Italy

Italy became a nation-state in 1861 when the regional states of the peninsula, along with Sardinia and Sicily, were united under King Victor EMMANUEL II. An era of parliamentary government came to a close in the early 1920s when Benito MUSSOLINI established a Fascist dictatorship. His alliance with Nazi Germany led to Italy's defeat in World War II. A democratic republic replaced the monarchy in 1946 and economic revival followed. Italy was a charter member of NATO and the European Economic Community (EEC). It has been at the forefront of European economic and political unification, joining the Economic and Monetary Union in 1999. Persistent problems include illegal immigration, organized crime, corruption, high unemployment, sluggish economic growth, and the low incomes and technical standards of southern Italy compared with the prosperous north.

Economical characteristics

 * Currency: Euro (ISO code: EUR)
 * Central bank discount rate: 3% (31 December 2008)
 * Commercial banks lending rate: 11.34% (31 December 2008)
 * is part of the Eurozone

Notable events:

 * Banking crisis: 1866-1868, 1891, January 1893, 1907, 1914, 1921, 1930-1931, 1935, 1990-1995, 2008
 * Hyperinflation: 1944
 * Years in inflation: 10.5% (share of years 1800-2009 with annual inflation above 20 per cent per annum)
 * Public default: 1940-1946 (external)

The Italian Miracle after WWII
From 1946 to 1962 the Italian economy grew at an average annual rate of 7.7 percent, a brilliant performance that continued almost until the end of the ’60s (the average growth over the whole decade was 5 percent). The so-called Miracolo Economico turned Italy into a modern and dynamic society, boasting firms able to compete on a global scale in any sector, from washing machines and refrigerators to precision mechanical components, from the food sector to the film industry.

The period 1956 to 1965 saw remarkable industrial growth in Western Germany (70 percent in the decade), France (58 percent), and the United States (46 percent), but all were dwarfed by Italy’s spectacular performance (102 percent). Major firms, such as the auto-maker Fiat; the typewriter, printer, and computer manufacturer Olivetti; and the energy companies Eni and Edison, among others, cooperated with an enormous mass of small firms, many managed by families, in accordance with the traditionally strong role of the family in Italian society. At least one-fift h of a population of fifty million moved from the poor, arid south to the rich, industrialized north, changing their way of life, buying cars and television sets, mastering standard Italian, enrolling their children in schools, saving money to buy houses and to help relatives still living in their old villages. After 1960, rapidly rising living standards, as well as growing business and job opportunities, brought about an end to the flows of Italians to the rest of Europe and the Americas, ending that Italian diaspora that had driven almost twenty million people to leave their homeland in less than a century.

In the very first years aft er the Second World War, a group of liberal market-oriented economists and politicians attained key positions in government, swept away Fascist legislation, and instituted democratic politics and free-market reforms. A central figure was the anti-Fascist journalist and economist Luigi Einaudi, one of the most prominent Italian classical liberals, who returned to Italy and served after the war as Governor of the Central Bank, then Minister of Finance, and finally President of the Republic; he greatly influenced the economic policies implemented by Prime Minister Alcide De Gasperi (1945–1953) and, after De Gasperi’s death, by his successor Giuseppe Pella, and others. The context they operated in could be hardly considered an easy one. Italy was a poor country that had been devastated by Fascist collectivism and war; most of the population was both unemployed and uneducated; infrastructure was absent or very poor; a powerful Communist Party threatened to replace Fascist collectivism with Communist collectivism; and state-controlled companies dominated much of the economy.

A careful monetary policy curbed inflation for at least twenty years (in 1959 the Financial Times celebrated the lira as the most stable Western currency); free-trade agreements helped Italy to re-enter the international market; a fiscal reform (the Vanoni Act, named for the minister who designed it) cut tax rates and simplified the tax collection system. In an era dominated by Keynesian ideas and easy spending, Italian public expenditure remained relatively controlled: in 1960 public expenditure barely reached the level of 1937 (30 percent of GDP, with a significant share of fixed-capital investments), whereas in other European countries it had risen dramatically.

From wealth to ruin
Rising prosperity seemed the perfect occasion for new government expenditures and interventions. As early as the 1950s the Italian government established Cassa del Mezzogiorno (similar to Roosevelt’s Tennessee Valley Authority, but in poor southern Italy). In the 1960s Italian governments passed legislation aimed at redistributing wealth, expanding government control of the economy (e.g., the nationalization of electric supply), and establishing a stronger welfare state.

