16 Feb 2016

The long-term Italian crisis

Federico writes*

The financial crisis that originated in the United States had a profound impact on Europe and questioned the stability of the Eurozone. In the first instances, Italy was considered to have a relatively stable economy and a contagion was not to be expected. Yet, the peninsula was hit first by the contraction of the interbanking loan market and then by a speculative attack on its public debt, where investors withdraw their financial capital from the economy. In this short essay I will discuss the fact that Italy already had long-term economic instabilities and that its current weakness is not only a result from the current crisis.

The 90’s were marked by an increase of new market economies and therefore of greater competition all throughout the world. Most Western European countries challenged the competition with high investments in highly specialized sectors, where capital is more necessary than a cheap labor force. This gave the rise of a high technological industry in Europe and an increase of the overall productivity. Italy did not experience this change and it barely specialized in high-tech sectors. Italy’s politicians preferred to protect the symbolic industries like Fiat, which at that point of time started to be artificially supported by the state. This was of course a big mistake, as other European countries would reap the benefits of the new sector. By the end of the 90’s, some reforms were introduced that aimed to restructure the labor market by making wages more flexible and therefore decrease the overall labor cost. However, these reforms changed the model of development, which provided a low growth of productivity, low investments on capital, but a high use of the labor force. Of course the goal was to increase the employment levels and to bolster again the manufacturing sector, but the results were not as promising as expected.

The economic situation was furthermore aggravated with the introduction of the Euro, which brought initially positive results in foreign direct investments but caused an increase of prices. In the early 2000s Italy was already starting to lose against the pressure of the global competition. Italy’s long-standing textile and machinery industry, once jewels of the Italian industry, were then lost to the competition. The prevailing liberal culture that resulted in this Italian economic miracle era of the 50s paradoxically created the structural problems that are now difficult to change. In the past 25 years, the Eurozone members spent more than Italy on research and development, with an average gap of 1 percent of GDP. In addition, strong patent laws mean that technological knowhow is not as widely spread in Italy. The resulting weakness in national innovation discouraged investments Italy's high-tech sector.

In conclusion, the long period of low occupational growth without a significant increase in productivity is one of the most fundamental problems of the Italian economy. The increase of prices caused by the introduction of the Euro, and the increase of competition from the emerging economies also severely affected Italy. The lack of incentives for innovation and policies of protectionism that only worsened the level of competition of key companies did also certainly not help and a fragility of the real economy was to be expected. The necessary reforms were dragged from government to government. As a result, the current economic crisis is just a mere reflection of Italy's failure to change in the past decades.

Bottom Line The Italian economic crisis is a result of bad politics of the 90’s that affected the model of production in Italy, in which a cheaper labor force was preferred over high investments in capital. This made Italy miss the opportunity to develop its industrial markets.
* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.