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Whatever happened to the economy? In Italy, nobody's asking

Italy is facing perhaps its most important election since 1948, when voters confirmed the emergence of Italy's new republic from the wreckage of Benito Mussolini's fascist regime. On the weekend, Italians must choose between Prime Minister Silvio Berlusconi's center-right government and the center-left bloc headed by Romano Prodi. But neither man seems the sort of decisive figure that overcoming Italy's bleak economic predicament demands.

Italy's economic malaise is obvious. Cumulative economic growth over the past five years was the slowest in the euro zone -- 3.2 percent, compared to an average of 7.8 percent -- with two years of stagnation. Per capita GDP, too, has fallen below the euro-zone average.

Employment has increased, but labor productivity has remained flat and total factor productivity has declined. Combined with strong real exchange-rate appreciation, this has led to a dramatic loss of competitiveness and weakening exports. Indeed, the only growth sector seems to be books about Italy's decline.

Berlusconi claims that statistics are unreliable, for they conceal a much rosier reality for today's well-off Italians. Other members of the government admit more soberly that Italy faces serious problems, but they lay the blame on factors beyond their control: a series of global economic shocks, a slow-down in continental Europe, the admission of China to the WTO and the role of the euro.

But such explanations are unconvincing. The global shocks affected all European countries alike, as did the entry of China (and other Asian countries) into the WTO, but French exports, for example, suffered much less, while German exports actually increased. True, European growth was dragged down by meager growth in Germany, but Italy grew marginally less than Germany.

Finally, while the euro has put a stop to competitive devaluations, it also provided Italy with a sizeable benefit: a reduction by 6 percent of GDP in interest payments on the huge public debt accumulated in the 1990s.

It would be unfair, however, to blame the Berlusconi government alone for this dismal performance. Italy's growth has been slower than Europe's, with weakening exports, for the past decade, because the country was ill prepared to adjust to the global revolution in information technology and the changing pattern of world trade. Its infrastructure, both material and intellectual, was poorer, and its economic structure was unfit for the new challenges, owing both to firm size and their specialization in traditional sectors, as well as low levels of education and research and development.

Yet the Berlusconi government did next to nothing to address these deficiencies, despite being the first government in Italy's history to survive a full five-year electoral term. With an unassailable parliamentary majority, it could have undertaken coherent supply-side reforms, even at the risk of some initial unpopularity.

A couple of reforms were belatedly enacted: timid intervention on pensions and a further increase in labor-market flexibility. But nothing was done to deregulate product markets or to give proper incentives to restructuring. Meanwhile, privatization came to a halt.

Instead, the government chose old-style Keynesian policy -- moderate tax cuts to increase disposable income and an increase in current expenditure. Between 2001 and last year, current non-interest expenditure rose by 2 percent of GDP, revenues fell by 0.5 percent of GDP and the general government deficit rose by 1 percent of GDP. Worse, the surplus fell from 3.2 percent to 0.5 percent of GDP, and fell even allowing for the business cycle. As a result, the debt-to-GDP ratio declined only modestly until 2004 and rose again -- to more than 106 percent -- last year.

The weak fiscal position will severely constrain whatever government comes to power. The center-left's ponderous electoral program includes a cut of five percentage points in payroll taxes, but it is not clear how it intends funding this initiative.

The idea of increasing the low, 12.5 percent, withholding tax on capital gains met with accusations that Prodi intends to expropriate wealth. But the right's slim manifesto includes its own unaffordable promises, such as cuts in property taxes and increases in low-level pensions.

Italian voters are perplexed. In 2001, Berlusconi signed a "contract with the Italians" containing promises that have gone unfulfilled. He has always fancied himself as a savior, convinced that he alone can fix the country. So he finds it inconceivable that anybody can feel otherwise or even that rules should stand in his way. Hence his government's efforts to pass laws changing judicial procedures, or to consolidate the oligopoly of public TV stations and his own, or to concoct a bizarre new electoral law favorable to his coalition.

But voters' frustration with Berlusconi is not necessarily good news for Prodi and the left. Opinion polls reveal that trust in all politicians and political parties has reached the lowest level ever. One hopes that whoever wins buckles down to the serious work that Italy so desperately needs.

Luigi Spaventa is professor of economics at the University of Rome and former chairman of the Italian securities commission.

Copyright: Project Syndicate
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