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Riding a bicycle and economic developments

Riding a bicycle and economic developments
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ARTICLE TYPE
Insights
TOPIC
Opinion
PUBLISHED
April 21,2021
READ TIME
3 mins
AUTHOR
Serdar Kucukakin
SHARE
Back
ARTICLE TYPE Insights
TOPIC Opinion
PUBLISHED April 21,2021
READ TIME 3 mins read
AUTHOR Serdar Kucukakin
SHARE

Learning to ride a bicycle requires serious effort, both from the child and the parents. But it also requires training wheels, as they will make the process of learning to ride a bicycle smoother and far less painful. Once you have mastered to ride a bicycle the training wheels and the support from the parents running along the bike are no longer needed. This support would even slow you down. Also, once learned, you will never forget how to ride a bike, but if you do not do it for a very long time you will become less skilled at it and practice makes perfect. But the most important lesson could be: if you stop, you could fall.

 

The Italian case

Turning to economics and relating these cycling wisdoms to Italy: Italy is certainly not the world champion or even EU or eurozone champion when it comes to economic growth. The average economic growth rate for Italy since the introduction of the Euro in 1999 up to and including 2020 was 0.04%! Many argue that one should disregard 2020, as it was an extra ordinary year that dragged the average down. I do not share this view. Yes, 2020 was a very extra ordinary year, but it was part of the business cycle and it also provides insights into the possible developments this year. By the way the average economic growth in the period 1999-2019 was 0.5%.

 

ECB lending a helping hand

Currently, Italy (and the eurozone) is given a sizable helping hand by the ECB. This helping hand arguably prevents Italy, with a public debt level of 155% of its GDP and faltering economic developments, from experiencing serious problems, such as possibly getting downgraded by the rating agencies. After all, as we learned before: standing still could lead to falling over. Actually, the rating agencies who measure the willingness and ability of the debtor to honour its debt, have stated that they are explicitly taking the ECB policy into consideration when assessing eurozone countries. Debt serviceability is with a 10Y-Italian rate of 0.791% not an issue at all I guess. Italy is even getting money for very short term borrowing, as the rates up to 4Y are in negative territory.

 

Déjà vu

At the same time it feel like I’m experiencing a déjà vu as we have seen this with some variation before, after the global financial crisis and the European sovereign debt crisis. The ECB provided a helping hand and doing so it increased its balance sheet to around 40% of GDP at the end of 2019 from around 10% before the global financial crisis. Now the balance sheet of the ECB has exploded to above 60% of GDP and more is yet to come. In the end, the outcome as of today is not much different from the previous once: countries are provided life support by the ECB, but the underlying challenges remain unsolved.

 

Solving underlying challenges

This was not unexpected as the late Dutch economist and Nobel prize winner Jan Tinbergen already argued a long time ago: you need as many instruments as problems you are trying to tackle. Thus, regardless of how big the monetary bazooka is, it will not solve the underlying challenges. The ECB support is buying the EU-governments time to act with the expected implementation of the huge EUR 750 billion EU-recovery fund, is the argument. Time will tell if this will make a real difference.

 

Too much help

We also learned from riding a bicycle that too much help can prevent you from properly learning how to ride the bicycle or to speed up. This is exactly what is happening to Italy (and possibly others). Since the global financial crisis neither the growth in the real stock of fixed assets nor the labour productivity (together with land and entrepreneurship factors of economic growth) showed a positive trend break because of ECB policies. Especially the growth of real stock of fixed assets (not the same as gross capital formation) took a beating during the global financial crisis and the subsequent sovereign debt crisis and never really recovered since. The coun­ter argument to this is that it is a very simplistic way of looking at the policies of the ECB and that the situation could have been worse if it wasn’t for the extraordinary ECB policies.

 

Finishing off, I am not criticizing the ECB here, on the contrary! I think the ECB is doing a good job. It is doing what it should and could do to help out the eurozone economy. Though, the ECB only has monetary instruments in its tool box while we learned from Tinbergen that we need more tools to tackle this problem.

 

Reforms, reforms, reforms

The key word here of course is “reforms”. The Italian economy needs to be reformed to make it more dynamic and this is certainly not the within the ECB’s remit but the responsibility of the politicians in Rome. After such a long time of more or less standing still, it is hopefully clear for the policy makers what needs to be reformed. They don’t have the luxury to practice, it has to be perfect the first time. Besides all the similarities between cycling and economic developments, this can make the big difference.

More about the authors

Serdar Kucukakin Senior Sovereign Research Analyst

Serdar Kucukakin is a senior sovereign research analyst and is responsible for sovereign analyses of Central European countries and the Middle East.

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