The Italian economy has not proved resilient to the global slowdown that started in 2001. The ambitious programme of structural reforms over the past decade allowed Italy to join the EMU and to improve macroeconomic fundamentals, but has not been enough to spare the country from a disappointing performance in 2002, when the deceleration of growth was one of the sharpest among OECD countries. Discretionary fiscal support and low real interest rates temporarily revived both consumer and business spending in the second half of last year; however, it is unlikely that activity will pick up in Italy in advance of that of its trading partners, with Italian GDP rising this year broadly in line with the Euro-area average. A bright spot in the current downturn has been a strong employment performance, a clear result of the greater flexibility of the labour market following the reforms of the 1990s...

Italy was for many of the post-war years one of the fastest growing countries in the OECD area, and its labour productivity is among the highest in the OECD.1 It embarked on an ambitious programme of structural reforms in the 1990s, and by 1997, achieved a dramatic reduction in the public sector deficit allowing Italy to qualify for entry into EMU. More recently, it has had a good record on employment creation, and is the only one of the three largest euro-area countries to respect the 3 per cent upper deficit limit of the Stability and Growth Pact in 2002...

Although the debt to GDP ratio continued to fall, the pace of fiscal consolidation slowed considerably in Italy in 2001 and 2002 (Figure 13). After rising from 1.8 per cent of GDP in 2000 to 2.7 per cent in 2001, a slight narrowing, to 2.5 per cent of GDP was registered for the budget deficit in 2002 in spite of the marked economic slowdown. The narrowing reflected the effects of a number of measures such as tighter controls on central government spending, enlargement of the business tax base and a strengthened health spending agreement with the regions. Recourse to one-off measures, particularly the sale of public-owned real assets and proceeds from securitisation (cartolarizzazioni) helped to contain the deficits in a period of marked cyclical slowdown. Nevertheless, there is also an underlying excessive debt problem, and addressing it will require measures of a more permanent nature in future. Thus, the fiscal consolidation process and the achievement and maintenance of the medium-term balanced budget targets may require additional measures...

The OECD (2001b) Review of Regulatory Reform in Italy acknowledged the vast distance that has been covered since Italy began liberalising product markets at the start of the 1990s. This entailed a sustained programme of privatisation, market opening, and deregulation followed by appropriate re-regulation and institution building. However, there is still considerable scope for further improvement, and raising growth will depend critically on removing the impediments and distortions to competition. Rigidities and protections have a large influence on the structural features of the Italian economy impacting upon, amongst other things, the intensity of product market competition, size and growth of firms, innovative activity, the capacity to attract foreign direct investment and employment growth. Problems with productivity and growth, and low R&D spending, are linked to an industrial structure heavily weighted towards small enterprises. Despite the large number of firms, the intensity of competition and rivalry is particularly weak in retail distribution and in professional services. Without the elimination of entrenched positions and an easing of barriers to entry and firm growth, innovative activity, one of the main engines of economic growth, is unlikely to thrive in Italy.

Italy faces two major medium-term challenges at present: how to raise the underlying growth rate, and managing public finances so as to reduce high debt levels and keep the deficit under the 3 per cent of GDP Stability and Growth Pact obligation. These objectives do not conflict in the longer term: higher growth would both generate more tax revenue for given tax rates and automatically reduce the debt to GDP ratio more quickly. The main reforms to which the administration is committed in the fields of education, labour markets and tax are likely to have positive effects on growth, but implementing them will have significant up-front budgetary costs. It is therefore important that they be phased in over time, with priority being given at first to those aspects of the reforms that can be implemented with comparatively lower costs and that can provide higher returns in a relatively short time...