Italy is growing

Do not adjust your set: Italy is growing faster than Germany

Germany’s struggles with Russia, China and fiscal orthodoxy are challenging established wisdom.

BY BEN MUNSTER

No, your eyes are not deceiving you: Italy, the eurozone’s perennial economic headcase, is growing faster than the bloc’s once formidable industrial engine.

Official statistics released last week revealed the Italian economy grew by 0.5 percent in the last quarter of 2023, while German growth, for all its manufacturing might, had shrunk by 0.2 percent.

And that might set the pattern for the whole year: the Bank of Italy forecasts 0.6 percent growth this year, while the Deutsche Bundesbank only expects 0.4 percent for Germany.

Italy's half-percentage point uptick isn’t a lot, but it does show that some perceptions about the European economy are — for now at least — at odds with reality.  Other favorite indicators also appear more positive than they often have in recent times: the infamous ‘spread’, which tracks the risk premium attached to Italy’s debt, is at its lowest in nearly two years, and unemployment hit a 15-year low (excluding one freakish month during the pandemic) of 7.2 percent in December compared to over 13 percent around a decade ago.

How long things stay that way is another question.

Analysts argue that it’s not that Italy is doing especially well. It’s that Germany, for once, is doing worse. Geopolitics has blown up both legs of a German bet on cheap Russian energy and deepening trade with China. And the Bundesbank warned last month that that process could get much worse if Chinese action, for example against Taiwan, caused a fresh rupture in trade patterns.

Franco Bruni, vice president of the Milan-based Institute for International Political Studies, noted that Germany’s position at the top of Europe’s manufacturing food chain has made it particularly vulnerable to China’s ongoing, grinding slowdown. Some 8 percent of German exports went to China in 2020, but last November, they accounted for just over 5 percent and were down 13 percent on the year. By contrast only 2.6 percent of Italian exports went to China in 2022.

Even so, any weakness in German manufacturing invariably feeds through to Italy’s which is deeply interconnected with it, said Antonio Villafranca, the co-chief of the Milan-based Center on Europe and Global Governance. 

Manufacturing everywhere has been suffering since the pandemic boom ended, and all of southern Europe — not just Italy — has benefited from a shift in spending to services, notably tourism, in the last couple of years.  But figures from the Florence Tourist Studies Center suggest that the rebound has now largely played itself out, with companies expecting bookings to be relatively flat in the first part of this year.

EU spending to the rescue

Another big reason for Italy’s moment in the sun is the role of fiscal policy, the eternal fault line that runs through the eurozone. Under then-Prime Minister Giuseppe Conte, Italy took full advantage of the extraordinary situation created by the pandemic to throw over €100 billion at improving the energy efficiency of the housing stock, largely  through a tax credit scheme known as the ‘superbonus’. Giorgia Meloni, who has led the country since October 2022, all but shut the scheme down at the end of last year, saying it was an unaffordable subsidy that generally benefited the better-off.

That kind of fiscal expansion would have been unthinkable without the Next Generation EU scheme, drafted during the pandemic. NGEU has backstopped much of that spending, and the EU has so far sent Italy over €100 billion, including €41 billion in grants, under that program. Another €90 billion is earmarked for it in the coming years.

Even so, Italy’s budget deficit blew out to nearly 9 percent of gross domestic product, and it is only slowly coming back into balance now: the European Commission’s forecasts show it running above 4 percent of gross domestic product both this year and next. 

Germany has been no stranger to badly targeted environmental subsidies over the years, but a bold green budget last year fell foul of the notorious ‘debt brake’, a constitutional limit on borrowing. 

A hastily reworked budget that finally completed its passage through Germany's parliament on Friday caps this year’s deficit below 0.4 percent of GDP, but is likely to constrain growth because of the tax hikes and subsidy withdrawals needed to make it balance. The new focus on tools such as expensive carbon taxes means it will take more time to bear fruit, said Holger Schmieding, chief economist at Berenberg Bank. 

“It turns out if you cut spending while the economy is struggling you get… lower growth!” said Dimitris Valatsas, a macro analyst for Europe at CFA, pouring scorn on what he called an “ideological opposition to deficit spending.” 

However, it won’t be clear for some time whether Italy’s spending binge over the last three years has actually improved its ability to grow.  While it is, for now, clearly ahead, short-term data may amount to little more than noise, economists say. 

“There is no growth to speak of,” said Tariq Chaudhry, an economist at Hamburg Commercial Bank, adding that even the improvement in unemployment is more a reflection of the scarcity of workers than anything else. 

“These are small numbers,” sniffed Bocconi Finance Professor Roberto Perotti. “We’re getting excited about 0.5 percent.”