A poor country full of rich people - the troubles of Italy

08.02.2019 20:26|Marcin Lipka

"The Italian economy has been in decline for more than two decades even without wars or cataclysms. High public debt, low levels of employment, corruption, inefficient administration and strong divisions between north and south form the problem. However, is it possible that the wealth of an ageing population also causes stagnation?" writes Marcin Lipka, Conotoxia Senior Analyst.

Soon it will be one year since the last elections to the Italian Parliament. An exotic coalition of the right-wing League and the left-wing 5 Star Movement did not negotiate well, even before it was formed. Populist slogans on guaranteed income or the reversal of pension reform have doubled the cost of financing Rome's new debt.

The later conflict with the European Commission over the budget for the next three years kept the country in uncertainty, and the global downturn immediately pushed Italy into recession. Why is Italy so fragile and inefficient? And whose fault is it?

Italian insufficiency

For over 20 years, Italy's GDP per capita has decreased by about 3%. At the same time, it has increased by more than 20% in Germany and by almost 25% in the USA. The GDP change is a result of labour productivity. According to IMF data, the productivity of Italians is today about 5% lower than at the beginning of the century, while in Germany it rose by 10%.

Italian workers are not only unproductive but also expensive. Unit labour costs in the Italian industry have increased by almost 30% since the beginning of the new millennium, while they have remained stable throughout the eurozone. Moreover, Italian workers are overpaid and underperforming as well as being reluctant to work. The percentage of the working or job-seeking population is even lower than in Greece.

Costs are killing

Low economic activity is a result of the late entry of young people into the labour market, as well as their early exit, i.e. retirement. This generates enormous costs for the public finance system.

Currently, Italy spends as much as 16% of the total GDP on pensions, i.e. about 250 billion EUR. Over the next 20 years this expenditure, according to IMF estimates, will increase to 21% of GDP, which may represent almost 50% of all public finance sector expenditure. Almost three times more than the current OECD average.

Italians also have to finance their huge debt which exceeds 2 trillion EUR. Due to the disastrous political decisions of recent months and the lack of serious structural reforms over two decades, the current cost of financing the new debt in Italy is almost three times higher than in Spain.

Prospects are getting worse

Apart from the over-indebted public finance sector or low labour productivity, Italians also have an extremely sensitive banking system. High financing costs of banks, a significant percentage of loans with a high risk of non-repayment and investments in domestic treasury instruments cause (even with a slight slowdown) the threat of credit holding, i.e. blocking capital for business development.

With a potential GDP growth estimated at around 0.5% per year and serious structural weaknesses (as early as in the scenario of a moderate slowdown), the debt-to-GDP ratio will increase above 150% (as simulated by the IMF in Article IV Consultation). In this whole mix of problems over the Tiber, there seems to be one positive element. Italians are rich. However, in this situation, wealth harms rather than helps them.

Wealth is the curse of Italy

IMF and ECB data show that the net assets of Italian households exceed those of Germany or the eurozone - for both 10% of the richest and the median and 30% of the least wealthy citizens. The average household in Italy has net assets exceeding 350,000 EUR.

However, these assets consist mainly of real estate (two thirds) and bank deposits or treasury bonds. Briefly speaking, the accumulated goods work insufficiently and ineffectively for the development of the country.

In Italy, to a much greater extent than in other countries, wealth is in the hands of the older generation, who are also beneficiaries of an extremely generous pension system (the replacement rate reaches almost 100% of the final wage, although it should ideally be around 60-70%). The part of the capital that is most liquid can also flow out very quickly abroad, as shown by Q2, 2018 when the outflow was higher than during the summit of the debt crisis in the eurozone in 2012.

Therefore, the general wealth of families is to a large extent illusory. In an economic downturn, falls in real estate prices can depreciate for a long time, and chronic state inefficiency can quickly melt the assets accumulated in government bonds. Capital is frozen, but it is not worthwhile to put it into action due to low demand (the new generation earns much less than the previous generation at the same age), a number of fiscal burdens and an inflexible labour market (it is difficult to release an inefficient employee).

No chance for improvement

In Italy, we have an extraordinary accumulation of negative economic factors. The high state debt and huge liabilities to pensioners do not allow investment in human capital or infrastructure to improve the potential of the economy.

The wealthy part of the society is wondering how to protect their assets, because there are no prospects for investment, thus killing the entrepreneurship or the remaining spirit of a rivalry of the new generation (so-called animal spirit). The situation is also not improved by the structurally ineffective labour market, corruption (especially in the south of the country) or populist authorities, which only reinforces the pathological situation. At the moment, there is practically no chance that Italy's condition will improve in the next few decades. However, there is a growing risk that Italy will share Greece's fate and go bankrupt.


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