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  Assessment and Recommendations

  Following a short period of economic growth at around 3 per cent, the economic climate began to deteriorate in late 2000. This was primarily related to external factors – the sharp slowdown in world trade, and the negative impact of higher energy prices on household incomes. Underlying domestic economic conditions remained more conducive to growth, with the positive performance of the labour market, especially in service and construction sectors, sustaining consumer confidence and limiting the domestic demand downturn.  Indeed, prior to the 11 September terrorist attacks in the United States, order books appeared to be improving. But a sharp near-term slowdown is now foreseen, as export markets stagnate, businesses delay investment plans in response to rising world uncertainty and households raise precautionary savings. The annual growth rate of the Italian economy in 2001 could fall to 1.8 per cent from the near 3 per cent registered in the previous year.

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  Macroeconomic Performance

  After slowing down through much of the decade, the Italian economy grew strongly in 2000. Employment rose and unemployment fell. Business and household confidence continued to be high for most of the year supported by fiscal reforms as well as progress in structural reforms in the product and labour markets. However, signs of weakness emerged towards the middle of the year and these were confirmed in 2001. The short-term outlook has been further clouded by the blow to confidence caused by the 11 September terrorist attacks in the United States (Table 1). The downturn is primarily attributable to external influences. Because of higher oil prices, consumer price inflation increased, peaking at 3 per cent in early 2001. This weakened consumer spending, and the slowdown of world demand led business to cut back investment. Improved conditions on the labour market, especially in the service and construction sectors, may have limited the setback to domestic demand growth, and the trend in inflation is now downwards. But protracted weakness abroad could undermine confidence and growth in the sectors where activity so far has held up well. Indeed, the main uncertainty facing the Italian economy would seem to be the timing and the momentum of the projected rebound of the world economy. The remainder of this chapter starts with a review of the recent macroeconomic developments and the short-term outlook. It then discusses the medium-term supply issues raised by Italian productivity.

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  Fiscal Policy

  The 2000 budget deficit was the lowest for over thirty years, at 1.5 per cent of GDP, benefiting from the favourable trend in interest rates and better than expected revenue growth. Taking into account the "una-tantum" proceeds of the sale of mobile phone licences, the deficit was even significantly smaller than that, at 0.3 per cent of GDP (Figure 10). Over the five years to 1997, the consolidation process (by which the general government structural deficit was reduced by 7 percentage points of GDP) was materially assisted by tax increases (especially in 1992 and 1997) and reductions in transfers, subsidies and public investment spending, while substantially helped by interest rate declines. But progress towards budget balance – the objective for 2003 – could prove difficult to maintain. Since joining EMU, Italy has been able to exploit continued favourable movements in interest rates, but that leeway is now much reduced. More critically, the increase in effective tax rates involved in meeting the Maastricht criteria moved Italy above the average fiscal pressure ratio of EU countries and this has placed tax reform, and reduction, at the top of the agenda (Figure 10).

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  Public Spending in Italy

  The control of public spending has been an essential element in bringing the general government deficit down to levels consistent with Italy’s EMU obligations, which required one of the sharpest retrenchments in the OECD (Figure 16). However, though a significant proportion of the savings made were structural in nature, the consolidation process was assisted by a series of "one off" interventions – such as a freeze on wage contracts, ad hoc interventions in the health service and curbs on investment spending – which have created large compositional imbalances in public spending. Moreover, pressures from certain programmes – particularly those related to one of the fastest ageing populations in the OECD and to the Mezzogiorno – could intensify. At the same time, it is desirable on efficiency grounds to reduce the tax burden, but this is impossible without spending economies, on account of Italy’s large public debt. Priorities in public spending will need to be reset and control mechanisms for their effective implementation put in place.

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  Structural Reforms to Raise Potential Growth

  As measured by potential (full employment) GDP growth, Italy experienced the largest slowdown among the major European economies between the 1980s and 1990s (Figure 20). Much of this could represent the end of catch-up, as Italy reached GDP per capita levels similar to those of France, Germany and the UK by the end of the 1990s (Figure 21), having outperformed them in growth terms in earlier decades. Profound macroeconomic and structural reforms over the decade of the 1990s may have suppressed output growth, during a transition period, as well. Indeed, Chapter I described an acceleration of activity around the turn of the millenium. But it also noted that Italy’s export performance has been, on balance, disappointing. And there remains a deep regional divide: the Centre-North has a per capita output level equal to 122 per cent of the EU average, whereas that of the Mezzogiorno is only 68 per cent. Thus, the need to continue and deepen the process of structural reform would appear to be strongly indicated.

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  Annexes
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