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Why does Italy not grow?

At this point in 2014 (in September), the prospects for Italian growth and inflation have weakened considerably—they may well be close to zero for the year. By U.S. criteria, as Frankel (2014) points out, Italy is now in a six-year-long recession. Indeed, the Italian economy has barely grown since it joined the euro area in 1999.

By: and Date: October 10, 2014 Topic: Macroeconomic policy

In April this year, the Italian debt-to-GDP ratio was expected to peak by year-end at 135 percent of GDP. That projection assumed a real GDP growth rate of 0.6 percent and inflation of about 0.7 percent. The projected decline in the debt ratio starting 2015 required a step up in growth and inflation along with historically large primary budget surpluses.

Italy is now in a six-year-long recession and has barely grown since joining the euro in 1999

However, at this point in 2014 (in September), the prospects for Italian growth and inflation have weakened considerably—they may well be close to zero for the year. By U.S. criteria, as Frankel (2014) points out, Italy is now in a six-year-long recession. Indeed, the Italian economy has barely grown since it joined the euro area in 1999.

The stakes are high. With the government committed to an austerity mode for several years, growth and inflation are likely to be held back. And households facing tougher times are unlikely to open their pockets and start spending. The public debt ratio could rise relentlessly. An urgent search is on for a restart to Italian growth.

Much hope has been pinned on “structural” reforms to jump start growth. Germany’s Hartz reforms are often invoked as the example to emulate. But as the recent research reaffirms (Dustmann et al., 2014), German growth after the Hartz reforms was due primarily to a prior, nearly decade-long, restructuring of German businesses in concert with labor and new outsourcing networks in Eastern Europe. These investments allowed the leverage of deep German expertise in manufacturing in an unusually buoyant period of world trade between 2003 and 2007. 

Italy has been technologically and physically aging for some decades. It has been unable to keep pace with the technological demands of a competitive global economy. The Italian technological lag reflects a falling behind in educational standards: low growth and weak investment in technology and human capital have reinforced each other. The aging population has made reversing these trends a formidable task.

The Miracle Fades

The Italian economic “miracle” after the Second World War was the economy bouncing back from devastation. Barry Eichengreen has described the bounce back as extensive growth—economic reconstruction based on widely-available techniques, requiring limited domestic technological effort to enhance and differentiate. Much of the early growth came in the agricultural sector, where this characterization was especially appropriate. However, that early dividend was self-limiting and growth gradually slowed down (Figure 1a). However, growth slowed everywhere in Europe—and, starting as a “poorer” country, Italy’s faster growth allowed it to catch up by the 1990s (Figure 1b).

Italy’s virtual economic stagnation after 1999 reflects, above all, a dismal productivity performance.

Italy, however, had not prepared to replace the fading momentum of the post-war bounce with a new source of growth. After the oil-price-induced turmoil in the second half of the 1970s, growth required more intensive domestic technological effort. But Italy was unable to rise to that challenge. Hassan and Ottaviano (2013) report that Italian total factor productivity began a steady decline from its 1970s pace, turning negative in the years after Italy joined the euro area. Italy’s virtual economic stagnation after 1999 reflects, above all, a dismal productivity performance.

In the rest of this article, we compare Italy’s economic performance with that of Sweden, which again raced ahead while Italy struggled to grow. France, which falls in between the two, helps emphasize the forces we focus on.

The Innovation Gap

We use the number of patents registered by the residents of each country in the United States patent office. By focusing on the United States, we apply the high standards of the world’s most competitive technological environment. As figure 2 shows, despite swings over time, Sweden has continuously had a sizeable lead over Italy (and France) in terms of patenting propensity.

