Why Italy's stay-home shop­pers ter­rify the euro zone

The Financial Daily - - INTERNATIONAL -

GAVIN JONES "Three for the price of two" used to be the most com­mon spe­cial of­fer in Gior­gio San­tam­bro­gio's su­per­mar­ket chains. It has barely been used this year. The rea­son ex­plains why ef­forts to re­sus­ci­tate Italy's mori­bund econ­omy are fail­ing.

"Peo­ple aren't stock­ing up be­cause they know prices will be lower in a month's time," says San­tam­bro­gio, chief ex­ec­u­tive of Vege, a Mi­lan-based as­so­ci­a­tion cov­er­ing 1,500 su­per­mar­kets and spe­cial­ist stores. "Shop­pers are de­mand­ing steeper and steeper dis­counts."

Italy is stuck in a rut of di­min­ish­ing ex­pec­ta­tions. Numbed by years of wage freezes, and skep­ti­cal the govern­ment can im­prove their eco­nomic for­tunes, Ital­ians are hoard­ing what money they have and cut­ting back on ba­sic pur­chases, from de­ter­gent to win­dows.

Weak de­mand has led com­pa­nies to lower prices in the hope of lur­ing peo­ple back into shops. This sum­mer, con­sumer prices in Italy fell on a year-onyear ba­sis for the first time in a half­cen­tury, and they have barely picked up since. Fall­ing prices eat into com­pany profits and lead to pay cuts and job losses, fur­ther de­press­ing de­mand. The re­sult: Italy is be­ing sucked into a de­fla­tion­ary spi­ral sim­i­lar to the one that has af­flicted Ja­pan's econ­o­my­for much of the past two decades.

That is the night­mare sce­nario that pol­i­cy­mak­ers, led by Euro­pean Cen­tral Bank chief Mario Draghi, are des­per­ate to avoid.

The euro zone's third-big­gest econ­omy is not alone. De­fla­tion - or con­tin­u­ously fall­ing con­sumer prices - is con­sid­ered a risk for the whole cur­rency bloc, and par­tic­u­larly coun­tries on its south­ern rim. Prices have fallen for 20 months in Greece and five in Spain, for ex­am­ple. Both coun­tries are suf­fer­ing through deep cuts in salaries and state wel­fare. Yet Italy, a large econ­omy with a huge pub­lic debt, is the coun­try caus­ing most worry.

Part of the rea­son de­fla­tion is seen dif­fer­ently across south­ern Europe is cul­tural. Greeks and Spa­niards are his­tor­i­cally big spenders. The Span­ish econ­omy surged for a decade thanks to a prop­erty and con­sump­tion bub­ble that crashed in 2008. Greece grew strongly in the same pe­riod, be­fore be­ing brought to its knees in 2009 by its govern­ment's clan­des­tine fi­nances. This year, fall­ing prices are help­ing these economies sell more of their prod­ucts at home and abroad, fu­elling a nascent re­cov­ery.

Ital­ians, how­ever, are his­tor­i­cally big savers. One rea­son, says Chiara Sara­ceno, so­ci­ol­ogy pro­fes­sor at Turin Univer­sity, is that Ital­ian par­ents tra­di­tion­ally save for decades in or­der to buy their chil­dren homes when they marry.

An­other fac­tor is Italy's fa­mously cash-based econ­omy. Italy has fewer credit cards per per­son than any other coun­try in the euro zone ex­cept Slo­vakia, ac­cord­ing to ECB data. That damp­ens con­sump­tion be­cause peo­ple who use credit cards buy more freely, econ­o­mists say. Even the houses par­ents buy their chil­dren are of­ten paid in one lump-sum rather than with mort­gages.

Like Ja­pan, Italy has one of the world's old­est and most rapidly aging pop­u­la­tions - the kind of peo­ple who don't spend. "It is young peo­ple who spend more and take risks," says Ser­gio De Nardis, chief economist of the Bologna-based Nomisma think­tank. In re­cent years, young peo­ple have been the hard­est hit by lay­offs, he says. Many have left the coun­try to seek work else­where.

Peo­ple tend to spend more when they see a bright fu­ture. Ital­ian con­fi­dence has steadily eroded over the past two decades, hurt by a re­volv­ing door of in­ef­fec­tual gov­ern­ments. In Italy, as in Ja­pan, the lack of eco­nomic growth has be­come chronic. DEBT TRAP Un­der­pin­ning econ­o­mists' wor­ries is Italy's big­gest hand­i­cap: a huge na­tional debt equal to 132 per­cent of na­tional out­put and still grow­ing.

