COMMISSION STAFF WORKING DOCUMENT In-depth review for ITALY in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL AND TO THE EUROGROUP Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances
Date: 2013-04-10
Institutions: European Commission
Subjects: Italy, competitiveness, economic growth, economic recession, economic reform, financial institution, fiscal policy, macroeconomics, public debt

EUROPEAN 
COMMISSION 

Brussels, 10.4.2013  
SWD(2013) 118 final 

COMMISSION STAFF WORKING DOCUMENT 

In-depth review for ITALY 

in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and 
correction of macroeconomic imbalances 

Accompanying the document 

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN 
PARLIAMENT AND THE COUNCIL AND TO THE EUROGROUP 

Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and 
correction of macroeconomic imbalances 

{COM(2013) 199 final} 
{SWD(2013) 113 final} 
{SWD(2013) 114 final} 
{SWD(2013) 115 final} 
{SWD(2013) 116 final} 
{SWD(2013) 117 final} 
{SWD(2013) 119 final} 
{SWD(2013) 120 final} 
{SWD(2013) 121 final} 
{SWD(2013) 122 final} 
{SWD(2013) 123 final} 
{SWD(2013) 124 final} 
{SWD(2013) 125 final}

EN 

   EN 

 
 
 
 
 
  
 
 
  
 
Contents 

1. 

2. 

2.1. 

2.2. 

2.3. 

2.4. 

3. 

INTRODUCTION ..............................................................................................................6 

MACROECONOMIC SITUATION AND POTENTIAL IMBALANCES ........................................7 

Macroeconomic scene setter.........................................................................................7 

Sustainability of external positions...............................................................................8 

Private and public sector indebtedness .......................................................................15 

Real estate market developments................................................................................19 

IN-DEPTH ANALYSIS: COMPETITIVENESS ......................................................................20 

3.1. 

Competitiveness developments in Italy ......................................................................20 

3.2.  Wage growth, labour market responsiveness and taxation.........................................25 

3.3. 

A closer look at selected drivers of productivity slowdown.......................................32 

3.3.1.  The business environment and structural features of firms........................................32 

3.3.2.  The specialisation of manufacturing exports..............................................................36 

4. 

POLICY CHALLENGES...................................................................................................40 

REFERENCES .........................................................................................................................43 

2 

 
 
 
 
 
 
EXECUTIVE SUMMARY AND CONCLUSIONS 

In May 2012, the Commission concluded that Italy was experiencing serious macroeconomic 
imbalances,  in  particular  related  to  the  high  government  debt  and  declining  external 
competitiveness.  In  the  Alert  Mechanism  Report  (AMR)  published  on  28  November  2012, 
the Commission found it useful, also taking into account the above conclusions, to examine 
further  in  a  second  in-depth  analysis  the  risks  involved  and  progress  in  the  unwinding  of 
imbalances.  To  this  end,  this  In-Depth  Review  (IDR)  takes  a  broad  view  of  the  Italian 
economy  in  line  with  the  scope  of  the  surveillance  under  the  Macroeconomic  Imbalance 
Procedure (MIP). Italy's high government debt, as well as the loss of external competitiveness 
and 
the  main 
macroeconomic  imbalances  identified.  While  some  important  measures  have  been  adopted 
over the past year to address these imbalances, their full implementation remains a challenge, 
and there remains scope for further action in many areas. Meanwhile, the prolonged crisis has 
weakened the ability of Italy's banking sector to support the required economic adjustment. 

its  underlying  sluggish  productivity  performance,  continue 

to  be 

The most important observations and findings from this in-depth analysis are the following: 

•  Long-standing structural weaknesses have reduced Italy's capacity to withstand and 
absorb economic shocks. Compared to other euro-area countries, Italy entered the global 
crisis  with  fairly  strong  private  sector  balance  sheets  and  a  sound  banking  sector.  The 
crisis  however  has  highlighted  the  country's  long-standing  structural  weaknesses.  Real 
GDP contracted by more than 7% since the onset of the crisis in mid-2008. According to 
the Commission services' Winter 2013 forecast, the protracted recession is set to bottom 
out in mid-2013, under the assumption of a stabilisation in financial markets and restored 
investor  confidence.  However,  financial  conditions  remain  fragile  and  growth  prospects 
in the medium term remain subdued.  

•  The  high  government  debt  remains  a  heavy  burden  for  the  Italian  economy, 
especially against the background of persistently slow growth, and is a major source 
of  vulnerability.  During  the  past  two  years,  the  negative  feedback  loop  between  high 
debt and low growth has increased concerns among investors regarding the sustainability 
of  Italy's  high  debt.  Indeed,  the  sharp  rise  in  the  sovereign  risk  premium  in  2011-12, 
which increased the pressure arising from structural weaknesses, translated into a higher 
cost of capital for the private sector, hampering productive investment. Moreover, in the 
context  of  banks'  high  exposure  to  government  debt  and  a  euro-area  financial  market 
highly  fragmented  across  national  borders,  funding  problems  in  the  banking  sector 
worsened. In response, a sizeable consolidation effort was undertaken by the government, 
which  entailed  significant  short-term  economic  costs  as  the  tax  burden  was  raised  and 
spending was compressed. This has decisively helped to reduce the borrowing cost of the 
government since the second half of 2012. However, Italy remains vulnerable to sudden 
changes  in  market  sentiment,  highlighting  the  need  to  maintain  the  budgetary 
improvement in structural terms in order to put the debt ratio on a steadily declining path. 

3 

 
 
 
The  potential  economic  and  financial  spillovers  to  the  rest  of  the  euro  area  remain 
sizeable,  should  financial  market  turmoil  related  to  the  Italian  sovereign  debt  intensify 
again. 

•  The  loss  of  external  competitiveness  of  the  Italian  economy  highlights  Italy's 
productivity  growth  problem.  Persistently  slow  growth  of  productivity  –  in  particular 
total  factor  productivity  –  is  the  key  factor  that  has  been  hampering  overall  economic 
growth for several years. As stagnant productivity growth has not been fully reflected in 
wage  dynamics,  Italy's  cost  competitiveness  has  deteriorated,  as  reflected  in  increasing 
unit labour costs (ULC) compared to peers. The appreciation of Italy's nominal effective 
exchange  rate  (NEER)  between  2003  and  2009  has  also  played  a  role.  After  steadily 
deteriorating  since  the  adoption  of  the  euro,  the  current  account  balance  improved 
significantly in 2012, as imports collapsed and export growth was sustained by demand 
from  non-EU  trade  partners.  From  a  saving-investment  point  of  view,  the  recent 
improvement  in  the  current  account  is  mainly  driven  by  a  fall  in  investment,  while  the 
national  saving  rate  has  stabilised  at  the  low  level  reached  in  2009.  A  recovery  in 
investment  would  entail  a  new  worsening  of  the  current  account  balance  if  it  is  not 
accompanied by a corresponding rise in national saving.  

•  Italy's  export  performance  continues  to  suffer  from  an  unfavourable  product 
specialisation  model  and  the  limited  ability  of  Italian  firms  to  grow.  Italy's 
specialisation model is very similar to that of emerging markets such as China, with most 
of the value added in relatively low-tech traditional sectors, mainly due to Italian firms' 
limited innovation capacity. The predominance of micro- and small enterprises highlights 
the difficulties faced by Italian firms to grow and become international players, owing to 
institutional  and  regulatory  barriers,  structural  firm  features  and  an  unfriendly  business 
environment.  These  factors  also  limit  the  inflow  of  foreign  direct  investment  (FDI), 
preventing Italy from taking advantage of the direct and indirect benefits that inward FDI 
entails,  such  as  the  transfer  of  capital  and  knowledge,  increased  involvement  in  world 
trade and the impulse for a more competitive business environment and modern corporate 
management. 

•  The  resilience  of  the  Italian  banking  sector  has  severely  weakened  since  mid-2011, 
undermining banks' ability to support economic activity and adjustment. The loss of 
access of Italian banks to international wholesale funding following the extension of the 
euro-area sovereign debt crisis to Italy has significantly increased the sector's dependence 
on Eurosystem refinancing. The double-dip recession in Italy has increased credit risk in 
the  private  sector,  burdening  Italian  banks  with  a  large  stock  of  non-performing  loans 
(NPLs),  mainly  to  private  companies.  In  combination  with  subdued  credit  demand,  this 
has led to a protracted contraction in credit, while the average cost of new credit remains 
elevated despite an accommodative monetary policy at euro-area level. Low net interest 
margins, increased NPL provisioning and low cost efficiency all act as a drag on Italian 
banks' profitability.  

4 

 
 
•  Italy  is  thus  confronted  with  severe  adjustment  challenges.  The  improving  current 
account does not alter Italy's need to address the serious productivity and competitiveness 
challenges which the country faces. However, a particularly unfavourable environment – 
characterised by a high cost of capital, lack of support from the financial sector and fiscal 
policy,  as  well  as  limited  scope  to  raise  investment  without  increasing  the  economy's 
reliance  on  external  financing  –  constrains  the  needed  adjustment.  In  this  context, 
improving the allocation efficiency in the Italian economy becomes essential in view of 
channelling  the  available  resources  in  both  the  private  and  public  sector  to  their  most 
growth-enhancing uses. 

•  Key fiscal measures and structural reforms have been adopted over the past months 
to  address  the  main  challenges  of  the  Italian  economy,  which  need  full 
implementation to bear fruit. Italy has embarked on a wide-ranging strategy to restore 
fiscal  sustainability  and  improve  long-term  growth.  Together  with  determined  action  at 
the euro-area level, this helped to restore some market confidence. To consolidate these 
benefits  and  strengthen  Italy's  resilience  against  possible  renewed  financial  tensions, 
Italy's public debt-to-GDP ratio needs to be put on a steadily declining path. To support 
fiscal consolidation and unleash the country's growth potential, the gains from structural 
reforms  should  be  secured  by  ensuring  their  full  implementation  and  maintaining  the 
reform momentum. 

The  IDR  also  discusses  the  policy  challenges  stemming  from  these  developments  and 
possible  policy  responses.  While  acknowledging  the  efforts  which  have  already  been  made 
since the end of 2011, the IDR highlights a range of domains in which Italy's policymakers 
could act further to strengthen the adjustment capacity of the Italian economy. These include 
the strengthening of competition in some product and service markets, the development of a 
more  growth-friendly  tax  system,  the  further  decentralisation  of  the  wage  bargaining 
framework, the upgrading of the educational sector, and the decisive improvement of public 
administration efficiency and of the business environment. The IDR also highlights the need 
to improve the capacity of the Italian banking sector to support the adjustment of the Italian 
economy.  Finally,  regarding  Italy's  public  indebtedness,  the  IDR  confirms  the  necessity  to 
pursue sustained high primary surpluses in order to put the country's high public debt-to-GDP 
ratio  on  a  downward  path,  in  full  compliance  with  its  budgetary  commitments  and  the 
reinforced Stability and Growth Pact (SGP).  

