Italy is one of the most fascinating economies in the world because it is facing most if not
all the major economic challenges that other countries around the world are experiencing,
but it is somehow dealing with them all at the same time.
Italy has some of the highest levels of national debt in the world,
it has an aging population, an exodus of what few young skilled workers it still has,
it's also dealing with regional inequality, sluggish growth, unreliable tax revenues
and it's once world-leading industries have been out-competed across the globe.
Italy also serves as an amazing case study as a country that has dealt with problems like
globalisation, French shoring and restricted trade which is causing a lot of concern between
countries such as the USA, Russia, China, the Gulf states and of course Europe itself.
A lot of these unknowns are something that Italy has been dealing with for at least the
past two decades and that's part of the reason why the country has been an economy in decline
for 15 years now. Which sounds bad, but it's strangely something that on one hand the economy
is taking in its stride and on the other hand has made it home to some of the highest rates
of poverty in the European Union, a collection of countries that people normally associate with
relative wealth at least compared to most of the world. Even if the similarities are not perfect,
there is still a lot that economists can learn from these challenges.
Beyond just being a great insight into what the future of our own economies may look like,
Italy just has some truly fascinating economic features that are worth exploring individually
even if for no other reason than they're just really interesting.
Italy together with Germany and France makes up over half of the total economic output of
the European Union, a union which collectively forms the second-largest operating economy in
the world. Despite this already quite impressive scale, Italy's economy might really be much bigger
than its government would like to admit. In recent years the black market has been responsible for as
much as a quarter of Italy's total economic output, and while the logical assumption here
would be to think about the godfather, the reality is even stranger and more interesting.
So to understand all that Italy's economy can teach us, we must as always answer a few simple
questions. How did one of the fastest-growing advanced economies in the world just stop
growing almost instantly? Not once, not twice, but three times? What has the country done right
and wrong when dealing with its long list of challenges? Who was really to blame for
the country's economic stagnation? How has Italy been impacted by a unique form of destructive
inequality? And finally, is the country's economic model just incompatible with the
new global environment it finds itself in? Italy has had its fair share of economic
scandals in the last few years, but you might not know what's actually going on if you only
read a few news sources or rely on social media algorithms to tell you what's going on.
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Italy as an economy peaked in 2008. Since then, it's been mostly stagnant,
with an overall slow decline losing about 20% of its nominal economic output over the past decade.
Looking further back in history reveals, however, that this is not really anything new for Italy,
and its economy today is the continuation of a trend that has been repeating itself
in the country since the end of the second world war.
The country has had decades of rapid growth, broken up by decades of almost complete stagnation,
and in many cases negative growth, before it gets right back to growing again.
Economic output is just one measurement of the health of an economy,
but even a chart as basic as this tells us a really interesting story about how
Italy got into the situation it finds itself in today.
Italy was historically the most powerful industrial economy in all of Europe before
it was overtaken by the Netherlands and England as they became global colonial powers.
Even after that, and despite industrializing slower than other major European powers like
France and Germany, Italy in its various forms has remained within the top 5 European economies
for effectively thousands of years. Its strong geography, protected by mountains in the north,
but with easy access to the Mediterranean for fishing and trade in every other direction,
has meant it naturally became a great place for civilizations to flourish.
And that's as true for its economy today as it was in 500 BC.
The economy of Italy as it exists today really got started during the aftermath of the second
world war. The country was rebuilt, in many cases from the literal rubble, as wartime
industries were converted back into domestic industries with assistance from and under the
watchful eye of the USA. The USA through the Marshall plan was investing billions of dollars
into the reconstruction of western Europe, and this was back in the 1950s when billions of dollars
actually mattered to government budgets. The motivation for this spending was partially
to build out a new customer base that could buy all of the goods that the US industrial sector
could produce, but it was mostly to redevelop strong dependent allies to stop the spread of
communism from the Soviet Union. The USA also carried out similar rebuilding efforts in Korea
and Japan to stop the spread of communist influence coming from the People's Republic of China.