In turn, the Swedish patenting advantage derives from its lead in research and development (R&D).  While Swedish R&D ratios have been in the range of 3.5 to 3.8 percent of GDP, the Italian ratios have been between 1 and 1.3 percent of GDP. France has fallen in between at about 2¼ of GDP. The differences in R&D propensities across these countries represent two sources. Sweden moved to a “high-technology” based production economy in the 1990s after a period of eroding international competitiveness in the 1980s. The higher Swedish R&D ratio reflects, in part, the fact that high-tech production sectors are, by definition, more R&D intensive. But, in addition, a sectoral analysis shows that Italian R&D ratios are lower even when compared sector-by-sector. In other words, not just the composition of production, but an overall lag explains the lower Italian R&D ratio.

Compromises between egalitarianism and efficiency have largely resulted in achieving neither, as Italy has fallen behind its peers

The Swedish innovation lead is attributed to many factors—more public support of entrepreneurship, university-business links, availability of venture capital. However, at its core, Swedish innovation capacity and growth derive from the country’s long-standing commitment to education.  This proposition mirrors the diagnosis by Alesina and Giavazzi (2006) and Bertola and Sestito (2011) that at the root of Italian economic ills is an education gap. Bertola and Sestito conclude that a set of compromises between egalitarianism and efficiency have largely resulted in achieving neither, as Italy has fallen behind its peers.

The Education Gap

Figure 3a—an index of human capital per person—shows that Italy’s human capital is of lower quality than Sweden’s (and France’s) human capital. The index reflects a combined measure of years of education and returns to education in the domestic economy, providing a general measure of how much education contributes to a person’s economic life in each country.  

In 2012, only 18% of the Italian labor force had some tertiary education, compared to Sweden’s 34%

Italy measures even more poorly against Sweden when rates of tertiary education are isolated (Figure 3b). Ang, Madsen, and Islam (2011) find that tertiary education is more appropriate to innovation, whereas primary and secondary education are more useful for adopting foreign methods and technologies. In 2012, only 18 percent of the Italian labor force had some tertiary education, compared to Sweden’s 34 percent.  Bertola and Sestito (2011) emphasize that not only in terms of quantity, but the Italian quality gap relative to peers has also increased over time.

Piero Cipollone (2010) suggests that Italian educations levels are low because returns to education are relatively low in Italy. This tends to be self-perpetuating. The OECD (2012) reports that children of poorly-educated parents are often caught in a low-education trap. Additionally, Figure 4 shows that government spending on education in Italy is also relatively low when compared to Sweden and France. Indeed, in 2011, Sweden invested 6.82 percent of its GDP on education, France 5.68 percent, and Italy only 4.29 percent of its GDP.  Not only do Italians invest less in their education because of lower returns to their efforts; the Italian government also sees it as less worth its while to spend money on education.

As the Italian growth crisis digs in, the returns to education continue weaken, compromising future growth. With high unemployment, Italian children are at elevated risk for underperforming in school or even dropping out of school (OECD, 2012).

The Demographics

With an ever declining share of young citizens, who are likely to be most technologically dynamic, the demographic trend is aggravated by extremely high youth unemployment (unemployment among those between the ages of 15 and 25 years, which reached as high as 33 percent in 1999 and in January 2014 topped 42 percent).  Moreover, in 2013, among unemployed Italians under the age of 25, the share of long-term unemployment was possibly as high as 46.8 percent, according to Eurostat. These young long-term unemployed tend to have limited education and reside largely in the Italian South.

The more highly-skilled Italians leave, the worse the domestic economic performance

Finally, traditionally, Italians with tertiary education have been more likely to emigrate than their counterparts in Sweden and France. 1990, 4.5 percent of Swedes with tertiary education migrated abroad whereas 10.28 percent of Italians did. Although the gap between Sweden and Italy appears to be slowly closing, Italians with tertiary education continue to migrate in large numbers: In 2010, 6.55 percent of tertiary-educated Swedes migrated abroad, while 9.14 percent of Italians did so. France consistently fell in between. Presumably, many of the most educated Italians have left because of the poor future prospects for the Italian economy. But the more highly-skilled Italians leave, the worse the domestic economic performance, which perpetuates the tendency for future generations to also leave.

