Chapter 1

Economic recovery by rationalising resources (Note 1)


1.1 - The economic situation

The last decade has proven to be a poor one in sustainability terms. Too much imbalance and instability led to the 2008 financial crisis and the ensuing recession; monetary policy was too slack and boosted prices, in particular on the housing market. Fiscal policy was unbalanced with deficit problems even during boom years and US foreign debt and consequent reliance on foreign creditors in many Asian countries soared. The financial system was far from stable and aggravated the crisis that it had unleashed The business cycle of the last decade has been called 'a bubble economy' (Note 2) and is impossible to sustain.
For the whole of 2010, the world's mature economies found themselves facing a series of dilemmas that had been caused by attempts to kick-start a recovery; on the one hand fiscal policies were supposed to prop up a recovery and on the other launch budget policies that would reduce public deficits in the medium and long term. Monetary policies were supposed to restore normality on liquidity and public-fund markets, and lower real short-term interest rates to near zero, but also to make the budgetary policy less onerous. Governments were also supposed to introduce stricter regulations for financial markets, bank capitalisation and bank monitoring, but still not create additional or indeed new obstacles to financing enterprises.
If we look at the current situation, we find that the economy is fighting back, but it is clear that some of the causes behind the worst recession in the last eighty years have not yet been cured: monetary policy is still slack, public deficits are still sky-high, the US trade balance is still negative, and the regulations of world finance are still practically the same as the pre-crisis ones. The markets have also realised that the productivity and competitiveness gap between mature economies and emerging ones is vast, as is the North-South divide within the EU.
On top of this sits the crisis in North Africa, which exploded in early 2011; in the space of a few short weeks, it set the business cycle back due to the possible consequences of oil prices on growth, inflation and interest rates. Macro-economic effects aside, the popular revolts in North Africa have focused international debate on the need for sustainable development that encompasses a more equitable distribution of freedom, democracy and justice.
The world economy
Figures for 2010 confirm the recovery is underway: Gross World Product (GWP) rose by 5% due to a +12.4% spurt in international trade. The recovery, however, is two-track: growth in mature economies is still fairly sluggish and unemployment is still high, whereas activity in emerging economies is quite sprightly. (Figure 1.1.1) and (Figure 1.1.2)
If the positive trend in industrial production is an indicator that the economy took off in 2010, there is still, however, a noticeable gap between mature and emerging economies. The same situation applies to trends in consumption and investment. In 2010, global demand was in fairly robust health in terms of consumption, while investments were still poorly. Consumption exceeded pre-crisis levels by some way in the aggregate of emerging economies, whereas mature economies were making up for their losses. Investments in industrialised countries are still below pre-crisis levels, but they are driving the economies of emerging countries.
The International Monetary Fund forecasts that GWP will rise by 4.4% in 2011.
The US economy has grown in fits and starts since summer 2009 when the slump that started in late 2007 came to a halt. In 2010 US Gross Domestic Product (GDP) rose by 2.9%; the International Monetary Fund and the main international study centres predict a growth of between 2.8% and 3% in 2011. Unemployment, however, is still high, say the centres, and it will remain within a whisker of 10%. Property prices, which collapsed by about 30% in 2006, could fall by a further 10% this year (Note 3), while the situation for mortgage arrears continues to worsen. Families have been suffering serious losses to property value, finances and pensions since early 2008. Although these resources are being rebuilt thanks to a major return to saving, many US consumers have very few financial resources available.
Japan closed 2010 up by 3.9%, but its future is still uncertain as it has been hit hard in the aftermath of the catastrophe in March 2011. There may be two main effects of the destruction wrought by the tsunami: it may worsen the situation, or the reconstruction may spark a recovery (Manzocchi).
Emerging and developing countries are driving the world recovery as they recorded growth of 7.3% in 2010 and estimates of 6.5% in 2011. BRIC-area countries (Brazil, Russia, India and China) are spearheading this recovery, although to insist on calling them 'emerging' countries is somewhat forced nowadays, as a glance at their contribution to GWP will confirm. China is the world's second biggest economy and its GDP contributed to 13.6% of world GDP in 2010; the US, in first place, accounted for 19.7%. Brazil, Russia and India, combined, make up 11.3%. These countries have 'emerged' from their Third-World status and they should be replaced with other  'emerging' countries with identical capacity for growth, such as Turkey, Mexico, Indonesia and South Korea. (Table 1.1.1) and (Table 1.1.2)
Tension in North Africa
The explosion of popular revolts in Egypt, Tunisia, Libya and Syria early this year and the concern that protests could spread to other Arab countries such as Yemen and Bahrain led us to reflect both upon the ethics and the effects on the business cycle, as the consequences are similar to those of the fall of the Berlin Wall in 1989.
Tension in North Africa is due to widespread social and economic malaise that has been bubbling under a surface of apparent immobilism for many years. Some simple indicators demonstrate the social and economic imbalance, although some of the economies have grown considerably in the last decade. GDP per capita is under 2,500 dollars in Yemen, just above 6,000 dollars in Egypt, and under 10,000 dollars in Tunisia. One of the problems for these countries is unemployment: overall unemployment rates are very high and reach 30% among the young; this is particularly worrying in areas with high population growth and where the number of under-30s tops 50%. The political and social situation of these peoples was aggravated in the second half of 2010 when the prices of primary food goods rose on the back of soaring international prices for agricultural raw materials. (Table 1.1.3)
In general, an initial problem of the North Africa crisis concerns oil, which could be in short supply worldwide due to a lack of Libyan crude on the market, but the overall effect will depend on whether the other oil-producing countries manage to compensate for the shortage. The natural candidate is Saudi Arabia, which is expected to increase production due to the recent increases in oil prices and to the need to distribute revenue to the population. The situation would become increasingly complex if it were to continue in the long term and tension were to spread to other oil-producing countries. Rising oil prices are also causing havoc because the problems with crude oil supply come at a time when there are hopes for a recovery in global demand.
Higher oil prices affect inflation and should inflation continue to rise, there would be repercussions on interest rates. In a few short weeks, in February and March 2011, rising oil prices weighed on inflation and led to a review of international economic policy; the European Central Bank (ECB), in particular, has recently announced that it wants to begin normalising interest rates in order to cope with the risk of rising inflation.
A possible slump in demand in North Africa is also holding back the international economy in 2011. North Africa actually accounts for a very small slice of international imports, about 1%. The area receives about 4% of Italy's exports, while Morocco, Algeria, Tunisia, Libya and Egypt account for 2.5% of Veneto's total export value.
Raw materials and inflation
A recovery in industrial production in 2010 caused a surge in the prices of raw materials; in line with trends in the second half of the 2000s, the price elasticity of raw materials on the international market was particularly high. The increase in the prices of food raw materials, which started in summer 2010, extended over the next few months and was fed by freak weather conditions in Asia, Europe and America. These conditions led to a shortage, in particular of cereals and grain, which will continue to affect food prices in 2011. (Figure 1.1.3)
The biggest increases were felt by the prices of the industrial commodities most exposed to China's growth, such as non-ferrous metals. The prices of copper and some agricultural commodities, such as natural rubber and cotton, hit a record high in the second half of 2010. Growth in energy products was bright, but a little dimmer than growth in energy raw materials, and this reflected fading end demand in Organisation for Economic Cooperation and Development (OECD) countries, who are the main consumers of oil products. It was only in the latter part of 2010 when US demand picked up that the price of Brent crude topped 90 dollars a barrel. Brent crude prices closed the year with major rises and this continued in early 2011 due to a temporary fall in US domestic supply; prices then surged on the back on the revolts in Arab countries.
Rising commodity prices kick-started inflation, which rose from the lows of 2009. Rapidly soaring prices in emerging countries were fuelled by the demand for raw materials, which rose due to a need for investments and to an increase in the prices of the main foodstuffs in consumers' shopping baskets.
At the same time, mature economies proved to be fairly immune to the recovery in inflation until the end of 2010 when food and energy prices began to make themselves felt on consumer prices in the US and the Euro Area.
Exchange rates
In the last two years, US monetary policy has weakened the dollar, which has become a currency for carry trades, a speculative practice whereby money is borrowed in countries with lower interest rates and then exchanged for the currency of countries where investments have a better return. In many cases, the falling trend in the dollar is countered by reserve accumulation in emerging countries. The difficult situation of public finances in European countries affects the development of exchange markets; and indeed for a while the euro stopped its strong run against the dollar and started to lose ground. As the dollar was unable to strengthen against the euro and could not even cause an appreciation of the Chinese Yuan due to the fixed exchange rate policy followed by the Chinese authorities, it offloaded onto a limited set of currencies, such as the Japanese yen or the Swiss franc, or even onto some emerging economies, which thus recorded an appreciation against the dollar, euro and Yuan at the same time.
The economic situation in March 2011 saw the euro gain ground on the dollar as there were fresh announcements that the ECB was in favour of raising interest rates; on 29 April one euro was worth 1.486 dollars, the highest rate since the peak of 5 November 2010 and one that beat its 13 January 2010 record when one euro was worth 1.456 dollars. (Figure 1.1.4).
2010 in Europe
The European Union closed the year with 1.8% growth, as did the Euro Area, proof that a recovery was underway. The last few months of the year saw a rise in domestic demand and a recovery in exports, which was fostered by renewed world trade.
In the Euro Area, the German economy was the main contributor as it experienced a surge in international trade and investments in machinery and equipment. Nearby economies, such as Austria, Belgium and Holland, followed in Germany's wake, as did Finland. Economies in the Mediterranean area, however, were still sluggish; in addition to Italy's structurally weak trend and the recession in Spain, France's economy was also fairly wobbly despite having held out well against the crisis. Other countries experiencing a downturn included Ireland and Greece. Although the PIGS, the unflattering acronym for Portugal, Ireland, Greece and Spain, had left behind the trough of the first quarter of 2009, their GDP still shrank by -0.7% in 2010. Without the PIGS, Euro Area GDP increased by 2.3% in 2010 compared to 2009. (Table 1.1.4) and (Figure 1.1.5).
The Italian economy
In Italy, GDP rose by 1.3% in 2010, the result of a minor recovery early in the year which stabilised at around 1.5%. The sectors driving this trend were industry in the narrow sense and services in retail and transport. Despite growth in private consumption and investments, levels were still well below pre-crisis ones due to the 2009 slump. (Figure 1.1.6)
In 2010, industrial activity was looking up: the industrial production index continued to increase, up 6.4% on the previous year; the turnover index also grew, up 9.9% on 2009, driven both by foreign demand, up 15.6%, and by domestic demand, up 7.5%; the new orders index for 2010 was up 13.9%, a figure mainly buoyed by orders from abroad, up 21.2%. All of the indices made a large improvement on the lows of spring 2009, but the gap between these and pre-crisis figures has still not been bridged. Trends in industrial production varied according to the type of goods: falls on 2009 production levels of consumer goods were fairly contained, but there was only a weak recovery in 2010; producers of intermediate goods, and especially of capital goods, witnessed a heavier fall in 2009 on account of tumbling demand by enterprises during the crisis, but their recovery in 2010 was much sprightlier. (Figure 1.1.7)