In relatively prosperous Italy, redistributionist movements gained broad popular support. In 1962, during important negotiations on job contracts for metal workers, unions asked for shorter hours, more vacation, and more power to organize union activities in factories. Partito Socialista Italiano joined the ruling coalition with the Christian Democrats and the first "center-left government" was formed. In 1963, a public housing program undertaken through the nationalization of land aroused strong opposition from entrepreneurs’ associations and private owners (among them the Catholic Church), which convinced Democrazia Cristiana to abandon the idea, but such collectivist causes dominated the rest of the decade and the 1970s.

Several important public policies adopted in that period laid the foundations for Italy’s current crisis. The first was a weakening of fiscal discipline, due to a 1966 Constitutional Court decision that loosely interpreted the constitutional balanced budget constraint; that suspension of constitutional limits allowed the Parliament to pass laws for which annual expenses were covered not by fiscal income (taxation), but by the issue of Treasury bonds. That decision tore a leak in the public budget that grew larger every year. Until the early 1960s the "primary deficit," which is calculated by deducting interest payments from the total budget deficit, was almost zero; it rose quickly after the Court’s decision and accelerated after 1972, when deficit spending became a systematic policy strategy. In 1975 the primary deficit had already reached a dangerous 7.8 percent of GDP.

The second was the introduction of a generous pension system in 1969 (the Brodolini Act). The previous contribution-based mechanism was replaced with a redistributive system, according to which retirees received pensions that were not determined by the total amount of compulsory savings collected during their working years, but merely by their previous wages. A "social pension" for every citizen was established, along with a seniority criterion for pensions, thus allowing workers to retire early and a lax approach was adopted to awarding disability pensions in southern Italy, which was considered a surrogate for more effective pro-growth policies. Few paid any attention to the issue of financial sustainability. Afterall, the voters of the future do not vote today.

The third was heavier regulation of labor markets through the adoption in 1970 of the so-called Workers’ Statute, including Article 18, which stipulates that if a court finds unjust the dismissal of an employee of a firm that employs more than fifteen employees with long-term fixed contracts, then the employee has the right to be reinstated. The burden of proof rests entirely on the employer. By making it very costly to dismiss employees, the law at the same time made it very costly to hire employees, which both reduced workplace mobility and encouraged illegal work.

The fourth established, through successive acts between 1968 and 1978, a nationalized health care system that was almost fully financed by taxes, meaning that there was little incentive for consumers to economize on use of medical services.

Finally, in January 1970, the government imposed a compulsory rule for all employees in the engineering and metal sectors, which substantially regulated and limited working times.

The long-run negative effects of those and other policies were obscured in the short run by Italy’s still strong growth and by the low average age of the population. Generous pensions and health care expenses for small numbers of retired people were paid by large numbers of young workers. Year after year those policies, along with ever-heavier regulation of the labor and services markets, reduced productivity, made the labor market more rigid, dramatically raised the costs of hiring, and promoted ever-greater public expenditures and the accumulation of state debt, which in turn absorbed an ever-greater share of private saving.

Over time an aging population reduced the ratio between the working population and the retired population, making pension and health care systems more demanding and less sustainable. During the 1960s and the 1970s all European countries enlarged their public expenditures, but Italy literally went out of control. Public spending rose from 32.7 percent of GDP in 1970 to 56.3 percent in 1993, spurred on in part by a reckless policy of hiring more civil servants to make up for the lack of private jobs, especially in the south. While public debt had been stable at an average 30 percent of GDP during the 1950s and 1960s, it reached the astonishing total of 121.8 percent in 1994.

Thus ended the Italian miracle. Average GDP growth rate was still 3.2 percent in the 1970s, but it fell to 2.2 percent in the 1980s. Thanks to systematic devaluation of the lira, Italian firms could maintain their international competitiveness for a while, but high inflation and public debt were clearly jeopardizing the future. Various attempts at reform were made in the 1990s, especially after the financial and political crisis of 1992–1993, when the country risked a sovereign default and the post-war political system was swept away by corruption charges. Some privatizations of state-owned industries helped to lower public debt to a slightly more viable level. Minor changes were made to the pension system and in 1997 the Italian parliament passed legislation to modernize labor laws, but the political obstacles to abolishing Article 18’s provisions (regarding the right to reinstatement of laid-off employees) led to the establishment of a cumbersome two-tier market, including both hyper-regulated and rigid old-style contracts, as well as flexible new fixed-term contracts. Those reforms provided some fuel to an exhausted engine and postponed for a while the reckoning. The run, however, was over.

