Italy’s Supply Constraint

The OECD estimates the current potential capacity growth rate of the Italian economy at 1.25% a year. Actually I suspect even this very low number is over-optimistic. Growth since 2002 has been as follows: 2003 – 0.1%: 2004 – 0.9%: 2005 – 0.1%. To be sure forecast growth for this year is somewhat higher, at 1.4%, and optimists are expecting this to be more or less repeated next year. But I suspect this outcome is unlikely simply because the global economy now seems to be slowing (and in particular the ever important US economy),so the strongly advantageous situation of 2006 is unlikely to be repeated, while next year the Italian government has promised to introduce an important package of spending reductions which are bound to negatively affect growth, at least in the short term..

But why is potential growth capacity in Italy so low?

Well, as you might have imagined, my focus here will be more or less on the limited capacity for Italy to increase the size of its workforce after 20 odd years of low fertility. In this sense this post is a practical case study of my more theoretical “Of Population Pyramids and Value Chains“. Now again according to the OECD:

With employment rising by only about ½ per cent per year, there should be some recovery of productivity, in turn accentuating disinflation and facilitating export growth. Without bold structural reforms by the new government to raise the economy’s low supply potential and reverse its huge cost disadvantage……… sub-par growth is likely to persist.

This again is just one example of why I was so tenacious in the comments on the recent ‘Reform Has Become A Dirty Word‘ thread. Italy urgently needs reform. And it is because of the apparent difficulty that Italy has in carrying out reform that I am so adamant that Italy may well reach a situation where it has little real option but to default on the public debt, with all that this implies. Indeed Italy seems set to become the ‘test bed’ of how the ageing process works out in practice.

Of course the ‘drying up’ of the labour supply in Italy which is reflected in this low potential growth estimate is producing historic lows in the Italian unemployment rate (a phenomenon we are also seeing in Japan):

Italy’s unemployment rate fell to the lowest in more than 14 years, a government report showed today. The unemployment rate fell to 7.0 percent in the three months through June from a revised 7.3 percent in the first quarter. That was the lowest the statistics institute started its survey in 1992. It was expected to remain at 7.3 percent, according to the median forecast of 23 economists in a Bloomberg News survey.

Italian joblessness has fallen to the lowest of the euro region’s four-largest economies even though growth has averaged just 0.6 percent in the past five years. The expansion in Italy’s $1.8 trillion economy will lag behind that of the euro region for at least a 10th year in 2006, expanding 1.7 percent, compared with a 2.5 growth rate for the 12-nation bloc, according to the European Commission.

So what we have in Italy is pretty low unemployment, and a miserable growth record, strange isn’t it? Even stranger perhaps is the fact that most economists don’t seem to be giving much importance to thinking about just why this is happening.

The latest data from the Italian Statistical Office ISTAT is interesting (in Italian only unfortunately), since it shows that, year-on-year, the number of people actively seeking work declined to 1.621.000 which was a reduction of 11.8% (or 216.000 people) over the second quarter of 2005. And this situation has only produced an annual estimated growth rate of 1.4%. Put simply, this is because – without a significant change in participation attitudes, especially among women (and which is, in part, what the reforms are about) – Italy’s available workforce is now set to decline.

Of course Italy is creating new jobs, but as Bloomberg point out, to a great extent it needs immigrants to do the work:

More than 30 percent of the rise in registered employment in the quarter and almost 40 percent of the increase in the past year came from immigrant workers, the national statistics institute said today in Rome. Many of these registered jobs are low-skilled positions, meaning the economy isn’t as healthy as the numbers might otherwise suggest.

The statistics show that the biggest gains in registered employment have come from immigrants gaining legal status, many of whom are already working. More than 900,000 foreign immigrants, the equivalent of almost 2 percent of the population, have won residency in the past three years through a series of government amnesties.

Italy’s position is in fact even more complicated since the recent employment growth is largely in low skill activities (which means that if Italy is moving up the value chain it is in fact doing so very slowly, far too slowly for its needs):

“I’ve worked at unpaid internships for years, but the number of jobs out there isn’t growing,” said Carlo Massoni, 32, who’s only been able to land short-term contract work since earning a degree as a telecommunications engineer six years ago.

