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FOREIGN TRADE UNIVERSITY MACROECONOMICS ESSAY ITALY’S PUBLIC DEBT AND LESSONS FOR VIETNAM Group members Tran Minh Thuy 1113150044 Do Thi Hai Ha 1113150045 Dang Huyen My 1114150042 Dang Huyen Anh 11141.
FOREIGN TRADE UNIVERSITY MACROECONOMICS ESSAY ITALY’S PUBLIC DEBT AND LESSONS FOR VIETNAM Group members: Tran Minh Thuy - 1113150044 Do Thi Hai Ha - 1113150045 Dang Huyen My - 1114150042 Dang Huyen Anh - 1114150040 To Huyen Linh - 1114150041 Pham Thu Hang - 1114150039 Ha Noi, May 30th, 2013 CONTENT I Introduction II Italy’s public debt crisis Public debt and its composition .3 The public debt crisis in Italy 2.1 Overview 2.2 The causes a Poor Performance of Economic Growth .5 b Long Term Tax Collection Problems c Competitiveness 2.3 Impacts on Italy’s economy 2.4 Policy reactions a Political change b Economical change 10 c Social change 12 III.Public debt in Vietnam and lessons from Italy 13 Overview of public debt in Vietnam 13 1.1 Government revenues and expenses 13 1.2 Budget deficit and public debt 14 1.3 Risks related to Vietnam public debt 15 The inferred lesson from the public debt crisis of Italy .15 2.1 Management policies 16 2.2 Increasing government revenues and decreasing government spending 17 2.3 Improvement in economic efficiency .18 2.4 Expansion of the domestic financial market 19 IV Conclusion 21 V References 22 I Introduction In the framework of the European debt crisis 2011-2012, Italy seems to have become the democratic world’s most threatened European ally Italy’s debt crisis is on a different level than the previous European crises, given that Italy is four times the size of Greece, Portugal and Ireland combined with a gross GDP of $2.1 trillion, making it the 8th largest economy in the world and the third largest in the Euro-zone after Germany and France Italy is characterized by the second richest private wealth in Europe – that is, 130,200 Euro savings per capita, just behind France and private debt is well below $10,000 per household The combination of private wealth and private liabilities puts Italy far ahead of the U.S and most other Western countries in terms of per capita net savings However, it has been considered to be the most vulnerable of the national economies threatened by the European debt crisis because of its huge public debt, which reached 119% of GDP in 2011 though the country is regarded as "too big to fail" There have been many over-alarmist voices about the economic and political situation of Italy on the international scene - both before and after the change of government on November 12, 2011 Moreover, interest rates paid for Italian public debt rose to record highs in fall 2011 peaking at 7.3%, which is beyond the threshold risk zone of 6-7% that forced Italy to slip under the rescue programme Through an in-depth review of Italy’s public debt crisis in the context of European debt crisis in terms of the causes, consequences and solutions of the government, this paper will bring you a close look on what was going on during that period Along with that, we also aim at drawing an inferable lesson to Vietnamese public debt II Italy’s public debt crisis Public debt and its composition Public debt, which is also referred to as government debt or national debt, is all of the money owed at any given time by any branch of the government It includes debt owed by the federal government, the state government, and even the municipal and local government Public debt or public borrowing is considered to be an important source of income to the government When the revenues a government collects are not sufficient to cover its expenditures, a government usually resorts to borrowing Such borrowings become necessary more in times of financial crises and emergencies like war, droughts and other disasters … Public debt can be categorized either as internal (domestic) debt or external (foreign) debt Internal debt refers to any money or services owed to individuals, businesses, or financial institutions within the country which is more often created by state or municipal governments, since they generally not have the power to negotiate with other nations External debt, on the other hand, is money, services or goods owed by the government to foreign lenders, either in the form of other governments, international organizations such as the World Bank, or financial institutions in other countries The public debt crisis in Italy 2.1 Overview Italy was hit hard by the economic crisis of 2007–2011 The national economy shrunk by 6.76% during the whole period, totalizing sevenquarters of recession According to the EU's statistics body Eurostat, Italian public debt stood at 116% of GDP in 2010, ranking as the second biggest debt ratio after Greece (with 126.8%) The IMF predicts public sector debt of 123.4 % of GDP in 2012 By 2013, Italian national debt is forecast to reach 123.8% Source: Debt and Growth in G7 The figure above shows that Italy has struggled to reduce national debt as a % of GDP since government debt has risen to over 100% of GDP in the late 1980s 2.2 The causes a Poor Performance of Economic Growth There are many factors that cause Italy to experience a public debt crisis The first and foremost reason is that since 1990, Italy has experienced sluggish growth With only small increase in real GDP it has proved difficult to reduce the debt to GDP ratio Starting