Wide-ranging structural reforms are underway in Italy, aimed at addressing key bottlenecks in the product and labor markets. This paper reviews and assesses the authorities’ reform plans in each area. In most cases, the reforms go in the right direction, and their impact would depend on consistent and prompt implementation. In some areas, especially in the labor market, reforms would benefit from further strengthening. Our model-based analysis suggests that the potential gains to the economy from deeper reforms can be sizeable. The priorities should be to strengthen competition in the non-tradable sector and increase flexibility and participation in the labor market, supported by growth-friendly fiscal reforms.

Abstract

Wide-ranging structural reforms are underway in Italy, aimed at addressing key bottlenecks in the product and labor markets. This paper reviews and assesses the authorities’ reform plans in each area. In most cases, the reforms go in the right direction, and their impact would depend on consistent and prompt implementation. In some areas, especially in the labor market, reforms would benefit from further strengthening. Our model-based analysis suggests that the potential gains to the economy from deeper reforms can be sizeable. The priorities should be to strengthen competition in the non-tradable sector and increase flexibility and participation in the labor market, supported by growth-friendly fiscal reforms.

Wide-ranging structural reforms are underway in Italy, aimed at addressing key bottlenecks in the product and labor markets. This paper reviews and assesses the authorities’ reform plans in each area. In most cases, the reforms go in the right direction, and their impact would depend on consistent and prompt implementation. In some areas, especially in the labor market, reforms would benefit from further strengthening. Our model-based analysis suggests that the potential gains to the economy from deeper reforms can be sizeable. The priorities should be to strengthen competition in the non-tradable sector and increase flexibility and participation in the labor market, supported by growth-friendly fiscal reforms.

A. Introduction

1. Italy’s economy has a number of important strengths. Italian households have sound balance sheets, and private savings have traditionally been high. Private debt, at about 125 percent of GDP, is among the lowest in the euro area. The public sector, despite having one of the largest debt in the world, has also large as sets.2 With net foreign liabilities at around 20 percent of GDP, Italy’s net international investment position is more favorable than in other euro area periphery countries, and its current account deficit is relatively low. Italy’s exports, though lagging in terms of high value-added contents, are among the most diversified in the world.

2. Despite these strengths, Italy’s economic performance has lagged behind its peers. Growth averaged less than ½ percent in the last decade (against over 1 percent in EU15 and 1¼ percent 4 in G7 countries), while total factor productivity growth was negative. Potential growth is estimated to have stalled in recent years or even turned negative. In the absence of major changes to trends in productivity, employment, and investment, potential growth is likely to remain close to zero over the medium term.

Italy: Growth Accounting

(Average growth rate per decade; percent)

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Sources: OECD; and IMF staff estimates.

3. Italy’s weak growth performance has been attributed to a number of structural factors.

  • Limited competition. Regulatory rigidities and entry barriers have limited competition and kept rents high, especially in non-tradable sectors (Figure 1). This has adversely effected the business environment (Figure 2), increasing costs for the sectors that need to compete globally and eroding the competitiveness of the economy. With firms unable to grow and benefit fully from economies of scale, the efficiency of the productive system has remained low, innovation has been limited, and specialization has not moved sufficiently up toward more high-skill sectors (Figure 3), leading to a loss in export market shares.

  • Labor market rigidities. Mirroring these problems, the labor market is marred by low labor participation, dualism, and low educational attainment (Figure 3).

  • Weak public services. Deficiencies in the product and labor markets have been accentuated by the high tax burden coupled with inefficient public spending (Figure 4), a lengthy legal system, limited FDI penetration, large regional disparities, and a sizeable unofficial economy.

Figure 1.
Figure 1.

Regulatory Barriers and High Profit Margins in Nontradable Sectors

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Sources: OECD; Eurostat; and IMF staff calculations.1/ Difference between gross operating surplus in percent of production value in services and manufacturing sectors.2/ Net operating surplus in percent of sectoral value added, 2008 (latest available year).
Figure 2.
Figure 2.

Difficult Environment for Doing Business

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: World Bank Doing Business 2012.1/ OECD high-income economies;2/ For each topic, the ranking among 31 OECD countries is reported.
Figure 3.
Figure 3.

Low R&D, Poor Educational Attainment, and Insufficient Complexity of Exports

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Sources: OECD; and Felipe and Kumar (2011).1/ Products with revealed comparative advantage (RTA) >=1, where RTA is the ratio of the export share of a given product in the country’s exports to the same share at the worldwide level (or the country’s share of world exports of a given product in its share of total world exports).
Figure 4.
Figure 4.

Inefficient Public Administration and High Tax Burden

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Sources: OECD (2012); World Bank Doing Business 2012; and Sustainable Governance Indicators 2011.1/ A composite indicator for public administration outcome based on international surveys on the quality of justice and the level of corruption, both taken from the Global Competitiveness Report, and the levels of bureaucracy in the economy measured by OECD’s Product Market Regulation indicator.2/ Spending on general public services (excluding interest payments) and public order and safety, 2007.3/ Business tax evasion and avoidance: 6 = more than 50% of business is unofficial or unrecorded, 0 = all businesses are registered.4/ The total tax rate measures the amount of taxes and mandatory contributions payable by the business in the second year of operation, expressed as a share of commercial profits.

4. Against this backdrop, the government has recently taken important steps in a wide range of structural areas. Product market liberalization and competition measures, introduced with the several packages in 2011 and 2012, cover many key areas. Administrative simplification reforms to lower the cost of doing business have also been approved. The government’s labor market reform, yet to be approved by the parliament, aims at making the labor market more flexible and inclusive.

5. To assess the potential impact of these reforms, this paper uses a model-based approach. We begin by reviewing product and labor market reforms in Italy (Sections B and C), highlight the main structural problems, and contrast these with the actions proposed. Section D estimates the impact of structural reforms in Italy using a simulation framework. We conclude with a brief discussion of reform priorities and implementation issues.

6. Our main findings can be summarized as follows:

  • Reforms go in the right direction. They cover the key structural bottlenecks in the product and labor markets and address most key priority areas.

  • In product market reform, prompt and consistent implementation is key, especially in the energy sector, where the gains could be sizeable. Labor market reform should aim to lower labor adjustments costs, introduce more flexibility at the core, increase participation, especially among women, and improve activation policies.

  • Three important areas for the public sector reform include: (i) liberalization in the areas where the central government is a major stake-holder; (ii) liberalization and increasing competition in local public services; and (iii) regional differentiation and more flexibility in the public sector employment and wages.

  • The impact of structural reforms on GDP can be sizeable. We confirm the findings from the literature using IMF’s Global Integrated Monetary and Fiscal model (GIMF) showing that policies that would close roughly half the gap in product and labor markets with the rest of the euro area and best practice cases in OECD, respectively, could raise real GDP by 5¾ percent after 5 years and by 10½ percent in the long run. A broader set of reforms including also fiscal measures to lower direct taxation and increase investment spending (both in a deficit neutral way) could amplify the gains and contribute further to closing Italy’s competitiveness gap.

B. Product Markets: Enhancing Competition and Deregulating

7. Liberalizing economic activity and enhancing competition are the main objectives of the ongoing product market reforms.3 Unlike past approach to structural reforms, the latest interventions by the government of Prime Minister Monti are more comprehensive and incisive. In general, the measures aim to address excessive monopolistic rents, reduce entry barriers and information asymmetries as well as remove unnecessary regulation of economic activities. They also address some of the key regulatory shortcomings from the 2001 constitutional reform that re-allocated significant legislative and regulatory powers to sub-national authorities in commercial distribution, energy, and transport, where strong connections to local vested interests exist.

8. The key problems in the product markets and measures addressed in the January 2012 liberalization package are concentrated in the services and public sector (Table 1).4 They cover largely non-tradable sectors, including network industries (energy and transport, also at the local government level), professional services (e.g., legal/notaries, accounting, medical/pharmacists, engineering), and provision of local public services/utilities. Together these sectors amount to about one-third of the total value added in the economy and contribute about 40 percent of total inputs used (intermediate consumption) by other industries and close to 30 percent of the households’ final consumption expenditure.5

Table 1.

Italy: Product Market Reforms—A Summary of Main Problems and Actions Taken

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Source: IMF staff.

Energy Sector

9. Italy’s energy prices are among the highest in Europe, reflecting limited competition and the lack of energy policy coordination across levels of government. High gas prices and large reliance on gas in electricity production have contributed to electricity prices in Italy being 50 percent higher than the European average (Antitrust Authority, 2012), especially for industrial users.6 The limited import infrastructure, the existence of a strong incumbent (ENI) in all segments of gas importation/ transport/storage, and long-term import contracts hamper competition and discourage investments. Achieving coordination on the projects of national interest (e.g., liquefied natural gas (LNG) facilities) is complicated by a veto power of regional/local governments. While also in other countries, sub-national governments exercise such veto power, the project authorization process in Italy is exceptionally long. Information asymmetries discourage competition in the final sale of electricity. Prices of petroleum products (with and without taxes) are also higher in Italy as a result of outdated and oversized distribution network, barriers to entry, and contractual restrictions.

