This Selected Issues paper describes stylized facts, institutions, and directions for reform in the Italian labor market. The paper examines developments in aggregate features of the labor market. It highlights that during the latest cyclical recovery, total employment has remained stagnant and the unemployment rate has not declined despite modest output growth. The paper examines different features of labor market developments from a longer-term perspective, reviewing developments in regional labor markets as well as the evolutions of employment shares and relative wages across sectors. The paper also describes the Italian social protection system.

Abstract

This Selected Issues paper describes stylized facts, institutions, and directions for reform in the Italian labor market. The paper examines developments in aggregate features of the labor market. It highlights that during the latest cyclical recovery, total employment has remained stagnant and the unemployment rate has not declined despite modest output growth. The paper examines different features of labor market developments from a longer-term perspective, reviewing developments in regional labor markets as well as the evolutions of employment shares and relative wages across sectors. The paper also describes the Italian social protection system.

Italy: Basic Data

Area:(Thousands sq. km): 301.3
Population;(millions, 1996) 57.5
GDP per capita:(1996, US$) $21,130
(Percentage changes, except as otherwise indicated)

Sources: Data provided by the Italian authorities; and Fund staff estimates and projections.
1/

Staff estimates and projections, unless otherwise indicated.

2/

Excluding workers in the Wage Supplementation Fund.

3/

Volumes and unit values are customs basis; trade balance and current account are balance of payments basis.

4/

For 1993, unrevised series.

5/

Excluding long- and medium-term certificates of deposit.

6/

End-of-period.

7/

Period average.

Introduction and Overview

1. The past year has witnessed remarkable progress in the two primary areas of Italy’s macroeconomic adjustment effort since 1992: price stability and fiscal consolidation. Together with improving short-term economic prospects, which stand to be bolstered by possible EMU participation, there is now scope for a set of medium-term structural issues to take the center stage in the policy agenda. Clearly, successful performance under monetary union will demand not only macroeconomic stability, but also microeconomic flexibility. As in other EU countries, securing the latter will require structural action across a broad spectrum, embracing areas such as the tax system, the welfare system, and labor and product markets, in a manner that would exploit the complementarities between such policies. This paper explores three sets of issues from such a medium-term, structural perspective: labor market dynamics and policy options; the structure of the welfare system and related reform proposals; and the recent and prospective evolution of saving and investment, against the backdrop of Italy’s large current account surplus and the prospective locking-in of exchange rates in monetary union.

2. Despite various initiatives in recent years, the performance of Italy’s labor market has remained disheartening. While aggregate indicators of labor market performance are not particularly out of line with the rest of the EU, regional patterns suggest that problems in Italy may be more deep-rooted. Thus, the substantial North-South differential in unemployment rates—making for the highest dispersion of regional unemployment rates among OECD countries—has in recent years widened further, with unemployment rising unrelentingly in the South while declining gradually in the Center-North. Combining these trends with substantially lower participation rates in the South and very low levels of labor mobility, the emerging picture is one in which traditional adjustment mechanisms would seem to be operating rather poorly. Chapter I (by Eswar Prasad and Francesca Utili) empirically explores some of the factors that could underlie this performance, using data at different levels of disaggregation. In addition, the analysis employs a microeconomic data set containing information on household incomes, wealth, and demographic characteristics, derived from a survey conducted by the Bank of Italy. This approach has the advantage of controlling for individual characteristics that may be relevant, such as levels of human capital.

3. The chapter first looks into the question of whether unemployment persistence in recent years might simply reflect sectoral shifts, and rejects this hypothesis: while there has undoubtedly been structural change of this type, its rate has been fairly typical by historical standards. The analysis then turns to recent trends in sectoral wage dispersion, which past work based on aggregate data had shown to be particularly low. The results suggest that, while some increase in wage dispersion can be detected in the most recent period, sectoral and regional wage dispersion remains very narrow—especially, in the latter case, if one controls for hours worked. Finally, the chapter examines the main patterns and determinants of employment and labor force participation behavior. The results emphasize the regional dimension of the problem, but also point to a relatively weak link between education and employment outcomes and an inefficient job-matching mechanism, especially for first-time job seekers. In terms of policy proposals, the results suggest that, in addition to encouraging greater wage differentiation and reducing constraints on hiring and firing, priority should also be attached to a number of other areas, including: strengthening the educational system (especially basic education) by emphasizing marketable skills, so as to facilitate school-to-work transitions; a more active encouragement of flexible work arrangements, that show a still comparatively low diffusion; and allowing for unfettered competition in providing employment intermediation, where the ineffectiveness of formal job-matching through public employment agencies has also hampered labor mobility. In closing, the chapter emphasizes the need to adopt a broad-based approach, within a broader framework of structural reforms that also tackle rigidities in product markets, as policy complementarities are likely to be important. It concludes that the longer-term macroeconomic performance of the Italian economy could well hinge on the success of these reforms.

4. The need to reform the social welfare system has gained prominence in the public debate in recent years. In addition to its budgetary cost, the system has come under criticism for being inadequately targeted, fragmented, and excessively complex. It has also been pointed out that, in being skewed toward pensioners and “insiders,” it may entail significant distortions on incentives of economic agents. In this sense, it could be partly responsible for the unsatisfactory performance of the Italian labor market. Chapter II (by Massimo Rostagno and Francesca Utili) attempts an assessment of the welfare system. The chapter begins by comparing Italy’s social programs to those prevailing in other EU countries. While Italy’s system shares a number of features with those of its main partners, it is atypical in a number of respects. Notably, it spends considerably more than other European countries on pensions, and the amount of resources left available to satisfy other forms of assistance (such as unemployment, family, and housing benefits, as well as active labor market policies) is markedly lower than in partner countries. Also, in contrast to almost all EU countries, Italy does not have a national scheme of residual protection of the poor. Thus: excess expenditure on pensions overprotects retirees at the expense of other categories, the absence of more general support mechanisms may have discouraged mobility and risk-taking in the labor market (and has hindered labor layoffs where required, such as in the banking sector), and the system fails in its primary task of providing an effective safety net for those most in need, notably among women and the young.

5. The paper then examines the fiscal aspects of the welfare system, by setting up a consolidated presentation of the social security accounts, not hitherto available, that aims at greater transparency of the financial flows between the different levels of government and agencies involved. This presentation facilitates forming a judgment on the extent to which the pension system diverts resources from other uses, notably from the protection of people of working age and, in particular, of those among them lacking a sufficient record of participation in formal employment. Finally, the paper turns to an empirical assessment of the effectiveness and efficiency of the social welfare system, relying on the same micro data set on households’ income and wealth used in Chapter I. Specifically, the analysis attempts to test the effectiveness of the instruments of social protection in reducing the incidence of economic disadvantage among covered groups, as well as their efficiency in doing so at a minimum cost to the budget. It concludes that the system fails on both fronts. It inter alia finds that, out of a total expenditure of 3.3 percent of GDP on the selected welfare instruments reviewed, as much as one-third accrues to individuals clearly not in “need,” due essentially to ill-designed targeting mechanisms. The chapter concludes by reviewing a number of reform proposals put forward by an ad hoc government commission (Onofri Commission) in February 1997, and the policy response to date. Despite moves in certain areas—most notably the further changes to the pension system introduced with the 1998 budget, and discussions on a new means-testing mechanism—broader reform initiatives of the welfare system as a whole remain to be defined.

6. Italy’s external current account balance has undergone sharp shifts in recent years, swinging from a substantial deficit in 1992 to a surplus which, expressed as a share of GDP, constituted the largest such imbalance among the G-7 countries in 1996, and—despite some narrowing in 1997—remains significantly in excess of its medium-term sustainable equilibrium level as estimated by the staff. In this setting, were such large surpluses to persist (as projected by certain forecasters), questions about the compatibility of the lira’s exchange rate with medium-term fundamentals would arise. To examine this issue further, Chapter III (by Ioannis Halikias) explores recent developments in the current account and its likely medium-term evolution from a saving-investment perspective. On the saving side, a number of key relations governing the various components of national saving are empirically estimated, and the question of potential offsets between these components is addressed. In turn, these offsets hinge crucially on three factors, subject to empirical testing: the extent of “Ricardian equivalence,” the incidence of liquidity constraints, and the ability of households to take into account corporate profits in making their consumption and saving decisions. On the investment side, the most striking feature is the break since 1992 of the link between business profits and business investment, which had been particularly strong in previous periods.

