It Could Only Happen in Italy

By Roy C. Smith

Though a founding member of the European Economic Community and of the European Union, and a first round participant in the euro, Italy has always posed an existential threat to these institutions because its heavily working class voting population has never trusted the so-called elites, was always suspicious that the wheeling and dealing politicians that came forth were corrupt or incompetent, and never felt very European.  

In 1946, after more than 20 years under Mussolini, Italy established by referendum a democratic republic. But Italy was not a normal country then; from 1943 when the Italians surrendered until well after the German forces exited in 1945, Italian partisans rose up aid allied forces fighting the Nazis, but also to seek revenge on Italian fascists and/or supporters of the Germans and their collaborators. As many as 30,000 Italian were killed by their countrymen in 1945 and 1946 alone.

For most of the next 50 years, however, the dominating political party was the center-left Christian Democrats, whose main job was to keep the Italian Communist Party (the largest and most accepted in Europe) from gaining control of a government. In these 50 years, however, Italy had more than 50 governments, as the Christian Democrats wheeled and maneuvered to stay in control through coalitions, alliances, pay offs and deals of various kinds. But, the Christian Democrats kept their hands on the tiller through this time (making Italy less volatile than it seemed), but voters continued to seethe with a long list of discontents (including too many politicians with their hands in the till).

In the 1970s, the extreme left Brigate Rosse (Red Brigades) emerged and introduced terrorism to Italian politics in a “Decade of Lead.” The group was not part of the Communist Party but seemed aligned in political objectives. In 1978 the Red Brigades assassinated prime minister Aldo Moro.  They have been associated with 14,000 acts of violence. But they had some public support from the working class, whose sentiments were portrayed by the hugely popular Italian comic playwright Dario Fo (Nobel Prize in Literature 1997) in The Accidental Death of the Anarchist and Can’t Pay! Won’t Pay! (Fo is now a mentor to the populist-left, protesting Five Star Movement founded by a popular TV comedian and social media blogger, Beppo Grillo, in 2009).

In the 1990s and 2000, Silvio Berlusconi, a media billionaire with characteristics resembling Donald Trump, entered politics and was elected prime minster three times, serving a total of 9 years, longer than any other post-war Italian leader.  Though a successful businessman, Italy’s economy lagged the EU average during this time, and unemployment was higher. Berlusconi never attempted any of the labor and other reforms that other countries in Europe were undertaking at the time. He was very popular with the working class - running for office as an in-your-face conservative but governing as a populist. In 1994 his first government was defeated and a “technocratic government” headed by a former government official was appointed to run things.

Berlusconi resigned again in 2011 during the European Sovereign Debt crisis, and economist and former EU commissioner, Mario Monti, was appointed prime minister of another technocratic caretaker government until 2013.

During this time, Matteo Renzi formed a new Democratic Party to bring about needed reforms and bring Italy into the European mainstream. He was elected prime minister at 39 in 2014, with 60% of the vote and immediately began to introduce long overdue labor reforms, and to modernize Italy’s state-owned-industries and sell off assets. Despite much opposition he was successful in getting labor and other laws changed. He also introduced a change in Italy’s constitution to reduce the power of the Senate and make the Italian legislative voting system more democratic. Though the constitutional reform had the approval of the legislature, it had to pass a referendum, which in late 2016 it failed to do. Renzi then resigned as prime minister.

Italy’s next election in 2018 resulted in a surprise victory by the Five Star Movement, which gained a plurality of 32.2% of the vote, beating out the Democratic Party (18.9%), still led by Matteo Renzi, that only barely outdid an upstart, far-right League Party (17.7%), forcing an awkward coalition attempt between the far-left and the far-right.  

This effort, which involved the designation of a prominent lawyer without government experience to be prime minister (instead of either party’s head, a difficult and cumbersome compromise) failed when the two parties proposed an 81-year old anti-euro former Bank of Italy economist to be Minister of the Economy.

President Sergio Mattarella, acting within the constitutional powers of his office, rejected the coalition proposal on the grounds that the election was not about leaving the euro, which the proposed ministerial appointment foretold, and voters did not know when they voted that the parties might attempt a ”back-door exit” from the currency system that Italy had supported from the beginning. Instead, President Mattarella designated Carlo Cottarelli, a former IMF official, to become prime minister and to form another (a third) caretaker government. This new government, though, is opposed by the two parties that are attempting the coalition, so it is certain to not gain parliamentary approval, therefore triggering a snap election in the fall of 2018.

Such an election may legitimately be presented as a referendum on the euro, which considering populist sentiment in Italy could result another ill-informed Brexit.  Referendums in Europe are dangerous things.

Mattarella was not eager to have an early election under these conditions, so he was open to a different proposal from the coalition - to appoi9nt a different Minister of the Economy and let the 81-year old economist take another position in the government. Talks continue, but meanwhile, interest rates on Italian government bonds rose by  150 basis points in just a day. 

