Download Italy in Doldrums

Golden Handcuffs
With Italy in the Doldrums,
Many Point Fingers at the Euro
Strong Currency Hurts Exports,
Causing Some to Want Out;
Another Blow to the EU
Buying Baby Formula in Austria
By GABRIEL KAHN and MARCUS WALKER
Staff Reporters of THE WALL STREET JOURNAL
June 13, 2005; Page A1
CAPOLONA, Italy – Rossano Soldini, the 60-year-old head of a family-owned
shoe factory in this tiny Tuscan town, is getting creamed by Chinese imports.
But Mr. Soldini isn't only blaming China. He also wants to give Europe's common
currency the boot.
Like other shoe manufacturers across Italy, Mr. Soldini says the euro's sharp rise
against the dollar inflated the price of the shoes he ships to the U.S. and left him
defenseless against Asian rivals. Italian shoe production dropped almost 8% last
year, the fourth straight year of declines. In 2004, Italy imported more shoes than
it exported for the first time.
In the past, Italy would devalue its old currency, the lira, to help businesspeople
claw back to competitiveness against other countries. But since Rome gave up
control of currency policy to join the euro in 1999, Mr. Soldini, who also heads the
National Association of Italian Shoe Manufacturers, has watched his fortunes
slide. Having the euro has been like "wearing handcuffs," he says, adding:
"Without a doubt, I'm nostalgic for the lira. Europe is not listening to us."
Six years ago, 11 European nations made a bold bet that a common currency
would unify and fortify the continent from Sicily to Helsinki. Now, as many of the
nations in what is known as the euro zone slog through an economic funk, the
experiment is helping to drive countries further apart -- and fueling a growing
resentment of the wider European Union.
In Italy, an anti-euro backlash is ricocheting up and down the peninsula as the
country sinks deeper into a recession. Consumers, businesspeople and some
politicians now bemoan a currency they claim has left them poorer and less
competitive. Earlier this month, the welfare minister, Roberto Maroni, called for a
referendum to bring back the lira. The daily newspaper of his party, the Northern
League, has just begun rendering prices in euros and lira in its news columns,
even though the lira no longer exists.
The euro-bashing isn't confined to Italy. A poll for Stern
magazine this month found that 56% of Germans want the mark
back.
The mounting dissatisfaction is another blow to the authority of
the EU. The 25-member union was pitched into confusion two
weeks ago by the rejection by French and Dutch voters of a
proposed new constitution for the union. Underpinning those
votes and the grousing over the euro are deep anxieties about
slow growth, high unemployment and the future of Europe's
generous welfare states.
The anti-euro feeling also underscores just how hard it is to
forge a common currency. It took the U.S. nearly a century to
create a truly national currency. Before the Civil War, thousands
of American banks issued notes that in effect worked like independent
currencies, varying widely in value from state to state. Only in the midst of war
was the Union finally able to impose a uniform greenback.
The euro has faced different but daunting challenges since the experiment was
launched in 1999. The U.S. has one national government that can direct aid to
depressed corners of the country; the euro zone has 12, each with its own fiscal
policy. Workers in the U.S. can freely move from a slumping area to seek jobs in
a prosperous one. Europeans, tied down by different languages, pension plans
and legal systems, are far less mobile.
Still, the euro is in many ways a triumph. It is so sound that it has quickly
emerged as the world's second-most-widely-held currency by central banks after
the dollar. The euro has brought big benefits for companies trading across
European borders by eliminating currency swings and foreign-exchange fees. It
created huge, unified capital markets akin to the U.S.'s, which have helped many
European companies raise capital. Returning to a weaker currency would mean
returning to higher interest rates.
Thus no one is expecting Italy or any of the other 11 euro members to bolt any
time soon. And many analysts say Italy's problem doesn't lie with the euro, but
with Rome, which has failed to slim down the country's vast bureaucracy or break
down the barriers to competition in big parts of the economy. "The remedy is not
to leave the euro, but to correct the structural issues," says Patrick Artus, an
economist at French bank Groupe Caisse d'Epargne.
