Mario Draghi: Overview of economic and financial developments in Italy
Concluding remarks by Mr Mario Draghi, Governor of the Bank of Italy, at the Ordinary Meeting of
Shareholders, Rome, 31 May 2007.
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Ladies and Gentlemen,
I wish to pay grateful and affectionate tribute to the members of the Directorate who left the Bank in
2006 after decades of dedicated, rigorous and judicious work. They accompanied me in my first steps
in this institution, providing the support of their loyalty and experience.
Vincenzo Desario, who was appointed Director General in 1994, served the Bank in the exercise of
highly sensitive functions, notably in the area of banking supervision. He led the Bank on an interim
basis after the resignation of Antonio Fazio. He stamped his mark indelibly on the Bank's approach to
prudential supervision, principles of internal organization and daily administrative practices. The Board
of Directors has named him Honorary Director General.
Pierluigi Ciocca, who had been Deputy Director General since 1995, gave the Bank the benefit of his
profound, original thinking and his vast economic and legal knowledge. He promoted the study of law
and economics, inspired research for many years and helped to refine the analysis of the functions of
central banking.
In 2006 the Directorate acquired new members with expertise and experience, some of it gained
abroad. Fabrizio Saccomanni, who as Vice President of the European Bank for Reconstruction and
Development was in charge of risk management at that institution for three years, has been Director
General since October. Ignazio Visco, Central Manager for Economic Research and previously Chief
Economist of the OECD for five years, and Giovanni Carosio, formerly Central Manager for Banking
and Financial Supervision, joined Antonio Finocchiaro as Deputy Directors General in December. The
Directorate's new membership combines valuable experience in the international arena with intimate
knowledge of the Bank, analytical and research skills with specialization in the area of regulation and
central banking.
The Bank's new Statute was approved last year. It modifies the operations of the Bank's
decisionmaking bodies: the Board of Directors, the Board of Auditors and the Directorate. It establishes the
principle of collegiality for measures that have external significance.
The Bank intends to renew itself, and has already begun to do so. The reorganization taking place
affects the functions of the Head Office, the branch network and the representative offices abroad; it
provides for the full integration of the Italian Foreign Exchange Office. The aim is to reduce
bureaucratic procedures, simplify and rationalize working practices, thus fostering individual
responsibility, reallocate resources from the Bank's internal administration to its institutional functions,
and tap into new recruitment channels, as with the forthcoming competitive examination for
economists that is open to applicants from abroad.
We are on the point of implementing the reorganization of the activities of economic research and
international relations, with the objective of structuring their tasks better according to particular needs:
to contribute to setting the common monetary policy by monitoring and forecasting short-term
economic developments and analyzing monetary strategy and transmission mechanisms; to study the
fundamental problems of Italian economic development; to carry out research on the world economy
and cooperate with international organizations; to refine economic statistical methodology and
disseminate economic and financial statistics. The plan for the reorganization of the supervisory
departments is being finalized, to give greater weight to the macroeconomic analysis of risk, the
quality of regulation and consumer protection. There will be more interaction between research and
supervision, and off-site and on-site supervision will be more closely integrated and have more
methods in common. Measures affecting the other functions will follow in due course.
The Bank of Italy is also reviewing the principles and procedures for managing its own portfolio of
financial assets. The aim is to increase transparency and separate the investment of its own resources
more clearly from its other institutional activities.
The Bank of Italy has recently introduced numerous innovations in its operating procedures. Since the
beginning of 2007 banks have been permitted to include bank loans among eligible collateral for
Eurosystem financing operations. Since mid-April the Bank has conducted new very-short-term
borrowing transactions on behalf of the Ministry for the Economy and Finance, making treasury
management easier and more predictable. On behalf of the same Ministry, it has launched the
General Government Transactions Information System, which will enable government entities to
evaluate their cash flows in real time and facilitate the adoption of electronic payment procedures. The
project for the development of the new TARGET2 platform for settling large-value payments, which is
being carried out in conjunction with the Bank of France and the Bundesbank, has reached an
advanced stage. TARGET2, which will come into operation in November, centralizes the technical
infrastructure of the European payment system, reducing the cost of cross-border interbank
transactions. It will allow the ever-growing number of banks with a presence in more than one
European country to operate with a single account in central bank money and curb the cost of treasury
operations.
