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Italy's Outlook Dismal After Monti Reforms

Prime Minister Mario Monti may have saved Italy from ruinous default, but the growth potential of Europe's most sluggish economy is as weak as ever, and that means prospects for lasting debt reduction remain fragile.

Mario Monti
Alessia Pierdomenico | Bloomberg | Getty Images
Mario Monti

Thanks to his decisive austerity measures and personal credibility, the economist and former European commissioner has put Italy back at the centre of European decision making and helped to lower its borrowing costs.

Yet only by boosting its growth potential — the ability to grow consistently without generating inflation — can he hope to lower a debt pile of more than 120 percent of output, second only to Greece's in the euro zone.

With the end of Monti's term just six months away, and no clarity about what sort of government will follow him let alone how committed it will be to austerity and deregulation, most economists say progress on this front has been disappointing.

"I think that Italy's growth potential is exactly what it was when Monti arrived," said Daniel Gros, head of the Brussels based Centre for European Policy Studies (CEPS).

Italy grew at an average rate of 0.25 percent per year in the decade to 2011, the worst performance not only in the EU but also among the G20 and the 34 states that make up the Organisation of Economic Cooperation and Development (OECD).

The economy is once again in steep recession, forecast by economists to contract by around 2.5 percent this year. The OECD says its growth potential is now a paltry 0.3 percent.

The government aims to cut the debt from 123.4 percent of gross domestic product this year to 114.4 percent in 2015. The debt ratio could fall to 100 percent of output in 2019 and 60 percent in 2025, according to the government.

However, this depends on borrowing costs stabilizing at pre-crisis levels, tough austerity at least until 2015 and a return to stable and steady growth.

The combination of all three looks like wishful thinking. The economy is already shrinking far more than the government forecast, deficit reduction is off target and belt tightening will continue to weigh on falling domestic demand.

Societe Generale projects that under the Italian growth profile it expects — weaker than the government's — debt will still be above 120 percent of GDP in 2020.

Gros said Italy's growth potential had fallen because of years of corruption, weak application of laws and declining administrative efficiency at all levels.

"Turning things around would take years of dedicated attention from a number of governments, supported at the local level and by popular consensus," he said. "I don't see that in Italy at present."

This month, the World Economic Forum put Italy 42nd in its world competitiveness table, which measures a raft of criteria from judicial independence to accounting standards -- below countries like Poland and Panama.

On labour market rigidity, Italy actually fell one spot from last year to 127th of 144 countries, despite Monti's labour reforms which were supposed to make the system more flexible.

Tax Hikes

When Monti replaced scandal-plagued Silvio Berlusconi last November, he rushed through 20 billion euros of deficit cuts to placate markets, including a tough pension reform that raised the retirement age.

Monti was forced to start with deficit cuts to try to meet Berlusconi's pledge to balance the budget by 2013, a target that has now slipped. Yet Italy's real problem was never the deficit, which was already among the lowest in the EU, it was growth.

Even the pension reform, considered Monti's most convincing measure by far, assumes growth will average around 1.5 percent in the medium term, or six times its rate over the last decade.

Moreover, three quarters of Monti's belt tightening was made up of tax hikes — the opposite approach to that recommended by the European Commission, which prefers spending cuts —crushing already weak domestic demand and deepening the recession.

Giacomo Vaciago, economics professor at Milan's Cattolica University, said Monti may even have reduced Italy's potential growth by aggravating the second steep recession since 2008, because businesses being destroyed will never be replaced.

"The size of the market economy is still shrinking and business people are worrying that we will never return to our production capacity of 2007," he said.

Monti, a former economics professor, has paid much lip service to growth, but the reforms passed to achieve it are generally considered far more timid than his austerity drive.

These have focused mainly on labour reform, a package to deregulate some service industries which he dubbed "Grow Italy" and a set of measures to cut red tape called "Simplify Italy".

The reforms are frequently described as impressive by European leaders concerned about the survival of the euro, but it is hard to find an economics professor or business leader in Italy who says the same.

The labour reform, aimed at easing firing restrictions and reducing temporary contracts, was panned by employers' lobby Confindustria for being hard to interpret, increasing the role of the courts and raising costs for business.

Monti's service deregulation package, touching on a range of sectors from insurers to taxis, was dismissed by the Bruno Leone free market think-tank as "timid and ineffective".

The government says its deregulation and simplification measures alone can raise growth by 0.2 to 0.3 percentage points per year — a major impulse for a stagnant economy — but most independent analysts are sceptical.

"The changes were useful but that estimate seems very excessive and I don't think it's credible," said Tito Boeri, economics professor at the same Bocconi University in Milan where Monti was rector.

After parliament's approval of the "Grow Italy" deregulation plan, the OECD forecast Italian growth between 2012 and 2017 would average just 0.5 percent, even lower than debt-stricken Greece and the lowest rate of 41 countries it assessed.

Implementation Gap

"In Italy the biggest problem is not so much the laws as their implementation," said Gros.

"You liberalize partially but some regulations must remain and they have to be implemented, and that is the problem. It's the same with the labour market reform. Labour disputes will go to the judges, and then will their decisions be made and implemented in 10 days, or in a year? No one knows."

In May, the OECD said the government needed "to close the gap between legislation and its effective implementation, traditionally wider in Italy than in many countries."

There are signs that this gap has actually widened under Monti, because he does not have a party behind him to press reluctant bureaucrats into putting his measures into practice.

According to business daily Il Sole 24 Ore, out of some 400 measures approved by parliament under Monti, around 350 still lacked the administrative authorizations needed to make them operative, including most of his Grow Italy package.

"We all applaud Monti's attempts but we will all be disappointed by the effects," said Vaciago. "Almost nothing is fully operative, and it is impossible to argue that Monti has increased Italy's growth potential in the slightest."

There are numerous examples of reforms announced but either not approved by parliament or not put into practice, from the abolition of the provincial layer of government, to a ceiling on public sector pay, to a reduction of defence employees.

"This is an unelected cabinet of outsiders which struggles with the machinery of government," said Vaciago, "Why should bureaucrats cooperate with a government that proposes to reduce bureaucracy?"

One gauge for what Monti has achieved might be the letter of reform prescriptions sent by the European Central Bank to Berlusconi in the summer of 2011 as Italy's borrowing costs soared to crippling levels.

To help growth it called for a "major overhaul of the public administration"; "the full liberalisation of local public services and professional services,"; "large scale privatisations", a roll-back of collective wage bargaining to encourage company-level pay deals and a "thorough revision" of hiring and firing rules to make dismissal easier.

All this was supposed to be done through emergency decrees to be adopted inside a couple of months.

The list was probably unrealistic, especially so quickly, and Berlusconi tried vainly to play for time before being forced to resign. Monti has made modest progress on the areas he has addressed, but most remain untouched.

The public administration is unreformed; there have been no privatisations, no liberalisation of local public services and no changes to collective wage bargaining.

"The ECB's letter was a series of recommendations which haven't been followed or have been followed only very weakly, and that's why we are still in our current situation," said Gian Maria Gros-Pietro, economics professor at Rome's LUISS university and a board member at carmaker Fiat, the country's largest private company.

Contact Europe: Economy

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