Both Italy and Spain did not face any serious current account problems. From 1992-96, the current balance rose in Italy to 3.4% but then began to fall in 1996. This is combined with the deep recession the country faced at this time. Spain’s current balance also increased from 1992 onwards but just like Italy, it began to decrease after 1997, leading back towards its current account deficit similar to earlier in the decade.
Overall, the recent years show that the Italian economy has been characterised by a relatively low growth rate. During the period of 1997 to 2000, the growth rate averaged approximately 1.5%. Unemployment has seen a constantly decreasing trend, from 11.9% in 1998 to 9.6% in the following years. Italy has also reduced its budget deficit because in 1997, it was 2.7% and in 2001 it fell to 1.2%, which was somewhat higher than the 0.8% goal set at the beginning of the year. During the 1990’s Italy had adopted policies to reduce its inflation rate and curb it government spending deficit. These policies have tended to have a deflationary impact because from 1995-97, inflation deceased by 4%.
In recent years, Spain has had an economic growth rate that is among the highest in the EU. At the same time, the country has succeeded in reducing unemployment and balancing public finances. This has led to better living standards. In spite of the fact that approximately two million new jobs were created between 1996 and 2000, the official unemployment rate remains high (approximately 13% of the work force). Average income in Spain is only 80% of that of the rest of the EU, therefore the country still has some way to go. The inflation rate of 3% in 2000 was above the EU average.
2.) What problems may these countries face in the future and how would they impact on their economic performance?
The main economic challenges facing Italy are keeping the government deficit under control, implementing a plan to reduce the high level of government debt and addressing unemployment. Since Italy's economy barely rose in the beginning, growth will fall short of the government's target of 1.3% for all of 2002. Instead, real GDP will probably edge up by 0.5%. Despite slow economic growth, Italian inflation is creeping up. Consumer prices rose 2.4% in the year ended in August, up from 2.2% in June, and consumer groups have protested that the official index undercounts the price hikes faced by shoppers after Italian retailers switched over to the euro early this year.
Sluggish economic activity means that Rome will be hard-pressed to meet the European Union's directive that members of the euro zone have a balanced budget by 2004. The government's target now calls for a budget deficit of no more than 1.1% of GDP this year and falling away to zero by 2004. But a survey compiled by trade group Confindustria shows that private economists expect a ratio of 1.8% in 2002 and holding at 1.4% in 2003 and 2004. Italy will be under pressure to meet these demands. Italian companies are also expected to boost investment in response to domestic demand as Italy's slow economic recovery continues and in response to increased export demand in European Union markets that are seeing more robust economic growth than Italy.
Looking back on Spain’s economic performance, there are a few concerns that need focusing on. One of them is continued high unemployment. Even with continued economic growth, the population growth is greater than the number of new jobs created. Although unemployment rates have fallen in the recent economic upswings, they still haven’t recovered completely from the severe recession of 1992-93. Moreover, recent data suggests that the unemployment rate is on the rise for the first time in several years. Currently agricultural production accounts for only 4% of Spanish GDP and it is the only sector to experience consistently high rates of job loss. The tourist industry provides a huge number of jobs but they are not year-round positions.
In fixing its exchange rate to the Euro, Spain received increased inflation stability and financial integration with other Euro countries but also opened itself to a new set of risks. Leading up to the Euro, Spain’s convergence policy led to economic recession as officials corrected the overvalued peseta, and the recession of 1993 helped re-adjust the balance of payments. The increased stability in the inflation rate and credibility gained over the last few years benefited the Spanish economy. But now, with the EBC controlling monetary variables, monetary policy must balance regional interests. Actions taken by the ECB may not reflect the optimal policy for the Spanish economy.
Supporting a fixed exchange rate with its main trading partners may pose particular problems for Spain in the near future. Although Spain currently enjoys a very high growth rate, the low interest rate provides little incentive for saving and is driving investment far above net domestic savings. The negative current account has worsened with the growth in GDP, as Spain imports more and foreign demand has still not fully revived exports. Foreign capital funds an increasing portion of investment. These problems are even more complex given the uneven growth patterns in the Euro currency zone.
Spain needs to look towards ensuring further steep reductions in unemployment from its striking high levels and achieving a broader distribution of the benefits of economic growth. A deepening of reforms would also engender a more rapid convergence of incomes to the levels of other European Union countries, much greater resilience in the face of shocks to the economy, and a more secure future for coming generations. Italy, on the other hand, is not expected to have a growth rate as high as Spain in the next few years and it is believed that the effect of global economic slowdown on Italy has been growing. It had originally been forecasted that the economy would grow to 2.9% in the next few years and this was later trimmed to 2.5%. Thinking that the figure was too optimistic, it is now believed to have gone down to 2% economic growth.