“I haven’t had a break since I graduated.”

The number of workers with non-permanent contracts grew 8 percent in the second quarter and those short-term contracts now account for 9.5 percent of total employment, up from 9.0 percent a year earlier, Istat said today.

The lack of permanent job opportunities has left Italy with the second-highest youth jobless rate in the European Union after Greece, currently 24.1 percent of those aged between 15 and 24. Almost half the increase in registered employment in the first half came from people over the age of 50, Istat said.

So those seeking work in low paid unskilled jobs are finding them, whilst those who are young and qualified seem to be finding the going tough. Something somewhere is going very wrong here.

And even if the Italian economy did finally manage to break into more new sectors the supply problem still exists, since a very significant proportion of Italians in the 25 to 34 age group have very low education levels. Again lets look at what the OECD had to say last year:

Compared with other OECD countries, an above-average proportion of the Italian population has only lower-secondary education. This is especially true for older age-groups, but it is also true for younger ones. Forty per cent of 25-34 year-olds are in this category compared with an EU and OECD average close to 25%, and the results of the OECD Programme for International Student Assessment (PISA) show that Italian 15-year olds have attainments well below the average in particular in mathematical and problem-solving skills. There is a high proportion of youth which is in neither education nor the labour force, suggesting a difficult school-to-work transition. The risk of unemployment later in life is also considerably higher for those with only lower secondary education.

Furthermore, a smaller proportion than the OECD average has completed tertiary education, even though a relatively high proportion embarks on it. Years spent in obtaining an undergraduate degree are greater than the average, raising the opportunity cost of tertiary education and discouraging the formation of high level skills. The demand for high-skill workers may be hampered by the specialisation of Italian industries in low tech sectors and the small size of Italian firms, which reduce their R&D spending capability. At the tertiary level, a problem is an insufficient number of younger professors, for whom there are barriers to entry. Academic appointments lack transparency, promotion is not always linked to productivity, and Italy spends far less than the OECD or EU average on research and development, and significantly less on tertiary education. As a consequence Italy suffers from a pronounced net brain-drain.

So there we have it. Italy seems to be caught in a very strange kind of trap, where a very inefficient education system means that only a small proportion of young Italians stay the distance to get their final qualification, and as a result there are insufficient qualified people to help make that much-needed leap upwards. And even if Italy was succesful in attracting a large number of older women into the workforce (but in which case who would look after the increasing number of dependent old people?) this wouldn’t resolve the problem, since the low educational level would strongly constrain the kinds of work which they could do. As I say, a strange kind of trap.

19 thoughts on “Italy’s Supply Constraint

  1. There’s an article in today’s NYT which looks more at the social rather than economic consequences of Italian demography & paints a depressing picture.

  2. Of course the ’drying up’ of the labour supply in Italy which is reflected in this low potential growth estimate is producing historic lows in the Italian unemployment rate (a phenomenon we are also seeing in Japan)

    If this is the case, why doesn’t Germany show the same effect?

  3. “If this is the case, why doesn’t Germany show the same effect?”

    Well, in some skilled areas it already is. You have comparatively high unemployment among unskilled (sort of the opposite to Italy), while employers keep complaining that they have trouble finding highly trained staff.

    Two things about why the unskilled work more in Italy than they do in Geramny immediately come to mind:

    i) the difference in the relative values of the welfare systems. I mean you bring German benefits down to Italian levels and let people be paid what they are paying in the new ‘growth’ sectors in Italy, and you would soon find some things had changed.

    ii) the extent of the informal economy in Italy.

    Also no politician in Germany is suggesting a set of reforms where you move down the value chain to where Italy is.

  4. Oliver,

    “why doesn’t Germany show the same effect?”

    You have raised a very interesting question. Sleeping on it I am not at all happy with the answer I have given. Not because of the comparison with Italy, but because of the one I make in my head with Japan. Why is the German employment profile so different from Japan, which in many ways is a much more comparable situation, given the kind of economic activity profile the two of them have.

    Needs thinking about.

