III. ECONOMIC TRENDS AND OUTLOOK MAJOR TRENDS AND OUTLOOK The government of former Prime Minister Amato embarked on a major economic adjustment program in 1992. The goal was to reduce the public sector deficit and the role of the government in the economy. The program was continued by the Ciampi government in 1993. A new government headed by Prime Minister Silvio Berlusconi and labeled Right Wing, came into office in May 1994. He has said that his government will continue the adjustment process while taking steps to reduce unemployment which is over 11 percent. The economic policies of the conservative coalition government is not expected to be dramatically different than those of prime Ministers Amato and Ciampi because there is no alternative to tight fiscal policies, the continued floating of the lira, and privatizations. The key elements of Forza Italia's economic platform were the decentralization of the tax system, the creation of a unified personal income tax rate at 30 percent, a reduction in the number of taxes from 200 to around 10, a reduction in taxes on primary residences, and tax incentives to stimulate employment. However, the need to reduce the public sector deficit is incompatible with cuts in taxes. Berlusconi promised to create a million jobs through incentives for the labor market and small and medium sized businesses and labor market flexibility. Berlusconi also promised to reform the health care, pension, and educational systems. The right supports the continuation and expansion of the privatization program to include health care and education. The Northern League is pushing to transfer taxing power from the central government to local authorities. An unanswered question is what effect these policies will have on the deficit and how successful the government will be in reducing the deficit. The pace of Italy's economic expansion began to slow in mid-1990. The slowdown continued throughout 1991, worsened in 1992, and worsened even more in 1993. Real GDP fell by 0.7 percent in 1993, the largest drop since 1975. Domestic demand fell, exceeding the substantial increase in export growth. Industrial production fell sharply, while the service sector only increased modestly. Economic growth is expected to recover moderately in 1994. Real GDP is projected to increase by 1.5 percent, industrial output by 1.3 percent and services by 1.4 percent. As was the case in 1993, GDP growth will be export-led. Exports should increase by 6 percent, while consumption and investment will continue to decrease by small amounts, 0.3 and 0.5 percent, respectively, much less than the declines registered in 1993. As bad as the recession was, it has triggered some positive and long overdue changes which will improve economic performance in the long run. Wage agreements signed in the summers of 1992 and 1993 have brought wages under control. Throughout the 1980s, wages were growing faster than the rate of inflation. That trend has been reversed. Wages and salaries are increasing at less than the rate of inflation. The growth in wages decreased by two percentage points from 1992 to 1993. Moderation in wages has played a major role in the decline in inflation and the increased competitiveness of Italy in international markets. Despite increasing unemployment and some labor unrest, the wage agreements begun in 1992 will be maintained resulting in moderate wage increases, at less than the rate of inflation. While restraint in wages has had an overwhelmingly positive effect on the economic reform program, it has had a dampening effect on economic activity. Before the 1992 and 1993 wage agreements generous wage settlements stimulated consumer demand and economic growth. The wage and salaries index increased on average in 1993 by 2.8 percent. This was 1.4 percent below the corresponding increase in the cost of living index of 4.2 percent. Inflation has moderated significantly in recent years because of the recession and the wage agreements. Inflation will be moderate again in 1994, about 3.9 percent, based on continued weak domestic demand combined with some tax increases. Although not a welcome event, the floating of the lira in September 1992 has turned into a positive development for Italian exports. The lira depreciated by 22 percent against the dollar and by 17 percent against the deutschemark during 1993. Italian exports boomed in 1993, increasing 10 percent in volume. Without the support of exports, the 1993 recession would have been much worse. Exports will be strong again throughout 1994. The lira will continue to float throughout 1994, as there is little talk in Europe about changes in the ERM this year. The biggest challenge facing Italy is reducing the public sector deficit. Italy has made some progress on this, thanks primarily to cuts in spending, particularly in health, wages, and transfers to local governments. The deficit declined in 1993 in absolute terms and in terms of GDP capitals. These results are especially positive given the recession and high real interest rates. Still the public sector deficit was one of the highest in Europe at 9.8 percent of GDP. According to the latest government figures, the 1994 deficit is 15 trillion lire (9.5 billion USD) over the deficit target of 144 trillion lire (91.6 billion USD). There will be a 5 trillion lire package (3 billion USD) budget reduction package in July 1994 and the government might move up the 1995 budget