Once again, Romanians are taking to the streets to protest the government’s plans to undermine the justice system. A raft of new laws currently being rammed through parliament would decriminalise high-level corruption and weaken the country’s checks and balances in an obvious attempt to shield the political class from prosecution.
The authority of Romania’s Anti-Corruption Directorate (DNA) would be severely curtailed and the judicial inspection body overseeing the work of judges would be brought under the auspices of the Justice Ministry. These actions, which have drawn the ire of the U.S. State Department as well as of the European Commission, risk upping the temperature of Romania’s already heated economy.
Growing at 8.8% year on year in the third quarter of 2017, Romania’s GDP expansion has outpaced China’s for the first time in a decade. The tech and automotive industries are thriving, owing to the fact that Romania’s education system has an excellent reputation for producing a labour-force well-versed in STEM subjects. This has proved attractive for global IT firms such as Microsoft, Oracle and IBM, which have established major hubs in the country.
Strong economic growth has also led to the lowest unemployment rate in eight years, which stood at 5.6% in October. However, economic accomplishments notwithstanding, Romania’s economic success is running on borrowed time – suspicions that will only grow if the policies that brought about the growth are considered.
The government, led by Prime Minister Mihai Tudose, has aimed to make Romania an attractive place to invest, both to fuel the economy and to let the citizens partake in the resulting spoils. To this end, wages were increased across the board in order to stimulate consumption – with the result that consumption has been the main driver. Large-scale tax cuts, including to value-added and income tax, further boosted private spending.
Is It Unsustainable?
However, economic observers warn that this type of growth is hardly sustainable. The government’s wage hike in the public sector means that public debt has surged simultaneously. Latest available data place the country’s debt at 37.6% to GDP, a ratio more than double than that in 2008. Though the debt is relatively low in global comparison, Romania’s economists are rightfully alarmed: when the next inevitable crisis hits, the country could well be pushed to the brink of Greece-style debt default.
Exacerbating the situation is the fact that Bucharest has financed the wage increases by cutting investment in infrastructure and other public works, both of which are key for future economic performance. In the light of these conditions, the government stands accused of having launched the economic reforms for the sake of popular short-term benefits, but without a clear strategy for the long-term.
It is no surprise that officials fiercely refute this, yet the assessments of international observers are crystal clear. Following an analysis of public debt growth, Moody’s downgraded the country’s outlook, believing that Romania’s growth is built on shaky foundations and that the integrity of the public finances is in jeopardy.
Still, this is not the only thing that is making investors wary. Bucharest sought to attract FDI to fuel the economy, and launched an anti-corruption campaign to instil confidence in investors. Ironically, the campaign achieved the opposite, as it exposed the degree to which corruption is part and parcel of the political system.
In 2014, Romania’s National Anticorruption Directorate was lauded by the European Commission for its positive impact on reducing graft and prosecuting lawbreakers, even in the upper echelons of the political elite. In November, Liviu Dragnea, President of the ruling Social Democrats, was charged by the DNA with abusing public office and embezzling EU funds following an investigation by the European Anti-Fraud Office (OLAF). The DNA subsequently froze in excess of €27.4m worth of Dragnea’s assets.
Dragnea is already under a two-year suspended prison sentence for electoral fraud in a 2016 referendum, but staunchly maintains his innocence. His alleged involvement in corruption is the primary driver for the government’s current attempt to alter the law in his favour, including a curtailment of the DNA’s powers.
DNA Under Attack
It does not help that – besides Dragnea – the DNA is under attack from another high-profile figure. Businessman Alexander Adamescu is wanted by the DNA for bribing judges under a European Arrest Warrant, which would allow his repatriation from his London exile. The repatriation is fiercely resisted by Adamescu’s lawyers, who have started a smear campaign to undermine the DNA’s credibility. With the help of some British MPs and leading Brexiteers, they have portrayed the DNA’s pursuit of their client as politically and anti-semitically motivated, while breezing over the facts of the case.
None of these efforts improve Romania’s image and are holding up further EU-integration in certain areas, such as the country’s bid to join the EU Schengen area or adopting the common currency. In fact, the attempts to sabotage the DNA’s work are indicative of a pervasive lack of political will to tame official corruption, and investors are, unsurprisingly, scared off by the resulting uncertainty. Consequently, FDI has been on a downward spiral, declining by roughly 40% between 2011 and 2016. In the first quarter of 2017 alone, FDI was 22% lower compared to the previous year.