Electricity Prices

(Euro/tonne of oil equivalent)

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: OECD.1/ Peers = Average of Austria, Belgium, France, Germany, Netherlands, Portugal, and Spain.

10. The authorities plan to encourage competition and infrastructure investments by separating the ownership of the gas transport/storage companies from ENI. The modalities of the ownership unbundling have been outlined in the May 2012 decree, which envisages a sale of ENI’s shares in SNAM to Cassa Depositi e Prestiti (CDP). The share transfer is set to be completed by May 2013. Some measures are also in place to address the delays in authorization process for strategic infrastructure projects, promote investments in gas and electricity sectors, and reduce the cost of gas for companies (through additional access to storages) and vulnerable customers. Some restrictions on exclusive contracts between fuel distributors and suppliers have been lifted, and measures to enhance information transparency have been introduced.

Transport Sector

11. The bottlenecks in the transport sector include a fragmented regulatory framework, lack of liberalization in the railways services, and limited competition in the highways industry. Regulatory functions have been scattered among various agencies and levels of government, while not always respecting the distinction between regulator and service provider necessary to avoid a conflict of interest (OECD, 2009a). Progress in improving passenger (especially regional) and freight services has been held back by also the lack of vertical separation in the sector: the state-owned incumbent monopolist (FS) owns both most of railways infrastructure and main transport operators and benefits from government subsidies and entry barriers. The current tariff system and the very long duration of concessions hinder investments in the highways network and limit competition while generating high profits for operators (Antitrust Authority, 2012; Asquer, 2011). Supply restrictions on the taxi services remain despite past liberalization efforts.

12. An independent Transport Authority will be established in the coming months to strengthen the regulatory framework. This represents a major institutional change, with specific measures on the transport sector delegated to the Transport Authority, including on the vertical separation in the railways industry. In some areas, reform guidelines have already been provided, such as extending competitive tendering to the regional passenger railways services and establishing new tariff systems for new highways concessions. However, in taxi services, the role of the Transport Authority will be limited, and the decision on licenses will remain with the sub-national governments.

Professional Services

13. Italy has one of most restrictive regulations in professions among the OECD countries (Figure 1). This has limited competition, protected incumbents’ rent, and increased costs for businesses and households. Unlike most of the OECD, Italy featured (until recently) price regulations, particularly in the form of minimum fees, while entry to and conduct in the market are subject to stringent controls. Pharmacists are particularly heavily regulated (ownership restrictions, limits on number/location/products), while the structure of lawyers’ fees creates incentives to prolong litigation. Regulations also create uncertainty about the ultimate costs of resorting to the justice system. The supply of notarial services is low, reflecting shortcomings in the process of entry exams and the organization of notaries throughout the country. In general, the governance of professional orders creates a possible conflict of interest as some members could be both competitors and responsible for the oversight of the order’s activities and disciplinary matters.

14. Tariffs for regulated professions are being abolished, and a reform of professional orders is underway. The reform, to be completed by September 2012, should ensure liberal access to professions and increase competition by strengthening the governance (including in the areas of training and oversight) and removing restrictions on advertising. A decree to establish parameters for setting professional tariffs is to be issued by the Ministry of Justice by end-July 2012. The number of pharmacies and notaries will be increased, and some restrictions on pharmacies’ activities are abolished. However, reforms have fallen short of a more complete opening up of these sectors.7

Local Public Services

15. Non-competitive contract awards, ineffective regulation, and constraints to economic activities have affected the costs, quality, and efficiency of local public services. These are cross-cutting issues, spanning from gas/electricity distribution and water supply to local public transport, waste industry, and other areas under the competencies of local governments (e.g., commercial distribution).8 The use of “in-house” contracting has created a conflict of interest between regulator (local authority) and service provider (closely linked to the local authority). The devolution process has also contributed to the proliferation of regulations and regulators, but the enforcement of competition rules has been weak, especially given the constitutional autonomy that the sub-national governments enjoy and strong connections to local vested interests. A substantial privatization of local public services has not yet taken place. Overall, in recent years, utility tariffs have increased more in Italy than in other euro area countries, especially in the sectors not subject to independent regulation (OECD, 2009a).

Local Public Services: Cumulated Change in Consumer Prices, 2008–12

(Percent change in HICP components between Jan 2008 and Jan 2012)

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: Eurostat.1/ Available data limit a specific analysis of local public transport services.

16. Stronger enforcement of competition rules for providing local public services is a key focus of reforms. Sub-national governments are required to clearly define public service obligations, provide services through competitive tendering, and deviate only in exceptional cases. The latter will be subject to a mandatory evaluation by the Antitrust Authority. The Antitrust Authority has also been given the power to challenge in court the decisions made at all levels of government that infringe competition. To increase efficiency and reduce costs, service provision will be organized over “optimal territorial areas”. A monitoring mechanism by the Presidency of the Council of Ministers has been set up; sanctions, including fiscal, for non-compliance have been introduced; and instances where the State can intervene within its constitutional “substituting powers” have been broadened. Other changes include providing more flexibility to potential service providers to adjust organizational needs after winning a tender. However, effective implementation of the new framework remains the key issue in light of fiscal pressures at the local level, capacity constraints, and uncertainties arising from frequently changing regulatory framework. While reforms include some measures to encourage asset sales by local governments, more focus on privatization is still needed.

C. Labor Market: Improving Participation and Productivity

17. Making the labor market more dynamic and inclusive are the main objectives of the authorities’ reform proposal. The government’s proposal, as presented in the April draft law, is wide-ranging and addresses most of the key aspects of the labor market (Table 2). In general, the reform aims at tackling job insecurity and dualism, making employment protection and unemployment insurance more even, encouraging more stable employment relationships while also lowering the firing costs, and ultimately increasing employment and participation, especially of youth. The reform also envisages strengthening active labor market policies, but does not address internal flexibility and wage bargaining decentralization. Also, the implications of the reforms for the public sector are left for a future (legislative) action. The draft proposal is still waiting approval from the parliament.

Table 2.

Italy: Labor Market Reform—A Summary of Main Problems and Actions Proposed

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Source: IMF staff.Note: Reforms marked with (*) have already been introduced (in part or fully) in earlier legislation.

18. High inactivity, dualism, and inertia are the main elements of labor market outcomes in Italy (Table 3).

Table 3.

Italy’s Labor Market: What are the Chances

(Percent, unless otherwise indicated)

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Sources: Eurostat; Istat (2011); and IMF staff calculations.

Percent of respective population group.

Results for 25–49 age group are reported for 25–39 age group because of data unavailability.

Transitional probabilities for 2007Q1–2008Q1; probability of finding a job (becoming inactive) is estimated to have decreased (increased) in 2008–10, as a result of the global crisis (Bank of Spain, 2012; Bank of Italy, 2011; Lucarellia and Mussida, 2010).

Non-temporary employees in percent of total employees.

Temporary employees with duration of the work contract <12 months in percent of total temporary employees.

  • For a 15–24 year-old, the chance of being in education is about 60 percent and being employed is slightly over 20 percent compared to over 35 percent in the euro area.

  • For a 40–64 year-old, the chance of being employed is only 60 percent (mainly driven by low female employment) and being inactive about 35 percent (almost 50 percent if a woman).

  • If employed, a 15–24 year-old would have a 50 percent chance that the contract would be open-ended, while for a 40–64 year-old this chance would be over 90 percent.

  • Alarmingly, the transition probability from unemployed to inactive is higher than in other countries, especially for women and in the South (Istat, 2011) while inactivity tends to be almost permanent.

Enhancing Internal Flexibility

19. The need for more flexibility and inclusiveness in the labor market and rigidities at the core have led to increased flexibility at the margin, affecting primarily the youth. The two main reforms—the Treu reform in 1997 and the Biagi reform in 2003—aimed to promote and deregulate temporary and atypical contracts, provide incentives for part-time work to increase employment, and introduce new types of atypical work arrangements (see, for example, Schindler, 2009). As a result, youth (15–24) and female (15–64) employment increased, respectively, from about 25 percent in 1997 to a high of 27.6 percent in 2004, and from 36.5 percent in 1999 to a high 47.2 percent in 2008. However, most of the increase was at the margin: the share of temporary workers among youth increased from less than 20 percent in 1997 to almost 50 percent by 2010. This phenomenon is not unique to Italy, and in fact, the share of temporary employment in total employment in Italy was lower than in Spain and Germany in recent years (Table 4). However, limited absorption of temporary workers9, high youth unemployment (record high at about 35 percent in 2012), a rigid core with little internal flexibility, and abuse of atypical contracts can cause lasting damage to human capital and skill accumulation.

