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# 52015SC0031

**COMMISSION STAFF WORKING DOCUMENT Country Report Italy 2015 including an In-Depth Review on the prevention and correction of macroeconomic imbalances {COM(2015) 85 final} This document is a European Commission staff working document. It does not constitute the official position of the Commission, nor does it prejudge any such position. /\* SWD/2015/0031 final \*/**

  

Executive summary  1

1.       Scene
setter: Economic situation and outlook  3

2.       Imbalances,
Risks, and Adjustment 11

2.1.   High public
indebtedness 13

2.2.   Loss of
external competitiveness 23

2.3.   Special
topic: Italy's banking sector in a protracted low-growth environment 37

2.4.   Euro-area
spillovers 47

3.       Other
structural issues 50

3.1.   Public
administration and business environment 51

3.2.   Competition,
infrastructures and innovation  57

3.3.   Labour
market, education and social policies 63

3.4.   Taxation  71

3.5.   Special
topic: Regional disparities 75

AA.   Overview
Table  79

AB.   Standard
Tables 86

LIST OF Tables

1.1.     MIP
scoreboard indicators 9

1.2.     Key
economic, financial and social indicators - Italy  10

3.2.1.  Type of award   58

AB.1.  Macroeconomic
indicators 86

AB.2.  Financial
market indicators 87

AB.3.  Taxation
indicators 88

AB.4.  Labour market
and social indicators 89

AB.5.  Expenditure on
social protection benefits (% of GDP) 90

AB.6.  Product market
performance and policy indicators 91

AB.7.  Green Growth  92

LIST OF Graphs

1.1.     Growth
accounting, 2001-13  3

1.2.     GDP and its
components 3

1.3.     Evolution
and breakdown of Italy’s net international investment position  4

1.4.     Real gross
fixed capital formation, index (2000=100) 5

1.5.     Real net
capital stock, million Euros 5

1.6.     HICP
inflation and components 6

1.7.     Italy’s
inflation-linked swap rates 6

1.8.     Headcount
employment and unemployment rate  7

1.9.     Wage
supplementation schemes, million of hours authorised   7

1.10.   Unemployment
by duration, (thousands) 8

2.1.1.  Italy — medium
and long-term sovereign debt average yield at issuance ( %) 13

2.1.2.  Italy — Gross
debt-to-GDP  15

2.2.1.  Breakdown of
the year-on-year change in goods components of Italy’s trade balance  23

2.2.2.  Italy’s export
performance since mid-2010, intra and extra euro area breakdown  24

2.2.3.  Share of
tradable sectors in gross value added   25

2.2.4.  Average annual
growth rate of gross value added over selected periods 25

2.2.5.  Shares of
gross value added in manufacturing by technology intensity  25

2.2.6.  Export
propensity by technology intensity  26

2.2.7.  Export
propensity by manufacturing sector, 2012  26

2.2.8.  Labour
productivity by firm size (100 = average over total firm population) 27

2.2.9.  Export
propensity by firm size  27

2.2.10. Goods exports
of manufacturing sectors, by shares and dynamics 27

2.2.11. Shares of
goods exports by manufacturing sector, 1995 and 2013  28

2.2.12. Shares of
manufacturing exports of goods, by technology intensity  28

2.2.13. Change in
sectoral export market shares 2010-13, percentage points USD   28

2.2.14. Cost and price
developments  (2010-2014 average) 29

2.2.15. Unit labour
cost index for selected countries, tradable vs. non-tradable sectors (1998=100,
based on hours worked) 29

2.2.16. Unit labour
cost index (based on full-time equivalents) by technology intensity, 1998=100  30

2.2.17. Indicators of
competitiveness: producer prices of manufactures (December 2010 =100) 30

2.2.18. Export quality  31

2.2.19. The role of
services in Italian non-cost competitiveness 31

2.2.20. Compensation
per employee by sector 32

2.2.21. Actual and
negotiated wages 32

2.2.22. Phillips curve
for Italy: annual growth of compensation per employee  33

2.2.23. Phillips curve
for Italy and euro area based on negotiated wages, 2008-2014  33

2.2.24. Age-earning
profile, 2012  34

2.2.25. Incidence of
over- and under-qualification ( % of workers), 2012  34

2.2.26. Growth of new
contracts signed and contributions by contractual forms, y-o-y % change  35

2.3.1.  Share of
domestic bank loans in total financial debt of the non-financial corporate
sector at end-2013  37

2.3.2.  Financial
leverage of the non-financial corporate sector 38

2.3.3.  Number of
bankruptcy and non-bankruptcy insolvency procedures and voluntary liquidations
in Italy  38

2.3.4.  Change in
turnover and gross operating margin between 2007 and 2013 by firm size  39

2.3.5.  Corporate
non-performing loan ratio of Italian banks 39

2.3.6.  Ratio of loan
impairments to total operating income and return on equity of Italian banks 40

2.3.7.  Credit supply
and demand conditions for Italian non-financial corporates 40

2.3.8.  Bank interest
rates on new loans to Italian firms 41

2.3.9.  Deleveraging
and credit rationing of Italian firms per leverage quartile  41

2.3.10. Sales of impaired
assets by Italian banks 44

2.3.11. Italian banks’
domestic sovereign exposure and Italian 10-year sovereign yield   46

2.4.1.  Italy —
Imports by county of origin (top 15 EU countries) 47

2.4.2.  Italy —
Exports by destination (top 15 countries) 47

2.4.3.  Italy —
Partner’s exposure to liabilities (top EU 15, excl. LU) 48

2.4.4.  Italy — EU
bank claims, by sector 48

3.1.1.  Ratio of
time-barred criminal cases to total resolved criminal cases per instance  54

3.3.1.  Discouraged
workers by age groups 63

3.3.2.  General government
expenditure on tertiary education (index 2007=100) 67

3.4.1.  Tax wedge and
recent changes for 100% average production wage (APW) earner 71

3.4.2.  VAT gaps in
the EU (2014) 73

3.5.1.  Regional
employment (1977=100) 75

3.5.2.  Regional
unemployment rate  75

3.5.3.  Regional
employment rate and labour costs 76

3.5.4.  Labour
productivity, labour costs and unit labour costs in Mezzogiorno relative to the
North-centre, manufacturing sector 77

3.5.5.  European
Quality of Government Index 2013 (EQI) and the regional country variation  78

LIST OF Boxes

1.1.     Economic
surveillance process 9

2.1.1.  Impact of
fiscal consolidation and structural reforms on public debt 17

LIST OF Maps

No table of contents
entries found.

After a long contraction, growth is
expected to turn positive in 2015 but remains well below the EU average and the
public debt-to-GDP ratio is set to increase further. Inflation is projected to turn negative due to the fall in oil
prices. Unemployment remains historically high and domestic demand is weak.
Increasing global demand, a lower euro and falling oil prices could support
economic growth in the future. Current account surplus is expected to
strengthen slightly. The government deficit is set to reach 3 % of GDP in 2014
and to decrease in 2015 and 2016. Italy's public debt-to-GDP ratio is expected
to peak in 2015 at 133 % of GDP based on the Commission 2015 winter forecast.
The current low growth and inflation outlook pose a challenge to its
reduction.

In March 2014, the Commission concluded
that Italy was experiencing excessive macroeconomic imbalances requiring
specific monitoring and strong policy action. This Country Report assesses
Italy’s economy against the background of the Commission's Annual Growth Survey
which recommends three main pillars for the EU's economic and social policy in
2015: investment, structural reforms, and fiscal responsibility. In line with
the Investment Plan for Europe, it also explores ways to maximise the impact of
public resources and unlock private investment. Finally, it assesses Italy in
the light of the findings of the Alert Mechanism Report published on 28
November 2014, in which the Commission found it useful to examine further the
persistence of imbalances or their unwinding. The main findings of the in-depth
review contained in this Country Report are:

· Persistently low productivity growth continues to perpetuate Italy's
macroeconomic imbalances, namely the very high level of public debt and the
weak external competitiveness. Italy’s real GDP has
fallen to the early 2000s levels, while the euro area GDP is more than 10 %
higher. The poor performance of total factor productivity accounts for most of
the difference and is at the root of Italy’s declining competitiveness, while
the low growth weighs on the sustainability of the high public debt. Structural
reforms — implemented and foreseen — should reduce public debt-to-GDP ratio and
improve competitiveness through their positive impact on productivity and GDP. Strong
commitment to these reforms is crucial, also in the light of Italy’s past
record marked by important implementation gaps.

· The very high government debt remains a heavy burden for the Italian
economy and a major source of vulnerability, especially in a context of
protracted weak growth. The fiscal adjustment and
easing in market conditions have helped avert immediate sustainability risks.
Past pension reforms should have a beneficial effect in the
medium-to-long-term. However, public debt impact assessments show that strong
growth-friendly consolidation, sustained nominal growth and ambitious
structural reforms are key to a substantial debt reduction.

· Italy's competitiveness has not improved significantly yet: sluggish
productivity growth continues to push up unit labour costs, while non-cost
factors remain unfavourable. Italy’s export
competitiveness remains weak. Unit labour costs have been rising relative to
trade partners, driven by the slow productivity growth. Italy’s product
specialisation and high share of small firms with a weak competitive position
in international markets further hamper its competitiveness.

· The protracted crisis has exposed the risks inherent in the Italian
banking sector’s close relationship with the domestic corporate sector and the
sovereign. Corporate non-performing loan ratio has
increased to just over 27 %. Bank credit to corporates continues to contract,
driven by weak demand and tight supply to SMEs with a high credit risk. Italy
has also taken several measures to reform the banking sector and diversify
firms’ funding sources. The banking sector’s exposure to domestic government
bonds is expected to remain high, and so its vulnerability to unfavourable
market developments in the Italian sovereign debt market.

· Investment was particularly hard hit during the crisis aggravating
the long-run deterioration in its quality. Since
the crisis, productive investment in Italy has declined significantly and it is
now 1.5% below the EU average as a share of GDP. The decline in the amount of
investment is compounded by a long-term deterioration in its quality.

· The Italian economy’s size makes it a potentially important source
of spillovers to other Member States while its recovery depends on propitious
external conditions. The trade, financial and bank
funding links harbour the potential to cause spillovers in other EU countries.
At the same time, external demand and the inflation environment are paramount
to Italy’s export-led recovery, the debt-to-GDP reduction effort and to
recovering competitiveness.

The Country Report also analyses other
macroeconomic and structural issues and the main findings are:

· Weaknesses in public administration and justice system hamper the
quality of the business environment and reduce the capacity to implement
reforms effectively. Despite marginal improvements,
inefficiencies in the public administration and justice remain. According to several
national and international sources, corruption is high, which damages the
economy.

· Lack of competition in product markets, infrastructure gaps and low
spending on research on development, particularly in the business sector, are
hampering productivity growth. Restrictions on
competition and infrastructure bottlenecks in important sectors of the economy
remain present, while a very high number of inefficient companies owned by
local authorities weigh on the country’s public finances and economic performance.
Investment in research and innovation is low.

· Labour market participation remains low and active labour market
policies are weak. The participation of women,
although growing, remains among the lowest in the EU. Youth unemployment has
increased dramatically with the crisis. Employment services, fragmented across
the country, are inadequate to match the supply of labour to demand.

· The Italian education system continues to suffer from long-standing
problems. The early school-leaving rate is well above
the EU average and school education in Italy produces mixed results in terms of
skills attainment.

· The taxation system hinders economic efficiency. The tax burden on labour has been reduced considerably in the past
year but remains high. Tax compliance is low and time-consuming for Italian
taxpayers, posing risks to fair competition in the market and a fair burden
sharing.

· Social and regional disparities are growing wider. Poverty and social exclusion have greatly increased while the
social protection system is fragmented and fails to address these challenges
properly. The southern regions have suffered a sharper fall in employment due
to their long-standing structural weaknesses.

Overall, Italy has made some progress in
addressing the 2014 recommendations. A significant
shift of the tax burden away from labour has been undertaken. The ongoing
reform of the labour market has potential to address long-standing rigidities
and improve the allocation of labour resources. Some progress has been made to
improve the education system as well as the governance and resilience of the
banking sector. Initial steps have been taken to streamline institutions and
administration. A draft law for competition has been adopted by the government
in February 2015. However, progress has been much more limited, and sometimes
delayed, in several important areas. The spending review is not yet part of
regular budgeting procedures, and the privatisation programme also incurred
delays in 2014. Only limited progress made in addressing corruption and
infrastructure bottlenecks.

The Country Report shows the policy
challenges stemming from the analysis of macroeconomic imbalances. Italy's main
challenges regard growth-friendly fiscal consolidation and the implementation
of structural reforms to improve productivity growth. Other challenges concern
infrastructure bottlenecks, the efficiency of the tax system and the efficiency
of the public administration, including justice.

Macroeconomic developments

Italy’s real GDP is back to levels seen
at the start of this century, given also the sluggish productivity performance. This stands in sharp contrast with the euro area GDP, which is more
than 10 % higher than its early 2000 levels. Breaking down Italy’s GDP growth
between 2001 and 2013, the poor performance of total factor productivity
accounts for most of the difference (Graph 1.1), whereas the contributions of the other
components have been broadly in line with those in the euro area. As the crisis
hit, not only did Italy’s GDP contract significantly more than the euro area
average, but Italy’s potential output also declined. An ageing population and
weak labour market participation have also contributed negatively to potential
growth. In addition, the government’s fiscal consolidation effort combined with
private sector deleveraging has had a detrimental impact on capital
accumulation.

Graph 1.1:     Growth accounting, 2001-13

Source: European Commission

The Italian economy is still struggling
to come out of recession. In the first three
quarters of 2014, the Italian economy underperformed the euro area and it
contracted further by 0.4 % year-on-year. While private consumption has been
stabilising since mid-2013, the saving rate has increased as waning inflation
and new income support measures sustain real disposable income. Investment –
both in equipment and construction –contracted substantially over the course of
the first nine months of 2014, reflecting uncertain demand prospects as well as
tight financing conditions. Exports have continued to sustain GDP growth,
albeit only moderately (Graph 1.2).

Graph 1.2:     GDP and its components

w

Source: ISTAT

Financing conditions remain tight,
although they gradually loosened over the course of 2014. Following completion of the Single Supervisory Mechanism’s
comprehensive assessment of euro area banks, overall credit supply tightness
has decreased. Bank lending to Italy’s corporate sector, and small firms in
particular, continued to contract by 2.6 % year-on-year in November 2014, but
the contraction has slowed in recent months. However, small firms continue to
face funding constraints due to high risk premiums. Credit demand remains weak
due to subdued investment prospects related to economic uncertainty and spare
capacity, firms’ need to deleverage, and increased bond issuance by
medium-sized and large firms (see Section 2.3). The cost of credit has been
declining further for both households and firms, driven by lower policy rates.
However, the very low inflation rate implies high real interest rates and
Italy’s financing cost (both for the sovereign and the real economy) remains
above the euro area average.

Looking ahead, external demand is
expected to trigger a slow and gradual recovery.
The indicators currently available point to a further slight fall in output in
the last quarter of 2014 driven by the manufacturing sector, while the service
sector is expected to have stabilised. Overall, the Commission 2015 winter
forecast projects a contraction of GDP by 0.5 % in 2014 and a gradual recovery
in 2015 and 2016. Real GDP is forecast to expand by 0.6 % in 2015, supported by
exports and only moderate improvements in domestic demand. The recovery is
projected to strengthen in 2016 as financing conditions normalise and external
demand reinforces triggering an increase in investments.

Italy’s current account surplus has
further increased, mirroring public and private sector deleveraging. On the external side, the 12-month cumulative balance recorded a
surplus of EUR 27.7 billion (1.7 % of GDP) in November 2014, almost double the
EUR 15.2 billion surplus recorded one year before. The ongoing correction in
Italy’s current account is driven by the further improvement of the trade
balance (see Section 2.2), which in turn is caused by an expanding non-energy
goods surplus ([1]) in
combination with a shrinking energy goods deficit due also to falling oil
prices. From a savings-investment point of view, the trend in Italy’s current
account is primarily due to a contraction in investment on account of
deleveraging by the public and private sectors (the corporate sector turned
into a net lender in 2012), while households are restoring  their savings.

Graph 1.3:     Evolution and breakdown of Italy’s net international investment position

Source: European Commission

Italy has turned into a net lender to
the rest of the world, but its net international investment position has
slightly deteriorated. The recovery in foreign net
portfolio investment in Italy seen since mid-2012 continued and was mirrored by
a downward trend in foreign net other investment related to the gradual decline
in reliance on Eurosystem liquidity. In the second half of 2014 however, this
trend was interrupted by the reduced government bond issuance due to the
Treasury’s strong liquidity position, and by Italian banks’ participation in
the Eurosystem’s targeted long-term refinancing operations. Although overall
Italy has become a net lender to the rest of the world, its net international liabilities
increased somewhat in 2014 as a result of net negative valuation adjustments
related to the substantial decline in risk premiums on its own debt
instruments. At around 30 % of GDP in 2014, Italy’s negative net international
investment position does not pose sustainability concerns, but the bias in its
composition towards interest-bearing debt – reflected in the higher net
external debt level – remains a vulnerability (Graph 1.3).

Graph 1.4:     Real gross fixed capital formation, index (2000=100)

Source: European Commission

Since the crisis, productive investment
in Italy has declined significantly and by more than the euro area average. As a share of GDP, investment fell from 21.6 % in 2007 to 17.8 % in
2013, 1.5 percentage points below the EU average (19.3 %). As shown in Graph 1.4, following a period of subdued growth,
the non-residential component of investment was the hardest hit, reaching a
level in 2013 that was 15 % below that in 2000 in real terms. Investment also
continued to fall in the first nine months of 2014 (by 2.2 % in real terms
year-on-year), particularly in construction (-3.4 %), but also in machinery and
equipment (-1.7 %).

The fall was common to both the public
and the private sectors. In nominal terms,
investment by the government sector fell by 18 % over the 2008-13 period, with
its share of GDP declining from 2.9 % in 2007 to 2.4 % in 2013. Investment by
the corporate sector fell by nearly as much and accounted for 9.5 % of GDP in
2013, down from 11.3 % in 2007. Investment by the household sector and
non-profit sector serving households was also affected, although to a lesser
extent, with a share of GDP of 6  % in 2013 (-1.3 percentage point from 2007).

Graph 1.5:     Real net capital stock, million Euros

Source: European Commission

The persistent fall in investment is
hindering Italy's future prospects. The significant
and protracted fall of gross capital formation led to the stabilisation of
Italy’s capital stock, net of depreciation (Graph 1.5). Specifically, the fall in new
investment was particularly marked in the manufacturing sector, leading to a
significant depletion of net capital stock in this sector of the economy. The
insufficient capital accumulation ultimately hampers Italy's potential output.

The decline in the amount of investment
is compounded by a long-term deterioration in its quality. The marginal efficiency of capital – a proxy for the impact of
investment on growth – has been dropping since the early 1990s  and has been
consistently below the euro area average. While capital deepening continued to
have a positive impact on labour productivity, the observed accumulation
pattern did not lead to rapid technological change and total factor
productivity growth (Graph 1.1). This may reflect a limited ability of
the economy to reallocate resources to more productive firms and sectors.

Graph 1.6:     HICP inflation and components

Source: European Commission, ISTAT

HICP inflation has been falling since
mid-2012, driven by sluggish domestic demand and falling oil prices. HICP inflation averaged 0.2 % in 2014, less than in the euro area.
The price adjustment has been substantial, particularly considering that
inflation in Italy had been above the euro area average since the creation of
the Economic and Monetary Union. In fact, since the end of 2012, inflation has
been steadily declining driven down by the appreciation of the euro and lower
import prices, in particular for energy products (Graph 1.6). The sluggish domestic demand
contributed to the decline in core inflation. In the final months of 2014, the
significant slump in oil prices pushed down HICP inflation to extremely low
levels which turned negative in December 2014 and January 2015.

Inflation is expected to be slightly
negative in 2015. According to the Commission 2015
winter forecast, the fall in oil prices is expected to feed quickly into the
energy component of HICP inflation. This is projected to be negative on average
over the year and to increase very gradually afterwards as economic prospects
improve and oil price rise marginally. The increase in Italy’s VAT rate by 2
percentage points as of January 2016, enshrined in the 2015 Stability Law, is
set to increase HICP inflation in 2016 to 1.5 %.

Graph 1.7:     Italy’s inflation-linked swap rates

Source: European Commission

The expansionary monetary stance reduces
the risk of a deflationary spiral. Inflation
expectations, measured in terms of inflation-linked swap rates, have been
declining (Graph 1.7). The current context of i) the
zero-lower bound on official interest rates in the euro area, ii) very low
inflation and iii) high unemployment have heightened the risks of medium-term
inflation expectations deviating substantially from the ECB target and of
second round effects of the lower oil price on other prices and wages. However,
the measures recently announced by the ECB are set to reduce substantially
these risks and ultimately avoid a deflationary spiral.

Employment has broadly stabilised. Following significant labour shedding in 2012 and 2013, headcount
employment has broadly stabilised over the course of 2014 (Graph 1.8). Another signal that most of the labour
adjustment has already occurred comes from the slight reduction in the number
of wage supplementation hours (Cassa Integrazione Guadagni) ([2]), as Graph 1.9 shows. Moreover, in the third quarter of
2014, the total number of hours worked returned to growth compared with the
previous quarter driven by the manufacturing and private services sectors.

Graph 1.8:     Headcount employment and unemployment rate

Source: European Commission, ISTAT

Graph 1.9:     Wage supplementation schemes, million of hours authorised

(1) Ordinary wage supplementation scheme (CIGO) is a short-term working scheme granted to firms to avoid labour shedding during period of temporary shortfalls of sales. The special wage supplementation scheme (CIGS) is granted to restructuring firms or those initiating a bankruptcy procedure. The under-waiver component of CIG is for employees excluded from CIGO or CIGS. Source: INPS

The unemployment rate has reached
historically high levels as more people joined the labour force. The unemployment rate increased to the historically high level of
12.8 % in 2014 from 12.2 % in 2013, driven almost entirely by the growth in the
participation rate (See also Section 3.3 and Section 3.5). Women contributed
most to the increase in the labour force, possibly because household economic
needs became more pressing. The Commission 2015 winter forecast projects the
unemployment rate to remain above 12 % over 2015-16 due to the ample room for a
recovery of hours worked and more people joining the labour force as economic
prospects improve. As shown in Graph 1.9, the rise of the extraordinary wage
supplementation scheme (CIGS) points to the risk of unemployment rising
further, inasmuch as the 2012 and 2014 labour market reforms aim at limiting
the use of this wage supplementation scheme to allow for labour reallocation
(see Section 2.2). This would result in workers previously eligible for the
scheme to become unemployed. Still, the recent measures taken to support job
creation ([3]) may foster
new hirings and therefore provide an upside risk to the forecast central
scenario.

Long-term unemployment has been rising
with potentially damaging effects on job finding rates and labour market
matching. Persistently low job finding rates due to
a weak demand for labour have resulted in rising long-term unemployment, which
reached 63.1 % of unemployment in Q3-2014 (7.4 % of active population). In that
quarter, almost 2 million people had been jobless for more than a year – most
of them for between 18 and 47 (Graph 1.10). Despite the increase in unemployment
duration does not yet point clearly to a deterioration of matching efficiency ([4]), prolonged cyclical weakness and lingering unemployment may turn a
temporary increase in unemployment into a structural problem, especially if the
long-term unemployed get discouraged and reduce job search intensity. The
proportion of the young population that has experienced spells of unemployment
longer than 12 month increased from about 38 % in 2008 to 60.6 % in Q3-2014.
(See also Section 3.3).

Graph 1.10:    Unemployment by duration, (thousands)

Source: Eurostat

Poverty and social exclusion continued
to grow. Between 2008 and 2013 there has been an
increase by 2 227 000 of people at risk of poverty and social exclusion (+14.7
percentage points). Children have been those characterised by the highest risk.
Hence, Italy faces serious social challenges in this respect (see Section 3.3).

Public finance developments

The government deficit is expected to be
3 % of GDP in 2014 and 2.6 % in 2015, with overall no further improvement in
the structural balance over these two years. The
deficit is anticipated to have remained within the 3 % of GDP Treaty threshold
in 2014, implying a marginal deterioration from the 2.8 % recorded in 2013.
Overall primary expenditure is expected to have increased by around 1 % in
nominal terms year-on-year despite the significant increase of around 3 % in
social spending due to the tax credit of 80 EUR per month since May 2014 to
employees with low or medium income. Despite the flat nominal GDP, revenues
increased slightly mainly thanks to higher VAT and property taxation intakes.
Lower yields reduced the debt service bill by more than 0.1 percentage point of
GDP. The 2015 Stability Law projects a reduction of the headline deficit to 2.6
% of GDP. The Commission Winter 2015 forecast is in line with this projection.
Thanks to the planned savings (especially at local level) and the extension of
the public sector wage freeze in force since 2010, nominal primary expenditure
is forecast to record only a mild increase. Revenues are forecast to grow at
broadly the same pace as nominal GDP, as the enacted cut in the labour tax
wedge is largely compensated by measures to improve VAT collection (reverse
charge and split payment for the public sector) and by the expected pick up in
the corporate income tax after the fall recorded in 2014. The Commission
forecast also factors in a further reduction in interest expenditure (-0.4
percentage point of GDP) thanks to the significant drop in yields over recent
months. The structural balance is forecast to remain broadly stable over
2014-2015, with a small deterioration in 2014 followed by a similar improvement
in 2015. Negative economic conditions, with an estimated negative potential
growth and very low inflation, make more difficult the needed adjustment
towards a balanced budgetary position in structural terms (i.e. Italy’s Medium
Term Objective).

The government debt-to-GDP ratio is
still increasing. Negative economic conditions re
also weighing on debt developments through their impact on the primary surplus
and an unfavourable denominator effect, which are only partially compensated by
lower interest expenditure (see Section 2.1). In 2014, the debt-to-GDP ratio is
expected to have risen to around 132 % (from 127.9 % in 2013). This was also
due to the ongoing settlement of trade debt arrears, further support to euro
area programme countries, and a new increase in the Treasury’s liquidity
buffer. The debt-to-GDP ratio is projected to increase again in 2015, to around
133 % of GDP, despite some privatisation proceeds incorporated in the forecast
(0.5 % of GDP) and the expected reduction in the Treasury’s liquidity buffer.
In 2016, the higher nominal GDP growth and primary surplus (forecast on a
no-policy change basis) is expected to allow for a small reduction in the debt
ratio.

Table 1.1:       MIP scoreboard indicators

Flags: b: break in time series. p: provisional. Note: Figures highlighted are the ones falling outside the threshold established by EC Alert Mechanism Report. For REER and ULC,  the first threshold concerns Euro Area Member States. (1) Figures in italic are according to the old standards (ESA95/BPM5). (2) Export market shares data: the total world export is based on the 5th edition of the Balance of Payments Manual (BPM5). Source: European Commission

Box 1.1: Economic surveillance process The Commission’s Annual Growth Survey, adopted in November 2014, started the 2015 European Semester, proposing that the EU pursue an integrated approach to economic policy built around three main pillars: boosting investment, accelerating structural reforms and pursuing responsible growth-friendly fiscal consolidation. The Annual Growth Survey also presented the process of streamlining the European Semester to increase the effectiveness of economic policy coordination at the EU level through greater accountability and by encouraging greater ownership by all actors. In line with streamlining efforts this Country Report includes an In-Depth Review — as per Article 5 of Regulation no. 1176/2011 — to determine whether macroeconomic imbalances still exist, as announced in the Commission’s Alert Mechanism Report published on November 2014. Based on the 2014 In-Depth Review for Italy published in March 2014, the Commission concluded that Italy was experiencing macroeconomic imbalances, requiring specific monitoring and strong policy action, in particular, the very high level of public debt and the weak external competitiveness, both ultimately rooted in the protracted sluggish productivity growth. This Country Report includes an assessment of progress towards the implementation of the 2014 Country-Specific Recommendations adopted by the Council in July 2014. The Country-Specific Recommendations for Italy concerned public finances, taxation, public administration, access to finance, labour market, education, market opening and business environment, and infrastructure.

