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November 9, 2011

As Europe's politicians struggle to rescue Greece, Italy has increasingly become the epicenter of the eurozone debt crisis and must pay even higher interest rates on bonds. But how dangerous is the situation for Europe?

An Italian euro sinks in water with an Italian flag reflected on the surface
The markets' trust in Italy is sinkingImage: picture alliance/dpa

Highly-indebted Italy is increasingly coming under pressure from the financial markets. On Tuesday, the yield on 10-year government bonds reached record levels, rising around a quarter of a percentage point to 6.8 percent. The spread between Italian and German benchmark bonds also widened to a new high of nearly 5 percent. It is this high yield and high risk which is contributing to a greater mistrust among investors.

The Italian economy isn't growing. With an economic output of around 1.5 trillion euros ($2.1 trillion), the eighth-largest economy in the world generated almost no economic growth in real terms between 2000 and 2010. Indeed, its economic growth is the weakest in Europe. Nevertheless, for a long time, Italy was thought to have had a stable economy.

With a national debt of almost 1.9 trillion euros, or 120 percent of its gross domestic product (GDP), its total debt is second only to Greece in the eurozone. Yet Italy's net private capital is 180 percent of GDP, while in France and Germany it is only 140 percent. Almost 60 percent of government bonds are also held by Italian investors, suggesting that Italy remains relatively stable. So why is it under so much pressure from the financial markets?

Excessive government spending

Beneath the outward facade of stability in Italy, a withering political system has existed for a long time. In its "October Outlook for Europe," the International Monetary Fund (IMF) acknowledged enormous structural problems.

Silvio Berlusconi
Berlusconi has been part of Italy's struggling political systemImage: picture alliance/abaca

Among those are excessive and inefficient government spending and a tax system that puts an extreme strain on the economy with its tax and contribution ratio of 43 percent.

Traditionally, the contribution of the shadow economy has been quite high - estimates place it between 18 and 30 percent of annual output.

In international competition, Italy has been continually bringing up the rear since its exchange rate was tied to the euro in 1996. Ten years ago the percentage of exports in the GDP was 30 percent; in 2005, it has shrunk to a fifth of that amount.

While countries like Germany, Austria or the Netherlands have been able to more or less sustain their share of the world market, Italy - along with France and Britain - are among the countries that have seen their portion of the world market go down. Ten years ago, Italy was exporting more goods than it imported. Now, that's reversed, and the trade balance is negative.

Market share lost

The reason is the lowered competitiveness of Italian companies on the world market. As in the past, Italy still exports machines, cars, chemicals, valuable textiles and designer fashion, but the low productivity resulting from rising labor costs and high taxes are making Italian products increasingly unattractive.

A Fiat factory in Cassino, Italy
Italian companies are losing their share in the global marketImage: dpa

Italy used to be among countries that regularly devalued its currency. With the adoption of the euro, Italy lost that ability.

A further problem is unemployment in Italy. While the country's current unemployment rate of 8.7 is under the EU average of 10 percent, Italy still has trouble keeping its workforce busy.

Only 59 percent of the working population has a regular job - significantly lower than other EU countries. Unemployment among the country's youth is particularly dramatic, with around every third person under 25 without a job.

Loss of trust

The lack of competitiveness is especially draining on Italy's economy, although the country did not have to deal with a housing market crisis or a banking sector crisis. But, a consequence of the lack of trust has been a self-perpetuating decline of financing conditions.

Unlike Germany, France, and Britain during the period from 2007 to 2011, Italy's debt was not affected by stimulus packages, bank bailouts or drops in tax revenue, but rather nearly entirely from rising costs of refinancing.

Italy is suffering from a lack of confidence from the markets. The country has enough economic mettle to work on the deficits brought to light by the IMF. But structural reforms take time.

At the same time, pressure is mounting to produce quick results, because neither the European Central Bank nor the EFSF (European Financial Stability Facility) can save Italy from the costs of refinancing.

Author: Rolf Wenkel / mz
Editor: Nicole Goebel

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