The Economic Consequences of Silvio Berlusconi

MILAN – Silvio Berlusconi has survived a confidence vote, but his government is virtually dead. One cannot rule a country with so scant a majority. Not for long.  

The one important decision that this, Berlusconi’s fourth government, ever bothered to take was a decision not to decide. Two years ago, when financial crisis shook the world, Berlusconi’s choice was to avoid any policy intervention to counteract the Great Recession. This contributed to the deepest fall in output in Italy’s postwar history, with a cumulative 6.5% decline in GDP. Within the G-20, only Japan did worse.

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Remarkably, Italy had twice the fall in output seen in France, another large OECD country that, like Italy, had avoided the root causes of the crisis: a housing boom-bust sequence and a serious bank crisis. The paradox is that the Berlusconi government’s inaction did prevent a major deterioration in the public deficit. In light of the current debt crisis roiling the eurozone, the advantages of a policy of inertia are easy to appreciate. Italy’s position today could have been much worse than it is.

The Italian economy’s problems, and the major issues concerning the sustainability of the country’s huge public debt, are rooted in low growth of potential output. As is also revealed by the term structure of credit-default swaps for Italian debt, investors are not worried about, say, the 2011 budget law. Instead, they are worried about Italy’s economic conditions in 5-10 years.

It is these medium-run problems that Berlusconi’s government has overlooked. None of the structural reforms essential to improving Italy’s growth potential – for example, labor-market and unemployment benefit reforms, product market liberalizations, improvements of the education system, reforms of the public administration in the South  –  has been carried out, even though Berlusconi could count on solid majorities in both chambers of Parliament.

Why did Berlusconi’s government choose such a passive economic policy? One reason is that the level of Italian debt did not leave much room for countercyclical fiscal policy. But some effort to stimulate the economy at the outset of the crisis could have been attempted. For instance, it would have been possible to provide income support to job losers – which would have been useful after the crisis as well – by reforming the system of unemployment benefits.

A possible explanation for the government’s inaction over the past two and half years is that the measures agreed upon within the coalition that won the 2008 elections were not tailored to a country entering a major recession. There was no leadership over economic policy defining new priorities and measures to meet the changed macroeconomic conditions.

In its first month after coming to power, the government did actually try to do something for the economy. It took three decisions, all of which were soon revealed to be utterly wrong.

The first decision was to reduce taxes on overtime work, a measure clearly aimed at increasing the number of hours worked. Needless to say, as unemployment rose and many other countries decreased hours worked in order to contain job losses, tax reductions on overtime were phased out and the scope of short-time work was enhanced.

A similar fate occurred to a Robin Hood tax, which, according to Finance Minister Giulio Tremonti, should have forced banks and oil producers to provide resources for the poor. The tax on banks had to be transformed into a commitment to provide fresh money to troubled financial institutions via the so-called “Tremonti Bonds.” And the increase in the tax on oil producers, implemented when the oil price stood at $160 per barrel, had to be postponed when the price per barrel fell to $30.

The last measure taken was the dismantling of the real-estate tax, a major source of revenue for local governments. This tax has not yet been restored, but the government is planning to introduce a number of new levies on housing, which would ultimately restore the lost revenues.

In this way, Italy lost 30 months without enacting the structural reforms that it so badly needs to restore the country’s growth potential. True, such reforms are particularly difficult during bad times, but a large number of them have been carried in the European Union precisely during recessions. The fact of the matter is that downturns are times of “extraordinary politics,” in which it is possible to create larger coalitions for far-ranging economic-policy changes.

A government pursuing a reform agenda should, under these circumstances, make the public aware of the emergency conditions and appeal to the responsibility of the opposition. But the Berlusconi government, and the media directly or indirectly controlled by the prime minister, chose a different communication strategy. They constantly underplayed the extent of the crisis, and tried to sell the idea that Italy had largely been insulated from the global recession.

This strategy may have prevented the dramatic fall in popularity experienced by other governments in the middle of the Great Recession, but sooner or later will backfire. The disappointment of the majority of Italians with Berlusconi’s rule will be even larger when they realize that this government never presented the facts as they are.

Read more from our "Italian Ice" Focal Point.