Italy is one of the most fascinating economies in the world because it is facing most if not all the major economic challenges that other countries around the world are experiencing, but it is somehow dealing with them all at the same time. Italy has some of the highest levels of national debt in the world, it has an aging population, an exodus of what few young skilled workers it still has, it's also dealing with regional inequality, sluggish growth, unreliable tax revenues and it's once world-leading industries have been out-competed across the globe. Italy also serves as an amazing case study as a country that has dealt with problems like globalisation, French shoring and restricted trade which is causing a lot of concern between countries such as the USA, Russia, China, the Gulf states and of course Europe itself. A lot of these unknowns are something that Italy has been dealing with for at least the past two decades and that's part of the reason why the country has been an economy in decline for 15 years now. Which sounds bad, but it's strangely something that on one hand the economy is taking in its stride and on the other hand has made it home to some of the highest rates of poverty in the European Union, a collection of countries that people normally associate with relative wealth at least compared to most of the world. Even if the similarities are not perfect, there is still a lot that economists can learn from these challenges. Beyond just being a great insight into what the future of our own economies may look like, Italy just has some truly fascinating economic features that are worth exploring individually even if for no other reason than they're just really interesting. Italy together with Germany and France makes up over half of the total economic output of the European Union, a union which collectively forms the second-largest operating economy in the world. Despite this already quite impressive scale, Italy's economy might really be much bigger than its government would like to admit. In recent years the black market has been responsible for as much as a quarter of Italy's total economic output, and while the logical assumption here would be to think about the godfather, the reality is even stranger and more interesting. So to understand all that Italy's economy can teach us, we must as always answer a few simple questions. How did one of the fastest-growing advanced economies in the world just stop growing almost instantly? Not once, not twice, but three times? What has the country done right and wrong when dealing with its long list of challenges? Who was really to blame for the country's economic stagnation? How has Italy been impacted by a unique form of destructive inequality? And finally, is the country's economic model just incompatible with the new global environment it finds itself in? Italy has had its fair share of economic scandals in the last few years, but you might not know what's actually going on if you only read a few news sources or rely on social media algorithms to tell you what's going on. That's why I always use our sponsor, Grand News, because it gives me an easy, data-driven, objective way to read the news. On Grand News, every story comes with a quick visual breakdown of political bias, factuality, and the ownership of sources reporting, all backed by ratings from three independent news monitoring organizations. For example, this recent story on Italy's plan to seize $835 million from Airbnb was covered by over 50 news outlets. 30% of these outlets lean left, while 25% lean right. And I've been using their new comparison feature to see specific differences in left and right reporting. For this story, left-leaning outlets highlighted the broader inquiry into multinational corporations, while right-leaning outlets focused on Airbnb's claim of full law compliance. If one side of the political spectrum is ignoring a story, the blind spot feed will let you know so you can make up your own mind about how reliable the reporting is. Right now, Grand News is having their biggest sale of the year. You can use my link, ground.news.explained, to get 40% off their Vantage subscription, which gives you unlimited access for just $5 a month. So sign up today and support an independent news platform working to make the media landscape more transparent. Italy as an economy peaked in 2008. Since then, it's been mostly stagnant, with an overall slow decline losing about 20% of its nominal economic output over the past decade. Looking further back in history reveals, however, that this is not really anything new for Italy, and its economy today is the continuation of a trend that has been repeating itself in the country since the end of the second world war. The country has had decades of rapid growth, broken up by decades of almost complete stagnation, and in many cases negative growth, before it gets right back to growing again. Economic output is just one measurement of the health of an economy, but even a chart as basic as this tells us a really interesting story about how Italy got into the situation it finds itself in today. Italy was historically the most powerful industrial economy in all of Europe before it was overtaken by the Netherlands and England as they became global colonial powers. Even after that, and despite industrializing slower than other major European powers like France and Germany, Italy in its various forms has remained within the top 5 European economies for effectively thousands of years. Its strong geography, protected by mountains in the north, but with easy