Table 1.2:       Key economic, financial and social indicators - Italy

1 Domestic banking groups and stand-alone banks. 2 Domestic banking groups and stand-alone banks, foreign-controlled (EU and non-EU) subsidiaries and branches. 3 Real effective exchange rate \* Indicates BPM5 and/or ESA95 Source: European Commission, 2015 winter forecast; ECB

Overview and trends

High public debt is a major source of
vulnerability for the Italian economy and, given its large size, it is
considered of primary importance for world markets.
Italy’s public debt holds back growth through the high present and expected
level of taxation needed to service it, the high interest bill limiting the
room for productive public expenditure and the constrained ability to respond
to economic shocks. Conversely, slow growth keeps the indebtedness level high.
Furthermore, the large stock of public debt implies substantial refinancing
risk and makes the country vulnerable to sudden rises in sovereign yields and
financial market volatility in periods of increased risk aversion. Risks to the
financial and economic stability of the euro area and beyond (spillovers) are
considerable due to the variety of institutions and investors holding Italian
sovereign securities across the world ([5]) (see Section 2.4 on spillovers).

Since Italy joined the euro, growth
dividends have not been sufficiently earmarked to public debt reduction. Indebtedness decreased only by 11 percentage points from 111 % GDP
in 1998 to 100 % in 2007 and then ballooned to 132 % in 2014 despite strong
fiscal consolidation undertaken in response to sovereign debt market turmoil.
In addition, pension reform, once fully implemented will have a beneficial
effect on the medium-to-long term sustainability of public finances. Italy’s
general government debt-to-GDP ratio is now expected to peak at around
133 % in 2015, and decline slightly in 2016 thanks to the higher primary
surplus and nominal GDP growth.

More recently, negative growth and low
inflation are key factors explaining the increase in the debt-to-GDP ratio,
while the fiscal stance and the composition of the consolidation have kept the
evolution of the nominal debt in check. The nominal
debt level at the end of 2014 was lower than planned, thanks also to low
interest expenditure and the fact that part of the resources earmarked for the
settlement of trade debt arrears was not necessary. Indeed, financing costs hit
an all-time low (see Graph 2.1.1).

Graph 2.1.1:   Italy —  medium and long-term sovereign debt average yield at issuance ( %)

Source: European Commission

Despite the large decline in Italy’s
sovereign risk premium in recent months, low inflation raises the real implicit
interest rate on outstanding government debt, thereby worsening debt dynamics. In addition, low inflation expectations would weigh on the real
cost of financing for the economy, worsening growth prospects in turn. To
illustrate the importance of the risk of deviation of medium-term inflation
expectations from the 2 per cent target for price stability, it is worth noting
that a 1 percentage point decrease in inflation per year over the 2014-17
baseline would mechanically increase debt-to-GDP ratio by about 5 percentage
points at the end of the forecast period, other things being equal. ([6]) At the same time, price-competitiveness adjustment requires Italy
to run inflation at below the euro area average. Counteracting the impact of
possibly lower inflation on debt ratios would require even lower interest rates
and further improving the primary balance in a growth-friendly manner (e.g. by
focusing cuts on government consumption, limiting tax hikes and preserving
productive investment, as well as spending on education and research and
development). Indeed, despite decreasing nominal interest rates, the implicit
cost of servicing debt increases in the short term because this lower cost of
financing is reflected in the outstanding debt stock only gradually (given the
maturity of the Italian debt and the roll-over period). This entails that the
debt-increasing impact of the implicit real cost of debt (i.e. net of the
impact of inflation) rises from around 3 % of GDP over 2011-2013 to around 4 %
foreseen over 2014-2015. This more than offsets the debt-reducing effect of the
positive primary surplus (1.8 % of GDP over 2011-13). The debt-to-GDP ratio has
also increased because of low or negative GDP growth (1.5 % of GDP over
2011-13). This trend should be reversed as growth becomes positive again, while
the primary surplus also contributes to debt reduction. A fiscal framework
supported by the on-going spending review, expenditure rationalisation
programmes and the action of the newly-created Parliamentary Budget Office,
should be conducive to an appropriate multiannual fiscal stance, and thus help
put public debt on a downward path (see Section 3.1 for further details).
Regarding the impact of monetary policy, the European Central Bank purchase
programme of sovereign debt announced on 22 January 2015 will cover a wide
range of medium to long-term maturities, thus supporting the lengthening of
debt maturity, while reducing the risk deviation of medium-term inflation
expectations from the 2 per cent target for price stability.

Against this challenging background,
Italy’s public debt management office continues to deliver in terms of risk
management and anchoring of market expectations.
The average maturity of public market debt currently stands at 6.4 years
(against 7 years back in 2011) and given the currently large liquidity buffer
and relatively smooth redemption profile, the refinancing risk remains rather
low. Auctions are usually met with high demand, as the successful issuance in
mid-January 2015 of EUR 6.5 billion 30-year bonds at an average yield of 3.29 %
shows. The investor base is very stable, with about 60 % of government
securities held domestically, a third of which by Italian banks (see Special
Topic: Financial Sector). Demand is solid in a number of market segments and
international investors are increasing their exposure. Market conditions
allowing, some issuances are also planned in 2015 on the dollar market.

The privatisation programme of some
state-owned enterprises and the sale of public real estate should contribute to
the debt-reduction effort. While there have been
some delays in implementation, the privatisation programme should accelerate in
2015 and targets generating proceeds amounting to 0.7 % of GDP per year over
the period 2015-17. More precisely, this year should see the privatisations of
Poste Italiane (up to 40 %) and ENAV (up to 49 %), through initial public
offerings as well as the sale of Grandi Stazioni. Administrative procedures for
dismissals, privatisations and valorisation of public real estate have been accelerated.
Invimit and Cassa Depositi e Prestiti, both state-owned, are involved in the
valorisation and sale of unused public real-estate assets. Sale of local
real-estate assets generated proceeds of some EUR 600 million in 2014. Until
2017, one should expect yearly proceeds of around EUR 1 billion from the sale
of real estate assets of local governments and of the Ministry of Defence.
These funds can then be directed to the Sinking Fund for the Redemption of Debt
Securities to buy back public debt, though with no significant impact expected,
given current figures.

Assessing Italy’s
debt sustainability

Bearing in mind that there is no fixed
threshold for debt sustainability, a number of criteria should be considered
for its analysis. Italy’s scoreboard on variables relevant for debt
sustainability shows a mixed picture. The high
level of indebtedness and the large financing needs of the country exert upward
pressures on the refinancing costs and the roll-over risk. But on external
debt, the current account and the net international investment position, which
are also very relevant for investors, Italy has a relatively good record and
stands out against south European countries with a negative net international
investment position of only 30 % GDP as of end-2014. One should, however, bear
in mind that this does not make Italy immune to a reversal of foreign capital
inflows as experienced in mid-2011.The larger share of domestic creditors
(about 60 % for Treasury bonds) can also be seen as an asset which shelters the
Treasury from volatility in international market sentiment.

There are three channels through which a
decrease in public debt over GDP can be achieved: higher GDP growth, lower
interest rates on government debt and a higher primary surplus. Bearing in mind that a country’s debt is generally considered
sustainable if its public debt, as a percentage of GDP, declines over the
medium term under plausible macroeconomic assumptions, a debt sustainability
analysis for Italy is presented in what follows. ([7]) Debt projection results are presented under alternative scenarios,
aimed at assessing the possible future evolution of debt under different
macroeconomic conditions.

Graph 2.1.2:   Italy —  Gross debt-to-GDP

Source: European Commission

Baseline debt projections presented below
are based on European Commission forecasts ([8]) and the assumption of no fiscal policy change beyond the forecast
period (after 2016). Debt projections are additionally presented under an
alternative scenario reflecting the macro-fiscal context reported in Italy’s
2015 Draft Budgetary Plan. ([9]) The
government structural primary balance is kept at
3.5 % - 3.7 % of GDP beyond 2016 for the two scenarios
respectively. Under this condition, the Italian public debt is put on a
decreasing path, as shown in Graph 2.1.2.

Additional scenarios run around the
baseline provide an assessment of the impact that changes in the macro-fiscal
context would have on projected public debt dynamics. Given the persistently disappointing growth performance of the
Italian economy over the seven-year long crisis, a scenario (scenario 3 in
Graph 2.1.2) is run to capture risks from lower
GDP growth and inflation. Under this scenario, the indebtedness level would
peak in 2017 at 136.4 % GDP and then stay broadly flat over the remaining
projection period. Investor confidence is underpinned both by fiscal
performance and macroeconomic prospects. In a protracted low-growth,
low-inflation environment, an increase in sovereign yields, especially for
countries with high indebtedness ratios, could take place. An alternative debt
projection scenario (scenario 4) is therefore run in which lower growth and
inflation are combined with an increase in sovereign bond yields (an increase
by 2 percentage points phased in over 2015-17, followed by a gradual return to
baseline assumptions on the interest rate). Under this scenario, the increased
debt service would lead to a debt-to-GDP level that keeps increasing, reaching
almost 143 % of GDP in 2025. Assuming a persistent accommodative monetary
policy response to low growth and inflation, the interest rate on government
debt would be brought down. This is represented in scenario 5 (where a gradual
and permanent 1 percentage point decrease in the interest rate is assumed). In
this case, public debt over GDP would again be slightly decreasing after 2017.

Box 3.1.1: Impact of fiscal consolidation and structural reforms on public debt DSGE simulations (using QUEST) allow carrying out an impact assessment on debt of fiscal and structural policies, in a dynamic way ([1]).  The interactions between policy and macroeconomic variables are indeed embedded into the model. Simulations combining and macroeconomic shocks with different fiscal-structural policies show the latter’s potential impact on debt-to-GDP. The elements of the simulations are detailed individually below before assessing their combined effects. Macroeconomic risks: below-target inflation and financial market pressures Two macroeconomic risks are considered. First, the risk of very low inflation, decoupled from the euro-area average. This is modelled by a negative demand shock which confines inflation in Italy to 1 % for first two years of the simulation period, the baseline level for the rest of the euro area being 2 %. The second risk is that of financial market turmoil that translates into a protracted period of higher sovereign spreads (meaning higher borrowing costs for the government). Currently the implicit interest rate on debt is 3.6 %, while the sovereign interest bill stands at some 5 % of GDP. This financial market risk is modelled by a shock that increases by 2 % the effective government interest rates and which is phased out once it has gone over the whole debt stock (assuming a 6-year average maturity). Fiscal stance: increase or reduction of the primary surplus by 1 % of GDP As fiscal consolidation is of primary importance to put public indebtedness on a downward path, the impact of an increase or reduction by 1 percentage point of the primary surplus is considered. In light of the recent tax cuts and spending review, consolidation is assumed to be implemented in a growth-friendly way (2), opting for expenditure cuts rather than tax increases. Structural policies: tax shift, simplification, deregulation, and labour market reforms Structural reforms affect economic activity and, through the related denominator and tax-base effects, debt dynamics. These policies usually generate negative (nominal) GDP effects in a first phase, as prices decline, before yielding positive growth benefits in the medium term. Some of the main reforms fully legislated in Italy in 2013-14 are considered here: -Tax shift: while the VAT rate has already been raised in 2013, 2014 saw the enactment of three reforms to shift the tax burden away from productive factors: (i) the cut in IRAP (regional corporate income tax) through the deduction of labour component from the tax base, (ii) the IRPEF (labour income tax) reduction for low-income earners or € 80 bonus, (iii) the strengthening of ACE (aid to economic growth measures) leading to a deduction of notional cost of equity from the corporate income tax base. The quantification of the impact and financing of these measures are translated by negative shocks on the implicit tax rates on labour (-1.5 p.p.) and capital (-0.2 p.p.). -Administrative simplification: several measures have been taken to simplify the administrative framework for citizens and business in 2012-14. To capture their effect, overhead labour costs are reduced by 3%. Reductions are phased in for a full effect within 3-4 years. ([1])  In the model, current debt is a function of debt in the previous period, related interest payments and the current primary budget deficit. Both the real GDP and the GDP deflator that make up the denominator in the deficit-to-GDP and debt-to-GDP ratios are endogenous variables, as are tax revenues and benefit payments for given tax and replacement rates. Hence, structural reforms affect economic activity, which then feeds back to budgetary variables and debt dynamics. (2)  Here the fiscal multiplier is about 0.5. For an illustration of the effects of fiscal consolidations according to their composition see In't Veld, J., ‘Fiscal consolidations and spillovers in the Euro area periphery and core’, European Economy, Economic Papers 506, October 2013, http://ec.europa.eu/economy\_finance/publications/economic\_paper/2013/ecp506\_en.htm.

(Continued on the next page)

-Product market reforms and deregulation: measures taken in 2012-13 aimed at deregulating and simplifying procedures for setting up a business. They have been quantified as leading to final goods mark-up reduction of 0.09 p.p.(3) compared to an initial level of  13%(4). In the model, these measures are captured by the respective mark-up reduction. -Labour market reforms: the June 2012 labour market reform lightened the employment protection legislation (among others). This is modelled by a gradual increase in labour-augmenting productivity by 0.7 %. Some reforms with a potential impact on GDP growth and, hence, the debt-to-GDP ratio are not included, either because of modelling limitations (justice reform described in Section 3.1, duration of work contracts reform described in 3.3), or because the final legal texts were still forthcoming at the time of writing (Jobs' Act, annual law on competition, education reform). Overall, the measures included here amount to only modest structural improvements, so that their impact on the primary balance and on government debt is a priori moderate.                                                              Privatisation programme In May 2014, the Italian government re-launched a privatisation programme with increased receipts targets, namely €30 bn over 2014-2017 that should be allotted to reduce public debt. None of the above-described measures is to be implemented on its own. Instead, a reforming government would rather adopt a combination of them. We develop five fiscal-structural policy combinations and show their respective impact in Graph 1. The simulation results for the debt-to-GDP level are displayed as percentage-point deviations from its baseline path. Hence, deviations indicate the additional effect of the measures considered (translated into shocks) and are in general combinable with different assumptions about the underlying baseline. In particular, the baseline could be the continuation of the status quo, or could already incorporate fiscal and structural measures other than the one analysed here (e.g. the baseline presented in the debt sustainability analysis). The simulations can hence also be seen as an assessment of positive and negative risks around a baseline projection for debt dynamics. (3)  European Commission  calculations based on Thum-Thysen, A., and Canton, E., ‘Service sector mark-ups and product market regulation’ (forthcoming) (4)  ECFIN's methodology to estimate service sector mark-ups takes into account the level of product market regulation (PMR) as measured by the OECD's PMR indicators. With a 13% mark-up on the final goods sector, Italy is doing rather well, as the best euro area performers register a mark-up level in the final goods sector of 9.6 %.

Box (continued)

(Continued on the next page)

Box (continued) Graph 1:   Italy — Impact of fiscal-structural policy combinations on debt-to-GDP Source: European Commission, simulations carried out using QUEST.

•               Combination 1: Primary surplus undershoot, tax shift, structural reforms This policy combination includes a loosening of the fiscal consolidation stance by 1 % of GDP combined with the implementation of the tax shift, product market deregulation, administrative simplification, and labour market reform. In this combination, despite the structural effort, the fiscal relaxation leads to an increase of the debt level of +10 % of GDP by 2028 relative to the baseline. In other words, the measures undertaken on the structural side have, given their limited size and scope, a limited positive impact on public finances through the denominator and tax-revenue effects, which does not compensate the negative impact of less ambitious discretionary fiscal measures on public finances. •               Combination 2: Primary surplus overshoot, tax shift, structural reforms The only difference to combination 1 is the tighter fiscal stance. The opposite debt evolution with this combination (-19 % of GDP relative to baseline by 2028) shows clearly the pre-eminence of the fiscal stance in curbing public indebtedness in the set of policy measures considered. The simulation results do not address the question of the political palatability of protracted fiscal consolidation given consolidation fatigue and the electoral cycle, however. •               Combination 3: Combination 1+ market confidence shock The sovereign crisis has shown that in times of high policy scrutiny, sovereign spreads are usually dependent on key fiscal variables such as the deficit or gross debt. Therefore, it seems more likely that a country would face higher borrowing costs if its fiscal stance is looser than expected. The shock increasing sovereign yields is therefore implemented with combination 1 (as opposed to combination 2). The effect of such a shock to financing costs is very large. Indebtedness rises to 10 % of GDP above the level in combination 1 by 2020. •               Combination 4: Combination 3 + privatisation Adding privatisation to combination 3 shows that privatisation alone is certainly not a solution to the Italian high indebtedness as the contribution to lowering debt-to-GDP is incremental. •               Combination 5: Combination 2 + negative demand shock leading to lower inflation

(Continued on the next page)

Box (continued)

The latest data has shown very low inflation in Italy, prompting fears of a debt-deflation spiral, and so a policy response combining strong fiscal consolidation and structural reforms to counter act this adverse effect (combination 2). A negative demand shock that reduces inflation by 1 % below baseline implies an increase in the debt-to-GDP ratio relative to baseline: (i) nominal debt (numerator) increases given the reduction in tax revenues in response to lower domestic demand (deterioration of the primary balance), while (ii) nominal GDP (denominator) increases because of lower growth and inflation. This results in a 13 % of GDP increase in public indebtedness within three years, before the effects of the shock are gradually phased out and debt is put back on a downward path through strong and protracted consolidation. Should similar negative demand shocks occur in the entire euro area and put downward pressure on prices in a low interest environment, the impact on Italian output and debt would be even more adverse, because falling prices in Italy would not (or less) translate into real depreciation and competitiveness gains. Thus, net trade would contribute less to supporting economic activity amid weak domestic demand (5).  (5) In the model, Italy has a trade openness ratio (sum of export and imports over GDP) of 58% and a trade openness    ratio towards the rest of the euro area of 25%.

Finally, in a context of low growth and low inflation, it would be
more difficult to pursue rapid fiscal consolidation. Scenario 6 shows the impact that this would have on debt dynamics.
Fiscal fatigue in the form of a 1 percentage point decrease in the structural
primary balance would lead the debt-to-GDP ratio to rise rapidly, reaching
148 % in 2025.

The analyses presented in this section
show that the first lever determining the pace of debt reduction is fiscal
consolidation but that the condition for its success is a growing GDP. To achieve a larger reduction of public indebtedness, the
second and necessary policy lever is that of large-scope structural reforms. The
current structural fiscal position — if further improved and maintained — will
reduce the public debt imbalance. Keeping the structural primary balance at 3.5
% (as a minimum) is key to bringing public debt over GDP below 110 % by 2025. A
large primary surplus could help preserve market confidence (and keep the risk
premium low) even if growth prospects and inflation remain weak in the short to
medium term. However, past experience suggests that achieving and maintaining
such a high primary surplus is challenging and all the more when economic
activity remains subdued and when there are deflationary pressures.  Forceful
consolidation to put debt on a downward path in a depressed macroeconomic
context could indeed be self-defeating. Hence the only policy lever left is
that of structural reforms large enough in scope and impact to push GDP
significantly up in the medium-term (as the short-term effects of structural
reforms are usually mixed and positive effects come in only with a few years'
lag). In Box 2.1.1, these fiscal, structural and macroeconomic interactions are
integrated in a dynamic model. Simulations show that some recently implemented
reforms (on taxation, simplification, deregulation and labour market) bring
about growth gains so that debt is also reduced thanks to the higher GDP and
tax intake. Additional reforms, as those foreseen for instance on competition
or on the labour market, would bring the debt-to-GDP ratio further down.
(Privatisation can only be a complementary measure and would not suffice to
bring public indebtedness significantly down in the medium term.) Following previous announcements by the Ministry of Finance and
endorsed by the Italian Government on 20 February 2015, Italy committed to
adopt and implement an ambitious agenda of structural reforms.[10]   If
implemented, these reforms should increase Italian GDP by a few percentage
points over the medium-term, thereby contributing to the long-term
sustainability of Italy’s public finances.

External position and export performance

The improvement in Italy’s current
account balance is mostly non-cyclical, reflecting the decline of potential
growth and thus import demand. Having returned to
surplus in 2013, Italy’s current account is expected to have further increased
to 1.8 % of GDP in 2014. The positive trend in the trade balance is primarily
explained by shrinking nominal imports, whereas nominal exports have grown only
moderately (Graph 2.2.1). In 2014, the gap between nominal
growth of exports and imports is expected to have narrowed, but mainly owing to
a smaller contraction of imports in the context of Italy’s slow exit from
economic recession. The correction seen in Italy’s current account balance is
mostly non-cyclical. The improvement in its cyclically-adjusted current account
([11]) by 3.3
percentage points between 2008 and 2013 mainly reflects Italy’s negative
potential growth since the start of the crisis. The resulting decline in
potential output constrains Italian domestic and thus import demand below
pre-crisis levels. For export capacity to become the driver of significantly
higher potential growth, Italy would need a reallocation of resources towards
the tradable sectors but this shift does not seem to be happening so far.

Graph 2.2.1:   Breakdown of the year-on-year change in goods components of Italy’s trade balance

Source: European Commission

Italy’s recent export performance has
been largely driven by external demand developments.
The contraction in demand from euro area trade partners over 2011-2012 was
reflected in a similar fall in exports to those markets (Graph 2.2.2). In this period, falling demand from
vulnerable euro area countries was in fact compounded by weak demand also from
countries with no financial constraints in the euro area, like Germany. ([12]) With some lag, Italy’s exporting firms have taken advantage of the
very gradual recovery in demand from the euro area, which started at the
beginning of 2013. The fall in the euro exchange rate and steady demand had
instead supported exports to non-euro area markets in 2011 and 2012. However, in
2013 and 2014 demand from some emerging markets faltered, while the euro
appreciated again until the first quarter of 2014. As a consequence, Italy’s
export performance towards non-euro area trade partners suffered. The
depreciation of the euro boosted exports to outside the euro area again in the
second half of 2014. Further favourable exchange rate developments together
with strengthening external demand, are expected to be the main engine to
restart a gradual recovery in economic activity in 2015 and 2016.

Graph 2.2.2:   Italy’s export performance since mid-2010, intra and extra euro area breakdown

Source: Bank of Italy (based on national accounts ESA95-ESA2010)

The shares of tradable sectors in
Italy’s gross value added and employment have fallen significantly over the
last two decades, mainly driven by the declining share of manufacturing
industries. Between 1995 and 2013, the share of
Italy’s tradable sectors ([13]) in total
gross value added declined from 53 % to 44.5 % (Graph 2.2.3). This decline has been common to most
advanced economies, with the exception of Germany, and it reflects the
reorientation of economic activity away from industry towards services. Since
the onset of the crisis, the share has broadly stabilised in Italy. Overall,
the decreasing importance of tradable sectors is mainly driven by the declining
share of manufacturing industries, which in 1995 accounted for roughly 21 % of
total gross value added and fell to 15 % in 2013. In particular, the evolution
of the manufacturing sector’s gross value added slowed down already after
Italy’s adoption of the euro in 1999 and turned strongly negative in 2008 when
the crisis started (Graph 2.2.4). The declining importance of the
tradable sectors is also visible in employment terms: over the period
1995-2013, the share of tradable sectors in Italy’s
(full-time-equivalent-based) employment decreased from 53.8 % to 48 %.
Again, the bulk of the shift is explained by manufacturing sector’ lower share
of employment. Apart from manufacturing, other sectors which have contributed
to the decrease in the gross value added and manufacturing’s share of
employment between 1995 and 2013 are wholesale/retail trade and motor vehicle
repair, as well as agriculture, forestry and fishing. Industries which somewhat
offset the tradable sector’s share decline are accommodation and food service
activities, information and communication (mainly computer programming,
consultancy and information service activities) and transportation and storage.
Given that the Italian manufacturing sector accounts for a rather stable 95 %
of Italy’s goods exports, the subsequent analysis will focus on the export
performance of manufacturing sectors. The decreasing importance of
manufacturing within the Italian economy has been driven mainly by those firms
dependent on the domestic market alone and which were not able to re-orient
their production towards foreign markets. In addition, domestic market
developments may adversely affect export growth. ([14]) Overall, the erosion of Italy’s manufacturing base may have a
negative impact on the country’s export capacity.

Graph 2.2.3:   Share of tradable sectors in gross value added

Source: European Commission, ISTAT

Graph 2.2.4:   Average annual growth rate of gross value added over selected periods

Source: European Commission, ISTAT

Italy is endowed with a diversified
manufacturing base, which has undergone a very slow shift towards more
technologically intensive activities since 1995. In 2013, Italy’s largest
manufacturing sectors (in terms of their share of manufacturing gross value
added) were in basic metals (15.7 %), machinery and equipment (14 %), food
products and beverages (11.9 %), textiles and leather (9.7 %), rubber and
plastic products (8.7 %), and furniture and miscellaneous ([15]) (8.6 %). High-tech industries remain small in total manufacturing
gross value added (8.4 % in 2013), while around 60 % of Italian manufacturing
gross value added was still generated in low- or medium-low tech sectors, owing
to the continued specialisation in 'traditional' sectors. Since 1995, however,
a gradual shift away from low- and medium-low-tech sectors has taken place: the
latter’s share in total manufacturing gross value added decreased by 5.3
percentage points (Graph 2.2.5), mainly owing to the textiles and
leather, wood and paper, and rubber and plastics industries. However, the food
products and beverages, basic metals, and furniture and miscellaneous
industries recorded a gross value added share increase, against the general
trend. The increase in the gross value added share of medium-high- and
high-tech industries took place mainly thanks to machinery and equipment,
pharmaceutical products, electrical equipment, and computers and electronics
sectors. The chemicals and motor vehicles and transport equipment industries
went against the general upward trend.

Graph 2.2.5:   Shares of gross value added in manufacturing by technology intensity

Source: European Commission, ISTAT

Exposure to external markets has
increased in manufacturing sectors. Over the
1995-2013 period, all manufacturing sectors have increased their propensity to
export ([16]), with the
exception of the computer and electronic products sector. The increase has been
more pronounced since the crisis in almost all sectors, as shown in Graph 2.2.6. Aggregating the sectors by technology
intensity, export propensity is higher in medium-high and high
technology-intensive sectors. This suggests that firms producing these types of
products are more exposed to demand from abroad, which could also be due to
higher integration of these products into global value chains.

Graph 2.2.6:   Export propensity by technology intensity

Source: European Commission, ISTAT

The demography of exporting firms is biased
towards those with low export propensity.
Aggregating firm-level data, Graph 2.2.7 shows that average export propensity ([17]) is close or above 50 % in five manufacturing sectors (i.e. leather
and related products, machinery and equipment, other transport equipment, other
manufacturing, and pharmaceutical), meaning that half or slightly more of the
total output of these sectors is sold abroad. In addition, the graph shows that
the distribution of firms’ export propensity is wide in almost all sectors. In
particular, the export propensity of the median is on average 30 percentage
points lower than that of the third quartile. This suggests that there is room
to increase exports at the intensive margins in all manufacturing sectors.

Graph 2.2.7:   Export propensity by manufacturing sector, 2012

Source: ISTAT

Italy’s export propensity and
performance is being held back by the bias in the country’s firm demography
towards small firms with low productivity. Italy’s
firm demography is characterised by a high concentration of very small firms:
in 2012, 99.9 % of Italian firms were small and medium-sized enterprises (up to
250 employees), whereas the share of micro-firms (up to nine employees) was
95.2 % of all companies. Micro-firms’ labour productivity is however
significantly below the firm average (Graph 2.2.8). The literature suggests a strong
positive correlation between firm size, productivity and export capacity and
performance, with a presence in geographically more distant markets requiring a
higher level of efficiency. Consequently, the dominant presence in Italy of
very small firms with low productivity is holding back an increase in the
country’s export propensity. This is reflected by the fact that Italian export
propensity at firm level is clearly negatively correlated with firm’s size
(Graph 2.2.9).

