Forum Radicali.it

SOUTHERN CROSS What can be done to make it more bearable
IT IS easy to think of European countries that have trouble with their regions. There is Spain, with Basque and Catalan aspirations for independence; Germany, with feistily autonomous Bavaria and a depressed east; perhaps France, with Corsica and other little pockets of independent-mindedness. But Italy seldom figures on the list, and indeed it does not suffer from serious or violent separatism—even the Northern League's talk of a breakaway “Padania” is really just a way of pressing for more regional devolution, not independence. Yet Italy has a regional problem that is in some ways more serious than all the rest: its south, or mezzogiorno, with its chronically troubled economy.
Italy's regions have been given significant extra powers and substantial budgets (notably for health care) over the past decade, largely in response to the Northern League's demands. Cities have elected mayors, some of whom—such as Walter Veltroni in Rome—are figures on the national stage. The government recently brought in a set of constitutional changes, now passed by both houses of parliament, to give regions even more powers over education and social services.
This is said to be the biggest change to Italy's constitution in 50 years. But the centre-left opposition is against it, and the measure needs approval in a referendum, probably after the next election. Moreover, it fails to settle what is always the trickiest issue in any devolution of power: money. The regions and provinces do control some taxes, but one of the most important of these is IRAP, a form of local value-added tax on business that is of questionable legality under the EU treaties and is due to be abolished. For the time being, a big part of the regions' money will continue to come from central-government grants. This is a recipe for duplication, waste and unaccountable spending, and it may make Italy's already messy public finances harder to control.
Even so, if designed sensibly, more federalism would be a good thing in a disparate country that was united less than 150 years ago. Piedmont and the Veneto feel utterly different from Apulia or Sicily. Federalism also pleases the Northern League and its supporters. But it will not do much for the mezzogiorno. The two big problems of the Italian south are a poorly performing economy, too dependent on the public sector; and pervasive corruption and organised crime. These cannot be solved merely by giving the regions greater autonomy. In many ways, Italy, once many countries, is now two: the affluent 37m who live in the north, and the much poorer 20m who inhabit the south.

In search of a cure
Over the years, many cures have been prescribed for the southern economy. The first was migration: a disproportionate share of Italian emigrants in the late 19th and early 20th centuries came from the south. Large numbers of southerners also went north to work in new car plants and factories. But although emigration can produce a flow of remittances, it removes some of the brightest and most energetic workers and does nothing to create a dynamic economy at home.
In any case, the south now faces an entirely different migration problem: the huge numbers of illegal immigrants trying to enter the country from northern Africa across the Mediterranean. Many of them come in leaky boats, hoping to land on the islands of Lampedusa or Pantelleria. Italy is less used to handling immigration, whether legal or illegal, than most other EU countries; for many years it allowed people to enter fairly freely in the expectation that most would merely pass through on their way to their final destination, Germany or elsewhere in northern Europe. But as a member of the borderless Schengen group, Italy has now been forced to tighten its controls, especially in the south. Ironically, this comes at a time when the country's population is shrinking and it should—like the rest of Europe—be looking for more, not fewer immigrants.
The second attempt at curing the south's economic troubles came in the form of investment in factories, often state-owned. These included giant steel and chemical works, the Alfa Sud car plant, shipbuilding and others. These plants became known as “cathedrals in the desert”. They suffered from chronic low productivity, low-quality output and relatively high costs, as well as growing competition from other countries. Most of them have been closed down over the past three decades.
The third prescription was to encourage small firms to set up in or move to the south to replicate their success in the north. The region around Naples, especially around Mount Vesuvius, is littered with small textile companies, many of which resemble the sweatshops of Asia. Farther south, Basilicata has lots of small furniture-makers. But the entire mezzogiorno is suffering from low-cost Chinese competition. And this is not a region famous for its strong entrepreneurial spirit or its flexible labour market. A big reason why unemployment is so high is that wages tend to be set nationally, when they really ought to be much lower in the south. In a region with little respect for the law, the underground economy is also large.
It is not all hopeless, however. Gianfranco Miccichè, the Italian government's minister for the mezzogiorno, points to successive OECD and IMF reports which have acknowledged that public administration in the south is improving. He also claims that the unemployment gap with the north is shrinking: in 2001, he says, unemployment in the south was 21%, but it has since come down to only 14%. Over the same period, he adds, the rate of take-up of available EU regional funds has risen from a paltry 40% to almost 100%. The eastern regions seem to be doing better than the western ones. The biggest problems are now concentrated in Campania, Calabria and Sicily.The south is not without its successful industries and cities. The mayor of Naples, Rosa Russo Jervolino, agrees that the city has suffered from a loss of basic industries over the past decade, but points to aerospace and high technology as areas of growth. The universities in Naples have a high reputation for engineering. She concedes that Naples's image needs “revitalisation”, but the recovery that was set in train in 1994 by her predecessor, Antonio Bassolino, has continued. The city's infrastructure is improving, and the local economy has recovered from the near-demise of its biggest bank, Banco di Napoli, which is now part of San Paolo IMI.
Two centuries ago Naples was one of the biggest cities in Europe and capital of a prosperous kingdom (hence the venerable, note-issuing Banco di Napoli). Its setting below Vesuvius is spectacular, its archaeological museum world-beating, and the San Carlo opera house claims to be Europe's oldest. Naples ought easily to outdo such other Mediterranean cities as Barcelona in tourism and as an investment location. Yet Barcelona, boosted by the 1992 Olympics, has left Naples in the dust. Mr Bassolino, now regional president of Campania, made much of his city's hosting of the G7 summit in 1994, but the legacy has endured less well. Naples may have escaped from the deep quagmire it found itself in 15 years ago, but the city still has plenty of catching up to do.
Perhaps its biggest problem is its reputation for violent crime and corruption. Last year it was hit by a wave of gangland and drug-related killings. Although the police seem to have stopped these, the Camorra (the Neapolitan version of the Mafia) remains powerful. It did well out of relief money sent to Naples after the 1980 earthquake. If you want to know why the streets of Naples and the roads up Vesuvius are covered with rubbish, the answer lies with this organised-crime group.
And the Camorra is not alone. Calabria has the 'Ndrangheta, reputedly the toughest and hardest-to-penetrate of the southern criminal groups. It is believed to have been responsible for last month's assassination of the deputy chairman of the region, although no clear motive has yet been discovered. Mr Berlusconi was heavily criticised for his failure to speak out against the attack or to attend the funeral. Both the Italian president, Carlo Azeglio Ciampi, and the opposition leader, Romano Prodi, were there.

Cosa Nostra at work
And then there is the Mafia in Sicily. Of all the organised-crime groups in Italy, it is the Mafia that has most directly challenged the state in the past 20 years. The challenge has been partly beaten back, thanks to the bravery of a string of dedicated and hard-working magistrates in Palermo. Many top mafiosi have been convicted and jailed, often on the basis of confessions by pentiti, former Mafia members who have turned state's evidence. Yet the price has been fearful. Outside the Palace of Justice in Palermo is a moving memorial to the 12 Sicilian magistrates who have been assassinated since the 1980s.
The magistrates have not been overwhelmed by help from Rome. One former (Christian Democrat) prime minister, Giulio Andreotti, was tried but not convicted for complicity with the Mafia; the appeal court said he had merely been “friendly” with it. Marcello Dell'Utri, a close colleague of Silvio Berlusconi, who was intimately involved in the establishment of Forza Italia, was convicted of the same offence, though he has launched an appeal. Magistrates in Palermo believe that the Mafia, which was weakened in the late 1990s, has grown stronger in the past four years, partly because Mr Berlusconi and his friends have undermined the work of the judiciary.
The Mafia certainly adds to the cost of doing business in Sicily. Yet, as elsewhere in the mezzogiorno, it is the economy and high unemployment that are the most serious challenges. As Pietro Busetta, an economist in Palermo, puts it, Sicily has 5m people, but only 1m in work—replicating the general southern (and Italian) problem of too low a rate of participation in the workforce. Mr Busetta sets great store by the plan recently approved by the Berlusconi government to start work on a much-discussed bridge across the Messina straits, connecting Sicily and Calabria. Critics see this as a boondoggle that will greatly benefit a few construction companies—and no doubt both the Mafia and the 'Ndrangheta.
One thing on which Sicily should work much harder is its tourist industry. The island ought to be the jewel of the Mediterranean. It has a superb climate, wonderful scenery, an active volcano, delightful beaches and excellent food and wine. Its abundant cultural treasures range from the extraordinarily well-preserved Greek temples and theatres at Segesta, Agrigento and Taormina to the Baroque beauty of Catania and Noto. Even the Mafia tradition might attract tourists to places such as Corleone. And yet, complains Mr Busetta, Sicily gets far fewer tourists than Ibiza, and about the same number as Malta.
Sicily is a paradigm for what is wrong with the mezzogiorno, and indeed with the whole of Italy. It has a high-tech cluster near Catania and some good universities. But its tourist industry and its entire service culture are underdeveloped. The same is true right across the south—a region that should have been at least as well placed as Spain to benefit from the boom in European tourism over the past 40 years. In a very Italian way, it has manifestly failed to realise its full potential.

