At the end of this month, Italian voters will choose their next government, from which they expect jobs and a more level economic playing field – and from which Italy’s European partners expect structural reforms and fiscal probity. What should the new government’s economic-policy agenda be?
To reduce public debt, which stands above 120% of GDP, while minimizing painful adjustments, Italy needs economic growth – something that has eluded policymakers in recent years. Indeed, Italy’s average annual GDP growth rate since joining Europe’s economic and monetary union in 1999 has been an anemic 0.5%, well below the eurozone average of nearly 1.5%. In the four years since the global financial crisis struck, the growth rate fell to -1.2%, compared to the eurozone average of -0.2%, and it is expected to remain negative this year.
The new government’s biggest challenge will be to implement reforms that enable Italy’s economic performance to catch up to that of its neighbors after years of bad policies and neglect. This requires increased investment in innovation and human capital.
From 1992 to 2011, labor productivity grew at an average annual rate of 0.9%, the lowest in the OECD. Since 2001, unit labor costs have been growing faster than real GDP and employment, undermining the economy’s competitiveness vis-a-vis developing countries. In the last decade, Italy’s share of global exports dropped from 3.9% to 2.9%.
Persistently weak labor-productivity growth has created a situation in which unit labor costs do not fall, even if real wages remain stagnant or decline. Indeed, despite a 1.3% drop in real wages in 2011, unit labor costs remained unchanged.
Italy’s new leaders must address this situation by decoupling labor’s contribution to productivity growth from that of capital and total factor productivity. According to the OECD, lower regulatory costs and more efficient public administration (building upon measures introduced by the previous government, led by Mario Monti) could add 0.3-0.4% to average annual GDP growth by 2020.
Likewise, labor-market reform, improved education, and enhanced human capital could contribute an additional 4% to GDP growth in the next decade. Moreover, Italian policymakers should strive to boost the female labor-force participation rate, which, at 49%, is one of the lowest in the OECD. Doing so would raise per capita income by 1% annually through 2030.
At the same time, fiscal adjustment remains essential to Italy’s short- and long-term stability. According to the International Monetary Fund, the budget deficit is declining, and the primary surplus (net revenues minus interest payments) is growing. Italy’s new leadership must sustain this progress.
Despite positive developments, the road ahead is bumpy. Navigating it will require Italy to retain its credibility with other European Union member states and international investors. The new prime minister will need to persuade Germany, financial markets, and the European Council that Italy is a reliable partner.
The ability to refinance government debt and keep costs down is essential to strengthening public finances and boosting GDP growth. Furthermore, attracting more direct investment is crucial, given that capital inflows, while recovering, remain 30% below their pre-crisis level; with outflows exceeding inflows, Italy has become a net capital exporter.
“Selling” Italy in Europe should entail more than photo opportunities with other leaders in Brussels and the occasional road show to financial institutions in London. Italy’s leaders should engage actively in commercial diplomacy, using the country’s embassies and trade agencies to promote Italy globally, while working to build strong bilateral relations with other EU members, particularly southern countries like Spain.
At the same time, the new leaders need to “sell” Europe in Italy, where Euro-skepticism is rampant. According to the Pew Research Global Attitudes Project, only 30% of Italians view the euro positively. In the country’s wealthier north, where average per capita income, at €30,000 ($40,500), approaches that of Germany, people are questioning the rationale of EU membership. The costs are evident, they argue, but what are the benefits? Meanwhile, fears of structural decline pervade the country.
The crisis has lasted for a long time, and people are tired. Unemployment has risen to a record 11.2%, with 35% of young people jobless. And the tax burden, which has exceeded 40% of GDP since 1990, now stands at almost 43% of GDP.
A Scandinavian level of taxes would be bearable if public services did not remain inferior to those offered in Scandinavia. For example, per capita health-care spending in Sweden, Denmark, and Finland exceeds $3,000, compared to only $2,300 in Italy, where households must contribute roughly 20% of total health-care spending.
Moreover, Italy spends around 4.5% of GDP on education, while the Scandinavian countries spend more than 6% of GDP. As a result, Italian students’ scores in the Program for International Student Assessment are significantly lower than those of their counterparts in many other OECD countries.
Italy’s new government will have to display leadership and vision to guide the economy toward stable growth, avert a race to the bottom, and stem growing social tension. Most important, economic renewal depends on the next government’s willingness and ability to address the institutional weaknesses that have made concerted action increasingly urgent.
Paola Subacchi is Research Director of International Economics at Chatham House.
Copyright: Project Syndicate, 2013.