the other great crisis
While attention was last week focused on the crisis surrounding News Corp, another crisis was slowly burning away elsewhere in Europe. Italy was facing a sovereign debt crisis. The shockwaves of the financial crisis continue to reverberate. There are lessons here for the UK and for Labour.
The catalyst was Silvio Berlusconi. The Italian premier criticised his well respected finance minister as the country considered budget cuts. Market attention had been focused on so-called peripheral countries in the Eurozone - Greece, Portugal, and Ireland, as well as on Spain. Now crosshairs have also focused on Italy. The yield on Italian government debt jumped last week - in other words, Italian government bond prices fell. The government sold tranches of new debt, but at higher interest rates. The prospect loomed of a downward spiral in which higher costing debt required more debt to be issued, so driving up the cost further.
Why did this happen to Italy? It is a much larger economy than Greece and it has a primary surplus outgoings. However, Italy's public debt is 120 per cent of its GDP and the GDP growth rate is relatively low. In a quieter time in British politics we would expect George Osborne to be claiming loudly that Italy's travails demonstrated that his spending cuts are justified, as he has done over Greece.
There are key differences between the UK and Italy. One is that the UK is outside the euro; the UK could ultimately print money so it will always pay back its debt (at a risk of higher inflation). Our net debt-GDP ratio, while high by our recent standards, is only expected to peak around 70 per cent, which is well below Italy's. The average maturity of our government debt, at 14 years, is almost twice that of Italy. Another difference is that the UK does have a plan to bring debt down. We might not like the plan, believing it risks growth and cuts spending too far and too fast, but to the world at large this country at least has a plan that it has embarked upon.
The risks to the UK include lower than expected GDP growth, leading to lower tax receipts and hence lower public debt reduction (and a debt-GDP ratio that is higher for longer). This is what the sharp spending cuts may bring to pass. The market debate about Italy has included comment on its growth outlook. Where a country has a high debt level but poor growth outlook, the bond markets can take fright. That is why a government needs not only a credible plan to reduce public debt to manageable levels, but also a clear idea of how growth will be encouraged. This is lacking under our Tory-Liberal Democrat government.
This article was first published by Progress on 19 July 2011.
Progress, 19 July 2011, 19/07/2011