The growth of Italian exports has lagged that of euro area peers. Against the backdrop of
unit labor costs that have risen faster than those in euro area peers, this paper examines
whether there is a competitiveness challenge in Italy and evaluates the framework of wage
bargaining. Wages are set at the sectoral level and extended nationally. However, they do
not respond well to firm-specific productivity, regional disparities, or skill mismatches.
Nominally rigid wages have also implied adjustment through lower profits and
employment. Wage developments explain about 45 percent of the manufacturing unit
labor cost gap with Germany. In a search-and-match DSGE model of the Italian labor
market, this paper finds substantial gains from moving from sectoral- to firm-level wage
setting of at least 3.5 percentage points lower unemployment (or higher employment) rate
and a notable improvement in Italy's competitiveness over the medium term.