The Bucharest Academy of Economic Studies

- MMIB

Course: International Economics

Group 966

ITALY - Before and after

the 2008-2009
Team members:
Liane Tancelov
Ali Rammal
economic crisis
George Theodor
‘If these things were so large, how come everyone missed them?’
Question asked by the Queen Elizabeth the II of the United Kingdom to the professors
of the London School of Economics about the global economic crisis.

The financial crisis of 2007–2008, also known as

the global financial crisis and the 2008 financial
crisis, is considered by many economists to have
been the worst financial crisis since the Great Massive bail-outs of financial institutions
Depression of the 1930s. and other palliative monetary and fiscal
policies were employed to prevent a
It began in 2007 with a crisis in the subprime possible collapse of the world financial
mortgage market in the US, and developed into a system.
full-blown international banking crisis with the
collapse of the investment bank Lehman
Brothers on September 15, 2008. The crisis was nonetheless followed by a
global economic downturn, the Great
Excessive risk-taking by banks such as Lehman Recession.
Brothers helped to magnify the financial impact
globally.
The European debt crisis, a crisis in the banking
system of the European countries using the euro,
The crisis has had significant adverse
followed later.
economic effects and labor market effects
and was blamed for subdued economic
growth, not only for the entire euro zone,
The detailed causes of the debt crisis varied. In but for the entire European Union.
several countries, private debts arising from a
property bubble were transferred to sovereign
debt as a result of banking system bailouts and
government responses to slowing economies post-
bubble. The structure of the euro zone as a
currency union (i.e., one currency) without fiscal
union (e.g., different tax and public pension rules)
contributed to the crisis and limited the ability of
European leaders to respond. European banks
own a significant amount of sovereign debt, such
that concerns regarding the solvency of banking
systems or sovereigns are negatively reinforcing.
ITALY before the crisis

Being a country with very few natural resources, Italy is strongly dependent on
oil imports. The economy was hit hard by the two oil crises during the 1970s. As
a result, it experienced a stage of stagflation—weak economic growth combined
with high unemployment and a high inflation rate. The economy began to
recover in the early 1980s due to the implementation of a recovery plan.
Restrictive monetary policies brought inflation down, while fiscal- and growth-
oriented policies reduced public spending and tightened the budget deficit.

Before the 1980s, most of the Italian state-owned companies were a key drivers of
growth. However, in the mid-1980s, the state sector started to create distortion in the
economy. The mismanagement of public spending led to a deterioration of public
finances and triggered excessive corruption. A round of privatization was carried out
at the end of the 1980s and beginning of the 1990s. The diminishing role of the state
in the economy created more space for private investment. In 1999, Italy qualified to
adopt the euro and entered the European Monetary Union (EMU). The Euro was
officially introduced into the economy on second of January 2002.
Another problem which has historically hindered Italy’s economic growth is the regional divide
between its Northern and Centre regions and the South. Still in 2009, the average per capita GDP
in the eight Southern regions – Euro14,449.75 - was remarkably lower than the value registered
in the Centre and the North (Euro 22,801.00); these figures showing only a very limited
improvement in terms of convergence over the last decades. The South has traditionally had
twice as high an unemployment rate than the North; the GDP share originating from public
services and agriculture is much higher than the average while exports account for a much more
limited share of GDP.

The detailed causes of the debt crisis varied. In several countries, private debts arising from a
property bubble were transferred to sovereign debt as a result of banking system bailouts and
government responses to slowing economies post-bubble. The structure of the euro zone as a
currency union (i.e., one currency) without fiscal union (e.g., different tax and public pension rules)
contributed to the crisis and limited the ability of European leaders to respond. European banks
own a significant amount of sovereign debt, such that concerns regarding the solvency of banking
systems or sovereigns are negatively reinforcing.
The roots of this economic backwardness have been widely investigated, and several factors
have been called on to explain the persistent regional gap. Some invoke geographical distance
from trade networks and infrastructural weaknesses, others prefer to name historical and
cultural reasons, let alone the more rooted presence of organized crime.

Another sector in need of structural reform is the labor market. Despite significant reforms in
the 1990s and early 2000s, employment rates in Italy lag far behind most other European
countries. The extent and width of employment protection varies considerably across
workers’ groups and while the country’s social safety net is generous for some workers’
categories, it is virtually inexistent for several other groups.

