Italy: Fat PIIG or Lazy Cat?
Observers of the Italian economy have split between two radical camps: emphatic doomsayers and ardent optimists. Both attitudes are symptoms of an understandable difficulty in comprehending the contradictory developments of the Italian economy and society in the last two decades: Italy has a surprisingly solid fiscal structure. But it is worryingly weak over the longer term because of its growth capacity.
This dichotomy is increasingly relevant in light of the Greek emergency, which has raised questions about Italy's capacity to withstand the crisis. Both Greece and Italy have been burdened by high public debt and a loss of competitiveness since the onset of the euro 11 years ago. Italy is therefore seen as exposed to a contagion that could spread from a Greek default. Italy's economy constitutes 17 percent of the euro area's GDP, compared with 2.5 percent for Greece. Its economic stability, even more than Greece's, thus poses a defining test for the euro. Of course, Greece and Italy are seen by many as sharing similar problems along with Ireland, Spain and Portugal, giving rise to the unfortunate but popular group acronym, PIIGS.
For now markets seem more favorably impressed by Italy's fiscal performance than commentators in international media. The 10-year yield gap with the German Bund is not particularly affected by the Greek contagion, and credit default swap (CDS) spreads are relatively stable compared with those of the other peripheral countries. Other indicators show that in some instances investors have used Italian bonds to hedge the Greek risk, as they normally do with German bonds. Indeed, if risk aversion does not become indiscriminate throughout the euro area, Italy could come out of the crisis as a "fiscal winner."
Despite this outlook, the global crisis will likely take its toll on the Italian economy. Though its industrial structure is changing, long-standing structural weaknesses, particularly the prospect of persistently low growth, threaten its economic future. Italy is one of the few countries with a public debt higher than its GDP for the entire last quarter of a century, foreshadowing the troubles faced by many countries, including the United States and the United Kingdom.
Before the financial crisis, the debt to GDP ratio in Italy had already been expected to reach the threshold of 100 percent in 2011 for the first time since the end of the 1980s, and decline afterwards. The global crisis has put that goal out of reach. But it has also changed the fiscal landscape for the whole euro area and paradoxically improved Italy's relative fiscal position in the eurozone. In 2020 the European commission assumes that the average public debt in the eurozone will range around 120 percent, around the same level as in Italy. So Italy will not be Europe's fiscal outlier anymore but an average "core" country.
In the last 20 years, Italy's governments have, on average, adhered to a strict fiscal course. The primary surplus has consistently been above the euro area median level. After a major and politically costly correction in 2005–06, fiscal stability has been consolidated. In the latest crisis, Italy's fiscal stimulus package has been the smallest in Europe. In 2010 Italy's expected fiscal deficit will be at a slightly lower level than that in Germany, at 5.3 percent of GDP, among the lowest in the eurozone and much lower than the expected average of the area (7.3 percent).
Bringing the deficit from around 5 percent of GDP this year to less than 3 percent in 2012 (as requested by the European Commission) will thus be easier to carry out than it will be for most euro countries. Furthermore the process of deleveraging is facilitated by the high saving propensity of Italian households (14 percent of disposable income) and companies. A low consumption propensity reduces the standard multiplier effect of fiscal stimulus, but it also dampens the negative impact of fiscal retrenchment on output, easing the problems associated with fiscal corrections.
The outstanding level of private savings and of private wealth (the highest in Europe relative to GDP) among the Italian households is another factor in preserving fiscal stability. The net savings level in the economy is negative as shown by the current account deficit, but still manageable at around 2 to 3 percent of GDP. The high level of savings is consistent with a high share of the debt held by domestic investors. Residents hold around 60 percent of Italian government debt. This compares with one-quarter for Portugal and Ireland, one-third for Greece, and about 40 percent for Spain. In Germany and France, the share of public debt held domestically is lower than in Italy. Domestic investors are normally more stable than foreign, and this is consistent with the relative longer duration of Italian debt maturity (seven years). The high savings propensity and a certain caution in the savings pattern helped Italian banks weather the financial crisis and required a very modest support by the State (0.6 percent of GDP).
The relative stability of Italian fiscal accounts has been acknowledged by the Sustainability Report of the European Commission, which projects the path of the debt to GDP ratio for Italy in 2060 to come in at a substantially lower level than those of Germany, France, and the United Kingdom. Vito Tanzi (former IMF executive director) made a similar comparison with the Congressional Budget Office's US fiscal projections showing a more favorable position for Italy.
A more concrete element of confidence comes from the assessment of the pension expenditures. The European Commission expects a decrease in pension expenditures of 0.4 percent of GDP between 2009 and 2060 in Italy—against an increase of 2.7 percent of GDP in the euro area. Reforms carried out in the early 1990s have put pension expenditures on a virtuous track. Most recently, the introduction of an automatic link between pension benefits and life expectancy has further strengthened the system.
