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Italy: Willingness to Reform Is the Issue, Not the Referendum

Posted by hkarner - 3. Dezember 2016

By on December 1, 2016  RGE EconoMonitor

Italy: Willingness to Reform Is the Issue, Not the Referendum

 Key takeaway – Italy’s prospects are lacklustre, growth is stagnant. Focused on privilege preservation, the political system fosters anti-establishment feelings. Reforms are needed but – due to a reluctant electorate and a cumbersome legislative process – are difficult to implement. Cognizant of the country’s challenges, over the past three years Renzi’s government announced many important reforms, but implemented few. According to Renzi, the ineffectiveness of the legislative process is the culprit; hence, tackling institutional paralysis is the key priority. On Sunday December 4, Italy will hold a constitutional referendum to streamline lawmaking. The ‘No’ camp, an heterogeneous coalition of political forces, questions both the substance and the process of the proposed reforms and is ahead in the opinion polls. The referendum is likely to be rejected by a narrow margin. Political, economic and market concerns of a ‘no’ vote are overblown. Yes, the political process would become more uncertain, the economy would keep stagnating and market volatility would temporarily rise. But in the short term nothing will change. To enhance the long term competitiveness of its economy, Italy needs a comprehensive modernization. In other words, passing laws is a necessary, but not sufficient condition. Government needs to show willingness to reform, and burn political capital in getting transformational laws through parliament.  

Growth is stagnant … The Italian economy is large and diversified[1]. Yet, growth is hampered by long-standing rigidities: a) demographics are unfavorable[2]; b) established power structures hinder meritocracy and risk taking; c) innovation is limited and total factor productivity (TFP) often negative[3]; d) labor laws are rigid and costly; e) wage growth is above productivity growth[4]; f) the public sector is inefficient, burdened by a sclerotic bureaucracy[5]; g) over-regulation, backdoor dealings, crony politics, corruption and organized crime hamper economic performance; h) the judicial system is slow[6]; i) at 132.7 percent of GDP, public debt is larger than ever[7], perhaps too big to rescue; l) taxes are high[8]. As a result, per capita GDP is stuck at the level of the late 1990s and growth is sluggish: over 2016-21, Italy’s economy is expected to grow at around 0.8-1 percent[9].

… and prospects are lackluster. Over the last three decades, piecemeal reforms attempts failed to address structural rigidities. Employment is well below pre-crisis levels – and lower than in any other EU country, except Greece. Stagnant salaries, inflexible labor markets and 2.9 million unemployed (out of 60.8 citizens) put pressure on welfare systems. Poverty and inequality are on the rise. The investment climate is challenging: when compared to its EU peers, Italy attracts little foreign direct investment (FDI)[10]. After a decade-long stagnation and in presence of deflation risks, capital is leaving the country: outflows – as recorded in the balance sheet of the Bank of Italy (BoI) – have reached their highest level since 2011[11]. In the banking system, non-performing loans (NPLs) amount to a fifth of the country’s GDP[12] and hinder the recovery.

The political system, focused on privilege preservation … Entrenched interest groups – e.g.: large (family-owned) firms, unions, protected professions – benefit from the status quo, and heavily influence the political process to preserve their privileges. The political establishment, myopic and self-serving, is unwilling to rock the boat. Disillusioned voters – disgruntled by austerity policies believed to be dictated from Brussels and Berlin – are asked to take political responsibilities via referendum and fail to elect capable, visionary leaders[13]. In the 71 years since 1945, Italy had 65 governments and 41 prime ministers (PMs), of which four since the financial crisis – with the last three appointed, not elected.

… fosters anti-establishment feelings. In the post 2008-crisis environment, citizens don’t feel represented and vote “against” rather than “for”, undermining the political debate. Traditional parties are unable to manage. Populist movements – by showing hostility to globalization, free-trade, migration and promising simple solutions to complicated problems – are rapidly gaining ground, pushed by protest vote, euroscepticism and xenophobia[14]. Electoral systems fail to aggregate individual preferences and cannot build consensus. The resulting (incongruous) coalitions lead to political impasse and paralysis, boosting far-right and national-socialist factions.