REFORM OR DIE Does Italy need a crisis to get things moving?
CAN Italy reform itself, or is it doomed to decline? It is always dangerous to project a trend set by a few years' under- (or over-) performance far into the future. Both Japan and Germany, once thought unstoppable and then, not so many years later, irredeemable, now seem poised to recover, and Britain's sorry post-war performance has been forgotten in the euphoria of the past 15 years. Italy's problems are as deep-rooted as any: its potential growth first slowed some two decades ago, and its demographics have looked ominous for many years.
But time can be a great healer. In the long run, Italians' natural flair, inventiveness and creativity should be enough to rescue what is still a rich country in every sense. After all, this is where much of European capitalism began, complete with modern banking and double-entry book-keeping. The country's plethora of small firms and its lack of big companies may seem a weakness right now, but in future it might prove an advantage again, providing flexibility to cope with change.
In the short term, though, there are good reasons for remaining gloomy about Italy. As in the rest of the euro zone, only more so, the country desperately needs structural reforms to liberalise markets, inject greater competition and shake up a bloated, inefficient and sometimes corrupt public sector. Currency devaluation to offset deteriorating competitiveness is no longer an option, and the vulnerability of small manufacturing firms to cheaper imports from Asia, especially China, has become painfully clear.
Faced with such huge structural problems, Mr Berlusconi's centre-right coalition government has done nothing like enough to put matters right. Unfortunately, even if the centre-left under Romano Prodi wins the election next April—which looks likely, but by no means certain—it too will find that reforms are hard to get past some of the more recalcitrant small parties in its coalition, to say nothing of Italy's entrenched special interests.
In some ways, things may need to get worse before they get better. Giuliano Amato, a canny centre-left politician who served as prime minister in the early 1990s and again in 2000-01, observes that “timing is an essential variable in economic matters.” In his first term he was able to push through a ruthless budget, slashing spending and drastically reducing the deficit, because Italy's ejection from the European exchange-rate mechanism in September 1992 produced a consensus that tough measures were unavoidable. That budget laid the foundation for the measures introduced by Mr Prodi's 1996-98 government to ensure that Italy could join the euro from the start.
Mr Monti at Bocconi University offers a similar conclusion. He says that Italian governments can take tough decisions, but only if two conditions are met: there must be both a visible emergency and strong pressure from outside. In the 1990s, the emergency was the impact of the fiscal position on interest rates and the exchange rate; the outside pressure stemmed from the desire to get into the euro.
Now, says Mr Monti, such a moment of truth is lacking. Italy is suffering from slow growth and a steady deterioration of its competitiveness, but both started long before the Berlusconi government came to office. As for external pressure, the European Central Bank, the European Commission and the financial markets are all doing their best to apply some. But Italian enthusiasm for things European has cooled markedly, and membership of the euro has had the perverse effect of dissipating some of the market signals that might otherwise have forced change.
Italy needs to look to the example of other countries that have successfully introduced reforms, and not just Britain. A more telling case across the Mediterranean is Spain. Thirty years ago, the notion that Spain, as it emerged hesitantly from the Franco era, might set Italy an example would have seemed laughable. The Spanish economy is still far smaller than Italy's, and living standards are lower—but they are catching up. The Socialist government of José Luis Rodríguez Zapatero that came to power in March last year has kept up the momentum of economic reform inherited from its centre-right predecessor.

The gain in Spain
Spain's public finances are also a lot healthier than Italy's, which is one reason why it has been able to afford such impressive infrastructure investments as the high-speed railway to Seville or the burgeoning airport at Madrid (bigger than any in Italy). The biggest Spanish companies, such as its two largest banks and Telefónica, have built up a stronger global presence than their Italian counterparts.
The differences between the two countries are palpable even to the passing visitor. There is a buzz of optimism in Madrid and Barcelona that often seems lacking in Rome and Naples. When the Guggenheim Museum in New York was looking for a new foreign outpost a few years back, a natural choice would have been Venice, which already has a Peggy Guggenheim gallery. But it spent years dithering over the site, so the prize was snatched away by Bilbao in Spain's Basque country.
Italy is not about to be overtaken by Spain. But if it is to stay ahead for long, it needs bolder political leaders who are prepared to override opposition to reform even in the absence of an immediate crisis. At the end of “I Pagliacci”, Leoncavallo's verismo opera about Sicily in the 1870s, Canio the clown, who has just stabbed his wife and her lover to death, concludes: “La commedia è finita.” It is time for Italy, too, to get serious.

ADDIO DOLCE VITA AT FIRST blush, life in Italy still seems sweet enough.
The countryside is stunning, the historic cities beautiful, the cultural treasures amazing, and the food and wine more wonderful than ever. By most standards, Italians are wealthy, they live for a long time and their families stick impressively together. The boorish drunkenness that makes town centres in many other countries unpleasant is mercifully rare in Italy. The traffic may be bad, and places such as Venice and Florence are overrun by tourists, but if you go off-season—or merely off the beaten track—you can have a more enjoyable time in Italy than practically anywhere else.
Yet beneath this sweet surface, many things seem to have turned sour. The economic miracle after the second world war, culminating in the famous 1987 sorpasso (when Italy officially announced that its GDP had overtaken Britain's), is well and truly over. Italy's average economic growth over the past 15 years has been the slowest in the European Union, lagging behind even France's and Germany's (see chart 1). Its economy is now only about 80% the size of Britain's. Earlier this year Italy briefly tipped into recession; for 2005 as a whole, its economy is likely to be the only one in the EU to shrink. Growth next year is expected to be anaemic at best.
Italian companies, especially the small, family-owned firms that have been the backbone of the economy, are under ever-increasing pressure. Costs have risen, but productivity has remained flat or even declined. Membership of the euro, Europe's single currency, now rules out devaluation, which for many years acted as a safety-valve for Italian business. Italy's competitiveness is deteriorating fast, and its shares of world exports and foreign direct investment are very low. The World Economic Forum in its annual competitiveness league table recently ranked the country a humiliating 47th, just above Botswana. The economy has also proved highly vulnerable to Asian competition, because so many small Italian firms specialise in such areas as textiles, shoes, furniture and white goods, which are taking the brunt of China's export assault.

