## 1. Italy: Product Market Reforms––A Summary of Main Problems and Actions Taken

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### I. Introduction and macro-financial context
- Households: sound balance sheets; private savings traditionally high.
- Private debt: about 125 percent of GDP.
- Public sector: one of the largest debt in the world but also large assets.
- Net foreign liabilities: around 20 percent of GDP.
- Current account deficit: relatively low.
- Exports: among the most diversified in the world but lag in high value-added content.
- Growth: averaged less than ½ percent in the last decade; EU15 over 1 percent; G7 over 1¼ percent.
- Total factor productivity growth: negative.
- Potential growth: estimated to have stalled or turned negative; likely to remain close to zero absent major changes.

### II. Main structural problems identified
- Limited competition
  - Regulatory rigidities and entry barriers limit competition and keep rents high, especially in non-tradable sectors.
  - High rents increase costs for globally competing sectors, erode competitiveness, limit firm growth, innovation, FDI penetration, and movement toward high-skill specialization—contributing to loss in export market shares.
- Labor market rigidities
  - Low labor participation, dualism, and low educational attainment mirror product market problems.
- Weak public services and institutional factors
  - High tax burden coupled with inefficient public spending.
  - Lengthy legal system, large regional disparities, sizeable unofficial economy.

### III. Policy actions taken (government measures described)
- Product market liberalization and competition measures introduced in 2011 and 2012 covering many key areas.
- Administrative simplification reforms approved to lower the cost of doing business.
- Labor market reform aiming to make the labor market more dynamic and inclusive.

### IV. Assessment approach and purpose of the paper
- Uses IMF’s Global Integrated Monetary and Fiscal model (GIMF) to simulate impacts.
- Reforms are mapped through markups on prices of non-tradable and tradable goods and on wages.
- Simulation horizon and mapping: reforms assumed to close roughly half the gap with best practice over a five-year period (implementation period assumed: 2013–18).

### Main findings (summary)
- Reforms cover key structural bottlenecks; prompt and consistent implementation, especially in energy, is important.
- Labor market reform should lower adjustment costs, increase internal flexibility, link wages and productivity, raise participation (especially among women), and improve activation policies.
- Quantified impact on GDP:
  - Closing roughly half the gap in product and labor markets could raise real GDP by 5¾ percent after 5 years and by 10½ percent in the long run.
  - Broader reforms including fiscal measures (deficit-neutral lowering of direct taxation and increasing productive investment) could amplify gains and further close competitiveness gaps.

### Product market reform scope and sectoral focus
- Objective: liberalize activity and enhance competition to remove monopolistic rents, entry barriers, and unnecessary regulation.
- Target sectors: services and public sector, largely non-tradable (network industries—energy and transport, professional services, local public services/utilities).
  - These sectors: about one-third of total value added; about 40 percent of total inputs used by other industries; close to 30 percent of households’ final consumption expenditure.
- Key sectoral measures (high-level):
  - Energy: ownership separation of ENI from gas distribution; lower tariffs for vulnerable customers; promote investments in transmission and storages; eliminate contractual restrictions; improve information transparency.
  - Transport: establish independent Transport Authority; competitive tender processes for local railway services; review tariff systems for new concessions; taxi guidelines pending operationalization.
  - Professional services: abolish tariffs for regulated professions (judicial settlement exception); reform orders to ease entry and activity restrictions; separate administrative, education, disciplinary functions; increase pharmacies and notaries; abolish some pharmacy restrictions.
- Illustrative statistics:
  - Electricity prices: 50 percent higher than European average (Antitrust Authority, 2012a), especially for industrial users.
  - Professional services: contribute 6 percent of total value added and 10 percent of total intermediate consumption used by all industries; Italy among most restrictive OECD regulations for professions.

### Labor market reform objectives, measures, and gaps
- Objective: make labor market more dynamic and inclusive; reduce dualism; harmonize employment protection; encourage stable employment; strengthen active labor market policies.
- Measures (high-level):
  - Encourage stable employment relationships; promote apprenticeship via tax incentives.
  - Tax disincentives for fixed-term contracts; control abuse of atypical contracts.
  - Reduce individual dismissal costs by limiting compulsory reinstatement for economic reasons; accelerate legal processes; incentivize out-of-court settlements.
  - Reorganize social safety net to make coverage more uniform by 2017.
  - Boost female and youth participation (vouchers, tax incentives, special company types).
  - Promote firm-level contracts and productivity-based pay.
- Caveats:
  - Positive direction, but implementation crucial; some measures incremental and may not address dualism fully.
- Suggested policy options:
  - Flexible open-ended contracts with protection increasing with tenure.
  - Make firm-level contracts operational by default unless parties opt out.
  - Greater regional differentiation of public wages to support private wage flexibility.
  - Reduce marginal tax rates for married second-earners to boost female participation.

### Empirical literature and Italy-specific evidence
- General findings:
  - Long-run: product and labor market reforms positive for growth, employment, productivity.
  - Short-run: reforms can have small or negative impacts due to adjustment costs.
  - Broad packages and cross-country coordination yield larger benefits.
- Italy-specific quantitative findings from literature:
  - OECD (2009): labor productivity could increase by about 14 percent over 10 years if product market regulation aligns with international best practice.
  - Bouis and Duval (2011) and OECD (2012b): closing gap with best practice could raise GDP per capita by about 7 percent after 5 years and close to 15 percent after a decade.
  - Forni and others (2011): increasing competition in services could raise real GDP by up to 11 percent in the long run, half in first three years.
  - NRP (2012): recent liberalization/simplification could increase real GDP by 2.4 percent over 2012–20; closing gap with best performers in Europe could raise real GDP by 5 percent by 2020.
  - Annicchiarico and others (2012): comprehensive package closing half the gap to EU best performers could increase output by almost 4½ percent after 5 years and 5¾ percent over a decade.
  - OECD estimate: product market reforms adopted 2008–12 could increase TFP by 2–3 percent in 2020.

### Model and simulation design (GIMF) — key calibration and assumptions
- Model: GIMF with monopolistic competition; two sectors (tradable and non-tradable); wage and price markups calibrated to Italy and euro area.
- Two-sector shares and markups:
  - Non-tradable sector ~50 percent of the economy.
  - Non-tradable sector price markup: 61 percent versus 35 percent for the rest of the euro area; tradable sector price markup: 17 percent.
  - Wage markup: same values as non-tradable price markup per Forni and others (2010).
- Input-output: energy, utilities, construction, trade, transport, professional services and services = about 47½ percent of total value added in 2008 (Eurostat).
- Reform mapping: distance-from-frontier; closing roughly half the gap over five years (2013–18).
- Credibility scenarios:
  - Immediately credible: agents believe policies are permanent immediately.
  - Stepwise credible (benchmark): agents perceive permanence only after 5 years; used in benchmark simulations.
- Household heterogeneity: liquidity-constrained households = 25 percent of households (benchmark).

