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Rome Business School Research Report on Public Debt in Italy

The gap between North and South, inflation and labour costs. The key is to dare: the PNRR to reform, transform and innovate

Rome, January 25, 2022. Rome Business School, a post-university training institute part of the Planeta Formación y Universidades network created in 2003 by De Agostini and the Planeta Group, has published the research “The public debt in Italy: which post-pandemic scenarios?” , edited by Valerio Mancini, Professor and Director of the Research Center of Rome Business School, Leila Chentouf, Program Director of the Master in International Management (MIM) of Rome Business School and Ekkehard Ernst, macroeconomist at the International Labour Organisation.

The research examines the increase in public debt in the world caused by the Covid-19 pandemic and the country Italy specifically, to what extent and with what tools the Italian debt should be used to support economic growth. The research shows that the total world debt has increased by 28 percentage points to reach 256% of global GDP in 2020. The increase in debt is particularly marked in advanced countries, where public debt has risen from around 70% of GDP in 2007 to 124% of GDP in 2020. In the case of Italy, according to the International Monetary Fund, debt has risen from 134.6% of GDP, in 2019, to 157.5%, in 2020. This year it will grow again, reaching 159.7% (about 2,569 billion euros), worsening compared to last October’s estimate, when the Fund predicted debt at 158.3%.

  • Italy and Japan are the two developed countries with the highest public debt relative to GDP: 238% and 157.5%, respectively.
  • Italy’s public debt is 30% held by foreign investors, in France it is 56%.
  • In Italy, the best debt/GDP ratio belongs to Lombardy (71.9%), the worst is Calabria (305.3%), the North/South divide is set to increase.
  • The fiscal impulse for Italy from the NextGenerationEU funds would allow the debt/GDP ratio to go below the 140% threshold by 2025.
  • The overall labor supply is about one percentage point below its pre-pandemic level and was even lower at the peak of the pandemic last year.
  • Increased emergency-related costs from Covid-19, raised the inflation rate by one to three percentage points in 2021.
  • If the decline in the working population, rising prices and labor costs continue – the wages-prices gap will become difficult to control.

The situation in Italy

According to the most recent estimates, approximately one third of Italian public debt is in foreign hands and, as a whole, the Italian system has a debt/GDP ratio in excess of 160%. This creates a strong imbalance for the entire system, also due to the high taxation required to support public spending and repay interest on debt. Some Italian regions, however, stand out: Lombardy, Emilia-Romagna, Veneto, Tuscany, Marche and Piedmont have a debt/GDP of around 80%, which makes their economic system better than the German one and in line with the most virtuous European countries. On the other hand, the South has a debt/GDP of 230% with peaks of over 300%. The best performance is found in Lombardy (71.9%), while the worst is Calabria (305.3%). The North-South divide is evident, and is destined to increase.

Not only that, “the public debt in Italy is a so-called high debt, which is financed at a low rate. This situation, which, at first glance, seems complex, leads to questioning the very sustainability of the debt”, says Professor Chentouf, one of the authors of the research. However, it is necessary to underline that this debt was contracted in a period of high interest rates: Italy is refinancing at 1%, which means that the situation is comfortable from this point of view.

Another factor to consider with regard to the solvency of the country is the nationality of the debt holders: public debt held by domestic investors is less risky than public debt held by foreign investors, who are by definition more unpredictable. In the case of Italy, only 30% of it is held by foreign investors. This level is still reasonable compared to, for example, France, where 56% of public debt was held by non-residents in 2017.

Along with Italy, Japan, remains one of the most indebted advanced countries, with the highest public debt as a percentage of GDP. In 2019, Japan reached the 238% public debt figure and also remains in the lead in terms of debt per capita, with an average of 80,447 euros of debt for each Japanese citizen. The other country with the highest public debt in relation to its GDP is Singapore, with a score of 110.9%, the highest amount in the average of developed countries, having a small number of inhabitants and a debt per capita of 54,000 euros in 2017.

