Economic growth of italy

Executive Summary

The report aims at analyzing the Italian economy from the perspective of its growth over the last 40 years. The first feature pertaining to Italy’s economy as presented is its inherent Dualism, existing cause of the presence of a developed North and underdeveloped South. The decade of 1971-80 was riddled by stagflation in the country due to a series of events starting from the price and wage control policies in 1971 and the oil crisis shock in 1973. The negative effects of the price control policies, high inflation and the unprofitable growth of the companies leading to the lay-off of the workers sent the Italian economy into a downward spiral, from which it was only able to recover after a few successful policies like deregulation of some industries and relaxed control on bank interest rates.

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The consequent decade, 1981-91, first saw Italy endure a period of recession which can be attributed to the continuance of the trend in 1970’s further fueled by a second oil crisis in 1979. It was only after 1983 that the country began to recover and witnessed economic expansion resulting from the effect of a few fiscal policy changes by the administration. The last part of the decade i.e. 1988-91 saw moderate economic growth and a check on unemployment while the overall growth rate settled around 2.4%.

The year 1992 marked Italy’s worst depression since World War-II where the growth rate fell below 1% and there was mass unemployment. The Italian debt too rose to unprecedented levels of 108% of GDP. The tightening interest rates due to the policies of other European countries and the instability of European markets due to the ratification of the Maastricht Treaty, 1991 were the leading causes for the depression and only after a profound reorientation in institutional, legal and economic policies leading to privatization was Italy able to strengthen its financial status.

The post 1992 period saw Italy consolidating its growth and catching up with its western European neighbors. It witnessed a growth in certain industries like motor vehicles, machinery that led to its stabilization and eventually being able to join the EMU and have a single currency being established between all member states in 2002.

The latter part of the report analyses the current scenario of Italy and the country reeling under the effects of the global recession in 2008. Lastly, for the way forward a few suggestions and recommendations have been made by our group in regards to the policies that need to be implemented in the country to foresee stronger economic growth.

Methodology

Through the use of data collated from different sources, this report analyzes the macro-economic growth of Italy, a developed nation, over a period of 40 or so years. The analysis divides the economic history of Italy into certain periods, “epochs”, and concentrates thoroughly on each epoch to describe the important factors contributing to the results for that period.

The report also analyses the motor-vehicle industry with regards to a specific company, “Fiat”, in tandem to the economic growth of Italy, so as to gain further insights of the policies and the general environment pertaining in the country on one of its leading industries.

2. Political Background

Italy has a republican form of government, governed on principles set out in the 1948 constitution. The political scene is dominated by a number of parties with diverse ideologies. In the absence of a clear mandate, these parties have entered into coalitions to form the government. After being dominated by socialist forces for three decades the country saw a change in its political and economic system in the 1990s, when more liberal forces came into power. Under the leadership of Silvio Berlusconi, the present government represents a centre-right ideology. Although Berlusconi’s government commands a majority in the parliament, economic recession poses a serious challenge to it. The poor state of government finances has limited the scope for such measures.

Analysis of Italy’s present political landscape

3. Introduction To Study: Problems And Propositions

The purpose of this study is to critically analyze the economic growth of Italy and also identify the factors and circumstances contributing towards the economic growth. The study further divulge in examining the impact of macroeconomic factors in a business environment. The study limits itself to past 40 years and is supported by relevant facts wherever appropriate data is available.

Economic growth indicates the increase of total GDP of a country. It is measured as the rate of change GDP. It is a representation of the quantity of goods and services produced. Growth accounting explains what part of growth in total output is due to growth of different factors of production (capital, labour etc.). Growth theory helps us understand how economic decisions determine the accumulation of factors of production. Italy has witnessed a shift primarily from agriculture based economy in 1940s to a matured economy, seventh largest in the world as of 2009. It lays a foundation to understand why economies grows at different growth rate in short run and why the growth rate shrinks and try to stabilize in the long run.