The climate of confidence in Italy

Manufacturing industry confidence continued to improve throughout 2010, returning to the levels of early 2008, when a recession was still nowhere in sight. This trend may give rise to some doubt as to the reliability of these qualitative indicators because industrial production at that time had undergone losses in product volume. The fall is most likely due to failing enterprises, but the ones that managed to survive saw an improvement in their production and confidence was therefore higher, although not all of their problems had been ironed out. Overall confidence was good among entrepreneurs in terms of both new orders, especially among manufacturers of intermediate and capital goods, and production.
The optimism of manufacturers, however, is not shared by the construction industry, which has suffered falls in the construction of buildings rather than in civil engineering and specialised construction work. (Figure 1.1.8)
Regarding consumers, Italy's Institute for Studies and Economic Analyses (ISAE) revealed that families' confidence was good. However, although it was up on the 2008 lows, confidence rose until summer 2009, settled, but then dipped in early 2010; it then picked up towards the end of the year, but was up and down in early 2011. Although families showed a certain optimism, they were still uncertain about the economic climate on account of the labour market. (Figure 1.1.9).
Veneto's economy
Official figures from the regional government's accounts department stop at 2009, the year that measures the impact of the international recession. Italy's GDP narrowed by 6% in the North West, 5.6% in the North East, 3.9% in the Centre and 4.3% in the South. The North West was the area worst hit by the crisis. The differences between areas depend mainly on the make-up of their sectors. The crisis hit the North harder because of its high percentage of industry in the narrow sense. Economic activity held out better in Southern and Central Italy because of their concentration of services, which experienced gentler and fairly even falls throughout the country.
Against this backdrop, Veneto's economy slowed in line with those of the other heavily industrialised regions; in 2009, Veneto's GDP narrowed by 5.9%.
The worst effects of the economic and financial crisis were felt in Italy's more industrialised regions: industry value added fell heavily in Piemonte (-16%), Lombardia (-15%), Veneto (-14.1%) and Emilia Romagna (-13.7%). Other sectors of Veneto's economy also experienced a fall in value added: -2% in agriculture and -2.2% in services. Household expenditure in Veneto, which accounts for 8.9% of the Italian total, dipped in line with the rest of the country, down 1.8%.
GDP per inhabitant, equal to 28,856 euro compared to 25,237 euro at national level, fell by 4.9%.
Despite these falls, once again in 2009, Veneto was found to be the third largest regional contributor to Italy's GDP: the region contributed 9.3% of the national total, behind Lazio (11.1%) and Lombardia (20.4%).
Forecasts for 2010 by the Prometeia research institute state that Veneto's economy will grow by 1.6%, more than the national average of 1.3%, and is likely to grow by 1.3% in 2011.
The 2010 forecasts are attributable mainly to a bounce back in the industry in the narrow sense, where value is expected to grow by almost 4 percentage points and to a recovery of 1.2 percentage point in both agriculture and services. The construction sector is expected to narrow by 0.9%.
Lively international trade in 2010 most certainly made a major contribution to growth. Exports will continue to drive growth in 2011, although uncertainty about markets in North Africa and Japan may put a dampener on prospects. Morocco, Algeria, Tunisia, Libya and Egypt, however, account for very little of Veneto's exports (2.5%). Japan accounts for 1% of Veneto's exports and this mainly concerns the fashion industry. (Table 1.1.5), (Figure 1.1.10), (Figure 1.1.11) and (Figure 1.1.12)

