Understanding Italy’s Stagnation
Why did we write the paper?
Following our work on German fiscal policy, we asked: what could good fiscal policy in the Eurozone look like? Here, Italy quickly emerged as pivotal: it is too big to fail, so that a fiscal framework that does not work for Italy will not work for the Eurozone. But what does it mean for fiscal rules to “work” for Italy? Given that low growth is perhaps the central challenge, undermining both debt sustainability and political stability, “work” means helping Italy grow. We therefore had to understand what caused Italy’s economic stagnation, particularly with respect to productivity growth. If we knew those causes, we could think more constructively about whether, and if yes, under what circumstances a reform of the fiscal rules might contribute to raising Italy’s growth.
What did we learn?
We learned that Italy’s stagnation is not caused solely by excessive austerity or an inability to depreciate one’s currency, nor by a general absence of reform efforts over the last twenty years. Simply lifting deficit or debt limits or doubling down on past reform packages appears unpromising.
Instead, the problem appears to be that Italy adopted a doubly incoherent mix of structural reforms and austerity, and then stuck to it after its ineffectiveness had become apparent. This reform mix consisted in fiscal austerity combined with generally liberalizing structural reforms. The mix proved incoherent, first, because structural reforms struggle to produce good outcomes where aggregate demand is insufficient. It also proved incoherent, second, because the various reforms pulled against each other. For example, while some labour market reforms encouraged an Anglophone model of generalist skills and high labour mobility, others aimed at the German model of facilitating investments in firm-specific skills via stability and employment protection. As a result of this double incoherence, the reforms of the last twenty years dismantled Italy’s old, worn-out growth model without establishing a new one. Besides this incoherent reform mix, three institutional features appear to be important roadblocks to investment and productivity growth: organized crime, the judicial system, and – to a lesser extent – the quality of public administration, esp. at the local level. These reduce private investment and lower the quality of public investment.
Concerning our original question, whether and how European fiscal rules could be made to work for Italy, we learned the following: first, austerity-centric fiscal rules likely create an environment in which required structural reforms are harder to implement and less likely to succeed. Second, a focus on Italian firms and their management may be a useful lens to guide the next wave of reforms. Specific aims could be to raise management quality and facilitate the emergence of more large, successful, high productivity firms in Italy. Specific measures to this end could include improvements to the judicial system, better and a more even enforcement of taxation (to end the implicit subsidy given to small firms via laxer enforcement), better policing of organized crime, coherent reforms to banking and corporate finance to apply stronger pressure on low quality management, and an industrial strategy to integrate Italy’s manufacturing sector with the central European manufacturing core. Third and finally, an overarching aim of further reforms efforts should be the transformation of Italian capitalism from an extractive-selfish to a cooperative-inclusive kind. Extractive institutions may be the deepest cause of productivity stagnation – until these are tackled, private investment may languish, human capital wilt, and public investment remain ineffective.
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