The automobile industry is arguably the best indicator of an economy; its growth rate almost follows the same trend as of the economic growth. The Italian vehicle industry is dominated by the Fiat Group (Fiat and its subsidiaries), that is present in all segments of the industry from mass production to niche segment manufacturing. In 2001 over 90% of all vehicles produced in the country were made by one of the group’s core brands, Fiat, Alfa Romeo, Lancia or its truck-making division Iveco. Much of the remainder was made either by Fiat-owned companies or manufacturers in alliances with the Italian giant. Fiat’s share in the automotive market has seen a steady decline due to market expansion and a large number of competitors as well (market share of 80% in 1920, 62% in 1984, and 41% in 1998). But, still it is the single largest organization in the Italian automobile industry. Therefore Fiat can be considered a fair representation of the automobile industry, which has a vital contribution to the Italian economy.

This study represents and tries to reflect and examine the various concepts of the macroeconomics. The historical data has been analyzed and inferences are drawn to substantiate the harmony between concepts and real world. The study reflects the contribution of technology, capital and labour towards the growth of an economy. It also builds behaviour between unemployment and inflation. The study also reflects the control of exchange rates on the economy. While concluding the study a relationship between economy and automobile sector is laid. This hypothesis is analyzed with the growth of Fiat and the automobile market also.

4. Features And Periods Of Italian Economy

Dualism In The Italian Economy

Dual economy: Adual economyis the existence of two separate economic systems within one country. The Dual economies are common in less developed countries, where one system is geared to local needs and another to the global export market, or a developed country with a slightly undeveloped part. Dual economies need not be across economic sector boundaries. Italy is example of such an economy

The main characteristic of the Italian economy in the post-war period has been a series of profound dualisms: between the industrialized North and the underdeveloped South, the public and private sectors, and large industrial enterprises and small family-ran firms. Economy in Italy in the southern regions is little less developed as compared to the industrial north, owing to the extensive agricultural activities carried out by a section of the country’s population. This is an area which is responsible for unemployment of more than 20 percent. The northern part of the country concentrates with capitalistic economy, where the private sector companies account for the total productivity and profitability.

The often spectacular growth of the economy just as often exacerbated internal divisions. The rise of the Northern industrial complex largely depended on internal migration and wage differentials between the North and the South. Highly politicized attempts of the state to mitigate discrepancies of regional (under)development resulted in public sector inefficiencies and redundant industrial projects. Support of large public and private corporations perpetuated the rigidities of the internal labour market and indirectly encouraged the surge of an informal economy where labour had remained unregulated until the early 1990s.

One of the possible reasons is that North Italy is close to the rest of Europe. It can interact with other countries quite well where as South Italy is far away from the rest of Europe and is hence a little less developed comparative to North Italy. Another thing is presence if more Human capital in North Italy. Environmental conditions and infrastructure also supports the North Italy and these are the reasons of this. Enormous differences still exist between the regions,

the northeast being by far the most dynamic. Overall, despite some progress in certain areas of the so-called Mezzogiorno1, which includes the south and the islands of Sicily and Sardinia, the north-south gap is still huge. According to Istat (Istituto Nazionale di Statistica) the underground economy accounts for 15% of GDP, but the most recent IMF estimate puts this figure at 27% of GDP. Underground businesses are widespread in agriculture, construction and services. There are few large private companies in operation, but those play a major role in the economy. The strongest components of the economy are the clusters of small and medium-sized, family-owned companies in so-called industrial districts, mostly in the North East and the Centre of the country. With the exception of firms in the machine tool industry, most small and medium-sized companies (SMEs) produce high-quality consumer goods, including clothing, furniture, kitchen equipment and white goods. Despite being traditionally export-oriented, SMEs face the serious challenge of global economic integration and increased competition. After World War II, in an attempt to develop the Mezzogiorno(south), the region that starts south of Rome and ends in Sicily, the Italian Government spent billions of dollars southward for ambitious public works projects. But instead of spurring development, the Cassa per il Mezzogiorno, as the fund was known, succeeded best at spawning more corruption and mismanagement. Many of the jobs it created had evaporated by 1993, when the fund was shut down under a cascade of scandals. Italy is also known as the real sick man of Europe due to the fact that the economic growth of South Italy is a parasite for the growth of rest of the Europe. This co-existence of high wage and low wage sectors is the defining feature of labour market dualism, the generalization of which is labour market segmentation. Besides real wages being higher in the good jobs, dualism and segmentation require that access to the good-job segments be restricted in the sense that not all who want to work in those segments are able to.

