France, Italy Hastily Implementing Austerity

Paris and Rome rush to cut public spending after a week of turmoil in the financial markets.

Rome, Italy at dusk, October 17, 2008
Rome, Italy at dusk, October 17, 2008 (Andreas Caranti)

Responding to market jitters about French and Italian creditworthiness, both European countries rushed to enact austerity measures this week. In agreement with their fellow European Union member states, the conservative governments in Paris and Rome pledged to reduce their deficits to under 3 percent of GDP by 2013, necessitating tens of billions more in reductions than previously planned.

France, which is the second largest economy in the eurozone after Germany, is struggling to regain growth amid high unemployment and high deficit spending. The International Monetary Fund forecast last month that France could miss its 3 percent deficit target for 2013 unless it implemented deeper cuts which it might also need to safeguard its coveted AAA credit rating.

After the United States were downgraded by the Standard and Poor’s rating agency, France came under scrutiny from investors because of its lackluster economic performance. Although major credit raters have affirmed France’s AAA status, nearly one out of ten French workers remain out of a job while industrial output contracted by 1.6 percent this June.

During that same month, France’s trade deficit reached an unprecedented €5.6 billion, reflecting the high cost of labor in the country as well as its many impediments to entrepreneurship and private-sector growth.

The French state accounts for more than half of the national economy and continues to dominate entire industries including electricity, postal services and railways. The private labor market is burdened with rigid regulations that exacerbate unemployment and undermine France’s competitiveness within the eurozone.

Fiscally, France’s woes are solvable. Its deficit this year will likely amount to 7 percent of GDP and is expected to drop to 5.3 percent in 2013 — short of its 3 percent goal but wholly incomparable with the financially untenable situation in the United States where the federal governments borrows more than a third of what it spends.

At nearly 84 percent of GDP, France’s public debt is formidable but not much higher than Germany’s 79 percent. Italy, by contrast, has among the most heavily indebted governments in the world. Its debt amounts to more than 120 percent of the economy.

Italy’s creditworthiness hasn’t seriously been called into question yet because the Italian people are savers but there is certainly a need to reduce expenditures. Prime Minister Silvio Berlusconi previously announced up to €48 billion worth of spending reductions with most cuts postponed until after the parliamentary elections of 2013.

Under pressure from markets and coalition lawmakers, the Italian cabinet laid out another €20 billion in cuts between now and 2013 to achieve its 3 percent deficit target. Berlusconi’s finance minister also expressed support for a balanced budget amendment to the Italian constitution which he deemed “essential.”

French president Nicolas Sarkozy similarly advocates constitutional reform in order to enshrine fiscal discipline in his nation’s highest law although the socialist opposition is skeptical. One leftist presidential contender has suggested another amendment, one that would force the government to adequately reduce its shortfall by 2013.

Austerity was never a favorite topic of French and Italian politicians but until this week, they had never to worry about being able to borrow cheaply for their country either. The European Central Bank even intervened to buy some of Rome’s sovereign bonds to bring down the interest rates it pays on its debt this week.

The second- and third largest economies in the single currency area respectively, France and Italy are pivotal to the credibility of the European Financial Stability Facility which is designed to assure investors that the whole continent will rally to bail out whichever country in the euro might come under fire. If their debt isn’t considered a safe investment anymore, the whole house of cards could fall apart and the euro with it.