Temporary Employees by Age Group

(Percent of total employees)

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

20. An emphasis on open-ended contracts and apprenticeship, in particular, is a key focus of the reform but more should be done to bridge the gap between permanent and temporary workers. Building upon the existing apprenticeship regime, the reform proposes a few novelties which could result in more stable employment relationships for youth.10 However, apprenticeship contracts have fiscal costs (100 percent exemption from social security contributions) and age limits. A variety of atypical contracts will still remain under the reform, though fixed-term contracts will cost somewhat more (1.4 percent higher social contribution rate). At the same time, some more flexibility in hiring is introduced, and the total duration of fixed-term contracts at 36 months will remain at a higher end compared to, for example, 24 months in Spain and Germany (Table 4).11 To bridge the gap between different types of workers and simplify the system, a more flexible open-ended contract for new workers that gradually increases employment protection with tenure could be considered. This would help encourage hiring by lowering the cost of new regular hires, remove discontinuity in firing costs that employers face, and reduce incentives for excess turnover in favor of longer tenures and skill accumulation.

21. The mismatch between wages and productivity needs to be addressed to raise competitiveness. Italy’s aggregate wage distribution is too compressed, in stark contrast to large regional differences in productivity (Schindler, 2009; Boeri and Perotti, 2004). Indeed, the significant mismatch between wage and productivity growth has increased unit labor cost in Italy’s manufacturing sector since 2000, well above that in Germany and France, and eroded its competitiveness. In this context, the June 2011 agreement among social partners and the August fiscal package (Article 8 of Decree Law 138/2011) which allowed firm-level contracts to derogate from legislation and industry-wide collective agreements by generally binding decentralized agreements were welcome steps but their adoption is slow.12 With exception of some limited fiscal incentives that were re-introduced to encourage firm-level wage bargaining, these initiatives have not received any further push as part of the current reform proposal.

Contribution to Unit Labor Cost Change in Manufacturing and Total Economy, 2000–11

(Cumulative percent change)

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Sources: AMECO and IMF staff calculations.1/ Negative = Increase in labor productivity;2/ 2000–10.

Reducing Firing Costs

22. Employment protection legislation (EPL) in Italy does not appear particularly restrictive at first sight but some elements make firing costs prohibitively high. Both for open-ended and temporary workers, the EPL restrictions place Italy at about the OECD average. However, Italy scores the highest in collective dismissal, because of special costs to employers and cumbersome procedures. The breakdown within the EPL indices points to the length of trial process and possibility of reinstatement following unfair individual dismissal for companies with 15 employees and more (Article 18 of the Workers’ Statute) as the areas where Italy’s performance is particularly weak. Uncertainty and costs associated with dismissals are likely to prompt employers to rely more on temporary contracts to cope with workforce adjustment needs or to deter hiring in general.13 Use of out-of-court settlements is limited while courts are burdened by a huge backlog of labor dispute cases.14

Employment Protection in Selected European Countries, 2008

(Scale from 0=least restrictions to 6=most restrictions)

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: OECD.

23. Proposed modifications to dismissal regulations should allow firms to more flexibly adjust to economic conditions (Table 5). In particular, in case of an unfair dismissal for economic reasons, the reform introduces a possibility of limiting legal remedy to compensation only (equivalent to 12–24 months of salary). Still, the possibility of reinstatement, unlike the original reform proposal, is retained. Compared to other countries, this may still make Italy’s dismissal rules more restrictive (see Table 4). Further, on the positive side, a mandatory conciliation is introduced, the time to lodge a complaint before a judge is reduced (from 270 to 180 days), and the procedures for labor disputes are streamlined. Overall, the modifications may increase the role of judges,15 highlighting the need to improve the efficiency of the judicial system. However, the issue of the backlog of pending cases is not covered, which, if not urgently addressed, may impede the implementation of the proposed labor reform.

Table 4.

Labor Market Institutions and Reforms at a Glance

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Sources: OECD; Eurostat; ILO; and IMF staff.Notes: 1/ Reflects the latest reform proposals, where applicable; 2/ For contracts signed after Feb 10, 2012; otherwise max of 42 m wage; 3/ No severance pay as such; there is an end-of-employment contract indemnity (TFR), a wage share set aside by employer and paid upon employment termination; 4/ Priority given to the use of firm-level agreements over industry or region-wide collective agreements.
Table 5.

Article 18 of the Workers’ Statute—Before and After Proposed Modifications (as of April 5, 2012, draft law)

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Sources: Official reports.

The provisions below apply to employers who have >15 employees within each seat, branch, office or >60 overall, or in case of discriminatory dismissal.

6–12 months wage if the employee sues the employer exclusively on the grounds of formal and/or procedural violations.

Social Safety Net

24. A fragmented and uneven social safety net has added yet another layer to the dualism and inefficiencies in the labor market. Italy’s system of income support for the unemployed relies on a large short-time work scheme (Cassa Integrazione Guadagni (CIG); or Wage Guarantee Fund) and several unemployment insurance benefit schemes. The latter are limited in time and access, while CIG can be substantially more generous but it has traditionally been limited to large firms in manufacturing. In recent years, some schemes have been extended to the workers who were previously ineligible (fixed-term and atypical contracts). This played an important role in containing the impact of the crisis on employment, but the use of CIG hours is still well above the pre-2008 levels, while unemployment has been on a rise. Unlike the German short-time scheme, CIG is not designed explicitly for temporary shocks, but allows also for short-time work in case of structural adjustment, hence potentially delaying needed firm restructuring/liquidation. Also, its expansion was financed through the budget and not employer contributions, providing little incentives to firms to reduce its use (Boeri and Bruecker, 2011). Overall, the lack of a broad and well-developed social safety net inhibits efficient worker mobility and reallocation, both regionally and in terms of skill mismatches.

Hours Worked, Use of Wage Guarantee Fund (CIG), and Unemployment Rate

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Sources: Istat; and Eurostat.1/ CIG hours per 1,000 hours worked.

25. The reform proposal aims to make the unemployment benefit system more universal by 2017, along with extending the wage guarantee funds. A new scheme (ASpI) will be introduced starting in January 2013, which will consolidate the existing non-CIG income support schemes and have a wider coverage, including apprentices and workers with short work experience, but not public sector employees on open-ended contracts. There would be little change in the unemployment benefit and duration from the current regimes. The reform will also have fiscal costs (estimated at €1.7 billion per year), which is expected to be covered in part by higher social security contributions for fixed-term contracts. To improve the current CIG system, the extraordinary CIG—the scheme used in case of firm restructuring and prolonged crisis/bankruptcy—will not apply if business activity ends. The ordinary CIG, however, which covers temporarily suspended workers in manufacturing and construction sectors for up to 12 months, will remain unchanged, while a new wage supplementation scheme will be introduced for other sectors.

Activation and Participation

26. Regional fragmentation, inefficiencies, and limited fiscal resources impede the effective use of active labor market policies (ALMP). Following the 1997 liberalization of job placement services, competencies in ALMP have been devolved to regions, resulting in large heterogeneities in the efficiency of the services provided. Mediation between labor supply and demand both by public and private employment offices is limited. Italy’s spending on ALMP (in percent of GDP) is relatively small compared to other EU and OECD countries, and less than on passive policies. Lack of a single system of skill certification and recognition of vocational/training standards that is acknowledged across the country impedes labor mobility (European Council, 2011). Female labor participation, especially in the South, is particularly low.

27. The reform intend to strengthen active labor market policies and reduce regional differences in employment services. Minimum levels of employment services will be established to help ensure more uniform provision of such services across the country. The implementation risk of these policies, however, is large given the dependence on the regional governments to enact and implement these policies. The specific measures in the area of promoting labor participation, especially among women, are very modest, and only partially address the key issue of Italy’s relatively high taxation of labor, especially for second earners. Some ad hoc tax incentives for hiring women and youth have recently been introduced, but it would be too early to assess their effectiveness.

D. Assessing the Impact of Structural Reforms: Using the IMF’s GIMF

28. An extensive literature finds a positive relationship between structural reforms and economic performance, especially in the long run.16 Four key findings emerge from the recent empirical studies:

Complementing the recent literature, Box 1 discusses an alternative cross-country analysis which looks at the determinants of the change in growth trend. The results, in line with the above findings, suggest that reforms aimed at deregulating product markets, especially network industries, and reducing the share of direct taxes increase the probability of exiting a low-growth phase.

29. Italy-specific empirical results also point to potentially sizeable positive effects of structural reforms on GDP and productivity. In particular:

  • OECD (2009a) simulations suggest that Italy’s labor productivity could increase by about 14 percent over 10 years if its product market (especially professional services) regulation is aligned to international best practice.

  • Bouis and Duval (2011) and OECD (2012b) illustrate that, under an ambitious and broad reform agenda to close the gap with the best practice or most liberal cases (labor market reforms), Italy’s GDP per capita could increase by about 7 percent after 5 years and close to 15 percent after a decade.

