Dear Santa, all we want for Christmas is more freedom – sincerely, the economy

What does the economy want for Christmas?

The answer is what it always wants, but rarely gets: more economic freedom.

Economic freedom is actually two presents, not one. To make this Christmas one to remember, the economy wants to unwrap both public and private sector freedom.

Thursday 20 December 2018 8:33am
Graeme Leach

Is Santa a “big state” man? (Source: Getty)

Public sector freedom comes in the form of a smaller state as measured by taxation, public spending, and regulation. Private sector freedom means increased competition, the stronger entry and exit of firms, less market concentration, and reduced monopoly power.

Every year the economy asks for a smaller state, but unfortunately Santa has become a “big state” man.

The queue for his grotto is full of politicians who want to sit on his knee and whisper how kind it would be to increase the size of the government. So as far as Santa is concerned, all anybody should want for Christmas is a bigger government.

Exasperated, the economy has come up with a different letter to Santa this year. It doesn’t just ask for a smaller state, it also points out that there is very strong economic evidence of a negative trade-off between the size of the state and economic growth.

In fact, recent research suggests that if the size of the state is reduced by 10 percentage points of GDP, the GDP growth rate is likely to accelerate by 0.5 to one percentage points.

The economy hopes that this approach will appeal to Santa, but unfortunately the progressive elves who advise him on such matters have a nasty habit of tearing up any letters from the free market.

But the free market shouldn’t be disheartened. Anybody who can coordinate all those reindeer – and all those presents – is not daft. And as Santa flies his sleigh across the globe, he’s noticed that the economies with the most freedom send the biggest Christmas presents. They’re also the ones most able to help those with the least resources.

Santa can see with his own eyes the blessings from economic freedom, and yet the politicians still sit on his knee and tell him the opposite.

All is not lost though. Santa has noticed that, as the state has got bigger, the reindeer and elves have become far less efficient in certain countries. The Singapore elves are outstanding. The French and Italian ones, not so much.

Santa has also known for a while that when the reindeer turn north from South Korea, they get lost because there are no lights to guide them at night outside of Pyongyang.

Even the reindeer comment that the difference between north and south of the 38th parallel must have something to do with economic freedom, and if that is such an important issue, why do western politicians not see it?

The worst part of Christmas for Santa is when he’s in his grotto with politicians sitting on one knee and big business on the other. Big business hates competition and loves to be protected.

But this year, Santa has had enough. To make a point, he’s going to give one country the opportunity to reduce the size of the state and increase competition. That present is called Brexit, and if Santa can sort out his “Remainer” elves, Christmas might be a tad late, but it will certainly be here by 29 March next year.

http://www.cityam.com/270817/dear-santa-all-we-want-christmas-more-freedom-sincerely

The EU “customs partnership” is one of the most half-baked ideas in history

Over the past week, the Prime Minister has confirmed that the UK will definitely leave the EU customs union, while a Downing Street spokesperson has reiterated that this is indeed government policy.

Thursday 26 April 2018 4:02am

Graeme Leach is chief executive and chief economist of Macronomics

UK officials would have to police both regimes (Source: Getty)

This naturally leads to the question of what leaving the customs union will mean in practice.

Last August, the government set out two options for the UK outside of the customs union. Neither received intense scrutiny at the time, but thankfully that has now changed.

Read more: Bouncing into a customs union would be a betrayal of Brexit

The first option was a highly streamlined arrangement based around technology, cooperation, and indeed reality (the fact that almost 98 per cent of container traffic is not physically inspected and is pre-cleared): it entailed removing any need for a hard border with the EU.

The second option was the proposed “customs partnership” with the EU, and it is this arrangement which is now under the spotlight, up for discussion at this week’s meeting of the cabinet’s Brexit sub-committee.

However, any discussion is a waste of time. It is one of the most half-baked ideas in economic history. It should never have seen the light of day. It should have been strangled at birth.

The idea behind the customs partnership is that British exports to the EU would be tariff-free, and that the UK would not be part of the EU’s Common External Tariff (CET). Being outside the customs union would then permit the UK to negotiate and sign trade agreements with other countries across the globe.