submission to July- August. The 1995 budget reduction package should be about 40 trillion lire (25 billion USD). The public sector deficit should continue to decline slowly. It should decline in absolute terms and in terms of GDP in 1994. The deficit should be about 9.6 percent of GDP. These results will be less impressive than the 1993 results because the economy will be growing and average real interest rates will be much lower in 1994 than they were in 1993. Still, greater efforts are needed to reduce the deficit further. In addition, the foreign accounts performed well. Italy posted a 32.5 billion USD trade surplus, compared to a 3.1 billion USD surplus a year earlier. In addition, there was a slight improvement in invisibles, due to a doubling of tourism receipts. Italy posted a current account surplus of 11.4 billion USD, compared to a 27.9 billion USD deficit a year earlier. Italy has been rebuilding its foreign reserves since the 1992 foreign exchange crisis. Reserves totalled 51 billion USD at the end of 1993. The foreign accounts will continue to improve in 1994. Export performance will continue to be strong with a moderate increase in imports. The trade surplus should be almost 40 billion USD, 4 percent of GDP. Italy should again post a current account surplus, about 1.9 percent of GDP. Economic Trends and Outlook for Agriculture The economic climate over the last several years has profoundly affected agriculture. In general, the price of agricultural inputs has risen and production has fallen. In 1993, the value of agricultural production declined 1.2 percent from the previous year's level. Although Italian grain production increased 1.5 percent from the previous year's level, industrial crops (oilseeds, sugar beets, sunflower seeds, and tobacco) decreased 20 percent, horticultural products 12.5 percent, and livestock 0.3 percent. The importance of agriculture within the economy also declined. In 1993, Italian agriculture, fishing, and forestry accounted for less than 5% of GDP and 7.6% of total employment. Over the last several years the agricultural sector has become more concentrated with many smaller farms going out of business. Nevertheless, in the long run, consumers are expected to benefit from the ongoing trend toward concentration in the farm and food sector, which should improve cost-efficiency. Profit margins, already low by European standards, have been squeezed further due to the recession. In 1993, there was a marked increase in international mergers in the extended food manufacturing and distribution industry as larger companies increased their marketing and advertising efforts via the supermarket chains. In 1992, there were 34,000 registered food processing companies in Italy. This number does not include family businesses that continue to dominate the industry. Located mostly in northern Italy, these family-based firms often have important regional bases. About 50 percent of the food industry's sales are generated by companies with less than 20 employees. Low profit margins have forced many small companies to sell to larger companies or to find industrial and financial partners. COMPOSITION OF ITALIAN FOOD PROCESSING SECTOR (PERCENT OF TOTAL TURNOVER, 1992) Meat Processing 21% Dairy Processing 17% Pasta Processing and Milling 9% Confectionery 9% Bakery 7% Fruit and Vegetable Processing 6% Feed Processing 6% Wine, Beer, Alcoholic Beverages 5% Mineral Water, Non Alcoholic Beverages 4% Vegetable Oil Processing 3% Other Sectors 13% Source: Alimentarista May/June '93 The move toward modernization is described as a survival technique by many food processing companies. Federalimentaria reports that food companies are listening to their customers more closely now and that brand name processors are branching out and looking for more diversified product lines. Federalimentaria notes that the food companies which were strong before the recession began will likely increase market share and profits in the long run after the current restructuring is accomplished. However, weak companies will not last long in the current low-margin environment. PRINCIPAL GROWTH SECTORS In 1993, both agriculture and industry suffered significant declines. Industry fell by 2.1 percent. Agriculture fell by 3.2 percent. The drop in the industrial sector reflects a 1.9 percent decrease in manufacturing and a 4.6 percent drop in construction and public works. Public works contracts had been frozen for over a year because of investigations into the corruption scandals. Activity in the energy sector was flat. Services increased by 1.1 percent. Domestic demand fell by 5.0 percent in 1993, due to the particular weakness of consumption and investment. Investment fell 11 percent due to a 15.6 percent drop in purchases of machines and equipment, primarily transportation equipment, combined with a 6.2 percent drop in construction. Consumption dropped 1.6 percent with private consumption dropping 2.1 percent. Exports increased 10 percent due to the impact of the lira depreciation and of the two labor cost agreements. Growth in both agriculture and industry will be positive, but modest in 1994. Agriculture should grow by 1 percent and industry by 1.3 percent. Activity in the service sector should be stronger in 1994 than in 1993. Services should grow by 1.4 percent. Domestic demand will be flat in 1994. Investment will be slightly negative. Consumption, both private and