'La Dolce Vita' Ain't So Sweet for Investors

 | Aug 22, 2011 | 11:43 AM EDT
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Although my Italian has gotten rusty since college, I can still make out a lot of what is said on Italian TV. And as I'm vacationing on Lake Como this week, it's been hard to avoid seeing Italian Prime Minister Silvio Berlusconi on the boob tube, energetically pitching his new austerity package.

Since Italy's economic fate has the potential to put the entire eurozone into an economic tailspin, its success or failure can have an impact on your investment portfolio far beyond your unlikely exposure to the country through the iShares MSCI Italy Index (EWI).

Here's a quick reprise of the economic state of play in Italy.

As European markets were falling off a cliff, on Aug 12, Berlusconi announced a series of measures whose goal is to eliminate Italy's budget deficit by 2013. That's on top of an austerity budget that Italy's Parliament had approved a month earlier.

The new €45.5 billion ($66 billion) package imposes a "solidarity" tax of 5% on incomes over €90,000 ($130,000) and 10% above €150,000 ($217,500). Spending by ministries is being cut by €6 billion ($8.7 billion). Local government transfers are being slashed and 36 provincial authorities with fewer than 300,000 inhabitants will be scrapped.

Now consider how much more stringent these measures are than even the most radical proposals to cut U.S. government spending. Only the most hardcore Tea Party members would have no problem with balancing the U.S. government budget by 2013. Yet in Italy, it's already mainstream government policy.

That highlights a surprising important point about Italy's "spending problem." Italians themselves haven't been on a spending binge like, say, the Greeks or Americans. In fact, Italy's budget deficit, at 3.9% of GDP, is already one of the lowest in the eurozone. And Italians' personal savings rates are quite high.

Granted, it wasn't always so. Back in the mid-1980s when Italy was run by a socialist government, some public workers retired as early as 35 -- about 10 years after they finished (mostly free) university studies.

So what gives? Well, thanks in part to legacy costs of paying pensions for retired 35-year-olds, Italy's debt is among the highest in the eurozone at nearly 120% of GDP.

But Italy's real problem is about getting back the country back to work. Its economy has been stagnant for more than a decade. Nor do the current numbers look good. The economy grew by only 0.3% in the second quarter from the previous three-month period -- though the second-quarter rate was up from the 0.1% growth recorded in the previous two quarters.

Italy's problem is a simple function of mathematical ratios. The numerator of (naturally increasing) government debt is overwhelming the (stagnant) denominator of GDP.

Put another way, it's not that government spending is out of control. It's that the Italian economy is just staying on place.

It's not hard to see why...

Based on a few days spent in Italy's business capital of Milan, you don't get the sense that workaholism and high blood pressure is a big health hazard in Italy. Windows in apartments and businesses are shuttered for a big chunk of July and August. There is hardly a soul in the city except for a couple hundred tourists and a skeleton staff of Eastern European service staff minding the store. Try getting your dry cleaning done, and you're greeted with a curious smile. Security guards in Milan's skyscrapers are nowhere to be found. In Italy, apparently even criminals go on holiday in August.

That leads to my own radical proposal for Italy's "debt problem":

Reduce government-mandated vacation times to, say, to three weeks a year, and you'd probably boost Italy's economic output by 3% a year. And Italy's "debt problem" would be solved in no time.

And that just might put the "sweet" back into Italy's "dolce vita."

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