Down at heel
The effects of decline are starting to show. Increasing numbers of Italians are finding their living standards stagnating or even falling. The cost of living is widely believed to have risen sharply since euro notes and coins replaced lire in January 2002. Property prices have certainly shot out of reach for many first-time buyers in Rome, Milan and even Naples. Many Italians are cutting back on their annual holidays, or even going without. Others are putting off buying new cars or even new suits, a real deprivation for such design-conscious people. Supermarkets report that spending now falls in the fourth week of every month before the next pay cheque arrives, a sure sign that families are struggling to make ends meet.
A lacklustre economy is causing broader problems too. Italy's infrastructure is creaking: roads, railways and airports are falling below the standards of the rest of Europe, and public and private buildings are looking ever shabbier. Educational standards have slipped: the country comes out badly in the OECD's PISA cross-national comparisons, and no Italian university now makes it into the world's top 90. Spending on research and development is low by international standards.
Italy has also suffered more than its fair share of corporate scandals, notably the bond default by Cirio and the collapse of Parmalat. And the public finances are in a shambles. Respectable estimates put the underlying budget deficit for next year, ignoring one-off measures, at 5% of GDP, way above the 3% ceiling set by the euro area's stability and growth pact. The public debt stands at over 120% of GDP and is no longer falling.
Even Italy's social fabric is coming under strain. The family remains strong and divorce rates are relatively low. But the fact that 40% of Italians aged 30-34 are reportedly living with their parents is not just a happy sign of family harmony or attachment to mamma's cooking. Many young Italians stay at home because they cannot find work or because they do not earn enough to afford a place of their own.
Social trust, a concept that is admittedly hard to measure, seems unusually low in Italy—one reason, perhaps, why family firms have always played such a big part in the economy. And respect for the rules, and even the law, never high, appears to have fallen further in recent years. Both tax evasion and illegal building, encouraged by repeated amnesties, seem to be on the rise. Organised crime and corruption remain entrenched, especially in the south.
To cap it all, Italy's demographics look terrible. The country has one of the lowest birth rates in western Europe, at an average of 1.3 children per woman, and the population is now shrinking; yet Italians are living ever longer, so it is also ageing rapidly. The economic consequences—too many pensioners, not enough workers to maintain them—are worrying enough on their own. What makes them worse is Italians' low rate of participation in work. Only 57% of those in the 15-64 age range are in employment, the smallest proportion in western Europe. Germany, by comparison, has an employment rate of 66%, and Britain one of 73%. Although overall unemployment in Italy is not too bad by west European standards, it is disturbingly high among the young and in the south.

Berlusconi's legacy
What has gone wrong with the Italian economy, and how can it be put right? These are the main questions this survey will seek to answer. But it will do so in the context of Italy's unruly political scene. Silvio Berlusconi's centre-right government, elected in May 2001, seems likely to manage the rare feat of staying in office for a full term (ending next spring)—a first for a post-war government in Italy. Mr Berlusconi is immensely proud of this. But he has much less to be proud of when it comes to the economy. In his 2001 election campaign, he promised to apply the business acumen that had helped him to become Italy's richest man to make all Italians richer. This he has conspicuously failed to do.
The Economist's view of Mr Berlusconi is well known. We declared in April 2001 that he was unfit to lead Italy, because of the morass of legal cases brought against him at various stages of his business career and because of the conflicts of interest inherent in his ownership of Italy's three main private television channels. Almost five years on, he still faces legal problems (of which more later), and he has done little to resolve his conflicts of interest: indeed, because the government owns RAI, the state broadcaster, Mr Berlusconi now controls or influences some 90% of Italian terrestrial television (which does not stop him complaining about his critics on TV). Our verdict of April 2001 stands.
Yet, as we acknowledged at the time, in 2001 there was nevertheless a case to be made for electing Mr Berlusconi's centre-right coalition. Italy badly needed a dose of pro-market reforms, liberalisation, privatisation, deregulation and a shake-up of the public administration, all of which Mr Berlusconi had promised. He even pledged to cut taxes. A majority of Italian voters, backed by much of Italian business, were willing to overlook both his legal entanglements and his conflicts of interest and give him a chance to reform the country. But as the next election approaches, very little of what he promised has been delivered, so many of his erstwhile supporters are feeling disillusioned.
Even the apparent political stability that Mr Berlusconi has fostered is deceptive. His six-party centre-right coalition has come close to collapse more than once, usually thanks to squabbling between Umberto Bossi's Northern League and Gianfranco Fini's National Alliance. Last April a row with a smaller ally, the Union of Centre and Christian Democrats, forced Mr Berlusconi to resign and form a new government.
On current form the centre-left opposition under Romano Prodi looks the likeliest victor in the election planned for April 9th 2006. But even if he manages to win, Mr Prodi will find it hard to introduce reforms—not least because his coalition embraces no fewer than nine parties, several of which will obstruct change. It was an ally of Mr Prodi's, Fausto Bertinotti, and his unreconstructed Communists that pushed him out of office in 1998. In truth, neither of the two main groupings in Italian politics offers much hope to those who believe that the country needs radical (and painful) reform.
Yet Italy is approaching a crunch. Rather like Venice in the 18th century, it has coasted for too long on the back of its past success. Again like Venice, it has lost many of the economic advantages which underpinned that success. For Venice, it was a near-monopoly on trade with the East that paid for the creation of its beautiful palaces and churches; today's Italy has benefited hugely from a combination of low-cost labour and a switch of workers away from low-productivity farming (and the south) into manufacturing (mostly in the north). But such good things invariably come to an end.
That is what happened to La Serenissima at the end of the 18th century. Venice was contemptuously swept away by Napoleon, and the last doge voted himself out of office. The serene republic is now little more than a tourist attraction, however beguiling. Could this become the fate of Italy as a whole?

THE SEARCH FOR SCAPEGOATS Economic troubles are always someone else's fault
SOME of the ills that have made Italy the new “sick man of Europe” may be beyond its control. The present government certainly likes to suggest that they are. Ministers point out that the whole of the EU, and especially the euro zone, has also been struggling economically, especially since the terrorist attacks on America of September 11th 2001. Italy's finance minister at the time, Giulio Tremonti, was quick to blame the terrorists for Italy's sluggish economy.
When he returned to his old job two months ago, after the sudden resignation of Domenico Siniscalco, Mr Tremonti soon found two new scapegoats at which to point an accusing finger: the euro and China. The political subtext was none too subtle. It was the opposition leader, Romano Prodi, who as prime minister in 1998 took Italy into Europe's single currency; and who as a former president of the European Commission could be charged with favouring globalisation and opening up the European market to Chinese imports.
Certainly the macroeconomic background of the past few years has been unhelpful to Italy. A near-stagnant, ageing Italian population has done little for domestic demand. Fiscal policy has of necessity been constrained: the previous government had to cut the budget deficit sharply in order to qualify for the euro, and the present one has had its hands tied by the EU's stability and growth pact. In its early years the European Central Bank's monetary policy has, arguably, been too restrictive for countries such as Italy and Germany, reflecting the difficulty of setting a single interest rate to suit 12 hugely diverse economies.
But Italy's biggest weakness over the past few years has been its export performance. The country's largest market is Germany, whose domestic economy, and hence appetite for imports, has recently been far from hale and hearty, although its exports are booming. Italy suffers from the opposite problem: its domestic consumption is holding up reasonably well, but its competitiveness has been sliding, which has led to a fall in its share of world exports.
This is where the euro comes in, albeit not in quite the way that Mr Tremonti and some of his colleagues like to argue. Many Italians sincerely believe that the changeover from the lira to the euro triggered a burst of inflation that cut living standards and eroded competitiveness. These problems, they feel, were exacerbated because the euro rose against the dollar. Persuaded by this argument, some in the Northern League, notably Roberto Maroni, the welfare minister, are now saying that the lira should be brought back. Mr Maroni has even tried to collect enough signatures for a referendum on the matter. Mario Monti, a former European commissioner and now president of Bocconi University in Milan, points out that the Northern League has performed a complete about-turn. In the mid-1990s it was so enthusiastic about the single currency that it wanted the north (“Padania”) to join alone if the country as a whole found itself unable to meet the conditions.
In reality the euro has not been nearly as bad for Italy as the critics suggest. Inflation, which came down sharply ahead of Italy's entry into the fixed-exchange-rate regime in 1999, has remained low; indeed, this has been one of the key benefits of euro membership. The switch to euro notes and coins three years later had a negligible effect on the general price level, according to Italy's generally reliable statistical office. Admittedly the price of a few everyday goods and services rose steeply as some tradesmen exploited the confusion at the time of the switch-over. Restaurants and bars were certainly guilty of cashing in: hence the often-heard complaint that the price of a cup of coffee doubled overnight. The government should have done more to stop such profiteering. But this sleight-of-hand does not support the argument, which even senior politicians like to trot out, that many Italian businesses chose to convert all their prices at 1,000 lire to €1, not the correct rate of 1,936 lire to €1.