If Not a Fat PIIG (or Pig), Then What Else?
The concluding statement of the International Monetary Fund's 2010 Article IV Consultation mission is relatively neutral: "The recession in Italy's main trading partners led to a sharp fall in exports. Although there was no fallout from the banking system, financing conditions tightened and credit growth fell. Despite strong household balance sheets, private consumption declined significantly, mainly reflecting higher uncertainty. Fixed investment and inventories also fell sharply, owing to weak demand prospects." The reality is that Italy's economy fell in 2009 by more than 5 percent (more than the EU average of 4.1 percent). Much of this performance resulted from a total lack of public expenditure in support of domestic demand. But unfortunately no official forecast indicates that Italy's economy will recover as fast as the European average. So although Italy may become a "core country" in terms of fiscal stability, it remains a diverging country in terms of income growth. Since the sustainability is a product of the ratio between debt and income, Italy's economic stability remains in some doubt.
Low growth has been the hallmark of the past two decades. Between 2005 and 2008 Italy's GDP grew 8 percent less than the eurozone average and 4 percent less than France and Germany (whose growth, as well as Italy's, was not inflated artificially by housing or financial bubbles). Tabellini and Barba Navaretti ("Il Sole-24 Ore" April 2) show a 20-year decline in the labor productivity rate of growth as well as in total factor productivity: even the vaunted performance of the export manufacturing industry was dismal: hourly added value increased by 6.6 percent between 1995 and 2007, compared with 51 percent in France and 45 percent in Germany. The level of salary is lower in Italy than in France or Germany, but the unit labor costs have increased since the onset of the euro by 10 percent against the euro average and by 25 percent more than in Germany.
The different dynamics of unit labor costs across the European Union provide striking evidence of Italy's loss of competitiveness. But using price indicators instead of input or cost indicators—Italy's divergence is much less evident. Italy's real effective exchange rate (REER) increased by almost 40 percent between 2000 and 2008, but the equivalent increase for the consumer price index (CPI)-based REER (calculated on the basis of the consumer price index) is only 14 percent (10 percent for Germany and France). So Italy's external competitiveness problem may be overstated, but the figures hide a number of profound internal economic divisions. These include differences between exporting and nonexporting industries, between unionized workers and low-paid immigrants, between productive regions and inefficient subsidized ones, and between taxpayers and tax evaders. These tensions reinforce the power of special interests to maintain the status quo, underscoring Italy's underlying political fragility.
A completely different picture is offered by those who exalt the actual export performance of Italian industry. Italy has defended its world market share better than others. Between 2005–08—as Fondazione Edison points out using UN data—manufacturing exports had the highest rates of increase both in value terms (44 percent) and in volume (22 percent). The discrepancy between value and volumes indicates the shift of exporters moving from material production to intermediation, research, marketing, branding—and to taking advantage of outsourcing from Eastern Europe, the Far East, and Northern Africa.
The small size of Italian firms has led to a low level of research and of technology. The size is also consistent with a widespread pattern of family ownership that generally implies more risk aversion and reduced investments (as showed by Bugamelli et alia). But the fragmented Italian industrial landscape has some positive sides too. Eurostat counts around 500,000 Italian firms compared with around 200,000 in Germany or France. The best among them specialize in niche products and lead in global markets, outcompeting the standardized production of multinationals: Think Ferrari instead of Volkswagen.
Italian producers rarely range among the world's top three in any of industrial macrosectors (i.e., mechanics, chemicals and so on) but once the data are broken down to single product categories (from over 5,000 categories in the UN database), Italy's exporters range in the top three positions in more than 1,000. The detailed data suggest an Italian economic structure of unsuspected feline flexibility.
A Cat Then, but a Lazy One
There is no point in being fast and flexible if you have a leash around your neck. The overarching conventional explanation for Italy's low growth focuses on its flawed resources allocation, preventing the most efficient firms from growing abroad. Infrastructural programs are constantly delayed and research expenditures kept at minimal levels. The selection of people and of projects is not based on merit. Italy's quality of education remains poorly and unequally distributed. As remarked by Reichlin ("Il Sole-24 Ore" April 7, 2010): "Italy is the only country in the OECD [Organization for Economic Cooperation and Development] where the level of education does not contribute to raising the individual income." The special interest of insiders make the market liberalization reforms politically costly, restrain the access of new players and let protectionism prevail both in politics and in the economy. The decline in the growth rate is strongly related to this defensive attitude of special interests and to its divisive political expressions.
Unfortunately, the lazier the cat, the happier he is. But one day he might not be able to catch mice anymore.