BTP-Bund Spread? The Real Emergency In Italy Is Unemployment

Includes: EWI
by: Alberto Abaterusso

The real emergency for Italy is not the spread between Italian BTPs and German Bunds, but unemployment that has reached clamorous levels, especially youth unemployment. The Italian Government has to apply the urgent reforms and measures to reduce youth unemployment below the threshold of 30% within eighteen months (this is the priority of the action plan that Italy will present at the next European summit) and to get Italy out of the recession.

CGIL (trade union organization) highlighted the gravity of the unemployment problem in Italy. According to a study of its economic bureau, entitled La ripresa dell'anno dopo - Serve un Piano del Lavoro per la crescita e l'occupazione, it will take not less than 60 years for employment to return to its pre-crisis levels, if Italy will be able to take the train to economic recovery (here).

Here are the solutions considered by the Italian Government for the reduction of unemployment in general and youth unemployment in particular:

a) The reduction of labour costs to encourage the creation of new job positions. The reduction of the tax wedge (the spread between the total expenditure incurred by the company for taxes and social contributions and net salary received by the worker) has always been a hotly debated topic in Italy which continues to confront the Italian political forces. On one hand there are political forces that have always expressed doubts and criticism to this measure, especially with regard to the funding of the reduction of the tax wedge. On the other hand there are political forces that believe that a considerable reduction of the tax wedge is the solution to generate the financial resources for businesses and consumers to lead the economic recovery.

But what is the situation of the labour cost in Italy?

According to the OECD Italy is sixth in the ranking of the tax burden on labour (47.6% for a single person with no children). The ranking is led by Belgium (56%), followed by France (50.2%) and Germany (49, 7%). At the very bottom of this ranking are Hungary (20%), Israel (19.2%), Mexico (19.0%) and New Zealand (16.4%). In the United States, tax wedge is about 30% (see the graphic here).

Regarding unemployment figures, according to recent data from Eurostat (graphic here), as of April 2013 among the Member States of EU, the lowest unemployment rates were recorded in Austria (4.9%), Germany (5.4%) and Luxembourg (5.6%) and the highest rates in Greece (27.0% in February), Spain (26.8%) and Portugal (17.8%). Italy (12%) and France (11%).

Countries such as France and Germany, that have a welfare system very similar to that of Italy, have a tax burden higher than Italy, but their level of unemployment is lower than the Italian one. In the case of Germany the unemployment rate is even less than half that of Italy, but with a higher tax wedge by almost 3 percent.

The data on youth unemployment show this difference even more between the three countries that have a similar welfare system and have the highest tax wedges in Europe.

Even if the reduction of the tax wedge leads to a reduction in the rate of unemployment in Italy, we must see how the government intends to cover this reduction. It would not make much sense if the government will decide to financially cover the reduction of tax wedge by increasing and /or by introducing other taxes. The pressure of taxation is 4.5 scores higher than the average of the member countries of the Euro zone (we have already explained here).

b) Generational handover, i.e. a mechanism that facilitates the exit from the labour of the elderly in favour of the entry of young people. In essence, employees who have a few years of career ahead of them will be offered the opportunity to work part-time, that is with reduced schedules and salaries thus leaving the possibility to give the job to a young worker, under 35, who would have the possibility of being hired. At the same time, however, the company will continue to pay the same amount of contributions expected for a full-time schedule job, in order to avoid a cut of the pension check accrued by the employee.

This solution has already been disapproved by the ILO (International Labour Organization). ILO during the presentation of its World of Work Report 2013: Repairing the economic and social fabric, in the tab on Italy, said that the government should find other means to support youth employment. According to ILO Italy should monitor ''a typical forms of employment'' and ''it needs to put more effort to encourage the processing of fixed-term contracts into permanent jobs.''

By analyzing the differences between the Italian (and European) unemployment with that of the U.S.A and Japan, it allowed the economists to identify the causes of this disparity and to consider more effective measures to combat unemployment.