public, will be slightly negative. GOVERNMENT ROLE IN THE ECONOMY In July 1992, the Amato government announced a major privatization program designed to reduce the role of the state in the economy and to reduce the large public sector deficit and public debt. The government controlled about a third of all industrial activity and almost two-thirds of banking operations before the privatization program began. The first privatization was in July 1993 starting with Italgel which was sold to Nestl . Since that time, two major banks, Credito Italiano and Commerciale Italiana, have been totally privatized. They had been owned by IRI, the largest state holding company. A third bank, IMI, which was majority owned by the Treasury, was partially privatized. IRI also sold Cirio-Bertolli- De Rica (canned foods), part of its food holding company, SME. From July 1993 through May 1994, Italian privatizations have raised 8.6 Trillion lire (5.1 billion USD). IRI has received 5.5 trillion lire (3.2 billion USD) and almost 2 trillion lire (1.2 billion USD) has gone to the Italian Treasury. There are a number of major privatizations in progress: ILVA (steel), GS/Autogrill (highway restaurants and supermarkets), STET (telecommunications), ENEL (electricity) and ENI (energy). These should raise from 9 to 15 trillion lire (5.3 to 8.8 billion USD). The conventional wisdom is that the Berlusconi government will have no choice but to continue selling state enterprises because the Italian government can no longer afford the subsidies, and subsidies are now tightly controlled under EU rules. Prime Minister Berlusconi on May 16, 1994 when presenting his government's program to the Senate, made a commitment to speed up the privatization of INA, STET, ENEL, and ENI. On May 20, a few hours after receiving the Chamber of Deputies vote of confidence, the new Prime Minister called his first Council of Ministers meeting to approve the decree law setting the terms of the privatization of INA, scheduled for June 27. The May 20 meeting indicated that the new government is intent on keeping its commitment to continue the privatization program begun two years ago. The decree law authorizing the sale of INA was passed by parliament on June 22. Since Italy is a member of the European Union (EU), virtually all of its agricultural sector is governed by the Common Agricultural Policy (CAP). The CAP's function is to 1) increase agricultural productivity; 2) ensure a fair standard of living for the agricultural community; 3) stabilize markets; 4) assure the availability of supplies; and 5) ensure that supplies reach consumers at reasonable prices. The main tools used to meet these objectives are: 1) levies and duties are applied to imported commodities to assure internal prices are not under-cut; 2) excess domestic production is bought up at prices above world levels and then stored and disposed of by the EU through an intervention mechanism; and 3) export subsidies are granted so domestic produce can be sold on the World market. In 1993, reforms to the Common Agricultural Policy (CAP) substantially altered the market in Italy. The changes caused more production to end up on the market, rather than in the intervention stocks and thus processors were able to obtain products such as fruits, wine, oilseeds, sugar beets, tobacco, and swine at lower prices. According to ISTAT, the national statistics bureau, neither farmers nor consumers, however, appear to have benefited from these changes, since food prices have continued to rise, but farmer incomes have not increased substantially. BALANCE OF PAYMENTS SITUATION Italy's current account of the balance of payments improved dramatically in 1993. The current account balance switched from a 34.2 trillion lire deficit (27.8 billion USD) in 1992 to a 18.0 trillion lire (11.4 billion USD) surplus in 1993. This was due primarily to a 47.2 trillion lire (30 billion USD) improvement in the trade balance in response to the sizable depreciation of the lira since September 1992 and price restraint on the part of Italy's suppliers of foreign goods. In addition, the deficit on invisibles decreased by 5.0 trillion lire (3.2 billion USD), due to declining Italian interest rates. The capital account registered a net 10.8 trillion lire (6.7 billion USD) inflow in 1993, basically the same as in 1992. Net investment inflows improved by 90.3 trillion lire (57.4 billion USD) from 1992 to 1993. Investment inflows totalled 76.5 trillion lire (48.7 billion USD) in 1993. Offsetting this, net inflows from foreign banks deteriorated by almost 80 trillion lire (50 billion USD) and private and public loans deteriorated by 7.4 trillion lire (4.7 billion USD) in 1993. The current account and capital account surpluses plus errors and omission resulted in a 2.2 trillion lire (1.4 billion USD) increase in the Bank of Italy's official reserves in 1993. TRADE AND INVESTMENT BARRIERS Agricultural Product Subsidies Italy subscribes to EU directives and organization for economic cooperation and development agreements on export subsidies. Through the EU, it is a member of the GATT subsidies code. Italy also provides extensive export refunds under the Common Agricultural Policy (CAP), which as of October 1993 are being scrutinized under CAP reform and the GATT negotiations. Italy has an extensive array of export promotion programs. Grants range from funding of travel for trade fair participation to funding