5 

 
 
1. 

INTRODUCTION 

On  28  November  2012,  the  European  Commission  presented  its  second  Alert  Mechanism 
Report (AMR), prepared in accordance with Article 3 of Regulation (EU) No. 1176/2011 on 
the prevention and correction of macroeconomic imbalances. The AMR serves as an initial 
screening device helping to identify Member States that warrant further in depth analysis to 
determine whether imbalances exist or risk emerging. According to Article 5 of Regulation 
No. 1176/2011, these country-specific “in-depth reviews” (IDR) should examine the nature, 
origin and severity of macroeconomic developments in the Member State concerned, which 
constitute,  or  could  lead  to,  imbalances.  On  the  basis  of  this  analysis,  the  Commission  will 
establish  whether  it  considers  that  an  imbalance  exists  and  what  type  of  follow-up  it  will 
recommend to the Council. 

This  is  the  second  IDR  for  Italy.  The  previous  IDR  was  published  on  30  May  2012  on  the 
basis of which the Commission concluded that Italy was experiencing serious imbalances, in 
particular as regards developments related to the export performance, competitiveness and the 
high government debt. Overall, in the AMR the Commission found it useful, also taking into 
account the identification of serious imbalances in May, to examine further the risks involved 
and  progress  in  the  unwinding  of  imbalances  in  an  in-depth  analysis.  To  this  end  this  IDR 
takes a broad view of the Italian economy in line with the scope of the surveillance under the 
Macroeconomic Imbalance Procedure (MIP). 

6 

 
 
 
2. 

MACROECONOMIC SITUATION AND POTENTIAL IMBALANCES 

2.1.  MACROECONOMIC SCENE SETTER 

During the decade leading up to the current crisis, long-standing structural weaknesses 
significantly  constrained  Italy's  growth  potential.  Between  euro  adoption  and  the  year 
preceding the global financial crisis, Italy's real GDP growth averaged 1.5%, around 0.75 pp. 
below the euro-area average. The main reason for the protracted underperformance was weak 
growth in productivity, in particular as total factor productivity stagnated (see Section 3.1), 
indicating  low  absorption  of  new  technologies  and  limited  innovation  capacity  by  Italian 
firms, an unfavourable business environment and insufficient human capital accumulation. 

The  Italian  economy's  capacity  to  withstand  the  negative  economic  shocks  stemming 
from the crisis was therefore limited. Italy's real GDP contracted sharply during the 2008-
09  economic  and  financial  crisis.  The  recovery  that  followed  was  modest  and  short-lived: 
economic  growth  started  contracting  again  in  the  second  half  of  2011,  when  the  euro-area 
sovereign  debt  crisis  spread  to  Italy.  Over  2012  as  a  whole,  real  GDP  contracted  by  2.4% 
owing to a strong fall in domestic demand. Despite significant measures at national and EU 
level in 2011-12 to tackle the economic crisis and rebuild confidence, uncertainty in financial 
markets  remained  elevated  until  the  final  months  of  2012,  affecting  households'  and  firms' 
confidence.  Net  exports  on  the  other  hand  have  contributed  positively  to  Italy's  real  GDP 
growth  –  mainly  because  of  a  fall  in  imports,  but  also  thanks  to  some  export  dynamism  – 
implying a strong improvement in Italy's trade balance since mid-2011. Available indicators 
point  to  some  further  contraction  in  economic  activity  in  the  first  quarter  of  2013,  before 
growth is expected to gradually resume in the second half of the year as demand from non-
EU  trade  partners  supports  exports  and  the  assumed  lower  yields  on  Italian  government 
securities gradually translate into improving financing conditions and confidence. However, 
the negative carry-over from 2012 implies that real GDP in 2013 as a whole is still projected 
to decline by 1.0% (Graph 1). 

7 

 
 
 
Graph 1: Decomposition of Italy's GDP growth  

%, pps

6

4

2

0

-2

-4

-6

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Investment (inventories)
Investment (gross fixed capital formation)
Consumption
Net exports
Real GDP growth

Note: Figures for 2013-14 are forecasts based on the Commission services' Winter 2013 forecast. 

Source: Commission services 

2.2. 

SUSTAINABILITY OF EXTERNAL POSITIONS 

Italy's current account balance deteriorated steadily since the adoption of the euro and 
up  until  mid-2011.  From  a  surplus  of  1.8%  of  GDP  in  1998,  the  current  account  balance 
turned slightly negative over 2002-05 and deteriorated significantly after the 2008 financial 
crisis, reaching a deficit of more than 3% of GDP in 2010-11 (Graph 2). Part of the decline in 
the current account balance was driven by worsening terms of trade as the increasing price of 
imported oil – on which the Italian economy is structurally dependent – negatively affected 
the  goods  balance  (Graph  3).  As  from  2007,  this  was  compounded  by  a  negative  services 
balance. Finally, ever since the late 1990s, both the income balance and the transfers balance 
have recorded a deficit. In 2008-09, the dramatic drop of (mostly equity) income from abroad 
as  a  consequence  of  the  financial  crisis  opened  up  the  deficit  on  the  income  balance.  The 
deficit on the transfers balance gradually widened over the decade and reached almost 1% of 
GDP  by  2011,  mainly  due  to  Italy's  net  contribution  to  the  EU  budget  (more  than  0.3%  of 
GDP) and foreign workers' remittances, which rose to around 0.5% of GDP. 

8 

 
 
 
 
 
Graph 2: Decomposition of Italy's 
external accounts 

Graph 3: Italy's goods trade balance, by 
category of goods 

4

3

2

1

0

-1

-2

-3

-4

P
D
G

f
o
%

Total goods

Intermediate goods

Fuel

Consumer goods

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12*

Capital goods

Capital account
Current transfers
Income balance
Trade balance - services
Trade balance - goods
Trade balance

-4

-2

0

2

4

Balance of  trade in goods, % GDP

2000-2001

2010-2011

Note: 2012 figures are estimated using quarterly data. 

Source: Commission services 

Source: Commission services 

As  from  mid-2011,  the  Italian  current  account  balance  has  improved  significantly.  In 
2012, the deficit narrowed to 0.6% of GDP. The lower deficit is due to an improving trade 
balance, which in turn is driven by a decline in imports owing to weak domestic demand, but 
also some recovery in exports. While demand from other EU countries remains weak, exports 
to non-EU trade partners improved in 2011-12, also owing to the depreciation of the euro that 
enabled Italy to regain some cost and price competitiveness vis-à-vis non-EU trade partners. 

From a saving-investment perspective, the recent improvement in the current account is 
mainly  driven  by  the  fall  in  investment,  while  the  national  saving  rate  has  remained 
broadly stable at the low levels reached in 2009. The stable national saving rate is the result 
of  an  increase  in  the  government  saving  rate  –  as  a  consequence  of  the  ongoing  fiscal 
consolidation – offset by a decrease in the private-sector saving rate (Graph 4). A recovery in 
investment  as  the  economic  outlook  improves  would  entail  a  new  worsening  of  the  current 
account balance if not accompanied by a corresponding increase in the national saving rate. 

9 

 
 
 
 
 
 
Graph 4: Italy's saving, investment and current account 

25

20

15

10

5

0

-5

P
D
G

f

o
%

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

Current account balance
Gross saving; general government
Gross national saving

Gross saving; private sector
Gross capital formation; total economy

Source: Commission services 

Italy's net foreign financial liabilities increased between 1999 and 2012, but their level 
remains  moderate.  Italy's  net  international  investment  position  (NIIP)  deteriorated  since 
euro adoption: it stood at -9% of GDP at the end of 1998, but declined to -22.5% by the end 
of the third quarter of 2012 (Graph 5). This compares with a NIIP at around -92% of GDP in 
Spain and -105% of GDP in Portugal at the end of 2011. The accumulation of current account 
deficits since 2006 explains only part of the deterioration of Italy’s NIIP. The main drivers 
were negative valuation effects linked to the appreciation of the euro between 2003 and 2009 
(which reduced the value of assets held in foreign  currencies,  mainly  US  dollar)  and  lower 
interest rates up to 2011 (which implied an increased market value of liabilities in the form of 
debt securities). The negative valuation effect has been partially reversed since the financial 
crisis  in  2008  when  the  US  dollar  appreciated  and  the  market  value  of  Italian  equities  fell 
sharply  (Graph  6).  Looking  at  the  composition  of  the  NIIP,  the  negative  net  portfolio 
investment  position  is  related  to  rising  overall  indebtedness  of  the  Italian  economy,  with 
foreign investors holding around 62% of GDP of Italian debt securities at the end of the third 
quarter of 2012, against a stock of foreign debt securities worth 28% of GDP held by Italian 
residents.  This  is  partially  compensated  by  higher  holdings  by  Italian  residents  of  portfolio 
equity capital (around 23% of GDP versus 8.5%). By contrast, Italian investors' FDI abroad 
has  consistently  been  higher  than  foreign  investors'  direct  investment  in  Italy  (around  27% 
versus 17% of GDP respectively at the end of the third quarter of 2012). Finally, the increase 
in other investment liabilities in 2011-12 is mainly related to higher liabilities of Italian banks 
towards the Eurosystem.  

10 

 
 
 
 
 
 
 
Graph 5: Decomposition of Italy's net international investment position 

P
D
G

f
o
%

150

100

50

0

-50

-100

-150

-200

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

Assets - Direct investment
Assets - Portfolio investment (debt securities)
Assets - Other investment
Liabilities - Direct investment
Liabilities - Portfolio investment (debt securities)
Liabilities - Other investment

Assets - Portfolio investment (equity capital)
Assets - Derivatives
Assets - Official reserves
Liabilities - Portfolio investment (equity capital)
Liabilities - Derivatives
NIIP

Note: Data for 2012 run up to the third quarter only. 

Source: Bank of Italy 

Graph 6: Decomposition of the changes in Italy's net international investment position 

)

%

(
e
g
n
a
h
c
P

I
I

N
o
t

s
n
o
i
t
u
b
i
r
t
n
o
C

10

8

6

4

2

0

-2

-4

-6

-8

-10

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Valuation changes
Net transaction effect (rest FA bal.)
Investment income effect
Nominal growth effect
Change in NIIP (annual growth rate (%))

Note: Data for 2012 run up to the third quarter only. 