 Business and consumer confidence in Veneto

The most recent quarterly indicators at regional level regard the perceived confidence of both entrepreneurs and consumers.
According to an ISAE/ISTAT report, confidence in Veneto's manufacturing industry surged in the first nine months of 2010, but then faded towards the end of the year. Opinions improved both concerning the state of order books and production expectations. Particular optimism surrounded opinions on orders from overseas. The optimism of late 2010 fell in early 2011 on account of a slight drop in forecasts for new orders and production. (Figure 1.1.13)
The overall consumer confidence index, which measures the optimism/pessimism of consumers based on the average of nine indices related to general and individual economic circumstances, was up and down for the whole of 2010. Although certainly brighter than the darkest moments of the crisis, the index slumped in February 2010 only to pick up again a little later. (Figure 1.1.14)

 Value added by sector

In 2009, the most recent figures for Veneto, the services industry, which accounted for 65.4% of Veneto's entire value added, narrowed by 2.2%, a little better than services at national level, down 2.6%. Agriculture, which makes a limited contribution to regional wealth (1.6%) fell by 2.0% in 2009, again slightly better than agriculture at national level, down 2.3%. Industry in the narrow sense, which accounts for 26% of Veneto's entire value added, was hit hard by the international slump in demand, falling by 15.4%, in line with the national figure, down 15.6%.
Forecasts for 2010 suggest a general increase, which will be strongest in industry in the narrow sense. The construction industry is expected to need another year before making a recovery. In 2010, agriculture value added is expected to rise by 1% at national level and by 1.2% in Veneto. Italy's industry in the narrow sense increased by 4.8% in 2010, but its construction industry is still frail, down 3.5%. Forecasts for Veneto state that value added for industry in the narrow sense will rise by 3.9%, but that construction will narrow by 0.9%. Wealth produced by services in 2010 will increase by 1.1% on 2009 at national level and by 1.2% in Veneto.
There will be positive variations in all sectors in 2011, except in agriculture. (Figure 1.1.15), (Figure 1.1.16), (Figure 1.1.17) and (Figure 1.1.18)


In 2010, at national level, there was an increase of 2.5 percentage points in gross fixed investments due to an 11.1% surge in investments in machinery and equipment and an 8.5% increase in investments in vehicles; there was, however, a 3.7% fall in investments in construction.
There was a sharp rise in the purchases of vehicles during the first three quarters of the year, and of machinery, equipment and other products in the central months. Investment expenditure in capital goods almost reached pre-crisis levels and it only slowed in the final quarter due to the expiry of the fiscal incentives introduced by the Tremonti-ter financial law, which had previously supported demand.
The construction industry continued the downward trend that had started in the fourth quarter of 2007, worsened in 2009 (-8.7%) and fell again in 2010 (-3.7%).
On a regional level, the last official figures are from 2007, when investments increased on the values of the previous year, up 1.6%; this was the result of positive investment in industry in the narrow sense, up 7.3%, stagnation in the primary sector, up 0.6%, a steep decline in construction, down 19.6%, and a rise in the tertiary sector, up 0.7%.
A similar fall in investments for Veneto's construction industry to the one at national level is estimated in 2008 and 2009, but in 2010 a recovery in exports, which are closely linked to investments, will help this sector. (Figure 1.1.19)


In 2010, there was an increase in real terms of 0.6% in final national consumption, produced by the 1% rise in household expenditure and by the 0.6% fall in government and private social institutional expenditure.
Expenditure on private consumption across the national economy in 2010 stopped the falling trend that had started in 2008 and underwent a mild recovery. Both this trend and the economy, however, confirmed that progress was sluggish and uncertain. Italian families are still suffering from the currently weak recovery and labour market uncertainty. Both lead families to postpone non-essential spending; indeed, purchases of durable goods experienced a -1.9% fall. Consumption of semi-durable goods saw a strong recovery (+4.1%), while spending on non-durable goods and services had more modest variations: 1% and 0.9% respectively. (Figure 1.1.20), (Figure 1.1.21) and (Figure 1.1.22)
In Veneto, figures for 2009, the most recent, show that household consumption expenditure fell by 1.8%. In 2010, expenditure is expected to increase by 0.7%, with recovery still being weak in 2011 at +0.9%. (Figure 1.1.23).

Prices in Veneto

In 2010 in Italy inflation stood at 1.5%, a rise on figures for 2009 when the consumer price index was the lowest it had been for 50 years. The year just passed showed a growth rate that was double the previous year, but despite this it did not reach a high value. Average inflation in Veneto was 1.4%, slightly lower than the national level; the provincial capitals that stood out for their lower rates were Treviso, Vicenza and Belluno.
In Veneto, expenditure by category showed a similar trend to national figures: the largest contributions to average growth over the last year were made by transport, but alcoholic beverages, tobacco, services and education also played their part.
A major contribution to rising inflation was made by transport prices, boosted by energy prices, which recovered by approximately 13 percentage points between 2009 and 2010; they rose from around -9% to +4%, contributing just under one percentage point to the inflation rise of the last year. Prices of petrol and heating products were driven higher by the price of oil, which shot up by more than 30% over the year. This trend had an impact on rising inflation against a backdrop of generally weak economic growth. (Figure 1.1.24).

Figure 1.1.1

Percentage variations in world trade of goods and services and in Gross Domestic Product. World - Years 2007-2012

Figure 1.1.2

Industrial production in the world, emerging countries and advanced economies (2000=100) - Jan. 2004-Feb. 2011

Table 1.1.1

Economic indicators in the major industrialised countries - Years 2009-2012

Table 1.1.2

Economic indicators in BRIC countries - Years 2009-2012

Table 1.1.3

Social and economic indicators in some countries of North Africa and the Middle East - Various years

Figure 1.1.3

Economist price indices ($) for raw materials (2000=100) and oil prices ($/barrel) - Years 2005-2011

Figure 1.1.4

Exchange rates for dollar-euro and yen-euro - Jan. 2007-Mar. 2011

Table 1.1.4

Economic indicators for the major countries in the Euro Area - Years 2009-2012

Figure 1.1.5

Percentage variations in Gross Domestic Product in some countries - Years 2008-2010

Figure 1.1.6

Percentage variation in GDP, in final consumption and investments compared to same period of the previous year. Italy - I Quarter 06 - IV Quarter 10

Figure 1.1.7

Seasonally adjusted indices of industrial production, turnover and orders. Italy - Jan. 2008-Feb. 2011

Figure 1.1.8

Monthly confidence figures for the manufacturing and construction sector (seasonally adjusted data, 2000=100). Italy - Jan. 2008-Apr. 2011

Figure 1.1.9

Monthly figures for consumer confidence (seasonally adjusted data, 1980=100). Italy - Jan. 2008-Apr. 2011

Table 1.1.5

Macro-economic overview (percentage variations in constant values. Base year 2000). Veneto and Italy - Years 2008-2011

Figure 1.1.10

Estimate for 2010/09 percentage variation in Gross Domestic Product (2000 prices)

Figure 1.1.11

2010/09 percentage variation in value added by sector of economic activity. Veneto and Italy

