13 Dic The Italian Economy Through The Lens Of Productivity & TFP
Italian economy viewed through the lens of productivity and capital allocation
Italy, aka the “Sleeping Beauty”, is a country renowned worldwide for its millenarian history and numerous talents. The “Made in Italy” is one of the most recognized brand and it is today often referred to signature industries such as luxury, design, fashion, food & beverage and tourism. In the 70s and 80s, exploiting the Italian unique capabilities and related competitive advantage, Italy has been the top-performer in Western Europe, with GDP per capita growth rate steadily above the European average. However, since 1994 Italy has struggled to grow, stuck in a long-lasting recession that turned the country into a stagnating economy.
Brief history of Italian economy
In the 60s, Italy has experienced the so-called “Boom Economico” with fast improving life conditions and hectic economic activity. With one of the lowest cost of labour in Europe, Italy shaped itself as the European “factory” for industries such as household electrical appliances, textiles and furniture. Resulting strong demand for exportations stimulated industrialisation, which boosted the job market and the migration from the rural south to the urbanised north.
The 70s have been characterised by stronger union claims and improving work conditions, including salaries, for blue-collar workers. Seeking higher margins, due to increased costs, Italian entrepreneurs started producing higher quality products, leveraging the Italian attitude to design and style. 80s represented the golden age for Italy.
In the early 90s, Italy had symptoms of slowdown. With a more open market and rising external competition, Italian enterprises struggled to adapt themselves to a changing environment. The patriarchal governance and the limited size of Italian enterprises held back innovation and investments. The government was swallowed by corruption and instead of tackling issues, went for the easy road, increasing public spending to support the economy.
From 1995 to early 2000 three shocks happened that significantly changed the context (i) the consolidation of globalization, (ii) the ICT revolution and (iii) the introduction of the Euro (Bugamelli, Schivardi, et al., 2010). In a context of SMEs inadequately managed and of a Government unable to act with effective policies, it does not come to a surprise the economic slowdown.
The decrease of TFP: intrinsic characteristics and capital misallocation
The “Total Factor Productivity” represents the part of growth in an economy that cannot be explained through the change in labour quantity or capital accumulation.
For an economy, the aggregate TFP represents the weighted average of its firm’s TFPs. The growth of the aggregate TFP will therefore depend not only on the individual TFP growths, via technology, but also on the effectiveness of the resource allocation among the different industries. In perfect markets, assuming a decreasing marginal output, capital should move from lower TFP to higher TFP, accelerating the capital accumulation and therefore reducing marginal returns until the steady state. With non-perfect markets, frictions and distorted policies could generate a “misallocation” of capital, where capital flows into low FTP companies.
Figure 1. TFP and GDP growth. (Lusinyan and Muir, 2013)
The most basic hypothesis to explain the negative trend of Italian TFP, as presented by Luigi Zingales and Bruno Pellegrino (2014), is that Italy in the 60s and 70s specialised in sectors with slower productivity growth, generally in low-tech industries with limited potential impact by technology and innovation. The analysis, performed comparing the individual sectors’ GDP/hour-worked cross-country, showed that the main explanation for the poor performance was not the diverse capital allocations among industries but the underperformance of each individual sector compared to its relative European peer. Naturally, the inefficient sectorial specialization (misallocation) have negatively impacted the level of GDP/hour worked but it did that in the 80s as much as in the 90s, although FTP growth trend was different. Therefore other intrinsic factors entered into play in the 90s.
ICT is generally claimed to be one of the main drivers of productivity boost experienced in the US in the mid-90s. Italy is renowned for its late adoptions of technological change and this could explain a large part of TFP trend. Figure 2 (Hassan and Ottaviano, 2013) shows the share of ICT investment on total investment for Italy, France, and Germany, providing evidence of the lack of technological push in Italy.
Figure 2. Share of ICT investment in non-residential fixed capital formation. (Hassan and Ottaviano, 2013)
Data: OECD – Productivity database
Several reasons help explain the data, including the small size of Italian enterprises and their lack of resources for ICT investments, the prevalence of low-technology firms in the economic system and the strongly unionized market that limited firms’ ability to re-organise the workforce to adopt innovations.
As mentioned above, the Italian lag in the innovation factor resides also in the fragmentation of the economic system with the prevalence of SMEs unable to bear the risks and the high costs of R&D. Furthermore, the inefficient financial sector amplifies the issue, with scarce availability of equity resources, better designed to finance innovation than debt.
De Nardis (2014) analysed the productivity levels in Germany and Italy for different clusters of companies based on size. Figure 3 shows the differences in productivity of Italian enterprises compared to the German’s (base 100), evidencing the largest negative difference in the micro-segment (1-9 employees), which is the most prominent in Italy. As a result, the overall productivity gap between Germany and Italy is c.20%, but excluding the micro-segment it decreases to 10%.
Figure 3. Productivity gap by size. Cluster in # of employees. (De Nardis, 2014)
Corporate governance, labour market and government inefficiency
Other intrinsic factors negatively affecting TFP growth are:
- Inadequate corporate governance: family run businesses are often less effectively managed and tend to be less meritocratic in the management selection (Bloom, Sadun, et al., 2012) (Caselli, Gennaioli, 2013).
- Labour market regulation: Daveri and Parisi (2010) demonstrated that the 1997 Italian labor market reform, introducing temporary employment contracts, discouraged investments in technology substituting it for low cost temporary labor.
- Government inefficiency, heavy bureaucracy, corruption, difficulties in setting up/doing business disincentivize investments and new business ideas.
Globalisation the trigger
China has been a major issue for the Italian economy from the mid-90s. China has not been very different from Italy in the 60s, where, as mentioned previously, cost of labour was very low and exports were driving the economy. China’s cost advantage significantly affected both exports and internal demand for European low-tech manufacturing industries, but while in other countries this new competition forced incumbents to innovate, in Italy the factors described above did not allow that.
The second component to explain the TFP trend is the misallocation of capital, defined as the inefficient allocation of productive factors across firms. The explanation of the methodology presented by in quantifying the impact of misallocation is out of the scope of the paper, however results are key for the analysis.
The main takeaway in the analysis by Calligaris, Del Gatto et al. (2016) is that if misallocation had remained at the level of 1995, “in 2013 aggregate TFP would have been 18% higher than its actual level”. This demonstrates that from 1995 onwards, the misallocation has increased, with more capital flowing into low growth TFP.
This is further supported by the analysis of Bugamelli, Schivardi, et al. (2010) that shows the increase in investments in sectors with lower TFP growth compared to Germany between 1995 and 2006.
Figure 4. Investment growth and TFP. (Bugamelli, Schivardi, et al., 2010)