A particularity of the Italian industry if compared with other EU countries is the small percentage of firms that adopt product innovation if compared with the high share of firm that introduce process innovation. This feature can be also found in the Mezzogiorno, where the gap in product innovation with the rest of the country is deep, while is modest for process innovation.

As R&D is concerned, the weak presence of high tech industries in Italy and the sluggish innovative process is also due to a lack of resources, public and private, devoted to research and development. The North-south gap divide continues to be there in Italy despite of many steps taken by the Italian government. And hopefully the sick old man of Europe will be able to make the entire nation a one nation.

Stagflation, 1971-80

1970s Economy of Italy:

When people think of the Italian economy in the 1970s the following comes to mind:

High oil prices

Inflation

Unemployment

Recession

That all was a result of stagflation. Stagflation is an economic situation where there is a coupling of sluggish economic growth, high inflation rate and often unemployment.

In Economic terms:

Stagflation = Stagnation + Inflation

Stagflation describes the combination of slow economic growth and high rate of unemployment along with continues rise in prices. Italian economy too felt the heat of stagflation during 1970-1981 when the economy wasn’t growing but prices were.

Stagflation of 1970: Following imposition of wage and price controls on August 15, 1971, an initial wave of cost-push shocks in commodities was blamed for causing spiralling prices. Perhaps the most notorious factor cited at that time was the failure of the Peruvian anchovy fishery in 1972, a major source of livestock feed. The second major shock was the 1973 oil crisis, when the Organization of Petroleum Exporting Countries (OPEC) constrained the worldwide supply of oil. Both events, combined with the overall energy shortage that characterized the 1970s, resulted in actual or relative scarcity of raw materials. The price controls resulted in shortages at the point of purchase, causing, for example, queues of consumers at fuelling stations and increased production costs for industry. Until the 1970s, many economists believed that there was a stable inverse relationship between inflation and unemployment. They believed that inflation was tolerable because it meant the economy was growing and unemployment would be low. Their general belief was that an increase in the demand for goods would drive up prices, which in turn would encourage firms to expand and hire additional employees. This would then create additional demand throughout the economy.

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According to this theory, if the economy slowed, unemployment would rise, but inflation would fall. Therefore, to promote economic growth, a country’s central bank could increase the money supply to drive up demand and prices without being terribly concerned about inflation. According to this theory, the growth in money supply would increase employment and promote economic growth. These beliefs were based on the Keynesian school of economic thought. In the 1970s, Keynesian economists had to reconsider their beliefs as the industrialized countries like Italy entered a period of stagflation.

The economic growth continued unabated until the mid-1970s, when the oil crisis and other international monetary developments gripped the Italian economy. Also the country also faced a large number of terrorist attacks, which hampered the growth prospects of the country and the accumulated result of all these was the stagflation.

Looking at the graph and figure on next page, we can clearly infer that Italy was reeling under the stagflation during 1970-1981 as the growth was declining and continuously and even inflation was soaring high. Usually during stagflation the economy sees huge unemployment.

One unusual thing about this era was Basically that there was plenty of liquidity in the system and still there was such a situation. The reason was people were spending money as quickly as they got it because prices were going up quickly, (price inflation) which was accompanies by the rapid price increases in the price of oil caused many businesses to become unprofitable, so they began laying off workers. This threw the economy into a tailspin as unemployment grew in spite of an increase in the money supply.

