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.