All things considered, existing conditions do not bode well for Romania’s future economic performance. Bucharest promised to spread the spoils of economic success evenly, but reliance on purely consumption-driven growth has its inevitable limits. And with the anti-corruption campaign reduced to a farce, the government’s credibility is increasingly undermined. Unless consumption is reduced and investments into infrastructure stepped up, it is only a matter of time until the economic house of cards collapses.
Brexit Phase Two: EU-UK Trade Talks
What unites European political parties across the political spectrum is a demand that while Britain discusses its future with the EU, it adheres to the principle of freedom of movement throughout the phase two transitional period. This is together with all the other rules of EU membership, including compliance with decisions of the European Court of Justice (ECJ).
While Brussels conducts day to day negotiations, it will fall to rotating EU presidents to secure cohesion and solidarity among EU27 member states holding diverse agendas for the conduct of Brexit talks. For the next six months, this leadership task falls to Bulgaria. Romania – the EU’s fastest growing economy (in 2017) – takes on the role in January 2019 at what will be a critical time when Britain (finally) leaves the European Union.
On the 29th March next year, Britain will become a ‘third country’ putting its relationship with the EU on a par with Turkey subject to any refinements on single market entry or a ‘bespoke’ customs union granting limited rights for its financial services sector. Business confidence continues to focus on going concerns that without regulatory alignment with the EU, few benefits will be provided from Brexit. It lobbies for ‘frictionless’ trade, which effectively must keep it in line with single market rules for both goods and services.
Car manufacturers have constantly reminded government ministers of potential damage to supply lines by the imposition of trade barriers. They would assert that decades of foreign investment (FDI) in the UK car industry was made in good faith in the knowledge that Britain, with its flexible and liberalized economy, provided the best entry point for the more lucrative EU market. In fairness, other factors also played a part – not least that UK employment laws were less restrictive than in mainland Europe as a result of the Thatcher government’s reforms in the 1980s.
There is still a question whether Britain leaves next year without a deal. Although this looks unlikely, Michel Barnier’s team at the EU Commission prepares for this scenario – taking repeated threats from the hard Brexit camp at face value. Tracking progress for the shape of an eventual deal is not easy, but clues are already appearing. French President Macron’s visit to London on Thursday 18th January helped to re-invigorate the ‘Entent Cordiale’ which historically focused on European military defence cooperation. A renewed Calais Agreement to maintain a tight border on migration would also help to improve Franco-Anglo relations.
But on a post- Brexit trade agreement Macron stands firm in stating:
“If you want access to the single market – including financial services be – my guest. But you need to contribute to the budget and acknowledge European Jurisdiction. There will be no hypocrisy in this respect otherwise it would not work. It would destroy the single market.”
It is hard to see from this statement that the EU27 will weaken from this stance, or that France can be persuaded of a more pragmatic approach by other EU members.
However, this did not stop PM Theresa May from re-iterating her desire for a deep and special partnership with the EU: “I believe it should cover goods and services.” She went on to say “I think the city of London will continue to be a major global financial centre… That is an advantage not just for the UK, it’s actually good for Europe and good for the global financial system.”
In the coming months, understandably, Britain will seek to pick off different EU states to push forward its vision of future trade relations. It is unlikely this “divide-and-rule” strategy will ultimately succeed, and it may well delay the satisfactory outcome of negotiations within the agreed timeline. It is in the interest of both sides to hammer out a deal for the stability of the EU and UK economies.
Sweden Issues War Pamphlets
The Swedish government is preparing a brochure on how to act in wartime due to fears over Russia.
Editor’s Remarks: The pamphlet is to be sent to 4.7 million homes and will explain how Swedes can participate in a “total defence” during a war and ensure that their basic needs – water, food and shelter – are tended to. The last time a document such as this was given out to Swedish citizens was in 1961 at the height of the Cold War. In recent years, Sweden has upped its military spending, reintroduced conscription and placed a garrison on the island of Gotland as fears over Russian aggression have mounted. For the first time ever, the country’s four right-leaning opposition parties agree that Sweden must now join NATO.