Reforms are needed … Over the next few years, global growth will remain sluggish. In absence of reforms and with limited fiscal space to respond to shocks, the Italian economy will: a) remain too weak to address financial fragilities and create employment; b) not return to its pre-crisis (2007) real output peak until the mid-2020s; and, importantly c) be exposed to adverse shocks. To avoid two lost decades, Italy should not count on external growth-drivers but should instead proactively build internal growth-drivers via structural reforms. In absence of productivity-enhancing measures, either competitiveness or real wage growth will lag trade-partners, reducing potential growth and spurring further emigration.

… but – due to a reluctant electorate and a cumbersome legislative process – are difficult to implement. The majority of voters does not back the needed reforms, and – as a result – politicians avoid pushing them. Moreover, the legislative process makes the ratification of controversial laws difficult and slow. Italy’s parliamentary system is based on: a) proportional representation – i.e.: divisions in the electorate are reflected proportionately in the elected body; and b) bicameralism – i.e.: the legislative power is equally distributed between the upper (Senate) and lower house (Chamber of Deputies). In Italy’s “perfect bicameralism”, both chambers are required to vote on: a) each law; and b) each other’s amendments – back and forth. As a result: 1) governments need to gain the support of both chambers; and 2) each chamber can block government legislation indefinitely. Consequences are frequent institutional gridlock, weak and unstable government, and political stagnation.

Renzi’s government announced many reforms, but implemented few … Cognizant of Italy’s challenges, in February 2014 – when it came to power – Renzi’s government announced a list of important reforms, to be carried out at the impressive speed of one a month: it would remodel key institutions, the public administration, the tax system, the labor market, and the banking sector. Yet, it achieved little: a new electoral law – so-called “Italicum” – was approved in May 2015. The labor market legislation, the Jobs Act, is being implemented, with mixed results[15]. The rest has largely stalled[16].

… ending up – so far – with incongruous electoral laws. The yet-to-be-tested “Italicum” regulates the election of the Chamber of Deputies. On paper, it follows a proportional system (i.e.: it favors representativeness) but de facto – because of a series of corrections[17] – it works as majoritarian (i.e.: it favors governability). Instead, the law that regulates the election of the Senate follows a system of pure proportional representation. If left unaddressed, different systems in each house are unlikely to be conducive to good governance.

According to Renzi, tackling institutional paralysis is the priority. According to the Italian PM, the approval of needed structural reforms is impeded by: a) weak governments, held at ransom from minority interest groups (public sector employees, teachers, liberal professions, taxi drivers, etc.) made strong by the current proportional system; and b) the cumbersome, paralyzing legislative system. In his view, a reduction of the Senate’s size and powers – coupled with the recently-approved Italicum, can streamline the implementation of economic reforms; in other words, more authority to legislate will impose on political leaders greater accountability to deliver results. In 2014, PM Renzi and the center-left Democratic Party (PD) proposed[18] the most extensive constitutional changes since the end of the monarchy, aimed at changing 36 out of the existing 139 articles of the constitution.

On Sunday December 4, 2016, Italy’s will hold a constitutional referendum. The constitutional reform is subject to a referendum[19] that has no quorum (its validity does not depend on the number of voters), and three objectives: a) end “perfect bicameralism” and streamline, speed up lawmaking by increasing the legislative powers of the Chamber of Deputies[20]; b) provide greater government stability and minimize the risk of post-election paralysis[21]; and c) transfer back key powers from the regions to the central government, e.g.: decision-making over infrastructure spending[22].