7. On the basis of the empirical analysis, the chapter concludes that the trends in the current account since 1992 have to a large extent been driven by a set of mutually reinforcing factors that reflected the exceptional circumstances of the period, and can be expected to reverse themselves over the medium-term, leading to a narrowing of the current account surplus to more sustainable levels—without any appreciable change in the lira’s effective exchange rate. This adjustment is projected to entail a small reduction in the national saving rate, with a decline in household and business saving more than offsetting a moderate increase in public saving, and a strong recovery of private investment. The paper’s conclusions thus support, from a different perspective, earlier staff analysis that found the exchange rate value of the lira, and its ERM re-entry rate, to be broadly consistent with medium-term fundamentals (see IMF Staff Country Report No. 97/44, May 1997).

I. The Italian Labor Market: Stylized Facts, Institutions, and Directions for Reform1

A. Introduction

8. As Italy prepares for European Monetary Union, the potential role of domestic short-term stabilization policies in responding to exogenous shocks has declined. This has brought to the forefront of policy discussions those structural features that could influence the ability of the economy to adjust to such shocks. As in other EU countries, the efficient and flexible functioning of the labor market is of particular importance in this regard and could become a key determinant of the economy’s long-term growth prospects. This chapter provides a descriptive analysis of the main features of the Italian labor market, including certain key institutional features. Empirical aspects of the labor market are then characterized using a variety of econometric techniques and by examining data at different levels of disaggregation. This analysis sets the stage for an evaluation of recent reforms aimed at improving the functioning of the labor market and points to directions for further changes.

9. This chapter begins by examining recent developments in aggregate features of the labor market. During the latest cyclical recovery, total employment has remained stagnant and the unemployment rate has not declined despite modest output growth. These aggregate figures, however, conceal striking disparities in labor market outcomes across regions. For instance, by the end of 1997, the unemployment rate in the Northern part of Italy had declined to about 6 percent while the unemployment rate in the South was about 23 percent and rising. In addition, there are considerable disparities in employment and unemployment rates across different demographic groups. Section B examines these and other salient features of labor market developments from a longer-term perspective, reviewing developments in regional labor markets as well as the evolutions of employment shares and relative wages across sectors. The possible role of inter-sectoral labor reallocation in contributing to unemployment is also analyzed.

10. Section C provides a brief discussion of some of the main institutional features of the Italian labor market. In particular, the wage indexation and wage bargaining structures prevailing through most of the period examined here resulted in marked rigidities that constrained the ability of the economy to respond to adverse macroeconomic shocks. Further, they have resulted in narrow wage differentials across regions, sectors, and occupational classifications, possibly hindering the efficient allocation of labor, for instance, by reducing the incentives for inter-regional and inter-sectoral mobility. A number of changes and reforms to these institutional features of the labor market have been introduced in recent years. Although these reforms have had a salutary effect on aggregate wage and inflation dynamics, and played a major role in containing inflationary pressures following the Lira’s exit from the ERM in September 1992, they have had scant success thus far in boosting employment growth and reducing unemployment.

11. An evaluation of these reforms and suggestions for further changes based on an analysis of aggregate data are, however, complicated by the fact that such data could mask substantial compositional effects due to heterogeneity in the labor force. For instance, observed wage differentials between two sectors might be over- or understated simply on account of differences in the average level of human capital of workers in those sectors. To control such observable worker characteristics and to gain a more precise understanding of the wage structure, Section D uses micro data from the 1995 household survey conducted by the Bank of Italy. This micro data set is also used to examine the determinants of employment and labor force participation propensities. This analysis, combined with direct evidence from the survey on the characteristics of unemployed workers and reasons for non-participation in the labor force, provides insights that could be useful for designing measures to improve the efficient functioning of labor markets.

12. Section E draws together the implications of the different strands of empirical analysis and indicates specific directions for further labor market reforms. Although recent reforms, including the measures in the September 1996 tripartite agreement, indicate a recognition by the main social partners of the structural problems in the Italian labor market, a more concerted effort is required to tackle many of these problems. The analysis in this chapter points to the need for comprehensive rather than piece-meal reforms in the labor market, within a broader framework of structural reforms that also tackle rigidities in product markets.2 The longer-term macroeconomic performance of the Italian economy could well hinge on the success of these reforms.

B. Recent Developments

13. This section reviews the main developments in the Italian labor market from an aggregate perspective. An examination of disaggregated data is then used to show that the aggregate data mask substantial variation in labor market developments across different sectors, regions, and demographic groups. These differences have potentially important implications for formulating and implementing labor market policy.

The broad picture

14. As in other European countries, the unemployment rate in Italy has drifted up over the last two decades (Figure 1, upper panel). The aggregate unemployment rate, however, masks enormous differences in regional unemployment rates. The differential between the unemployment rates in the South and the North has widened markedly since the 1970s. By the end of 1997, the unemployment rate was about 6 percent in the North, 10 percent in the Center, and 23 percent in the South.

Figure 1
Figure 1

Italy

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.

15. A notable feature of the recent recovery has been the widening differential between unemployment rates in the North and the South. While the unemployment rate in the North has declined during the recovery, the unemployment rate in the South has continued to increase, reaching a historical high in 1997.3 Figure 1 (lower panel) shows that, during the recent recession, sustained negative employment growth over a period of three to four years resulted in employment losses that were especially large in the South. Employment in the South has only recently stabilized, after almost four years of successive declines, leaving the level of Southern employment substantially below that prevailing in 1992. Employment growth rates in the North and in the Center, on the other hand, turned positive in the latter half of 1995 but have tapered off since early 1997.

16. The unemployment rate is affected not just by developments in employment but also by changes in labor force participation rates that could be related to the business cycle as well as longer-term factors. To abstract from the effects of such changes and to obtain a more accurate picture of the evolution of employment and non-employment, it is useful to examine the employment-population ratio, defined as the ratio of employed persons to all potential labor force participants between the ages of 15 and 65.4

17. Figure 2 shows the employment-population ratio in Italy and also provides a crosscountry comparison. This ratio has declined gradually in Italy since the early 1980s and, in 1997, stood at 52 percent. A striking fact is that this ratio has been historically much lower in Italy than in most other continental European countries and substantially lower than the ratios in Japan and the Anglo-Saxon countries. These figures imply that, even at those times during the last three decades when the Italian economy might be characterized as having been at “full employment,” the employment-population ratio was below 60 percent, well below the corresponding ratios for other countries shown here. These data indicate a higher rate of non-employment among potential labor force participants in Italy than in other countries. It should be noted, however, that the low employment-population ratio in Italy, based on official employment statistics, is likely also partly to reflect the higher share of employment in the informal sector in Italy than in other industrial economies.5

Figure 2
Figure 2

Italy Employment-Population Ratios: A Cross-Country Perspective

(In percent)

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: OECD Analytical Databank.Notes: The employment-population ratio is the ratio (multiplied by 100) of total civilian employment to the total civilian population between the ages of 15 and 65.

Some disaggregated perspectives

18. The relatively stable aggregate employment-population ratio, however, conceals large disparities in the levels and evolutions of this ratio for males and females. Figure 3 (upper panel) shows that the employment-population ratio for males has declined gradually from 85 percent in the mid-1970s to about 72 percent in 1997. The employment-population ratio for females rose from 35 percent in the mid-1970s to about 40 percent in 1990 and has since remained essentially unchanged. Figure 3 (lower panel) also shows that the labor force participation rate for males has declined by about 10 percentage points over the last two decades, offset by a corresponding increase in the participation rate for females. The increasing presence of women in the labor force and in employment is similar to the experience of other industrial countries. Nevertheless, the participation and employment rates of women in Italy remain far below those in most other industrial countries. The increasing role of women in determining aggregate labor market dynamics has important implications for labor market policy that will be discussed later in the chapter.

Figure 3
Figure 3

Italy Labor Force Status by Gender

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.

19. Figure 4 shows employment-population ratios broken down by region. Not only has this ratio been lower in the South of Italy compared to the Northern and Central regions, but has declined in the South since 1990, and continued to decline, although at a slower rate, even during the recent recovery. In all three areas, the employment-population ratio for males has fallen over the last decade, but the decline has been especially sharp in the South. The female employment-population ratio has increased gradually since the 1970s in the North and the Center, but has remained essentially flat—at a low level of less than 30 percent—in the South.

Figure 4
Figure 4

Italy Employment-Population Ratios by Region

(In percent)

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.

