Italy on the Edge: Recovery or Backward Walk? A snapshot on the EC 2016 Country Report

The European Semester 2016 is in full swing. This year the emphasis is on employment, competitiveness, investment and social performance.

As part of efforts to streamline the semester, the EU Commission has recently published country-specific reports  analyzing Member States’ economic and social policies in light of the Commission’s Annual Growth Survey released in November 2015.

The country reports offer a starting point for the dialogue among Member States on the socio-economic challenges they face and, together with the country-recommendations (published every Spring), they should feed the National Reforms Programs to be presented in April.

For the 18 Member States – including Italy – the country reports include an in-depth review under the macroeconomic imbalance procedure.

The country reports identify a situation of overall macroeconomic stabilization. have made progresses in addressing country-specific recommendations issued in 2015 and they appear to be on their way to meet the Europe 2020 strategy targets.

Member States are on track towards reaching their targets on emissions reductions, renewable energy and energy efficiency as well as education and early school levy by 2020. While reaching the employment target still proves to be a real challenge for many Member States, the employment situation has improved almost everywhere: in 2016 the unemployment rates fell by 0.5%, particularly in the countries where labor market reforms have been implemented.

Overall, EU economy is forecasted to grow in 2017 from 1,9% to 2% of GDP, also benefiting from exogenous factors, such as low oil prices, a relatively weak euro pushing exports and lax monetary policies. At the same time, geopolitical tensions, security concerns, the unprecedented inflow of refugees and asylum seekers over the last years have made the economic outlook more challenging.

In a context of fragile and slow recovery, a key role to build a more competitive economy is played by structural reforms, both at the national and EU level. Reforms of the labor and product markets, national election calendars as well as pension systems and banking sectors are in the pipeline of many countries’ policy agenda, but their implementation takes long to materialize due to the complexity involved.

The economic performance and social conditions as well as reform implementation remains uneven across the EU, with many economies still facing slow productivity growth, high private and public debt levels, in turn negatively affecting investment, competitiveness and living standards.

The Country Report on Italy indicates that after three years of recession, the country is now experiencing a slow recovery started in 2015 and expected to strengthen in 2016 and 2017.

The Report recognizes the efforts Italy has made to address the 2015 country specific recommendations. Particular emphasis is on the actions taken to address the country’s longstanding weaknesses, like tackling the inefficiencies of the public administration and reducing the administrative burdens for citizens and business, a barrier to competition. The Commission also acknowledges the reforms of the governance of the banking sector and of the ongoing reform of the school system, which is considered to reward merit and support vocational training.

However, the recovery is still weaker than the rest of the euro-area and it is subject to potential risks imposed by both structural and exogenous variables. Italy’s high debt remains a source of vulnerability for the whole economy. The report insists on the need to undergo a systematic spending review to increase the efficiency of public expenditure and make it more growth-friendly by supporting structural reforms.

After a prolonged recession, labour market participation has increased. In 2015 unemployment rate averaged 11.9% down from 13% at the end of 2014. However, the report highlights that the risk for job market exclusion remains high, particularly for categories as young people, women and the elderly. In fact, the rate of young people not in education, employment and training is the highest in the EU. Prolonged joblessness can have detrimental consequences in the long-term at an individual and societal level, eventually hampering the growth potential of the country.

The Report also stresses the serious brain drain caused by the crisis. Since 2010 statistics report that a high number of young Italian citizens with a tertiary degree emigrated, reflecting better job opportunities and conditions abroad. These emigrants show a very low propensity to return to Italy and emigration is not matched by an in-flow of high skilled foreigners. Thus, this results in a permanent net loss of highly qualified labour supply and eventually in a loss of country’s competitiveness and growth prospects.

The Commission highlights the positive impact of the Job Act in reforming Italy’s labour market institutions and favouring open-ended recruitment (with fiscal incentives), labour reallocation and increasing exit flexibility (a measure opposed by labour unions). However, the higher flexibility imposed by the measure is expected to be complemented by more comprehensive unemployment benefits and assistance.  Some initial positive outcomes of the new discipline for contracts and the accompanying tax relief are already visible in terms of increase of open-ended hiring (increased by 37% in 2015 compared to 2014).

Individual support for young people looking for jobs has increased since 2015 with the EU-sponsored Youth Guarantee a pilot scheme aiming at promoting new forms of cooperation between public and private services. The number of young people enrolled has steadily increased in the last year, but regional differences persist in the delivery of the services offered. As the report highlights, the success of the reform is largely dependent on the extent of national/regional cooperation.

According to the Commission doing business in Italy remains more difficult than in other major EU economies: this is mainly due to an inefficient public administration. In order to fill the gap with its peers, Italy needs to make the business environment more favorable. For example, the time needed to open a start-up has considerably decreased, yet the costs are much higher than in France, Germany or Spain. Getting loans from banks, enforcing contracts, tax payment are also amongst the least favorable aspects of the Italian business environment.

Italy is still characterized by low R&D investments compared to other EU countries, and this is particularly true for expenditures by private businesses (0.53% of GDP compared to an EU average of 0.72%).  Small and young firms don’t have sufficient internal resources to invest in R&D projects; high-skilled workers are relatively scarce, as many Italian researchers left the country; and the cooperation between university and industry remains weak, thus limiting the potential of bi-directional knowledge transfer. Further, the Italian business model – characterized by small, family-owned firms and by low-tech and medium-tech manufacturing activities – is also a factor explaining the lower R&D investments in the country.

The Report acknowledges the policy initiative at the national level to foster the innovation system: tax credits for firms’ R&D activities, ‘privileges’ for the so-called ‘innovative Small and Medium Enterprises’; and a revision of the regulatory framework on equity crowdfunding in order to develop an alternative financing channel. Further, Italy has joined the European unitary paten scheme, which once in place will make easier for firms to obtain patent protection for their discoveries.

Re-launching investment, pursuing structural reforms to modernize the economy and responsible fiscal policy remain – according to the Commission – the recipe to recover from the crisis and fostering new growth opportunities.

The European Structural and Investment Funds (ESIF) are playing a critical role in promoting national reforms and convergence across the EU Member States. As beneficiary of the ESIF, Italy can receive up to EUR 43 billion for the period 2014-2020 (equivalent to the 0.4% of the GDP) for supporting structural reforms in areas identified in the context of the European semester and under the Europe 2020 strategy. The delivery of reforms in these critical fields – such fight against poverty, state aid, public procurement and reform of public administration, and improvement of education and training – is regarded as an ‘ex ante conditionality’ to use the ESIF funds. Hence, Italy and its long roadmap to structural reforms remain under the spotlight.

The centrality of the Italian economy within the EU makes it a source of major economic and financial spill-overs for the whole euro area. The financial and trade links directly and indirectly spurring from Italian economy are considerable. Italy is the third largest economy in the euro area

If the state of the Italian public debt remains a key concern and a potential vulnerability factor for the European economy, the report seems to challenge the (still unrealised) potential of the Italian economy to be a key actor for European recovery.