IS ITALYS EXPORT LED GROWTH MODEL IN TROUBLE?

UNCLAS SECTION 01 OF 03 ROME 004923

SIPDIS

DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA
PARIS ALSO FOR USOECD
TREAS FOR OASIA HARLOW, STUART
FRANKFURT FOR WALLAR
USDOC 6800/ITA/TD/OTEA/TISD/HSCHULTZ AND
4212/ITA/MAC/OEURA/CPD/DDEFALCO
STATE PASS USTR

E.O. 12958: N/A
TAGS: ECON EFIN ETRD IT EXPORT CONTROLS
SUBJECT: IS ITALYS EXPORT LED GROWTH MODEL IN TROUBLE?

REF: A. ROME 4236


B. ROME 2853


1. SUMMARY: ITALIAN EXPORTS TO ITS MAJOR MARKETS ARE
FACING STIFF COMPETITION FROM, AND LOSING MARKET SHARE
TO, CHEAPER EXPORTS FROM ASIA. THE THREAT HAS TRIGGERED
MUCH POLITICAL POSTURING IN ITALY, WITH FINANCE MINISTER
TREMONTI AND UMBERTO BOSSI, NORTHERN LEAGUE LEADER AND
MINISTER OF REFORMS, CALLING FOR A REVIEW OF, IF NOT
RETALIATORY ACTION AGAINST, CHINA, INDIA, BANGLADESH, AND
PAKISTAN. OTHER PRESSURES SUCH AS THE STRONGER EURO AND
SLUGGISH ECONOMIC GROWTH IN EUROPE ALSO ARE AFFECTING
ITALIAN EXPORTS, WHICH ALREADY ARE DOWN 2.5 PERCENT THIS
YEAR.


2. IN THE LONG TERM, ITALY FACES REAL PROBLEMS IN ITS
EXPORT SECTOR, WHICH IS THE BACKBONE OF THE ECONOMY AND
ACCOUNTS FOR 25 PERCENT OF GDP. THE LIMITED INVESTMENT
IN TECHNOLOGY IN THE PAST DECADE HAS PRODUCED A
SPECIALIZED, BUT A HIGHLY LABOR-INTENSIVE EXPORT SECTOR,
WHICH IS PARTICULARLY VULNERABLE TO COMPETITION FROM
COUNTRIES WITH LOW LABOR COSTS. END SUMMARY.

BACKGROUND
--------------


3. ITALIAN EXPORTS ARE HEAVILY CONCENTRATED IN HIGH-END
CONSUMER GOODS, THE DEMAND FOR WHICH IS PARTICULARLY
INFLUENCED BY IMPORT PRICE. AS SUCH, THESE PRODUCTS ARE
SUSCEPTIBLE TO EXCHANGE RATE FLUCTUATIONS. IN HIS ANNUAL
REPORT ON MAY 31, CENTRAL BANK GOVERNOR ANTONIO FAZIO
ARGUED THAT THE COMPOSITION OF ITALIAN EXPORTS, DOMINATED
BY FURNITURE, LEATHER PRODUCTS AND MANUFACTURED GOODS,
MAKES THEM HIGHLY VULNERABLE TO IMPORT PRICE TRENDS (REF
B).

POOR PERFORMANCE OF ITALIAN EXPORTS THIS YEAR
--------------


4. ACCORDING TO THE CENTRAL BUREAU OF STATISTICS (ISTAT),
EXPORTS DECREASED BY 2.5 PERCENT, WHILE IMPORTS INCREASED
BY 1.8 PERCENT IN THE FIRST SEVEN MONTHS OF 2003 COMPARED
WITH THE CORRESPONDING PERIOD IN 2002. THESE TRENDS HAD
A DRAMATIC IMPACT ON THE TRADE BALANCE. ITALYS FOREIGN
TRADE THROUGH JULY 2003 REGISTERED A 1.6 BILLION EURO
DEFICIT, COMPARED TO A FIVE BILLION EURO SURPLUS IN THE
CORRESPONDING PERIOD IN 2002. CONFINDUSTRIA, ITALYS
LARGEST EMPLOYERS ASSOCIATION, ESTIMATES THAT ITALIAN
EXPORTS WILL DECLINE OVERALL BY 1.3 PERCENT THIS YEAR.
ITALYS SHARE OF WORLD TRADE IS EXPECTED TO SHRINK, BELOW
THE 3.9 PERCENT SHARE IN 2002 AND SIGNIFICANTLY BELOW THE
AVERAGE 4.6 PERCENT SHARE IN THE PERIOD 1991-1995.

