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The Italian government has approved a new package of austerity measures worth 45.5 billion euros. The aim of the measures is the country to achieve a balanced budget a year ahead of what was envisaged - in 2013, instead of 2014. Only a month ago the government adopted another package of measures worth 48 billion euros. Among the new measures, along with draconian spending cuts, a tax increase is provided - for example through a “solidarity contribution” for people with higher incomes. There are plans to increase taxes on capital from 12.5% to 20%, excluding investment in government bonds, The Financial Times reported.

“Our hearts pour with blood if we think that our point of pride was that we had not put our hands in the pockets of Italians. But the global situation has changed and we are facing a planetary challenge,” Prime Minister Silvio Berlusconi stated. President of the European Council, Herman Van Rompuy expressed his support for “the timely and rigorous financial measures” stressing that they “are crucially important not only for Italy but for the Eurozone as a whole.”

In the past month market pressure shifted on Spain and Italy, and now all eyes turn to France. It reflects investors' fears that the eurozone is not able to decide once and for all the problems that led to the debt crisis. Rising interest rates, however, can quickly become prohibitive for Italy, which is one of the most indebted countries in the world - its public debt has exceeded 100 percent of GDP since 1992, Uri Dadush and Bennett Stancil with the Carnegie Endowment recall in a comment.

However, in the past 4 years the Italian debt has increased only by 17% of GDP - in comparison, during the crisis, the German debt jumped by 15%, the Irish- by 89%, the Greek by 47%, the US by 37%, Spanish and Portugal – both by 27%. In addition, during the pre-crisis decade, Italy maintained a rigorous financial management, scoring an average primary surplus (revenue minus spending, excluding interest payments) of 3 percent of GDP, over twice the eurozone average. Where is the problem then?

The “anaemic” economic growth, the authors answer. Since the 1990s, the labour force's growth has slowed in parallel with investment’s growth which, combined with a significant decline in productivity, has hindered economic growth. Moreover, like Greece, Ireland, Spain and Portugal, Italy has rapidly lost competitiveness after the introduction of the euro. Thanks to the single currency, market confidence in these countries rose and the interest rates fell, which “created a wave of spending and borrowing that raised the price of non-tradable goods and services relative to those that are tradable, and wages (labour is internationally immobile) relative to productivity.” For these reasons and against the background of reduced unit labour costs in Germany, the presence of these countries on export markets has significantly dropped. In recent years, Italy’s competitiveness gap with Germany has stopped widening, but is not reduced.

What is the solution, according to the analysts? Given that Italy’s interest rates reached 6.2%, it should aim at a surplus of 5% and reduce public sector wages by 10%. Decisive structural reforms are needed to restore competitiveness and growth, starting with the labour market. But what if Italy still needs to be saved? The experts estimate the cost of such operation to 1.4 trillion dollars (the price of saving Spain is twice less - 700 billion dollars). Such a financial burden would be impossible for the euro area, even if the IMF contributes with a third, under the scheme implemented so far.

The decision, according to the Carnegie analysts is “a globally coordinated bailout - led by the IMF and including bilateral assistance from the United States, Japan, China, the UK, and other countries”. Such a large-scale plan would inevitably be linked to far-reaching conditions not only for Italy but also for the euro area as a whole, the analysts say. It is possible that these conditions “would essentially push for changes that many European observers have been advocating but that politicians have been reluctant to pursue.” For example - allowing the possibility of leaving the euro area on the one hand and on the other - increased fiscal transfers in the euro area, closer coordination of fiscal policies and “shared fund-raising (such as through the euro bond)”.

It was the Eurobonds that were defined as “the best solution” to the debt crisis by Italian Finance Minister Giulio Tremonti. Last year, Mr Tremonti, together with Jean-Claude Juncker, Prime Minister of Luxembourg and President of the Eurogroup, proposed to establish a European debt agency to issue Eurobonds worth 40% of EU's GDP. Although the idea met support from the European Commission and the European Parliament, it has been rejected mostly because of the Germany's opposition. Finance Minister Wolfgang Schäuble's reaction was again categorical: “I rule out eurobonds for as long as member states conduct their own financial policies and we need different rates of interest in order that there are possible incentives and sanctions to enforce fiscal solidity”.

In other words, according to Germany, the creation of Eurobonds would relieve market pressure on the troubled economies and therefore would weaken governments' resolve to pursue tight fiscal policies. However, the risk will be borne by all eurozone countries, especially those with the highest AAA credit rating.

The idea of Eurobonds deserves “serious consideration” and deeper integration of the euro area is inevitable, British finance minister George Osborne told Radio BBC. While firmly holding the position that it would not join the single currency, the UK is insisting on a better cohesion in the euro area. “An unstable euro is very bad news for us, we have to ensure that our influence on important decisions like financial services is not undermined. But we do have to allow greater fiscal union while protecting our own national interest.”

Against this background, German Chancellor Angela Merkel and French President Nicolas Sarkozy are meeting on Tuesday in Paris. On the top of the agenda are the changes in the eurozone governance, which to be presented by both countries in October. Some of the ideas, which euinside wrote about, are not new - such as the euro area to obtain a permanent leader in the face of the President of the European Council, Herman Van Rompuy. A novelty is, however, the proposal to establish a Stability Council for the euro area, made by German Economy Minister Philipp Roesler, although it is unclear whether the idea is supported by Chancellor Merkel and the government. According to German sources, quoted by The Financial Times, we should not expect big news from the meeting, but in any case we would see at least where the wind of change is blowing to.