Italy Prices, Costs and Income Distribution

Only in the second half of the 1980s did inflation return in Italy to the average levels preceding the 1973-74 oil shock. The end of the seventies was in fact marked by the persistence of double-digit inflation (close, in 1979, to 15%), despite the exhaustion of the pressures deriving from the increase in oil prices and the devaluation of the lira connected with the currency crisis of the January 1976. The strong increase in the cost of imported raw materials in lire was accompanied in those years by a very significant expansion in labor costs (table 20). Inflationary inertia found support in the high indexation of wages, close to unity in industry between 1976 and 1977.

The share of labor in income produced, which from 68% in the processing industry and 70% in the entire private sector in 1970 had risen to about 75% in 1975, returned in 1980 to levels below those achieved ten years earlier.. To mitigate in no small part the costs of businesses were a consistent reduction in the manufacturing sector of social contributions paid to them and the elimination of indexation (to the change in the cost of living) of the funds set aside for the payment of seniority allowance (this indexation was reintroduced in 1982, after a substantial reduction in real terms). Between 1976 and 1978, in particular, labor costs increased in industrial transformation by more than 10 percentage points less than gross wages; in terms of unit of product the

Production prices also began to show significant reductions in growth rates when the onset, in 1979, of the second oil crisis caused a new inflationary flare-up, continuing the system’s inability to avoid a rekindling of price and wage chases..

In 1980, inflation exceeded 21%. It took almost five years for it to be halved: only in 1985 did the change in consumer prices return below 10%. In this period, the continuous, albeit gradual, decline in inflation mainly derived not only from a substantial change in industrial relations, but also from the restrictive attitude of monetary and exchange rate policy, after the adhesion of the lira to the European Monetary System (EMS) in March 1979. The decline in inflation took place despite an uninterrupted appreciation of the dollar (offset only in part by the decline in the international prices of raw materials, particularly agro-food and energy products).

In 1984-85, unit labor cost growth fell below 6% in the manufacturing sector and to around 8% in the entire private sector; the distribution of income continued to shift in favor of profits, with the labor share falling, after a brief cyclical recovery, below 67% and 70% respectively in 1985.

In 1985 the dollar revaluation process was interrupted; after having appreciated from 856 lire on average in 1980 to 1909 in 1985, a period of progressive depreciation began for the US currency, which brought it below 1300 lire in 1987. The weakening of the dollar was joined in 1986 by the exceptional fall of the oil prices, equal to 49% in dollars and 60% in lire during the year. The Italian economy has benefited from this in many respects; despite a gradual recovery in the international prices of other basic materials, between 1986 and 1988 inflation was below 6%. Over the same period, wages in the private sector grew by about 2 percentage points a year more than consumer prices; in industrial transformation wage increases on average exceeded that of the value added deflator by 3 percentage points. The increase, less than that in productivity, reflected a further shift in the distribution of income in favor of profits: the share of labor fell in 1988 to about 62% in the manufacturing sector and to almost 67.5% in the whole private sector. Under the pressure of factors of internal origin, in the three-year period 1989-91 inflation returned to exceed 6%, the cost of labor per employee grew at average rates of around 9%, and the distribution of income quickly recovered. on the levels prevailing in the early 1980s. reflected a further shift in the distribution of income in favor of profits: the share of labor fell in 1988 to around 62% in the manufacturing sector and to almost 67.5% in the entire private sector. Under the pressure of factors of internal origin, in the three-year period 1989-91 inflation returned to exceed 6%, the cost of labor per employee grew at average rates of around 9%, and the distribution of income quickly recovered. on the levels prevailing in the early 1980s. reflected a further shift in the distribution of income in favor of profits: the share of labor fell in 1988 to around 62% in the manufacturing sector and to almost 67.5% in the entire private sector. Under the pressure of factors of internal origin, in the three-year period 1989-91 inflation returned to exceed 6%, the cost of labor per employee grew at average rates of around 9%, and the distribution of income quickly recovered. on the levels prevailing in the early 1980s. Exchanges with foreign countries. Despite the strong increase in exports resulting from the competitive gain of devaluation (table 16), the worsening of the terms of trade caused a high deficit in the trade balance in 1976 which the large surplus of services, especially tourism, was unable to compensate.: the current account deficit exceeded 2,000 billion lire (1.2% of GDP). The last few years of the decade benefited, however, on the one hand from the considerable containment of domestic demand following the currency crisis, and on the other hand from the good trend in world demand. The trade balance was on average in equilibrium and the surplus of the current account as a whole made it possible to cancel the foreign debt. The network of administrative controls, defined after the oil shock and the currency crisis,commercial partners without, at the same time, having negative consequences on the front of capital outflows.

The accession of the lira to the EMS was preceded in 1978, and in the first weeks of 1979, by a last significant devaluation such as to improve the price competitiveness of the productive sectors; in the following years the nominal exchange rate depreciated slipping within the fluctuation margins allowed for the lira, without however bridging the inflation differential: in particular, between the first quarter of 1979 and the end of 1982 the real exchange rate appreciated 7% as a response, together with monetary and credit tightening, to the inflationary shock that followed the second oil crisis in 1979-80. The drop in exports in quantity and the strong loss of terms of trade meant that the current account deficit exceeded 8500 billion lire in 1980, equal to 2.2% of GDP. The deficit continued to be very large in the following two years, despite the brake on imports resulting from the decline in domestic demand; only in 1983 there was a very slight surplus. The current account deficit was mainly determined in those years – as well as by the structurally negative balance of the agro-food balance – by the heavy deficit of the energy balance, consequent to the very strong increase in the price of oil, which more than doubled between 1978 and 1980. Despite the considerable improvement in the balance of non-energy products and the good performance of services, in the two-year period 1984-85 there were still current account deficits of just under 1% of GDP. The oil counter-shock of 1986 brought about a drastic change in the situation, with a large improvement,

A total positive balance in 1986 of the order of 0.5% of GDP was followed in the last years of the decade by modest but growing deficits in the current account. In 1991, in particular, the deficit, equal to 1.8% of GDP, was the result of a slight deficit in the trade balance and a substantial deficit for all transfers and services, among which, in addition to a now modest surplus of the tourism balance, a deficit of almost 20,000 billion in capital income (1.4% of GDP) should be reported. This reflects the interest burden on a foreign debt which, excluding gold reserves of over 29,000 billion lire, increased over the decade, following the current account deficits, to almost 150,000 billion in 1991 (10.5% of gross product).