The long shadow of European shoppers

If there is one thing I’ve learned in Rome over the past week, it’s that this morning’s headlines are correct:  the Euro zone is headed for more trouble.  While Rome’s streets are crowded and people are eating their fill, the cashiers are idle and the shopping bags empty.

That’s because of two factors:  taxes and uncertainty.  Prime Minister Mario Monti moved quickly once Silvio Berlusconi was out of the way to raise taxes and cut government expenditures.  The big tax hit comes at the end of June, when real estate taxes have to be paid.  People I am talking with claim they will double, but just as important is the uncertainty.  The complicated way they are calculated, and their different application in different localities, means that no one really knows yet how much they are going to have to pay.  The natural reaction is to cut back on expenditures until you are sure you can pay the piper.

Contrary to their image, Italians are big savers.  The savings rate has dipped to around 11 per cent recently, a high level compared to the U.S.  A lot of those savings have been plowed into real estate, which Italians generally buy mostly with cash.  It is common for people to own three or four abodes–a house they live in, one in the country, and one or two rented out until the kids are old enough to occupy them.  I don’t imagine it will be long before the costs of carrying all this real estate motivate a lot of Italians to sell, creating a bear market in real estate that hasn’t been seen since World War II.  Buyers will be few:  mortgage rates are rising in Europe, not low and sometimes falling as in the U.S.

The Italian government is trying to promote more growth, largely by loosening up what has been an extraordinarily rigid labor market:  Italian firms don’t hire readily because they can’t fire readily, or at all.  But there is still a lot of negotiating to do before the system begins to yield. And there is a serious risk of a two-tier labor market, with older workers holding on forever while younger ones never really get onto the first rung of the ladder.

In the meanwhile, Italian industry is losing competitiveness fast.  A stop in Deruta earlier this week suggested that the ceramics business is beyond rescue.  Dozens of firms have closed and the remaining ones have prohibitively high labor costs.  No one but the very rich is going to be able to afford the hand-decorated plates my wife and I bought 40 years ago.

Official projections for this year have the Italian economy shrinking one per cent.  That looks likely to be over-optimistic.  With the Euro still strong–easily 25% higher than its purchasing power parity with the dollar–I’d bet on a lot deeper recession than that.

This will have a serious impact beyond Europe’s borders.  First, in my beloved Balkans:  it is hard to find anyone here interested in seeing even Serbia become a European Union member.  Second, in the Arab uprising countries.  Libya is important to the Italians.  They are pleased that oil and gas exports are rebounding.  But Syria is ignored here.  In a week of lots of conversation with internationally-minded Italians, no one has mentioned it before I did.

But most importantly:  a big European recession could affect the recovery in the United States, crimping growth and increasing risks of another relapse, if not into recession then into very slow growth.  Barack Obama’s reelection prospects depend on at least moderate growth continuing in the U.S.  Republicans who see Barack Obama as a European socialist will think it only just if a recession in overly-regulated Europe leads to his defeat.

It is still far too early to count either Obama or the Europeans out. Even with empty shopping bags, the Italians are still living well and enjoying life.  Barack Obama has a difficult seven months ahead:  the Iran nuclear issue is likely to come to a head during that time, and he’ll have some tough choices to make on how fast to withdraw from Afghanistan and whether to intervene in Syria as well.  But the presidency is still the best place to be running for president from.  The consequences of a European recession will dim his prospects, but not rule him out.