After recovering throughout most of 2004, the economy fell into recession early in 2005. High unit labour cost growth, coupled with euro appreciation and strengthening global competition in Italy’s areas of specialisation, have entailed large losses of market shares. Domestic demand, once sustained by strong employment growth and low real interest rates, has been slowing. Activity is projected to strengthen towards end-2005, reflecting a renewed upturn in world trade, improving labour productivity, and tax cuts.

Structural reforms are needed to address the underlying causes of poor competitiveness. Wage bargaining should be adapted to better reflect productivity developments. Sheltered sectors should be made subject to more effective competition to reduce downstream costs and inflation pressures. Debt reduction should be quickened to make room for lower taxes and higher human and physical capital investments.