The branch network will be reorganized on a regional basis in forms that are more appropriate for the
present day and without abandoning the Bank's nationwide presence. Reducing the tasks of
selfadministration and increasing those with greater technical content will give branch staff new
opportunities for learning and professional growth.
Wide-ranging discussions with the trade unions on the organizational changes have been under way
for several months. I hope that broad consensus will be reached before long on action to strengthen
the Bank's role and prestige and an agreement concluded on the necessary measures to assist the
workers involved.
The Bank's expanding international commitments, the reform of its governance and the new
operational initiatives have posed important challenges. The staff have faced them with their
customary professionalism and dedication, born of a tradition that has cultivated the spirit of public
service, a sense of identification with the institution and merit-based selection in recruitment and
promotions. I wish to express my gratitude to all the members of staff .
The principles of Community law, primary legislation and the provisions of the Bank's Statute protect
the absolute autonomy of the Bank in the performance of its institutional functions from possible
influence by its shareholders. However, the criteria for share ownership appear obsolete and do not
ensure a sufficiently broad distribution of shares. The new bill on the reform of the regulatory
authorities goes in the right direction, being based on the principles of the independence of the Bank
and of a balanced distribution of its share capital.
Credibility and independence are essential to the performance of our duties. The autonomy of the
central bank, though protected by law, can be fragile unless it is supported not only by authoritative
analysis but also by consequent action.
The world economy, finance and monetary policy
The world economy grew by 5.4 per cent in 2006, the highest rate for more than thirty years. The
slowdown in the United States was off set by continued strong expansion in China and the other
emerging countries and by the recovery taking place in the euro area and Japan.
World trade continued to expand at a rate of over 7 per cent. Economic integration has been an
important driving force of the uninterrupted growth of recent years. It is threatened by the resurgence
of protectionist tendencies; the signs are visible, most notably in the stalled negotiations on the Doha
Round of liberalization measures.
The persistent increase in current payments imbalances continues to pose a risk. The current account
deficit of the United States reached 6.5 per cent of gross domestic product in 2006, the highest ratio
ever recorded; with its counterpart in the growing surpluses of China and other Asian countries and oil
producers, it has been financed easily thus far, but the share held by foreign authorities is rising.
The financial sector has made a fundamental contribution to economic growth in recent years by
permitting unprecedented capital mobility and facilitating efficient capital allocation and by smoothly
financing imbalances that in another era would have been disruptive. Financial innovation has
enhanced market liquidity and reduced volatility.
The expansion in the markets and the continued process of financial innovation are also changing the
pattern of risks.
The use of derivative instruments has grown further. Their notional value is now equal to ten times
world GDP. Alongside instruments serving to hedge market risks, there has been a rapid expansion in
those for the transfer of credit risk; the notional value of credit default swaps more than doubled in
2005 and doubled again in 2006. By making it possible to slice up credit risk and evaluate it precisely,
allocating it and spreading it among a multitude of market participants, credit derivatives help to raise
the productivity of the financial system, just as new production technologies boost that of the real
economy. However, they can become a source of instability if intermediaries use them not to hedge
existing risks, but to increase the volume of risks they assume. In addition, credit derivatives can
modify the modus operandi of the banks that use them. If lenders transfer part of the risk to others, the
incentive to evaluate borrowers' creditworthiness can weaken. A sign of this is to be seen in the rise in
sub-prime mortgage defaults in the United States, where the transfer of risk is commonplace.
Abundant liquidity and low interest rates have contributed to the vigorous growth of hedge funds and
private equity funds. Their role in the functioning of the markets has been positive, but the scale of the
phenomenon, the high leverage of hedge funds, the demand from investors and counterparties for
greater transparency and the potential risks of instability require the attention of the market and
regulators. Supervisors seek to limit systemic risk, relying on market discipline by pressing the
intermediaries under their direct supervision to obtain the necessary information from hedge funds and
satisfy themselves that procedures are in place for the best management of risk.
