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Anna Maria Grimaldi Euro area Economist, Banca Intesa

Italy: Where is the Exit?. Anna Maria Grimaldi Euro area Economist, Banca Intesa. Milan, March 2006. Manufacturing: it ‘s (soft ) party time. Manufacturing output moving more in sync with managers judgment. Demand offering support ahead. Source: NTC, ISAE and ISTAT.

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Anna Maria Grimaldi Euro area Economist, Banca Intesa

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  1. Italy: Where is the Exit? Anna Maria Grimaldi Euro area Economist, Banca Intesa Milan, March 2006

  2. Manufacturing: it ‘s (soft ) party time Manufacturing output moving more in sync with managers judgment Demand offering support ahead Source: NTC, ISAE and ISTAT • Italy manufacturing has certainly improved. Since the Spring, confidence gained ground, mostly on solid gains in orders. Yet, industrial production only recently moved more in sync. With managers judgment.

  3. Services: mangers say the future is bright Yet, we are still waiting for the VA to step up We’ re even doing better than the EU average Source: NTC, ISAE • The services confidence indicators have moved on a steep upward trend since teh start of the summer. The Italian PMI is now even above the EU average. Yet, so far actual output has disappointed, stagnating in the summer. We are confident value added will have contributed positively to GDP growth already in 2005.T4.

  4. Disposable income holding up Employment to gain traction in 2006 Wages still growing more than inflation Source: NTC, ISTAT • The PMI composite job index suggests employment growth should gain traction over the coming months. Contractual wages are slowing down, but still growing well in excess of inflation. Thus, we see a modest pick-up in disposable income in the near future, which in turn should support consumer spending.

  5. Short - term prospects still betting on trend growth GDP growth to return to trend driven... ...by domestic demand • Taking stock of the latest developments , we envisage gradual return to trend growth in 2006, as domestic demand should pick up and net trade should become less of a drag at least in 2006H1.

  6. The “sick man” needs more than a few quarters of stronger growth Trend in GDP constant prices • Italy has cumulated a 10pp growth gap with the rest of the EU since 1995. • The gap has widened since early 2001. • The differential with the EU could widen further unless serious reforms are implemented. Source: Eurostat

  7. 220 France 155 France Germany Germany Italy Italy 195 145 Spain Spain Euro Area ex -Italy Euro Area ex-Germany 135 170 125 145 115 120 105 Export at constant prices (1994 Q1=100) Domestic demand at constant prices (1994 Q1=100) 95 95 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Exports is the culprit, so far! Trend in domestic demand at constant prices Trend in exports at constant prices Source: Eurostat • Italy underperformance is largely accounted for by the weakness of export growth vis-a-vis its EMU partners.

  8. 101.4 101.2 100.2 Germany 101.0 Japan 100.1 100.8 US UK 100.0 100.6 China 99.9 100.4 100.2 99.8 Germany 100.0 France 99.7 US UK 99.8 Spain 99.6 Italy 99.6 99.5 1995 1997 1999 2001 2003 2005 1995 1997 1999 2001 2003 2005 The good, the bad and the ugly! Export market performance cumulated changes (1995 = 100) Source: OECD Source: OECD • Export market performance has diverged markedly within the EU starting from 1995. In particular, competitiveness deteriorated dramatically in Italy and to a lesser extent in France, while Germany and Spain have been able to maintain a much better position in global markets.

  9. 110 115 1992 Q1 = 100 EU - 12 Italy Germany 105 110 Germany France France Spain Spain 100 Italy 105 95 100 90 95 85 90 80 85 75 80 1992 1994 1996 1998 2000 2002 2004 1992 1994 1996 1998 2000 2002 2004 Price competitiveness is part of the story ... Real effective exchange rate deflated with export deflator Relative export prices 1992 Q1 = 100 Source: EU Commission • The divergence in export performance can be partly explained looking at price competitiveness. • Italy fared a much worse export market performance as it failed to cut export prices by as much as its competitors did.

