Italy: The real sick man of Europe

Italy's economy is stagnant, its businesses depressed - and its reforms moribund

IT WAS Tsar Nicholas I of Russia who reputedly coined the phrase, to describe the Ottoman empire. Since then, many other countries have been called “the sick man of Europe”. In the 1960s and 1970s, a strike-prone, slow-growing Britain was the favourite. In the 1990s the title passed to Germany. Now a new patient has emerged: Italy.

For a while, the country's ills have seemed merely part of those of the wider euro zone, whose poor performance has reflected the sluggishness of its three core economies, Germany, France and Italy, which account for 70% of euro-area GDP. All three suffer from Europe's familiar troubles of excessive labour- and product-market rigidities, too high public spending and taxes, and too much regulation. Yet last week's news that Italy fell back into recession in the first quarter of 2005, while France and Germany picked up, suggests that Italy has even graver problems than the bigger two.

Those problems are spread wide across the economy, business and politics. As this week's OECD report on Italy highlights again, the country's slow economic growth mainly reflects its structural failings. The miracle years of the 1950s and 1960s created an economy that depended heavily on small manufacturing firms, many of them concentrated in the north and in such specialist areas as textiles, furniture, machine-tools, food-processing and white goods. Such companies needed a low cost-base to sustain competitiveness; in times of inflation, this was secured by devaluations of the lira. That get-out is no longer available now that Italy is using the euro.

It also happens that these industries are the ones most vulnerable not just to competition from the rest of Europe, but increasingly from Asia, notably China. It is no surprise that Italy's textile firms are in the forefront of those demanding new protection from Brussels against Chinese exports. Makers of furniture and white goods are suffering similarly. And Italian companies are losing market share to Chinese rivals not just in Europe but in world markets too.

No wonder businessmen in Italy are feeling ever more pessimistic. Even as they struggle to cope with a somnolent economy, they can also point to a string of recent steps that have undermined their own confidence as well as that of foreign investors. Things began to go visibly wrong two years ago when trouble (still unresolved) erupted at Fiat, the country's flagship carmaker, and when Italy's retail banks arrogantly sold high-risk bonds to their customers as if they were safe. The bonds were issued by Argentina and by two Italian firms, Cirio and Parmalat. The country defaulted, while the two food groups went bust. The fraud that brought down Parmalat showed that Italy's system of corporate governance was rotten. The regulatory response, though quick at first, became sluggish once politicians thought a crisis had been averted. Although Parmalat has been rescued, prosecution of those who nearly destroyed it has been less than zealous.

Corporate governance continues to suffer big reverses, none bigger than the ousting last week by the government of Vittorio Mincato, boss of Eni, the world's sixth-largest oil-and-gas company. Not only was this talented and apolitical manager replaced by somebody who knows nothing of the industry (Paolo Scaroni, boss of Enel, Italy's electrical utility); but also that ignorance is now shared by Eni's entire board. The political nature of Mr Scaroni's appointment suggests that the government considers any company in which it holds a stake as essentially state-owned and therefore susceptible to political direction. This reverses a slow trend for such companies to become independent of the political graft and favours that once made Italy pay a big premium to borrow in international markets. Mr Scaroni now has a chance to prove that he can resist political interference, just as Mr Mincato did. But Eni's shareholders will be watching nervously to see how the company behaves under its new management. Similarly, foreign investors are waiting to see whether the extraordinary saga of two attempted takeovers of Italian banks by foreign ones ends happily (ie, the foreigners win) or in farce. At this point, the outcome remains hazy, but the Bank of Italy and Consob, Italy's stockmarket regulator, have so far displayed a disturbing mixture of protectionism and sloth.

Where is the government?

Italy's poor performance has not only damaged business; it has also undermined living standards. That is the main reason Italians are turning away from the centre-right coalition led by Silvio Berlusconi that has been in office since 2001. Although Mr Berlusconi got better news from local elections in Sicily this week, other recent elections have confirmed that his government is now deeply unpopular.

The Economist made no bones about its views of Mr Berlusconi in 2001: we argued that he was unfit to be prime minister of Italy. Our case focused on his long history of legal entanglements, plus the jarring conflicts of interest that he faced from being in charge of the government (and so, indirectly, its public television) while controlling almost all of Italy's private television stations. Yet even we conceded one hope: that the businessman-turned-politician might bring in the economic reforms Italy needed and get a grip on the public finances.

Four years on, the Berlusconi government has failed to do even this. Distracted by legal matters, dependent on his fractious coalition partners, Mr Berlusconi has delivered too few reforms (though his personal business interests have prospered). His cure for Italy's public finances has been mostly one-off measures such as tax amnesties; the budget deficit is now ballooning again. He has managed to cut taxes a little, but nothing like as much as he once promised. He has made some changes to pensions and social security, but in general his reform efforts have been too little, too late. And the really bad news is that, were Mr Berlusconi to lose the general election due next spring, the centre-left opposition, led by Romano Prodi, a former prime minister and ex-president of the European Commission, appears not to have any more dynamic economic policy or reforms to offer. Italy's new title could go unchallenged for quite a while.

Editorial says: Italy's economy is stagnant, its businesses depressed - and its reforms moribund.