### Benchmark scenario results — product market reforms (GIMF)
- Aggregate impacts (product market reforms closing half the markup gap):
  - Output: +4.0 percent in 5 years; +7.7 percent in the long run.
  - Consumption: long-run +9.0 percent.
  - Investment: long-run +6.5 percent.
  - Exports: long-run +5.8 percent.
  - Real wages: long-run +7.3 percent.
  - Hours worked: slightly lower in the long run (income effect > substitution effect).
  - Labor productivity: almost +8 percent long-run; unit labor cost declines.
  - Real exchange rate: depreciates by 3.5 percent.
- Professional services-specific simulation:
  - 40 percent cut in wage markup in professional services ≈ 3.4 percentage point cut in economy-wide wage markup.
  - Effect on real GDP: +0.2 percent after 5 years; +0.6 percent in the long run.

### Benchmark scenario results — labor market reforms (GIMF)
- Aggregate impacts (labor market reforms in benchmark mapping):
  - Real GDP: +1.1 percent after 5 years; +1.8 percent in the long run.
  - Investment: permanently +1.5 percent.
  - Real depreciation: long run ~0.7 percent.
  - Wages: fall by 0.9 percent after 5 years (larger short-run fall).
- Interpretation:
  - Modest impact because Italy is not as far from best practices in EPL, ALMP, and childcare; empirical elasticity of these reforms on productivity/GDP relatively small.
  - ALMP and childcare modeled as increased government spending offset by reductions in transfers (fiscal offset reduces net effect).
  - Stepwise credibility mutes short-run impacts.

### Combined product and labor market reforms
- Joint implementation impacts (benchmark, stepwise credibility):
  - Real GDP: +5¾ percent after 5 years; +10½ percent in the long run.
  - Combined impact slightly greater than sum of separate packages (combined = 5.7 percent after 5 years versus sum = 5.6 percent).
  - Complementarities: product market reforms boost consumption and productivity; labor market reforms raise hours worked medium/long term; real wages higher despite downward labor pressures.
  - External spillovers:
    - Rest of euro area: medium-term real GDP +0.3 percent from Italy’s reforms.
    - If rest of euro area also closes half its non-tradable markup gap, Italy’s medium-term real GDP would be +1.7 percent from those rest-of-region reforms; with domestic reforms Italy’s output would increase by 7.5 percent.
  - Coordination gains: coordinated reforms slightly exceed sum of individual region reforms.

### Decomposition of real GDP effects (percent deviation from baseline)
- Product and labor market reforms:
  - Year 1: 0.8
  - Year 2: 1.6
  - Year 5: 5.7
  - Long run: 10.5
- Product market reforms:
  - Year 1: 0.4
  - Year 2: 1.0
  - Year 5: 4.4
  - Long run: 8.3
- Tradables sector:
  - Year 1: 0.1
  - Year 2: 0.3
  - Year 5: 0.9
  - Long run: 0.8
- Non-tradables sector:
  - Year 1: 0.3
  - Year 2: 0.7
  - Year 5: 3.3
  - Long run: 6.9
- Professional services:
  - Year 1: 0.0
  - Year 2: 0.0
  - Year 5: 0.2
  - Long run: 0.6
- Labor market reforms:
  - Year 1: 0.5
  - Year 2: 0.6
  - Year 5: 1.1
  - Long run: 1.8
- Employment protection:
  - Year 1: 0.0
  - Year 2: 0.0
  - Year 5: 0.1
  - Long run: 0.3
- Active labor market policy:
  - Year 1: 0.3
  - Year 2: 0.3
  - Year 5: 0.4
  - Long run: 0.5
- Female participation rate:
  - Year 1: 0.2
  - Year 2: 0.3
  - Year 5: 0.7
  - Long run: 1.0

### Effects of deeper labor market reforms (range estimates)
- Short- to medium-run GDP impact: from 0.5 percent (under a 5 percentage point reduction in the wage markup) to about 1.5 percent (under a 20 percentage point reduction in the wage price markup).
- Long-run GDP impact: varies from close to 1 percent to over 3.5 percent.
- Labor supply: increases in medium and long run.
- Real wages: decline beyond the fall in the wage markup.
- Labor productivity: declines slightly (between 0.25 percent and 1 percent in the long run).
- Unit labor cost: declines.
- Combined with benchmark reforms: could raise real GDP by up to 7¼ percent after five years (results noted but not reported in detail).

### Fiscal reform scenarios (deficit-neutral, two types)
- Tax-switching scenario: lower labor and corporate taxes by 2 percent of GDP combined, offset by broadening the VAT base (immediate and permanent; immediately credible).
  - GDP: +0.5 percent on impact; up to +2 percent in the long run.
  - Real wage: +1.3 percent in long run.
  - Exports: +1.5 percent in the long run.
  - Real exchange rate: depreciates by less than 1 percent.
- Expenditure-switching scenario: shift 1 percent of GDP from lump-sum transfers to infrastructure investment (phases in over 5 years; not fully credible until year 5).
  - On-impact: real GDP +1 percent relative to baseline.
  - Long run: real GDP more than +5 percent relative to baseline.
- Combined fiscal and structural reforms:
  - Real GDP: about +8½ percent after 5 years and almost +22 percent in the long run (assumptions include immediately credible tax switch and phased credible expenditure switch).
  - Synergies: higher GDP increases tax revenues; productivity gains amplified by infrastructure spending.
  - Competitiveness: simulated real exchange rate depreciation ~3 percent after 5 years and over 7 percent in a decade; unit labor cost decline ~4½ percent after 5 years.
  - Short-run current account: may deteriorate due to higher investment; medium/long run: exports grow faster and current account converges to zero or slight surplus.

### Sensitivity analysis and limitations
- Key sensitivities tested:
  - Mapping of product market reforms to markups: ±25 percent change in mapping alters 5-year real GDP gains by +1.1 or −1.2 percentage points relative to benchmark.
  - Mapping of labor market reforms: ±25 percent change in mapping alters 5-year gains by about ±0.2 percentage points.
  - Short-run nominal rigidities: faster price adjustment (equal to U.S.) raises short-run gains by ~0.5 percentage points by year 5; long-run unchanged.
  - Share of liquidity-constrained households: increasing LIQ share from 25 percent to 50 percent reduces short-run gains from product market reforms (4.3 percent versus 4.5 percent in benchmark) but increases short-run gains from labor market reforms.
- Model caveats and limitations:
  - Two-sector (tradable/non-tradable) restriction makes direct analysis of specific reforms approximate.
  - Simple labor market representation: only total hours modeled; no explicit unemployment, participation, or working-age population distinctions.
  - Analysis around initial steady state; does not capture differing cyclical positions.
  - Does not capture hiring-firing dynamics important for short-term assessment.

