Sun, Dec 19, 2010 - Page 9 News List

Silvio Berlusconi’s inaction has lasting economic consequences

By Tito Boeri

Italian Prime Minister Silvio Berlusconi has survived a confidence vote, but his government is virtually dead. One cannot rule a country with so scant a majority. Not for long. The one important decision that this, Berlusconi’s fourth government, ever bothered to take was a decision not to decide.

Two years ago, when the financial crisis shook the world, Berlusconi’s choice was to avoid any policy intervention to counteract the Great Recession. This contributed to the deepest fall in output in Italy’s postwar history, with a cumulative 6.5 percent decline in GDP. Within the G20, only Japan did worse.

Remarkably, Italy had twice the fall in output seen in France, another large Organisation for Economic Co-operation and Development country that, like Italy, had avoided the root causes of the crisis: a housing boom-bust sequence and a serious bank crisis. The paradox is that the Berlusconi government’s inaction did prevent a major deterioration in the public deficit. In light of the current debt crisis roiling the eurozone, the advantages of a policy of inertia are easy to appreciate. Italy’s position today could have been much worse than it is.

The Italian economy’s problems and the major issues concerning the sustainability of the country’s huge public debt are rooted in low growth of potential output. As is also revealed by the term structure of credit-default swaps for Italian debt, investors are not worried about, say, next year’s budget law. Instead, they are worried about Italy’s economic conditions in five to 10 years.

It is these medium-run problems that Berlusconi’s -government has overlooked. None of the structural reforms essential to improving Italy’s growth potential — for example, labor-market and unemployment benefit reforms, product market liberalizations, improvements of the education system or reforms of the public administration in the South — have been carried out, even though Berlusconi could count on solid majorities in both chambers of parliament.

Why did Berlusconi’s government choose such a passive economic policy? One reason is that the level of Italian debt did not leave much room for counter-cyclical fiscal policy. However, some effort to stimulate the economy at the outset of the crisis could have been attempted. For instance, it would have been possible to provide income support to job losers — which would have been useful after the crisis as well — by reforming the system of unemployment benefits.

A possible explanation for the government’s inaction over the past two-and-half years is that the measures agreed upon within the coalition that won the 2008 elections were not tailored to a country entering a major recession. There was no leadership over economic policy defining new priorities and measures to meet the changed macroeconomic conditions.

In its first month after coming to power, the government did actually try to do something for the economy. It took three decisions, all of which were soon revealed to be utterly wrong.

The first decision was to reduce taxes on overtime work, a measure clearly aimed at increasing the number of hours worked. Needless to say, as unemployment rose and many other countries decreased hours worked in order to contain job losses, tax reductions on overtime were phased out and the scope of short-time work was enhanced.

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