of export consortia and market penetration programs. Many programs are aimed at small-to-medium size firms. Italy provides direct assistance to industry and business firms to improve their international competitiveness. This assistance includes export insurance through the state export credit insurance body, as well as direct export credits. With respect to export-promoting subsidies, U.S. Industries have recently expressed particular concern over Italian government subsidies to the steel and shipbuilding industries. Broadcast Directive and Motion Picture Quotas In keeping with the 1989 EU broadcast directive, Italy's 1990 broadcast law requires that upon conclusion of three years from concession of a national broadcast license, a majority of tv broadcast time for feature films be reserved for EU-origin films. The Italian law also requires that half of the European quota be dedicated to Italian films. The Italian law is more narrowly focused than the broadcast directive, since it encompasses only films produced for cinema performance, and excludes tv films and series and other programming. The film sector decree-law enacted on January 18, 1994, calls for application of the Italian broadcast quotas proportionally during evening viewing hours, but its language is strictly hortatory. A separate but related issue concerns films shown in Italian theaters. The film sector law approved by parliament on February 23, 1994 eliminated obligatory screen quotas for Italian films (heretofore 25 days per quarter subject to closing of the theater, under a 1965 law), and in their place substituted discretionary rebates on Italy's box office tax for theaters that show italian films. The rebates and eligibility thresholds (percentages of screenings required to qualify) vary according to the category of the film. The United States continues its efforts both to obtain elimination of discriminatory laws and regulations in the audiovisual sector and to limit their impact in the interim. Civil Aviation Since 1990, the United States/Italy civil aviation relationship has undergone some liberalization, including the entry of new U.S. carriers in 1991 and 1992. Nevertheless, the market remains restrictive. U.S. carriers have expressed concern over a range of issues, including a number of which relate to the services monopolies at international airports. Government Procurement In Italy, highly-fragmented, non-transparent government procurement practices and significant problems with corruption create obstacles to U.S. firms' participation in Italian government procurement. A widening investigation of abuses in this area has created pressure for reform. On January 13, 1994, the Italian Parliament enacted legislation which should provide more transparent procurement procedures, including establishment of a central body to monitor implementation. However, the reforms envisaged in the legislation will not be fully implemented until 1996 and are under review by the Berlusconi Government. Investment barriers Until 1992, meaningful privatization of Italian government parastatals was thought to be unlikely. However, on August 7, 1992 legislation was enacted which began the process of converting major groups such as IRI (the industrial state holding company) and ENI (the state energy company) into joint-stock companies. Privatization of subsidiaries, including banks, industrial and energy companies, the state insurance company and telecommunications companies, is still in the early stages. Italian interests may well have the inside track in acquiring the more attractive subsidiaries. While official Italian policy is to encourage foreign investment, industrial projects require a multitude of approvals and permits from the many-layered Italian bureaucracy. Foreign investments often receive close scrutiny. These lengthy procedures can, in and of themselves, present extensive difficulties for the uninitiated foreign investor. There are several industry sectors which are either closely regulated or prohibited outright to foreign investors. These sectors include domestic air transport, aircraft manufacturing, and the state monopolies (e.g., railways, tobacco manufacturing and electrical power). As of January 5, 1992, all foreign (and Italian) securities firms wishing to do business in Italy or with Italian clients must create a "Societa` di Intermediazione Mobiliare" (security intermediation company or SIM) in Italy. A SIM is a joint stock company, with prescribed capital, staff, and structural requirements. The fact that it is costly to create a SIM is likely to preclude many foreign firms from competing in an important part of the italian securities market. The SIM law conflicts with basic tenets of the OECD codes of liberalization. The United States is pressing Italy, bilaterally and in the OECD, to amend this law. The EU commission has challenged the SIM law as a violation of the Treaty of Rome. It would be clearly in violation of the EU's investment services directive, which will enter into force on January 1, 1996. On January 18, 1994, the commission initiated proceedings against the SIM law in the European Court of Justice. In September 1990, the Italian Parliament approved an anti-trust law. The law gives the government the right to review mergers and acquisitions over a certain threshold. The government has the authority to block mergers involving foreign firms for "reasons essential in the