Why are Italian bankruptcies so high?

Whether looking at GDP figures or unemployment statistics, confidence indicators or inflation numbers, the perception is that European countries are at very different points of the economic cycle.

The chart below provides yet another measure of the wide (and still widening) divergence within Europe’s economy. The figure offers an illustration of an index of the number of enterprises facing bankruptcy, setting Q1 2007 equal to 100. This allows to effectively compare trends, cutting through the different inherent economic characteristics of countries. As this data is cumbersome to produce, it is only available for a limited set of countries. Interesting patterns can however nonetheless be detected.

As is to be expected, most countries experienced an increase in the number of enterprise bankruptcies as the financial crisis hit its darkest moment in early 2009. From then onwards, different economies behaved in different ways, with the UK progressively normalising, France stabilising at higher levels, and the Netherlands experiencing a second bout in 2012-2013. Germany’s firm mortality was not significantly affected throughout the time period analysed, possibly also thanks to its flexible working part-time arrangements.

Italy stands out of the crowd as a country where enterprise bankruptcy has now more than doubled (266% in Q2 2014) with respect to the pre-crisis period, and we still see no sign of a reversal in this trend. The more ‘supply-side’ economists among us might partially welcome this as good news as, the Schumpeterian ‘creative destruction’ story goes, when more unproductive firms leave the market, factors of production (capital and workers) get redistributed to the surviving/higher productivity firms. Moreover, this will open up space for new firms entering the market. Although true in principle, we still see very little signs of these positive mechanisms being at play, with the country now having the second highest NEET rate (27.3% for the age bracket 15-34 in 2013) in the whole EU after Greece. Moreover, the number of new firms entering the market in Q2 2014 was roughly 20% less than what it used to be before the crisis (83.5%).

In a compelling recent paper, Pellegrino and Zingales (2014) suggest that the origins of the Italian malaise are to be identified in an incapacity of Italy’s firms to face up to competition from China, to embrace the ICT revolution, and a generic lack of meritocracy in managerial selection and promotion. At the same time, ECB (2014) illustrates how in Italy firm size and productivity levels are weakly correlated, suggesting resources are poorly allocated not only across sectors but also within the same sector.

If this is the case, support to existing firms is not the right cure, but rather a temporary palliative, for the Italian malaise. What is rather needed is a set of broad-based reforms that ensure that, as these old inefficient firms fail and exit the market, resources do flow to where they can be used productively. This includes less stringent employment protection legislation, active labour market policies aimed at re-training dismissed workers, abridging cumbersome procedures now required to set up a business, decentralised wage bargaining, just to mention a few. The longer this is procrastinated, the more Italy will experience unused talents and entrepreneurial destruction, rather than ‘creative destruction’.

This article was originally published on Bruegel Blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Alessio Terzi is an Affiliate Fellow at the Hertie School of Governance.

Image: Fake euro banknotes are seen in a block of ice symbolizing austerity measures. REUTERS/Eric Vidal.