20. Figure 5, which shows labor force participation rates broken down by region and by gender, also indicates marked regional differences, with a high and relatively stable participation rate in the North and the Center, and a low and declining participation rate in the South. While participation rates for males have fallen over the last two decades in all three areas, the participation rates for women have increased significantly in the North and the Center, but not in the South.

Figure 5
Figure 5

Italy Labor Force Participation Rates by Region

(In percent)

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.

21. In summary, the Italian labor market is characterized by relatively low levels of labor force participation and employment in the formal sector. In particular, the constraints on female labor supply, which, until recently, included the lack of temporary and flexible work arrangements that tend to induce more women to enter the labor force, appear to be significant in Italy and to be particularly acute in the South.

Sectoral developments in employment

22. Examining labor market dynamics at the sectoral level can be quite helpful in understanding patterns of overall labor market developments. Both short-term and longer-term evolutions of sectoral employment and wage structures are of interest in this regard.

23. Figure 6 (upper panel) plots the employment shares of five broadly defined sectors in the Italian economy over the last two decades. As in other industrialized countries, the share of employment in agriculture and manufacturing has trended downward over this period while the share of service sector employment has increased. The share of employment in public administration is quite high in Italy, although not atypical by European standards, and has in fact increased from 18 percent of total employment in 1977 to about 23 percent at present.6

Figure 6
Figure 6

Italy: Sectoral Employment Patterns

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.

24. Another distinctive feature of the Italian labor market is the significant proportion of employment that is classified as self-employment as opposed to dependent employment. In part, this reflects the pervasiveness of labor market regulations, which are particularly onerous for larger firms. These regulations have resulted in a large share of employment being in small businesses and in self-employment. The welfare implications of this phenomenon are not obvious, although it might be conjectured that larger firms have scale economies and that the preponderance of small firms and of self-employment therefore implies certain efficiency losses. In any case, it is useful to examine the prevalence of self-employment since this could have implications for designing labor market policies.

25. Figure 6 (lower panel) plots dependent employment as a share of total employment for the economy as a whole and also for each sector except public administration. The aggregate share of dependent employment has remained relatively stable at around 70 percent over the last two decades.7 While the share of dependent employment has declined in construction, the shares in other sectors have remained quite stable. These figures indicate that the share of self-employment in total employment is about 12 percent in manufacturing, 50 percent in services, and 65 percent in agriculture. It is possible, however, that these shares overstate the importance of self-employment. Anecdotal evidence indicates that dependent employment in small business enterprises is sometimes masked as self-employment in order to obviate onerous labor market regulations. The recent strong growth of employment under the category termed lavoro parasubordinato (a form of free-lance employment) appears to be consistent with this interpretation.

26. Figure 7 provides an indication of the shorter-term evolution of sectoral employment. The top panel shows annual growth rates of employment in each sector while the bottom panel shows the contributions of each sector to total annual employment growth during the 1990s (the sectoral contributions sum up to total employment growth). Apart from a small increase in employment in construction in 1992, employment growth in all sectors of the economy was negative during the years 1992–94. Since then, employment levels in manufacturing and in agriculture have continued to decline while service sector employment has been the main contributor to overall employment growth. The decline in manufacturing sector employment during and after the recession is attributable in part to labor shedding prompted by the easing of layoff restrictions in the early 1990s.

Figure 7
Figure 7

Italy: Sectoral Employment growth

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.Note: The sectoral contributions sum up to total annual employment growth in each year.

Sectoral shifts and labor reallocation

27. These inter-sectoral disparities in employment growth rates raise some interesting issues. Changes in the patterns of net labor flows across sectors could indicate the success of recent reforms (discussed below) in enhancing the efficient allocation of labor. Further, it is of interest to examine if the recent persistence of Italian unemployment could in fact be attributable to sectoral shifts. Lilien (1982, 1990), for instance, has argued that large sectoral shifts in employment attributable to exogenous shocks could result in significant but temporary increases in unemployment. To shed some light on this, the following statistical measure of employment growth dispersion suggested by Lilien can be used to proxy for inter-sectoral labor reallocation:

σt2=i=1N(xitXt)(Δxit-ΔXt)2(1)

where Xit is employment in sector I at time t, Xt is aggregate employment at time t, and the operator A represents the growth rate of a variable. Each industry’s weight was divided by the variance over time of that industry’s employment growth rate in order to adjust for the effects of different cyclical sensitivities of employment growth rates across industries. Note that this measure captures only net rather than gross flows of labor across sectors. Typically, this measure of employment growth dispersion tends to rise during periods of major structural change when there are increases in net flows of labor across sectors.8 Since annual data are used here in constructing this variable, some of the higher frequency movements in employment growth dispersion that are related to the business cycle rather than longer-term structural change are smoothed over in this analysis.

28. Figure 8 (upper panel) shows that this measure of employment growth dispersion has been relatively low over the last few years and well below its peak in the mid-1980s, when the economy was clearly undergoing considerable structural change. Thus, at first glance, there is little evidence of a recent increase in the pace of structural change in the Italian economy at this broad level of sectoral disaggregation.

Figure 8
Figure 8

Italy Measures of Sectoral Labor Reallocation

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.Note: See the text for details on computations of these measures.

29. Davis (1987) has argued that Lilien’s measure of the sectoral dispersion of employment growth rates may be inadequate for capturing longer-term flows of labor. In particular, sectoral or aggregate shocks that lead to labor flows in one direction could be reversed by a subsequent shock. Thus, Lilien’s measure would tend to be dominated by short-term labor flows rather than longer-term labor reallocation. Davis constructed the following labor reallocation measure that attempts to measure whether net inter-sectoral flows of labor in one period are reinforced or reversed by subsequent flows of labor:

σt,j2=i=1N(xitXt)(Δxit-ΔXt)(Δjxit-1-ΔjXt-1),(2)

where ∆j represents the percentage change in a variable over j periods. Relatively large (small) values for σt,j2 indicate that the time t direction of labor reallocation reinforces (reverses) the time t-1 reallocation over the preceding j-period horizon. This measure is designed to examine whether, over different time horizons, labor flows are consistent with patterns of structural change in the economy, where structural change is to be interpreted as reflecting changes in the sectoral composition of total employment.

30. Labor reallocation measures computed with j equal to 2 and 4 are displayed in the lower panel of Figure 8. These measures of labor reallocation are well below their respective levels reached in the mid-1980s, although there is a modest increase in both measures of labor reallocation since 1994. The measures of employment growth dispersion and labor reallocation examined here portray a similar picture of an economy that is undergoing some structural change but at a modest rate that is fairly typical by historical standards. Hence, the recent persistence in the unemployment rate cannot be attributed to sectoral shifts. Further, there is at best limited evidence that recent labor market reforms have increased net labor flows across sectors. However, it should be recognized that, at finer levels of disaggregation than those used here, the evidence for structural change could be stronger.

Developments in nominal and real wages

31. During the 1970s and 1980s, the wage formation process in Italy was characterized by annual indexation of nominal wages to realized inflation and by what was effectively a centralized wage bargaining structure. The first of these features implied that real wage flexibility was constrained by a floor of zero real wage growth. This is quite evident in the evolution of real wage growth in industry shown in Figure 9 (top panel). Except for brief periods where the annual frequency of indexation implied that nominal wage growth could be temporarily below CPI inflation, real wage growth was positive virtually throughout the 1970s and 1980s, irrespective of aggregate business cycle conditions. This element of wage indexation also appears to have contributed to the persistence of inflationary shocks throughout this period.

Figure 9
Figure 9

Italy Real Wage Growth (four-quarter growth rates, in percent)

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.Notes: The wage indexes for industry used in the top panel are (i) minimum contractual hourly wage for laborers, (ii) minimum contractual wage (weekly) for laborers, and (iii) minimum contractual wage per employee for all workers. This third measure is used for the lower two panels.

32. A key aspect of the 1992–93 labor market reforms involved changes in the wage formation process.9 The automatic indexation of wages was eliminated. Instead, an agreement was reached with the unions whereby sectoral contracts negotiated at the national level would determine nominal wages for a period of two years, based on targeted inflation, and employment and working conditions for a period of four years. After two years, wage contracts could be re-negotiated. The most important feature of this agreement was that discrepancies between actual and targeted inflation pver the duration of a contract were to serve only as a guide for future wage negotiations and would not result in an automatic compensation for this differential.