A different model
What is undeniable is that the euro has perforce broken Italy's habit of frequent devaluation. In effect, membership of the single currency has forced Italy to change its entire economic model. Instead of relying on high inflation, high budget deficits and currency devaluations, it has had to learn to live with low inflation, low budget deficits and a fixed single European currency. It is not surprising that such a massive adjustment has been painful, and so far remains incomplete—notably because wage and price inflation are still higher than in other euro-zone countries.
Does that mean that Italy should have made a different choice? Mr Maroni and his allies like to point to Britain to show that a country can thrive inside the EU but outside the euro. Yet the comparison is misleading. Britain has not followed a path of high inflation, a high budget deficit and frequent devaluation outside the euro, and nor would it have been possible for Italy to do so. The sharp devaluations of the lira in 1992, and again in 1995-96, brought furious responses in other European countries, especially France. Had Italy persisted with its previous practice, it is hard to see how the single European market could have survived.

Don't cry for me, Italia
More dramatically, Italy might have come a cropper too. For there is another, more unnerving example of a country that has preferred to go its own way: Argentina. The worrying parallel is not that Argentina is a country with a strong Italian heritage, or that it was once rich but has become relatively poorer, but rather that it adopted an extreme variant of the old Italian model: high inflation, high public spending, high budget deficits and frequent devaluations. All this came to a halt in 1991, when Argentina adopted its “convertibility” plan to fix the peso against the dollar, the equivalent of Italy's decision to join the euro in 1998. Yet in Argentina, inflation, high public spending and budget deficits persisted. The result was a loss of competitiveness and a wrenching recession—and, in January 2002, the sudden demise of the convertibility plan as Argentina simultaneously devalued and defaulted (which, incidentally, proved costly for Italian savers, many of whom were heavily invested in Argentinian debt).
It makes a grim story, and there are plenty of gloomy analysts who predict a similar fate for Italy. Yet the analogy with Argentina might have been closer still had Italy retained the lira, and thus been subject to the same sort of speculative pressure that eventually broke Argentina's link to the dollar. For example, an Italy outside the euro would not have escaped relatively unscathed from the recent resignation of Mr Siniscalco and the associated controversy over the governor of the Bank of Italy (see article).
Indeed, it is membership of the euro that has made Italy's public-debt burden bearable by cutting its servicing costs sharply. Mr Siniscalco declares that, when he was finance minister, he thanked God every day for the euro, without which his job would have been even more impossible than it was already. Most Italian businesses also strongly support Italy's continuing euro membership.
This implies, however, that to remain competitive without recourse to devaluation, Italy must introduce structural reforms to boost productivity and hold down costs, as well as sorting out its public finances. The euro has, in effect, exposed Italy's true weaknesses, which are microeconomic in nature. They include rigidities in product and labour markets and insufficient competition. These structural problems are to some extent shared by all countries in the euro zone, but in Italy they often seem worse. They will be discussed in more detail in the next article.
If nothing is done, might Italy end up on the same track as Argentina, forcing it to leave the euro, devalue and perhaps default? In a country that is a member of the rich G7 club, such an event would be cataclysmic, which may be why financial markets do not seem to expect it. The spread of Italian debt over German debt remains relatively small. But it has widened in the past year or so, and credit-rating agencies have begun to sound the alarm over Italy's government debt, the third-biggest in the world. Italy remains highly unlikely to leave the euro, voluntarily or otherwise. Even so, the country should pay heed to the warnings it is starting to get from the markets.
Paradoxically, although euro membership has made it more urgent for Italy to deal with its structural faults, it may also have made it easier to avoid doing so, by cutting interest rates and eliminating exchange-rate crises. As the OECD puts it in its most recent report on Italy: “It is somewhat ironic that EMU membership...may, in effect, have relaxed the perceived need for structural adjustments on both the supply and fiscal sides.”
Something similar happened in Argentina after it adopted its convertibility plan: people started to believe that biting the bullet of a permanently fixed exchange rate was enough, on its own, to cure the economy's problems. In both countries, the new fixed-exchange-rate regime came to be seen as the end point of the reforms, rather than a prelude to broader structural adjustments. The need for these in Italy is now greater than ever.

STRUCTURALLY UNSOUND So easy to pinpoint what is wrong, so hard to put it right
OVER the past decade or two, the structural failings of the Italian economy have become brutally clear. What makes them especially hard to deal with is that for years many of them were seen not as weaknesses but as strengths. Asked to explain what is wrong with Italy, Francesca Bettio, an economist at Siena University, has an instant answer: the family. It is responsible for the fact that most Italian companies are small and privately owned; it has contributed to a low female participation rate in the workforce; and it is at least partly to blame for low social and labour mobility.
Yet for many years after the second world war, the family was considered an asset, not a liability, in Italian business. This can be seen most clearly in the proliferation of (often family-owned) small firms across northern Italy, many of them grouped in clusters: woollen goods in Biella, cotton textiles in Varese, shoes in Ascoli Piceno, knitwear in Carpi, women's clothing around Treviso (home of Benetton, among others), and so on. At one time these clusters figured in business-school studies as a key source of Italy's economic strength, especially in the north, now one of Europe's richest regions.
Indeed, Italy as a whole became a case study in “small is beautiful”. About two-thirds of manufacturing workers are in firms with fewer than 100 employees, compared with 37% in America and 31% in Germany. Italy has more small and medium-sized enterprises than any other country in Europe: some 4.5m, or roughly one-quarter of the total in the EU 15.
The flip-side of having lots of small firms, however, is a dearth of big ones. For a member of the G7, Italy has remarkably few big companies: for many years the list barely ran beyond Fiat, which at one time accounted for almost 5% of Italy's GDP. One reason for this is the heavy weight of the state, which used to own most of the big banks, utilities and even many industrial firms. IRI, the giant state holding company originally created by Mussolini, was once run by none other than Romano Prodi. Even today, many of the big companies in Italy are formerly state-owned utilities and banks. Over the past two decades, while Italy's nifty small firms were garnering so much praise, the country has lost much of its presence in industries such as chemicals, pharmaceuticals, computers and food processing.