So far so good, you might say, but dig deeper, and the partnership proposal justifies Jacob Rees-Mogg’s description of it as “completely cretinous”. The proposal bears all the hallmarks of an EU-leaning Whitehall bureaucracy intent on trying to hoodwink ministers and the general public.

Essentially, the UK would mirror the EU’s requirements for imports from the rest of the world when their final destination was the EU.

Britain would be a border agent for the EU, collecting the CET on EU-destined goods at a UK border entry point, but operating its own post-Brexit WTO tariff schedule for goods destined for here. These goods would ultimately pay a UK tariff, while those destined onwards for the EU would pay the EU’s CET at the UK border.

You only need to think about this for a moment to realise that it is completely impractical. There would need to be a tracking mechanism to check that those goods with the UK as the stated destination weren’t being forwarded on to the EU without paying the CET. As yet, no such tracking technology exists. It is yet to be designed, built, and tested.

And the problems get worse.

EU customs procedures require all countries to operate all tariff and non-tariff procedures in the same way. Under the partnership proposal, the UK would not only be collecting the EU’s CET and enforcing its tariff rate quotas, alongside its own tariff schedule. It would also have to enforce the EU’s non-tariff rules as well.

UK officials would have to police both regimes. This is completely bonkers.

One suggested way around some of these problems is that UK-destined goods could also pay the CET on arrival, with exporters then claiming back the difference between the higher EU and lower UK tariffs.

But this is hardly evidence of the UK taking back control. Imagine Liam Fox telling an American or Australian trade negotiator that they would have to pay the CET and then claim back a refund.

The fact that Whitehall came up with such a plan is deeply disturbing and makes one fear what the officials might do next.

Read more: Govt's customs partnership proposal "completely cretinous", says Rees-Mogg

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

http://www.cityam.com/284713/eu-customs-partnership-one-most-half-baked-ideas-economic

The five economic freedoms that Britain can win by leaving the EU

This November marks the 75th anniversary of the publication of the Beveridge Report, or more precisely, Beveridge’s report on Social Insurance and Allied Services.

Beveridge set out his five “social” freedoms from squalor, ignorance, want, idleness, and disease.

Today, 75 years on we need to set out five “economic” freedoms from the EU.

Read more: 10 reasons the UK should not fear a ‘no deal’ Brexit outcome

Beveridge talked about freedom from these five “giant evils”, and while such language is inappropriate and wrong with regard to any description of our relationship with the EU, the economic freedoms are still giant.

Thursday 2 November 2017 4:01am

Graeme Leach

EU regulation applies to the whole economy even though only around one tenth of UK GDP is actually attributable to the EU (Source: Getty)

The five economic freedoms provided by Brexit are: freedom from the EU protectionist fortress, freedom from EU budget payments, freedom from uncontrolled EU migration, freedom from EU product market regulation, and freedom from EU labour market regulation.

These are giants walking our land, but they walk unseen. If asked about the EU, focus groups show people associate the bloc with free trade, not protectionism. They have little or no idea that they live within a protectionist fortress with tall and thick walls to the outside world.

The best example of this is in the reaction to the fall in sterling post-Brexit.

People associate Brexit with higher prices (from higher import costs). They do not realise that being outside the Common External Tariff will lower prices if we pursue genuinely free trade. The weekly shop at the supermarket will become a whole lot cheaper. Forget “that’s Asdaprice” – remember “that’s Brexit price”.

The cost of EU budget payments has been analysed to death. The £350m per week figure is a step too far, but the amount is around half that, and possibly more depending on how you judge the effectiveness of funds returned to the UK by the EU. If you’re sceptical as to their benefit, then the weekly total ratchets up towards £250m, because of the opportunity cost.

Freedom from uncontrolled migration is not nationalist or isolationist. Rather, it is the opportunity to implement an open, outward, global policy, which allows in those from across the world who can make an economic contribution.

