WHAT CAN ITALY LEARN FROM CYPRUS & GREECE? AMELIA HUTCHLEY

Amelia Hutchley

WHAT CAN ITALY LEARN FROM

CYPUS & GREECE?

The flag of the European Union. Courtesy of Wiktor Dabkowski, Creative Commons The 2008 financial crisis sparked a period of economic uncertainty that resulted in near-bankruptcies and dramatic increases in national debts. The European Union, particularly the euro zone within it, was the site of many of these crises, with good reason: a common currency between many separate nations means that each nation's economic health is linked. This renders these nations, such as the ones that make up the euro zone, vulnerable to recessions or financial crashes both domestic and international; the euro zone demonstrates this weakness via its multiple financial crises over the past ten years. Many members of the euro zone, such as Portugal and Ireland, have faced rising debts since 2008, but perhaps the most famous case is Greece: its debts and subsequent inability to borrow money came on the heels of the 2008 financial crisis, leading the country almost to bankruptcy within a year. In 2009, Greece's debt was at 126.7% of GDP, rising to 146.2% of GDP in 2010. Meanwhile, nearby countries that had purchased Greek government bonds, such as Cyprus, lost money, sometimes enough to cause another crisis. Greece's ratios of debt to GDP in 2009 and 2010, while dramatic, are not unique and are in fact common enough that patterns emerge.

While Greece has taken steps to pay back debts and restore trust in government finances, its financial situation of 2009 is reflected now in its neighbor, Italy. Like Greece, Italy's debt, over 130% of GDP in 2018, has soared past the maximum set by the EU of 60%. Bond yields have risen substantially, indicating that investors are concerned about Italy's ability to repay loans. Italy's new government has also come into conflict with the EU over its proposed national budget, which includes even more government spending and borrowing; this budget would increase the national debt even further, worsening the issue. Additionally, both Greece and Italy have or had substantial amounts of government bonds held by foreign banks. Greece sold billions of euros' worth of bonds to Cypriot banks, and Italy owes large sums of money to foreign European banks. Any substantial decline in investors' confidence in Italy, therefore, will drastically affect the stability of those banks and their customers. The same applied to Greece. This paper will compare Italy's looming financial crisis with previous ones faced by the euro zone and propose how the Italian government can best address their debt.

The use of the euro substantially shapes how each of these countries can respond to financial crises. Investors who lose confidence in the government of one country will sell their bonds, driving interest rates up and creating even more uncertainty about whether the government will be able to pay. The declining bond prices hurt banks, which, combined with increasing economic uncertainty, can worsen recessions. Countries in the euro zone do not have much control over the money supply due to a shared currency, but they can make deals to receive large bailouts, as seen in the billions of euros Greece received from the International Monetary Fund, the European Central Bank, and the European Commission. Additionally, because so much of the debt of countries like Greece and Italy is held by other members of the EU, the EU itself has a vested interest in ensuring that none of its members collapse or go bankrupt. A financial crisis in one country can spread to many others, as seen with Greece and Cyprus, potentially leading to international financial instability.

It would be a gross exaggeration to say that Italy's problems can be solved by copying Cyprus or Greece. Italy's economy is substantially larger, as is its debt: while "[g]overnment-to- -government loans were enough to bail out smaller countries such as Greece," Italy's trillions of euros of debt would have to be guaranteed by the European Central Bank. While this exacerbates the urgency of the issue, as more money is at stake, the increased scale does not impact the basic ideas of how Italy can deal with their debt. However, their possible strategies are complicated by political turmoil. In late May of 2018, the two political parties that were recently elected, Lega and the Five Star Movement (M5S), failed to establish a new government, which caused a sharp depreciation in the euro and a rise in the perceived risk of Italian bonds. As part of Italy's financial trouble comes from its political instability, any financial solutions introduced by Italy will have limited success. The government needs stability to reinvigorate investors' confidence in their ability to pay back loans. That

being said, political stability in and of itself cannot solve their debt crisis, and Italy can take its lead financially from other countries such as Cyprus and Greece that have recently gone through similar situations.

