Europe's Crisis, Europe's Future

4. Italy: Strategies for Moving from Crisis to Growth

64 The current economic crisis in Italy stems from a period of stagnating growth and little progress in total factor productivity that began, it should be stressed, a decade before the global financial crisis of 2008. The governor of the Bank of Italy (2013) stated that the country “failed to respond to the extraordinary geopolitical, technological, and demographic trends of the last quarter-century” (p. 10). This is evident from the exceptional growth in other major advanced economies in the late 1990s and early part of the 2000s, growth that was absent in Italy. From 1991 to 2013 the economies of the United Kingdom and the United States grew by more than 60 percent (see figure 4-1). Italy’s eurozone partners, notably France, Germany, and Spain, experienced economic growth of over 30 percent. Italy’s economy, however, fell well below the European average of 37 percent, growing by a modest 15 percent. Many members of the eurozone realized exceptional growth by taking advantage of the more integrated European capital markets, but Italy failed to undertake significant investments using long-term loans available at low interest rates. Italy: Strategies for Moving from Crisis to Growth domenico lombardi and luigi paganetto 4 The authors acknowledge comments on an earlier draft presented at the Brookings–Robert Bosch Foundation Workshop, “A Growth Strategy for Europe,” held in Berlin on May 24 and 25, 2013. They also wish to acknowledge the outstanding research assistance of Samantha St. Amand. italy: strategies for moving from crisis to growth 65 The global financial crisis emphasized the structural problems underlying Italy’s stagnant growth and productivity. As such, Italy was hit particularly hard by the recession and is weathering one of the slowest recoveries within the eurozone. The country entered the recession with aggregate debt above 100 percent of GDP. Despite steadily improving its fiscal position since joining the eurozone, a deep recession in 2008 and 2009 caused a sharp increase in the debt-to-GDP ratio. After the implementation of austerity measures in 2012, further economic losses amplified by fiscal multipliers drove the debt ratio even higher. Debt-to-GDP is expected to peak in 2014 at 133 percent. Fiscal sustainability should be achieved by implementing structural reforms that adopt a long-term strategy and that emphasize growth and productivity . Short-term strategies may encourage government deficits that hinder growth and promote rent-seeking behaviour. In order for the Italian economy to improve its competitiveness and adapt to economic shifts, it must foster balanced and strategic growth opportunities. Source: International Monetary Fund, World Economic Outlook (WEO) database, 2013 (www.imf. org/external/pubs/ft/weo/2013/02/weodata/index.aspx). a. Unless otherwise noted, all tables and figures that use data from IMF WEO are from the October 2013 WEO database. b. Values for 2013 are estimates. 105 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013b 110 115 120 125 130 135 140 145 150 155 160 165 170 GDP at constant prices Index: 1991 = 100 Italy United Kingdom France Germany United States Spain Euro area Figure 4-1. Economic Growth in Selected Advanced Countriesa 66 domenico lombardi and luigi paganetto In this chapter we first review debt dynamics, the size of fiscal multipliers, and the effectiveness of the government’s budget and consider the appropriate path to fiscal sustainability. Next we highlight structural impediments in the product and labor markets and finally discuss effective long-term growth strategies that improve productivity by expanding the stock of human capital, encouraging innovation, and deterring corruption. Fiscal Consolidation Policy and Macroeconomic Strategy As in many other advanced economies, Italy’s public debt as a percentage of GDP skyrocketed after the onset of the global financial crisis. While other advanced economies—for example, Greece, Ireland, and Spain—experienced a surge in their debt levels due to large primary deficits in the form of fiscal stimulus, Italy has maintained relatively sound fiscal expenditures. This section explores the reasons for the deterioration of Italy’s fiscal position and considers the appropriate path to consolidation. Debt and Deficit Dynamics Upon joining the eurozone in 1999, Italy’s debt-to-GDP ratio was 114 percent , higher than that of France, Germany, Greece, or Spain. Italy’s high public debt makes its fiscal position particularly vulnerable to downside risk in the rate of growth, inflation, and interest on public debt. After gradual improvement in its fiscal position, with public...