### Reform priorities and policy recommendations (policy checklist)
- Product market:
  - Open services sector (professional services), key network industries, local public services.
  - Reduce entry barriers and promote investment in productive infrastructure.
  - Ensure consistent, sustained, and early implementation; target infrastructure in network bottlenecks.
- Labor market:
  - Reduce uncertainty and costs from employment protection; promote internal flexibility and closer link between wages and productivity.
  - Strengthen job matching (ALMP) and augment labor participation (especially female participation).
  - Consider default firm-level contracts, tenure-based protection increases, and tax measures to reduce disincentives for second earners.
- Fiscal and institutional:
  - Growth-friendly fiscal reform: shift taxation from labor and corporate income to indirect taxes; reallocate expenditure toward productive infrastructure.
  - Establish independent review/advisory body to foster consensus and continuity of reforms.
  - Implement justice system reforms and secure buy-in from sub-national governments.
  - Apply competition enforcement effectively and monitor reform progress.

* _wp1322 - 2.2 percent in six years._

### 1. Italy: Product Market Reforms––A Summary of Main Problems and Actions Taken ........7

### 1. Italy: Product Market Reforms––A Summary of Main Problems and Actions Taken

### I. Introduction and macro-financial context
- Italian households have sound balance sheets and private savings have traditionally been high.
- Private debt is about 125 percent of GDP.
- The public sector, despite having one of the largest debt in the world, has also large assets.
- Net foreign liabilities are around 20 percent of GDP.
- Italy‘s current account deficit is relatively low.
- Italy‘s exports are among the most diversified in the world but lag in high value-added content.
- Growth averaged less than ½ percent in the last decade (against over 1 percent in EU15 and 1¼ percent in G7 countries).
- Total factor productivity growth was negative.
- Potential growth is estimated to have stalled in recent years or even turned negative.
- In the absence of major changes to productivity, employment, and investment trends, potential growth is likely to remain close to zero over the medium term.

### II. Main structural problems identified
- Limited competition
  - Regulatory rigidities and entry barriers have limited competition and kept rents high, especially in non-tradable sectors.
  - High rents and limited competition have adversely affected the business environment, increasing costs for sectors that need to compete globally and eroding competitiveness.
  - Firms are unable to grow and benefit fully from economies of scale, leading to low efficiency, limited innovation, limited FDI penetration, and insufficient movement toward high-skill sector specialization—contributing to a loss in export market shares.
- Labor market rigidities
  - Low labor participation, dualism, and low educational attainment mirror product market problems.
- Weak public services and institutional factors
  - High tax burden coupled with inefficient public spending.
  - Lengthy legal system, large regional disparities, and a sizeable unofficial economy accentuate deficiencies in product and labor markets.

### III. Policy actions taken (government measures described)
- Product market liberalization and competition measures introduced in 2011 and 2012 covering many key areas.
- Administrative simplification reforms approved to lower the cost of doing business.
- A labor market reform aiming to make the labor market more dynamic and inclusive.

### IV. Assessment approach and purpose of the paper
- The paper uses a model-based approach to assess the potential impact of the reforms.
- It begins with an overview of product and labor market reforms, highlighting main structural problems and contrasting these with the actions proposed.

*IMF Working Paper excerpt: 1. Italy: Product Market Reforms––A Summary of Main Problems and Actions Taken*

### Section III estimates the impact of structural reforms in Italy using a simulation framework.

### Section III — Estimates of the Impact of Structural Reforms in Italy (Simulation Framework)

### Main findings
- Reforms go in the right direction. They cover the key structural bottlenecks in the product and labor markets and address most priority areas.
- In product market reform, prompt and consistent implementation is important, especially in the energy sector, where the gains could be sizeable.
- Labor market reform should aim to lower labor adjustments costs, introduce more internal flexibility and a closer link between wages and productivity, increase participation, especially among women, and improve activation policies.
- The impact of structural reforms on GDP can be sizeable:
  - Policies that would close roughly half the gap in product and labor markets with the rest of the euro area and best practice cases in OECD, respectively, could raise real GDP by 5¾ percent after 5 years and by 10½ percent in the long run.
  - A broader set of reforms including also fiscal measures to lower direct taxation and increase productive, well-targeted investment spending (both in a deficit neutral way) could amplify the gains and contribute further to closing Italy‘s competitiveness gap.

### Product market reforms: scope, problems, and actions
- Objective: Liberalizing economic activity and enhancing competition to address excessive monopolistic rents, reduce entry barriers and information asymmetries, and remove unnecessary regulation.
- Reforms target services and the public sector, largely non-tradable sectors (network industries—energy and transport, professional services, local public services/utilities) that:
  - Amount to about one-third of total value added.
  - Contribute about 40 percent of total inputs used (intermediate consumption) by other industries.
  - Contribute close to 30 percent of households‘ final consumption expenditure.
- Key sectoral measures (summary from Table 1):
  - Energy: ownership separation of ENI from the gas distribution company; lower tariffs for vulnerable customers; promoting strategic investments; promoting investment in transmission network; increasing information transparency; eliminating restrictions on contractual arrangements; improving information transparency.
  - Transport: establishing independent Transport Authority; measures to be defined by Transport Authority for railways and highways; competitive tender process for local railway services introduced; tariff systems for new concessions to be reviewed; taxi guidelines provided but yet to be operationalized.
  - Professional services: abolishing tariffs for regulated professions (with judicial settlement exception); reforming professional orders to ease entry and activity restrictions; separating administrative, education, and disciplinary functions; increasing number of pharmacies and notaries; abolishing some restrictions on pharmacies.
- Illustrative cases:
  - Energy sector: electricity prices are 50 percent higher than the European average (Antitrust Authority, 2012a), especially for industrial users; reform includes ownership unbundling (sale of ENI‘s shares in the gas transport company set to be completed by May 2013), measures to address authorization delays, promote investments, provide additional access to storages, lift some exclusive contract restrictions, and enhance information transparency.
  - Professional services: Italy has one of most restrictive regulations in professions among the OECD countries; professional services contribute 6 percent of total value added and constitute 10 percent of total intermediate consumption used by all the industries; reforms propose abolishing tariffs (with limited exceptions), strengthening governance of orders, removing advertising restrictions, increasing number of pharmacies and notaries, but outcomes depend on implementation by professional orders.