Risk premiums have now fallen for a broad spectrum of financial instruments and markets. Investors'
perception of risk could suddenly change; an abrupt portfolio adjustment, whatever the cause, would
have destabilizing effects on exchange rates and financial markets. Although it is more able than in
the past to absorb small and medium-sized shocks, the financial system may have become more
vulnerable to "extreme" events that have a low probability of occurring but potentially disruptive effects,
due not least to the system's increasing complexity and the growing interdependence between
markets.
The development of new instruments and the emergence of new types of intermediary also pose
unprecedented challenges for monetary policy. More than ever before, the financial markets are a
source of information on trends in economic activity and the expectations of economic agents; central
banks' actions are reflected more rapidly in the prices of financial assets. At the same time, the money
and credit aggregates are being increasingly affected by the conduct of non-bank intermediaries;
financial innovation is complicating the interpretation of the behaviour of monetary aggregates.
From December 2005 onwards the Governing Council of the European Central Bank has gradually
moved towards a less accommodating monetary policy stance; it has raised official interest rates by
1.75 percentage points since then. At a time of strengthening economic activity, expanding
employment and sharply rising energy and commodity prices, our decisions have kept inflation
expectations firmly anchored to the objective of price stability. For the first time a powerful oil shock
had no repercussions on inflation.
Money and credit continue to grow strongly. Despite the impact of financial innovation on the velocity
of circulation, monetary aggregates remain a fundamental element in the strategy of the Eurosystem.
In nominal effective terms, the euro appreciated by almost 5 per cent in 2006. One factor in the
strength of the single European currency has been the improved economic outlook for the area, in the
face of fears of a slowdown in the United States.
Monetary policy has remained conducive to growth. Real short-term interest rates are still below the
average for the area over the last twenty years. Long-term rates have risen, but by less than in
comparable phases of past cycles. The gradualness and careful communication of monetary policy
decisions have helped maintain stable conditions in the money and financial markets.
Consumer price inflation in the euro area was 2.2 per cent in 2006, just over half the rate recorded in
the early nineties. A similar reduction occurred in the industrial countries as a whole, while in the
emerging economies inflation fell from 60 per cent to 5 per cent. This remarkable achievement is
attributable to the independence of central banks and the clarity of their statutory objectives, and also
to the increase in competition triggered by the opening-up of markets.
To strengthen growth in Italy
The Italian economy has been recovering since the middle of 2005. Growth strengthened during 2006,
to an average of nearly 2 per cent, a result that had not been achieved for five years. A similar rate of
growth is expected in 2007, despite the slowdown in the first quarter. The recovery has been fuelled
by investment and the growth in demand abroad, especially in Germany. Employment has risen
substantially, but still largely in the number of temporary jobs.
The Italian economy may have shaken off economic stagnation, but its rate of growth is still one of the
lowest in the euro area. In the first half of this decade labour productivity fell in every sector, and
especially in industry. The disparity in relation to the rest of the euro area indicates slowness in the
adaptation of Italian industry to the changes in the technological and competitive environment.
The recent improvements in productivity and exports, though still modest and largely cyclical, may
nevertheless suggest that a process of restructuring has begun.
The restructuring of the industrial sector
A survey of more than 4,000 firms carried out in recent months by researchers at the Bank provides
initial indications that this is indeed happening. More than half of the industrial firms in the sample
have changed strategy in the last five years. The 12 per cent of firms that have shifted their product
range towards new sectors earned higher than average profits in 2006. One firm in five, almost double
the ratio compared with the beginning of the decade, is adopting some form of internationalization,
ranging from cooperation with foreign partners, the preferred solution for small firms, to the
outsourcing of manufacturing or marketing. In all the firms the importance of investment in product
development, design, brands, and distribution and customer-service networks has increased. Among
medium-sized and large companies the use of new technologies for integrated corporate management
is becoming more prevalent and the proportion of better-educated staff is rising; corporate profits have
benefited as a result. Profits are also inversely correlated with the age of company leaders, a fact of
great significance in the country of family capitalism: firms that have tackled generational changeover
report higher average profits.