Italy can turn to different examples for how to respond to its growing debt. Greece raised enough money to begin repaying loans from the IMF early. The actions they took to solve their debt problem resulted in reduced debt and even a budget surplus beginning in 2016. However, Italy could also look toward Cyprus's example. While Cyprus also needed sizable loans from the IMF, EU nations, and even Russia, it exited its bailout program early and fully paid off its loans in September of 2019. Italy's plan for addressing its national debt should take into account the factors that made both Greece and Cyprus successful in reducing debt, as well as the differences that allowed Cyprus to pay off its loans quickly and forced Greece's economy into a dramatic decline. While doing so, Italy should take steps to ensure that their current taxation system and government spending are efficient; otherwise, they cannot achieve maximum benefit from the money they raise. The sooner Italy creates and implements such a plan, the longer their time horizon will be to implement it. The EU and IMF can be expected to set a deadline for paying back a certain percentage of the debt if Italy accepts bailout funds from them. In line with that expectation, the more debt that Italy can pay back before its situation is drastic enough that it must accept loans from the EU and IMF to recover, the more freedom it has to set smaller, gradual goals that will not risk shocking the economy. Addressing Italy's debt before it becomes a crisis with international implications is a necessary step, although perhaps unlikely as of right now. The previous party in control of the government adhered to the austerity measures set by the EU, making it and its leader grossly unpopular with its citizens; the current two parties were elected based on campaign promises of increased spending. Nevertheless, in order for Italy to steer clear of bankruptcy, its government must immediately acknowledge the debt problem and begin to take steps to pay it back, protecting the stability of its economy as much as possible.

Cyprus' addressing of its national debt is relevant to Italy's current situation because of both the speed with which Cyprus paid back its loans and the way in which it did so. Its main success lies in how it raised sufficient funds without levying taxes on smaller bank deposits, which protected both its citizens' bank accounts and the stability of its economy. The crisis in Cyprus proves that financial issues in one country in the euro zone can easily affect other countries. When Cypriot banks bought large quantities of bonds from the Greek government, they unwittingly made themselves vulnerable to the Greek financial crisis and later lost billions of euros. Between 2009 and 2011, their debt climbed from 54.3% to 65.9% of GDP and continued to rise, hitting its highest point at 109.2% in 2014. Once Greece crashed, Cyprus's own rising deficit made it unable to sell bonds as well. Its government secured loans from the IMF and other European countries by agreeing to make substantial changes: for instance, they restructured banks, even closing down the second-largest bank in Cyprus, levied taxes on deposits of over €100,000, and adopted austerity measures. Originally, Cyprus had planned to levy taxes on all deposits, but fierce popular protest and fears of a bank run led them to protect deposits of under €100,000 and establish capital controls. The key component of the Cypriot government's plan remained, however: taxes. Austerity measures can focus on raising funds from either increased taxes or decreased government spending; because changes in government expenditures have a stronger effect on the economy, raising taxes allows governments to raise the same amount of money with less risk of worsening their recession. Cyprus's focus on taxing bank deposits meant that its economy could avoid the losses associated with large cuts in government spending. While protecting smaller deposits may have reduced the amount of money the Cypriot government could raise to pay back loans, it did not significantly harm their recovery. Cyprus exited their bailout program early, and this year, it financed the repayment of a large loan from Russia through the sale of long-term government bonds and a budget surplus. The finance minister, Harris Georgiades, stated that "Cyprus can now comfortably finance its needs from the international markets." Cyprus's successful issuing of new bonds, an indication that investors trust the government's ability to pay back loans, proves that it has overcome the worst of its debt crisis and can largely return to normalcy.

So what can Italy learn from Cyprus? At first glance, not much. While the drastic restructuring of the Cypriot banking system was a requirement for Cyprus to receive bailout funds, doing so in Italy's larger economy might send shockwaves through other countries from which large deposits have been made to Italian banks. Whether the benefits are worth the risks is impossible to know for certain; certainly, other countries might prefer Italy fund their loan repayments through austerity measures that place the

burden of raising funds solely on Italy. As Italy's economy has striking differences from Cyprus's, notably scale, copying Cyprus's financial restructuring would not have the same effects. However, Cyprus's government proved responsive to its citizens' opinions, dramatically revising the parts of their plan that drew protest.

