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 general meeting
of shareholders, Rome, 31 May 2006.
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Ladies and Gentlemen,
As I take the floor for the first time before this annual meeting, allow me to begin by conveying my best
wishes to the President of the Republic, Giorgio Napolitano, to whom I confirm the continuing
institutional commitment of the Bank of Italy to serving the nation. In the same spirit of invaluable
institutional continuity, I pay my respects to the Government that led Italy for the duration of a
legislature and wish the Government that has just taken its place success in its endeavours.
In December of last year Antonio Fazio resigned as Governor of the Bank of Italy. He had joined the
Bank in 1965, become Head of the Research Department and then Central Manager for Economic
Research. As Governor since May 1993, he directed the monetary policy that accompanied Italy's
entry to Economic and Monetary Union.
His actions towards the end of his tenure are still open to judgement. To him I wish to express
recognition that is not merely formal for having dedicated his entire professional life to the service of
this institution.
The end of last year brought with it the conclusion of a convulsive period of scandal and speculation,
during which it had seemed that the market, the savings of Italians, and the destiny of companies in
key sectors of the national economy were prey to the caprice, self-interest and schemes of a few
individuals.
The action of the judiciary prevented these schemes from succeeding. The outcome of the judicial
proceedings now under way is awaited. Although the institutional integrity of its supervisory structure
was unscathed, the Bank of Italy has been wounded. As President Carlo Azeglio Ciampi did me the
honour of appointing me Governor, on the proposal of Prime Minister Silvio Berlusconi, it was and it is
my responsibility to lead the Bank in the restoration of the prestige it has always enjoyed, and to guide
its evolution in a national and international environment radically different from the one that has
shaped its history.
The field of action is vast: contributing substantively to the formulation and implementation of monetary
policy in the euro area; expanding and strengthening banking supervision while adapting it to the new
international rules; making the Bank once again the trusted, independent advisor to Parliament, the
Government and the general public; and, internally, reconfiguring the central administration and
branches, with a rethinking of their tasks and structure, and reconsidering the role of the Italian
Foreign Exchange Office. These are the lines of action to be undertaken. In tackling the evolution of
the Bank in these new circumstances, the contribution of the staff and of the trade union
representatives is essential. In a few days' time I shall set out these strategy guidelines to them in
practical terms, confident that they will share my belief in their necessity.
At its next meeting the Board of Directors will discuss the proposed amendments to the Statute of the
Bank, in compliance with the new legislation. This begins the mandated procedure, which will
culminate in examination by the Government and the issue of a decree by the President of the
Republic.
I know, to borrow an expression from Guido Carli, that my strength is not equal to the objectives. I
would doubt ever being able to attain them if I could not count on the integrity, professional
competence and sense of institutional responsibility of the entire staff of the Bank. But there is also
something else on which I am certain I can rely: the rightful pride of this institution, which has always
transformed difficulties into a spur to growth. In the Bank of Italy, which from Einaudi to Ciampi has
provided the nation with Presidents of the Republic, Prime Ministers and cabinet Ministers, I have
found an institution of excellence, where the nobility of public service is deeply felt.
It is to that service that I, like other Governors before me, intend to dedicate my efforts. It is from this
collective sentiment that I shall draw my strength.
Returning to growth
The cyclical recovery that is now beginning in Italy cannot by itself solve the growth problem that has
afflicted the country for more than a decade, but it will facilitate the necessary structural changes.
If slow growth persists for long, it stifles an economy's ability to innovate, saps the aspirations of the
young and portends regression. It is especially worrying in a country such as ours, with its adverse
demographic trend and high public debt.
Financial stability is a necessary condition for economic growth, but in Italy growth is in turn a
prerequisite for financial stability. It is essential, while preserving the one, to rekindle the other.
The international context
In the last two years the world economy has grown at an average rate of 5 per cent, the euro-area
economy at an average of 1.7 per cent. World trade has increased by just under 9 per cent.
Increasing demand, supply bottlenecks and geopolitical tensions have driven up the prices of raw
materials and energy. The latter have more than doubled in real terms in the last three years.
