Italy’s economy was able to stay afloat for a long period of time, before beginning to sink. However, in 2007 during the financial crisis on Friday the 14th of September, the economy finally sank below zero in terms of Gross Domestic Product (GDP) growth and has barely recovered since. Italy’s economy has shrunk by around 10% since 2007, as it endured a triple-dip recession
The financial crisis of 2007-2008 is regarded by many economists as the worst financial crisis since the Great Depression in 1930. The financial crisis had several negative impacts on banks, financial institutions, households, businesses and the global economy.
In this essay I’m going to discuss the impact the recession had on the Italian economy, focusing on economic growth, unemployment, country debt, banking collapse and budget deficit.Furthermore, I going to examine how a breakdown in market discipline played a role in triggering the financial crisis.
The financial crisis had a major impact on production in Italy with GDP and unemployment falling at an alarming rate. Immediately after the financial crisis, unemployment, rose to 7.8%, and GDP decreased by 5% in 2008. According to the National Institute of Statistics
During the 2007 recession, confidence became low meaning Italy suffered from demand deficit unemployment, this is when individuals lose their jobs due to decline in the aggregate demand (AD). This results in a negative economic growth and output. Therefore firms employed fewer workers as they produced fewer goods, due to lower consumer demands due to reduced disposable income and reduction in consumer confidence, some firms went bankrupt leading to more people being laid off. Firms began to minimise cost this meant firms were extremely unlikely to hire anyone as they keep laying people off. This meant a significant amount of the population were unemployed, reducing investment and consumption meaning a reduction in AD as consumption and investment are both components (C+G+I+(X-M). This makes the recession worse as there is no money to stimulate the economy.
Employment in 2009 declined by 380,000, while the unemployment rate rose to by 1% from 2008. The largest job losses affected workers on temporary contracts also known as “zero hours” contracts. From 2008-2009, the number of workers on fixed-term contracts decreased by 11% compared to temporary contract workers dropped by 16%. Unemployment among young Italians is above 27%, they are forced to sign short-term contracts, this means the labour force is not very productive as they are not being utilised fully due to the state of the economy.
With the data I have provided you can clearly see the impact the financial crisis of 2007 is having on employment in Italy. Workers who are fortunate to keep their jobs are often forced to take wage cuts which means there is a further fall in consumer spending leading to a greater fall in AD.Therefore making unemployment worse.
Output and economic growth
The financial crises led to lower investment, therefore damaged the long-term productivity of the economy. The damage has been long term for Italy, has about 15% of Italian industrial capacity has been destroyed, reducing employment and growth potential. This makes it harder for Italy to recover from the aftermath of the 2007 financial crisis.
Government spending and taxation
Governments saw a fall in tax revenue as a result of the financial crisis, due to a lack of AD in the economy. This meant firms made less profit, therefore government received less revenue from corporation tax. Workers received lower wages, as firm cut costs therefore a reduction in income tax. Even worse, people were unemployed and still are, therefore aren’t legible to be taxed which leads to further reduction in income tax revenue. Households had lower disposable income while some had to sign up for unemployment benefits, this caused a rise in government spending on welfare payments.
It is estimated about $160 billion in taxes are uncollected each year, which ranks the third highest rate in Western Europe. According to the World Bank, Italian corporate tax is around 65%, this has disincentives firms from investing as they can pay low corporation tax in a more stable economy such like Switzerland which tax rate is about 29%. I believe the money potentially generated from taxes could have been reinvested into the economy to help rebuild it, but due to employment issue and firms cutting cost, the government receives less money due to the effect of the financial crisis.
Effects on banking system
Italian banks are stuck with around €150-200 billion of bad loans and are unable to sort out this problem, therefore, has exposed its inadequate capital and reserves. During the financial crisis, many banks suffered substantial losses, and some forced into bankruptcy like Lehman Brothers. Banks lost a large amount of capital as consumers lost confidence. Therefore consumer deposits, which was a source of fund for the banks fell due to a loss in confidence, meant fewer funds for the banks. The crisis affected banks’ future profits, as regulatory and capital requirements became stricter, meant a reduction in previous profitable opportunities. Such as securities loans which were off-balance sheet activities.
Non-bank financial institutions such as pension funds, insurance, and finance companies are now subject to stricter regulatory requirements due to new regulations. This can be viewed as a positive as this means the investors are better protected if another financial crisis happens, therefore won’t lose as much compared to 2007.
Italy’s total economy debt which includes government, household and business is around 259% of total GDP and has increased by 55% since 2007. Investors are concerned about Italy’s ability to cover its interest payments without gaining higher levels of debt. This has forced Italy to pay more for credit making it more expensive, and less appealing, for investors to lend Italy money as it less likely they would get their money back. There is a fear that is the Italian government may never be able to cover its old debt and the lack of credit available will limit any possible recovery from the crisis.
Reduction in tax revenues and rising government spending through welfare payments, since 2007 has caused an increase in the budget deficit, and total government debt. Italy saw a rise in the budget deficit because they relied heavily on tax revenues from property and the financial sector. The fall in the property market hit tax revenues hard, meaning there was less money in the economy which made the recession worse as they depended on the money received from properties but the market plummeted as well.
Budget deficit usually increases as the government impose expansionary fiscal policy, in the hope of stimulating economic activity. Expansionary fiscal policy involves a reduction of taxation and increased government spending in order to increase AD to stimulate the economy. Italy’s budget deficit is currently at about 3% but government debt is estimated at $2.4 trillion which equates to about 140% of GDP. Italy’s debt ratio is the second worst in the eurozone, Greece being first.