Don't mock the clown

Hey Italy, I suppose it's none of my business, but haven't you done this backwards? In most countries, we elect people who claim to be politicians and only find out they're clowns once they get into office.  You've just elected a comedian, Beppe Grillo,  and now you have to wait to find out if he actually knows how to be a politician.

Here is an excellent summary of the political situation created by the Italian elections, written by someone who knows a lot more about it than I do. It's not easy to see who will end up forming the government, but who ever gets the job faces a formidable task, thanks to a uniquely toxic mix of heavy debt, low economic growth and a rapidly aging population.  Did I say "uniquely"?  Actually, Japan has been in much the same situation for years, and the bad news is that on current trends, much of the developed world will be facing the same problems as Italy in a very few years' time.

Remarkably, Italy's sovereign debt market is the third largest in the world, surpassed in size only by those of the United States and Japan. The country's debt/GDP ratio stood at 120.1% in 2012, way above the OECD average.  Interestingly enough, the debt wasn't really seen as a problem until the financial crisis hit in 2008.  For one thing, the debt/GDP ratio had been falling steadily since about 1994.  For another, Italy's current public sector deficits are under relatively good control -- the budgeted 2012 figure of 2% was much lower than in countries such as Spain and Greece, not to mention the UK, which never tires of lecturing the rest of Europe about fiscal discipline. Lastly, and in common with the Japanese, Italians are traditionally great savers, so the country has not generally relied on foreign investors to finance its deficits.

The outlook has darkened since the 2008 financial crisis, for two main reasons.  First, Italy's growth rate  has shuddered to a halt as the entire European economy has slowed, making the debt more burdensome.  Second, 2008 marked the first economic/ financial crisis to hit Italy since the country joined the single currency.   Since the advent of the Euro, the bond markets of the participating countries have tended to converge, as the perceived removal of exchange rate risk has made investors more willing to cross borders in search of higher returns.  A higher degree of foreign ownership increases the vulnerability of the Italian market to speculative activity.  Moreover, membership in the Euro deprives the Italian authorities of the option of currency depreciation, which has proven to be a path out of problems many times over the years.

Turning to the demographics: Italy's total fertility rate is only 1.4 per thousand, well below the "replacement rate" of about 2.1 that is needed to keep the population stable.  Like Japan and Russia, Italy is faced with a steady decline in its population.  In the absence of mass immigration, it will be harder and harder for the country to generate the kind of economic growth that would make the debt more bearable.  Moreover, aging populations such as Italy's regularly show themselves unwilling to contemplate the kinds of cuts in generous social programmes that might help to cut current deficits.

The situation in which Italy now finds itself provides an object lesson for why governments should never let reliance on debt financing become a way of life.  Borrowing in bad times is fine as long as you make an effort to pay back the debt when things improve.  If you just let the debt sit there, as Italy did, you find that you rapidly run out of room to manoeuvre when a crisis hits.

Unfortunately, Italy (and Japan) are just the canaries in the coalmine when it comes to sovereign debt problems.  Just about every developed country has at least two of problems those two countries face.  Among the richer countries, only the US has relatively favourable demographics, and only Germany can be said to be really in control of its debt situation.  So the message, if you're in northern Europe or North America, seems to be this: don't mock Beppe Grillo or whoever it is that has to try to solve Italy's problems, because the chances are, you're next in line.