Graph 2.2.8:   Labour productivity by firm size (100 = average over total firm population)

(1) Labour productivity calculated as gross value added at factor cost divided by the number of persons employed Source: ISTAT

Graph 2.2.9:   Export propensity by firm size

(1) The bars represent the ratio of the value added accounted for by firms which belong to a specific export propensity and firm size class and the total value added accounted for by all firms which belong to that firm size class (irrespective of their export propensity class). Hence bars with the same colour add up to 100 %. Source: ISTAT

Export growth has varied quite significantly
across sectors, the biggest exporting sectors being less dynamic. As shown in Graph 2.2.10, the sectors that experienced the
fastest growth in exports over the 1995-2013 period were those producing coke
and petroleum, and pharmaceutical products. However, these sectors accounted
for a low share of total goods exports in 1995. The two sectors with the
biggest shares then were textiles and leather, and machinery and equipment,
which together accounted for one third of total goods exports in 1995. However,
their export dynamics have been respectively below the average and broadly in
line with it. The different dynamics of exports by sector has brought some
changes in the composition of Italy’s goods exports.

Graph 2.2.10: Goods exports of manufacturing sectors, by shares and dynamics

Source: European Commission, ISTAT

Some change in the sectoral composition
of exports has taken place since the early 2000s.
Exports of machinery and equipment accounts for one fifth of the total –
broadly stable over the period 1995-2013 – and are the largest category of
exported goods (Graph 2.2.11). Textiles and leather has dropped
significantly (by around 5 percentage points) as have furniture and
miscellaneous, rubber and plastics, and computer and electronic products (by
5.5 percentage points all together). The fall in their share of total exports
has been compensated by an increase in metal, food and beverages,
pharmaceutical, and coke and petroleum products (by an overall 10.6 percentage
points). This change in sectoral composition reflects a shift from low to
medium-low technology-intensive sectors (Graph 2.2.12), with the latter accounting for
almost half of the total exports of manufactured goods in 2013. High-tech
sectors, however, have broadly remained stable over the period and represent a
small share of the total, around 8.5 percentage points.

Graph 2.2.11: Shares of goods exports by manufacturing sector, 1995 and 2013

Source: European Commission, ISTAT

Graph 2.2.12: Shares of manufacturing exports of goods, by technology intensity

Source: European Commission, ISTAT

The marginal decline in Italy’s export
market shares between 2010 and 2013 conceals a heterogeneous performance across
sectors. While the sectoral growth of exports in
absolute terms explains the changes in the composition of Italy’s goods
exports, only the sectoral export market shares show which sectors have been
exporting in line with or above total external demand. Over the 2010-13 period,
export market share expressed in current prices and US dollars terms has
declined only marginally (-0.2 percentage point). The performance by sectors ([18]) has been heterogeneous (Graph 2.2.13). Machinery and electrical products
as well as metals, which accounted respectively for 26 % and 10 % of total
goods exports in 2013, saw their export market shares stabilise over the
period. The chemical products, leather and related products, and art and
antiques sectors have been the only ones to experience some increase in their
shares. However, these sectors together represented 12.5 % of total Italy’s
total exports of goods in 2013 and they have been more than offset by the rest,
whose export market shares declined. In particular, transport equipment – which
accounted for 9 % of total exports – have lost slightly more than the average
(-0.3 percentage points vs. -0.2). Traditional sectors such as textiles and
footwear have continued losing market shares in recent years, suggesting that
competition from emerging markets has remained intense.

Graph 2.2.13: Change in sectoral export market shares 2010-13, percentage points USD

Source: European Commission

Cost/price and
non-cost competitiveness

Cost-competitiveness has been
deteriorating primarily due to sluggish productivity performance. After the financial crisis Italy’s core inflation was on average
well below 2 % (see Graph 2.2.14). The same applies to compensations
per employee, which also reflected the freeze in public sector wages. Unit
labour cost benefitted from those moderate developments. However, driven by the
weak productivity dynamics, Italy’s cost competitiveness relative to the rest
of the euro area did not improve as in other countries ‑ like Spain ‑
that had to embark on an aggressive cost adjustment due to a deteriorated
external position.

Graph 2.2.14: Cost and price developments (2010-2014 average)

Source: European Commission

Graph 2.2.15: Unit labour cost index for selected countries, tradable vs. non-tradable sectors (1998=100, based on hours worked)

Source: European Commission, Eurostat

Recourse to labour hoarding has also played
a significant role in the lack of adjustment in Italy’s unit labour cost
relative to the rest of the euro area, as it affected the country’s already
unfavourable productivity position of the country.

Unit labour cost in tradable sectors has
grown less than in non-tradable ones; nevertheless its upward trend has been
more sustained than in France, Germany and more recently Spain. In the pre-crisis period, the rise in Italy’s unit labour cost was
more sustained in non-tradable sectors as labour productivity declined on
average (Graph 2.2.14). However, as the crisis hit, the
non-tradable sectors limited the growth in unit labour costs thanks to a much
slower pace of increase in compensation per full time equivalent, which can
also be explained by the public sector wage freeze. However, from a
cross-country perspective, the increase in unit labour costs in both tradable
and non-tradable sectors since 1999 has been more sustained in Italy than in Germany
and France. Looking at the tradable sectors in greater details and grouping
them according to their technology intensity, Graph 2.2.16 shows that unit labour costs has held
broadly stable in high-tech sectors, while increasing in the others. In fact,
high-tech sectors have seen higher productivity growth than the others over the
whole period.

Graph 2.2.16: Unit labour cost index (based on full-time equivalents) by technology intensity, 1998=100

Source: European Commission, ISTAT

Most price-competitiveness indicators
continue to show a better picture of Italy’s competitive position than the real
effective exchange rate based on unit labour cost.
For instance, the Bank of Italy’s competitiveness indicator based on producer
prices of manufactured goods for a set of 62 countries indicates that since the
financial crisis Italy’s competitiveness position has improved more than for
Spain’s and by about the same as France and Germany (Graph 2.2.17). However the difference between
labour cost and price indicators might also point to a squeeze in profit
margins for Italian industrial firms, which are compressing their mark-ups in
order to remain competitive in their markets. Both cost/price-competitiveness
indicators will benefit from the recent euro depreciation.

Graph 2.2.17: Indicators of competitiveness: producer prices of manufactures (December 2010 =100)

Source: Bank of Italy, European Commission

Gains in non-cost competitiveness have
not fully offset Italy’s loss of cost competitiveness. One aspect of non-cost competitiveness is export quality which – if
increasing over time – may shelter a country from cost competition from
emerging markets or rising product standardisation. For Italy, a modest further
specialisation in exporting goods of medium-high quality can be observed
between 2005 and 2011 at the expense of exporting low- and high-quality goods
(Graph 2.2.18). A second aspect of non-cost
competitiveness is the quality of 'forward' or 'supply' linkages of services
with the rest of the economy, i.e. efficient service industries supplying
inputs to the production process of (exporting) sectors, thus supporting the
latter’s competitiveness. In Italy, forward linkages of services are rather
strong, but their competitiveness-enhancing effect (as measured by labour
productivity growth over the period 2007-11) on the rest of the Italian economy
is negative (Graph 2.2.19). This is particularly the case for
business services which are de facto still quite heavily regulated and
protected from external competition. A third aspect of non-cost competitiveness
is the degree of integration in global value chains. Compared with other large
EU Member States like Germany and France, Italy participates to a similar
extent in global value chains, as measured by the sum of backward and forward
vertical specialisation shares. Within global value chains, Italian firms are
mainly intermediate suppliers (i.e. occupying upstream positions), but their
position may be relatively weaker because of the firms’ small size and low
productivity (in spite of considerable firm heterogeneity). ([19])

Graph 2.2.18: Export quality

(1) The evolution of the quality of a country’s exports is shown here on the basis of the distribution of normalised quality ranks of individual manufacturing products exported to a specific destination market (here the EU-15 market) by a defined set of exporters. Shifts in the distribution of such ranks thus reflect changes in the quality dynamics of a country’s exports over time. Source: ‘Quality in exports’, European Economy – Economic Papers, no. 528, September 2014.

Graph 2.2.19: The role of services in Italian non-cost competitiveness

(1) The value of a services industry’s forward linkages is an indication of how much of its production contributes to the production of other industries. The horizontal-axis figure shows the share of the various services sectors in the total value of intermediate inputs used in the economy. Source: European Commission

Wages and productivity misalignments and the
labour market reform

Nominal wage growth has slowed down. In 2014 (based on the first three available quarters) compensation
per employee increased by 1.3 %, about the same rate as in the previous year
(Graph 2.2.21). On an hourly basis, wage growth
decelerated from 1.4 % in 2013 to 0.6 % in 2014. Aggregate wages conceal a
different dynamic at the sectoral level (Graph 2.2.20). Wage growth is more moderate in
market services and public administration than in manufacturing, which would
support labour reallocation toward the tradable sector. The proportion of the
labour force comprised by young people, by low-wage earners and by people with
short tenure (probably on lower wages) in the private sector fell during the
period, so that the adjustment of wages is likely to be stronger once these
effects are taken into account. ([20])

Graph 2.2.20: Compensation per employee by sector

Source: European Commission, Eurostat

Graph 2.2.21: Actual and negotiated wages

Source: European Commission,  Eurostat

Negotiated wages have started to respond
to the prolonged weakness in the labour market. The
Phillips curve, i.e. the relationship between nominal wage growth and the
unemployment rate, is the standard tool to assess the response of wages to
labour market conditions. Graph 2.2.22 relates actual wages to the
unemployment rate for the periods 2000-08 and 2009-13. In both periods, the
correlation between the growth of actual wages and unemployment rate is weak
(as shown by the flat curve). However, during the crisis, the average growth in
actual wages drops (i.e. in the second period the curve shifts downward). Graph
2.2.23 reports for the period 2009-14 on the
relationship between the growth in contractual wages and unemployment for Italy
and the euro area. The graph shows that on average contractual wages in Italy
respond to changes in the unemployment rate in a similar manner to those in the
euro area as a whole (the two lines are parallel). The differences in the
response of contractual versus actual wages reflect a number of factors. First,
actual wages include variable components of pay that have been increasingly
squeezed since the start of the crisis, which make them less responsive to
unemployment. Second, a framework agreement signed in 2009 (the 'Productivity
Pact') set the duration of collective contracts to three years, while until
then contracts has lasted for two years for the economic provisions and four
years for the normative ones. The agreement also established that wage
increases were linked to three years inflation forecast based on the HICP net
of imported energy products. ([21]) The
increase in duration of contracts for the economic provisions together with
their staggered nature (i.e. sectoral negotiations occur at different point in
time) may have contributed to delaying wage adjustments. With HICP inflation
slowing down, newly signed contracts will incorporate the lower inflation rate.
However, delayed wage adjustment in a context of low inflation and sluggish
labour productivity growth may make it challenging to align real wages with
productivity. More frequent renegotiation of collective contracts and greater
coordination at different bargaining levels might improve the response of wages
to cyclical developments.

Graph 2.2.22: Phillips curve for Italy: annual growth of compensation per employee

Source: European Commission, Eurostat, ISTAT

Graph 2.2.23: Phillips curve for Italy and euro area based on negotiated wages, 2008-2014

Source: European Commission, ISTAT, Eurostat, European Central Bank

There are indications that the
allocation and rewarding of labour does not reflect skills and productivity. First, differently from Germany and the United Kingdom, in Italy
earnings increase continuously with age, indicating that wages may not reflect
the productivity of workers. ([22]) Second,
among the countries participating in the OECD Programme for the International
Assessment of Adult Competencies (PIAAC), Italy has a lower-than-average share
of workers that are over-qualified for their job (13 % compared with 21 %), but
it has the highest share of under-qualified workers (22 %). Given the Italian economy’s
specialisation in low-to-medium technology products, one would expect the
opposite. In terms of skill mismatches, Italy has rather high shares of both
over-skilled and under-skilled workers. ([23]) Overall, these misalignments between wages, jobs, skills and
productivity at the micro-level have both static and dynamic negative effects:
they weigh on aggregated productivity, and reduce the returns to education for
the young, and thus the rate of human capital accumulation. ([24])

Graph 2.2.24: Age-earning profile, 2012

(1) Wages are calculated from EU SILC data on yearly gross employee cash or near cash income, which includes salaries and other benefits (e.g. holiday and overtime payments). The yearly income is divided by the average hours worked to approximate an hourly wage. The lines are polynomial interpolation of actual data. Source: European Commission, EU-SILC

Graph 2.2.25: Incidence of over- and under-qualification ( % of workers), 2012

Source: OECD, PIAAC

Aligning wages with productivity and promoting
the adoption of innovative solutions at firm level remain challenges for Italy. Decentralised bargaining can play an important role in
strengthening the responsiveness of wages to productivity as well as to labour
market conditions. Firm-level contracts on economic issues still concern a
minority of firms, with the share being lower in southern regions. ([25]) In January 2014, the social partners signed a further agreement for
the manufacturing sector, laying down the procedures for measuring trade union
membership in line with the criteria for certification of trade unions’ representation
defined by a previous  2011 agreement. The 2014 agreement is however not
operational yet due to administrative and institutional issues, while a large
majority of collective contracts in the manufacturing sector are coming to an
end in 2015. Pending the implementation of the agreement, a number of obstacles
continue to prevent firms and workers from engaging in firm-level negotiation.
If properly implemented, the agreement could also make effective the
possibility of derogating from national collective contracts, which was
formally introduced by the 2011 intersectoral agreement but rarely implemented.

Building on earlier reforms, the current
government has initiated a comprehensive reform to improve labour market
functioning, while reducing segmentation.  In
December 2014, the parliament approved an enabling law, the 'Jobs Act' for the
reform of the labour market. The act follows the pattern and direction of
previous reforms. It makes decisive changes in employment protection
legislation, the unemployment benefits system and wage supplementation schemes,
and the governance and functioning of active and passive labour market
policies. It also envisages action to reduce the administrative burden on
firms, improve the effectiveness of the labour inspectorate and promote reconciliation
between family and working life (see Section 3). Implementing legislative
decrees have to be enacted within six months. Swift implementation of the 'Jobs
act' should improve entry and exit flexibility, enhance labour reallocation and
promote stable open-ended employment, most notably for the young.

The first legislative decree revises
dismissal rules for new hires under open-ended contracts. The decree de facto revises for new hires the article of the Worker
Statute (i.e. Article 18) that regulates unfair dismissals. The decree has
completed the legislative process and will enter into force in March 2015. In
particular, it substantially reduces the scope for reinstatement following
unfair dismissals and expands the number of cases where the sanction leads to a
monetary compensation, which rises with tenure. Reinstatement can be ordered
only in case of discriminatory dismissal or if the disciplinary reason put
forward by the employer is false. It cannot longer be ordered in case a
dismissal motivated by economic reason is judged unfair. Compensation is also foreseen
in case of collective dismissal procedures, thereby extending the scope of the
new rules in case of restructuring.   Compensation for unfair dismissal remains
much higher than for fair dismissals (which is virtually zero in Italy), which
may increase both the incentive to go to court and the cost of the litigation.
To limit court cases, the decree further facilitates the settlement of
dismissal disputes through conciliation, also through fiscal incentives. For
workers laid off, the decree introduces, the “contratto di ricollocazione”,
i.e. a voucher for laid-off workers. The government is accompanying the reform
with hiring incentives for permanent contract (see Section 3.4).

A complementary decree revises labour
contracts and allows a more flexible use of labour within the firm. With a view to reducing duality, the enabling law foresees that
the revision of dismissal rules is accompanied by a revision of labour
contracts. The respective legislative decree has been tabled in February, and
is now subject to the non-binding opinion of the Parliament. The decree
provides a clear definition of dependent employment, under which all existing
atypical contracts have to be brought back as from January 2016, with the
exception of well-defined circumstances. This is an important step to reduce
duality. The 2012 reform has already reduced the use of atypical contracts
(Graph 2.2.26) and this was accompanied by an
increase in the use of temporary contracts, especially of young people, also
driven by further measures to liberalise temporary contracts introduced in 2013
and 2014. The decree also clarifies certain provisions for temporary
contracts, seasonal work, part-time, agency work and job-on-call. It also
reviews apprenticeship contracts, by reducing the costs for the employers and
enhancing the scope of formal education, in the attempt of encouraging its
uptake – so far very limited – and moving closer to a dual system. Finally, the
decree enhances flexibility in the allocation of labour within the firm, by
allowing workers to be assigned to different tasks during restructuring
periods.

The new rules have several benefits for
the labour market functioning and the potential for reducing duality. Overall, the new provisions reduce the uncertainty and costs
associated with the dismissal procedure, including by further fostering
pre-trial negotiation, and reduce the scope of atypical contracts. In the
medium- to long-term, as the number of workers under the new regime increases,
this could improve reallocation across sectors, promote stable employment
prospects, not least for young people and encourage job-specific training. Its
effects on total factor productivity growth are therefore likely to be
positive. However, the labour judges’ interpretation of the new legislation
will be important for the reform to have a rapid impact. Its effect on labour
market duality will depend on the scale of the take-up of open-ended contracts,
which will be influenced also by the effectiveness of rebates on social
security contributions introduced by the 2015 Stability Law and available for
three years for contracts signed in 2015.

Graph 2.2.26: Growth of new contracts signed and contributions by contractual forms, y-o-y  % change

Source: European Commission, Ministry of Labour Comunicazioni Obbligatorie

A more integrated unemployment benefit
system is being developed, based on unemployment insurance with broader
coverage and stronger conditionality, and on a newly introduced unemployment
assistance for long-term unemployed. A
second legislative decree will enter into force in March 2015. The decree
introduces a new unemployment benefit (Nuovo Assegno per l’Impiego – NASPI)
targeting all employees in the private sector who become unemployed from May
2015 onwards. Compared to the previous system, NASPI provides for a longer
duration of benefits (from 18 to 24 months) while broadly maintaining their
level and reduces the contribution periods. Furthermore, it strengthens the
conditionality with regard to job-search or training activities. In an
experimental manner for 2015, two additional schemes are introduced. The first provides an unemployment insurance scheme (Indennita’ di
disoccupazione per i lavoratori con rapporto di collaborazione coordinate e
continuative e a progetto – DIS-COLL) to workers in atypical
(collaboration) contracts who become unemployed in  2015. The second (Assegno di disoccupazione, ASDI) is an
unemployment assistance scheme, means-tested and linked to activation measures,
which provides an extra six months’ cover to unemployed workers with children
or close to retirement who have exhausted their right to the NASPI. It is
non-contributory and it may imply a positive step in providing some income
support and activation measures to the long-term unemployed (see Section 3.3).

The new unemployment benefit system represents
a substantial change supporting workers’ in transition from unemployment to
employment, in particular in light of the envisaged revision of wage
supplementation schemes. The measures introduced
address the rigidities of dismissal procedure while securing workers’
transition between different jobs. Flexibility for workers to move between
different occupations and location is combined with more secure transitions
between different employment statuses. The risks of unemployment traps, in
particular at low level of incomes, stemming from more generous unemployment
benefits need to be addressed with cost-effective activation policies, for
which new implementing legislation is needed. An additional important
complementary provision is the revision of the wage supplementation schemes (Cassa
Integrazione Guadagni), also due under the enabling law. Wage
supplementation schemes provide an effective way to avoid wasteful labour
shedding during recessions, but also delay economic restructuring and labour
reallocation, with negative effects on productivity growth and workers’
employability. The government intends to review and substantially streamline
these schemes, among other things by reducing their duration and the cases
where they can be used and by improving the insurance dimension (firms using
more frequently the scheme will contribute more to its financing).

Bank-corporate nexus

The protracted crisis has exposed the
vulnerability inherent in the close intertwining between Italian banks and
corporates. This mutual vulnerability is rooted in
the significant presence of overleveraged bank-dependent companies, firms’
weaker financial health and creditworthiness due to the protracted crisis, the
high stock of non-performing loans on banks’ balance sheets, and contracting
bank credit to the non-financial corporate sector.

Italian banks are relatively more
exposed to corporates through lending than banks in other euro area countries,
while Italian firms are more reliant on external debt financing (bank loans)
than their European peers. The former fact is due
to their business models which are strongly focused on traditional
intermediation through deposit-taking and lending. Regarding the latter fact,
in 2013, bank loans represented 64.7 % of Italian firms’ total financial debt,
more than 20 percentage points higher than the euro area average (Graph 2.3.1).

The demography of the Italian non-financial
corporate sector is skewed towards very small businesses which explains the
high incidence of bank loans in firms’ external funding. SMEs are the backbone of the Italian economy. In 2012, 99.9 %
of Italian businesses employed fewer than 50 employees, generated almost 70 %
of value added and accounted for just over 80 % of people employed. Micro-firms
(with up to nine employees) — of which a substantial share are 'artisanal'
firms — accounted for 95.2 % of all companies and were good for around 30.8 %
of value added and close to 50 % of persons employed. As small firms — and
especially micro-firms — tend to have only limited access to capital market
funding, their high share in the total number of Italian firms helps to explain
the high incidence of bank loans in corporates’ external funding. Other
relevant factors include the strong presence of banks focused on traditional
deposit-taking and lending, underdeveloped capital markets, the high incidence
of family ownership of firms (implying reluctance to give up control) and a
long-standing bias in taxation towards debt financing.

Graph 2.3.1:   Share of domestic bank loans in total financial debt of the non-financial corporate sector at end-2013

Source: European Commission, European Central Bank

The financial structure of Italy’s
non-financial corporate sector is characterised by relatively high financial
leverage, where the latter is inversely proportional to firm size. In 2013, the average financial leverage ([26]) of the Italian corporate sector was 44.1 %, around 4 percentage
points higher than the euro area average. This implies that Italian firms on
average are less well capitalised than businesses in other euro area countries
and thus less resilient to financial shocks. After 2011, the contraction of
bank lending to firms and the increased recourse of medium-sized and large
firms to capital markets caused financial leverage to start falling, a trend
which began earlier in other large euro area economies (Graph 2.3.2).

Graph 2.3.2:   Financial leverage of the non-financial corporate sector

Source: European Commission

The deep and protracted recession in
Italy has severely affected the creditworthiness of Italian firms and has
widened the gap between small and large companies.
Over the period 2008-2013, the gross operating surplus of the Italian
non-financial corporate sector has decreased by more than 10 %. Compared to
before the crisis, the share of firms making a profit has declined by around 10
percentage points to around 55 %. The negative effect of the decline in sales
and profits on firms’ financial health and creditworthiness is exacerbated by
the high financial leverage of many Italian firms. A recent study by the Bank
of Italy has found that a 10 percentage points increase in financial leverage
implies a 1 percentage point higher probability of default, and that the
adverse impact of a drop in sales on a firm’s solvency is almost four times
greater for businesses in the highest quartile of the financial leverage
distribution than for companies in the lowest quartile. ([27]) At the end of June 2014, the average interest expense coverage
ratio of Italian firms ([28]) — a measure
of debt-service capacity — reached a new peak of close to 22 %. A third of
Italian companies are estimated to be financially fragile as their interest
expense coverage ratio is above 50 %. The deterioration in Italian firms’
creditworthiness is also clearly visible in the number of bankruptcies which
has increased steeply since 2008. In addition, recourse to non-bankruptcy
insolvency procedures and voluntary liquidations has gone up (Graph 2.3.3). Furthermore, the long crisis has led
to a polarisation of financial health by firm size. The turnover and gross
operating margin of small firms — on average characterised by lower
productivity, higher financial leverage and higher dependence on domestic
demand — have been affected more severely than those of medium-sized and large
businesses (Graph 2.3.4). The future financial situation of
Italy’s corporates crucially depends on how soon the economy will return to
growth.

Graph 2.3.3:   Number of bankruptcy and non-bankruptcy insolvency procedures and voluntary liquidations in Italy

(1) Seasonally-adjusted data Source: Cerved Group, Rapporto Cerved PMI 2014, 2014

Graph 2.3.4:   Change in turnover and gross operating margin between 2007 and 2013 by firm size

Source: Cerved Group, Rapporto Cerved PMI 2014, 2014

The deterioration in the quality of
loans to firms has led to a sharp increase of non-performing loans and a
substantial erosion of banks’ profitability. Since
the end of 2008, the non-performing loan ratio of the Italian banking sector as
a whole has more than tripled and stood at 16.6 % in the third quarter of 2014.
Bad debts — the worst category of impaired loans in Italy ([29]) — amounted to EUR 177 billion (i.e. 9.3 % of total customer
loans). The increase in the non-performing loan ratio is mainly due to banks’
corporate exposures. Considering only non-financial corporations and producer
households, Italian banks’ non-performing loan ratio has risen from 6.8 % in
the fourth quarter of 2008 to 27.3 % in the third quarter of 2014 of which more
than half (i.e. 15.4 % or EUR 141 billion) was bad debt (Graph 2.3.5). The corporate non-performing loan
ratio is significantly higher in southern Italy. Part of the increase in the
non-performing loan ratio is denominator-driven (i.e. the contraction of
outstanding credit to firms). In the course of 2014, the inflow of new
corporate non-performing loans and of bad debts stabilised at around 7 % and 4
% of the stock of loans to firms respectively. The inflow is higher for small
firms and those that are more dependent on bank loans. Despite this
stabilisation, a further increase in the corporate non-performing loan ratio is
likely as the transition dynamics of impaired loans to the corporate sector are
still very much biased towards further deterioration. The dramatic increase in
non-performing loans has significantly undermined Italian banks’ already weak
profitability: in 2013, almost half of banks’ total operating income was
absorbed by loan impairments (Graph 2.3.6). The recognition of loan losses by
banks has been accelerated in recent years by the strict loan portfolio reviews
conducted by the Bank of Italy and as part of the European Central Bank’s
comprehensive assessment of euro area banks as well as the increased tax
deductibility of loan-loss provisions and loan write-offs. This is reflected in
the coverage ratio for non-performing loans ([30]) which increased from 37.7 % in June 2012 to 42.4 % in June
2014, and for bad debts, which rose from 54.7 % to 57.1 %. Medium-sized banks
seem less well covered than the largest banks, while small banks compensate for
their lower coverage ratio with more collateral.

Graph 2.3.5:   Corporate non-performing loan ratio of Italian banks

Source: Bank of Italy

Graph 2.3.6:   Ratio of loan impairments to total operating income and return on equity of Italian banks

Source: European Central Bank

Banks’ credit to Italian firms has contracted
strongly in response to higher credit risk and other supply constraints, but
weak credit demand has increasingly become the main driver of the downward
trend. On the supply side, the contraction is
mainly explained by increased credit risk which has made banks much more
selective in granting credit and looking for opportunities with better
risk-return profiles such as securities investment. Temporary uncertainty over
the evolving regulatory framework and the conclusion of the European Central Bank’s
comprehensive assessment of euro area banks may also have played a role. On the
demand side, the main drivers are subdued investment due to the uncertain
economic outlook and high spare capacity, the increased recourse of large
corporates to alternative funding channels such as bond issuance (this explains
why bank credit contracted more for large than for small firms), and to some
extent deleveraging needs among highly-indebted corporates. Over the past two
years, the gradual withdrawal of credit supply conditions from contractionary
territory has preceded that of credit demand conditions, which are now
considered the main determinant of observed lending trends (Graph 2.3.7). Since mid-2014, credit supply
conditions have been close to neutral, but access to finance for small firms
with weaker balance sheets remains precarious. Given the uncertain economic
outlook and continued high credit risk, lending volumes are not expected to
recover quickly.

