A Letter to Italy's Prime Minister

Dear Prime Minister Giorgia Meloni,

I am writing to recommend a set of policies as a remedy for the urgent situation of Italy’s economy; a situation which includes a low material standard of living compared to rest of Western Europe, extreme debt levels, exorbitant unemployment, a huge unofficial economy, massive regional disparities in income, and more. Since the end of the War, the country has had 69 governments, excluding yours, lasting on average 13 months. You’ve already been Prime Minister for 11 months. So, you may not have much longer left – therefore, I believe it is paramount that you implement this letter’s policy suggestions as quickly as possible. They are, after all, the only permanent solutions to the country’s problems.

Take Italy off the Euro

Economists have demonstrated pretty strongly that EU membership enhances economic growth – free trade and open immigration enable capital to migrate without impediment, creating jobs and raising productivity. Italy will have undoubtedly benefitted from these institutions. However, there is one large part of EU membership holding it back – adherence to the Euro. This hugely amplifies economic fragility for two reasons: firstly, it makes the currency’s value nominally rigid. When hard times hit, it cannot fall to maintain economic competitiveness, endangering exports, and foreign investment. This is a reason why the Financial Crisis bore such a toll on the Italian economy. Secondly, it increases the inherent risk of assuming large quantities of public debt, as Italy has, because if a central bank doesn’t have sovereignty over its own currency, it has greater difficulty in monetizing that debt to pay off bondholders. Failure to do this can result in a sovereign debt crisis, as Greece found out the hard way.

Policy advisers may fear the abandonment of the Euro will produce a speculative attack on any new currency (say, the reinstallation of the Lira), bringing about severe devaluation. However, this can be pre-emptively mitigated by abstaining from accumulating large amounts of foreign reserves and reducing Italy’s high degree of restrictiveness on foreign investment relative to the EU, as a subsequent boom in investment will allow the currency’s value to appreciate.

Reduce public debt levels

Although the Euro dramatically amplifies the risk of debt, Italy’s current debt level is dangerous regardless of currency status. At 134.8% of GDP, the impacts of the country’s liabilities resemble the medical effects of extreme blood pressure – hugely harmful to everyday health, and capable of bringing collapse at any moment. I fear that in the event of a large recession, investors will no longer have the confidence to finance Italian bonds, precipitating a government default. Biting fiscal austerity would have to ensue. Meanwhile, the extreme degree of public debt has everyday effects on economic vitality. Research generally indicates that once debt levels exceed 90% of GDP, they begin to reduce economic growth, by diverting capital from the free-market and increasing interest rates on private sector loans.

This begs the question, of course, how Italy should go about reducing its debt. Economists have long debated whether states should prioritise tax hikes or reductions in government spending, given both may reduce aggregate demand – until the question was answered effectively by renowned economist Alberto Alesina, whose research into fiscal consolidations found that spending cuts are far more likely to stimulate growth than raising taxes. This certainly makes sense, as tax hikes place burdens on private sector agents (such as consumers, workers, and owners of capital), depressing aggregate demand. Cuts to government spending, meanwhile, enhance the efficiency of the economy, as the state reduces its hold on capital and (perhaps most importantly) labour, which allows the private sector greater access to resources, hence growing output.

Stop whining about immigration

Italy’s ostensible ‘immigration crisis’ was one of the things which brought you to power. Nationalists who populate your government scold immigration at every possible opportunity, claiming it deprives the native population of high wages and job opportunities. You fear this to such a degree that you once expressed a willingness to use the navy to block incoming refugee boats. Concerns that immigrants drag down national living standards have been extensively investigated by economist Giovanni Peri. On the wage issue, he analysed 27 studies. As it turns out, there are two scenarios which are equally likely: either a one percent increase in the immigrant population reduces wages by 0.1%. If not, it raises them by the same amount. Regardless, immigration has no meaningful impact on wages whatsoever. As for the jobs claim, another study by the same man found that immigration generally creates employment opportunities for natives, as it reallocates them away from low-paying manual-intensive jobs to higher-paying communication-intensive ones.