  • Forni and others (2011) find that increasing competition in services sector in Italy could raise its real GDP by up to 11 percent in the long run, half of which comes in the first three years.

  • In the National Reform Programme 2012 (NRP, 2012), the authorities estimate that the impact of recent liberalization and simplifications measures could increase the level of real GDP by 2.4 percent over 2012–20 while closing the gap (in terms of the degree of competition, entry barriers, and administrative costs) with the best performers in Europe could raise real GDP by 5 percent by 2020.18

  • The OECD estimates that product market reforms adopted in Italy over 2008–12 could potentially increase TFP by 2–3 percent in 2020 (NRP, 2012).

Turning Points in Growth and Structural Reforms 1/

This box asks whether structural reforms can help economies exit a protracted period of low growth. This is particularly relevant for Italy where growth has slowed down markedly in the last decade (Section I). But slow-growth episodes are not uncommon in general: indeed, growth tends to be highly unstable, and the more typical pattern is that countries experience phases of growth, stagnation, or decline of varying length (Easterly and others, 1993; Pritchett, 2000; Hausmann and others, 2005). While commonly used determinants of growth tend to be more stable, smoothing the growth series for a long-term analysis comes at a cost of removing important variation in growth rates. As an alternative, turning points in growth experience and events around them can be analyzed explicitly. In our analysis, these would be the turning points when countries exited a protracted period of low growth.

Our analysis is related to the recent literature on growth accelerations, which provides partial evidence for the importance of economic reforms for sustained growth takeoffs. The literature has focused on growth acceleration episodes and mainly on the impact of economic openness and political factors, using a mixed sample of developed and developing countries. In particular, Hausmann and others (2005) find that growth accelerations tend to be highly unpredictable and in most cases are not preceded or accompanied by major changes in economic policies, institutional arrangements, political circumstances, or external conditions. Still, they show that economic reform—proxied as the start of trade liberalization—has a significant impact on the likelihood of sustained accelerations, as also confirmed by Aizenman and Spiegel (2010), Xu (2011), and Jong-A-Pin and De Haan (2011).

We use a two-stage approach to estimate the impact of structural reforms on the probability of exiting a low-growth spell. We first identify low-growth episodes within a sample of OECD countries spanning over 1960–2010, and then use a probit model to look at the determinants of the turning point following such episodes.2/ In contrast to the existing studies, we have limited the country sample to the advanced economies, but have significantly expanded the set of explanatory structural reform variables.

Our empirical results suggest that reforms aimed at deregulating product markets increase the probability of exiting a low-growth spell. In particular, deregulation of network industries has a statistically significant impact: the predicted probability of exiting a low-growth spell varies in the range of 0.09–0.18 if a reform effort is taken to deregulate network industries. When combined with reform efforts in liberalizing the domestic financial sector and reducing public sector ownership in the economy, the predicted probability increases to almost 0.40 (column 3).

Other predictors show expected signs but employment protection reforms do not yield robust results. A reduction in the share of direct taxes in the total tax revenue (column 4) and being open economy (column 5) increase the predicted probability of exiting a low-growth phase. Real effective exchange rate depreciation, in contrast, has not been found statistically significant (column 6). Also, employment protection reforms yield unstable results (not reported here), likely as a result of data limitations.

Predicting Exit from Low-Growth Episodes: Probit Regression Results

(Dependent variable: Dummy variable for the timing of exit from low-growth phase)

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Source: IMF staff estimates.Notes: Annual data over 1960–2007 (sample period varies); robust population-averaged estimation; z-statistics in parentheses; ***(**, *) = significant at the 1 (5, 10) percent level; time fixed effects are included but not reported.For definition/sources of the variable: See Ostry and others (2009) for Reform effort_network industries and Reform effort_financial sector; Conway and Nicoletti (2006) for Reform effort_public ownership; Share of direct taxes is the sum of income, payroll, and social security contribution taxes in total taxes (OECD); Openness is the share of exports and imports in GDP (OECD); and REER depreciation is the change in CPI-based real effective exchange rate (OECD).
1/ Based on Lusinyan (2012).2/ A period is defined a low-growth episode if the annual (logarithmic) growth rate of real per capita GDP is below g¯-percent over at least 7 consecutive years, where g¯ is the estimated growth rate from a pooled (OLS) regression of the growth rate on the initial real GDP per capita level. Alternative definitions have also been used.

The Model and Simulation Design

30. The impact of structural reforms is simulated using the IMF’s Global Integrated Monetary and Fiscal model (GIMF) (see Annex).19 Because of the presence of monopolistic competition in firms and in labor markets, GIMF can be used to generally assess the effectiveness of structural reforms in those markets, through markups on the price of non-traded and traded goods, and on wages. This is useful, since structural reforms are usually framed in terms of making those markets more competitive, for example, through reducing entry barriers. The labor market in GIMF, while containing a wage markup, is relatively simple, as only total hours are modeled, with no true distinction between unemployment, participation, and working-age population. However, through a proper mapping to the labor supply shock, GIMF can capture most labor reform measures.

31. The standard calibration of GIMF is augmented with additional information for Italy and the euro area. Liquidity constrained households make up 25 percent of all households, in both Italy and the rest of the euro area. The share of non-tradable sector accounts for roughly 50 percent of the economy.20 The markups are calibrated to be consistent with data from Forni and others (2010) for wage and price markups, such that the non-tradable sector price markup is 61 percent versus 35 percent for the rest of the euro area, and 17 percent for tradable sector price markups. As for the wage markup, we follow the assumption in Forni and others (2010) and use the same values as for the non-tradable sector price markup.

32. As with any macroeconomic model, our analysis has limitations. GIMF can only approximate the extent of the reforms, as the model is restricted to two sectors, tradable and non-tradable goods. This makes the direct analysis of specific reforms, such as a reduction of professional services costs, or a cut in the energy costs as a result of more competitive energy market, only approximate, through the broader aggregates. Also, since the analysis is conducted around an initial steady state, it does not account for differences in cyclical position that can affect the impact of policies, especially in case of labor market reforms (OECD, 2012b; Bouis and others, 2012). Finally, different from Cacciatore and others (2012), this model does not capture well the hiring-firing dynamics which can be important for assessing short-term effects of structural reforms.

33. The analysis is conducted along two approaches used in the literature: A positive approach, which shows a range of possible outcomes for two major areas of structural reform—policies that promote competition in the non-tradable sector and increase flexibility in the labor market. These are achieved by lowering the markup on prices in the non-tradable sector and on wages. For Italy, price markups in the non-tradable sector are high relative to the rest of the euro area, and there are indications that this is also true for the wage markup.21

  • We consider an array of reductions in the markups for non-tradable goods and wages (5, 10, 15 and 20 percentage points), where the policy reform is phased in over five years.

  • Policy is either immediately credible or stepwise credible. The former assumes households and firms believe government policies to be permanent, and markups adjust permanently. In the latter, households and firms believe that the policies will lead to no further reductions in markups in the following years, so that the future announced path of policy changes has no effect on current decisions by households and firms. However, since the government continues to implement its new policies over time, households and firms eventually perceive the entire change to be permanent, after 5 years. The difference in the outcomes between the immediately and stepwise credible policies is only over the short/medium term.

A normative approach, which uses the distance-from-frontier approach, whereby the gap between Italy’s indicators and the best practice in OECD and euro area is assumed to be closed in part.

  • For labor market reforms, we use the OECD estimates and a methodology developed in 2011 for the IMF’s contribution to the G-20 Mutual Assessment Process.22 For product market reforms, we base our reforms on the data and assumptions in Forni and others (2010). The specific reform measures and proxies used in the simulations are reported in Table 6. The bulk of the reforms are implemented over the 2013–18 period and assume that the reform measures will close roughly half the gap between the current situation in Italy and a best practice measure (the OECD for labor markets, rest of the euro area for product markets).23 For product market reforms, in particular, closing half the gap over a five-year period may still be ambitious considering deeply-rooted structural problems.

  • We supplement these simulations with an analysis of the impact of (deficit neutral) fiscal policies based on tax and expenditure switching, which could potentially enhance growth.

Table 6.

Main Reform Measures and Proxies Used in Simulations

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34. Product market reforms introduced by the Italian authorities are expected to increase competition, especially in the non-tradable sector. As discussed above, we map these reforms through a reduction in price markups over a range of values given uncertainties in the impact and implementation of these measures. In mapping product market reforms into the model (QUEST III) parameters, NRP(2012) distinguishes between specific measures which are expected to: (i) increase competition in both tradable and non-tradable sectors (price markup reduction); (ii) reduce entry barriers (price markup reduction); and (iii) reduce administrative costs (reduction in overhead labor, i.e. a shock to labor demand).24 However, we do not distinguish between these cases mainly because of model limitations.

