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Italy's Draghi recovery at risk

Jan 23,2022 - Last updated at Jan 23,2022

LONDON  —  As Italy scrambles to control surging COVID-19 infections, including by making vaccination compulsory for anyone over 50, cracks are appearing in the broad ruling coalition led by Prime Minister Mario Draghi. A crucial test will come next week, when Italy’s 630 members of parliament, 321 senators and 58 regional representatives elect a new president.

Many names have been put forward, including former Prime Minister Silvio Berlusconi, who appears to have the backing of the centre-right bloc, despite a long history of scandals and a tax-fraud conviction. Another leading contender is Draghi himself, who has built a strong reputation as a highly capable leader.

Following two decades of stagnation, Italy’s economic outlook is bright. After shrinking by nearly 9 per cent in 2020, GDP grew by more than 6 per cent in 2021, largely owing to the government’s expansionary fiscal policy, funded by the 750 billion euros Next Generation EU recovery fund.

Under the 2022 budget law, pandemic-related measures, such as income support to households, will be phased out. But welfare provisions, such as universal child allowance, will be expanded, and tax-payment deferrals have been extended. So, while growth will most likely slow slightly this year, it is expected to remain robust, at about 4.3 per cent.

It helps that consumer confidence, in particular, is at its highest level in a decade. This partly reflects strong employment growth, which has fuelled household demand, even though most new jobs are on fixed-term contracts.

But there are plenty of risks on the horizon, not least the surge in COVID-19 infections. On January 11 alone, about 220,000 new COVID-19 cases were reported. Inflation, which reached 4.2 per cent in December 2021, is also a concern, with rising consumer prices threatening to dampen confidence and constrain spending.

To prevent GDP growth from reverting to its historical trend, Italian policymakers will need to engineer a virtuous circle of long-term growth and investment. Fortunately, they have a head start: the EU Recovery and Resilience Facility, the centerpiece of Next Generation EU, is deliver to Italy 68.9 billion euros in grants and 122.6 billion euros in loans over the plan’s lifetime.

Between now and 2026, these funds should support the creation of up to 240,000 new jobs and a 1.5-2.5 per cent increase in Italy’s GDP, with another 0.3 percentage points coming from the facility’s impact in other EU member states. Italy’s real GDP is expected to be about 3 per cent higher in 2026 than it would have been without Next Generation EU.

But, to make the most of this opportunity, Italy’s leaders will have to implement a long list of reforms that has remained largely the same for the last 20 years. That means making the public administration leaner and more efficient, reducing bureaucratic red tape, and upgrading the tax system with clearer rules, fewer loopholes and better enforcement. A faster-moving judiciary and a fairer, more geographically and demographically skill-balanced labour market should also be top priorities.

Such interventions would go a long way toward improving Italy’s business environment. Among G-7 countries, only Japan attracts less foreign direct investment.

Robust and sustainable long-term growth is a priority for any economy. But, for Italy, the imperative is almost existential. For starters, its population is aging rapidly: the country has the world’s second-highest old-age dependency ratio.

In addition, Italy has the second-largest public-debt burden in the European Union, at about 160 per cent of GDP. To reduce this burden, which increased significantly in 2020, owing to the combination of economic contraction and fiscal expansion, the government will ultimately need to run primary budget surpluses, which exclude debt-servicing costs.

This will be no easy feat, given that the budget deficit stood at 9.4 per cent of GDP in 2021. The government hopes to reduce it to 5.6 per cent of GDP this year, with the primary deficit dropping to 1.2 per cent of GDP by 2023. Achieving this, and, ultimately, a primary surplus, will depend significantly on higher tax revenues through stronger economic growth.

If the government is to implement the national Recovery and Resilience Plan, including the relevant economic reforms, it will need to continue to inspire confidence. And that requires political stability.

What stability currently exists can be attributed largely to Draghi. He was sworn in as prime minister early last year precisely to break a protracted political. And it was under his leadership that a broad coalition drafted the national recovery plan, applied for funding, and initiated its implementation.

But Draghi can remain prime minister only until the general election in March 2023, meaning that he has about a year to lay the foundations for many recovery-plan projects. Moreover, Draghi’s broad governing coalition may not remain effective, or even intact, after the coming presidential election.

Whatever the outcome of the presidential election, will Draghi be able to create a more compact coalition, capable of implementing the national recovery plan? Would Europe continue to view Italy as a reliable partner if Berlusconi became president, or if early elections produced a Euroskeptic nationalist government? Can Italy forestall a new political, and, ultimately, economic, crisis?

These are some of the possible scenarios now confronting Italy and Europe. Some are low-probability, but the chance of them materialising is not zero. Next Generation EU has afforded Italy a once-in-a-generation opportunity to reset its economy. But the country’s still-tenuous political situation makes it far from clear that the government will manage to seize it.


Paola Subacchi, professor of International Economics at the University of London’s Queen Mary Global Policy Institute, is the author, most recently, of “The Cost of Free Money” (Yale University Press, 2020). Copyright: Project Syndicate, 2022.

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