Source: Commission services 

Amid  increased  risk  aversion  towards  vulnerable  euro-area  economies,  the  negative 
NIIP  has  become  a  source  of  vulnerability  for  the  Italian  economy.  Capital  flows  into 
Italy  dried  up  with  the  global  financial  crisis  in  2008-09.  In  2010,  Italian  monetary  and 
financial institutions (MFIs) regained some access to international financial markets, and the 
net inflow of foreign capital into Italy – measured by the financial account in Italy's balance 

11 

 
 
 
 
 
 
 
 
 
 
 
 
of payments – rebounded somewhat (Graph 7). However, as of mid-2011 the flow of private 
net foreign claims started to decline quickly as investor sentiment towards Italy deteriorated 
and  the  sovereign  debt  crisis  hit  the  country.  As  a  result,  the  composition  of  the  external 
financing  of  Italy's  NIIP  changed  dramatically.  First,  private  foreign  investors  drastically 
shed  their  holdings  of  debt  securities  issued  by  the  Italian  sovereign  and  to  a  lesser  extent 
Italian MFIs. The resulting sharp fall in net portfolio investment in Italy was to some extent 
offset  by  Eurosystem  purchases  of  Italian  sovereign  bonds  under  the  Securities  Markets 
Programme  between  August  2011  and  March  2012  (around  EUR  100  billion).  Second, 
foreign loans and deposits to Italian MFIs also declined substantially due to the strong link 
between the (weakening) Italian sovereign and banks (see Box 1). Third, the net outflow of 
private foreign funding was compensated by a very strong increase in external liabilities held 
by  the  Bank  of  Italy,  which  on  behalf  of  Italian  banks  took  in  ample  Eurosystem  liquidity 
under  the  two  3-year  long-term  refinancing  operations  (LTROs).  Following  the  collapse  of 
interbank market activity between surplus and peripheral euro-area countries in the course of 
2011,1  Italy's  TARGET  2  liabilities  vis-à-vis  the  Eurosystem  increased2  and  stood  at  EUR 
256  billion  (or  16%  of  Italy's  GDP)  at  the  end  of  February  2013.  As  foreign  private-sector 
funding  of  Italy's  negative  NIIP  has  to  a  significant  extent  been  replaced  by  official-sector 
funding in 2011-12, the overall exposure of foreign investors to Italy has remained broadly 
stable.  The  expected  surplus  in  the  current  account  in  2013,  as  set  out  in  the  Commission 
services' Winter 2013 forecast, will help to improve the NIIP going forward.  

Graph 7: The external financing of Italy's 
current account in flow terms, January 
2000 – October 2012 

Graph 8: Italian government's and MFIs' 
foreign liabilities and TARGET 2 balance, 
cumulative changes since Q1 2011 

250
200
150
100
50
0
-50
-100
-150
-200
-250

n
o

i
l
l
i

b
R
U
E

0
0

n
a
J

0
0
t
c
O

1
0

l

u
J

2
0
r
p
A

3
0

n
a
J

3
0
t
c
O

4
0

l

u
J

5
0
r
p
A

6
0

n
a
J

6
0
t
c
O

7
0

l

u
J

8
0
r
p
A

9
0

n
a
J

9
0
t
c
O

0
1

l

u
J

1
1
r
p
A

2
1

n
a
J

2
1
t
c
O

Foreign loans and deposits to Italian MFIs

n
o

i
l
l
i

b
R
U
E

50

0

-50

-100

-150

-200

-250

-300

11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3

Italian MFIs' foreign liabilities (cumulative)

Foreign portfolio investment in Italian debt securities

Italian government's foreign liabilities (cumulative)

Foreign loans to Bank of Italy (Eurosystem)

Italy's TARGET 2 balance

Note: The graph shows selected monthly flows of 
external funding of Italy's current account. 

Source: Bank of Italy, Commission services 

Source: Bank of Italy, Commission services 

1 See for instance De Grauwe, P. and Y. Ji (2012). 
2 See for instance Cecioni, M. and G. Ferrero (2012). 

12 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                            
Box 1: THE ROLE OF THE ITALIAN FINANCIAL SECTOR IN ITALY'S ADJUSTMENT  

The  longest  economic  recession  since  World  War  II  has  significantly  impaired  the  Italian 
financial  sector's  capacity  to  support  the  economic  recovery  and  favour  the  needed 
adjustment towards more productive activities. 

Compared to some other euro-area Member States, the Italian financial sector proved to be 
relatively  resilient  during  the  global  financial  crisis  of  2008-09,  requiring  only  marginal 
public  support.  Contributing  factors  included  a  largely  traditional  intermediation-based 
business  model,  a  sound  regulatory  and  supervisory  regime,  the  absence  of  a  real  estate 
bubble  in  the  country  and  the  low  level  of  household  debt.  Since  2011  however,  the 
vulnerability  of  Italian  banks  has  increased  significantly,  owing  to  the  negative  feedback 
loops  between  fiscal  sustainability  concerns,  banks’  exposure  to  the  Italian  sovereign  and 
weakening  real  economic  activity,  resulting  in  a  loss  of  access  to  international  wholesale 
funding  markets.  The  risk  of  a  liquidity  crunch  in  Italy  and  other  vulnerable  euro-area 
countries  led  the  Eurosystem  to  provide  ample  long-term  funding  through  the  two  3-year 
long-term  refinancing  operations  (LTROs)  in  December  2011  and  February  2012.  The 
participation  of  Italian  banks  in  these  operations  corresponded  to  a  net  increase  in 
Eurosystem funding of EUR 117 billion between November 2011 and March 2012, up to a 
total  of  around  EUR  270  billion.  However,  the  actual  uptake  of  LTRO  funding  was 
significantly higher than EUR 117 billion as almost all outstanding short-term funding under 
the  Eurosystem's  main  refinancing  operations  was  replaced  by  LTRO  funding.  Banks 
invested  a  significant  share  of  the  allotted  LTRO  funds  in  Italian  sovereign  bonds,  while 
foreign  investors  were  reducing  their  sovereign  exposure  to  Italy  (Graph  9).  Despite  the 
relaxation of liquidity constraints, the average cost of new credit to firms in Italy remained 
significantly  higher  than  in  Germany  or  France,  indicating  continued  impairment  of  the 
monetary policy transmission mechanism (Graph 10). 

Graph 9: Share of Italian government debt held by Italian MFIs and Eurosystem 
refinancing of Italian credit institutions 

n
o

i
l
l
i

b
R
U
E

300

250

200

150

100

50

0

20%

18%

16%

14%

12%

10%

1
1

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1
1
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1
1
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1
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1
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2
1

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2
1

l

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J

Eurosystem refinancing of Italian credit institutions (outstanding)

Share of Italian government debt held by Italian MFIs (rhs)

Source: Bank of Italy, Commission services 

13 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Graph 10: Interest rates on new bank 
loans to non-financial corporations in 
selected countries  

Graph 11: Volume of loans to Italian non-
financial corporations 

%

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

9
0
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2
1

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2
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Germany

Italy

France

ECB policy rate

e
g
n
a
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c
%

r
a
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y
-
n
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-
r
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Y

16

12

8

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-8

7
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2
1

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2
1
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2
1
p
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S

Source: European Central Bank  

Source: Bank of Italy 

Although the liquidity situation of Italian banks has improved considerably since the LTROs, 
other weaknesses have emerged which prevent the Italian banking sector from playing its role 
of  supporting  the  real  economy  adjustment.  The  double-dip  recession  has  burdened  Italian 
banks'  balance  sheets  with  a  large  and  rapidly  increasing  stock  of  non-performing  loans 
(NPLs)  (Graph  12),  mainly  to  non-financial  corporations  (NFCs),  a  problem  that  is  further 
aggravated  by  the  slowness  of  credit  recovery  procedures.  In  response,  credit  supply 
conditions tightened considerably over the period bridging 2011 and 2012 (Graph 11). SMEs, 
which for their financing are very dependent on banks, were particularly affected: compared 
to larger companies, they pay significantly higher interest rates on loans and more often face 
a  rejection  of  their  loan  applications.3  Demand  for  bank  loans  is  also  subdued,  and  this 
situation is expected to last well into 2013. Furthermore, lending growth has been held back 
by  the  need  to  maintain  tight  control  over  capitalisation  in  view  of  increased  credit  risk. 
Finally,  the  profitability  outlook  for  Italian  banks  does  not  look  encouraging.  Net  interest 
margins  are  under  pressure  from  low  benchmark  interest  rates  and  still  elevated  funding 
costs, while the credit contraction causes a decrease in core revenues and slows down the re-
pricing of banks' assets. The cost efficiency of Italian banks is low in an international context: 
high cost-to-income ratios, mainly due to extended branch networks, act as a further drag on 
profitability. 

3 See for instance European Central Bank (2012). 

14 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                            
Graph 12: Evolution of Italian non-performing loans 

14

12

10

8

6

4

2

0

s
n
a
o

l

l

a

t

o

t

f

o
%

16

14

12

10

8

6

4

2

0

)

%

(

e

t

t

a
r
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w
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r
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Q

9
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9
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2
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2
1
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Bad debts

Past-due loans

Substandard loans

Restructured loans

NPL ratio growth rate (rhs)

Note: International comparisons of NPL stocks involving Italy should take account of the fact that Italian 
accounting criteria to determine loan quality are stricter than in other countries, resulting in a positive bias in 
Italian NPL ratios. 

Source: Bank of Italy 

2.3. 

PRIVATE AND PUBLIC SECTOR INDEBTEDNESS 

The net financial position of Italian households continues to be relatively strong. Italian 
households have continued to accumulate assets as they have maintained a positive, though 
declining, saving rate (Graph 13). Their net financial wealth is still above the level estimated 
for France (135%), Germany (122%), and the euro-area average (128%), even though the fall 
in market prices reduced its value from 177% of GDP at the end of 2010 to around 165% at 
the  end  of  2011.  Overall  household  wealth  –  i.e.  including  real  assets  –  is  estimated  to  be 
around  550%  of  GDP.4  The  indebtedness  of  Italian  households  continues  to  be  among  the 
lowest in the euro area and their financial vulnerability – measured as the ratio of debt service 
to income – remains low.5 Nevertheless, the fall in households' real disposable income since 
the onset of the financial crisis has been significant due to both a weakening labour market 
and the impact of the sizeable fiscal consolidation. This, combined with some consumption 
smoothing, has implied a decline in the household saving rate to historically low levels. 

4 Bank of Italy (2012b) 
5 According to Magri, S. and R. Pico (2012), "The percentage of vulnerable households, i.e. those with a high 
debt service to income, remained unchanged from 2008 to 2010, when the sharp reduction in income was offset 
by a marked fall in interest rates; simulations for 2011-2012 show modest changes in this indicator. Over-
indebted households, i.e. those permanently unable to repay their debt, are estimated at 160,000 or 0.6 per cent 
of the total." 

15 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                            
Graph 13: Balance sheet of Italian households by instrument 

300

250

200

150

100

50

0

-50

-100

P
D
G

f
o
%

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

A - securities (other than shares)
A - loans
A - shares and other equity
A - insurance & techn. reserves
A - other accounts
A - currency and deposits

L - securities (other than shares)
L - loans
L - shares and other equity
L - insurance & techn. reserves
L - other accounts
Net financial assets

Note: 2012 figures are estimated using quarterly data. 

