Italy's Supply Constraint

The OECD estimates the current potential capacity growth rate of the Italian economy at 1.25% a year. Actually I suspect even this very low number is over-optimistic. Growth since 2002 has been as follows: 2003 - 0.1%: 2004 - 0.9%: 2005 - 0.1%. To be sure forecast growth for this year is somewhat higher, at 1.4%, and optimists are expecting this to be more or less repeated next year. But I suspect this outcome is unlikely simply because the global economy now seems to be slowing (and in particular the ever important US economy),so the strongly advantageous situation of 2006 is unlikely to be repeated, while next year the Italian government has promised to introduce an important package of spending reductions which are bound to negatively affect growth, at least in the short term..

But why is potential growth capacity in Italy so low?

Well, as you might have imagined, my focus here will be more or less on the limited capacity for Italy to increase the size of its workforce after 20 odd years of low fertility. In this sense this post is a practical case study of my more theoretical "Of Population Pyramids and Value Chains". Now again according to the OECD:

With employment rising by only about ½ per cent per year, there should be some recovery of productivity, in turn accentuating disinflation and facilitating export growth. Without bold structural reforms by the new government to raise the economy’s low supply potential and reverse its huge cost disadvantage......... sub-par growth is likely to persist.

This again is just one example of why I was so tenacious in the comments on the recent 'Reform Has Become A Dirty Word' thread. Italy urgently needs reform. And it is because of the apparent difficulty that Italy has in carrying out reform that I am so adamant that Italy may well reach a situation where it has little real option but to default on the public debt, with all that this implies. Indeed Italy seems set to become the 'test bed' of how the ageing process works out in practice.

Of course the 'drying up' of the labour supply in Italy which is reflected in this low potential growth estimate is producing historic lows in the Italian unemployment rate (a phenomenon we are also seeing in Japan):

Italy's unemployment rate fell to the lowest in more than 14 years, a government report showed today. The unemployment rate fell to 7.0 percent in the three months through June from a revised 7.3 percent in the first quarter. That was the lowest the statistics institute started its survey in 1992. It was expected to remain at 7.3 percent, according to the median forecast of 23 economists in a Bloomberg News survey.

Italian joblessness has fallen to the lowest of the euro region's four-largest economies even though growth has averaged just 0.6 percent in the past five years. The expansion in Italy's $1.8 trillion economy will lag behind that of the euro region for at least a 10th year in 2006, expanding 1.7 percent, compared with a 2.5 growth rate for the 12-nation bloc, according to the European Commission.

So what we have in Italy is pretty low unemployment, and a miserable growth record, strange isn't it? Even stranger perhaps is the fact that most economists don't seem to be giving much importance to thinking about just why this is happening.

The latest data from the Italian Statistical Office ISTAT is interesting (in Italian only unfortunately), since it shows that, year-on-year, the number of people actively seeking work declined to 1.621.000 which was a reduction of 11.8% (or 216.000 people) over the second quarter of 2005. And this situation has only produced an annual estimated growth rate of 1.4%. Put simply, this is because - without a significant change in participation attitudes, especially among women (and which is, in part, what the reforms are about) - Italy's available workforce is now set to decline.

Of course Italy is creating new jobs, but as Bloomberg point out, to a great extent it needs immigrants to do the work:

More than 30 percent of the rise in registered employment in the quarter and almost 40 percent of the increase in the past year came from immigrant workers, the national statistics institute said today in Rome. Many of these registered jobs are low-skilled positions, meaning the economy isn't as healthy as the numbers might otherwise suggest.

The statistics show that the biggest gains in registered employment have come from immigrants gaining legal status, many of whom are already working. More than 900,000 foreign immigrants, the equivalent of almost 2 percent of the population, have won residency in the past three years through a series of government amnesties.


Italy's position is in fact even more complicated since the recent employment growth is largely in low skill activities (which means that if Italy is moving up the value chain it is in fact doing so very slowly, far too slowly for its needs):

``I've worked at unpaid internships for years, but the number of jobs out there isn't growing,'' said Carlo Massoni, 32, who's only been able to land short-term contract work since earning a degree as a telecommunications engineer six years ago.

``I haven't had a break since I graduated.''

The number of workers with non-permanent contracts grew 8 percent in the second quarter and those short-term contracts now account for 9.5 percent of total employment, up from 9.0 percent a year earlier, Istat said today.

The lack of permanent job opportunities has left Italy with the second-highest youth jobless rate in the European Union after Greece, currently 24.1 percent of those aged between 15 and 24. Almost half the increase in registered employment in the first half came from people over the age of 50, Istat said.

So those seeking work in low paid unskilled jobs are finding them, whilst those who are young and qualified seem to be finding the going tough. Something somewhere is going very wrong here.

And even if the Italian economy did finally manage to break into more new sectors the supply problem still exists, since a very significant proportion of Italians in the 25 to 34 age group have very low education levels. Again lets look at what the OECD had to say last year:

Compared with other OECD countries, an above-average proportion of the Italian population has only lower-secondary education. This is especially true for older age-groups, but it is also true for younger ones. Forty per cent of 25-34 year-olds are in this category compared with an EU and OECD average close to 25%, and the results of the OECD Programme for International Student Assessment (PISA) show that Italian 15-year olds have attainments well below the average in particular in mathematical and problem-solving skills. There is a high proportion of youth which is in neither education nor the labour force, suggesting a difficult school-to-work transition. The risk of unemployment later in life is also considerably higher for those with only lower secondary education.

Furthermore, a smaller proportion than the OECD average has completed tertiary education, even though a relatively high proportion embarks on it. Years spent in obtaining an undergraduate degree are greater than the average, raising the opportunity cost of tertiary education and discouraging the formation of high level skills. The demand for high-skill workers may be hampered by the specialisation of Italian industries in low tech sectors and the small size of Italian firms, which reduce their R&D spending capability. At the tertiary level, a problem is an insufficient number of younger professors, for whom there are barriers to entry. Academic appointments lack transparency, promotion is not always linked to productivity, and Italy spends far less than the OECD or EU average on research and development, and significantly less on tertiary education. As a consequence Italy suffers from a pronounced net brain-drain.

So there we have it. Italy seems to be caught in a very strange kind of trap, where a very inefficient education system means that only a small proportion of young Italians stay the distance to get their final qualification, and as a result there are insufficient qualified people to help make that much-needed leap upwards. And even if Italy was succesful in attracting a large number of older women into the workforce (but in which case who would look after the increasing number of dependent old people?) this wouldn't resolve the problem, since the low educational level would strongly constrain the kinds of work which they could do. As I say, a strange kind of trap.