Thinking beyond public debt | FinancialTimes

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Marcello Minenna is an economist and technical evaluator for the Calabria region, assistant professor of financial econometrics and empirical finance at the Università Telematica San Raffaele and columnist at Il Sole 24 Ore. The opinions expressed are strictly personal.

Our readers are largely aware that Italy’s public debt burden is very high, both in absolute terms and in terms of debt-to-GDP ratio.

But that ignores an important part of the debt landscape: when non-financial private debt is included, Italy doesn’t look so burdened.

To set the scene, let’s first look at the evolution of public debt over time in the EU.

Public and private debt

For our purposes today, we will compare the four largest eurozone economies — and Greece, with its historically high debt and recent signs of a turnaround — using BIS data on the market value of private and public debt.

The debt-to-GDP ratios of European countries have mostly increased between 2008 and 2022, with Germany being the exception:

As shown above, debt-to-GDP ratios have declined since February 2021. This decline has been global, as shown the IFF, and is attributable to two different factors. First, there has been an increase in GDP linked to the post-pandemic recovery of economic activities and international trade. Second, governments have relied less on debt issuance to finance themselves since the end of the Covid-19 crisis.

And while the chart above shows that Italy’s public debt level remains high relative to its peers, there are other ways to gauge a country’s debt load.

When non-financial private debt is taken into account, Italy’s debt levels sit at considerably lower levels than many of its major European counterparts. Families in Italy, for example, have lower debt than any of our comparator countries:

Italy also stands out for its relatively low levels of non-bank corporate debt:

Low overall debt, high sovereign rates

In fact, if we combine public debt and non-financial private sector debt and then compare them to GDP, Italy has the second lowest debt of the bunch, just behind Germany:

This is an element to be taken into consideration, since a high level of private indebtedness can contribute to financial instability. This was the case in Iceland where, just before the 2008 economic crisis, the private debt/GDP ratio reached 450%.

The analogies don’t end there, as this crisis hit hard when interest rates started to rise. (While Iceland’s financial sector was the source of its problems, the 2008-09 crisis showed that many governments are unwilling to let their banks fail, giving them semi-public status.)

Yet even with its relatively low aggregate non-bank debt levels, Italy’s sovereign yields remain high. Italy’s average 10-year bond yield is the highest of the lot, at 4.45% versus Greece’s 4.42%:

It could be argued that investor expectations are affected more by EU regulatory oversight than by macroeconomic conditions.

From this point of view, Italy appears disadvantaged by a regulatory system that focuses far too much on public debt/GDP ratios, while underestimating or ignoring other parameters. A potentially useful parameter overlooked by EU regulatory oversight is the debt-to-GDP ratio of the non-financial private sector. from Eurostat monitoring of macroeconomic imbalances prescribes that the ratio remains below 133%, while the comparable threshold for a country’s public debt-to-GDP ratio is 60%.

Another parameter overlooked by EU regulatory oversight is the measurement of trade balances. Germany, for its part, spent years with a trade surplus above the regulatory threshold of 6% set by Eurostat, and its trade surplus hovered above or just around this level from 2012 to 2021:

Modification of the convergence criteria

An advantage of basing convergence rules on measures of public debt is that EU member governments have direct control over their own borrowing. With private debt surveillance, governments’ relationships with borrowers and investors are subject to market rules, mediated only by government economic policy actions.

Nevertheless, it might be necessary to reconsider and complete the standard measures in the revision of the convergence criteria expected in the coming months. This review will take into account the exogenous variables that have affected the EU in the recent past (e.g. pandemic, war) or will affect it in the near future (climate change, immigration flows) and their consequences on the EU. real economy (ie, inflationary pressures, employment levels and the need for structural investments). Policy makers may also consider taking private debt levels into account.

For example, it can be expected that a low level of private sector indebtedness and/or a high level of private savings are likely to contribute to the stability of the system, and, therefore, such phenomena should be taken into account by public debt management rules.

A recent study shows that only once since 1950 has a reduction in public debt been accompanied by a reduction in private sector debt.

These results could be explained by considering that a higher exposure to private debt could have stimulated the economy, therefore increasing tax revenues and reducing the expenditure ratio of the automatic stabilizers. Conversely, the strengthening of fiscal discipline aimed at reducing public debt may have drained resources from the private sector and pushed businesses and families to take on more debt.

Be that as it may, data collected over the past 70 years shows that unless the private sector increases its exposure to debt, it is unlikely that EU countries will be able to achieve a significant reduction in the public debt/GDP ratio.

In Italy, the ratio of public debt to GDP has increased since 2008. This continued until the end of the pandemic. In contrast, data on private debt shows a slowdown in growth since July 2009, followed by a less than proportional decline that began in late 2012, except for a temporary surge during the pandemic:

The total wealth of Italian families (if we also consider real estate, net of liabilities) is over 10 billion euros. In 2021, the net wealth of Italian families was the highest in Europe, at 8.7 times their disposable income (France: 8.6; Germany: 8.8).

Nonetheless, Italy’s savings rate, which has long been the highest in the developed world, has been falling for at least two decades. But there was a reversal of the trend with the start of the pandemic:

It’s not surprising. In a climate of uncertainty, individuals are less likely to consume, and more likely to allocate part of their income to savings. This is exactly what happened between January 2020 and September 2021, when the financial wealth of families increased by 334 billion euros, most of it deposited in bank accounts.

In 2004, Italians saved around 15% of their annual income, an average savings rate only surpassed by Germany and Belgium and higher than that of the wider euro area.

The situation today is quite different. It is estimated that Italian families save on average only 10% of their annual income, the lowest in Italian history, while the euro zone averages 14%. The gap is widening between the savings rates of Italian families and German families.

After the pandemic, private debt and family savings rates increased in Italy: this is a clear indicator of increasing social inequality. In other words, the poorest individuals and those who suffered a decline in income took on debt to maintain their standard of living, while the wealthiest individuals invested even more.

Savings, debt, wages and social inequalities

The continued impoverishment of the Italians is confirmed by the results of a study conducted by the International Labor Organization, or ILO: at purchasing power parity (PPP), the Germans and the French today perceive higher wages than in 2008, while Italian wages fell by 12%:

It is important to keep in mind the challenges Italy faces in its efforts to close the gap with other eurozone countries in terms of real income. The surest way to achieve this, and to strengthen the eurozone and the EU in the process, is to review convergence policies that are far too focused on public debt alone.