Source: Commission services 

The  increasing  trend  in  non-financial  corporations'  indebtedness  has  come  to  a  halt 
since 2008. Indebtedness of non-financial corporations (NFCs) increased by around 25 pps. 
of GDP over the decade up to 2008. As the total amount of loans to Italian NFCs fell by more 
than  2%  year-on-year  in  December  2012,  the  stock  of  consolidated  debt  of  Italian  NFCs 
stabilised  at  around  80%  of  GDP  and  remains  slightly  below  the  euro-area  average.  While 
this is largely reflected in depressed investment, the corporate sector has somewhat increased 
its reliance on self-financing. Taken together with the low level of household indebtedness, 
the overall indebtedness of the Italian private sector as a share of GDP remains nearly 20 pps. 
below the euro-area average (Graph 14). 

16 

 
 
 
 
 
 
 
Graph 14: Decomposition of Italy's debt 

350

300

250

P
D
G

f
o
%

200

150

100

50

0

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Financial corporations

Government

Household

Private sector EA17

Non financial corporations

Private sector

Note: 2012 figures are estimated using quarterly data. 

Source: Commission services 

The  high  government  debt  represents  a  major  burden  for  the  Italian  economy, 
especially  against  the  background  of  subdued  growth.  With  a  general  government  debt 
which is estimated to have reached around 127% of GDP by the end of 2012, Italy has by far 
the highest public debt-to-GDP ratio among the large euro-area countries. After a major fiscal 
consolidation in the run-up to euro adoption, Italy did not take advantage of the lower interest 
expenditure in the years preceding the global financial crisis to ensure sound public finances. 
On the contrary, the erosion over the years of the primary surplus achieved at euro-area entry 
slowed the pace of reduction of the debt-to-GDP ratio (Graph 15). While low growth makes it 
more  difficult  to  achieve  and  maintain  the  large  primary  surpluses  required  to  put  Italy's 
government debt-to-GDP ratio on a steadily declining path, a high stock of public debt may 
in  turn  hamper  growth  prospects.6  In  particular,  the  present  and  expected  high  level  of 
taxation needed to service the debt dampens domestic demand and may raise the distortionary 
costs  of  taxation.  Indeed,  the  tax  burden  in  Italy  is  high  and  weighs  heavily  on  labour  and 
capital,  to  the  detriment  of  growth  (see  Section  3.2).  Furthermore,  the  high  interest 
expenditure  to  service  the  debt  may  crowd  out  productive  public  expenditure,  especially  to 
support human capital accumulation and physical and technological infrastructures. In 2012, 
government  interest  expenditure  was  at  around  5.5%  of  GDP,  almost  3  pps.  higher  than  in 
Germany  and  France.  By  contrast,  structural  primary  expenditure,  just  below  43%  of 
potential GDP, was in line with that in Germany and more than 8 pps. lower than in France. 

6 See also European Commission (2012b). 

17 

 
 
 
 
 
 
 
 
                                                            
Graph 15: Decomposition of the changes in Italy's public debt-to-GDP ratio 

P
D
G

f
o
%

15

10

5

0

-5

-10

-15

1995-1998

1999-2007

2008-2012

Primary balance

Real GDP growth

Interest expenditure

Inflation (GDP deflator)

Stock-flow adjustment (including support to EA)

Average annual change in debt-to-GDP ratio

Source: Commission services 

The  public  debt  represents  a  major  vulnerability  for  Italy,  with  potential  spillovers  to 
the rest of the euro area. The sovereign debt crisis has exacerbated the negative feedback 
loop between high debt and low growth. Between end-2007 and end-2012, Italy's government 
gross debt ratio increased by around 24 pps. of GDP. This was largely explained by the sharp 
GDP  contraction,  while  in  a  context  of  limited  fiscal  space  the  authorities  maintained  a 
prudent fiscal stance. Meanwhile, as Italy's sovereign risk premium soared between 2011 and 
2012,  the  cost  of  capital  for  the  private  sector  also  increased,  hampering  productive 
investment. Moreover, given the considerable fragmentation of the euro-area financial market 
across  national  borders,  the  exposure  of  Italian  banks  to  Italy's  high  government  debt  has 
exacerbated the funding problems of the banking sector (see Box 1). As the Italian economy 
is the third largest in the euro area and Italian government debt at around EUR 2 trillion the 
second largest, the potential economic and financial spillovers of financial market tensions to 
the  rest  of  the  euro  area  are  sizeable.  However,  thanks  to  the  credible  fiscal  strategy  and 
growth-enhancing  reforms  at  national  level  as  well  as  progress  towards  more  economic 
integration at euro-area level, yields on government bonds have declined significantly since 
the last months of 2012. 

The  debt  sustainability  analysis  presented  in  the  Commission's  Fiscal  Sustainability 
report 20127 underscores the importance of securing high primary surpluses to put the 
Italian public debt-to-GDP ratio on a steadily declining path. Provided that the expected 
structural fiscal adjustment is achieved – i.e. that the structural primary surplus is increased to 
5% of GDP by 2014 and is maintained at that level afterwards – the downward trajectory of 
the debt ratio over the medium term is preserved under temporary interest rate shocks, even if 

7 European Commission (2012a) 

18 

 
 
 
 
 
 
                                                            
they are rather sizable or result in temporarily lower growth. However, if the primary balance 
targets  are  not  achieved,  then  the  debt  ratio  remains  vulnerable  to  adverse  interest  rate  and 
growth developments. The negative feedback loops between higher interest rates and lower 
growth  would  exacerbate  the  vulnerabilities.  The  reinforced  SGP  provides  the  appropriate 
framework  to  secure  a  steadily  declining  path  of  the  government  debt-to-GDP  ratio,  as  the 
new debt rule requires that the gap between the actual debt ratio and the reference value of 
60%  of  GDP  is  reduced  at  an  average  rate  of  one  twentieth  per  year  as  a  benchmark. 
Compliance with the debt rule might also help anchor market expectations and lower the risk 
premium on Italy's government debt. 

2.4. 

REAL ESTATE MARKET DEVELOPMENTS 

The risk of a severe downturn in the Italian real estate market, with adverse effects on 
household wealth and a sharp fall in the value of banks' collateral, appears limited. Italy 
did not experience a housing bubble during the pre-crisis years. At the end of August 2012, 
mortgage  lending  in  Italy  constituted  only  around  18%  of  total  bank  credit,  which  is 
significantly below the euro-area average of 33%. Two thirds of outstanding mortgages are 
variable-rate contracts, which limit banks' exposure to interbank interest rate changes. Loan-
to-value  ratios  are  relatively  low  in  Italy  and  have  decreased  considerably  since  the  mid-
2000s, as banks have applied conservative policies when granting mortgage loans. 

The Italian real estate market has weakened considerably against the background of the 
deep  economic  recession  in  Italy.  Construction  firms'  weak  turnover  and  the  restricted 
capacity to obtain financing in this sector led to a sharp contraction in construction activity. 
Real estate prices (in nominal terms) have declined modestly since mid-2011, slightly more 
for non-residential property than for houses. Real estate transaction volumes have decreased 
more significantly. Households' demand for mortgage loans has contracted, while the amount 
of building permits – especially for housing – has remained at a low level. The increase in 
recurrent taxation on immovable property ('Imposta Municipale Unica') from a relatively low 
level, adopted with the December 2011 economic and budgetary package (see Section 3.2), 
may have also affected the real estate market in 2012.  

The weakening of the construction sector weighs on banks' balance sheets. In December 
2012, the construction sector represented around 18% of all loans granted by banks to NFCs, 
while the sector's share of total NPLs (related to NFCs) amounted to 24%. On average one 
third of the monthly net increase in NPLs since mid-2011 is due to the construction sector. 

19 

 
 
 
3. 

3.1. 

IN-DEPTH ANALYSIS: COMPETITIVENESS 

COMPETITIVENESS DEVELOPMENTS IN ITALY 

Italy has been losing export market share since euro adoption, and the pace of erosion 
has accelerated with the eruption of the global crisis. Although it is normal for a mature 
economy to lose export market share in the context of strong export-led growth of emerging 
markets,  Italy’s  export  performance  nevertheless  compares  unfavourably  with  that  of  other 
euro-area countries. Graph 16 shows nominal export growth in value terms for selected euro-
area  countries  net  of  global  nominal  import  growth,  distinguishing  between  the  pre-crisis 
years  (2000-07)  and  developments  over  the  crisis  period  (2007-10).  During  the  pre-crisis 
years,  Italy  was  already  losing  market  share,  although  at  the  moderate  pace  of  1.2  pps.  per 
year  on  average,  while  the  euro  area  as  a  whole  maintained  its  market  share.  France 
experienced  a  more  dramatic  loss  while  in  Germany  and  Spain  exports  grew  faster  than 
global imports. The Italian export market share fell dramatically – by a sizeable 6.3 pps. on 
average per year – during the crisis years 2007-10, i.e. more than the euro-area average of -
4.2 pps. 

Graph 16: Net nominal export growth for selected euro-area countries 

n
i
(

t

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w
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D
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6

4

2

0

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-4

-6

-8

DE

FR

IT

ES

EA

2000-07

2007-10

Note: A country's net nominal export growth is defined as nominal export growth net of global nominal import 
demand. Positive/negative net nominal export growth implies a gain/loss of export market share. 

Source: Commission services 

The loss of cost and non-cost competitiveness vis-à-vis Italy’s trading partners has been 
a  key  driver  of  the  country’s  subdued  export  performance.  The  following  factors  are 
relevant in this respect: 

20 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
•  Unit labour costs in Italy have increased more rapidly than in the rest of the euro 
area  since  1998.  During  the  period  1999-2012,  Italian  nominal  unit  labour  costs 
(ULC)  grew  by  2.3%  per  year  on  average,  implying  labour  cost  pressures  on  prices 
above  the  ECB  inflation  reference  value.  In  France,  ULC  grew  by  1.9%  per  year, 
while in Germany the average annual growth rate, at 0.7%, was well below the euro-
area average of 1.6%.  

•  Persistently weak productivity growth is the key driver of increasing unit labour 
costs.  Total factor productivity growth came to a halt at the beginning of the 2000s 
and has been subdued or even negative since then (Graph 17). This reflects a reduced 
ability of Italian firms to incorporate new technologies in their production processes 
and  improve  labour  force  organisation  consistently  with  a  changing  and  more 
competitive environment, as well as the scarcity of skilled labour (see Box 2). 

Graph 17: Total factor productivity in Italy and the euro area  

)
0
0
1
=
0
9
9
1
(

x
e
d
n

I

115

110

105

100

95

90

92

94

96

98

00

02

04

06

08

10

12

EA-12

IT

Source: Commission services 

•  The  negative  impact  on  competitiveness  of  rapidly  rising  ULC  has  been 
amplified by the sizable appreciation of Italy’s nominal effective exchange rate. 
A  decomposition  of  the  appreciation  of  Italy’s  ULC-based  REER8  since  1998  into 
changes in the nominal effective exchange rate (NEER) and in nominal ULC relative 
to trade partners shows that the appreciation of the former component between 2003 
and 2009 is the main driver (Graph 18). Germany experienced a similar appreciation 
of its NEER, but its impact on the REER was offset by declining relative ULC, driven 

8 An alternative measure of price competitiveness would be the Italian REER based on the producer price index, 
especially for traded goods. 