Controlled migration also means that, when there are global tragedies, we can open our arms to help. It’s much more difficult politically to have open arms if you already have open borders.

EU regulation applies to the whole economy even though only around one tenth of UK GDP is actually attributable to the EU.

Brexit provides the opportunity to take down the regulatory state. Not to abandon workers’ rights or lower safety standards in goods, but instead to undertake a regulatory reset, identifying a common sense approach.

Politicians have talked of a bonfire of controls, but over recent decades all they’ve delivered has been a small spark, which was quickly snuffed out. Brexit offers an opportunity to explode a thermonuclear device underneath the regulatory state.

Over the past 75 years we have made great strides in overcoming squalor, ignorance, want, idleness, and disease. They’re still there though, and the best way of continuing to overcome them is to generate the economic wealth which is central to their solution.

This is why the five economic freedoms from the EU are so important – 75 years from now, the UK economy has the potential to be a lot bigger than if we’d stayed in the EU.

It’s by no means a guarantee – we have to make the right economic policy decisions ourselves. Corbynomics would be a an economic disaster, and the last thing we need is a soft Brexit and Venezuelan economic policies.

But it’s an opportunity we simply wouldn’t have if we stayed in the EU, and we have a duty and a responsibility to make the most of it.

http://www.cityam.com/275006/five-economic-freedoms-britain-can-win-leaving-eu

10 reasons the UK should not fear a ‘no deal’ Brexit outcome

The good cop, bad cop routine between the European Council and Commission makes it very difficult to assess whether or not the Brexit negotiations will lead to acrimony and breakdown.

Thursday 26 October 2017 4:01am

Graeme Leach

There is a 50:50 chance that the UK could end up walking away with no deal (Source: Getty)

My guess is that there is a 50:50 chance that the UK could end up walking away with no deal. And we know what would happen the morning after.

Politicians, business groups, the chattering classes, the establishment, and the media would work themselves up into a right lather. Those who remember Dad’s Army will see Corporal Jones marching around everywhere shouting “don’t panic, don’t panic”.

Read more: DEBATE: Do UK businesses need a status quo Brexit transition deal?

Frightened that the economy were about to fall off a cliff, financial markets would sell the UK and short sterling big time.

But they’d be wrong, very wrong.

Amid the chaos, more sober minds would recognise the 10 unique opportunities, which would rise like a phoenix from the ashes.

1. The divorce settlement would have just got much cheaper. The UK would honour its financial obligations up until the end of the Article 50 period, but that would be the end of it.

The chancellor would have 0.5 per cent of GDP per annum to play with, and no additional costs associated with the divorce.

2. The UK would definitely be leaving the EU’s Common External Tariff. The protectionist wall surrounding the UK at present would be removed if we imposed zero tariff and non-tariff barriers on UK imports from across the globe. Regular readers of this column will be familiar with the benefits to consumers in the short term, and consumers and producers in the long term, from gaining the freedom to operate unilateral free trade.

The UK could become the world’s biggest advocate of genuinely free trade overnight.

3. The UK would also be leaving the Single Market. You would never know it, from reading the news and watching the TV, but this would be good news, not bad. The UK would become a rule maker not taker, and could begin to take down the regulatory state. Only 10 per cent of UK GDP is engaged in trade with the EU, but 100 per cent of UK companies are subject to EU regulation.

And as my Legatum Institute colleague Shanker Singham constantly points out, we need to be outside the Single Market, so as to have “skin in the game” in trade negotiations focused on services – where the UK’s comparative advantage lies.

4. The benefits of leaving the Customs Union and the Single Market would begin in 2019, not years later after a transition period.

5. The shock of no deal is likely to push the political class towards deep cuts in corporation tax (say a commitment to a 10 per cent rate by 2025) in order to boost competitiveness – every cloud has a silver lining.

6. We could move to complete and implement free trade agreements with the rest of the world, far more quickly than if there was a transition period. The Anglosphere economies alone (US, UK, Canada, Australia, New Zealand) account for 33 per cent of global GDP.