### Labor market reforms: objectives, measures, and remaining gaps
- Objective: Make the labor market more dynamic and inclusive—tackle job insecurity and dualism, make employment protection and unemployment insurance more even, encourage more stable employment relationships while lowering firing costs, and strengthen active labor market policies.
- Summary of problems and actions (from Table 2):
  - Contracts and labor market entry: encourage stable employment relationships; promote apprenticeship via tax incentives; condition new contracts on past conversion into open-ended positions.
  - Temporary contracts: tax disincentives for fixed-term contracts; control abuse of atypical contracts.
  - Employment protection: reduce costs of individual dismissal by limiting compulsory reinstatement for economic reasons; harmonize collective dismissal with individual dismissal modifications; establish accelerated legal processes for dismissal litigations; incentives for out-of-court settlement.
  - Social safety net: reorganize to make coverage more uniform by 2017; instruments for employer-financed early retirement schemes.
  - Labor participation: measures to boost female and youth participation (vouchers, tax incentives, special company types for entrepreneurs).
  - Internal flexibility: promote firm-level contracts; tax incentives for productivity-based contracts; agreement between social partners to promote wage bargaining decentralization.
  - Public sector: reforms not yet covered; earlier modernization stalled because of fiscal constraints.
- Key implementation caveats:
  - Positive direction, but impact depends entirely on implementation and developments in other areas (judicial system, fiscal federalism).
  - Some measures are incremental and do not provide a clear structural shift (e.g., addressing dualism).
  - Areas remaining to be addressed include internal flexibility, better linking wages and productivity, and extending reforms to the public sector.
- Specific policy options suggested:
  - Introduce a more flexible open-ended contract for new workers that gradually increases employment protection with tenure.
  - Make firm-level contracts more operational—allow companies and workers to first set firm-level contracts unless they opt out and abide by national ones.
  - Greater differentiation of public wages across regions to support private wage flexibility and employment, especially in the South.
  - Boost female labor participation by reducing marginal tax rates for married second-earners.

### Empirical literature: recent findings and Italy-specific evidence
- Four key findings from recent empirical studies:
  - In the long run, product and labor market reforms can have positive effects on growth, employment, and productivity.
  - In the short run, reforms can have small or even negative impacts because of adjustment costs, especially for job protection and unemployment benefits reforms in severely depressed economies.
  - Broad reform packages are generally more beneficial than individual reforms because they can lower transitional costs.
  - Cross-country coordination of reforms could produce larger and more evenly distributed positive effects.
- Italy-specific quantitative findings from the literature:
  - OECD (2009): labor productivity could increase by about 14 percent over 10 years if product market regulation is aligned to international best practice.
  - Bouis and Duval (2011) and OECD (2012b): under ambitious broad reforms closing the gap with best practice, Italy‘s GDP per capita could increase by about 7 percent after 5 years and close to 15 percent after a decade.
  - Forni and others (2011): increasing competition in services sector could raise real GDP by up to 11 percent in the long run, half of which comes in the first three years.
  - National Reform Programme 2012 (NRP, 2012): recent liberalization and simplification measures could increase real GDP by 2.4 percent over 2012–20; closing the gap with best performers in Europe could raise real GDP by 5 percent by 2020.
  - Annicchiarico and others (2012): a comprehensive package aiming to close the gap towards EU best performers by half over five years (including labor market and fiscal reforms) could increase output by almost 4½ percent after 5 years and 5¾ percent over a decade.
  - OECD estimate: product market reforms adopted in Italy over 2008–12 could potentially increase TFP by 2–3 percent in 2020.

### Model and simulation design (GIMF)
- Model used: IMF’s Global Integrated Monetary and Fiscal model (GIMF).
- Rationale: GIMF has monopolistic competition in firms and labor markets; reforms are mapped through markups on prices of non-tradable and tradable goods and on wages.
- Labor market representation: relatively simple (only total hours modeled; no explicit unemployment, participation, or working-age population distinctions), but labor supply shocks are used to capture most labor market reform measures.
- Calibration: standard GIMF calibration augmented with additional information for Italy and the euro area.
- Household heterogeneity: liquidity constrained households make up 25 percent of all households, in both [text truncated at this point in the provided content].

*Source: IMF staff (Section III of the supplied content).*

### 2.2 percent in six years.

### _wp1322 - 2.2 percent in six years.

### Model framework and calibration
- Model: Global Integrated Monetary and Fiscal model (GIMF) with overlapping generations framework; fully endogenous net foreign asset position; richer fiscal framework and more realistic baseline fiscal rule.
- Two-sector structure: tradable and non-tradable goods.
- Sector shares and markups:
  - The share of non-tradable sector accounts for roughly 50 percent of the economy.
  - Non-tradable sector price markup is 61 percent versus 35 percent for the rest of the euro area, and 17 percent for tradable sector price markups.
  - Wage markup: same values as for the non-tradable sector price markup (per the assumptions in Forni and others (2010)).
- Input-output statistic: energy, other utilities, construction, trade, transport, professional services and services sectors in total value added in Italy amounted to about 47½ percent in 2008 (Eurostat).
- Reform implementation period assumed: 2013–18.
- Mapping of reforms: distance-from-frontier approach; reforms assumed to close roughly half the gap between Italy and best practice (OECD for labor markets, rest of the euro area for product markets) over a five-year period.
- Credibility assumptions for policies:
  - Immediately credible: households and firms believe government policies permanent and markups adjust permanently.
  - Stepwise credible: agents do not expect further reductions in markups in the following years; policies implemented over time and are perceived fully permanent after 5 years. Benchmark simulations assume stepwise credibility.

### Limitations of the analysis (model caveats)
- Two-sector restriction (tradable/non-tradable) makes direct analysis of specific reforms (e.g., reduction of professional services costs, energy cost cuts) only approximate.
- Analysis conducted around an initial steady state; does not account for differing cyclical positions which can affect policy impact.
- Model does not capture well hiring-firing dynamics important for assessing short-term effects of structural reforms.

### Benchmark scenario: product and labor market reforms (stepwise credible)
- Product market reform measures (broad package):
  - Reduce barriers to entry and exit; eliminate restrictions on economic activities.
  - Reduce business costs (energy, administrative); provide transport and other local public services on a more competitive basis.
  - Reduce public involvement in the economy.
  - Liberalize professional services (reducing input costs and easing supply restrictions, with labor market impacts).
- Labor market reform measures:
  - Lower adjustment costs through easing employment protection legislation (EPL).
  - Improve job matching by strengthening active labor market policies (ALMP).
  - Policies to increase female employment (expanded childcare).
  - In benchmark, measures aimed at promoting stable employment relationships, apprenticeship, and social safety net reorganization are not simulated.

