The faces of the Italian Economy

Anthony Smith
April 28, 2005

Italy's Economy - As Bad as Most Italian's Think?

Bring up one subject with your average Italian and you can expect a real ear-bashing – the economy. Italians love to lamentarsi, “si lamenta” (one complains), about many things, but especially about the grim outlook for the country’s economy, like those in other developed countries that feel increasingly threatened by the mighty Chinese tiger.

 

But just how badly is Italy doing in the economic stakes? Is it a misfiring basket case or just another European country in need of a little more of the Thatcherite medicine it’s been taking in steady doses since the mid Nineties?

 

Italy- A Tale of Two Quite Different Economies

First off for the uninitiated it does well to remember that Europe’s fourth largest economic power (after Germany, France, and the UK) in economic terms, and not only economic terms, is not really a single country at all but two quite distinct economic entities: a pumped-up, super-charged and extremely dynamic North, and a depressed, under-performing subsidy-dependent South. The two are linked, both geographically and economically, by the slightly above-average performing Centre containing Tuscany, Umbria, Marche and Latium.

 

Northern Engine Room

Northern Italy includes nine regions most of which are economic powerhouses in European terms, some even in global terms. The Alpine region of Bolzano-Bozen is one of the top ten in Europe in terms of Gross Domestic Product “GDP” per capita at almost 160% of the EU average. The engine-room of the Italian economy, Lombardy containing the business capital Milan, recorded high GDP per capita growth between 2000 and 2002, up from 142% to 144% of the EU average. The North is a patchwork of industrial districts, highly specialized in a wide range of segments such as leather goods, tiles, glass and ceramics, and eyeglasses, making many of them global leaders in their fields.

 

Mezzogiorno- Southern Backwater

Unfortunately for Italy, the South is as far removed from the country’s North as could be. Here regional per capita wealth was around 74% of the EU average and, unlike many northern regions, those in the south experienced little improvement in respect of the average between 2000 and 2002. The poorest region, Calabria, at just under 68% only managed to grow by 0.2% over the period, paltry in comparison to European regions in the new EU member states.

 

Years of massive state subsidies (reaching up to €100 billion a year) have done little to reverse the huge disparity in GDP per capita between the two halves of the country, which if anything has only widened. Indeed, many economists now blame north-south transfers for accentuating the problem by raising labour costs to uncompetitive levels and encouraging the pervasive culture of corruption and sponging that plagues much of the South. The social consequences are there for all to see with unemployment of 19% in the South compared with only 4% in the North, and the enduring and insidious problem of organised criminality.

 

Reforming Italy- Tackling Over-regulation

In common with other continental European economies, Italy’s is beset with the kind of “structural problems” (i.e. red-tape, trade unionism, state interference) that International Monetary Fund “IMF” and Organisation for Economic Co-operation “OECD” reports periodically slam for stifling business and entrepreneurship. Or is it?

 

These days Italy tends to score highly among western nations for reform of such areas as labour and financial markets.

 

Due to the introduction and rapid expansion of short-term contracts almost nobody in Italy expects to get a “job for life” with an indefinite contract any more. Those that have them, many of them employed in large companies or the public sector, jealously guard what has now become a privilege rather than a right. The trade unions remain very powerful and frequently bring chaos to the country’s transport system for instance over wage bargaining and working conditions. But their power will eventually wane as the increasing millions of unprivileged Italians without indefinite contracts spurn union membership and push for lower taxes.

 

Trade on the Milan borsa has benefited from newer clearer company laws which have strengthened shareholder rights and improved accounting standards, making it one of continental Europe’s better performing stock markets.

 

Bright Lights?

While there is still considerable room for improvement, especially in simplifying Italy’s arcane and labyrinthine tax laws, the knock-on effect of reforms now sees Italy as the seventh most “business-friendly” country in the 24-member OECD. Foreign investment may not exactly be pouring in but there is at least a trickle. In such areas as call centres and temp agencies looser laws on hiring and firing have created new markets for foreign companies where they simply did not exist under the previous conditions when jobs were created by the state.

