I. Introduction and Overview
1. Concern about medium-term growth prospects has been an increasingly common theme of public policy debate in Italy. It has also been a theme of past Article IV discussions, inter alia because of its critical implications for medium- and long-term fiscal trends.. The policies needed to support faster medium-term growth were a major focus of the 2004 Article IV consultation, as well, as reflected in the following chapters. The first uses new techniques to update estimates of Italy’s potential growth rate, and underscores that stagnant productivity is at the root of the disappointing growth performance of the last decade. A number of commentators have pointed to concerns about the implications of Italy’s business environment for growth, and the next chapter, building on work undertaken by the World Bank and other institutions, provides empirical support for these worries, with special attention to the role of the legal system. Chapter IV focuses on another aspect of the business environment, providing an assessment of an area—corporate governance—that has important implications for not only for trend growth but also for macrofinancial developments . Finally, in response to a request at the Executive Board discussion of the 2002 Article IV consultation, Chapter V reviews developments in fiscal federalism in Italy and draws on cross-country experience to offer suggestions on how the decentralization process now under way can be most effectively managed.
2. Chapter II presents updated estimates of potential growth, using new techniques that draw on comovements of output, employm entand inflation over the business cycle to distinguish trends from cycles. One puzzling aspect of Italy’s growth performance over the last several years has been the limited response of output growth to the steady increase in labor supply that has accompanied structural reforms. The chapter’s results indicate that, even after correcting for cyclical factors, trend productivity growth—already on a downward slope for decades—has declined further since the mid-1990s, and it remains a drag on growth going forward. Nevertheless, there is also evidence that a significant portion of the very sharp fall in labor productivity over the current downturn is cyclical rather than structural, with capacity utilization falling despite the rise in the labor input. This provides a basis to hope for some modest improvement in growth in the near future, as cyclical conditions improve and firms seek to maximize labor efficiency.
3. Chapter III uses cross-country data compiled by the World Bank and other sources to explore the implications of a country’s business environment for output growth. A number of recent studies have explored these links, but they have typically relied on subjective surveys to document the quality of a country’s institutions. One advantage of the World Bank dataset used in this chapter is that it provides objective measures—such as the financial costs involved in starting a new business or the number of days required to settle a particular type of legal claim—that may be a more accurate gauge of the quality of the business environment. The results provide additional evidence of the importance of institutional factors for growth. Given that a number of surveys point to concerns about the quality of the business environment in Italy, this suggests the potential for reforms to increase medium-term growth.
4. Two high profile corporate bankruptcies have prompted the government to propose changes to Italy’s corporate governance system. Chapter IV—produced as an outgrowth of the recent Financial Sector Assessment Program mission to Italy—reviews the current state of the system and evaluates the proposed reforms. The study gives a positive overall assessment of corporate governance in Italy. While it does identify some weaknesses in investor protection, it finds that these would largely be rectified by the proposed reforms (which, as of early-January 2005, remained under parliamentary debate). The chapter goes on to note some additional measures that could further strengthen corporate governance, including regarding protections for minority shareholders.
5. Italy has been engaged in a process of fiscal devolution for many years, but progress has generally been slow. Chapter V reviews developments over the years, and draws on experience in other countries to offer some guidance on how to design a framework to implement the planned decentralization. While recognizing that political choices are by necessity central to the process, ruling out a “one-size-fits all” approach, the review of experience highlights the importance of transparent and stable rules, effective monitoring, and credible enforcement mechanisms.