7. No deal could be beneficial for the City if it triggered a shift towards an offshore model, free from Mifid II and tens of thousands of pages of prescriptive regulation.

8. It would shift the UK’s entire economic focus away from the EU (with its sharply declining share of global GDP), and outwards towards the big wide world, where the greatest opportunities from economic growth are to be found.

9. As a free market economist, I’m uncomfortable with industrial strategies, but exiting the EU would provide far more opportunities to dabble with such interventions and buy off certain key sectors.

10. Sterling would undoubtedly plummet the morning after, but that would be a helpful boost to exporters, and introducing zero tariffs on imports would counter the sterling effect on import prices. Brexit with unilateral free trade will lead to lower prices.

http://www.cityam.com/274574/10-reasons-uk-should-not-fear-no-deal-brexit-outcome

We have four post-Brexit trading options: Graeme Leach

EU Referendum Anniversary: There are four dimensions to the UK’s future trading relationship with the EU and the rest of the world.

Friday 23 June 2017 4:02am

Graeme Leach

Graeme Leach is chief executive and chief economist of Macronomics, a macroeconomic, geopolitical and future megatrends research consultancy.

Do we want a free trade agreement with the EU? (Source: Getty)

First, whether or not we will be in or out of the Customs Union. Second, whether or not we will be in or out of the Single Market. Third is the potential negotiation of bilateral free trade agreements. Fourth is the nature of future independent WTO membership.

When the Prime Minister set out her 12 principles earlier in the year, she clearly set out a hard Brexit, with quotes such as “what I am proposing cannot mean membership of the Single Market” and a desire to conclude “bold and ambitious free trade agreements” with “old friends and new allies” and “be free to establish our own tariff schedule at the WTO.”

With Single Market and Customs Union membership ruled out, the focus turned to the breadth and depth of potential free trade agreements, and the nature of the UK’s future tariff schedule to be submitted to the WTO. Economists for Free Trade (I should declare an interest here as a member) argues for unilateral free trade and a zero tariff schedule. Others argue for the retention of tariffs as a tit for tat bargaining chip in negotiations.

But in the wake of the General Election there is intense debate as to whether or not all four dimensions are now in play and could come to pass. Over the past week foreign secretary Boris Johnson has spoken of his desire for an “open Brexit”. The debate is now around how the government might shift its red line on immigration and free movement.

So let’s take a look at the most likely potential options.

Single Market

Option 1 involves leaving the Customs Union but remaining a member of the Single Market (EEA). This option would permit bilateral free trade agreements (outside the Customs Union) and an independent tariff schedule at the WTO. Option 1 has huge political challenges, relating to continued free movement, ECJ supremacy and EU budget contributions. 

There is also a potential hybrid version, whereby free movement of people and annual budgetary contributions are restricted – i.e. a bigger divorce settlement cheque, but with reduced annual maintenance. EU supremacy would remain a significant political obstacle. Option 1b would be this scenario with a zero WTO tariff schedule – i.e. unilateral free trade.

Customs Union

Option 2 entails leaving the Single Market but remaining a member of the Customs Union. Consequently this option also rules out independent bilateral trade agreements and a separate tariff schedule at the WTO. The problem with this scenario is that in one fell swoop it removes the potential benefits to consumers and intermediate producers from trading at – lower – world prices outside the common external tariff.

Free trade agreement with the EU... or not

Option 3 means leaving the Customs Union and Single Market, and striking a free trade agreement with the EU. This option could also come with or without unilateral free trade.

Option 4 would also involve leaving the Customs Union and Single Market, but without striking a free trade agreement with the EU. Again, there are two scenarios, with or without unilateral free trade.

Staying in the Customs Union is economic nonsense. The gains to consumers and intermediate producers, from exiting the common external tariff, would vastly exceed the cost to other producers. With regard to the Single Market we are back where we started a year ago, with a need to understand why the conventional wisdom on single market participation is deeply flawed. Yes we need freedom of movement for skilled workers, but aside from that the benefits of membership are decidedly vague.

