Reform, not a bailout, will save Italy

Matthew Melchiorre is Warren T. Brookes journalism fellow at the Competitive Enterprise Institute.

WITH Greece on life support from the European Union and Spain squirming in the financial vice grip of its insolvent banks, talk of an Italian bailout is nigh. Without a growing economy to generate wealth, Italy is having a hard time convincing current and prospective bondholders that it can pay its debts. But throwing money at Italy’s problems won’t make them go away.

Substantive structural reform is the only way to restore prosperity, by spurring competitiveness and entrepreneurship. High taxation, a completely inflexible labour market, and poor governance stand in the way.

Italy’s tax wedge – the difference between before-tax and after-tax wages – is the fourth highest in the Eurozone. Italy’s tax on consumption, the value-added tax (VAT), is only 2 per cent below that of Greece and Portugal, which are at 23 per cent. Making a bad situation worse, Prime Minister Mario Monti’s December 2011 reform package raises VAT to 23 per cent starting in October.

High taxes discourage employment. A 2010 study by Primož Dolenc and Suzana Laporšek of Slovenia’s University of Primorska found that EU countries with higher tax wedges had lower employment growth. Increases in the tax wedge had a strong negative correlation with employment growth. Given Italy’s mile-high tax rates, it’s no surprise that it suffers the second lowest rate of employment – at 56.9 percent – within the monetary union. Greece is dead last at a dismal 55.6 percent.

At the heart of Italy’s employment problem is its rigid labour market, in which firing workers is virtually impossible. Incompetence cannot constitute grounds for dismissal. In fact, the law states that worker incompetence is the fault of the employer, not the employee. Employers may only dismiss employees if they can prove “concrete and wanton negligence” on the part of the employee in a labour court. Rigid labour laws cover 87 per cent of the entire Italian workforce, according to Datagiovanni, a statistical agency that studies Italy’s youth.

Entrepreneurs are extremely hesitant to hire new help and expand their businesses because they don’t want to take the risk of hiring a worker for life. Italy has the smallest proportion of employment in medium-sized firms within the entire EU. It also has the highest proportion in micro-firms, those with fewer than 10 employees.

Monti’s labour reform this spring was geared more to placating unions and party leaders, than to making the labour market more flexible. Businesses may now fire workers in times of economic distress, but only after they dish out up to 24 months of severance pay and prove their financial straits to a labour judge. And it made temporary work contracts – the only hope of employment for many of Italy’s work-starved youth – more expensive to enter into.

Italians know drastic changes to their labour market are necessary. In a autumn 2011 Eurobarometer survey, Italians identified labour reform as the most important policy initiative needed to get out of the economic crisis.

Italian businesses have a relatively poor security on investment, due in large part to poor and declining governance. Over the past decade, Italy has plummeted in the World Bank’s World Governance Indicators in control of corruption, rule of law, and government effectiveness. In the latest rankings, Italy stands below Greece in all three categories.

Italy’s broken court system is a testament to this. The average time to adjudicate a lawsuit is nearly three and a half years. Italy ranks last of all OECD high income countries in contract enforcement, according to the World Bank. That’s discouraging to entrepreneurs who rely on an effective legal system to protect their property and their contracts.

But despite Monti’s failure to enact real reform, he seems to be Italy’s only hope of averting complete disaster. With Berlusconi waiting in the wings and the rise of the populist Five Star protest movement, the alternatives to a weak Super Mario are his video game nemeses, King Bowser and Walluigi.

Super Mario had to face his rivals to save the Mushroom Kingdom. Monti must face down cowardly politicians, intransigent union leaders, and an onerous tax regime to save Italy.

Matthew Melchiorre is an adjunct analyst at the Competitive Enterprise Institute. He lived, worked, and studied in Italy.

City A.M.'s Opinion pages are a place for thought-provoking opinions and views. These are not necessarily shared by City A.M.

Show Comments

In Other News