Departing the euro would be far more painful to Italy than Brexit would be to the British. Leaving the euro would mean readopting the Lira, watching it fall in value relative to the euro and increasing the burden of Italy’s $3.2 trillion debt (173% of GDP) on its citizens, and limiting the availability of new credit to Italy’s government and private sector. Banks would be forced to curtail loans, interest rates and unemployment would rise, probably sharply. Growth rates would slump into a recession that could last a long time, like Greece’s. And, in its economic distress, it would get no help from the European Stability Mechanism or European Central Bank, which can only aid euro members. As in the case of Brexit (where the issue was leaving the EU, not the euro), it is unlikely that the average voter will be aware of these consequences of an anti-euro vote or believe what they are told about them.

All this could be worse for Italians if the Five Star/League consortium also choses to leave the EU, something that some of their fervent anti-immigrant advocates believe is necessary. Italy has been awash with immigrants from Africa for several years. Leaving the EU would mean leaving the custom union (the Single Market) and the Schengen Area (no passports needed) that could curtail Italian economic growth and inward investment flows further.

Some Italian observers believe that a September election will ignite the worse of Italy’s populist complaints. Mattarella, who believed the coalition’s government proposal was harmful to Italians of all classes, nevertheless is seen as being outrageously wrong in cancelling the results of a democratic election. The populists also believe that the “establishment” political parties are not listening to the common pleading of all Italians to limit immigration and unwanted, unfair pressures on Italian life by the EU that leaves too many Italians poor and unemployed. They want the government to extend social services further to help all who need it, whatever the cost. Italy’s government debt, already 131% of GDP (the highest in the EU except for Greece) would likely explode if the coalition’s announced plans to block immigration and increase social spending were implemented.

Italy’s EU allies, some of which are fighting similar political battles in their own countries, are powerless to help. They know that an exit from the euro by Italy would be a grave threat to the ability to hold the currency together. But also, that Italy could face a banking and sovereign debt liquidity crisis similar to that confronted by Greece, Ireland, Portugal and Spain. Such a crisis would be too big to handle, and beyond the limits of voters in Germany, Holland, Denmark and other countries to tolerate as a cost of being in the currency.

Brexit may not be enough to break up the EU, but an Italexit could break the euro.   

True enough, but this is Italy – anything can still happen.

  

China, Trade and Trump

By Roy C. Smith

Perhaps it is now not unusual in the age of Trump to send an inexperienced team of officials with differing views on trade to Beijing for a two-day photo-op to deliver their “demands” for adjusting the “unfair” US-China trade balance. Among the seven US delegates, only Robert Lighthizer, the official US Trade Representative, has expertise in negotiating the endless minutia of trade issues. Though nominally led by Treasury Secretary Mnuchin, no one on the delegation seemed to be in charge or to speak for the president, something Commerce Secretary Wilbur Ross knows very well - last summer he negotiated a deal with China to reduce steel production that Mr. Trump later rejected as insufficient.

The Chinese side, quickly banged together by Liu He, president Xi Jinping’s new economic chief, replaces officials from the Commerce Ministry that were the previous trade experts. Liu’s team, trained in economics and finance, but inexperienced in trade details, seems to be fielded particularly to respond to the Trumpian form of blustery, highly politicized negotiations.

Neither side knows each other very well. Mr. Lighthizer said “we are going to spend the next year developing how we deal with each other.” If so, Mr. Lighthizer must assume his Chinese counterparts will not respond to the demands soon, or even take them seriously until they know each other better.

The US demands were an opening salvo of an economic artillery barrage that will go back and forth for a while. They include a unilateral reduction in China’s trade surplus with the US of $200 billion by 2021 (increased from $100 billion indicated before the meeting, which the Chinese said would be impossible), the ending of subsidies to Chinese tech companies competing in world markets, an immediate end to cyberespionage of commercial trade secrets and a strengthening of intellectual property protections, a lowering of Chinese tariffs on products in “non-critical” areas, opening of Chinese markets to foreign investments and services, and a promise to take no action, especially in the agricultural sector, in response to unilateral US tariff increases and other moves. These include the recent US announcement of higher tariffs on $150 billion of Chinese exports, restrictions on acquisitions in the US by certain Chinese companies and of exports to China of certain high-tech products, and penalties imposed last month on ZTE, a Chinese telecom company, for violating US sanctions on Iran.

China has already said it might open its markets to easier terms for foreign investment and is considering lowering some tariffs, but was unwilling to commit unilaterally to slashing the trade deficit. China recently announced a Made in China 2025 program as an essential upgrading of the economy with an emphasis on high technology industries. On May 5, a day after the Beijing talks ended, China announced the formation of a $47 billion China Integrated Circuit Industry Investment Fund to advance the 2025 plan. The US objects to this plan because of the large amount of government subsidies it will contain.

So, a year-long set of trade negotiations has begun with both sides firmly dug in. Nothing much is likely to happen for a while. China is not in a hurry and doesn’t face mid-term elections in the fall.  