Monetary policies are becoming less accommodating everywhere, though differences in the timing and
intensity of the change reflect different cyclical conditions and inflationary risks. Fiscal policies have
not yet taken advantage of global growth to make the adjustments to the public finances that are
necessary to reduce imbalances and cope with the ageing of the population. A rise in interest rates
tends to increase the cost of servicing the public debt. The higher the debt, the greater the effect; Italy
is particularly exposed.
Balance-of-payments disequilibria have become more pronounced. While current account surpluses
are widely distributed, the deficit is concentrated in the United States, where it has reached nearly 2
per cent of world GDP, a record high. A rise in the US domestic saving rate, a recovery in growth in
Europe and Japan and an acceleration in domestic demand in China and the oil-producing countries
may lessen the danger that the inevitable correction of the disequilibria will come about by means of
disorderly changes in exchange rates.
The expansion in world liquidity and low interest rates contributed to the rise in the prices of financial
assets and housing. Interest rate differentials and the volatility of the financial variables fell to
historically low levels. The possibility that investors will underestimate risk is a potential source of
instability. The volatility of exchange rates and securities prices has increased in recent weeks,
triggering a rapid unwinding of carry trade positions that in its turn has affected exchange rates.
These factors of fragility are counterbalanced by the credibility of monetary policies, which has
subdued inflation expectations. The recent rise in energy prices has not affected core inflation, which
has been contained partly by international competition. The talent, capital and technology now
available in the financial markets have increased their ability to reallocate risk and strengthened their
resilience to shocks. However, the rapid spread of derivatives may amplify the transmission of shocks,
with systemic implications that have still not been fully quantified.
Persistent disequilibria, high oil prices and the protracted, rapid growth in liquidity are a cause of
concern to monetary authorities in view of their potential repercussions on inflation, the prices of
financial assets and exchange rates.
The distinctive features of the international scene today are the development and spread of new
information technology and the rapid growth of the large emerging economies.
The digital revolution that took place at the end of the last century has triggered an efficiency
competition between national economies. It is essential to rise to the challenge.
The emerging economies' share of world exports of manufactures has risen to 30 per cent, and the
proportion of their products with a medium or high intensity of capital and technology is increasing.
Consumers in the advanced countries have derived large and immediate benefits. Producers can
meet the fierce challenge from competitors with low labour costs if they seize the opportunities offered
by the internationalization of production and the emergence of new markets.
In a situation of continuing rapid growth in the world economy and world trade, we must be guided by
the optimism of initiative, not by melancholy regret for a protectionism that has had its day.
Italy's productivity crisis
Since the middle of the nineties output per hour worked has risen much less in Italy than elsewhere:
on average, by over one percentage point less each year than in the OECD countries. The delay in
adapting the technological and organizational capacities of firms and the economy in general has
caused total factor productivity to decline, making Italy unique among industrialized countries.
Improvements in efficiency are being impeded by the skewed size distribution of firms, which is
scarcely compatible with the new paradigms of technology and competition. This is accompanied by
sectoral specialization that is still excessively geared towards traditional products. Removing the
obstacles to the expansion of firms is a prerequisite for seizing the opportunities offered by market
globalization and for stimulating the widespread and systematic application of innovations in corporate
organization, production processes and product ranges. This is the way to regain international
competitiveness and to stimulate renewed growth.
Defending competitiveness by devaluing the currency, which in any case gave only temporary relief
from the effects of a productivity gap, is now impossible. The only options are increasing output per
man-hour and containing nominal incomes. In the long run, only rising productivity generates
economic well-being.
This year the growth in gross domestic product could be close to 1.5 per cent, thanks to a recovery in
exports and investment. The cyclical upturn may facilitate measures to encourage adjustment in the
economy.
Stability: a necessary condition for growth
Macroeconomic policies contribute to stimulating renewed growth by ensuring a framework of stability.
The common monetary policy has given the euro area price stability and protection from the volatility
of the financial markets. Between 1999 and today, actual and expected consumer price inflation in the
area has been barely above 2 per cent, albeit with significant rises in the prices of some items, in
particular in sectors less exposed to competition. The price stability objective established by the
Eurosystem anchors the expectations of producers, consumers and the social partners. Testifying to
the credibility that the European Central Bank has acquired, short-term interest rates in the euro area
reached their lowest level in fifty years.