Our survey, the many case studies accompanying it and data from other research bodies paint a
picture of change, owing partly to a more severe winnowing of firms. According to the Chambers of
Commerce, the number of manufacturing firms deleted from the registers has exceeded new
registrations by more than 50,000 over the last five years. Confronted with the dual shock of
globalization and technological change, the economy is beginning to react.
It would be wrong to conclude that the crisis of productivity and competitiveness of the last few years
is now behind us. Productivity in industry, which fell by 3 percentage points between 2001 and 2005,
rose by just over 1 point last year; in Germany, France and Spain it increased by between 3 and 6 per
cent. The divergence of trends in unit labour costs has become more pronounced. We still have a long
road ahead of us.
Company size remains crucial. Companies must achieve sufficient scale to support the high fixed
costs of continuous innovation and an active presence in distant markets; even more than in
manufacturing plant, scale matters in developing products, fostering brand recognition and standing,
and organizing production. Field surveys reveal obstacles to growth. In our study, 40 per cent of the
firms that considered themselves to be too small missed out on opportunities to expand by means of
acquisition or merger over the past decade.
A gap to close
The transformation of the economy is being hampered by an institutional framework that still has major
shortcomings, although it must be recognized that progress has been made. The reduction of
unemployment, though important, is the only area in which Italy is in step with the timetable envisaged
in the Lisbon Agenda. Italy is behind schedule as regards raising the employment rate, especially for
women and older workers, education, vocational training, reducing the risk of poverty, innovation, and
compliance with environmental constraints; in many cases the lag is greater than the average for the
Union as a whole.
Last year I pointed to areas where structural measures are of particular importance for the growth of
the economy and its enterprises. I would like to revisit some of those issues in the light of
developments since then.
Education continues to head the list of fields where change is most necessary. The low international
ranking of the Italian school system has a geographical aspect that deserves attention. The disparity in
levels of scholastic achievement between North and South is significant even in primary school and
tends to widen thereafter. One of every five 15-year-olds in the South is "knowledge poor", which is the
prelude to economic poverty; the disparity is even larger if the South's higher drop-out rate is taken
into account. Such a marked geographical difference shows that the problem lies not only in the rules
but also in their practical application.
The recruitment of teachers, their distribution between regions and different types of school, and their
career paths are governed by mechanisms that feature, at different stages, both precariousness and
irremovability. Mobility bears little relationship to educational need, merit or capability. Every year more
than 150,000 of Italy's 800,000 teachers change assignments in an arduous progression towards their
desired position. Another negative factor is the delay in developing an effective school assessment
system, which the experience of other countries suggests is an indispensable complement to school
autonomy. Changing the Italian school system must begin with a recognition of the vicious circles that
penalize it, demoralize teachers and betray the mission of public education. It is here that the
problems originate, and not in a shortage of resources for education per student, which in Italy are
actually above the European average.
For an advanced economy, an even more direct and immediate contribution to growth comes from the
university system. Some important reforms enacted in the past, ranging from financial autonomy to the
evaluation of the quality of research, have still not been completed. Priority in the allocation of public
resources should be given to financing scholarships for worthy and less welloff students. Universities
should be able to compete for students and public funding on the basis of the quality of their teaching
and research staff , selected for their academic standing and paid accordingly.
The degree of competition in the domestic market in both public and private services affects the
growth of firms competing in the international arena. In the countries where the legal and regulatory
obstacles to competition in energy, telecommunications, transport and professional services are
greater, manufacturing industry grows more slowly. Until a short time ago Italy was - and in some
respects still is - among the countries where regulation is most unfavourable to consumers. To date,
liberalization in the energy sector has been halting. Although the price of electricity for industrial users
in Italy has risen only very slowly in recent years, excluding taxes it is still among the highest in
Europe, about 20 per cent above the average. Action to liberalize the market for services, which has
been initiated, is essential to regain competitiveness and growth. This objective should also be
pursued because of the effects it will have on consumers' welfare, not least in terms of income
distribution. In 2005 more than 15 per cent of the monthly consumer spending of the poorest 20 per
cent of the Italian population went for goods and services now the subject of liberalization measures:
€140 out of a total of €940, half of which was for energy in various forms.
