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Why Italy Declines

Media headlines no longer contain articles about debt crises in EU countries. But there is the possibility that these troubled countries (Portugal, Italy, Greece, and Spain) may experience debt crises again because they have deep-seated structural problems that are the ultimate causes of their stagnation. A recent article about Italy provides some insights into Italy’s economic circumstances.

Consider the following facts from this article.

  • Since 2008, GDP has declined by 9 percent.
  • The ratio of government debt to GDP is 133 percent.
  • Ninety eight percent of the firms in Italy have 15 or fewer employees.
  • Bureaucratic red tape is severe.
  • The legal system processes court cases very slowly.
  • Tax avoidance is widespread.

Each of these facts provides insights into the Italian economy’s structural problems.

The decline in GDP, and the debt-income ratio, reveal that Italy’s problems stretch back over many years. The government has yet to implement any serious structural reforms that may reverse the decline. Structural change is extremely difficult to impose because there are entrenched interests who benefit from the status quo.

The fact that firms are usually so small is striking. Economists usually argue that there are scale economies associated with size so that, as firms grow, they can provide products more efficiently (and cheaply). The small size of firms provides part of the explanation for the inability of the economy to grow but the article points out that there are cultural aspects associated with the population making Italians reluctant to expand the size of their firms. In addition, the larger is the firm, the more likely it is that government regulations affect the management of the firm, providing an incentive for firms to avoid expansion.

The government has imposed barriers to entry that are so severe that regulations prevent firms from moving into Italy. The article provides an anecdote that it took over 4o years for a firm to get building permits! Further, the legal system is slow to determine property rights and settle disputes so a firm has difficulty managing itself properly.

Finally, tax avoidance by individuals and firms (for example, doing work off the books in the underground economy) means that those who do pay their taxes wind up paying more than they should, further reducing the rewards to their labor supply. Thus the tax burden is arbitrarily distributed across households and firms. Tax avoidance is a response to hight marginal tax rates and/or a lack of respect for the government’s activities.

The overall picture is one of an economy hobbled by many structural impediments put in place because they benefit entrenched interests. For example, workers who can’t lose a job will fight hard to keep their benefits, punishing any politician who removes their pet program. Politicians respond to incentives. The real question is whether there are enough people in Italy who will make it politically profitable for politicians to implement the structural reforms that will allow Italy to grow again and create wealth for its citizens.



Categories: Uncategorized
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  1. February 20, 2015 at 1:54 PM

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