Graph 2.3.7:   Credit supply and demand conditions for Italian non-financial corporates

Source: Bank of Italy

Small Italian
firms have become the main victim of banks’ tight credit conditions in recent
years due to their vulnerability stemming from strong dependence on bank
funding and high financial leverage. This is
reflected in the increase in lending rates which banks have been charging on
new loans to Italian SMEs, adding further to their financial difficulties by
undermining their debt service capacity and profitability. Although since
mid-2011 the cost of new bank loans to Italian companies has risen for all firm
sizes, the spread between the average interest rate charged to small firms
(proxied by loans below EUR 250,000) and large firms (proxied by loans above
EUR 1 million) has widened (Graph 2.3.8). Since mid-2014, nominal lending
rates have started declining (in part thanks to the European Central Bank’s
further monetary easing), but the beneficial effect has been offset by the fall
in inflation which has pushed real interest rates up. The asymmetric impact of
tighter bank lending conditions on small firms is also reflected by the inverse
relationship between firm size on the one hand and the share of discouraged
borrowers ([31]), the share
of firms of which the loan application was rejected, and the share of firms
declaring their liquidity situation as insufficient on the other hand.
Similarly, the deleveraging of the Italian non-financial corporate sector — in
part due to the strong credit contraction — has mainly involved those firms
with the highest leverage before the recession, in particular small firms
(Graph 2.3.9). Looking ahead, firms’ lower leverage
should in principle have a beneficial effect on their financing conditions
given improved creditworthiness.

Graph 2.3.8:   Bank interest rates on new loans to Italian firms

Source: Bank of Italy

Graph 2.3.9:   Deleveraging and credit rationing of Italian firms per leverage quartile

Source: Bank of Italy, Financial Stability Report, no. 2/2014, November 2014

Over the past year, the Italian
authorities have enacted several structural measures targeted at diversifying
firms’ funding sources, decreasing dependence on banks and fostering more resilient
financial structures. In the course of 2014,
several important measures were taken which could contribute to weakening the
bank-corporate nexus in Italy. Recent survey evidence suggests however that
SMEs’ awareness of the measures remains rather limited which may in part be due
to increasing policy fragmentation. ([32]) First, to give Italian firms an incentive to make their equity
base more robust, the Italian government has further strengthened the so-called
'allowance for corporate equity' (ACE) framework ([33]). It has done so in particular by extending the benefit to firms
without income tax liabilities through the provision of a regional tax (IRAP)
credit instead (to be split into five equal yearly amounts), and by allowing
firms that have decided to list themselves on a stock exchange to benefit from
a 40 % increase in the amount of equity capital raised to determine the
allowance during the first three years of being quoted (super-ACE) (the
latter measure is however still under approval by the European
Commission). According to a recent Bank of Italy survey of firms ([34]), only around 10 % of firms that have increased or expect to
increase net equity do so because of the allowance for corporate equity
framework. This situation may however have changed given the recent measures
strengthening the allowance for corporate equity, but lack of data prevents a
further assessment at this stage. Second, measures were introduced to encourage
the stock-market listing by SMEs. Third, the so-called 'mini-bond' framework ([35]) has been further strengthened to support a decrease in bank
dependence of Italian firms. In particular, the favourable withholding tax
regime already applicable to interest paid by listed bonds has been extended to
interest paid by unlisted (mini-)bonds, and mini-bonds as well as portfolios
thereof have become eligible for guarantees by the Central Guarantee Fund for
SMEs. Since November 2012, there have been around 70 mini-bond placements for a
total value of almost EUR 8 billion (ca. 10 % of total bond issuance over the
period). Initially, issuance was dominated by larger corporates with strong
balance sheets which replaced bank debt with mini-bonds, but the recent
decrease in average issuance size suggests a growing presence of medium-sized
firms, many of which are first-time issuers. For small firms however, mini-bond
issuance seems realistic only in combination with securitisation given the low
liquidity and higher risk of individual placements, and assuming small firms
are willing to bear the costs of higher transparency requirements. A fourth
measure is the exemption of institutional investors and foreign investors from
the withholding tax regime applicable to their medium- and long-term financing
to the Italian economy, as such fostering their development as alternative
lenders to the economy. Fifth, insurance companies (in addition to
securitisation firms and collective investment funds) have been allowed to
provide lending to firms, either directly or together with banks, and subject
to prudential rules and monitoring from the insurance supervisor IVASS. A
similar mandate is being granted to export insurance agency SACE. Although the
long-term nature of insurers’ liabilities makes them suitable alternative
lenders and corporate lending may currently offer better returns than insurers’
traditional investment policies, it remains to be seen whether this measure
will be successful in reducing Italian SMEs’ credit constraints. In particular,
the current economic climate and high corporate credit risk, the high cost of
setting up a credit monitoring capacity, preparations for the introduction of
the Solvency II framework and the improved opportunities to acquire exposure to
the corporate sector by investing in (loan) securitisations may make insurance
companies reluctant to embark on direct lending. Sixth, Cassa Depositi e
Prestiti has decided to invest EUR 350 million in a private-debt and
venture-capital funds, thus supporting the further development of capital
markets in Italy. Finally, the Italian government has decided to create a
service company to capitalise and restructure of promising Italian industrial
firms in temporary financial difficulties. However, further details are still
lacking.

Other policy measures have been targeted
more at overcoming firms’ more immediate access-to-finance obstacles in the
context of the current protracted crisis.
Overcoming access to finance and the liquidity problems of SMEs — the backbone
of the Italian economy — is essential to keeping viable firms in business and
supporting Italy's economic recovery, in particular through investment. In
terms of mitigating credit risk, the most significant measure has been the
progressive strengthening of the Central Guarantee Fund for SMEs in various
ways in recent years. During the crisis, reliance on the Central Guarantee Fund
has increased strongly, and the Fund has played an important role in supporting
the observed increase in the share of secured bank loans. During the first 10
months of 2014, EUR 6.5 billion of guarantees were granted in relation to a
loan volume of EUR 10.2 billion. More than 80 % of the loans concerned were
contracted by micro- and small firms. However, only a small share of the volume
of guaranteed loans (ca. 20 %) was meant to finance investment, whereas 80 %
was granted for supporting firms’ working capital. This suggests that Italian
SMEs continue to face challenges in expanding investment. A recent impact
study ([36]) of the
Central Guarantee Fund’s activities suggests that firms which access the Fund
have mainly benefitted from increased loan size rather than a lower interest
rate. Further crisis-inspired initiatives to ease access to finance for firms
and SMEs include in particular the increased involvement of Cassa Depositi e
Prestiti which in cooperation with the Italian Banking Association (ABI) has
been supporting investment by SMEs (for example in new machinery and equipment
through the EUR 5 billion Nuova Sabatini programme), as well as several
debt moratoriums. Finally, also the repayment by the public administration of
trade debt arrears (EUR 35.3 billion reimbursed at the end of January 2015) has
also helped to alleviate credit constraints on firms, but most of the
reimbursed funds have been used to reduce debt towards suppliers, employees and
banks rather than to finance new investment.

The very large stock of impaired loans
that built up during the crisis represents a crucial challenge for Italy in the
years to come. In the third quarter of 2014,
Italian banks’ balance sheets were burdened with a non-performing loan stock of
around EUR 315 billion, of which EUR 250 billion related to corporates. In
addition to being a drag on new loan generation in favour of the real economy,
undermining banks’ profitability and capital adequacy, this large impaired loan
stock may put strain on the capacity of many Italian banks — especially
medium-sized and small ones — to appropriately manage arrears. Now that the
inflow of new non-performing loans is stabilising, banks have started to
concentrate their efforts on raising the rate at which impaired loans are
cleared from their balance sheets. Italy’s two largest banks have taken the
lead by preparing to set up a common private vehicle dedicated to the proactive
management of restructured loans, also leveraging the knowledge and expertise
of external partners. Smaller banks with limited or insufficient in-house
capacity to service impaired assets are increasingly outsourcing this activity
to non-performing loan servicing companies. Another way to dispose of non-performing
loans is their sale on the distressed-debt market. Banks’ incentives to do this
include the removal of overhead expenses related to non-performing loan
management, the reduction of risk-weighted assets and consequent freeing up of
regulatory capital, and the recovery of profitability. In Italy however, the
size of the distressed-debt market is very small compared to the impaired loan
stock, despite the recent gradual increase in transactions (Graph 2.3.10). On the back of the still uncertain
economic outlook, the reasons for this include: (i) the lack of sectoral
coordination which would especially benefit smaller banks (further exacerbated
by the fragmentation of the Italian banking sector); (ii) banks’ reluctance to
sell in anticipation of a recovery in collateral values or given their
preference to preserve long-standing customer relationships; (iii) Italy’s very
slow and inefficient judicial processes which undermine the recovery value of
collateral; (iv) a thin capital buffer to absorb losses in the case of some
individual banks. ([37])
Nevertheless, a number of obstacles to the development of a distressed-debt
market in Italy have recently been removed. First, the improved tax
deductibility of loan-loss provisions and write-offs enacted in 2013 has
removed banks’ fiscal disincentives to recognise losses and has as such — in
combination with a lower haircut required by potential sellers due to the
slowly improving economic outlook — narrowed the spread between the bid and ask
price of impaired assets. Second, the conclusion of the European Central Bank’s
comprehensive assessment of euro area banks has increased transparency on the
quality of asset portfolios of the banks covered by the exercise. ([38]) Third, anecdotal evidence suggests that in recent months foreign
investors have become increasingly interested in investing in Italy. For the
time being however, the non-performing loan work-out rate in Italy remains
currently too low to achieve a significant reduction in the non-performing loan
stock over a reasonable time period. If the write-off rate does not increase
significantly, the stock of non-performing loans is likely to remain a drag on
Italian banks’ activity for a protracted period of time, also contributing to the
holding back of the Italian economy's recovery.

Graph 2.3.10: Sales of impaired assets by Italian banks

Source: PriceWaterhouseCoopers (PWC), European Portfolio Advisory Group - Market update, November 2014

Although Italy’s insolvency framework
has been modernised in recent years to facilitate corporate restructuring and
rescue, the beneficial effects are being held back by Italy’s inefficient and
overburdened court system (see Section 3.1).
Efficient (pre-)insolvency frameworks play an important role in fostering the
early restructuring and rescue of financially distressed but viable firms and
the speedy liquidation of non-viable ones. As such, these frameworks speed up
the deleveraging process of the corporate sector, support the resolution of
impaired assets on banks’ balance sheets, support recovery values and
contribute to a culture of second chance and entrepreneurship. Since 2005,
Italy’s general insolvency law (legge fallimentare) has been subject to
several modernisation efforts which have mainly promoted the rescue of viable
firms. A diverse set of tools — including out-of-court ones — is now available,
such as the restructuring-driven preventive composition (concordato preventivo)
for companies in financial crisis which is similar to the 'Chapter 11' process
in the United States. Further innovations include the super-seniority status of
interim financing and the immunity of out-of-court certified rescue plans (piani
di risanamento) from claw-back actions in case of subsequent insolvency.
Small enterprises are eligible for the personal insolvency framework (procedura
liquidatoria per sovraindebitamento) following an amendment in 2012 and the
recent creation of a special body to facilitate the preparation of
restructuring plans and support the overall process. The recent reforms
have done much to bring Italy’s insolvency framework into line with
international best practices. However, some of their effectiveness is being
significantly undermined by the insufficient capacity of the country’s court
system, which has come under additional pressure from the high inflow of new
cases due to the protracted recession. This is inter alia reflected in
the very long average duration of bankruptcy procedures which still averaged
7.9 years for cases closed in 2013, albeit one year less than in 2011. ([39]) Although their impact is not yet known, measures have been taken
to address the shortcomings of the court system (e.g. the arbitral transfer)
which are to apply also to disputes emerging in the context of bankruptcy. On
the other hand, the steadily increasing number of bankruptcies indicates that
there is room for improvement in the timely use of the pre-insolvency
instruments. A detailed analysis of the effectiveness of the various new
tools in Italy’s insolvency framework — also taking into account the diluting
impact of the crisis — is needed to determine whether further policy
intervention is required. In this context, the Italian Ministry of Justice
decided in January 2015 to establish a commission of experts which is expected
to make proposals for the reform and streamlining of the Italian insolvency and
collateral framework by end-2015. In addition, soft-law guidelines (such as
best practices among banks, including those for promoting early-warning
systems) may help to encourage stakeholders to take timely steps towards
restructuring.

Excessively long judicial proceedings
are an important obstacle to the proper functioning of the legal framework on
collaterals in Italy, further reform of which is under discussion. In general, speedy, cheap and simple collateral enforcement
procedures facilitate the work-out of secured impaired loans, maximise the
recovery value of pledged assets, foster thereby foster the development of a
private distressed-debt market, and have beneficial effects on the availability
and cost of credit to firms. Although Italy’s collateral seizure framework has
in recent years undergone some reforms aimed at simplifying the enforcement
procedure, there seems to exist scope for further intervention. Important
proposals have been tabled to tackle remaining framework-related and existing
practice-related obstacles, but they have not been pursued on so far to their
full extent. Innovations put forward include fine-tuned non-possessory liens,
also enabling automatic collateral appropriation by the creditor if the debtor
fails to comply with his obligations, and tools such as an electronic database
allowing the traceability of movable-asset collaterals. In addition, some
proposals based on the experience of other jurisdictions have been floated,
such as the fiduciary loan contract. ([40]) Discussions would need to produce a result which fits the Italian
context and legal system. Last but not least, in the interest of efficient
enforcement, it is essential that the bottleneck of Italy’s underperforming
court system which has come under further strain from the long crisis is
tackled: on average, it still takes around three years to foreclose and collect
collateral through court procedures in Italy.

The reform of the governance of Italy’s
largest cooperative banks (banche popolari), recently adopted by the
government, may kick-start a process of consolidation which could strengthen
the banking sector’s capacity to work out non-performing loans. In January 2015, the Italian government adopted a decree
law requiring Italy’s 10 largest cooperative banks (banche popolari)
to abolish the so-called 'one-head-one-vote' principle ([41]) and the 1 % ceiling on the stake of individual shareholders and to
transform themselves into joint-stock companies. Furthermore, the decree law
relaxes the voting rules applicable to mergers and acquisitions and decisions
on a change of legal form, while also relaxing rules on proxy votes. As such,
the decree law addresses long-standing concerns regarding the vulnerability of
Italy’s largest banche popolari. In addition to improving effective
oversight and shareholder control over the banks’ management and making the
banks more attractive to new investors, the reform — if not watered down in
parliament — is expected to trigger consolidation within the market segment.
This may in turn strengthen banks’ impaired-loan work-out capacities, apart
from creating scope for cost synergies. Finally, contrary to the governance
reform of the banche popolari, there has not yet been a specific
intervention reviewing the role of foundations in the Italian banking sector.

Bank-sovereign nexus

The Italian banking sector traditionally
holds a large amount of domestic government bonds which are generally
considered highly liquid. Since the beginning of
2012, domestic banks have significantly increased their domestic sovereign
exposure, to a large extent absorbing volumes shed by foreign investors and
thereby sustaining bond prices and expanding their collateral pool. By relying
on cheap Eurosystem funding through participation in the two three-year
long-term refinancing operations (LTROs), several Italian banks were able to
support their profit through carry trade. ([42]) In June 2013, domestic banks’ sovereign exposure reached a peak of
EUR 426 billion (corresponding to 10.2 % of total bank assets). Since then,
banks’ holdings have been broadly stable, fluctuating around EUR 400 billion
(Graph 2.3.11).

In spite of some new disincentives,
Italian banks are expected to remain closely intertwined with the sovereign. In the medium term, Italian banks’ holdings of domestic sovereign
debt securities are likely to remain high due to the substantial financing
needs of the Italian sovereign and the attractiveness of sovereign security
investment compared to alternatives such as lending in the current weak
economic environment ([43]). However,
there are other developments which are likely to lower incentives for banks to
invest in sovereign debt. One of these is the gradual phase-out of prudential
filters which neutralised the valuation effects of changes in bond prices on
banks’ capital under the EU’s new legal framework on capital requirements.
Others include the lower relative attractiveness of Italian sovereign
securities due to the substantial fall in the return they offer, and the
Eurosystem’s replacement of long-term refinancing operations with targeted
long-term refinancing operations (T-LTROs) ([44]) of which the use by participating banks is more constrained. The
continued high exposure of Italian banks to domestic sovereign debt implies
risks for both the banks and the sovereign. First, in spite of the current
favourable market conditions, the banking sector remains vulnerable to adverse
yield and credit rating developments in the Italian sovereign debt market. In
combination with the planned phase-out of prudential filters, these would
result in more volatile capital ratios, depending on the portfolio in which
banks hold the government bonds. Second, given the historically high share of
Italian government bond holdings in banks’ total assets, the willingness of
banks to sustain demand for sovereign debt may be limited. Should Italian banks
start reducing their exposure significantly, sovereign yields may rise with
potentially negative effects on the rest of the economy (for example through
higher lending rates). This risk is however mitigated by the gradual decline in
the Italian government’s borrowing requirement if the path of fiscal
consolidation is maintained, and the expansion of the European Central Bank’s
asset purchase programme which will also involve euro area sovereign bonds ([45]). The latter creates the opportunity for Italian banks with the
highest domestic sovereign exposures to reduce their holdings, and allows all
banks which sell government bonds to the European Central Bank to realise
capital gains following the strong decline in secondary-market yields in recent
months.

Graph 2.3.11: Italian banks’ domestic sovereign exposure and Italian 10-year sovereign yield

Source: Bank of Italy, European Central Bank

The large size of the Italian economy
makes it a potentially important source of spillovers in other euro area Member
States. Conversely, the Italian economy’s recovery is dependent on propitious
external conditions. Though geographically diverse,
the links between trade, finance and bank funding have the potential to cause
spillovers in other large EU Member States, neighbouring countries and central
and east European Member States.  Italy is also susceptible to spillovers from
outside: external demand, from both EU and non-EU countries, is paramount as
Italy’s GDP growth is largely export-led. The inflation environment in the euro
area is also crucial to the debt-to-GDP reduction effort and competitiveness
recovery.

Italy accounts for around 16.5 %
of overall euro area output and is tightly bound to other euro area countries
through trade and financial links. Concerning
trade, it is among the most important export markets for other large euro area
economies such as Germany, Spain and France, as well as for neighbouring
Slovenia. For Slovenia and Luxembourg, Italy-bound exports account for almost
10  % of their GDP. For nine other Member States, the weight of
their trade linkages with Italy varies between 3  % and 5  %
of GDP (see Graph 2.4.1).

Graph 2.4.1:   Italy —  Imports by county of origin (top 15 EU countries)

Source: European Commission calculations based on UN (2012 data)

Total exports of goods and services
represent approximately 29 % of Italian GDP.  Italian exporters depend to
a large extent on the German and French markets, whose imports correspond to
3.7 % and 3.1 % of Italy’s GDP, respectively. However, the inability
to contain existing surpluses in the euro area has put a strain on aggregate
demand. As Italy's growth hinges crucially on its export performance, those
asymmetric adjustment patterns between debtor and creditor countries within the
euro area weigh down on Italy's recovery. With a combined export weight of
3 % of Italian GDP, the United Kingdom and Spain are also significant
trade partners. Outside the EU, the United States and Switzerland are sizeable
export markets (approximately 2 % of GDP each) (see Graph 2.4.2).

Graph 2.4.2:   Italy —  Exports by destination (top 15 countries)

Source: European Commission calculations based on UN (2012 data)

Regarding financial links, most euro areas
countries’ financial exposure to Italy via equity and debt instruments is
relatively moderate ([46]) with the
exception of Ireland and Malta. Ireland’s total exposure to Italy represented
83  % of Irish GDP in 2012 while for Malta the figure was
38  %. Five other Member States had exposure of more than
10  % of their GDP, including France and the UK. EU Member States’
financial exposure to Italy mostly takes the form of debt instruments, rather
than foreign direct investment or portfolio investment in equity (see Graph 2.4.3). Conversely, Italy is significantly
exposed to equity investments in Luxembourg (approximately 15 % of Italian
GDP in 2012). Relevant though more modest gross financial investments (ranging
between 7  % and 10  % of Italian GDP in 2012) are in the
UK (essentially via debt instruments), France, the Netherlands, Ireland and
Germany.

Graph 2.4.3:   Italy —  Partner’s exposure to liabilities (top EU 15, excl. LU)

Source: European Commission calculations based on Hobza, A., Zeugner, S., ‘Current accounts and financial flows in the euro area’, Journal of International  Money and Finance, 2014. Debt excluding official equals other investment (e.g. loans) plus portfolio investment in debt securities, minus official amounts linked to TARGET2, the European Central Bank’s Securities Markets Programme and euro area financial assistance programmes. 2012 data.

Graph 2.4.4:   Italy —  EU bank claims, by sector

(1) Based on a EU sample of 12 countries; sum of sectors may not add to total due to unallocated claims Source: BIS consolidated banking statistics (ultimate risk basis, 2014Q2), IMF, own calculations

Data on banks’ cross-border exposure
show Italy’s crucial importance for the French banking sector. French banks’ exposure to the Italian economy ([47]) amounted to approximately 13 % of French GDP in the second
quarter of 2014, essentially concentrated in the non-bank private sector
(8 %). Seven other Member States had exposures to Italy of roughly
2 % to 4 % of their GDP, with Germany showing the second highest
total exposure in absolute values (see Graph 2.4.4). As for Italy’s exposure to other
countries, in the second quarter of 2014 the Italian banking sector was
significantly exposed to Germany, with claims worth approximately 12 % of
Italian GDP, mainly in the German non-bank private sector. Italy’s claims on
other countries are more moderate, with the UK, France, the US and Croatia
coming next in line with figures between 1.5 % and 2.5 % of Italy’s
GDP. Non-EU countries account for only about one quarter of Italian banks’
foreign claims; exposure to Russia was 1.3 % Italy’s GDP in the second
quarter of 2014.

Italy’s high public indebtedness could
have adverse effects on other euro-area countries.
The transmission channel here is financial markets’ sentiment and risk
perception. The high debt level and the challenge the government faces in
getting it onto a downward path in a context of low growth could create market
uncertainty if fiscal adjustment fatigue set in and/or reform action was
further delayed. Recent analyses of determinants of sovereign spreads in the
euro area ([48]) ascribe an
important role to the increase in general risk perception which particularly
affected vulnerable euro-area economies, including Italy. Furthermore, changes
in Italian sovereign CDS spreads appear to carry a significant potential to
negatively impact on spreads of periphery and southern member states ([49]).

Modest growth, prolonged low inflation
and insufficient policy coordination make the adjustment in Italy more
challenging. Sluggish demand in Italy’s main trade
partners, driven by simultaneous fiscal consolidation in several other euro
area countries and adjustment of excessive private indebtedness, makes it more
difficult for Italy to turn its export performance around. This is further
exacerbated by zero-lower-bound constraints on euro-area monetary policy to
counter deflationary pressures and to prop up economic activity. Low inflation,
much below the 2 per cent target for price stability, makes reducing Italy’s
debt-to-GDP ratio more challenging (see Section 3.1). It also reduces the room
for using price adjustment to recover competitiveness and makes the realignment
in relative prices within the euro area difficult. The European Central Bank
recently announced measures of quantitative easing, that should help anchor
positive inflation expectations while keeping the cost of sovereign financing
low. However to strike the right policy-mix balance, the fiscal-structural
stance would need to be less accommodative, and structural efforts stepped up.
In fact, Italy could take advantage of the accommodative monetary policy to
forcefully implement structural reforms to cushion the economy against
potential short-term negative effects on growth and consumption. Given the
potential beneficial effect of those reforms (in particular on competition) on
the functioning of Single Market, they could contribute to growth and
rebalancing in other euro-area partners.  There is also a case for coordinating
the structural effort, at the euro-area level, as there seem to be positive,
even if small, spillover effects of structural reforms. (See footnote 48
page 46)  Indeed, QUEST simulations show that the output gain of coordinated
structural reforms is about 10 % higher than in a scenario where each
country acts alone.

It is hard to quantify the extent to
which weaknesses in public administration affect Italy’s productivity
performance, yet evidence confirms that they weigh on the business environment
and the country’s capacity to reform. There are
numerous and diverse transmission channels by which inefficiencies in public
administration affect productivity performance, not least through the broader
business environment in which firms invest and operate. These include market
regulation, effective contract enforcement and justice systems, and the
productivity of the public sector. This makes it hard to conclusively estimate
how far the long-standing underlying weaknesses in the public administration at
large might have contributed to Italy’s low productivity dynamics over the last
two decades. Weaknesses in Italy’s public administration have included skills
mismatch, lack of transparency, and cronyism. ([50]) The World Bank 2014 Worldwide Governance Indicators show that
Italy’s performance is well below the European average in each of the six
dimensions covered by the index, including government effectiveness, control of
corruption, and rule of law. The 2013 European Quality of Government Index
showed Italy has the widest variation across EU regions among others in public
service quality and impartiality (see also Section 3.5). According to the World
Bank’s Doing Business indicators the excessive regulatory burden is a
major cause of competitive disadvantage for Italy: starting a company remains
costly while tax compliance and contract enforcement are cumbersome. In Italy
it takes over 1 000 days to enforce a contract, more than twice the OECD
average, and the still high backlog of civil cases — 5.2 million — points to
difficulties in absorbing pending cases and coping with incoming ones. Several
gaps also remain in the uptake of online public services, with Italy third from
bottom among OECD countries in use of the Internet for dealing with public
administrations. In addition to the direct costs on businesses that weigh on
cost-competitiveness, the weaknesses mentioned are shown in the literature ([51]) to have sizeable negative effects on the economy, by hindering
foreign direct investment and company growth, constraining labour
participation, and hampering reallocation.

A major effort is underway to improve
Italy’s institutional capacity to adopt and implement legislation. Italy’s broad structural reforms programme over recent years
contained measures that were only partially implemented or even abandoned, thus
depriving the economy of the full benefits of reforms. As of mid-January 2015
it is estimated that, among the 1102 decrees needed to implement the reforms
adopted by the last three governments over 2012-2015 ([52]), 47 % have been passed, 34 % are pending, and 19 % have an
implementation deadline that has already expired. Insufficient coordination and
overlapping responsibilities between different layers of government are a major
factor hampering the effective implementation of the measures adopted. Changes
in the institutional framework to remove bottlenecks holding back the adoption
and implementation of reforms are currently being discussed. In particular, a
constitutional reform expected by end‑2015 reviews the structure of
law-making process and the allocation of responsibilities between central and
sub-national governments. On the first point, the Senate would retain
legislative powers on only a narrow range of issues, a change that is likely to
speed up the legislative process. On the second point, some devolved functions
(e.g. energy and infrastructure) would be centralised again, the division of
responsibility between the centre and the regions clarified, the provincial
level of government phased out, and most concurrent competences (e.g. for
retail regulation) abolished, which could contribute to more uniform regulation
and more effective implementation.

Despite recent progress, a comprehensive
reform of the public administration is still pending. A recently enacted reform to modernise the public administration
aims to facilitate staff turnover, thereby reducing average age, improve
voluntary and compulsory mobility, limit the compensation of state attorneys
and top officials in local administrations, and streamline public bodies and
procurement. In addition, a ‘Simplification Agenda for 2015-17’ was adopted in
December 2014 to foster cooperation between central and regional governments in
establishing a more coherent simplification framework. However, swift and
effective operationalisation is proving challenging: a decree defining the
modalities of staff mobility in the public administration is still missing, and
a draft law enabling the government to reorganise the public administration
— including local public services, state administration, the evaluation of
managers’ performance, the business friendliness of administrative procedures,
and corruption prevention — is pending in the Senate. This reform could be
an important step forward.

