Italy’s youngest-ever prime minister

From Mayor of Florence to Italy’s new Prime Minister: At just 39 years of age, Matteo Renzi became Italy’s youngest-ever prime minister in late February.

Following his December victory for the leadership of the Italian Democratic Party, Renzi quickly became frustrated with the government’s prolonged stalemate. In mid-February, having lost patience, he called a meeting of the Parliamentary Party, during which he briefly thanked Letta for his leadership but also called for his resignation.He had always maintained he wanted to become prime minister after a popular vote. On the other hand, he understood that a bad result at European elections would have undermined his leadership. If he had to pay this (electoral) price, better to be in the front line. Over the course of his relatively short political career, Renzi earned the nickname of “il Rottomatore”, meaning “the demolition man”, thanks to his reputation for taking on the establishment and pushing through political reforms. The Financial Times has dubbed him “a young man in a hurry,” but a number of commentators have questioned whether his lack of experience at the national level could undermine his ability to modernize Italian politics and kick-start economic growth. Others, however, suggest his very willingness to shake things up is what Italy needs and that this willingness to push for reforms will be precisely the source of his success.

INSTITUTIONAL REFORMS

Renzi’s institutional reform agenda: Renzi firmly believes that Italy is a country that has succeeded over the previous decades in spite of its politicians, not because of them. Renzi has committed to implement some institutional reforms. Italian politics are, of course, famous for instability and gridlock. Since 1945, Italian governments have, on average, lasted just more than 18 months, and Renzi is Italy’s fourth prime minister in just more than three years. This instability is in part due to the caprices of how the Italian Parliament is elected – the system favors support of small minority parties and, as a consequence, requires complex coalitions; but it is also in part due to the recalcitrance of the Senate, which has often sought to block reform. Renzi will seek to reform both: through the abolition of the Senate and the reform of the electoral law.

ECONOMIC REFORMS

Renzi’s economic reform agenda and challenges: Renzi has begun laying out the new government’s economic policy agenda, intended to kick-start Italy’s recovery. European Parliament elections in late May will be regarded as an assessment of his first hundred days in office (for more info on European Parliament elections’ analysis and scenarios, please see speaking notes “Ahead of the 2014 European Parliament elections”). He is therefore under pressure to prove he can lead to a change of pace compared to the previous government in the lead-up to the vote. Progress on economic reforms will be incremental although technical challenges, mainly related to the government’s persisting fiscal constraints, may make it difficult for the new administration to implement the proposed measures in full. The spending review, thanks to which some of the proposed tax cuts will be financed, for instance, is not merely a technical exercise but it will require contentious political decisions, such as a public sector hiring freeze, cuts to military spending, and a major re-structuring of procurement mechanisms.In parallel, political constraints, stemming from the diverse composition of the ruling coalition and from deep divisions within Renzi’s own Democratic Party, will limit the scope of structural reforms the new government will be willing and able to enact.

Economic agenda measures: On April 8^th the Italian government approved the government’s annual economic and financial review (DEF), which is composed of two main sections: 1. the stability program, which deals with the macroeconomic and fiscal projections for the years 2014 to 2018, and 2. the national program of reform (PNR), which is an update of the structural reforms and growth measures already approved and in the pipeline. The main tax measures will be – a € 10 bn cut in income taxes for lower wage earners, and a cut in a regional corporation tax.  Renzi said the government would fund the tax cuts in 2014, which would give low-income workers an extra €80 a month from May, by cutting public spending by €4.5bn, raising €2.2bn through higher VAT revenues (that are expected to come from payments of government arrears to the private sector) and increasing the tax rate on income for Italian banks derived through a recent revaluation of their shareholdings in the Bank of Italy. The least expected new measure in fact is an increase in the tax banks have to pay for their revaluation of their share in the Bank of Italy.

In more detail, the structural reforms and growth measures contained in the government’s annual economic and financial review (DEF) include:

1. Cut in the tax wedge (effective on 1 May): envisaging a cut in personal income tax (worth € 10 bn at full regime and € 6.6 bn in 2014) and a cut in the regional income tax (IRAP) rate for private firms by 10%. The Def is likely to confirm that the implementation of the growth measures should be budget neutral and won’t, therefore, affect the fiscal projections presented in the stability program. This has swept away concerns about the government’s commitment to keeping the deficit on a downward trajectory firmly below 3%. In a nutshell, the personal income tax cut will be financed mainly via the spending review process – worth EUR 32bn over the period 2014-2016, EUR 4.5bn of which will come in 2014 – while the cut in the IRAP will be offset by an increase in the withholding tax on financial income (with the tax rate being raised from 20% to 26%). 