The convergence towards price stability has served the interests of all the participants in the monetary
union, and continues to do so. The benefits of the euro are especially valuable in Italy. The decline in
interest rates enabled firms to keep their financial costs low in relation to value added, even during a
downturn in which corporate debt increased. The interest rate differential between Italian and German
long-term government bonds had averaged 340 basis points between 1992 and 1998; between 1999
and 2005 it fell to just 25 basis points. Interest expenditure on new issues of public debt was
drastically reduced.
The benefits of the single currency for the public finances have been largely dissipated, however. The
upward trend in rates now calls for urgent action on the structural determinants of public spending.
The burden of the public debt must begin to diminish again. Its ratio to GDP increased by 2.5
percentage points last year to 106.4 per cent, despite asset disposals worth about one point. General
government net borrowing rose to 4.1 per cent of GDP; it exceeded the limit set by the Treaty of
Maastricht for the third consecutive year. The primary surplus has steadily declined, from 6.6 per cent
of GDP in 1997 to 0.4 per cent last year. Net of privatization receipts and excluding the effect of
oneoff measures, the borrowing requirement - on which the trend in the public debt depends - came
close to 6 per cent of GDP.
Net borrowing may again exceed 4 per cent of GDP in 2006; the debt ratio would rise further.
To bring the public finance balances back to levels that permit a predictable, continuous and
permanent reduction in the debt ratio, structural adjustments affecting the main expenditure items and
all levels of government are necessary. In the light of current trends, a correction of around two
percentage points of GDP is needed to achieve the net borrowing objective of 2.8 per cent of GDP set
out in government programmes for 2007 and to begin to reduce the ratio of debt to GDP again.
Additional resources would have to be found to fund any measures to ease the burden of taxation or
boost public investment.
Primary current expenditure, which has risen in real terms by 2.5 per cent per year over the past
decade, has to be curbed. In addition to containment of the operating cost of government, there are
two unavoidable priorities: tackling the problem of the average age at which people retire and making
regional and local governments fully responsible for controlling their expenditure.
Pension outlays amount to 15.4 per cent of gross domestic product. Almost one quarter of this
consists of old-age and seniority pensions paid to persons under 65 years of age. The greatest
number of workers retire when they meet the minimum pension requirements. In recent years, as a
result of the reforms that tightened the eligibility requirements, the average age at retirement has been
about 60 in Italy; it is 61 in Germany, 62 in the United Kingdom and over 65 in the United States. At
age 60, women can expect to live another 25 years and men another 21. In the future, together with
the development of supplementary pension schemes, only a significant rise in the average age at
retirement can square the payment of adequate pensions with the financial sustainability of the
contributions-based pension system. A lengthening of the working life will also help raise the labour
force participation rate.
Regional and local governments account for more than 40 per cent of total general government
expenditure on labour costs; they make nearly 80 per cent of total public investment. Health care,
which is a regional responsibility, constitutes more than 13 per cent of general government spending.
The decentralization of government functions can improve the overall efficiency of the system only if a
close link is created between spending and responsibility for its financing. The decentralization of
spending has not yet been accompanied by sufficiently broad powers of taxation, transparent and
systematic criteria for revenue equalization and effective constraints on borrowing.
In order to contribute to stimulating renewed economic growth, not only must budget balance be
restored but the composition of expenditure must also be modified. Savings on other items would
release resources with which to improve infrastructure, strengthen social security, thus facilitating the
operation of the labour market, and reduce the tax burden to enhance competitiveness. A lasting
impact on the budget requires a decisive change in the laws and rules on expenditure. Otherwise, as
experience has shown, even dramatic budget adjustments produce only short-lived results.
Measures to stimulate renewed growth
Heightened competition and a broadening of the scope for market mechanisms to operate are
necessary for a revival in production and complementary to decisions regarding equity. Competition is
the best agent of social justice in an economy, and in a society such as Italy's in whose history the
privileges of the few have commonly been rooted in the protection of the State.
