Italy’s economy: Cocaine and prostitutes to the rescue!

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.

italian-republic-emblem-largeUnfortunately, 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.
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The problem with GDP

Gross Domestic Product (or GDP for short) has been a good blunt instrument since the 1930s for getting a quick reading of economic growth in an country. However, with every passing year, it has become waved around more and more as an accurate measurement of the economy, even as criticisms of its flaws mount. It’s become used for way more than it was ever intended, and that causes policy problems. David Moberg wrote a good piece last week for the newspaper In These Times, in which he laid out some of the major criticisms of GDP as a measurement and looked at some of the possible solutions people are developing. Here are some of the main problems:

Before the crash, GDP reports were just as out of sync with people’s experiences [as they are now with GDP growing again and jobs stagnating]. GDP rose throughout the Bush era, but people were largely unhappy with the economy. Most people’s real incomes weren’t growing, just those of the rich. It became clear that much of the GDP boom was an illusion. It was composed of a bubble of housing assets and funny-money financial derivatives. And since current growth is creating a climate crisis, it is also environmentally unsustainable.

One of the key problems with GDP as a measure of national welfare is that it treats “bad goods (and services)” the same as “good goods.” If it costs $100 million to clean up a toxic waste dump but only $1 million to avoid it, the clean-up directly contributes 100 times as much to the GDP as the prevention, making the country “wealthier.”

In other words, waste and inefficiency can make GDP bigger but leave people worse off. For example, healthcare expenditures rose rapidly in recent years, but overall care and health outcomes did not keep pace. A single-payer system could have provided better health at lower cost, but the GDP would have been smaller in the short term.

Also, the GDP does not distinguish between the long-term significance of different types of economic activity. (That fact didn’t bother Michael J. Boskin, chairman of President George H. W. Bush’s Council of Economic Advisers, who said that “it doesn’t make any difference whether a country makes potato chips or computer chips.”) Likewise, the GDP does not recognize the loss of value when a dead-end job replaces one with more meaning. And it does not distinguish between egalitarian societies and those, like the United States, where the rich have recently captured most of the GDP growth.

It’s a serious issue because policymakers need something simple and easy to understand when writing legislation… and GDP is both, but wildly inaccurate. The fact that — and this is hypothetical, though I’ve heard it proposed — knocking down and rebuilding a foreclosed neighborhood has more GDP value than trying to help people adjust their mortgages so they can stay and improve the neighborhood is deeply troubling to me. The similar example above about pollution cleanup having more GDP value than preventing the pollution is a classic scenario among critics.

Fortunately, according to the article, some big politicians (e.g. French President Nicolas Sarkozy) are pushing for a change, and there are some big name economists (Amartya Sen and Joseph Stiglitz) out there drafting alternatives to Gross Domestic Product. There are already some ideas floating around that haven’t caught on, including the Index of Sustainable Welfare:

Ecological economists Herman Daly and John Cobb developed an Index of Sustainable Welfare, which expanded the GDP to include indicators such as income distribution, natural resource depletion, environmental damage and the values of leisure. Their index showed that “sustainable welfare” tracked the GDP fairly closely in the United States until the late 1960s, then was flat or declined through the late 1980s, even as GDP grew.

There’s also the oft-mentioned “Gross National Happiness” measurement in use in Bhutan, but it wouldn’t export well. In any case, it’s unsustainable to keep using GDP, so there needs to be something better put into place fast if we want to operate a good society.

This post originally appeared on Starboard Broadside.