Figure 1.1.12

Gross Domestic Product per capita by region (current euro) - Year 2009

Figure 1.1.13

Monthly confidence figures for the manufacturing sector (seasonally adjusted data, 2005=100). Veneto - Jan. 2008-Apr. 2011

Figure 1.1.14

Monthly figures for consumer confidence (seasonally adjusted data, 1980=100). Veneto - Jan. 2008-Apr. 2011

Figure 1.1.15

Percentage variations in value added in agriculture at constant prices (base year 2000). Veneto and Italy - Years 2004-2012

Figure 1.1.16

Percentage variations in value added in industry in the narrow sense at constant prices (base year 2000). Veneto and Italy - Years 2004-2012

Figure 1.1.17

Percentage variations in value added in construction at constant prices (base year 2000). Veneto and Italy - Years 2004-2012

Figure 1.1.18

Percentage variations in value added in services at constant prices (base year 2000). Veneto and Italy - Years 2004-2012

Figure 1.1.19

Percentage variations in fixed gross investments at constant values (base year 2000). Veneto and Italy - Years 2004-2012

Figure 1.1.20

Annual percentage variations in household spending on durable goods. Veneto and Italy - Years 2004-2010

Figure 1.1.21

Annual percentage variations in household spending on non-durable and semi-durable goods. Veneto and Italy - Years 2004-2010

Figure 1.1.22

Annual percentage variations in household spending on services. Veneto and Italy - Years 2004-2010

Figure 1.1.23

Percentage variations in spending on final consumption at constant prices (base year 2000). Veneto and Italy - Years 2004-2012

Figure 1.1.24

Percentage variation in consumer price index for the whole nation. Italy and provincial capitals in Veneto - Year 2010

