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Italy in Crisis

Monday, December 18, 2006

Can Prodi surpass Berlusconi when it comes to free-market reforms? Yes, and reforms wouldn’t come a moment too soon…

Fourth in an occasional series on European politics.

Italy’s economy is among the most sluggish in Europe. Spain, formerly a poor nation on Europe’s Southern periphery, is set to surpass Italy’s GDP per capita by 2009 at the latest. As early as 2004, Martin Larch noted that “Within the EU, Italy ranks second last in terms of average real GDP growth [from 1992 through 2003] outperforming only Germany.” Italy’s average rate of growth during that period was 1.4%, compared to more than 3% for the U.S. and more than 2% for the EU as a whole.

Since 2004, things have not gotten better. Unemployment currently stands at around 7% [L’Espresso-Italian text], and this year’s deficit stands at 4.8 percent of GDP, much higher than the 3 percent permitted by the EU’s Stability Pact. Moreover, Italy’s national debt now stands at a remarkably high 108% of GDP, even as labor unions continue to veto proposals that could lead to more economic vitality.

To put it plainly, Italy is in trouble.

The new Prime Minister, Romano Prodi, is left-of-center but not a Socialist in the mold of François Mitterrand, Oskar Lafontaine, or Ken Livingstone. Rather, Prodi is pragmatic, moderate and very much reform-oriented. And unlike Gerhard Schroder or Lionel Jospin, Prodi in his youth was not caught up in wild ideological excesses: he was a conventional, studious youngster, “the eighth in a family of nine children, seven of whom went on to be university lecturers.” He is also a devout Catholic.

More importantly, when he was Prime Minister from 1996 to 1998, Prodi built up a solid track record as a reformer. As noted by Tito Boeri, an economics professor at Bocconi University, “‘It was the center-left that did the fiscal adjustment to Italy’s economy in the 1990s… Prodi can do it again.’” Boeri refers to the reforms that Prodi initiated between 1996 and 1998 when he was Prime Minister: these included significant deficit reductions and privatizations in order to allow Italy to participate in the Euro.

Prodi built on the free-market legacy of one of his left-of-center predecessors, Giuliano Amato, and reduced government ownership in ENI (Italy’s national oil company). He also privatized Telecom Italia, formerly STET, in 1997. These were strong free-market measures for a left-of-center Italian leader, all the more so because the privatization of Telecom Italia, at about 13 billion Euros ($17 billion at current rates) was “the largest privatization transaction of the year” and the “largest privatization ever outside Japan.” [Comincialitalia-Italian link, OECD, EU, Global Finance.]

Unfortunately, Prodi is raising taxes at present, driven by many of the same factors that led him to raise taxes in the 1990s. Today, just as he did then, he faces a towering deficit, and wants to secure Italy’s continued participation in the Euro (in the mid-1990s he wanted to secure Italy’s accession to the Euro). And just as in the mid 1990s, he has initiated cuts in government spending that, while modest, are not negligible.

A few weeks ago, in early December, about 80,000 right-leaning Italians took to the streets of Rome to protest measures taken by Prodi’s new government to get a grip on the deficit by cutting spending and substantially raising taxes. Most “protesters” were normal, middle-class Italians—small business owners, small-scale professionals, law-abiding citizens. Encouraged by Silvio Berlusconi, they angrily but peacefully voiced their displeasure with Prodi’s proposed tax increases.

Until he was replaced by Romano Prodi in May of 2006, of course, center-right Silvio Berlusconi was the leader of Italy. One of the most strident free-market ideologues in Western Europe, Berlusconi was courageously pro-American, to the chagrin of many European elites. He tirelessly defended free enterprise (as a concept) against domestic socialist ideologues and European naysayers, and gave the United States remarkable support in its military operations abroad. For all this, he deserves great praise. Unfortunately, in the field of economic reforms, Berlusconi’s rhetoric was far more impressive than his actions were.

During his time in office, Berlusconi cut the corporate tax rate “from 36 percent in 2002…to 33 per cent in 2004.” While that is good, Germany’s Gerhard Schroder, a center-left leader, was able to slash the basic German corporate tax rate from 40 to 25% during his time in office, and Tony Blair, also a left-of-center leader, was able to cut it from 33 to 30%. One would have expected a center-right leader like Berlusconi, with strong control over his faction in Parliament to boot, to do much better.

What about income taxes? Berlusconi's 2001 ``Contract With Italians'' promised to cut the top income tax rate from 45 to 33 percent. Instead, the top rate was only cut from 45 to 43 percent. Schroder, by contrast, surpassed Burlosconi in this regard, cutting the top German income tax rate from 53 to 42 percent during his time in office. Even France’s Jospin, the Socialist who railed against hedge funds and globalization, managed to cut the top income tax rate from 54 to 50 percent, and Jospin was in the toughest position of all: nestled in a coalition with the French Communist Party, which views high income earners as a class of oppressors. [French Senate, La Vie Financière, French language.]

When measured by the fiscal achievements of his left-of-center colleagues in other Western European countries, therefore, right-of-center Berlusconi falls short. Nerio Alessandri, the pro-market founder of a $333 million maker of fitness equipment in the Italian town of Gambettola, went as far as to say “I’m extremely discouraged about the time we’ve lost” over the past five years when it comes to structural reforms.

In addition to the tax burden, Italy faces another serious obstacle to dynamic growth: rigid labor laws that make firing an employee almost impossible. Berlusconi’s government timidly attempted to reform the labor laws in but did not succeed.

Whether Prodi can get Italy’s economy back on track will depend on whether he can control the radical leftist groups in Italy’s notoriously fragile coalition system. At present, Prodi is almost shackled by them—“reformed communists” as they call themselves, scruffy looking, generally bitter and morose people who have a  zero-sum view of economics. Already, they have succeeded in forcing Prodi to backtrack on mild reforms of the pension system, accept more far-reaching tax increases, and substantially limit proposed spending cuts.

Prodi may ultimately unshackle himself from the far left. If he rises to the occasion, through a combination of political adroitness and savvy deal making, it is almost certain that he will surpass Berlusconi as a free-market reformer, and his legacy as one of the greatest Italian reformers of the modern era, barring an unforeseen scandal, will be assured.

If, on the other hand, Prodi fails to control Italy’s far-left, and succeeding Prime Ministers fail to enact far-reaching reforms, Italy can expect to fall even further behind other nations in terms of per capita wealth.

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