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Italy Needs Our Attention

Italy Needs Our Attention

As a key player in keeping the Euro stable, Italy’s problems are everyone’s problems.

Paul DeRosa

In a world preoccupied with the life and death conflict in Ukraine, it is easy to dismiss the directionless political leadership and economic stagnation in Italy as third-order problems. Italy, however, is a good bit more than just a nice place for vacation and a source of elegant clothing, and its failures warrant more attention than they have received.

As a nation of nearly 60 million with a large GDP, Italy represents a considerable part of what can be called the Alliance of Democracies—the developed countries that are organized as democracies and comprised of the United States, Europe, Japan, Britain, Canada, Australia, and New Zealand. By itself, Italy represents only between 3 and 4 percent of the Alliance’s combined GDP. It was once more important, but twenty years of stagnation have diminished its economic heft. Italy is also a key member of the European Union and of the Euro currency bloc, both of which have been important to European prosperity over the past several decades. It doesn’t require much imagination to foresee a crisis in the Euro bloc if Italy cannot find prosperity within its framework.

Furthermore, the concept of collective security suggests that the United States at least cannot be indifferent to the fate of its more significant allies, especially given its uneasy rivalry with China today. Headlines frequently warn that China is “overtaking” the United States, with the GDPs of the two countries approaching parity. Given its population advantage, the concern is that China could eventually have a larger economy than that of the United States. The countries of the Alliance, however, have a combined population of about one billion, and they collectively produce some 60 to 65 percent of world GDP. As it is currently organized, China has little to no hope of attaining parity with the Alliance, barring a significant blunder on the part of the democracies.

Global strategy aside, there is yet another, if equally abstract, reason for being concerned with the fate of Italy. In the years after World War II, like the other countries of Europe, Italy set out to create a workers’ paradise under the banner of Social Democracy. Social Democracy—to oversimplify a bit—is a doctrine that recognizes the productive power of laissez faire capitalism but that rejects its distribution of income. The social democrat looks to the state to correct what he sees as an injustice, and to direct toward labor a larger portion of national income than it would otherwise receive. Such a doctrine, as many writers have noted, requires a legal system that is something less than even-handed.

In practice, Social Democracy has evolved into a system of full market intervention, designed to constrain competitive forces and to assure to workers their “fair share.” This is a political choice, one that many countries have made in hopes of finding social harmony, and as such it is certainly understandable. And yet it leaves open a question that should concern every thoughtful social democrat: At what point does the state’s hand become too heavy? How much abuse can the capitalist goose endure before she stops laying the golden eggs? After more than fifty years of probing the proposition, the Italians seem to have found out the answer. They have performed what in retrospect looks like a laboratory experiment, placing an ever-greater burden on both investors and workers until economic growth has finally come to a halt. In so doing, they have provided the rest of us with valuable information—if only we are wise enough to take advantage of it.

The full and complete lab notes of this Italian experiment can be found in the recent volume Meritocracy, Growth, and Lessons From Italy’s Economic Decline by Lorenzo Codogno and Giampaolo Galli. In its pages the authors provide a full list of the tortures that have been meted out to this poor goose and the steadily rising toll they have subsequently taken on Italian living standards. Indeed, their book could just as easily have been entitled A Handbook on How To Stop Prosperity Before It Gets Out of Hand. Employing an extensive array of databases and survey materials, Codogno and Galli catalogue the ways in which ever more intrusive market interventions, even if motivated by the best of intentions, have led to the steady immiseration of the Italian people—to the point where labor productivity and living standards have actually begun to decline over the past twenty years.

While several European economies have grown rather slowly in recent decades, in part a consequence of slowing population growth, Italy’s situation is unique. To put it in perspective, consider the fact that at the outset of the Euro currency in 2000, the economies of Italy, France, and Great Britain were of approximately equal size. Today, Italy is some twenty percent smaller than the other two countries. If this trend continues for another two decades, Italy will be reduced to half the size of France or Britain and will barely qualify to belong to the Organization for Economic Cooperation and Development (OECD).

There is a vague awareness within Italy that something has gone wrong. Residents of the Mezzogiorno are struggling to put food on the table, while their cousins in Westchester are among the wealthiest people on Earth. Yet, Codogno and Galli are not optimistic about change. The vested interests in the status quo are heavily fortified, and Italians are bitterly divided among themselves on everything related to work and entitlements. Readers might recall the somber case of University of Bologna professor Marco Biagi, who worked with the Berlusconi government in 2002 to design a plan to liberalize Italy’s labor market, only to be assassinated while riding home on his bicycle for lunch. Just a year ago, then-Prime Minister Mario Draghi was thought to be Italy’s last best hope. Now he too has been brushed aside.

