10-04-2013 10:29 AM

Italy's productivity puzzle

OVER the last few years, many commentators have called the Italian economy the basket case of Europe. Growth has stalled over the last decade. Current real Italian GDP is now lower than it was in 2001, before physical euros began circulating. With a debt-to-GDP ratio of over 120%, Italy's fiscal hangover may stretch many years into the future. Most notably, Italy’s unit labour costs have increased relative to competitors, leading to the suggestion that falling productivity may lurk behind its current economic malaise.
But curiously, other evidence suggests Italy may not be quite doing as badly as a first glance at the headlines suggests. Italian GDP fell much less during the euro crisis than output in countries like Greece and Ireland. It has not had a property crash as severe as many other countries'. There are even grounds for optimism on its fiscal position. The Italian state has a primary budget surplus, something of a rarity in much of Europe.

Most interestingly, Italy’s exports have held up surprisingly well during the crisis for a country often seen as having serious competitiveness problems. Exports in high-value sectors, such as fashion, have proved particularly robust. For instance, brands like Gucci have almost never had it so good, even as many of their products are still made in Italy. According to UNCTAD’s Trade Performance Index, Italy has remained, during the downturn, the world’s top ranking exporter in textiles, clothing, and leather goods. Even for non-electronic machinery and manufactures it is still ranked second in the world, behind only Germany.
So why is Italy doing so badly on cost competitiveness measures when much of its industry looks like it is doing quite well?
The International Monetary Fund, in a report published last week, has suggested that traditional cost competitiveness measures may no longer be the best way of calculating how well countries like Italy are doing. The ICT revolution in the 1990s is regarded by many economists to have widened the difference behind the two main ways of measuring competitiveness. Trends for cost competitiveness, which focus on how fast unit labour costs are falling in an economy, are diverging from technological competitiveness. An increase in technological or design innovation might boost wages in an economy as high-skilled jobs are created. *An increase in unit labour costs can therefore be a sign of more high-level jobs being created in an increasingly innovative and competitive economy.
This divergence can also be seen in other statistics on Italy’s productivity. In terms of unit labour costs, Italy appears to be doing badly. They have risen 5% in Italy since 2002, against a 20% fall for Germany. But other measurements suggest that the true gap is much smaller than this. Measures based on producer price index data, for instance, suggest that Italian industry has not materially become less competitive than it was in 1999.*
Adjusting measures of competitiveness to focus on the value-added by the Italian and German economies also reduces the gap in performance between them in the 1999-2012 period. Italy has been able to withstand high labour costs as the imports for its export industries come from low-inflation countries, a benefit Germany has not enjoyed as much. This has meant Italian exports have remained as competitive as in many other European countries; Italy’s market share of global exports has shown very similar trends to Britain's and France’s over the last decade.*
Overall measures of unit labour costs may have also hidden the resilience of Italy’s high value-added and high-margin sectors during the crisis. Its makers of precision machine tools and high-class fashion have built themselves international reputations for innovation and boosted GDP. The solutions to Italy’s unemployment problems and flagging output figures may be to try and grow these high-value and high-quality industries further. But this is much easier said than done. More structural reforms are still required. The IMF suggests that reforms are urgently needed to reduce bottlenecks in Italy’s snail-pace judicial system and to write-down the bad debts of its dysfunctional banking system.
With an underlying competitiveness picture not quite as bad as it first looks, and a fiscal deficit of under 3% of its GDP, Italy should be the envy of many of its neighbours. But the innovative, design-led, fashionable part of its national character seems to be held back by regulation and the shenanigans of some of its politicians. Sadly, as the past week has demonstrated, it may be some time before Italy enjoys stable, reform-minded government.



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