When building their own loan repayment plan, Italy should consider Cyprus' focus on tax-based austerity measures while still protecting smaller bank deposits . Because Italy is already politically unstable, they cannot afford to adopt wildly unpopular measures, such as the bank levy in Cyprus on deposits under €100,000. Implementing austerity measures in Italy will be difficult enough, even without directly taxing citizens' bank accounts, because the governing parties both promised during campaigns that they would increase government spending. The potential civil upheaval as a result of policies drawing money from personal bank accounts would further reduce confidence in the Italian government and Italian banking, worsening their situation even more. However, austerity measures in their most basic form, the idea of increasing revenue and decreasing expenditure, are necessary to reverse a pattern of accumulating debt and begin paying that debt back before interest accrues to an unmanageable amount; thus, the government must find a way to implement them. If Italy focuses on raising taxes on large bank deposits, and increasing taxes in general as opposed to cutting spending, they can raise money without overtly breaking campaign promises; successfully reducing debt while maintaining or increasing spending on public services would also assist in retaining popular Italian support for their government.

Greece is an example of another approach to reducing debt, with considerably different results. While Greece has also raised enough money to begin paying back loans, its economy has suffered; the plans it made involved dramatic cuts to public spending in ways that would ultimately cause a substantial contraction in the national economy. Greece needed to be stabilized for the sake of other countries, such as Cyprus, and to maintain faith in the euro as a sustainable form of currency. Like Cyprus, Greece also had to implement austerity measures to receive bailout funds from the IMF and the EU; for example, they reduced pensions, raised the retirement age, cut pay for public sector workers, and raised taxes. However,

Cyprus, Aiya Napa; image from Wikimedia Commons

unlike Cyprus, Greece's austerity measures hurt its economy in the long run, meaning that its recovery will take significantly longer. As we know, expenditure-based austerity measures are less effective than tax-based measures and can even harm economies through reduction of output, meaning that the results of Greece's drastic austerity measures come as little surprise.

Reducing the income of a large amount of the population exponentially reduces the amount that an economy can grow, because those people will have less money to circulate back into the economy; Greece was no exception to this principle. The cuts that the Greek government made to government spending included large cuts to sources of income for many Italian citizens, compounding the risks of their expenditures-based approach to austerity. While Greece has had a rising budget surplus since 2016, and it began issuing bonds in 2017, indicating that it too is past the worst of its crisis, the process of reducing its debt has severely impacted its economy. Unemployment is strikingly high, at over twenty percent, and almost fifty percent among younger workers; government spending decreased by over thirty percent and the economy itself "has contracted by more than 25% since the peak of the pre-crisis boom". Losing output, as Greece did, makes government debt an even higher percentage of a newly lowered GDP; such a situation means that the government has imposed or worsened a recession to pay back debts that become harder and harder to pay. Greece has made drastic, often unpopular changes (such as those that reduced both pay and employment for public sector employees) to keep their economy afloat, making their victory hard-won. However, where Cyprus acceded to

The Euro, the currency in Italy. popular protest, such as that which took place against the potential Cypriot bank levy, Greece stood firm. The alternative measures that Cyprus took, which involved shutting down one of their largest banks, may have seemed too drastic and destabilizing to Greek authorities; nevertheless, the fact remains that Cyprus exited their bailout program and paid off their loans much earlier. Economic losses aside, Greece's approach did succeed in its most important goal: reducing the critically high levels of debt that the country had accumulated. They even managed to do so without leaving the euro as a form of currency altogether. In that regard, their example also provides key takeaways for Italy.

