Italy’s dash for growth: can it succeed?

A charismatic leader conquers power by promising sweeping change and quick results. The new Italian Prime Minister Renzi seems to have adopted Caesar’s motto “veni, vidi, vici”, promising to adopt sweeping changes within two months. But is this approach what Italy needs?

Bringing a budget under control and reforming a sluggish economy demands not only vision, but most of all patience and perseverance. The most brilliant vision is worth only as much as its implementation on the ground. It is here that the success of Renzi’s reforms will be measured.

Unfortunately, the omens are not good. It is relatively straightforward to pass new laws in parliament, but many of these laws require legislation, or risk remaining ineffective. This is what happened with many of the key measures of the Monti government. Over two years later, more than half of the laws adopted under his government are still not fully implemented. Instead of a further flurry of reforms, the country first needed a pause to digest and implement the reforms, which in principle had already been agreed.

It is difficult to see how even the most energetic prime minister can alone accelerate the work of a vast administration that has its own rules and methods of working. Both the Monti and the Letta governments, which preceded that of Renzi, had very competent experts in key positions. It is thus unlikely that the new team will be able to achieve much more in terms of implementation than its predecessors.

Moreover, the new government has been in office for just a few weeks. There was therefore not enough time to elaborate a concrete plan of action for the new strategy that was just announced. For the time being the new government has basically announced only its general intention to cut some taxes. Adding yet another change in tax policy can only increase the degree of complexity of the tax system, especially if new tax rates come into effect in the middle of the year. The tax accountants and advisers will certainly be one of the few categories that benefits from this change.

Implementation is thus likely to be even more difficult than usual. But the entire new strategy seems built on shaky foundations. In an economy with such high unemployment rates it makes sense to shift taxes from labour to capital. But the cut in taxes will probably cost much more than the increase in taxes on capital income; unfortunately, nobody know by how much, since the government did not have the time to make precise estimates.

For this reason, most of the offset for the lower taxes is going to have to come from cuts in spending. But the savings planned from things such as better public procurement are highly uncertain.

Another important part of lower expenditure comes from the recent fall in the risk premium on Italian debt. But this is also highly uncertain – its interest cost could rise again even if the risk premium continues to fall, because German interest rates might also increase as its economy strengthens.

Moreover, this is not the first time that the country has banked on lower interest costs to save its budget. For example, in 2001 Italy also experienced a windfall from lower debt service burden, but it decided to spend it because the economy was in a recession (albeit a rather mild one by today’s standards). This decision to spend the windfall was not reversed in subsequent years, with the result that Italy continually violated the 3% limit on the deficit ratio in the Stability and Growth Pact, a framework for the coordination of national fiscal policies in the European Union. At the time Italy was in good company, as Germany and France also had deficits above 3% of GDP.

Italy’s economy has clearly underperformed since it entered the euro, both relative to its peers and relative to the previous decade – despite a fiscal policy that has continued to try to stimulate demand. The new package of reforms goes in the right direction, but its financing (or rather lack thereof) is modelled mostly on the same approach that failed in the past. There is little reason to believe that it will work now. It would have been much better if the new government had stuck to the promises made a few months ago, namely that reductions in expenditure would be used to reduce the deficit and thus the debt level.

Author: Daniel Gros is director of the Centre for European Policy Studies and a Member of the World Economic Forum’s Global Agenda Councils.

Image:  Rome’s Colosseum lit-up REUTERS/Max Rossi