### Quantitative impacts — Product market reforms (GIMF simulation results)
- Output and long-run impacts:
  - Increasing competition in tradable and non-tradable sectors could increase output by 4.0 percent in 5 years and 7.7 percent in the long run.
  - Long-run increases: consumption +9.0 percent; investment +6.5 percent; exports +5.8 percent.
  - Real wages increase by 7.3 percent in the long run.
  - Hours worked slightly lower in the long run due to income effect > substitution effect.
  - With labor productivity almost 8 percent higher, unit labor cost declines, and the real exchange rate depreciates by 3.5 percent.
- Professional services specific simulation:
  - A 40 percent cut in the wage markup in professional services ≈ 3.4 percentage point cut in the economy-wide wage markup.
  - Resulting effect on real GDP: 0.6 percent in the long run and 0.2 percent after 5 years.
  - Professional services statistics: contribute 6 percent of total value added in Italy and 10 percent of total intermediate consumption used by industry.

### Quantitative impacts — Labor market reforms (GIMF simulation results)
- Long-run and medium-term impacts:
  - Labor market reforms raise real GDP by 1.8 percent in the long run (most driven by reforms boosting labor supply, particularly higher female participation).
  - Investment permanently higher by 1.5 percent.
  - Real depreciation in the long run: almost 0.7 percent.
  - After 5 years, real GDP gains relative to baseline: 1.1 percent.
  - Wages fall by 0.9 percent after 5 years (larger short-run fall than long-run).
- Interpretation and constraints:
  - Modest impact because Italy is not as far from best practices in EPL, ALMP, and childcare; empirical elasticity of these reforms on productivity/GDP is relatively small.
  - ALMP and childcare modeled as increased government spending offset by reductions in transfers (fiscal offset reduces net effect).
  - Stepwise credibility assumption mutes short-term impacts.

### Combined product and labor market reforms
- Joint implementation impacts:
  - Real GDP increase by 5¾ percent after 5 years and by 10½ percent in the long run.
  - Combined package impact slightly greater than sum of components: combined = 5.7 percent (after 5 years) versus sum of separate packages = 5.6 percent.
  - Complementarity: product market reforms strongly boost consumption; labor market reforms raise hours worked in medium and long term; real wages remain higher despite downward pressure from labor reforms.
  - Strong labor productivity increase driven by product market reforms dominates; unit labor cost declines.
  - Real exchange rate depreciation and terms-of-trade deterioration stronger when reforms combined.
- Spillovers to rest of euro area:
  - Medium-term real GDP in rest of euro area increases by 0.3 percent from Italy’s reforms.
  - When rest of euro area also implements non-tradable sector reforms closing half of its markup gap (10 percentage points in that exercise), Italy’s medium-term real GDP would be 1.7 percent higher from those rest-of-euro-area reforms; together with domestic reforms Italy’s output would increase by 7.5 percent.
  - Combined effect of coordinated reforms slightly higher than sum of individual region reforms, supporting benefits of reform coordination.

### Comparative results and robustness
- Comparison to literature:
  - Forni and others (2010): reduction of Italian service price markup to euro area level (around 25 percentage point reduction) could increase real GDP by close to 11 percent in the long run (close to GIMF result of 10 percent for a 20 percentage point reduction where about half materializes in first five years).
  - Gomes and others (2011): 15 percentage point reduction in services markups could raise real GDP by about 4.5 percent in the long run (Germany case).
  - NRP (2012) estimate: recent liberalization measures would yield about 2 percentage points reduction in both tradable and non-tradable price markups by 2020, with an estimated increase in real GDP by 1.2 percent. Simulating such markup reductions in GIMF gives very similar estimates.

### Decomposition of real GDP effects (percent deviation from baseline)
- Product and labor market reforms:
  - Year 1: 0.8
  - Year 2: 1.6
  - Year 5: 5.7
  - Long run: 10.5
- Product market reforms:
  - Year 1: 0.4
  - Year 2: 1.0
  - Year 5: 4.4
  - Long run: 8.3
- Tradables sector:
  - Year 1: 0.1
  - Year 2: 0.3
  - Year 5: 0.9
  - Long run: 0.8
- Non-tradables sector:
  - Year 1: 0.3
  - Year 2: 0.7
  - Year 5: 3.3
  - Long run: 6.9
- Professional services:
  - Year 1: 0.0
  - Year 2: 0.0
  - Year 5: 0.2
  - Long run: 0.6
- Labor market reforms:
  - Year 1: 0.5
  - Year 2: 0.6
  - Year 5: 1.1
  - Long run: 1.8
- Employment protection:
  - Year 1: 0.0
  - Year 2: 0.0
  - Year 5: 0.1
  - Long run: 0.3
- Active labor market policy:
  - Year 1: 0.3
  - Year 2: 0.3
  - Year 5: 0.4
  - Long run: 0.5
- Female participation rate:
  - Year 1: 0.2
  - Year 2: 0.3
  - Year 5: 0.7
  - Long run: 1.0

*Italic source attribution: _wp1322 - 2.2 percent in six years.*

### 0.5 percent (under a 5 percentage point reduction in the wage markup) to about 1.5 percent

### _wp1322 - 0.5 percent (under a 5 percentage point reduction in the wage markup) to about 1.5 percent

### Effects of deeper labor market reforms
- Short- to medium-run GDP impact: from 0.5 percent (under a 5 percentage point reduction in the wage markup) to about 1.5 percent (under a 20 percentage point reduction in the wage price markup).
- Long-run GDP impact: varies from close to 1 percent to over 3.5 percent.
- Labor supply: increases in both the medium and long run.
- Real wages: decline beyond just the fall in the wage markup.
- Labor productivity: declines slightly (between 0.25 percent and 1 percent in the long run).
- Unit labor cost: declines.
- Consumption and investment: impact more muted compared to product market reforms.
- Net external sector effects in the medium term: exports grow faster and imports decline; real exchange rate depreciation similar in size to product market reforms.
- Combined with benchmark scenario reforms: could raise real GDP by up to 7¼ percent after five years (results not reported here).

### Fiscal reforms considered (deficit-neutral, aimed to lower labor tax wedge and increase infrastructure spending)
- Two reform types:
  - Shifting taxation from direct to indirect taxes: Lowering both labor and corporate taxes, offset by broadening the VAT base.
  - Shifting expenditure from transfers to investment: Shifting expenditure composition from general lump-sum transfers to productive, well-targeted infrastructure investment.
- Tax-switching scenario (lowering labor and corporate taxes by 2 percent of GDP combined, offset by broadening the VAT base):
  - GDP relative to baseline: 0.5 percent on impact and by up to 2 percent in the long run.
  - Hours worked: after a positive short-term reaction, marginally higher in the long run (real wage will increase by 1.3 percent).
  - Exports: rise by about 1.5 percent in the long run.
  - Real exchange rate: depreciates by less than 1 percent.
  - Mechanisms: labor income tax cut offsets negative effect of higher consumption taxes on household spending power; corporate income tax cut reduces cost of capital and encourages demand for capital, investment goods, and labor.
- Expenditure-switching scenario (shifting 1 percent of GDP from lump-sum transfers to infrastructure investment):
  - On-impact: real GDP 1 percent higher relative to baseline.
  - Long run: real GDP more than 5 percent higher relative to baseline.
  - Rationale: temporary increase in government investment improves public capital stock, raising economy-wide productivity and producing long-lived gains.
- Credibility considerations:
  - Gains may be delayed if fiscal reforms are not perceived as fully credible in the short run.
  - For tax switching, short-run costs of higher consumption taxes could be perceived without belief in long-run benefits, reducing immediate gains.
  - For expenditure switching, temporary but perceived infrastructure improvements can still yield positive gains, with a large short-run fiscal multiplier if perceived as credible.

