Improving the performance of Italy’s labor market

While Italy’s labor market performance has improved over the past decade, reflecting previous reforms, employment and productivity continue to lag its peers. This column argues that fixing these problems requires a “second generation” of reforms to reduce labor market asymmetries and liberalize product markets.

Italy’s labor market trends have improved in recent years. Spurred by the Treu and Biagi reforms of the mid-1990s, strong employment growth has outstripped rising labor market participation, halving the unemployment rate and keeping earnings growth moderate. But these trends are flagging and Italy’s labor market outcomes remain among the worst in Europe. In particular, relatively few people work and productivity growth has stalled (which lies behind the rapid growth in unit labor costs).

What accounts for these poor labor market outcomes? Part of the answer lies with the labor market institutions.

·                     A rigid collective wage bargaining system. Although the system has not led to excessive wage growth overall, it leaves little scope for many firms, especially small enterprises and in the South, to set wages according to their specific conditions, exacerbating regional differences and hindering small businesses.

·                     Narrow and uneven unemployment insurance. While ordinary unemployment benefits are initially relatively high, they drop off quickly and the complex eligibility criteria imply only a few receive them. Wage supplementation funds (cassa integrazione guadagni) can be more generous, but are limited in coverage. The lack of a fully-fledged system inhibits efficient worker allocation, both regionally and in terms of skill mismatches.

·                     Asymmetric employment protection. Recent reforms substantially liberalized restrictions on fixed-term and part-time employment, resulting in strong growth in these segments (which are now around EU averages), but left restrictions on permanent employment unchanged. This asymmetric deregulation tilted incentives for job creation toward “atypical” contracts, leading to higher employment risk for an increasing share of the labor force and lower productivity growth.

International experience suggests that successful labor market reform requires a comprehensive, not piecemeal, approach. For Italy, this suggests that while labor tax cuts are important to lower the cost of labor, they should be broad-based and implemented in a way that ensures that tax cuts benefit both firms and workers. For example, unions could commit to moderate wage demands at the national level to broaden the scope for firm-level agreements. It also suggests that employment protection should be reduced and equalized across employment types, in return for a broader and longer-duration unemployment insurance system.

But labor market regulation is not the full story. Italy’s regulatory framework (including taxation) is not dramatically out of line with its EU peers. Indeed on some dimensions, Italy’s labor market is relatively lightly regulated. Both international experience and a growing body of academic research suggest that spillovers from other markets, especially the product market, may be an integral part of the problem. And indeed, Italy ranks high in terms of product market regulation, especially relating to economic structure and competition. In less competitive markets, firms earn excessive profits and restrict both output and employment. Such conditions create a classic “insider-outsider” conflict, where unions strive to extract a share of the rents on behalf of the “insiders” (workers in permanent employment), but at the expense of the “outsiders” (the unemployed and those in “atypical” employment). And lowering the rents arising from uncompetitive markets through product market deregulation would also ease subsequent labor market reforms. Another advantage of addressing labor market problems via the product market is that such reforms do not imply a cost for the budget—of special importance for Italy given its exceptionally weak public finances.