Rampant corruption – not just the euro – has doomed Italy to stagnation

So farewell then, Matteo Renzi! The resignation of the Italian Prime Minister after his heavy defeat in Sunday’s referendum on constitutional reform has created turmoil. Fears have been resurrected about the stability of the Italian banking system, and even the possibility of Italy leaving the euro has been raised.

But the problems of the Italian economy, along with the rest of the PIGS (Portugal, Greece and Spain), go much deeper. The long boom of the 1990s and 2000s in the Western economies ended in 2007. GDP began to fall in almost all Western economies during 2008. In the US, output is now some 10 per cent higher than it was at its previous peak in 2007. In the UK it is around 9 per cent up, and in Germany the increase is 8 per cent.

In Italy, GDP is still 8 per cent below its level of 2007. In Spain, the fall is 3 per cent, in Portugal 5 per cent, and the Greek economy is a staggering 26 per cent smaller than it was in 2007.

This is an exceptionally long period for output to remain below its previous peak level. By the early 1950s, for example, West Germany, which had been heavily bombed and overrun by foreign armies, had surpassed its previous peak level of output of the mid-1940s. So, too, had Japan, which had been attacked with nuclear weapons.

Why have the PIGS performed so spectacularly badly? A conventional reason, and one which has considerable force, is membership of the euro. The average growth rate since 2007 in the Eurozone member countries is negative: -1 per cent. In contrast, the average in Western economies which are not members of the Eurozone, such as Australia, the US and the UK, is a positive 10 per cent.

But there is an even more fundamental reason for the failure of the PIGS to recover, which goes to the heart of why Renzi wanted a radical reform of the constitution. Their societies are corrupt. The problems this creates can be plastered over in good times. But a major shock like the financial crisis opens the cracks.

Transparency International rates all countries on a scale of one to 10, with 10 being the most transparent and least corrupt. In 2007, most Western countries scored eight or more, the UK being 8.4. Spain was 6.7 and Portugal 6.5, which puts them at the level of Costa Rica. Italy registered 5.2 and Greece 4.6, down with the likes of Ghana.

Even after allowing for the effect of the euro, there is a strong negative correlation between the Transparency International scores of the Western economies and their GDP growth over the 2007-2016 period. Full technical details are in a paper I published in Economic Affairs in October. The more corrupt a society, the less able it has been to recover from the crisis.

The reforms proposed by Renzi were just the first step in what is needed to modernise the structure of Italy’s society and economy. Their failure means that Italy is doomed to stagnation.

Paul Ormerod 

As published in CITY AM on Wednesday 7th December 2016

Image: https://www.flickr.com/photos/sozialdemokratie/ is licenced under CC BY 2.0

Share this post