 

There have also been rich pickings in Italy over the past ten years as the state has sold off or part-privatised whole branches of industry such as oil and gas, electricity and telecoms, once the sole preserve of state-run monopolies. The public sector now accounts for just one-tenth of bank assets in Italy compared with over two-thirds in the early 1990s.

 

So if things are looking so (relatively) rosy, why all the gloomy faces?

 

Storm Clouds Forming

Despite the progress, there remain a number of deep-seated problems that recent governments have failed to address and over which crisis point may be looming very soon. These largely concern Italy’s declining competitiveness and productivity in certain sectors, especially textiles, and the looming catastrophe in public finances.

 

The threat posed by China, India and other developing countries to the Italian textile industry is acute and a fine, if extreme, example of the dangers facing a variety of key sectors. Up until this year, the EU has been the world’s leading exporter of textiles thanks to the top design houses in France and Italy and, no less importantly, to the substantial barriers in Europe to imports from developing countries. Half of the EU’s textile firms are in northern Italy, some 50,000 small and medium-sized family-run businesses that face an onslaught of cheap Chinese imports following the final phasing out of restrictions in line with WTO rules in January 2005. One option is to shift production overseas, as many French producers have been doing since the mid-Nineties. Or alternatively they may simply go bust or be bought up by foreign companies, something even Chinese investors keen to acquire Italian expertise are silently hoping for.

 

House of Disorder

At the macro-level things are even worse. Public debt in Italy now stands at 106% of GDP according to data for 2004. With growth so feeble it is more or less cancelled out by inflation, the chances of repaying any of that debt are remote. The IMF was even forced to criticise Italy over its debt problem recently citing the impending crisis in its pensions system.

 

Many developed economies may be failing to deal with the ‘problem’ of ageing populations and Italy is no exception. But hang on, it is an exception because in Italy the problem is about as serious as it gets.

 

Italians simply produce too few children and live too long to finance their later lives. The birth rate in Italy has sunk to just over 1 child per adult female, making it one of the least fertile countries in the world. Add to that Italians’ exceptional longevity (with modern medicine and the Mediterranean diet largely responsible), given there are more aged per capita in Italy than anywhere else in Europe. Top it off with extremely generous state pensions provisions and what do you get? A ticking time-bomb for public finances.

 

A major reform of pensions in 1995 altered the method for payment from an inflation-indexed to a contributions-based system. This was a necessary corrective measure, which unfortunately came about 20 years too late for the new crop of retirees never mind those who will retire a generation from now. The legions of pensioners who retired in the years up to 1995 often receive a salary-indexed payment worth 80% of their former wages. As a result pensions consume just under 14% of Italian GDP and, before the reforms have even the slightest chance of biting that percentage is predicted to rise to 15% by 2015. As the ratio of workers to pensioners rapidly falls, the public purse is heading for bankruptcy. The only way to avoid such a collapse may be to radically slash state pensions once and for all. As yet, no politician has dared raise the notion, which would be tantamount to electoral suicide, or even worse – Italian economists have been assassinated for less.

 

Taxing Times Ahead

If things were not bad enough the Italian government received something of a potential killer blow earlier this year as a case against the state for unlawful tax collecting went before the European Court of Justice. The so-called Irap, introduced in 1998, is a regional tax on Italian businesses that is levied on turnover in a manner similar to VAT. The preliminary report by the Court’s advocate general agreed with the plaintiff, disgruntled Italian companies, that the tax did indeed contravene EU rules on indirect taxes and should, therefore, be repaid. If the Court agrees, a massive tax return bill of some €120 billion will have to be found to reimburse taxpayers, a sum equalling about 10% of Italian GDP. Although there is little chance that any companies will see much of their money any time soon, the Italian state may be forced to include its obligations for progressive repayment over the course of future budgets. Not what the doctor ordered the ailing patient.

 

So having started with a mixed picture of an Italy both dynamic and depressed, losing ground in some areas, gaining in others, the overall picture gets progressively bleak once the potentially disastrous state of public finances enters the picture. Italy’s economic future and with it that of its working age population are intimately intertwined with two things: the success or otherwise of its core businesses to adapt to the new globalised reality and the ability of its politicians and central bankers to resolve the pensions crisis. But neither will be easy, hence si lamenta.

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