For the first time, in the upcoming days, the Eurogroup and the European Council will take account of the Commission’s communication on flexibility when they are called to give opinions on the 2015 update to its stability and convergence program, which Italy had to submit to the Council and the European Commission in mid-April.
The Italian government is very interested in the application of new margins of flexibility that would allow for a less stringent fiscal policy. Prime Minister Matteo Renzi is already envisioning an expanded interpretation of flexibility, one including not only the already agreed-upon €10bn, but an additional €3bn. Overall, Italy’s fiscal position will be less aligned with the rules prescribing a sizable reduction in structural deficit and public debt. The mitigating factors that should justify more flexibility have their fundamental reasoning in creating the premises for higher economic growth. An accelerated increase in economic activity is per se a factor that allows for a reduction in the ratio of deficit and debt to GDP.
Ultimately, the premises for faster growth should be redirected to structural reforms and, in particular, to those leading to a higher level of Total Factor Productivity. Broadly speaking, TFP is what ultimately determines economic grwoth. It is generally defined as a function of within-firm and across-firm efficiency. The former is linked to investments in human capital, innovation, management quality, and technology. The latter relates to the efficiency of labour and capital reallocation. In the Italian case, there seems to be a clear relationship between low levels of TFP and the size of firms. Under this light, we question the character of Italy’s political economy and highlight a fundamental intervention that seems to be lacking: significant incentives for increasing the size of Italian firms.