On Italy's Economic Reforms

An Interview with Filippo Taddei

Filippo Taddei Facebook
On Italy's Economic Reforms : An Interview with Filippo Taddei - The Editorial Staff


Filippo Taddei is an Assistant Professor of Economics at SAIS’ Bologna Center, where he teaches macroeconomics and monetary theory. He also serves as a chief economic advisor to the Partito Democratico (PD), which heads Italy’s current coalition government under Prime Minister Matteo Renzi. Prof. Taddei holds degrees in economics from the University of Bologna and Columbia University, where he earned a PhD in 2005. We asked him about Renzi’s plans for Italy and his transition from academic to political advisor.

Question 1

Can you outline the economic plan that Italian Prime Minister Matteo Renzi announced after taking office in March?

The plan is a story about change, flexibility, and responsibility. Italy has seen the slowest growth rate among all OECD countries over the last two decades. The issue with this fact is that Italy has not always been a country of minimal growth. This is a country that has grown a lot and changed dramatically since WWII. From the end of the 1990s and into the 2000s, the country began to slide into slow growth. And from 2000 to 2013, it has had one of the slowest rates of growth among advanced economies in the world. 

So, our challenge is how to change this. Our proposal is to do so by providing the flexibility that was not there during the years of stagnant or minimal growth. This means taking advantage of the high primary surpluses the country has experienced in the past eight years. Despite these primary surpluses, Italy does maintain a high level of public debt due to previous government spending coupled with a decrease in tax revenues. One of the issues with Italy's tax revenue is the fact that the country has one of the highest labor income tax rates in Europe. To address this, we provided the largest fiscal stimulus and tax cut on labor income of the last 20 years, a cut that amounts to nearly 0.7% of GDP on a permanent basis. We believe this will correct our tax system, and specifically the tax burden on labor, and that it will push people toward employment. As the Italian constitution states, Italy is a country founded on labor. We believe that this tax cut will encourage people to seek greater employment opportunities and bring the country back into alignment with the principles of its constitution.

By realigning Italy’s tax policies with its fundamental values, we can change the direction of the country. We believe this will result in greater cooperation at the European level, specifically recognition for our commitment to economically responsible policies. Cutting government spending is, however, a challenge that takes time. We expect cooperation and flexibility from Europe.

Question 2

How do reforms of Italy’s labor markets, such as making it easier for businesses to hire and fire employees, fit into PM Renzi’s plans for reform? 

There is certainly some improvement in that direction, but I wouldn't characterize it as a large part of the overall plan. There are some rules and regulations currently in effect that may be attractive conceptually, but don't make much sense in practice. For example, if you are hired on a temporary basis on a fixed-term contract in Italy for less than 12 months, the employer is not required to report a specific reason for hiring you. However, if a business wants to hire someone for longer than 12 months, they must provide a specific reason or a specific task that they are hiring the employee to carry out. There are constraints on the type of tasks one can be assigned, and so the employer is required to prove that the task is truly a temporary assignment. In practice, this situation is virtually impossible to verify, so it creates controversy in the judicial system and distortions in the economy.

We want to provide the people of this country and foreign investors with a guarantee that the climate and culture is changing on a permanent basis. The largest ingredient in that change is the shift from the current government structure to a smarter government and the subsequent reduction in the labor income tax. That is the centerpiece. The Italian labor market is relatively flexible. The problem is the uncertainty that comes with a lack of concrete boundaries. This is self-defeating for both entrepreneurs and for the labor force.

Question 3

Though many in Italian politics agree on the necessity of reducing taxes, there is disagreement about whether it is more productive to reduce taxes on labor or taxes on firms. Which is the priority of the Renzi plan?

We believe that the priority is to cut taxes on labor. We would like to establish a clear identity for this country, one that is based on clear values, particularly the belief that if you work hard, you will be rewarded. We believe that such a policy is designed to support for the middle class in this country. Whenever I meet entrepreneurs from the most dynamic sectors, they never complain about the cost of labor. It is a second order problem. They care more about the cost of credit and the speed of bureaucracy. By cutting labor income tax on a permanent basis, and by slashing government spending in a way that reduces bureaucracy, we can address these problems.

Rules and regulations are endogenous to government spending. Labor income taxation, government spending, and bureaucracy are all connected. Without changing the structure of government spending, everything grows back, particularly the bureaucracy.

Question 4

What effect do you anticipate these policies will have on growth? Won’t the reduction in government spending and bureaucratic employment reduce growth?

We are not cutting the bureaucracy at the expense of someone's job. The number of public employees in Italy is actually low in comparison to other advanced economies. We are not going to put anybody out on the street.