in 2001, Italy's GDP growth turned absolutely paltry It finally plunged below zero during the global recession and has barely recovered since Moreover, the Italian economy has performed badly compared to its Eurozone counterparts From 1990 to 2004, the average annual GDP growth of Italy was approximately 1.5% (National Statistics) which was a half of that of Spain It is unsurprising that growth forecasts have been slashed and Source: National Statistics Italy is stuck in an unfortunate deflationary debt spiral b Long Term Tax Collection Problems Another cause of the crisis is due to a poor track record on tax collection and wasteful government spending Corruption and weak rule of law are poisonous for business Beyond that, they also allow the country's robust underground economy to flourish In particular, the size of the black economy means that substantial parts of economic activity remain untaxed Since 2000, most measures of good government have been on a downward slope Gros breaks out the following chart: Economists estimate that around 540 billion euros (£434 billion) is lost through Italy’s black economy through tax evasion by individuals and companies – the figure is around 35 per cent of the country’s GDP and last year more than 12 billion euros were recovered (Tejvan Pettinger) c Competitiveness The other issue is the long-term decline in Italian competitiveness Italy has lagged behind the EU average for competitiveness Italy’s position deteriorated steadily during the first ten years of euro area membership, after a decade of already sluggish growth and market slowdown in the dynamics of exports Stagnation in productivity since the end of the 1990s and the correlated rise in unit labor costs reduced its market shares for goods and services measured in volume terms by almost 3.5 percent per year on average over the 2000-2009 periods Italy’s total market share in world trade has declined significantly since the mid-1990s, and the country has not profited from increased demand in fast-growing emerging markets Prime Minister also states that a noticeable proportion of women and adolescents have not actively participated in the economy while producers are in shortage of human resource Albeit the reasonably unsuitable situation for motivation policies, Monti calls out for as much as possible citizens indiscriminately age, gender…to make a contribution to national GDP Also, the Prime Minister would willingly fix the retirement age to increase the national working force III Public debt in Vietnam and lessons from Italy Overview of public debt in Vietnam 1.1 Government revenues and expenses In the case of Vietnam government, revenues are derived primarily from taxes and a small part from capital incomes and non-refundable aids Vietnam's government revenues are relatively stable, ranging from 25-30 percent of GDP Government expenses include government consumption, government investment expenditures and transfer payments Starting from 2009, total government expenditures have decreased due to the implementation of government’s austerity policies to stabilize the economy 1.2 Budget deficit and public debt a Budget deficit In the past ten years, Vietnam has been suffering from budget deficits The levels of budget deficit of Vietnam are considered high compared to those of neighbor countries Still, since 2011, Vietnam has been improving its situation, offsetting half of its budget deficit Vietnam's budget deficit from 2001 to 2011 (% GDP) 200 200 200 200 200 200 200 Mo - 200 200 201 201 - - - - -1.8 -1.1 -0.9 -0.9 F Mo F2 IMF 1.76 1.81 3.69 2.36 2.11 -4.9 -4.9 -6.9 -5.5 -4.9 4.86 4.99 5.65 4.58 2.7 3.2 0.30 2.35 0.19 1.31 2.18 0.54 7.17 5.19 2.69 AD -3.5 -2.3 -2.2 0.2 -1.1 1.3 -1.0 0.7 -3.9 -4.5 -2.5 B Source: Disclosure of State Budget (Ministry of Finance) World Economic Outlook 2012 (IMF) and Key Economic Indicators (ADB) MOF1 – international practices (excluding amortization) MOF2 – Vietnam practices (including amortization) b Public debt It is considerably difficult to achieve an exact number for the sum of government debt of Vietnam Still, it can be estimated that the level of public debt of Vietnam in recent years has far exceeded the safety threshold However, Vietnam public debt is forecasted to be on the downward trend in the near future 1.3 Risks related to Vietnam public debt Vietnamese Government can hardly rely on increasing revenues from taxes in order to tackle public debt On the other hand, it has to face decreasing rate of economic growth if it is to cut down spending In recent years, Vietnam dong has been depreciating due to the global financial crisis, which in turn inflates Vietnam’s foreign debt Besides, investors have ceased to consider Vietnam as a potential destination Those reasons prove that Vietnam can no longer rely on foreign debt Moreover, the European public debt crisis, especially in Italia, has alerted Vietnamese policymakers of the risk of insolvency For a long time, Vietnam has suffered from bureaucracy, corruption and misusage of government spending Thus, Vietnam will have to invest wisely the limited foreign debt that it currently holds in order to recover the economy as well as regain investors’ confidence in its future The inferred lesson from the public debt crisis of Italy Although Vietnam has not yet fallen into a debt crisis like Italy has, we may so if we don’t have appropriate measures to tackle the