to increase “jointness”. This term, borrowed from Western military jargon, refers to the ability of different services—army, navy and air force—to co-operate on the battlefield quickly and seamlessly. Jointness is especially important for fighting wars that break out abroad. It can be difficult for commanders at national headquarters to choreograph soldiers, sailors and pilots from a great distance. The different services must be able to work together without instruction from on high.

China’s model is the United States, which—under the Goldwater-Nichols Act of 1986—drastically reformed its own armed forces in order to achieve this goal. The Pentagon carved up the globe into “combatant commands”. No longer would services squabble among themselves. All soldiers, sailors and pilots in a given area, such as the Persian Gulf or the Pacific, would take orders from a single officer.

Mr Xi has followed suit. Before his reforms, army and navy commanders in the country’s seven military regions would report to their respective service headquarters, with little or no co-ordination. In February 2016 Mr Xi replaced the regions with five “theatres”, each under a single commander (see map). The eastern one based in Nanjing would prepare for war with Taiwan and Japan, for instance. The sprawling western theatre, in Chengdu, would handle India. The southern one in Guangzhou would manage the South China Sea.

As well as these geographic commands, two others were formed in 2015, each aimed at an American vulnerability. American forces depend on communications via satellites, computer networks and other high-tech channels. So Mr Xi created a new Strategic Support Force to target these systems. It directs space, cyber, electronic and psychological warfare.

In 2018 it conducted exercises against five PLA units in what the Pentagon called a “complex electronic warfare environment”. American military power in Asia also depends on a network of bases and aircraft carriers. Mr Xi took aim at these by establishing a new service called the PLA Rocket Force—an upgrade of what was previously known less rousingly as the Second Artillery Corps.

He has also been trimming the armed forces’ bloated ranks, though they remain over 2m-strong. Since 2015 the PLA has shed 300,000 men, most of them from the land forces, which have lost one-third of their commissioned officers and shrunk from 70% of the PLA’s total strength to less than half (though happily the army has kept its dance troupes, which it had been told it would lose).

By contrast, the marines are tripling in size. Navy and air-force officers have gained more powerful posts, including leadership of two theatre commands. This reflects the PLA’s tilt towards the seas—and the skies above them.

It is hard to tell whether the new PLA is more proficient on the battlefield. China has not fought a war in four decades. The last Chinese soldiers with experience of a large-scale conflict—a war with Vietnam in 1979—will retire shortly.

But there is evidence that the PLA is getting better at jointness. Some of China’s growing number of forays beyond its borders, notably bomber flights around Taiwan and over the South China Sea, indicate increasing co-ordination between air and naval forces. “We see a lot of joint exercises to work out kinks in the system and get the services used to working with each other,” says Phillip Saunders of the National Defence University in Washington, DC.

Chinese war games were once highly scripted affairs. Now officers are assessed on the realism of their training, says Meia Nouwens of the International Institute for Strategic Studies in London. Before Mr Xi’s reforms the “blue team”, which simulates an adversary, would always ritually lose large-scale annual exercises known as “Stride” in Inner Mongolia. Now they usually win.

But China’s troops may still be ill-prepared for complex warfare. In America promotions depend on officers’ ability to work with other services. Their Chinese counterparts often spend their entire careers in one service, in one region and even doing the same job. Political culture is another problem.

“The structures that China is trying to emulate are based on openness, on delegation of authority and collaboration,” notes Admiral Scott Swift of MIT, who retired last year as commander of America’s Pacific Fleet. He says modern warfare requires decentralised decision-making because cyber and electronic warfare can sever communications between commanders and units. “Militaries that are founded on democratic principles are going to be much more adept at adapting to that environment,” Admiral Swift suggests.

Mr Xi is an authoritarian who strives for centralised control. His predecessor, Hu Jintao, did not have a tight grip on the PLA, says Mr Saunders. That is because Mr Hu’s own predecessor, Jiang Zemin, had appointed the two vice-chairmen of the Central Military Commission, a powerful body that oversees the armed forces. They stayed throughout Mr Hu’s tenure, frustrating any efforts to reform the PLA and curb its endemic corruption and ill-discipline.