When bigger is better
What is wrong with having lots of small firms? There are two answers. One is that globalisation and competition from Asia (especially China) have put a bigger premium on size. In the 1960s and 1970s it was enough to supply the home market, or at most reach out to such near neighbours as France and Germany, and to rely on your local bank for finance. Now to be successful a company such as Benetton has had to grow to the point where it supplies a world market and obtains its products far beyond Italy; it is quoted not only on Milan's stockmarket but New York's too.
Italy's stockmarket is tiny in relation to the size of the economy, with fewer than 300 quoted companies. The market's chief executive, Massimo Capuano, has plenty of ambition to lure more, not least through a special second market for smaller enterprises. But many owners of such firms resist any loss of control and even dislike relying on external finance. Restoring public confidence in a market that was hit hard in December 2003 when Parmalat, one of Italy's biggest food groups, went bust is also proving challenging. Parmalat had claimed to have large cash balances that turned out to be fictitious. Government legislation to improve corporate governance in the wake of the scandal is currently becalmed in parliament.
The other problem with Italy's small firms is that too many of them are in the wrong industries, relying for too long on cheap labour for their competitive advantage. The textile firms in the north that have spent much of the past year bleating for protection are classic examples. They had ten years' warning of the demise of the World Trade Organisation Agreement on Textiles and Clothing that limited imports from developing countries. Yet when the agreement expired at the start of this year, many firms rushed to Brussels to demand “voluntary” restraints on Chinese exports. Others joined the chorus attacking Italy's membership of the euro. Very few seemed willing to accept any blame for failing to establish new niches based on good design, marketing or the use of technology, rather than cheap labour.
Yet there are many examples of successful Italian firms, even small ones, that have made just such adjustments. Fifteen years ago Benetton produced almost 90% of its clothing in Italy; now the share is down to less than 30%. Geox, an innovative and successful shoemaker, produces most of its goods abroad, as does Luxottica, the world's leading maker of sunglasses. In white goods, Merloni (now Indesit), which was set up 30 years ago, has become Europe's third-biggest supplier of fridges, cookers and washing machines. Its founder, Vittorio Merloni, who is still chairman, notes that almost half the company's products are made abroad, including in China, which he first visited back in 1975. China is also, he complains, a source of counterfeit goods, complete with the “Made in Italy” label and even the washing-machine guarantee.
Another successful example is Cerutti, a maker of sophisticated printing presses based in Casale Monferrato, near Turin. Its chief executive, Giancarlo Cerutti, remembers that when his father founded the firm after the second world war, it had seven rivals. Now there is just one other maker of big printing presses, and Cerutti has almost 60% of the world market. It supplies many of the newspapers and magazines in Europe, as well as several in America. Recently it bought a production facility in China. It also has a technical centre in India, employing some of the country's finest engineers.
Italy's flagship computer firm, Olivetti, went under in the mid-1990s, but there are some Italian success stories in information technology too—and not only in the north. Near Catania, in Sicily, ST Microelectronics, a chipmaker, is part of a vibrant high-tech cluster. ST was founded in the 1960s, but was on the verge of bankruptcy when Pasquale Pistorio, now its honorary chairman, rescued it in the early 1980s. Mr Pistorio not only turned the company round, but expanded it by opening production plants near Naples and in Bari. He has nothing but praise for the skill and high quality of Italian engineering graduates.
Yet Mr Pistorio also concedes that Italy has plenty of problems. He notes that high-tech exports make up only 12% of the total, half the European average. Italy spends only 1.1% of its GDP on research and development, compared with the EU average of almost 2% and as much as 3.2% in Japan. Bureaucracy and the judicial system are slow, liberalisation is incomplete, infrastructure is poor, and the tax “wedge” that pushes up labour costs is one of the largest in Europe. Mr Pistorio reckons that the Berlusconi government has failed to create the right conditions to attract investment, whether from domestic sources or from abroad, and has not done enough to encourage innovation.
The theme is taken up vigorously by Luca Cordero di Montezemolo, chairman of both Fiat and Confindustria, the Italian business lobby. Mr Montezemolo knows all about business turnarounds: he rescued Ferrari and has helped to pull Fiat Auto back from the brink. Yet Fiat's recovery owes much to financial, not mechanical engineering. It has extracted cash from GM to allow the American car firm to drop an option it unwisely took out to buy the whole company, and it has insisted that its banks convert some of their loans into equity. Whether it has a long-term future will depend on its new models, notably the new Fiat Punto.
Sitting in his office above the glitzy Ferrari production line in Maranello, south of Modena, Mr Montezemolo says that Italy will pay a high price if it fails to introduce structural reforms. Top of his list is more competition, which among other things will involve more privatisation. His other priorities for reform are educational change, including in the universities; infrastructure, throughout the country; public administration, including the tortuously slow judicial system, which he sees as a big deterrent to foreign investors; and, echoing Mr Pistorio, more innovation and investment in R&D.
Mr Montezemolo makes it clear that Italian business is deeply disappointed with Silvio Berlusconi's centre-right government, which had promised so much when it took office in 2001. At the time Mr Berlusconi told Confindustria that “your programme is my programme”, but he has not delivered. However, Mr Montezemolo does not confine his criticism to Mr Berlusconi: he attacks all the politicians who have run the country in the past two decades for failing to take tough decisions. Nor does he accept that reform-minded governments always lose elections, citing counter-examples such as Britain.
It would be wrong to say that the Berlusconi government has done nothing in the way of reform. In two areas, pensions and the labour market, it has been quite bold, although it has built on changes set in train by previous governments. Given its demographic outlook, Italy still needs to do more to reduce its formidable pensions burden; and the government has timidly put off the start of some of its more painful reforms until 2008. But by raising the retirement age, cutting pension values and encouraging private pension funds, it has done more than some other EU countries to tackle this looming problem.
Reforms in the labour market have been even more striking. The Biagi law, named after Marco Biagi, a labour-market adviser who was assassinated for his pains, exempted many new jobs from rules that required most work to be full-time and permanent. This has led to a boom in temporary and part-time posts. The privatisation of labour exchanges and changes to apprenticeship contracts will inject even more flexibility into the Italian labour market, promises Maurizio Sacconi, the minister responsible.
Mr Sacconi claims that, in the past five years, Italy has created a net 1.2m new jobs, 700,000 of them for women, a better record than any other country in Europe (including Britain). Yet although unemployment for Italy as a whole, now just under 8%, is relatively low by European standards, Mr Sacconi acknowledges that it remains high among the young (almost 23%), the old and in the south.
Moreover, Italy's strong employment record has a downside: zero or even negative productivity growth, as more marginal and less productive workers have been brought into the workforce. It is the combination of poor productivity growth and rising wages that has caused Italy's unit labour costs to rise so much faster than those in other euro members in the seven years since the euro started.

So much to do
Mr Siniscalco, who quit as finance minister in late September, praises the government's pension and labour-market reforms, but acknowledges that too little has been done to increase competition, to liberalise protected parts of the economy or to privatise (indeed, the centre-left government before Mr Berlusconi's sold more assets than he did). As for the EU's “Lisbon agenda” of economic reform, Italy has consistently come out bottom in the scorecards of the London-based Centre for European Reform—although that may change now that a liberal-minded Europe minister, Giorgio La Malfa, is in charge of Italy's Lisbon strategy.
The obstacles to greater competition in Italy are legion. The OECD reckons that Italy suffers from the heaviest product-market regulation in Europe. Energy markets need a lot more liberalisation to match the most open in Europe; Italian energy prices are correspondingly high. The government remains the largest single shareholder in ENI, the big oil company, and Enel, the main electricity firm. It still has a golden share in Telecom Italia, although it has at least pushed through the sale of its remaining shareholding in the company. Antitrust enforcement in general is patchy.
Murky corporate governance in Italy has also been a deterrent to investment, and perhaps even to the creation of successful companies. For years even quite big firms were controlled by small groups of shareholders, often through a cascade of different holding companies. Mediobanca, a secretive Milan-based investment bank, pulled many strings from afar. Minority shareholders were mostly ignored. More recently, Italy's stuttering economy has exposed a series of corporate scandals that have weakened investor confidence.
Finance, a crucial area for an economy's competitiveness, is another big Italian weakness. The banks have changed a lot over the past 15 years: an industry that was mostly state-owned and highly fragmented is now 90% private, and the Bank of Italy has fostered a spate of domestic mergers. A few banks have emerged as kingpins: Banca Intesa; Unicredit, which this year took over Germany's HVB; Sanpaolo IMI; and Capitalia. Yet the Bank of Italy has tried to keep out foreign investors, which may help to explain why bank charges (and profits) are among the highest in Europe. The governor of the Bank of Italy, Antonio Fazio, did himself and his institution no good by trying to prevent a takeover of an Italian by a foreign bank earlier this year (see article).
Banking is not alone in benefiting from protection by its own regulator. There is not enough competition in services in general, which matters because the share of services in the Italian economy, as elsewhere, is going up—they now account for two-thirds of GDP. Small shops, taxi firms, pharmacies, notaries, tradesmen: in the land that invented guilds in the Middle Ages, most are still protected from competition by special rules, often administered by local authorities. As an example, Vito Tanzi, formerly Italy's director at the IMF in Washington, DC, tells the tale of a man who wanted to open a fish shop in a small town in Apulia but was turned down by the council on the ground that the town had one already.
Tourism is another area that would benefit from both more investment and more competition. For a country that has so much to offer in the way of culture, nature, climate and cooking, Italy's tourist industry is surprisingly undeveloped—and hotel and restaurant prices seem unduly high. In 1970 Italy was the world's top tourist destination. Today it comes fifth, after France, Spain, America and China.
One general problem is that the whole notion of service is rather undervalued. Indeed, Italy often seems to suffer from a pervasive anti-business, anti-customer culture. Italians may be entrepreneurial and creative, but they are by no means pro-market. Neither of the two main post-war political parties, the Christian Democrats and the Communists, could be described as economically liberal. Nor is the Catholic Church, still a huge influence in the country, which has always affected to disdain profit. In any case, many businessmen in Italy do better by exploiting contacts and seeking favours from the state than by building up companies or trying to serve customers better. A prime example is Mr Berlusconi, whose business success was based largely on the help and protection of certain Italian politicians.
This cultural preference for favour-seeking and the creation of protected monopolies over free-market competition could take a long time to shift. It is, naturally, also reflected in Italian politics. Why have Italian politicians, on both sides, been so slow to embrace reforms, and what are the prospects for change?