EXPORTS TO THE EU
--------------


5. EXPORTS TO EU COUNTRIES (MORE THAN 50 PERCENT OF TOTAL
TAL
EXPORTS) FELL BY 1.8 PERCENT IN THE FIRST SEVEN MONTHS OF
2003 COMPARED TO THE CORRESPONDING PERIOD IN 2002, WHILE
IMPORTS FROM THE EU (ALMOST 60 PERCENT OF TOTAL IMPORTS)
INCREASED BY TWO PERCENT DURING THE SAME TIME. TRADE
WITH EU COUNTRIES THROUGH JULY 2003 REGISTERED A 3.3
BILLION EURO DEFICIT, COMPARED TO A TWO BILLION EURO
DEFICIT REGISTERED IN THE CORRESPONDING PERIOD IN 2002.
THROUGH JULY 2003, THE LARGEST DECREASES WERE REGISTERED
IN LEATHER AND LEATHER PRODUCTS (DOWN 12.1 PERCENT) AND
TEXTILES AND APPAREL (DOWN 8.1 PERCENT).

EXPORTS TO NON-EU MARKETS
--------------


6. THE PERFORMANCE OF ITALIAN EXPORTS TO NON-EU MARKETS
HAS BEEN EVEN WORSE THAN THAT OF EXPORTS TO EU MARKETS.
IN THE FIRST NINE MONTHS OF 2003, ITALIAN EXPORTS TO NON-
EU COUNTRIES, WHICH INCLUDES THE U.S., TURKEY AND THE
FOUR MERCOSUR COUNTRIES, DROPPED BY 3.5 PERCENT, WHILE
IMPORTS INCREASED BY 1.6 PERCENT. THE GREATEST DECLINE
WAS IN EXPORTS TO MERCOSUR, DOWN 16.1 PERCENT, TO THE

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003 OVER THE
CORRESPONDING PERIOD IN 2002. THE STRONGER EURO VERSUS
THE DOLLAR IS THE KEY FACTOR BEHIND THE DECLINE IN
EXPORTS TO MERCOSUR AND THE UNITED STATES. THESE TRENDS
HAD A NEGATIVE IMPACT ON ITALYS PREVIOUS TRADE SURPLUS
WITH NON-EU COUNTRIES. TRADE WITH NON-EU COUNTRIES
REGISTERED A 3.5 BILLION EURO TRADE SURPLUS THROUGH
SEPTEMBER 2003, LESS THAN A HALF OF THE 7.9 BILLION EURO
SURPLUS REGISTERED IN THE CORRESPONDING PERIOD IN 2002.

THE THREAT FROM LOW-COST EXPORTING COUNTRIES
--------------


7. ITALY, WITH ITS HIGHLY SPECIALIZED BUT ALSO HIGHLY
LABOR-INTENSIVE EXPORT SECTOR, IS VULNERABLE TO
COMPETITION FROM COUNTRIES WITH LOW LABOR COSTS, SUCH AS
INDIA, BANGLADESH, PAKISTAN, CHINA AND KOREA. WITH
RESPECT TO LEATHER AND WOOL PRODUCTS, INDIA AND PAKISTAN
NOW EACH HAVE LARGER MARKET SHARES THAN ITALY DOES IN THE
GERMAN, FRENCH AND SPANISH MARKETS. MEXICO ALSO NOW
OFFERS STIFF COMPETITION IN FURNITURE (CHAIRS ANDS SOFAS)
FOR THE U.S. MARKET.

THE SPECIFIC MENACE FROM CHINA
--------------


8. POLITICAL LEADERS IN ITALY ARE POINTING FINGERS AT
CHINESE EXPORTS AS THE LEADING CAUSE FOR THE DECLINING
MARKET SHARE OF ITALIAN EXPORTS. FINANCE MINISTER
TREMONTI RECENTLY DECLARED TO ITALIAN JOURNALISTS: IN
THOSE MARKETS WHERE CHINA ENTERS, IT TENDS TO EXCLUDE
ITALY. (REF A REPORTS ON THE POLITICAL POSTURING
REGARDING THE THREAT FROM ASIA.) MARKET ANALYSTS ALSO
ARE BEGINNING TO MAKE SIMILAR OBSERVATIONS. THE EDISON
FOUNDATION, A MILAN-BASED INSTITUTE THAT PROMOTES
BUSINESS R&D, ARGUES THAT ITALIAN EXPORTS ARE RAPIDLY
LOSING MARKET SHARE IN THE EU TO ASIAN AND, IN
PARTICULAR, TO CHINESE COMPETITION.