sovereign debt problem In this part, we will be discussing the lessons that can be drawn from Italy’s case, as well as our modifications to those solutions and our own suggestions to the situation that Vietnam is facing 2.1 Management policies Due to certain characteristics of politics in Vietnam, there is no need to establish a group of experts to deal with political conflicts among parties about financial matters like there is in Italy However, we need to set up a group of economic and financial specialists in order to better consult the Ministry of Finance and the Government on matters related to sovereign debt Besides, although unemployment in Vietnam is not at an alarming level, the rate of highly-skilled and educated workers is rather low Therefore, capital resources should be reallocated so that education becomes our focus, through acts such as general education be made compulsory and career orientation be provided for every student Apart from the Italian’s lessons, we should practice publicizing information on government budget and public debt in order to tackle public debt and budget deficit In Manual on Fiscal Transparency (IMF 2007), it is clearly stated that: “The government sector should be distinguished from the rest of the public sector and from the rest of the economy, and policy and management roles within the public sector should be clear and be publicly disclosed.” Also, the fiscal powers of the executive, legislative, and judicial branches of government should be well defined, while responsibility need to be distributed appropriately accordingly to each organization and section To so, we should make improvements to the budget system law or the constitution The relationship between the general government and state-owned enterprises (SOEs) needs to be transparent as well, especially on public finance In particular, the question of how profits from public corporations should contribute to the government requires a clear and reasonable answer SOEs must release their financial statements to the public, making profits and the portion that will be taxed open Likewise, government spending on behalf of public corporations must appear in government budget statements as well as in these enterprises’ financial statements 2.2 Increasing government revenues and decreasing government spending Despite the high ratio of government revenue in the region, Vietnam still suffers budget deficit and high rate of public debt This is due to the high level of public spending that was spent on recurrent expenditures, not on investment and development Therefore, Vietnam should reduce and reallocate government’s recurrent expenditure effectively, starting with cutting down on the administrative mechanism which is a cumbersome trouble of the economy Streamlining this sector could be made through privatization of some parts of the public sector such as education, public transport, information, etc However, these cuts need to be made as a roadmap because they may leave negative consequences, especially unemployment Inferring lessons from Italy, we should prolong retirement age to not only alleviate this problem but also reduce the burden of pension on the state budget The implementation of policies to reduce the burden of the budget deficit and public debt has been applied in many countries Specifically, the austerity policies that the European countries have used to deal with the debt storm in the area In Vietnam, the feasible measures to increase government revenues could be conducted, such as increasing higher levels of taxation or VAT or impose new taxes on detrimental and luxury goods, real assets and assets with high values as well as levying greater taxes on people with high income, using progressive taxation Still, we should decrease domestic tax rates and impose higher tax rates on major importers of Vietnam, e.g China, India and Korea, in order to solve budget deficit as well as raise a higher level of demand for domestic goods and services However, the application of these policies should be done carefully to avoid the negative reactions from public as well as social unrest If possible, Vietnam surely overcomes the situation of its budget deficit and high rate of public debt 2.3 Improvement in economic efficiency One of Vietnam economy’s major issues is that government debt and investment don’t yield adequate benefits In other words, funds from government don’t function effectively This mismatch affects the economy tremendously Besides, more and more giant corporations have been declaring bankruptcy, adding up to the anxiety of the domestic and foreign investors Too many bad debts may force the government to use its budget to pay, leading to more severe deficits Moreover, public investment in Vietnam has been taking over private investment, while ICOR of Vietnam in the period 2010-2012 has been on the upward trend, indicating ineffectiveness of investment Therefore, the restructuration of the SOE system and the enhancement of public investment efficiency need to be prioritized in alleviating Vietnam’s public debt burden The restructuring of SOEs, apart from eliminating corruption in government apparatus, needs adopting new administrative regulations More specifically, a free and competitive “market” for CEOs may be established in order to avoid bureaucracy Also, SOEs need to make information and documents related to their activities disclosed