FAZIO'S FOLLY A central banker too independent for comfort
IT USED to be an article of faith among Italy-watchers that, however incompetent the country's other institutions might be, at least the Bank of Italy could be relied upon. In the 1990s it even supplied two prime ministers, Carlo Azeglio Ciampi (now the country's president) and Lamberto Dini. But the central bank's credibility has been shot to pieces by the intransigent behaviour of its governor since 1993, Antonio Fazio.
Mr Fazio has long opposed foreign takeovers of Italian banks. Even so, earlier this year, a Spanish bank, BBVA, and a Dutch one, ABN Amro, made bids for two Italian banks. Mr Fazio promoted rival domestic bids for their targets, leading the European Commission to ask whether Italy was discriminating against other EU countries. Central banks in other European countries may have their own ways of discouraging foreign bidders, but none is as explicit about it as Mr Fazio.
As it happens, Mr Fazio has pursued some perfectly sensible policies, promoting privatisation and mergers among Italian banks. Yet his response to the bid by ABN Amro for Banca Antonveneta was outlandish. He overruled his advisers by endorsing a rival bid by Banca Popolare Italiana, a shaky institution run by a close friend, Gianpiero Fiorani. Wiretaps leaked by prosecutors recorded Mr Fazio phoning Mr Fiorani after midnight to say he had just approved the bid. But when it became clear just how rocky BPI's finances were, its bid fell apart and ABN Amro won the day.
For Mr Fazio, the story is by no means over. His intervention was attacked from all sides. His friends were quick to detect an anti-Catholic, masonic or even Jewish conspiracy against him (Mr Fazio is an ardent Catholic who goes to mass every day). Exasperated members of the government, including the finance minister, Domenico Siniscalco, called for his resignation. When Mr Siniscalco failed to win the cabinet's backing, he quit (although not solely over the Fazio affair: problems with the 2006 budget also played a part). Following Mr Siniscalco's departure, even the prime minister, Silvio Berlusconi, called for Mr Fazio to go, and suggested that the European Central Bank might boot him out.
The trouble is that, in the mid-1990s, the Italian government, in its eagerness to join the euro, made its central bank more independent than any other in Europe. Mr Fazio's appointment is for life. He thinks he has done nothing wrong and is reluctant to sacrifice his job as the best-paid central banker in Europe. He can be removed only by the board of directors of the Bank of Italy, which is technically a private institution—and he chose most of the board members himself.
The government has drafted a new law to renationalise the Bank and make its governor subject to a term limit, but it is languishing in parliament. A defiant Mr Fazio has shown that he has friends in high places, not only in the Vatican but in the Northern League, the National Alliance and even in some opposition parties. The odds are that, whatever the pressures on him, he will stay until the next election—and he might not quit even then. After all, at 69, he is two weeks younger than Mr Berlusconi. Why should he give up any sooner than Il Cavaliere?

YOU CAN'T WIN Why Italian politics is impossible
MANY countries have complex political systems that reflect their past more than their present. But Italy's politics is unusually hard to fathom—just as its governments have been unusually fragile. In fact, considering the umpteen governments and prime ministers the country has got through, the system was for many years surprisingly stable.
Until the 1990s, Italian politics was dominated by two parties: the Christian Democrats and the Communists. Because by common consent during the cold war the Communists were kept out of government, every administration from 1946 to the early 1980s was led by a Christian Democrat. There followed a decade of coalitions, all of which included the Christian Democrats, but some of which were led by a Republican, Giovanni Spadolini, and others by a Socialist, Bettino Craxi.
This stable system was blown apart by three events that reverberate still. The first was the collapse of Soviet communism in the late 1980s, which led to a split in the Italian Communist Party. The second, starting in Milan in early 1992, was a series of bribery cases known as tangentopoli (bribesville), led by a group of magistrates who became known as mani pulite (clean hands). These cases led to the conviction and flight of Mr Craxi, as well as to the demise of most of the old parties. The third event grew out of the second: the decision by Silvio Berlusconi, a media magnate, to enter politics and found a new party, Forza Italia (roughly, “Go, Italy!”).
Thanks in part to his money and his media empire, and in part to Italians' disillusionment with the old system, Mr Berlusconi enjoyed instant success. His centre-right grouping won the election in 1994, only a few months after the establishment of Forza Italia. But his government lasted only eight months before being brought down by one of his allies, Umberto Bossi's Northern League.
The first Berlusconi government was followed by a technocrat-led one. The next three governments were headed by centre-left prime ministers, the first of whom, Romano Prodi, led his “Olive Tree” coalition to victory over Mr Berlusconi's “House of Liberties” in the 1996 election. Mr Prodi brought in painful budget cuts and a special tax to ensure that Italy got into the euro, but the coalition then suffered a fit of internal squabbling. Mr Prodi was ousted and, in May 2001, Mr Berlusconi's House of Liberties coalition won a convincing majority over the Olive Tree coalition in both houses of parliament.

Go, Berlusconi!
This was the moment that Italian business had been waiting for. Here, at last, was a coalition of the right with sufficient political clout to bring in long-overdue reforms. Yet, as we have seen, they were destined to be disappointed. The House of Liberties coalition has implemented reform only in limited areas, and the economy's poor performance and the country's loss of competitiveness have continued unchecked. Budget deficits have been kept down mainly by one-off measures. And for the past 18 months or so, the centre-right has been trounced every time Italians have been allowed near a ballot box, starting with the European elections in June 2004 and culminating in the rout at the regional elections last April, when the centre-left won every region being contested except Lombardy and Veneto.
This dismal performance has four explanations. The first is that, right from the start, the Berlusconi government was distracted by the time and energy it devoted to measures to deal with the prime minister's own interests and to fend off judicial cases against him (see article). These included laws to downgrade the offence of false accounting, to make it harder to use evidence from abroad, to provide for cases to be moved to a different court if there is any suspicion of judicial bias, and to shorten the statute of limitations after which offences are automatically expunged. To top it all, in mid-2003 a new law was passed to give the prime minister, as well as four of his associates, blanket immunity from prosecution while in office. This law was, deservedly, struck down by Italy's constitutional court.
The second reason that reform has proved difficult is the state of the economy. As other European countries have found, it is much harder to deregulate product markets or promote more competition when there is little or no growth. Low growth also confounds the budget arithmetic and leaves no scope for higher spending or tax cuts to cushion the short-term impact of changes. The catch-22 is, of course, that reforms become essential precisely when the economy has run out of steam. The Berlusconi government is not alone in Europe in failing to resolve this conundrum.
A third factor is, however, more peculiar to Italy. The country has moved towards a bipolar system of two broad groups, the centre-right and the centre-left, in part thanks to an electoral reform in the 1990s which provided for some 75% of the seats in parliament to be elected on a first-past-the-post basis. This was meant to discourage splinter parties, yet the influence of smaller parties remains disproportionately strong. It may even increase if, as seems likely, the government succeeds in changing the electoral law to move back to full proportional representation. The opposition has cried foul over this reform, which seems tailor-made to disadvantage the centre-left. As things stand, it will also introduce a complicated system of thresholds for representation in parliament the effect of which on smaller parties is not yet clear. But most parties seem resigned to the new system.
The big problem, as Mr Siniscalco knows from bitter experience, it that pushing through potentially unpopular reforms is extremely hard when every party within a coalition has a veto. Although Forza Italia is the biggest party on the centre-right, Mr Berlusconi has had to keep on board the National Alliance, the Northern League and the Union of Centre and Christian Democrats. Each of these has its own constituency to protect, and none is a natural supporter of free markets.
The fourth point is perhaps the most important: that Mr Berlusconi himself is not a true believer in free markets either. His own business success was built on the creation of near-monopolies that, far from being attacked by antitrust authorities, benefited from political friendships. The most notorious example is his Mediaset television empire, which needed the strong support of a Socialist leader, Mr Craxi. But even his early business career depended on favours, such as diverting the flightpath out of Linate airport to boost the value of his properties near Milan. Mr Berlusconi's instincts are those of a trader in favours and privileges, not of a competitor in unfettered markets. That is a useful qualification for a politician, but less so for building a successful liberal economy.
Despite all this, the Berlusconi government has done some things right, and not only in labour-market and pension reform. The education minister, Letizia Moratti, has worked hard to promote research and to improve Italian universities, though there is still a long way to go. As one Italian university professor disarmingly puts it, “the nice thing about this job is that you don't have to do any work.” Pay and promotion are largely determined by seniority, and Italy has proportionately fewer foreign academics than most other countries. Recent street protests in many cities led by university professors denouncing Mrs Moratti must be a sign that she is doing something right.

