Italian autumn

Italys cost of borrowing shot up after its prime minister,Silvio Berlusconi,announced his resignation. This will make Italys fiscal borrowing costs unsustainable and push it into a crisis requiring a bailout and exacerbating the eurozone turmoil. The most important message from Greece and Italy is the importance of fiscal space as a buffer. There is an important lesson for India in this.

In the decade prior to the crisis,Greece and particularly Italy seemed to be doing fine fiscally. As an example,Italy has had fiscal numbers through the last decade which were better than those seen in India. However,when the stress test commenced,the fiscal situation deteriorated dramatically. Fiscal health is critically connected with economic growth. A fiscal stance consistent with earlier assumptions about economic growth fell apart when economic growth slowed. In a similar fashion,Indias simmering fiscal crisis is only held in check by growth of above 7 per cent. If GDP growth were to drop below 7 per cent,the economy could collapse into a full-blown fiscal crisis. It would have been wise for Italy to hold bigger buffers in terms of fiscal strength in good times,so as to be ready for bad times.

When the chips are down,all economics is political. The crisis in Greece and Italy vividly teaches us how mistakes in economic policy must be resolved by the political system,and when politicians fail on the stress tests that will inevitably arise,the administration should leave. Politicians and political observers are often sanguine about bad economic policy. Bad economic policy is a lot like being overweight. In the short term,the man who weighs 100 kg feels fine. But bad economic policy is like diabetes or heart disease. Matters will sooner or later come to a crunch. We do not know how to predict when a heart attack will come. Similarly,we cannot predict when bad economic policy will lead to an economic crisis. But such a stress test is almost inevitable. The political system,and ultimately the Constitution,must ultimately be designed to be able to survive such tests with flying colours. Greece and Italy appear to,so far,be failing the test their political system has fatal flows. The citizenry of these countries is now paying the price with a decade or more of slow or zero growth.