Mr Xi is determined not to suffer the same fate. His anti-corruption purges have ensnared more than 13,000 officers (three serving generals were demoted in June, according to the South China Morning Post, a newspaper in Hong Kong). Mr Xi slimmed down the military commission from 11 to seven members, kicking off the service chiefs and adding an anti-graft officer. The body was also given control of the paramilitary People’s Armed Police, which in turn absorbed the coast guard.

Predictably, the restructuring has generated resentment. Senior officers are irked at losing privileges. Demobilised soldiers sometimes take their grievances to the streets—one reason why Mr Xi founded a ministry of veterans’ affairs in 2016. But, says Ms Nouwens, younger ranks benefit from merit-based promotion, take pride in the growing prominence of the PLA in Chinese film and television, and admire Mr Xi’s “great rejuvenation of the Chinese nation”.

They will have an opportunity to show off on October 1st when a huge military parade will be staged in Beijing to mark the 70th anniversary of Communist rule. It will be the first such show in the capital since Mr Xi launched his reforms. Expect a world-class performance.

Farewell, Flat World

The single most important economic development of the last 50 years has been the catch-up in income of a large cohort of poor countries. But that world is gone: in an increasingly digitalized global economy, value creation and appropriation concentrate in the innovation centers and where intangible investments are made.

Jean Pisani-Ferry


PARIS – Fifty years ago, the conventional wisdom was that rich countries dominated poor countries, and it was widely assumed that the former would continue getting richer and the latter poorer, at least in relative terms. Economists like Gunnar Myrdal in Sweden, Andre Gunder Frank in the United States, and François Perroux in France warned of rising inequality among countries, the development of underdevelopment, and economic domination. Trade and foreign investment were regarded with suspicion.

History proved the conventional wisdom wrong. The single most important economic development of the last 50 years has been the catch-up in income of a significant group of poor countries. As Richard Baldwin of the Geneva Graduate Institute explains in his illuminating book The Great Convergence, the main engines of catch-up growth have been international trade and the dramatic fall in the cost of moving ideas – what he calls the “second unbundling” (of technology and production). It was Thomas L. Friedman of the New York Times who best summarized the essence of this new phase. The playing field, he claimed in 2005, is being leveled: The World is Flat.

This rather egalitarian picture of international economic relations did not apply only to knowledge, trade, and investment flows. Twenty years ago, most academics regarded floating exchange rates as another flattener: each country, big or small, could go its own monetary way, provided its domestic policy institutions were sound. The characteristic asymmetry of fixed exchange-rate systems was gone. Even capital flows were considered – if briefly – to be potential equalizers. The International Monetary Fund in 1997 envisaged making their liberalization a goal for all.

In this world, the US could be viewed merely as a more advanced, bigger country. This was an exaggeration, to be sure. But US leaders themselves often tended to play down their country’s centrality and its correspondingly outsize responsibilities.

Things, however, have changed again: from intangible investments to digital networks to finance and exchange rates, there is a growing realization that transformations in the global economy have re-established centrality. The world that emerges from them no longer looks flat – it looks spiky.

One reason for this is that in an increasingly digitalized economy, where a growing part of services are provided at zero marginal cost, value creation and value appropriation concentrate in the innovation centers and where intangible investments are made. This leaves less and less for the production facilities where tangible goods are made.

Digital networks also contribute to asymmetry. A few years ago, it was often assumed that the Internet would become a global point-to-point network without a center. In fact, it has evolved into a much more hierarchical hub-and-spoke system, largely for technical reasons: the hub-and-spoke structure is simply more efficient. But as the political scientists Henry Farrell and Abraham L. Newman pointed out in a fascinating recent paper, a network structure provides considerable leverage to whoever controls its nodes.

