Reform or die

Let's go, but where?

Does Italy need a crisis to get things moving?

CAN Italy reform itself, or is it doomed to decline? It is always dangerous to project a trend set by a few years' under- (or over-) performance far into the future. Both Japan and Germany, once thought unstoppable and then, not so many years later, irredeemable, now seem poised to recover, and Britain's sorry post-war performance has been forgotten in the euphoria of the past 15 years. Italy's problems are as deep-rooted as any: its potential growth first slowed some two decades ago, and its demographics have looked ominous for many years.

But time can be a great healer. In the long run, Italians' natural flair, inventiveness and creativity should be enough to rescue what is still a rich country in every sense. After all, this is where much of European capitalism began, complete with modern banking and double-entry book-keeping. The country's plethora of small firms and its lack of big companies may seem a weakness right now, but in future it might prove an advantage again, providing flexibility to cope with change.

In the short term, though, there are good reasons for remaining gloomy about Italy. As in the rest of the euro zone, only more so, the country desperately needs structural reforms to liberalise markets, inject greater competition and shake up a bloated, inefficient and sometimes corrupt public sector. Currency devaluation to offset deteriorating competitiveness is no longer an option, and the vulnerability of small manufacturing firms to cheaper imports from Asia, especially China, has become painfully clear.

Faced with such huge structural problems, Mr Berlusconi's centre-right coalition government has done nothing like enough to put matters right. Unfortunately, even if the centre-left under Romano Prodi wins the election next April - which looks likely, but by no means certain - it too will find that reforms are hard to get past some of the more recalcitrant small parties in its coalition, to say nothing of Italy's entrenched special interests.

In some ways, things may need to get worse before they get better. Giuliano Amato, a canny centre-left politician who served as prime minister in the early 1990s and again in 2000-01, observes that "timing is an essential variable in economic matters." In his first term he was able to push through a ruthless budget, slashing spending and drastically reducing the deficit, because Italy's ejection from the European exchange-rate mechanism in September 1992 produced a consensus that tough measures were unavoidable. That budget laid the foundation for the measures introduced by Mr Prodi's 1996-98 government to ensure that Italy could join the euro from the start.

Mr Monti at Bocconi University offers a similar conclusion. He says that Italian governments can take tough decisions, but only if two conditions are met: there must be both a visible emergency and strong pressure from outside. In the 1990s, the emergency was the impact of the fiscal position on interest rates and the exchange rate; the outside pressure stemmed from the desire to get into the euro.

Now, says Mr Monti, such a moment of truth is lacking. Italy is suffering from slow growth and a steady deterioration of its competitiveness, but both started long before the Berlusconi government came to office. As for external pressure, the European Central Bank, the European Commission and the financial markets are all doing their best to apply some. But Italian enthusiasm for things European has cooled markedly, and membership of the euro has had the perverse effect of dissipating some of the market signals that might otherwise have forced change.

Italy needs to look to the example of other countries that have successfully introduced reforms, and not just Britain. A more telling case across the Mediterranean is Spain. Thirty years ago, the notion that Spain, as it emerged hesitantly from the Franco era, might set Italy an example would have seemed laughable. The Spanish economy is still far smaller than Italy's, and living standards are lower - but they are catching up. The Socialist government of Jose Luis Rodriguez Zapatero that came to power in March last year has kept up the momentum of economic reform inherited from its centre-right predecessor.

The gain in Spain

Spain's public finances are also a lot healthier than Italy's, which is one reason why it has been able to afford such impressive infrastructure investments as the high-speed railway to Seville or the burgeoning airport at Madrid (bigger than any in Italy). The biggest Spanish companies, such as its two largest banks and Telefonica, have built up a stronger global presence than their Italian counterparts.

The differences between the two countries are palpable even to the passing visitor. There is a buzz of optimism in Madrid and Barcelona that often seems lacking in Rome and Naples. When the Guggenheim Museum in New York was looking for a new foreign outpost a few years back, a natural choice would have been Venice, which already has a Peggy Guggenheim gallery. But it spent years dithering over the site, so the prize was snatched away by Bilbao in Spain's Basque country.

Italy is not about to be overtaken by Spain. But if it is to stay ahead for long, it needs bolder political leaders who are prepared to override opposition to reform even in the absence of an immediate crisis. At the end of "I Pagliacci", Leoncavallo's verismo opera about Sicily in the 1870s, Canio the clown, who has just stabbed his wife and her lover to death, concludes: "La commedia e finita." It is time for Italy, too, to get serious.

Article forms part of a survey of Italy. Author asks if Italy needs a crisis to get a serious reform process under way?