Regular evaluation of the impact of
spending is not yet an integral part of the budgetary process across all
government levels. Building on past experiences of
spending reviews, a number of initiatives have recently been launched to
improve the efficiency of public spending in Italy. At central level, ministers
were directly involved in selecting areas within their own budgets eligible for
targeted savings without recourse to linear expenditure cuts as in the past.
However, the need to preserve growth-enhancing expenditure items and improve
the economic efficiency of the public administration would still require
top-down coordination and monitoring. In this context, the government is also
empowered to complete by 2015 a reform of the budgetary process that could be
more in line with a performance budgeting approach over the medium term. This
overall process could be supported by a fiscal framework strengthened by the
newly-established Parliamentary Budget Office, the national fiscal monitoring
institution that has been operational since September 2014. At local level, the
2015 Stability Law envisaged additional savings from regions (EUR 4 billion),
combined with the application of the balanced budget rule in 2015, i.e. one
year earlier than initially planned. If properly implemented, this may address
some of the problems experienced under the previous Internal Stability Pact,
such as the strong influence of historical spending on central transfers to
sub-national governments. However, since sound coordination of budgetary
responsibilities across government levels is not yet in place, the outcome of
the legislated cuts in terms of capital and current expenditure as well as
local taxation remains uncertain. Moreover, the needed agreement between the
state and the regions to decide on the distribution of expenditure cuts has
been delayed, which entails some risks to the achievement of the 2015 budgetary
targets. Among the initiatives to improve efficiency in public spending and
achieve the planned savings at all government levels, wider use of centralised
public procurement envisaged by the Public Spending Rationalisation Programme
was partly implemented as of January 2015, by establishing a restricted list of
‘procurement aggregator bodies’ — including CONSIP the national
central purchasing body and a territorial procurement aggregator per
region — together with a technical working table coordinated by the
Ministry of Economy and Finance. To become fully operational, a further
governmental decree is needed specifying the product categories covered and the
spending thresholds above which central and local administrations must use
centralised procurement.

Some relevant reforms have been enacted
to improve the efficiency of the justice system. In
the past few years, Italy’s judicial system has undergone several reforms. In
September 2013, Italy completed a broad reorganisation of judicial geography,
decreasing the number of first instance civil courts by around 50 %, as
well as creating specialised courts for businesses aimed at achieving economies
of scale and promoting professional specialisation. Other reforms include the
2013 reintroduction of compulsory mediation in specific civil and commercial
matters, although with mixed success in terms of uptake ([53]), measures to limit excessive recourse to appeals through an
eligibility filter, and an increase in court fees. In the course of 2014, a law
introduced further digitalisation measures in civil, administrative, and
tax-related trials, established ‘proceedings offices’ supporting the judges,
and provided for accelerated administrative proceedings concerning public
procurement. A second reform sought to reduce the backlog of civil cases by allowing
the transfer of pending cases to arbitration and introducing a new form of
out-of-court settlement, on top of new measures to improve the enforcement of
judicial decisions. In this context, crucial aspects are the adequate
operationalisation of these measures, including in terms of incentives to the
uptake of new alternative dispute resolution mechanisms, as well as the regular
government monitoring of their success in tackling long-standing
inefficiencies. In particular, it is important that the new measures to favour
out-of-court settlements would not end up increasing the overall length and
costs of civil proceedings. November 2014 data on the uptake in five judicial
districts of the ‘digital civil trial’, now compulsory in first instance,
indicate a reduction between 19 % and 60 % in the time to deal with a specific
type of case and savings estimated at around EUR 43 million. In early 2015, two
draft enabling laws forming part of justice reform package announced by the
government at the end of August 2014 were presented to parliament. The first
concerns honorary magistrates and ‘judges of peace’. The second aims to reform
the civil proceedings in order to reduce their length, extend the competences
of business courts specialised in company-law cases, and create courts
specialised in family-law disputes and human rights.

Despite some progress in terms of
judicial efficiency, lengthy trials remain a major factor behind Italy’s poor
business environment. Beneficial impacts on the
functioning of the justice system and on the economy at large may be expected
from the judicial reforms enacted by Italy over the recent years. In fact,
predictable, timely, and effective enforcement of obligations and rights in
fields such as property (including intellectual property rights), insolvency,
and labour law help create a trustworthy and business-friendly environment
conducive to investment and entrepreneurial activity. However, the latest
available evidence for Italy does not reflect the expected efficiency gains
yet. Namely, according to the latest data , a decrease by around 5% in the
number of pending litigious civil and commercial cases can be observed between
2012 and 2013, essentially due to relatively high clearance rates ([54]). However, the absolute backlog per 100 inhabitants, at around 5.3,
is still the third-highest in the EU ([55]). On the other hand, while the disposition time decreased for civil
and commercial cases (litigious and non-litigious) in both first and second
instance ([56]), it
increased for litigious cases by some 3 % over the previous year, remaining the
third highest in the EU. Although first instance courts account for the largest
part of pending cases, recent evidence  shows that their capacity to reduce
them is much greater than in higher instances ([57]). Between 2012 and 2014, the percentage of Italian consumers
finding it easy to resolve disputes with businesses through either courts or
out-of-court bodies increased from 24 % to 30 % and from 30 % to 43 %,
respectively, but remained well below the EU average (36 % and 46 %). ([58]) Overall, only real and perceivable progress in terms of efficiency
of the justice system, ensured by adequate follow-up on the reform momentum,
could contribute to make the business environment more conducive to foreign
direct investment.

Corruption in Italy is still a major
problem and the statute of limitations remains an obstacle to the fight against
it. The 2014 EU anti-corruption report highlights
the persistence of challenges such as high-level corruption and links with
organised crime, conflicts of interest and asset disclosure, infrastructure and
other large public works, and corruption in the private sector. This is
confirmed by several international indicators: the World Economic Forum Global
Competitiveness Report 2014-15 ranks Italy 102nd out of 144
countries on indicators related to ethics and corruption. The World Bank
governance indicators ranked Italy 25th in the EU for control of
corruption in 2013 data. It is estimated that ineffective anti-corruption
measures have so far deterred inward investment and economic growth. ([59]) Transparency International and the Council of Europe Group of
States against Corruption have pointed to the statute of limitations as a major
weakness in Italy’s system for preventing corruption and called for a thorough
assessment of the reasons behind the large number of time-barred corruption
cases and for a comprehensive plan to tackle them. ([60]) A first-instance conviction does not make any difference in the
Italian system as regards the possibility that a case be dismissed as
time-barred once the legal prescription term expires, which, especially in the
presence of lengthy investigations and appeal procedures as it is often the
case for corruption offences, creates high incentives for delaying tactics by
the defendants and low incentives to resort to optional expedited procedures. ([61]) Indeed, the evolution over time in the ratio of time-barred
criminal cases to the total number of resolved cases reported in Figure 3.1.1 shows that, while prescription rates
in first instance remained quite stable over time, prescriptions in appeal
courts significantly increased from 15 % to 22 % over 2005-13. This confirms
the significant level of cases that are time-barred after first instance
convictions. While since 2013 the Council has addressed a country-specific
recommendation to Italy requesting a revision of the statute of limitations,
this process is still in the initial phase. Namely, draft laws are under
discussion in the Parliament to suspend prescription terms for two years after
first-instance convictions and for a further year after conviction on appeal,
to raise penalties and thus also prescription terms for corruption offences, to
introduce new offences such as accounting fraud and step up the fight against
mafia. Swift and joint approval and operationalisation of these norms could
represent a step change in the fight against corruption.

Graph 3.1.1:   Ratio of time-barred criminal cases to total resolved criminal cases per instance

(1) Total resolved criminal cases in 2013 are reported in parenthesis per relevant instance Source: Ministry of Justice, European Commission

Some efforts have been made in enhancing
the prevention and repression of corruption, but operationalisation is often
challenging. Some progress in preventing corruption
has been made by broadening rules on transparency and conflict of interest for
independent authorities and public administrations contracting out studies and
consulting activities, as well as the powers of the national anti-corruption
authority. This was merged with the former procurement supervisory body and
given powers to oversee the awarding of public contracts and recommend stopping
tenders deemed at risk of mafia infiltration, bribery or other corruptive
phenomena. Over 2014, the authority intervened in several high-profile
procurement cases by making recommendations to local prefects. Following this
reform, the authority is being reorganised internally on the basis of a plan
presented by its president at the end of 2014 but yet to be endorsed by the
government. However, the authority has no fully enforced powers to penalise
violations, its opinions are non-binding, and its capacity remains to be proved
in the proactive monitoring of the corruption prevention plans due by all
administrative bodies and state-owned companies. In early 2015 the offence of
self-laundering — i.e. the re-employment or transfer of resources stemming
from an assumed illegal activity like tax evasion — was introduced in the
Italian criminal code in order to prevent the use of resources from tax evasion
or slush funds. This could benefit the new rules on voluntary disclosure aiming
to collect more tax revenues (EUR 671 million are expected) from the
repatriation of Italian capitals that had been deposited abroad by September
2015. However, it is too early to assess the effectiveness of this provision, on
which the success of a deal with Switzerland to abolish bank secrecy and
introduce the principle of cooperation in identifying dubious cash flows could
also impact.

Italy’s management of EU funds remains
poor but recent reforms may deliver improvements.
The use of EU funds over the 2007-13 programming period continued to rank low
with an absorption rate for all structural funds of 70.7 % of total planned
resources at end-2014, still substantially below the EU average. Part of the
gap is due to delays, bottlenecks, and administrative weaknesses, particularly
in the south of Italy. However, some steps are being taken to improve the
situation at all levels. The 2014-20 Partnership Agreement, approved by the
Commission in October 2014, envisages that all EU co-funded operational
programmes will have to be accompanied by plans of administrative
reinforcement. These plans are designed to guarantee that administrations have
the basic level of structure and competence necessary to manage the resources
entrusted to them. They also include measures to strengthen public
administration in general in fields that are crucial for proper and effective
management of EU funds, such as public procurement, state aid and corruption
prevention. Furthermore, after long delays, Italy’s agency for territorial
cohesion is about to become operational: the director has been named, part of
the personnel from the existing Department for development and social cohesion
is being transferred to it, and open competitions to recruit further staff are
under way. The agency will focus its attention and the bulk of its resources on
Italy’s less developed southern regions. The prime minister has been given
direct monitoring and intervention powers to ensure the timely use of funds,
which should particularly help regions with a lower absorption rate.

Market opening

Barriers to competition remain, thus
hampering productivity and investment. Service and
product market reforms facilitate resource reallocation and investment, and are
thus a necessary complement of labour market reforms. Italy has made some
progress in the last two decades. On the OECD synthetic index for product
market regulation Italy is now in line with the OECD average, while it was
among the most restrictive countries in 1998. After a wave of reforms in 2012,
the pace had stalled, however, and barriers to competition remain in many
sectors of the economy.

In February 2015, the government has
adopted a draft law on competition addressing barriers to competition in
several sectors of the economy, but with measures of various depth and scope. In February 2015, the government adopted a draft law on
competition, abiding for the first time by the 2009 legislation that requires the
government to present such draft law every year on the basis of the National Competition
Authority's proposal. This is an important step and may set in motion a
positive mechanism, whereby regulatory barriers to competition are regularly
reviewed and tackled. The draft law covers most of the sectors identified by
the Competition Authority and in the 2014 country-specific recommendations,
although with differentiated scope and ambition. Measures are particularly
incisive in the insurance sector, aimed at fighting fraud, broadening the scope
for discounted policies under specific conditions, and enhancing transparency
and the possibility of comparing across offers. In the telecommunication
sector, positive measures are taken to ease switch also through increased
transparency on the conditions and penalties. The draft law almost completes
the liberalisation of fuel distribution, removing remaining restrictions to new
entries, as limits to fully automatised stations had been already removed in
October 2014.  Measures of more limited scope are taken for the legal
professions.  For notaries, the draft law removes the compulsory notarial deed
for some specific acts, the minimum reference turnover, allows active
promotion, and enlarges the geographical scope of activity to the whole
administrative region. However, the reference maximum number of notaries per
number of inhabitant remains. For lawyers, the draft law allows
non-professional shareholders but maintains the scope of activities reserved to
lawyers and the parameters set by the Ministry of Justice in the event of
litigation (which could translate into de facto minimum tariffs). The scope of
activity for limited liability companies is also enlarged for the engineering
profession. In the context of the mutual evaluation exercise of regulated
professions conducted at European level, Italy has still to complete for all
its regulated professions the analysis to see whether the existing regulatory
approaches are justified by general interest and proportionate, and explore the
use of alternative forms of regulation. With regard the distribution of
pharmaceutical products, the draft law removes the limit to own more than four
pharmacies and allows corporate bodies to own pharmacies. However, it does not
remove the quota regime, does not open the market for drugs with compulsory
prescription but no state reimbursement and does not address the bottlenecks to
the uptake of non-patented drugs, as identified by the Competition Authority. Market
opening measures had been already taken in the banking sector with respect to
the portability of check accounts and in the rental market for large buildings.

Other important sectors are however not
covered by the draft competition law. Some
important sectors identified by the Competition Authority are not covered by
the draft law, namely the allocation of radio spectrum frequencies, health
sector, taxis, ports and airports, and local public services (see below).([62]) Competition in the maritime and hydroelectric sectors is severely
hindered by authorisation schemes under which service providers are given the
right to use public infrastructure for long periods without competitive
procedures. Evidence show that the award of hydroelectric and beach
authorisations through competitive and transparent procedures reduces costs for
consumers and increases the payments by concession holders to the state.
Furthermore, a measure introduced in 2014 allows the incumbent motorway
concession holders to propose changes to the concession contracts that could
result in lengthy extensions, which may foreclose the market and raise possible
issues of compatibility with EU law. Finally, Italy remains characterised by a
fragmented and stratified system of laws and regulations emanating from
different levels of government. In particular, Italy’s retail sector remains
one of the most regulated in Europe, according to the OECD product market
regulation indicator, and differences in the way national legislation is
interpreted and implemented at the regional and local level may also stifle
competition.([63])

Local public enterprises and local public
services

Italy's more than 8 000 local
state-owned enterprises weigh on the efficiency of the economy and public
finances. The report of the Commissioner for the
spending review records 7 726 local State-owned enterprises, which are active
in all sectors of the economy. ([64]) Around 35 % of the 3 152 companies surveyed by the Court
of Auditors in 2012 reported losses in at least one year from 2010 to 2012.
According to the spending review Commissioner, around 438 local state-owned
enterprises (598 including those in liquidation) had recorded yearly losses
over 2010-12, which questions their viability. The share of aggregate losses
borne by the public administration is estimated at EUR 1.2 billion per year, of
which around 25 % are borne by local state-owned enterprises that do not
provide local public services or other services of general interest. There are
important signs of inefficiencies: (i) at least 3000 local state-owned enterprises
have fewer than six employees and in about half of local state-owned
enterprises the number of directors is higher than the number of employees;
(ii) 44 % of municipal state-owned enterprises are co-owned by municipalities
with fewer than 30 000 inhabitants, indicating there are important potential
economies of scale to be made through consolidation; (iii) in a large number of
local state-owned enterprises, the public shareholder's stake is very low —
below 5 % for some 1 400 local state-owned enterprises, below 10 % for about 1
900 and below 20 % for 2 500 — which appears too low if participation served
the general interest.

The regulatory framework for state-owned
enterprises is unclear. Although state-owned
enterprises are in principle subject to private law, special provisions or
features of public law add to the legal framework. This complicated framework
is the result of developments over the years, which have seen the introduction
of several legal tools reflecting the contemporary trends and addressing the
needs of the moment. This gives rise to inconsistencies and uncertainties which
result in cumbersome court proceedings in order to be resolved.

The vast majority of state-owned
enterprises are sheltered from competition. The
Court of Auditors reports data by contract award procedure for 2012, summarised
in Table 4.2.1 below. Open tendering is used for a very small proportion of
contract awards, while the vast majority of contracts is done either through
‘in-house’ awards (with no open tender) or similar procedures. According
to the Competition Authority, some of the in-house contracts refer to services
that could be provided by different operators through open competition, as they
entail potentially profitable and therefore attractive business (e.g. car and
bike- sharing schemes, tourist transportation). Furthermore, several in-house
awards do not comply with the conditions of the EU and national framework.

Table 3.2.1:     Type of award

Source: Corte dei Conti, Gli organismi partecipati degli enti territoriali, 2014.

The need for a comprehensive reform is
acknowledged by the government but action is weak as derives from the extension
granted for rectifying non-compliant in-house contracts. The enabling law for the reform of public administration would
delegate to the government the power to enact legislative decrees for a
comprehensive reform of local state-owned enterprises and local public
services. This would include making the involvement of local authorities in
state-owned enterprises more transparent; promoting the consolidation of local
state-owned enterprises across municipalities; defining optimal territorial
areas in the context of providing local public services; strengthening competition
and protecting consumers' interests in local public services; introducing
mechanisms to reward local administrations that use open tendering; and
streamlining the overall regulatory framework on state-owned enterprises to
prevent overlaps and contradictions. Pending such reform, the 2015 Stability
Law includes measures to improve transparency and foresees a rationalisation
process based on rationalisation plans to be submitted by local and regional
authorities by end-March 2015.. However, the rectification of contracts not
complying with the EU and national requirements on in-house awards has been de
facto postponed to 31 December 2015 despite the end-2014 deadline set in
Italy's 2014 country-specific recommendation. Nor has there been yet any
official assessment on the number and economic features of such contracts.

Public procurement

Italy's public procurement system faces
a significant number of important problems:
complexity, fragmentation and instability of the legal and institutional
framework; administrative burden; excessive length of procedures; high
litigation rate; fragmentation of e-procurement solutions; contracting
authorities’ lack of administrative capacity; significant barriers to
competition in key economic sectors; and inefficiency of the system of
supervision and control. The government has announced a reform of the code of
public contracts aimed at transposing the new directives on EU public
procurement and concessions and at simplifying the currently fragmented legal
framework. A national strategy for public procurement is also being developed.
It is to identify measures to overcome the country’s systemic public
procurement problems. It could also include e-procurement, which is currently
done at national, regional and local level, increasing complexity and the risk
of duplication or redundancy.

Network industries and infrastructures

The competition framework and
infrastructure are still major weaknesses in the transport sector. Inefficiency is particularly critical in local and regional
transport services, which account for around 28 % of companies in local
public services described above. In road transport, recent research shows ample
evidence of inefficiencies, in terms of substantial oversupply, high ticket
evasion, fragmentation (the largest operator in Italy employs 12 000, against
120 000 in the UK) and under-investment in the fleet. Italian companies have
lower revenues per km than their counterparts in the UK, Germany, France,
Sweden, Belgium and the Netherlands (EUR 1.08 per km against an average of EUR
1.34) and receive higher public subsidies (EUR 2.2 per km against an average of
EUR 1.4). ([65]) In
railways, the majority of the public service contracts between the incumbent
operator (i.e. Trenitalia) and the regions expired at the end of 2014 and the
absence of a structured framework for competitive tendering procedures
precludes a real improvement in competition in the sector. The amount paid by
the state as a compensation for the obligation of public services is however
relatively low at 12 EUR per 1 000 passenger/km against an EU average of around
60 EUR per 1 000 passenger/km. In addition, public aid for railway
infrastructure development more than halved between 2009 and 2012, from over
EUR 8 billion to less than EUR 4 billion. Italy’s trade would also greatly
benefit from better port infrastructure. The lack of intermodal connections
with the hinterland remains one of the major causes of inefficiency. The
situation is particularly difficult in the southern regions. For instance, only
8 % of ship berths are connected to the inland railway network in the south
against 48 % in the north. Furthermore, lengthy and costly administrative and
customs procedures, insufficient coordination and lack of strategic planning of
port development also affect the way they function.

The Transport Authority is operational
and is consolidating its work and activities. The
Transport Authority, legally established in 2011, was set up in September 2013
and became operational in January 2014. Full staff enrolment is still pending,
but the authority has already started taking some regulatory actions, for
example on access to railway infrastructure, passenger rights, airport tariffs
and tender criteria for highways and local public transport. This could help to
address some of the major barriers to competition. The national reform
programme also envisaged the adoption of specific measures to improve the
sector's efficiency, such as increasing the use of open tendering procedures
and standard costs in public procurement and the use of intelligent transport
systems by December 2014. However, no significant progress has been made in
this respect. Italy did not provide the Intelligent Transport System progress
report that was due in 2014.

No significant progress has been made to
improve the management of ports and their connections with the hinterland. Decree law ‘Sblocca Italia’ mentions the adoption of a National
Strategic Plan for Ports and Logistics which will mainly focus on reorganising
existing port authorities and promoting intermodal transport by strengthening
certain connections (e.g. crucial port/airport links). However, so far concrete
steps have not been taken and political discussions to determine the details
are expected in 2015. On interconnections only limited improvements have been
made, among them the new Venice-Mestre access to the North Sea-Baltic and
Mediterranean Corridora and rail and road access to the port of Civitavecchia
from the Scandinavian-Mediterranean Corridor. Works to improve the
accessibility of the other Trans-European Transport Network core network ports
to the Trans-European Transport Network core network corridors are lagging
behind. A national airport plan was approved by the Council of Ministers in
September 2014 and final adoption should follow soon.

Next generation broadband networks,
digital skills and the use of information technology by firms, households and
government are not adequate for the needs of a modern knowledge-based
society. ([66]) Italy features the lowest share of fast and ultra-fast broadband
subscriptions relative to total broadband subscriptions in the EU. In 2014 only
2.2 % of subscriptions had a speed above 30Mbps, considerably lower than the EU
average (22.5 %), and next generation networks were available to only 21 % of
households, the lowest value in the EU. Only 47 % of the Italian population has
at least basic digital skills (vs an EU average of 60 %), while the share of
the workforce with sufficient digital skills is also well below the EU average (38
% vs 54 %). These figures partly reflect little use of the internet: in 2014,
31 % of the population had still never used the internet, significantly higher
than the EU average of 18 %. Furthermore, in 2014 only 23 % of people dealt
with public authorities online, half the EU average of 47 %. In addition, only
a fifth (22 %) of Italian consumers bought goods or services online in 2014
(the third lowest percentage in the EU), with very little increase (2
percentage points) since 2013. ([67]) Consumer confidence in buying online domestically is the fifth
lowest in the EU. ([68]) On the
business side, companies in Italy are still lagging behind in their use of
digital technology to sell products and services. In 2014 only 18 % of large
companies were selling on-line, almost half the EU average of 35 %. Small and
medium-sized companies were even less active with only 5.1 % of them selling
online — the worst performance in the EU, and far less than the EU average of
15 %. Italian firms' low use of digital technology is particularly critical in
the textile sector where Italy is strongly specialised. They risk losing out to
competitors investing more in digital technologies to make innovations in their
business processes.

The government has set out some plans to
address these bottlenecks but progress remains limited. Italy’s plans for a digital growth strategy and next generation
networks remain vague in terms of implementation details and targets. They also
do not provide enough support to public and private investment to reach the EU
Digital Agenda targets by 2020. In the context of the grand coalition for
digital jobs, Italy has set up a national coalition for digital jobs to address
the digital skills gaps at national level. In 2013 the Italian government
started working on a national plan for digital culture, education and
competencies but to date this has produced very few concrete initiatives. In
the context of the digital agenda strategy the government has set up three
priority initiatives: e-invoicing (for public administrations), e-identity and
a unified population registry. Compulsory e-invoicing of public administrations
has been operational for central administrations since June 2014 and its
extension to local administrations is planned for March 2015. E-identity and
the unified population registry are supposed to be gradually introduced
starting from 2015. Other initiatives described in the digital agenda strategy
include provisions of e-payments, e-justice and e-health. The main concerns
about Italy's strategy are the long deadlines set for full implementation
(prone to additional delays), local administrations' compliance and issues with
interoperability standards across public administrations for some public
services (health in particular). A detailed national strategy on e-procurement
with specific objectives, targets and indicators in line with EU e-procurement
objectives is also missing from the digital growth strategy.

Insufficient grid capacity hampers the
smooth functioning of the electricity market and contributes to higher
wholesale prices, while security of supply in the gas sector is sometimes at
risk from insufficient storage capacity. The
national electric power grid is not sufficient to meet demand and this creates
bottlenecks across the country. This is reflected in regional price variations
between different price zones. The situation is currently improving, except in
Sicily where electricity prices are significantly higher than in the rest of
Italy. Depressed internal energy demand and the marked slowdown in the Italian
electricity market represent the main obstacles to a significant upgrade of
infrastructure capacity. In particular, several gas projects have been delayed
or cancelled (Galsi, Tauern, perhaps IGI-Poseidon, while TAP has not secured a
final landing site). Complex and regionally inconsistent procedures for
building plants and strengthening the grid are also hampering the full
deployment of renewables.

The policy response to these challenges
has been mixed. Some Italian projects have been
included in the first Projects of Common Interest list. These projects could
further develop much-needed infrastructure in particular in the northern part
of the country where they will improve interconnectivity with the European
market (e.g. France, Austria and Slovenia). Some other projects of common
interest involving Italy will strengthen the southern electricity internal line
and reduce bottlenecks inside the country. The issue of ‘price zones’ and
north-south disparities may decrease through the new Sorgente-Rizziconi
electricity cable connecting Sicily with the mainland. Italy has identified the
categories of infrastructures to be considered as 'strategic' but not the
specific projects, a step that was foreseen in the 2013 National Energy Strategy.

Energy efficiency, renewable energy, climate
and the environment

Italy has made some progresses towards
achieving its renewables and energy efficiency 2020 targets. In 2012 renewable energy in Italy accounted for 13.5 % of gross
final energy consumption, showing that there is some progress towards meeting
its 2020 target of 17 %. To alleviate cost pressures on Italian firms, in line
with the national reform programme, in October 2014 the government cut feed-in
tariffs for photovoltaic and other renewables energy plants. Experience
elsewhere in Europe shows that such retroactive changes can undermine investor
confidence and may increase the cost of capital for future investments. On
energy efficiency, Italy appears to have achieved its 2020 targets for primary
and final energy consumption in 2012, which could be partly explained by the
lower than expected economic growth. Italy has indicated to be on track with
the implementation of the EU acquis but red tape and a fragmented regulation at
the regional and local level may hold back investment, particularly in the
building sector.

Waste and water management is
inefficient and a strategy for the adaptation to climate change is lagging. Environmental problems such as inadequate waste management and
lacking or non-functioning water infrastructure are a persistent concern,
particularly in southern Italy. In the centre and northern regions poor
land management, flooding and air pollution are the main challenges with a
significant impact on the national budget. ([69]) It is estimated that air pollution causes almost 67 000 premature
deaths and over 16 million workdays lost per year (2010) and that flooding cost
the economy €11 billion between 2002-13. As recognised by Italian Authorities ([70]), infrastructures and economy could be seriously affected by
climate change, in particular in areas including tourism and agriculture. The
Italian government has prepared a National Adaptation Strategy to take
appropriate action to prevent or minimise the damage caused by climate change,
which has been discussed with the regions. However the strategy has not yet
been adopted despite the strong encouragements made in the EU's Adaptation
Strategy.

Research and innovation

Research and development intensity and
innovation are low in Italy and public-private collaboration remains weak. Business research and development intensity in Italy was 0.67 % in
2013, against an EU average of 1.29 %. Public sector research and development
intensity is also at a significantly lower level than the EU average (0.54 %
instead of 0.72 % in 2013. This is also because Italy has been cutting its
public research and development budget at a higher rate than the overall public
budget (the share of research and development in government expenditure fell to
1.02 % from 1.32 % in 2007). At the same time, Italy’s weak innovation
performance is not able to contribute to the renewal of the economic fabric, in
particular in terms of fast-growing innovative firms and employment in
knowledge-intensive activities. Italy also has an only modest level of
public-private cooperation in research and development and public-private
scientific co-publications are well below EU average (33.4 co-publication for
million population in Italy vs. 52.8 for the EU). ([71]) Public research and development financed by business represents
only 0.014 % of GDP (EU: 0.051 %). In Italy, public-private
cooperation occurs on an ad-hoc and sporadic basis in the absence of
well-developed networks and formal structures. The low research and development
activity is both a consequence and a factor of Italy’s relative specialisation
in low-to-medium technology products and weigh on the non-price competitiveness
of the economy (see Section 2.2.3).