Codogno and Galli both are experienced research economists; they are careful to distinguish between cause and effect. As a means of identifying the fundamental cause of Italy’s contemporary problems, and also to give their narrative an organizing principle, Codogno and Galli focus on the disregard for merit as a criterion for social advancement within Italy: University professors advance not because they are distinguished scholars but because they have served their time carrying the books of a more senior professor. Physicians are promoted to department heads not because they are great clinicians, but because they have the favor of an important politician. Even landing an ordinary job in Italy today depends less on demonstrated ability than upon the right recommendation. The word “competition” is a profanity.

Like most things in Italy, the disregard for merit does have long historical antecedents. Codogno and Galli choose to begin their tale of decline with the writing of the Italian Constitution in 1948, but they just as easily could have begun with the Articles of Justice that expelled the Magnati from Florence in 1292. In Italy it seems, it is always the same problem: an unwillingness to live in an open society. In any case, unlike Germany and Japan, Italy after WWII was given latitude to write its own constitution without Allied supervision. The document that emerged is the product of a negotiation between the only two coherent groups in the country at the time, the Communist Party and the Catholic Church.

Who better to write the founding document of a democracy than two autocratic entities with long histories of egalitarianism, a suspicion of competitive markets, and an antipathy to all notions of spontaneous order? Indeed, the field of agreement between the two parties was so broad, but for the doctrinal anticlericalism of the Communists they could well have been allies rather than adversaries in the postwar years. Their resulting constitution supported a structure of law that left property rights contingent at best and that gave to the state nearly unlimited power to intervene in those industries it didn’t outright nationalize.

Codogno and Galli’s book, then, is a detailed analysis of the state to which postwar Italy’s founding logic has permitted the Italian economy to devolve. Their approach is extensive rather than intensive: Instead of relying on economic theory to identify a few critical failures and then exploring these in depth, the authors use survey data—collected by the World Bank and the World Economic Forum, and organized by the Legatum Institute—to describe what at times reads like a laundry list of ailments. In social capital Italy ranks 25 out of the 34 OECD countries. In investment environment, Italy is 32 out of 34; in governance, 33 out of 34; in education 30 out of 34; in female labor force participation, 34 out of 34—and so on for the better part of 150 pages. This approach, while at times it does tax the reader’s patience, has the advantage of slowly accreting a mosaic image of a country that is now fully prepared to deal with the inequities of the 19th Century. But while that might be an amusing realization for us, for a young Italian today it is no laughing matter.

Despite the limitations of their methodology, Codogno and Galli are too good as economists to not eventually get to the heart of Italy’s problems. The overall impression of Italy that they convey is of a centrally planned economy behind a façade of private property: Business enterprises fall into either of two categories, those owned by the state and those the state manages by proxy through the legal system. Codogno and Galli give several examples of how the system works, the most notorious of which is control of the labor force. Labor laws are rigid to say the least; firms have no latitude to adjust their work force in response to declining sales. A firm trying to dismiss an employee runs the risk of having to pay severance equal to several years of salary. Union contracts are negotiated on an industry wide basis, so wages are determined by seniority rather than by actual skill on the job. Workplace rules are fiercely defended, and firms attempting to relocate or materially alter their methods of operation must confront the risk of criminal prosecution. Laws passed in 2015 in an attempt to make the labor market more flexible have been struck down since as unconstitutional.

Workers who cannot be fired are only reluctantly hired. Despite having a population that doesn’t grow, Italy’s recent graduates spend a long time looking for work, and youth unemployment there is second in Europe only to Spain. Aside from these relatively obvious problems, the Italian economy also loses the benefit of labor force turnover. In the United States, in a work force of 160 million workers, approximately four million employees change jobs every month. Most of these are young workers in their first ten years post-graduation, who in some cases change jobs four or five times before finding their niche. It would only be by chance that a person’s first job is the one  that suits his or her  individual talents. What normally ensues is a process of search, one that matches skills to job requirements and personalities to environments. But Italy has none of this. A job finally acquired is a job for life, and turnover is so low the government doesn’t even collect the data.

This simple fact more or less encapsulates the central message of Codogno and Galli’s valuable book: Economies deprived of dynamism are bound to fail.

Paul DeRosa taught economics at Columbia, ran a hedge fund for some thirty years, served on the research staff of the Federal Reserve Bank of New York, and has written extensively on topics related to economics.

Image:A close-up of Michelangelo's David, 1501-1504, Galleria dell'Accademia, Italy. (Jorg Bittner Unna)