Reading Italy’s inability to implement reforms and mainstream communication tactics from an organizational point of view.
The downgrade objective facts
About two weeks ago, Standard & Poor’s downgraded Italy’s long-term credit rating to BBB-, one-step far from the chasm. The below charts show a constant rating decline during the last 10 years, which corresponds to a recent sharp increase of the Debt/GDP ratio up to the latest 2014 IMF estimate of 136.7%.
The reason underlying this clear objective decline is mainly the lack of growth. The purpose of this post is not to drill down into the recession dynamics and therefore I will just briefly mention some relevant facts. Italy’s economy is stagnant after years of recent recession interspersed by a feeble recovery flash (see the below GDP chart – source: ISTAT).
After Lehman Brother’s crack in 2007, the very unstable Italian economy never managed to recover stably. The below chart clearly shows a Debt/GDP trend inversion in 2007 which led to a currently unsustainable level of debt, unless real credible unlikely reforms will be implemented to unleash the country remarkable potential.
The subjective house of cards
The above charts (based on widespread available public data) do not leave doubts: no signs of clear positive inversion and long-term sustainability. However, why did Italians get surprised and outraged by S&P’s recent downgrade? What is it that is shaping their wrong perception of objective facts? The recent succession of downgrades has always triggered pages of newspapers and politicians commenting each episode as the nth attempt to undermine an Italian economy which, according to them, considering the “black” GDP (the one out of the fiscal authority radar), is one of the most robust in the Euro area. The consequence is a moderate polarization of the audience against the European Union (and the Euro currency) as the reason for Italy’s decline.
Is the international conspiracy theme enough to justify the exploding unemployment rate and the consumption level back to the 70’s? Probably not.
There is a crisis, there is a consequent recession, there are clear root causes, and there is a Government with the potential to make the structural reforms needed to jump-start the value-creating machine. Why does not this happen?
A pinch of historical background
After the moderately “risk-seeking” Berlusconi’s government strategy was annihilated by the 2007 crisis and finally the rigid European Union could get rid of an inconvenient player, elections took place resulting in an ungovernable situation where “revolutionary” populists (Movimento Cinque Stelle) gained nearly 25% of the electorate. At that point, the President of the Republic, Giorgio Napolitano, was obliged to step in and institute a technical government to avoid bankruptcy in a period of frequent speculative attacks in the debt market. From that moment on, Italy changed three different non-elected Prime Ministers: Mario Monti, Enrico Letta and ultimately Matteo Renzi (still in charge supported by a bipartisan broad coalition) but the country does not have the needed reforms yet and macroeconomic indicators keep getting worse with recovery forecasts punctually revised downward by national and international institutions. Where does this inability to implement reforms come from?
Diversionary communication strategy
In spite of numbers, the messages that the Government uses to convey are positive, announcing changes and reforms that rarely take place in the way they are stated, but rather become subject of sterile discussions within the slow Parliament, aiming at maintaining the status quo.
At the same time, national media impose topics such as gay marriage, femminicidio (female murder), illegal immigration and more, which appear secondary when compared to the unemployment emergency or the huge number of companies closing or relocating abroad. Is there an attempt to defocus people’s attention from numbers? What is the Government trying to achieve?
Well, someone might say there surely is a desperate need for growth, which could not be easily achieved within the EU financial constraints. Is the Government trying to regain economic momentum by leveraging on perceptions rather than implementing actual reforms? Perception is an important variable, especially when read within an electoral context. An example was reducing taxes to push consumption, right before the European elections, by EUR 80/month for lower incomes, leading to an unperceivable macroeconomic effect but generating an outstanding electoral result for the governing party (Democrats – share about 40%).
The final backlash?
Italy has always been characterized by a clear rivalry between political class (often referred to as “the caste”), accused and several times found to be colluded with the various mafias, and the rest of the people. Such a contrast has considerably worsened with the recent crisis, which allowed populist movements made of “normal people” to thrive. Even the young and energetic Renzi’s Government, which is trying to implement sometimes questionable reforms, has a hard time digging into the “public machine” and uncovering bipartisan mafia-like organizations where important politicians, half of which belonging to the governing faction, collaborate with well-known criminals to get a hold of public money. See the recent Rome example.