Inflation and possible ways out of the post-pandemic government debt

The pandemic caused a severe global economic crisis and rising inflation. Several economic activities were no longer allowed, but many other activities remained in operation and advanced economies such as Italy provided generous support measures – so people continued to spend, just not on services but on goods for example related to health and IT. Continued disruptions in economic activity, spikes in demand in specific sectors, supply difficulties, and skyrocketing container prices, among other factors, led to cost increases that raised the inflation rate by one to three percentage points in 2021, according to Bank for International Settlements estimates. Not only that, according to the latest estimates from the International Labor Organization (ILO), in early 2022, the global labor supply is now about one percentage point below its pre-pandemic level and was even lower at the height of the pandemic last year.

As a result of the labor shortage, wage and price pressures have increased. In the United States, workers with non-college education saw one of the highest wage increases in decades last year. In the euro area, the working population has roughly fallen by 1.5 million workers, a decline caused by a combination of factors, including an aging population and the pandemic, with Italy and Germany being the largest contributors to this decline in labor supply. So far, however, wage inflation has remained docile in Europe. Although, as labor markets tighten and inflation runs high, labor costs are likely to accelerate here as well, and increasing corporate market power will prevent persistent wage increases, particularly among low-wage workers.

Indeed, there is concern that inflation expectations will rise, leading to a wage-price gap, last seen in the 1970s, that may quickly become difficult to control.

What would be the possible way to reduce the debt of member states? The various possible solutions aimed at reducing or resolving the sharp increase in public debt and its consequences, seem very expensive or not feasible at all. In fact, it seems unlikely that any country in the eurozone would be able to restructure its debt today or would choose to opt for a full-blown default.

Given the slight recovery of the economies of the union, the ECB’s plan is to release the funds of the Pandemic Emergency Purchase Programme to the open market, forcing governments to find – possibly more expensive – financing options on international markets. The implicit political program is therefore to force governments to adopt austerity policies in order to save on public debt and potentially higher interest payments.

According to Valerio Mancini, “a better and more feasible strategy would be to release the PEPP into a special purpose vehicle, possibly as part of a pan-European effort to restructure Covid-linked national debt, similar to the current ESM Pandemic Crisis Support”.  The latter was created specifically to support EU member countries in their recovery efforts through a mutual issuance of government bonds, and is a missing piece in the European monetary and financial construction that could help strengthen the public sector balance sheet of the entire Eurozone”.

Specifically, looking at Italy, according to the estimates of Oxford Economics, the fiscal impulse allocated to Italy of funds from the NextGenerationEU recovery program would allow the debt/GDP ratio to go below the 140% threshold by 2025. However, the program is ambitious, entrusted as it is to the objective of around 45 billion euro of extra growth over the next three years, also fed by a revival of private investment which, according to the macroeconomic programmatic framework, would rise by 27%. European funds will be an important part of relaunching the economy and lowering the debt, but an effort is required at all levels, institutions, public and private.

Possible future trends for Italy

Italy is today in an unprecedented favorable situation, thanks to the economic support of the Recovery Fund, however it suffers from a structural lack of competitiveness and productivity. Particularly limiting for Italy is the high labor costs that increased by 15% between 2009 and 2019 (Eurostat).

“Public debt should be used to solve many of these problems, to increase Italy’s productive potential, to finance public infrastructure, the education system, research and innovation in order to support growth and reduce the level of debt,” says Chentouf.

In particular, it is necessary to focus on: restructuring and rationalization of public spending and balancing public accounts, with the aim of seeking the surplus necessary to ensure a sufficient margin to face the forecasts of the post-Covid era.

According to ISTAT, net borrowing jumped to 8.9% in 2020, just better than the government’s estimates (-9%) and after the +0.3% recorded in 2019. 2021 closed with a rebound of +6% and currently the Update Note to the DEF (NADEF) projects a scenario of continued growth of the economy and gradual reduction of the deficit and public debt in the coming years.

Some possible future macro-trends for Bankitalia are: the North/South divide is destined to increase and the national interventions foreseen by the PNRR will take longer and will be protagonists of growth only from 2023.

According to Prof. Ernst: “It is clear that the key word today, in the face of an unprecedented global pandemic and with a substantial recovery fund, is dare: reform, transform and innovate”.