America's friend, and Russia's
On the whole, the government's foreign policy must be counted a success too. Mr Berlusconi braved the wrath of many of his EU allies and his own public opinion by sending troops to join America and Britain in Iraq, though he is now trying to argue that he had misgivings about the war and sought to talk George Bush out of it. His government has generally been more assertive about Italy's role in the world than its predecessors. Within the EU, it has been less deferential towards France and Germany. If Mr Prodi returns to office, he is likely to switch the emphasis back towards backing the Franco-German duo.
Mr Berlusconi's government has been more staunchly pro-American (and pro-Israel) than most previous ones. The one blot in foreign policy has been Mr Berlusconi's partiality for Russia's Vladimir Putin, whom he appears to see as another businessman-turned-politician under unfair attack from the media. During Italy's six-monthly presidency of the EU in 2003, Mr Berlusconi caused consternation in Brussels by refusing to criticise Mr Putin at an EU-Russia summit meeting in Rome. He also lost international credibility for his chairing of the EU summit in Brussels in December 2003 that failed to agree on the text of a draft EU constitution.
On defence, although like many other European countries Italy still spends too little, it has in the past few years made a useful contribution in places such as Kosovo and Afghanistan as well as in Iraq. The defence minister, Antonio Martino, is also seeing through a plan to abolish conscription and to overhaul the arms-procurement system. If Mr Prodi returns to office, there is a serious risk that his government might choose to pull troops out of Iraq too quickly, as Spain's then new prime minister, José Luis Rodríguez Zapatero, did after March 2004.
Mr Martino is one of Italy's few avowed liberals, but his influence on economic policy has, sadly, been small. Still, the government has at least brought in some tax cuts. Its stewardship of the public finances, however, has been dreadful. It inherited a useful primary budget surplus (ie, before interest payments) of as much as 5% of GDP, but it has frittered that away to zero. Moreover, although Mr Tremonti's repeated tax amnesties have seemed to keep annual budget deficits within bounds, the price of this may have been to increase Italy's already high level of tax evasion. Opposition politicians claim that tax evasion now adds up to as much as euro200 billion ($234 billion) a year. This bears heavily on those in paid employment, who find they have to pay higher taxes than they otherwise would.
Nor has the government made much of a dent in public spending. It is not hard to come up with ideas for cuts, just as it is not hard to find things to privatise. Giovanni Tamburi, an investment consultant based in Milan, has produced a detailed list of possible asset sales, including of foundations that still own some banks, as well as a programme of liberalisation. Such measures would, on his estimates, yield as much as euro200 billion a year. Some of these assets are, admittedly, in the hands of local authorities, but it remains striking how reluctant Mr Berlusconi has been to sell anything. Patronage, it seems, retains its allure.
Another undesirable legacy of the Berlusconi government is a devaluation of civic and public ethics. When a prime minister attacks his country's magistrates as part of a left-wing conspiracy, passes laws that benefit his own interests and issues repeated amnesties for people who have evaded taxes and ignored planning controls, he sends a message to the average citizen: do not bother to obey the rules. The judicial system badly needs modernising to speed up the processing of cases and reduce queues, and his government has introduced reforms which it claims will do this, but no one else seems to agree.
Would the opposition be a big improvement? It would undoubtedly encourage people to be more law-abiding, although even Mr Prodi has had minor brushes with scandal. Yet there is something dispiriting about the fact that Italian voters next April are likely to face the same choice as they did ten years earlier, between two candidates in their late 60s. Mr Prodi says many of the right things about introducing more competition and liberalisation, but you would hardly call him a liberal or a reformer. Moreover, like Mr Berlusconi, he will be hostage to other parties in his own coalition. He notes that, unlike in 1996, the Communists under Fausto Bertinotti are now formally part of the centre-left coalition, as opposed to backing it from outside, and denies that he is some sort of Mr “Prodinotti”. But he knows that he will not find it easy to keep all the small left-leaning parties behind him.
He has made several efforts to increase his chances. The first was to suggest that the parties of the left should campaign on a single platform. This was shot down by one of his closest supporters, Francesco Rutelli of the Democracy and Freedom Party. However, the idea may now be revived, partly thanks to Mr Prodi's second plan: to hold a primary of all Italian voters to endorse the centre-left's candidate for the election. This was duly put into effect, and last month Mr Prodi overwhelmingly won the ballot, on a surprisingly high turnout. That has left him rather better placed not merely to face Mr Berlusconi but perhaps also to keep a grip on his own coalition if it wins.

What next?
Mr Berlusconi now seems sure to be the candidate facing Mr Prodi. Earlier this year he flirted with the idea of stepping down to make way for somebody more popular to lead his alliance, most likely Pier Ferdinando Casini, the speaker of the Chamber of Deputies. But he changed his mind, and after a few hiccups and with a few reservations, his coalition partners now seem to endorse his candidacy.
What would happen to the centre-right if Mr Berlusconi loses the election? Presumably he would quit, and few would then expect Forza Italia to survive in its present form. There are no obvious successors to lead the centre-right. Mr Casini is a possibility, but a more plausible candidate for the leadership might be the present foreign minister and leader of the National Alliance, Gianfranco Fini.
Mr Fini is certainly a man to watch. When he first joined Mr Berlusconi's government in 1994, he was only just emerging from the neo-fascist MSI party, which formed the basis of the National Alliance. He once declared that Mussolini had been the greatest statesman of the 20th century. But for the past ten years he has been increasingly distancing himself from this past, denouncing Mussolini, cultivating Israel and serving as a briskly efficient foreign minister. Along the way he has shed some of his harder-line supporters, including the Duce's grand-daughter, Alessandra, and cemented his position as the most popular leader of the centre-right.
The only political leader who is even more popular than Mr Fini is Walter Veltroni, an ex-Communist who served as culture minister under Mr Prodi in the 1990s and is now a successful mayor of Rome. When Mr Berlusconi and Mr Prodi eventually retire, Mr Fini and Mr Veltroni may be well set to take over as the next generation of political leaders.
One thing that Italy lacks is a truly liberal-minded party. The closest are Giorgio La Malfa's Republican Party, a tiny group that has thrown in its lot with the centre-right; and the Radical Party of Marco Pannella and Emma Bonino, which is not now represented in parliament. Mario Monti, at Bocconi University, caused a stir recently by questioning the ability of either coalition to implement reforms. Many saw this as a call for a new centre party, but Mr Monti seems to have no serious plans for one. More's the pity: Italy badly needs more believers in the free market.

