Italy’s economic miracle is not what it seems

Missed opportunities for growth are clouding the outlook

Is Italy experiencing a new economic miracle? When manipulated, numbers can say anything you want them to. But there are limits. And if we leave the demagoguery aside, the figures still do not seem to offer much hope for Italy’s long-term economic prospects.

First, we should put aside the bad habit of attributing the economy’s successes and failures to the current and previous governments. In the short term, economic performance rests on factors that are not entirely under the control of any government in office. It mostly depends on exogenous variables and policies cumulated over the years – for better or worse.

It would instead be more beneficial to make a careful and independent estimate of the effectiveness of the new policies introduced – something which in Italy has been done very little and sometimes even badly. Effective economic policy actions can make a difference to a country’s prospects if consistently built up over time.

Attempts at economic reform

Having removed any pointless political controversy, the question remains of whether, with the slightly more reassuring data of recent times, it is appropriate to talk about a structural recovery of Italy’s economy that goes beyond the short-term stimulus to demand. After all, the fundamental objective of Next Generation EU and the various anti-crisis packages was to facilitate structural reform through investments and temporary support. It is an economic objective, but it is also a political one.

The various attempts to reform the Italian economy have always clashed with the need to make the reforms socially compatible and somehow compensate for the short-term political and social costs. Temporary demand support is a way to overcome these obstacles. Therefore, European and national funds for digitalisation and climate transition should not only be spent well but also help to raise the country’s economic growth potential. Can we say that this is happening?

Despite some undoubtedly positive moves linked to the National Recovery and Resilience Plan, the impression is that the current efforts are aimed at ticking the boxes agreed with the European Union to obtain new funds without the current government convincingly taking ownership of the reform process. The €45.6bn of the NRRP resources spent by the end of 2023 – 2.2% of gross domestic product – is insufficient to change these prospects. But there is three times as much left to spend by 2026.

Deteriorating public finances

During the pandemic, Italy decided to introduce the Superbonus 110%, a generous subsidy scheme to allow the energy-efficient renovation of residential buildings. It ended up impinging on the same sectors supported by the EU-funded investment plan, resulting in significant capacity constraints and misallocation of resources. It also brought a massive deterioration in public finances.

Its returns in terms of economic growth appear to be short of expectations. According to data up to February 2024, total investment reached €113.1bn, of which €111.6bn was allowed as tax credits and €104.5bn (93.6%) of works were completed. Adding all other bonuses, the total amount might have reached €200bn, which is around 10% of Italy’s GDP.

Even assuming that only half of the renovation works would not have happened without the benefits and that other types of investment activity have been crowded out, the GDP impulse appears modest. The impact might have been much more significant, and the underlying performance was most likely dismal. With such a massive fiscal stimulus, one wonders whether Italy’s 4.2% GDP rise since 4Q19 – slightly above the euro area’s 3.5% – is indeed something worth celebrating.

The effects on GDP growth of demand stimulus, whether related to European funds for digitalisation or linked to the Superbonus, tend to vanish if they do not lead to an increase in productive capacity. Meanwhile the debt remains, and interest on debt tends to grow as a percentage of income. Italy will also have to repay its part of the EU debt on top of the additional national debt in the future. The Maastricht-definition accrual-basis net borrowing was 7.2% in 2023, boosted by the frontloaded recording of the Superbonus. The impact on cash borrowing, and thus on public debt, is mostly yet to come as it will emerge once tax credits offset fiscal revenues. This will make it challenging to reduce Italy’s public debt over the coming years.

Amid a political and economic constraint not to further increase taxes and the well-known difficulty in compressing current public spending, the risk is that Italy is moving ever closer towards a point of no return. Radical and politically difficult actions would be needed that only a government with a medium-term perspective can undertake. The current government enjoys a large majority in parliament and opinion polls. Therefore, regardless of political colour, it should be able to take up this challenge.

Declining productivity and growth

Italy has been in structural decline, and not just since the 1990s. Productivity problems are much longer-standing, deeper, more entrenched and thus more concerning. Total factor productivity –a measure of technological advancement, innovation and the ability to efficiently use factors of production – has stopped growing since the mid-1970s. Since the 1970s, Italy has artificially propped up its GDP growth with continuous devaluations of the lira and an enormous expansion of public debt. However, once these artifices were no longer possible due to the process of convergence towards monetary union, GDP stopped growing.

It is not enough to move incrementally to reverse all this. An unprecedented commitment and a true economic revolution is needed. Everything should be directed towards a long-term vision, including the funds granted by the EU precisely to help Italy face its challenges.

In ‘Meritocracy, Growth, and Lessons from Italy’s Economic Decline’, Giampaolo Galli and I identified the red line that runs through Italy’s recent history: the lack of meritocracy, or the broader concept of incentive structure or markets and rules. The ‘incentives’ should not be those of the public budget, given generously to make this or that interest group or voter happy. There should be clear and simple rules to ensure that economic players do not spend their time trying to evade taxes, grab state incentives or bypass market rules. Instead, they should focus on the critical dimensions of human capital and competitiveness. This is the real revolution that Italy deserves. Can we say that this is happening?

Despite the massive use of public money, economic data suggest a modest overall impact on GDP growth. Structural indicators show Italy still languishing between 30th and 35th place in international rankings on the various dimensions of growth and prosperity. Even anecdotal evidence allows for little optimism. Businesses and workers continue complaining about Italy’s old problems that have impeded its growth in recent decades.

Therefore, the moderate economic recovery from the pandemic seems mostly linked to a massive stimulus to demand, with modest repercussions on the supply side. It could even be argued that the effects of the stimulus and the underlying performance were both disappointing. What will remain of the current economic growth when the European funds, the Superbonus and the other demand stimuli financed by Italian or EU public debt have run out in two or three years?

Making the correct diagnosis is an essential first step. So many diagnoses have been made in the past that it would be enough to act using only part of them to restore momentum to the Italian economy. However, there seems to be no overall vision or coherent strategy for its implementation.

Lorenzo Codogno is Founder and Chief Economist of Lorenzo Codogno Macro Advisors and Visiting Professor at the London School of Economics.

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