What the officials tried to do was to combat economic weakness and unemployment by increasing government spending, and they established voluntary wage and price guidelines to control inflation. Both were largely unsuccessful. A perhaps more successful but less dramatic attack on inflation involved the “deregulation” of numerous industries, including airlines, trucking, and railroads. These industries had been tightly regulated, with government controlling routes and fares. Support for deregulation continued beyond the Carter administration. In the 1980s, the government relaxed controls on bank interest rates and long-distance telephone service, and in the 1990s it moved to ease regulation of local telephone service.

And the impact was also huge. In the 1980s, the government loosened the controls on bank interest rates. In 1990, the loosened the regulation of local telephone service. The Federal Reserve Board refused to supply all the money to the inflation desolated economy and caused interest rates to rise. As a consequence, consumers spending and business borrowing decelerated suddenly and at the same time, the economy of the country fell into a period of recession. Until the 1980s, no efficient policy succeeded in stopping inflation in the entire economy.

Disinflation, 1981-93

This period was marked by the constant deceleration of inflation accompanied by a progressive increase in unemployment. The disinflationary effects of a very tight monetary policy were somewhat offset by a liberal policy of deficit spending. This was reflected in concurrent raise in real interest rates and public debt. In this period monetary policy had to curtail the surplus of inflation discouraging the competitiveness of the Italian industry, while the troublesome implications for unemployment were moderated by a fairly lenient budgetary policy.

Second Oil Shock (1980-1983)

The 1970s and 1980s saw an irregular development. Italy is heavily reliant on Algerian gas and Arab oil supplies, so it was hit hard by the second oil crises in 1979, in addition domestic political mayhem created high unemployment and high inflation. The drop in growth rate in 1975 and 1980-1983 could, at least in element be apportioned to the first and the second oil shock respectively, and to the enhance in international, particularly Asian, competition in sectors such as automobile, steel, and consumer electronics.

At the beginning of the decade (early 1980s), the major developed economies had to deal with the impact of the second oil shock. The response of the western economies was mostly one-sided and uncoordinated: some countries encouraged the inflow of petrodollars, other tried to increase the exports by devaluating their currencies or to reduce the imports of oil. In most countries, including the U.S., interest rates were raised to attract foreign capital. Such action ultimately led to the debt crisis of emerging nations and the U.S. stock exchange crash of 1987.

From 1981 through 1983, Italy suffered a period of recession, with mounting budget deficits, interest rates above 20%, practically no real GDP growth, and an unemployment rate approaching 10%.

The Recovery (1983-87)

With Italy caught up in recession in the early 1980s, economic policy was aimed at decreasing the deficit, increased controls on credit, and sustaining a stable exchange rate, primarily through a variety of short-term variables. The restrictive monetary policy and the appreciation of the lira caused a reflective structural alteration in the economy and in specific in the manufacturing sector. The executive, technological and financial structure of the firms was re-designed in order to comfort a higher level of flexibility. The same re-structuring towards flexibility also happened in the human relations and in the management of the work force. Domestic prices were impacted to a lesser extent by imported inflation, the growth cost of capital, the raise in the price of public services, and deficit spending, while the impact of the indexing mechanism was gradually undermined. The accumulation of productive capital decelerated but the economic efficiency of investment increased as a result of a shift towards more flexible forms of investment, this process was consistent with innovation in the productive process but was inconsistent with product innovation, particularly in the high-tech sector which requires long term investment in R&D and in new manufacturing units, and this in due course improved the technological gap between Italy and other industrialized nations.

At the same time, the financial system boarded on a process of change that decentralized a few vital categories of financial decisions giving more importance to competition and balancing in a more efficient manner the financial risks, but increasing the fragility of the financial system. A decrease in inflation was accompanied by a decrease in the budgetary stability and rise in public deficit.