First of all, Greece's debt built up over a long period of time, just as Italy's has; officials cannot claim ignorance about the dire state of Italian finances. Part of the severity of Greece's austerity measures came from their necessary ambition. They needed to cut government spending by thirty billion euros within three years, and to achieve that goal, they targeted anything they could, including everything from reducing pensions to cracking down on tax evasion. Because both Lega and M5S promised to make earlier retirement possible when campaigning, imitating Greece's approach of raising the retirement age would substantially hurt popular support of the government. To avoid cutting government spending so drastically, especially in areas that hurt citizens such as pensioners and public sector workers, Italy should implement austerity measures immediately, before a bailout deal with the EU forces them to impose a strict deadline. They can address debt more incrementally than Greece did and therefore have the luxury of avoiding cutting spending in areas that their citizens depend on as a source of income; this mitigates the risk of recession as a result. Additionally, protecting the incomes of their citizens will in turn protect the Italian government from the protests that Greece endured and prevent the kind of economic overhaul that hurt Greece's growth. The central reason that Greece's austerity measures led them into a deeper recession is that Greece took a government expenditures-based approach to raising funds; by minimizing cuts to government spending in their plan for austerity measures, Italy can then in turn minimize its risk of a similar result.

An Italian recession would signal a potential increase in economic problems throughout the rest of the EU and even the rest of the world. Each country in the euro zone has an impact on not only its own economy, but that of every other country that uses the euro. In 2018, the euro zone comprised over sixteen percent of global GDP; thus, the economic health of the euro zone, the financial rating of its governments, and the security of its banks also have a significant impact on the health of the global economy. Just as Greece's national debt caused a corresponding crisis in Cyprus, Italy's debt represents not only a threat to the economic stability of a subsection of European countries, but a threat to the stability of international economies. The possibility of a snowball effect with global implications makes Italy's quick and non-disruptive recovery from this debt a necessary priority.

By using the examples of Cyprus and Greece, Italy can make informed decisions about how best to approach its financial situation while mitigating the risk of recession. The EU frequently requires austerity measures before providing bailout money, and the only way to reduce debt is to have it erased or to pay it back; given these two conditions, reducing government spending and increasing taxes seem inevitable, even if the government focuses on one or the other. Adding to the burden, Italy's debt has more in common with Greece's than Cyprus's in terms of scale. Protecting smaller bank customers as Cyprus did is less feasible because Italy simply needs to raise more money, so the Italian government may have to cut spending and raise taxes in many more areas than Cyprus did to pay back its debts. The size of Italy's national debt will prohibit its government from adopting certain strategies and may force it to create a budget more in line with Greece's approach than Cyprus's.

That being said, Italy can still apply lessons learned from Cyprus along with the ones it can take from Greece:

Cyprus's tax-based austerity measures proved more successful than Greece's expenditure-based measures; thus, Italy should implement a plan where the majority of funds are raised from increa-

sing taxes rather than cutting government spending.

Taking steps to protect the customers most vulnerable to substantial financial loss in a recession can help solidify popular support of Italy's government, an especially important measure because of the current Italian political turmoil. The government should focus on taxes that will impact large corporations and the wealthy, such as levying a tax on bank deposits over a certain amount.

The governing party should maintain popular trust in their government as much as possible. They can do so by making a visible effort to preserve their constituents' livelihoods and avoiding cutting government spending, a goal that has positive implications for the Italian economy in general.

Cyprus' approach preserved the long-term health of the economy by targeting wealth held in savings for fundraising, rather than wealth being re-circulated into the economy such as pensions and the wages of public-sector employees. Italy can and should follow their example of where to draw funds from to ensure that their economy is still able to grow.

Time is a crucial factor in determining the success of this strategy. By taking a proactive approach to the issue, Italy can begin reducing its debt before conditional bailout funds from the EU impose a deadline; the government can then take a more incremental, less invasive route to financial stability than Greece did.

Italy's debt is on a scale larger than Cyprus's and Greece's, which raises legitimate concerns about whether the government will be able to successfully reduce debt enough to avoid a crash or bankruptcy. Italy's current system of taxation and government expenditures may also be contributing to the rising debt through inefficiencies and wasteful spending. However, by drawing on these six conclusions, Italy can begin to address its debt with a plan that minimizes risk to the health and stability of its government and economy. In turn, a return to financial stability in Italy will maintain faith in the viability of the euro as a common currency and reduce pressure on other EU countries to contribute money for bailout funds, as well as protecting against crashes like Cyprus' in other countries. Given these results, the rest of the euro zone has a financial stake in the health of the Italian economy and may attempt to push Italy to adopt austerity measures and other plans to reduce debt. Italy's populist government may need some kind of international pressure to actually take action; further research could look at the political and economic incentives that the rest of the EU might offer to force Italy to address its debt. Overall, while it might not be in the current government's interest to acknowledge problems resulting from high expenditures, failing to do so will result in economic instability and renewed fears of crashes in every country financially tied to Italy.

