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Getting Italy's 'Demolition Man' Going Again

When Prime Minister Matteo Renzi took office in February 2014, he pledged to shake up Italy with reforms that would bring its moribund economy back to life. For that he was nicknamed “il rottamatore” (“demolition man”).

Today, Italy is back in the black, with a modest 0.5% second-quarter GDP growth. Yet the recovery is still too timid to shake off three years of stagnation, and the initial enthusiasm for Mr. Renzi among the Italian public has faded. Has the demolition man failed?

Over the past 18 months, the Renzi government introduced a reform package aimed at modernizing the country. Italy’s inefficient public administration became leaner, through the centralization of local authorities. Simpler contracts made it easier to hire and fire workers and reduced the role of national-level labor negotiations that for decades have given unions disproportionate influence in wage-setting. Banks saw major reforms too, which should encourage consolidation. Privatizations continue, including a recently announced initial public offering of 40% of Poste Italiane, scheduled for October.

Results so far have been mixed. Unemployment has climbed to 12.7% from 12.4% at the start of the year. This has put the government under fire for its labor reforms, but these are not to blame. If anything, they have been too slow to make an impact. The reforms apply only to new contracts—phasing in the new framework will likely take decades.

Meanwhile, competitiveness has improved slightly. Italy climbed 15 positions in the World Bank’s ease of doing business ranking for “starting a business” but lost ground overall, down to 56th from 54th out of 189 countries. It is ranked 141st for its tax burden and at 147th for enforcing contracts. Despite the recent streamlining, Italy’s public administration remains a drag on competitiveness, according to the International Monetary Fund. A new law approved this month links public managers’ compensation to performance. Still, despite a rally in stocks and bonds, investment in Italy’s real economy fell by around 35% since the crisis, according to Eurostat, and failed to recover since.

Banking reform promises better results. Italian banks cut €108 billion ($119.4 billion) of corporate funding since the crisis. With €350 billion, or 17% of GDP, of bad loans still on their balance sheets, they are hardly able to lend. They still generate weak profits while costs remain high, with more branches per capita than pharmacies or restaurants, according to the Organization for Economic Cooperation and Development. Reform will push midtier banks to become joint-stock companies and should improve their efficiency.

Privatizations will have a positive effect on various industrial sectors, but will still leave the state as the largest owner of public firms. It is yet to be seen whether their management style changes to a merit-based system from the current one, where management is hand-picked by the government in power.

Finally, a reform to Italy’s justice system is still in its early stages. Italian justice remains the slowest across developed economies, together with Greece and Slovenia, requiring an average of eight years for a case to reach trial.

To fulfil its reform mandate, the Renzi government faces two major obstacles. The first is political. Mr. Renzi remains an unelected leader who succeeded former Prime Minister Enrico Letta after an internal battle within the center-left Democratic Party.

Since then, Mr. Renzi has been working to simplify Italy’s complex electoral system, which in the past often generated hung Parliaments. But the reform isn’t complete and, until new elections are held (2018 at the latest), his party enjoys a full majority only in the lower house. Mr. Renzi has won favor so far by cutting payroll taxes by €80 a month, and recently announced a €45 billion three-year stimulus plan. Eventually, however, he will have to face the vote.

The second, more substantial obstacle is a growing social crisis. Some 44% of Italians below the age of 25 are unemployed, up from 41% in 2014 and not far from Greece’s youth-unemployment rate of nearly 52%. The situation is worse in the country’s south, which continues to drift behind Italy’s rich north. Per-capita GDP in the south has fallen to 53.7% of that of Italians in the north, the lowest ratio in 15 years.

Adding to the north-south divide has been the increase in migration: the International Organization for Migration recorded 98,369 migrants having landed on Italy’s southern shores in the first half of this year, equal to half the total in Europe.

Rising unemployment and immigration have proven fertile ground for anti-euro, anti-immigration parties, including the Northern League, whose leader Matteo Salvini now ranks second to Mr. Renzi in opinion polls.

Italy needs deeper reform to get back on track.

The current plans are essential, and have won approval in financial markets. But the real economy will recover only with bolder steps tackling the core of Italy’s problems—including the justice system. The challenge is daunting, yet Mr Renzi and his team are up to it. Now it’s time to take off the white gloves.

This article was originally published by The Wall Street Journal on August 26, 2015.

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