access to the Mediterranean for fishing and trade in every other direction, has meant it naturally became a great place for civilizations to flourish. And that's as true for its economy today as it was in 500 BC. The economy of Italy as it exists today really got started during the aftermath of the second world war. The country was rebuilt, in many cases from the literal rubble, as wartime industries were converted back into domestic industries with assistance from and under the watchful eye of the USA. The USA through the Marshall plan was investing billions of dollars into the reconstruction of western Europe, and this was back in the 1950s when billions of dollars actually mattered to government budgets. The motivation for this spending was partially to build out a new customer base that could buy all of the goods that the US industrial sector could produce, but it was mostly to redevelop strong dependent allies to stop the spread of communism from the Soviet Union. The USA also carried out similar rebuilding efforts in Korea and Japan to stop the spread of communist influence coming from the People's Republic of China. It wasn't starting from a great position, but these rebuilding efforts did lead to a long, sustained period of growth. However, under the surface there were still political tensions causing a range of very serious domestic issues like the 1980 bombing of the Bologna railway station, which still to this day remains one of the deadliest attacks ever carried out in Europe. These political tensions were in many ways the cause of, and were simultaneously accelerated by, other economic problems in the country. Just by economic output figures, it looked like Italy was doing very well, but it's relatively easy to grow an economy by just taking on a lot of debt to fund major development projects, especially when the major power in the world was more than willing to loan money to stop the spread of communism. The challenge is taking that development and using it to sustainably produce value for the domestic economy and export markets, which Italy was struggling to do. Once construction and rebuilding efforts had slowed down, or couldn't get any further funding, Italy's economy fell into its first modern decade of stagnation, although this first one really only lasted about 6 years. During this time, the Italian government simultaneously had to deal with mass unemployment, a large debt burden, high inflation, and external challenges like rising energy costs for the fossil fuels its young industries had become heavily dependent on. Now, despite not being good things to live through, economic slowdowns do serve as a good opportunity for a country to change policies and cut down on industries that caused the problems in the first place. During this first stagnation, that's exactly what happened. The country restructured away from just building infrastructure, and turned its attention more towards using that infrastructure to create things that it could sell all around the world. It also enacted reforms like giving independence to its central bank, which was then allowed to raise interest rates to fight off inflation. At the same time, the laws around index wages were relaxed. Wage indexation is not very common today, mainly because of the market problems it causes, but it's a rule that means that wages keep up with inflation no matter what, even if it's not what was agreed to in an employment contract. On the surface, this sounds fair. If inflation is high, it's perhaps not right that workers effectively get paid less because they agreed to a salary, when that same amount of money could buy a lot more. The problem, though, is that automatic wage indexation accelerates one of the most dangerous processes in economics, a wage price spiral. If inflation is high, workers will demand higher wages to keep up with the rising cost of goods and services that they need to buy. If businesses agree to pay these higher wages, they will have to increase their prices to maintain profitability, and higher prices cause more inflation all over again. The one thing that saves a lot of economies from this is the lag between inflation happening and people demanding higher wages. If inflation is low, there are a lot of people that won't even know that their wages aren't keeping up, which is terrible for them, but does act as a moderating force in the economy. If wages are automatically kept up with inflation, like they were in Italy at this time, then it just makes this process known as the wage price spiral much faster and much harder to correct. The stagnation was undoubtedly painful for Italy, but by forcing some necessary changes it came back as one of the fastest-growing economies not only in the world, but in history. In just 7 years between 1985 and 1992, Italy tripled its economic output in an export-led industrial boom. The country has a major advantage in this regard that's hard to tell from looking at economic figures alone. International customers pay a premium for Italian-made goods because the country had and still has a strong reputation for high-quality craftsmanship and skill in producing everything from fast cars to luxury handbags and even things like olive oil. If an exported good has a made in Italy logo on it, the price of that good can be higher than a competitor good from most other countries in the world and a lot of consumers would still be willing to pay a premium for it. Some countries have to go to extreme measures to undercut a long list of international rivals at every possible opportunity to