### Combined reforms (product, labor, and fiscal)
- Combined effect:
  - Real GDP could increase by about 8½ percent after 5 years and almost 22 percent in the long run (assumptions: tax composition switch is one-off and immediately credible; expenditure switching occurs over 5 years and is not fully credible until year 5).
  - Effects of package roughly twice as large when fiscal reforms included, with synergies:
    - Higher real GDP increases tax revenues, amplifying fiscal multipliers of tax switching.
    - Productivity gains from product market reform amplified by higher government infrastructure spending.
- Competitiveness and external sector:
  - IMF estimates suggest competitiveness gap (real exchange rate overvaluation) could be of the order of 5-10 percent.
  - Simulated real exchange rate depreciation from reforms: close to 3 percent after 5 years and over 7 percent in a decade.
  - Unit labor cost: decline of just about 4½ percent after 5 years as increased labor productivity more than offsets the increase in wages.
  - Short-run current account: deteriorates reflecting higher investment relative to private savings; price shift from depreciation (terms of trade deterioration) may worsen nominal trade balance.
  - Medium term: real exports rise faster than real imports (though real imports accelerate in the short run from stronger investment).
  - Long run: current account converges to zero and turns slightly into surplus.
- Net conclusion: combination of structural reforms in product, labor, and fiscal sectors produces long-run gains; effects reinforced if euro-area peers undertake similar reforms and via cross-reform feedbacks.

### Sensitivity analysis around the benchmark scenario
- Key dimensions tested:
  - Mapping of product market reforms to changes in markups.
  - Mapping of labor market reforms to changes in labor supply and productivity.
  - Degree of short-run nominal rigidities.
  - Share of liquidity constrained households in the economy.
  - Immediately credible versus stepwise credible policies.

- Mapping product market reforms:
  - Benchmark assumption: gap between non-tradable (tradable) price markups in Italy and rest of euro area (rest of the world outside euro area) halves over five years (implies, for non-tradable sector, on average, a 3 percentage point reduction in markups per year).
  - Sensitivity: reduction in price and wage markups 25 percent more or 25 percent less than benchmark.
  - Outcome: relative to benchmark, after five years total gains in real GDP would be 1.1 percentage points higher or 1.2 percentage points lower, respectively.

- Mapping labor market reforms:
  - Benchmark mapping uses OECD-based estimates from cross-country regressions linking EPL, childcare benefits, and outcomes.
  - Sensitivity: mapping coefficients 25 percent higher or 25 percent lower than benchmark.
  - Outcome: after five years, total gains in real GDP would be about 0.2 higher or lower depending on strength of reform impact.

- Degree of short-run nominal rigidities:
  - Benchmark calibration: changes in prices take roughly 50 percent longer to work through the economy than in the United States.
  - Sensitivity test: set nominal rigidities equal to the United States (faster price adjustment).
  - Outcome: long-run results unchanged; short-run gains slightly greater (0.5 percentage points in real GDP by year 5) as firms and households adjust prices and wages more rapidly and incur lower costs from short-run inertia.
  - Note: these short-run gains would be muted if nominal adjustment costs decrease only gradually.

- Share of liquidity-constrained (LIQ) households:
  - Benchmark: roughly 25 percent of households are liquidity constrained.
  - Sensitivity: LIQ households make up 50 percent of the economy instead of 25 percent.
  - Characteristics: LIQ households consume all income each period; expectations of future outcomes do not affect current spending.
  - Effects:
    - Product market reforms: with higher LIQ share, smaller positive impact on real GDP in short run (4.3 percent versus 4.5 percent in benchmark), roughly unchanged in long run; LIQ households consume less during implementation due to income decline.
    - Labor market reforms: with higher LIQ share, consumption increases more rapidly in short run because LIQ households immediately experience higher labor income as labor supply increases.
  - Net: higher share of LIQ households reduces short-run gains from product market reforms but augments short-run gains from labor market reforms.

*Source: IMF staff estimates.*

### 1.2 percent of real GDP after 5 years, instead of only 1.1 percent (and 2.0 percent versus 1.8

### _wp1322 - 1.2 percent of real GDP after 5 years, instead of only 1.1 percent (and 2.0 percent versus 1.8

### Key simulation results and magnitudes
- Structural reforms could raise real GDP by 5¾ percent after 5 years and by 10½ percent in the long run.
- In one comparison point: 1.2 percent of real GDP after 5 years, instead of only 1.1 percent (and 2.0 percent versus 1.8 percent in the long run).
- In the full package of structural reforms, real GDP would be slightly smaller after 5 years (less than 0.1 percent) but larger in the long run (10.7 percent versus 10.5 percent).
- Product market reforms could raise real output by 4½ percent in the medium term if reforms close half the gap in the degree of competition with the rest of the euro area.

### Credibility scenarios and dynamics
- Benchmark: policies are assumed to be stepwise credible.
- Immediately credible versus stepwise credible:
  - Immediately credible reforms cause households that can save to perceive future wealth earlier and increase present consumption, accelerating the increase in real GDP.
  - Under immediate credibility, labor use rises quickly as firms and households foresee potential future production; employment peaks early (in year 3) and then declines as capital accumulation catches up.
  - Under stepwise credibility, the short-run consumption and labor responses are weaker; employment builds gradually, peaks at a lower level (in year 5), and sustains the peak for longer.
  - Once credibility is established, results converge to the full credibility case after about 10 years, as the economy has almost adjusted to its long run path.
- Stepwise credible policies could delay potential gains from reforms and emphasize the need for a more predictable regulatory and legal environment.

