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In my Economy column last week, I argued that the euro area’s flaws explain much of Italy’s economic problems over the past decade. In particular, the single currency has transformed government bonds from rate products into credit products. This forces fiscal policy to be too tight, especially during downturns, and also makes monetary policy tighter than it should be.

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Some readers disagreed. Italian borrowing costs, in their view, would always have a pro-cyclical credit component even if Italy had its own currency the Bank of Italy could print. Brazil, for example, has its own currency and a large locally denominated sovereign bond market, yet was forced to raise interest rates and cut its budget deficit in the midst of its worst recession in decades. Jokesters drew Venn diagrams noting that Italy and Argentina both have large populations of ethnic Italians, while Italy and Turkey both call their traditional local currency the lira. The implication is that Italy is somehow destined to be a basket case.

These arguments miss the mark. Italy is no more of an emerging market than the United Kingdom, either historically or today.

First, consider their track records with inflation. It is difficult to distinguish which one is the “responsible” economy and which one is not:

More important than inflation is the history of interest rates. The value of monetary sovereignty is that the cost of capital follows the growth outlook. The chart below compares the benchmark interest rates on sovereign debt in Italy and the U.K. after subtracting inflation:

As you can see, the Italian government has paid essentially the same interest cost as the U.K. for the past four decades, with two notable exceptions. These were the ERM crisis of the early 1990s and the euro crisis of the past few years. The U.K. would have had a similar experience to Italy, except the British government, unlike the Italian one, decided to abandon the peg to the deutschmark during the ERM crisis and consequently missed the opportunity to join the euro.

Italy has plenty of other problems. As I wrote last week, Italy has exceptionally bad demographics, a stark division between the north and the south, and an antimeritocratic business culture. But the U.K. has plenty of problems too, including a similarly stark division between north and south and an educational culture that often prizes “good sportsmanship” and “gifted amateurs” over academic rigor. Both are plagued by bloated banks. Take out Greater London—the prosperity of which depends to an uncomfortable degree on a willingness to provide services to oligarchs from the Middle East and the former Soviet Union—and the U.K. is one of the poorest countries in Western Europe.

All this helps explain why Italian workers have historically been more productive than British ones and even now are about the same. Neither Italy nor the U.K. has experienced much productivity growth since 2007. The U.K. government also needlessly raised taxes and cut spending after the 2010 election despite no pressure from the capital markets to do so. Yet the economic outcomes in the two countries have been noticeably different because the U.K. enjoys monetary sovereignty. This has partly offset the weakness of its institutions and the incompetence of its politicians. As a result, the U.K. has had more inflation and more job growth.

The chart below compares the changes in real gross domestic product per capita in Italy and the U.K. along with two hypotheticals:

The gray dashed line shows what would have happened if Italy had had the same increases in employment and hours worked as the U.K., while the yellow dashed line shows what would have happened if the U.K. had experienced the same job market outcomes as Italy.

Remember that GDP is simply output per hour (productivity) multiplied by the number of hours worked. Since Italy and the U.K. have had almost identical levels and growth rates of productivity in the past dozen years, the difference in the growth of GDP per capita is due entirely to the changes in hours worked.

The U.K. has long had higher employment rates than Italy because its labor market is less regulated and there are fewer cultural barriers to women in the workforce. Italians have historically offset this by working fewer part-time jobs. In 2007, the average Italian worker worked about 8.5% more hours each year than the average British worker, while the share of Brits with a job was about 13 percentage points higher than the share of Italians with a job.

There is clearly much room for improvement in Italian labor law. But what matters for this exercise is how the employment rate and the hours worked per job have evolved in each country. Since 2007, the U.K. employment rate has increased by three percentage points, while the number of hours worked per job has been flat. In Italy, the employment rate has dropped by almost a percentage point, while the number of hours worked per job has fallen by 5%. Neither country has made large changes in its incentives for working, which suggests these differences are due mostly to differences in the monetary regime.

The combined effect is striking. Had Italy shared the U.K. government’s low cost of capital and exchange-rate flexibility, it would be about 10% better off now. Conversely, if the U.K. had been saddled with Italy’s membership in the euro, its living standards would be about 10% lower now.

Italians are not living in the best of all possible worlds. If they had never joined the euro, their current woes would not have been replaced with the economic problems of Argentina, Brazil, or Turkey. They would not be doing well—Italy is the only major rich country to have done worse than the U.K. in the past decade—but they would be doing better than they are now.

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