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Italy's Main Challenge Is To Boost Growth

Shoppers at a market in Italy: boosting growth is main challenge for the country’s economy (photo: Lisa S. Engelbrecht/Newscom)

ITALY'S ECONOMIC HEALTH CHECK

Italy's Main Challenge Is To Boost Growth

IMF Survey online

July 12, 2011

  • Boosting growth is key policy priority
  • Fiscal consolidation is a prerequisite for growth
  • Banks to continue increasing buffers in response to turbulence in euro area periphery

A modest export-led recovery is under way in Italy, with growth of 1 percent expected in 2011. For growth to pick up substantively, reforms will be needed across the economy to address low productivity, an inefficient public sector, and the continued divide between the North and the South. Public debt remains high.

In an interview, IMF mission chief for Italy Antonio Spilimbergo discusses the challenges facing the European Union’s fourth largest economy amid continued market turmoil in Europe and concerns about sovereign debt.

IMF Online Survey: Italy’s growth has been consistently below the euro area average over the past 10 years. What factors constrain Italy’s potential growth, and how can growth be jumpstarted?

Spilimbergo: This is an important question, currently very much at the center of the political and economic debate in Italy. The problem of disappointing growth has not only characterized the last few years; there has been a declining growth trend in Italy for more than a decade.

The reasons are complex and cannot be ascribed to one single factor. The good thing is that the government has begun to tackle a number of issues, including reforming the university system, which was recently implemented, and addressing some regulatory bottlenecks.

Other problems are more deep-seated and will require more time to solve. The industrial structure is based on small and medium enterprises, which served Italy well for a long time. But many of these companies have been unable to grow and withstand the challenges of internationalization.

Furthermore, the high level of business and service regulation still hinders competition. The tax burden is heavy, but the quality of public service is low. Regional income disparities remain substantial.

IMF Online Survey: The staff report calls for the creation of a National Commission for Growth. Is the National Reform Program introduced by the authorities not enough?

Spilimbergo: As I said, there are a variety of reasons why Italy’s growth is lagging. One of these is that the urgency and the nature of the needed structural reforms are not shared by everybody, and the reform agenda often ends up being the victim of political deadlock.

The National Reform Program is certainly an important step in the right direction. Looking ahead, a National Commission for Growth, by being independent from the political cycle, would foster consensus on the reform agenda and ensure that a technical and monitoring framework is in place to create continuity and ownership of the reforms.

IMF Online Survey: What risks do you see for the government’s fiscal consolidation plan, especially considering Italy’s public debt dynamics?

Spilimbergo: Fiscal discipline is a prerequisite for growth and fiscal consolidation is a fundamental factor of stability. Because of its high level of public debt, Italy could not afford any significant fiscal stimulus to buffer the effects of the global financial crisis. Rightly, at that time, the government adopted a prudent fiscal stance. And most of the political spectrum has finally agreed that growth cannot be achieved through fiscal expansion.

The authorities’ target is a near-balanced budget by 2014. So far, they have achieved the target for 2010 quite comfortably, and the preliminary data for the first months of 2011 are promising. The authorities’ consolidation targets after 2012 are appropriate and a recent government decree has specified measures to make them more achievable. Across-the-board cuts are not sustainable, as they tend to penalize investment and be inequitable. In addition, they do not tackle Italy’s main problem—the inefficient level of public expenditure in some sectors and in some regions.

Moreover, the domestic budget procedure has been modified to reflect the new European Union fiscal framework, which retains the medium-term objective of a close-to-balance fiscal structural position and introduces more stringent fiscal rules. This will help support the authorities’ consolidation efforts.

IMF Online Survey: Does the proposed reform to strengthen fiscal federalism take Italy in the right direction?

Spilimbergo: Yes, fiscal federalism is going in the right direction. It is worth recalling that about one-third of public expenditure in Italy is local. Thus, it is of the utmost importance that the right incentives are in place—that is to say that local authorities are responsible not only for spending, but also for raising financing so they will not overspend or spend inefficiently.

A word of caution on the reform going forward: safeguards will need to be established to guarantee deficit neutrality and avoid increases in the tax burden.

IMF Online Survey: Italy’s financial system remained resilient during the global financial crisis but will that continue to be the case?

Spilimbergo: Italian banks have shouldered the crisis relatively well, mainly for two reasons. First, they are based on a traditional business model that relies on domestic funding and generally refrains from financial innovation. Second, the Bank of Italy put in place very prudent regulation. In addition, over the last decade, we have witnessed a consolidation trend in the Italian banking sector, with has resulted in larger, more solid banks.

Looking ahead, it is crucial that Italian banks continue boosting their capital buffers in line with the Bank of Italy’s forceful calls, and that public debt be steadfastly reduced.

IMF Online Survey: Italy’s labor market is characterized by low participation rates and a high level of youth unemployment. What should be done to create a more inclusive labor market?

Spilimbergo: The Italian labor market is split in two, with a group of highly protected full-time permanent workers earning good wages and a group of younger workers, who move from one temporary contract to the next, with little hope of finding longer-term employment. This has important negative consequences, not only for reasons of equity, but also because a lot of human capital is being wasted instead of helping the country achieve higher growth.

To further complicate this picture, Italy has one of the lowest overall employment rates in Europe, with exceptionally low female employment at around 40 percent. Youth unemployment is around 28 percent, with higher levels in the South of the country.

Harmonizing labor contracts to reduce the gap between protected and unprotected workers could boost employment. A more decentralized bargaining system could also better align wages with productivity and boost competitiveness. Here, a first step could include regional differentiation of wages in the public sector to better reflect the cost of living.

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