Read more on Conflict:
Silvio Berlusconi: Why Italy and Europe May Need Him
During the past year, several European countries have gone through important general elections that have drawn the attention of political actors and market participants. Now, it is Italy’s turn. However, the Eurozone’s third-largest economy has one difference: it has not had a government elected by the people since 2008, when Silvio Berlusconi was re-elected. Since 2011, technocratic and non-elected governments have run Italy.
Italy has had a difficult decade. It has been recovering in the past few years, but not fast enough. Too little has been done by its left-wing governments, who have been more preoccupied with the infighting in their own party, rather than implementing the correct reforms.
Recently, it would seem that the situation has stabilised. However, the risks are still there, making the country susceptible to even the slightest disturbance. The banking system is a very fragile one. It has a huge stock of NPLs that is estimated at around €250bn. Last spring, the government created the Atlante fund, with the help of insurers, investors and bank executives, who raised €5bn. The fund had the aim of buying poor loans from weak banks and invest in them in the hope that these banks would lend more to businesses and increase growth.
Moreover, the banks are also exposed to government debt, since they hold 20% of all long-term Italian government bonds. If the market starts to doubt the ability of the government to pay, the banks would be seriously in danger, sparking a selloff with serious consequences.
Furthermore, the economy has been considerably underperforming. The unemployment rate is currently at 11%. By comparison, in the same period, it was 8.7% in the Eurozone according to Eurostat. The economic growth, at the end of 2017, was 1.7%, while for the third quarter it was 0.4%. Therefore, growth has been non-existent.
What is worse is the debt that this country has. Its debt to GDP ratio is 133%, with only Greece, Japan and Lebanon having a higher ratio. The deficit to GDP rate is also high, at 2.4%, meaning Italy has to spend a lot of money in paying off interest on its debt. Expressed in numbers, the deficit is equal to €3.5bn.
Until now, the ECB’s ultra-low rates have been of great help to Italy, which managed to increase its S&P rating to triple-B. Nevertheless, in the past few years, the problem has not been over-borrowing, but rather the lack of productivity that has contributed to the very low growth. That is where the efforts of the next government should be focused: in restoring productivity.
It has been more than two decades that employees are working longer hours, yet produce less. Studies from many international financial institutions have continuously found that excessive regulation is strangling the Italian economy, which is mainly composed of SMEs. These enterprises find it very difficult to fund potential investments in new and more efficient technologies, develop economies of scale and scope and ultimately remain competitive and spur growth.
Very similar to France, the job market is very inflexible. This makes it very hard to hire and fire employees that are not productive. Young Italians are left with only short-term contracts.
Lastly, there is a terrible, corrupt and ineffective judicial system. Court proceedings are costly and go on for years, leading to the question of why investors should come to a country that has so many legal uncertainties.
Solving the Problems
Naturally, the new government needs to tackle and solve these issues. The program that comes from the centre-right coalition is the only one that provides solutions. Italy is in need of supply-side reforms to increase competitiveness, decrease regulations, lower taxes and ensure the flexibility of labour markets. An increase in the efficiency of the firms and in the competitiveness of the labour markets will lead to a reduction of real wage unemployment.
These policies will increase economic growth and perhaps bring an equilibrium on the balance of payment. The biggest political party of the centre-right, Forza Italia, led by Silvio Berlusconi, is presenting these supply-side reforms, the same that Ronald Reagan undertook in the US with excellent results, to the Italian electorate.
Silvio Berlusconi has been Prime Minister of Italy on four occasions. In 2011, he was removed from office. He had a very difficult relationship with two European leaders: Nicholas Sarkozy and Angela Merkel. It is widely believed that they put extreme pressure to force him out of office. Former US Treasury Secretary Timothy Geithner writes in one of his books that:
“At one point that fall, a few European officials approached us with a scheme to try to force Italian Prime Minister Silvio Berlusconi out of power; they wanted us to refuse to support IMF loans to Italy until he was gone.”
Thus, Italians did not have a say as to who should be the one leading them through the crisis. After witnessing four unelected governments that were unable to truly save Italy, many long for the days of Berlusconi back in office. He is perceived as a fighter who has the will and determination to pull Italy from the brink of the abyss.