  5. “Is this a German effect or an East German effect?”

    This again Charly is an interesting question. Maybe not simply East-West since North Western Germany seems to have many problems also in this regard, but the South does seem to be very different (but, and note, like the North of Italy).

    Slightly off topic, 1 in 4 of all the new migrant ‘regularisations’ in Spain are now taking place in Catalonia. This means that eventually 25% of the Spanish population will eventually live in Catalonia (the figure is currently around 15%), and that the popuation will be a lot younger than the norm. This is likely to have *large* political implications given all the debates about autonomy etc.

  6. sir,
    your data, suggestions and conclusions about italy are right taken one by one. But it happens I visited many different Italian regions lately (I am an Italian myself) and everywhere I found people getting richer. Where is the trick? Nobody knows. Statistics offer false digits and projections based on them are false too of course. Some facts:
    1)Italian informal economy is estimated at thirty per cent (30% !) .
    2)God knows how many small Italian firms have been outsourcing to China, India, Africa during the last 20 years.
    3)Italy is possibly the only country where Tourism, Agriculture and Manufacturing give a sound contribution to economy. Our services (say banking) are poor, but we are on the way to fill the gap. Research is weak too, but once we were kings and good old times may come back.
    4)Italians on retirement do not move to Florida or Black Sea Resorts. The gentleman may play the plumber, the electrician and the bricklayer,or help the ass-pupils to learn mathematics. Growing tomatoes and lemons in the garden near the house is considered respectable too. The lady will bake sweets and even bread.
    5)Wheater is fine, we have no tsunami or hurricanes, just a few earthquakes from time to time.
    6)We are co-founders of the European Union, the richest and most developed area in the world.

    Conclusions and forecasts? Sorry, you are the wizard.

  7. Hi Strudel,

    “Statistics offer false digits and projections based on them are false too of course.”

    Well yes, but they are all we have to go on, and the government debt which is a big part of the issue is a real number, as is the balance of trade deficit, and these things have to be repaid.

    Of course I agree that there is a tremendous underground economy, there is in Spain too, and I agree that by regularising the immigrants you will get more revenue, but still.

    My point is not to attack Italy. It is a lovely country with lovely people, but this is all about sustainability in the future, and I’m afraid the pension and health systems won’t run on people growing vegetables in their back garden.

    “Italy is possibly the only country where Tourism, Agriculture and Manufacturing give a sound contribution to economy.”

    This, I’m afraid is just the point, since these are not – in general – high value added activities, and it is in this direction that you need to advance.

    “the European Union, the richest and most developed area in the world.”

    Well, I guess there are some people in the US who might want to challenge this, but even so, the issue is how long does it stay like this?

    “Sorry, you are the wizard.”

    Well, I’m afraid I’m no wizard, unfortunately. If I were I would wave my magic wand right now and pay off all your debts.

  8. Dear Strudel,
    I’m Italian as well. I think that some of your points are valid, but you misresome aspects.
    1) Italian hidden economy accounts for a large portion of the GDP; as Italian I’m not proud about that – moreover, it is extremely dificult to undertsnad the magnitude of tax evasion and the source of hidden economy (does it come from legal or illegal sources? Is it 10%, 30% or 100%?)
    2)Compared to other European countries, not many companies outsourced to countries such as India, China and Africa (on the contrary, I believe that we have a cronic delay in taking opportunities). This aspect explains why the Italian Government rushed with a delegation of about 600 businessman to China few weeks ago.
    3) You might be right, but I look at the yearly statistics and, taking the tourism sector as an example, I see Italy falling behind countries that have been historically behind us ;-(. Moreover, I have the feeling that Italy is a land plenty of opportunities for low-skilled workers, but for people with a degree the only option is to go away (as you said, employment in the service sector is minimal)
    4) To this regard, there is a nice article recently published on one of the major italian newspaper. The author argues that the additional income earned by retired members in the family serves the purpose to offset the diminiushing income eraned by young generations (I’m one of those people who has worked for $600 euros per month for more than a year; with this salary my father has to work and help me pay the rent in Milan).
    5) I agree with you…. we are blessed in this sense
    6) Yes, we are the co-founders, but I’m afraid that Italy will really fall behind… nobody seems to care about anything: and businesses are afraid to grow and lose their family ownership, and young generations do not have real job opportunities (note, I’m not talking about a lifetime job, but a decent contract) and leave the country…