Read more: Brexit a year on: Four graphs that show how the economy responded

http://www.cityam.com/267188/we-have-four-post-brexit-trading-options

Remaining in the Customs Union is the very worst mistake the UK could make

This week’s newspapers reported that the Prime Minister wants to “stick to the plan” to leave the Single Market. And yet the chancellor is said to be pushing hard to maintain participation in the Customs Union.


Thursday 15 June 2017 4:02am

Graeme Leach

Graeme Leach is chief executive and chief economist of macronomics, a macroeconomic, geopolitical and future megatrends research consultancy.

A complicated EU negotiation just got more complicated (Source: Getty)

The HM Treasury line is deeply worrying. Retaining the common external tariff would remove any tariff threat from trading with the EU, but it would also be a very big mistake.

Outside the Customs Union, the UK could trade at world prices and, as Economists for Free Trade has shown, the gain from this to consumers would be roughly seven times the cost to producers.

But if gains of this magnitude are to be realised, we need to do two things.

First, we must leave the Customs Union. Second, we need to introduce unilateral free trade – zero tariffs on imports. The Treasury seems to stubbornly refuse this logic, as if it has a new secret model, which runs completely counter to economic history and conventional economic thinking.

Leaving the Customs Union provides a competitive spur on UK companies, and this will drive up performance and incomes in the long term. It’s not rocket science, but the Treasury seems to want to push it to the far side of the solar system and ignore it. So let’s be clear. Maintaining membership of the Customs Union is the absolute last thing we should be doing right now.

Having sorted out the Customs Union, what about the Single Market? In the wake of the General Election result, speculation is rife that a new softer Brexit will emerge. But this is a lot easier said than done. Maintaining free movement, budget payments and ECJ supremacy doesn’t sound a lot like Brexit to me.

Still, if freedom of movement becomes less of a priority thanks to the post-election politics, I can envisage a scenario whereby the UK participates in the European Economic Area (EEA) – at least for a transitional period. This would fend off business concerns regarding labour supply, maintain free access to the EU and permit the UK to negotiate trade deals independently.

But – and it’s a huge but – the maintenance of free movement would be upfront and central. Is that deliverable politically? The answer is possibly yes in the House of Commons, but boy would there be a fight.

The simple truth is that if moves to soften Brexit take us down the EEA road, maximising the benefit of leaving the Customs Union becomes more, not less, important. That potentially ratchets unilateral free trade up the political agenda.

Two further considerations apply. The Norwegian model is accepted by the rest of the EU because it is basically a small single commodity oil economy. In contrast, the UK is a large heterogeneous economy, which would gain a competitive edge if it was outside the Customs Union and inside the Single Market. Would the EU accept that? I don’t know.

Finally, the thorny issue of the DUP comes into play. The DUP wants to maintain freedom of movement and a soft border with the Republic of Ireland. It also wants the UK to have the freedom to negotiate trade deals, and for the UK to negotiate a comprehensive free trade agreement with the EU. A complicated EU negotiation just got more complicated.

http://www.cityam.com/266674/remaining-customs-union-very-worst-mistake-uk-could-make

The Brexit I love versus the Brexit I fear: A British renaissance or a missed opportunity

What will the UK economy look like outside the EU, 10 years from now? Nobody knows the precise answer to this question but we can generate likely potential scenarios. What follows are two scenarios, the Brexit I love and the Brexit I fear.

Thursday 19 January 2017 4:45am
Graeme Leach

The Brexit I love is where the UK is open to the world, outward looking and the leading global advocate of completely free trade. This is a Britain which for the second time in its history – the first was the repeal of the Corn Laws in the nineteenth century – leads the way on free trade. This is a Britain which can confirm the iron law of economics, that greater free trade always leads to greater prosperity ultimately.

The Brexit I love is the fastest growth scenario, resulting in much higher per capita income. This is the scenario where exit from the Customs Union enables the UK to trade at world prices (with zero tariffs on all imports), fully exploiting its comparative advantage, spurred on by global competition – a more powerful force than that available within the EU protectionist wall.