Limited steps were taken in 2014. First, Italian authorities launched a new research and development
tax credit for all types of businesses investing in research and development
and released all secondary regulations needed to make the measures included in
the start-up law operational. The tax credit is however temporary (2015-19), in
continuity with past experiences whose frequent changes, temporal character and
low predictability have weakened the effectiveness. Second, a growing share of
public research and innovation funding was distributed on the basis of performance
indicators and some barriers to the recruitment of full and associate
professors were removed. Finally, measures to facilitate innovative firms’
access to the credit market and to innovative financial instruments, such as
equity crowd-funding (see Section 2.2.4) will also help. While these measures
are likely to improve efficiency in resource allocation and might to some
extent help leverage private research and innovation investment, the overall
underfinancing of research and innovation activities, the weak public-private
collaboration, and the continued lack of effective and timely policy
implementation remain problematic.

Labour market

While no progress has been achieved
towards meeting the 2020 employment targets, activity rates have remained
resilient, reflecting rising participation in the labour force by the elderly
and women. However, falling labour market participation among young people
shows their increasing discouragement. Between 2007
and 2014 the proportion of the population in the labour force increased from
62.5 % to 63.7 %, an unusual development given the increase of long-term
unemployment and the protracted slack of labour utilisation (see Section 1).
The increase of labour supply was particularly strong during the recession
triggered by the 2011 sovereign debt crisis. In single-earner households,
more stringent household’s economic needs resulting from uncertain or lacking
labour income had a positive effect on the activity rate (the so-called added
worker effect) that compensated for the ‘discouraged worker’ effect
typical of recessions. The added worker effect led to a significant increase of
female activity rates, from 50.7 % in 2007 to 54 % in 2014 ([72]), while tax incentives for women adopted in 2012 might have also
played a role. This increase is particularly large for prime age workers (age
group 25-54), in particular women aged over 40, whose activity rate increased
to 75 %, 5 percentage points higher than in 2007. For this age group, female
employment kept rising throughout the period; this increase was matched by an
increase in unemployment as a result of expanding activity rates. Yet, female
activity and employment rates remain very low compared to the EU average. ([73]) In the case of older workers (age group 55-64), their activity
rate increased from about 35 % in 2007 to 48.4 % in the first three quarters of
2014. A number of factors contributed to these developments, including the
pension reform in late 2011 which raised the retirement age and led to changes
in the attitudes towards female employment. These positive developments
contrast with falling participation among younger cohorts aged below 35.
Furthermore, the discouraged worker effect is becoming stronger, in light of
the persistently low job‑finding rates and prolonged labour market slack.
The number of those willing to work but not seeking a job because they believe
no work is available increased from 5 % of the potential labour force in 2005
to 7.5 % in 2013. ([74]) The
increase was stronger among young people than for other cohorts (Graph 3.3.1). The number of residents moving
abroad also increased, of which more than 30 % had a university degree ([75]).

Graph 3.3.1:   Discouraged workers by age groups

The graph shows the number of persons willing to work but not seeking because they think that no work is available, as a percentage of the sum of those plus the labour force. Source: European Commission, ISTAT

Persistently high rates of youth
unemployment and of young people not in employment, education or training point
again to the risk of discouragement from entering the labour market. This may
have potentially severe consequences on Italy’s human capital accumulation. Youth unemployment has almost doubled over the past decade to reach
almost 43 % in Q3-2014. It is also characterised by marked regional variations.
The proportion of young people aged between 15 and 24 not in employment,
education or training rose from 16.2 % in 2007 to 22.2 % in 2013 (32.9 % for
those aged 25-29) and is now the highest in the EU. Among these the big
majority (77.5 %) is willing to work but 56.3 % are economically inactive.
Furthermore, contrary to the pattern seen in some other Member States (e.g.
Spain), the fall in youth activity rates has not been associated with longer
time spent in education and training. The big gap between young graduates’
competencies and labour market needs has made the transition from education to
work increasingly difficult. Only 54.6 % of those aged 15-34, who
graduated from the first and second stages of tertiary education within the
previous three years were employed, against the EU average of 78.6 %. In addition,
having a foothold in the labour market is often not sufficient to ensure
lasting involvement and the Italian labour market remains segmented.

Active labour market policies are not
sufficiently developed to address the foregoing shortcomings, not least because
of the fragmentation of employment services across the country. Expenditure on active labour market policies is below the EU
average and is biased against job-search assistance. Furthermore, there is no
effective coordination between activation policies and the unemployment benefit
system. Also, the evaluation of active labour market policies is occasional and
not based on systematic monitoring. A crucial element holding back effective
active labour market policies is the poor performance of employment services,
which show limited capacity to provide transparent information to job-seekers
and to address the needs of employers. Furthermore, there are enduring regional
disparities in the quality of services provided by public employment services
and in the quality of cooperation between public and private employment
services.

The 'Jobs Act' includes promising
measures to reform the governance of active labour market policies and their
interplay with passive policies. The establishment
of a national coordination agency envisaged by the 'Jobs Act' is a promising
step to improve the governance of the system as well as the link between
passive and active policies. The creation of the agency is also expected to
entail planning and implementing a comprehensive national strategy on
employment services, including a better integration between public and private
services. The related legislative decree is foreseen for spring 2015, only then
a full assessment of the measure will be possible. The definition of the basic
levels of provision of public services, which was already envisaged by the 2012
labour market reform, remains pending.

Limited progress has been made in
promoting female employment. Some measures to
foster female employment have been initiated, but their operationalisation and
effectiveness needs to be monitored. In 2013, financial incentives for hiring
unemployed women were introduced. To be effective, these incentives would
benefit from the provision of childcare facilities. Measures have been tabled to
counter regional disparities in the availability of childcare facilities
through structural funds and the Cohesion Action Plan, and additional funding
for early childcare have been envisaged by the 2015 Stability Law. However, the
percentage of children in the age range 0-3 who were in any kind of formal
childcare in 2012 (21 %) was still largely below the EU average
(28 %). No measures have been enacted to date to remove the financial
disincentives deterring married women in particular from entering the labour
market. Long-term care remains expensive and this reduces the labour supply of
women aged over 50 (see below). An additional ‘baby bonus’ of EUR 80 per month
(see section on social policy) has been established by the 2015 Stability Law
but its impact on the participation of women is likely to be limited. A scheme
to favour the reintegration of women into work after maternity, by providing a
benefit in return for curtailing parental leave, had a very low uptake and was
reformulated in 2014. The 'Jobs Act' includes some promising elements, such as
the extension of maternity allocations to all categories of female workers; tax
credit for working mothers; revision of existing tax credits for family
members; incentives for reconciliation arrangements included in collective
contracts; and improvement of child-care services. Some of these elements have
been included in the related implementing legislative decree, presented on 20
February 2015.

Measures taken to tackle youth
unemployment have not been sufficient; supporting young people in their
transition from school to work remains a major challenge. Several positive developments took place within the framework of
the Youth Guarantee Implementation Plan. To promote job creation, incentives
were introduced to hire young people between 18 and 29 years old and out of
work for at least 6 months on permanent contracts; the conditions for hiring on
apprenticeship contracts were simplified to make them more attractive for
employers; profiling methods were adopted to identify young job-seekers
according to the type of intervention required; a national website was launched
to foster outreach. To improve the efficiency of support measures, services
delivered to young people such as training, apprenticeships, assistance for
employment search, etc. were standardised in terms of costs, modalities and
duration, and an increased use was made of private placement agencies. However,
and in spite of EU funds being mobilised rapidly, youth employment prospects
remain a major challenge. Young people registered to the Youth Guarantee
account for about one fifth of the total potential clients (1.7 million young
people not in education, employment or training) and those with low education
and further away from the education and labour systems have been less involved
so far. ([76])
Interventions from public employment services towards young people are still
weak, especially in southern regions. Targeted approaches for differentiated
needs (such as ‘second-chance’ pathways in education), specific training
focusing on the skills required by the labour market, and work-based
experiences leading to qualifications remain underdeveloped. Despite recent
agreements between the Ministry of Labour and employers’ associations, more
concrete collaboration with stakeholders to provide for offers of sufficient
number and quality that respond to the needs of both demand and supply of
labour, in line with the objective of the Youth Guarantee, is still missing.
The apprenticeship contract does not yet represent a key port of entry in the
labour market.

Progress in combating undeclared work is
limited. In 2014, no additional legislative steps
against the shadow economy and undeclared work were taken. The most prominent
aspect of the fight against irregular work and evasion of social security
contributions was the increase and indexing of fines for violations of
regulations on safety and security of the workplace and irregular work (in
particular, administrative sanctions for undeclared work were increased by 30
%). However, the foreseen hiring of 250 inspectors and technical experts within
the Ministry of Labour and Social Policies was not confirmed by the Stability
Law. The 'Jobs Act' announces the creation of a dedicated agency that
should incorporate and better coordinate the different bodies involved in
labour inspection. The relevant implementing decree is planned for spring 2015.

Education

School outcomes and adult skills are
below the EU average and entry to the labour market is difficult for the
high-skilled. The early school-leaving rate remains
well above the EU average (17 % compared to 12 % in 2013), although it is
approaching the 2020 national target of 16 %. School education in Italy
produces rather mixed results in terms of basic skills attainment, with very
large regional differences between the centre-north and the south.
Italy’s tertiary education attainment rate is the lowest in the EU (22.4 % in
2013 for 30-34 year-olds), remaining well below its 2020 national target of
26-27 %. While the school-to-university transition rate is close to the EU
average, the drop-out rate is very high (45 % in 2012). ([77]) Entering the labour market is also difficult for the high-skilled;
for the 25-29 age group, the employment rate of tertiary graduates is 50.1 % compared
to an EU average of 78.5 % in 2013. Italy has a very low share of young people
in work-based learning and a very high and increasing share of young people not
in education, employment or training (26 % of 15-29 year-olds in 2013).

Italy does still not have a
comprehensive career guidance system at all education levels. Recent surveys show that many students made an ineffective choice
of their educational paths. At upper secondary level, 46 % of 2014 graduates
would not choose the same programme/school again. ([78]) At tertiary educational level, 66 % of recent first-cycle
graduates and 61 % of second-cycle graduates make no or limited use in their
job of the competences acquired during tertiary studies. ([79]) Starting with the 2013-14 year, career and counselling activities
became compulsory during the penultimate year of upper secondary education and
the last year of lower secondary education, but with limited additional
resources allocated (EUR 6.6 million in 2013-14). The national guidelines for
career guidance issued by the Ministry of Education in February 2014
acknowledge the need for extending and improving career guidance activities in
schools at all education levels. This would help increase the labour market
relevance of education and reduce early school leaving.

Italy’s adult population has one of the
lowest levels of numeracy and literacy skills among EU countries and lifelong
learning is not sufficiently developed. According
to the OECD Programme for the International Assessment of Adult Competencies,
close to 30 % of adults (aged 16-65) have low literacy and numeracy skills,
compared to an EU average of 19 % for literacy and 24 % for numeracy. The
youngest generation (aged 16-24) scores better than the overall population;
however, recent tertiary graduates (aged up to 29) do not score better than
upper secondary graduates in the best performing European countries. Adult
participation in lifelong learning remains low compared to the EU average (6.2
% compared to 10.5 %, in 2013) and has broadly stagnated over the last few
years. Compared to the EU average, it appears that the widest gaps concern
groups in the active population aged between 35 and 54, with low (ISCED 0-2)
and high (ISCED 5-6) educational attainments, and residing in the south. Italian
expenditure on training activities has fallen slightly over time (from 0.18 %
in 2007 to 0.14 % in 2011) whereas it slightly increased in the EU (from 0.18 %
to 0.20 % over the same period). Expenditure on general public financed
lifelong learning activities amounted to EUR 1.2 billion in 2012. Compared to
the period before the economic crisis, these measures were significantly
reduced as their funding was redirected to shoring up wage supplementation
schemes.

The government is prioritising
expenditure on school education after several years of cuts. The government held a public consultation on a reform of the school
system, to be financed by EUR 1 billion in 2015 and EUR 3 billion from 2016
through a fund created by the 2015 Stability Law. The public consultation ended
on 15 November 2014 and a legislative follow-up is expected by end-February
2015. The government also intends to provide broadband and wi-fi connections in
all educational institutions. This is linked to more general plans to improve
school infrastructure: EUR 1 billion has been earmarked in 2014-15 for actions
on safety measures, energy efficiency and anti-seismic regulations, as well as
to renovate schools.

Measures to improve school outcomes are
promising. The implementation of the first
three-year cycle of the National System for Evaluation of schools has started
in the 2014-15 school year. Properly involving all relevant actors and
stakeholders will be key to making it a success. One of the main measures of
the planned reform consists in replacing the current purely seniority-based
teacher career system with a system that includes also merit-based elements.
This would be a major innovation for Italy’s education system. Meanwhile, the
government also proposes to recruit on a permanent basis as of September 2015
almost 150 000 teachers who have so far worked under short-term contracts; from
2016 onwards access to the profession would be possible only through open
competitions.

Spending in tertiary education as a
share of GDP is well below the EU average but quality of higher education is
receiving more attention. Between 2009 and 2013,
overall public funding to tertiary education was cut by approximately 20 % in
real terms and general government expenditure on tertiary education as a share of
GDP is the lowest in the EU (0.4 % in 2012). (Graph 3.3.2) According to the principles of the
2010 reform, an increasing proportion of public funding for universities should
be allocated on the basis of research and teaching performance. However, until
2013 this has been difficult to implement in practice due to cuts in higher
education funding and restrictive rules that limited the annual changes in the
amount of funds each university could receive. In 2014, the share of performance-related
public funding to universities has increased from 13.5 % to 18 % (with less
restrictive implementing rules compared to 2013) and standard costs were
defined and are gradually being introduced by 2018 as criteria for allocating
the remaining share of public funding. In the medium- to long-term,
adequate funding will be key to improve the performance of Italy’s tertiary
education sector.

Graph 3.3.2:   General government expenditure on tertiary education (index 2007=100)

Source: European Commission, Eurostat

The labour market relevance of education
is still limited. In the area of work-based
learning, the government plans to make traineeships of at least 200 hours per
year compulsory for pupils in the last three years of upper secondary
vocational education. As from September 2014, a pilot project allows students
in the last two years of upper secondary education to participate in on-the-job
training periods in companies, using apprenticeship contracts. However, it
started on a very small scale. The national register of qualifications is
planned to be ready with some delay in the first half of 2015 and will consist
of a single database containing existing regional skill qualification systems.
Concerning vocationally-oriented tertiary education, a quality-rewarding
financing model for the Higher Technical Institutes will be introduced in 2015,
with 10 % of funding allocated according to performance indicators. This is a
welcome step, although the Higher Technical Institutes remain a small education
niche: only about 5 000 students were attending them at end-2013, although data
on graduate employability are encouraging. ([80])

Social policies

Italy faces serious social challenges
with poverty and social exclusion continuing to grow, affecting children in
particular. Progress towards the Europe 2020
national target for poverty reduction has not occurred; on the contrary, the
number of people at risk of poverty and social exclusion increased by 2.3
million between 2008 and 2013 (+14.7 percentage points). This accounted for
nearly half (46 %) of the total increase in Europe during the same period. In
2013, 28.4 % of people in Italy were at risk of poverty or social exclusion (EU
average: 24.5 %). Despite severe material deprivation dropped to 12.4 % in 2013
from 14.5 % in 2012, it remained above the EU average and the significant
increase recorded during the crisis was unusual compared to other Member States.
Children remained the age group at highest risk of poverty and social exclusion
and the presence of children remained a discriminating factor in Italian
households, with higher poverty and social exclusion in households with
children. Among households with children, the in-work poverty rate was
particularly high for single parent households (24.7 %, among the highest in
the EU). The in-work poverty rate for all employed persons remained high at
10.6 %, which may be linked to the high level of atypical contracts. People
over 18 born outside Italy are also increasingly at risk of poverty, with an
increase of 8.3 percentage points between 2008 (34 %) and 2013 (42.3 %). Income
inequalities continued to increase, with the ratio of total income of the top
20 % to the income of the bottom 20 % rising to 5.7 in 2013 (the EU28 average
ratio was equal to 5). Structural disparities between the south and the other
regional areas in terms of poverty and social exclusion indicators remained
significant.

The social protection system is
fragmented and not well equipped to address the challenges of poverty and
social exclusion. Social
expenditure in Italy is largely oriented towards the elderly and dominated by
pension expenditure, which represented 16.6 % of GDP in 2012, the second
highest share in the EU. This leaves little scope for the other functions of
social protection, namely to support families and children and address the risk
of social exclusion and poverty. Social assistance expenditure is fragmented
and there is no nationwide minimum income scheme or framework in place. As a
result, Italy has the third highest share of people living in poor or jobless
households that are not covered by social transfers, and a larger share of the
working age population is dependent on the pension income of a family member.([81]) Given the absence of an overarching
long-term strategy to reduce poverty and promote social inclusion, funding
priorities tend to shift from year to year. There are many different schemes
and actors in the provision of social services and it is difficult for
recipients and operators alike to have a complete picture of the support
available. A nationwide database of social benefit recipients and services is
not yet in place and this strongly limit the efficiency and consistency of
services. No standards for basic levels of provision of services have been
developed at the national level, allowing deep territorial differences to
persist and a fundamental inequality in the support to people in need. ([82])

Some positive initiatives to address
poverty and social exclusion have been experimented, but it is unclear how they
coordinate. The launch of the pilot scheme on the
support for active inclusion represented a significant step toward the
development of an efficient minimum income scheme combining cash benefits with
compulsory activation and social services programmes (a large part of it funded
by the European Social Fund). Its implementation required putting in place
adequate control systems and reached 6 517 households (corresponding to 26 863
persons) in September 2014. However, dedicated resources were allocated to the
scheme in 2014 but no additional resources are envisaged by the 2015 Stability
Law. It is unclear whether and how the support for active inclusion will evolve
after the introduction of new unemployment assistance scheme (Assegno di
disoccupazione ASDI) foreseen by the draft legislative decree adopted in
December 2014 under the 'Jobs Act', as the main aims and beneficiaries of the
two measures largely overlap. Whether these tools will complement each other as
a broader safety net against poverty will depend on the level and stability of
funding, to be found within the budgetary constraints, on the proper
identification and coverage of relevant target groups, and on the quality of
accompanying support provided by employment and social services across
different regions, pending the long-awaited reform.

Progress in improving the effectiveness of family support schemes and quality
services favouring low-income households with children has been limited. In relation to family support schemes, the
2015 Stability law introduced a ‘baby bonus’, providing a benefit of EUR 80 per
month to families below a certain income level, for each child below the age of
three. The measure does not seem to be based on an impact assessment analysis,
and its funding may risk competing with other more structural investments (such
as the pilot social assistance scheme for low-income households with children
and investments in childcare facilities). In 2014, the scheme covering expenses
for childcare or babysitting for working mothers who decide to curtail parental
leave and to return to work was reformulated in light of its very low uptake.
The revised measure addresses a wider group (including private sector workers)
and provides for a more generous contribution.

Serious weaknesses continue to affect
availability and access to child care. While
childcare places increased by 22 % between December 2008 (234 703 places) and
December 2012 (287 149 places), availability, particularly for low-income
families, remains an issue. In 2012, 79 % of children aged 0-3 were not in any
formal childcare against the EU average of 72 %. Territorial differences are
very marked: in the regions of the south, only 22.5 % of municipalities run
nurseries and crèches (with extreme situations such as in Calabria, where they
exist in 9 % of municipalities) while these services exist in 76.3 % of
municipalities in northern Italy.  In future, municipalities, responsible for
most of the expenditure, will have to cope with a substantial reduction in the
national support to finance these services.

No significant progress has been seen on
long-term care, a particularly important topic in a country with a
significantly ageing population. Resources
dedicated to the National Fund for Not-self-sufficient Persons were slightly
increased in the 2015 Stability Law. Overall, the long-term care system is
characterised by a high degree of fragmentation between institutions, sources of
financing and governance, and by significant variation between regions. In the
past few years, money transfers from the social services to the
non-self-sufficient elderly and disabled have greatly increased while the
services provided directly by the social services have decreased: state funds
for 2013 were in fact significantly lower than the funding a few years ago (60
% less than in 2008). ([83]) The system
thus has a very strong prevalence of cash benefit programmes over services (45
% of the overall long-term care expenditure is dedicated to cash benefits,
mostly on companion allowance). This cash benefit is provided as a lump sum
payment with no differentiation regarding the severity of the disability. At
the same time, Italy has a relatively low coverage of institutional care (the
lowest capacity of all OECD countries) although in the number of long-term care
beds increased by 5.2 % over 2000-2011. Therefore, support for the elderly and
not-self-sufficient people continues to rely mainly on informal care provided
by relatives over 50 (mostly women) and, when affordable, by migrant care
workers, often with irregular contracts. The care frequency is relatively high
with 74 % of informal carers providing care on a daily basis.

The Italian government has committed to
developing a framework strategy for social inclusion by mid-2016. The work will be based on a broad consultation of stakeholders that
will start by March 2015. This may represent an opportunity to ensure a better
integration and consistency of measures and programmes, and a longer term
planning, thus overcoming the current fragmentation and instability of
instruments and programmes, which reduces their effectiveness and efficiency.

European Structural and Investment Funds
(European Social Fund, National Operational Programme on Social Inclusion) will
provide the framework for developing and testing basic levels of services (livelli
essenziali di prestazione) in different fields.
The same funds will also support the development of a national database on
services and benefit recipients, so as to improve access to and comparability
of resources and thus the overall efficiency of the system. The first step in
this rationalisation was the in-depth revision of means-testing mechanisms
(ISEE), which was implemented in late 2014. This is expected to provide
parameters for the harmonised delivery of social services, with better
targeting of benefits and assistance.

Graph 3.4.1:   Tax wedge and recent changes for 100% average production wage (APW) earner

(1) Tax wedge of single earner without children at 100 % of the average wage. No recent data are available for Cyprus. Data for Croatia are only available for 2013. EU average does not include Cyprus and Croatia. The tax wedge for Italy does not include the labour-related part of the regional tax on businesses, which is however included in the implicit tax rate on labour. Source: Commission services

The very high tax burden on labour and
capital in Italy compared to other Member States hinders the efficient
allocation of productive factors. The implicit tax
rate ([84]) on labour
was 42.8 % in 2012, the highest in the EU and well above the EU (GDP-weighted)
average of 36.1 %. Also the tax wedge (Graph 3.4.1) in 2013 was among the highest in the
EU and at a similar level to 2012 (47.8 % versus the EU average of 43.6 %). The
implicit tax rate on corporate income was 25.9 %, the third highest in the
EU. The implicit tax rate on capital (which includes taxation on immovable
property) increased from 32 % in 2011 to 37 % in 2012. Conversely,
the implicit tax rate on consumption was 17.7 %, significantly lower than
the EU average of 19.9 %.

Action to lower the taxation of labour
is being taken. The 2015 Stability Law introduced
several measures to reduce the tax burden on labour. First, the law provides
for a full deduction of the labour costs of employees under open-ended
contracts from the regional tax on productive activities (IRAP) in a permanent
way. At the same time however, it envisages the abrogation of the previous
generalised reduction in IRAP rates, enacted in April 2014. In net terms, the
measure should lead to a permanent reduction in the implicit tax rate on labour
of around 1 percentage point. Second, the 2015 Stability Law makes permanent
the tax credit to low-wage employees (also known as the monthly bonus of EUR
80), which was first enacted in 2014 and financed only for 2014 (worth 0.6 % of
GDP per year). This measure intends primarily to support private consumption
but could also have a positive impact on labour demand and competitiveness in
the medium-to-long term to the extent that it translates into lower wage
claims. This single measure should bring about a permanent reduction in the
implicit tax rate on labour of 0.4 percentage points. Cumulatively, the
two permanent measures would reduce the implicit tax rate on labour by some 1.5 percentage
points, closing about one fourth of the gap to the EU average. According to
Bank of Italy, the tax wedge for employees with a gross wage which is one third
below the national average (EUR 19 707) would be reduced by
4.6 percentage points of the total labour cost (1.3 percentage points for
employers and 3.3 percentage points for employees). ([85]) Finally, the law exempts private employers (with the exception of
the agricultural sector and household services) from paying social security
contributions for three years for new personnel hired in 2015 under open-ended
contracts (with a ceiling of EUR 8 060 per year). In the short term, this
temporary measure could help labour demand and thus job. The three measures are
financed by spending cuts and an increase in VAT rates and excise duties
equivalent to 0.8 % of GDP in 2016, 1.2 % in 2017 and 1.4 % in
2018, as such ensuring the achievement of fiscal targets over the period. Such
increases may however be replaced by spending cuts or other saving measures
with an equivalent budgetary impact. In the short term, these measures’
potentially positive impact on growth could be at least partially offset by the
expenditure savings and/or the higher taxation on consumption which are needed
to finance them. However, long-term growth could be positively affected to the
extent that the spending cuts effectively tackle the inefficiencies in Italy’s
public expenditure at all levels of government and preserve growth-enhancing
spending like research and development, innovation, education, and essential
infrastructure projects.

Improving the design of environmental
and property taxation could help achieve the Europe 2020 national climate and
energy targets and improve the equity and efficiency of the tax system. Environmental taxation reached 3 % of GDP in 2012, compared
with around 2.4 % for the EU. Most of this comes from energy (2.3 %
of GDP) and transport taxation (0.7 % of GDP) which are relatively high
compared with the EU average. However, revising energy and transport taxation could
help Italy to reach the agreed Europe 2020 climate targets in a cost-effective
way (according to the latest national projections submitted to the Commission
in 2013 and taking into account existing measures, Italy is set to miss these
targets). The pollution/resources component (0.03 % of GDP) still plays a
marginal role in taxation. In 2012, Italy’s taxation of property – at
2.5 % of GDP – was above the EU average, but a growth-friendly shift from
taxes on property transactions to recurrent taxes on immovable property
(considered the least harmful to growth) is taking place following reforms in
2012 and 2014. However, the planned revision of the outdated cadastral values
is progressing slowly (see below). Revenues from inheritance and gift taxation
are low compared with other Member States.

The numerous tax expenditures weigh on
the efficiency of the tax system. The annex to the
2015 Stability Law reports 282 provisions that prescribe exemptions or
reductions with respect to benchmark tax levels. Such provisions are estimated
to account for EUR 161 billion of foregone revenues in 2015 (about 10 % of
GDP). A more in-depth analysis carried out by the Ministry of Economy and
Finance in 2011 counted 720 such provisions. ([86]) International comparisons are difficult because of differences in
the way tax expenditures are defined and identified. There is some evidence,
however, that the number and scope of tax expenditures in Italy are overly
high. According to the OECD (2010), in Italy foregone revenues from tax expenditures
as a share of GDP were among the highest in OECD countries covered and Tyler
(2014) reports similar results for a wider set of countries. ([87]) While several of the tax expenditures in place can be justified,
there is for example a general consensus that reduced VAT rates are an
inefficient instrument to improve the equity of the tax system — as the same
welfare objectives could be pursued at less cost through social spending — and
that direct taxation is better suited for distributional purposes. In Italy,
reduced VAT rates and exemptions are estimated to account for 45 % of
potential revenues in 2012, the sixth highest value in the EU (EU average:
36 %), although there are no significant VAT exemptions that deviate from
the common regime. ([88])

Tax compliance remains low and
time-consuming, which could harm fair market competition and social equality. Different sources indicate the presence of a large shadow economy
and concerning levels of tax under-declaration and VAT fraud. This could
adversely affect the Italian economy by undermining tax revenues, threatening
competition, and hindering the financing of social protection. For instance,
the Italian statistical office reports that tax evasion/elusion is larger in
sectors with very low productivity growth and large shares of
micro-enterprises, hinting at it as a de facto disincentive to grow. ([89]) A report on tax evasion published by the Italian government in
October 2014 ([90]) estimated
an average total tax gap of EUR 91 billion (5.6 % of GDP) over the period
2007-12, of which around EUR 44 billion concerned direct taxes (2.7 % of
GDP), EUR 7 billion the regional tax on productive activities (IRAP)
(0.4 % of GDP), and EUR 40 billion VAT (2.5 % of GDP). Italy’s VAT
compliance gap ([91]) was
estimated to be among the highest in the EU (32 %) in 2012 and to have
slightly increased compared to 2011 (Graph 3.4.2). In addition, the administrative
burden created by the Italian tax system for a medium-sized company is much
higher compared to the EU average (filing and paying taxes was estimated to
take 269 hours in 2014. against the EU average of 179), mainly due to labour
taxation. Finally, frequent changes to tax regulations undermine the stability
and predictability of the business environment which may affect firms’
investment decisions.

