Roger Bootle
The last few years have been remarkable for smashing established preconceptions about economic performance. Two weeks ago, I analysed Germany’s economy and made it clear that not only is it currently weak but its economic prospects look pretty poor as well. As I know from the subsequent reaction, this came as a shock to many people.
Readers are likely to be equally shocked by the revelation that Italy, supposedly a perennially weak economic performer, has recently done relatively well. But is this likely to continue? My colleague, Jeremy Warner, last week gave an upbeat assessment of Italy. He was certainly right to emphasise that since the pandemic, of the eurozone’s four major economies, Italy has grown the fastest.
Admittedly, this is not saying a great deal. Since 2019, Italy’s economy has grown by only 4pc. Even so, for Italy to come out ahead of Spain, France and Germany is pretty surprising. In fact, the four southern European countries – Italy, Spain, Portugal and Greece – have all done relatively well and, in particular, have outgrown Germany and some other normally successful Northern economies.
This is partly explained by a major revival in tourism as people embarked on foreign holidays again post-Covid. Also, compared to Germany, this group of countries has a lower share of manufacturing in GDP and was not as hard hit by the surge in energy prices following Russia’s invasion of Ukraine.
But in Italy’s case, recent relatively strong growth has been mainly driven by a huge surge in construction output owing to a substantial tax incentive scheme led by Giorgia Meloni’s government. This surge is likely to continue for a while longer but by the end of the year, it should be fading, not least because the tax incentive scheme is being wound down.
Moreover, it seems likely that capacity constraints will prevent construction activity from continuing much longer at this level. The upshot is that next year Italian growth will probably come in at something like 0.5pc, compared with a eurozone average of nearer 1pc. When it comes to medium-term prospects, Jeremy Warner may be right that Italy has turned a corner.
There is certainly more political stability than Italy has been used to. But on economic prospects there is plenty of room for reasonable people to differ – and I do. Italy’s recent comparative success has done little to alter the picture of a country held back by major structural problems. The country faces two key supply difficulties. First, the working population is set to fall considerably.
Admittedly, in Italy the female participation rate is pretty low by normal European standards and therefore there is some scope for the fall in working-age population to be compensated by an increase in the female participation rate. Also, the retirement age is automatically geared to increasing longevity. Even so, these factors will not be enough to stop the labour force from declining over the coming years and decades.
The second problem is more serious. Productivity growth in Italy is pitifully low. This is, of course, a problem across most of the world but in Italy, the difficulties are deep-seated. From 2000 to 2022, the average Italian growth rate was 0.2pc per annum, in other words, next to nothing. Over this period, productivity growth was flat.
There are several causes. The education system is not well geared to producing people with the requisite skills to succeed in the modern world, with a relatively low proportion of students studying STEM subjects. Italy also suffers from a lack of digital advancement, while corruption poses an ongoing problem. Most aspects of public administration, including the justice system, are also riddled with bureaucracy and endemic delays. If the outlook for economic growth across the West is brighter in the coming years – and I think it is – then the main reason will be the productivity growth unleashed by the AI revolution. Yet Italy is poorly placed to take advantage of AI. It ranks 25th out of 30 economies in the Capital Economics AI Economic Impact Index.
A major symptom of Italy’s economic difficulties, and a possible cause of further challenges, is its fiscal position. Italy is a test case of how a country can end up in a debt trap. The ratio of government debt to GDP is running at about 140pc, compared with 65pc in Germany and about 100pc in the UK.
Before the pandemic, it was normal for Italian governments to run a primary surplus on their budgets, that is to say, an excess of revenues over expenditure, excluding interest payments. More recently, however, Italy has been running a large primary deficit. It was about 3.4pc of GDP last year. What’s more, interest payments are huge, currently running at over 4pc of GDP. The result is that despite raking in tax revenues successfully, last year the Italian government ran an overall deficit of 7.2pc of GDP.
This year the deficit is likely to be more than 5pc of GDP. This wouldn’t matter so much if the economy were growing strongly. But, as noted above, this doesn’t seem likely. Recently, the spread of Italian bond yields over their German equivalents has been comparatively low at 1.4pc. If this spread were to widen, however, then Italy’s budget deficit would increase again and require further fiscal tightening to stop the debt ratio from rising. As it is, it looks as though this ratio is set on a path that will take it to about 150pc of GDP by 2050. None of this is to say that Italy is bound to face an imminent crisis. Just as in the UK, it might be better if it were. Rather, again just like in the UK, without fundamental and radical reform, the outlook is probably something that looks and feels like stagnation, with living standards managing to increase only by negligible amounts. We both deserve much better.
The Telegraph
