The unexpected ‘rebirth’ of the Italian economy: it leaves Spain behind and approaches France and Germany

The Italian economy is usually a case study due to the poor results of the last decades. Real GDP per capita has not grown at all since the creation of the euro. More than two decades of stagnation and dark clouds that, however, do not prevent the sun from rising from time to time, even timidly and for a short period of time. Since 2019, the Italian economy has performed better than the rest of the big ones in the Eurozone. Rather than doing it well, it could be said that it has done less badly, because growth has continued to be meager. Faced with what has been happening in recent decades, the composition of the economy has played in favor of Italy. Against all odds, Italy (GDP per capita) has cut some ground from France and Germany, at the same time that it is once again taking some distance from Spain, whom it leaves behind.

When analyzing the evolution of real quarterly per capita income (chained volumes), it can be seen how Italy has been cutting ground with Germany and France (although it is still very far away) and has once again gained distance with Spain since 2019 at this point. In terms of quarterly per capita income, Italians are 860 euros ahead of Spain (third quarter of 2022), compared to 470 euros in 2019. In the third quarter of this year, Italian GDP has also been the one that has grown the most among the large economies.

What is happening for Italy to show a better performance than the big countries of Europe? UBS economists have been publishing from 2021 to today various documents explaining and analyze the reason for this surprising ‘recovery’ of the Italian economy compared to the German, French and Spanish: “A year ago we wrote about the reversal of growth momentum in the large economies of the euro zone, highlighting in particular the rapid recovery of Italian GDP during 2021. Now, in 2022, Italy’s outperformance relative to its peers has continued with Italian real GDP growth since the fourth quarter of 2021 outpacing that of Germany, France and Spain,” these experts conclude.

Italy has more than recovered from the covid crisis

Compared to the quarter before the covid crisis, “Italy’s GDP rebound is equally impressive: Italian real GDP is now 1.8% above the level of the fourth quarter of 2019 (France: 1.1%, Germany: 0.3%, Spain: -2%). Given that all countries were exposed to the same shocks (covid, the energy crisis and supply interruptions), what explains the continuous outperformance of Italian GDP (at least until the third quarter of 2022)? Swiss bank analysts.

While the composition of the Italian economy has been a drag on the country in recent decades, it appears to be supporting growth in recent years. Since the birth of the euro, Italy has been the ‘sick’ of the monetary club. Little or no structural reforms, massive and growing public debt, absolutely frozen total factor productivity, political scandals and uncertainty have dominated the Italian economy. However, in recent quarters it can be seen how public investment, housing and tourism are playing in Italy’s favor.

“Construction growth in Italy is much stronger than elsewhere. The breakdown by sector shows that construction made the biggest difference: in Italy, gross value added (GVA) in construction has added 1.1 percentage points ( pp) to overall growth since Q4 2019, versus between 0.2 pp and 0.7 pp in Germany, France and Spain.In addition, the industry has held up better in Italy, with GVA holding steady relative to pre-covid levels, while it decreased in the other countries,” say the UBS economists.

Evolution of GDP in the large economies. Graphic by Enrique Boyero

Italian construction has been driven by housing (in principle, Italy should be the countries less exposed to possible correction facing global housing markets), but also by public investment. “The difference in construction activity between Italy and the other countries is surprising, with an increase in GVA in that sector of 25.1% in Italy since the fourth quarter of 2019, compared to a decrease between 3.9% and 11.9% in Germany, France and Spain”, maintain from UBS.

Public works and engine

The construction sector has similar weights (VAB) in all countries (ranging from 4% in Germany to 5.4% in Italy). What explains the particular strength of Italian construction activity? Looking at the breakdown, it’s equally driven by ‘housing’ and ‘other buildings and structures’. It seems likely, according to UBS experts, that the latter reflects significant public spending on funded projects. by European recovery funds (for a value of 10.5% of GDP until 2026). In 2022, Italy received the first two payments, worth €42 billion (2.4% of GDP), plus €24.9 billion (1.4% of GDP) in financing. “However, the EU recovery fund only tells part of the story, as residential investment also showed a big rebound, after declining substantially during 2008-19,” the UBS experts say.

The key in the industry lies in the composition of its business fabric within this sector. Italian industry has better withstood headwinds from supply disruptions and higher energy prices. For example, the Italian manufacturing sector grew 3.6% compared to the pre-Covid era, while in Germany it contracted 1.8%. The two sectors that weighed the most on German industrial production, motor vehicles and the chemical sector, performed better in Italy and, more importantly, accounted for a smaller share of total production in Italy (motor vehicles: 8 .8% in Italy versus 18.9% in Germany; chemicals 5.1% versus 6.9%, respectively). So while the industry is also very important in Italy, it is much less geared towards motor vehicles, which have been hit hardest by supply chain disruptions, according to UBS data.

By contrast, the recovery in the services sector since the lifting of covid restrictions has been fairly similar across all countries, with positive contributions from professional services and trade, travel and accommodation across all four countries.

How long will Italy hold out?

How long will this rebirth last? Everything indicates that this better relative performance of the Italian economy over the rest of the large members of the euro will have very short legs. Italy has withstood the covid crisis better than expected and has recovered quickly, but, except for surprise, the growth trend of In the long term it should be the same as it was before the covidespecially if structural reforms remain unimplemented. In a ‘normal’ economic context, Italy should return to the tail wagon of Europe.

In addition, from UBS they believe that the environment is becoming complicated for Italy. “Although payments from the EU recovery fund should continue to support construction as spending remains high, or slightly lower, the contribution to growth should decline (base effect) as funds do not grow Second, rising interest rates are likely to be a major hurdle and prevent further recovery in the housing sector Third, the easing of supply disruptions is being resolved and has already started to benefit the economy. automobile production, which implies that this sector in Germany and France could recover”.

“More generally, we project that the energy crisis will affect Italian GDP during the winter months, with GDP declining in the fourth quarter of 2022 and the first quarter of 2023. While we project that activity in France and Spain will remain much better“, says the UBS report.

The unexpected ‘rebirth’ of the Italian economy: it leaves Spain behind and approaches France and Germany