  10. 125 EU - 12 Germany Spain 104 120 France Italy EU-12 115 103 France 110 102 Germany 105 Spain 101 Italy 100 100 95 99 90 85 98 80 97 75 96 1995 1997 1999 2001 2003 2005 1998 1999 2000 2001 2002 2003 2004 ... but cost competitiveness matters too Higher prices only barely enough ... ... to cover spiralling unit labour costs Real effective exchange rate deflated with ULC Margins; 1998=100 Source: EUROSTAT National Accounts Note: Data are indexed 100 in 1992Q1. Source: EU Commission • The trend in margins suggests that higher export prices were not sufficient to cover the massive increase in Italy unit labor costs (ULC). • Thus the ability to tame ULC seems the key in order to stay competitive in export markets.

  11. 6.0 6.0 Italy France Germany 4.0 4.0 2.0 2.0 0.0 0.0 -2.0 -2.0 -4.0 -4.0 -6.0 -6.0 1989 1991 1993 1995 1997 1999 2001 2003 There is more ... Residuals of a regression of export market performance on relative export prices • The residuals of a regression of export market performance on relative export prices suggest that price competitiveness alone is not enough to explain Italy export market underperformance vis-a-vis its EU partners. Source: OECD and Banca Intesa estimates

  12. EU World Germany France Italy 2000-01 2000-01 1985-89 2000-01 1985-89 2000-01 1985-89 1985-89 2000-01 1985-89 Low Tech (Food, textiles, paper, wood, 29.7 38.4 32.8 41.1 21.0 26.0 28.0 38.0 44.0 47.0 basic metals) Medium Tech (Chemicals, manufacture of agricultural & industrial 48.9 47.6 36.6 40.4 58.0 58.0 51.0 48.0 44.0 42.0 machinery, manufacture of transport equipment) High Tech (professional & scientific equipment, manufacture of 21.4 14.0 30.6 18.5 21.0 15.0 21.0 14.0 13.0 12.0 electrical machinery) . “What” you sell ... Euro area and world exports by sector Source: ECB calculations in “Competitiveness and the export performance of the Euro area”, Working paper n. 20, June 2005 • The euro area is specialized in medium tech exports (49% of total exports) vis-a-vis 37% in world exports, while it is less specialised in high tech exports, which have become more relevant in recent years.

  13. 8% Germany Italy 7% France 6% 5% 4% 3% 2% 1% 0% 1995 2000 2004 ... and “where” are also key factors! Exports to China as a %of total Extra EU exports Exports to Eastern Europe as a %of total Extra EU exports Exports to OPEC as a %of total Extra EU exports 18% 10% Germany Italy Germany Italy 16% 9% France France 8% 14% 7% 12% 6% 10% 5% 8% 4% 6% 3% 4% 2% 2% 1% 0% 0% 1995 2000 2004 1995 2000 2004 • The geographical specialization penalizes Italian exports in particular vis-a-vis to Germany. Indeed, Italian exports towards China count less on total exports than they did in 1995. • Italy exhibits a share of exports towards Eastern European countries similar to the one of Germany. Yet, Italian exports are mainly intra-industry and thus not too sensitive to these countries’ cyclical trends.

  14. 150 135 EU-12 130 EU-12 140 France France 125 Germany Germany 130 Spain Spain 120 Italy Italy 120 115 110 110 105 100 100 95 90 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Italy structural problems do not end here Unit Labor Costs (ULC) Compensation per employee Source: EUROSTAT, National accounts • Italy underperformance in international markets is largely explained by the massive increase in ULCs. • The divergence in ULC trends can be ascribed only in part to the dynamics of compensation paid by companies and it is largely due to those of productivity.

  15. 5.0 3.5 Eu-12 corrected 4.5 France corrected Eu-12 corrected 3.0 Italy corrected France corrected 4.0 Spain Italy corrected Germany Spain 2.5 3.5 Germany 3.0 2.0 2.5 1.5 2.0 1.5 1.0 1.0 0.5 0.5 0.0 0.0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 Italy is clearly loosing the productivity race Hourly productivity % change Labor productivity % change Source: OECD Economic Outlook Note: data are rolling five years averages

  16. Italy industry structure is penalizing... Italy counts the largest number of small & medium size enterprises Italy industry value added is low-tech intensive Source: Eurostat Note: data refer to 2002