THE STRANGE CASE OF SILVIO BERLUSCONI A prime minister with nine legal lives
SILVIO BERLUSCONI proudly points out that, for all the legal cases brought against him over the years, he has never been convicted. He seems to see this as evidence that the magistrates involved must be biased, part of a left-wing or even a Communist conspiracy. Yet the picture is not quite as simple as he maintains.
Over the past few years, The Economist has studied the charge sheet against Mr Berlusconi extensively. We published our findings in the issues of April 26th 2001 and July 31st 2003. (On the second date, much of the detail was published on Economist.com only.)
The table summarises Mr Berlusconi's legal travails. Two points stand out. The first is that, even though he has not been definitively convicted in all of these cases, Mr Berlusconi has not been definitively cleared, either. In several cases he was initially found guilty but then acquitted simply because the statute of limitations had kicked in.
The second point is that his election victory in 2001 enabled his government to change the law in various ways that have made it easier for him to escape further convictions. The most notable example was the offence of false accounting, which was downgraded and had its statute of limitations shortened early in the present parliament.
Even so, two of Mr Berlusconi's closest friends have fallen foul of the law. Marcello Dell'Utri, a Forza Italia senator from Sicily who once ran Publitalia, the advertising wing of Mr Berlusconi's Mediaset empire, was convicted in 2004 by a court in Palermo of aiding and abetting the Mafia ( he is appealing against the verdict). Prosecutors in Palermo do not suspect either him or Mr Berlusconi of being, or having been, mafiosi. But they know that the Mafia strongly supported the establishment of Forza Italia, and that it may have found Mr Dell'Utri a useful channel. In the 2001 election, the centre-right captured every one of the 61 first-past-the-post seats in Sicily.
The second friend in trouble is Cesare Previti, formerly Mr Berlusconi's personal lawyer and defence minister in his 1994 government. Mr Previti was convicted in a judge-bribing case, but Mr Berlusconi himself escaped under the statute of limitations. Mr Previti is appealing, but the government has been trying to rescue him with a new law, known as the “Salva Previti” bill, to shorten the statute of limitations. The bill might not now save Mr Previti, but it could help Mr Berlusconi in his latest case, on charges of tax evasion and misappropriation of funds. If it is passed, it will bring further discredit to Italian public life.

[=13]SOUTHERN CROSS What can be done to make it more bearable
IT IS easy to think of European countries that have trouble with their regions. There is Spain, with Basque and Catalan aspirations for independence; Germany, with feistily autonomous Bavaria and a depressed east; perhaps France, with Corsica and other little pockets of independent-mindedness. But Italy seldom figures on the list, and indeed it does not suffer from serious or violent separatism—even the Northern League's talk of a breakaway “Padania” is really just a way of pressing for more regional devolution, not independence. Yet Italy has a regional problem that is in some ways more serious than all the rest: its south, or mezzogiorno, with its chronically troubled economy.
Italy's regions have been given significant extra powers and substantial budgets (notably for health care) over the past decade, largely in response to the Northern League's demands. Cities have elected mayors, some of whom—such as Walter Veltroni in Rome—are figures on the national stage. The government recently brought in a set of constitutional changes, now passed by both houses of parliament, to give regions even more powers over education and social services.
This is said to be the biggest change to Italy's constitution in 50 years. But the centre-left opposition is against it, and the measure needs approval in a referendum, probably after the next election. Moreover, it fails to settle what is always the trickiest issue in any devolution of power: money. The regions and provinces do control some taxes, but one of the most important of these is IRAP, a form of local value-added tax on business that is of questionable legality under the EU treaties and is due to be abolished. For the time being, a big part of the regions' money will continue to come from central-government grants. This is a recipe for duplication, waste and unaccountable spending, and it may make Italy's already messy public finances harder to control.
Even so, if designed sensibly, more federalism would be a good thing in a disparate country that was united less than 150 years ago. Piedmont and the Veneto feel utterly different from Apulia or Sicily. Federalism also pleases the Northern League and its supporters. But it will not do much for the mezzogiorno. The two big problems of the Italian south are a poorly performing economy, too dependent on the public sector; and pervasive corruption and organised crime. These cannot be solved merely by giving the regions greater autonomy. In many ways, Italy, once many countries, is now two: the affluent 37m who live in the north, and the much poorer 20m who inhabit the south.

In search of a cure
Over the years, many cures have been prescribed for the southern economy. The first was migration: a disproportionate share of Italian emigrants in the late 19th and early 20th centuries came from the south. Large numbers of southerners also went north to work in new car plants and factories. But although emigration can produce a flow of remittances, it removes some of the brightest and most energetic workers and does nothing to create a dynamic economy at home.
In any case, the south now faces an entirely different migration problem: the huge numbers of illegal immigrants trying to enter the country from northern Africa across the Mediterranean. Many of them come in leaky boats, hoping to land on the islands of Lampedusa or Pantelleria. Italy is less used to handling immigration, whether legal or illegal, than most other EU countries; for many years it allowed people to enter fairly freely in the expectation that most would merely pass through on their way to their final destination, Germany or elsewhere in northern Europe. But as a member of the borderless Schengen group, Italy has now been forced to tighten its controls, especially in the south. Ironically, this comes at a time when the country's population is shrinking and it should—like the rest of Europe—be looking for more, not fewer immigrants.
The second attempt at curing the south's economic troubles came in the form of investment in factories, often state-owned. These included giant steel and chemical works, the Alfa Sud car plant, shipbuilding and others. These plants became known as “cathedrals in the desert”. They suffered from chronic low productivity, low-quality output and relatively high costs, as well as growing competition from other countries. Most of them have been closed down over the past three decades.
The third prescription was to encourage small firms to set up in or move to the south to replicate their success in the north. The region around Naples, especially around Mount Vesuvius, is littered with small textile companies, many of which resemble the sweatshops of Asia. Farther south, Basilicata has lots of small furniture-makers. But the entire mezzogiorno is suffering from low-cost Chinese competition. And this is not a region famous for its strong entrepreneurial spirit or its flexible labour market. A big reason why unemployment is so high is that wages tend to be set nationally, when they really ought to be much lower in the south. In a region with little respect for the law, the underground economy is also large.
It is not all hopeless, however. Gianfranco Miccichè, the Italian government's minister for the mezzogiorno, points to successive OECD and IMF reports which have acknowledged that public administration in the south is improving. He also claims that the unemployment gap with the north is shrinking: in 2001, he says, unemployment in the south was 21%, but it has since come down to only 14%. Over the same period, he adds, the rate of take-up of available EU regional funds has risen from a paltry 40% to almost 100%. The eastern regions seem to be doing better than the western ones. The biggest problems are now concentrated in Campania, Calabria and Sicily.The south is not without its successful industries and cities. The mayor of Naples, Rosa Russo Jervolino, agrees that the city has suffered from a loss of basic industries over the past decade, but points to aerospace and high technology as areas of growth. The universities in Naples have a high reputation for engineering. She concedes that Naples's image needs “revitalisation”, but the recovery that was set in train in 1994 by her predecessor, Antonio Bassolino, has continued. The city's infrastructure is improving, and the local economy has recovered from the near-demise of its biggest bank, Banco di Napoli, which is now part of San Paolo IMI.
Two centuries ago Naples was one of the biggest cities in Europe and capital of a prosperous kingdom (hence the venerable, note-issuing Banco di Napoli). Its setting below Vesuvius is spectacular, its archaeological museum world-beating, and the San Carlo opera house claims to be Europe's oldest. Naples ought easily to outdo such other Mediterranean cities as Barcelona in tourism and as an investment location. Yet Barcelona, boosted by the 1992 Olympics, has left Naples in the dust. Mr Bassolino, now regional president of Campania, made much of his city's hosting of the G7 summit in 1994, but the legacy has endured less well. Naples may have escaped from the deep quagmire it found itself in 15 years ago, but the city still has plenty of catching up to do.
Perhaps its biggest problem is its reputation for violent crime and corruption. Last year it was hit by a wave of gangland and drug-related killings. Although the police seem to have stopped these, the Camorra (the Neapolitan version of the Mafia) remains powerful. It did well out of relief money sent to Naples after the 1980 earthquake. If you want to know why the streets of Naples and the roads up Vesuvius are covered with rubbish, the answer lies with this organised-crime group.
And the Camorra is not alone. Calabria has the 'Ndrangheta, reputedly the toughest and hardest-to-penetrate of the southern criminal groups. It is believed to have been responsible for last month's assassination of the deputy chairman of the region, although no clear motive has yet been discovered. Mr Berlusconi was heavily criticised for his failure to speak out against the attack or to attend the funeral. Both the Italian president, Carlo Azeglio Ciampi, and the opposition leader, Romano Prodi, were there.

Cosa Nostra at work
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