3 Reasons Italy is back in recession
The bureaucracy, trade unions, business and finance and a cozy political class all benefit from the present system and see no reason to change
Economists, and perhaps only economists, were surprised by Italy’s preliminary estimates that suggest the economy is back in recession. The forecasts for second quarter GDP were for growth of at least 0.1%. Instead, Italy's GDP fell by 0.2%. Despite some previous optimism the reality is that Italy never emerged from the recession. Its economy is still 9% below its size in 2007. In the past 12 quarters it has experienced only one quarter of growth. At least it is in good company. Germany reported last week that its economy had also contracted by 0.2%.
What is a country to do? Italy’s solution is to elect a 39-year-old former mayor of Florence, Matteo Renzi. Mr Renzi promised to reform Italy and get the economy moving, but like his counterpart, Shinzo Abe in Japan, promising reform and actually doing it are two different things.
Like Mr Abe, Mr Renzi started his ‘reform’ in the usual way, with money. He recently gave lower paid workers a tax break. He also wants to start, or restart, infrastructure projects. But he again he has the same problem as Mr Abe, money. Italy has a €2 trillion debt, which is projected to reach 135% of GDP this year. Though not quite up to the 227% of Japan, it is much higher than that of most of its peers.
Italy desperately needs reform. It ranks 65th in the World Bank’s Doing Business rankings. This is far below other countries in Europe. To start, Mr Renzi has been concentrating on labour and judicial reforms.
Italy desperately needs labour reform. Its unemployment rate is 13%, the highest in 37 years. By contrast the unemployment rate in Germany is 5.1% and 10.4% in France. Its problems are typical. There is a duality of the labour market: the haves and the have-nots. There is the vast majority of the work force, who have permanent positions. Their rights are highly protected. Then there is a growing sector of temporary workers with few rights and benefits.
Mr Renzi’s proposed reform does little to change this. Instead it affects only temporary contracts by making it easier to extend them. But even this small change was exceptionally difficult to pass into law.
Indians would be sympathetic to another one of Mr Renzi’s proposed reforms. The Italian judicial system is a byword for glacial. It is harder to enforce a contract in Italy than in Haiti. The average civil law suit takes eight years. The European average is two years. The case backlog is 5.2 million cases. As much as Mr Renzi wants to reform the system, he is limited as to what he can do. Judges are answerable only to the self-governing Superior Council of Magistrates and not to the justice ministry. Obviously the Superior Council has had a lot of time to reform, before Mr Renzi took office, but did little.
The real obstacle to reform in Italy is the same everywhere. The bureaucracy, trade unions, business and finance and a cozy political class all benefit from the present system and see no reason change.
Japan’s economy, like Italy’s, has also fallen. The Japanese economy contracted by 1.7% in the second quarter. It also suffers from a “duality”. Temporary workers make up 36.8% of the work force. Unlike regular employees, they do not enjoy any protection against being fired. This is particularly a problem for Japan. Japan’s population is aging. Despite an unemployment rate of only 3.7%, Japanese wages are not going up. Firms already have too many highly paid unproductive employees to buy more. It is simply cheaper to hire temporary workers, mostly women, who can be laid off any time.
Both, Japan and Italy stand in contrast to Spain. Spain has made changes to its labour laws. It has been rewarded with accelerating growth of 0.6%.
It is not only the entrenched power groups in these countries that hold back their economies. Their central banks are doing their best to stymie the economies as well. They consistently issue over optimistic economic forecasts. For example, in 2013 they estimated a contraction of only 0.5%. It turned out to be 1.9%.
What should be obvious is that the economic models simply do not work well enough to help policy. By consistently over estimating growth and propping up unprofitable companies with free money, they allow governments to avoid making the hard choices required for real reform. So despite the best efforts of Mr Renzi and Mr Abe, their economies will stagnate until they get so bad that reform will be the only option.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)
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