supply the cheapest, and therefore most competitive goods to the global market. The fact that Italy can add as much value, if not more, by simply producing stuff within its borders is a huge advantage that is only really enjoyed by a handful of other countries around the world. These good times, unfortunately, didn't last forever because the rapid period of growth yet again led to underlying problems in the Italian economy. Debt started to creep back up again as both the government and its people began to borrow irresponsibly to bet on even more future growth. The country also had problems with tax avoidance. The small industries that formed the backbone of the Italian export miracle were notoriously hard to tax, and taking advantage of weak government controls and poorly planned loopholes in order to pay little to no tax almost became a national pastime. Now overall, whether willingly or not, reducing taxation and government restrictions while increasing spending through debt is a classic expansionary economic policy. Even if the government doesn't necessarily mean to do it, this is probably what the country needed to get out of the rut it found itself in in the 1980s. But in order to get into the eurozone and be allowed to use the European Union's new currency, Italy was forced to clean up its act. It had to reduce its debt load and do a better job of getting its people to pay their taxes. Increasing regulation, reducing debt, and raising taxes all works to take money out of the economy which, even if it was the right thing to do, still put the brakes on economic growth. For the rest of the 1990s, the economy of Italy once again entered an almost decade-long period of stagnation. Fortunately for the country, the adoption of the euro in 1999 created something of a golden opportunity for Italy to start growing again. After a brief lull, the country in what was becoming a recurring theme more than doubled its economic output in less than a decade, once again becoming one of the fastest-growing advanced economies in the world. Entering the eurozone made it easier to attract foreign investment, foreign workers, and foreign buyers of its goods. Its trading partners also didn't have to worry about foreign exchange risk of the notoriously unstable era. The advantages of the eurozone also coincided with the further general development of Italian manufacturing and the rise of industries like tourism. Then of course the country was hit by the GFC and the eurozone crisis, and ever since it's fallen into yet another period of stagnation, only this time, instead of lasting less than a decade, it's gone on for almost 15 years now. The reason that we have spent so long exploring the details of Italy's unique economic histories of booms and plateaus is because it raises an obvious question for the nation, can it do it again? Obviously no one can predict the future, least of all economists, but if history repeats itself it looks like Italy is overdue to take another step up in this weird staircase of economic output. Unfortunately of course, it's not that simple, and there are a range of new challenges that are combining with some of the old historic challenges that are making a trademark Italian turnaround unlikely. The first is simply an aging population. Italy has one of the oldest populations in the world, and a lot of its workforce is getting close to retirement. This wouldn't be a problem by itself, except for the fact that it has a low birth rate, so young people are not joining the workforce to make up for the people leaving the workforce, who will ultimately, and unfortunately there's no nice way to put this, become a drain on resources. This problem has also been accelerated by the fact that Italy has one of the highest rates of young graduates moving to other countries where they can earn more money for their skills. Earlier this year we were lucky enough to talk to Professor Billeri from the University of Bocconi in Italy. As both a very well-respected economist and someone who has first-hand experience training some of Italy's brightest students, he gave us a fantastic insight into this problem. Actually, Italy is a net sender of graduates rather than a net receiver, and that's one of the parts that the country is complaining about. So we'd love to attract more people with a degree rather than letting them leave to other countries. So I think from the country perspective it is a problem, especially if you are one of the sending countries. However, let me say two things on this. One is that from the individual level perspective, having more freedom of movement is certainly giving the right incentive to individuals. You want to build a good life, you have good ideas, it's fantastic for the world to let these people move. The second point of view is that we have to understand from the competition for talent perspective that countries that are losing these individuals, maybe because they tend to be overeducated for the level of the economy in that country, should think seriously about the opportunities that in a specific country or region are given to these individuals. Membership in the EU has only heightened this problem because Italian students who want to go to work in places like Germany, France, the Netherlands or even Luxembourg don't even need to apply for a visa thanks to the EU's policy of allowing workers to work anywhere within the member states. Raising wages could help to stem this exodus of skilled young Italians, but the country's industries can't afford to compete anymore with their largest European