  9. Paola,

    I could guess you have an average degree in what? Political Science, or something equally vague. A not particularly useful degree and probably no work experience to speak of with precious little work skills. However, this is neither here nor there. Employment conditions have always been poor in Italy. And we could go back centuries on this one. Hence the very large number of Italian communities abroad. Exploitation of the younger generation and of the unemployed is something that Italians have always excelled at. This attitude did not prevent industrialisation nor the emergence of Italy as a major industrial power. It is a cultural problem and should be addressed as such. I don’t think it’s necessarily an economic problem at the aggregate level. What it is is a problem concerncing the distribution of resources.

    Italian economic growth has never depended on the creation of more well paid jobs. It has always been based on family-owned businesses, entrepreneurship and private sector savings and investment in productive capacity. Italy is not the United States or the U.K. and, without some kind of an idea of how things work in Italy, the economic analysis on this page in this regard is pretty worthless.

    In Italy once upon a time if you wanted reasonably well paid employment, with secure tenure, you joined the public service and then proceeded to do very little and retire insanely early. Thankfully there has been a reduction in that type of employment, which wasn’t at all productive. The real growth and money was created at the level of privately-owned entreprise. And that is pretty much still the case: from Berlusconi at MediaSet to Armani at Armani or Benetton at Benetton.

    So, while I would encourage you to emigrate if your family does not run a business which can employ you, that does not mean that Italy’s longer term growth outlook is necessarily poor simply because it is not providing salaried work for all those who seek it. And I would guess again that you are looking for some king of office job rather than say a job as a brick layer or in a factory. In both areas there is strong demand.

  10. Paris

    “I could guess you have an average degree in what? Political Science, or something equally vague. A not particularly useful degree and probably no work experience to speak of with precious little work skills.”

    Well you guessed wrong. Paola is an economist, she studied economics, and is in fact an extremely able young macro-economist.

    In fact she just joined me on Italian Economy Watch.

    But as you say, this is neither here nor there.

  11. And what you don’t pay her more than 600 euros a month? Or is that at her previous employment? Or has she since left Italy? What gives?

  12. FWIW – There are a lot of people with degrees in Italy. And a lot of people with Economic Degrees. I know, I got one. At the Bocconi. Full marks. I never looked for work in Italy after graduation, although I know lots of people who did. Most found work on reasonable pay, those with worse marks or skills did less well. I’ve worked in Milan since, money was OK, not terrific, just reasonable. But the way the labour market works in Italy (and always HAS worked) really doesn’t mean all that much with regard to longer term economic prospects for the country as a whole. That’s the reality. And if Paola can’t find the type of work she wants with the qualifications she has and doesn’t want to work as a highly paid plumber etc. then she will either have to set up her own business, join the family firm or emigrate. Competition for employment at the entry level among young graduates is extremely fierce.

  13. “And what you don’t pay her more than 600 euros a month? Or is that at her previous employment?”

    I don’t pay her anything Paris. Blogging is a voluntary activity, a hobby. Yes, she was talking about what she used to earn.

    “And if Paola can’t find the type of work she wants with the qualifications she has and doesn’t want to work as a highly paid plumber etc.”

    I think the point she was making, and it is relevant to what we were talking about here, is that she was trying to support herself, to become independent from her parents, not that she eventually can’t find appropriate work.

    It’s the ‘eventually’ part that seems to be the current issue in Italy.

    “There are a lot of people with degrees in Italy. And a lot of people with Economic Degrees.”

    Yep, I know. And this is good. But what Italy needs to do is generate meaningful employment so that all this talent can be put to good use. This is what moving up the value chain means. Italy needs to develop the kinds of economic activity which mean that educated people don’t have to wait till they are 31 or 32 to get their first ‘well-paid’ permanent job – or contemplate becoming an ‘Italian plumber’ as an alternative. The fertility problem is also connected with this.