Opponents vocally disagree. According to its opponents, the proposed constitutional change: a) is poorly thought out[23], inadequate and hence ineffective. For example, with a ‘Yes’ vote, the Chamber of Deputies – thanks to the Italicum’s supermajority and the weakened role of the Senate – would alone be responsible for confirming the government through confidence votes. Instead, with a ‘No’ vote, each chamber would be elected under different rules, increasing the probability of hung parliaments and coalition governments[24]; b) it makes the government too powerful by removing checks on the executive, and – with populism on the rise – creating elected strongmen is an unnecessary risk; c) the members of the new Senate would be chosen by regional assemblies among regional councilors and mayors, raising questions of competence and accountability[25]; d) citizens are called to make an historical choice while key aspects remain unexplained (for example, the criteria for the appointment of senators have not been established); e) the reform was pushed through parliament without getting sufficient support from opposition parties, and the campaign was superficial, based on “slogans, without explaining the real issues”; and f) finally, some disapprove the centralization of power, especially for infrastructure projects.

The ‘No’ camp is an heterogeneous coalition of political forces. Renzi is confronted by a coalition of establishment, who benefit from the current arrangements and anti-establishment parties, including: a) the PD left-wing; and b) three opposition parties, all of which questioned Italy’s membership of the euro: 1) the anti-establishment, populist Five Star Movement (M5S), led by comedian Beppe Grillo. The party’s economic platforms include renegotiating Italy’s debt and calling a nonbinding referendum to leave the euro. During the summer of 2016 it won mayoral seats in Rome and Turin and in most public opinion surveys is nearly tied with the PD at about 30 percent; 2) Silvio Berlusconi’s conservative Forza Italia, anti-euro since 2011, after the former PM was forced out of office; and 3) the separatist, anti-immigrant Northern League led by Matteo Salvini. Opposition parties hope to use a Renzi’s defeat as a springboard to power at the next national elections, due at the latest in early 2018. According to ‘no’ supporters, Italy needs a return to the old consensus politics against authoritarianism to head off the M5S challenge.

Opinion polls show the ‘No’ camp ahead. The referendum is likely to be rejected by a narrow margin. Over the last months, support for the ‘Yes’ vote has weakened. The latest polls show the ‘No’ camp ahead at 53.1 percent, with the ‘Yes’ camp at 46.9 percent. The ‘No’ lead ranges from 5 to 7 points. Undecided voters are estimated at 16.5 – 25.9 percent, a significant share of the total.

Impact of a ‘No’ vote: concerns are overblown. The referendum has become a confidence vote on the government and its reform efforts. While a ‘No’ vote is likely to bring about political instability, economic damage and market turmoil, concerns that – after Brexit and the election of Trump – a ‘No’ could contribute to undermine the existing international order and the Eurozone (EZ) are overblown.

Impact on politics: rising uncertainty. Initially, Renzi committed to resign if the reforms were not approved, then backtracked (and received support to stay even in defeat) and then – in the last weeks, hinted[26] again that if the referendum fails, he will step down. Renzi resignation would lead to political uncertainty: the country’s president, Sergio Mattarella, after consulting political leaders, would either: a) designate a PM to attempt to form a new interim government[27]; or b) appoint an institutional or technocratic caretaker government; or c) call for a snap general election in early 2017. The first two solutions – a) and b) – could preserve stability after the vote but would likely be unpopular[28] with the public, boosting anti-establishment sentiment. In case of early elections, the M5S would become the front-runner[29], as a ‘No’ vote is likely to weaken an already divided PD.

Impact on the economy: more stagnation. If ‘No’ wins, any government – even if led by Renzi – will inevitably struggle to: a) implement growth-enabling reforms; b) support – and bail out if needed – the banking system[30]; and c) avoid elections. In a context of low growth[31], high debt[32], financial sector fragility[33] and declining credit[34] to the private sector, consumption and investment will stagnate. If the proposed 2017 budget is passed (but there are tensions with Brussels on the plan), government spending will support growth from 0.8 percent in 2016 to 1.0 in 2017[35]. Political uncertainty could also derail recapitalization bank plans[36].

