The worrying data on Italy’s recession

The latest data release of the Italian second quarter gross domestic productshows that the economy shrank 0.2 per cent, confirming that the country is back in recession. This is worrying in several ways. It brings GDP below the 2000 level, making Italy the worst performer since the start of the European monetary union. The slowdown in exports, the only component of GDP that had grown in the recent past, shows the underlying fragility of the country’s economy and its lack of competitiveness. The negative result, together with the very low level of inflation, makes debt sustainability more difficult to achieve, thus raising new concerns in financial markets.

The most worrying aspect, however, is that the recent number proves once again how wrong economic forecasts have been about the Italian economy. At the end of last year, the consensus of Italian and international institutions projected the 2014 GDP growth at about 0.6 per cent. The Italian government courageously aimed at 0.8 per cent. These forecasts were revised down earlier this year – and lately by the International Monetary Fund – to 0.3 per cent. The last release will probably induce a further correction towards zero.

This is the fourth year in a row that Italy’s growth forecasts have proved to be over optimistic. The year 2011 started with the expectation of a 1.1 per cent growth (according to the European Commission) and ended with only a 0.4 per cent rise in GDP. In 2012 the forecast error was even bigger, with an initial expected growth of 0.1 per cent and a final 2.3 per cent contraction. In 2013 the projected recession was initially estimated at 0.5 per cent but in the end resulted in a fall of 1.9 per cent. In the past four years the one-year-ahead forecast errors have been all of the same sign, and on average by 1.2 per cent a year (expected growth of 0.4 per cent against a final outcome of -0.8 per cent).

The magnitude and consistency of the error suggests that the available economic models no longer represent an adequate instrument to understand what is really happening in the Italian economy. In particular, they do not seem to capture the effects of the loss of competitiveness accumulated by Italy in a changing global environment.

These shortcomings represent a significant problem not only for professional forecasters but also for policy makers, who lack an essential tool to calibrate their actions. There is a wide consensus, even in Italy, that the country needs wide-ranging reforms. However, these reforms have been difficult to implement, first because of the complexity of the institutional system; and second because of opposition by powerful interest groups. The reforms brought forward by the the government of Prime Minister Matteo Renzi in order to change the electoral law and eliminate the “perfect” bicameral parliamentary system (where the lower house and senate hold equal powers), which are expected to be approved shortly, tackle the first aspect. They will also make it easier to fight against conservative forces that oppose change. However, when it comes to the substance of economic reforms, which must address the critical areas where Italy has lost competitiveness – such as the bureaucracy, the judicial system, the tax system, and the labour markets – there is a risk of underestimating how deep and far-reaching they need to be.

The first announcements that have been made suggest that the proposed changes might be marginal and expected to be implemented within a relatively long time horizon – the government announced a 1,000-day programme of reform. The recent GDP release should instead make the case for more fundamental changes, if not a complete overhaul of the economy. Without such reforms growth is likely to stagnate or decline.

The problem is that the economic case for such a conclusion has not been made in a clear and consistent way, in particular by international institutions. As long as economic forecasts continue to project a recovery over the coming year, the case for adopting a minimalistic approach and for postponing action will be strengthened. Indeed, why should political authorities accelerate the reform agenda if next year’s GDP growth bounces back, to above 1 per cent as projected by the IMF? Why should they incur the political cost of reforms if the recovery is around the corner?

But what if these forecasts prove wrong yet again, as in the past few years? It will confirm that prevailing economic models are useless. More importantly, it will entail a loss of precious time and political capital. The trust in national and international institutions would be further undermined.

When it comes to Italy, forecasters should thus be more humble and revise their models to reflect more closely the underlying economic trends. Policy makers, on the other hand, should stop calibrating their reforms on prevailing economic models. They should revert instead to the forgotten Lisbon Agenda, initiated in 2000. The aim is to identify the best performers in crucial economic areas, so as to create an incentive for emulation. Economic reforms should thus be targeted at copying best performers, concerning goods and labour markets, tax systems, judiciary infrastructure and bureaucracy. Concerning the labour market, for instance, the recent reform implemented in Spain – which is at the origin of the country’s recovery – should represent one of the main benchmarks.

The important message for Italy’s policy makers, and for the citizens, is that without these reforms income will continue to stagnate at best, and may even decline, especially on a per-capita basis, putting at risk the wellbeing of society and the wealth accumulated over the past decades. The best way to put public finances back onto a safe path is to revive Italy’s growth, through fundamental and far-reaching reforms, rather than by taking short-term budgetary measures. The expectation that growth will come back by itself – just because forecasters say so – and will solve Italy’s longstanding problems is at best a hope, at worse an illusion. And to borrow a phrase from Rudy Giuliani, former mayor of New York, hope is not a strategy.

Lorenzo Bini Smaghi is a former member of the executive board of the European Central Bank and currently visiting scholar at Harvard’s Weatherhead Center for International Affairs and at the Istituto Affari Internazionali in Rome




Fonte: FT