Germany and Italy : stumbling giant and prodigal son? : social pacts and the political economy of fiscal consolidation (1991-1998)

• Main Author: Marzinotto, Benedicta
• Published: London School of Economics and Political Science (University of London) 2005
• Subjects: 332.4943
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.420471

In the run-up to European Monetary Union (EMU), Italy put in place an extraordinary fiscal adjustment, whereas Germany encountered serious difficulties that go beyond the re-unification shock. "War-of-attrition" models are employed to explain this puzzle. It is argued that Italy's high debt burden and soft currency regime from 1992 to 1996 turned out as an opportunity. The prospect of EMU membership opened up room for market-induced credibility gains. By allowing a sensible reduction of interest payments, the high-debt GDP ratio de facto reduced the scope for welfare retrenchment, thus minimising conflicts between socio-economic groups over the distribution of the fiscal adjustment burden. At the same time, social concertation offered a locus of conflict resolution. Social partners' fiscal preferences stemmed from an evaluation of the distributional impact of deficit reduction and of trade-offs in other policy areas, e.g. exchange rate policy. Thanks to Italy's soft-currency regime, domestic business agreed to unions' demands for a tax-imposed fiscal consolidation as the devalued Lira allowed them to maintain a competitive edge. The opposite is true for Germany, where the low debt burden and hard currency regime functioned, paradoxically, as straightjackets. With a low debt level, deficit reduction had to come from real government activities, either on the revenue or on the expenditure-side. Also, the appreciated Deutschmark did not offer an alternative "pressure valve" to Germany's export-oriented business. The failure of the 1996 social pact is understood against this background. This thesis sheds light on the political economy of EMU-induced fiscal adjustment as well as on the determinants of social concertation in the EU. In this respect, it contributes simultaneously to two strands of literature; the now flourishing research agenda on fiscal policy in EMU -of which it rejects the strong institutionalist flavour, and the equally recent revival of corporatist studies since the 1990s.