35. Our labor market reforms reflect the authorities’ reform agenda to introduce more flexibility in the labor market and increase its inclusiveness. To achieve this, we consider first a reduction of wage markups over a range of values, and, in the case of the normative approach, more flexibility in employment protection, stronger activation policies, and higher female participation (through childcare support measures).

Simulation Results: Positive Approach

36. A sustained reduction in the non-tradable price markup could increase output by over 4 percent in 5 years and almost 10 percent in the long run (Figure 5). Consumption, investment, and exports are over 8 percent higher in the long run. While real wages increase by almost 10 percent, labor productivity increases by more as a result of capital accumulation, resulting in a slight reduction in unit labor costs. Hours worked is slightly lower in the long run as a result of a stronger income than substitution effect. These policies produce a real exchange rate depreciation of up to 5 percent (for details of the transition dynamics, see Annex). In the medium term (5 years), when the markup reduction process is still ongoing and the model dynamics have not settled yet, the outcomes differ from the long-term results. Investment is much stronger than consumption, hours worked are still increasing as the substitution effect from higher real wages outweighs the income effect, and productivity has not yet caught up with higher wages to lower the unit labor cost. Imports increase by more than exports although the real exchange rate already shows a small depreciation.

Figure 5.
Figure 5.

Italy: Immediately Credible Reduction in the Non-tradable Price Markup over 5 years

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: IMF staff estimates.Note: Horizontal axis=time (years), and SS=steady state.

Italy: Reduction in the Non-trable Price Markup over 5 years

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: IMF staff estimates.Note: Horizontal axis=time (years), and SS=steady state.

37. When households and firms find the reform measures to be not immediately but stepwise credible, the rise in real GDP will be slower. Much of the gains from increased competitiveness come from the perception of a future increase in wealth from the promised continuation of the reform process, by the households that can save, allowing higher consumption in the present. When the reforms are stepwise credible, this source of increased consumption is no longer present.

38. The labor market also behaves very differently under immediately credible and stepwise credible policies. In an immediately credible scenario, firms and households foresee the potential for future production, and more labor is used in the short run, until such time that firms can invest enough to generate a higher capital stock to permanently increase their productive capacity. In the case of stepwise credible policies, the labor response is much weaker, as no long-run needs are perceived. After year five, labor will pick up as the full future benefits are understood, and firms still do not have enough capital in place. So, in the immediately credible case, labor peaks early (in year 3) and declines, while in the stepwise credible case, labor builds gradually, peaks at a lower level (in year 5), but sustains the peak for longer. Once credibility is established, the results are the same as under the full credibility case, after about 10 years, as the economy has almost adjusted to its long run path.

39. Labor market reforms that could help reduce wage markups would raise output but at a more modest rate than product market reforms (Figure 6). After 5 years, real GDP gains, relative to the baseline, vary from 0.5 percent (under a 5 percentage point reduction in the wage markup) to about 3 percent (under a 20 percentage point reduction in the wage price markup). The long-run impact on GDP would be similar. As the labor market becomes more flexible and competitive, labor supply will increase in both the medium and long run. As a result, real wages will decline beyond just the fall in the wage markup. Labor productivity will decline slightly (between 0.25 percent and 1 percent in the long run), but unit labor cost will decline, too (for details of the transition dynamics, see Annex). Compared to product market reforms, the impact of a commensurate wage markup reduction on consumption and investment is more muted, but, in the medium term, exports grow faster and imports decline although the size of the real exchange rate depreciation is similar.

Figure 6.
Figure 6.

Italy: Immediately Credible Reduction in the Wage Markup over 5 years

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: IMF staff estimates.Note: Horizontal axis=time (years), and SS=steady state.

Italy: Reduction in the Wage Markup over 5 years

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: IMF staff estimates.Note: Horizontal axis=time (years), and SS=steady state.

40. As a special case, a reduction in the markup in professional services can be considered. Our calculations imply a small impact on the overall wage markup: a 20 percentage point cut in the wage markup in the professional services sector is approximately equal to a 1.7 percentage point cut in the economy-wide wage markup.25 The growth impact of this would be relatively small, about 0.3 percent in the long run, most of which will be achieved in the medium term. However, this is likely to underestimate the impact of increasing competition in the professional services since non-cost aspects, such as length of procedures that effect the business environment, are not fully taken into account. These factors, as Figure 2 shows, are as important in Italy as direct costs. Indeed, in OECD (2009) simulations, a reform of professional services is showed to give the most significant effects on labor productivity when compared to the effects from other sectoral reforms (energy and retail).

41. Combining product and labor market reforms would reinforce the effect of the reforms on output and hours worked (Table 7). On average (with a 10 percentage point reduction in both price and wage markups), output gains would reach over 3 percent after 5 years and almost 6.5 percent in the long run. Product market reforms would strongly boost consumption even as labor market reforms act as a drag, especially in the short run. Hours worked would increase in both the medium and long term, and real wages would still be higher despite downward pressure from the labor market reforms. Unit labor cost would decline, and a strong labor productivity increase, driven by product market reforms, would dominate. In the medium term, the asymmetries in real exports and imports would also disappear as the rise in import from product market reform would match the rise in exports from reducing labor costs. Since effects on the rest of the euro area would be driven by the trade balance, the overall spillovers would be small as exports and imports would be roughly in balance.

Table 7.

Reforms in Italy and the Rest of the Euro Area

Scenario: 10 percentage point reduction in non-tradable (NT) price and wage markups

(Percent deviation from baseline)

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Source: IMF staff estimates.

Italy: Reduction in Both the Non-tradable and Wage Markups over 5 years

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: IMF staff estimates.Note: Horizontal axis=time (years), and SS=steady state.

42. When product and labor market reforms in Italy are implemented in the context of wider euro area product market reforms, the gains for Italy would increase (Table 7). Assuming that the euro area, as a whole, implements reforms on the same scale as that carried out by Italy, Italy’s gains will be reinforced. As in the case of Italy, there is an increased demand for imports, as households become wealthier in the long run. Since Italy has strong trade linkages with the rest of the euro area, exports by Italy will increase, to meet increased euro area demand.

43. Overall, our results on the GDP impact of structural reforms are similar to those found in the literature as well as the authorities’ recent estimates. Forni and others (2010) find that a reduction of the Italian service price markup to the level prevailing in the euro area (around 25 percentage point reduction) could increase real GDP by close to 11 percent in the long run. This is close to the 10 percent real GDP increase when simulating a 20 percentage point reduction in GIMF, where also close to half of the GDP increase would materialize in the first five years.26 For the case of Germany, Gomes and others (2011) find that a 15 percentage point reduction in services markups could raise real GDP by about 4.5 percent in the long run (and a similar impact from reducing wage markups). Spillovers to the rest of the euro area would be positive but small, and simultaneous reforms in Germany and rest of euro area would have large positive effects on the euro area. Hobza and Mourre (2010) look at a similar set of reforms that increase competitiveness in labor and product markets and find a similar impact on GDP as in our simulations. the response of real GDP Finally, in assessing the impact of the recent liberalization and simplification measures, NRP (2012) estimates that these measures would result in about 2 percentage points reduction in both tradable and non-tradable price markups by 2020, with an estimated increase in real GDP by 1.2 percent. Simulating such markup reductions in GIMF would result in very similar estimates.27

Simulation Results: Normative Approach

44. Comprehensive product and labor market reforms are needed to bring Italy’s economy closer to other euro area countries and the OECD best-practice frontier. For product markets, we look at the impact of reforms that could increase competition and productivity especially in non-tradable sector toward those in the rest of the euro area by lowering costs for doing business. For labor market reforms, our focus is on the policies that would increase efficiency in the labor market (lower adjustment costs and better job matching) and boost labor participation, and we use the OECD best practices frontier to quantify the reforms. Furthermore, cross-cutting fiscal reforms which would—in a deficit-neutral way—lower the labor tax wedge and increase infrastructure spending are considered.

45. In particular, the impact of the following reforms are analyzed (for further details, see Table 6):

  • Increasing competition in product markets (tradable and non-tradable): Reducing barriers to entry and exit, lowering the cost of professional services, reducing other business costs, such as energy costs for the tradable sector, and providing local public services on a more competitive basis.

  • Easing employment protection: Reducing costs of labor adjustment for the firms, and lowering bargaining power of insiders.

  • Strengthening active labor market policies: Encouraging the unemployed or those no longer participating in the work force to retrain to fields with greater employment, leading to an overall increase in labor supply; increasing government spending for ALMP programs.

  • Increasing female participation: For example, increasing the availability of childcare available to women (through increased government spending).

  • Shifting taxation from direct to indirect taxes: Lowering both labor and corporate taxes, offset by broadening the VAT base.

  • Shifting expenditure from transfers to investment: Shifting expenditure composition from general lump-sum transfers to infrastructure investment.