Neoclassical economists identified the flexibility of the labour market as the reason for the gap between the unemployment rate in the U.S.A. and in the European countries.

The flexibility of the labour market has two aspects:

1) Flexibility of wages. In Europe wages are not flexible downwards (as it for example happens in the U.S.A. ). U.S. workers, just to have a job, are willing to earn less. In Italy this is not easy because trade unions do not let employers decrease wages. The labor market is characterized by the existence of collective bargaining covering an entire industry, that sets minimum wages that the company is required to pay to the workers. The margin that remains for an agreement between employer and individual employee, besides rare exceptions, is very low. As a result, companies cannot lower the cost of production and therefore prices of goods remain high when consumption and investment are discouraged by restrictive economic policies.

2) The mobility of workers. In general a U.S. citizen is willing to move to any area of the U.S.A to have a job. This fact is less evident in Europe, especially because many employers, both public and private, are still not aware of EU regulations in the field of mobility and free circulation of European citizens within the EU area. This is what the European Commission lamented during the presentation of the proposal for a directive that has as goal the enforcement of existing rules in the EU to ensure and to facilitate the mobility and free circulation of workers. The Commissioner for Employment and Social Affairs and Inclusion in the Barroso II administration of the European Commission, Laszlo Andor, stated that ''Labour mobility is a win-win - it benefits both Member States' economies and the individual workers concerned. This proposal will help workers to overcome obstacles to work in another EU country'' (source here).

There is evidence that Italians are moving the most among European citizens. In fact according to the European Commission last year of the approximately 6.6 million Europeans who worked and resided in an EU country (equal to 3.1% of the total workforce of the 27 EU Member States), the Italians are the third largest group with 672,200 emigrants (3.0% of the labor force of the peninsula), preceded by Romanians and Polish (respectively 1,212,000 and 1,016,000, or 13% and 6.5% of the labour force of each country).

Summing-up the government's agenda in terms of labour, Minister Enrico Giovannini said that "there are 650 thousand unemployed young people: a number that can be tackled." And that "it is not true that 40% of young Italians are out of work because it is 11% of young Italians who are unemployed that is 40% of young active people."

But if we also consider the number of young Italians who have emigrated to another EU country to find a job (who otherwise would be unemployed) and if we also include all those unemployed people who worked even only one hour per week and those who have given up looking for work, the total number of young unemployed Italians would be of an even more troubling size.

According to Keynesian theory the difference between the U.S. and European unemployment rate depends on the different economic policies adopted by the two areas. The United States in the past years have adopted an expansive economic policy (increase in public spending and tax reductions). In Europe, however, the authorities have pursued a restrictive economic policy because the European countries had high levels of public spending and inflationary trends in their economies.

But as we have already explained in this article, Italy has little room for maneuver (here) because the country is in the grip of rigor imposed by the EU.

As a matter of fact, the Financial Times and The Wall Street Journal consider the actions taken by the Government of Enrico Letta being scarce.

"The relatively modest measures reflect the government's limited room for maneuver as it attempts to meet its 3 percent budget deficit target and to exit the European Commission's excessive deficit procedure later this month." (here)

"The measures were the bare minimum of what the new government has pledged." (here)

The Keynesian theory has been criticized by the monetarists who argue that the use of monetary policy to adjust the level of aggregate demand is wrong. Because the increase of money supply in the early stages of unemployment (and its reduction in the early stages of a full employment situation) exacerbates the instability of the economy. The monetary authorities must expand the money supply at a constant rate of 3-4% per year, roughly equal to the growth rate of national income. The vision of the monetarists involves the adoption of automatic rules by the monetary authorities rather than the application of discretionary rules, as suggested by the Keynesian school.

About two months ago, from Frankfurt, Mario Draghi stressed that the process of reforms - the only way to restore economic growth - must be continued by the Italian Government as if it is inserted "on autopilot," refusing to answer the question about the hypothesis of a referendum to take Italy out of the euro.

Is there really somebody who thinks that Italy should leave the Euro?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.