In all, your government’s immigrational neurosis has no grounding. Given Italy’s declining birth rate, I would suggest you take conscious effort to increase population growth - relax border regulations and provide asylum to refugees. The economic research is overwhelmingly clear on the benefits of this: by expanding the labour force, greater inflows of immigrants help grow output and subsequently reduce consumer prices, while highly skilled immigrants play a crucial role in raising economic productivity through bringing new knowledge and entrepreneurship over the border.

Improve property rights and rule of law

Italy has suffered from enormous regional disparities in standard of living for decades. The reason why this has persisted is that successive governments have pursued the wrong strategy to levelling up. From 1950 to 1992, the country transferred 1% of its GDP each year in an attempt to boost living standards in the South. The policy hasn’t worked, and in 2020 Italy was more regionally unequal than in 1950. A likely reason for this failure is institutional quality, which Italy fairs more poorly on than every Western European country aside from Greece. Without institutional quality – defined as “the absence of corruption, respecting property rights, and the rule of law”– government spending won’t pay off with higher growth, as corruption will often mean funds don’t reach their desired destinations, while weak property rights will make entrepreneurs too unconfident to commit to investment. The best evidence for this comes from Barone and Mocetti, who compare two Italian regions affected by earthquakes within short time of one another, Friuli in 1976, and Irpinia in 1980. They are good objects of comparison, because they both received huge amounts of post-crisis structural aid yet diverged hugely in economic terms in the 3 decades following their respective disasters. In fact, relative to the synthetic counterfactual, Friuli became 23% richer, while Irpinia became 12% poorer. The economists’ use of the synthetic control approach find the strongest explanation for this phenomenon is disparate institutional quality – Friuli enjoyed robust institutions, while Irpinia not so much.

In other words, institutions, not government spending, determine prosperity, and if Italy became more institutionally sound, it would enjoy far greater economic vitality.

Cut regulation on markets  

Italy suffers from a youth unemployment crisis, a huge unofficial economy and, since the 1990s, stagnant productivity. 21.3% of young people are jobless, one of the highest rates in the EU; the unofficial economy constitutes 23.7% of GDP, a similarly high rate within the EU. Data show that overregulation may well be the source of the problem, as it raises the costs of conducting business, incentivising firms to cut back on investment, reduce workforce size and disguise themselves within the unofficial economy. After all, the Italian economy is highly overstrained by regulation, ranking 41^st on the regulation component of the Fraser Institute’s Economic Freedom of the World Index, and 58^th on the World Bank’s Ease of Doing Business Index. A study led by Simeon Djankov showed that the degree of labour regulation is a potent predictor of both unemployment and the size of the unofficial economy.  

As for the productivity issue, regulation has indubitably played a role. According to a study by Pellegrino and Zingales, more than half of the stagnation of Italian productivity since the 1990s can be explained by a cumbersome presence of inefficient patronage-based firms which didn’t fully invest in the ICT revolution. A plausible cause of this presence, the study argues, is the extensive of regulation and onerous bureaucracy which give disadvantages to meritocratically-managed firms, as opposed to patronage-based ones.

If you desire to expand economic opportunity in your country, you are obliged to give entrepreneurs more breathing room; job creation, productivity growth, and economic formalisation are natural consequences of businesses investing to expand and compete in a marketplace.

Conclusion

All I can do is urge you to consider these policy recommendations. The empirical evidence is clear as water that overregulation, poor bureaucracy, an inflexible currency high debt levels have reduced economic development, while your government has allocated attention to the wrong policies: the policy prescriptions of right-wing nationalism will only make things worse, not better.

Sincerely,

The Econ Rave

P.S. Of course I didn’t send this to Italy’s Prime Minister. Those of you telling me to translate it into Italian, your requests shall be ignored.