    “Or has she since left Italy? What gives?”

    Well, I’m sure Paola is well able to speak for herself if she happens by again, but actually she is in Canada, she won a scholarship for a year. Soon she will be headed back home.

    “But the way the labour market works in Italy (and always HAS worked) really doesn’t mean all that much with regard to longer term economic prospects for the country as a whole. That’s the reality.”

    Well this is just what needs to change.

    “Competition for employment at the entry level among young graduates is extremely fierce.”

    And this is why.

    If Italy is going to avoid that default which you assure me won’t happen then the “this is the way it always was and this is the way it always will be” approach is exactly what has to change.

  14. Please. Italy needs to make entry level jobs easier to find in order to avoid default? You must be joking.

    Italy will change its culture when Italians change. I am sure that when Paola eventually finds her job she will hang on to if for dear life, not willingly change, expect good benefits and be unwilling to move aside for the younger generation.

    This is a culture. And it has nothing to do with the economy. Whether it has to change is debateable.

  15. Paris,

    Edward has already mentioned many things that I wanted to comment. Anyway, I paste below some of the thoughts I wrote last night:

    “Dear Paris, When I answered to some comments in this blog, I should have been more careful and state more explecetly some background information about Italy.
    Having said that, you gave a very good background of how business is done in Italy (probably better than I could have ever done, so I’m really glad you did it). You mentioned important facts, including that the “Employment conditions have always been poor in Italy”. My line of reasoning is different, because I do not want to look just at the past or present, but I want to look at the future and question: can Italy go on doing the same things in the future, only because it has done until today and “It is still a major economic power”? I would agree with you if the world had remain constant. But the reality is that phenomenon such as Globalization call for a change. Not only, Italians have changed as well: migration partterns, education levels, culture, life expectancy and, one of the most critical aspects related to these points, the birth rate. And, I would argue, even the culture of young generations in terms of jobs is changing rapidly…
    As many other young graduates, I do not look for a lifetime job, but I have a dream: I would like to see Italy give a chance to us in two ways: 1)have the possibility to have job offers that permits us to learn and express our potential in the organization/country and 2) receive a dignitous salary to enable young generations to make some plans for the future. Right now in Italy none of these things is happening, aside for few exceptions…

    Luckily we can all leave our country…but, still, I think that it’s sad…”


  16. Paola Italy’s answer to unemployment has always been immigration. Some like, Braudel, even suggest that is a good thing because it meant Italians brought good food, building skills and an appreciation for beauty to many corners of the world (to name just a few Italian positives). As for change, I would argue that that is a constant. You wish for a lot. Fair enough but what Italians (particularly the younger generation) sometimes lack is flexibility and a willingness to engage with the world as it is. That is: you need to adapt to reality. Italy is not an English speaking country, it does not have an Anglo-Saxon economy and there are consequences to that. One of those is less rotation in the work force and a greater presence of family owned and financed business. There is a lot of positives in that structure: greater stability but less opportunity for new entrants to the work force who don’t have specialised skills or connections. Things are changing. One main thing I would note is the entry to the Euro, the liberalisation of capital markets and the resultant fall in domestic interest rates. Why is this important? Because it shifts power from savers to borrowers. Who are the savers? The older generation. Who are the borrowers? The younger generation. You can’t see it now, but look back in 20 years and it will become obvious. There are lots of positive changes going on. I’m not going to go into all of them here. Suffice to say that I would urge you to make the most of your overseas experience while you have it and don’t pine for a perfect world because that doesn’t exist and never will. Make the most of your Italian culture because, believe me, it gives you an advantage. I never forget going to an interview overseas and being told I had “perfect qualifications”. I got the job. I worked hard. I did well. So can you. But remember the Anglo-Saxon economic model is not perfect and the instability and uncertainty it generates has many negative consequences. Right now you are focusing on the positives, there are many, many negatives. Canada, perhaps, has a bit of both. Good luck.

  17. Ooops. I meant to say: emigration. Although as an Italian who grew up overseas I always think of myself as an immigrant. Forgive the Freudian slip.

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