Both Greece and Italy (possibly also Spain and Portugal) share the same fundamental economic problem that is productivity and terms of trade. Simply put, they cannot compete on the international market in some sectors, with the exchange rate of the Euro, their real wages and price level.
Structural problem
A pre-euro Italy would look like this:
w↑→PItaly↑
That is, high wages, high price level
Eeuro↓
The euro is appreciated.
Competition from China→Pworld↓textiles
Productivity not increased.
Real price = w/productivity
q= ↓E(pWorld ↓)/PItaly ↓)=>q ↓=>demand ↓
The solutions:
Avoid semi-centralized wage bargaining. If real wages are fixed => inflation eats real wage, but inflation low by ECB.
Increase competitiveness through fiscal contraction
G↓ → P↓→q↑ But this will lower output.
Increase demand through G↑ Mainly Italian products. But a restricted GDP ratio.
Increase demand through G↑ Mainly Italian products. But a restricted GDP ratio.
Industrial restructure away from manufacturing; painful in the short run, but the effect in the long run.
Leaving the EMU?
Without the EMU exchange rate depreciates E↑. Lower prices. But also higher inflation, should not affect real terms of trade. Italy can now compete but it does not solve the basic efficiency problem that is productivity. Italy has a history of inflation, however, this does not necessarily stipulate continued problems.
Also it’s a very high political cost, but it is a cost that for every day the problems gets worse, and the problems aren’t solved, the benefits will ultimately outweigh the costs.