From the caste preservation perspective, it is not surprising the President of the Republic, Giorgio Napolitano, a week ago talked about the “subversive threat of anti-politics”, indirectly referring to populist movements such as Movimento Cinque Stelle and the rapidly-growing renovated Lega Nord. However, aren’t these populist movements taking political actions? Aren’t such actions anti-party rather than anti-politics? May this sentence be seen as contradictory? Could we see Napolitano’s statement as a way to protect the current Government, a sort of backlash before his resignation expected by the end of this year?
Let’s try to give a possible explanation of the above phenomena from an organizational point of view.
Leveraging control over GDP to remove the barriers to growth
GDP, by far, is the fulcrum of the raising Public Debt issue: one of the few figures Italy may really work on to recover. Currently, the Government controls around 65% of the Italian GDP and this means nearly any decision affecting this big chunk of the overall value creation passes through politicians. How about the remaining 35%? Well, lawmakers who belong to the political class regulate businesses and markets, as almost everywhere happens. Historically, the peculiarity of Italy’s overstaffed public machine was the almost total lack of control and transparency, being a resource pool for political parties and their clients, as it turns out from several well-known investigations (e.g., Mose project, Mani Pulite, and many more), which discovered the existence of innumerable black holes absorbing public funds. This means 65% of the value created is highly inefficient and the rest of the policies to rule the private world may look conceived to create favorable conditions for the political class to thrive.
Would economic reforms be effective in an environment characterized by such a highly negative public influence?
For sure, we know that places where the public control over GDP is around 30% or less, like the United States, economic dynamics are governed by the market, which is able to react faster than a much slower legislator. However, the price to pay to have a quick recovery is a welfare system that is necessarily more iniquitous and governed by economic principles. Wouldn’t it be possible for the government to lower control over GDP from 65% to 45-50% and still being able to provide high welfare standards? Considering what belongs to the public machine and the huge amount of resources wasted, this could be a possible option; private providers might more effectively manage plenty of possible services without political meddling, positively affecting the final users.
However, the achievement of that result is hindered by an organizational problem that looks unsolvable, at least by the current Government.
The higher the influence over the GDP, the higher the reach of the political class, the higher the opportunity for clientelism, the higher the power to shape people’s electoral preferences (insuring caste sustainability), the higher the resources politicians can rely on to finance political parties and their members, the higher the level of unnoted and unpunished corruption.
Who would be able to erode public control of the GDP? This would be a type of radical change that could not be triggered endogenously. The current Government is made by apparently “rebel children” of the traditional caste; however, given the fact they grew up and became successful within the caste rules and their political identity is strictly tied to their past, would they be determined enough to get rid of their “parents” and all their bipartisan interlaced interests? The child of a dinosaur is always a dinosaur, only smaller.
According to Cognitive Science, change is typically triggered by an external painful episode that initiates the process (a cognitive process that should have changed the caste organizational identity). The raise of populist movements might have had the potential to trigger real genuine change, but their impact was not big enough, unfortunately. The great broad governing coalition proves that left and right wing, which lately turned out to be colluded on several affairs, joined together to hedge against political innovation.
If Matteo Renzi wants to make the difference, given the lack of available financial resources, he should focus on releasing control of the public machine over the GDP and fostering market dynamics rather than reforming the way the public machine handles that high percentage of value creation. Lowering the interference of the State would be one of the enabling factors to amplify the effect of growth-oriented measures by contrasting the public machine inertia. Releasing control, along with a strong reduction of tax rates, would be a shock and a risk and poses feasibility questions, given the EU rigid financial constraints; are we sure the Government would be able to sustain the caste conversion costs? Is the Government focusing on other topics because such reforms are not implementable by the same parties that sustain themselves and their clients through the inefficient system they have created?
If we believe the statement whereby real change can never be endogenous, populism might not appear that bad, after all.