The Italian job

TO LOSE Greece or Portugal may be regarded as a misfortune; to lose Italy looks like carelessness. It is hard to imagine the single currency surviving a showdown with Italy, the currency club’s third-biggest economy (and the world’s eighth-biggest, just ahead of Brazil). Perhaps that explains the recent pugnacity of Matteo Renzi, Italy’s prime minister, regarding European fiscal rules. In an article published in the Guardian newspaper in mid-January, he sounded positively Greek, complaining that the European Union’s “fixation on austerity is actually destroying growth”. His finance minister, Pier Carlo Padoan, has been tangling with the European Commission over how to deal with the €350 billion ($382 billion) of bad loans clogging up the Italian banking system. Mr Renzi is demanding the Eurocrats’ forbearance as he tries to restart Italy’s long-stalled economy.

Italy’s experience within the euro zone has been miserable. It has been in recession for five of the past eight years. Real (ie, adjusted for inflation) GDP per person is lower than in 1999. Sovereign debt has risen above 130% of GDP. Worse, Italy’s economy is woefully uncompetitive. Since 1998 productivity has fallen steadily. Labour costs, however, have not (see chart). Since Italy joined the euro, exports have ceased to be a driver of growth, which has consequently slowed. A slowdown is not something a country with such daunting debts can afford.

Mr Renzi came into office at a propitious moment, in early 2014. The tight fiscal and monetary policy that had contributed to the euro zone’s poor performance in the years after the financial crisis was becoming less of a drag. Soon afterwards the ECB began to use quantitative easing to pep up domestic demand, with salutary effects on Italian interest rates.

But the problem of competitiveness remains. There is no shortage of explanations for Italy’s slump in productivity. Thanks to punitive regulation of labour and product markets, it is one of the most expensive places in the rich world to start a new business. Taxes and red tape strongly discourage productive firms from growing very large. Nearly 70% of Italian workers labour in firms with fewer than 50 employees, compared with about a third in America. The government taxes income from labour far more heavily than consumption, discouraging work (and encouraging evasion). Perhaps most worrying, the share of young Italian workers with a university degree is among the lowest in the rich world. At just under 10%, the share of highly educated Italians living abroad is also among the highest in the rich world.

The slowdown in productivity occurred just as Italy joined the single currency. Some economists see this as coincidental. The euro was born just as the global economy was undergoing a rapid bout of globalisation. Italy’s small firms did not scale up to capitalise on emerging-market demand, as Germany’s did. By the same token, its under-skilled population could not take advantage of the rising return to trade in professional services, as firms in America and Britain did.

But such problems were predictable. Whereas many euro-area governments prepared for a world in which they could not depreciate by adopting structural reforms, Italy was a laggard. Once the euro was in place, Italian wages rose as capital flowed in from northern Europe. Exporters grew ever less competitive, and workers and capital shifted from manufacturing to services, where productivity was even lower.

Rome is where the Hartz is

Mr Renzi wants to alter this dynamic. He has in mind something truly ambitious—an overhaul of the labour market not unlike Germany’s sweeping Hartz reforms, which are often credited with the rejuvenation of its economy a decade ago. He has taken steps in this direction—adopting rules to make it easier to sack workers, for instance. But even Mr Renzi’s advisers acknowledge that progress has been frustratingly slow.

The IMF reckons that Italy’s economy will manage growth of just over 1% a year over the next three years. A recent analysis by economists at the European Commission found that a truly ambitious reform plan could boost GDP substantially—by nearly 24% relative to their baseline forecast. But that gain would materialise over the course of half a century, with very little of the benefit coming during the first decade.

Rather than waiting for productivity to rise, a quicker route to faster growth is to drive down wages. The Hartz reforms succeeded in part because they prompted a decline in real wages in Germany. Real GDP per person has soared in Germany since the introduction of the euro, but workers’ pay has not. Reforms that decentralised collective bargaining in Italy, and that therefore helped to contain wages in less productive regions and firms, would be a step in the right direction, reckons Pietro Reichlin of LUISS, a university in Rome. Indeed, Mr Renzi’s advisers suggest that the government may seek to impose a decentralised wage-setting process if negotiations between trade unions and industry do not yield one.

Yet even the benefits of wage restraint could be disappointing. Germany’s competitiveness drive occurred during an era of relatively strong global growth and relatively buoyant inflation, which made the suppression of real wages both less painful and less noticeable. Italy will enjoy no such help. Any growth scheme that rests on falling wages is unlikely to endear Italians to Mr Renzi. For his reforms to work, he will need time that voters are unlikely to grant him. Keeping Italy happy enough to stay in the euro zone will, in the short term, take much faster growth across the euro area as a whole, fostered by continued dovishness from the ECB and less finickiness from the European Commission. The deal that Mr Padoan and the commission struck this week to allow a state guarantee for sales of Italian banks’ bad debts is a step in the right direction. If the euro area is to keep Italy on board, it will need to become a bit less austere and a bit more Italian.