1.2 The sustainability of public finances

The financial crisis has had a devastating effect on the public finances of all developed economies: plummeting real economic growth combined with discretionary support measures caused an inevitable fall in revenue in the face of an increase in public spending.
Since the downturn in the economic cycle ended in mid 2009 and the recovery seemingly got underway, attention can now be focused on how the recession has affected public finances and how to consolidate them in order to ensure that they are sustainable.
US public finances, which had been sickly since the beginning of the millennium, worsened with the credit crunch, stagnation and the thousands of billions of dollars spent to bailout Wall Street. In April 2011, US public debt exceeded 14,200 billion dollars, double what it was six years ago and just a step away from 100% of its GDP.
The majority of US public debt is financed by foreign countries that have purchased state bonds from the US Treasury. At the end of February 2011, foreign countries held US bonds that amounted to a total of 4,474.3 billion dollars.
The reason behind these purchases, mainly by foreign central banks, is linked to what is known as the "Currency War". The central banks of other countries are forced to purchase dollars in an attempt to counter the excessive appreciation of their currencies against the dollar. China is the US's main foreign investor; in February 2011, Beijing held 26% of the US debt, followed by Japan with 20% (890 billion dollars).
International Monetary Fund projections in April 2011 stated that in the US, government deficit was expected to drop in 2011 (to 10.6% of GDP), and then again to 7.5% in 2012. The debt-to-GDP ratio, which rose to more than 20 percentage points between 2008 and 2010, is expected to grow by another 10 percentage points in the next two years, bringing it to 99.5% in 2011 and to 102.9% in 2012.
In January of this year, the rating agency Moody's said that it could not rule out reducing the rating of the US, which still today enjoys the much-coveted Triple A rating, and warned that it may have to review its long-term outlook to negative. On 18 April 2011, Standard & Poor's confirmed the US's Triple A rating, but reviewed its outlook from stable to negative. This decision is unprecedented in history and was taken due to the US's high deficit and the lack of clarity as to how the deficit was to be reduced. The agency will lower Washington's credit rating "if the administration and Congress can't articulate a credible plan to bring down public debt levels by 2013". (Figure 1.2.1)
The situation of Japan's public finances is also worrying: in January 2011, Standard & Poor's cut its rating on account of the health of its finances, the first downgrade (from "AA" to "AA-") in almost nine years.
Japan's downgrade seems to be the culmination of a process that has characterised its public finances for a number of years. In relative terms, Tokyo's public debt is the highest in the world, one that is more than 220% of its GDP and the result of a downward spiral that started in the 1990s. To face the recession, Japan pledged to find liquid credit and then put it onto the market as economic stimulus. Despite everything, interest rates remained low, as did foreign exposure, given that Japan's bonds, still today, are almost completely owned by Japan's banks and savers. These are two decisive features that have enabled the Yen to remain one of the world's main currencies, thus preventing the country, despite its record debt, to become 'the next Greece'.
On the other hand, a part of the world that for decades had been synonymous with instability and high investor risk, today is below the limit established by the EU's Stability Pact, i.e. a deficit-to-GDP ratio of 3%. If we use the Maastricht parameters as reference, we can see that the emerging economies have held out and that their governments have kept to the parameters. In 2010, China's net borrowing was 2.6% of its GDP and Latin America had an average of 2.9%.
In Europe
At European level, the situation in Greece, which shot into the news in spring 2010, revealed how urgent it was to deal with the Euro Area budget, and indeed that of the entire EU; it also focused attention on the high and rising public debt of Europe's governments and fears for their solvency.
When the European Commission presented its Europe 2020 Strategy in March 2010, its immediate priorities to beat the crisis and face the challenges of the next decade were "to pursue the reform of the financial system, to ensure budgetary consolidation for long-term growth, and to strengthen coordination within the Economic and Monetary Union." (Note 4).
Following the tension surrounding the Greek crisis and to deal with the issue of sovereign debt, on 9 May 2010, the European Council adopted a 500 billion euro package that aimed to preserve the EU's financial stability. The package included a European Financial Stability Facility (EFSF) and a European Financial Stabilisation Mechanism (ESFM), which provided emergency resources for countries in economic difficulty. These measures are a sign that the Council is bent on ensuring fiscal sustainability, as well as greater economic growth in all Member States, and that it has understood the need to speed up fiscal consolidation and structural reform. On 24 and 25 March 2011, the European Council implemented the proposals put forward by the European Commission in 2010. These proposals, which had been approved on 15 March by the EU's finance ministers, were geared towards ensuring tighter budgetary discipline and more efficient monitoring of macro-economic imbalances. The proposals aim to strengthen the Growth and Stability Pact, both in its preventive phase by introducing monetary sanctions and in its corrective phase by defining a regulation that enables an excessive debt procedure to be launched not only when debt exceeds 3% of GDP, but also whenever the reduction in public debt towards the threshold of 60% of GDP is not considered to be satisfactory. In order to reinforce the stability mechanisms in the Euro Area and to support Member States in financial difficulty, the European Council approved the extension of the European Financial Stability Facility's lending capacity from 250 to 440 billion euro; furthermore, it established the features of the European Stability Mechanism (ESM), which had already been largely agreed on 28 November by the Euro Area's finance ministers. (Figure 1.2.2).
The deficit and public debt of European Member States have soared since 2007. In 2007, the year preceding the economic and financial crisis, the EU's public finances were healthy.
The crisis, which started in 2008, saw a brusque deterioration in the budgets of EU27 countries due to a slump in the real economy and the ensuing adoption of support measures that were introduced by the governments, most of which are set to expire in 2011. Net borrowing (Note 5), which was 0.9% of GDP in 2007, soared to 6.8% in 2009; it was 6.4% of GDP in 2010 and is estimated to be 6.5% in 2011 (Note 6).
Public debt (Note 7), which was 59% of EU27 GDP in 2007, reached 74.4% of GDP in 2009, 80% in 2010, and is estimated to be 83.8% in 2011.
Net borrowing and public debt calculated as a percentage of GDP are two key indicators for evaluating public finances: the first is particularly useful for evaluating budget management and the latter for public-finance management.
The level and trend of the ratio between net borrowing and GDP not only depends on budgetary policy, but also on economic growth (which acts on the denominator and on revenue), as well as on the incidence of spending on interest (the trend in nominal and real interest rates over the course of a loan). If spending on passive interest is subtracted from net borrowing, we obtain the primary balance which, as a proportion of GDP, is an indicator of the "strength" of public finances (e.g. public savings, or resources injected into the system net of debt burden). The ratio between net borrowing and primary balance may vary greatly from country to country in accordance with the difference in debt burden.
Debt-to-GDP ratio is a solvency indicator that compares the overall amount of national debt (Central and Local government, and Social Security) with the flow of goods and services produced by the economy, which determines tax imposition and is thus an indirect measure of repayment capacity. A high debt-to-GDP ratio is a major constraint on economic policy, as it forces governments to earmark a large amount of public resources to debt repayment in order to prevent debt increasing further; a high ratio also raises risk premium, i.e. placing a comparatively high interest rate on debt.
This is why the Maastricht agreements fixed criteria for countries joining the Economic and Monetary Union (EMU): the net borrowing-to-GDP ratio may reach a maximum of 3% and the debt-to-GDP ratio must be lower than 60%.
The constraints decided by the European Council on 25 March 2011 included as a mid-term objective balancing the budget and the so-called structural reform, i.e. "in most cases an annual structural adjustment well above 0.5% of GDP. Consolidation should be frontloaded in Member States facing very large structural deficits or very high or rapidly increasing levels of public debt." (Note 8). It also introduced a regulation that envisaged a 1/20 reduction in debt-to-GDP ratio from 2015.(Table 1.2.1).
In the two-year period 2009-2010, the budgetary positions in the Euro Area deteriorated even further. Average net borrowing in the sixteen euro countries reached 6.3% of GDP in 2009, increasing from 0.7% in 2007 and 2.0% in 2008. Provisional data for 2010 forecast a slight improvement to 6.0% of GDP. A European Commission report states that this deterioration is due to economic factors rather than to a worsening in the balance of budgetary structure. (Figure 1.2.3).
The Euro Area in 2009 saw a major rise in net borrowing in Spain and Ireland, where deficit rose by seven percentage points, and also in Portugal, Belgium, France, Cyprus, Slovenia and Slovakia. There was also cause for concern in the Netherlands and Finland where a budget surplus turned into a deficit.