33. Although the two-year duration of wage contracts may have introduced some inertia in nominal wages, overall the incomes policy has had a clear salutary effect on real wage formation. It is particularly noteworthy that, unlike in previous instances of exchange rate depreciation, the substantial depreciations of the lira in 1992 and in 1994–95 did not feed through into wages. As shown in the middle panel of Figure 9, real wage growth was significantly negative in industry from the latter half of 1992 through the first half of 1996. A similar picture is revealed by the general wage index (for the overall economy) shown in the bottom panel of this figure. This evidence suggests that changes in the wage formation process have had a significant effect on improving real wage flexibility.10

34. However, nominal wage growth has increased marginally since the beginning of 1996, while the rate of inflation has declined significantly. Consequently, real wage growth turned positive in the latter half of 1996 and has continued to increase through 1997. The increase in nominal wage growth during 1997 partly reflects an element of catch-up in newly negotiated wage contracts that were based on targeted inflation for the next two years (as per the wage bargaining framework) but that also sought to make up the difference between actual and target inflation over the previous two years. In addition, some of the contract negotiations concluded during 1997 were for contracts that had expired in 1996. Consequently, lump-sum payments were made in 1997 to account for the retroactive wage increases for 1996.

35. Table 1 shows the pattern of wage negotiations within the context of the new wage bargaining framework introduced in July 1993 for certain important industries. The table shows, for the duration of the contract, the “target” inflation rate underlying the contract negotiations, the average nominal wage increase, and, where available, the realized rate of CPI inflation. A notable feature is the significant decline in target inflation underlying contracts renewed in 1997.

Table 1.

Inflation and Wage Dynamics Under the New Wage Bargaining Framework: Evidence from Major Wage Contracts.

(Total increase over duration of contract, in percent)

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Source: ISCO.Notes: Negotiations on certain contracts that expired in 1996, such as the one for metal workers, were completed in 1997, but were made effective retroactively.

36. Thus, despite the uptick in nominal wage growth during 1997, it is clear that inflation expectations have been brought down markedly by both the good inflation performance in recent years and the prospects of restrained inflation under EMU. However, these wage developments, occurring as they have in an environment with modest employment growth and persistently high aggregate unemployment, indicate the risks inherent in longer-duration nominal wage contracts since such contracts could implicitly result in some degree of real wage inflexibility in the short run.

37. An examination of sectoral wage growth figures (Table 2) reveals a picture similar to that conveyed by the aggregate figures. Real wage growth during the period 1993–1995 was negative in nearly all sectors of the economy. In 1996, as inflation continued to decline from the average levels seen in recent decades, real wage declines moderated considerably. In 1997, on the other hand, real wages increased significantly. This increase was quite broad-based, except in agriculture and in transport and communications, which had small real wage declines. As noted above, these wage increases partly reflect special and transitory factors. Nevertheless, they raise concerns that some real wage rigidities remain in the economy especially since, except for services and public administration, most of the sectors and industries with real wage increases in 1997 also continued to have declines in their employment levels (see Figure 7), despite the recovery in aggregate demand. This also raises some longer-term issues concerning the sectoral wage structure, which are the topic of the next sub-section.

Table 2.

Italy: Real Wage Growth

article image
Source: Bank of Italy’s Household Survey, 1995, and authors’ calculations.Notes: Annual growth rates of real wages were computed using indexes of minimum contractual wages per employee (excluding family allowances) for all workers. The aggregate CPI was used as the price deflator. The figures for 1997 are based on data for the first two quarters of 1997 relative to the first two quarters of 1996.

The sectoral wage structure

38. An important characteristic of the Italian labor market is considered to be the lack of sectoral (and, as discussed later, regional) wage differentiation.11 The narrowing of differentials in wage levels in the 1970s and the prevalence of centralized wage bargaining are believed to have resulted in a rigid sectoral wage structure. This has adverse implications for labor market adjustment. The lack of inter-sectoral wage flexibility implies that the brunt of adjustment to sector-specific shocks would have to be borne by employment levels, with consequent adverse effects on aggregate unemployment. Further, the lack of wage differentiation could reduce incentives for inter-sectoral labor mobility, thereby constraining both the short-run and longer-run adjustment of labor markets to exogenous shocks.12

39. To provide a measure of wage differentiation across sectors, Figure 10 (upper panel) shows the dispersion—as measured by the standard deviation—of (the logarithms of) nominal wages for dependent employees in 11 industries using three alternative wage series: (i) minimum contractual hourly wage indices for laborers, (ii) the minimum contractual wage per employee for all workers, and (iii) the minimum contractual wage per employee for laborers.

Figure 10
Figure 10

Italy Wages and Hours

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.Notes: The coefficients of variation in the top panel are based on the logarithms of three alternative indexes of wages in eleven industries: (i) minimum contractual hourly wages for laborers (WAGE1); (ii) minimum contractual wage per employee (WAGE2); and (iii) minimum contractual wage for laborers (WAGE3).

40. As has been documented by numerous other authors (e.g., Erickson and Ichino, 1994), the wage indexation system resulted in a significant compression of wage differentials during the 1970s, both across sectors and across skill groups. The sharp decline in the sectoral dispersion of wages during this period is evident for all three measures of wages. Changes to the wage indexation system in the mid-1980s resulted in an increase in wage dispersion but, thereafter, wage differentials across sectors continued to decline gradually. Since 1995, however, the sectoral dispersion of wages appears to have increased, as evidenced by increases in all three dispersion measures. This suggests that the 1992–93 changes in wage bargaining arrangements (see discussion below) have been effective in promoting flexibility in the sectoral wage structure by, inter alia, providing an enhanced role for enterprise-level contracts that explicitly link wage settlements to measures of productivity and profitability. Nevertheless, the substantial compression of sectoral wage differentials relative to historical levels suggests that the Italian labor market remains relatively inflexible in this dimension and that further progress is necessary.

41. An additional fact gleaned from the sectoral data is the reduction in contractual annual working hours in the industrial sector (Figure 10, lower panel), indicating an even greater decline in labor input in this sector than would be derived by examining only employment figures. This is consistent with other evidence on the substitution of capital for labor in the manufacturing sector in Italy and other European economies (see, e.g., Blanchard, 1997) and has implications for long-term employment levels in the industrial sector.

C. Labor Market Institutions and Their Effects

42. As is the case with labor markets in other economies of continental Europe, the Italian labor market has been characterized by a number of inefficiencies engendered by institutional factors. This section provides a brief review of the key institutional features that may have played a role in hampering the efficient functioning of the labor market. Recent reforms and changes in these features are also examined.13

43. The unemployment insurance system in many industrial countries is viewed as having adverse incentive effects that lead to the persistence of increases in unemployment. Loosening of eligibility criteria, increases in benefits, and broadening of coverage of income support mechanisms that are not directly tied to incentives for job search or retraining often tend to exacerbate and prolong the unemployment problems that they are intended to allay. In addition, the financing of such income support programs often involves increases in distortionary taxation which could worsen the problem.

44. The Italian unemployment insurance (UI) system has a rather atypical structure, especially in comparison to other continental European countries. For instance, the total expenditure on public unemployment benefits (only about ½ percent of GDP) is consistently lower than in other European countries (on this, see Chapter II of this paper). Further, since the coverage of unemployment benefit schemes is lower in Italy than in most other EU countries, the usual disincentive effects that plague many UI systems are comparatively less pronounced.

45. While direct unemployment insurance benefits are quite limited, a more important component of the benefits system is the Cassa Integrazione Guadagni (CIG). The CIG was originally designed to compensate for hours not worked due to temporary reductions or suspensions of activity by industrial firms, but has become a key instrument of income protection for workers in the manufacturing sector. The coverage of CIG has expanded over time and now includes the construction sector, although it is still limited to industrial firms with 16 or more workers and other commercial enterprises with more than 200 workers. The CIG provides, for a period of up to twelve months, a benefit replacement rate equal to 80 percent of the last earned wage. A special component of the CIG allows similar benefits to be extended for a period of up to four additional years in cases of restructuring or reorganization by firms.

46. The number of hours compensated under the provisions of the CIG are shown in Figure 11 (upper panel). Clearly, the CIG has played an important role in unemployment stabilization in the Italian economy over the last two decades, with a large number of manhours compensated under this scheme in the early 1980s. During the recent recession, there was a cyclical increase in the number of hours compensated under the CIG but the level remained well below that reached in the 1980s. In the 1990s, the role of the CIG has partly been substituted for by “mobility lists”, which make the cyclical component of unemployment more transparent.14 In addition, a mobility allowance was introduced in 1991 to replace Special Unemployment benefits.

