Informative Contagion

Kash Mansouri writes about the Italian debt crisis as a pure case of contagion—insolvency in Greece made people start to worry about Italy, which is creating a self-fulfilling downward spiral.

I don’t disagree with any of that, but it’s worth distinguishing between two kinds of contagion. One is pure association contagion. There are a whole bunch of Spanish-speaking countries located in the Western Hemisphere that are collectively known as “Latin America.” The fact that both Mexico and Peru are part of “Latin America” doesn’t actually tell us anything about their budget outlook or economic policy, but most of us mentally associate Mexico and Peru are two component parts of “Latin America” in a way that we don’t associate Peru and Thailand. So you can imagine a situation where funnybusiness in Mexico leads to a crisis there, which then creates a self-fulfilling downward cycle of investor confidence in Peru simply through unfair association of the two countries as part of “Latin America.” So maybe Italy is like that, just victimized by a loose “Southern Europe” association.

But another view is that the Greece episode actually taught us things and provides new information that investors in Italian debt ought to consider. I would argue that this is the case, and the Greek debt crisis actually provides relevant information about Italy. In particular, I learned the following things:

— One: The German government has proven to be stingier than I thought. Pre-Greece, I thought that the German political class would on some level welcome an opportunity to open the German pocketbook in exchange for political domination of the entire continent. This turns out not to be the case. Germans would really like to mind their own business and export capital goods and luxury cars to China.

— Two: The informal “everyone must agree, but in reality France + Germany = ‘everyone'” rule of EU decision-making is in somewhat rocky shape. First Finland and later Slovakia held things up over domestic political controversies that were only loosely related to the core issues. This makes it extremely difficult for the EU to make credible commitments. Olli Rehn can’t make promises about the stability of the coalition government in the Netherlands.

— Three (and perhaps most important): We learned from Greece that EU member states have greater capacity for secret budget shenanigans than I would have thought possible. We always knew that governance in Greece and is weaker than governance in Denmark, but it turns out that the quality of the supervisory governance from Brussels is also rather poor. Given that Italy, especially under Berlusconi, is not exactly above suspicion in terms of governance quality Greece gives us reason to wonder whether the easily accessible public data about Italy is accurate.

Maybe some people were smarter than me and saw all of this all along. But I think I’m not alone in being somewhat surprised by these revelations, and thus genuinely more skeptical of Italy than I was a year ago.