Our take: A reduction in the tax wedge is a necessary measure to foster Italy’s economic recovery in the short term, therefore the government’s decision to reduce the tax wedge is certainly a step in the right direction. The cut in personal income tax is expected to support real disposable income and revive private consumption, given government’s decision to target this measure at low-income earners who have a high propensity to consume (rather than save). In contrast, we think the cut in taxes levied to firms will have only a limited impact on firms’ labor cost. This intervention is not bold enough to address the reduction in the labor cost Italy needs to regain competitiveness, implying a reduction of less than 1%, according to our estimates.

2. An intervention to speed up payment of public administration arrears (by July 2014): which should be worth € 13 bn by 3Q14 (totaling EUR 60bn, when we take into account about € 47 bn already approved by the previous governments). This looks to fall short of the previous announcements made by Renzi, which referred to € 68 bn.

Our take: In our view, this is a very welcome step, which confirms the new government’s commitment to pushing ahead with urgent measures to alleviate the severe situations of firms, while putting further effort to achieve a complete liquidation of all arrears and avoiding a further accumulation in the future. 

3. The overhaul of the labor market (the so called Jobs Act): the government announced several measures. Some of them will be implemented via a decree law: they are therefore detailed and become immediately effective, although the parliament has to transform the decree into law within the next two months. Some others will be approved by a longer legislative process and still need to be formalized. As for the first group of measures, the government announced: 1. A change in the regulations for fixed-term contracts that eliminates the need for employers to specify the reason behind the fixed-term contract if applied for the first time, provided that its duration does not exceed 36 months (which is also the maximum duration of this type of contract). It is now also possible to renew the fixed-term contract several times (the Fornero reform allowed for a single renewal) within a 36-month period. Last but not least, companies will be allowed to hire 20% of their workers on rolling, short-term contracts for up to three years. Previously, these contracts had been limited to a maximum of 12 months on rolling, short-term contracts. While the reform has been heavily criticized by the CGIL – the left-wing trade union confederation – market analysts suspect it will provide a boost to employment in SMEs, which account for 9 out of 10 jobs in Italy. 2. simplification of the existing regulation for apprenticeship contracts, to provide the employer with more incentive to use this kind of contract. Moreover, companies are no longer obliged to give apprentices open-ended contracts, before hiring a new apprentice.

Our take: The direction is the right one, as the whole set of measures, if implemented, would tackle several vulnerabilities of the Italian labor market. As for the changes in the regulation of apprenticeships and fixed-term contracts, we like the measure to make it easier for firms to offer apprenticeships, as this type of contract can really represent the most appropriate tool to match supply and demand of labor, particularly for the youngest. We also think that the new regulation would restore, and rightly so, some of the flexibility that was eliminated by the Fornero reform. However, we would have preferred to see this change going hand in hand with the immediate introduction of the single open-ended contract (SEC) as the main entry contract. The SEC has always been one of the key features of Renzi Job’s acts, but it looks as if the government’s commitment to implement it is now a little bit less strong than it was before. Last but not least, the idea of strengthening the unemployment benefit system and of introducing a minimum guaranteed wage has several positive aspects, particularly in the current environment in which poverty is spreading fast. 

These measures will be effective in lifting economic growth but cutting significantly the tax wedge in the component related to taxes levied on the employer would be a much more effective: UniCredit thinks that these measures to revamp economic activity, particularly the cut in the component of the tax wedge related to the taxes levied on employees as well as the repayment of the public administration arrears, will be effective in lifting economic growth somewhat. Nevertheless, cutting significantly the tax wedge in the component related to taxes and contributions levied on the employer would be a much more effective way of tackling Italy’s structural problem of excessive unit labor cost growth.

Renzi has proven he is willing to take risks, but in doing so, he has, of course, made enemies: In less than two months, Renzi went from being mayor of Florence to leader of the Democratic Party to prime minister. In doing so, it seems, he has swept away the old guard of the Democratic Party. His objective now is to transform Italy’s political infrastructure and institutions. While inexperienced, Renzi has proven he is willing to take risks that previous generations of Italian politicians have refused even to take into consideration. As a consequence, he has begun much-needed reforms to the labor market, electoral law, the political bureaucracy, and the tax system. In doing so, he has, of course, made enemies among the old political elite and the Italian establishment. For now, however, Renzi seems to be enjoying a honeymoon period with the Italian public. Recent opinion polls show that 69% of the population views his 100-day plan favorably.

Can Renzi succeed? Despite the reforms he wants to put in place will face the many informal veto players which in Italy have always tended to preserve their own interests, if the Italian public perceives that the reforms will more or less benefit the majority of the population, his honeymoon is likely to continue. Renzi knows its government must be fast, both because the reforms are very far reaching and also because as he used to say, he and his government are on a bike: if they stop biking, they fall. But if they bike fast, they will be able to keep the necessary balance to reach the destination.