But, China too has large political interests at stake in these negotiations. Newly anointed president-for-life Xi Jinping is in the process of consolidating all powers in China in the Chinese Communist Party (and himself).  His propaganda machine is constantly busy promoting Xi’s dynamic leadership, his “thought” and his “Chinese dream” even though growth is slowing, financial risks are increasing, and the problems of China’s huge aging population are becoming apparent. Like Mr. Trump, Mr. Xi has a populist side that appeals to nationalistic sentiments that the propaganda folks keep warm. He wants China to be recognized by the US and other countries as a great power, and not appear as Japan in the 1980s, so driven by economic ambitions that it could be forced into concessions by the US. Indeed, after the recent negotiations with the US team, Xinhua, China’s official news agency, pointed out that in a trade war, China was better off because of its strong centralized leadership, strong domestic consumer base, and “greater desire” (than the presumably soft Americans) to protect the current global trade system.

Mr. Trump’s style of deal-making is not unique in trade negotiations. Indeed, Richard Nixon, frustrated that Japan was not conceding to his trade policy demands, suddenly imposed a 10% surtax on all Japanese imports to the US. Japan responded by offering some concessions on quotas that solved the political problem Nixon had with US job losses for a while. But the trade imbalances continued and Ronald Regan followed a similar strategy a decade later.

China has emphasized that it is in a stronger bargaining position than Japan in the 1980s. Maybe it is, but the US is China’s largest trade partner, and its open markets continue to be important to China’s future. Meanwhile, China’s economic growth rate has declined from the 10% range to something around 6% despite enormous stimulus efforts and lose credit standards that threaten its financial stability. A trade war with the US certainly would not be convenient.

Economic forces already at work, however, will reduce the trade deficit on their own over time – rising costs for labor, land and raw materials have already caused some companies to move their manufacturing to a lower cost locale, and China will have a growing requirement to import goods as it becomes more of a market-driven consumer society. Meanwhile, while the deficits remain, US consumers enjoy lower prices and corporations pay lower interest rates as China recycles the surplus to invest in US securities, factories and acquisitions to protect its global market access. A great many Americans benefit a little from our present trade with China, but a few have lost their livelihoods. Cold-blooded economists don’t lose any sleep over the disparity, but hot-blooded politicians do.

China was admitted to the World Trade Organization in 2001 at president Bill Clinton’s strong urging. The US trade deficit with China was then less than $100 billion (it is now $375 billion, 2% of US GDP). China was granted some relief from WTO rules because it was a developing country. Some say because of China’s enormous growth since then, and the impact of its concentrated export activity on local businesses in the US and the EU, China should be regarded as a fully developed country and play by all the rules. China says with 60% of its population still poor and an urgent need to upgrade local manufactures to supply local markets, it should not be required yet to do so. And, China is still a one-party state with 150,000 state-owned enterprises that retains many aspects of the command economy it once was.

What's needed now is a set of practical compromises that both sides can live with and feel good about because they add real value.

These might start with a revised accounting system for calculating export values – The iPhone X costs about $370, according to one expert, for its various software and hardware components. Chinese content for assembling the units, however, is only 3% to 6%, or only $10 to $20 per unit. (The rest goes to companies in South Korea, Japan, Taiwan, the EU and the US, illustrating how Apple’s global supply chain works). On the other hand, Chinese content of commodity items like steel exports is nearly 100%.  If we ran the accounting to count only Chinese content, the pressure points would be different. China has excess and unprofitable capacity in steel and other commodity items that China needs to shut down in its own interest. If they are not shut down, the US can file dumping charges with the WTO and impose a special tariff on steel. Such tariffs have been imposed by almost all of Mr. Trump’s predecessors on a case-by-case basis. Mr. Trump could score some points by claiming his metal tariffs would be used for job retraining for displaced workers. But shutting down excess capacity, as Mr. Ross tried to do would be better. China knows it must do this sooner or later and would be better off doing so now.

Mr. Trump might propose that China agree to use its best efforts to offset the adjusted, net trade deficit with the US by increasing imports from the US, which could be of agricultural commodities, liquid natural gas (soon to be abundant in the US) and various forms of financial and other services. An accounting could be kept, and the process monitored to be sure that China conforms to the agreement, but how it does so would be left to it.

A special US-Chinese unit could also be established to continually monitor and address mutual security issues. The US wants to be sure that Chinese hacking of commercial trade secrets is ended and intellectual property protected. The Chinese want to be able to develop their technology industries, which the US should not object to if the effort conforms with restrictions on government subsidies recognized by the WTO and the EU. The US should leave private sector trade and investment in the high-tech sector to market forces, except for highly specific cases involving national security.

Having had the necessary dramatic opening session to satisfy local populations that each country is hanging tough on this important round of trade talks, it is time to get them off the stage and settled into quiet discussions of the complicated but hugely important trade relations between the two countries. A pragmatic solution awaits.