Italy ranks 5^th in the global league for tourist destinations, and its easy to see why, beautiful countryside, great weather and a rich legacy of art and culture.  But, these historic assets have been unable to prevent Italy being one of the worst-performing economies in the past 25 years.

Since the millennium, Italy’s GDP per capita has not only slipped behind every major economy but actually declined. Stuck in a spiral of stagnation, high debt and low growth, Italians have become used to falling real wages, whichever measure you use, it looks grim for the Italian economy.

It wasn’t always like this, when Italy joined the EEC in 1958, it was the poorest of the founder members – over the next few decades, helped by EEC transfers, Italy saw rapid growth as it caught up with other European countries. By the late 1980s, Italy had the same per capita living standards in $ terms as Germany. But, from 2000, there has been a spectacular decline.

10 Reasons for Italian Economic Decline

1. Cronyism

In an Economic paper Bruno Pellegrino, argues a very significant factor is Italy’s tendency to nepotism and cronyism, which has led to poor quality management. The NBER paper argues that Italian firms do not promote managers based on a meritocracy but on cronyism. This became a particularly serious barrier to growth with the IT revolution from the late 1990s. With poor management and inertia, Italian firms were not flexible enough to deal with the rapid advances in technology. The paper argues this cronyism is not just about firms, but related to other aspects of Italian society such as the legal system, government and the awarding of contracts. The result is a stifling of enterprise and growth and an acceptance of mediocrity.

2. Entry into Euro

Italy’s economic decline happened to coincide with its entry into the Euro. In the post-war period, Italy’s economic growth relied on rising wages and then devaluation in the Lira to restore competitiveness. In the Euro, Italy needed a new economic model which didn’t rely on devaluation. They needed to improve competitiveness by introducing much needed structural reforms to increase competition, reduce closed shops, improve innovation and increase investment. But, unfortunately, the opposite happened. Italy’s labour costs rose, and productivity dramatically declined. But in the Euro, there was no fall back – they could neither devalue or cut interest rates. The result was a decline in economic growth. In the first decade of the Euro, the Economist reports, that with the exception of Haiti and Zimbabwe Italy had the worst performing economy in the world.

3. Political inaction

The Italian economy was like a slow motion car crash. It needed attention, but it never came to a head a real crisis like say the Greek economy. Italy desperately needed a huge range of reforms to revitalise the economy for the modern world. But, any long-term reforms were difficult with frequent changes of government. Since the Second World War, Italy has had 68 governments in 77 years. It’s no wonder economic policy has been somewhat piecemeal.

4. Productivity collapse

Since 1999, Italian productivity has declined and this is the key factor underpinning the dreadful economic performance. Whilst Germany and Sweden invest up to 3% into research and development, Italy has one of the lowest at 1.5%.

5. Education

Education is another problem, with Italy having one of the lowest rates of higher education in Europe. Italy has the 2^nd highest rate of young people not in employment, education or training in the EU behind only Romania. The perceived poor quality of higher education deters young people from entering university creating a cycle of lower skills, that prevents upward mobility. In fact, young people are leaving Italy in droves. 10% of highly educated Italians live abroad, the highest rate in the developed world.

And given Italy’s demographic decline, this is a loss of young, skilled workers they can ill-afford. In the past 10 years, Italy has already seen a fall in the working-age population. And with one of the lowest birth rates in Europe it has a rapidly ageing population and its population is forecast to halve from 60 million to 30 million within the century, and that forecast was before Covid, accelerated the decline in birth rates.

Despite a long running debt crisis, which we will look at soon, Italy spends 16% of GDP on pensions, another unwelcome European record. It’s hard to invest in education and new skills, when there is a burden of an ageing population. The fall in the birth rate is so acute, remote towns and villages are literally running out of people. With an ageing population it becomes more difficult to transform an ailing economy. Italy needs more young entrepreneurs and skilled workers, not less. Even with regard to female participation in the labour market, Italy has the lowest rates in Europe.

6. High debt

For the first seven years of the Euro, it was much cheaper for Italy to borrow and so Italy continued to borrow, with public debt remaining above 100% of GDP. Originally, the Maastricht criteria for joining the Euro had limited public debt to 60%. But to accommodate Italy, the Maastricht criteria were quietly forgotten. But, then in 2010, disaster struck, the global recession led to a surge in borrowing, and markets took fright at levels of debt in southern Europe. Bond yields in Italy surged as markets no longer were willing to give Italy the benefit of the doubt. In response, the government chose to pursue prolonged austerity, which reduced demand in the economy. In the 2010s, debt as a % of GDP continued to rise. You may think this reflects profligate spending, but actually, it doesn’t. Throughout the 2010s, Italy has run a primary budget surplus, which means after paying interest payments on debt, government spending is actually less than tax receipts. The problem is that high debt causes a large interest burden and the very low Italian growth rates make it hard to reduce debt to GDP. It’s the worst of both worlds, high debt, and low growth. Government austerity caused weak demand. Now if the private sector had been strong, it wouldn’t matter, but the private sector in Italy has myriad problems of its own.

7. Chinese Competition

In the 2000s, world trade was liberalised and Italian firms soon fell behind much more efficient Chinese manufacturing firms.  Italian firms lacked the willingness and ability to invest in new technology.  Italy attracted a low share of Foreign direct investment Italy has a surprisingly small number of large firms. In Italy 70% of employers work for firms of less than 50 people, in the US, it is 33%. In the post-war this dependence on small firms helped the economy to be more flexible. But, in the 2000s, they were swamped by bigger multinationals exploiting huge economies of scale.

8. Difficulty of doing business

The World Bank ease of business index which measures the cost and difficulty of doing business in a country ranked Italy 57^th, just behind Kenya and Kosovo. This includes prohibitive regulations, local corruption and cosy relationships between the state and local business lobbies. For example, the Economist points to the example of family run balneari who run beach-side establishments. They rake in €10bn a year but despite being on public land, the government receives only €100m. The EU has sought to promote competition in this lucrative business – it would mean lower prices for consumers, a chance for new entrepreneurs and greater incentives to be efficient. But, the lobbying power of entrenched interests have successfully blocked competition; this kind of closed shops are common in other areas of the Italian economy such as taxis. Incumbents are protected with jobs for life, whilst the unemployed struggle for opportunity.

9. North-South Divide

Another issue is that the Italian economy suffers from an acute north south divide with GDP per capita at least 40% lower in the south. Unemployment is higher and opportunites less. Some say, this divide goes back to pre-unification and the cultural and social divides of the time. But, this is a weak reason, In 1870, the north south divide was much less and many countries with such economic divides tend to see them reduce over time. Italy’s divide has persisted for decades, with the problem exacerbated by outflows of people from the south.

Any good news for Italy? Unemployment rate has fallen in recent years, still high by European standards, but at least moving in the right direction. Not everything is about economics, Italy is ranked 11^th in terms of life expectancy.

You could argue there are advantages to an economy based on family business and family ties. It may be less innovative and dynamic, but more personal than ruthless multinationals. Not everything is about GDP per capita. But, without productivity growth, everything becomes harder, not least dealing with climate change, ageing population and high levels of government debt. Lorenzop Codogno a professor who wrote on Italy’s decline claimed Draghi’s reforms may have worked if he had 10 years rather than 21 months.

Sources

• Reforms needed in Italy – Economist
• External Shocks have hit Italy hard
• Italian economic problems – Economist
• Lessons from Italy’s Economic Decline.