Because Italy can do it

13.11.11 Publication:

Watching Italy during the past few years has been like watching a slow-motion car crash. Or perhaps a better, more English analogy would be to compare il Bel Paese to the Titanic. It is strong, full of rich people and built with fine engineering, but through its own complacency it has been heading slowly for an iceberg. Now, however, the analogy has to change. We have to ask what Professor Mario Monti can feasibly do to revive and cure the sick Italian patient.

The President of the European Council, Herman Van Rompuy, surely got it right when he said on Friday that “Italy has a potentially high economic performance, yet it needs huge efforts to unleash it in a structural and permanent fashion.” That is pretty close to what Professor Monti has also been saying in his increasingly outspoken articles and speeches in recent months.

In truth, Italy’s economic strength has played a rather contradictory role during the long run-up to this crisis. Many economists have rightly said that the country’s “fundamentals” are good: high levels of household wealth and savings, low private debts, a stable banking system and a favourable balance of trade in manufactured goods. In that sense, Italy is not like Greece. Yet politicians have abused that argument by using it to suggest that nothing much needed to be done.

The limit to the “fundamentals” argument begins with the fact that when the problem is a crisis of confidence in sovereign debt, these strengths are almost irrelevant. The issue is the fact that Italy’s government owes 1.9 trillion euros, a figure equivalent to 120% of GDP, the same level as it was in 1994 when Silvio Berlusconi entered politics. All that matters to those lending money to the Italian government is whether the government can service the debts.

Private wealth and low corporate indebtedness is relevant to that only if they mean that the government can raise more taxes from the private sector or persuade savers to buy more government bonds. Yet the most relevant “fundamental” fact shows why that is hard: Italy’s economy grew by a mere 3% in 2001-2010, while France’s grew by 12%. In this sense Italy is indeed not Greece: it is worse. Greece’s income per head grew by about 2% per year on average in 2001-2010, while Italy’s actually fell.

Italy felt and in some ways looked strong and wealthy but was in fact not just stagnating but getting poorer. Household incomes are lower than they were ten years ago. The government’s debt is larger than it was then. The idea that the country was nevertheless in a fine position was used, by the President of the Council, by his ministers and sometimes by business leaders too, as a pretext for avoiding the need for tough decisions.

The “good fundamentals” argument is, however, correct in the way President Van Rompuy used it: Italy’s potential remains strong. That is why this financial crisis is both a tragedy and a crime: steady, modest changes, made year after year for the past decade or more, could both have trimmed back the public debt to make the country less vulnerable and unleashed more of the country’s natural economic vigour, making the debt more affordable, all without causing too much pain. The new government’s task will be to do that not steadily or modestly, but quickly and ambitiously.

No one, least of all Professor Monti, will expect this to be easy. The easier part, in fact, will be cutting the budget deficit more quickly than the plans that have now passed through Parliament. The strong, national sense of financial crisis will make sure that that effort will command support, at least for the next few months, despite the inevitable protests against this cut or that cut. Ideally, that early austerity should also be made part of a longer-term framework for cutting Italy’s government-debt burden down to, say, 80% of GDP over the next ten years.

The problem for the new government will, however, be similar to Greece’s: fiscal contraction may be necessary to restore investors’ confidence and reduce Italy’s borrowing costs, but it risks sending the country into a recession, perhaps even a deep one, especially as the rest of the eurozone is, according to Mario Draghi in his first press conference as President of the European Central Bank, destined for a “mild recession”. An Italian recession could depress tax revenues further, making budget targets harder to meet, and setting off a vicious downward spiral.

So what is needed is a combination of austerity and of reform that plays to the country’s true strengths, making growth likelier. The life of the Monti government is likely to be too short for it to be able to implement a really profound programme of reform. But it could push things in that direction as well as arguing a clear, public case for reform. Then, whichever government is elected in 2012 or 2013 would be in a better position to carry it out.

Can Italy really accept reform? That is a question I am often asked by my non-Italian friends. It is thanks to the journey around Italy that I made for my book, “Forza, Italia: Come ripartire dopo Berlusconi” (published one year ago by Rizzoli) that I feel confident that the answer is Yes. My confidence begins, in fact, in Torino.

Reform requires consensus to be built and a vision of a better future to be shared. That, I believe, is what Mayor Valentino Castellani achieved in Torino in the 1990s, when he formed the city’s equivalent of a “governo tecnico”, and then the plan was extended and implemented by his more conventional political successor, Sergio Chiamparino. Torino’s financial and political crisis led to change. The same can happen at national level.

Belief in such change also requires examples of success, of companies that have built themselves into not just national but also global leaders and can inspire others. Too often, commentary on Italian success limits itself to small and medium-size manufacturers. Many are excellent, but it is not enough to have excellence in a sector that represents just one-fifth of the economy. Nor are small companies often capable of competing globally. So what is needed is success more widely across all the country’s business sectors, and the establishment of bigger companies.

The examples are there, in new sectors as well as old ones: Luxottica’s leadership of the world market in sunglasses and Ferrero’s in chocolate, but also Technogym’s in health clubs, Autogrill’s in mass catering and duty-free retailing, and Rainbow’s in children’s animation.

What these companies also show, however, is that the obstacles to growth are many and various. And, since they are exceptions, they show how much the obstacles prevent other companies from emulating them. Labour laws that discourage firms from hiring workers in Italy, and working practices that make Italian companies less productive than in neighbouring countries, are high on the list. But so are the restrictive rules and cartels that raise costs and prevent companies from entering new fields, making it more rewarding to expand abroad than at home in Italy.

The sort of reform programme that is needed to unleash Italy’s potential is one that will remove rights, protections and privileges from a very broad range of groups and organisations. As such it will be highly controversial. So it will need the careful building of consensus, a process that is made harder by the current electoral laws, which encourage polarisation and a focus on personalities. As has been widely discussed, a reform to that electoral law is vital.

Such consensus will also be essential for the major reform to labour laws that is required, to achieve a unified labour market, combining flexibility and security. That will need collaboration between the government, trade unions and the employers’ federations, which is never easy. Yet it was done before, to remove the scala mobile, so it could surely be done again.

The biggest effort will need to be the painstaking removal of rights and privileges that impede competition and innovation. In “Forza, Italia”, I proposed that a new Italian government should contact a man who had just compiled a report for the European Commission on how to deepen the European single market, ask him to do the same exercise for Italy, and then put him in charge of implementing it. The man’s name was Professor Mario Monti. He will now have to find someone else to do that job, but at least he will know what he wants to be done.