Italy Needs Structural Reform, Not Austerity

There is no question that Italy desperately needs to begin the process of structural reform. In terms of “ease of doing business” Italy ranks 75th (according to The World Bank), behind nations such as Azerbaijan, Botswana and Kazakhstan. That means that its regulatory environment is simply not conducive to operating a business. However, one thing that is likely to prove very advantageous for Italy going forward, is its huge gold reserves – the world’s 4th largest if the data is to be believed.

The objective of Germany and other northern creditor nations should be to improve the solvency of southern debtor nations like Italy and Spain. The best strategy is not to impose harsh austerity.

Silvio Berlusconi may have many faults, but when he claims that Italy’s austerity policies have become self-defeating by causing an “endless recession”, he is making a valid point. Austerity is paradoxically worsening the distressed nations’ solvency; by reducing growth more than the deficit, the strategy is becoming self-defeating.

As such, instead of imposing harsh tax hikes and spending cuts, Italy needs to focus on structural measures such as labour market reforms to boost its productivity growth. Since the launch of the euro, Italy’s labour productivity growth has underperformed not only Germany’s, but also France’s and Spain’s. However, to stay solvent, Italy needs steady state nominal GDP growth of around 3%. This is achievable, but will be much easier if there is some contribution from real productivity growth on top of inflation.

Policymakers are slowly but surely softening their tone on the pace of austerity (for example, by extending timetables for deficit reductions in Greece and Spain).

A dramatic easing of austerity could be the big U-turn of 2013.

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