ROME—The global policy trend of heavy fiscal stimulus, led by the U.S., faces a test case in Southern Europe.
Italy, Greece and Spain, hit hard in Europe’s sovereign-debt crisis a decade ago, are once again running big budget deficits and planning to spend on a grand scale to revamp their economies.
Italian Prime Minister
and other leaders in the region are betting that ambitious investments can give a lasting boost to growth. If the gamble doesn’t work, these countries will be saddled with some of the world’s highest debt ratios, potentially destabilizing the eurozone.
After years of running tight budgets with little room for transformative investments, they now see a once-in-a-generation chance to revitalize their economies.
Mr. Draghi, presenting his plans to Italy’s Parliament, said they contain not just a list of public works but “the destiny of the country.”
Many developed countries are embracing President Biden’s conviction that aggressive fiscal stimulus and public works can not only repair the economic damage from the Covid-19 pandemic but also improve growth for years to come.
The heavy borrowing plans, exploiting historically low interest rates and the willing support of central banks, are in marked contrast to Western countries’ tilt to austerity after 2010, when many governments cited Greece’s debt crisis as a warning about where excessive deficits can lead.
The European Union, which has for years promoted balanced budgets even when that required painful austerity measures, is joining in the borrowing spree. The centerpiece is an EU recovery fund worth 750 billion euros, equivalent to $900 billion, officially known as Next Generation EU. The mixture of grants and cheap loans will be financed by common EU bonds and aims to support investments and overhauls that boost productivity and long-term growth.
Europe’s Economic Struggles
“It’s a clear change of economic paradigm. Taking on debt to finance growth, doing it on such a large scale, and on top of existing debt which is already high, was something we had not seen before,” said
Enzo Moavero Milanesi,
a former Italian foreign minister.
Mr. Draghi, who as president of the European Central Bank played a leading role in defusing the euro’s near-terminal debt crisis in 2012, now has a unique chance to shake up Italy’s struggling economy.
Since the 1990s, Italian leaders have tried to overhaul the country’s sclerotic economy while also running tight budgets. Mr. Draghi is the first in decades who can deploy massive fiscal firepower to help.
Italy’s economy has rarely grown by more than 1% annually over the past quarter-century. The economy has never fully recovered from the global financial crisis and subsequent eurozone crisis, and slumped by another 9% in 2020 amid the pandemic and strict lockdowns.
Germany, France and other EU countries backed the recovery fund mainly for fear that Italy and Southern Europe could get stuck in another deep economic slump that once again tests the cohesion and survival of the eurozone.
“I think that there is widespread agreement this time that we need economic growth rather than fiscal tightening to exit the crisis and sustain the enormous public debts,” said
analyst at risk consulting firm Eurasia Group.
Italy is to be the largest recipient of the EU funds with around €190 billion, of which €70 billion are grants. The country will add almost €60 billion from its own coffers to fund the investment plan.
Italy’s debt has reached 156% of gross domestic product, mainly because of the pandemic. Greece’s has risen to 206%, the highest ratio in the developed world after Japan.
Most of Greece’s debt is in the form of bailout loans from the rest of the eurozone, with no repayments due for many years, making another Greek debt crisis unlikely for a long time.
Europe’s main long-term risk about debt sustainability concerns the much larger Italian economy. The euro’s future could once again hinge on how Mr. Draghi performs.
“The huge risk is that these investments won’t increase the country’s ability to grow, which means that they will only stimulate GDP for a few years. The effect of the higher demand will then go down, growth will be low again but debt will be much higher,” said
a London-based consultant and former economist at Italy’s Treasury.
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Financial markets are relaxed about the risk, for now, in the expectation the ECB will continue its large-scale purchases of government bonds, keeping countries’ borrowing costs down.
“I think the ECB will keep an accommodating monetary stance for two to three years no matter what. I expect it to give all the support that’s possible in this phase,” said Francesco Daveri, an economist at Milan’s Bocconi University.
However, financial-market pressures could start to emerge in the longer run if economic growth becomes sluggish again, debts remain high and the ECB tightens its monetary policy, economists say.
While the thinking behind U.S. and European fiscal packages is partly parallel, the scale is much bigger in the U.S., which has so far enacted fiscal measures worth around 26% of its GDP, far exceeding all stimulus efforts in Europe.
European spending plans are aimed less at boosting household spending and more at improving the productive side of the economy, through investments in digital and physical infrastructure, education, environmental efficiency and other long-term needs.
Mr. Draghi also aims to improve the training and technology of Italy’s inefficient public administration, as well as streamlining the notoriously slow justice system.
If Mr. Draghi’s efforts and those of his Greek and Spanish counterparts don’t bear fruit, the experience is likely to lead to renewed pressure for fiscal discipline from Europe’s financially conservative north. But if the return to big borrowing pays off, it will strengthen calls for a European fiscal union that uses the EU’s collective strength to invest in its weaker economies.
“If Bidenomics works in the U.S., President Biden will go down in history as the new Roosevelt,” Mr. Moavero said. “In Europe, the effect may be to set a precedent which will be hard not to repeat.”
Write to Giovanni Legorano at firstname.lastname@example.org
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