46. All product and labor market reforms have a positive impact in the medium term, and together, could raise real GDP in Italy by 5¾ percent after 5 years and by 10½ percent in the long run (Table 8). The reforms with the greatest impact are those that affect the competitiveness of the non-tradable sectors given the assumed large reduction in markups to close half of the gap with the rest of the euro area. The labor market reforms focused on labor supply are smaller since in the areas of employment protection legislation, active labor market policies, and childcare services, Italy, according to the OECD estimates, is not as far off from best practices. Moreover, the effects of these reforms on productivity and GDP are empirically found to be relatively small (e.g., Barnes and others, 2011; Bouis and Duval, 2011), even more so when government spending associated with these measures (in case of ALMP and childcare) are offset as assumed in our simulations. Finally, in the short run, their impact is muted also because of the assumed stepwise credibility of the reforms (per design of the exercise) such that the future shocks are not fully taken into account in households’ and firms’ decisions in the first years. Yet, given these factors, the effects of labor market reforms are not inconsequential.

Table 8.

Italy and Euro Area: Combined Reforms Scenario

(Percent deviation from baseline)

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Source: IMF staff estimates.

Italy: Product and Labor Market Reforms—Decomposition of Real GDP

(Percent deviation from baseline)

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Source: IMF staff estimates.

47. There appears to be a payoff from doing all product and labor market reforms simultaneously, as also shown earlier. The impact of the total simultaneous reform package is greater than the sum of the components. This result is somewhat counter to the recent findings by OECD (Cacciatore and others, 2012) arguing that in the long run there might be substitutability, rather than complementarity, between product and labor market reforms. The degree of complementarity in our simulations reinforces the point that a broad reform package would be highly beneficial.

48. A tax reform to shift taxation from direct to indirect taxes could promote growth, hours worked, and exports (Figure 7). In particular, a tax reform package, which lowers both labor and corporate taxes (by 2 percent of GDP combined), offset by broadening the VAT base, could raise GDP relative to the baseline 0.5 percent on impact and by up to 2 percent in the long run. Hours worked, after a positive short-term reaction, will be marginally higher in the long run (although the real wage will increase by 1.3 percent). Exports will rise by about 1.5 percent in the long run, while the real exchange rate will depreciate by less than 1 percent. While an increase in consumption taxes will lower the amount consumed by households, the distortions removed by lowering corporate and labor income taxes are much greater. Moreover, the labor income tax cut will offset the negative effects from consumption taxes on households’ spending power and will provide an incentive for more labor supply. The corporate income tax cut will reduce the cost of capital faced by firms, encouraging greater demand for capital, investment goods, and labor.

Figure 7.
Figure 7.

Italy: Fiscal Reform

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: IMF staff estimates.Note: Horizontal axis=time (years).

49. An expenditure reform to shift government expenditure from transfers towards investment (by 1 percent of GDP) would produce larger gains. Spending on infrastructure has the greatest return: instead of the fiscal outlay just entering real GDP on impact for that year, it improves the stock of infrastructure (for example, in key network industries) in Italy, making all sectors more productive as a whole. Therefore the temporary increase in government investment in infrastructure leads to a long-lived and persistent gain in economy-wide productivity. To make this increase in spending neutral, general lump-sum transfers, which have a smaller negative multiplier, are cut. On net, real GDP will be 1 percent higher on impact, and more than 5 percent in the long run, relative to the baseline.

50. The gains in growth might be delayed if the fiscal reforms are not perceived as fully credible in the short run.28 In the case of tax switching, households and firms would not perceive the long-run benefits from lower labor and corporate income taxes, but the short-run costs of higher consumption taxes would be relatively high. In contrast, if households and firms perceive the expenditure switching as temporary, there would still be positive gains, just fewer than in case of a immediately credible reform. Additional infrastructure spending, even temporarily, would provide a large short-run fiscal multiplier, as there would be a temporary but long-lived public capital stock improvement that would increase economy-wide productivity.

Italy: Combined Reforms Scenario—Decomposition of Real GDP

(Percent deviation from baseline)

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Source: IMF staff estimates.

51. By combining fiscal reforms with product and labor market reforms, real GDP in Italy could increase by about 8½ percent after 5 years and almost 22 percent in the long run (Table 8). In this case, we assume the switch in tax composition is one-off, and therefore fully credible from the beginning. The expenditure switching, however, occurs over 5 years, and is not fully credible until year 5. Nonetheless, by including fiscal reform, the effects of the package are roughly twice as large. Plus there are some synergies. Increased real GDP from the higher productivity also increases the tax revenues collected, and can amplify the fiscal multipliers of the tax switching. This is also true of the expenditure switching measures. And the productivity of the economy, already improved by product market reform, has its effects amplified by the productivity-enhancing effects of the higher government infrastructure spending.

52. Implementing a comprehensive package of structural reforms could contribute to closing Italy’s competitiveness gap accumulated over the past decade. In particular, IMF’s estimates suggest that the competitiveness gap (real exchange rate overvaluation) could be of the order of 5–10 percent.29 Our simulations suggest that the above discussed structural reforms, especially in product markets and fiscal reforms, could result in real exchange rate depreciation of close to 3 percent after 5 years and over 7 percent in a decade. Unit labor cost would decline, by just about 4½ percent after 5 years, as increased labor productivity more than offsets the increase in wages. In the short run, however, the current account would deteriorate reflecting higher investment relative to private savings. In the medium term, real exports rise faster than real imports, although real imports would accelerate in the short run from stronger investment that is taking advantage of tax reform and productivity gains. In addition, the price shift from the depreciation (terms of trade deterioration) would adversely affect the nominal trade balance. In the long run, however, current account would converge to zero and turn slightly into surplus.

Italy: Combined Reforms Scenario - Impact on Competitveness

Citation: IMF Staff Country Reports 2012, 168; 10.5089/9781475506525.002.A001

Source: IMF staff estimates.Note: Horizontal axis=time (years), and SS=steady state.

53. In sum, a combination of structural reforms in the product market, labor market and fiscal sector will produce long-run gains for the Italian economy. As the results from the positive approach suggest (Table 7), these effects could be reinforced if the rest of the euro area engages in similar reforms simultaneously. Also, there will be positive feedback effects across the different types of reforms, as demonstrated particularly with the labor and product market reforms. Moreover, the fiscal reforms could provide positive feedback effects for labor market reforms, as they use many of the same channels, particularly productivity, and could provide a stimulus for greater consumption and labor supply.

E. Reform Priorities and Implementation

54. Italy needs comprehensive reforms to raise growth and restore competitiveness. To increase competition and productivity in product markets, there is a need to further open services sector, especially, professional services, key network industries, and local public services; reduce entry barriers; and promote investment in productive infrastructure, thus lowering the costs of doing business. In the labor market, reforms should focus on allowing firms and workers to more easily adjust to changing economic conditions by: (i) reducing uncertainty and costs associated with employment protection; (ii) promoting more internal flexibility and closer link between wages and productivity; and (iii) improving employability and efficiency of job matching process of the work force at the same time as also augmenting labor participation. Reforms coordinated at a wider European level could be beneficial for all.

55. The reforms introduced by the authorities go in the right direction but more needs to be done.

  • In the product market reform, the agenda is comprehensive, and its consistent, sustained, and early implementation is key. Depending on the implementation and hence on the achieved reductions in price markups, the economic gains could be sizeable: the real output could increase by 4½ percent in the medium term if the reforms could close half the gap in the degree of competition with the rest of the euro area. Well-targeted and timely executed infrastructure projects in the areas of main network bottlenecks could further increase productivity in the economy with significant implications for potential output, as our simulations suggest.

  • In the labor market, the impact of the reforms that bring Italy close to the OECD best practices in employment protection legislation, active labor market policies, and female participation support through childcare services could be relatively modest. However, there is an important scope to strengthen the proposed reform further. More needs to be done to increase flexibility of the core via more firm-level arrangements that favor employment rather than wages and to bridge the gap between permanent and temporary workers. A tax reform to lower the labor tax wedge and remove disincentives for labor supply, especially for second earners should be considered.

  • Growth-friendly fiscal reform, by shifting taxation from labor and corporate tax to indirect taxes and by prioritizing public expenditure away from general transfers toward more targeted infrastructure spending could lead to significant growth and competitiveness gains.

56. The signaling role of the public sector is important both for the reform impetus and credibility. There are three key areas where public sector reforms would be particularly important: (i) liberalization in the areas where the central government is a major stake holder (e.g., gas sector); (ii) liberalization and competition where local governments play the major role (local public services); and (iii) regional differentiation and more flexibility in the public sector employment and wages.

