I. Introduction and Overview

1. The factors accounting for Italy’s poor growth performance over the last few years have been at the forefront of public policy debate in that country, and were also at the core of discussions during the 2005 Article IV consultation. The following chapters explore various aspects of this theme, with a view both to establishing the facts about the challenges confronting Italy and laying out aspects of the policy framework needed to meet them.

2. Italy’s economic problems are clearly illustrated in its external sector performance, as explored in Chapter II. The external sector should be the primary channel for the elimination of cyclical divergences within a monetary union, as countries facing weaker domestic demand should enjoy a gain in external competitiveness through slower wage and price growth relative to partner countries. Despite weak domestic demand, however, Italy has continued to lose market share over the last several years, and far from promoting a recovery, the external sector has actually been a drag on growth. Various factors have been posited to explain Italy’s poor external performance, including increasing competition from emerging market countries and, until recently, the strength of the euro. This chapter finds, however, that weak long-run productivity performance is the primary factor accounting for the loss of competitiveness suffered by Italian firms in recent years. Slow productivity growth, in turn, is likely to be rooted in country-specific factors, including the vulnerability of small, family-owned Italian firms and their product specialization. The persistence of these factors is itself a reflection of rigidities and inefficiencies in the Italian economy, many of which can be addressed through policy reform.

3. The link between policies and growth is explored further in Chapter III. Specifically, the chapter finds evidence that rigid product markets and a high tax burden on labor have been associated with slower growth in European regions. These findings are noteworthy, given Italy’s high tax burden and the country’s poor showing on indexes of product market regulation. Within Italy, the chapter finds some evidence that differences in rates of growth across the regions can be explained by their export specializations, but the effect is not significant. Overall, the results of the chapter are encouraging, as they suggest that the right mix of policies can have an important impact on growth performance, and within a surprisingly short period of time.

4. Chapter IV focuses on the role of fiscal policy and its implications for household consumption decisions. Specifically, it estimates fiscal multipliers for Italy based on an intertemporal model of nondurables consumption. In such a theoretical framework, the impact of shifts in fiscal policy on consumption depends on three characteristics: whether households anticipated the change; how long they expect the new policy to remain in effect; and the extent to which households are “short-sighted,” discounting future income streams at a rate higher than the market rate of interest. The results suggest that Italian households are in fact relatively far-sighted, putting a high value on the future and offsetting most of the impact of temporary tax cuts with higher saving. An important implication of this finding is that for tax cuts to have a significant impact on demand they must be seen as sustainable over the long term. This underscores the need for durable expenditure-based consolidation as a precursor to any reduction in tax rates to promote growth.

5. There is a broad consensus on the need to increase infrastructure investment to support growth in Italy. Given tight budget constraints, public-private partnerships have been seen as attractive vehicles for promoting these projects. PPPs are still relatively little-used in Italy, but—as noted in Chapter V—are expected to become increasingly common. The chapter stresses, however, that experience in a number of countries has shown that while these types of operations can play an important role in promoting investment, they should not be seen as a means of evading budgetary restrictions. In addition, considerable care needs to be taken in implementing these projects, including by strengthening project prioritization and evaluation; enhancing transparency in the recording of theses operations; and transferring an adequate degree of risk to the private partner, to ensure that it operates efficiently.

6. Recent events regarding high-profile takeover bids for two Italian banks have focused attention on issues related to competition in the banking sector. The importance of this issue extends beyond the headlines, however, as a competitive and efficient financial sector is essential to promoting growth. Chapter VI examines the issue of competition in Italian banking in detail. It finds that while competition has increased in recent years, banks still operate in a relatively high-cost, high-income environment, suggesting that consolidation has yet to produce significant gains in efficiency. Greater market contestability would serve as a powerful stimulus to innovation and growth.