We are trying to shift the mentality of this country from one that does not grow and is waiting for the storm to pass to a country that takes charge of its economy. By empowering the people of the country, we have reason to believe that the country will return to the dynamic nature it had prior to the 1990s.

Question 5

Some European leaders have reacted positively to Renzi’s proposals, but some have expressed concern that these programs might require Italy to go beyond EU regulations that prohibit budget deficits larger than 3% of GDP. How do you see the interaction between Renzi’s proposals and Italy’s deficit reduction goals?

We are optimistic that we will not go beyond the 3% boundary. The projected deficit for Italy in 2014 is 2.6%. We have room to go to the 3% threshold, but that room is conditioned on reaching a different agreement from the one we had in the past with Europe. To do so, we would need to renegotiate our agreement with Europe. But that is a measure of last resort.

We see three sources for the funding of these tax cuts. First, if interest payments stay subdued, Italy should save between €2 and 3 billion in interest payments if our interest rates remain within 180 basis points of Germany. Second, we are providing stimulus to the economy, which should have positive growth effects. Third, we are signing a very important voluntary disclosure agreement regarding tax evasion. In the past, people evaded taxes and maintained offshore accounts in various fiscal havens. With this agreement, we are giving people the opportunity to receive amnesty for their past crimes if they pay all the taxes that they owe, plus a connected penalty. The projected revenue from this program, as estimated by the previous government, is €8 billion. Even if that figure is too optimistic, we still expect the deficit to be below the 3% mandate.

Question 6

Given that many of these changes involve challenging entrenched interests in the Italian political system, do you believe that the Renzi government has the political capital needed to carry out these reforms?

This is a coalition government and the PD is the main shareholder with an important contribution from parties of the center-right, which is an essential ingredient. Without their support, there is no majority in both houses.

In reality, coalition governments are far more effective in pushing through reforms that are controversial because you can blame the opposing party. If a politically homogenous government attempted to push through these reforms, everyone will blame you for attacking the interest group that did not vote for you. In a coalition government, they cannot do that, because there are both center-left and center-right parties in the coalition. This political heterogeneity, which may seem to be a weak point, is actually a source of strength. 

Question 7

The schedule that the government has laid out for these reforms is very ambitious. Are you concerned about being able to stick to the timetable?

No, I am not concerned. We are committed to achieving our plan. It is only fair to be evaluated on the ambition of our commitment and our ability to fulfill them.

Question 8

The US and Europe have taken very different approaches to the recessions following the financial crisis in 2008. Whereas the US initially used Keynesian stimulus, Europe has relied on austerity. In your opinion, how can we judge the merits of these policies six years later?

Unfortunately for Europe, the US has been far more effective in their efforts to combat the crisis. In the US, both the monetary reaction and the fiscal stimulus were quite timely. The historical trauma of the Great Depression in the US has played a significant role in shaping their quick response.

Europe, on the other hand, had a very hard time dealing with the heterogeneity of its member states. 2009 was a dramatic year for everyone in Europe, with many countries contracting. After 2009, the paths seemed to diverge among European countries. The euro zone faced a dilemma, as different countries began to recover more quickly than others. Germany, with its history of fiscal prudence, recovered quickly. Italy did the least fiscal stimulus of all Eurozone countries. France greatly expanded spending, and if you ask me now, I think the next fiscal crisis in Europe is not coming from Italy, but from France. France is on an unmanageable path of government spending right now.

The problem in Europe was the pursuit of a unified policy. I don't believe that a single policy that is very cautious, with divergent fiscal policies, will work. It is a mess. We had to wait until 2011 and the famous "whatever it takes" speech by the President of the European Central Bank, Mario Draghi, in which he guaranteed that he would do everything in his power to ensure the survival of the Eurozone. This was the turning point for Europe in its efforts to combat the crisis. Moving forward, Italy must change the structure of the country so we can start over and return to a period of growth.

Question 9

What has it been like to transition from being an academic economist to being a political policy advisor, where optimal economic policies have to be weighed against political considerations?

One of the advantages of my position is that I can bring a fresh view as well as a bit of ingenuity. You learn very quickly that the typical response of politicians is "yes, but…" And after the "but" usually comes a lot of strings, but the strings are seldom substantial. They are very procedural.

For example, the typical response is "yes, but it would take too long to change the law" or "yes, but it would be hard to place it on the parliamentary calendar." I have realized that if you have been in the game long enough, and you learn the "political rules,” you can find a creative way around them in order to get things done. Renzi has a strong will to get things done.