  17. ...as it acts as a cap on productivity growth Size also matters Productivity varies with tech intensity Source: Eurostat , GGDC productivity database Note: data refer to 2002

  18. Productivity losses now spreading to services Productivity in the services sector Productivity in wholesale and retail trade Source: Eurostat and ISTAT

  19. 6.5 EU-12 France Germany 1.60 Euro-zone Germany 6.0 Spain France Italy US Spain 1.40 Italy US 5.5 1.20 5.0 4.5 1.00 4.0 0.80 3.5 0.60 3.0 0.40 2.5 2.0 0.20 1.5 0.00 2000 2001 2002 2003 2004 1977 1980 1983 1986 1989 1992 1995 1998 2001 Looking for a turn Total factor productivity is on a declining trend in EU-12 even more so in Italy Italy ICT intensity is one of the lowest in the EU-12 Source: EU Commission AMECO database Source: Eurostat structural indicators database Note: Data are in % of GDP • The decline in labor productivity is explained by the slowdown in total factor productivity namely a deterioration in the overall efficiency of the production process. • Lower investment in ICT capital also plays a role. The EU-12 has a large gap to fill, for Italy the distance is massive.

  20. 60% 40% EU -12 Denmark France EU -12 Denmark France Germany Italy Germany Italy 50% 30% 40% The increase in the low skilled workers in Italy coincides with the tax credit 30% 20% 20% 10% 10% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 A supply shock behind the trend reversal in productivity? Share of low skilled in total employment Share of high skilled in total employment Source: Eurostat Structural Indicators Database • One of the explanations provided for the trend reversal in productivity growth is a supply side shock namely the labor market reforms of the 90s. If that was the case the reversal in productivity should be temporary and not structural. Yet, a recent EU Commission study shows that the supply shock can only account for a small part of the productivity decline. • But let us also make a positive remark. The EU has large room for improvement, if the appropriate reforms are implemented. Certainly, at this stage they are mandatory.

  21. 75 75 80 70 70 70 65 65 60 60 60 50 40 55 55 30 50 50 20 45 45 Italy EU -12 France Spain Germany US 10 40 40 0 1990 2000 2001 2002 2003 2004 Germany Italy Eu -12 Neth Spain US France Labor force participation and human capital must rise Female participation rate ( in % of working age population) 2003 total graduate per 1000 of population aged 20-29 Source: OECD Employment Outlook Source: Eurostat • Labor market reforms still have a long way to go to increase the utilization of labor input. Labor participation in the EU remains almost 10 percentage points below the US level despite the increase seen in the 90s. The gap remains particularly dramatic for women. • Not only should reforms in Europe aim at increasing the use of labor input but also the skill content of its labor force.

  22. 5.0 6.0 4.5 1998 2003 5.0 4.0 1998 2003 3.5 4.0 3.0 3.0 2.5 2.0 2.0 1.5 1.0 1.0 0.5 0.0 US UK Italy US UK Italy Spain Japan Turkey France Spain Greece Sweden Turkey France Greece Germany Sweden Netherlands Germany Czech rep. Czech rep And don’t forget about product markets State ownership remains very high in the EU and... ... so is involvement in business operations Source: OECD Product Market Regulation Indicators. OECD working paper 419, April 2005. • The product market reforms of the 90s have yielded some results. Yet, there is still a long way to go and further benefits could result if the deregulation process continues in particular both in the services sector and network industries.

  23. Public finances: Italy’s Damocles' sword! Tentative paths of Italy’s public finances under different election outcomes • The electoral programs of the competing parties are both vague. Public spending increases are on both agenda. • Yet, Mr Prodi has clearly stated he plans to:> unify capital gains taxation to 20% = this should earn the government around 4/5 bln €.>reintroduce tax on bequests for assetts worth more than 500k € . We think it is highly unlikely the tax will bring the government’s coffer sizeable additional revenues.>In previous legislation, Mr Prodi managed to bring public finances on a sustainable path and keep expenditure under control. Yet, back the EMU entrance race was on.

  24. What’s needed to mend the hole? The debt will explode unless a larger primary surplus is restored Delaying the correction will only increase the pain for future generations

  25. Italy: main macro projections

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