But the chafing of Italians and Germans at the euro, coupled with the anti-EU
feeling exposed by the French and Dutch "no" votes, have raised questions
about long-term political support for the currency. All four countries are euro
members. "Breakup is back on the radar screen as a theoretically possible
option" for the monetary union, says Holger Fahrinkrug, an economist at Swiss
bank UBS in Frankfurt.
When the new currency was launched on Jan. 1, 1999, it was greeted with
champagne toasts in Rome, Paris and Frankfurt. Economists and politicians
predicted the euro would one day rival the dollar as a benchmark currency and,
consequently, Europe would one day rival the U.S. as a superpower.
The euro was all things to all nations. Italians thought the euro would let them
trade their feckless politicians in Rome for technocrats in Brussels. The French
gambled that monetary union would enhance their own power. Newly reunified
Germany, haunted by Europe's history of wars, thought giving up the mark was a
necessary sacrifice for durable peace and acceptance by its neighbors.
Euro advocates vowed Italy would emerge as a big winner from the new money.
Ceding monetary policy to the European Central Bank and joining the euro would
usher in stable interest rates, which in turn would help Italy pay down its crushing
public debt, the third largest by value after Japan and the U.S., and larger than
Italy's entire gross domestic product.
Much of that came true. Interest rates fell and Italy cut in half the interest it pays
on its debt. But adopting the euro had two downsides.
First, the euro shot up in value against the dollar -- by nearly 50% since 2000.
Three of Italy's biggest exports -- shoes, clothing and furniture -- are facing huge
competition from China, which pegs its currency to the dollar. That currency
swing priced Italian exports out of the market, and gave an extra advantage to
already-cheap Chinese products.
More fundamentally, joining the euro took away Italy's trusty safety valve of
devaluation. Large parts of the Italian economy, from trucking to electricity, are
clogged by red tape and cartels, which hold down competition. That pushes up
costs for Italian businesses, hurting their ability to compete with rivals from
Germany or France.
In the past, when the prices of Italian exports got too high, currency markets
would adjust, sending the lira lower and spurring demand. That would give Italian
exporters a quick shot of adrenaline, but it didn't cure the economy's underlying
problems.
Now, the only way Italy can compete is to cut prices. The only way it can cut
prices is to cut costs. But the opposite is happening. Inefficiencies in Italy's cartelpocked economy have caused prices of everything from electricity to zucchini to
shoot up faster than elsewhere in the euro zone.
Unions began demanding higher wages to offset lost spending power.
Companies had to grant raises that outstripped any gains in worker output.
Adjusted for productivity, Italian labor costs have risen 17% since the euro came
in, while German labor costs have risen only 1%, according to Barclays Capital.
Italian productivity grew just 0.5% a year in the past decade, compared with 1.6%
in Germany, and 2.4% in the U.S., according to the Organization for Economic
Cooperation and Development.
The result: Italy is falling further behind other countries inside the euro zone. The
euro's one-size-fits-all value was supposed to be the glue binding the currency
zone into a whole stronger than its parts, but instead has highlighted the
discrepancies among the European economies. Sluggish euro members like Italy
need low interest rates, while faster-growing ones like Ireland could use higher
ones.
The OECD says the 12-nation euro zone is the weakest major component of the
global economy, and predicts it will grow only 1.2% this year, compared with
3.6% in the U.S. Italy's economy contracted 0.9% over the most recent two
quarters, and the OECD forecasts that it will shrink 0.6% in 2005.
All that is prompting a rethink of the logic underlying the single currency. "It would
have been better for Italy to stay out [of the euro] for a few years," says Julian
Callow, chief European economist at Barclays Capital in London. "There's no
easy solution now."
The risk: The weaker countries in the euro zone will return to heavy deficit
spending, undermining the euro's strength. With Italy's public debt already at
106% of its GDP, rampant deficit spending could mean other euro members
would have no choice but to bail Rome out.