In recent years numerous areas of action have come to the attention of observers and economic
policy-makers as crucial for restoring the growth of the economy: employment, education, services
and the legal and administrative environment are issues of particular importance.
Labour costs are affected directly or indirectly by the level of wages, by taxation and social security
charges and by the rigidity of regulations.
The coordination of wage bargaining at national level not only safeguards equity but also helps to
ensure that wage trends in sectors where there is little competition and areas of the country with low
unemployment do not become incompatible with price stability. The 1993 agreements between
employers and trade unions assigned the distribution of productivity gains to decentralized bargaining.
The adoption of employee-compensation schemes explicitly linked to the firm's productivity is still very
limited, however, and remains concentrated among large industrial enterprises.
In 2005 State levies, in the form of taxes and social security contributions but not counting the regional
tax on productive activities, amounted to 45.4 per cent of the cost of employing a typical worker in
industry. The average in the OECD countries is 37.3 per cent. Too large a tax and contribution wedge
distorts resource allocation and hampers growth.
The budget constraints leave little room for financing a reduction. Shifting taxation from labour to
consumption offers benefits in terms of resource allocation and certainty of coverage, but it has
macroeconomic and distributive effects that need careful assessment, in conjunction with the social
partners.
Rigidity in the utilization of labour has implicit costs for business. It may be rooted in hiring procedures,
in the deployment of human resources within the firm, or in termination procedures; the latter are
made onerous, above all, by the length and cost of possible legal proceedings, which are uncertain
and frequently very high. Some flexibility has been recovered during recent years with the spread of
atypical employment contracts. If the labour market is well-regulated and typical contracts not overly
rigid, atypical contracts will offer a useful range of options to firms and workers. However, if they
become a surrogate for ordinarily flexible employment, they prevent many young people from planning
for the future, reduce the incentives for firms to invest in training and curb macroeconomic productivity.
Efficiency and equity require that market segmentation be lessened by establishing more uniform rules
under which employment becomes more stable with the passage of time. In an age in which the
economy must rapidly reallocate resources in the changed competitive environment, it is the worker
rather than the job that must be protected by ensuring - subject to budget constraints - a decent and
non-distorting level of unemployment benefits and real opportunities for training and career change.
This is not enough, however. A return to productivity growth calls for innovation and investment in
research and technology, and entrepreneurs with the courage and far-sightedness not to remain
passive in the face of difficulties but to seize the opportunity to change the way their businesses
operate.
The stagnation in productivity is partly due to the shortage of human capital. The low level of
employment among members of the most vital and promising segment of the working population is a
serious waste: in Italy the employment rate for people in their twenties is 10 points lower than the
average for the European Union.
In the past ten years Italy has narrowed the gap with the other advanced countries as regards young
people's educational attainment, but the cumulative deficiencies will be reflected in the average
educational level of Italians for a long time to come. In 2003 secondary-school and university
graduates made up 34 and 10 per cent respectively of the age group from 25 to 64, compared with
averages of 41 and 24 per cent in the OECD countries.
The quality of academic results is also unsatisfactory in several respects. By the age of 15 Italian
students are the equivalent of one school year behind in mathematics: according to an OECD survey,
Italy ranks 26th out of 29 countries. This lack of educational effectiveness is compounded by a lack of
equity: in terms of the variability of achievement levels among 15-year-olds, Italy is in 23rd position
among the OECD countries; success in secondary school and at university is closely correlated with
the socio-economic status of the student's family.
The seriousness of the problem is a compelling reason to examine the experience of other European
countries, such as Sweden, Finland and the United Kingdom, which have experimented with ways of
improving the performance of the education and research system by increasing competition among
schools and universities; even more than additional expenditure, what is needed are new rules to
reward teachers and researchers on merit.
The productivity of the service sector is essential for economic growth. Services account for over 70
per cent of value added in the OECD countries; they are used in production by all the other branches
of activity. Monopoly rents that keep prices high, impede innovation and productivity, and depress the
economy's competitiveness are more prevalent in the service sector.
