25 January 2013

IMF: Assessing the macro-economic impact of structural reforms - The case of Italy

This analysis attempts to quantify the potential gains to the economy from a comprehensive package of structural reforms. IMF finds that these gains can be sizeable. While in most cases the reforms go in the right direction, their impact would depend on effective and timely implementation.

In some areas, especially in the labour market, reforms would benefit from further strengthening. The priorities should be to strengthen competition in the non-tradable sector and make the labour market more efficient and inclusive, supported by growth-friendly fiscal reforms.  

Italy needs comprehensive reforms to raise growth and restore competitiveness. To increase competition and productivity in product markets, there is a need to further open services sector, especially professional services, key network industries and local public services;  reduce entry barriers; and promote investment in productive infrastructure, thus lowering the costs of doing business. In the labour market, the focus should be on allowing firms and workers to more easily adjust to changing economic conditions. To achieve this, there is a need to reduce uncertainty and costs associated with employment protection, promote more internal flexibility and closer link between wages and productivity, and improve employability and efficiency of job matching process of the work force at the same time as also augmenting labour participation.

Italy‘s recent reforms go in the right direction of increasing the competition and flexibility in the economy but more needs to be done. IMF simulations suggest that the type of reforms that are currently in place in Italy could potentially raise real GDP by 5¾ per cent after 5 years and by 10½ per cent in the long run. 

In the labour market, the impact of the reforms that bring Italy close to the OECD best practices in employment protection legislation, active labour market policies, and female participation support through childcare services could be relatively modest. However, there is an important scope to strengthen the proposed reform further. More needs to be done to increase flexibility of the core via more firm-level arrangements that favour employment rather than wages and to bridge the gap between permanent and temporary workers. A tax reform to lower the labour tax wedge and remove disincentives for labour supply, especially for second earners, could be considered.

Growth-friendly fiscal reform, by shifting taxation from labour and corporate tax to indirect taxes and by prioritising public expenditure away from general transfers towards well-targeted productive infrastructure spending could lead to significant growth and competitiveness gains.

The main results largely depend on the extent to which the on-going reform efforts are successful in bringing Italy‘s economy closer to the peers in terms of its openness to  competition, business costs, flexibility and labour utilisation. Hence, the effective implementation of the reforms is key, but it can face a number of challenges such as stemming from the unfavourable macro-economic environment, reliance on sub-national governments, and pressures from on-going fiscal adjustment. Stepwise credible policies could  delay the potential gains from reforms, as IMF simulations suggest, emphasising also the need for a more predictable regulatory and legal environment.

To increase credibility and effectiveness of the reforms, consideration could be given to establishing an independent  review and advisory body for reforms which could foster consensus and focus policies on priority areas, while ensuring the continuity of the reform agenda. It would be important to effectively apply the competition enforcement framework, along with continuously monitoring, assessing and communicating on the reform progress. A strong buy-in from the  main implementing agents, especially the sub-national governments, would be essential. Other reforms that are essential for the success of labour and product market reforms, particularly the justice system reforms, would need to be implemented in parallel.

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