national economy" if the home government of the foreign firm does not have a similar anti-trust law or applies discriminatory measures against italian firms. A similar provision in the law applies to purchases by foreign entities of five or more percent of an Italian credit institution's equity. The expansion of modern distribution units, such as chain stores, department stores, supermarkets, hypermarkets, and franchises is severely restricted by local practice and national legislation which subjects applications for large retail units above a certain merchandising surface to a lengthy and cumbersome authorization process. Italy provides a number of investment incentives (consisting of tax breaks and other measures to attract industrial investment) to depressed areas, especially in the south of Italy. Standards, Testing, Labeling and Certification In the areas of standards and standards setting, Italy has been slow in accepting test data from foreign sources, but is expected to adopt EU standards in this area. In sectors such as pollution control, the uniformity in application of standards may vary according to region, thus complicating certification requirements for U.S. Business. Italian requirements for agricultural imports are, in many cases, more rigid than those required under EU legislation. These restrictions have impeded or prevented the following U.S. Agricultural products from entering Italy: citrus (except Florida grapefruit), deciduous fruits and table grapes, selected vegetables (including tomatoes, peppers, and eggplants), certain seeds for planting, poultry meat, live horses, beef offal, bull semen, honey and seafood. Italian food additive requirements are also more restrictive than EU norms. In addition, some agricultural items (mainly citrus derivatives) are subject to discretionary licensing requirements. In the absence of these restrictions, U.S. exports of these products to Italy could increase by an estimated 50-100 million dollars. The European Single Market, which entered into effect on January 1, 1993, should have eased some of these restrictions, but actual results will depend on Italy's implementation, which is likely to be delayed. LABOR FORCE IN ITALY There are 22,519,000 workers in the Italian workforce (40 percent of the population), 14,138,000 males (51.7 percent) and 8,381,000 females (29.0 percent). A worker is defined as one who is capable and available to enter the workforce if offered a job and who has made a job search in the 30 days preceding the labor force survey. Of the workers in the Italian workforce, 19,908,000 are employed and 2,611,000 are in search of jobs. Of those in search of jobs 1,005,000 lost their previous jobs and 1,074,000 are in search of their first job. The unemployment rate in all of Italy is 11.6 percent comprised of varying regional differences, with unemployment at 6.9 percent of the workers in the North, 9.4 percent in central Italy, and 20.1 percent in the South. MAJOR LOCAL & THIRD COUNTRY COMPETITORS IN SPECIFIC SECTORS The following industrial sectors, which are Best Prospects for American firms, are somehow influenced by local (A) and third country (B) competition. 1. Aviation A. very moderate; Alenia is the only major Italian competitor. B. moderate to strong: France (Airbus) is the major competitor, U.K., Germany and Holland are somewhat competitive. 2. Information Technology (both hardware and software) A. moderate: Olivetti is the major Italian competitor. B. moderate: Germany and France are the major third country competitors. 3. Telecommunications A. moderate: The Government controlled STET group of companies have a significant influence in competition with U.S. telecommunications companies. B. moderate: France and Germany have a strong presence in Italy. 4. Medical A. limited: Esaote and Gilardoni are the only significant competitors. B. strong: Holland, Germany and Japan are the major competitors in Italy. 5. Chemicals A. limited: ENICHEM and Montedison are large suppliers of basic chemical products. B. moderate to strong: Germany and U.K. take the lead in specialized chemicals. INFRASTRUCTURE SITUATION RE: GOODS/SERVICE DISTRIBUTION Transportation Railroad--The railroad system is nationalized and operated by the Italian State Railways (Ferrovie dello Stato, abbreviated FS), a government agency. The railroad provides an efficient and economical method of transportation. More than half of the rail system is electrified. Highway--The highway system is approximately 197,000 miles, including over 3,000 miles of super highways called the autostrade. The network connects the major industrial centers and offers easy access to Northern Europe. Trucking services are operated mainly by private companies under government concession. Air--Alitalia, a state-owned company, is Italy's principal airline providing both international and domestic service. Additional domestic service is provided by ATI, which is a wholly owned subsidiary of Alitalia, Itavia, and Alisarda airlines. Charter service is offered by SAM, also an Alitalia subsidiary, while air-taxi service is available from Unijet Italia in Rome and Agena in Milan. Italy has an extensive airport network consisting of 19 international, 17 domestic, and 59 general aviation airports. Sea--Italy has six major seaports--Genoa, Livorno, Naples, Palermo, Trieste, and Venice. In addition, there are 35 smaller ports mostly used for coastal shipping.