The European Commission forecasts that Italy’s gross domestic product (GDP) will grow by 1 per cent in 2024-25. Encouraging though this may seem, it hardly justifies much optimism in a longer-term perspective.
First, it reflects two large, one-off stimuli. In addition to massive public subsidies for home renovations, vast investments, funded by NextGenerationEU, are laid out in the country’s National Recovery and Resilience Plan (NRRP).
Secondly, the overall direction of economic policy is unconvincing. As with several previous governments, Giorgia Meloni’s administration appears to have resigned itself to the ineluctability of Italy’s decline, which began three decades ago, and seeks rather to secure privileges for special interests and its own electorate.
Roughly, the prevailing analyses of Italy’s singular decline belong to one of two schools of thought. A liberal one focuses mostly on the supply side, while a more interventionist strand mainly blames the weakness of aggregate demand.
Productivity obstacles
Inspired by the distinction made by Peter Hall and David Soskice between ‘liberal’ and ‘co-ordinated’ market economies, the first school—mainly associated with Bocconi University and authors such as Francesco Giavazzi and Luigi Zingales—holds that, to reverse Italy’s decline, market forces must be unleashed. In this view, Italy approximates a co-ordinated market economy. As in Germany and much of continental Europe, Italian firms rely on strategic co-ordination with their workers, shareholders, customers, banks and competitors. Yet they generally achieve significantly worse results.
In this reading, three main obstacles hinder productivity growth. First, doing business in Italy is hard. Access to credit is limited, especially for small and medium-sized enterprises. Taxation is high and complex, the judicial system is extraordinarily slow and high entry barriers stymie competition.
Secondly, the skills of Italian workers are inadequate. There are too few graduates in the 25-34 age group—fewer than in any other European Union economy, except Hungary and Romania. This is exacerbated by a ‘brain drain’ elsewhere.
Thirdly, and relatedly, too many Italian firms remain distant from the ‘technological frontier’. The share in GDP of low-productivity, low-innovation sectors, such as tourism, is larger than in other advanced economies. And investment in research and development is comparatively low: in 2022 gross investment in R&D in Italy was 1.33 per cent of GDP, well below the EU average of 2.24 per cent.
Strangled demand
The other school of thought, represented by scholars such as Lucio Baccaro and Jonas Pontusson, focuses more on aggregate demand. Depending on the relative importance of its components, including domestic demand and net exports, they identify different ‘growth models’. In their analysis, Italy’s growth model, based on a combination of internal consumption and exports, proved ineffective and led to prolonged stagnation.
A recent paper by Dario Guarascio, Francesco Zezza and Philipp Heimberger follows the same line. They identify three ‘original sins’: the development gap between the north and the south of the peninsula, the low productivity of small firms—which typically retain outdated management practices and seldom innovate—and the large share in GDP of labour-intensive sectors such as textiles and tourism.
Before the 1990s, this growth model relied on two compensatory mechanisms. There were frequent currency devaluations to increase international competitiveness. And a relatively interventionist industrial policy—often conducted through state-owned enterprises, active in strategic sectors such as banking, steel and telecommunications—sustained investment.
These mechanisms are however no longer available. Monetary union with the euro removed the former, making wage moderation the main policy tool to raise competitiveness. Meanwhile EU rules on ‘state aid’ and industrial policy, along with a vast privatisation programme in the late 1990s, severely constrained the second lever. Thus two fundamental components of aggregate demand—household consumption, financed by wages, and public investment—were strangled.
Tying funds to reforms
Although this sketch of the two schools of thought oversimplifies the academic debate, it sheds light on its political uses. Depending on their ideological inclination, Italian parties have selectively drawn from one or the other to formulate their strategies—with the centre-left calling for more public investment, the centre-right insisting on deregulation. Neither of these approaches has been coherently implemented, however, because the political will has been lacking or the ‘fiscal space’ deemed too limited.
Enter the Italian NRRP. By tying investment for post-pandemic recovery to adequate reforms, it appeared to have lifted both constraints, in a serious effort to reverse Italy’s decline. The plan mobilises €194.4 billion, close to 11 per cent of GDP, and lays out an ambitious reform programme covering most critical areas: public administration, the justice system, competition and business regulations.
Yet, the NRRP is no panacea. Its contribution to long-term growth largely depends on implementation of the planned reforms, which aim to change the behaviour of millions of firms, citizens and public officials. In the past, equally ambitious reforms fell short, precisely because they were not perceived as credible—primarily because in Italy rules are too often ignored.
Weak rule of law
Every indicator suggests that, compared with other advanced economies, the rule of law in Italy is woefully weak. For example, the gap between theoretical and actual revenue from value-added tax, accurately comparable across the EU, is between 7 and 9 per cent for France, Germany and Spain yet 21 per cent for Italy.
Mass illegality is not tackled but rather tends to be tolerated. This is not just informal practice but includes explicit amnesties for lawbreaking, mainly for tax evasion and illegal building—something unheard of in other advanced democracies.
Meloni’s government has already issued three amnesties, including one largely tailored to small entrepreneurs, professionals and the self-employed, who allegedly pay less than one euro in three of what they owe the public purse. Moreover, it gifted a flat-rate income tax to those same categories of taxpayers (2.6 million people), harming tax progressivity. And it has stalled on liberalisations and competition reform, protecting special interests as petty as taxi drivers and beach operators.
It is a government merely managing Italy’s decline and redistributing its effects. Its approach will undermine the investments and reforms of the NRRP—the only question is where the damage will fall.
Decisive cause
The comparative weakness of the rule of law, which encapsulates the shortcomings of Italy’s political and economic institutions, is a decisive cause of the country’s decline. Italy has been stagnating for decades, mainly because it effectively stopped innovating. And a persuasive literature, theoretical and empirical, suggests that the rule of law is critical precisely for innovation—the main engine of long-term growth, especially in advanced economies.
The details of this causal chain can be debated endlessly. Yet it seems undeniable that mass illegality, and official tolerance of it, depress growth by comparison with countries where laws are more credible.
Neither of the two schools of thought seems to share this analysis. Neither ignores the weakness of the rule of law, of course, but neither views it as decisive. Were they to incorporate the issue into their analyses, it could seep into public debate and raise the political cost of tolerance for widespread lawbreaking.
That would be a necessary first step to reverse Italy’s decline.
Enrico Borghetto and Igor Guardiancich acknowledge the financial contribution of the Research Projects of Significant National Interest (PRIN), funded by the NextGenerationEU REPLAN-EU Project (2022ABWLJA)
Andrea Lorenzo Capussela is the author of The Political Economy of Italy’s Decline, Declino Italia and State-Building in Kosovo. He is a visiting fellow at the London School of Economics and writes for Le Grand Continent, Domani and, occasionally, the Financial Times.
Enrico Borghetto is an associate professor in the Department of Political and Social Sciences and the 'Cesare Alfieri' School of Political Science, University of Florence. His research interests include legislative studies, policy agendas and European Union studies.