rivals because they are simply not as productive. The average size of an Italian business is significantly smaller than the average size of a business in other advanced European economies. Italy on average has 3.6 workers per company, where the average for Western Europe is 15, so effectively 4 times as many workers per organisation. In industrialised economies size does matter and larger companies are able to produce more specialised and more value-added items. In most highly advanced industries the marginal advantage of adding an additional worker is positive because it lets workers in the business focus on one aspect of production and do it really well. Given that automobiles are one of Italy's biggest industries and also probably the first thing that people think of when they think of Italian manufacturing, it makes for a great example. 10 companies that each have one employee that makes cars from scratch will produce fewer cars in a year than one company that has 10 employees that each focus on one part of putting a car together. If one employee just builds the engine they can get really good at doing just that. A company with 10 employees can also spend 10 times as much on tools for those workers, which even though it still works out to be exactly the same amount of costs for each individual employee means that the tools can be more specialised. The worker who just makes engines can be given tools that are just made for working on engines, whereas a worker that has to make the entire car will need to spread out their budget for tools over everything that is needed to make the car making them less specialised and ultimately less efficient. Now tools to build cars are one thing, but something that Italian firms have really failed to invest in is technology. Computers and related technologies have massively increased how much economic value one worker can produce in a given day. The classic example of this is that one accountant with something basic like excel can produce the same amount of financial reports as 10 accountants using abacuses. Italy's small firms have lagged behind the rest of Europe in the adoption of technology, and Western Europe itself has lagged behind the USA and a lot of economies in Asia. Besides making investments into industries more efficient, technology has become a massive industry in its own right, with the majority of the largest companies in the world being tech companies. Italy of course in some ways benefits from these cottage industries, because it helps them to maintain their reputation as a place where businesses focus on quality over quantity when producing luxurious goods. But countries like the UK, France and Germany achieve the same thing without actually making the trade-off for size. Mercedes from Germany employs a similar amount of workers to Fiat in Italy, but Mercedes is far more premium and generates far higher export markups than economy cars. A large amount of small companies is also harder to tax than a small number of large companies, which also highlights another problem that the Italian economy has. The black market in Italy is exceptionally large for an advanced economy, and despite the reputation, most of that isn't thanks to the mob, it's just unofficial businesses operating in grey markets to skirt around regulations and avoid tax. In the past, as much as 25% of the nation's economy was made up of black market industries. That figure is more like 12% today, which is an improvement, but it's still pretty bad, and it's not only costing the nation potential tax revenues, it's also contributing to social problems. Part of the reason the informal economy remains so large is that people don't have many other options. Italy is an advanced economy, but it has some of the highest poverty rates in all of Europe, and that is particularly severe in the south of the country, which is significantly poorer than the north, which as we have already explored is still struggling itself. Unfortunately today, Italy finds itself in a position with high unemployment, stagnant economic output, an aging population, uncompetitive industries, low tax revenues, high debt and increasing interest payments on that debt, all while having less control than it did in the past with its own currency. If it raises taxes and lowers spending to try and reduce its debt burden, it will crush its local industries that are already struggling. If it borrows more, it risks bankrupting itself, and if it does nothing the situation is probably only going to get worse. There is the assumption in economics, in most sciences for that matter, that we are moving towards an idealised version of the future, because for the last two centuries that's exactly what's been happening. The world today is thousands of times wealthier than it was at the beginning of the industrial revolution, but that's been the exception rather than the norm. Italy is just another in a long list of advanced economies that are finding it increasingly hard to compete in an increasingly competitive global economy, and just because we have enjoyed growth for all of living memory, doesn't guarantee it into the future. Now one thing we did address in this video briefly is infrastructure and the role that it plays in economic development, but Italy has in many ways over-invested into infrastructure, which is a mistake that we have already made an entire video about, but as always we didn't want to repeat too much here, so we will leave a link to that which you should be able to click to on your screen now. Thanks for watching mate, bye.
