Europe Economy

Five Labor Market Flaws Italy Needs to Fix

Italy's new Prime Minister Mario Monti is expected to win a confidence vote in the Chamber of Deputies on Friday after having won a vote in the Senate late on Thursday with pledges to cut widespread tax dodging and reform rigid labor markets.

ROME, ITALY - NOVEMBER 16: New Italian Prime Minister-designate, Mario Monti, speaks during a press conference to present the new government, at Quirinale Palace, on November 16, 2011 in Rome, Italy. Following the resignation of Italian Prime Minister Silvio Berlusconi, after a political career spanning over 20 years, Prime Minister designate Mario Monti presents the new Italian government. Their main task is to resolve Italy's deepening financial crisis within the Eurozone and address the cou
Giorgio Cosulich

But this is just the beginning of a series of substantial and painful reforms that Italy has to make to its "dual" labor market if it wants to reduce its debt burden and escape the credit crisis which has nearly engulfed it, analysts told CNBC.

They identified five main problems — among them, over-regulation and low productivity — the country needs to tackle to make its economy more competitive.

“Without reform, Italy is going to have continued problems with income inequality, poor labor productivity, uncompetitive exports, and high youth unemployment,” Mark Willis, Western Europe analyst at Roubini Global Economics, told CNBC.

“Without the economy being able to expand, it has no chance of reducing its debt burden,” he said. 

A sharp divide exists between employees on permanent contracts, who receive extensive protection from redundancy and wage freezes, and those on short-term contracts, who are generally more poorly paid and much easier to let go.

“If there’s a firm with a mixture of both types of employee, it will tend to cut those on temporary contracts, regardless of who is the most or least productive,” said Ben May, European economist at independent research firm Capital Economics.

“If labor market reforms meant everybody received more equal protection, perhaps somewhere in between [the two extremes currently afforded to different workers], that would be beneficial,” he added.

High Youth Unemployment, Income Inequality

The dual labor market has resulted in high income inequality in Italy, as well as low levels of participation among women and young people, who are less likely to obtain permanent contracts. 

The youth unemployment rate is particularly high, reaching 29 percent in 2010.  In comparison, Italy’s overall unemployment rate was 8.5 percent. 

Other than low participation, Italy’s labor market is also hampered by industry-wide collective wage bargaining, which can result in inflated paychecks.

“There is collective wage bargaining across entire sectors, making it difficult for employers to adjust to difficult economic circumstances. It is very difficult to decrease wages, and wage levels may not be a proper reflection of living costs,” said Willis.

May said: “Some firms end up paying their workers more than productivity developments reflect. A more localized bargaining model might be better, meaning people are paid what they deserve, with a closer match between productivity and wages.”

Italy’s wage bargaining model has contributed to a fall-off in labor productivity. 

“Real wage growth has outpaced productivity growth, contributing to sharp and sustained increases in unit labor costs since 2000,” said Fitch Ratings analysts, David Riley, Gergely Kiss and Raffaele Carnevale, in an October 2011 report.

As a result, Italy’s products and services have become increasingly uncompetitive in the global market, losing out not only to developing nations, but also euro zone competitors like Germany.

“Since the economic recovery, Italy has not recovered at all in exports; it has lost its share of the global markets,” said Willis. 

Over-Regulation Impedes Business

The competitiveness of Italy’s products, and particularly, its services, is also impeded by over-regulation. Certain professions require licenses to practice, in others, such as law, there are minimum tariff rates. According to Willis, "closed professions" include pharmacy, taxi driving, public notary and licensed tour guiding. 

Previous attempts to reform Italy’s labor market have been hampered by opposition from politicians (particularly those on the Left), incumbent monopolies, public sector workers and public- and private-sector unions.

For instance, in 2008, union opposition to the privatization of airline Alitalia ended the prospect of a takeover by Air France, while in July 2011, the government dropped proposals to liberalize professional services due to parliamentary resistance.

The installation of former European Union commissioner, Mario Monti, as the prime minister of a technocrat government, has increased the prospect of changes being made, said Willis.

However, he warned that labor market reforms typically take years rather than months to be applied.

“They should have been introduced 10 years ago. In the short-run, trying to implement these reforms while moving into recession is likely to have a negative effect; it will increase unemployment,” he said.