Economic surveys and country surveillance

Economic survey of Italy 2007: Italy's key challenges

 

Contents | Executive Summary | How to obtain this publication | Additional information

The following OECD assessment and recommendations summarise Chapter 1 of the Economic survey of Italy published on 4 June 2007.
See also an excerpt related to this chapter.

Contents                                                                                                                       

What are the main challenges?

A welcome economic rebound is underway in Italy. After having recorded real GDP growth of 1.9% last year – below the average for the euro area, but above the potential rate – growth is set to maintain that pace in 2007. While this partially reflects ebullient foreign demand, there are also early signs of more fundamental improvements. Some Italian exporters have regained export market shares in the segment of high-quality consumer items and machinery to produce them, in which they have traditionally specialised. The rapid increase of export prices may signal that these firms have recouped some of their pricing power and moved upscale towards highly-priced products. However, there are also firms that failed to restructure, innovate or outsource and must still downscale, as suggested by the overall decline of profitability and continuing loss of export market shares in the aggregate. The fact that Italy’s export structure remains heavily biased towards low-skill production, hence exposing it to competition from emerging market economies, continues to handicap growth.

In addition to early signs of export revival, labour market performance has also been impressive. The level of job creation has been remarkable, bringing down the unemployment rate sharply, below that of neighbouring countries. Several forces seem to have acted in boosting employment gains. First, there has been a long period of wage moderation in the private sector following the renegotiation of wage contracting arrangements (elimination of scala mobile) in the early 1990s, bringing to a halt past overruns in real wages. Second, the reform of labour contracts and taxation have triggered a surge of atypical jobs, notably part-time and fixed-term contracts for low-skilled workers with reduced social security contributions. Third, inward migrants have contributed positively by filling vacancies unoccupied by Italian workers, helping a better matching and lowering structural unemployment. Finally, the regularisation of migrants has helped the functioning of the labour market, not by directly creating new jobs (existing jobs were brought into the formal economy), but by allowing migrant workers to build up their skills and move upscale in their careers. The burst of new jobs has been highly beneficial, but the increase in labour market flexibility implied by rising fixed term contracts (some 12% of total employment), has mainly affected workers at the margin of the labour market as the protection of workers with indefinite contracts remained untouched. There is a need for rebalancing employment protection legislation so as to reduce labour market duality, while still providing adequate security for workers. Other employment issues also remain unresolved. Levels of participation are low in the formal economy, notably among women and older workers, making it crucial to reduce marginal effective tax rates, particularly for groups with high labour supply elasticities, and to implement the increase in the pension age. There are large regional gaps in labour market participation and unemployment rates, which is a source of unrealised growth potential.

Notwithstanding the early signs of better export and employment performance, it is too soon to say that the economy has turned the corner. Italy’s trend growth was held back by the weak growth of total factor productivity (TFP) during the latter half of the 1990s, and TFP growth further declined during the first half of the present decade, particularly in manufacturing. In the service sector, there has not been the type of productivity acceleration witnessed in other countries following the diffusion of new technologies. Special factors such as immigrant regularisations could have contributed to depress measured productivity growth, though to a relatively minor extent. Other explanations have been put forward to explain this sluggishness, such as the entry of low-skilled workers on the labour market. As well, weak investment in research and development may reflect the specialisation of firms in traditional sectors, such as textiles and automobiles, and the prevalence of small family businesses, which appear to be less prone to innovate. While acknowledging these factors, analysis presented in the present Survey suggests that the stagnation of productivity results mainly from the setting of structural policies and their effects on human capital utilisation and market competition. Structural reforms to boost productivity are therefore essential to spur economic dynamism. Otherwise, Italy may very well face a long-lasting slowdown in income growth, widening the gap vis-a-vis other OECD countries.

A variety of structural policy settings exert a drag on trend economic growth. The stifling of competition in the sector of services reduces incentives for firms to operate efficiently, invest into innovative technologies and undertake organisational changes. As well, regulations give firms incentives not to expand, notably thresholds in labour market regulation and in some tax provisions, so they mostly stay small and remain unable to exploit scale economies. The inefficient judicial system deters business development, as investors run into difficulties in enforcing their legal rights, although the bankruptcy reform enacted at the end of 2005 goes in the right direction. The equity market is not deep enough and competition in the financial system should be increased so as to support enterprise growth and risk-taking. The weak level of educational achievement by international standards is an impediment to the expansion of living standards relative to many OECD countries. In addition, achieving fiscal sustainability is a precondition to enhance long-term economic growth. The high public debt ratio prevents significant reductions in the tax burden; yet tax cuts would be necessary to restore work and employment incentives. A solution must be found in the restraint of discretionary public spending, but past efforts in this direction have failed, as shown by the strong growth momentum of primary public spending, notably at the regional level. The Italian authorities are determined to confront all of these challenges and have outlined a strategy for this purpose in the Documento di Programmazione Economica e Finanziaria adopted in July 2006 (DPEF 2007-2011). The five policy priorities outlined in Going for Growth also encompass a variety of these goals. While past Economic Surveys of Italy discussed challenges related to the labour market and human capital which remain important, the present one focuses on:

  • Liberalising competitive forces, via easier regulatory burdens, so as to boost productivity;
  • Ensuring fiscal sustainability, via spending restraint, so as to lower debt and allow tax cuts;
  • Making fiscal federalism work, via improved policy rules, so as to enhance public services.

Decomposition of potential growth: an international comparison
Annualised growth rate

1. 1991 to 1995 for Germany.
Source: OECD Economic Outlook 80 database.

How to obtain this publication                                                                                      

The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.

The complete edition of the Economic survey of Italy 2007 is available from:

Additional information                                                                                                  

 

For further information please contact the Italy Desk at the OECD Economics Department at eco.survey@oecd.org.  The OECD Secretariat's report was prepared by Alexandra Bibbee and Benoît Bellone under the supervision of Patrick Lenain.

 

 

 

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