MONTI´S MEDICINE / THE ECONOMIST

Italy’s economy
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Monti’s medicine
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Mario Monti has restored Italy’s credibility but much more must be done to restore its fortunes
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Dec 8th 2012
ROME
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AN ABIDING image of Italian cinema is the statue of Christ dangling from a helicopter above Rome on its way to St Peter’s Square, in Fellini’s “La Dolce Vita”. It is just over a year since the political equivalent occurred, when Mario Monti was winched into the Chigi palace, the prime minister’s official residence, to replace the lamentable Silvio Berlusconi as foreign funds fled the country and bond yields soared. Mr Monti, an unelected economist, called his first reform package “Save Italy”. As the end of his technocratic government nears—an election is due to be held in the spring—how has he done?
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Mr Monti’s government wins more plaudits from the markets than the public, which may be the right way round for a country with the highest ratio of sovereign debt to GDP in Europe, bar Greece, and the biggest absolute debt pile anywhere bar America, Japan and Germany. Helped by the actions of Mario Draghi, who became boss of the European Central Bank just days before Mr Monti took over, Italian ten-year bond yields have fallen to a two-year low. The Italian electorate is less grateful. Confidence in the government has ebbed away (see chart 1).




A loss of popularity was inevitable. The very point of a non-partisan government was to go where elected ministers feared to tread. Thanks to Mr Monti’s doses of austerity—and to the malaise affecting the euro zone as a whole—the economy, in recession since mid-2011, is forecast by the European Commission to shrink by 2.3% this year and by a further 0.5% in 2013. The overall unemployment rate has jumped from 8.8% a year ago to 11.1% (still below the euro-zone average); for young people, it is a desperate 36.5% (well above it).




The pain has yielded some gain. The European Commission expects Italy to have a primary budget surplus (ie, before interest payments) of 3.5% of GDP next year. Provided bond yields remain under control and modest growth returns from the middle of next year, that should be sufficient for debt to start edging down from a peak in 2013 of 127.6% of GDP. Vittorio Grilli, the economy and finance minister, thinks that debt could fall by as much as four percentage points a year by the middle of the decade, if the proceeds of planned privatisations worth an annual 1% of GDP are also used to pay it down.




That sounds optimistic. It took Italy more than a decade to lower its debt-to-GDP ratio from an earlier peak of 121% in the mid-1990s to 103% in 2007, and conditions were far more favourable then. The severity of the recession has taken Mr Monti by surprise, and a big concern is that GDP may be weaker next year than expected. The economy is suffering a financial squeeze as well as a fiscal one, with credit to firms falling at an annual rate of 3% and interest rates on new loans still well above the euro-area average.




Anaemic growth has long been Italy’s big problem. Indeed, in some other respects the country is in a position of strength. Its government may owe a lot but its households and businesses do not by international standards.




Italy’s foreign liabilities do not exceed its foreign assets by much: the gap is about 20% of GDP compared with about 100% for Ireland, Portugal and Spain. Italian banks are under pressure but on the whole they have been cautiously managed.
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Growth is a different story. A combination of lacklustre productivity and continuing wage increases has pushed up unit labour costs, resulting in a loss of competitiveness against Germany in particular (see chart 2)—and also against other southern European economies, where they have been falling recently. Italy was once extolled for its clusters of little firms, but small is no longer beautiful now that competition from low-cost Asian producers has intensified. The country has too few global champions.




That’s why a vital part of Mr Monti’s agenda has been “structural reforms”, jargon for policies designed to ginger up the economy by making both labour and product markets work better. Estimates from the IMF suggest that a feasible set of structural reforms could by itself lift the level of GDP by almost 6% over five years.




Italy’s failure to exploit its labour resources is apparent in an employment rate among 15- to 64-year-olds of just 57% in 2011, the second-lowest in the euro area and far below Germany’s 73%. That reflects early retirement, low female participation and a dual labour market, in which long-standing employees are virtually impossible to sack and newcomers—called the precari because of their precarious grip on work—have to take one temporary job after another.




Mr Monti has made some changes. A pension reform which was part of the “Save Italy” programme will help by extending working lives. It clamps down on early retirement and switches all workers into the contribution-based state pension first introduced in 1995, which makes it worthwhile for people to work longer. Elsa Fornero, the labour minister, acknowledges that the reform has hurt many workers, especially women in their late 50s, but says it was vital to restore fiscal sustainability and “generational equity” to pensions. It will contribute annual savings that will reach 1.2% of GDP in the 2020s.




Another reason for low employment is that businesses are reluctant to hire because workers are hard to fire. Employers have long faced heavy penalties, reinstatement of sacked workers and lengthy legal delays under cases brought to labour courts. Mr Monti’s government tried to sweep this regime away earlier this year but had in April to concede that judges could after all reinstate staff if they found that the economic grounds for dismissal were manifestly lacking. Even so, the reform will help employers by capping redundancy payments to two years.




Overhauling product markets is even more vital. The IMF’s research ascribes about four-fifths of that potential 6% gain in GDP to these reforms. Italy has not just a dual workforce but also a dual economy in which cosy domestic monopolies impose high charges on the trading sector. Electricity prices are among the highest in Europe. Professions like pharmacists and notaries enjoy fat profit margins.




The government’s attempts to deal with these distortions have again met with only partial success. It has forced ENI, a partially state-owned energy group, to hive off the gas network it controls. This may bring down electricity prices since much is generated from gas.




But the grid has not really been privatised, since ENI has sold a 30% stake in it to a state lender. Professions have been shaken up by the abolition of minimum fees and measures to encourage new entrants. But determined lobbying watered down the original proposals by, for example, reducing the number of new pharmacy licences.




The overall verdict on Mr Monti’s reforms is that they are a step in the right direction but there is a long way still to travel. Recently published rankings from the World Bank for the ease of doing business in 2012 put Italy among the worst in Europe. Among 185 countries, it came 73rd; on civil justice (ie, enforcing contracts) it ranked an astonishing 160th.




Many worry whether Mr Monti’s reforms will be properly implemented. And there is still so much to do, says Guido Tabellini of Bocconi University in Milan: cutting through the tangles of bureaucracy, for instance, or improving the efficiency and quality of Italian public services such as schools and universities.
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Hanging over any assessment of Mr Monti’s legacy is that election early next year, when politicians will probably be back in power. Italy has had technocrats in charge before (notably Lamberto Dini in 1995-96, who pushed through the earlier bold pension reform) but not managed to maintain momentum. It is absolutely crucial for Italy’s future that a new, elected government carries on where Mr Monti left off, says Giovanni Sabatini of the ABI, Italy’s banking association. Without such continuity Italy will struggle to regain la dolce vita.