A Look at the Italian Economy and Ramifications of the 2018 General Election

Last week, Italy had its General Election for its parliament members after the Italian Parliament was dissolved by President Sergio Mattarella. No single party won the majority, and there is not even enough consensus at the moment to form a coalition government. Even so, it became clear that the influence of the center-left is greatly diminishing in Italy, and that anti-establishment populism is surging, much like it has in other developed countries. While the hung parliament is figuring out what sort of coalitions to build, I would like to take a look at the state of the Italian economy. Over the years, I have heard criticism about the Italian economy, but have never personally taken a particularly deep look at the economic data to make my own determination. Today, I would like to take a look at the Italian economy because it is the third largest economy in the Euro Zone. Italy took a particularly huge hit since its economy shrunk by nine percent and subsequently dealt with a triple-dip recession. If the Italian economy takes a downturn, its effects on the Euro Zone, as well as the global economy, would make Greece's government-debt crisis look like a cake walk in comparison.  With that being said, I would like to examine the state of the Italian economy, followed by a preliminary take on what the elections could mean for Italy's economic future.



Italy is in the process of a recovery that is gaining traction. As the OECD points out in its November 2017 report, the growth in business investment and export demand has helped the Italian economy (p. 178). Lending to non-financial rate corporations has are also helping with the recovery, as is Italy's booming manufacturing base. What's nicer is that the Italian government is repealing the value-added tax hike (which is good considering how high it is already) and providing businesses with tax incentives to invest in the Italian economy. Standard and Poor's felt confident enough in the Italian economy that in October 2017, it raised Italy's credit rating to BBB, the first such increase in three decades because of greater economic growth, growing investment, and increased employment.

Nevertheless, I do have concerns about the Italian economy. The OECD finds that Italy's greatest vulnerabilities are the high levels of non-performing loans (NPLs) and its high level of public debt (p. 180). Italy has a higher NPL ratio than its European counterparts. In its 2017 report, the European Systemic Risk Board (ESRB) covers the topic of NPLs and why they are a risk to the stability of the European financial system. At the very least, tying up resources in NPLs detracts from investing in productive sectors of the economy. More to the point, high levels of NPLs stifle lending and investment. If it does not get better, banks would be less likely to give loans, which could reverse Italy's progress. The quicker the resolution to Italy's NPL problem, the better.

The OECD also views debt-to-GDP ratio as a threat. The bad news is that Italy's debt-to-GDP ratio is already high. The good news is that the OECD does not anticipate the debt-to-GDP ratio getting higher. Nevertheless, the OECD realizes that Italy is prone to higher interest rates, which is why it recommends that "continuing pro-growth reforms and gradually raising the primary surplus are key to reducing the public debt ratio (ibid.)."

Dismal levels of GDP growth have fed insecurity. Demographics imply that Italy could use more immigrants based on its really low fertility rate of 1.34. However, given how the elections went and how anti-immigration sentiment has been growing in Italy, good luck with that! That set aside, the Italian GDP grew 0.4 percent last quarter. Although that is better quarter-to-quarter growth than in recent years, it is still below the Euro Zone average (Banca d'Italia), not to mention that its GDP is still below pre-crisis levels. While IMF, the European Commission, and Banca d'Italia are anticipating higher short-term GDP growth (see EC projections below), Fitch is anticipating lower medium-term GDP growth due to economic slack, declining wages, and a highly fragmented political landscape.

The International Monetary Fund (IMF) points out additional concerns in its July 2017 Article IV Consultation for Italy. The IMF is concerned that the risks to Italy are significant, most notably because of weak productivity and low aggregate investment. Much like the OECD illustrated, the IMF points out that until Italy can deal with its NPLs and high debt-to-GDP ratio, economic growth in Italy will be stalled (IMF, p. 4). And as much as Italy has maintained its debt-to-GDP ratio, which is the second-highest in the EU, there is no sign of Italy being able to slow down the spending buildup that has amassed over the years (p. 10). At least from the IMF's point of view, risks are significant and tilted to the downside because of political uncertainty, financial fragility, and possible setbacks to reforms (p. 11).

Conclusion: What does this mean for the Italian government? That remains to be seen. It is difficult to speculate on what exactly the parties would compromise in order to form their coalitions. Some of the larger parties had Euro-skepticism as part of their party platform. The good news is that Italy is most probably not going to cause volatility by leaving the Euro Zone. Brexit shows us that it is difficult enough to leave the European Union when you're not even part of the Euro Zone. Italy would have an even more difficult time doing so since it is part of the Euro Zone. Limiting its contagion effect on the global economy is always nice. There is also the worry that the Italian economy could tank and crash out of the Euro Zone, as this report from the American Enterprise Institute alludes (Lachman and Nabil, 2018). To reiterate, so much of this depends on the coalitions formed and how they enact economic policy.

I still wonder if it would have a major impact on the Italian economy itself. After all, Italy has a habit of churning through governments. Italy has had 65 governments since 1945, which suggests that changes to the economy might not be so everlasting. A coalition government means that the Italian parliament will have to compromise more, which means less likelihood for more drastic economic policy. This is not to say that Italy does not need economic reforms because it clearly does. However, given the major parties that won a plurality of the votes, it is unclear as to how much of that reform would be in Italy's favor. The greatest challenge for the Italian government post-election is to ensure economic and financial stability. As the OECD already pointed out, that includes pro-growth reform and keeping the debt-to-GDP ratio low. If Italy could manage to do that without doing anything radical, the results of the Italian election should not be particularly worrisome.


Main Sources
Organization for Economic Co-Operation and Development (OECD)
Banca d'Italia [see here and here]
International Monetary Fund (IMF)
European Commission (EC)