Figure 11
Figure 11

Italy Trends in Labor Disputes and Hours under the Cassa Integrazione

Citation: IMF Staff Country Reports 1998, 057; 10.5089/9781451819717.002.A001

Source: Bank of Italy and authors’ calculations.

47. With these changes, permanent redundancies are now identified more promptly. Moving workers from the CIG to mobility lists and providing them with a mobility allowance has had the advantage of improving the incentives of workers who are laid off to engage in active job search. Firms are required to give priority in their hiring to workers on mobility lists and, in some cases, also receive subsidies for such hiring. Further, recent measures to tighten eligibility requirements have also led to a decline in the total number of hours compensated under the CIG and suggest that some of the adverse incentive mechanisms engendered by this scheme have been dealt with to a significant extent.

48. However, the Italian UI system does still suffer from a few shortcomings. The CIG scheme effectively provides income protection to “insiders,” thereby reducing the role of “outsiders” in influencing wage and employment bargaining outcomes. Further, the limited coverage of other forms of unemployment insurance tends to inhibit mobility across jobs by acting as a disincentive for risk-taking in the labor market. Another concern is the fact that first-time job seekers and labor market re-entrants receive no income support through the UI system. Thus, while the Italian UI system has not, unlike in many other European countries, contributed significantly to increases in aggregate unemployment, deficiencies in the structure of this system have in some respects inhibited the efficient functioning of the labor market.

49. The role played by unions is also an important determinant of the nature of labor market adjustment in response to shocks. For instance, unions tend to be more concerned about wage and employment prospects of “insiders,” with consequent implications for employment and unemployment dynamics in response to shocks. One measure of the power of labor unions is their degree of militancy, measured by strike activity. Figure 11 (lower panel) plots the number of work hours lost in labor conflicts since 1970. This figure shows the high degree of union militancy during the 1970s and early 1980s and a steady reduction in strike activity thereafter; union density has also declined in recent years, as documented by numerous authors (e.g., Demekas, 1994). Nevertheless, labor unions continue to play a key role in wage negotiations, especially since wage contracts negotiated by national unions tend to form the basis for wage formation in all sectors of the economy.15 The reduction in labor disputes is, therefore, also a positive indication of changing attributes to wage formation.

50. An important determinant of the ability of different parts of the economy to respond to shocks is the degree of aggregate as well as disaggregate wage flexibility. Industry- and region-specific shocks play an important role in economic fluctuations in most industrial countries. Rigidities in wage differentials across sectors and across regions could translate temporary shocks into permanent effects on employment and unemployment. Further, wage differentials that do not accurately reflect productivity differentials are likely to hinder the. efficient allocation of labor by reducing the incentives for labor mobility. This is evidenced, for instance, by the steady decline over the last decade in inter-regional migration despite the widening disparity of regional unemployment rates.16

51. Certain institutional features appear to have contributed to a sub-optimal degree of wage differentiation. Two features, in particular, are widely regarded as being responsible for the limited wage differentiation observed in Italy—the wage indexation system and the wage bargaining system. In an attempt at promoting greater wage equality, the wage indexation scheme known as the scala mobile was modified in 1975 to provide similar cost-of-living adjustments for all workers. This resulted in a sharp compression of wage differentials across occupational classifications in the 1970s. The 1983 reform of the indexation system halted the decline in wage differentiation and the indexation system was abolished altogether in 1992.17

52. The centralized wage bargaining system has also contributed to the relatively small inter-sectoral and inter-regional wage differentials in Italy compared to most other industrialized countries. The wage bargaining procedure resulted in legally binding wage floors that were negotiated for each sector and for category of occupation by unions and employers at a central level and that were applied uniformly across regions. Since negotiated wage floors have traditionally accounted for a substantial fraction of most workers’ earnings, this centralized bargaining procedure resulted in relatively narrow differentials in wages across regions and across sectors.

53. The new wage negotiating framework introduced in 1993 formalized a two-level wage bargaining structure, where the second level of bargaining was not limited to larger firms, as had been the case before. Under this framework, national industry-level contracts determine the structure and evolution of wages over a two-year period and determine employment and working conditions over a four-year period. Industry-level wage contracts are to be set in a manner consistent with official inflation targets. The second level of bargaining would be at the firm level and would allow wages to be linked to productivity or profitability indicators.

54. The change from a relatively centralized to a decentralized wage bargaining system carries risks and opportunities. As noted by Calmfors and Driffill (1988) and Calmfors (1993), there is likely to be a non-monotonic relationship between the degree of centralization of wage bargaining and labor market outcomes. Centralized unions are more likely to internalize the externalities inherent in the fact that unions are more beholden to “insiders” than to unemployed workers who are not union members. On the other hand, centralized unions could lead to lower wage differentiation, as has been the case in Italy. Further, these factors interact with the degree of union power and the degree of co-ordination among unions in the wage-setting process.18 Hence, it is difficult to determine precisely the optimal wage bargaining structure for maximizing social welfare.

55. Nevertheless, given the changes in the wage bargaining structure and other aspects of wage formation, it is useful to provide a preliminary empirical assessment of the effects of these reforms on the wage formation process. The next section of this chapter provides a more detailed empirical examination of the Italian labor market that assists in a preliminary evaluation of the reforms described here and points to fruitful directions for further reforms and associated institutional changes. More recent labor market reforms, covered by the tripartite agreement of September 1996 (Accordo per il avoro), will also be discussed below.

D. The Structure of Earnings and Employment: Evidence from Micro Data

56. This section presents an alternative perspective on the main features of the Italian labor market. Individual data from the Bank of Italy’s household survey are used to analyze the wage structure in more detail. Further, evidence from this micro data set on the reasons for unemployment and for non-participation in the labor force could help gain some insights into factors that affect employability and labor supply decisions and that could be used in formulating appropriate policy measures.

Earnings

57. Average measures of wage differentials across regions and across sectors could be contaminated by aggregation bias due to worker heterogeneity. For instance, an apparently large average wage differential between two sectors could simply reflect differences in the average level of human capital of workers in the two sectors. Micro panel data can be used to control for observed worker attributes and thereby provide more accurate measures of wage differentials. In addition, such data can also be used to obtain measures of wage differentials between male and female workers, across different skill levels, across different firm sizes, etc., that control for other observed attributes of workers.19

58. The data used in this part of the analysis are drawn from the 1995 version of the Bank of Italy’s household survey, which includes data on individual workers’ earnings and other characteristics. The analysis of the wage structure is limited here to dependent workers (employees) and excludes self-employed workers. An important caveat is that the earnings data represent net after-tax earnings. Given the progressivity of the income tax structure, this could in principle understate wage differentials across, for instance, skilled (high wage) and unskilled (low wage) workers. Since the tax structure is similar across regions and local income taxes are not significant, estimates of regional wage differentials are less likely to be affected by this feature of the data.

59. Table 3 reports results for regressions of weekly earnings. The first column of this table shows the results from the regression using the full sample of employed workers. The estimated coefficients on the industry dummies are shown in one of the bottom rows of the table (relative premium). These coefficients represent estimates of earnings differentials across sectors, relative to earnings in the manufacturing sector. Since the earnings variable is expressed in logarithms, the coefficient estimates are interpretable as percentage differences relative to earnings in manufacturing.

Table 3.

Italy: Wage Regressions

(Dependent variable: Log net earnings)

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Source: Bank of Italy’s Household Survey, 1995, and authors’ calculations.Notes: The firm size dummy variables are based on the total number of registered employees (indicated in parentheses) in the establishment. The relative premium is the estimated average sectoral earnings premium relative to the manufacturing sector, expressed as a percentage of average earnings in manufacturing. These premia were computed from the coefficients on the industry dummies in the regression with all observations (column 1). The additional controls included in the regressions are Experience and its square, and the following dummy variables: MARRIED, URBAN, INVALID, and SICK (persons with chronic diseases). An asterisk indicates statistical significance at the 5 percent level.

60. Average earnings in agriculture are estimated to be about 60 percent lower than in manufacturing. Among other sectors, however, the earnings differentials are in general quite narrow. There is only about a 10 percent differential between earnings in manufacturing and average earnings in trade, transport and communications, and real estate. As in other countries, earnings in the household and personal services sector are lower than in manufacturing while earnings in the financial sector are among the highest

61. The coefficients on the dummy variables Center and South (in the first column) capture the estimated earnings differentials of workers in these regions relative to workers in the North, after controlling for worker characteristics as well as sector of occupation. These coefficient estimates indicate that, relative to the North, average earnings are 8 percent lower in the Center and 18 percent lower in the South.