Main reform efforts were the Treu reform in 1997 and the Biagi reform in 2003. The so-called
”Treu measures” (named after the then Labor Minister) aimed at increasing labor market flexibility
and employment rates with particular attention to the South; however, the reform operated “at
the margin”, i.e. it introduced temporary contracts and provided incentives mainly for part-time
work.

Although both reform packages contributed to the growth in aggregate employment, they led
to an increasing dualism in Italy’s labor market as most employment gains since mid-1990s were
in temporary and part-time employment. Italy’s labor market outcomes are among the worst in
the EU in spite of a regulatory framework ranking mid-field in European comparison, suggesting
inefficacy of some labor market institutions.
Another well-known structural problem is the country’s high level of public debt which can be
traced back to the 1970s. In the early 70s, public expenditure only amounted to roughly one-
third of GDP. Afterwards Italy’s public debt/GDP ratio reached 57.7 percent in 1980 and 98.0 in
1990. The highest ever level – 124.9 percent - was reached in 1994. This large increase resulted
partly from increased public education and health spending, partly from generous industrial
policies intended to help the reconstruction of manufacturing firms. Tax revenues failed to
keep pace with this steady expenditure increase.

Inefficiency in the public administration also appears to be strictly linked to the rate of fiscal evasion in the
country, as many studies suggest.

Nonetheless, the high level of already accumulated public debt meant that high shares of public expenditure
were needed yearly to pay the interest rates on debt servicing, thus weakening the positive effect of current
account surpluses on the balance of payments.

In the domestic debate on Italy’s growth performance, it has been emphasized that, in the first
quarter of 2009, Italy’s GDP was down 5.9% from the first quarter of 2008.

This drop is only partly related to the crisis, however. During the two quarters prior to the Lehman
collapse (the second and the third quarter of 2008), the Italian economy had already entered a
recession, while the other countries were still away from it.
 In a nutshell, the trend data indicate that Italy was faring worse than the Euro area and the other big European
countries, well before the current crisis.

To be sure, as emphasized in the picture below, Italy’s hardships do not originate so much from the crisis, but
rather from long before it.

Due to a prolonged low-growth period starting around 1995 (the last year when the Lira devalued
with respect to the Deutsche Mark), Italy fell 20% behind the average of the other “EU big four” in
1995-2008.
Figure 1. GDP growth in Italy and in the other big four
European countries, 1995-2008
ITALY during the crisis

In parallel to the worsening sovereign debt crisis, Italy slipped into a political crisis in the second
half of 2011. Berlusconi’s government increasingly showed signs of instability, affecting the
confidence of financial markets and European leaders. Bad results for the governing party in local
elections in the second half of May 2011 and successful referenda on 12-13 June 2011 were
significant setbacks for the government. While popular demonstrations called for earlier elections
and wide-ranging reforms, Berlusconi’s main coalition partner Lega Nord signaled increasing
impatience with the slow implementation of federal fiscal reform and Italy’s high level of taxation.

Many believe that the crisis from (2007-2013) is in many ways much worse than the 1929-1934
contraction. In the present crisis, investments have collapsed by 27.6% in the five year period,
against 12.8% in the interwar depression. GDP has declined by 6.9% against 5.1%.
Italy, with the second largest manufacturing sector in Europe after Germany, has lost about 24%
of its industrial production, going back to the 1980s level. From the beginning of 2013, the
country has lost over 31,000 companies. Every day 167 retail units are lost, signaling an authentic
disintegration of the retail sector. The automotive sector, a crucially important one for the Italian
economy, has been constantly contracting: from about 2.5 million cars sold in 2007, sales in 2012
reached only the 1.4 million mark (the 1979 level) and they are still contracting this year.
Construction, the other pillar of the national economy, is in rout: the 14% slump in 2012 is only
the last in a series of difficult years. Home sales have dropped by 29% in 2012 against the already
miserable 2011, to the 1985 level of 444,000 units, about half the number of 2006.

The consequences of this economic disaster in terms of loss of employment are dire: unemployment
is at almost 12% and growing fast.

Half a million workers have been put in stand-by and receive a state funded social benefit (cassa
integrazione).

The Italian state has so far managed to defend its financial position by means of increased
taxation, limited spending cuts and more borrowing. The borrowing scheme has been engineered
with the help of the ECB and the banking sector.
Taxation has reached unprecedented levels, and it is asphyxiating the economy together with the
credit crunch.

Under pressure from the European Union, Italy has committed to a rigorous budget and it has even
introduced a balanced-budget amendment in its constitution. Absurdly, the Italian state runs a
surplus when public debt interest payments are excluded, but this only appears to be because, purely
and simply, the state often “forgets” to pay its suppliers.