Tourism, as we can see from the case of Italy, has become a major industry in times of economic crisis Vietnam should also exploit the potential of tourism, but with investment from and management by private sector, because it will be more likely to yield more profits and function more effectively this way Likewise, in order to restructure public investment, there should be a steady progress in which the proportion of public investment is reduced in the total investment Public investment should not be allocated in industries that private investors can better Apart from that, a geographically economic region may comprise many adjacent provinces to reinforce the investment on infrastructure and the economic efficiency 2.4 Expansion of the domestic financial market Like many other developing countries, Vietnam has the problem of original sin, in which debts are made in powerful foreign currency However, unlike Italy, Vietnam needs to rely on its domestic market, since we cannot borrow from the ECB, nor can we incur ODA debts with preferential interest rate, since we’ve become a nation with average income In the short run, Vietnamese government will have to pay high coupon in order to attract domestic investors With time, we need strategies to increase the proportion of domestic loans in public debt, as well as policies for transactions and loan exchanges in primary and secondary markets with the aim of increasing liquidity Once liquidity is ameliorated, the government can incur debts when necessary with low risk because they are issued in Vietnam dong, which has longer maturity and fixed interest rates IV Conclusion The Italy’s public debt crisis results from loose management of Italian government, which includes flaws in long-term tax collection, high labor cost and poor performance of economic growth This crisis leads to a number of consequences such as social instability and negative growth of the economy Learning from the experience of Italy, Vietnam should have rational policy dealing with sovereign debt so as not to fall in debt crisis By conducting this research, we intend to provide readers a profound look into Italian public debt crisis, from which we infer valuable lessons for Vietnam Regardless of doing a thorough research, we cannot help exposing some shortcomings since it is our first time doing such a kind of research This means our research might need to experience some alterations We hope you overlook any shortcomings that are caused by our lack of experience We look forward to hearing all of your comments on this research so as to grow and conduct a more methodical research in the future V References Jordan Weissmann, ‘4 Reasons Why Italy's Economy Is Such a Disaster’, The Atlantic Journal, November 2011 Tejvan Pettinger, ‘Italy Debt Crisis’, Economics Journal, Une 2012 Elisa Cencig, Italy’s economy in the Euro zone crisis and Monti’s reform agenda, Berlin Anton, B., Florence, P and Emile, G The sovereign debt crisis placing a curb on growth, Paris, Centre for European Policy Studies Industry minister calls to lower tax burden for companies www.ansa.it Nick Squires, Rome 2013 Italy to lease old castles and prisons in bid to chip away at country's debt www.telegraph.co.uk Rushe, Domenic 2011 Italy downgrade deepens contagion fears over euro debt crisis www.guardian.co.uk William L Watts, 2012 ECB-fueled optimism aids Italian bond auction , www.marketwatch.com Giavazzi F and Spaventa L.1988 High Public Debt: The Italian Experience Cambridge University Press Baliño, T and Sundararajan, V 2008, ‘Public Debt Management in Developing Countries: Key Policy, Institutional, and Operational issues’, Workshop on Debt, Finance and Emerging Issues in Financial Integration, Financing for Development Office (FFD), DESA and April 2008, Centennial Group Holdings LLC, Washington DC, USA Egert, Balazs (2012) : The impact of changes in second pension pillars on public finances in central and Eastern Europe, CESifo working paper: Public Finance, No 3801, http://hdl.handle.net/10419/57960 IMF 2010, Public Sector Debt Statistics - Guide for Compliers and Users Radelet, S and Sachs, J (1998), The Onset of the East Asian Financial Crisis, National Bureau of Economic Research (NBER) Working Paper Vân Du, Nợ công người Việt tiếp tục tăng năm 2013 http://songmoi.vn/kinh-te-tien/no-cong-cua-nguoi-viet-tiep-tuc-tang-trongnam-2013 http://vietnamnet.vn/vn/kinh-te/118833/no-cong-viet-nam-128-9-hay-66-8ti-usd-.html World Economic Outlook, April 2012, Growth Resuming, Dangers Remain http://www.imf.org/external/pubs/ft/weo/2012/01/ Key Indicators for Asia and the Pacific http://www.adb.org/publications/series/key-indicators-for-asia-and-thepacific Disclosure of State Budget, Ministry of Finance http://www.mof.gov.vn/portal/page/portal/mof_en/State_Budget ... Vân Du, Nợ công người Việt tiếp tục tăng năm 2013 http://songmoi.vn/kinh-te-tien/no-cong-cua-nguoi-viet-tiep-tuc-tang-trongnam-2013 http://vietnamnet.vn/vn/kinh-te/118833/no-cong-viet -nam- 128-9-hay-66-8ti-usd-.html... working force III Public debt in Vietnam and lessons from Italy Overview of public debt in Vietnam 1.1 Government revenues and expenses In the case of Vietnam government, revenues are derived... ten years, Vietnam has been suffering from budget deficits The levels of budget deficit of Vietnam are considered high compared to those of neighbor countries Still, since 2011, Vietnam has been