Analysis: Why Europeans should lose sleep over Italy and not Turkey?

Soner Kistak

The financial net worth of the general government sector is the total value of its financial assets minus the total value of its outstanding liabilities. Positive financial net worth signals the strength and health of public finances. It also shows the government will be able to continue its policy programs without experiencing financial stress. Conversely, negative financial net worth points toward a level of fragility that requires policy actions such as tax increases and/or government expenditure decreases. It is true that this measure only reflects the financial side of the public sector’s balance sheet and does not consider the non-financial part. While a government’s non-financial assets include buildings, infrastructure, land, and machinery, its non-financial liabilities comprise pensions and health care related costs. Since the measurement of the non-financial part of the balance sheet is not standardized across OECD countries, drawing conclusions based on non-financial assets is rather challenging. For example, many macroeconomists claim that the negative financial net worth of countries like the U.S. and Japan isn’t worth worrying about because these countries are asset-rich. This short analysis focuses on the financial side of the balance sheet and uses Financial Net Worth (as percentage of GDP) to shed light on the current situation.

Based on 2017 OECD figures, the financial net worth of general governments across countries (excluding Norway) averaged a negative 74 percent of the GDP, meaning that for every 1 percent of the GDP in assets, governments owed 1.74 percent of the GDP (see table). It is worth noting that Nordic countries such as oil-rich Norway and Sweden have the best financial net worth levels, whereas Greece and Italy have the worst standings. The situation in Greece is well-known, the country has been struggling financially since 2010. However, now is when Italy has its moment of reckoning. The country’s governmental financial net worth stands at -126 percent of their GDP. It is a country that has been plagued by various problems for years. It ranks among the countries with the largest debt ($2.3 trillion) and the most unemployment. Moreover, Italy’s eclectic ruling coalition comprised of the Five Star Movement and the Lega Nord announced a budget that foresees a more-than-expected spending deficit in 2019. Given the country’s negative net worth, this is exactly the opposite of what markets are expecting. As a matter of fact, financial players were hoping for more responsible fiscal discipline and a plan to reduce the country’s debt. Moreover, Italy’s populist government and anti-EUR rhetoric have not helped either. This, in sum, explains the current anxiety surrounding Italy and why European financial markets have been under such pressure. Italy is simply too important for the EUR project and Europeans, especially Germans, cannot afford to have it exit the single currency.

In contrast, the Turkish governmental financial situation is much better with a financial net worth of -17.4 percent of the GDP, which is much more manageable. Naturally, we should strive for a situation like that of Sweden’s as we carry on with fiscal discipline. In sharp contrast to Italian policy makers, Turkish economic policy makers have recently been taking a cooperative stance with their European partners, Germany and France. This is not to say that everything is rosy for Turkey. There are serious issues such as private sector debt and asset-liability mismatch that need to be addressed. It is also true that the Turkish government has less non-financial assets than the Italian government. However, we can comfortably argue that it is much easier for Turkey to overcome its difficulties than it is for Italy, as the scale of the debt problem is much smaller. Of course, this argument is only valid on the condition that Turkey continues to determinedly tackle its financial issues in a serious manner. The government also needs to be creative in how it goes about fixing its problems. Rather than following traditional recipes, the Turkish state can afford to have an entrepreneurial role in order to transform its economy. All in all, it will be a hard road, but it will be a road worth taking.