Monday, September 1, 2014

Berlusconi on the Boil

Silvio Berlusconi was elected as Italy's prime minister after campaigning on a platform of reinvigorating the economy through tax cuts and liberalization. After three years in office, he has not delivered on his economic agenda and his government is in shambles. What went wrong?

Italy's economic ills are well known. At the risk of over-simplifying, they can be grouped under three headings:

· Weak public finances . When Italy joined the European Monetary Union, its primary budget surplus (tax receipts in excess of government spending, excluding interest payments) was about 5% of national income. In 2004, the surplus will shrink to about 1.5% - before the tax cuts that Berlusconi promised for next year. Excessive social welfare spending (mainly public pensions) and the cost of servicing the public debt drain resources from more productive government spending and impose a high tax burden. The government has failed to take any meaningful action, and the problem is getting worse. Unsurprisingly, the rating agency Standard & Poor's recently downgraded Italian public debt.

· Declining competitiveness . Italy's most dynamic producers are small manufacturing firms in traditional sectors with relatively low technological content. With these firms now exposed to foreign competition from low-cost producers in Asia and Eastern Europe, Italy's share of world exports has been shrinking in recent years. Italy has a few large corporations, mainly in services, utilities, or sectors shielded from competition. These monopolistic producers act like a distorting tax on the rest of the economy. Smaller but more competitive manufacturing firms lack the resources to expand in more advanced technological sectors. The volume of private and public R&D spending is one of the lowest among industrial countries. As a result, Italy is receiving immigrants with relatively low skills, while many of its most productive young graduates emigrate to the US, the UK, or other European countries. The government has done little to remedy this. Liberalization attempts in energy and public utilities have faltered, perhaps also because the government pockets monopoly rents through dividends from public enterprises. Privatization has stalled.

· The Mezzogiorno . Labor productivity is traditionally much lower in Italy's south than in the rest of the country. But centralized wage negotiations impose the same salary everywhere. So many in the South remain poor and out of work, particularly the young. Early on, the government proposed legislation to increase labor market flexibility and relax constraints on firing rules. But its strategy of dividing the trade unions failed and some of the proposed legislation was eventually withdrawn.

Why has the government achieved so little, despite a large majority in Parliament, widespread backing among the population, and supportive media? The main reason is government infighting. In a well functioning democracy, electoral competition between government and opposition induces the government to pursue efficient policies. Not so in Italy, where the main site of electoral competition has always been within the governing coalition. Each government party is afraid of losing votes to its coalition partners, and undermines or blocks whatever the government is trying to do. The result is policy paralysis, until time has run out for everyone.

The same problems led to the collapse of the previous government (a left-wing coalition led by current EU Commission President Romano Prodi), and they would certainly continue under a new government if a left-wing coalition was voted into office at the next election.

Unstable coalition governments have been typical of Italy's postwar politics. In an attempt to solve the problem, a mixed electoral system was introduced in the early 1990's, with about three quarters of the seats assigned under plurality rule in single member districts and the rest allocated under proportional representation. But the hope that this would ensure greater stability has been unfulfilled. The residual proportional component of the electoral system has kept many political parties alive. Because all of them compete for these proportional seats, government infighting remains acute.

A logical solution would be to scrap the proportional component of the electoral system altogether, and move decisively toward a two-party political system under fully majoritarian elections. But that is unlikely. On the contrary, the smaller centrist parties that scored a victory in the recent European Parliament elections are now demanding a return to full proportionality.

If they get it, matters will most likely go from bad to worse. Under the current system, Italian governments achieve little, but at least they last longer. A return to full proportionality would probably mean a return to rapid government turnover, which carries with it the risk that policy horizons will also become shorter. As Italians know all too well, government instability inevitably breeds financial volatility.

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