This Survey is published on the responsibility of the Economic and Development Review Committee of the OECD, which is charged with the examination of the economic situation of member countries.The economic situation and policies of Italy were reviewed by the Committee on 17 January 2013. The draft report was then revised in the light of the discussions and given final approval as the agreed report of the whole Committee on 01 February 2013.The Secretariat’s draft report was prepared for the Committee by Paul O’Brien and Oliver Denk, under the supervision of Patrick Lenain. Statistical assistance was provided by Josette Rabesona.The previous Survey of Italy was issued in May 2011.

Italy has embarked on a wide-ranging strategy to restore fiscal sustainability and improve long-term growth. Combined with measures at the euro area level, these welcome actions have reduced downside risks and the economy should emerge from recession during 2013. However, with the public debt-to-GDP ratio nearing 130% and a heavy debt redemption schedule, Italy remains exposed to sudden changes in financial market sentiment. Large and sustained reductions in public debt are therefore the top fiscal priority. The gains from recent structural reforms must also be consolidated and further measures to promote growth and improve competitiveness need to be implemented, to return Italy to healthy growth.

Since late 2011, Italy has been enacting a broad package of structural reforms and fiscal consolidation policies, together aimed at addressing a legacy of weak growth and high public debt. This strategy has been rewarded by higher confidence in financial markets and improved medium-term prospects. In the short term, however, though necessary to avoid even worse outcomes, it has been accompanied by significant output losses and social costs – unemployment has been rising and vulnerability to poverty has increased. Success in turning the economy round depends importantly on euro-area crisis resolution. In this regard, Italy has benefited from actions at the euro area level, including the European Central Bank’s readiness to provide support if needed. Success ultimately depends on full implementation of structural reform legislation and commitment to debt reduction policies, which will hasten the return to healthy growth.

Italy’s policy of fiscal consolidation and growth-friendly structural reforms has substantially improved its economic prospects, but the adverse sentiment that the country has faced in the sovereign bond market over the past years has deep roots. It reflects lingering anxieties over the euro area’s future, as well as persistent economic and financial difficulties, in particular the high level of public debt and low potential growth. The government has rightly aimed to halt the rise in the public debt-to-GDP ratio and put it on a downward path. This could be achieved either with a balanced government budget or a small fiscal surplus. While additional fiscal tightening would have transitory negative effects on output, it would be rewarded by faster debt reduction and lower risk of renewed financial-market reactions. In addition, automatic stabilisers should be allowed to work.Concerns about fiscal sustainability and the prolonged recession have spilled over to the financial sector. Lending conditions are tight, non-performing loans are high and rising, and capital flowed out of Italy to the core countries of the euro area. The Bank of Italy should continue to ensure that banks increase provisions against losses, and strengthen their capital asset position by raising new equity from private sources, including from foreign stakeholders, by retaining earnings, and by disposing of non-core assets. Resolution of the fiscal, economic and financial crisis in Italy depends in part on action at the euro area level. As a member of the euro area, Italy has benefited from the establishment of the European Stability Mechanism, the announcement by the European Central Bank of the Outright Monetary Transactions scheme and the plans for a euro-area banking union.

To lift Italy’s economic performance, the government has legislated reform measures in many areas: the pension system, the tax system, product markets, the labour market, the public administration, and the rule of law. These structural reforms have mostly been in line with previous OECD recommendations. They should be fully and consistently implemented. Overall, once implemented, they are expected to have a positive effect on GDP. Among the priorities for the future should be to continue to promote greater competition in product markets, to improve the education system and incentives for innovation, to enhance the inclusiveness of the labour market, and to broaden tax bases through a comprehensive reduction of tax expenditures.

OECD indicators of structural policy show that policy changes in Italy since 1998 should have improved the environment for entrepreneurship significantly, but in the same period its economic performance has deteriorated noticeably. This may be partly because there is a difference between policy measures intended by the government or parliament and their impact on the business environment perceived by entrepreneurs. There is no certainty as to what are the main culprits, but a number of policy steps would help to improve the situation. These include better thought out and better written legislation and implementing regulations, more use of performance-oriented management in public administration, and further streamlining and reduction of incentives to procrastination in the judicial system. Legislative simplification and transparency will increase economic efficiency in themselves, while also making a contribution to reducing the incentives and opportunities for corruption and organised crime to flourish. Clear operational independence with accountability is essential for bodies monitoring and assessing the extent of corruption.