Deficit in the vast majority of Euro Area countries exceeded the 3% of GDP stated in the Treaty; in fact no country recorded a surplus.
On average, outside the Euro Area, the impact was even worse; compared to the previous year, budgets grew increasingly weaker and deficits rose to 6.8% of GDP. The UK's deficit soared by more than seven percentage points.
The European Commission forecasts that the situation in the Euro Area will improve slightly in 2011 compared to 2009. These forecasts, however, are clearly linked to the speed of economic recovery; with prospects of 1.7% growth in 2011, net borrowing in the Euro Area is expected to reach 6.1% of GDP in 2011.
Public debt in the Euro Area reached 79.4% of GDP in 2009, a 9.4% increase on 2008. This situation is mainly due to the growth of public debt in Spain and Ireland, although the latter had a fairly low one to begin with. In 2010, Euro Area debt grew to 85.3%. Forecasts for the Euro Area predict an further increase to 88.5% of GDP by 2011, when primary deficit will be accompanied by a weak contribution to economic growth and the additional effect of spending on increasing interest.
Forecasts expect a slight recovery in the economy and the adoption of major consolidation measures, especially regarding expenditure.
In Italy
Italy has always had a high public debt. A Bank of Italy study in 2008 (Note 9), edited by Maura Francese and Angelo Pace, retraces the history of Italy's public debt from Italian Unification to 2007; results show that the years in which debt exceeded GDP were not isolated cases. In 147 years, Italy's debt-to-GDP ratio was 100% in 53 and exceeded 60% in 108. We should take the period after the Second World War as a one-off as it was characterised by the economic miracle and by a debt-to-GDP ratio that was well below 35%. Analysis started in 1861, when the Gran libro del debito pubblico (Grand Book of Public Debt) was set up after unification; it contained all of the debts run up by the states that now formed a united Italy. It outlines four phases of debt accumulation: the first encompassed the whole second half of the 1800s with debt reaching a high in the second half of the 1890s; the second and third phases (highs in 1920 and in 1943) are due to the two world wars. A breakdown of national and foreign debt helps to clarify the dynamics behind the two rapid adjustments that followed the world wars. In the years that followed the First World War, the fall in pre-war foreign debt (which was partly remitted) almost completely explains the lows in the 1920s and early 1930s; the weight of public debt (almost solely national) fell drastically, however, at the end of the Second World War mainly due to soaring inflation.
The fourth phase of public debt accumulation started after the minimum between 1963-1964 when debt began to rise sharply. In the 1980s, public debt hit levels similar to those of the 1890s, an all-time high at that time if we exclude the foreign debt connected to the First World War. Public debt reached its zenith in 1994, when debt-to-GDP ratio reached 121.8%. In the following years when Italy joined the European Monetary Union, a process of progressive adjustment was introduced to redress the imbalances in its public finances. By the end of 2007, Italy's public debt was 1,599 billion euro, 104.1% of GDP. (Figure 1.2.4)
Figures for 2009, the most recent available, state that debt-to-GDP ratio was 116.1%, the second highest in the EU after Greece. In the same year, Italy's primary balance was negative for the first time since 1991, falling to -0.7% of GDP, while net borrowing more than doubled on 2008 levels to stand at 5.4 percentage points of GDP.
If we look at trends in the government's quarterly figures, in the first six months of 2010, net borrowing as a percentage of GDP improved on the same period of 2009; at the end of 2010, it was 4.6% of GDP  (Note 10). The primary balance as a percentage of GDP in 2010 was negative, equal to 0.1% of GDP, an improvement of 0.6 percentage points on the previous year.
According to the forecasts in the government's Economic and Financial Document, which are also included in the tables of ISTAT's Notification of government deficit and debt figures, in 2011, net borrowing and primary balance are expected to stand at around -3.9% and +0.9% of GDP respectively, while debt is expected to be 120% of GDP.
For the three-year period 2010-12, the European Commission also forecasts a gradual improvement in Italy's deficit (to 3.5% of GDP) and a slight increase in debt-to-GDP ratio (to 119.9%); in international terms, Italy's public finances in recent years have benefited from the fact that public money was not needed to bail out the country's banks. (Figure 1.2.5)
The fear is that Italy may become one of the countries "under observation", otherwise known by the unflattering acronym PIGS: Portugal, Ireland, Greece and Spain. However, these countries are not only exposed to increased risks in terms of their public debt, but are also suffering from a structural economic crisis that is tormenting the private sector. Greece had the aggravating circumstance of a serious revision of its public finances when it was already being strangled by its enormous public debt; the current situation is due to a correction of the major imbalances that had accumulated in the first decade of the Euro Area. For the whole of that period, peripheral countries had an excess of demand over supply, often of enormous proportions. This occurred mainly by exploiting the lever of an increasing debt that was made possible by easy access to credit and by the tumbling interest rates that followed admission to the Euro Area; this allowed much more sustained rates of growth than the Euro Area average (Note 11).
These countries became major capital importers and, in Ireland's case, this capital was offloaded onto the financial sector, which was being promoted by particularly favourable fiscal legislation. On the other hand were countries such as Germany, Belgium and the Netherlands, who were exporting capital.
These considerations lead us to wonder whether it would be restrictive to assess the overall financial sustainability of a country on the basis of the two aforementioned public debt indicators. It would also be useful to consider the country's net foreign position, i.e. the balance of financial surplus and deficit with the rest of the world.
Although Italy's net foreign position has worsened over time, if calculated as a percentage of GDP it totals -19.3%. Italy therefore has a net foreign debt that is in line with the European average and much lower than that of Portugal, Ireland, Greece and Spain. (Figure 1.2.6)
Many economists have stated recently that a country's debt must be considered in a sort of aggregate that includes both the public sector and the non-financial private sector. If we consider Italy's public debt together with the non-financial sector as a percentage of GDP, its situation seems to be more favourable than that of the Euro Area, as the debt exposure of households (Note 12) and enterprises is relatively smaller in Italy than in many other European countries. (Figure 1.2.7) and (Figure 1.2.8)
By cross-referencing the net financial position, i.e. financial vulnerability index, with household debt as a percentage of GDP, i.e. capacity for debt coverage, we obtain a sort of "financial stability matrix" which maps out countries on the basis of their vulnerability indices. The most exposed countries are the ones who are in a weak financial situation and also have high private debt. This is the case with Portugal, Ireland Greece and Spain. Italy is characterised by high debt, but it has a fairly strong financial position, or at least one that is not as weak as that of other countries; it also has less private debt than the other countries considered. France and Italy seem to have similar characteristics, also in terms of trend, whereas Germany is in a much stronger position financially.
Italy's situation within Europe is even better in terms of the net financial wealth of the private sector; between 2000-2009, wealth as a percentage of GDP was well above the average of the Euro Area. Italy's strength is the solid financial situation of its families: during this period, their average net financial wealth was around twice the country's GDP. In 2009 the ratio between the net financial wealth of households and GDP in Italy was almost 180% compared to 130% in the Euro Area; Italy's figure was far higher than France's (131.5%) and Germany's (131%). (Figure 1.2.9)
The Bank of Italy also proposes another indicator of public finances known as the sustainability indicator; it is the increase in the ratio between primary surplus and GDP needed to stabilise the debt-to-GDP ratio (Note 13). This indicator suggests that Italy is in a better position than the other countries in the group as it puts the Euro Area at 6.8% and Italy at 2.6%. The indicator, however, suggests that Greece, Spain and Ireland still pose the greatest problems, followed by the UK and the USA. (Figure 1.2.10)
Until now, the financial market has evaluated Italy positively throughout the crisis. The rates of Italy's 10-year securities remained within the 4%-5% bracket, a level that is completely within the norm for long-term securities and sustainable over time. Furthermore, as stated by the Director General of the Bank of Italy, Fabrizio Saccomanni, the market's assessment also reflects the low level of Italy's private debt, its solid bank system, high real and financial wealth of its families and its sophisticated manufacturing industry, which works in all main sectors. Finally, it also takes into consideration that Italy's multi-year Financial Stabilisation Plan is expected to narrow deficit-to-GDP ratio to below 3% in 2012 and then to 2.6% in 2014, in line with the objective to balance the budget in the following years. The plan has been approved by the Italian parliament and confirmed in the Economic and Financial Planning Document 2011, which was approved by Italy's Council of Ministers on 13 April 2011.
Overall, it seems that the market believes Italy is able to face the structural problems that afflict it.