Utility companies in Italy were still entirely publicly owned until the middle of the nineties. The
largescale privatization programme involving them helped to reduce the public debt in relation to GDP. The
liberalization of these markets has not progressed to the same extent. The problems of network
operation and expansion of the number of suppliers remain largely unresolved. Where local public
services are concerned, even privatization has made little progress, and liberalization is practically
non-existent; contracts can be let to public or mixed companies without a call for tenders. Local
authorities still control many enterprises supplying public services. Sometimes they attempt to
increase the range of services offered, triggering a return to public control.
Obstacles to competition also stem from restrictive regulations, which in several branches of activity
harm the majority of consumers and workers.
In the retail sector the average number of employees is about half the euro-area average. The degree
of fragmentation impinges on efficiency; it slows the adoption of new technologies, which are an
important source of productivity growth in the sector in other countries. The reform law of 1998
liberalizing the establishment of small shops empowered the regional authorities to regulate the
opening of larger outlets. Not all of the regions took this opportunity to liberalize. In the regions that
applied the most restrictive standards this hindered productive efficiency and the spread of new
technologies, to the detriment of consumers and even of employment growth in the sector.
The European services directive currently in the process of being adopted can offer only modest
stimulus to competition. The undertaking of more resolute liberalization policies is still left mainly to the
discretion of national governments. Italy has everything to gain by moving resolutely in this direction.
The legal and administrative system significantly affects the costs and competitiveness of businesses.
In Italy it has long been indifferent to market considerations. In a World Bank classification of the
bureaucratic and administrative formalities affecting businesses, Italy comes 70th, last but one among
the OECD countries.
From the middle of the nineties onwards, steps were taken to simplify administrative procedures and
improve the system of regulation. They have been only partially successful. The discrepancy between
measures as formally drafted and their practical application continues to be a general problem of the
Italian system.
The recent reform of bankruptcy law has introduced instruments to promote earlier detection of critical
situations and the rapid reorganization of firms in temporary difficulty; it has streamlined and
modernized liquidation procedures. However, the new legislation only applies to about half of all
businesses; in particular, a large set of firms are not eligible for the cancellation of residual debts at the
end of the procedure. The penal provisions, based on a punitive view of bankruptcy, remain
unchanged.
Much remains to be done in the general area of the application of the law, although this is not the
place to suggest remedies, which can be sought in the experience of other countries. The reforms
passed in the last fifteen years to speed up civil proceedings have not yielded the desired results. Civil
actions still last far longer than in other European countries; debt recovery proceedings in Italy take
five times the OECD average. International studies show that, in relation to the size of the population,
the number of judges and officials in Italy and the amount of public spending on the justice system are
comparable to the figures for other countries of similar size and legal tradition.
In the tax field, action to improve the clarity of the rules and regulations and the way they are applied
reduces litigation and guarantees firms a more certain framework in which to operate. Compliance with
tax and social security obligations is discouraged by frequent recourse to amnesties and immunity
from prosecution; between 1970 and 2004 only two fiscal years were not covered by provisions of this
kind.
The revival of domestic economic growth and the reduction of geographical disparities are
complementary objectives. Measures that will have an impact on the structure of the economy,
particularly on the growth in the size of firms and changes in their product specialization, serve both
purposes. In fact, they bring greater benefits to the economy of the South, which suffers more acutely
from the national ills, notably in public services and infrastructure but also in the enforcement of law
and order.
Specific policies offering incentives to firms may be helpful, but their usefulness must not be overrated.
They involve administrative costs, possible distortions in the allocation of resources, and the risk that
they will be abused, especially if they rely on discretionary mechanisms. Even the benefit of
stimulating investment, despite being greater for firms in the South, is modest in relation to the
resources employed. According to Bank of Italy surveys, one fifth of industrial firms in the South
received public incentives in 2005, compared with nearly one quarter of those in the rest of Italy. In the
case of firms in the South, the additional investment generated is less than 30 per cent of the funds
distributed; in the Centre and North the corresponding figure is about 10 per cent.