The nation began to recuperate about 1983 and moved toward a new epoch of economic expansion, leading to increased output and decreased inflation but also to increased unemployment. Better economic performance allowed following governments to make improvements in the welfare state that provides education, pensions, health care, benefits, and infrastructure.

On the one hand, there was no doubt that Italy’s membership in the European Monetary System (EMS) was most responsible for the decrease of inflation rate from 21.2 percent in 1980 to 4.5 percent in 1987. On the other hand, a strong lira, together with an even stronger deutsche mark, exposed Italian export competitiveness, particularly amongst its chief European trading partners, France and Germany, and competitors, Spain, Greece, and Portugal.

Unemployment Check (1988-91)

While the 1970s and the 1980s saw the materialization of Italy as a maturing economy, the growth rate decelerated to 2.4% during the period 1980-90. The economic policy focus in 1987 integrated the decrease of the public-sector deficit and unemployment. Additionally, improvement in the external sector (due mainly to the depreciation of the dollar and fall of oil prices) led to liberalization of the foreign exchange market in May 1987. The disinflationary process had succeeded for the first instance in driving the inflation rate under the threshold of 5% although only at the cost of a more than 12% of unemployment. The last part of the period (1988-91) was marked by a moderate expansion that succeeded in cutting the unemployment rate at the cost of a limited jump back in inflation.

Though modeled on the principle of a free market economy, state control persisted to play a major role in Italy. While earlier on, the state-owned organizations did add to economic growth, by the mid 1980s, state organizations were riddled with corruption and inefficiencies. The situation was further exacerbated by the high costs of the welfare system which put a strain on the nation’s budget. These economic factors, coupled with pressure to qualify as an entrant to the European Monetary Union (EMU), triggered drastic reforms by the end of the 1980s and early 1990s. Priorities of the early 1990s were reducing government spending, combating tax evasion to reduce public debt, and selling off state-owned organizations. At the end of the decade the results of these policies were varied. Liberalization provided the momentum for increased foreign investment, while the funds generated from privatization decreased the public debt.

Financial Crisis Of 1992

The September crisis in Europe had its root in the monetary policy adopted by Germany and other countries in the European Monetary System (EMS). This arrangement limited the exchange rate fluctuations among members. Since Germany was the largest economy in Europe, accounting for 25 percent of the European Community Output, its central bank, the Bundesbank, was the dominant central bank in the EMS. Over the years the Bundesbank adopted a conservative monetary policy stance and hence it gained credibility as an inflation controller.

Because of the credibility it provided about long run inflation expectations most EMS members had linked their currencies to the German mark. The link effectively required that they maintain their monetary policies roughly in line with Germany’s.

The situation changed in the mid-1990s. The rise in fiscal expenditures to achieve reunification with East Germany caused Germany’s general government budget to grow from near balance in 1989 to 2.5% of GNO in 1990 and 4.4% of GNP in 1991. A real demand shock of this nature generally leads to higher real interest rates and a real appreciation of country’s currency, which together reduce the strain on domestic resources. And the mark appreciated both in nominal and real terms against dollar and yen.

However the constraints of EMS limited the nominal appreciation of the mark against the currency of other member countries. Thus the pressure for a real appreciation of the mark within the EMS has taken the form of relatively higher inflation in Germany than in its neighbours. The Bundesbank responded to these inflationary pressures by tightening monetary policy. The discount rate was raised roughly 3 percentage points between 1990 and mid 1992 to 8.75 % (the highest level since 1948)

As a result the burden of achieving the necessary real appreciation of the mark within the EMS fell on the other member countries that were compelled to deflate in order to maintain their currencies’ link to the mark. To maintain their currency parities with the mark, these countries matched the high German interest rates. This deflationary trend resulted in sluggish growth in France, Italy and most other EMS member.

