Business in Italy: In need of repair

Italian business is in deep trouble

WHEN it rains it pours. Not only do the latest figures show that Italy is in recession, GDP having fallen by 0.5% in the first three months of this year after a similar drop in the final quarter of 2004, but also the trade balance has gone into the red for the first time since the early 1990s. On May 17th, Domenico Siniscalco, the economy minister, said Italy would probably halve its current (already halved) forecast of 1.2% growth this year.

Italy's business model has stopped working and businessmen are utterly depressed about it. The latest sign of industry's sorry state is the heavier hand of the fractious governing coalition of Silvio Berlusconi. Last week Mr Berlusconi decided to replace Vittorio Mincato, boss of Eni, the world's sixth largest oil company and Italy's only truly successful big multinational, with Paolo Scaroni, the head of Enel, a big electricity firm. Fulvio Conti, Enel's chief financial officer, will replace Mr Scaroni. The state is the controlling shareholder of both firms.

Although he is now aged 69, there was little reason to oust Mr Mincato, who is famous for his ability to say no to politicians. Both he and Mr Scaroni have done well for their firms, and shareholders other than the government would have been happy for them to stay where they were. Mr Scaroni had unfinished work in restructuring Enel. Mr Mincato wanted to shepherd Eni's investment in Kazakhstan's Kashagan field in the Caspian Sea and to decide future international expansion.

So why the reshuffle? Mr Scaroni was keen to run Eni. The government apparently did not want to risk him leaving Italy for a top job abroad - where he has prospered before. And he is closer to political circles than Mr Mincato. But Mr Scaroni's appointment is unsettling for shareholders aware that the struggling government might be tempted to use state-controlled companies to advance its political goals.

This further dents Italy's business reputation, which has already been marred by a string of disasters. The gloom started to descend in June 2002 when the departure of Paolo Cantarella, boss of Fiat, exposed the depths of the crisis in the firm's car division. Then Cirio, a food processor, defaulted on its bonds. At the end of 2003 Parmalat, Europe's biggest dairy group, almost collapsed after a huge fraud.

The troubles of Italian business are not confined to big firms, of which there are few. Small firms are the backbone of the economy. As industries in other euro-zone countries consolidated, Italy defended small operators. “We are afraid of size,” says Alberto Nagel of Mediobanca, a powerful investment bank. Many are now struggling - not least because of China's low-cost operators in the basic industries that Italy has kept going longer than most European countries. They have no cash for expansion or investment in research and development. They are also stuck with the high costs of Italian labour. Italian wages used to be lower than in other European countries. Now Italian workers are amongst the best paid and most protected in the world. Adjusting for productivity, Italian wages exceed those in Germany. The OECD says that since 2000 Italian unit labour costs have risen by a remarkable 40% relative to Germany's.

Italian entrepreneurs moan about high taxes, high social costs and red tape. Italy's income- and corporate-tax rates are among the highest in the EU, although the overall tax take as a proportion of GDP is only middling because of Italians' inclination to evade the taxman. Moreover, the tax system is extraordinarily complicated. “We need radical reforms very quickly,” says Andrea Pininfarina, vice-president of Confindustria, the employers' association. Most important, he says, is a reduction of the social costs that employers must add to wages, lower corporate taxes and less tax on mergers between small companies.

To make life a bit easier for business, Mr Siniscalco has promised to cut IRAP, an unpopular regional tax on firms. But he can ill afford lower tax revenues. Italy's budget deficit is forecast to grow from 3% of GDP in 2004 to almost 4% this year.

Yet the worst structural problem is Italy's historic strength in low-growth, mature industries, such as textiles, clothing, shoes and white goods. Manufacturing still accounts for about one-quarter of the country's economy. While Britain, for example, has made the transition to services, Italy has held on to its manufacturing base.

The cure may be even tougher than it was for Britain and is for Germany. Job cuts will mean less demand and even more unemployment. According to analysts at ABN Amro, for Italy's existing firms to become competitive again up to 500,000 factory workers would need to lose their jobs - about 10% of the manufacturing workforce. That would lift the jobless rate from 8% to about 10%. When will Italian industry bite this bullet, if the unions allow it? According to Mr Berlusconi, Italy is not in recession, but going through a phase of “stagnation”. That suggests there will be no quick recovery.

Italian business is in deep trouble.