Rising prices make it eas­ier for high­debt coun­tries like Italy to pay the fixed in­ter­est rates on their bonds. And debt is usu­ally mea­sured as a pro­por­tion of na­tional out­put, so when out­put grows, debt shrinks. Be­cause out­put is mea­sured in money, rising prices - in­fla­tion - boost out­put even if eco­nomic ac­tiv­ity is stag­nant, as in Italy. But if ac­tiv­ity is stag­nant and prices don't rise, then the debt-to-out­put ra­tio will in­crease. That could po­ten­tially reignite the sort of in­vestor panic that set off the euro zone debt and eco­nomic cri­sis four years ago.

Mar­cello Mes­sori, eco­nom­ics pro­fes­sor at Rome's LUISS univer­sity, es­ti­mates that with­out eco­nomic growth, prices in Italy would have to rise at least 3.2 per­cent a year for its debt to fall at the rate the Euro­pean Union re­quires.

"I see an enor­mous dan­ger that we will still be in this sit­u­a­tion in six months' time, and the longer it lasts the harder it is to get out," says Gus­tavo Piga, an eco­nom­ics pro­fes­sor at Rome's Tor Ver­gata Univer­sity.

Se­bas­tiano Sal­zone, a diminu­tive 33year-old from the poor south­ern re­gion of Cal­abria, left with his wife five years ago to run the his­toric Cafe Fi­ume on Via Salaria, a tra­di­tion­ally busy shop­ping street near the cen­ter of Rome.

Sal­zone was ex­cited by the chal­lenge. But af­ter four years of grind­ing re­ces­sion, his busi­ness is strug­gling to sur­vive. "When I took over they warned me de­mand was weak and ad­vised me not to raise prices. But now, I'm be­ing forced to cut them," he says.

A lunch at Cafe Fi­ume with a pasta course, min­eral wa­ter, fruit and cof­fee costs 7 eu­ros and 30 cents. That's the same as it was eight years ago. In Septem­ber, Sal­zone cut the price of his pani­nos by 40 cents to 2 eu­ros 80, and cut the price he charges for soft drinks by 30 cents, to 2 eu­ros. De­spite the lower prices, sales have dropped 40 per- cent, or 500 eu­ros a day, in the last three years. Sal­zone has re­duced staff to 12 from 15 to break even. CAN'T SAVE, WON'T SPEND Through the mid-1990s Ital­ians saved a large pro­por­tion of their in­come by in­ter­na­tional stan­dards. Sav­ings be­came a buf­fer against the un­pre­dictable eco­nomic ef­fects of the po­lit­i­cal in­sta­bil­ity that has given Italy nearly one govern­ment a year since World War Two. Sav­ing was also en­cour­aged by the high in­ter­est rates on govern­ment bonds.

As growth has slowed and dis­pos­able in­come has fallen, how­ever, peo­ple have set aside a smaller and smaller pro­por­tion of their salaries. The sav­ings rate now stands at 8 per­cent, one third of its level in 1991. The av­er­age Ital­ian had less spend­ing power in 2013 at the end of each month than they did at the start of the cen­tury, ac­cord­ing to Ital­ian sta­tis­tics in­sti­tute Is­tat.

For hard-pressed in­di­vid­u­als, low and fall­ing prices can seem a god­send; but low prices lead to busi­ness clo­sures, lower wages and job cuts - a lethal spi­ral. Since Italy en­tered re­ces­sion in 2008 it has lost 15 per­cent of its man­u­fac­tur­ing ca­pac­ity and more than 80,000 shops and busi­nesses. Those that re­main are slash­ing prices in a bat­tle to sur­vive.

Home fix­tures maker Iaquone is the kind of small, fam­ily-run com­pany that is the back­bone of Italy's econ­omy. The nine-per­son firm has been mak­ing doors, win­dows and blinds for the last 25 years in Frosi­none, 90 km (56 miles) south of Rome.

But owner Benedetto Iaquone says peo­ple are now only chang­ing their win­dows when they fall apart. To hold onto his 500,000 eu­ros-a-year busi­ness, Iaquone says he is cut­ting prices. He has also changed sup­pli­ers, shav­ing the cost of buy­ing glass and iron by 15 per­cent and 10 per­cent, re­spec­tively. By do­ing so, he is help­ing fuel the chain of de­fla­tion from con­sumers to other com­pa­nies.