57. Rigorous monitoring of the reforms should be a priority, and the authorities should stand ready to intervene if policies appear ineffective in addressing reform priorities. Implementation of structural reforms can face a number of challenges because of unfavorable macroeconomic environment, reliance on sub-national governments, and pressures from ongoing fiscal adjustment. Stepwise credible policies could delay the potential gains from reforms, as our simulations suggest, emphasizing also the need for a more predictable regulatory and legal environment. To increase credibility and effectiveness of the reforms: (i) consideration could be given to establishing an independent review and advisory body for reforms (“growth commission”) which could foster consensus and focus policies on priority areas, while ensuring the continuity of the reform agenda; (ii) the competition enforcement framework should be effectively applied (especially in the areas of local public services, transport, and local business regulations); (iii) a strong buy-in from sub-national governments should be garnered; and (iv) efforts to monitor, assess, and communicate on the reform progress should be reinforced.

58. Other reforms that are essential for the success of labor and product market reforms would need to be implemented in parallel. In particular, without improving the efficiency of the judicial system, labor marker reform implementation will be hindered, with the result that dismissal costs may remain high and uncertain. The envisaged streamlined procedure for labor disputes as well as special business courts to deal with industrial disputes can be important in accelerating judicial procedures, provided the implementation is not impeded by the huge backlog of outstanding cases. Strengthening contract enforcement, streamlining legal procedures, and reducing costs should be a key priority in any reform aimed at improving Italy’s business environment.

Annex: IMF’s GIMF and Transition Dynamics

GIMF is a multi-region micro-founded dynamic stochastic general equilibrium (DSGE) model. The version used in this analysis has six regions: Italy, the euro area (excluding Italy), emerging Asia, Japan, the United States, and a remaining countries bloc. GIMF has optimizing behavior by households and firms (divided between tradable and non-tradable goods sectors), and full intertemporal stock-flow accounting. Frictions in the form of sticky prices and wages, real adjustment costs, liquidity constrained households that cannot save, and households with finite planning horizons that can save give the model certain key properties—notably, an important role for both fiscal and monetary policy.

For fiscal policy, GIMF has certain advantages. It is based on the Blanchard-Weil-Yaari overlapping generations model, which leads to a significant break in Ricardian equivalence. Therefore households can save and choose to hold government debt, which is important for permanent fiscal reforms. This saving-investment decision means that large-scale reforms in large countries lead to long-run movements in the global real interest rate. This non-Ricardian feature is complemented by the presence of liquidity-constrained households that cannot save.

The fiscal rule maintains a deficit-to-GDP target (equivalent to a long-run debt-to-GDP target), with an endogenous countercyclical response of general lump-sum transfers based on an output gap measure, parameterized as found in Girouard and André (2005). Fiscal policy is conducted using seven instruments—government spending, government investment (infrastructure spending), general lump-sum transfers, lump-sum transfers targeted to liquidity-constrained households, the consumption tax (VAT), the corporate income tax, and the labor income tax.

In each region, monetary policy is an inflation-targeting regime in tandem with a flexible exchange rate regime. The monetary policy rule is a standard CPI-inflation-forecast-based interest rate reaction function. For Italy and the rest of the euro area, they are governed by one interest rate reaction function, based a euro-area-wide measure of CPI inflation, where Italy has a weight of roughly 1/6th.

Impact of a Permanent Increase in the Non-tradable Price Markup

Policies to promote competition in non-tradable sector lead to a reduction in price markups. This leads to a reduction in costs in the non-tradable sector, similar to an increase in productivity in the non-tradable sector. Demand for the factors of production increase. Consequently, the real wage increases, leading to higher households’ wealth, resulting in higher consumption. The higher demand for capital also stimulates investment, both in order to accumulate a higher capital stock, and to maintain its permanently higher level.

The real exchange rate depreciates, as the relative price shifts between tradable and non-tradable goods in Italy. The adjustment however is restricted by the nominal exchange rate peg required maintain the monetary union (but interest rates still have some reaction to the economic developments in Italy, unlike a conventional nominal exchange rate peg). The real depreciation, strongest against the rest of euro area, leads to higher real GDP in the rest of the euro area from cheaper imports.

On the price side, there is downward pressure on prices from production, but slightly higher from stronger domestic demand. In the short run, inflation increases slightly, but falls after about 2 years. However, the policy rate is governed by the monetary union, and Italy is only a small portion (roughly ⅙th). Since the rest of the euro area is subject to a sustained increase in aggregate demand and inflationary pressures, there is a sustained increase in the euro area-wide policy rate.

In the long run, output is higher across the euro area, particularly in Italy, and there are higher real wages. The higher real wage and stronger consumption lead to consumers decreasing their supply of labor in the long run. However, on the demand side, there is a shift in the use of labor from the non-tradable to the tradable sector, as tradable firms hire more workers in order to take advantage of their higher export opportunities from the permanent depreciation. After 20 years, real GDP gains, relative to the baseline, vary from 2 percent (under a 5 percentage point reduction in the non-tradable price markup) to over 10 percent (under a 20 percentage point reduction in the non-tradable price markup).

Impact of a Permanent Increase in the Tradable Price Markup

Policies to promote competition in tradable sector lead to a reduction in price markups. This leads to a reduction in costs in the tradable sector, similar to an increase in productivity in the tradable sector. Demand for the factors of production increase. Consequently, the real wage increases, leading to higher households’ wealth, resulting in higher consumption. The higher demand for capital also stimulates investment, both in order to accumulate a higher capital stock, and to maintain its permanently higher level.

The real exchange rate appreciates, as the relative price shifts between tradable and non-tradable goods in Italy. The adjustment however is restricted by the nominal exchange rate peg required maintain the monetary union (but interest rates still have some reaction to the economic developments in Italy, unlike a conventional nominal exchange rate peg). However, the euro area still imports cheaper goods from Italy, which depresses their GDP, and dampens inflation, leading to euro-area-wide interest rate cuts.

On the price side, there is downward pressure on prices from production, but cycles higher from weaker monetary policy. In the short run, inflation falls slightly, but rises for about after about 2over the first 10 years, before decelerating. The inflation dynamics are driven by the decline in euro-area-wide interest rates.

In the long run, output is in Italy, and there are higher real wages, but roughly unchanged in the euro area. The higher real wage and stronger consumption lead to consumers decreasing their supply of labor in the long run. However, on the demand side, there is a shift in the use of labor from the tradable to the non-tradable sector, as tradable firms face the negative effects of the permanent appreciation.

Impact of a Permanent Decrease in the Real Wage Markup

Reforms to make the labor market more flexible and competitive lead to a lower wage markup by households. Costs in both the non-tradable and tradable sectors will decline, and the demand for labor will increase by firms, as wages fall in the short run. In the medium to long run, households benefit from higher wealth, as both the amount of workers increase, while the fall in the real wage from the drop in the markup is mostly offset by higher labor demand boosting the real wage. In the more competitive environment, households also supply more labor, which contributes to the lower real wage. Overall labor income rises, and there is higher consumption. The higher demand for labor also stimulates demand for capital, so investment rises in order to accumulate a higher capital stock, and to maintain its permanently higher level.

Since the cut in the wage markup is tantamount to an increase in productivity across the economy, the real exchange rate depreciates. The adjustment however is restricted by the nominal exchange rate peg required to maintain the monetary union (but interest rates still have some reaction to the economic developments in Italy, unlike a conventional nominal exchange rate peg). The real depreciation, strongest against the rest of euro area, leads to stronger growth in the rest of the euro area from cheaper imports, although this effect is quite small.

On the price side, there are downward pressure on prices from production, but slightly higher from stronger domestic demand. In the short run, inflation increases slightly, but falls after about 2 years. However, the policy rate is governed by the monetary union, and Italy is only a small portion (roughly ⅙th). Since the rest of the euro area faces little impact from the reforms in Italy, there are no inflationary pressures in the euro area, so the euro area-wide policy rate remains effectively unchanged.

In the long run, output is higher in Italy, and there are lower wage costs, leading to higher labor demand. However, there is upward pressure on the real wage (that is, much of the cut of the markup is offset), as stronger consumption and wealth leads consumers to face downward pressure on their supply of labor, given their utility function. So in the long run, consumption and investment is higher, as is output, labor is stronger, and wages are only slightly weaker.

There is little effect in the rest of the euro area. As with the price markups on non-tradable goods, households and firms find the policy reform measures to be stepwise credible, the rise in real GDP will be much slower. Once credibility is established, the results are the same as under the full credibility case, after some additional time has passed, and the economy has adjusted to its long run path.

Other Shocks

An increase in labor supply: Higher labor supply lowers the real wage, lowering the costs of goods for both home and foreign markets. There will be downward pressure on inflation, although there will not be a strong response on the part of the ECB, since Italy is only ⅙th the euro area, and will have limited impact on the euro-area-wide measure of inflation. In GIMF, the substitution effect generally outweighs the income effect slightly, so labor income will be higher, allowing for higher consumption. Investment will be higher from the increased demand for capital to complement the increase in labor available for production. In general, with more labor available, the effects of other shocks considered in the simulations will be amplified.

