Look at the dynamics, not the levels

Elena D’Alfonso and Andrea Brasili

The performance of the Italian economy has been quite disappointing. GDP growth has been lower than that of other European countries (in 2001-2007, it was on average 1.1% vs. 1.8% in the Eurozone, 1.7% in France and 3.4% in Spain). Investment and export growth have in particular been weaker than elsewhere (in the same period export volumes grew by 2.1% in Italy vs. 2.6% in France, 3.9% in Spain and 7.2% in Germany). Again in 2001-2007, competitiveness indicators calculated by the European Commission (the real effective exchange rate with a group of 41 trade partners, weighted for trade flows and considering the increases in different price indices) clearly shows that Italy’s position has deteriorated, with an appreciation of the REER (using unit labour costs as a price indicator) of 21% for Italy, 15% for Spain and 13% for France. Germany shows a 3% improvement.  

These difficulties are also emphasised in the April 2008 OECD Factbook, which showed that GDP per hour worked in 2001-2006 registered zero growth in Italy, putting the country last among OECD countries. Very recent data also clearly indicates that the Italian economy looks more fragile than its European counterparts in the current turmoil, despite being subject to the same external conditions. Jokingly, an Italian observer commented that the US slowdown hit Italy before it hit the US itself. Not surprisingly, in its WEO, the IMF revised sharply downwards its forecasts for Italian GDP growth in 2008-2009, to 0.3% (which we think is a little too pessimistic).  

Hence, macroeconomic evidence suggests that the frequently discussed long list of structural issues that weigh on the Italian economy continue to make their presence felt. These include an ongoing specialisation in slow-growing, mature sectors, a productive sector with an insufficient number of big firms, a proprietary structure based on family control with problems of generational succession, and an inability to incorporate the benefits of advances in ICT in the productive process.  

A lot of analysis and policy suggestions came out ahead of the general elections in mid-April, and sometimes pointed to mainly external causes: Italian specialisation accentuates its exposure to increasing competition from low-cost countries and the appreciation of the euro (as opposed to the periodical devaluation of the lira) emphasises its effects, and Italian trade flows are oriented towards slow-growth countries. Others, starting from the loss of competitiveness, hinted at the necessity to reduce the wedge (which is fairly high in Italy) between the workers’ perceived salary and whole labour costs to producers. These are useful devices but we do not believe they are sufficient. A measure of this kind was actually implemented last year, and, as clearly pointed out by the proponents themselves, it is tantamount to a devaluation, a one-time adjustment with the aim of giving the economy a push, and alternative more structural ways to trigger growth need to be found.   

But as the productivity (non-)growth record shows, problems are in the “dynamics” not in “levels”. To analyse this issue, it is necessary to take a microeconomic look at individual firms’ behaviour. At this level, perceptions often vary a great deal: newspapers reveal anecdotal evidence that firms are successfully operating in a difficult environment, with many entrepreneurs emphasising positive elements while highlighting the current problematic period. There are various success stories; one example is that the biggest manufacturer in the country is actually experiencing a very positive phase. The problem lies precisely in this dualism: the productive system no longer seems able to make these these individual results relevant on a macroeconomic level. The positive spillover from success stories to the rest of the economy is too low.  

An analysis of balance sheet data reveals that the productive sector generally has a certain degree of rigidity (common to Europe at large, see Philippon-Veron, and even higher in Italy): for example, the most productive firms show no particular tendency to increase their market share over time. Rankings in terms of productivity are largely permanent and hence it seems that not only do the most efficient firms not grow but also that the less efficient do not have learning processes in place. The only positive effect in terms of market share is recorded by firms that register productivity improvements, but this is a pro-cyclical phenomenon and does not correspond to a stable growth path. This suggests that there are not enough incentives to embark on a long-term strategy that aims to move as close as possible to the market best practice.  

So what? If this diagnosis is correct, the real issue is to recast the dynamics within the market mechanism, to give impetus to selection and Schumpeterian creative destruction engines. Financial markets must play a significant role in this context. This line of reasoning is not at all new, but is an attempt to place within a coherent framework certain measures, some of which have been already proposed or initiated but probably without sufficient resolution.  

In order to stimulate the responsiveness of the productive sector, we propose the adoption of an integrated package which impacts the firm’s whole life cycle. It should support firms’ entry to new sectors, growth, consolidation, and possibly their transformation and exit, in a context in which competitive pressures are enhanced, as are incentives to increase efficiency.


Entry: Fiscal incentives: a simpler system of taxation is needed, with tax deductions for the business start-up phase      

Further simplification in company formation is also required. The law that simplifies the setting up of new firms has already been approved, and allows for new firms to be constituted online. We think that this law should be definitively implemented.  






Entry and growth

SBLG programmes:      

The system of public guarantees for SMEs in Italy exists, but is still too small compared with other economies. In the US and the UK, similar programmes supply funds totalling respectively USD 17 bln and GBP 200 mln every year, managed directly by private lenders that transmit them directly to public institutions.

Encourage firms to list their shares, as this represents a check on management efficiency. Managers are forced to change when a firm’s profits are lower than those of its competitors. This means that companies must be as efficient as possible, given the technologies affordable in the market. In the last two years, equity issuance on the Italian market has accounted for just 5.6% of the European total.   Consolidation      





Efficiency and competition: The programmes already started by the previous government to foster competition in the Italian market must be increased: the aim should be to liberalise the market, bearing in mind the issue of consumer protection   Competition and liberalisation  
Bankruptcy law: Current legislation should be partially changed, introducing a faster way of declaring bankruptcy. This should in principle make it easier to start again with a new activity Starting again

 Philippon, T. and Veron, N.  Financing Europe’s fast movers http://www.bruegel.org/Public/Publication_detail.php?ID=1169&publicationID=6343 Bruegel policy brief 2008/01  

D’Alfonso, E. and Federico, L. Does Eurozone need a productivity revival? Economics Monitor 2007/2, http://www.unicreditgroup.eu/en/ufficio_studi/pdf/em_0002.pdf D’Alfonso, E. and Giannangeli, S. Learning and Selection in Italian Industries: the halted competition Finance Monitor 2008/1, http://www.unicreditgroup.eu/en/ufficio_studi/pdf/fm_0001.pdf

One Response to "Look at the dynamics, not the levels"

  1. interested reader   May 5, 2008 at 1:59 pm

    Nice analysis and I fully agree. I would go even further and say that next to vigorous deregulation, Italy needs a boost of public investment: as the German experience shows, removing structural barriers and enhancing productive capacity is a necessary but not sufficient condition if there’s a lack of sustainable private sector demand.