Italians had worked hard just to get into the euro club, fearing that if they didn't
get their act together Europe's third-largest economy would be shunted to the
sidelines. The race to qualify, which forced Italy to cut its budget deficit to under
3% of GDP in 1997 from over 11% in 1990, galvanized Italians to act. The
government was able to levy new taxes to pretty up Italy's books ahead of the
entry into the euro.
When Rome made the cut, by a hair, on May 1, 1998, Italians were elated. But
there was little political will left over to tackle the root causes of Italy's
inefficiency: a huge and stifling public bureaucracy, and vast swaths of the
economy that were still insulated from competition.
"Our mistake was thinking that joining the euro was the solution, the end to our
problems," says Vincenzo Visco, a silver-haired politician who served as finance
minister and then treasury minister from 1996 to 2001. "Instead, it was only the
beginning."
One problem never fixed is the country's
creaky infrastructure. Andrea Tomat,
president of sport-shoe maker Lotto Sport
Italia SpA, is dealing with the
consequences. To ship its goods, the
company, based in Treviso near Venice,
must truck them about 170 miles to the
nearest international air hub in Milan. The
only highway is usually clogged, meaning
the journey often takes six hours. To be sure
of catching flights, Lotto's delivery trucks
leave during the night -- or arrive a day in
advance. "This basically doubles our cost of
moving goods," says Mr. Tomat.
Another drag, he says, is Italy's
bureaucracy. Lotto is trying to bring two
employees from China, where it produces
60% of its goods, to work in Italy, but getting
the paperwork approved will take six months. "In a world where in six months you
can develop whole new stores over there, we are traveling by bicycle when
everyone else has a car," he says.
Other business owners feel like they are in a losing battle. Maurizio Brevini, an
engineer in Reggio Emilia, runs a 130-person maker of specialized hydraulic
pumps founded by his father. Over the past five years, he has boosted his
revenue by 13%, to €18.4 million, or $22.3 million. But his costs have risen even
faster in the same period and his profits have fallen more than 10%, he says.
Part of the problem: two wage increases for his workers.
"I feel badly for them because they have lost spending power," he says. But the
salaries are rising faster than worker productivity. "This is like poking holes in the
bucket," he says.
Federica Mongiello, a 31-year-old mother from Rome, was shocked when,
traveling in the Austrian Alps last year, she discovered that baby formula cost the
equivalent of about $10 for 2.2 pounds, when she was paying $48 in Italy. The
reason for the huge difference? In Italy, baby formula can be sold only in
pharmacies, where discounting is rare.
"Fa schifo," she says, Italian for "disgusting." Some friends have since joined
Internet-based collectives of mothers who import baby milk from Austria and sell
it for sub-Italian prices.
After years of trying to adhere to the euro zone's strict fiscal criteria, which
require that deficit spending not exceed 3% of GDP, Rome is now letting down its
guard. The EU estimates Italy's deficit will hit 3.6% of GDP in 2005 and 4.6% in
2006. France and Germany have already busted through the 3% limit, but Italy,
with much higher public debt, presents even more of a risk of destabilizing the
currency's soundness.
Brussels has been urging Italy to pass a new round of spending cuts to keep its
budget in line. Prime Minister Silvio Berlusconi has rejected the idea. Instead, Mr.
Berlusconi has argued that a just-approved law that will, among other measures,
make it easier for many of Italy's small companies to merge will improve the
country's competitive position.
Despite the chorus for a return to the lira, an Italian exit from the euro zone looks
extremely unlikely. For now, such a move would cause interest payments on
public debt to skyrocket and might force more onerous taxes on Italian citizens
and businesses in order to cover the cost.
Nonetheless, a growing number of Italians profess a new affection for their old
currency. After stocking up on cheap baby formula in Austria, Mrs. Mongiello's
enthusiasm for the euro has waned. "There's no doubt," she says. "We were
richer when we had the lira."