The shortcomings are particularly prevalent in local public services, notably urban public transport and
the collection and disposal of waste. The succession of rules enacted in the nineties were designed to
separate the management of services, to be awarded by competitive mechanisms, from activities that
are natural monopolies, and assigning regulatory powers to local government. These guidelines have
been frequently disregarded. The results in terms of the cost and quality of services have been
disappointing, with geographical differences depending on the administrative capabilities of local
authorities.
Liberalization has progressed in other fields. In professional services, where Italian regulations had
been the most restrictive among the advanced economies, the initiatives undertaken in 2006 have
brought the level of regulation close to the middle of the international range. Action in the retail sector
needs to be continued, by establishing not only in law but also in practice the principle that sales
outlets should not be rationed geographically except on sound environmental grounds and by
guaranteeing the full application of this principle at regional and local level.
The failings of the Italian civil justice system are documented in international studies and
demonstrated by the inconvenience suffered by individuals and firms. An international comparison of
the length of legal proceedings is unforgiving. To take just one example: labour disputes take an
average of more than two years to pass through the lower courts in Italy, compared with a year in
France and less than six months in Germany. The slowness of justice is due not so much to lack of
resources as to organizational weaknesses and defects in the system of incentives. Here too there is a
specific Southern problem; an ordinary civil case in lower court takes three times as long in Messina
as in Turin, averaging 1,500 days against 500. The universal application of information technology
would make proceedings speedier and more efficient and the operation of the various offices
transparent; it would also supply the basic information that is indispensable for effective
reorganization.
Information is vital if inefficiencies are to be eliminated. The quality of the services supplied must
become the yardstick for evaluating government departments and the activity of their managers. The
objectives must be clear and verifiable. Differentiating earnings partly on the basis of individual
productivity, evaluated uniformly and transparently, would help attain them. This is provided for in the
Memorandum of Understanding concluded between the Government and the trade unions last
January.
Infrastructure represents an unresolved problem. The experience of recent years, after the
amendment of Title V of the Constitution, has shown that concurrent decision-making between central
and regional government is laborious and frequently ineffective. In the general interest, consideration
should be given to the possibility that in certain cases it would be advisable, once a certain time has
elapsed, to relieve the central government of the obligation to obtain the assent of the regional and
local authorities. It must be possible to allow local needs to be expressed without for ever blocking
public works that are necessary to the modernization of the country.
Sustainable public finances
According to Government estimates, net borrowing will come to 2.3 per cent of GDP in 2007, half a
percentage point better than the target set at the end of last year. The primary surplus will rise to 2.6
per cent.
To ensure the sustainability of the public finances, deficit reduction must continue, with incisive action
on the size and composition of the budget.
At the end of 2006 Italy's public debt reached €1,575 billion, or nearly €27,000 per person. For thirty
years, from 1964 to 1994, its ratio to GDP rose steadily, from 32 per cent to 121 per cent. It then
declined by 18 points by 2004, turning upwards again since then. Without asset disposals and the
restructuring of liabilities, the ratio of debt to GDP would be approximately the same today as in 1994.
The accumulation of debt has not helped Italy to grow. It has not endowed the country with adequate
infrastructure.
High debt constrains public policies; it requires higher taxes and reduces the resources available for
investment and welfare expenditure. With interest rates rising, albeit by very little so far, interest
payments are again tending to increase. They are already equal to the amount spent on public
education and to two thirds of that spent on health care.
In 2005 there were 42 persons aged 60 or more for every 100 of working age. By 2020 they will have
risen to 53 and by 2040 to 83. These trends will affect spending on pensions, health care and social
assistance. The choice we face is whether to reduce the debt burden in the next ten years, before the
aging of the population becomes more pronounced, or to wait, but in this case accepting major
changes in the support that society will be able to provide to its weakest members.
The recent improvement in the public finances is due to the sharp increase in revenue. According to
the Government's estimates, the ratio of tax and social security contributions to GDP will rise further
this year. It is higher than the European average and close to the peak levels of the last few decades.