Figure 1.2.1

Countries holding US government securities (%) - February 2011

Figure 1.2.2

Trend in net borrowing and public debt as a percentage of GDP from 2005 to 2010

Table 1.2.1

Public debt and net borrowing as a percentage of GDP in some countries - Year 2010

Figure 1.2.3

Variation in net borrowing and its components as a percentage of GDP. Euro Area - Years 2007-2011

Figure 1.2.4

Government debt as a percentage of GDP. Italy - Years 1861-2007

Figure 1.2.5

Net borrowing and primary balance as a percentage of GDP. Italy - Years 1987-2011

Figure 1.2.6

Net external debt position of some countries as a percentage of GDP - Year 2009

Figure 1.2.7

Private debt of families and non-financial enterprises as a percentage of GDP - I quarter 2010

Figure 1.2.8

Private debt of families and net external debt position as a percentage of GDP of some countries - Year 2009

Figure 1.2.9

Net financial assets of families as a percentage of GDP of some countries - Year 2010

Figure 1.2.10

Public debt as a percentage of GDP and stability indicator of debt-to-GDP ratio of some countries - Year 2009

1.3 The long-term sustainability of social expenditure

The EMU's 2010 report on public finances, which was published by the European Commission's Directorate General for Economic and Financial Affairs, raises concerns regarding the vulnerability of government public financing on account of the ageing population.
In the next few decades, factors such as low birth rates, increased life expectancy and plummeting population of working age will only be partially counterbalanced by migratory flows; therefore the age of Europe's population will change. All of these factors will have major repercussions on public finances and on the social and economic situation.
In order to face this challenge and ensure long-term sustainability in accordance with the 2005 Stability and Growth Pact, the European Commission (Note 14) made long-term budget projections for the entire EU by taking in account "age-related expenditure", which includes pensions, health, long-term care and unemployment benefit.
These projections are based on the demographic and macro-economic assumptions for the basic scenario and were used to forecast the items of age-related expenditure in the Ageing Report, which was published in April last year (Note 15). These are simulations that represent a mechanical extension of the items contained in the updates for the Stability and Convergence Programme 2009-2010; between 2010 and 2012, they expect GDP in the Euro Area to rise by 1%, 2% and 2.3% and debt-to-GDP ratio to 84%, 87% and 87%. These figures highlight the extent of the risks and the challenges regarding the future consolidation of public finances, but they should not be mistaken for forecasts.
According to these assumptions, if current policies are maintained, age-related expenditure will increase in the next 50 years by 4.6% of GDP for the entire EU, by 5.1% for Euro Area countries and by 1.6% for Italy.
Age-related expenditure is expected to increase the most, by 7 percentage points of GDP, if not more, in nine EU Member States:  Luxembourg, Greece, Slovenia, Cyprus, Malta, Netherlands, Romania, Spain and Ireland. The cost will be more limited for a second group of countries: Belgium, Finland, Czech Republic, Lithuania, Slovakia, UK and Germany, but it will still be very high, i.e. between 4 and 7 percentage points of GDP. The most moderate increase, 4 percentage points of GDP, or less, will be in Bulgaria, Sweden, Portugal, Austria, France, Denmark, Italy, Latvia, Estonia, Hungary and Poland. Most of these countries, including Bulgaria, Estonia, Latvia, Poland and Switzerland, have already introduced substantial pension reforms. (Figure 1.3.1) and (Table 1.3.1)
Italy's Ministry of Economics and Finance (Note 16) has calculated that the country's ageing population will have a similar impact on public expenditure. The assumptions are the same as those used by the European Commission, with the scenario being updated on the basis of the crisis's effects and the legislation introduced in April 2011, in particular the amendments on the pension requirements for women in Italy's public administration (Note 17). (Figure 1.3.2)
The Italian government estimates that between 2005 and 2060, age-related expenditure as a percentage of GDP will rise by 2.1 percentage points and overall expenditure will fall by 3.2 percentage points of GDP. Most of this age-related expenditure will be concentrated between 2008 and 2009, and will be due mainly to a reduction in GDP due to the crisis. In the years following 2010, it is expected to fall slightly and then rise again from 2027 to 2040-2046, when Italy's so-called baby boom generation will start to draw its pension, and then reach 30% of GDP around 2045. From 2055 there will be a reduction in its ratio to GDP until it falls to levels even lower than those of 2010. (Figure 1.3.3)
After an initial phase of light growth, pension expenditure as a percentage of GDP will fall until 2027. It will then start to rise again and reach a high of 15.7% of GDP around 2040; in the following years, however, expenditure will fall until it reaches 13.9% of GDP in 2060.
The assumption for health expenditure (Note 18), which is expected to grow as a percentage of GDP for most of the forecast period, will settle at around 8.8% of GDP during the final decade.
Expenditure on social care and healthcare for the elderly (Note 19) as a percentage of GDP will grow for the whole of the forecast period until it settles at 1.7% in 2060.
Expenditure on education (Note 20) as a percentage of GDP, which stood at 4.2% in 2010, including the effects of the State-school reform, will fall in the next thirty years and then rise again towards the end of the forecast period, settling at around 3.4% in 2060.
Forecasts for social security expenditure-to-GDP ratio will rise from the 0.4% of 2008 to 0.7% in the three-year period 2009-2011; one reason is the higher spending due to the unemployment caused by the economic crisis. After 2011, when extended social security will no longer be financed, as per current legislation, there will be a realignment of the expenditure-to-GDP ratio to about 0.4%, a figure that will be fairly stable for the entire forecast period.

Figure 1.3.1

Estimate for age-related expenditure as a percentage of GDP and 2060/10 % var. EU27 countries

Table 1.3.1

2060/10 % var. in estimate for age-related expenditure as a percentage of GDP by expenditure type in some EU27 countries.

Figure 1.3.2

Total public expenditure and age-related expenditure as a percentage of GDP. Italy - Years 2005-2060