Read more: Forget trade deals: Unilateral free trade can be our Berlin Wall moment

Brexit is not just about Brexit. This is also a scenario where the years following the Great Repeal Act are a period of intense deregulation, particularly with regard to employment law. Such a scenario sees the UK taking advantage of Brexit to trigger a supply-side renaissance and an acceleration in potential output growth to 3 per cent. This could well include a reduction in Corporation Tax to 10 per cent by the early 2020s. There might also be a significant easing in planning law in order to facilitate an increase in housing supply, in response to increasing housing demand in the wake of a stronger economy.

Trading at world prices would be a challenge for the agricultural sector, but an easing in planning law to allow limited extra residential construction on agricultural land could keep farmers happy and address housing issues all at the same time.

Stronger growth and stronger public finances could also provide the funding for two areas of expansion in government spending. First, with regard to transport infrastructure. Second, with regard to defence spending on new kit and more men and women in the armed forces, to help fly the flag overseas and promote an Anglosphere of the US, UK, Canada, Australia and New Zealand.

Read more: Five reasons the Anglosphere has real geopolitical teeth

The Brexit I fear is something very different. This is a Brexit where the EU protectionist wall is replaced by the UK’s own tariff wall. In such a world the UK would never reap the benefit of trading at world prices. A Brexit to fear is one where the entire body of EU law is transposed onto the statute book and then stays there, permanently.

This is a very different scenario, devoid of any supply-side renaissance. It is also a scenario which leads to permanent sniping at having left the EU. The Brexit I love is one where the benefits are clear for all to see. The Brexit I fear is one where the benefits are far less visible and it becomes a permanent political battleground.

This is not to argue that the Brexit I fear makes the case for staying in the EU. Rather that we would not have seized the opportunity to make so much more of leaving.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

The optimal Brexit strategy is really quite simple – if Britain leaves the Customs Union

Discombobulate means to confuse or disconcert. It’s a word which is likely to become very apt as politicians and the media struggle to define the Brexit strategy between now and the end of March – the deadline for initiating Article 50.

Thursday 5 January 2017 4:45am
Graeme Leach

The greatest benefit of Brexit is the competitive boost of slashing tariffs on imports (Source: Getty)

For the life of me I can’t work out why everybody seems to be in such a spin about Brexit strategy. It’s really quite simple. The focus of our attention needs to be on the Customs Union, not the Single Market. So let’s get back to basics.

There are three economic elements to our EU membership. First, the Customs Union. Second, the Single Market. Third, budget contributions. Within the Customs Union there are three elements as well, namely import tariffs, export tariffs and the ability (or not) to negotiate free trade deals as a sovereign nation.

Within the Single Market are the familiar four freedoms (goods, services, people and capital), and the impact of EU product and labour market law – in the case of employment law, applying across the whole economy not just the EU tradable sector. Budget contributions are the final element, with the net amount around 0.5 per cent of GDP.

So with regard to the Customs Union, the ideal economic scenario is for the UK to trade at world prices with zero tariffs on goods imported into the UK. This most important element is totally within our control. If we leave the Customs Union, we can unilaterally – under WTO rules – impose zero tariffs on imports.

It would be nice, of course, to have zero tariffs on UK exports to the EU. But this isn’t a necessity. Outside the EU the 0.5 per cent of GDP budget contribution could, theoretically, be allocated to specific sectors (e.g. £1bn to compensate car exporters for a 10 per cent tariff) or more generally in a sharply reduced rate of Corporation Tax.

The idea that we have to be in the Single Market, at all costs, is nonsense. Leaving aside the political reality that Brexit will require an end to the free movement of people, there is the added factor that EU law and regulation is a cost that applies across the whole economy.

Moreover, each passing day seems to add to the news that the threat to the City has been way overblown. My prediction is that within months the consensus will have shifted – to Brexit being a net positive, not negative, for financial services. Throw in the fact that there isn’t a Single Market in services and all the fuss, while not much ado about nothing, is heading in that direction. Those who point to a competitive stimulus from the Single Market need to remember that the greatest competitive stimulus comes from the greatest market i.e. trading at world prices.