Graph 3.4.2:   VAT gaps in the EU (2014)

(1) EU-26 excludes Cyprus and Croatia Source: CBP/CASE, Study to quantify and analyse the VAT gap in the EU27 Member States, commissioned by the European Commission, 2014.

Some measures have been taken to improve
tax compliance as part of the fiscal strategy in 2015. In October 2014, a legislative decree introduced pre-filled tax
declarations for employees and pensioners and several simplifications
concerning the declarations of individuals, companies and tax refunds. The 2015
Stability Law included two main provisions aimed at fighting tax fraud and
evasion. The first aims at reducing VAT evasion through a permanent or
temporary extension of the ‘reverse charge system’ for VAT payments to four
sectors foreseen in EU VAT legislation — services related to immovable
property, cleaning, green certificates and gas supplies — plus the retail
sector and a ‘split payment system’ for goods and services supplied to Italian
public bodies. The reverse charge is applied as a derogation under the EU VAT
Directive and has the advantage of making ‘carousel fraud’ impossible in all
supply chain stages, except at the retail level (in particular, VAT cannot be
embezzled to the extent that no VAT is charged and paid in business-to-business
transactions). However, this mechanism is not devoid of shortcomings ([92]) and should be considered carefully. Should the reverse charge not
be applied to the retail sector, the 2015 Stability Law foresees a safeguard
clause increasing excise duties on fuel as of 2015 which would anyhow ensure
the expected resources. The second provision (‘adempimento volontario’) aims to
foster tax compliance based on the cross-check of existing databases
(‘spesometro’) and subsequent communications between the tax office and
taxpayers who could thereby induced to autonomously revise their previous
declarations. The 2015 Stability Law also modifies the simplified tax regime
for the self-employed and two sets of rules have been adopted to improve
voluntary disclosure by taxpayers, one for activities and assets held abroad
and another to ease the regularisation of taxpayers’ tax position. Finally,
Italy has signed the Foreign Account Tax Compliance Act with the United States
and a multilateral agreement to automatically exchange financial information
based on OECD global standards (as of early 2017). Furthermore, Italy and
Switzerland have recently reached an agreement on cooperation in tax matters.
As of early March 2015, this should facilitate the regularisation of capital
held abroad through the newly-introduced voluntary disclosure, as well as end
double taxation between the two countries. Other stated objectives include the
switch to automatic exchange of information on capital held abroad and an
adaptation of the Swiss tax regime.

The implementation of the enabling law
on taxation is progressing slowly. An
enabling law for the reform of the tax system was passed by the Italian
Parliament in March 2014. Implementing legislative decrees have to be adopted
by the government by March 2015. To date, three legislative decrees have been
enacted (i.e. on the revision of cadastral committees, the simplification of
the tax system and the revision of taxation on tobacco production and
consumption). A large package of legislative decrees is expected to be
adopted by the government by end-February 2015, which are subject only to the
non-binding opinion of the parliament. These include: (i) the reform of
cadastral values (to be finalised within five years); (ii) increasing the
certainty of tax law; (iii) the revision of taxation of individual
entrepreneurs; (iv) the reduction of tax evasion and elusion and its
monitoring; (v) VAT e-invoicing and other ways to improve the traceability of
payments; (vi) the revision of tax collection procedures; (vii) the
simplification of taxation of international businesses; and (viii) the revision
of taxation of the gambling sector. Given that the parliament needs 30 days to
issue its non-binding opinion, the expiry date of the enabling law may have to
be extended. Anticipating this extension, the government now foresees the
adoption of the legislative decree on the revision of tax expenditures by
September 2015. In particular, it envisages the establishment of a specific
parliamentary session review tax expenditures during the annual budget session.
On the revision of environmental taxation, there is no legislative decree so
far. The revision of tax expenditures and of environmental taxation could help
prevent the legislated increase in the standard VAT rate from setting in fully
and eventually further finance the reduction in the labour tax wedge.

The crisis has exacerbated the long‑standing
socio‑economic divide between the north-centre and the Mezzogiorno. ([93])  Since the
reunification of Italy in 1860s, the country has been characterised by a
significant and enduring divide between the north-centre and the Mezzogiorno
regions. The last six years of the crisis have helped accelerate this divide,
which had already started to widen in the 1990s. Between 2008 and 2013, real
GDP in the Mezzogiorno dropped by almost twice as much as it did in the north‑centre
(about 13 % versus 7 %, respectively). Particularly after 2010, the
economy of Mezzogiorno, more domestically oriented and more dependent on public
spending, was particularly hit by fall in domestic demand (partly compensated
in the north-centre by the recovery of export).

The impact of the crisis on the labour market
and productivity

Most of the gap in real growth is due to
the much faster fall of employment in the Mezzogiorno. Labour market disparities between the north‑centre and the Mezzogiorno
increased to very high levels (Graphs  3.5.1 and 3.5.2) during the crisis and regional
variations in employment are among the highest in the EU (Graph 3.5.2A). Most of Italy's downturn in
employment was borne by the Mezzogiorno, which accounted for approximately
65 % of Italy’s loss of head‑count employment during the crisis
(2007-12), even though it provides only one third of Italy's population.
Unemployment in the Mezzogiorno increased from 11 % in 2007 to 19.7 %
in 2013 and is now more than 10 percentage points higher than the one in the
north-centre. Differences in employment rates can explain two thirds of the GDP
per capita gap between the Mezzogiorno and the north-centre.

Graph 3.5.1:   Regional employment (1977=100)

Source: ISTAT

Graph 3.5.2:   Regional unemployment rate

Source: ISTAT

Women and young people are the most
disadvantaged categories in the Mezzogiorno. Out of
all 272 NUTS2 EU regions, eight Mezzogiorno regions are among the 10 European
regions with the lowest participation of women in the labour market. While the
female employment rate in the north-centre is at 60 %, close to the euro‑area
average of 62 %, the Mezzogiorno rate is only about half this level
(30 %). During the crisis, male employment fell more significantly than
female employment. Unemployment among young people aged 15-24 skyrocketed
during the crisis. In 2013, the employment rates of young people in Italy and
Mezzogiorno are respectively only about half and a third of that in the euro
area. In some southern regions (such as Calabria, Basilicata and Sicily) youth
unemployment rate reaches 55 %, more than double that in the north-east
regions. Over the 2001-13 period, net emigration totalled around 710 000
persons, primarily young people with a high level of education. The departure
from the Mezzogiorno has been growing in recent years: from approximately 47
800 a year in 2001-11 it peaked at circa 92 100 per year in 2012‑13.

Graph 3.5.3:   Regional employment rate and labour costs

Source: European Commission, Eurostat

During the crisis, labour productivity
in the Mezzogiorno also fell faster than in the north‑centre, reversing
the catching‑up of the previous decade. In
relative terms, productivity in the Mezzogiorno fell between 2009 and 2013 from
85 % to 83 % of that in the north‑centre, accelerating the
previous trend (it was about 80% in mid‑90s). Particularly in the
manufacturing sector, Mezzogiorno’s relative productivity (compared to north‑centre)
has been on a long‑term downward trend since the early 1970s (from
99 % of that in the north-centre to about 78 % now), while there was
some catch up in the services sector (both market and non‑market).

Wage developments are misaligned from
productivity, particularly in the tradable sector.
Italy shows low variation in regional wages with high regional variation in
employment, suggesting that some of the workers may be priced‑out of
employment (Graph 3.5.2). Graph 3.5.4 shows that, particularly in the
tradable sector, the long‑term relative productivity decline was not
matched by wages adjustments. The current system of wage bargaining centred on
national sectorial contracts seems to limit the scope for adjusting wages to
the locally differentiated productivity levels and to affect employability,
particularly of the most disadvantaged, in terms of skills, gender, age or
regions ([94]). Moreover,
empirical evidence suggests that in the context of centralised wage bargaining
and wages determined predominantly by leading regions, negative economic
shocks, such as the current crisis, have a bigger impact on lagging
regions. ([95]) In Italy
indeed since the late 1970s, north-centre was more resilient during the shocks.

Graph 3.5.4:   Labour productivity, labour costs and unit labour costs in Mezzogiorno relative to the North-centre, manufacturing sector

Source: European Commission

Structural differences holding back
productivity growth in the Mezzogiorno

Productivity differentials, reflecting
structural differences in many areas, are responsible for the remaining one
third of the GDP per capita gap.  This section
focuses on the quality of governance, the education system, and the business
environment. Other disparities, for instance in infrastructures, are covered in
the relevant sections.

The quality of governance is very low
and an major barrier to economic development. A
simple, transparent and efficient regulatory system with legal certainty and
reliable public services, devoid of corruption, are crucial for the
effectiveness of public spending, a well‑functioning business environment
in general and the attractiveness of foreign investment. The European Quality
of Governance Index (2013) ([96]) (Graph 3.5.5) ranks Italy as the fifth least‑performing
country in terms of quality of governance in the EU, while at the same time
showing the largest variation between its best and worst performing regions
(Graph 5). While the Trento and Bolzano regions rank among the best 10 %
of performers, the regions in the south (and Lazio, the region which includes
Rome) are among the worst performers in the EU. A study by the European
Commission ([97]) shows that
the index is highly correlated with the level of trust and socio-economic
development indicators, such as income levels, educational attainment or
technology. It also finds evidence of a clear positive correlation between the
index and absorption of EU funds, which is below the EU average for Italy. Part
of the poor performance in absorption of structural funds is due to delays,
bottlenecks and administrative weaknesses, particularly in the Mezzogiorno (see
Section 2.1). The quality of regional governance and legal certainty is not
only a key driver of productivity in the long-term ([98]) but also crucial for the successful use of the EU funds and the
implementation of the Investment Plan for Europe in the short term. Improving
the Mezzogiorno’s administrative capacity is also important as its economy is
much more heavily dependent on the public sector. Public services account for
about 30 % of value added in the Mezzogiorno against about 17 % in north-centre.

Graph 3.5.5:   European Quality of Government Index 2013 (EQI) and the regional country variation

Source: European Commission

There are also important regional
differences in the performance of the education system, which produces rather mixed results in terms of basic skills
attainment across regions. As in previous rounds, the 2012 OECD Programme for
International Student Assessment (PISA) shows that the performance of Italy's
education system is in line with or above the EU average in the northern
regions but significantly worse in the south. Similar regional differences can
be seen also in the 2011 Trends in International Mathematics and Science Study
& Progress in International Reading Literacy Study on 10 year-olds,
conducted by the International Association for the Evaluation of Educational
Achievement.

The business environment is much worse
in the Mezzogiorno than in the north-centre. The
World Bank's Doing Business Indicator reveals particularly high regional
variation in Italy, with the Mezzogiorno clearly lagging behind in terms of the
quality, timing and costs of the administrative procedures relevant for
businesses. For example, obtaining the construction permits for a warehouse
requires 164 days in Bologna (Emilia-Romagna) at a cost equivalent to
177 % of income per head, while in Potenza (Basilicata) it takes 208 days
at a cost of 725 % of income per head.  Enforcing a contract takes an
average of 855 days and costs 22 % of the claim in Turin (Piedmont) as
compared with 2 022 days and a cost of 34 % of the claim in Bari (Puglia).
Starting a business takes from 6 days in Padua (Veneto) to 16 days in Naples
(Campania), while registering a property takes 13 days in Bologna and 24 days
in Rome. ([99])

Commitments || Summary assessment ([100])

CSR 1: Reinforce the budgetary measures for 2014 in the light of the emerging gap relative to the Stability and Growth Pact requirements, namely the debt reduction rule, based on the Commission services 2014 spring forecast and ensure progress towards the MTO. In 2015, significantly strengthen the budgetary strategy to ensure compliance with the debt reduction requirement and thus reaching the MTO. Thereafter, ensure that the general government debt is on a sufficiently downward path; carry out the ambitious privatisation plan; implement a growth-friendly fiscal adjustment based on the announced significant savings coming from a durable improvement of the efficiency and quality of public expenditure at all levels of government, while preserving growth-enhancing spending like R&D, innovation, education and essential infrastructure projects. Guarantee the independence and full operationalisation of the fiscal council as soon as possible and no later than September 2014, in time for the assessment of the 2015 Draft Budgetary Plan. || || Italy has made limited progress in addressing CSR 1 (this overall assessment excludes an assessment of compliance with the Stability and Growth Pact): · Limited progress was made to improve the efficiency and quality of public spending. Ministers were directly involved in selecting areas within their own budgets eligible for targeted savings without recourse to linear expenditure cuts as in the past. However, the need to preserve growth-enhancing expenditure items and improve the economic efficiency of the public administration would still require top-down coordination and monitoring. The identification of additional savings at regional level (EUR 4 billion in 2015) has been delayed. · Limited progress was made with regard to privatisation. Privatisation proceeds in 2014 amounted to 0.2% of GDP (mainly related to the reimbursement of Monti bonds by Banca Monte dei Paschi), short of the target of 0.7% per year. · Substantial progress was made with regard to the Italy's Fiscal Council, which has been operational since September 2014.

CSR 2: Further shift the tax burden from productive factors to consumption, property and the environment, in compliance with the budgetary targets. To this end, evaluate the effectiveness of the recent reduction in the labour tax wedge and ensure its financing for 2015, review the scope of direct tax expenditures and broaden the tax base, in particular on consumption. Ensure more effective environmental taxation, including in the area of excise duties, and remove environmentally harmful subsidies. Implement the enabling law for tax reform by March 2015, including by adopting the decrees leading to the reform of the cadastral system to ensure the effectiveness of the reform of immovable property taxation. Further improve tax compliance by enhancing the predictability of the tax system, simplifying procedures, improving tax debt recovery and modernising tax administration. Pursue the fight against tax evasion and take additional steps against the shadow economy and undeclared work. || || Italy has made some progress in addressing CSR 2: · Some progress was made in shifting taxation away from labour. A tax credit (of EUR 10 billion or 0.6% of GDP per year) was introduced for low-income earners in April 2014 and the labour component was excluded from the calculation of the regional business tax (IRAP) from Jan 2015. For new hires under open-ended contracts in 2015, private sector employers will not pay social security contributions for three years. · Limited progress was made on tax expenditures, environmental taxation, and removal of environmentally harmful subsidies. · Some progress was made to simplify procedures (including pre-filled tax returns) and improve compliance (including measures to prevent carousel fraud in VAT and facilitate voluntary disclosure). A report on tax evasion was published in October 2014, which assesses the tax gap (EUR 91 billion).

CSR 3: As part of a wider effort to improve the efficiency of public administration, clarify competences at all levels of Government. Ensure better management of EU funds by taking decisive action to improve administrative capacity, transparency, evaluation and quality control both at national and regional level, especially in southern regions. Further enhance the effectiveness of anti-corruption measures, including by revising the statute of limitations by the end of 2014, and strengthening the powers of the national anti-corruption authority. Monitor in a timely manner the impact of the reforms adopted to increase the efficiency of civil justice with a view to securing their effectiveness and adopting complementary action if needed. || || Italy has made limited progress in addressing CSR 3: · Limited progress was made to improve the efficiency of public administration, although some effort is under way. The Senate completed its first reading of the draft constitutional bill clarifying the competences of different levels of government. A draft enabling law envisaging a comprehensive reform of the public administration is currently being considered by the Senate. The agency for territorial cohesion is about to become operational. · Limited progress was made in the fight against corruption. In particular, the process to revise the Italian stature of limitations is still in the initial phase. However, the powers of anti-corruption authority ANAC were enhanced and the new offence of self-laundering was introduced into the Italian criminal code.. · Some progress was made towards improving the functioning of civil justice. Electronic filing in civil, administrative and tax-related trials became obligatory and the ‘office of proceedings’ was established. The possibility to transfer pending cases to arbitration and a new pre-trial procedure of 'assisted negotiation' (negoziazione assistita), mandatory in certain cases, was introduced. Simplification measures were also introduced. Further reforms are under way.

CSR 4: Reinforce the resilience of the banking sector and ensure its capacity to manage and dispose of impaired assets to revive lending to the real economy. Foster non-bank access to finance for firms, especially small and medium-sized businesses. Continue to promote and monitor efficient corporate governance practices in the whole banking sector, with particular attention to large cooperative banks (‘banche popolari’) and the role of foundations, with a view to improving the effectiveness of financial intermediation || || Italy has made some progress in addressing CSR 4: · Some progress was made on the disposal of impaired assets, but the efforts were concentrated only in the largest banks, especially in the context of the European Central Bank's comprehensive assessment of the euro-area banking sector. · Some progress was made on addressing the corporate governance weaknesses in the banking sector. The Bank of Italy has strengthened the corporate governance of banks by requiring inter alia a clear distinction of responsibilities and powers of corporate governance bodies, the effectiveness of controls and a composition of governing bodies which is consistent with the size and the complexity of banks. Italy's largest cooperative banks (banche popolari) – i.e.  those with more than EUR 8 billion assets – are required to transform themselves into joint-stock companies, thus abolishing the ‘one head-one vote’ rule. No specific initiative was taken yet on the role of foundations in Italy's banking sector. · Substantial progress was made towards facilitating and diversifying firms' access to finance. Measures include the strengthening of the allowance for corporate equity (ACE) framework, tax incentives for investment in mini-bonds by institutional and foreign investors, the further enhancing of the Central Guarantee Fund for SMEs, the introduction of direct lending by insurance firms, incentives for SMEs to list themselves on the stock market, investment support programmes by Cassa Depositi e Prestiti (e.g. Nuova Sabatini), the extending of the existing research and development tax credit framework and the introduction of a favourable tax regime ('Patent Box') for revenues from the use or sale of patents and trademarks.

CSR 5: Evaluate, by the end of 2014, the impact of the labour market and wage-setting reforms on job creation, dismissals' procedures, labour market duality and cost competitiveness, and assess the need for additional action. Work towards a more comprehensive social protection for the unemployed, while limiting the use of wage supplementation schemes to facilitate labour re-allocation. Strengthen the link between active and passive labour market policies, starting with a detailed roadmap for action by December 2014, and reinforce the coordination and performance of public employment services across the country. Adopt effective action to promote female employment, by adopting measures to reduce fiscal disincentives for second earners by March 2015 and providing adequate care services. Provide adequate services across the country to non-registered young people and ensure stronger private sector commitment to offering quality apprenticeships and traineeships by the end of 2014, in line with the objectives of a youth guarantee. To address exposure to poverty and social exclusion, scale-up the new pilot social assistance scheme, in compliance with budgetary targets, guaranteeing appropriate targeting, strict conditionality and territorial uniformity, and strengthening the link with activation measures. Improve the effectiveness of family support schemes and quality services favouring low-income households with children. || || Italy has made some progress in addressing CSR 5: · Some progress was made to reduce segmentation, increase exit flexibility, reform passive and active labour market policies and foster participation. A broad-ranging enabling law for reforming the labour market was adopted in December 2014, with two important legislative implementing decrees on employment protection and the revision of unemployment benefits being already adopted and two, respectively on labour contracts and work-life balance, subject to the non-binding opinion of the Parliament. Other implementing legislative decrees (on active labour market policies, review of wage-supplementation schemes and inspections) are expected to follow before June 2015. · Limited progress was made on youth unemployment. The implementation of the Youth Guarantee started in May 2014 but take-up is limited. · Limited progress was made to address exposure to poverty. A pilot project on the social inclusion scheme (SIA) has been carried out in 12 metropolitan cities. Under the labour market reform, an unemployment assistance scheme is being established (ASDI).

CSR 6: Implement the National System for Evaluation of Schools to improve school outcomes in turn and reduce rates of early school leaving. Increase the use of work-based learning in upper secondary vocational education and training and strengthen vocationally-oriented tertiary education. Create a national register of qualifications to ensure wide recognition of skills. Ensure that public funding better rewards the quality of higher education and research. || || Italy has made some progress in addressing CSR 6: · Some progress was made in implementing the National System for Evaluation of schools, which is being phased in. A public consultation on the reform of the education system was closed in November 2014 and legislative follow up is expected in early 2015. · Some progress was made towards increasing the share of performance-related public funding for universities (from 13.5% in 2013 to 18% in 2014). Standard costs will gradually be introduced over 2014-18 as criteria for allocating the remaining share of public funding. · Limited progress was made on vocational training. The national register of qualifications is due to be ready by early 2015. More action is expected under the forthcoming broader reform.

CSR 7: Approve the pending legislation or other equivalent measures aimed at simplifying the regulatory environment for businesses and citizens and address implementation gaps in existing legislation. Foster market opening and remove remaining barriers to, and restrictions on, competition in the professional and local public services, insurance, fuel distribution, retail and postal services sectors. Enhance the efficiency of public procurement, especially by streamlining procedures including through the better use of e-procurement, rationalising the central purchasing bodies and securing the proper application of pre- and post-award rules. In local public services, rigorously implement the legislation providing for the rectification of contracts that do not comply with the requirements on in-house awards by 31 December 2014. || || Italy has made limited progress in addressing CSR 7: · Some progress was made simplify the regulatory environment for business and citizens. The government has adopted the ‘Simplification Agenda for 2015-17’ to foster cooperation between central and regional governments in establishing a more coherent simplification framework and measures have been taken to simplify authorisation procedures in environmental and construction matters. · Limited progress was made in improving public procurement. Measures to rationalise public procurement have taken and a draft enabling law for the reform of the public procurement code was tabled government. · No progress was made to reform local public services. The deadline of end-2014 for rectifying contracts that do not comply with EU law has been postponed to end-2015. The observatory that is supposed to oversee the implementation of relevant legislation is not yet operational. The draft enabling law for the reform of the public administration includes measures to reform local public services. · Limited progress was made to address restrictions on competition in other sectors, for which a ‘law for competition’ has been announced. In the banking sector, the regulation concerning the portability of  bank accounts was improved. The rental market for non-residential large buildings was opened. Italy is actively participating in the mutual evaluation exercise provided for in the Directive amending the Professional Qualifications Directive but has yet to complete its review.

CSR 8: Ensure swift and full operationalisation of the Transport Authority by September 2014. Approve the list of strategic infrastructure in the energy sector and enhance port management and connections with the hinterland. || || Italy has made limited progress in addressing CSR 8: · Substantial progress was made on the Transport Authority, which is now operational, although understaffed. · Limited progress was made with regard to strategic infrastructures in energy and ports. Decree-law 90/2014 sets out criteria for selecting strategic infrastructures and envisages a strategic plan for Italian ports but no concrete steps to implement it have been taken yet

Europe 2020 (national targets and progress)

Employment rate target: 67-69 % || The employment rate was 61.2 % in 2011, 61 % in 2012 and 59.8 % in 2013. No progress has been achieved towards meeting the target.

Research and development target: 1.53 % of GDP || Gross domestic expenditure on research and development was 1.21 % in 2011, 1.26 % in 2012 and 1.25% in 2013 (provisional). No progress has been achieved towards meeting the target.

Greenhouse gas emissions target -13 % (compared with 2005 emissions); ETS emissions are not covered by this national target. || According to the latest national projections submitted to the Commission in 2013 and taking into account existing measures, it is expected that the target will be missed: -9.5 % in 2020 as compared with 2005 (i.e. a projected shortfall of 3.5 percentage points). However, according to approximated data for 2012, emissions are lower than expected as they decreased by 18% between 2005 and 2012.

Renewable energy target: 17 % || Renewables’ share of gross final energy consumption was 12.3 % in 2011 and 13.5 % in 2012. Despite recent changes to support schemes, Italy is on track to reach its 17% target in 2020.

Energy efficiency: absolute level of primary energy consumption of 158 Mtoe || Progress needs to be sustained over time. In 2012, primary energy consumption in Italy stood at 155.2 Mtoe, below the 2020 target but this evolution is also related to economic recession.

Early school leaving target: 16 % || Some progress has been made towards meeting this target. The early school leaving rate (the percentage of the population aged 18-24 with at most lower secondary education and not in further education or training) fell from 18.2 % in 2011 to 17.6 % in 2012 and 17.0 % in 2013.

Tertiary education target: 26-27 % || Some progress has been made towards meeting this target. The tertiary educational attainment rate rose from 20.3 % in 2011 to 21.7 % in 2012 and 22.4 % in 2013.

Target on the reduction of population at risk of poverty or social exclusion in number of persons: -2 200 000 (compared to 2008, thus corresponding to 12 899 0000 people at risk of poverty or social exclusion in 2020) || Limited progress has been made in meeting this target. The number of people at risk of poverty or social exclusion fell from 18 194 million  in 2012 to 17 326 million in 2013.

Table AB.1:     Macroeconomic indicators

1 The output gap constitutes the gap between the actual and potential gross domestic product at 2010 market prices. 2 The indicator of domestic demand includes stocks. 3 Unemployed persons are all those who were not employed, had actively sought work and were ready to begin working immediately or within two weeks. The labour force is the total number of people employed and unemployed. The unemployment rate covers the age group 15-74. Source: European Commission 2015 winter forecast; Commission calculations

Table AB.2:     Financial market indicators

1) Latest data November 2014. 2) Latest data Q2 2014. 3) Latest data September 2014. 4) Latest data June 2014.  Monetary authorities, monetary and financial institutions are not included. \* Measured in basis points. Source:  IMF (financial soundness indicators), European Commission (long-term interest rates), World Bank (gross external debt) and ECB (all other indicators).

Table AB.3:     Taxation indicators

1. Tax revenues are broken down by economic function, i.e. according to whether taxes are raised on consumption, labour or capital. See European Commission (2014), Taxation trends in the European Union, for a more detailed explanation. 2. This category comprises taxes on energy, transport and pollution and resources included in taxes on consumption and capital. 3. VAT efficiency is measured via the VAT revenue ratio. It is defined as the ratio between the actual VAT revenue collected and the revenue that would be raised if VAT was applied at the standard rate to all final (domestic) consumption expenditures, which is an imperfect measure of the theoretical pure VAT base. A low ratio can indicate a reduction of the tax base due to large exemptions or the application of reduced rates to a wide range of goods and services (‘policy gap’) or a failure to collect all tax due to e.g. fraud (‘collection gap’). It should be noted that the relative scale of cross-border shopping (including trade in financial services) compared to domestic consumption also influences the value of the ratio, notably for smaller economies. For a more detailed discussion, see European Commission (2012), Tax Reforms in EU Member States, and OECD (2014), Consumption tax trends. Source: European Commission

Table AB.4:     Labour market and social indicators

1 Unemployed persons are all those who were not employed, but had actively sought work and were ready to begin working immediately or within two weeks. The labour force is the total number of people employed and unemployed. Data on the unemployment rate of 2014 includes the last release by Eurostat in early February 2015. 2 Long-term unemployed are persons who have been unemployed for at least 12 months. Source: European Commission (EU Labour Force Survey and European National Accounts)

Table AB.5:     Expenditure on social protection benefits (% of GDP)

1 People at risk of poverty or social exclusion (AROPE): individuals who are at risk of poverty (AROP) and/or suffering from severe material deprivation (SMD) and/or living in households with zero or very low work intensity (LWI). 2 At-risk-of-poverty rate (AROP): proportion of people with an equivalised disposable income below 60 % of the national equivalised median income. 3 Proportion of people who experience at least four of the following forms of deprivation: not being able to afford to i) pay their rent or utility bills, ii) keep their home adequately warm, iii) face unexpected expenses, iv) eat meat, fish or a protein equivalent every second day, v) enjoy a week of holiday away from home once a year, vi) have a car, vii) have a washing machine, viii) have a colour TV, or ix) have a telephone. 4 People living in households with very low work intensity: proportion of people aged 0-59 living in households where the adults (excluding dependent children) worked less than 20 % of their total work-time potential in the previous 12 months. 5 For EE, CY, MT, SI and SK, thresholds in nominal values in euros; harmonised index of consumer prices (HICP) = 100 in 2006 (2007 survey refers to 2006 incomes). 6 2014 data refer to the average of the first three quarters. Source: For expenditure for social protection benefits ESSPROS; for social inclusion EU-SILC.

