The economic challenges we are facing at present and those ahead for the coming few years are significantly more complex than what we saw in the 2008 crisis aftermath. Back then, the imbalances were “textbook” cases: wide twin deficits and excessive leverage. It took a while for European politics to come to terms with the unprecedented policy decisions, but we got there, in the end, and the gap between interest rates at the peak of the previous business cycle and the zero bound was wide enough to heal the imbalances and support a very long economic and financial expansion.
What we are facing now is a crisis that will see many “episodes”. This suggests to me that the recovery will not be genuinely V- or U- shaped, but more akin to W-, or worse, Z-. Each “episode” has its own “pace” and, thus, should affect financial markets at different junctures. At this stage we have a critical amount of policy announcements to tackle the first challenge linked to the epidemic and support a rebound of financial markets. The second phase, related to the traditional end-of-business cycle adjustment, will probably need additional fiscal measures and will affect mostly 2021E. The third phase, which relates to the architecture of the EU, is harder to pin down in terms of timing, but I would bet it will hit a critical juncture next year/2022E.
We are facing an underlying political paralysis in the Eurozone to tackle the real underlying malaise in the Union. This is a much harder challenge than we faced 10 years ago, because it requires a bigger ideological leap for politicians, and because the situation of Italy, the weakest of the big member states at the moment, is much weaker than back then. In my view, the problem is not whether we can reach an agreement on coronabonds/warbonds/Eurobonds/ESM – all these things are financial tools that may or may not help to cure the underlying condition.
The problem is that the Italian economy will not return to a sustainable growth path unless there is a legislative and political framework that can lead and sustain a major investment and reform phase that probably needs to last a decade. This requires two (possibly three) fundamental changes in the philosophy of policy making at the EU and Italian levels: fiscal policy cannot be planned and assessed with a three-year horizon – this is too short relative to the length of the business cycles today, which last at least 10 years. The truth is that, to make sense, fiscal policy would need a planning horizon of 20 years. The second issue is that we urgently need to rethink the policies required to support a genuinely competitive environment. Competition is essential for growth and prosperity. It evolves over time and, in this historical period, is not going to flourish without measures that support a high birth rate of companies and the conditions for many of them to flourish. Today, instead, there is too much structural support for the companies that are already large, relative to a vastly inadequate system to support the small ones.
Without these ideological leaps, the Eurozone structure can only add more “plasters” to the wound, but it cannot cure the disease. If it cannot cure the disease, then the risk of another departure from the European Union remains positive and material. How this will affect the non euro EU member states is hard to summarise in a few words, because it could prove to be a positive structural change or a very negative one, at different junctures. So far, Central Europe has benefited from relocating companies from Italy and elsewhere in the Eurozone. This trend persists, in our view, and it is one of the factors that makes the position of Italy increasingly unsustainable.