Spain and Portugal, two problem children in the eurozone, have improved economically over the last couple years. Italy, in contrast, continues to labor with structural imbalances. A telling statistic is that since the creation of the euro currency 16 years ago, it has grown only 4% in total.
The three biggest issues Italy faces are low growth and unemployment, excessive debt and sick banks. Each one bleeds into the other, making it very difficult to bring Italy back from its black hole.
Low Growth and High Unemployment
Although Italy moved out of a long recession in early 2015, real gross domestic product (GDP) is still 9% below the 2008 level. Its core growth problem heading into 2016 is poised to continue even if there is modest improvement.
For example, the European Union forecasts GDP growth of 1.5% in 2016 compared to less than 1% in 2015. Real GDP is at a level last experienced in 2000. Real GDP for the eurozone as a whole is 10% higher than in 2000, so Italy again lags.
Severe unemployment remains an immense problem. From 8.4% in 2010, the unemployment rate reached about 12% in 2015 and is expected to stay close to that level in 2016 and 2017. Youth unemployment is very high, with many giving up job hunting. Italy also has one of the lowest literacy rates in Europe, and the number of citizens moving into poverty has exploded since 2008.
Gross public debt as a percentage of GDP is forecast at 132% in 2016, hardly changed from 133% in 2015. It is an unmanageable burden exacerbated by several problems.
Although Italy experienced high inflation for many years, low inflation is now the problem given the country's excessive debt level. Low inflation increases the real cost of debt. This is seen at the extreme when inflation falls below zero, creating deflation and a debt spiral. Inflation was about 0.2% in 2015 and is expected to rise to 1% in 2016.
Italy's government debt is especially onerous as the country struggles with a bloated welfare system created by politicians many decades ago. Public debt rose to 2.3 trillion euros in 2015; only Greece has a higher number.
There are many downsides to an excessive public debt level. Growth is constrained based on the higher taxation level required to service the debt interest. Economists have found a consistent relationship between low economic growth and high levels of public debt.
The non-performing corporate loan ratio in Italy is over 25%, equivalent to $370 billion or 21% of GDP. The government is talking about loading these unproductive assets into a bad bank, erasing them from the balance sheets of banks and giving them a fresh start, in theory.
In early December, the authorities took a step in this direction with the rescue of four small floundering banks, a move that generated protests from retail investors that lost money in the bailout. UniCredit and other big Italian banks put up most of the money for the rescue, but the problem is much bigger than anything the private sector can handle.
Compared to other European banks, Italian banks are more exposed to corporate bank loans. These Italian corporate clients also tend to be more leveraged and less creditworthy. The availability of capital to these companies is now constrained by the size of non-performing loans, and there is little hope of any sustained growth in GDP until a workable plan is implemented to dispose of these loans.
There is one glimmer of hope for the bad bank solution. The concept worked well enough in Ireland and Spain, and it worked especially well during the savings and loan crisis in the United States.
Italy's Economic Challenges in 2016
Italy faces another year of economic difficulties because its problems have become so ingrained and systemic. Monetary authorities in the United States and Europe have pushed the easy money gas pedal to the floor since 2009, and it hasn't helped laggards like Italy. Finding a way to solve the banking crisis would be a meaningful first step on Italy's road to recovery.