UK sees May recovery, Italy descends, but can the west grow its way out of crisis?

I see only one hope for the economy and in the long run - equities, and the data out earlier this week tells us whether this hope may be realised?

Article updated: 6 June 2018 9:00am Author: Michael Baxter


I see desperation. Look at the policies being put forward by the new coalition government in Italy and there is only one word I can think to describe them and that is ‘desperate’. The economic prospects are so awful that only something radical can save the economy, or so the new policies being put forward seem to tell us. Meanwhile, the UK has seen good news this week. The US looks strong. But there are much bigger things to worry about.


So, Italy has got huge levels of government debt and along comes a new Italian government planning to slash taxes and introduce a new basic income. If the coalition can get its tax through, corporate tax is going down to 20 per cent, while Italy is set to see two income tax rates – 15 per cent for most citizens and 20 per cent for families that see a joint income of more than 80,000 euros. You could say that these are bold plans, some might say they are downright irresponsible.

Actually, there is a sense of Trumponomics about them, with one big difference. In the US there is very little spare capacity. Recent data suggests that there are now more job openings than job seekers in the US. The Trump tax plans will stimulate the economy when there is little evidence it needs stimulating. A sharp rise in inflation leading to much higher interest rates than the markets expect is a possible consequence.

In Italy, there is lots of spare capacity. Unemployment is at 11.2 per cent, youth unemployment is at 33.1 per cent. Italy urgently needs stimulus, whether the proposed tax cuts are the right kind of stimulus is debatable, but it needs something.

I read that the euro is the problem, that since the formation of the single currency, unit labour costs in Italy have risen by around 20 per cent relative to Germany. But to blame all this on the euro is too easy. The euro was introduced for a reason – the previous system of floating exchange rates was not working either and too often falls in a currency, such as the lira, were accompanied by rising inflation cancelling the gains outs.

And if Italy needs a cheaper currency as so many suggest, explain why it has a substantial current account surplus.

What Italy really needs is more aggregate demand. Only this can fix its problems. The new government is gambling that fiscally expensive tax cuts will create so much economic growth that tax receipts will come pouring in again. The big risk is that the markets will force the yield on Italian government bonds so high, that the interest on debt will become unaffordable.

The underlying threat to the euro area has not changed. The region needs stimulus, it needs more demand, and this has to come from Germany. Meanwhile, the Italian crisis has hit the euro which is good for German exporters. Germany is the biggest beneficiary from the euro, it must do more to stop its collapse.

But what Italy, along with Spain and Greece really need is more growth. For that matter, so does the UK, and that brings me to the latest data.

The latest data

The beginning of each month sees the latest purchasing managers indexes (PMIs), for providing the timeliest indicator of how the economy is performing.

There was good news for the UK, bad news for Italy, and ‘so so’ news for the other major European economies.

The latest PMIs tracking UK manufacturing, construction and services rose, pointing to a reasonable pick-up in the second quarter, with growth expected to come in at around 0.4 per cent, compared to 0.1 per cent in Q1. That is still a slow growth rate, but it is an improvement. (Also, the data does seem to point to a slowdown later in the year).

As for the euro area, the PMIs pointed to growth of between 0.4 and 0.5 per cent, the slowest growth rate for some time. Disappointingly, the latest PMI tracking Italian services fell to a two year-low.

Forgive me for using that ‘D’ word again, but Italy desperately needs growth, instead it is slowing.

Trade War

But if you fret that the Italian crisis could spew over and create some kind of global crisis, I think you are fretting about the wrong thing.

The big danger to the global economy lies with trade wars. A recent report from the World Bank has warned that a trade war could hit the global economy harder than the credit crisis of 2008 did.

The markets are betting that President Trump is bluffing with his planned tariffs. I think they are being way too complacent. Trump calls his negotiating tactic ‘the art of the deal’, I think it is more akin to using bullying tactics to get his own way and Mr Trump has had very little experience of what happens when people stand up to him.

I don’t think either he or the people who support him have an inkling of the damage a trade war will do, or the sense of frustration come irritation building up against the US across the rest of the world.

Such frustration may turn into fury, I think the risk of a calamitous trade war is very real.

See also:

Is the global economy really heading for another 2008 style crisis? 

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

See what else we have to say
Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.