62. The earnings premium for workers with a high school education compared to workers without a high school degree is 19 percent. Workers with a college degree earn an additional premium of about 10 percent. The large earnings premium for workers with higher levels of general human capital is consistent with other evidence of large and increasing skill premia due to skill-biased technological change since the 1970s—similar to evidence that has been documented for other industrial countries. The coefficient on the dummy variable for males indicates that male workers on average have 28 percent higher earnings than female workers, even after controlling for education levels, labor market experience, region and sector of employment, and other observable attributes. The coefficient estimates for the firm size dummies clearly show that, despite controlling for observed worker characteristics, workers in larger firms have significantly higher earnings.20

63. The estimated sectoral and regional earnings differentials for 1995 suggest that the labor market reforms introduced in 1992–93 do appear to have helped in fostering some degree of wage differentiation.21 It is useful, in this context, to examine regional and other aspects of differentials within each sector. Hence, the earnings regressions were also run separately for workers in each sector. The only difference relative to the regression for the full sample is that the sectoral dummies were excluded. The sector-specific wage regressions are reported in columns 2–10 of Table 3.

64. The North-South earnings differentials are greater in industries such as construction and, particularly, in industries that typically have lower union densities—including agriculture, real estate, and household and personal services. Not surprisingly, the regional differentials are among the smallest in public administration. The existence of a statistically and economically significant earnings premium for workers in larger firms is a robust finding across virtually all sectors of the private economy.

65. A different perspective on the wage structure is provided by using hourly, rather than weekly, earnings. It is possible that employment contracts stipulate specific weekly wages but, as part of an implicit bargain between firms and employees, both regular and overtime hours could bear the brunt of adjustment in response to changes in demand conditions. Table 4 reports results from wage regressions similar to those reported in Table 3 but using hourly earnings as the dependent variable.

Table 4.

Italy: Wage Regressions

(Dependent variable: Log net hourly earnings)

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Source: Bank of Italy’s Household Survey, 1995, and authors’ calculations.Notes: The firm size dummy variables are based on the total number of registered employees (indicated in parentheses) in the establishment. The relative premium is the estimated average sectoral earnings premium relative to the manufacturing sector, expressed as a percentage of average earnings in manufacturing. These premia were computed from the coefficients on the industry dummies in the regression with all observations (column 1). The additional controls included in the regressions are Experience and its square, and the following dummy variables: MARRIED, URBAN, INVALID, and SICK (persons with chronic diseases). An asterisk indicates statistical significance at the 5 percent level.

66. The regression with all observations (column 1) shows that differentials in hourly wages between the North and the South are about 12 percent, much lower than the estimated weekly earnings differential of 18 percent. Thus, measures of weekly earnings appear to overstate the extent of inter-regional wage differentiation. The hourly wage premium for workers with a college degree compared to workers with only a high school degree is estimated to be about 28 percent, much larger than the weekly earnings premium. The male-female earnings differential, on the other hand, drops to 9 percent using this measure of hourly earnings. The estimated effect of firm size on earnings remains essentially unchanged.

67. The estimated sectoral differentials for hourly wages, shown in the bottom row of Table 4, are in many cases quite different from the differentials in weekly earnings. For instance, the average hourly earnings differential between agriculture and manufacturing is close to zero, compared to the 60 percent differential in weekly earnings. This discrepancy, of course, reflects the substantially lower average weekly hours worked in agriculture compared to manufacturing. Another notable feature of these results is the substantially lower dispersion of hourly earnings across sectors, compared to the dispersion of weekly earnings.

68. The results of sectoral wage regressions using the hourly earnings measures are reported in columns 2–9 of Table 4. Consistent with the aggregate results, these results show that, in most industries, the North-South differentials in hourly earnings are lower than the differentials in weekly earnings that do not adjust for hours worked. For some industries such as transport and communications, financial services, and public administration, there are essentially no significant differences in wages between the North and the South.

69. In summary, using measures of weekly earnings, there appear to be some indications of a recent widening in the structure of earnings differentials among geographical regions and across broad sectors of the economy. However, after adjusting for weekly hours worked, it appears that actual differentials in hourly earnings remain quite narrow.

Employment, unemployment, and nonemployment

70. Data from the Bank of Italy household survey can also be used to examine labor market activities—including the employment or unemployment status—of individuals in the sample. In addition, these data provide interesting insights on the labor market status of potential labor force participants, defined as including all persons between the ages of 14 and 64.

71. Labor force participation rates derived from this micro data set are broadly consistent with the picture obtained from other data sources, with the total labor force participation rate at under 60 percent, lower participation rates in the South than in the North, and much lower participation rates among women than among men.

Labor Force Participation Rates22

(In percent)

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72. One of the questions included in the survey is about the reasons for non-participation in the labor force. Although the information obtained from this question is limited, it is nevertheless quite revealing. As the tabulation below shows, a substantial fraction of persons between the ages of 14 and 64 who did not consider themselves to be active labor force participants identified themselves as housewives, indicative of the weak attachment of married women to the labor force. There are marked regional disparities in these data. Married women in the South appear to have much weaker labor force attachment than those in the North. Persons with pensions from work constitute about 30 percent of persons not in the labor force in the North but only 12 percent in the South.

Reasons for Lack of Labor Force Attachment

(In percent)

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73. Next, we examine the principal activities of labor force participants. The tabulation below classifies labor force participants into those who have dependent employment, the self-employed, those looking for their first job, and persons who have held jobs in the past but are currently unemployed. Overall, about 7 percent of labor force participants considered themselves unemployed while an additional 10 percent were unemployed and in search of their first job. These figures together indicate an aggregate unemployment rate higher than the official unemployment rate (based on the Labor Force Survey) largely because the latter measure uses a more stringent definition of labor force participation based on job search activity.

Labor Force Participants: Current Activity

(In percent)

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74. A striking feature of this tabulation is, again, the large discrepancy among regions. In the North, only a total of about 8 percent of labor force participants were looking for their first job or were unemployed in 1995. In the Center, this proportion was about 14 percent and, in the South, it reached 30 percent, of which almost two-thirds were first-time job seekers. The high percentage of labor force participants in the South in search of their first job hints at the inadequacy of mechanisms for school-to-work transitions. In the North, on the other hand, the fraction of labor force participants looking for their first job was less than 4 percent, indicating the relative tightness of the labor market in that region. The regional disparity of unemployment rates depicted by the numbers in this table also points to inefficiencies in the mechanisms for matching potential workers with available jobs. In particular, public employment agencies have hitherto enjoyed a monopoly in providing employment intermediation. These agencies did not provide job listings or other mechanisms for matching workers and jobs even across provinces, thereby failing to facilitate the geographical mobility of labor.

75. Mechanisms for absorbing new entrants into the labor force are an important determinant of the efficient functioning of the labor market. The above tabulation indicated that, in this regard, the Italian labor market appears to be inefficient. An examination of unemployment rates among younger workers, between the ages of 14 and 25, confirms this and reveals a sizeable youth unemployment rate (see tabulation below). This rate is about 20 percent in the North and over 60 percent in the South. Even young workers with higher levels of education appear to face high unemployment rates in all regions.23 This points to a crucial problem with the functioning of the labor market in Italy—the absence of mechanisms for facilitating the school-to-work transition for younger workers. A related hypothesis is that the educational system has not adapted to provide the right set of skills demanded in the labor market, where skill-biased technological change has increased the demand for specialized skills consistent with rapidly improving technology.

76. Another important aspect of unemployment that has been stressed in various contexts is the increasing share of long-term unemployment in total unemployment. This has implications for the persistence of unemployment as well as for social welfare in a broader sense. The long-term unemployed face an attrition of their skills, making them less attractive to prospective employers. Further, the attachment of the long-term unemployed to the labor force tends to weaken over time.

Youth Unemployment Rates

(In percent)

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77. The tabulation below shows the distribution of unemployment among labor force participants who have experienced only short spells of unemployment (less than 6 months) and those who have experienced at least one long spell of unemployment (6 months or more). Clearly, the contribution of the long-term unemployed to total unemployment is substantial, especially in the South, and indicates the possibility of substantial hysteresis in the unemployment rate.