Impact on the markets: uncertainty and volatility mildly up. If ‘No’ wins, uncertainty will spur volatility[37], and stocks will continue to struggle (year to date, the FTSEMIB has lost 21.3 percent); in particular, financials are likely to suffer[38], and might create spillovers into other markets. Yet, abundant liquidity[39] will keep any selloff short-lived. Yields on Italian – and other Euro-periphery – bonds are likely to increase, especially in case of a loss of investor confidence[40], but the ongoing European Central Bank (ECB) quantitative easing (QE) program will prevent reaching the levels of the 2011 European debt crisis[41]. The euro is likely to weaken further.

Reforms are needed, and willingness to reform is the key issue. Italy’s biggest problem is not just passing laws, but unwillingness to reform, i.e. bringing transformational laws to the parliament. Voters and politicians need to back the comprehensive structural reforms the country needs to enact: a) promote growth with counter-cyclical fiscal policies – while preserving macro stability[42] – and by further diversifying the economy[43]; b) reform a paralyzed legislative system with a proper amendment of the electoral law; c) address rent seeking and élite capture and improve the efficiency of the public administration; d) increase spending in infrastructure and education[44] and bet on public-private-partnerships (PPP)[45]; e) reduce taxes, especially on labor, to encourage job creation; f) stimulate productivity growth by removing protective barriers to entry, especially in the service sector; g) align wages with productivity and make the formal labor market more flexible, perhaps by adopting “flexicurity”, i.e.: the ability to balance the “flexibility” needed to adapt to economic changes with “security”, in order to maintain labor protection[46]; h) reform the judicial system and simplify settlement procedures; and i) promote the restructuring of the banking system, in order to improve its strength and reform NPLs insolvency procedures.


[1] Italy is the third economy in the Eurozone (EZ) and the eighth in the world by nominal gross domestic product (GDP). By purchasing power parity (PPP), Italy is the 12th largest economy in the world. It is also the second manufacturer in the EU, and the fifth in the world. Finally, with USD454.6 billion sold abroad in 2015, Italy is the eighth global exporter. Agriculture contributes 2.2 percent to total gross domestic product (GDP), industry 23.6 and services 74.2. Private savings are above the EZ average: households own net financial assets of more than EUR 3 trillion, one-third of which is held in the form of deposits. Furthermore, household debt (in 2014 at 62 percent of gross disposable income) is below EZ average (95 percent).

[2] Italy’s population is projected to shrink (from 59.7 million in 2015 to 56.5 in 2050, down to 49.6 in 2100) and age (in 2015, 28.6 percent of the population was aged 60-years-or-over; in 2050 the ratio will to rise to 40.7 and it will stabilize in 2100 at 39.9 percent). Source: UN, 2015.

[3] Since the adoption of the euro in 1999, Italy’s total factor productivity (TFP), the portion of economic output not explained by the amount of inputs used in production – i.e.: labor and capital – fell by about 5 per cent while in Germany and France it rose by about 10 per cent.

[4] Over the last three decades, Italy has experienced one of the lowest productivity growth rates among advanced economies.

[5] Administration processes are slow and procedural costs among the highest in Europe. On average, opening a new business requires 16 different procedures and around USD 5,000 in fees.

[6] On average, to resolve a civil action, courts take 2,000 days – i.e., seven years. A bankruptcy process lasts a decade, more than 90 percent of companies are liquidated and creditors get back only about 14 percent of their money.

[7] In 2015 – despite an improved fiscal deficit (at 2.6 percent of GDP, from 3.0 percent in 2014) – the public debt rose to EUR 2.2 trillion (tn), or 132.7 percent of GDP (from 123.3 percent in 2012 – the second highest of the Eurozone after Greece, at 175 percent). The 2007 (i.e. pre-crisis) level was EUR1.6tn, or 100 percent of GDP. The investor base is relatively stable and mostly domestic: 66.3 percent of Italian government bonds are owned by domestic investors, up from 56.7 percent in 2010, and Italian banks own about half of this amount (30.2 percent).

