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Italy’s finances and pensions system are more sustainable than they are given credit for

by Fabrizio Galimberti

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«Mirror, mirror on the wall, which is the sanest budget of them all?». If a Frau Merkel were to paraphrase the anxious question of Snow White's stepmother she might get a surprising answer. But before revealing the answer let us have a close look at Brussels's tunnel vision.
The Commission's myopia involves both space and time. As to space, the Eurocrats look South and point a wagging finger at the budget failings of Mediterranean countries. They seem unconcerned with other failings, even if these have been framed in the “Macroeconomic Imbalance Procedure” which is part of the so called ‘Six Pack': one of the rules states that countries' external current balances should be ranged between -4% and +6% of GDP. The upper limit is meant to ensure that a country does not pursue an export-led growth model: a policy that, if followed by all and sundry, would weaken any internal source of growth for the European economy. But Germany has been violating this rule for the last seven years, without a single peep out of the Commission (“excessive surplus procedure” anyone?).

It is, however, the myopia in time which is the most worrying. Many big firms in the Anglo-saxon world provide pensions for their employees, and the ‘unfunded liabilities' of their pension funds are a constant headache. There is an equivalent concept in public finance: the ‘implicit debt' describes the imbalance over time between contributions and payments of public pension schemes. Unlike the traditional public debt, this is a potential debt. It might not arise if – it is hoped – contributions and/or outlays will be changed. But, as Mario Draghi said in another context, «hope is not a strategy». The robustness of the public finance situation should be assessed in relation both to the present and to the future, lest we draw the wrong conclusions.

This assessment brings us to the surprising answer of the ‘mirror'. Italy is at the top of the ‘sustainability league of nations'. Both the ‘Fiscal Sustainability Report' of the European Commission (12/2012) and a study by the University of Friburg (12/2013) conclude that, thanks to the soundness of the pension system, the total governement debt (traditional+implicit) is lower in Italy than in Germany. High contribution rates and increasing retirement age ensure that the intertemporal budget constraint is much better abided by in Italy than in other EU countries.

Sustainability Indicators

% of Gdp, var. of primary balance required to satisfy the intertemporal budget constraint. Source: Rapporto stabilità finanziaria-Banca d'Italia 1/14

For sure, Italy still has many problems, from a suffocating bureaucracy to poor public services to the maze of tax rules, not to forget a maddeningly slow justice system and a ‘bipolar' labour market. But the soundness of the Italian public finances is not one of them. And the Commission would be well advised to encourage Italy to improve her performance in those areas instead of nitpicking on the decimals of the structural balance.

Total public debt

% of Gdp, including the implicit pension debt. Source: Stiftung Marktwirtschaft and Univ. of Friburg - December 2013