One of the key features of the European Union and eurozone currency system, as outlined in the early 1990s, is that member country’s would be expected to keep their budget deficits low and their public debt to gross domestic product (GDP) ratios reasonably under control. On the latter indicator, the debt is the numerator and can be changed by increasing or decreasing borrowing (and by extension, of course, annual spending). The GDP makes up the denominator and rises or falls as the national economy grows or shrinks. Changing either part affects the ratio.
The reason for such controls being imposed by the various European Union treaties is to limit currency value fluctuations in one country that will necessarily affect the currency’s value in another country also on the euro that might have a different set of economic concerns.
Unfortunately, one of the persistent features of Italy specifically has been high debt and low growth. In mid-2013, even after several years of cutbacks, the Italian debt to GDP ratio as a percentage was 130% (meaning the total debt was 30% larger than the entire calculated value of the Italian economy).
Moreover, GDP was growing on average at 0% a year (often actually negative in practice) in the fifteen years from 1998 to 2013. Similarly, annual deficit to GDP ratio targets demanded by the European Union were also not being met. And yet, the EU wanted the ratios reduced further, even though additional rapid cuts in the numerator (total debt or annual deficit, depending on the ratio in question) might start shrinking the denominator (the economy size), thus leaving the ratio more or less unchanged.
Enter the unelected Prime Minister Matteo Renzi — the former Mayor of Florence (and Italy’s youngest prime minister ever, even including Mussolini) — who dramatically assumed control of the country in February. His Finance Ministry has hit upon a brand new solution to help solve the problem in time for the next round of budgeting.
When your supranational federation orders you to rein in your deficit-to-GDP ratios, you can either slash all spending haphazardly until the deficit size falls to an acceptable level — the usual approach — or you can blow up your GDP massively by piling into your calculation everything under the sun, including hookers and blow. YAY MATH!
Drugs, prostitution and smuggling will be part of GDP as of 2014 and prior-year figures will be adjusted to reflect the change in methodology, the Istat national statistics office said today. The revision was made to comply with European Union rules, it said.
Renzi, 39, is committed to narrowing Italy’s deficit to 2.6 percent of GDP this year, a task that’s easier if output is boosted by portions of the underground economy that previously went uncounted. Four recessions in the last 13 years left Italy’s GDP at 1.56 trillion euros ($2.13 trillion) last year, 2 percent lower than in 2001 after adjusting for inflation.
“Even if the impact is hard to quantify, it’s obvious it will have a positive impact on GDP,” said Giuseppe Di Taranto, economist and professor of financial history at Rome’s Luiss University. “Therefore Renzi will have a greater margin this year to spend” without breaching the deficit limit, he said.
And that’s the big, dirty secret of the concept of GDP, as well as GDP-based targets: They are blunt instruments that depend at heart on a necessarily arbitrary system of measurement, which can be manipulated in the official figures in any given country by including or excluding various sectors of the economy — particularly in the gray or black markets.
Coke, prostitutes, and smuggling are obviously pretty extreme examples, but we’ve seen even external and internal re-evaluations of how to measure GDP happening in places such as Nigeria and Kenya already this year, with big jumps in GDP occurring as under-counted or ignored sectors (especially those involving newer technology) are brought into the calculations after years of being left out arbitrarily or by force of habit.
The European Union’s goals are fairly important for maintaining currency stability in a currency union that lacks an overriding central monetary policy or fiscal-political union, but they are also not made of iron. Blatant manipulation is probably a bad idea, but some flexibility (which hasn’t really been seen in the past few years) would be a good idea, particularly since everyone looked the other way during the “good times” and set these countries up to take the fall went things went bad.
And at the end of the day, these are a major part of economies such as Italy’s whether counted or not. Even if the Finance Ministry perhaps isn’t especially proud of that fact, as Bloomberg hints:
A spokesman for the Finance Ministry declined to comment on the new system.
I want to note, in fairness, that the Renzi government has also pushed through a lot of far more serious reforms to the economy, constitution, and electoral system — in an effort to try to provide some stability of corporate and political governance that Italy has been sorely lacking in the past two decades and the postwar period generally — but this is definitely the one most likely to generate global buzz. It’s also a testament to his government’s ability to think outside the box and get creative with reforms in a way so many staid and ineffectual Italian leaders haven’t.
Plus it’s just good to see a headline from Italy involving cocaine, prostitutes, and the government with no sign of Silvio Berlusconi’s involvement…
Thanks to a reader for flagging this story.