21 

 
 
 
 
 
 
 
 
                                                            
by  considerable  wage  restraint  (Graph  19).  According  to  IMF  estimates,  Italy’s  real 
effective exchange rate (REER) is modestly overvalued by around 5–10%. 

Graph 18: Decomposition of the 
cumulative change in Italy's ULC-based 
REER since 1998 

Graph 19: Evolution of relative nominal 
ULC in selected countries 

)

%

i

(
8
9
9
1
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s
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t

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C

16

14

12

10

8

6

4

2

0

-2

-4

-6

-8

99 00 01 02 03 04 05 06 07 08 09 10 11 12

ULC contribution

NEER contribution

REER

Source: Commission services 

)
0
0
1
=
8
9
9
1
(

x
e
d
n
I

115

110

105

100

95

90

85

80

75

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

DE

ES

FR

IT

Note: Performance relative to 36 industrial countries 
(double export weights) 

Source: Commission services  

•  Italy's  export  performance  continues  to  suffer  from  an  unfavourable  product 
specialisation.  To  identify  the  drivers  of  the  export  market  share  losses  that  were 
shown in Graph 16, Italian net nominal export growth before and during the crisis is 
decomposed into two structural indicators showing to what extent Italy's exports have 
been geared towards dynamic geographic and product markets, and two performance 
indicators  capturing  Italy's  success  in  achieving  above-market  export  growth  in 
geographic  and  product  markets  due  to  competitiveness  factors  (Graph  20).  At  the 
beginning  of  the  decade,  the  Italian  economy  presented  an  unfavourable  product 
specialisation  relative  to  global  export  patterns,  but  its  exports  remained  oriented 
towards still dynamic destination countries, which allowed it to take advantage of the 
distribution  of  global  demand.  However,  as  global  export  patterns  evolved,  Italian 
exporters  were  not  able  to  redirect  their  products  to  the  countries  where  import 
demand  was  most  dynamic.  Thus,  Italy  entered  the  crisis  with  an  unfavourable 
product and geographical specialisation of exports, and both these disadvantages were 
aggravated during the crisis, as the economy lacked sufficient dynamism to adapt to 
the  dramatically  changed  environment  and  import  demand  in  some  of  Italy’s  key 
trading partners – especially in Europe – dropped. 

22 

 
 
  
 
 
 
 
 
 
 
 
 
 
Graph 20: Decomposition of Italy's net nominal export growth according to 
geographical and sectorial composition 

2

1

0

-1

-2

-3

-4

-5

-6

-7

)

%

(
e
t
a
r

h
t
w
o
r
g

l

a
u
n
n
A

2000-2007

2007-2010

Market share gains in product markets
Market share gains in geographical destinations
Initial product specialisation
Intial geographical specialisation

Note: More information on the decomposition methodology can be found in European Commission (2012c). 

Source: Commission services 

23 

 
 
 
 
 
 
Box 2: THE CONTRIBUTION OF EDUCATION TO GROWTH  

Education  is  key  for  economic  growth.  The  quality  of  labour  is  particularly  important  for 
advanced economies, which compete in international markets with goods and services with a 
relatively high technological content. In fact, advanced economies operate close to or at the 
technological frontier, i.e. the maximum output that can be produced for any given amount of 
capital and labour using the most advanced technology available. In order to move closer to 
the  frontier  or  even  push  it  forward,  a  high-skilled  labour  force  and  R&D  investment  are 
required  (Vandenbussche  et  al.  (2006)).  The  empirical  literature  provides  evidence  that 
human capital has a positive impact on the macroeconomic performance of a country, notably 
by increasing productivity (Sianesi and Van Reenen, 2002). 

Graph 21 indicates a positive relationship between potential output per capita and the share of 
the population with upper-secondary or tertiary educational attainment for the former EU-15 
countries. It shows that Italy is outperformed by most other European countries. 

Graph 21: Potential GDP per capita and educational attainment in the EU, 2011 

)

R
U
E

(

S
P
P
a
t
i
p
a
c

r
e
p
P
D
G

l

a
i
t
n
e
t
o
P

35 000

33 000

31 000

29 000

27 000

25 000

23 000

21 000

19 000

17 000

15 000

NL

IE
BE

AT

DE

FI

DK

SE

UK

ES

IT

EA

FR

EL

PT

30

40

50

60

70

80

90

Share of persons (25-64 year-old) with upper secondary or 
tertiary education attainment 

Source: Commission services 

Indeed,  Italy's  human  capital  endowment  remains  weak  compared  to  other  advanced 
economies. The proportion of low-skilled people in the population is relatively high: in spite 
of  some  significant  improvement  in  recent  years,  completion  of  upper  secondary  education 
remains below the EU average, and the tertiary education attainment rate among those aged 
30-34  is  the  lowest  in  the  EU,  standing  at  21.3%  compared  to  an  EU  average  of  35.5% 
(Graph  22).  Similarly,  Italy  has  a  high  percentage  of  early  school  leavers  (17.7%  in  2012, 
compared to an EU average of 12.9%) and high rates of inactivity among its young people: in 
2011, more than one in five 15-29 year-olds in Italy were neither in education nor employed. 

24 

 
 
 
 
 
 
 
 
 
 
 
Furthermore, PISA test results show that school education produces weak results in terms of 
basic skills, especially in southern regions, and many children of parents with low levels of 
education are caught in a low-education group. All this points to a quality of education that 
still lags behind the OECD average. The gap with other industrialised countries also remains 
wide in terms of the transition from education to work, and many indicators suggest that the 
labour market for young tertiary graduates has become more difficult over the past decade. 

Graph 22: Share of persons (aged 30-34) with tertiary education attainment, 2011 

%

50
45
40
35
30
25
20
15
10
5
0

E

I

U
L

I

E F
S

Y
C

K
U

T
L

R
F

E
B

K
D

L
N

S
E

I

E S
E

L
P

V
L

E
D

L
E

U
H

G
B

T
P

T
A

Z
C

K
S

T
M

T
O I
R

2011

2000

Source: Eurostat 

7
2
-
U
E

In light of the above, the following sections of this in-depth analysis focus on the main levers 
for  improving  Italian  competitiveness:  wage  moderation,  a  more  growth-friendly  taxation 
structure and, most importantly, stronger productivity growth. 

3.2.  WAGE GROWTH, LABOUR MARKET RESPONSIVENESS AND TAXATION 

Since euro adoption, wage growth in Italy has been broadly in line with the euro-area 
average. Nominal compensation per employee grew by 2.5% on average per year over 1999-
2012,  with  some  deceleration  after  2008  (Graph  23).  The  euro  area  and  France  recorded 
similar growth rates at 2.4% and 2.6% respectively. By contrast, nominal compensation per 
employee  rose  much  more  significantly  in  Ireland,  Greece,  Portugal  and  Spain  before  the 
financial crisis, while afterwards it stabilised or fell sharply in the case of Greece. Germany is 
an outlier, with flat nominal wages up to 2008 and some acceleration afterwards. Growth of 
nominal compensation per employee is not only in line with the average growth in the euro 
area, but it also appeared to be consistent with domestic labour market equilibrium up to the 
financial crisis in 2008 and only slightly above what is predicted on the basis of fundamentals 
during the crisis years up to 2011.9 Dispersion in real wage growth (Graph 24) has been more 

9 Rawdanowicz, L. et al. (2013) 

25 

 
 
 
 
 
 
                                                            
contained  as  inflation  and  wage  developments  have  been  influencing  each  other.  More 
specifically,  after  euro  adoption  Italy's  real  compensation  per  employee  increased 
significantly only over 2009-10, as falling energy prices drove the decline in inflation. This 
increase  was  reversed  in  2011-12,  when  higher  indirect  taxation  and  oil  prices  pushed 
inflation up while wage growth was restrained by the economic slump and the enacted freeze 
in  public  sector  wages.  Over  the  period  1999-2012,  real  wages  increased  by  only  0.2%  on 
average per year in Italy. Real wage growth was  more  sustained  in  France  (1.0%),  while  it 
was similar to Italy (0.1%) in Germany. 

Graph 23: Nominal compensation per 
employee in selected countries  

Graph 24: Real compensation per 
employee in selected countries  

)
0
0
1
=
8
9
9
1
(

x
e
d
n
I

180

170

160

150

140

130

120

110

100

90

)
0
0
1
=
8
9
9
1
(

x
e
d
n

I

180

170

160

150

140

130

120

110

100

90

98

00

02

04

06

08

10

12

98

00

02

04

06

08

10

12

DE

FR

IE

IT

EL

PT

ES

EA-17

DE

FR

IE

IT

EL

PT

ES

EA-17

Source: Commission services 

Note: Based on private consumption deflator  

Source: Commission services 

The  share  of  wages  negotiated  at  firm  level  remains  small.10  Contractual  wages  set  at 
national sectorial level on the basis of the inflation benchmark for a 3-year period have been 
less responsive to productivity developments than actual wages. Actual wages rose as a result 
of  some  positive  wage  drift  just  before  the  financial  crisis,  as  economic  conditions  were 
improving.  By  contrast,  a  negative  wage  drift  has  been  visible  since  end-2008  and  became 
even  more  apparent  since  the  second  half  of  2011,  following  the  sovereign-debt  crisis  that 
severely hit the Italian economy (Graph 25). Firm-level bargaining can play an important role 
in  strengthening  wage  responsiveness  to  productivity  as  well  as  to  local  labour  market 

10 The adjustment of labour costs to changes in the economic situation can be gauged via different indicators. 
One such indicator is the wage drift, which measures the difference between the growth in the actual wages 
received by workers and that in negotiated wages. 

26 

 
 
 
 
 
 
 
 
 
 
 
 
                                                            
conditions.  However,  the  share  of  wages  negotiated  at  firm  level  is  still  limited  and  this 
hampers a better alignment of wages to specific economic and competitiveness conditions. 

Graph 25: Wage drift in Italy 

)
0
0
1
=
1
Q
5
0
(

x
e
d
n
I

120

115

110

105

100

95

05Q1 05Q4 06Q3 07Q2 08Q1 08Q4 09Q3 10Q2 11Q1 11Q4 12Q3

Contractual wages

Compensation per hour worked

GVA per hour worked

Wage drift

Source: Commission services 

The  dominant  level  of  collective  bargaining  in  Italy  remains  the  national  level,  even 
though important changes to the bargaining framework since the beginning of the 1990s 
have  promoted  a  gradual  shift  towards  the  company  level.  The  most  important  of  these 
changes was the tripartite agreement in July 1993, which formalised the company/local level 
within  a  two-tier  bargaining  framework.  Two  further  agreements  in  2009  and  2011  and  a 
controversial legal provision adopted by parliament in September 2011 constituted additional 
attempts to further shift the balance towards company-level bargaining, with the latter even 
allowing firm-level collective agreements to derogate from labour law. By allowing to locally 
negotiate trade-offs between job security conditions and wage concessions, these agreements 
may allow for better taking into account the needs of specific production activities. However, 
the evidence available so far shows that firm-level contracts concern a minority of workers 
and  firms,  with  this  share  being  particularly  low  in  southern  regions.  Large  and  more 
productive firms still dominate the bargaining process at the national sectorial level, making 
it  difficult  for  SMEs  to  adjust  wages  to  internal  productivity  developments  and  cyclical 
conditions. In addition, the 3-year duration of contracts, while reducing the negotiation effort 
of  social  partners,  might  be  too  long  to  adjust  to  unexpected  changes  in  cyclical  and 
competitiveness conditions. Finally, the 3-year inflation forecast excluding imported energy 

27 

 
 
 
 
 
 
 
 
prices, which since 2009 is used as a benchmark for wage setting at national level, does not 
take into account Italy's need to regain cost competitiveness relative to trade partners.  