In 1992, the Italian economy descended into its worst recession since World War II:

The rate of growth fell below 1 percent, half the average of other European countries. Unemployment dropped 11 percent nationwide and more than 20 percent in the less-developed South. The demand for domestic products declined, and import penetration increased resulting in the negative trade balance. Sales in foreign markets deteriorated due to a loss of price competitiveness, sluggish demand, and a lack of product differentiation. Italian public debt rose to 108 percent of GDP, second only to Greece among the 12 European Community (EC) economies.

The combination of economic and political crisis raised serious doubts about Italian ability to fulfill the so-called “convergence criteria” set by the Maastricht Treaty of 1991 as the entry requirements for the European Monetary Union (EMU). In 1992, Italy was the only major European country to widely diverge from each of the four Maastricht criteria on inflation, interest rates, the budget deficit, and public debt.

Fuelled by the general instability in European markets surrounding the ratification of the Maastricht Treaty and the stubborn insistence of the Bundesbank on high interest rates, the Italian lira came under a series of speculative attacks in summer of 1992. In September 1992, the government of Giuliano Amato was forced to abandon the European Monetary System (EMS) and devalue the currency. Economic analysts, both inside and outside Italy, agreed that the future of the Italian economy hinged upon the ability of small and medium-sized Italian enterprises to respond promptly to this devaluation and pull the country out of the crisis.

Both EMS and the Maastricht Treaty, the latter in particular, severely limited the government’s scope of manoeuvre. On the other hand, a strong lira, coupled with an even stronger deutsche mark, threatened Italian export competitiveness, particularly among its main European trading partners, France and Germany, and competitors, Spain, Greece, and Portugal.

Maastricht Treaty Of 1991

The “convergence criteria” were very clear and focused almost entirely on monetary aspects of economy.

Criteria:

1. Inflation Rate: The first criteria established the rate of inflation could not diverge more than 1.5 percent from the best performing member.

2. Government finance: According to the second criteria, planned or actual budget deficit should not be greater than 3 percent of the Gross Domestic Product (GDP), and the public debt should not exceed 60 percent of GDP.

3. Exchange rate: The third criteria required that currency must stay within the narrow band of the EMS for at least two years prior to admission into the EMU.

4. Long-term interest rates: Finally, the fourth criteria set the average nominal interest rates on long-term bonds to a maximum 2 percent divergence from the three best performing countries.

European Monetary System (EMS)

The main purpose of the EMS was to create a “zone of monetary stability in a world of wildly fluctuating exchange rates” in the late 1970s. It established a range—between 2.25 and 6 percent—within which the currencies of member countries could fluctuate against each other. Any fluctuation outside this range was supposed to require an officially agreed upon realignment of all currencies.

Eventually, the EMS also became a mechanism for combating inflation, synchronizing interest rates, and promoting growth in EC economies. On the one hand, there was no doubt that Italy’s participation in the EMS was most responsible for the reduction of inflation rate from 21.2 percent in 1980 to 4.5 percent in 1987.

Small Firms

Small firms have been the savior of the Italian economy particularly since the 1970s. Small and medium-size enterprises in traditional sectors have pulled the economy out of a severe crisis. In 1992, the SMEs accounted for nearly 70 percent of total sales in the Italian economy and for 40 percent of the country’s exports. The remarkable performance, particularly in exports, of small and medium-size firms in industrial districts and their ability to generate employment in times of crisis countered dominant economic and organizational models of the 20th century.

The success of the small firms can be attributed to a number of factors. The existence of networks between small firms and the division of labour according to the principles of specialization and subcontracting helped the firms create economies of both scale and scope for the district as a whole. The second important feature was the combination of cooperation and competition among the firms. The readiness to share information and services was balanced by competition on a range of dimensions—such as quality, design, innovation, speed—and not just on price. Finally, industrial districts generally possessed an unusual degree of entrepreneurial dynamism and an adaptable, well-trained, and cooperative workforce.

However, by the late 1980s, many of the exogenous factors that were responsible that had ad initially prompted the development and success of small firms had changed or disappeared. Italian entry into the EMS “put an end to the policy of gradual lira devaluation that had propped up Italia