Figure 1.3.3

Public expenditure by type as a percentage of GDP. Italy - Years 2005-2060

1.4 Federalism

(Note 21) Italy has taken measures to consolidate its public finances and they are expected to improve further with the introduction of fiscal federalism. Fiscal federalism is expected to be a turning point in the rationalisation of Italy's expenditure, as it plans to apply standard costs, streamline local bureaucracy and decentralise operations for some regions and autonomous provinces. It is also expected to improve revenue as it fights tax evasion with a sharing scheme for any recovered tax that should encourage local governments to take a more active role.
In this part of the chapter, we will first outline the economic efficiency stated by literature on fiscal federalism to support the processes of fiscal decentralisation; we will then go on to highlight the role that this efficiency in resource allocation will play in the sustainability of public finances. With the help of indicators, we will then provide a snapshot of the situation in Veneto against the backdrop of Italy's public finances on the eve of the reform envisaged by Proxy Law LD 42/2009, which will introduce fiscal federalism. Lastly, we will mention the main principles geared towards sustainable public finances that are contained in Italy's recent reforms.
Fiscal federalism: for an efficient public administration
Since the 1950s, economics literature has stated a series of reasons to support fiscal decentralisation. Economists have concentrated mainly on why fiscal federalism is the best way to improve the efficiency of resource allocation.
A more federal approach to fiscal policy would encourage economic efficiency for a range of reasons:
  • as local governments are closer to citizens, they are better placed than a more central system to listen to their needs for local goods and services;
  • if the cost of public services is supported at local level, citizens have more control over the work of local administrators, thus increasing their sense of responsibility (or accountability);
  • if individuals have a certain mobility, the differences in local budgetary policy (i.e. different combinations of public services and taxes) may introduce some form of competition between local governments and help to increase efficiency. Decentralisation reduces the information asymmetry between politicians and citizens and thus enables the latter to assess the choices by a range of local governments and to discriminate between good government and bad government, what is known as yardstick competition. This also enables local governments to compare their performance with that of other local governments and to set out best practices;
  • decentralisation is a context in which public policies can be tested at local level, as a way of improving the efficiency of the public sector and of introducing technical progress. If successful, projects tested by a local government could also be introduced by other local governments or even by central government;
  • lastly, all of these reasons suggest that fiscal decentralisation promotes economic growth, a statement that is also supported in the most recent empirical literature (Note 22).
From economic efficiency to sustainable public finances
As regards the sustainability of public finances, although fiscal federalism does not pursue this objective directly, over the last two decades it has featured in political debate as a means of making public administration more efficient and thus helping to balance public finances. A more federal approach promotes financial sustainability through these distinct features:
  • financial autonomy of local authorities, which ensures that revenue can be earmarked for real expenditure needs so as not to hinder re-entry within the parameters of the Stability and Growth Pact;
  • revenue planning, which enables local authorities to anticipate the trends of major components, including any negative fluctuations;
  • incentives for efficient and effective use of resources by local administrations;
  • full advantage can be taken of budget management autonomy, which enables local authorities to make a greater contribution to the reconstruction of public finances.
Public finances and federalism today: the situation in Veneto
With the financial and political crisis of 1992, Italy took a more decisive step towards fiscal decentralisation, making local governments more responsible for their budgets, reconstructing greater fiscal autonomy and offering more room for manoeuvre in expenditure.
On the eve of the reform envisaged by Proxy Law LD 42/2009, Veneto had 16% financial autonomy (For more information see: "Federalismo fiscale: temi e quadro attuale"), a figure measured on a fiscal decentralisation index calculated as a share that regional and local administrations hold of their own tax.
In 2008, taxes from public administrations (State, Regions, Provinces and Municipalities) amounted to 503.7 billion euro, 32.1% of Italy's GDP. The State keeps 84% of its own tax and the remaining 16% is shared among regions with ordinary statute (8.4%), regions with special statute (1.2%) and local administrations (6.3%).
However, overall expenditure by regional public administrations is 31%, mainly due to regional healthcare expenditure, which on its own accounts for 13.8% of the public total. (Figure 1.4.1) and (Figure 1.4.2)
The State redistributes resources to less wealthy regions and ones with special statute. This system is also linked to historic spending criteria, which have never been completely reviewed in order to direct them towards the more rational criteria for fiscal capacity and expenditure requirements established by constitutional lawmakers with the reform of Title V.
At this point, it would also be useful to analyse regional state expenditure starting with information in reports by Italy's State Paymaster's Office, the Ragioneria Generale dello Stato. The data cover State budget expenditure in the regions in 2009. The expenditure was either direct or transferred to other public administrations within the region. If we calculate expenditure per inhabitant, we see that Veneto is in last place in the regional rankings. In Veneto, the State spends 3,139 euro per inhabitant compared to an average of 3,900 euro in the regions with ordinary statute and 5,399 euro in regions with special statute. These regional differences in expenditure per capita suggest that it might be opportune to recalculate expenditure in accordance with objective regional needs and to bring it in line with these needs. (Figure 1.4.3)
Regional revenue is also governed by equalisation criteria that determine how resources are redistributed. Initial fiscal federalism reforms in Italy in the early 1990s did little to change the previous situation. Legislative Decree DL 56/2000 attempted to make interregional equalisation of resources more rational; it preceded the constitutional reform of 2001 with a new system for financing regions with ordinary statute which had the dual objective of extending financial autonomy and making regions more responsible for their expenditure and taxation policy.
However, this decree was limited by the fact that it introduced an equalisation system that mainly redistributed healthcare resources, which central and regional governments had already negotiated. Legislative Decree DL 56/2000 was brought to a halt in 2004 after some regions that had been penalised by the decree appealed to Italy's Regional Administrative Court (TAR) and its Constitutional Court against the Prime Minister's Decree (DPCM) of 2002 that applied the law.
Although it was clear where the redistribution effects of resources were heading as soon as the reform was issued, the penalised regions asked to have these new criteria suspended and corrected, announcing that the lower revenue would not enable them to balance their budgets or cover basic levels of healthcare, as safeguarded by Article 117, Paragraph 2 Letter m) of the Constitution. Interregional disputes over equalisation led to a rewriting of DL 56/2000 that began in 2005 to ensure greater 'solidarity'.
In 2008, the Veneto region paid less wealthy regions 824 million euro, almost one tenth of its budget revenue and one fourth of its VAT. (Figure 1.4.4)
Regional redistribution of resources is not only governed by the equalisation envisaged in DL 56/2000. There is also implicit equalisation in the allocation of government transfer payments that the regions use to finance sectors outside healthcare, sectors such social care, education, culture, housing, transport, financial support and local finance.
These allocations are covered by a range of criteria, but overall the equalisation is clear and consistent over time. Taking 100 as the average of tax transfers to regions with ordinary statute, each Veneto citizen receives an average of 68.
Veneto's lowly position in the tax transfer rankings is not only isolated to the year in question, 2007. It is the result of the equalisation that began in the 1970s and that was consolidated as time went by.
This is why the long and winding road towards a full and consistent implementation of fiscal federalism also requires the equalising criteria at the heart of the allocation plan to be analysed and revised so that the historical scenario can be changed once and for all. The previous regional allocation criteria should only be maintained if there are justifiable social and economic reasons for doing so, even in the light of the constitutional reform. (Table 1.4.1)
Lastly Veneto also sits at the foot of the rankings for government transfer payments to its local authorities.
There are huge differences between average regional values if we look at current revenue.
Regarding municipalities, in particular, tax autonomy, which is measured as a ratio between total tax revenue (net of income tax) and total current revenue, stands at an average of 37% and is extremely unequal throughout the country. However, contributions and transfers cover an average of 36% of the resources of regions with ordinary statute; these resources provide Italy's Northern regions with financing that is below the national average; the figure stands at 50% of current revenue for some regions in the South. Against this backdrop, although Veneto's municipalities receive less than the national average of transfers, they still manage to finance current expenditure without using the maximum taxes, which are lower than in Lombardia and Emilia Romagna. (Figure 1.4.5)
Sustainability within fiscal federalism reform
The approval of the proxy law on fiscal federalism (L no. 42 of 5 May 2009) marked the start of an important process that will re-establish and reform Italy's financial framework. The implementation of the proxy within the law is a source of great hope, both in the North and in the South of Italy, that it will bring the public administration closer to its citizens and make it more efficient, eliminate waste and consequently relieve overall fiscal pressure. The implementation of the proxy law is expected to provide Veneto with more fiscal autonomy and to redress a balance that has always penalised the region, thus enabling it to make decisions that will strengthen transparency and responsibility in the local area.
Laws L 42/2009 (fiscal federalism) and L 196/2009 (public finances reform) contain a host of opportunities to pursue the sustainability of Italy's public finances by making its public administration more efficient:
  • revision of historical expenditure and application of standard costs: one of the main objectives of Proxy Law LD 42/2009 is to change the transfer system based on historical expenditure to one based on the standard costs and requirements needed to ensure full financing of basic levels of local healthcare, social care, education, and public transport across the whole country. There will need to be a distinction between structural and objective cost factors and expenditure due to inefficiencies in the supply of services. Only the former are to be financed by an interregional support scheme, whereas the latter will need to be covered by autonomous fiscal efforts or by reducing the resources to other expenditure items;
  • increased financial autonomy: for the other items, lawmakers recognised that uniformity in the levels or features of local services is not only unnecessary, but may also be counterproductive when the aim is to create different policies that deal with specific local requirements. Meeting local requirements and having more resources that are geared specifically to the local area are two of the reasons that different levels of government exist. Therefore, the law envisages a financing system for these items based on regional revenue with an equalisation that is more geared towards enabling regional governments to exercise full autonomy at local level and to become more responsible;
  • more fiscal flexibility: more room for manoeuvre in terms of local tax and income tax i.e. more power to raise or lower income tax brackets, or the option of reducing income and local tax, will enable regions to run an active fiscal policy that will have a greater effect on the economic and social fabric and to take full advantage of horizontal subsidiarity;
  • incentives for virtuous behaviour: Proxy Law LD 42/2009 envisages a series of incentives that reward local authorities that adopt virtuous measures. In particular, rewards will be given to regions that introduce measures to combat tax evasion, e.g. any evaded tax that is recovered may be paid directly into the regional coffers; regions that each year comply with Italy's Health Pact and Internal Stability Pact will also be rewarded;
  • sanctions: Proxy Law LD 42/2009 also envisages a series of sanctions and restrictions for non-compliant regions. Any non-fulfilment of the Health Pact will affect the supply of additional government healthcare funding and the region will be given a warning, which may lead to local and income tax brackets being raised to the maximum envisaged by current law, an automatic freeze of regional healthcare staff recruitment until 31 December of the second successive year, as well as a ban on any non-essential expenditure during the same period. These sanctions may also lead to "political bankruptcy" and the regional council being dissolved;
  • coordination of public finances: lastly, Law L 196/2009 lays out a new financial planning cycle that sets the main objectives for public finances (e.g. for net borrowing, cash balance, debt and fiscal pressure). In this way, each level of government knows exactly what it needs to do in order to reconstruct its public finances.

Figure 1.4.1

Percentage distribution own tax by government level. Italy - Year 2008

Figure 1.4.2

Percentage distribution of total consolidated expenditure by government level. Italy - Year 2008

Figure 1.4.3

State budget expenditure per inhabitant by region (euro) - Year 2009

Figure 1.4.4

Equalisation of Legislative Decree  DL 56/2000 (in millions of euro) - Year 2008

Table 1.4.1

Current government transfer payments to Italy's regions (index numbers: national average=100) - Year 2007

Figure 1.4.5

Breakdown of current municipal revenue for regions with an ordinary statute (average for regions with an ordinary statute =100) - Year 2008

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