The same hub-and-spoke structure can be found in many fields. Finance is perhaps the clearest case. The global financial crisis revealed the centrality of Wall Street: defaults in a remote corner of the US credit market could contaminate the entire European banking system. It also highlighted the international banks’ addiction to the dollar, and the degree to which they had grown dependent on access to dollar liquidity. The swap lines extended by the Federal Reserve to selected partner central banks to help them cope with the corresponding demand for dollars were a vivid illustration of the hierarchical nature of the international monetary system.

This new reading of international interdependence has two major consequences. The first is that scholars have begun reassessing international economics in the light of growing asymmetry. Hélène Rey of the London Business School has debunked the prevailing view that floating exchange rates provided insulation from the consequences of the US monetary cycle. She claims that countries can protect themselves from destabilizing capital inflows and outflows only by monitoring credit very closely or resorting to capital controls.

In a similar vein, Gita Gopinath, now the IMF’s chief economist, has emphasized how dependent most countries were on the US dollar exchange rate. Whereas the standard approach would make, say, the won-real exchange rate a prime determinant of trade between South Korea and Brazil, the reality is that because this trade is largely invoiced in dollars, the dollar exchange rate of the two countries’ currencies matters more than their bilateral exchange rate. Again, this result highlights the centrality of US monetary policy for all countries, big and small.

In this context, the distribution of gains from openness and participation in the global economy is increasingly skewed. More countries wonder what’s in it for them in a game that results in uneven distributive outcomes and a loss of macroeconomic and financial autonomy. True, protectionism remains a dangerous lunacy. But the case for openness has become harder to make.

The second major consequence of an un-flattened world is geopolitical: a more asymmetric global economic system undermines multilateralism and leads to a battle for control of the nodes of international networks. Farrell and Newman tellingly speak of “weaponized interdependence”: the mutation of efficient economic structures into power-enhancing ones.

US President Donald Trump’s ruthless use of the centrality of his country’s financial system and the dollar to force economic partners to abide by his unilateral sanctions on Iran has forced the world to recognize the political price of asymmetric economic interdependence. In response, China (and perhaps Europe) will fight to establish their own networks and secure control of their nodes. Again, multilateralism could be the victim of this battle.

A new world is emerging, in which it will be much harder to separate economics from geopolitics. It’s not the world according to Myrdal, Frank, and Perroux, and it’s not Friedman’s flat world, either. It’s the world according to Game of Thrones.

Jean Pisani-Ferry, a professor at the Hertie School of Governance (Berlin) and Sciences Po (Paris), holds the Tommaso Padoa-Schioppa chair at the European University Institute and is a senior fellow at Bruegel, a Brussels-based think tank.

The Economic Bubble Bath

by Jeff Thomas

At the end of a long, tiring day, we may choose to treat ourselves to a soothing bubble bath.

Surrounded by steaming water and a froth of sweet-smelling bubbles, it’s easy to forget the cares of everyday life.

This fact is equally true of economic bubbles. When the markets are up, we’re inclined to feel as though life is rosy. Unfortunately, it does seem to be the norm that investors fail to recognize when a healthy up-market transforms into a dangerous bubble. We tend to be soothed into overlooking the fact that we’re in hot water, and economically, that’s not an advantageous situation to be in.

Periodically, any economy will experience bubbles. It’s bound to happen. Human nature dictates that, if the value of an asset is on the rise, the more success it experiences, the more we want to get in on the success.

Sadly, the great majority of investors have a tendency to fail to educate themselves on how markets work. It’s easier to just trust their broker. Unfortunately, our broker doesn’t make his living through our success; he makes it through brokering transactions. The more buys he can encourage us to make, the more commissions he enjoys.

It’s been said that a broker is "someone who invests your money until it’s gone," and there’s a great deal of truth in that assessment.

And so, we can expect to continue to witness periodic bubbles in the markets. They’ll occur roughly as often as it takes for us to forget the devastation of the last one and we once again dive in, only to be sheared once again.