It wasn't starting from a great position, but these rebuilding efforts did lead to a long,
sustained period of growth. However, under the surface there were still political tensions
causing a range of very serious domestic issues like the 1980 bombing of the Bologna railway
station, which still to this day remains one of the deadliest attacks ever carried out in Europe.
These political tensions were in many ways the cause of, and were simultaneously accelerated
by, other economic problems in the country. Just by economic output figures, it looked like Italy
was doing very well, but it's relatively easy to grow an economy by just taking on a lot of
debt to fund major development projects, especially when the major power in the world was more than
willing to loan money to stop the spread of communism. The challenge is taking that development
and using it to sustainably produce value for the domestic economy and export markets,
which Italy was struggling to do. Once construction and rebuilding efforts had
slowed down, or couldn't get any further funding, Italy's economy fell into its first
modern decade of stagnation, although this first one really only lasted about 6 years.
During this time, the Italian government simultaneously had to deal with mass unemployment,
a large debt burden, high inflation, and external challenges like rising energy
costs for the fossil fuels its young industries had become heavily dependent on.
Now, despite not being good things to live through, economic slowdowns do serve as a
good opportunity for a country to change policies and cut down on industries that
caused the problems in the first place. During this first stagnation, that's exactly what happened.
The country restructured away from just building infrastructure, and turned its attention more
towards using that infrastructure to create things that it could sell all around the world.
It also enacted reforms like giving independence to its central bank,
which was then allowed to raise interest rates to fight off inflation.
At the same time, the laws around index wages were relaxed.
Wage indexation is not very common today, mainly because of the market problems it causes,
but it's a rule that means that wages keep up with inflation no matter what,
even if it's not what was agreed to in an employment contract.
On the surface, this sounds fair. If inflation is high, it's perhaps not right that workers
effectively get paid less because they agreed to a salary, when that same amount of money
could buy a lot more. The problem, though, is that automatic wage indexation accelerates
one of the most dangerous processes in economics, a wage price spiral.
If inflation is high, workers will demand higher wages to keep up with the rising cost of goods
and services that they need to buy. If businesses agree to pay these higher wages, they will have to
increase their prices to maintain profitability, and higher prices cause more inflation all over
again. The one thing that saves a lot of economies from this is the lag between inflation happening
and people demanding higher wages. If inflation is low, there are a lot of people that won't
even know that their wages aren't keeping up, which is terrible for them, but does act as a
moderating force in the economy. If wages are automatically kept up with inflation,
like they were in Italy at this time, then it just makes this process known as the wage price
spiral much faster and much harder to correct. The stagnation was undoubtedly painful for Italy,
but by forcing some necessary changes it came back as one of the fastest-growing economies
not only in the world, but in history. In just 7 years between 1985 and 1992,
Italy tripled its economic output in an export-led industrial boom.
The country has a major advantage in this regard that's hard to tell from looking
at economic figures alone. International customers pay a premium for Italian-made goods
because the country had and still has a strong reputation for high-quality craftsmanship
and skill in producing everything from fast cars to luxury handbags and even things like olive oil.
If an exported good has a made in Italy logo on it, the price of that good can be higher than
a competitor good from most other countries in the world and a lot of consumers would still be
willing to pay a premium for it. Some countries have to go to extreme measures to undercut a long
list of international rivals at every possible opportunity to supply the cheapest, and therefore
most competitive goods to the global market. The fact that Italy can add as much value,
if not more, by simply producing stuff within its borders is a huge advantage that is only
really enjoyed by a handful of other countries around the world.