Italy in the European crisis
According to International Monetary Fund projections, Italy's headline debt will reach 120 percent of national output in 2011, and then decline only slightly to 118 percent by the end of 2016. As of July, 2011, Italian bonds yielded about 4.9 percent, with the spread over German bonds widening to about two full percentage points (in contrast, the Greek-German spread is now about 13 percentage points). Further increases in interest rates could push the forecasts for Italy's debt toward Greek levels.

Bailing out makes sense for smaller countries like Greece. It has about 360 billion euros in debt outstanding and the potential credit losses in any restructuring are in the range of 100 billion to 200 billion euros. The amounts are small relative to the EU's 12 trillion-euro economy.

Italy, though, has close to 2 trillion euros in debt outstanding. It's inconceivable that Germany or the IMF could provide a rescue to protect its creditors. Such a package would have to involve loans and guarantees of at least 500 billion, and possibly 1 trillion, euros to impress the markets. This would be a significant fraction of Germany's gross domestic product of about 2.5 trillion euros. With a debt-to-GDP ratio of about 80 percent, Germany's ability to take on new debt is limited.

The Netherlands, Finland and Austria, combined with Germany, have a GDP of about 3.5 trillion euros. France adds 2 trillion more, but its debt, already 85 percent of output, is expected to grow over the next several years.

Europe does not have enough fiscal firepower to handle an Italian crisis -- at least in such a way as to protect creditors completely. Beyond the difficult numbers, why would Germany or other EU countries lend to Italy, particularly when its politicians show no sign of coming to grips with their new reality?

Italian banks will be able to draw on substantial credit from the European Central Bank, especially once Mario Draghi, former head of the Bank of Italy, becomes the ECB president in November, 2011. But the entire euro system -- the ECB plus the 17 central banks sharing the euro -- has a combined balance sheet of only about 1.9 trillion euros. It's unlikely that ECB credit can do more than postpone sovereign-debt problems on an Italian scale.

The price of insuring Italian sovereign bonds against default risk has soared 11% since the weekend, when the European Union finally gave Greece the cash to make its July debt payments. Standard & Poor's warned that Greece could technically be considered in default. Faced with such a scenario, traders have already turned a cold eye to the other fragile economies of the euro zone: Portugal, Spain, Italy. The cost of insuring Spanish and Portuguese bonds surged 3% as of July, 2011, and credit default swap spreads on Italian debt, which was previously seen as relatively insulated, soared a full 6.7%.

European banks have total claims and potential exposures of $998.7 billion to Italy, more than six times the $162.4 billion exposure they have to Greece, according to Barclays Capital. European banks have $774 billion of exposure to Spain and $532 billion of exposure to Ireland.

In the United States, banks are also more exposed to Italy than to any other euro zone country, to the tune of $269 billion, according to Barclays. American banks’ next biggest exposure is to Spain, with total claims estimated at $179 billion.

Links

 * Italy on Wikipedia
 * Central bank of Italy
 * BBC country profile
 * Pre-Fascist Italy: Tax and Borrow and Spend by John T. Flynn, from As We Go Marching, 1944
 * Mafia cash in on lucrative EU wind farm handouts - especially in Sicily Nick Squires and Nick Meo, September 2010
 * Italian Banks Wage `War on Cash' as Consumers Pass on Plastic by Sonia Sirletti and Jeffrey Donovan, January 2011
 * Italy's 'nepotism' fuels supply of young, middle class and educated émigrés by John Hooper, July 2011
 * Austere Italy? Check the Traffic by Rachel Donadio, September 2011
 * The six things wrong with Italy – and how to solve them by Lizzy Davies, February 2013
 * Italian bank lending drops to record low, Gazetta del Sud, February 2013
 * How Italy’s Government Enables the Mafia by David Howden, March 2015