He is promising to substitute the five tax brackets that are currently in place with a flat tax rate of 23%. He believes that it may go down even more during his government, perhaps to 20%. His coalition allies, the Northern League, want a much lower rate at 15%. However, it is more likely that the final rate will be closer to 23%, which currently is the rate of the lowest tax bracket. Nevertheless, there is no doubt that there will be a tax cut for the majority of the population and a simplification of the tax code, just like recent events in the US.
Today, the tax filing is a document of 16 pages, accompanied by a 111-page long manual, making it very difficult to compile without financial advice. His plan is to make the tax filing in one page, with only six items to be filled: income; no tax area; deduction on a number of children; deduction on loan interests; deduction for medical expenses; taxes to be paid. People with an income under €12000 will be exempt from taxes. The exemption limit will be higher than the current €7000.
Secondly, he plans to raise the minimum pension to €1000, coupled with a revision of the pension system. Moreover, his program includes a dignity income for people with no or very low income. 4.7 million people live in absolute poverty, without any income. 10 million live in relative poverty, meaning they have a source of income, but it is so low that they can barely survive.
Furthermore, if elected, he will abolish IRAP, a regional tax imposed on production activities that are paid even if the company incurs a loss. This would most certainly be a relief for all these small or medium companies. Italy is the only country to have such a tax.
Lastly, he would call for the implementation of a Marshall plan for Africa. Both Italy and Europe cannot receive such large number of refugees at a time when they are unable to sustain millions of people living below the poverty line. Not to mention the difficulties that these refugees face by crossing sea and land to reach countries in which they would have many difficulties adapting to. In this context, it would make sense and probably be less costly and more humanitarian establishing an international plan to improve the lives of these refugees in their home countries.
The Cost of Reform
The cost of all these reforms is no doubt high – around €94bn. The question everybody asks is where the money will be found. Berlusconi says they will be self-financed. From the reorganisation of tax expenditures to deductions and credits that benefit specific activities and groups of taxpayers, the benefit will be between €36bn and €40bn.
From these changes, the inflow is expected to be €3bn. Due to the fair flat tax, companies and individuals alike will have an incentive to pay taxes, instead of resorting to tax evasion. From this, the benefit is valued at around €20bn. Berlusconi also mentions the assets that will be confiscated from the Mafia, which are considered to be around €5bn per year. Not to mention the benefit that will come in the form of economic growth. Therefore, the inflows are forecasted to be between €131bn and €140bn, versus a cost of the reforms of €90bn. If successful, it will probably lead to a reduction of the debt as well.
Yet, politically speaking, what is his campaign strategy? The people want an end to the ‘endless recovery’. They want jobs and security without all the drama that comes with populist and radical forces. Thus, the Five Star Movement will be his key to victory. That is why he has made them the centre of attacks. Just as in 1994, he came to the battlefield to save Italy from neo-communist forces, now he is perceived as the knight who will shield the country from disruptive and incompetent parties.
Il Cavaliere, as he is known, is a man who has created a media empire and left his mark on the real estate market. He has been able to create jobs, which is what people care for at the end of the day. Ironically, the figure, who has been Prime Minister four times, represents change. The Democratic Party has been in government for 7 years with no results, while the Five Star Movement has made a mess of Rome (which they won in the last regional elections), showing once again its incapability to govern.
He is hoping that undecided electors that have stayed home in the past elections will show up for him. The argument is that these are voters who have preferred to abstain from voting in the absence of a suitable candidate. However, with him back in the field, they will choose his coalition.
Berlusconi offers a deal for his sceptics as well. This will probably be his last campaign. He is simply asking for the last possibility to change his country through conservative policies that have worked in many other countries. In addition to these, his biggest achievement is being able to pacify the Northern League leader, Matteo Salvini, who is no longer seeking Italy’s exit from the Eurozone and has softened his tone about many issues to the relief of many.
A strong Italy that will abandon leftist and radical parties will certainly bring stability and contribute to a strong Europe that is in desperate need of a new direction and renewed hope.
The campaign has just started. However, with the Cavaliere back in play as a considerable force, it will undoubtedly be a confrontation full of surprises, charisma and charm.
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