Italy will simply run out of options, and it will require additional measures from the EU.
Essentially, some sort of bailout. But because of the sheer size of the economy and the public
debt, this is simply impossible. In the absence of any political consensus around a radically
different monetary policy of the ECB, which will probably never materialise, and which will clearly
not solve any of the country’s structural problems, the only realistic scenario will be that of a debt
restructuring or renegotiation. The collapse of the Italian state finances is rapidly approaching. It
will have an enormous impact on the Eurozone and the European Union.
Italy employment rate
Measures implemented to recover from the crisis

First it was Berlusconi’s government that dealt with the crisis.

First concentrating on two main ways: supporting banks and large firms, and cutting public
spending. At first glance, this kind of policy seems correct. Supporting banks avoided the domino
effect of their fall; support for large firms allowed them to retain their employees. Cuts in public
expenditure rather than tax increases avoided negative impacts on investment and consumers’
expectations. This policy had also been recognised as the correct one by the Opposition.

However, the way in which the Government put it into practice is more questionable, and it was
criticised for a lack of transparency (support to banks), inefficiency (support to firms) and inequity
(cuts). In particular, cuts were not distributed among different social groups but concentrated
mainly on the public sector and the pay of public employees.

Cuts in the funding of public-sector agencies were not accompanied by any real changes in their
responsibilities or structures. Government simply cut state transfers and payments, dismissing
criticisms of them with arguments which the Opposition claimed were ideological and designed
merely to justify reducing services and dismantling the Italy and the Global Economic Crisis public
sector. In other words, Berlusconi’s government confronted the crisis with a correct view of economic
policy but without a correct strategy.
 Since November 2011,Mario Monti replaced Silvio Berlusconi as caretaker prime minister. He has
been delivering on all the policy objectives set out by the EU, being a former European
Commissioner.

His austerity package included raising taxes and increasing the pension age, introducing new taxes
on luxury goods like yachts and gas-guzzling cars, as part of a crackdown on tax evasion, cash
transactions of more than 1,000 euro were banned.

The package also cut a number of local government functions in an attempt to reduce the cost of
public administration.

Measures to boost growth include tax incentives for companies to employ workers and special
measures to favor women and young people. These measures were deeply resented by the italian
people and even my Monti, who was replaced with Matteo Renzi.

Matteo s Renzi plan to save Italy was more an idealistical one, and it didn’t support Italy’s economy as
expected. He implemented reforms in the Justice system and intended to accelerate infrastructure
projects such as motorways between the largest southern cities.

Although fiscal policies were not very successful the situation in recent years seems to improve a
bit, thanks to the growth in the euro area.
 Driven by the accommodative monetary policy stance and increased international trade..

In Italy the recovery has been under way for more than two years and is taking hold.

Recently released data from ISTAT indicate that in the first quarter of 2017 GDP grew by 0.4 per
cent, pushed up by household consumption and firms’ inventories.

Investment, which had been accelerating strongly since the start of 2016, slowed, but this should
only be temporary. Analyses suggest that firms will expand their production capacity once again in
2017.

After the sharp increase at the end of last year, exports are continuing to grow in parallel with world
trade. The recent positive performances are partly unexpected and must be analyzed carefully; they
will have to be confirmed in the months to come.

They are, however, consistent with improvements in the labor market. Although excess labor
supply depresses wage growth, the number of people in employment continues to increase, with
an acceleration in April, and this despite the termination of the incentives for hiring new
employees on permanent contracts.

Inflation is rising but its core component remains weak. Similar developments can be seen in the euro
area. Although the risks of deflation have declined, upward pressures on prices have not emerged to
the extent that they are self-sustained in the medium term or that justify a revision of the monetary
policy stance. The outlook for the Italian economy is favourable.
GDP could grow by 1.0 per cent in the current year and by 1.2 per cent in the two following years.
National italian accounts data suggest higher growth at the end of the first quarter, which would
raise GDP growth, other things equal, to 1.3 per cent on average in 2017. The gap between Italy
and the other euroarea economies should continue to narrow.

Quat. GDP
Quat. GDP
Date Quat. GDP Mill.$ Annual Growth
Growth (%)
(%)

2017 Q3 504,861M.$ 0.4% 1.7%

2017 Q2 471,040M.$ 0.3% 1.5%

2017 Q1 452,118M.$ 0.5% 1.3%

Italy GDP 2017: Quaterly GDP evolution