Table AB.6:     Product market performance and policy indicators

1 Labour productivity is defined as gross value added (in constant prices) divided by the number of persons employed. 2 Patent data refer to applications to the European Patent Office (EPO). They are counted according to the year in which they were filed at the EPO. They are broken down according to the inventor’s place of residence, using fractional counting if multiple inventors or IPC classes are provided to avoid double counting. 3 The methodologies, including the assumptions, for this indicator are presented in detail here: http://www.doingbusiness.org/methodology. 4 Index: 0 = not regulated; 6 = most regulated. The methodologies of the OECD product market regulation indicators are presented in detail here: http://www.oecd.org/competition/reform/indicatorsofproductmarketregulationhomepage.htm 5 Aggregate OECD indicators of regulation in energy, transport and communications (ETCR). Source: European Commission; World Bank — Doing Business (for enforcing contracts and time to start a business); OECD (for the product market regulation indicators)

Table AB.7:     Green Growth

Country-specific notes: 2013 is not included in the table due to lack of data. General explanation of the table items: All macro intensity indicators are expressed as a ratio of a physical quantity to GDP (in 2000 prices)           Energy intensity: gross inland energy consumption (in kgoe) divided by GDP (in EUR)           Carbon intensity: Greenhouse gas emissions (in kg CO2 equivalents) divided by GDP (in EUR)           Resource intensity: Domestic material consumption (in kg) divided by GDP (in EUR)           Waste intensity: waste (in kg) divided by GDP (in EUR) Energy balance of trade: the balance of energy exports and imports, expressed as % of GDP  Energy weight in HICP: the proportion of "energy" items in the consumption basket used for the construction of the HICP Difference between energy price change and inflation: energy component of HICP, and total HICP inflation (annual % change) Environmental taxes over labour or total taxes: from DG TAXUD’s database ‘Taxation trends in the European Union’ Industry energy intensity: final energy consumption of industry (in kgoe) divided by gross value added of industry (in 2005 EUR) Share of energy-intensive industries in the economy: share of gross value added of the energy-intensive industries in GDP Electricity and gas prices for medium-sized industrial users: consumption band 500–2000MWh and 10000–100000 GJ; figures excl. VAT. Recycling rate of municipal waste: ratio of recycled municipal waste to total municipal waste Public R&D for energy or for the environment: government spending on R&D (GBAORD) for these categories as % of GDP Proportion of GHG emissions covered by ETS: based on greenhouse gas emissions (excl LULUCF) as reported by Member States to the European Environment Agency Transport energy intensity: final energy consumption of transport activity (kgoe) divided by transport industry gross value added (in 2005 EUR) Transport carbon intensity: greenhouse gas emissions in transport activity divided by gross value added of the transport sector Energy import dependency: net energy imports divided by gross inland energy consumption incl. consumption of international bunker fuels Diversification of oil import sources: Herfindahl index (HHI), calculated as the sum of the squared market shares of countries of origin Diversification of the energy mix: Herfindahl index over natural gas, total petrol products, nuclear heat, renewable energies and solid fuels Renewable energy share of energy mix: %-share of gross inland energy consumption, expressed in tonne oil equivalents \* European Commission and European Environment Agency \*\* For 2007 average of S1 & S2 for DE, HR, LU, NL, FI, SE & UK. Other countries only have S2. \*\*\* For 2007 average of S1 & S2 for HR, IT, NL, FI, SE & UK. Other countries only have S2. Source: European Commission, unless indicated otherwise; European Commission elaborations indicated below

([1])  EU sanctions on Russia impacted
negatively on Italy’s trade: exports to Russia declined by 11.6 % in 2014
year-on-year. However, they account for less than 3 % of total exports.

([2])  Cassa Integrazione Guadagni is a scheme
whereby employees temporarily suspend or reduce their activity in exchange of
an income support.

([3])  The reduction of the labour tax wedge
as well as the fiscal incentives to support the new permanent contract.

([4])  Rosolia, A., 'The Italian labor market
after the Great crisis' in 'Gli effetti della crisi sul potenziale produttivo e
sulla spesa delle famiglie', Bank of Italy – Workshops and Conferences,
No.18, 2014. The paper shows that matching efficiency temporarily deteriorated between
2011 and 2012. From late 2013, it returned toward its pre-crisis averages
suggesting that the low job finding rate was related to weak labour demand
rather than a mismatch between labour supply and demand.

([5])  See R. C. Merton, ‘Measuring the
Connectedness of the Financial System: Implications for Risk Management’, Asian
Development Review 31(1), Cambridge, MA: MIT Press, 2014, pp. 186–210.

([6])  This estimate only considers the ‘mechanical’
denominator impact of a higher/lower nominal GDP. In the short term, a
higher/lower inflation would also translate in a lower/higher deficit, via tax
revenue (the impact on expenditure being limited); in the medium term the
overall impact may be close to zero as inflation will increasingly affect
expenditure.

([7])  The debt sustainability analysis presented
here is based on the European Commission's Debt Sustainability Monitor model
(for more details, see ‘Assessing Public Debt Sustainability in EU Member
States: A Guide’, European Economy Occasional Paper No. 200, September
2014.).

([8])  Long-run convergence assumptions
covering real interest rate, GDP growth rate and inflation are used, in line
with what agreed with the Economic Policy Committee.

([9])  This Draft Budgetary Plan or DBP
scenario is still based on the assumption of no fiscal policy change beyond the
programme horizon.

[10] http://www.dt.mef.gov.it/it/analisi\_programmazione\_economico\_finanziaria/strategia\_crescita/

http://www.governo.it/Governo/ConsiglioMinistri/dettaglio.asp?d=77929

http://www.mef.gov.it/inevidenza/article\_0079.html

([11]) The cyclically-adjusted current account
balance is the current account balance which would prevail if the output gaps of
a country and of its trade partners were at zero, and therefore both domestic
demand (determining a country’s imports) and external demand (determining a
country’s exports) were at their potential.

([12]) See for instance in 't Veld, J., 'Fiscal
consolidations and spillovers in the Euro area periphery and core', European
Commission – DG ECFIN Economic Papers, No. 506, 2013

([13]) Following the NACE rev. 2
classification of economic activities, the tradable sectors are agriculture,
industry excl. construction (A-E), and some selected services (G-J).

([14]) Bugamelli, M., et al., 'Domestic and
foreign sales: complements or substitutes?', Bank of Italy Occasional Papers,
No. 248, 2014 This paper shows that over the 2008-12 period, there has been a
positive correlation between domestic and foreign sales at the firm level,
possibly explained by liquidity and credit constraints.

([15]) Jewellery, musical instruments and
toys; repair and installation of machinery and equipment

([16]) Measured as the share of goods exports
value out of total gross value added in each sector.

([17]) Measured as the ratio of turnover
realised with foreign sales to total turnover.

([18]) Sectors are classified by Harmonised System 1992.

([19]) Accetturo, A., Giunta, A., 'Global
value chains in the face of the Great Recession', Bank of Italy, mimeo, 2012

([20]) The proportion in employment of those
aged 15-24 and 25-39 fell respectively from 6.5% in 2008 to 4.3% of 2014 and
from 41% to 33%. Composition effects related to skill levels, age and tenure of
employed in the private sector account for one fifth of the overall changes in
wages over the period 2008-2013. Changes in the sectoral composition or the
higher share of temporary and part-time contracts played a minor role
(Relazione Annuale, Bank of Italy, 2014).

([21]) Differences between actual and forecast
inflation can be incorporated in wage increases ex-post, provided that the
difference is significant, and subject to agreement among social partners.

([22]) See also 'In-depth review of the
Italian economy', European Economy Occasional Papers, No. 182, 2014, p.
41, Graph 3.33. International comparisons are always difficult, as
cross-country differences may depend on factors unrelated to pay scale, such as
different turnover. In very flexible markets, such as in the UK, wages are
supposed to follow productivity, which is therefore expected to peak and then
decrease over time.

([23]) A worker is classified as (under-)
over-qualified when the difference between his or her qualification level and
the qualification level required in his or her job is (negative) positive. A
worker is qualified as (under-) over-skilled when her/his proficiency is (below)
above the (minimum) maximum required by her/his job. Full methodological
details are at OECD (2013), 2013 Skills outlook, percentage point 170-173, http://www.oecd.org/site/piaac/.

([24]) Hanushek E. A., Schwerdt G., Wiederhold
S., Woessmann L. (2013), 'Returns to skills around the world: evidence from
PIAAC', OECD Education Working Papers, No. 101. The paper finds that
returns to skills are on average lower in Italy than in most of the other OECD
countries, and that the differential between the return to skills for older
workers (those aged 55-65) and that for young adults (aged 25-34) is higher
than in the other OECD countries covered by the study.

([25]) 'Nota dal Centro Studi Confindustria', Confindustria, No. 2,
2015

([26]) Financial leverage is defined as the
ratio between financial debt and the sum of financial debt and equity.
Financial debt consists of loans and debt securities. This concept should be
distinguished from indebtedness, which is measured by the corporate debt-to-GDP
ratio.

([27]) ‘The role of leverage in firm solvency:
evidence from bank loans’, Bank of Italy Occasional Papers, no. 244,
2014.

([28]) The interest expense coverage ratio is
calculated as the ratio of net interest expense and gross operating profit.

([29]) In Italy, impaired loans are classified
into four categories: bad debts (sofferenze), substandard loans (incagli),
restructured loans (partite ristrutturate) and overdue/overdrawn loans (partite
scadute).

([30]) The non-performing loan coverage ratio
is the ratio of the stock of loan-loss provisions and the stock of
non-performing loans.

([31]) Discouraged borrowers are borrowers
deciding not to apply for a loan out of fear of rejection.

([32]) Ministero dello Sviluppo Economico (MISE), Indagine sulle micro,
piccole e medie imprese: sintesi dei principali resultati, July 2014. In this survey, high shares of respondents claiming that they did
not know the allowance for corporate equity (ACE) and mini-bond frameworks
(76.2 % and 75.2 % respectively). The most well-known initiatives are the
Central Guarantee Fund for SMEs (50 % of respondents knows it) and the 'Nuova
Sabatini' framework to support specific types of SME investment (60.8 % of
respondents knows it).

([33]) Since 2012, this framework allows
Italian firms to deduct a notional return on new equity capital or reinvested
earnings in computing taxable profits.

([34]) ‘Indagine sulle imprese industriali e dei servizi – Anno di
riferimento 2013’, Banca d’Italia - Supplementi al Bollettino Statistico,
no. 40, July 2014.

([35]) Mini-bonds are unlisted corporate
bonds, a funding instrument which was introduced in 2012 to diversify the debt
financing of medium-sized and small enterprises.

([36]) Promuov Italia, Rapporto di Approfondimento sul Fondo di Garanzia,
2014.

([37]) See for instance: ‘A strategy for
developing a market for non-performing loans in Italy’, IMF Working Papers,
WP/15/24, 2014.

([38]) Nine out of the 15 Italian banks
participating in the European Central Bank's comprehensive assessment
registered capital shortfalls based on 2013 balance-sheet data. All banks
passed the asset quality review when considering the capital increases made in
the first nine months of 2014, whereas the stress test revealed capital
shortfalls amounting to EUR 3.3 billion for four banks. By taking into account
other mitigating measures adopted in the course of 2014 (e.g. one-off asset
divestments, finalization of ongoing authorization procedures to use internal
models), the theoretical capital shortfalls were reduced to EUR 2.9 billion.
These shortfalls are currently concentrated in two banks, namely in Banca Monte
dei Paschi di Siena and Banca Carige.

([39]) Cerved Group, Rapporto Cerved PMI
2014, 2014.

([40]) IMF, Article IV Consultation –
Italy, 2014. See also the 2013 Belgian act on security
interests on movable assets.

([41]) Every shareholder holds one vote
irrespective of the size of his shareholding.

([42]) Carry trade exploits the positive
spread between the (high) yield on (domestic) sovereign bonds and the (low)
refinancing rate offered on Eurosystem liquidity facilities.

([43]) According to the Bank of Italy, lending
– when adjusted for the cost of provisioning – currently produces a return
which is clearly lower than investment in securities. See Bank of Italy, Financial
Stability Report, no. 2/2014, November 2014.

([44]) These refinancing operations are
specifically designed to support lending to the real economy. The first two
operations took place in September and December 2014, and the participation of
Italian banks is estimated at EUR 23 billion and EUR 26 billion respectively.

([45]) On 22 January 2015, the European
Central Bank announced an expansion of its assets purchase programme by adding
the purchase of sovereign bonds to the already existing private-sector purchase
programmes (i.e. for asset-backed securities (ABSPP) and covered bonds (CBPP3))
to address the risks of a too prolonged period of low inflation. Combined
monthly asset purchases will amount to EUR 60 billion, and this at least until
September 2016. Purchases of securities under the expanded asset purchase
programme that are not covered by the asset-backed securities and covered bonds
purchase programmes will be allocated across issuers from the various euro-area
countries on the basis of the European Central Bank's capital key.

([46]) Luxembourg, an
outlier country not included in the analysis, registered exposures equivalent
to almost 4 times its GDP. Also, Italian financial investments in Luxembourg
amount to six times the latter’s GDP.

([47]) Data on bank claims differs from data
on gross financial exposures as the latter covers the claims of the entire
economy, whereas the former covers the banking sector specifically.
Furthermore, the two data sources may not be entirely consistent as i) gross
financial exposures are based on 2012 data while bank claims are based on data
for the second quarter of 2014, ii) the countries in sample differ across
datasets and iii) data on bank claims is based on the country of ultimate risk
(the country where the guarantor of a claim resides) and includes claims of
banks' own foreign affiliates, while gross financial exposures are based on a
locational notion of counterpart that is consistent with balance of payments
statistics.

([48]) See for instance Giordano, L., et al., ‘Sovereign
risk premia in the Euro Area and the role of contagion’, Journal of
Financial Management, Markets and Institutions, 1/2013, January-June 2013.

([49]) ‘Cross-border spill-overs in the euro
area’, Quarterly Report on the Euro Area Vol 13 No 4, 2014.

([50]) See, among others, ‘Il Fenomeno della Corruzione in Italia. Prima Mappa
dell’Alto Commissario Anticorruzione’, Department of Public Administration -
Commission against corruption, 2008, and ‘La Corruzione in
Italia. Per una Politica di Prevenzione’, Commission on corruption in
public administration, 2012.

([51]) Lorenzani, D. and F., Lucidi, ‘The
Economic Impact of Civil Justice Reforms’, European Economy Economic Papers,
No 530, September 2014, show that halving the backlog is associated with an
increase in FDI net inflows by 0.5 percentage points. In Giacomelli, S., and
C., Menon, ‘Firm size and judicial efficiency: evidence from the neighbour’s
Court’, Bank of Italy Working Papers, No 898, January 2012, halving the
length of civil proceedings would increase the average firm size by 8 to 12 %.

([52]) Commission’s elaborations based on the
Italian government’s ‘Monitoraggio del Programma’ report, taking the 2015
Stability Law into account.

([53]) Between January and June 2014, the
parties appeared before the mediator in 39.1 % of cases, and agreements were
found in only 35.9 % of those. Source: Ministry of Justice. Beyond the economic
dimension, the respect of fundamental rights, in particular the right to access
to justice, and principles such as judicial independence should be the basis of
any justice reform. In this context, a general obligation to use alternative
dispute resolutions might be against the right to an effective remedy before a
tribunal, as per Article 47 of the EU Charter of Fundamental Rights.

([54]) Source: ‘Study of the European
Commission for the Efficiency of Justice’ (CEPEJ) prepared in view of the 2015
EU Justice Scoreboard (to be published in early March 2015). The clearance rate
was 106.6 % in first instance courts and 127.2 % in appeal courts in 2013.
Pending cases in first instance administrative courts have also been relatively
high but decreasing by around 12 % per year from 349 149 at the end
of 2012 to 262 775 at the end of 2014. Source: Consiglio di Stato.

([55]) The total number of pending civil cases
in all instances was 5 159 466 at the end of 2013, against
5 385 781 at the end of 2012 and 5 922 673 in 2009.
Source: Ministry of Justice.

([56]) The disposition time is an estimated
indicator of average trial length, comparing the number of resolved cases
during the observed period and the number of unresolved cases at its end. It
provides a measure of the average number of days necessary for a pending case
to be solved in court. The disposition time for civil and commercial cases decreased
from 395 days in 2010 to 369 days in 2013 in first instance courts and from
1 242 days in 2010 to 842 days in 2013 in second instance courts. Sources:
‘Study of the European Commission for the Efficiency of Justice’ (CEPEJ)
prepared in view of the 2015 EU Justice Scoreboard (to be published in early
March 2015)

([57]) ‘Giustizia civile: Censimento speciale sulle pendenze uffici
giudiziari’, 2014. Source: Ministry of Justice.

([58]) ‘Consumer attitudes towards
cross-border trade and consumer protection’, Flash Eurobarometer No 397, 2014.

([59]) ‘Corruzione freno allo sviluppo. Il rebus della ripresa’, Centro
Studi Confindustria, December 2014.

([60]) ‘Exporting Corruption, Progress Report
2014, Assessing Enforcement of the OECD Convention on Combating Foreign
Bribery’, Transparency International, 2014 and ‘Third Evaluation Round.
Evaluation Report on Italy Incriminations (ETS 173 and 191, GPC 2)’, GRECO,
2012.

([61]) For instance, the possibility to ask
for ‘pattegiamento’ in front of the preliminary hearing judge. See also
the ‘2014 EU anti-corruption report’, European Commission, 2014.

([62]) For more extensive analyses, see
European Commission, ‘Assessment of the 2014 national reform programme and
stability programme for Italy’, SWD (2014)413, 2014. See
also: Autorità garante per la concorrenza e il mercato, ‘Proposte di riforma
concorrenziale ai fini della legge annuale per il mercato e la concorrenza -
Anno 2014’, 2014.

([63]) Since 2012, the national competition
authority can issue an opinion requesting public local entities or
administration to repeal any administrative act that, in the view of the
authority, is contrary to competition law and principles. In case of
non-compliance to its opinion, the authority may challenge the act before the
Administrative Tribunal. Nearly ¼ of the 45 of the opinion issued concern the
retail sector.

([64]) Commissario alla spesa, ‘Programma di razionalizzazione delle
participate locali’, 2014, p. 4, Tavola II.1.

([65]) Fondazione Caracciolo, ‘Il trasporto pubblico in Italia. Stato,
prospettive e confronti internazionali’, 2012.

([66]) As regards the five main drivers of the
digital economy, Italy ranks 14th out of 28 Member States on digital public
services, 20th on  integration of digital technologies by business, 24th on
human capital, 27th on both connectivity and on use of internet services.
Source: Digital Economy and Society
Index, DG CNECT.

([67]) Eurostat, ‘Community Survey on ICT
usage in households and by individuals’, 2014.

([68]) ‘Consumer attitudes towards
cross-border trade and consumer protection’, Flash Eurobarometer 397,
2014.

([69]) For floods: Risk and Policy Analysts, ‘Study
on Economic and Social Benefits of Environmental Protection and Resource
Efficiency related to the European Semester’, 2014. For air pollution: European
Commission, ‘Impact Assessment of the Commission Integrated Clean Air Package’,
2013. For land management see: ‘Italian Partnership Agreement 29.10.14’, Section
on Analysis of Disparities, pp. 55-63.

([70]) ‘The Sixth National Communication under
the UN Framework Convention on Climate Change’, Italy, 2013

([71]) European Commission, ‘Innovation Union
Scoreboard 2014’, 2014.

([72]) Franceschi, F.,
'The Added Worker Effect for Married Women in Italy' in 'Gli effetti della
crisi sul potenziale produttivo e sulla spesa delle famiglie in Italia', Bank
of Italy – Workshops and Conferences, No.18, 2014. The paper shows that the
probability of a wife moving into employment increases by 2.1 percentage points
when her husband is laid off; the probability of joining the labour force for
an inactive wife increases by 3.5 percentage points The added worker effect
accounts for 8 % of the higher labour supply of married women during the 2011
crisis.

([73]) The gender gaps in employment and hours
worked translate into lower pension entitlements for women: the current average
gender pension gap in Italy is 31 % (still below the EU average of 39 %). See European
Network of Experts on Gender Equality, ‘The gender gap in pensions in the EU’,
p. 37, 2013

([74]) The potential labour force is
calculated here as the sum of labour force plus those willing to work but not
seeking because they think that no work is available (data from Labour force
survey, Istat).

([75]) In 2013 the number of residents
officially leaving the country increased by about 20 % over 2012. Most of the
people who left have Italian citizenship (+ 21 %, from 68 000 in 2012 to 82 000
in 2013), ISTAT 2014.

([76]) Youth Guarantee Monitoring, 23 January
2015. http://www.garanziagiovani.gov.it/Monitoraggio/Pagine/default.aspx.

([77]) ANVUR,‘Rapporto sullo stato del sistema universitario e della ricerca
2013’, 2014.

([78]) AlmaDiploma, ‘XII Rapporto sul profilo dei diplomati’, 2014,

([79]) AlmaLaurea, ‘Condizione occupazionale dei laureati. XVI Indagine 2013’, 2014 Recent
graduates are people that completed their studies one year before the survey
was conducted.

([80]) Ministero dell’Istruzione, dell'Università e della Ricerca, ‘Presentazione
del sistema di Monitoraggio e valutazione degli Istituti Tecnici superiori’, 2014.

([81]) European Commission, ‘Employment and
Social Developments in Europe report 2013’.

([82]) ISTAT, ‘Tendenze demografiche e trasformazioni sociali. Nuove sfide
per il sistema di welfare. 2014 Annual Report’, 2014.

([83]) Network Non Autosufficienza, ‘L'assistenza agli
anziani non autosufficienti in Italia - Rapporto promosso dall'IRCCS - INCRA
per l'Agenzia nazionale per l'invecchiamento’, 2013.

([84]) The ‘implicit tax rate’ is a measure of
the effective average burden on different types of economic income or activity,
e.g. labour, consumption or capital. It is calculated as the ratio of the
revenue from the type of tax in question to its (maximum possible) base.

([85]) ‘Audizione preliminare all’esame dei documenti di bilancio per il
triennio 2015-2017’, Banca d’Italia, November 2014.

([86]) The difference between the two
exercises is mostly due to the diverging definitions of the benchmark compared
to which a certain provision is considered a deviation. The first exercise
takes the tax laws as a benchmark, whereas the second estimate considers theoretical
concepts of income, consumption or value-added taxes. The second exercise may classify
as tax expenditures elements which may be considered part of tax design under
the first one.

([87]) OECD, Tax expenditures in OECD countries,
2010; Tyler J., Reforming tax expenditures in Italy: what, why and how?, IMF
Working Papers, WP/14/7, 2014.

([88]) CPB/CASE, Study to quantify and
analyse the VAT gap in the EU27 Member States, commissioned by the European
Commission, 2014. The VAT (policy) gap is defined as the  difference between
the expected VAT receipts if all the VAT which is due is collected and the
actual VAT collected. It is a measure of foregone revenues due to reduced VAT
rates and exemptions. The caveats related to international comparisons of the
tax gaps should however be taken into account. Some VAT exemptions are set
under EU law and are mandatory for Member States.

([89]) Istat, Rapporto Annuale. La situazione del paese, 2012.

([90]) Ministero Economia e Finanze, Rapporto sulla realizzazione delle
strategie di contrasto all’evasione fiscale, sui risultati conseguiti nel 2013
e nell’anno in corso, nonché su quelli attesi, con riferimento sia al recupero
di gettito derivante da accertamento all’evasione che a quello attribuibile
alla maggiore propensione all’adempimento da parte dei contribuenti (art. 6 del
decreto legge 24 aprile 2014 n. 66), October 2014.

([91]) CPB/CASE, Study to quantify and
analyse the VAT gap in the EU27 Member States, commissioned by the European
Commission, 2014. The VAT (compliance) gap is the difference between the amount
of actually collected VAT and the VAT total tax liability (i.e. the VAT that should
in theory be collected based on VAT legislation). It can be seen as an
indicator of the effectiveness of VAT enforcement and compliance measures. The
caveats related to international comparisons of the tax gaps should however be
taken into account.

([92]) First, it moves away from the principle
of ‘fractioned payment’ of VAT whereby each taxable person in the chain pays a
part of the total amount. Second, the potential for fraud remains and even
increases at the retail level because of the breach of the ‘self-policing’ principle
of fractioned payment which makes it more profitable. Third, when the reverse
charge mechanism only applies to a limited range of products and services,
carousel fraudsters are still able to carry out their activities by trading in
other products.

([93]) Mezzogiorno includes Abruzzo, Molise, Campania, Puglia, Basilicata,
Calabria and the two islands Sardegna and Sicilia.

([94]) Italy – Selected issues, IMF Country
Report No.11/76, July 2011

([95]) Pench, L., Sestito, P., Frontini, E., 'Some
Unpleasant Arithmetics of Regional Unemployment in the EU: Are there any
lessons for the EMU?', European Economy. No. 134, 1999, and Vamvakidis, A., 'Regional
wage differentiation and wage bargaining system in the EU', IMF Working paper
No.43, 2008.

([96]) The European Quality of Government
Index (EQI) is a composite index created by the European Commission (DG
REGIO) that enables the measurement of institutional quality on a regional
level. It combines country-level data from the World Bank's Worldwide
Governance Indicators (WGI) and adjusts using regional-level survey data (based
on answers form 85000 respondents across Europe) to include regional variation
as perceived by local inhabitants. It looks at categories such as control of
corruption, rule of law and government effectiveness.

([97]) Charron, N., Lapuente, V. and
Dijkstraet, L., 'Regional Governance Matters: A Study on Regional Variation in
Quality of Government within the EU', DG REGIO Working Papers 01, 2012.

([98]) Tabellini, G., 'Culture and
institutions: economic development in the regions of Europe, Journal of the
European Economic Association, European Economic Association, 8(4):677–716,
2010.

([99]) As reported in ‘Investment for jobs and
growth', Sixth report on economic, social and territorial cohesion, DG
REGIO, July 2014.

([100])         The following categories are
used to assess progress in implementing the 2014 country-specific
recommendations of the Council Recommendation: No progress: The Member State
has neither announced nor adopted any measures to address the country-specific
recommendation. This category also applies if a Member State has commissioned a
study group to evaluate possible measures. Limited progress: The Member State
has announced some measures to address the country-specific recommendation, but
these measures appear insufficient and/or their adoption/implementation is at
risk. Some progress: The Member State has announced or adopted measures to
address the country specific recommendation. These measures are promising, but
not all of them have been implemented yet and implementation is not certain in
all cases. Substantial progress: The Member State has adopted measures, most of
which have been implemented. These measures go a long way in addressing the country-specific
recommendation. Fully addressed: The Member State has adopted and implemented
measures that address the country-specific recommendation appropriately.

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