Government and Institutions

Another lost decade for Italy?

Matteo Renzi’s government was Italy’s 63rd since 1946. Now, the country – desperate for some internal political stability – will soon be heading to the polls, yet again. However, although all main opposition parties, including the populist and Eurosceptic 5-Star Movement, are calling for an early general election, the final say is in the hands of Sergio Mattarella, the Italian Republic’s President, who will soon open consultations to find a new Prime Minister. On Monday afternoon, Mattarella decided to “freeze” the Prime Minister’s resignations for a few days. Renzi will officially stand down as soon as the 2017 Government Budget Law is approved.

While a possible outcome, an early general election is only one of a handful of different potential scenarios. In fact, another likely possibility would be for Mattarella to begin consultation talks and – once a political majority has been formed – give custody of the new government to either Pietro Grasso, the current President of the Senate, or Pier Carlo Padoan, Renzi’s Minister of the Economy. As the Italian Treasury reports, Mr. Padoan has not taken off to Brussels to attend yesterday’s and today’s Eurogroup finance meetings.

There are widespread worries that political uncertainty will only compound long-standing economic problems which were never properly addressed by Mr. Renzi in his almost three years of office.

Contrary to conventional wisdom outside of Italy, the referendum had nothing to do with either the European Union or Italy’s euro membership. At the end of yesterday’s trading session, the euro gained against both the dollar and sterling, Italy’s 10-year government bonds did not shoot upwards and the Italian Stock Exchange lost only 0.21 percentage points. It is quite possible that larger fluctuations will take place over the next few days and weeks, but it is important to emphasise that Italians voted against a set of technical amendments to the constitution, not the preservation or abolition of the country’s economic and financial institutions. As Standard and Poor’s has noted, “the negative outcome of the referendum does not have an immediate impact on Italy’s creditworthiness as it does not have immediate implications for Italy’s economic or budgetary policies beyond likely near-term changes in Italian politics.”

It is however imperative that Italy pursue further market reforms once the new government is in place. Renzi’s government badly failed to tackle one of the key drags on growth: the high share of public expenditure in GDP. According to the Italian Treasury, Italy’s 2016 total government spending as a percentage of national income will be 49.6%, higher still than in 2011, when the country was hit hard by the European debt crisis. Meanwhile the budget deficit will remain at 2.4%, with no sign of further reductions for the years ahead.

Italy’s fiscal problems and the government’s inability to take effective action against excessive spending are at the core of the country’s poor economic performance and high national debt. With a debt-to-GDP ratio above 132%, Italy is second only to Greece among EU countries when it comes to public debt, but if one takes into account Italy’s primary balance we can better understand why the country has struggled to reduce it. As economic theory suggests, when a country has a high debt-to-GDP ratio, it also has the duty to run higher primary surpluses. However, that did not happen in Italy. Rather than moving towards a primary surplus, the last two governments have widened the gap.

Another long-term feature of recent Italian economic performance which remains unaddressed by policy-makers is stagnant productivity growth. Output per hour worked has remained largely unchanged over the last 15 years. In 2000, one hour of work generated an income of €37 in 2010 prices. As of 2015-2016 it generates €36.5. The Italian productivity puzzle is unique in its extent and duration, and it is challenging to disentangle all the different possible causes. Declining investments, unstable property rights, excessive taxes on businesses, an unproductive public administration, underdeveloped capital markets, a relatively weak education system unable to satisfy firms’ needs, cartelised utility markets and very poor contracts enforcement indicators are all determinants of the puzzle. Over the last two decades, Italian policy-makers have run away from all these issues.

Thus, what is clear is that since the late ’90s and early 2000s, Italy has not been able to grasp the benefits of joining the euro and its governments have not been able to liberalise markets, employment regulations and the public sector in a productivity-enhancing direction.

A related problem for Italy’s future growth prospects are the structural rigidities in many markets stemming in most cases from regulation. While Renzi tried to partially address this issue in the constitutional reform which was just rejected, his government had not been able to fulfil its pledge to liberalise the economy and reduce subsidies to railways and other state-owned enterprises.

As the latest 2015 Bruno Leoni Liberalisation Index highlights, Italy’s liberalisation process has never properly kicked off and the economy scores a relatively low grade of 67, on par with Romania and the Czech Republic, but below that of Spain and Portugal, which in recent years have undertaken some market reforms.

As Italy prepares for its 64th government in 71 years, the country’s long-term fortunes are not promising. For the country’s prospects to improve, a strong fiscal consolidation plan, tax reductions, a decentralisation of powers and the liberalisation of key markets such as fuels, natural gas, postal services, insurance, labour and air transport are much needed. Like his predecessors, Renzi has not been able to effectively tackle Italy’s deep-rooted economic problems. Only a liberalising agenda can help Italy to escape another lost decade. Nothing else.


This article was first published on the EPICENTER blog.

1 thought on “Another lost decade for Italy?”

  1. Posted 07/12/2016 at 12:43 | Permalink

    These quotes are taken from a recent OECD analysis:
    “Reducing the share of pension spending in primary spending yields sizeable growth gains with no significant adverse effect on disposable income inequality. This reduction could be achieved by an increase in the effective retirement age or by cutting the replacement rate. …Cutting public subsidies boosts growth, as public subsidies…can distort the allocation of resources and undermine competition.”
    I don’t think Italian governments are seriously trying to rein in the size of the State. Yet the best ways to do this are already known. It can’t be down to fear of getting turfed out either by election or by the force of special interest groups because every government gets turfed out of office in Italy in short order anyway. It makes no sense to me that it isn’t being tackled.

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