These good times, unfortunately, didn't last forever because the rapid period of growth
yet again led to underlying problems in the Italian economy. Debt started to creep back
up again as both the government and its people began to borrow irresponsibly to bet on even more
future growth. The country also had problems with tax avoidance. The small industries that
formed the backbone of the Italian export miracle were notoriously hard to tax, and taking advantage
of weak government controls and poorly planned loopholes in order to pay little to no tax
almost became a national pastime. Now overall, whether willingly or not, reducing taxation and
government restrictions while increasing spending through debt is a classic expansionary economic
policy. Even if the government doesn't necessarily mean to do it, this is probably what the country
needed to get out of the rut it found itself in in the 1980s. But in order to get into the
eurozone and be allowed to use the European Union's new currency, Italy was forced to clean
up its act. It had to reduce its debt load and do a better job of getting its people to pay their
taxes. Increasing regulation, reducing debt, and raising taxes all works to take money out of the
economy which, even if it was the right thing to do, still put the brakes on economic growth.
For the rest of the 1990s, the economy of Italy once again entered an almost decade-long period
of stagnation. Fortunately for the country, the adoption of the euro in 1999 created something of
a golden opportunity for Italy to start growing again. After a brief lull, the country in what
was becoming a recurring theme more than doubled its economic output in less than a decade,
once again becoming one of the fastest-growing advanced economies in the world.
Entering the eurozone made it easier to attract foreign investment, foreign workers,
and foreign buyers of its goods. Its trading partners also didn't have to worry about
foreign exchange risk of the notoriously unstable era. The advantages of the eurozone
also coincided with the further general development of Italian manufacturing
and the rise of industries like tourism.
Then of course the country was hit by the GFC and the eurozone crisis, and ever since it's fallen
into yet another period of stagnation, only this time, instead of lasting less than a decade,
it's gone on for almost 15 years now.
The reason that we have spent so long exploring the details of Italy's unique economic histories
of booms and plateaus is because it raises an obvious question for the nation, can it do it
again? Obviously no one can predict the future, least of all economists, but if history repeats
itself it looks like Italy is overdue to take another step up in this weird staircase of
economic output. Unfortunately of course, it's not that simple, and there are a range of new
challenges that are combining with some of the old historic challenges that are making a trademark
Italian turnaround unlikely.
The first is simply an aging population. Italy has one of the oldest populations in the world,
and a lot of its workforce is getting close to retirement. This wouldn't be a problem by itself,
except for the fact that it has a low birth rate, so young people are not joining the workforce to
make up for the people leaving the workforce, who will ultimately, and unfortunately there's
no nice way to put this, become a drain on resources. This problem has also been accelerated
by the fact that Italy has one of the highest rates of young graduates moving to other countries
where they can earn more money for their skills. Earlier this year we were lucky enough to talk
to Professor Billeri from the University of Bocconi in Italy. As both a very well-respected
economist and someone who has first-hand experience training some of Italy's brightest
students, he gave us a fantastic insight into this problem.
Actually, Italy is a net sender of graduates rather than a net receiver, and that's
one of the parts that the country is complaining about. So we'd love to attract more people with
a degree rather than letting them leave to other countries. So I think from the country perspective
it is a problem, especially if you are one of the sending countries. However, let me say
two things on this. One is that from the individual level perspective,
having more freedom of movement is certainly giving the right incentive to individuals.
You want to build a good life, you have good ideas, it's fantastic for the world to let
these people move. The second point of view is that we have to understand from the competition
for talent perspective that countries that are losing these individuals, maybe because they
tend to be overeducated for the level of the economy in that country, should think seriously
about the opportunities that in a specific country or region are given to these individuals.
Membership in the EU has only heightened this problem because Italian students who want to go
to work in places like Germany, France, the Netherlands or even Luxembourg don't even need
to apply for a visa thanks to the EU's policy of allowing workers to work anywhere within the
member states. Raising wages could help to stem this exodus of skilled young Italians,
but the country's industries can't afford to compete anymore with their largest European rivals
because they are simply not as productive. The average size of an Italian business is
significantly smaller than the average size of a business in other advanced European economies.
Italy on average has 3.6 workers per company, where the average for Western Europe is 15,
so effectively 4 times as many workers per organisation.