Conclusions

A consistent pattern emerges. Italy has failed to reshape its comparative advantage. Low GDP growth and virtually non-existent productivity growth reflect lagging innovation and educational attainments. In turn, the incentives to invest in education and innovation are weak since economic prospects are bleak. In an aging population, this trap has become self-reinforcing. Breaking the trap is the policy challenge. Ultimately, such particularities of Italy as the North-South differentials in economic dynamism will guide specific policy measures. Some have proposed more competition for Italian producers (Forni et al., 2012); Manasse and Manfredi (2014) propose that wage bargains should be decentralized to the firm-level. But, as Gros (2011) points out, both product and labor market competition in Italy are no lower than in Germany. A longer list of reform no doubt exits. But for Italy to grow again, it needs an audacious investment in a new generation of education and infrastructure.  

We are very grateful to Giuseppe Bertola and Ugo Panizza for their help.

References

Ang, James, Jakob Madsen, and M. Rabiul Islam. 2006. “The Effects of Human Capital Composition on Technological Convergence.” Journal of Macroeconomics 33: 465-476

Alesina, Alberto, and Federico Giavazzi. 2006. The Future of Europe: Reform or Decline. Cambridge, MA: MIT Press.

Bertola, Giuseppe, and Paolo Sestito. 2011.  "A Comparative Perspective on Italy’s Human Capital Accumulation", Banca d’Italia Quaderni di Storia Economica n.6, 2011. An abridged version is published as “Human Capital” (with Paolo Sestito), Chapter 9, 249-270 in G.Toniolo (ed.) The Oxford Handbook of the Italian Economy Since Unification, New York: Oxford University Press, 2013.

Brücker H., Capuano, S. and Marfouk, A. (2013). Education, gender and international migration: insights from a panel-dataset 1980-2010.

Cipollone, Peiro. 2010. “Spending on Research and the Returns to Education in

Italy.” Review of Economics Conditions in Italy 3: 323-343, 345-349.

Dustmann, Christian, et. al. 2014. “From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy.” Journal of Economic Perspectives 28(1): 167-188.

Eichengreen, Barry. 2007. The European Economic Since 1945: Coordinated Capitalism and Beyond. Princeton: Princeton University Press.

Eurostat Euroindicators. 2014. Accessed August 24, 2014 from http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/3-28022014-AP/EN/3-28022014-AP-EN.PDF. 28 February

Eurostat education and training indicators. 2014. Accessed August 26, 2014 fromhttp://epp.eurostat.ec.europa.eu/portal/page/portal/education/data/ main_tables

Forni, Lorenzo, Andrea Gerali, and Massimiliano Pisani. 2012. “Competition in the Services Sector and Macroeconomic Performance in the European Countries: The Case of Italy.” Vox EU. April 3, accessed August 26, 2014 from http://www.voxeu.org/article/raising-competition-case-italy

Frankel, Jeffrey. 2014. “Italian growth: New recession or six-year decline? Vox EU. August 11, accessed August 25, 2014 from http://www.voxeu.org/article/italian-growth-new-recession-or-six-year-decline.

Gros, Daniel. 2011. “What is Holding Italy Back?” Vox EU. November 9, accessed August 26, 2014 from http://www.voxeu.org/article/what-holding-italy-back

Hassan, Fadi, and Gianmarco Ottaviano. 2013. “Productivity in Italy: The Great Unlearning.” Vox EU. November 30, accessed August 24, 2014 from http://www.voxeu.org/article/productivity-italy-great-unlearning.

Manasse, Paolo, and Thomas Manfredi. 2014. “Wages, Productivity, and Employment in Italy: Tales from a Distorted Labour Market.” Vox EU. April 19, accessed August 26, 2014 from http://www.voxeu.org/article/wages-productivity-and-employment-italy

OECD. 2012. Education at a Glance 2012: Italy. Accessed May 29, 2014 from http://www.oecd.org/italy/EAG2012%20-%20Country%20note%20-%20Italy.pdf.

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