Italian Businesses Have New Reasons to Worry

(Bloomberg Opinion) -- Italy's populist coalition is showing its true color — and it's one business won't like. The first major decree of the Five Star League coalition government tightens labor laws and punishes entrepreneurs who choose to relocate parts of their production. This is not the way to encourage companies to invest.

Luigi Di Maio, the Five Star leader, presented this week a set of policies which he conveniently branded as a “dignity decree.” His aim is noble: Since the Great Recession and the ensuing sovereign debt crisis, Italy has faced mass deindustrialization; precarious work is widespread. The government wants to ensure that more workers are hired on permanent, rather than short-term contracts, and that businesses keep their plants in Italy.

However, Di Maio, who is both labor and industry minister, goes about addressing these problems in the worst possible way. The main reason why Italian companies do not offer more permanent contracts to workers is because the “tax wedge” — the difference between the cost of labor to the employer and after-tax wages received by the worker — is too high. The new government does nothing to make it more attractive for businesses to hire. In fact, it raises severance pay for workers on permanent contracts, while making temporary contracts more expensive and harder to renew. The likely impact is that the number of temporary hires will decrease without, however, resulting in an increase in permanent employment.

The government's fight against plant relocation is just as hopeless. The Italian government offers subsidies to encourage businesses to produce in more depressed areas of the country, for example in the south. Di Maio wants companies that choose to move parts of their production after receiving public subsidies to pay back the money they have received — in some cases with steep penalties. The idea risks backfiring: Di Maio's threat will simply discourage companies from investing in the first place.

The decree still needs to go through parliament and it is possible it will be changed. The League, in particular, is coming under pressure from its northern base, which includes many entrepreneurs who are fearful of tighter labor laws. There are also questions over whether the new rules against relocation breach existing EU laws on the single market.

Even so, Di Maio's signal to the business world is ominous. For years, successive Italian governments have tried to make the euro zone's third largest economy more welcoming to foreign and domestic investment. Most problems, including a snail-paced judiciary and excessive regulation in the service sector, have remained unsolved. But Rome has made some progress: In the World Bank “Doing Business” rating, Italy is now ranked 46, up from 87 in 2012. It should still aim higher.

The new administration is now reversing course — and not without consequences. The Italian government has limited room to engage in fiscal stimulus given the very high public debt. Exports, which have been a strong engine of growth in recent years, are slowing because of the darkening trade outlook. A decade of slow wage growth will continue to keep private consumption in check. Italy needs more investment to speed up its lackluster rates of output and productivity growth. The sooner the new populist government realizes it, the better.

To contact the editor responsible for this story: Therese Raphael at traphael4@bloomberg.net

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