A program of “rigor without austerity” for the Italian government

Enrico Letta has recently presented to Parliament the “grand coalition” government he chairs. In his parliamentary speeches, Letta has clearly indicated that he intends to pursue a growth strategy based on tax cuts (or cancelled/postponed tax rises), without this implying new debt or breaking European agreements. At the same time, he did not indicate too clearly where to find the resources to finance this fiscal easing.

In a recent piece, we suggested that the Italian government should implement a program of “rigor without austerity”, to promote fiscal consolidation and growth in economic activity. If such a program were implemented, fiscal consolidation measures would have a reduced impact on households’ disposable income, therefore reducing their recessionary (almost “depressionary”) impact. The two pillars of such a program should be (a) a reduction in the debt-to-GDP ratio and (via that) in the deficit-to-GDP ratio (i.e., the opposite of the current recipe) and (b) an increase in households’ and corporates’ disposable income.

Regarding the first pillar, the overarching aim would be to reduce the country’s gigantic public debt without impoverishing a large part of the population with excessive austerity measures. The latter were forced on Italy at the low points of the crisis in November 2011 and July 2012, when investors wanted the government to prove that it was able to generate the cash flows that would validate their investments in Italy’s sovereign debt (via expenditure reductions or tax increases, no matter how socially painful). At that point, the government had to adhere to the promise it made at the June 2011 Cannes EU/G20 meeting that it would achieve a nominal fiscal balance in 2013 (i.e., one year earlier than initially established). But insisting on deficit reduction for a country that has not exhibited meaningful fiscal slippages since the 1990s was a political-economy mistake, and dramatically backfired at the election. The road followed is not reducing the deficit to reduce the debt, but vice-versa. The second pillar aims at stimulating internal demand (household consumption and corporate investment), which is the real drag on economic activity from the demand side.

This program has been exposed in a detailed article published in the latest issue of LIMES, the Italian Journal of Geopolitics (in Italian only).

The key ingredients of the programs are the following:

First Pillar: Reducing the debt-to-GDP ratio and, via that, the deficit-to-GDP ratio

Growth-Enhancing Measures

Medium-to-Long-Term Measures

1) Continue the liberalization campaign started by Bersani in 2008 and reprised by Monti in 2012. This reduces the mark up (thus making Italy more competitive internationally) and increases household disposable income (thus positively impacting consumption).

2) Complete labor-market reform (re-introduce flexibility of hiring and firing). As a result, the number of employees in the least competitive sectors will probably fall, thus reducing ULCs. For this reason, this measure must be accompanied by a minimum guaranteed salary or citizenship income. The estimated cost is €20 billion, but €15 billion is already in place. Salary or income should be linked to professional qualification programs conducted by regions, which receive EU funds for that purpose.

3) Promote SME consolidation and incentivize R&D investment. This aims at promoting the innovation of product and processes, this increasing labor productivity.

4) Shift public expenditure from consumption to capital expenses, with public investments that should not be counted toward the calculation of the Maastricht-consistent fiscal deficit (ongoing discussion at EU level on the so-called “golden rule”). Public infrastructure should only be built if, at the same time, the environment is safeguarded. Safeguard historical and environmental heritage to promote price-insensitive tourism and exports.

Shock Therapy

5) Promote the inversion of brain drain (possible but difficult without a credible government); some projects are already in place (controesodo); others should be implemented (e.g., “productivity islands”). This is to enhance productivity (thus reducing ULCs) and shrink the growth differential with other countries (value added abroad starts being added domestically).

6) Large scale clean-up in public-auctioning procedures (infested by corruption) and zero tolerance (actual, perceivable and publicized internationally) on organized crime. This is to make Italy a safer place to invest, and to invert the FDI flows.

Debt-Reduction Measures

7) Privatize local providers of services after clean-up and consolidation. This is to cut the link between corruption and “bad politics” at the local and national levels.

8 ) Privatize local real estate via long-term leases rather than outright sales.

Second Pillar—Increase the Disposable Income of Corporations and Households

9) Reduction in the first two rates of personal income tax.

10) Re-modulation of the property income tax, to exempt the first property.

11) Unblock (at least a large part of) the €100+ billion credit that private nonfinancial corporates have versus public administration (some action has already been taken). For example, issue public bills to be sold to the personal owners of the companies.

12) Reduction in payroll taxes (cuneo fiscale); e.g., by increasing tax deduction for employers on IRAP.

As one can see, a policy of aggressive tax cuts can only be funded by a new round of privatizations or a very aggressive campaign of cuts to so-called unproductive expenditure (i.e., public expenditure wasted due to corruption and rent-seeking), as well as a strenuous fight against tax evasion. This is not on the agenda at the moment, and the government’s heterogeneity does not bode well for Letta’s ability to obtain those in the future. The prime minister has also said that he wants the EU’s excessive deficit procedure against Italy to be closed, and expects this to happen in June; if this does happen, Italy would regain the fiscal room to allow some investment to jump-start economic growth.

The reduction in the tax burden is a pre-requisite for Berlusconi’s participation in the government and a necessity for increasing households’ and companies’ disposable income, but covering these tax cuts appears to be virtually impossible. Therefore, we regard near-term fiscal slippage as almost inevitable, but not necessarily bad. In the context of Spain having secured two more years to meet its fiscal targets and France continuing to delay its fiscal consolidation, Italy will try to find European support to temporarily deviate from the 3% nominal deficit-to-GDP target ratio, and will probably find some.