"Ev­ery­one's profits are lower but at least we man­age to keep work­ing," says the 45-year-old busi­ness­man. "I al­ways tell my­self that if we can get through this pe­riod we will come out very strong, but I'm hon­estly not op­ti­mistic about the fu­ture."

In Italy's largest su­per­mar­ket chains, up to 40 per­cent of prod­ucts are now sold be­low their rec­om­mended re­tail price, ac­cord­ing to sec­tor of­fi­cials. "There is a con­stant ero­sion of our mar­gins," says Vege chief San­tam­bro­gio. LIMITED OP­TIONS What Italy would look like af­ter a decade of Ja­pan-style de­fla­tion is grim to imag­ine. It is al­ready among the world's most slug­gish economies, with youth un­em­ploy­ment at 43 per­cent.

As a mem­ber of a cur­rency bloc, Rome's op­tions are limited. It can't lower its do­mes­tic in­ter­est rate, nor de­value its cur­rency. Of­fi­cially, Italy's bud­get has to fol­low Euro­pean Union rules.

Last­ing de­fla­tion would force more com­pa­nies out of busi­ness, re­duce al­ready stag­nant wages and raise un­em­ploy­ment fur­ther, econ­o­mists say. The in­evitable rise in its pub­lic debt could even­tu­ally lead to a de­fault and a forced exit from the euro.

Opin­ions dif­fer over how to head off the risk. Some econ­o­mists say the Euro­pean Cen­tral Bank should fol­low the ex­am­ple of the U.S. Fed­eral Re­serve and in­ject thou­sands of bil­lions of eu­ros into the euro zone econ­omy by print­ing money to buy govern­ment bonds. ECB boss Draghi last week threw the door open to print­ing money, say­ing "ex­ces­sively low" euro zone in­fla­tion had to be raised quickly by what­ever means nec­es­sary.

Many in south­ern Europe say the EU should aban­don its strict fis­cal rules and in­vest heav­ily to cre­ate jobs. They also say Ger­many, the re­gion's strong­est econ­omy, should do more to push up its own wages and prices. Mediter­ranean coun­tries need to price their prod­ucts lower than Ger­many to make up for the fact that their goods - par­tic­u­larly en­gi­neered prod­ucts such as cars - are less at­trac­tive. But with Ger­man in­fla­tion at a mere 0.5 per­cent, main­tain­ing a de­cent price dif­fer­ence with Ger­many is forc­ing south­ern Euro­pean coun­tries into out­right de­fla­tion.

Italy's pol­i­cy­mak­ers are try­ing to stop the drop. Prime Min­is­ter Mat­teo Renzi cut in­come tax in May by up to 80 eu­ros a month for the coun­try's low earn­ers. He is also of­fer­ing work­ers the chance to dip early into a spe­cial fund that stores part of their wages un­til they leave their job.

But so far the emer­gency mea­sures have had lit­tle ef­fect - partly be­cause Ital­ians don't re­ally be­lieve in them. A sur­vey by the Euro­me­dia agency showed that, de­spite the 80-euro cut, 63 per­cent of Ital­ians ac­tu­ally think taxes will rise in the medium-term. Early ev­i­dence sug­gests most Ital­ians are sav­ing the ex­tra money in their pay­checks. If so, it will be rem­i­nis­cent of sim­i­lar at­tempts to boost de­mand in Ja­pan in the late 1990s. The Ja­panese hoarded the wind­falls of­fered by the govern­ment rather than spend­ing them.

Re­nato Gu, an en­er­getic 31 year-old who came to Italy from China at the age of six, is clos­ing down the small, mid-range women's shoe and ac­ces­sory shop he has run for the last four years in the heart of Rome be­cause he can no longer cover his costs.

Gu says shops like his, cater­ing to mid­dle-class Ital­ians, have been the ones most hit by the cri­sis, as on­ce­faith­ful cus­tomers look else­where for cheaper and cheaper prod­ucts. He says he has seen "no ef­fect" on spend­ing from the 80 euro tax cut. "I'll con­sider any line of work," says Gu, who is about to join the coun­try's 3.3. mil­lion un­em­ployed. "But I've had enough of try­ing to run my own busi­ness." Cour­tesy- Reuters

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