[8] The corporate tax rate is 31.4 percent (down from its 1981-2015 average of 41.60) and the income tax rate can reach 43.0 percent.

[9] In 2015, after three years of recession, the economy expanded by 0.8 percent, buoyed by accommodative monetary policy, declining commodity prices, and improved confidence. Private consumption and inventory re-stocking were key contributors, while external demand weighed on growth. According to the IMF, over 2019–21, back loaded fiscal consolidation would result in a decline in real GDP growth to around 0.8 percent, including a dividend on structural reforms of about 0.3 percent per year. Absent reforms, potential growth would decline to 0.5 percent, reflecting crisis legacies such as the collapse in investment as well as unfavorable demographics and slow productivity growth that predates the crisis.

[10] In the 2015 World Economic Forum (WEF) Global Competitiveness Rankings, Italy is ranked 43rd out of 140 countries; in the 2016 World Bank Ease of Doing Business Italy is ranked 45th out of 189 countries. In the Index of Economic Freedom 2015, the country ranked only 80th in the world, due to the slow legal system, excessive taxation, and a protective labor law.

[11] In September 2016, Italy’s borrowing from the Eurozone’s settlement system (so called Target 2) hit a record. Italy’s Target 2 balance rose by €34.9bn to a record €326.9bn in August, against a €3.2bn increase in July; Italy’s Target 2 balance now exceeds the previous peak at the height of the Eurodebt crisis in 2012, just prior to Draghi’s “whatever it takes” speech. Italy enjoys a current account surplus, which suggests that the rising Target 2 balance is due to capital flows. In other words, foreigners are selling Italian assets and Italians are buying foreign assets.

[12] In Italy’s €4tn banking system, banks have on their books €225bn of equity and – at 18 percent of total loans – about €360bn ($400 billion) of NPLs. In 2016, on NPL-related concerns the valuation of most lenders has more than halved in value.

[13] Because of the Dunning–Kruger effect, democracies rarely or never elect the best leaders. In other words, elections tend to lead to mediocre choices. The key assumption (i.e. citizens can recognize the best political candidate, or best policy idea) is erroneous, because the majority of citizens lacks those competences. In other words, unskilled individuals are inherently unable to judge the competence of other people, or the quality of those people’s ideas (e.g. on tax, pension, labour market reforms). The advantage over other forms of government is merely that democracies “effectively prevent lower-than-average candidates from becoming leaders”.

[14] Acting through the democratic process, populism relies on the “tyranny of the majority” to place its interests above those of (ethnic or religious) minority groups. It also challenges the separation of powers, the independence of judicial system, the Central Bank and the press.

[15] The Renzi Government tried to reform the labor market by attempting to dismantle the generous protections that make it difficult and expensive for companies to dismiss staff, and which therefore encourage businesses to hire only temporary workers, heightening economic insecurity among the young. But Renzi’s attempt ran into bruising opposition from Italy’s powerful trade unions. The results were a watered-down reform package that entitles existing permanent staff to a near-guarantee of lifetime employment, and a severe dent in Renzi’s popularity.

[16] Legislation has been passed on the reform of cooperative and mutual banks. The insolvency system is being revised. A framework law on public administration has been approved and some implementing decrees have been issued. A reform of the state budget is underway. A reform of the education system has been approved by parliament and is being implemented. Legislation has also been passed on institutional reforms aiming to facilitate decision making and the transfer of competencies from regions to the center. After passing a new electoral law in 2015, the government obtained parliamentary approval of the constitutional reform. However, this will be subject to the approval of the upcoming constitutional referendum.

