# Blog

Overcoming the hurdles to Italian growth

This opinion piece was published in La Republicca.

As the Italian government is contemplating its budgetary policy, it is useful to look at other countries’ experiences in how to deal with high debt levels. A salient example is Belgium as my colleague André Sapir is pointing out in an upcoming paper for Bruegel. Belgium and Italy both had comparable debt to GDP ratios in the early 1990s. But in Belgium the debt ratio declined by 51 points of GDP between the peak (of 138%) in 1993 and 2007, while in Italy it only declined by 27 points from the peak of 127% in 1994. As Sapir shows, the main reason for this difference in performance was the government’s primary balance. Belgium achieved a much higher primary surplus than Italy. But despite more than a decade of greater “austerity”, Belgium could achieve significantly higher growth rates in that period than Italy, with 2.4% growth vs 1.7% growth in Italy.

This example suggests that under certain conditions, high primary surpluses can be combined with relatively high growth rates. The focus of the debate should then be on what are those conditions.

One dimension is obviously the business cycle. If the output gap is large, a fiscal stimulus can be helpful to reduce unemployment and bring the economy back to potential. Yet, international institutions such as the IMF estimate that Italy’s output gap is tiny. The IMF may be wrong with its precise estimate. But the negative market reaction to Italy’s announcements to increase the deficit suggests that caution is warranted. Permanently higher funding costs would be a substantial burden to growth.

The second dimension is investment and the recent tragedy of the bridge of Genova have brought this to the forefront of the conversation. Clearly, more investment is needed not only in Italy, but also in Germany and in Europe in general. But the question should be what kind of investment and for what purpose. Currently, the Italian debate is mostly about public investment and empirical estimates suggest that it is often not very productive in Italy. So the focus should be on how to make public investment more productive to increase growth. For the fiscal lever to be effective, the focus needs to be first on improving the process for public investment.

The third and perhaps most important dimension is about how to increase productivity growth in Italy where it has been feeble for 20 years. A recent paper by the Banca d’Italia aims to identify the country’s structural weaknesses. This research suggests that a significant part of the problem lies with small firms in the services sector, while the large manufacturing firms are doing well in global comparison. Improving the conditions for the more productive firms among the small ones to grow is suggested as a good policy priority – a result echoing previous work by Carlo Altomonte and colleagues. And other Italian researchers found that resource misallocation is the main source of weak productivity growth.

The overall lesson is that Italy can manage to turn around its economy and improve growth and employment. But research also suggests that this requires focusing on how to improve the effectiveness of public investment and, more importantly, long-run productivity growth. There is already substantial knowledge on what constitutes the main structural bottlenecks to growth in Italy. Now is the time for refining recommendations and more importantly for a serious political debate on how best to overcome bottlenecks and improve the economic prospects of Italians.