### Reform priorities and policy recommendations
- Product market reforms:
  - Further open services sector, especially professional services, key network industries, and local public services.
  - Reduce entry barriers and promote investment in productive infrastructure to lower the costs of doing business.
  - Consistent, sustained, and early implementation is key; well-targeted infrastructure projects in main network bottlenecks could further increase productivity.
- Labor market reforms:
  - Allow firms and workers to more easily adjust to changing economic conditions by reducing uncertainty and costs associated with employment protection.
  - Promote more internal flexibility and a closer link between wages and productivity.
  - Improve employability and efficiency of job matching while augmenting labor participation.
  - Consider strengthening reforms to increase flexibility of the core via more firm-level arrangements that favor employment rather than wages and to bridge the gap between permanent and temporary workers.
  - Consider a tax reform to lower the labor tax wedge and remove disincentives for labor supply, especially for second earners.
- Fiscal and tax reforms:
  - Growth-friendly fiscal reform by shifting taxation from labor and corporate tax to indirect taxes.
  - Prioritize public expenditure away from general transfers toward well-targeted productive infrastructure spending.
- Coordination and institutions:
  - Reforms coordinated at a wider European level, especially in the energy sector and infrastructure, could be beneficial for all countries.
  - To increase credibility and effectiveness of reforms, consideration could be given to establishing an independent review and advisory body for reforms to foster consensus, focus policies on priority areas, and ensure continuity of the reform agenda.
  - Apply the competition enforcement framework effectively, and continuously monitor, assess, and communicate on reform progress.
  - Secure strong buy-in from main implementing agents, especially sub-national governments.
  - Implement justice system reforms in parallel with labor and product market reforms.

### Sectoral and institutional weaknesses identified
- Product market:
  - Overall product market regulation restrictiveness in Italy is in line with the EU and OECD averages, but Italy underperforms in services sector while public ownership remains high.
  - Profit margins reach over 60 percent in professional services; in manufacturing (less than 20 percent of total value added) profit margin is 13 percent and over one-fifth is exported.
  - More restrictive regulation in professional services is associated with higher profit margins.
- Doing business environment:
  - Among high-income countries, Italy ranks the last before Greece for doing business, particularly weak in enforcing contracts (#31), paying taxes (#31), and getting electricity (#29).
  - Specific frictions: enforcing contracts takes twice longer and more procedures and costs more; getting electricity takes more time and costs 4 times more; construction permits take more time and cost 3 times more; registering property has more procedures; resolving insolvency takes longer and costs twice with lower recovery rate; paying taxes takes more time and more payments and tax rates are much higher; getting credit has weaker legal rights and wider coverage in credit registries; trading across the board takes twice longer and costs about 20% more.
- Innovation, education, and export complexity:
  - Italy has one of the lowest investments in R&D and ICT specialization among OECD countries.
  - While Italy's exports are among the most diversified, it ranks only 24th in export complexity.
  - Italy scores among the worst in educational attainment, including PISA scores (among worst 8) in OECD.
- Public administration and tax burden:
  - Public expenditure quality and efficiency rank among the worst, especially for public administration.
  - Italy's tax burden is the highest in OECD, particularly for businesses, with alarming incidence of tax evasion.

### Simulation assumptions (Table 3 main entries)
- Product market reforms:
  - Decrease in tradable markup: phases in over 5 years; not fully credible until the fifth year; share of tradable sector in production = 50%; markup declines 2.5 ppt (= roughly 50% of gap with the rest of the world, outside the euro area).
  - Decrease in non-tradable markup: phases in over 5 years; not fully credible until the fifth year; share of non-tradable sector in production = 50%; markup declines 15 ppt (= roughly 50% of gap with the rest of the euro area).
  - Decrease in wage markup, economy wide (professional services): phases in over 5 years; not fully credible until the fifth year; markup declines 3.4 ppt (= 40% decline in the cost of professional services).
- Labor market reforms:
  - Easing employment protection: delayed for 1 year because of reform enactment issues; then immediate; not fully credible until the fifth year; employment protection legislation converges towards average of 3 lowest stances observed across the OECD; overall productivity increases 0.34% (= 50% of OECD best practices gap).
  - Strengthening active labor market policies (ALMP): delayed 1 year because of lack of fiscal space; then immediate; not fully credible until the fifth year; increase in ratio of per capita ALMP spending per unemployed over GDP towards average level in Denmark, Austria, Netherlands, Norway, Sweden, and Switzerland; participation rate increases 0.24%; fiscal costs = 0.45% of GDP (= 50% of OECD best practices gap).
  - Increasing female participation through childcare: delayed for 1 year because of lack of fiscal space; then immediate; not fully credible until the fifth year; increase in public childcare spending towards average level in Denmark, Norway, Sweden and the United Kingdom; participation rate increases 0.60%; fiscal costs = 0.3% of GDP (= entire OECD best practices gap).
- Fiscal reform through tax and expenditure switching:
  - Switching to consumption taxes from labor and corporate income taxes: all components exist in GIMF; immediate and permanent change; immediately credible; increase 2% of GDP on consumption taxes; decrease 1% of GDP on each of labor and corporate income taxes.
  - Switching to infrastructure from general lump-sum transfers: infrastructure is government investment; general lump-sum transfers are in GIMF; phases in over 5 years; not fully credible until the fifth year; 1% of GDP switch.

*Source: IMF staff estimates (extracted from the provided IMF PDF).*

### REFERENCES

### _wp1322 - REFERENCES

### IMF’s GIMF: model structure and calibration
- GIMF is a multi-region micro-founded dynamic stochastic general equilibrium (DSGE) model.
- Version used has six regions: Italy, the euro area (excluding Italy), emerging Asia, Japan, the United States, and a remaining countries bloc.
- Two regions of concern in the analysis are Italy and the euro area (excluding Italy); spillover effects on other regions from the reforms are negligible.
- Households and firms optimize; firms are divided between tradable and non-tradable goods sectors.
- Full intertemporal stock-flow accounting with frictions: sticky prices and wages, real adjustment costs, liquidity-constrained households that cannot save, and households with finite planning horizons that can save.
- Fiscal structure:
  - Based on the Blanchard-Weil-Yaari overlapping generations model (OLG), implying a significant break in Ricardian equivalence.
  - OLG households have a planning horizon of 20 years in length.
  - Intertemporal elasticity of substitution is set to 0.25 in all economies.
  - Liquidity-constrained (LIQ) households are calibrated as 25 percent of households for advanced economies and 50 percent in emerging markets.
  - Fiscal rule maintains a deficit-to-GDP target, equivalent to a long-run debt-to-GDP target.
  - Endogenous countercyclical response of general lump-sum transfers based on an output gap measure parameterized as found in Girouard and André (2005): 0.53 for Italy and 0.48 for the rest of the euro area.
  - Seven fiscal instruments: government spending, government investment (infrastructure spending), general lump-sum transfers, lump-sum transfers targeted to liquidity-constrained households, the consumption tax (VAT), the corporate income tax, and the labor income tax.
- Monetary policy:
  - Inflation-targeting regime in tandem with a flexible exchange rate regime in each region.
  - For Italy and the rest of the euro area, one interest rate reaction function is used based on a euro-area-wide measure of CPI inflation with a target of 2 percent.
  - Italy has a weight of roughly 1/6th in the euro-area-wide policy rule.

