Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey : Labor, Judiciary, Tax Reforms Can Help Boost Italy’s Economy
September 18, 2014
- Structural reforms can to help lift Italy out of a long recession
- Resolving more bad loans would alleviate tight credit conditions
- High public debt and geopolitical tensions pose additional risks ahead
Italy is struggling to emerge from recession, as tight credit conditions shackle investment, high public debt weighs on future growth prospects and long-standing rigidities hamper productivity, IMF staff said in a regular review of the country’s economy. Exports are expected to help growth recover in 2015 but deeper structural reforms could unlock further growth potential.
A container ship in Genoa. Italy’s exports have been strong but deep reforms will help unlock growth (photo: Ingram Publishing/Newscom)
Economic Health Check
“The Italian government is committed to implement a wide-ranging reform agenda in the labor market, judicial sector, and tax system. These reforms should be implemented quickly and together to give a maximum boost to potential growth,” said Kenneth Kang, who led IMF discussions with authorities.
Reform to release potential
Labor reforms are critical as unemployment reaches a post-war high of over 12 percent. Following a loosening of restrictions, 70 percent of new employment contracts are now temporary. Flexibility is important, but there are limits to the inroads it can make on improving worker productivity. IMF staff recommended introducing a single labor contract with gradually increasing protection. This would put workers on a more equal footing and give employers more of an incentive to invest in their staff.
Italy’s high regional disparities require special attention. GDP fell 13.6 percent in the South from 2007–13, compared with a less severe 6.7 percent in the North. The South’s unemployment rate increase was about 4 percentage points higher than the North. The IMF report recommended greater efforts at national level to help job matching and more firm-level wage negotiation.
Reforms to Italy’s sluggish judicial system are making headway in cutting the backlog of cases. In a selected issues paper, IMF staff recommended further measures, including better court management and greater use of mediation, which would speed up the resolution of legal disputes and benefit the economy in general.
Balancing spending to reduce debt
At 136 percent of GDP, Italy has the second highest public debt ratio in the eurozone. While sustainable, this level of debt makes the economy more vulnerable to swings in market confidence. As long as the recovery takes root, the government should aim for a modest structural surplus in 2015 to reduce public debt more quickly.
Adjustments are needed to both taxation and spending plans. Marginal taxes on labor and capital should be reduced and financed by savings elsewhere. The government’s efforts to target inefficient spending will be particularly important, as it reviews its budget priorities. Staff analysis also found that large social spending in Italy, particularly current pensions, will need to be tackled to generate sizable expenditure savings.
Helping credit get to the most productive ventures
Banks still have too many bad loans on their books, which is reducing their capacity to finance fresh and productive investment. The bank supervisor—through guidelines and monitoring—could help harmonize provisioning and encourage faster write-offs of non-performing loans. The right tax incentives could boost a private debt market, which would also help quicker resolution. Specialized insolvency courts, working to set deadlines, could cut the current drawn-out process for cases that are in the judicial system.
Many small and medium-sized businesses are struggling to find affordable credit as the cost of borrowing has increased. IMF staff said a new fiduciary loan contract should be made available to strengthen collateral enforcement and encourage banks to lend to firms. Efforts to coordinate a creditor-led restructuring of struggling but viable firms will also help ensure productive ventures do not fail.
External factors
Geopolitical tensions beyond Italy’s borders also pose a risk to its return to growth. Italian banks’ operations and investments in Russia and Ukraine are an important factor, as is Italy’s high dependence on imported energy (90 percent of its gas). If oil and gas prices were to go up 15–20 percent, Italy could lose half a percentage point of growth in the medium term.
Reforms and measures taken at the European level will be highly influential in Italy’s growth prospects. For example, further European Central Bank action will be needed if inflation remains low. At current levels, inflation is reducing prospects for real wage moderation and doing little to ease the corporate debt burden.