Economic, political paralysis threatens Italy

A decade's worth of missed reforms has put the eurozone's third-largest economy in critical shape, with a default on its $2.6 trillion debt likely to have global repercussions

In the 1990s Italy made a mighty effort to shape up its hidebound economy and qualify for the euro. Then it slacked off — and now it is under pressure to make up for a lost decade's worth of reforms to convince markets it can pay its debts.
The size of its huge debt pile, about 120 per cent of annual economic output, is nothing new. The problem is that because of the past two years of market turmoil in Europe, investors are suddenly reconsidering countries' abilities to repay their debt.
And as they take another look at Italy, they don't like what they see — dismally low growth that politicians have so far proved incapable of reviving.
The situation has become critical as investors lose faith in the eurozone's third-largest economy and charge more to lend it money. Italy is too big to be bailed out like Greece, Ireland and Portugal were. A default on its €1.9 trillion (US$2.6 trillion) in debt would threaten the euro and the global financial system with collapse.
It didn't have to come to this. Unlike much smaller, bankrupt Greece, Italy has a big, modern and industrialised economy that can actually make things people abroad want to buy — think Fiat, Armani, Benetton.
Its budget deficit, this year at 4 per cent of GDP, is below the eurozone average of 6 percent and it aims to balance government spending by 2013.
But the country still has the world's third-largest debt pile and the worry is that it is no longer productive enough to keep paying it off.
Italy's economy is hampered by high wage costs, low productivity, fat government payrolls, excessive taxes, choking bureaucracy, and an educational system that produces one of the lowest levels of college graduates among rich countries.
Its economic output last year was 1.9 per cent smaller than in 2005, adjusted for inflation. The International Monetary Fund projects anemic growth of 0.6 per cent this year and 0.3 per cent next year.
Economist Tito Michele Boeri, a leading expert on Italy's labour market at Milan's Bocconi University, says the economy underperforms because its restrictive labour laws and sluggish educational system leave large groups of people, particularly the young, languishing without well paid jobs or training that would make them more productive.
"There is a serious problem with the way we use human capital in our country," he said.
Established workers with seniority enjoy strong protections against being laid off and get extensive severance if they do. Meanwhile, new entrants into the labour force face low wages and temporary contracts that mean they can easily be fired. Companies do little to train them, treating them as temporaries.
University education can take years longer than in other countries, with five years of study for a basic credential and several more for professional specialisation. Lawyers in Italy must do a two-year apprenticeship, and most firms get free labour out of the trainees, many of whom don't even get expenses reimbursed.
The long education path is a deterrent that means only 20 per cent of people between 25 and 34 have a university degree. That leaves Italy 34th of 37 industrialised countries surveyed by the Organization for Economic Development and Cooperation.
One Italian in four under 30 is not in education, employment, or training.
The universities themselves contribute little to the economy. No Italian university made the Times Higher Education list of the world's top 200, and while Italy has prominent scientists and researchers many of them work abroad, where research grants and investment are easier to come by.
A whole list of trades and professions is protected, with entrance restricted and often based on connections: notaries, taxi drivers, pharmacists. The system discourages competition and limits opportunity.
Bureaucracy is legend. Italy ranks 87th on the World Bank's ease of doing business index, and 158th when it comes to getting a business contract dispute resolved — ahead of Afghanistan but behind Sudan, Togo and Kosovo. It takes 1,210 days to get a decision in Rome's district court, compared to 518 days for
the OECD average. Taxes take 68.5 per cent of company profits, compared to an average of 42 per cent among richer countries.
Prospects for change are uncertain. The fractious party system depends on coalitions, while Prime Minister Silvio Berlusconi is embroiled in criminal accusations he paid a minor for sex and appears barely able to get legislation passed. Berlusconi has lost markets' confidence — stocks rallied temporarily on Monday on a report that he intended to quit.
But Italy does know how to change — when it has to.
In the early 1990s, Italy's outsized budget deficits meant it faced the possibility of being left out of the euro — a deeply humiliating prospect. Deficits were slashed. The government confronted unions over cuts in pensions and won. Taxes went up. Government-owned companies were sold to reduce debt. Italy joined the euro as a charter member in 1999.
But once it got into the euro club, the country was sheltered from market speculation by sharing a currency with stronger economies in northern Europe.
Markets were willing to loan to Italy at just a few hundredths of a percent more than they did to financially solid Germany, letting it carry its large debt pile with ease. The pressure for reform eased.
The collapse of U.S. investment bank Lehman Brothers in 2008 and the ensuing financial crisis made investors look more closely at risk, but Italy stayed out of trouble while weaker countries like Greece, Ireland and Portugal lost access to affordable borrowing and needed bailouts. The turning point came in July, when European Union leaders decided that Greek bondholders would not be repaid 100 cents on the euro. That broke a fiercely held taboo that rich countries' government debt was supposed to be risk free, sacrosanct.
"What happened was, investors looked and thought, if you can impose haircuts on Greek government debt, maybe you can do it for Italy as well, and maybe we should start pricing in some level of credit risk," said Jacob Kierkegaard, a research fellow at the Peter G. Peterson Institute for International Economics in Washington, DC.
As a result, investors started asking for more interest to lend to Italy. The yield on the country's 10-year bond rose above 5 per cent, then above 6 per cent. On Tuesday, it hit 6.73 per cent, the highest since the euro was created in 1999.
Italy was "essentially bailed out for a very long time by what I regard as a very deep and persistent market failure," said Kierkegaard. "They managed to postpone the reforms they needed until the situation became acute and we're in the pickle that we are in today."
Now Berlusconi has a list of promised reforms, which economists say reads as if it were lifted from the 2011 OECD report on Italy's problems. That report noted that most of its issues were the same as in the 2009 edition.
Government have postponed change "because they tend to have a short-term horizon, they don't see the benefits of reforms because those only materialize years later," said Bocconi University's Boeri.
Meanwhile, the political costs of confronting unions and professional lobbies have to be faced today.
It's a luxury Italy doesn't have any more.