Farewell, Dolce Vita?

Italy is in deep trouble. Or is it? With the fall of the Prodi government, Italian politics has reverted to its usual postwar mess. In economic terms, the land of la dolce vita seems to have turned into the "sick man of Europe," falling behind in GDP growth, while the French economy is holding steady and the German export machine is powering ahead. A few smart money managers around the world are betting a collapse in exports caused by excessive wage costs will force Italy to leave the straitjacket of the euro currency within three years and reintroduce its old devaluation-prone lira instead. But this bet against Italy looks set to go wrong.

Rotting garbage in the streets of Naples has shown the world how Italy's public sector fails its citizens. There are other examples. For instance, Italy's official economic statistics are a mess. The Italian data show that the country's economy expanded by an average of 0.9 percent in the last seven years, far behind the 2.1 percent for the rest of Western Europe. Even worse, in the age of rampant globalization, Italy barely managed to raise its export volumes at all, while its Western European peers boosted foreign sales by a total of 40 percent. However, the standard data also show Italy increasing its payrolls by an astonishing 1.2 percent per year since 2001, ahead of the 1.0 percent gain elsewhere in Western Europe. A job miracle in an almost stagnant economy that is losing global market share at an alarming rate? The Italian statistics defy belief.

Both sets of data are probably wrong. A key reason for the surging job count is that changes in labor regulations have brought many workers in the shadow economy into the open.

How to explain the Italian data showing near-stagnant real exports? There are two ways to measure exports, by adding up the total value and by counting the number of units. In terms of value, Italy has seen exports grow by an annual average of 4.4 percent in the last seven years, outpacing the 2.2 percent gain for France and just behind the 4.7 percent average which the European Statistical Office recorded for Western Europe as a whole. The Italian statisticians would have us believe that the volume of Italian exports (that is the value of exports adjusted for the rise in export prices ) increased barely at all, while French exports rose a satisfactory 2.1 percent per year.

Once you look hard at the data, the solution seems obvious. Under the onslaught of fierce competition, not least from China and South Korea, Italian producers have moved upmarket fast. While they may not be selling more cars, skirts and handbags than before, the quality of what they sell—and thus the prices their goods can fetch on the world market—has improved dramatically. Italian statisticians seem to misrecord these quality gains as a higher price per handbag, car, or skirt, rather than a genuine increase in value added. The issue may sound technical, but it is crucial. Taken at face value, the official statistics suggest that Italian companies are trying to peddle—say—the same old shirts for much higher prices than before and are thus floundering on the world market. The truth seems to be that Italy's private sector is now successfully selling top-quality fashion to enthusiastic consumers around the world, and can command the better prices that go with its quality brands.

Looked at properly, Italian export data would put the country's performance in a much better light. Italian GDP growth is probably understated by 0.1 to 0.2 percentage points each year.

Of course, Italy has severe problems. The public sector is in need of root-and-branch reforms. Italy's open economy is highly exposed to the global downturn. Consumers—shocked by a steep rise in oil and food prices—have shunned the shops in the last few months. But once again, Italy looks more likely to muddle through than to go down the drain.

Those who depict the demise of the European monetary union often overlook one major fact: The currency union has survived one of the sternest tests possible, a wrenching five-year adjustment crisis in Germany, the biggest and most euro-skeptical member. Having lost its competitiveness in the aftermath of unification, Germany was forced to turn itself around early this decade by painful cuts in wage costs and government benefits. Despite the German misery, and despite the strains caused by the gap between near-stagnation in Germany and fast growth in many other parts of the eurozone, the monetary union was never seriously at risk. In early 2006, the euro emerged with flying colors from this test, ultimately propelling the currency to a record high of $1.50 in late 2007. The eurozone will also master the current challenges without ejecting any of its major members.

Italy is the land of the great opera, where grandiose words come naturally. But outside the great arenas, the deeds are often less daring. Of course, some politicians may occasionally reminisce fondly about a largely imaginary sweet life under a soft lira. But a serious political initiative to commit fiscal suicide by returning from low euro interest rates to the cripplingly high lira rates of yore does not look very likely. And that is putting it mildly.

Schmieding is chief European economist at Bank of America.

© 2008