Bibliography

"Explaining Greece's Debt Crisis," New York Times, Jun. 17, 2016, https://www.nytimes.com/interactive/2016/business/international/greece-debt-crisis-euro.html. "GDP (current US$)," World Bank, accessed Oct. 27, 2019, https://data.worldbank.org/indicator/NY.GDP.MKTP.CD. "General Government Deficit/Surplus," Eurostat, accessed Oct. 27, 2019, https://ec.europa.eu/eurostat/tgm/refreshTableAction.do?tab=table&plugin=1&pcode=tec00127&language=en "Government Finance Statistics and EDP Statistics: Statistics Illustrated," Eurostat, accessed Oct. 27, 2019, https://ec.europa. eu/eurostat/web/government-finance-statistics/statistics-illustrated. "In Graphics: Eurozone Crisis," BBC News, Apr. 25, 2013, https:// www.bbc.com/news/business-13361930 "Italy Risks Disciplinary Action for Violating EU Debt Rules," BBC News, Jun. 6, 2019, https://www.bbc.com/news/world-europe-48536954. "Q&A: Cyprus Deal," BBC News, Mar. 28, 2013, https://www. bbc.com/news/business-21922110. Andrew Walker, "Greece Makes First Return to Debt Market in Three Years," BBC News, Jul. 24, 2017, https://www.bbc.com/ news/business-40645195. Dharshini David, "Could the Next Euro Crisis Come from Italy?" BBC News, Jul. 9, 2019, https://www.bbc.com/news/business-48884517. Francesco Guarascio and Renee Maltezou, "EU Approves Greece's Repayment of IMF Loans, Cutting Its Debt Costs," ed. Larry King, Reuters, Oct. 28, 2019, https://www.reuters.com/article/us-eurozone-greece-esm/eu-approves-greeces-repaymentof-imf-loans-cutting-its-debt-costs-idUSKBN1X70Z9. Jack Ewing, "Greek Crisis Leaves Cyprus Mired in Debt," New York Times, Apr. 11, 2012, https://www.nytimes. com/2012/04/12/business/global/in-cyprus-a-national-questto-shore-up-teetering-banks.html. Marcus Walker, "As Euro Crisis Ends, Italy Stokes Fear of a Revival," Wall Street Journal, Aug. 19, 2018, https://www.wsj. com/articles/as-euro-crisis-ends-italy-stokes-fear-of-a-revival1534676400?mod=mktw. Michele Kambas, "Cyprus Says Pays Off 2011 Russian Debt," ed. Peter Graff and Catherine Evans, Reuters, Sep. 2, 2019, https:// www.reuters.com/article/cyprus-russia-loans/update-1-cyprussays-pays-off-2011-russian-debt-idUSL5N25T3ST. Nicola Acocella et al., “An Evaluation of Alternative Fiscal Adjustment Plans: The Case of Italy,” Journal of Policy Modeling (2019), accessed November 14, 2019, https://doi.org/10.1016/j. jpolmod.2019.07.007. Phillip Inman, "Italian Bank Fears Expected to Grow After Debt Downgrade," Guardian, Oct. 21, 2018, https://www.theguardian. com/world/2018/oct/21/fears-about-italian-banks-expected-togrow-following-downgrade. Roberto D'Alimonte, "How the Populists Won in Italy," Journal of Democracy 30, no. 1 (January 2019): 114, accessed November 4, 2019, https://muse-jhu-edu.ccl.idm.oclc.org/article/713727. Stephanie Kirchgaessner, Daniel Boffey, and Philip Inman, "Italy at Risk of New Financial Crisis In Wake of Coalition's Collapse," Guardian, May 29, 2018, https://www.theguardian.com/ world/2018/may/29/italy-risk-new-financial-crisis-wake-coalitions-collapse-investors-alarmed-mood-against-euro.