A Beautiful Mess
John Nash, the "Beautiful Mind" in the film based on Sylvia Nasar's biography, was a far less pleasant fellow than the character played by Russell Crowe, and the "Nash Equilibrium" a far less pleasant vision of the world than the book or film allowed. Nash demonstrated that it is quite possible for competitors to choose mutual annihilation as a matter of rational self-interest. Let's say you belong to a neolithic tribe that hunts mammoths. If the tribe next door kills more mammoths than you do, they eat more, get stronger, and kill you (and possibly eat you, too). So you kill as many mammoths as possible, both to eat more and deny sustenance to the competition. So does everyone else. Mammoths become extinct, and you all die out. A simple way to put it is that people only accept a solution as long as it includes them.
Europe is locked in something of a Nash Equilibrium: the political class will commit collective suicide and take what remains of the European economy down with it, rather than accede to terms that would save the economy, but eliminate the political class. The political class draws on a vast number of actual and prospective wards of the state who stand to live miserably if governments really were to cut spending enough to allay the fiscal crisis.
From the standpoint of many Italian voters, it makes no sense to accept budget cuts, because the proportion of elderly dependents will rise from 30% of the population today, to an impossible 65% around 2050. Italy's present generation, which had about 1.25 children per female, will age into a world in which the tax base cannot possibly support them for the simple reason that too few taxpayers will exist. Fiscal austerity is not a question of comfort but of survival, and Italians have no rational reason to accept the sort of terms that the European Central Bank would like, because under austerity, their lives would change beyond recognition. This is an existential crisis, as the consequences of Italy's gradual demographic death peak over the horizon.
Italians want to postpone the reckoning by extracting more subsidies from Germany, but German voters vehemently oppose this, and expressed their anger at their government by crushing the ruling party in six state elections in succession. By 2040, Germany's old-age dependency ratio will rise to 58%, almost as bad as Italy's. Because Germany has succeeded in dominating key niches in the world market for capital goods, Germany has more flexibility. But Germany's problem is almost as severe as Italy's, and Germans do not believe they should subsidize their feckless southern neighbors.
On the face of it, the stock market's fixation with southern Europe seems unwarranted; as I argued in this morning's Spengler column at Asia Times Online, national bankruptcy is the best thing that could happen to Italian manufacturing. FIAT, to be sure, probably will go bankrupt (and deserves to for the offense of pitching the poor man's car of the Italian 1960s, the Cinquecento, to downwardly-mobile American consumers). The real Italian economy exists off the books, in pockets of technical talent preserved in thousands of family-owned firms. Without the predatory incompetence of the Italian state, these talented companies could find Asian partners and extend their reach to the world market.