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December 12, 2016

Renzi without Renzi

This is a new Renzi administration, without Renzi. The names will be essentially the same, perhaps marginally reshuffled. The coalition majority is the same. The new government under Paolo Gentiloni continues as though almost nothing had happened. It looks to us like they will continue all the way until 2018, simply because there is no technical need for early elections.

It also looks to us like Renzi is preparing for another leadership bid. Corriere reports this morning that he is considering resigning as general secretary of the Partito Democratico, so that he can force an early party congress in which he could see his mandate renewed before entering the primaries of the party. What we expect to happen is that Gentiloni will have his usual honeymoon of about one year, and we would be very surprised if he voluntarily gave up his seat at the table with Angela Merkel and other leaders so that Renzi can take over once again. Watch out for disunity in the PD.

La Repubblica writes about the five top items on Gentiloni's agenda: the number one issue is, apparently, Italy’s relationship with Egypt and Libya; number two is the introduction of a more proportional voting system for the chamber of deputies and the Senate; number three is earthquakes; number four the banks; number five some minor changes to the public administration, mostly undoing some of the existing reforms. He has already decided to abolish the ministry for reforms, previous held by Maria Elena Boschi, Renzi’s most important minister, who may enter the Gentiloni administration in a different role though this is not clear yet.

Given Italy’s challenges, this is a truly bizarre political agenda. We would expect Gentiloni to be a smooth political operator, much easier to deal with than Renzi, much more likely to be told to toe the fiscal line, and much less likely to threaten vetos, as Renzi just did. Renzi had two qualities in his favour. He is charismatic. And he at least understands the need for change - though we believe that he had his priorities the wrong way round. With Gentiloni we are now looking at another 18 months of no action from the eurozone’s most vulnerable country.

Renzi without Renzi greatly increases the probability of an eventual election victory of the Five Star Movement, perhaps in a coalition with other euro-sceptic parties. We noted a poll in the Huffington Post Italia taken before Gentiloni was appointed prime minister. It confirmed that the Five Star Movement is going from strength to strength. It would now easily win a run-off against either the centre-right or the centre-left, having increased its margins by 4.5pp and 1.5pp respectively since October.

Wolfgang Münchau has written his FT column on Italy’s sustainability as a member of the eurozone, and argues that the threat of an Italian euro exit must be taken more seriously. Stranger things have already happened this year, and this is an accident waiting to happen. Münchau lists five avenues that could pave the way for a sustainable euro membership - economic convergence; fiscal transfers; political union; permanent debt monetisation; and politics overriding economics indefinitely. He says he can’t think of a sixth path, and notes that each one of the five is highly improbable. His analysis gives no clue as to when or how an Italian euro exit will happen, but he notes that lack of sustainability will lead to exit unless sustainability is achieved. Germany’s decision to target a zero deficit and to refuse any notion of fiscal transfers makes it virtually impossible for the eurozone to stay together in its current form. He says the most urgent task for the Italian prime minister is to confront the new situation head-on and to force one of these avenues to open, rather than hoping to stay below the radar screen. With Gentiloni, the Italians got another politician who will pursue the latter course.

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December 12, 2016

Shall we compensate the losers of globalisation?

Gavyn Davies addresses an important issue - how to compensate the losers from globalisation - but we are wondering whether he is maybe asking the wrong question. It is a very frustrating article to read because he shoots down virtually every solution. He notes that there is an emerging consensus among economists that there are losses to some groups in society from free trade, and that it would be wise to compensate the losers because otherwise we run the risk of an end to globalisation. While there is now agreement that the US rust belt needs help, nobody has any clue how to deliver it. Davies discusses transfers through the tax system, but says this could never be appropriately targeted to avoid multiple side effects. And the history of regional policies (Italy and German) have also not been encouraging.

The difference in focus between politicians and economists is that the former look at median values, whereas the latter look at averages. The median voters in the US and the UK are worse off than they were ten years ago, whereas per-capita GDP, an average measure, is still rising. This is why it is perfectly rational for politicians to ignore a macroeconomic optimal solution, since it does not affect the marginal voter who matters to them the most.

Furthermore, we doubt very much that the problem of globalisation could be brought under control by writing checks. From a political point of view, it is much more rewarding to protect industries from foreign competition through import tariffs than to redistribute the spoils of globalisation, because people in the rust belt want secure jobs, not welfare. It may be frustrating to economists, but non-economic factors dominate.

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December 12, 2016

The need for a partnership with China

We have not had the occasion to read Ian Bond's entire report yet - only the short summary - but the overall thesis strikes us as plausible. The Western powers should reorient their foreign policies and strike a strategic partnership with China. Of the four options we face: oppose both; oppose one, but not the other; or seek partnership with both; Bond recommends that we should oppose Russia and seek partnership with China. He notes that the two countries have diametrically opposed economic visions. China wants to link up with Europe through a "silk-road economic belt" crossing central Asia, whereas Russia's Eurasian economic union is the attempt to force a single economic space for the countries of the former Soviet Union. The agreement to bring the two initiatives together has so far not made any progress.

Given that Trump himself is favouring closer relations with Russia, Bond's policy recommendation translates into a call for the EU in particular, since we already know that the Trump administration will not follow his advice. It worth citing Ed Luce's take on the economics of Trump:

"The temptation to undermine the Fed’s independence, make a scapegoat of China, revive talk of deporting immigrants and slap tariffs on Mexico will grow with the trade deficit. At which point the markets will recall what it was they originally feared about Mr Trump."

We are as puzzled as anyone else is by Trump's pro-Russian stance, and feel that there is possibly more behind this than meets the eye. If the US and Russian align strategically, the EU may well consider a more strategic relationship with China - though we think this is unlikely given the close relations with Russia of European industry and their political puppets. The idea of the EU developing its own strategically-oriented foreign policy is too good to be true.

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