An increase in government spending: As government spending increases, real GDP increases immediately. The increase in aggregate demand will lead to higher inflationary pressures, but with only a minimal impact on the setting of the monetary policy rate, as Italy is only around ⅙th of the euro area. So there will not be much crowding out of real activity from monetary policy. However, increased spending also increases the government debt burden (albeit only slightly with the proposed reforms), which leads to increased crowding out of investment in debt-financing markets, and reduced fiscal room for other spending. The debt burden can be offset by either increasing taxes (distortionary or lump-sum), or decreasing other spending (such as lump-sum transfers, or government infrastructure investment).

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1

Prepared by Lusine Lusinyan (EUR) and Dirk Muir (RES). The authors are grateful to Gianluca Esposito, Benjamin Hunt, Yan Liu, Isabelle Mouysset, Justin Tyson, the staff of the Ministry of Economy and Finance and of the Bank of Italy, and other interlocutors during the 2012 Article IV Consultation mission for helpful discussions and comments.

2

Some estimates, for example, put the value of assets almost at the same level as the debt (Reviglio, 2011).

3

The recently updated OECD Product Market Regulation (PMR) indicators show that the overall PMR indicator has improved from 1.3 in 2008 to 1.2 in 2012, becoming less restrictive than the 2008 EU and OECD averages (Figure 1), with the indicator on the regulation restrictiveness in professions improving significantly to reach the 2008 average of the EU and OECD (NRP, 2012).

4

The package (DL n. 1/2012) was approved by the parliament on March 24, 2012 (Law n. 27/2012).

5

Not included here are financial/insurance activities, telecommunication, public administration, wholesale/retail trade, and accommodation/food services. For some of these areas, more general measures to abolish/reduce regulatory and administrative restrictions are introduced in the January 2012 liberalization and simplification packages.

6

Energy products constitute about 4 percent of total inputs used (intermediate consumption) by other industries, mainly manufacturing (Eurostat, Input-output tables, 2008). Italy is among the five most energy dependent countries in Europe (83 percent of its energy needs are met by net imports versus 54 percent for EU-27 average).

7

Efforts have been uneven and at times suffered setbacks, including most recently relating to the transparency requirements for professional fees (providing preliminary estimates of the cost of the service is not legally binding) and liberalization of pharmaceutical products.

8

There are, however, regional differences in the extent of these problems, which manifest in large productive disparities across regions (e.g., see IMF, 2011).

9

In 2008, estimated 65–70 percent of workers on atypical contracts found themselves in the state of precariousness after two years (UniCredit, 2012).

10

Three new types of open-ended apprenticeship contracts were introduced in 2011. In exchange for training services, these contracts allow employers to pay a wage below the level stipulated by collective agreements. Some guarantees are also provided to prevent employers from dismissing apprentices during the training period (OECD/ILO, 2011). The reform proposes to condition new contracts on past conversion into open-ended positions and increase minimum duration and share of apprentices.

11

Some suggest, however, that in the absence of a minimum wage, higher fiscal costs would simply be shifted to temporary workers, by lowering their wages (Boeri and Garibaldi, 2012a).

12

Already with the Mirafiori agreement of December 2010, Fiat chose to regulate labor relations through first-level plant agreements, abandoning the traditional reference point of the metalworking industry-wide agreement and the practice of second-level supplementary collective agreements at company and plant levels. In December 2011, the Federation of Metalworkers (Fiom-CGIL) left negotiations with Fiat on a new group-level agreement when Fiat declared the basis for talks would be the Pomigliano agreement of December 2010, which Fiom had refused to sign. The new first-level agreement was signed on December 13, 2011, covering some 86,000 workers and including common group-wide minimum wage rates. Fiom, which did not sign the new agreement, will not be allowed to have company-level representatives. Reflecting concerns over the effective implementation of the June 2011 agreement and the August package, Fiat withdrew, as of January 2012, from all existing collective agreements and left the Confindustria representation system, which governs Italian industrial relations. http://www.eurofound.europa.eu/eiro/2011/11/articles/it1111029i.htm.

13

Schivardi and Torrini (2008) find also that the firms’ growth slows down around the threshold of 15 employees above which the obligatory reinstatement is applied. However, they also note that the effect of stringent employment regulations on the firm size is quantitatively modest.

14

The Ministry of Justice’s statistics for 2009 indicates that over 300,000 labor dispute cases were pending in the 1st instance and in appeal, for both private and public sector employment disputes. Separately, ISTAT noted, in 2001, that the average length of a labor-related dispute in the 1st instance was 917 days and 884 days in appeal, for a total average length of labor-related disputes of almost 5 years.

15

Boeri and Garibaldi (2012a,b) argued that the reform, even in its original version, would give vast powers to judges, emphasizing also asymmetries in legal remedies depending on the reasons for dismissal and the fact that collective dismissals may cost less than individual ones.

16

For a detailed literature survey, see, for example, IMF (2011), and Schiantarelli (2010) for a comprehensive survey of the literature on the impact of product market regulation on macroeconomic performance.

17

For an average OECD country, the overall GDP gains from undertaking an ambitious and comprehensive package of product and labor market reforms (EPL) as well as reforms of unemployment benefit, labor tax, and pension system, could reach 10 percent over the next decade.

18

Also, a recent analysis by the Antitrust Authority, conducted in collaboration with the Bank of Italy, suggests that full and immediate implementation of the liberalization measures advocated by the Antitrust Authority would raise (as mapped through the OECD PMR indicators) the value added in the manufacturing sector by 2.2 percent in six years.

19

For a more detailed description of GIMF, see Kumhof and others (2010). GIMF differs from the Global Economy Model (GEM), used in Everaert and Schule (2008), as it has a fully endogenous determination of the net foreign asset position, because of its overlapping generations framework. It also has a richer fiscal framework, and a more realistic baseline fiscal rule.

20

According to the Eurostat’s input-output tables, the share of the energy, other utilities, construction, trade, transport, professional services and services sectors in total value added in Italy amounted to about 47½ percent in 2008.

21

In general, price markups, which measure the degree of competition in a sector, are found to be higher in non-tradable (services) sectors than in tradable (manufacturing) sectors across countries (e.g., Christopoulou and Vermeulen, 2008; Forni and others, 2010; Gomes and others, 2011). However, the average markups, especially in services are much higher in Italy than in other advanced economies. For example, Christopoulou and Vermeulen (2008) estimate that, over 1981–2004, the markups for the manufacturing/construction sectors were on average 1.18 and 1.23 in the euro area and Italy, respectively, while the markups for the services sector were 1.56 and 1.87 in the euro area and Italy, respectively.

22

The data is provided by the OECD for use in the G-20 Mutual Assessment Process. The methodology employed, and the results of the 2011 exercise can be found in IMF (2011a) “G-20 Mutual Assessment Process: From Pittsburgh to Cannes - IMF Umbrella Report”.

23

Some measures have fiscal outlays, so there is a 1-year delay in implementation, so that the government does not have to change its fiscal projections for the upcoming fiscal year. Also, we assume that polices are stepwise credible (until fifth year) such that the future path of shocks is not fully taken into account in households’ and firms’ decisions in the first years. This assumption affects only the short-term dynamics.

24

To complete the mapping, NRP (2012) assumes that recent liberalization and simplification measures will have a similar impact on price markups and business costs as estimated in the case of earlier major structural reforms.

25

Professional services contribute 6 percent of total value added in Italy and 10 percent of total intermediate consumption used by the industry (about 7 percent of total inputs to manufacturing and almost 12 percent of total inputs to non-tradable sectors). If we assume labor is roughly 60 percent of factor costs at the intermediates level, then professional services make up roughly 16 percent of labor costs. The wage markup in the Italian labor market is assumed to equal to the price markup in the non-tradable sector of 53 percent (consistent with Forni and others, 2010, of 61 percentage points, minus 8 percentage points markup at the final goods level, which is in GIMF, but not in Forni and others, 2010). 16 percent of 53 percent is roughly 8.5 percentage points, so a 10 percent reduction in the wage markup exclusive from professional services will translate to a 0.85 percentage point reduction in the wage markup for the entire Italian labor market.

26

However, the investment response is not as strong in GIMF, but the increase in real wages and exports as well as the terms of trade deterioration are similar. The differences in the response of labor and the size of the real effective exchange rate depreciation are likely driven by the differences between models. Forni and others (2010) also find that the impact of labor market reforms is smaller than in the case of product market reforms, but we find an even more muted impact from the wage markup reduction.

27

This is not surprising given similarities between GIMF and the QUEST III model used in NPR (2012). See Table 1 in Coenen and others (2012) for a comparison of the two models.

28

This is a common property across many macroeconomic models, and is also found in the literature. See Coenen and others (2012).

29

See, IMF 2010 and 2011 Article IV Consultation Staff Reports.