The Italian economy and its 10 (yes, ten) problems

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Deep crisis, deep soul searching. If there has ever been a time to raise fundamental questions about one’s own economy, this is it. For example, on June 23 last, a Financial Times editorial noted that keeping health, education and welfare policies in Britain at current levels “means shifting to a higher-tax economic model”. It sternly concluded that “The UK must not take the road to Stockholm”.

We Italians seem to be ducking the economic soul-searching trend, having perhaps had an overdose of it in recent years – remember The real sick man of Europe? We just seem content to have discovered that our financial institutions were sounder that expected. Or that the level of our private debt is so low compared to that of other major countries as to mitigate our perpetual shame, i.e. the very high level of our public debt. Some, including Giulio Tremonti, Italy’s minister of the economy, are politely beginning to say (here) that total debt, private and public, must be taken into account whenever the financial health of a given country is subject to assessment.

Italians keep somewhat overlooking, in my opinion, other relative strengths: real estate prices are holding their own; the balance of payments, never this decade in too bad a shape, is actually getting better (exports are shrinking less than imports); unemployment is, yes, rising, but from one of the lowest points in decades, 6.1% in 2007, half as much as ten years before. Now, just turn these three things upside down – collapsing real estate prices, big external deficit and exploding double-digit unemployment –  and you have Spain, the Wunderwirtschaft that only last year was supposed to be roaring ahead of Italy.

Last year. On June 25 the EU statistical office, Eurostat, released data on EU 2008 per capita Gross Domestic Product (GDP) expressed in purchasing power standards. Spaniards appeared then to be 4% richer than Italians. The website of the daily Il Corriere della Sera could not resist the temptation of promptly making a big deal out of it, with a headline that cried once again “Italy behind Spain”. Now, there are many things Spanish worth of envy from Italy’s point of view, beginning with their public administration and ending with their soccer teams. I am not so sure right now that the economy is among those things.

If we often don’t see our (relative) strengths it is perhaps because our weaknesses are so glaring. Growth is number one. Italy’s economy in the course of this decade constantly grew less than most of the other rich economies. The contraction foreseen for 2009 (- 5%) is one of the direst of the rich world. These growth problems, in good and bad times, Italy seems to share with two other countries: Germany and Japan. Similarities do not stop here: the trio has also in common a strong export-orientation, a high share of GDP from the manufacturing sector and most of all a very low rate of population growth – which makes high rates of economic growth practically unlikely if not unattainable.

The logical answer would be to boost productivity – Italy’s problem number two. But this is precisely what Italy failed to do this decade – total factor productivity was actually negative in 2000-2005. There may be measurement troubles behind this dismal results: part of the strong increase in Italy’s employment over the last 10-15 years was simply the regularization of people already at work in the black economy. Since Italy’s official GDP already comprises (an estimate of) the black economy, such regularization may end up negatively affecting productivity and unduly increasing relative unit labour costs.

A proper measurement of Italy’s economy is thus problem number three. Which leads us directly into problem number four: a black economy that in some estimates seem too big to be true, but that is however big enough as to make everything highly uncertain. And worse, highly unfair: the bigger the black economy the heavier the real tax burden on the honest taxpayer.

The tax burden is problem number five. With fiscal pressure at over 43% (and growing) of GDP and public expenditure at about half of it, shouldn’t we ask ourselves the same question raised by the FT? Is there no exit from this road to Stockholm? 

Seen from this angle, Italy is a bizarre country. We have a public administration – whose low productivity is problem number six – almost as costly as France’s without any of the advantages. There is no École Nationale d’Administration here, and no true state-owned industrial champion, with the possible exception of ENI, the oil company. If the country as a whole remains competitive enough this is due exclusively to the ingenuity of thousands of entrepreneurs who consistently do the right thing. And yet what do we do? We keep draining resources from them, in the wrong assumption that the government knows better how to allocate these resources.

Thanks to its vast class of most dynamic entrepreneurs, Italy would fit perfectly into the Anglo-Saxon model of laissez faire capitalism. And yet both the left and the right insist on giving the country a good dose of an indigenous version of French dirigisme.

The judiciary is part of the public administration but unfortunately no exception to its low quality standards. This is an economic problem on its own – problem number seven – because a weak civil justice means poorly enforced property rights, which in turn discourages entrepreneurship and foreign direct investments and on and on in a long chain reaction of negative outcomes.

Problem number eight is the composition of our public spending, almost a third of which goes to pensions. It’s the equivalent of 14% of Italy’s GDP, twice as much the OECD average. Note the gigantic transfer of resources from producers to rentiers. And an even worse injustice is that spending on pensions practically cancels out any other form of welfare, beginning with unemployment benefits. 

Drawing parallels with Japan and Germany, I forgot to mention above that incidentally Japan is burdened by public debt even more than Italy is, while Germany’s eastern Länder may be seen as the equivalent of Italy’s Mezzogiorno. 

The duality of the Italian economy means that while the North and the Centre have a high standard of living relative to the rest of Europe, the South is markedly poorer and a drag on the country’s economy as a whole. This is problem number nine, but it’s also the oldest, the mother of all our economic woes. We indeed had a century and a half of soul-searching on the South development lag but little practical results to speak of.

Time to close the list. Problem number ten is (the lack of) structural reforms. Italy continues to be an over-regulated economy: product and labour markets are too rigid and there is too little research and science-induced innovation. Confindustria, Italy’s business union, estimates (here) that these Lisbon-type structural reforms, have the potential if implemented over the next twenty years to raise our GDP by 30% – they would be worth doing, in my opinion, even for a fraction of that.

Well, ten may sound terrible and evocative of divine authority on Mount Sinai, and of sin and punishment and all the rest. But at the end of the day it is not an insurmountable number of problems as far as soul-searching on such a grand scale goes. Italians should be optimistic about their capabilities to solve them and start doing it right away. But that’s perhaps the eleventh and fundamental economic problem: optimism is the scarcest of commodities these days. Not only among Italians.

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