Exhausted Italy

Italy is facing perhaps its most important elections since 1948, when voters confirmed the emergence of Italy’s new republic from the wreckage of Mussolini’s fascist regime. On April 9-10, Italians must choose between Prime Minister Silvio Berlusconi’s center-right government and the center-left bloc headed by Romano Prodi. But neither man seems the sort of decisive figure that overcoming Italy’s bleak economic predicament demands.

Italy’s economic malaise is obvious. Cumulative economic growth over the past five years was the slowest in the euro zone – 3.2%, compared to an average of 7.8% – with two years of stagnation. Per capita GDP, too, has fallen below the euro-zone average. Employment has increased, but labor productivity has remained flat and total factor productivity has declined. Combined with strong real exchange-rate appreciation, this has led to a dramatic loss of competitiveness and weakening exports. Indeed, the only growth sector seems to be books about Italy’s decline.

Berlusconi claims that statistics are unreliable, for they conceal a much rosier reality for today’s well-off Italians. Other members of the government admit more soberly that Italy faces serious problems, but they lay the blame on factors beyond their control: a series of global economic shocks, a slow-down in continental Europe, the admission of China to the World Trade Organization, and the role of the euro.

But such explanations are unconvincing. The global shocks affected all European countries alike, as did the entry of China (and other Asian countries) into the WTO, but French exports, for example, suffered much less, while German exports actually increased. True, European growth was dragged down by meager growth in Germany, but Italy grew marginally less than Germany. Finally, while the euro has put a stop to competitive devaluations, it also provided Italy with a sizeable benefit: a reduction by 6% of GDP in interest payments on the huge public debt accumulated in the 1990’s.

It would be unfair, however, to blame the Berlusconi government alone for this dismal performance. Italy’s growth has been slower than Europe’s, with weakening exports, for the past decade, because the country was ill prepared to adjust to the global revolution in information technology and the changing pattern of world trade. Its infrastructure, both material and intellectual, was poorer, and its economic structure was unfit for the new challenges, owing both to firm size and their specialization in traditional sectors, as well as low levels of education and R&D.

Yet the Berlusconi government did next to nothing to address these deficiencies, despite being the first government in Italy’s history to survive a full five-year electoral term. With an unassailable parliamentary majority, it could have undertaken coherent supply-side reforms, even at the risk of some initial unpopularity.

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A couple of reforms were belatedly enacted: timid intervention on pensions and a further increase in labor-market flexibility. But nothing was done to deregulate product markets or to give proper incentives to restructuring, while privatization came to a halt.

Instead, the government chose old-style Keynesian policy: moderate tax cuts to increase disposable income and an increase in current expenditure. Between 2001 and 2005, current non-interest expenditure rose by 2% of GDP, revenues fell by 0.5% of GDP, and the general government deficit rose by 1% of GDP. Worse, the surplus fell from 3.2% to 0.5% of GDP, and fell even allowing for the business cycle. As a result, the debt-to-GDP ratio declined only modestly until 2004 and rose again – to more than 106% – in 2005.

The weak fiscal position will severely constrain whatever government comes to power. The center-left’s ponderous electoral program proposes a cut of five percentage points in payroll taxes, but it is not clear where the required €10 billion will come from to pay for this. The idea of increasing the low (12.5%) withholding tax on capital gains met with accusations that Prodi intends to expropriate wealth. But the right’s slim manifesto includes its own unaffordable promises, such as cuts in property taxes and increases in low-level pensions.

Italian voters are perplexed. In 2001, Berlusconi signed a “contract with the Italians” containing promises that have gone unfulfilled. He has always fancied himself as a savior, convinced that he alone can fix the country. So he finds it unconceivable that anybody can feel otherwise or even that rules should stand in his way. Hence his government’s efforts to pass laws changing judicial procedures, or to consolidate the duopoly of public (government-controlled) television stations and his own, or to concoct a bizarre new electoral law favorable to his coalition.

But voters’ frustration with Berlusconi is not necessarily good news for Prodi and the left. Opinion polls reveal that trust in all politicians and political parties has reached the lowest level ever. Italy has endured a sad and degrading electoral campaign, one that has generated a lot of heat, but little light. One hopes that whoever wins buckles down to the serious work that Italy so desperately needs.

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