Will the UK’s economy flatline like Italy’s?

The Resolution Foundation think tank and the London School of Economics (LSE) on Tuesday launched a major two-year research programme called The Economy 2030.

The goal of is to analyse “the nature, scale, and context for the economic change facing the UK during the 2020s”.

And its launch document argues that if policymakers and politicians make poor choices in the coming years the UK economy risks a period of decline relative to the other major European economies and “will end this decade closer to Italy than Germany when it comes to economic performance.”

It’s a striking warning, but it also raises three questions.

First: why is the Italian example something to be feared?

Second: what has happened to Italy?

Third: is it something that could realistically happen here?

A glance at the data confirms that Italy has experienced a long period of economic decline.

As recently as the 1980s the Italy was broadly equal in economic size, population and prosperity to the UK. Indeed, at one point in 1987 Italy was reported to have overtaken the UK as the world’s fifth largest economy in an event celebrated in Rome as “il sorpasso”, or the overtaking.

Whether that overtaking was genuine or not is unclear. The calculation seems to have hinged on the size of the black economy in Italy.

Nevertheless, it’s clear there has been a major divergence between the performance of the UK and Italian economies since then.

A gap began to open in the middle of the 1990s and it was a trend which accelerated from the turn of the millennium. Between 2000 and the eve of the pandemic the UK economy had grown by 40 per cent. Italy’s was just 3 per cent larger – a shockingly weak performance.

To some extent this divergence is due to differing rates of population growth. Both countries had roughly the same population in 1987. But the UK population has grown by around 10 million since then while in Italy it’s up by just 3 million.

All else equal a country with a larger population will have a larger economy. But all else has not been equal. Since 2000 the UK’s GDP per capita (so adjusting for the size of the population) is up by 20 per cent. Italy’s, by contrast, has fallen by 2 per cent.

That’s because the productivity, or efficiency, of the Italian workforce and its businesses has barely grown in 20 years.

The consequence of that stagnation that, broadly speaking, the Italian population are, on average, no better off than they were two decades ago.

More clear evidence of the malaise of the Italian economy is its unemployment rate. Since 2000 the average jobless rate in the UK has been 5.5 per cent. In Italy it has been over 9 per cent.

Another symptom of Italy’s malaise has been its high public sector debt.

Through the 2000s it was more than 100 per cent of GDP and is now, in the wake of the pandemic, more than 150 per cent (though the UK’s has risen a lot too since the 2000s).

So why has Italy fallen into this crisis? To some extent it is the consequence of joining the euro in 1999. Most economists agree that monetary policy, as administered by the European Central Bank (ECB), was far too tight for Rome in the wake of the global financial crisis in 2008.

And the ECB failed to stand behind the Italian sovereign bond market in these years, prompting a disastrous international market run on Italian debt in 2012 which forced up interest rates to unsustainable levels.

When the ECB eventually stepped in to calm the market the price of this assistance effectively imposed on Rome by the European Commission and Germany was a contractionary fiscal policy, which sent Italy back into repeated recessions and pushed up unemployment.

So the macroeconomic policy imposed on Italy has certainly been a big part of its economic distress, just as it has been a part of the suffering in other eurozone states such as Greece, Spain and Portugal.

But it is not all of it. Over the past three decades and more Italy’s politicians have also persistently failed to open up Italy’s sclerotic labour markets. They have shied away from tackling opaque governance in private business. They have not dismantled regulation and bureaucracy that chokes innovation and entrepreneurship. They have not cleaned up the banking sector. They have neglected weak educational standards in schools. All this has eroded the country’s competitiveness relative to other European economies.

This is a major part of the reason why Italy’s productivity has stalled for two decades. And this is also likely to be one of the reasons its population growth has been weak compared to the UK’s – economic stagnation may have both depressed the birth rate and attracted fewer migrant workers.

The malaise has also damaged the public finances, pushing up government deficits and the national debt as a share of national income.

When it comes to the question of whether the UK is in danger of following Italy into economic purgatory an optimist might point out that there is little likelihood of the UK joining the euro and risking a run on its debt, or facing overly tight monetary policy, or counterproductively contractionary fiscal policy.

Yet the point, as stressed by the Resolution Foundation and the LSE is that the UK has already been suffering some of the same ills as Italy outside the euro.

In both Italy and the UK, national productivity flatlined in the decade between the financial crisis and the coronavirus pandemic. In Germany it rose by 8 per cent.

Another decade of flatlining productivity in the UK could well leave us closer to Italy than Germany.

And Brexit, which analysts estimate will hold back UK productivity growth by between 4 and 6 per cent over the coming decade, will be a headwind because it will reduce our trade and business investment. Another headwind will be any permanent scarring to workers’ skills and the capacities of business from the coronavirus pandemic.

It is no exaggeration to say that the if UK policymakers make the wrong policy choices in relation to the big economic challenges of decarbonisation and technology – and duck politically inconvenient decisions on taxes, spending and regulation – relative national economic decline is a serious prospect.