Italy’s Growth Bubble Bursts, Revealing Fragile Economic Outlook

Italy’s post-pandemic economic recovery is faltering more rapidly than expected, with structural weaknesses re-emerging, raising concerns about the future of the country’s fragile public finances. After a surprising stagnation in GDP growth in the third quarter, Italy’s national statistics bureau, ISTAT, has revised its 2024 growth forecast down to just 0.5%, half of the government’s target of 1%. This projection marks a return to Italy’s position as one of the euro zone’s weakest performers, contradicting the optimistic outlook previously shared by Prime Minister Giorgia Meloni and some economists.

Structural Weaknesses Surface

Recent economic indicators have painted a bleak picture. Business confidence has dropped to its lowest point since 2021, while Italy’s long-standing manufacturing crisis deepens. Even the services sector, which had been a driving force behind the economy for much of the year, is now contracting. According to Francesco Saraceno, economics professor at Science Po and LUISS University, Italy’s reliance on small firms, insufficient public investment, and resistance to the green transition are impeding the country’s growth potential. Saraceno added that the country’s outdated business model is no longer conducive to economic expansion.

Lackluster Recovery Despite EU Funds

Italy continues to receive substantial funding through the European Union’s post-COVID Recovery Fund, yet its economic performance lags significantly behind other fund recipients, such as Spain, which is growing at a rate four times higher than Italy. While Italy’s economic resilience in 2021-2022 was largely driven by state-funded incentives, including the costly “superbonus” for the building sector, this temporary boost has now evaporated as the scheme is phased out.

Despite receiving EU funds, Italy’s economic stagnation threatens its public finances, which are already burdened by the debt accumulated from the superbonus. The government projects that public debt will rise to around 138% of GDP by 2026, up from 135% in 2023. If growth continues to underperform, as most forecasters predict, this debt ratio will likely climb even faster. This could make investors more hesitant to purchase Italian bonds, driving up Italy’s debt-servicing costs.

Comparison to Spain’s Robust Growth

In stark contrast to Italy’s struggles, Spain’s GDP is expected to grow around 3% this year. Over the past year, Spain’s economy has expanded at quarterly rates between 0.7% and 0.9%, while Italy has struggled with growth rates of just 0.3% to 0.0%. Angel Talavera, head of European research at Oxford Economics, attributed Spain’s success to its ability to attract and integrate migrants into the workforce, along with a strong tourism sector and robust consumer spending.

Italy, on the other hand, has struggled with fewer migrants, many of whom are confined to the informal economy, and has seen a significant outflow of young talent seeking better opportunities abroad. This demographic decline is a key factor in the country’s economic fragility.

Talavera noted that while Spain has modernized its infrastructure and public services over the last two decades, Italy’s economy remains hampered by its large but increasingly uncompetitive manufacturing sector, which limits expansion.

The Need for Structural Reform

Economists agree that Italy’s sluggish economy is the result of long-standing issues, including under-investment in education, infrastructure, and public services, as well as a burdensome bureaucracy, risk-averse banking sector, and an inefficient justice system. There is a growing consensus among experts on what should be Italy’s top policy priority to improve the situation: investment in education and research.

Roberto Perotti, Lorenzo Bini Smaghi, and Francesco Saraceno are among those who argue that reforming the education system is vital for Italy’s future growth. Meanwhile, Lorenzo Codogno, former chief economist at the Italian Treasury, has called for labor market liberalization to stimulate economic dynamism.

Conclusion

Italy’s fragile economic outlook calls for urgent reforms to address deep-rooted inefficiencies and structural challenges. While the EU’s financial support provides some cushion, without targeted investment in key sectors such as education and research, the country risks falling further behind its European counterparts. As economic growth remains sluggish and public finances weaken, Italy must take bold steps to avoid a prolonged period of stagnation.