GHEI: Italy on the brink

Collapse of a bloated European welfare state is inevitable

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The next domino is about to fall in the European debt crisis, and it’s the biggest yet. Greece, Portugal and Ireland have already received bailouts from the European Union and the International Monetary Fund (IMF). There’s no pot of rescue money big enough to save the European Union’s third-largest economy, Italy.

The Mediterranean nation’s borrowing costs have soared close to the levels that brought down crisis-convulsed Greece. No surprise then that Italian Prime Minister Silvio Berlusconi lost his parliamentary majority and faced calls for his resignation. The long-surviving “Il Cavaliere” has clung to power through allegations of tax fraud, soliciting underage sex, ties to the mafia and bribery, but even he could not stand against the wind of this fiscal storm.

Italy’s debt totals $2.6 trillion, which is 119 percent of its gross domestic product. Only Greece has a worse position in the European Union. The rule of thumb for most economists is that a debt-to-GDP ratio of 90 percent is the danger zone where economic growth falters. This is reflected in Italy’s lackluster growth numbers. After seeing 1.3 percent growth last year, the figure crawled at a pathetic 0.8 percent in the second quarter of this year.

The market sees the possibility of default on the horizon, so the Italian government’s cost of borrowing is escalating rapidly to reflect the risk. Italian bond yields hit 6.73 percent earlier this week, perilously close to the 7 percent mark where Greece, Ireland and Portugal were forced into the line asking for IMF handouts. On Wednesday, they climbed to 7.35 percent, suggesting the markets know the problem isn’t solved by finding a new prime minister. Investors also realize Italy, with an economy larger than Russia or India, cannot be bailed out.

The tragedy here, of course, is that, all of this could have been prevented. There were plenty of warning signs along the way that the situation was unsustainable. Mr. Berlusconi had many opportunities to enact reforms, and in fact was re-elected in 2001 on a reform platform. Italy desperately needed to revamp its welfare laws, its crushingly high and complicated taxes and its arcane labor regulations which made hiring and firing complex and expensive. Il Cavaliere failed to deliver on any of these fronts during his decade in office. This failure to enact structural reforms made Italy that much less attractive to investors. Take this along with the country’s demographic woes, and there’s no way the current system can last.

There’s no escaping the math because Italy’s numbers just don’t add up. Rome is not alone. Politicians on both sides of the Atlantic - and in China - engage in similar gimmicks. World leaders need to start taking the debt situation seriously. They might be able to fool the markets for a while, but the bills always come due and must be paid. Policy adjustments need to be made right now, because the longer they are delayed the more painful the process becomes. Mr. Berlusconi may no longer have his fancy office and impressive status as a global political star, but the real victims of the political mistakes are the taxpayers who end up with the bill.

Nita Ghei is a contributing Opinion writer for The Washington Times.

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