[17] To reduce political fragmentation and guarantee a stable majority, it excludes parties with less than 3 per cent of the total vote and provides a majority premium of 15 percent to the most voted party, granting the PM an almost guaranteed mandate for five years.

[18] The bill was first introduced by the government to the Senate on April 8, 2014. After several amendments by both the Senate and the Chamber of Deputies, the bill was first approved by the Senate on October 13, 2015 and by the Chamber of Deputies on January 11, 2016. Eventually, it got the second and final approval on January 20, 2016 (Senate) and April 12, 2016 (Chamber of Deputies). The bill was approved by absolute majority, but not by a qualified majority of two-thirds, in each house. In accordance with article 138 of the Constitution, a referendum is required within three months of the publication of a law on the Official Gazette if – like in this case – the law has not been approved in the second voting by a qualified majority of two-thirds in each house. This will be the third constitutional referendum in the history of the Italian Republic: the other two were in 2001 and 2006.

[19] The official text of the question is: “Do you approve the constitutional bill concerning the dispositions to overcome the perfect bicameralism, the reduction of the number of members of the Parliament, the restraint of the institutions’ operating costs, the abolition of CNEL and the revision of Titolo V of the 2nd part of the Constitution, which was approved by the Parliament and published on the Gazzetta Ufficiale n. 88, on April 15, 2016?”.

[20] With a “Yes” vote, the Senate will become a body of regional representatives (a “Senate of Regions“) with fewer legislative powers than the Chamber of Deputies. The number of senators will decline from the current 320 (of which 315 elected and 5 appointed by Italy’s president) to 100 (of which 74 regional councilors, 21 city mayors, and 5 appointed by Italy’s president). Senators will no longer be directly elected, will retain immunity but will lose financial indemnities. De facto the Senate will be reduced to a subordinated, advisory role to the Chamber of Deputies on most laws, like upper houses in Germany, Spain and Britain.

[21] With a “Yes” vote, the Chamber of Deputies will discuss and approve laws (except those on constitutional amendments, EU affairs, and local entities); the Senate will be able to request a review in the following 10 days (15 for the budget law) and will have 30 days to propose revisions. However, the Chamber will have the faculty to proceed without taking the Senate’s input into account.

[22] With a “Yes” vote, the regions will see their powers reduced: the State will retain full authority on – inter alia – energy, trade, and infrastructure and will delegate to the regions – inter alia – tourism, health, and education.

[23] To overcome “perfect bicameralism”, the government could have chosen amongst different models, such as: a) the German Bundesrat (Federal Council), where the government of each of the sixteen Länder (federal states) is represented at the national level; b) the US senate, where each of the 50 states, regardless of population, is represented by two senators who serve six-year, staggered two terms and hold powers not granted to the House; c) the UK House of Lords: a second chamber of reflection and orientation, which scrutinizes bills that have been approved by the House of Commons; or d) a tout court abolition of the Senate.

[24] With a “No” vote, a harmonization of the electoral laws would be needed to ensure consistent results across the two houses. Indeed, an election under the current laws would likely produce political gridlock. Yet, bringing the voting system for the Chamber of Deputies in line with that of the Senate would entail a higher probability of political fragmentation, unstable coalitions and weak governments – unable to deliver the structural reforms needed to revive long-term potential growth.

[25] Senators would enjoy immunity from prosecution, and regions and municipalities have proven not immune from corruption.

[26] Renzi said: “if the citizens vote no and want a decrepit system that does not work, I will not be the one to deal with other parties for a caretaker government”.

[27] An interim government would be established with a limited policy mandate to: a) align the electoral laws before the next general election, due in early 2018; and b) keep the public finances under control.

[28] Established parties would likely create a (possibly unstable) left-right coalition to keep the M5S out of government, with little prospect of implementing meaningful political or economic reforms. In other words, a ‘No’ vote will take institutional reform off the political agenda for the foreseeable future.

[29] According to the latest polls, in a snap election the M5S is set to become the largest party but would not obtain a majority of parliamentary seats.