A scaling-down of the system of transfers to firms would release resources for other spending priorities
and for reducing the tax burden and social security contributions. By contrast, an attempt to force the
growth of the South financially by assigning inappropriate tasks to banks could once again lead to
situations that have already proved harmful in the past both for the economy of the South and for the
stability and efficiency of the banking system.
The financial system in the South has made important strides in the last ten years, especially in the
quality and efficiency of banking, thanks in part to the involvement of banks based in the Centre and
North. On a risk-adjusted basis, the difference between the cost of credit in the South compared with
that in the Centre and North has almost vanished. However, there is still a lag in the spread of more
advanced financial instruments among households in the South, and even in the use of banking
services. Banks and financial institutions have considerable growth potential in the South.
A financial system serving development
The capital markets
Funds raised directly in the market by firms in the form of listed shares and bonds represent only 17
per cent of their financing in Italy, about a quarter less than in France and Germany; the figure is
higher than 40 per cent in the United States and close to 50 per cent in the United Kingdom. In relation
to the size of the economy, Italy's stock exchange is much smaller than the average for the advanced
countries.
Development of the capital markets is necessary for the growth of firms, and vice versa. The markets
play a crucial role in mobilizing financial resources. The total financial wealth of Italian households is
large in relation to GDP and also by comparison with the other major European countries. Although
the behaviour of savers has changed in the last few years, the diversification of households' portfolios
is still limited, to the detriment of the balance between returns on savings and protection from risk.
Broader, efficient and well-regulated financial markets will make it possible to encourage current
trends, benefiting households, firms and intermediaries themselves.
In the life of a firm, admission to stock exchange listing is the first step towards a more solid financial
structure, possibly paving the way for a leap in size, with a higher proportion of bond debt and often
with a lower cost of bank credit. But fear of losing control of the firm and the costs connected with the
transparency requirements for listed companies, including their tax implications, deter many
entrepreneurs from seeking a listing. Regulation must seek to strike a balance between safeguarding
investors and minimizing the costs for firms. It is up to the entrepreneur to assess the opportunities
offered by stock exchange listing, which detracts nothing from his passion or creativity; on the
contrary, in difficult moments of transition, it can represent a compromise between keeping all the
capital in his own hands, thereby sacrificing the opportunities for growth, and relinquishing control
entirely.
Development of the markets requires rapid and effective protection of minority shareholders from
opportunistic or non-transparent behaviour. Prevention must be able to rely not only on primary and
secondary legislation and its application by the supervisory authorities, but also on the autonomous
initiative of operators in the market: banks, rating agencies, investors. There is ample scope for
selfregulation and shareholder activism.
If this is not fully exploited in Italy, it is partly because institutional investors carry little weight. Their
voice, which is strong and insistent elsewhere, is faint in Italy. Their presence contributes to the
assessment of the quality of corporate management, the protection of minority shareholders and the
correct handling of conflicts of interest; it deepens the market and increases its allocative efficiency; it
facilitates the placement of equity capital and the spread of long-term financial liabilities. Where
institutional investors play a more prominent role, the average size of the companies that seek a listing
is smaller.
Pension funds in particular have great potential for growth in Italy. In the most advanced financial
systems they are among the main investors in listed shares. In the United States they hold about one
fifth of the market capitalization, corresponding to roughly one third of GDP; in Italy the proportion is
close to zero. The financial assets managed by Italian pension funds amount to 2.1 per cent of GDP,
those of funds created after 1993 to 0.8 per cent.
More rapid expansion is necessary. The income replacement delivered by the public pension system
will decline in the decades ahead as a consequence of the reforms introduced in recent years. The
rapid growth of supplementary pension schemes is essential to provide adequate incomes for future
generations of retirees.
In addition to workers' contributions, it will be necessary to use the flow of resources now set aside for
severance pay, which for the private sector amounts to approximately 1.5 per cent of GDP per year.
The advantages for workers are likely to be considerable. Greater investment in equities would
increase the return on retirement savings. Over the long run the rate of return on equities has been
substantially higher than that on bonds and well above the nominal rate of growth in GDP; it has been
far higher on average than that on accumulated severance pay.
Hitherto, the accumulatio