### Modeling of reforms: representation and general mechanism
- Structural reforms are represented by shocks that:
  - Reduce markups on the prices of non-tradable and tradable goods, and the nominal wage.
  - Increase labor supply and labor-augmenting productivity.
- General real-side effects of markup or productivity reductions:
  - Reduction in marginal production costs (akin to a productivity increase).
  - Increased demand for factors of production (labor and capital).
  - Higher real wages and higher household wealth lead to higher consumption.
  - Higher demand for capital stimulates investment to accumulate and maintain a higher capital stock.
  - Real exchange rate movements occur, but adjustment is constrained by the nominal exchange rate peg required to maintain the monetary union; however, interest rates still react to economic developments in Italy because of the euro-area-wide policy rule.

### Impact of a Permanent Decrease in the Non-tradable Price Markup
- Mechanism and short-run effects:
  - Reduction in non-tradable price markups reduces costs in the non-tradable sector, similar to increased productivity.
  - Demand for factors increases; real wage increases; household wealth and consumption rise.
  - Investment increases to accumulate a higher capital stock.
  - Real exchange rate depreciates (relative price shift between tradable and non-tradable goods in Italy); adjustment restricted by the monetary union peg.
  - Real depreciation strongest against the rest of the euro area, leading to higher real GDP in the rest of the euro area from cheaper imports.
  - Short-run inflation: increases slightly, but falls after about 2 years.
  - Euro-area-wide policy rate rises because the rest of the euro area faces sustained aggregate demand and inflationary pressures; Italy is only roughly 1/6th of the monetary union weight.
- Long-run effects:
  - Output higher across the euro area, particularly in Italy.
  - Higher real wages; households decrease labor supply in the long run due to higher wealth.
  - Labor shifts from the non-tradable to the tradable sector as tradable firms hire more to exploit export opportunities from the permanent depreciation.

### Impact of a Permanent Decrease in the Tradable Price Markup
- Mechanism and short-run effects:
  - Reduction in tradable price markups reduces costs in the tradable sector, similar to increased productivity.
  - Real wage increases; household wealth and consumption rise; investment increases.
  - Real exchange rate appreciates (relative price shift between tradable and non-tradable goods in Italy); adjustment restricted by the monetary union peg.
  - Euro area imports cheaper goods from Italy, which depresses euro-area GDP and dampens inflation, leading to euro-area-wide interest rate cuts.
  - Short-run inflation: falls slightly; then rises for about after about 2 over the first 10 years, before decelerating (inflation dynamics driven by decline in euro-area-wide interest rates).
- Long-run effects:
  - Output higher in Italy; real wages higher; euro-area output roughly unchanged.
  - Consumers decrease labor supply in the long run due to higher real wage and wealth.
  - Labor shifts from the tradable to the non-tradable sector as tradable firms face negative effects of permanent appreciation.

### Impact of a Permanent Decrease in the Real Wage Markup
- Mechanism and short-run effects:
  - Labor-market competition reduces wage markup by households; unit labor costs decline; firms demand more labor as wages fall in the short run.
  - In medium to long run, households gain higher wealth as employment and labor demand rise; higher labor supply in a competitive environment contributes to lower real wage.
  - Overall labor income rises; consumption and investment increase; investment rises strongly in the short run to accumulate a higher capital stock and remains higher in the long run.
  - The cut in the wage markup acts like an increase in productivity; real exchange rate depreciates (strongest against the rest of the euro area).
  - Short-run inflation: increases slightly, but falls after about 2 years.
  - Euro-area-wide policy rate remains effectively unchanged since the rest of the euro area faces little impact; Italy is only roughly 1/6th of the monetary union weight.
- Long-run effects:
  - Output higher in Italy; lower wage costs lead to higher labor demand.
  - Upward pressure on the real wage offsets much of the initial markup cut as stronger consumption and wealth reduce labor supply.
  - Long-run consumption, investment, output, and labor are higher; wages are only slightly weaker.
  - Little effect in the rest of the euro area.
  - Credibility matters: if reforms are stepwise credible, real GDP rise is slower but eventually reaches the same long-run outcome after additional time.

### Impact of a Permanent Increase in Labor-Augmenting Productivity
- Mechanism and effects:
  - Productivity increase in production of tradable and non-tradable intermediate goods raises marginal products of capital and labor, boosting their demand.
  - Firms offer higher real wages and real rental rates on capital; household income and private consumption increase.
  - Investment increases to accumulate and maintain a higher level of capital.
  - Marginal production costs decline; firms lower output prices; inflation falls slightly in the short run.
  - Lower nominal interest rates expected, but limited for Italy since it is only 1/6th of the euro area.
  - Fiscal authority reacts counter-cyclically by reducing general transfers to households, temporarily improving the fiscal balance.
- Long-run outcomes:
  - Real effective exchange rate depreciates, increasing export competitiveness.
  - Current account shifts to a small surplus; net foreign assets are higher as domestic households export excess capital after financing domestic capital stock increases.

### Impact of a Permanent Increase in Labor Supply
- Mechanism and effects:
  - Represented as an increase in total hours worked (no formal distinction among average hours, employment, participation rate, or size of labor force).
  - Permanent increase in labor supply lowers the real wage, reducing the price of domestically produced goods in home and foreign markets.
  - Higher household real purchasing power and cheaper production factors stimulate consumption and production.
  - Investment rises to accumulate the higher capital stock demanded (more so in the short run).
  - Reduction in marginal cost exerts downward pressure on inflation.
  - Limited ECB monetary policy response because Italy is only 1/6th of the euro area.
  - In GIMF, the substitution effect slightly outweighs the income effect, so labor income rises, enabling higher consumption and higher real GDP.
  - If paired with other shocks, increased labor share amplifies the effects of supply-side shocks on consumption and production over adjustment.

### Impact of New Fiscal Costs from Labor Market Reforms
- Fiscal cost examples: provision of child care to increase female participation; active labor market policies.
- Modeling approach: additional fiscal outlays offset with a reduction in lump-sum transfers, shifting composition of government expenditure.
- Short-run effects:
  - Increased government spending raises real GDP immediately via higher aggregate demand.
  - Inflationary pressures increase, but minimal impact on the monetary policy rate since Italy is around 1/6th of the euro area; limited crowding out from monetary policy.
  - Increased government debt burden would increase crowding out of investment in debt-financing markets and reduce fiscal room, but in the presented scenarios additional outlays are small and offset by reductions elsewhere.
  - When offset by reducing general lump-sum transfers, there is no crowding out of investment; slight downward pressure on consumption for saving households due to decreased expected wealth.
- Net effect:
  - Once positive demand effects from government spending are offset by negative impacts on consumption from lower transfers, the impact on real GDP is ambiguous.

*Source: _wp1322 - REFERENCES (IMF PDF)._

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1322.pdf_