The new productivity agreement signed by the social partners at the end of 2012 might 
further  facilitate  wage  setting  at  firm  level.  The  agreement  was  signed  on  21  November 
2012 by the social partners with the notable exception of the largest union CGIL. It aims to 
further strengthen the second level of bargaining. The agreement also emphasises the need to 
better link wages set in national contracts not only to the 3-year forecast inflation, but also to 
the economic and competitiveness conditions of the country and the sector in question. While 
confirming  the  traditional  set-up  of  the  collective  bargaining  regulation  in  Italy,  i.e.  with 
legislation  and  the  government  continuing  to  have  a  very  limited  role,  the  agreement  could 
promote a more efficient bargaining framework. The social partners also committed to further 
define  rules  for  representativeness  in  collective  bargaining,  in  view  of  establishing  a  more 
stable and effective industrial relations system. The government will support the agreement 
with tax rebates on productivity-related wage increases. 

The high tax burden on labour raises the pressure on competitiveness on the cost side 
and  contributes  to  Italy’s  unsatisfactory  employment  performance,  while  the  high 
taxation  of  capital  contributes  to  weak  investment  activity.  In  2010,  Italy  displayed  the 
highest  implicit  tax  rate  on  labour  income11  in  the  euro  area,  and  this  rate  has  actually 
increased considerably since 1995 (Graph 26 – Panel A). High labour taxation raises labour 
costs,  with  negative  impact  on  cost  competitiveness.  It  also  adversely  affects  both  labour 
demand and supply, especially of women, and can create an incentive to resort to the shadow 
economy. Similarly, in 2010 Italy displayed the fourth-highest implicit tax rate on capital12 
(Graph 26 – Panel B). High corporate income taxation can contribute to sluggish investment 
activity  and  also  to  the  limited  attractiveness  of  the  Italian  economy  for  FDI.  Consumption 
taxes finally, which are acknowledged to be less distortionary, represent only a small share of 
total revenues. In 2010 the implicit tax rate on consumption was still among the lowest in the 
euro area, and even declined somewhat between 2000 and 2010 (Graph 26 – Panel C). 

11 The implicit tax rate (ITR) on labour is calculated as the sum of all direct and indirect taxes and social 
contributions levied on employed labour income as a percentage of total compensation of employees from 
national accounts.  
12 The ITR on capital is calculated as the ratio between revenue from all capital taxes and aggregate capital and 
saving income in the economy. It should be stressed, however, that the analysis of the ITR on capital is greatly 
complicated by the fact that taxes on capital include a variety of taxes paid by both enterprises and households 
on many sources of revenue. In particular, in these calculations, receipts from taxes and social contributions 
levied on the self-employed, a relatively large group in Italy, are booked as capital taxes. 

28 

 
 
                                                            
50

45

40

35

30

25

20

15

10

5

0

Graph 26: Implicit tax rates on labour, capital and consumption in the euro area 

Panel A: Labour 

Panel B: Capital 

%

%

45

40

35

30

25

20

15

10

5

0

T

I

E
B

R
F

I

T F
A

E
D

E
E

L
N

I

S

S
E

U
L

K
S

L
E

Y
C

E

I

T
P

T
M

7
1
-

A
E

R
F

T

I

Y
C

T
P

E
B

I

S F
E

I

T S
A

E
D

L
E

K
S

E

I

L
N

E
E

7
1
-
A
E

2010

2000

1995

2010

2000

1995

Panel C: Consumption 

%

30

25

20

15

10

5

0

U
L

L
N

I

E F
E

I

S

E

I

E
B

T
A

E
D

R
F

T
M

Y
C

K
S

T
P

T

I

L
E

S
E

7
1
-
A
E

2010

2000

1995

Source: Commission services 

29 

 
 
 
 
 
 
 
 
 
The fiscal consolidation measures adopted by the Italian government in 2011 and 2012 
rebalanced  the  tax  burden  towards  consumption,  immovable  property  and  financial 
wealth.  The  fiscal  consolidation  packages  adopted  since  2011  increased  recurrent  property 
taxation (including the reintroduction of taxation of primary residences), raised the standard 
VAT  rate,  increased  taxation  on  luxury  durable  goods  and  financial  assets,  and  introduced 
higher  excise  duties  on  transport  fuels.  At  the  same  time,  taxation  on  the  labour  income  of 
new  hires  was  lowered  by  allowing  for  the  deductibility  of  the  labour  component  from  the 
Italian  regional  production  tax  (IRAP),  with  greater  reductions  for  women,  young  workers 
and  southern  regions,  while  an  allowance  for  corporate  equity  (ACE)  was  introduced. 
Allowances  for  dependent  children  on  personal incomes  were  also  increased  with  the  2013 
budget.  Finally,  a  number  of  new  measures  and  tools  were  introduced  to  improve  tax 
compliance, including intensified inspection activities, the reduction of the threshold for the 
mandatory use of electronic payments and the introduction of the so-called 'income-meter' to 
detect potential tax evaders based on a comparison between income declared for tax purposes 
and expenses made. 

While increasing the overall tax burden, the recently adopted fiscal measures have some 
desirable  properties  in  terms  of  efficiency.  Due  to  the  budget  constraints,  the  shift  of 
taxation away from labour and capital was relatively modest and, despite some rebalancing of 
the fiscal adjustment towards expenditure cuts, the overall tax burden increased. Against the 
background of Italy's persistently low growth combined with the pressing need to bring the 
public debt on a declining path, higher taxation of immovable property is preferable to other 
taxes: it is less harmful to long-term growth, while appearing broadly consistent with equity 
objectives  if  properly  designed.13  This  is  especially  true  for  Italy  as  the  country's  recurrent 
taxation  on  immovable  property  used  to  be  relatively  low  (Graph  27).  Some  aspects  of  the 
reformed property tax could however be further improved in order to enhance progressivity. 
Broadening  the  tax  base  by  bringing  real  estate  taxable  values  in  line  with  market  values 
could  yield  equity  gains  in  addition  to  bringing  in  additional  revenues  and  reducing 
distortions.  In  addition,  the  enabling  law  envisaging  a  comprehensive  review  of  Italy's 
outdated  cadastral  values  remains  to  be  adopted.  Regarding  other  tax  measures,  the 
introduction of ACE can reduce the 'debt bias' in corporate financing (Graph 28). As such, it 
is  expected  to  encourage  firms,  including  SMEs,  to  expand  their  capital  base  to  allow  for 
higher investment, and help reduce firms' leverage and reliance on bank financing which has 
tightened considerably. In addition, own equity and retained earnings are considered the most 
important source of funding for investment in research and innovation, as immaterial capital 
goods cannot offer the guarantees demanded by banks. 

13 See for instance Johansson, Å, C. Heady, J. Arnold, B. Brys and L. Vartia (2008). 

30 

 
 
 
                                                            
Graph 27: Recurrent taxation on immovable property in the euro area, 2010 

2.5

2.0

1.5
P
D
G

f
o
1.0
%

0.5

0.0

FR BE ES IE FI CY PT IT NL SI DE SK EE EL AT MT

EA

Note: This graph does not take into account the increase in recurrent taxation on immovable property enacted in 
Italy in December 2011. 

Source: Commission services 

Graph 28: Effective marginal tax rates (EMTR) for investment financed by debt and 
new equity in the euro area, 2011 

60

50

40

30

20

10

0

-10

-20

-30

%

MT EL LU FR PT IT BE ES DE NL AT FI SI SK EE IE

EA

EMTR new equity

EMTR debt

Debt bias

Source: Commission services 

31 

 
 
 
 
 
 
 
 
3.3. 

A CLOSER LOOK AT SELECTED DRIVERS OF PRODUCTIVITY SLOWDOWN 

3.3.1.  THE BUSINESS ENVIRONMENT AND STRUCTURAL FEATURES OF FIRMS 

The  high  cost  of  doing  business  and  the  unfriendly  business  environment  further 
undermine  Italy's  external  competitiveness.  Firms  operating  in  Italy  are  confronted  with 
high input costs in several areas. The cost of energy in Italy – in particular electricity prices – 
is  among  the  highest  within  the  EU  (Graph  29).  Rents  due  to  the  lack  of  competition  in 
sheltered sectors imply higher prices for a range of intermediate goods and services.14 As was 
explained  in  Box  1,  Italian  companies  –  especially  SMEs  –  also  face  considerably  higher 
interest rates on new bank loans than their peers in other euro-area countries due to the high 
cost  of  bank  funding  and  credit 
tightening.  Capital  markets  meanwhile  remain 
underdeveloped and difficult to access for small firms, despite recent government initiatives 
such  as  the  possibility  for  SMEs  to  issue  mini-bonds.  With  regard  to  the  general  business 
environment, an inefficient public administration, including in the area of public procurement 
and  the  civil  justice  system15,  pervasive  bureaucracy,  restrictive  labour  market  regulations, 
insufficient  infrastructure  and  an  inadequately  educated  workforce  all  constitute  major 
obstacles  to  the  creation16  and  growth  of  Italian  firms,  resulting  in  limited  business 
dynamism.  Survey-based  evidence  from  the  World  Economic  Forum  (2012)  on  the  most 
problematic factors for doing business in Italy (Graph 30) shows that Italy ranks particularly 
low  in  the  domains  of  institutions  and  goods  and  labour  market  efficiency,  and  to  a  lesser 
extent also financial market development and technological readiness. 

14 See for instance Bank of Italy (2012a). 
15 According to the World Bank's doing-business indicators, contract enforcement in Italy on average takes 1210 
days, compared to an OECD high-income average of just 510 days. 
16 Italy ranks only 84th in the World Bank’s ‘doing business’ indicator on ease of starting a business. 