Long-Term Unemployment Among Unemployed

(In percent)

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78. To buttress the descriptive results discussed so far, some simple probit regressions were used for a more formal analysis of the determinants of employment and labor force participation. After narrowing the sample to individuals between the ages of 14 and 64 who identified themselves as labor force participants, the employment dummy was regressed on a number of control variables. The results are reported in Table 5 (first panel). The first column contains the results for the full sample and the next three columns provide results broken down by region (and, therefore, excluding the regional dummies).

Table 5.

Italy: Probit Estimates

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Source: Bank of Italy’s Household Survey, 1995, and authors’ calculations.Notes: Additional controls included in the regressions are: Experience and its square, and the following dummy variables: URBAN, INVALID, and SICK (persons with chronic diseases). An asterisk indicates statistical significance at the 5 percent level.

79. For the full sample, relative to employment probabilities in the North, estimated employment probabilities are lower in the Center and markedly lower in the South. An interesting result is that higher education (a college degree) improves employment probabilities in the South but not in the North. This may simply reflect the relative tightness of the labor market in the North, where there appears to be strong demand for workers of all skill levels. Employment probabilities are higher for males and for married persons. Employment probabilities for married females are not different from those for unmarried females.24

80. Table 5 (second panel) also reports results of probit regressions that examine the determinants of labor force participation propensities. These propensities are significantly lower in the South than in the North or the Center. Higher levels of education are clearly associated with higher rates of entry into the labor force. Labor force participation propensities are higher for males than for females in the North and even more strongly so in the South. In addition, these propensities are much lower for married females than for single females. These last two results are indicative of problems in integrating women into the workforce. Thus, it appears that the limited availability of part-time and other flexible arrangements serves to dissuade women, especially married women, from entering the labor force.

E. Policy Implications and Recommendations

81. A number of labor market reforms were instituted during the early 1990s, with additional measures being taken in the context of the September 1996 tripartite agreement. These reforms, which are summarized in Table 6, indicate a recognition of many of the problems described in this chapter. Nevertheless, much remains to be done. Reductions in the constraints on hiring and firing workers, for instance, constitute an area where past reforms need to be strengthened. In addition, drawing on the empirical analysis presented above, this section outlines a few key areas where further change is required. Many of these reforms would result in improvements in the functioning of labor markets through changes in both labor supply and labor demand.

Table 6.

Italy: Improving Labor Market Performance

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Education

82. A fundamental problem that affects the Italian labor market appears to be the low level of human capital, especially in terms of job-related skills, among entrants into the labor market. The large earnings premium for skilled workers, especially in the higher-wage and dynamic sectors of the economy, indicates that, as in other industrial economies, skill-biased technological change has increased the demand for skilled relative to unskilled labor. Having only a limited pool of high-skill workers could affect the long-term growth prospects of the economy by limiting the ability of industries to adopt and implement technological advances. Further, in a dynamic economy undergoing significant structural shifts, workers with high levels of human capital would be better positioned to adjust to such shifts.

83. Numerous studies using micro data from the United States have indicated that the returns to improvements in basic schooling are much higher than the returns to retraining older workers, both in terms of employment probabilities and lifetime earnings.25 This might be less true in Italy, where there is a high unemployment rate even among prime-age labor force participants. Nevertheless, an increased focus on basic schooling is an important priority, especially from the perspective of longer-term growth.

School-to-work transitions

84. The high rate of youth unemployment and the relatively large fraction of young labor market participants looking for their first jobs indicates some basic problems with the prevailing job-matching mechanisms (examined further below). More fundamentally, however, these may also indicate a mismatch between the skills emphasized by the educational system and the skills desired by prospective employers. This suggests the need for re-examining the focus of the educational system and, from a shorter-term standpoint, providing more job search assistance for younger workers.

Flexible work arrangements

85. A salient aspect of the Italian labor market is the prevalence of low participation and employment rates for women. In many other industrialized countries, with the Netherlands and the United States being notable examples, increasing participation and employment rates for women at all skill levels over the last two decades have been a major contributor to increases in labor supply that have boosted overall employment growth despite subdued real wage growth.

86. As the evidence from household data indicated, married females have particularly low labor supply propensities in Italy. This suggests that easing of restrictions on and the active encouragement of temporary, part-time, and other flexible work arrangements could draw more women into the labor force.

87. Recent legislative measures have extended the use of fixed-term contracts (which had previously been allowed only for seasonal and certain other special categories of work) and have permitted the introduction of agency-intermediated temporary employment. Although the use of such contracts remains limited to date, these are steps in the right direction for increasing labor market flexibility.26 These measures do not, however, obviate the need for more fundamental reforms that would tackle the onerous restrictions that remain on hiring and firing of workers more generally.27 The prolonged judicial process involved in individual dismissals that are subsequently contested by workers, and the attendant uncertainties from the perspective of firms, has a deleterious effect on hiring decisions, and is also in need of reform.

Regional disparities

88. The regional segmentation of labor markets documented in this chapter remains a major source of inefficiency. The relatively poor infrastructure in the South and other structural problems in these regions have discouraged investment. Elimination of structural impediments—including inefficient public administration, inadequate infrastructure, and constraints on administering the rule of law—would be necessary for sustained improvements in attractiveness for new investment.28

89. Another central concern is the lack of wage differentiation between the North and the South. As documented by numerous authors, productivity levels in the South are much lower in the North while, as shown in this chapter, the wage differentials across these regions are quite narrow.29 To offset this discrepancy between productivity and wages, which imply significantly higher unit labor costs in the South, the government has resorted to measures such as reductions in the social security contributions by employers in the South. These measures, however, have a fiscal dimension that is ultimately reflected in other distortionary revenue measures that affect aggregate employment levels. In any case, these measures are to be phased out under EU rules.

90. Recent initiatives to tackle regional disparities include special contracts for depressed areas, such as the patti territoriali and contratti d’area. These schemes are intended to involve collaborative efforts by all social partners at the local level in promoting investment and increasing employment creation. For instance, under these initiatives, unions have permitted temporary derogations from national wage agreements and have agreed to a greater flexibility of working arrangements. These contracts, although limited in number thus far, appear to have had some success in increasing economic activity in depressed areas. However, the fact that, for instance, derogations from national wage agreements are intended to be only temporary, may have limited the impact on investment decisions, which typically involve a longer planning horizon.

91. A more forceful measure would be to restructure wage bargaining arrangements in a way that would allow for regional wage differentiation in line with productivity differentials in a more durable manner. This would enhance the incentives for inter-regional labor mobility and would simultaneously reduce regional imbalances in the demand for labor by inducing investment flows into high-unemployment areas.

Labor mobility

92. More generally, inter-sectoral and inter-regional labor mobility remain quite low in Italy, reducing the ability of the economy to respond to region- and industry-specific shocks without persistent effects on employment and unemployment.30 A key deterrent to labor mobility is the lack of wage differentiation across sectors and, as noted above, across regions. Allowing for wage contracts that more accurately reflect productivity differentials would enable a more efficient allocation of labor.

93. Another constraint on labor mobility appears to arise from the ineffectiveness of formal job-matching through public employment agencies, which have enjoyed a long-standing monopoly.31 These agencies apparently provide little assistance in job matching across regions. Further, they have been oriented more toward collecting employment statistics rather than assisting in employment intermediation. Allowing for an expanded role for private sector employment agencies, and fostering a greater role for both private and public sector agencies in providing cross-regional job listings, would be important steps in improving job matching.

94. Legislation to permit the operation of private employment agencies, as mandated by an EU Court of Justice ruling in December 1997, has been prepared by the government but remains to be enacted into law. A point of contention has been the span of time that should be given to public employment agencies to “adjust” to increased competition. Rapid enactment of this legislation and allowing for unfettered competition in providing employment intermediation would help increase the efficiency of job matching.

Other aspects of labor market policy

95. A number of other measures, such as reductions in the regulations governing hiring and firing of employees by firms, are equally important. The 1996 tripartite agreement indicates a clear recognition of these issues by the key social partners, although much remains to be done in terms of the promulgation and effective implementation of measures to address these issues. Certain other measures such as mandated reductions in the work week have, unfortunately, gained currency in recent public discussions. These measures are of dubious value in reducing unemployment and are unlikely to have a significant impact in addressing labor market inefficiencies. Further, reductions in weekly working hours by fiat, rather than as the outcome of a negotiation process between workers and employers, could lead to sub-optimal outcomes in wage and employment bargaining. Related measures such as employment subsidies would need to be carefully targeted to be effective and, even if so, are unlikely to have significant or long-lasting effects on employment creation.