In industrialised economies size does matter and larger companies are able to produce more
specialised and more value-added items. In most highly advanced industries the
marginal advantage of adding an additional worker is positive because it lets workers
in the business focus on one aspect of production and do it really well.
Given that automobiles are one of Italy's biggest industries and also probably the
first thing that people think of when they think of Italian manufacturing,
it makes for a great example. 10 companies that each have one
employee that makes cars from scratch will produce fewer cars in a year than one company
that has 10 employees that each focus on one part of putting a car together.
If one employee just builds the engine they can get really good at doing just that.
A company with 10 employees can also spend 10 times as much on tools for those workers,
which even though it still works out to be exactly the same amount of costs for each
individual employee means that the tools can be more specialised.
The worker who just makes engines can be given tools that are just made for working on engines,
whereas a worker that has to make the entire car will need to spread out their budget for
tools over everything that is needed to make the car making them less specialised
and ultimately less efficient. Now tools to build cars are one thing,
but something that Italian firms have really failed to invest in is technology.
Computers and related technologies have massively increased how much economic
value one worker can produce in a given day. The classic example of this is that
one accountant with something basic like excel can produce the same amount
of financial reports as 10 accountants using abacuses.
Italy's small firms have lagged behind the rest of Europe in the adoption of technology,
and Western Europe itself has lagged behind the USA and a lot of economies in Asia.
Besides making investments into industries more efficient,
technology has become a massive industry in its own right,
with the majority of the largest companies in the world being tech companies.
Italy of course in some ways benefits from these cottage industries,
because it helps them to maintain their reputation as a place where businesses focus
on quality over quantity when producing luxurious goods.
But countries like the UK, France and Germany achieve the same thing without
actually making the trade-off for size.
Mercedes from Germany employs a similar amount of workers to Fiat in Italy,
but Mercedes is far more premium and generates far higher export markups than economy cars.
A large amount of small companies is also harder to tax than a small number of large companies,
which also highlights another problem that the Italian economy has.
The black market in Italy is exceptionally large for an advanced economy,
and despite the reputation, most of that isn't thanks to the mob,
it's just unofficial businesses operating in grey markets to skirt around regulations and avoid tax.
In the past, as much as 25% of the nation's economy was made up of black market industries.
That figure is more like 12% today, which is an improvement, but it's still pretty bad,
and it's not only costing the nation potential tax revenues,
it's also contributing to social problems.
Part of the reason the informal economy remains so large is that people don't have many other
options. Italy is an advanced economy, but it has some of the highest poverty rates in all of Europe,
and that is particularly severe in the south of the country,
which is significantly poorer than the north,
which as we have already explored is still struggling itself.
Unfortunately today, Italy finds itself in a position with high unemployment,
stagnant economic output, an aging population, uncompetitive industries,
low tax revenues, high debt and increasing interest payments on that debt,
all while having less control than it did in the past with its own currency.
If it raises taxes and lowers spending to try and reduce its debt burden,
it will crush its local industries that are already struggling.
If it borrows more, it risks bankrupting itself,
and if it does nothing the situation is probably only going to get worse.
There is the assumption in economics, in most sciences for that matter,
that we are moving towards an idealised version of the future,
because for the last two centuries that's exactly what's been happening.
The world today is thousands of times wealthier than it was at the beginning
of the industrial revolution, but that's been the exception rather than the norm.
Italy is just another in a long list of advanced economies that are finding
it increasingly hard to compete in an increasingly competitive global economy,
and just because we have enjoyed growth for all of living memory,
doesn't guarantee it into the future.
Now one thing we did address in this video briefly is infrastructure and
the role that it plays in economic development,
but Italy has in many ways over-invested into infrastructure,
which is a mistake that we have already made an entire video about,
but as always we didn't want to repeat too much here,
so we will leave a link to that which you should be able to click to on your screen now.
Thanks for watching mate, bye.