32 

 
 
                                                            
Graph 29: Electricity prices for industrial consumers in the EU, 

CY
DK
IT
MT
DE
SK
IE
BE
ES
LV
HU
CZ
LT
EL
UK
NL
PL
SI
PT
LU
RO
SE
FI
EE
FR
BG

0

5

10

15

EUR / 100 KWh

20

25

2011

Source: Commission services 

Graph 30: The most problematic factors for doing business in Italy 

17.1

16.3

14.6

10.4

8.8

8.3

7.1

4.6

4.2

4.2

4.2

Tax rates

Inefficient government bureacracy

Access to financing

Restrictive labour regulations

Tax regulations

Inadequate supply of infrastructure

Corruption

Insufficient capacity to innovate

Poor work ethic in national labor force

Policy instability

Crime and theft

Inadequately educated workforce

0.4

Foreign currency regulations

Government instability/coups

Inflation

Poor public health

0

0

0

0

0

2

4

6

8

10

12

14

16

18

Note: From the list of factors above, respondents were asked to select the five most problematic for doing 
business in their country and rank them between 1 (most problematic) and 5. The bars in the figure show the 
responses weighted according to their rankings. 

Source: World Economic Forum (2012) 

33 

 
 
 
 
 
The predominance of small firms could be explained by a failure of small Italian firms 
to  enter  the  virtuous  circle  of  firm  expansion  and  productivity  growth.  In  2011  the 
average Italian firm employed 4.0 persons, compared to 11.8 in Germany and 5.6 in France. 
In the same year, micro-firms (i.e. employing less than 10 people) represented almost 95% of 
all  Italian  enterprises  in  2011,  whereas  in  Germany  and  France  the  corresponding  share 
amounted to 83% and 93%, respectively. Among Italian SMEs, especially micro-firms suffer 
from  a  significant  productivity  gap  vis-à-vis  larger  firms,  but  also  vis-à-vis  their  European 
peers: in 2011, the productivity of Italian micro-firms amounted to only 63% of that of the 
domestic  NFC  sector  as  a  whole,  well  below  Germany  and  France,  where  the  respective 
ratios  were  78%  and  94%.  Furthermore,  in  2011,  the  ratio  of  Italian  SMEs'  productivity  to 
German  SMEs'  productivity  was  71%,  whereas  for  micro-firms,  relative  productivity  was 
even lower, at 58%.17 

The failure of many Italian small firms to grow prevents them from reaping the benefits 
of globalisation. A growing body of economic research, based on firm-level data, suggests a 
strong  positive  correlation  between  firm  size,  productivity  and  export  performance:  firms 
engaged in international activities such as exporting are typically larger, employ more labour 
and  have  higher  innovation  capacity.  At  the  same  time,  larger  firms  are  typically  more 
productive and the probability of a firm to become active internationally increases with firm 
size. Moreover, the largest firms tend to have the furthest geographical reach and can pursue 
complex internationalisation strategies, enabling them to take advantage of the opportunities 
offered  by  globalisation,  which  in  turn  could  trigger  further  productivity  increases  (e.g. 
through  the  transfer  of  knowledge  and  technology).  Altomonte  et  al.  (2012)  show  that  in 
order  to  achieve  internationalisation,  companies  need  to  move  beyond  a  productivity 
threshold  that  enables  them  to  absorb  the  high  fixed  (and  often  sunk)  costs  related  to 
internationalisation and achieve the necessary efficiency to face international competition.  

Several  institutional  and  firm-level  features  hamper  the  growth  of  Italian  firms.  Low 
domestic competition in product and service markets shelters unproductive companies which 
would  otherwise  have  to  exit  and  slows  down  the  reallocation  of  resources  to  the  best 
performing firms. Various regulations, for example with regard to the labour market (such as 
dismissal  rules)  and  the  tax  system  (such  as  particular  tax  expenditure  items),  may  act  as 
disincentives  to  firm  growth  through  the  exemptions  they  provide  to  small  firms  and  thus 
represent  a  de  facto  tax  on  size.  Still  limited  decentralised  wage  bargaining  continues  to 
prevent employers to set wages in line with local productivity developments, which might act 
as a further obstacle to the efficient allocation of productive resources to the most efficient 
firms. Companies may also be encouraged to stay small by the complex tax regime or even 
organised  crime  in  some  regions.  Finally,  the  absence  of  specific  firm-level  features 
conducive  to  productivity  growth,  such  as  a  high  R&D  intensity,  performance-related 
incentives  and  equity  funding,  as  well  as  the  presence  of  firm-level  attributes  hampering 

17 Calculations are based on the database accompanying the European Commission's Annual report on small and 
medium-sized enterprises in the EU, 2011/12. 

34 

 
 
 
                                                            
productivity growth, such as family ownership and its effect on risk aversion and openness 
towards  (non-)technological  innovation  and  ICT,  hamper  Italian  firms'  ability  to  become 
active internationally.18 

The lack of a business-supporting environment is the main reason for Italy's low inward 
FDI. All the factors mentioned above that contribute to an unfriendly business environment 
hold  back  the  inflow  of  internationally  active  companies.  Italy's  limited  attractiveness  as  a 
business location implies that in 2010 the overall stock of inward FDI as a share of GDP was 
just around 16%, compared to 27% in Germany and 38% in France (Graph 31). This reflects 
significantly  lower  foreign  investment  in  financial  activities  and  professional  and  business 
services. Given FDI's positive external effects under the form of the reallocation of domestic 
productive resources to tradable sectors, transfers of technology and knowledge and exposure 
to  alternative  corporate  cultures,  Italy  misses  out  on  an  important  potential  source  of 
productivity enhancements. 

A range of measures was adopted over the past months to foster competition in product 
and  service  markets  and  improve  the  efficiency  of  the  business  environment.  First, 
progress was made to remove barriers to competition and open important market segments in 
the  services  sector,  in  particular  the  professional  orders.  Other  measures  were  aimed  at 
enhancing  transparency  and  improving  market  functioning  in  network  industries  such  as 
energy  and  transport,  notably  through  the  ongoing  unbundling  between  the  incumbent 
operator and the infrastructure manager in the gas sector and the envisaged empowerment of 
existing  and  newly  established  regulatory  authorities.  Second,  a  range  of  measures  was 
adopted  to  achieve  administrative  simplification,  improve  SMEs'  access  to  finance, 
modernise the public administration, promote the digitalisation of the economy and improve 
civil  justice  efficiency.  Regarding  the  latter,  the  enacted  revision  of  the  judicial  geography 
represents a key step to improve the judicial organisation. It was complemented by measures 
to  accelerate  judicial  procedures,  foster  the  specialisation  of  courts  and  judges,  reduce 
litigation and modernise the use of the judicial service. 

The  labour  market  reform  adopted  in  June  2012  could  contribute  to  improving 
productivity  growth  while  reducing  segmentation  in  the  labour  market.  The  reform 
tackles  the  asymmetries  and  segmentation  of  the  labour  market,  with  a  view  to  reconciling 
to  better  regulate  entry  flexibility  by  making 
security  with  flexibility.  It  strives 
apprenticeships the main point of entry towards stable jobs and reducing incentives to the use 
of  temporary  contracts  and  non-dependent  work  by  firms.  It  also  improves  exit  flexibility 
through  a  revision  of  employment  protection  legislation.  Finally,  the  reform  establishes  a 
more  comprehensive  insurance-based  system  of  unemployment  benefits.  The  revision  of 
employment  protection  legislation  can  reduce  the  uncertainty  and  cost  of  dismissals. 
However, the interpretation by the labour judge of the new legislation will be crucial for the 
success  of  the  reform,  while  the  new  constraints  on  the  use  of  non-regular  contracts  could 
negatively affect labour demand.  

18 See for instance Altomonte, C., T. Aquilante and G. I. P. Ottaviano (2012). 

35 

 
 
                                                            
The  adopted  reforms  could  bring  substantial  benefits  in  terms  of  raising  Italy’s 
competitiveness  and  potential  growth.  However,  their  full  implementation  remains  a 
challenge  and  further  effort  is  needed  in  some  areas.  A  more  detailed  account  of  the 
actions  taken  by  the  Italian  authorities  in  response  to  the  recommendations  issued  by  the 
Council in July 2012, which cover many of the issues discussed in this review as underlying 
Italy’s imbalances, will be undertaken in the context of the third EU semester. Overall, it is 
clear  that  the  adopted  reforms  can  potentially  raise  Italy’s  growth  potential  and 
competitiveness.  Lusinyan  et  al.  (2013)  estimate  that,  if  fully  implemented,  the  product 
market reforms can raise GDP by 1.0% in two years, 4.4% in five years, and 8.3% in the long 
term, whereas the recent labour market reform could increase GDP by 0.6% after two years, 
1.1%  after  five  years  and  1.8%  in  the  long  run.  However,  implementation  remains 
challenging for some measures, either owing to delays in their concrete operationalisation or 
due to still pending secondary legislation. In particular, this is the case for the envisaged new 
regulatory authority in charge of fostering competition in the field of transport which has not 
yet  been  set  up,  as  well  as  for  some  measures  oriented  towards  simplification  for  which 
implementing  provisions  are  still  expected.  Some  of  the  provisions  of  the  labour  market 
reform, notably those related to incentives for the recruitment of women and older workers, 
still require implementing legislation. 

Graph 31: Stocks of inward FDI in selected countries, 2010 

P
D
G

f
o
%

40

30

20

10

0

DE

FR

IT

Other activities
Professional, scientific and technical activities
Financial and insurance activities
Transportation and storage
Electricity, gas, steam and air conditioning supply

Administrative and support service activities
Real estate activities
Information and communication
Wholesale and retail trade; repair of motor vehicles and motorcycles
Manufacturing

Source: Commission services 

3.3.2.  THE SPECIALISATION OF MANUFACTURING EXPORTS 

The  Italian  economy  is  characterised  by  the  relative  importance  of  its  manufacturing 
sector. The sector represented 16.7% of the total gross added value of the economy in 2011 
(compared to 22.3% in Germany, 11.5% in France and 16.6% for the euro area as a whole). 

36 

 
 
 
 
 
 
 
However, this share has been declining over time (it was 21.5% in 1995) and the contraction 
has been particularly marked since the start of the global financial crisis: industrial output fell 
by more than one fifth between 2007 and 2012  and  the  net  amount  of  manufacturing  firms 
created in Italy has been negative throughout the 2000s (Graph 32). 

Graph 32: Net new firm creation in Italy's manufacturing sector 

20 000

15 000

10 000

5 000

0

-5 000

-10 000

-15 000

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

New firm registrations

Firm liquidations

Net new firm creation

Note: Excluding sole proprietorships 

Source: Infocamere (Movimprese) 

A  significant  share  of  Italy's  manufacturing  value  added  is  generated  by  traditional 
sectors characterised by low technological intensity, with minor changes over time. The 
share of manufacturing value added in the low and medium-low technology sectors amounted 
to 62% in 2009, compared to 44% in Germany, 59% in France and 64% in Spain (Graph 33). 
Over  the  past  two  decades,  Italy's  sectorial  specialisation  remained  broadly  stable:  the  high 
technology  sector  accounted  for  6.7%  of  total  manufacturing  gross  value  added  in  2011 
compared to 6.5% in 1992, a negligible increase over a time span of almost 20 years.  