But we’re presently seeing an economic anomaly – a host of bubbles, inflating dramatically at the same time.

The Stock Market Bubble

Only a decade ago, stocks plummeted and billions were lost by investors. But then, before the system could be cleansed of the detritus, more money was artificially pumped into the system and stocks began to rise again.

Margin debt is now at an all-time high and complacency is at a maximum. The present condition looks quite a bit more like 1929 than 2008, and the stock market is overdue for a crash. This time, it promises to be much greater than before, as the debt that’s fueling the bull market is at a level that’s historically unprecedented.

Back in 1929, communications were poor and stock market trades were recorded in handwritten ledgers. Today, the recording is entirely electronic, and in addition, in order to minimize losses, the investor may have his broker set electronic stops that will ensure that a given stock is offered on the market automatically, if it drops below the stop price.

This works quite well as long as times are good, but, if there were to be a crash, what it means is that, even if a crash were to be triggered in the middle of the night, when everyone is asleep, the market would awake in the morning to a sudden collapse, as prices blew through the stops of countless investors.

Therefore, the collapse would be much swifter and much more severe than in 1929.

The Bond Market Bubble

This bubble could just as easily be termed a "debt bubble," as bonds are simply a promise to pay a debt at a future date. (It’s important to note that the bond market consists of a far higher level of investment than the stock market and therefore has the potential to do far more damage in a crash.)

Bonds may be issued by companies, municipalities or central governments. By far, the largest portion of the bond market is that of Treasuries, or government-issued bonds.

Since 1944, the US has been in the catbird seat in the world, as its dollar has been the world’s default currency. But, as the US has, in recent decades, increasingly abused that privilege, the rest of the world has been looking for ways to extricate itself from this economic stranglehold.

With the introduction of new central banks in Asia, plus the new CIPS system (an alternative to the monopolistic SWIFT), it’s become increasingly possible for the East to wean itself from the dollar. Increasingly, this has meant dumping US Treasuries back into the system.

Bonds are presently in a bubble of epic proportions, and with every month, the foundation underneath them is crumbling more, due to ever-increasing dumping.

Even the perma-conservative Alan Greenspan now states that, "We are in a bond market bubble… Prices are too high… The bond market bubble will eventually be the critical issue."

The Real Estate Bubble

In 1999, the Fed, then under Alan Greenspan, convinced the US president to repeal the Glass Steagall Act, freeing the banks to create the types of loans that helped cause the Great Depression. This, of course, led to the real estate crash of 2007, but instead of the banks going belly-up, they were rewarded for their misdeeds through bailouts that were paid for by taxpayers.

Consequently, although there was a significant correction in real estate prices, this didn’t result in prices dropping to fair value.

They have once again risen and, at this point, are overdue for a major correction. That correction is now well under way. Since it has begun at a time when other markets are also in peril, the level of bailout required for all of them at the same time is impossible to achieve.

Had each of these markets been allowed to collapse in the normal manner, as would occur in a free-market system, they would have done so at levels below the present ones and would have done less damage when they burst. Additionally, each bubble would have burst at its own, logical time.
Instead, all are being propped up artificially, far beyond their natural sell-by date.

For this reason, they’re so over-inflated that, when one bubble is popped, it’s all but certain that they’ll all go down together.

And so, effectively, the financial world is in a bubble bath. The investor is surrounded by soothing bubbles, each of which is rising, reassuring him that his investments are growing.

Although it should be clear to him that he’s in hot water, the majority of investors are holding on to their bonds, rubbing their hands over the rising sale prices of homes in their neighbourhood and considering taking out a loan to buy more stocks on margin.

The collapse will therefore come to most as a complete surprise.

Economic bubbles are normal. They’re created by the lack of forethought that’s common to human nature.

But the present bubble bath is an anomaly without precedent and, as such, promises to result in a crash of unprecedented proportions.