Middle East

Fancy Draghi’s recovery seems to be at stake

Paola Subacchi / London

Italy’s scrambling to control the proliferation of Covid-19 infections has cracked a widespread coalition led by Prime Minister Mario Draghi, including mandating vaccinations for people over the age of 50. Next week, there will be an important challenge for 630 Italian parliamentarians, 321 senators and 58 regional representatives to elect a new president.
Despite the long history of scandals and tax evasion convictions, many names have been proposed, including former Prime Minister Silvio Berlusconi, who appears to be favored by the centre-right. Another strong candidate is Draghi himself, who has built a strong reputation as a very capable leader.
After 20 years of stagnation, Italy’s economic outlook is bright. After shrinking by nearly 9% in 2020, GDP grew by more than 6% in 2021. This is primarily due to the government’s expanded fiscal policy by the € 750 billion ($ 856 billion) Next Generation EU Reconstruction Fund.
Under the 2022 Budget Act, pandemic-related measures such as income support for households will be phased out. However, welfare regulations such as universal children’s allowance have been expanded, and the postponement of tax payment has been extended. Therefore, growth is likely to slow slightly this year, but is expected to remain strong at around 4.3%.
This especially helps consumer confidence to be at its highest level in 10 years. This partially reflects the strong growth of employment, which is stimulating household demand, even though most new employment is fixed-term contracts.
However, there are many risks on the horizon, especially with the proliferation of Covid-19 infections. On January 11th alone, approximately 220,000 new Covid-19 cases were reported. Inflation, which reached 4.2% in December 2021, is also a concern, and rising consumer prices could weaken confidence and curb spending.
To prevent GDP growth from returning to historic trends, Italian policy makers need to design a virtuous cycle of long-term growth and investment. Fortunately, they are off to a good start. The EU Recovery and Resilience Facility, the centerpiece of the next generation EU, will provide Italy with a € 68.9 billion grant and a € 122.6 billion loan for the entire duration of the plan.
Between now and 2026, these funds should support the creation of up to 240,000 new jobs and a 1.5 to 2.5 percent increase in Italy’s GDP, an additional 0.3 from the impact of facilities in other EU member states. You will get percentage points. Italy’s real GDP is expected to be about 3% higher in 2026 than it would have been without the next-generation EU.
But to take full advantage of this opportunity, Italian leaders need to implement a long list of reforms that have remained about the same for the past two decades. This means making the administration slimmer and more efficient, reducing bureaucratic bureaucratic formalism, and upgrading the tax system with clearer rules, fewer loopholes, and better enforcement. A fast-moving judiciary and a more equitable, geographically and demographically balanced labor market also need to be a top priority.
Such interventions will greatly help improve the Italian business environment. Of the G7 countries, only Japan does not attract foreign direct investment.
Strong and sustainable long-term growth is a priority for any economy. But for Italy, the order is almost existential. For starters, its population is aging rapidly: the country has the second highest age dependence in the world.
In addition, Italy has the second largest public debt burden in the European Union, accounting for about 160% of GDP. To alleviate this burden, which increased significantly in 2020 due to the combination of economic contraction and fiscal expansion, the government will eventually need to implement a primary budget surplus (excluding debt repayment costs).
Given that the 2021 budget deficit was 9.4% of GDP, this is not easy. The government hopes to reduce its budget deficit to 5.6% of GDP this year and its primary deficit to 1.2% of GDP by 2023. – And ultimately, the primary surplus – depends heavily on higher tax revenues from stronger economic growth.
If the government implements national reconstruction and resilience programs, including relevant economic reforms, it will need to continue to inspire self-confidence. And it requires political stability.
The stability that currently exists can be primarily due to Draghi. He took office early last year to break the protracted political impasse. And it was under his leadership that a broad coalition drafted a national reconstruction plan, applied for funding, and began implementing it.
However, Draghi can only serve as prime minister until the general election in March 2023. In short, Draghi has about a year to lay the foundation for many reconstruction planning projects. In addition, Draghi’s broad coalition may not be effective or even unharmed after the upcoming presidential election.
Whatever the outcome of the presidential election, can Draghi create a more compact coalition that can carry out national reconstruction plans? Will Europe continue to consider Italy a credible partner if Berlusconi becomes president, or if an early election creates a Eurosceptic national government? Can Italy prevent a new political and ultimately economic crisis?
These are some of the scenarios that Italy and Europe may currently be facing. Some have a low probability, but the chances of it happening are not zero. The next-generation EU has given Italy the opportunity to reset its once-in-a-generation economy. But the country’s still sparse political situation is not clear if the government can manage to seize it.
— Project Syndicate

• The writer is a professor of international economics at the Queen Mary Global Policy Institute at the University of London and, most recently, the author of The Cost of Free Money.

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