[30] In the financial sector, eight commercial banks are in distress: the third by assets, Monte dei Paschi di Siena (MPS), mid-sized Popolare di Vicenza, Veneto Banca and Carige, and four small lenders rescued last year: Banca Etruria, CariChieti, Banca delle Marche, and CariFerrara. A market solution is being tried: JPMorgan has proposed a complex rescue plan to recapitalize MPS – involving the sale of €28 billion of bad loans and €5 billion in fresh equity by year-end – while a government-sponsored private vehicle (Atlante) is attempting to backstop smaller banks. Seven banks require an estimated €40 billion ($50 billion) of capital, equivalent to 2 percent of GDP. If the banking system fails to attract private capital, a new regulatory mechanism under European Union (EU) rules (known as “single resolution mechanism”) will restructure and, if necessary, impose controversial, politically-damaging losses on: a) shareholders, many of which are politically-connected local charitable foundations; b) savers and bondholders – many of which are ordinary savers who were persuaded to switch low-yielding deposits into higher-earning bonds without being informed of the risks – via bail-in, which forces losses on bonds to share in the recapitalization burden; or c) the government, forced to provide resources to facilitate the reduction in NPLs, increasing public debt. Should an Italian bank necessitate either government or European Stability Mechanism (ESM) intervention, the EZ’s permanent rescue fund, EU banking rules would also require a bail-in of junior creditors. The government has already agreed with the EU it will inject public resources, limiting bondholder bail-ins to junior debtholders, while allowing for some compensation for vulnerable retail investors. According to IMF estimates based on mid-2015 data, about €200bn of €600bn in total Italian bank bonds are held by retail investors. These include about €30bn of €60bn in subordinated bonds, which would almost certainly be wiped out in the event of a bail-in.

[31] The economy is not expected to return to its pre-crisis (2007) real output peak until the mid-2020s. In 2015 nominal GDP was 17 percent below 2009-levels. Over 2016-21, Italy’s economy is expected to grow at around 0.8-1 percent, supported by expansionary monetary and fiscal policies.

[32] In 2015, the public debt rose to EUR 2.2 trillion (tn), or 132.7 percent of GDP (from 123.3 percent in 2012). The investor base is relatively stable and mostly domestic: 66.3 percent of Italian government bonds are owned by domestic investors, up from 56.7 percent in 2010, and Italian banks own about half of this amount (30.2 percent). According to the IMF, the 2007 (i.e. pre-crisis) level of public debt was EUR1.6tn, or 100 percent of GDP. According to Eurostat, the Italian government holds the second highest debt-to-GDP ratio in the eurozone after Greece (at 176.9 percent).

[33] In the banking system, a crisis is looming: non-performing loans (NPLs) amount to a fifth of the country’s GDP (18 percent or €360 billion, around $400 billion) and hinder the recovery and potential growth. In early-2016, NPLs totalled more than EUR300.0 bn, about 18 percent of all outstanding loans.

[34] Between July 2007 and December 2015 credit was constrained: new lending to SMEs fell by almost 20.0 percent and consumer credit declined, hampering banks’ profitability (profit margins are among the lowest in the EU). As credit restrictions depressed growth, a slower economic activity brought about new NPLs. The total stock of credit peaked at EUR 914 billion in November 2011, and declined to EUR 784 billion in August 2016. In 2015, total loans outstanding increased by 0.1 percent to EUR1.8tn and deposits by 3.5 percent to EUR1.4tn.

[35] Yet, if spending measures are not approved, growth could decline to 0.6 percent in 2017.

[36] The recapitalization plan of UniCredit, Italy’s largest bank by assets and its only globally significant financial institution, will be unveiled on December 13 and likely to include a €13 billion share sale, drastic cost cuts and asset sales.

