Who can save Italy?

Asks the Economist. Predictably they think that only economic liberalization will do the trick. (You already know that before actually reading any article in the Economist. But it's still interesting to see how their construct their case.) Basically, the argument is that Italy's main problem is slow, extremely slow productivity growth. The solution is to let loose the forces of innovation and investment but cutting red tape and regulations.

Anyone knowing Italy shudders at the number of professions that are protected by various forms of monopoly protection. Getting a cab in Milan on a rainy day is always a challenge and when you find one the price on the meter will be exorbitant. So are retail prices in general for everything from Paracetamol to Washing machines. Structural problems add to economic stasis. Small family owned companies abound in Italy. Much like France in the 18th century, they tend to be ill managed by scions of decadent dynasties whose only qualification to run a company is that they own it.

There is little doubt that unit costs of production could be lowered dramatically by deregulation and by substituting small family run companies with larger more efficient operations. This would dramatically increase the efficiency of the Italian economy and lower prices. (It would also take away much of the charme of Italian cities. You can still buy three screws in a small hardware store in central Milan. But of course this is a highly inefficient ways of retailing screws. Once these reforms will be done, the only way to buy a screw in Milan will be to drive to the outskirts of the city and buy a box of screws in a DIY market, while the centre will be populated by international chains. But that's an argument for sentimentalists.) The crucial question is if lowering costs will lead to growth. This is not a foregone conclusion. Much of the cost cutting would come from reduced labour costs. As it is now there are two people selling three screws: one getting them and wrapping them up and the owner hanging about doing nothing but operating the cash register. After the Economist is done, I will get a package of fifty screws in the suburban DIY and the only person involved will be a low paid cashier--deregulation of the labour market being a priority of all liberal reformers in Italy--who can pass thousands of screw packages past the scanner in a day. Reduced labour costs also mean less employment and less demand. So you get your screws for less, but you also have fewer people who can afford screws. However, if deregulation triggers capital investment a part of the efficiency gains would come from the use of new technology which would also create employment. But as things are this would probably create employment in Germany because one area in which the Italian economy is weak is the production of machines tools and other high tech products. Finally, a newly competitive Italian economy could begin to run large export surpluses and grow in this way. But with economies everywhere depressed this will be difficult.

Deregulation will not work on its own. Italy needs a targeted industrial policy. Skills training and research and development needs to be actively promoted. Most likely this will have to happen outside of existing companies because small family owned companies often don't have the muscle or the ambition to innovate. New industries like renewable energies need to be implanted through an aggressive state led drive for innovation. And by the way, this would also take care of the problem of domestic demand. Large infrastructure investments and the training of new qualified personel would create employment and strengthen domestic demand.

So is there a better solution than that proposed by the Economist? Of course there is. Is it likely to be implemented? No, of course not. The reason is not that too many people read the Economist--although the pervading influence of liberal economic ideas is important in this context--or that sinister forces are blocking Italy's ascend. It's not the masons or the illuminati this time. The problem is the weakness of the Italian state and Italy's social structure. More about that soon.