If the Customs Union is central, and within our control, it begs the question: could Brexit negotiations happen much quicker than we think? Leaving the Customs Union and implementing free trade under WTO rules does not require a great deal of negotiation – an email with a big zero on it should suffice. The lengthier process would arise from leaving the Customs Union and regaining the sovereign right to undertake trade negotiations. But free trade agreements are a secondary not primary consideration in this free trade strategy.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

Read more: "Brexit means Brexit" means something very different to what people think

Read more: Why the Single Market is the problem – not the solution

http://www.cityam.com/256407/optimal-brexit-strategy-really-quite-simple-if-britain

Italy’s exit from the Eurozone is almost inevitable – whichever way it votes this weekend

Two long-term trends make me worry about the Italian economy, regardless of the outcome of the referendum this weekend. First, the so-called Italian Death Cross, and second the prospect of three decades of lost growth (yes three, this isn’t a typo).

Thursday 1 December 2016 4:15am
Graeme Leach

Italy leaving the euro may be the only way to avert a catastrophic deindustrialisation of the country (Source: Getty)

In my view, these two trends make Italy’s exit from the euro almost inevitable at some stage. This is not if, but when. Italian 10-year treasury bonds are yielding 2 per cent, up from 1 per cent in the autumn, and other vital signs, such as the scale of current account and fiscal imbalances, are also very different from the onset of the Greek crisis. But while this provides some comfort, look elsewhere and there is much to fear.

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Nominal GDP in Italy is around 25 per cent below trend. This has given rise to the so-called Italian Death Cross chart, with nominal GDP relative to trend falling, and bad debt rising. When nominal GDP is this far below trend, banking sector difficulties are almost a given.

Read more: The new sick man of Europe is the continent’s entire banking sector

The stop problem (of international capital flows which came to an abrupt end), which triggered the original Greek crisis, has been replaced by a slow problem (of rising non-performing loans) in Italy. Unsurprisingly, research shows that an economy predisposed to grow slowly will experience a more virulent interaction between financial sector shocks and public debt.

Non-performing loans (NPLs) in Greece rose from 14 per cent of total loans in 2011 to 35 per cent in 2015. NPLs in Cyprus increased from 18 per cent in 2012 to 46 per cent in 2015. If the NPL ratio in Italy is 18 per cent before any crisis, where might it be in the event of a crisis? Because of the size of the Italian economy, banking sector difficulties would have major systemic implications for the entire Eurozone.

My second concern relates to lost growth. The Italian economy is already in its second decade of lost growth. Throw in demographic decline in the 2020s and it is reasonable to argue that Italy could face three decades of lost GDP growth.

Economic failure on such a scale will raise fundamental challenges to political and economic institutions. The continued deindustrialisation and hollowing out of the Italian economy will, rightly or wrongly, be blamed on the euro. Arguments over price versus non-price competitiveness are likely to receive a tin ear, as politicians yearn for the “good old days” of lira devaluations. Italy leaving the euro may be the only way to avert a catastrophic deindustrialisation of the country.

Read more: Italy is just three plausible steps away from crashing out of the Eurozone

But just when you thought that was bad enough, one economic commentator foresees even darker days ahead. Wolfgang Munchau, writing in The Financial Times, says: “An Italian exit from the single currency would trigger the total collapse of the Eurozone within a very short period. It would probably lead to the most violent economic shock in history, dwarfing the Lehman Brothers bankruptcy in 2008 and the 1929 Wall Street crash.”

It’s not difficult to see how worst case scenarios could play out. Market uncertainty would be fuelled by contagion fears, the solvency of Italian banks and the so-called sovereign-bank doom-loop. Throw in a potential change of government (and higher probability of exiting the euro) and there would need to be massive intervention by the ECB.

Financial markets aren’t signaling anything like this scale of problem. Let’s hope they’re right.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

http://www.cityam.com/254718/italys-exit-eurozone-almost-inevitable-whichever-way-votes