[37] A ‘No’ vote would create volatility. Investors worry about political instability reviving market fears about the sustainability of the country’s debts and the stability of its banking system. The Bank of Italy has warned that – in case of victory of a “No” – financial market volatility will increase, putting upward pressure on government borrowing costs and driving down equity prices. Financial market volatility risks derailing bank recapitalization efforts.

[38] The Italian listed mid-sized banks are on average only trading at about a quarter of tangible book value.

[39] The US elections were followed by a positive stock-market response and an initial selloff following the UK vote in June was followed by a recovery in risk assets.

[40] Italy’s government-bond market is the fifth largest in the world. Since the US election, bonds have sold off across the world, but Italy saw steepest declines, with the yield on the Italian 10-y bonds rising to 2,23 percent, the maximum since July 2015, and the yield on the 50-year Italian bond rising at around 3.5 percent from around 2.9 percent in mid-October. The spread between Italian and benchmark German government bonds has widened to around 1.9 percentage points, near the highest since the spring of 2014, though it remains far from the levels seen in late 2011.The annual cost of insuring against a default on $10 million of Italian debt for five years using credit-default swaps rose to about $170,000 this week from $97,000 at the start of the year.

[41] In November 2011, during the Italian debt crisis (the 10-year bonds yield rose to 6.74 percent; 7 percent is the level where Italy is thought to lose market access), Prime Minister Silvio Berlusconi was forced to resign. An economist, Mario Monti, who had served as a European Commissioner from 1995 to 2004, was appointed Prime Minister of Italy, and led a government of technocrats, composed entirely of unelected professionals.

[42] The Asian experience has shown the importance of sound economic management for job creation. Economic stability matters for employment, and maintaining it during a crisis requires strong institutional fundamentals as well as flexible macro-economic policies. When the 2008 crisis hit the Asian region, solid domestic fundamentals combined with a coordinated policy responses upheld growth. Supportive fiscal policies coupled with monetary expansion absorbed the economic and financial shocks. Importantly, large fiscal packages supported both GDP and employment: Asian countries spent on fiscal stimuli an average of 9.1 percent of 2008 GDP, far larger than the 3.4 percent of the advanced economies.

[43] For speedier growth, and to sustain employment generation in the long-term, the economy needs a competitive diversification. Cross country comparisons show that growth accelerations are associated with the production and export of non-traditional manufacturing and services, in other words the products “in demand” in the industrialized nations. Hence, development policies should strategically promote a structural transformation toward these “more sophisticated” economic activities, by providing production incentives to new exportables. Policies should promote the manufacturing – and export – of non-traditional manufacturing and services, to foster a market-driven expansion of non-traditional products.

[44] Over the years, access to infrastructure and a better educated labor-force will promote the circulation of goods, people and knowledge. A lack of infrastructure and an education of inadequate quality restrain growth, as they hurt SMEs and discourage entry of domestic start-ups and foreign investors.

[45] As private investment is constrained by a number of institutional factors that are difficult to address in the short run, schemes for more public-private risk sharing are also needed. To alleviate bottlenecks the government should both reduce the risk and increase the returns on private investment. In other words, it is necessary to stimulate risk-sharing among investors – for example, via PPP – by co-financing public works (transport and communications) and in education, by addressing under-provision of training in areas where skills are lacking. At the local level, people’s investment in skill acquisition and organizational capacity only materializes if private returns are appropriable.

[46] In Asia, as a result of past pressures from domestic employers and foreign investors, most countries’ labor regulation is sufficiently flexible and not financially onerous for employers. In the late 1990s, Korea eliminated the guarantee of lifetime employment but provided policies to compensate. In Singapore and Malaysia employment is not secure but supported by active policies, such as skills training and self-employment promotion. Over the past decade China and Korea reduced restrictions on retrenchment but introduced unemployment insurance. In China, India (e.g.:, the National Rural Employment Guarantee Scheme) and Sri Lanka, where the informal and rural economies are large, governments often used public works, self-employment programs and skills training to reduce



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