9 Responses to "A program of “rigor without austerity” for the Italian government"

  1. lucad10   May 7, 2013 at 10:14 pm


    I would like your comments on following questions:

    Shouldn't be taken into account that Italy, despite having reached a positive growth
    from exports during 2012, is facing a problem from a strong €uro x-rate ?

    Is internal devaluation aimed to reduce ULCs realistic without additional social distress ?

    Shouldn't European Union urgently solve the issue of currency x-rate regime vs. chinese currency (in order to change Renminbi x-rate regime to complete free floating) ?

    Finally, is it still sustainable an european monetary union without a fiscal one ?

    Kind Regards,
    Luca (from an almost de-industrialized italian economy)

    • Brunello   May 8, 2013 at 6:27 pm

      Hi Luca,
      thank you for your comment; let me quickly answer to your questions:
      1) true, Italy in 2012 has experienced a boom year for export. The exporters who managed to do so well are those who found the right combination between (unit labour) costs and quality (less price sensitive). However, there are a number of companies whose ability to export crucially depended on the competitiveness provided by the low exchange rate. Those are unable to export now, and closing down. To some extent, they ended in the non-tradable sectors. The sectors producing non-tradable goods are less competitive, and this is where the de-industrialisation is coming from.

      • lucad10   May 8, 2013 at 9:27 pm

        Hi Brunello,

        thanks for your replies; please allow me some clarification requests.

        I just found following examples of non-tradedle good in the net: internationally non-tradable goods may be found in the sectors of housing, electricity generation, transport, educational services, personal services, etc.

        I am sorry but do you mean that increase in unemployment in Italy is driven by above industries ? Except housing and transport I doubt on others

        I suppose current de-industrialisation disaster may be mainly caused by other kind of business closing (i.e.: textile, furniture, "simple consumers goods", etc) or re-location of multinational and/or local SME towards western europe and/or Asia.

        Could you please comment on that (or share some report) ?

        If above doubts are correct, a structural problem exist in the italian economy while no more free floating currency options for devaluation are available.

        So that, possible scenario seem a deep internal devaluation (but how much salaries reduction ? 50%?) or a decade of high official unemployment (while "over the counter" black money sector will growth) ?

        I doubt Italy (and southern europe too) may be in a sort of "structural overall competitiveness trap" which may last for a very long period.

        Finally, could you please comment why in your opinion international community is not trying to review Renminbi x-rate floating regime urgently ?

        Thanks in advance for your additional comments.

    • Brunello   May 8, 2013 at 6:27 pm

      2) You can reduce ULCs in the following ways:

      1) Reduce the gross salary of employees, which can be divided into:
      a. Reduce the nominal salary
      b. Reduce payroll taxes, other taxes and social contributions (what in Italy is called cuneo fiscale)
      2) Increase the value added per employee (this can be done via R&D that fosters product and processes innovation); i.e., increase labor productivity.
      3) Reduce the number of (unproductive) workers or the number of workers in unproductive sectors, which means:
      a. The opportunity to shed labor more easily (the Monti-Fornero reforms)
      b. Closing down uncompetitive companies (collapse in industrial production, industrial districts closing down)
      As you can see, the only way not to have social distress is lowering payroll taxes, but it's unliklely to be enough.

      3) Renminbi is an international story, not EU specific. US is even more affected. It would require an international agremeent, far from being in sight.

      4) In theory not, in practice Germany (but also France) will try to have a monetary union without a fiscal union for as long as possible, muddling through.

      Hope this helps, continue to follow us

  2. DiranM   May 8, 2013 at 6:38 am

    The only way to resolve this mess is that countries like Italy return to a proper national currency and central bank, instead of tying themselves to the millstone of a Germanic currency and forced to obey EU/ German dictats.

    Goodness, why do Russians, Americans, English and Chinese all have their national currencies and are proud of this??? Who are the fools here???

    • Brunello   May 8, 2013 at 6:31 pm

      Thanks for this; I am not sure going back to the national currency is the ideal solution. But assuming some countries decided to do so, the costs associated with the transition will be enormous, and the international repercussions immense. Post-Lehman will look like a healty stroll in the park, for comparison.

  3. uptime monitoring   May 23, 2013 at 7:17 am

    If above questions are appropriate, a architectural problem are available in the french economic system while no more free sailing forex choices for decline are available.

  4. DiranM   June 24, 2013 at 6:55 pm

    The argument of no return on the Eurozone resembles Dante and his epic poem Inferno: “Ye who enter,abandon all hope.” Certainly not a positive argument!

    Since this is uttered again and again pompously by the EU elite (thriving parasitically on this monstrosity) with the same fervour of a German POW prison guard, it is also a suspect argument. As my friend, Michael Pettis points out, the system is deeply flawed structurally. Few doubt anymore that is bring misery to millions. Should one have the courage to leave, others will follow. Survival takes courage!

    After all the Russians survived Communism and it finally collapsed, just as my Uncle survived WW2 marching in and pacifying the Germans.

  5. Iraqi Dinar   July 15, 2013 at 8:44 am

    Do you think two years are enough time to meet its fiscal targets?