No country epitomises the European economic malaise better than Italy. People often say that Italy cannot get into trouble because it is so rich. It is. Rich in natural beauty and historical treasures, with wonderful cities and beautiful countryside, lovely people, marvellous food and wine and an attractive way of life. But as a country it doesn't really work.
Some aspects of the problem have been there for ages; some are comparatively new. Before the war, much of Italy was poor. During the 1950s and 1960s, although Italian politics were chaotic and government was dysfunctional, as it industrialised the economy grew very fast and it climbed up the GDP leagues. In 1979, in respect of measured GDP, Italy even overtook the UK, an event that the Italians rejoiced in, calling it Il Sorpasso.
The underlying problems were disguised. Although there was a tendency for inflation to be high, relief was always close at hand in the shape of a weaker lira. And the economy kept growing. But then it all started to go wrong. The UK overtook Italy again in 1995 and the gap between the two economies has been widening ever since.
To get the problem in perspective, all G7 countries except Italy and Japan have now exceeded the level of GDP they enjoyed before the Great Recession. Canada is 9pc above the 2008 level, while Italian GDP is still 9pc below. What's more, the economy is contracting.
This is not a bolt from the blue. Since the euro was formed in 1999 the annual average growth rate of the Italian economy has been only 0.3pc - in other words, next to nothing.
Mind you, not all of this is due to the euro. There is a desperate need for reform yet the political system seems incapable of delivering what is needed. And Italy has been one of the prime sufferers from the rise of the emerging markets.
Whereas Germany produces high-spec, large consumer durables and machinery, Italy has been specialised in precisely the low-to mid-spec consumer goods which China and others have come to produce more cheaply.
The euro has certainly not helped because, from the start, Italian costs continued to rise faster than they did in Germany and other core countries. This time, though, there was no let out from the exchange rate. So Italian costs and prices were left high and dry.
True, the inflation rate has come down sharply. Indeed, it is now slightly negative. This is hardly surprising given that the unemployment rate is running at 12.6pc. Unlike some of the other peripheral members of the euro, however, Italy has not done much to reduce the competitiveness gap. With so much spare capacity, it is possible that pay and other costs will start to fall markedly, as they have in Spain, Greece and Ireland. But if this happens, although it will eventually make Italian products more competitive, it will also worsen Italy's other big problem - debt.
Although at 3pc, the government's deficit is not particularly high, the real financial problem lies with the stock of debt, built up through a long run of deficits. Strikingly, during the recent period of 'austerity', the debt ratio has been rising. It now stands at about 130pc of GDP. If the economy stagnates and prices drop, then nominal GDP will fall. That would cause the ratio of debt to GDP to rise even if the budget were in balance so that the amount of debt had stopped rising.
Italy is very close to the situation that economists call a 'debt trap', that is to say when the debt ratio rises exponentially. From this the only escape is through inflation or default. Italy cannot itself inflate while it has no separate currency. So, unless something big starts to change pretty soon, Italy is on course for the mother and father of a sovereign default.
You frequently hear the view that a government debt crisis in Italy is impossible because the Italians have such a high personal savings rate and, accordingly, there are always the funds to buy the debt. Equally, it is often argued that, unlike Portugal or Greece, the Italian external position is not too bad, with liabilities to foreigners only larger than external assets to the tune of about 30pc of GDP. This means that Italian debt is mostly owed to Italians.
This is largely true - so far as it goes. Admittedly, because Italy is not a big external debtor there is limited risk of a crisis of international indebtedness of the sort that periodically afflicts various emerging markets. But there can still be a fiscal crisis. Just because Italians have large savings does not mean that they will willingly pour money into government bonds, particularly when the unsustainability of the public finances implies that at some stage there will be a default.
As we have seen, Greek debt can be 'restructured' without shaking the financial system. This is because Greece is small. But Italy is decidedly not. The Italian government bond market is the third largest in the world, after the US and Japan. Someone somewhere is sitting on some huge stocks of Italian debt '- mostly Italian banks. So a debt crisis would morph into a banking crisis.
Not that you'd think there was a problem if you looked at market interest rates. The markets are happy to lend to the Italian government for 10 years at 2.4pc, only 1.3pc above the German equivalent. Mind you, before a crisis hits this is exactly what markets are typically like. Their speciality is to shift from insouciance to panic in a jiffy.
How could Italy escape from all this? The deep-seated problems will not improve overnight. The country needs fundamental reform of its political system, its courts, its tax system and its labour laws. Even if all this were achieved, though, Italy would still be mired in public debt.
Like the rest of the eurozone, what Italy needs most immediately is decent economic growth. Perhaps some Europe-wide upturn will be achieved through a combination of ECB boldness and German fiscal relaxation. But I wouldn't bank on it.
The radical option is for Italy to leave the euro and allow a weak currency to generate an export boom, higher inflation, more taxes and an easier debt burden. I wonder how many more wasted years Italy can stand until it finally dawns on its leaders that this is the only way forward.