Among the large European countries, France alone has a higher ratio. Because of tax evasion, which
remains high despite signs of a recovery in tax receipts, the difference between Italy and the rest of
Europe is greater in terms of the burden on honest taxpayers. The statutory tax rates on both labour
and capital are high; the corporate income tax rate is only lower than that in Germany, where the
Government recently announced a cut of 9 percentage points. An excessive level of taxation and the
variability and complexity of tax rules discourage investment in physical and human capital and raise
the cost of compliance.
Only by permanently reducing current expenditure can the deficit be curbed and the debt lowered
without increasing the tax burden. Since 2000 primary current expenditure has risen by an average of
one percentage point more per year than GDP. Its ratio to GDP has reached 40 per cent, comparable
to the highest post-war levels.
The expenditure mechanisms need to be changed. In 2006 primary current expenditure still grew by
3.6 per cent, compared with the Government's budget forecast of 1.1 per cent. There is scope for
saving in all the major items of the budget; the revision of expenditure programmes that the
Government has commenced goes in the right direction. Redistributive policies also need to be subject
to a cost-benefit analysis.
A lasting adjustment requires action on the pension system. Life expectancy continues to rise and the
number of Italians of working age to diminish; meanwhile, the employment rate is the lowest in the
euro area. It is necessary to raise the average effective retirement age over time, not least in order to
maintain an adequate level of benefit. The architecture of the system introduced in 1995 must be
applied. Close correlation between an individual's pension contributions and benefits reduces the
distortions in levies and disparities of treatment between different categories of worker, and permits
flexibility in the choice of retirement age. Rigorous and prompt application of the adjustment
mechanisms envisaged by the current legislation is essential.
But it will not be possible to return the system to a sustainable path and at the same time guarantee
workers adequate pensions without a rapid and resolute launch of supplementary pension provision,
which is still underdeveloped. The returns on investments in supplementary pension plans are likely to
be better than those on severance pay funds, and further advantages derive from the additional
contributions from employers and favourable tax treatment. The decision to bring forward the
introduction of implied consent for the assignment of accruing severance pay to supplementary
pension funds to 2007 and the new forms of flexibility in the use of accumulated savings move in the
right direction. However, in many cases enrolment in supplementary funds is being discouraged by the
excessive fees charged to savers; little of the benefit of the economies of scale generated by the
growth of pension fund assets has materialized so far. Competition must increase; fees are
insufficiently transparent and the restrictions on portability are excessive. The limits on the
transferability of employers' contributions need to be reconsidered. Information must be improved: if
workers are not fully acquainted with the facts of the public pension that they will receive in the future,
they are not in a position to make informed decisions. Supplementary pension plans need to be
extended to public employees as soon as possible.
Without prejudice to the stability of the public finances, and given that overall contributions to the
public pension system equal 33 per cent of wages, by far the highest rate among the major European
countries, thought should also be given to permitting individual employees to make voluntary
allocations of a limited portion of their public pension contributions to supplementary pension
schemes.
The financial industry and the capital markets
Italian open-end investment funds, which had 17 per cent of Italian households' savings under
management in 1999, now have barely 7 per cent. The outflow of resources, which is still influenced
by tax disparities, has gathered pace lately, and in the last three years amounted to almost €100
billion. The presence of foreign funds has grown as a result of distribution agreements with Italian
banks, while Italian banking groups have moved part of their operations abroad.
Asset management strategies are still subordinated in large part to those of the controlling companies.
Reducing the conflict of interest inherent in the cross-shareholdings with banks and insurance
companies and the consolidation of asset management companies are vital for the growth of the
industry. As I have already had occasion to remark, an open architecture and a clear separation
between companies and between owners benefit bank shareholders and fund clients alike.
The presence of private equity in Italy is growing, although the volume of transactions remains far
below that of the other main European countries. Between 2003 and 2006 the number of Italian
management companies rose from 26 to 49 and funds' financial resources from €3 billion to €6 billion.
Above all, the growth is among companies not belonging to banking or insurance groups; in 2006 they
accounted for more than half the total resources invested.
Intermed