A broad-based approach

96. An important consideration in addressing labor market problems is that a tentative and limited approach to labor market reforms is unlikely to yield significant results. In fact, the lack of credibility of such policies could, as suggested by Bertola and Ichino (1996), have adverse short-run effects on unemployment. Given the need to generate credibility for these reforms, and taking into account potential policy complementarities among various policy measures, suggests that it is essential to adopt fundamental and broad-based rather than piecemeal reforms.

97. Other aspects of macroeconomic policies also have a role to play in improving labor market performance. For instance, the large overall tax burden on labor incomes and the tax wedge between production and consumption wages are likely to have significant negative effects on labor supply and labor demand, respectively. Hence, the broader issue of reducing government expenditures and the associated tax burden that is used to finance these expenditures has implications for labor market outcomes as well. Further, reducing regulations and constraints on competition in product markets often tend to have positive spillover effects on labor market outcomes.32 Recognizing and exploiting these policy complementarities could be crucial for improving the functioning of the labor market and, more generally, for the longer-term growth prospects of the Italian economy.

References

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1

Prepared by Eswar Prasad and Francesca Utili (summer intern).

2

Bertola and Ichino (1996) argue that the limited and tentative reforms in recent years lacked credibility and may in fact have exacerbated the unemployment problem.

3

The dispersion of regional unemployment rates in Italy is estimated to be the largest among OECD countries. Other EU countries that have significant but smaller regional disparities in unemployment rates include Belgium and Germany. In Belgium, the unemployment rate in 1997 was about 17 percent in Wallonia compared to 9 percent in Flanders. In Germany, the unemployment rate in 1997 was close to 20 percent in the east compared to 10 percent in the west. An important difference relative to the Italian situation is that, in both of these countries, changes in regional unemployment rates have been positively correlated during the 1990s. See Pugliese (1993) for additional perspectives on the regional segmentation of the Italian labor market relative to other European labor markets.

4

These age brackets were chosen to facilitate international comparison. The minimum working age in Italy is 14.

5

The existence of a large informal sector, may in turn, be attributable among other factors, to the fact that Italy has one of the highest tax wedges among OECD countries.

6

The large share of employment in public administration appears to be a feature of other continental European economies as well. The OECD’s estimate of the proportion of general government employment in total-employment is close to 20 percent on average for the EU-15, compared to about 15 percent for the United Kingdom and the United States. It should be noted, however, that the definition of general government employment may be somewhat narrower than the measure of public administration used in this chapter.

7

Other European countries that have a share of self-employment greater than 25 percent are Greece, Portugal, and Spain. By comparison, the share of self-employment is less than 15 percent in France, Germany, and the United Kingdom.

8

Gross flows of labor across sectors generally dominate net flows in terms of magnitudes. In recessions and periods of major structural change, however, the ratio of net flows to gross flows tends to rise. Lilien (1982) has argued that a significant fraction of cyclical unemployment in the United States is attributable to such sectoral shifts.

9

Other aspects of these reforms are discussed below. For details on the July 1993 agreement, see Demekas (1994).

10

Fabiani, Locarno, Oneto, and Sestito (1997) argue that the wage moderation engineered by the incomes policy, embodied in the 1992–93 agreement may have contributed to some of the recent decline in inflation.

11

The OECD estimates that the coefficient of variation of labor cost levels per working hour for production workers across thirteen industries in the manufacturing sector was 0.15 in Italy in 1994, compared to about 0.30 for Canada, Japan, and the United States, and an average of 0.20 for France, Germany, Spain, and the United Kingdom (OECD, 1997).

12

Bayoumi and Prasad (1997) find that, for Italy, industry-specific shocks are more important than common shocks across all industries for explaining fluctuations in disaggregated output growth.

13

The 1970 Charter of Workers’ Rights (Statuto dei Lavoratari) resulted in substantial rigidities in hiring and firing procedures, the compensation structure, rules for workers’ mobility within firms, etc. These rigidities and their deleterious effects are well-documented in the literature. See Demekas (1994) and Bertola and Ichino (1996) for a comprehensive description of labor market institutions in Italy, and Brunetta and Ceci (1996) for details on the 1992–93 tripartite agreement and related reforms.

14

Workers covered under the CIG are not classified as unemployed in official unemployment statistics while workers on mobility lists are. The unemployment rates reported in this chapter incorporate the Bank of Italy’s adjustment to the unemployment figures to include workers compensated by the CIG.

15

Labor unions have also played an active role in the tripartite “consultation process,” for example, in recent negotiations of pension reform, labor market regulations, etc., indicating their continued importance as social partners.

16

Faini, Galli, Gennari, and Rossi(1997) document trends in inter-regional migration in Italy. Based on survey evidence, they also list a number of institutional factors, such as an inflexible housing market, that have hindered migration within Italy.

17

The 1983 reform of the indexation system included a 15 percent reduction in inflation coverage. As discussed by Bertola and Ichino (1996), the indexation system was then progressively weakened. In particular, a cap was instituted on scala mobile payments in 1984, and cost-of-living adjustments were made proportional to earnings in 1986.

18

Decentralized wage bargaining could enhance wage differentiation but could lead to a wage-price spiral if relative wage competition among unions is significant, thereby resulting in adverse effects on aggregate employment.

19

See Keane and Prasad (1996) for a discussion and an empirical example of how estimates of sectoral wage equations using data aggregated at a sectoral level can be biased by compositional effects.

20

This is potentially an important result. Since larger firms are permitted to link pay levels above nationally-contracted minimums to firm-specific productivity and profitability, this finding suggests that labor productivity is, on average, higher in larger firms. This indicates that there could be significant efficiency losses from the onerous labor market regulations that have fostered an industrial structure that is skewed toward smaller firms.

21

Bertola and Ichino (1995) and Erickson and Ichino (1995) examine wage inequality and changes in the Italian wage structure over time.

22

The numbers reported in this and subsequent tabulations in this section are derived from the authors’ calculations based on data from the Bank of Italy’s household survey for 1995.

23

This result should be viewed with some caution since the number of young college-educated labor force participants in the sample is quite small.

24

A further striking result (not shown here) is the substantially lower probability of employment for workers with a history of one or more long spells of unemployment. This is true in all regions and indicates the employability problems associated with long-term unemployment. The regressions containing this result are not reported here since this variable was available only for a limited sub-sample.

26

A recent report of the Associazione per lo Sviluppo dell’Industria nel Mezzogiorno (SVIMEZ) notes that, in 1997, part-time work accounted for about 6.4 percent of total employment in Italy (5.5 percent in the South), compared to about 15 percent in Germany and 24 percent in the United Kingdom.

27

See Demekas (1994) for a documentation of these regulations.

28

Castronuovo (1992) cites evidence that the profitability of investment (measured as the marginal ratio of capital to product) is lower in the South compared to the North.

29

For instance, Castronuovo (1992) estimates that, in the manufacturing sector, there was a gap of about 20 percent in labor productivity between the North and the South in 1989. Viviani and Vulpes (1995) estimate similar large inter-regional differentials in total factor productivity. Taylor and Bradley (1997) conclude that differentials in unit labor costs across Italian regions are statistically and economically significant determinants of both the levels and persistence of regional disparities in unemployment rates.

30

Attanasio and Padoa-Schioppa (1991) and Faini, Galli, Gennari, and Rossi (1997) document the low and declining levels of inter-regional migration, although these two sets of authors reach different conclusions about the role of income support mechanisms and other institutional factors in influencing such migration.

31

The SVIMEZ report for 1997 indicates that only about 7.5 percent of new job placements in Italy were arranged by (public) employment agencies. This proportion is substantially lower than in most other European countries, many of which permit the operation of private employment agencies. These include England (about 33 percent), Germany (37 percent), and the Netherlands (63 percent). Faini, Galli, Gennari, and Rossi (1997) cite evidence that informal networks (i.e., family and friends) play a far more important role in job matching in Italy, especially in the South, than in other countries.

32

To cite one example, it has been suggested by some observers that restrictions on shop opening hours may have hitherto limited the diffusion of part-time contracts in Italy. Recent measures to relax such restrictions in the retail sector could, therefore, have spillover effects on the demand for part-time labor and could encourage more women to enter the labor force.