37 

 
 
 
 
 
 
Graph 33: Manufacturing real value added by technological intensity in selected 
countries, 2009 

100%

10%

46%

26%

18%

DE

9%

29%

31%

14%

27%

30%

31%

29%

7%

28%

29%

36%

IT

FR

ES

Low-tech

Medium low-tech

Medium high-tech High-tech

Note: At factor cost 

Source: Eurostat 

Italy’s  specialisation  model  has  exposed  the  economy  to  fierce  competition  from 
emerging  economies.  Italy’s  specialisation  in  low  and  medium-low  technology  products 
implies  an  export  product  mix  that  is  very  similar  to  that  of  China  and  other  emerging 
markets that can benefit from low labour costs. Indeed, the similarity of Italian exports vis-à-
vis China is one of the highest among EU countries and the overlap of Italian and Chinese 
exports increases with decreasing technological intensity, as in high-tech exports China has 
built  a  much  stronger  position  than  Italy  (Graph  34).  Thus,  the  growing  role  of  China  in 
global trade – in particular since its accession to the World Trade Organisation at the end of 
2001  –  has  resulted  in  some  displacement  of  Italian  exports.  By  contrast,  Germany’s 
competitive  advantage  over  Italy  and  other  southern  countries  –  both  in  terms  of  costs  and 
non-cost  factors,  also  thanks  to  its  specialisation  in  medium-high  technology  exports  – 
resulted  in  strong  demand  for  German  goods  (mainly  machinery  and  equipment)  by  China 
and the oil producing countries.19 Germany was also better able to exploit the opportunities 
created  by  the  EU  enlargement  of  2004  through  substantial  FDI  into  the  newly  acceded 
Central and Eastern European countries in view of taking advantage of lower labour costs and 
higher return of capital.  

19 See for instance Chen, R., G. M. Milesi-Ferretti and T. Tressel (2012). 

38 

 
 
 
 
 
                                                            
Graph 34: Share in total exports by technological intensity, Italy and Germany versus 
China, 2010 

%

60
50
40
30
20
10
0

High tech Medium-high

tech

Medium-low
tech

Low tech

China

Italy

Germany

Source: OECD STAN database 

As  a  partial  response  to  the  competitive  pressures  from  low-cost  countries,  there  is 
evidence  of  some  restructuring,  within  sectors  rather  than  across  sectors.  The  main 
strategy  of  Italian  manufacturing  companies  to  face  increasing  competition  from  emerging 
markets since the beginning of 2000s and possibly even more during the current crisis20 has 
been to move up the quality ladder. These structural shifts, however, do not seem sufficient to 
warrant a full recovery of the country’s competitiveness. The impact of the global crisis may 
have  accelerated  the  process  whereby  less  efficient  companies  in  the  traditional  industries 
have  been  forced  to  exit  the  market,  with  a  consequent  shift  of  production  towards  higher 
quality  segments  more  sheltered  from  competition  from  low-cost  economies.  In  fact, 
evidence suggests that low and medium-low technology sectors have been hit the most by the 
crisis (Graph 35). 

Graph 35: Change in Italy's manufacturing real value added by technological intensity 

)

%

(
e
t
a
r

h
t
w
o
r
g

l

a
u
n
n
A

4

3

2

1

0

-1

-2

-3

-4

-5

1993-1998

1999-2007

2008-2011

Low tech

Medium-low tech

Medium-high tech

High tech

Source: ISTAT

20 See for instance Istituto Nazionale di Statistica (2013). 

39 

 
 
 
 
 
 
 
 
 
                                                            
4. 

POLICY CHALLENGES 

The Italian economy continues to be characterised by macroeconomic imbalances. The 
analysis  in  Sections  2  and  3  indicates  that  macroeconomic  developments  in  the  areas  of 
export  performance  and  the  underlying  loss  of  competitiveness,  as  well  as  the  high 
government debt, combined with subdued growth potential, are the main imbalances which 
Italy is facing. In particular, the high level of public debt represents a major vulnerability for 
the  economy  and  raises  concerns  on  cross-border  spillovers  given  the  country’s  systemic 
economic role within the euro area. It should be recalled that these challenges were identified 
under the MIP in the first IDR and relevant policy responses were reflected and integrated in 
the country-specific recommendations (CSRs) issued for Italy in July 2012. The assessment 
of progress in the implementation of those recommendations will take place in the context of 
the  assessment  of  Italy's  National  Reform  Programme  and  Stability  programme  under  the 
European  Semester.  Against  this  background,  this  section  discusses  different  avenues  that 
could be envisaged to address the challenges identified in this IDR. 

The loss of external competitiveness highlights the adjustment challenge which Italy is 
confronted with. The recent improvement in the current account does not alter Italy's need to 
enhance  its  productivity  growth  and  restructure  the  economy.  Microeconomic  evidence 
shows  that  stagnating  total  factor  productivity  growth,  which  underlies  Italy's  dismal 
productivity performance, is strongly related to the failure of many Italian firms to grow and 
become international players. Institutional and regulatory barriers to firm growth, structural 
features  of  Italian  companies,  and  the  high  cost  of  doing  business  are  at  the  root  of  this 
problem.  Removing  these  barriers  and  nurturing  a  better  business  environment  would 
encourage firm creation and growth and foster external competitiveness.  

If  fully  implemented,  the  recently  adopted  measures  to  address  Italy's  long-standing 
structural  weaknesses  should  help  to  raise  productivity  growth  and  thus  contribute  to 
regaining  competitiveness.  Since  late  2011,  Italy  has  been  pursuing  a  strategy  of  fiscal 
consolidation  and  structural  reforms  with  the  respective  aims  of  putting  its  public  debt-to-
GDP ratio on a downward path and lifting its economic growth potential. By addressing the 
existing asymmetries of employment protection legislation, while better regulating flexibility 
at entry and moving towards a more integrated social safety net, the June 2012 labour market 
reform  could  contribute  to  reducing  segmentation  in  the  labour  market  and  improving 
productivity  growth.  The  recent  social  partners'  agreement  could  contribute  to  a  better 
alignment  of  wage  and  productivity  developments  at  sectorial  and  firm  level.  These 
challenges were highlighted in the fourth CSR to Italy as part of the 2012 European Semester. 
Furthermore,  Italy  has  adopted  measures  aimed  at  fostering  competition  in  product  and 
service  markets  and  at  making  the  tax  system  more  growth-friendly,  as  suggested 
respectively  in  its  sixth  and  fifth  CSR  of  2012.  While  there  are  signals  that  some  of  these 
efforts are starting to bear fruit in some domains of the economy, the impact of many policy 
measures  –  especially  the  structural  ones  –  is  bound  to  emerge  only  gradually  over  the 
medium term, if fully implemented. 

40 

 
 
 
Productivity  growth  could  also  be  fostered  by  creating  an  environment  that  provides 
companies  with  incentives  to  acquire  the  appropriate  set  of  structural  firm-level 
features, in particular in the fields of innovation, finance, human resources and management 
practices.  The  introduction  of  a  tax  allowance  for  corporate  equity  (ACE)  in  2012,  which 
encourages the use of funding sources other than debt, constitutes a good example. Attracting 
FDI – best achieved through significant improvements in the Italian business environment – 
could  be  an  important  channel  for  addressing  structural  and  cultural  impediments  to  firm 
expansion, productivity growth and ultimately external competitiveness. 

Measures to alleviate the pressure stemming from the cost side could contribute to the 
improvement of the external competitiveness of the Italian economy. Wages in Italy are 
still not sufficiently responsive to productivity developments. In this area, further progress in 
promoting the shift of wage bargaining towards the company level would play an important 
role. In addition, the labour tax wedge in Italy is among the highest in the EU: a further shift 
of  taxation  away  from  labour  could  help  to  reduce  the  labour  tax  wedge  and  the  cost  of 
labour. Labour cost moderation could therefore help in the short to medium term, while being 
mindful of the risk of negative feedback loops related to deflationary pressures.  

Given the decreased national saving rate and the reduced availability of foreign private 
financing, growth prospects will necessarily depend more on the quality rather than the 
quantity of investment. Encouraging investment financed by equity rather than debt, as well 
as improving allocation efficiency in the Italian economy could be key steps forward in this 
respect. The ongoing spending review in the public sector could contribute to strengthening 
the  efficiency  and  effectiveness  of  government  spending.  Finally,  encouraging  inward  FDI 
would be another channel to increase the quality and stability of investment in the domestic 
market. 

The  potential  role  of  the  Italian  financial  sector  in  supporting  the  country's  economic 
adjustment  remains  limited  for  the  time  being.  The  crisis  has  put  Italian  banks  under 
severe  stress,  as  reflected  in  their  dependence  on  Eurosystem  funding,  the  further 
deterioration  of  asset  quality  and  the  low  level  of  profitability.  Lending  conditions  remain 
tight  and  interest  rates  on  new  loans  –  in  particular  to  small  firms  –  continue  to  be  high 
despite accommodative monetary policy. The ability of Italian banks to reassume their role in 
financing the Italian real economy and supporting its adjustment will crucially depend on the 
underlying  macroeconomic  conditions.  Key  elements  in  banks'  strategies  going  forward 
should  include  improving  profitability  in  view  of  strengthening  and  maintaining  the  capital 
base,  while  adequately  provisioning  for  deteriorating  asset  quality,  reducing  reliance  on 
temporary Eurosystem funding, and ensuring the allocation of savings to the most productive 
investment opportunities. 

A  high  primary  budget  surplus  is  essential  for  public  debt  sustainability,  as 
recommended by the Council in July 2012. The Fiscal Sustainability Report of December 
2012  concludes  that  "Italy  does  not  appear  to  face  a  risk  of  fiscal  stress  in  the  short  term. 
Sustainability risks appear to be medium in the medium run, while becoming low in a long-
term  perspective,  conditional  upon  the  full  implementation  of  the  planned  ambitious  fiscal 

41 

 
 
consolidation and on maintaining the primary balance well beyond 2014 at the level expected 
to  be  reached  in  that  year.  […]  Indeed,  risks  would  be  much  higher  in  the  event  of  the 
structural primary balance reverting to lower values observed in the past, such as the average 
for  the  period  1998-2012.  The  focus  should,  therefore,  be  on  resolutely  continuing  to 
implement sustainability-enhancing measures and reduce government debt." 

The  favourable  momentum  for  reforms  in  Italy  must  be  maintained.  Together  with 
determined action at euro-area level to put in place effective crisis resolution mechanisms, the 
reform efforts undertaken so far by the Italian authorities have helped to regain some market 
confidence.  To  consolidate  these  benefits  and  strengthen  Italy's  resilience  against  possible 
renewed  financial  tensions,  Italy  should  maintain  high  primary  budget  surpluses  to  ensure 
that  the  public  debt  is  put  firmly  on  a  declining  path.  To  support  fiscal  consolidation  and 
unleash the country's growth potential, the gains from structural reforms must be secured and 
the reform momentum sustained. 

42 

 
 
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44