9. EXPORTS FROM CHINA ARE THREATENING ITALYS MARKET
SHARE IN THE EU IN SUCH SECTORS AS KITCHENWARE AND
KITCHEN UTENSILS, MANUFACTURED MARBLE AND OTHER STONES,
FURNITURE AND FURNITURE PARTS, VALVES, AND LAMPS. IN
KITCHENWARE, ITALYS MARKET SHARE IN THE EU DECREASED
FROM 24 PERCENT IN 1990 TO 12 PERCENT IN 2002, WHILE
CHINAS MARKET SHARE INCREASED DRAMATICALLY FROM 3.5
PERCENT OF 1991 TO 37 PERCENT IN 2002. IN THE LAMP
SECTOR, FOR EXAMPLE, ITALY'S SHARE IN THE EU MARKET
DECREASED FROM 22 PERCENT IN 1990 TO 12 PERCENT IN 2002,
WHILE AT THE SAME TIME, CHINAS MARKET SHARE INCREASED
FROM 1.6 PERCENT IN 1990 TO 29 PERCENT IN 2002. EVEN IN
SECTORS WHERE ITALIAN EXPORTS HAVE TRADITIONALLY BEEN
DOMINANT (E.G., LEATHER SHOES),ITALIAN SHOES FACE STIFF
COMPETITION FROM LOWER-COST BUT STILL GOOD QUALITY SHOES
MADE IN CHINA AND KOREA. CHINA HAS BECOME THE LARGEST
EXPORTER OF SEMI-LEATHER SHOES TO THE U.S. MARKET, AND
ITALYS MARKET SHARE IS NOW LESS THAN ONE THIRD OF THE
CHINESE ONE. BUSINESS SOURCES IN THE SOUTHERN ITALIAN
REGION OF PUGLIA HAVE COMPLAINED THAT THE REGIONS
IMPORTANT SOFA INDUSTRY IS ENTERING A CRISIS PERIOD
BECAUSE OF AGGRESSIVE CHINESE COMPETITION. PREVIOUSLY,
CHINA HAD BEEN ACTIVE ONLY IN THE LOWER-END SOFA MARKET,
BUT IS NOW TAKING OVER THE LUXURY END AS WELL. ONE OF
THE REGIONS LARGEST SOFA FACTORIES HAS REPORTEDLY LAID
OFF 300 WORKERS AS A RESULT OF FALLING ORDERS.

THE EFFECT ON JOBS
--------------


10. GIVEN THE TRENDS, EMPLOYMENT IN THE EXPORT SECTOR
HAS DECLINED. PRATO CONFARTIGIANATO, THE CONFEDERATION OF
CRAFT ENTERPRISES THAT REPRESENTS 6,000 COMPANIES,
INCLUDING 2,800 IN THE TEXTILE SECTOR, CLAIMS THAT ALMOST
500 COMPANIES ARE HAVING DIFFICULTIES AND THAT ALMOST
2,000 JOBS HAVE BEEN LOST IN THE LAST TWO MONTHS.
LOCAL PLANTS IN THE TEXTILE DISTRICT OF PRATO IN TUSCANY

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S AS REASONS FOR THE
JOB CUTBACKS.

OTHER CONCERNS
--------------


11. WHILE EXPORTS HAVE TRADITIONALLY BEEN VULNERABLE TO
EXCHANGE RATE FLUCTUATIONS, ITALIAN EXPORTERS ARE LOSING
A COMPETITIVE EDGE FOR ANOTHER REASON, MANY ECONOMISTS
WORRY. ITALY INVESTS ONLY .75 PERCENT OF ITS GDP IN R&D,
COMPARED TO AN AVERAGE OF 1.75 PERCENT IN THE EU. THIS
LACK OF INVESTMENT IN TECHNOLOGY HAS REDUCED THE
COMPETITIVENESS OF ITALYS EXPORTS AND AGGRAVATED THEIR
SENSITIVITY TO EXCHANGE RATE FLUCTUATIONS.


12. IN THE LONGER TERM, ITALYS POLITICAL AND ECONOMIC
LEADERS WILL HAVE TO TAKE A HARD LOOK AT ITS EXPORT-
DRIVEN ECONOMIC MODEL. EU COMMISSIONER PEDRO SOLBES
RECENTLY TOLD ITALYS LEADING BUSINESS DAILY, IL SOLE 24
ORE, THAT HE IS SKEPTICAL ABOUT THE GOVERNMENTS
PREDICTION THAT ITALYS EXPORTS WILL INCREASE IN 2004.
HE REMARKED THAT IT HAS BEEN A LONG TIME SINCE ITALY WAS
ABLE TO HOLD ON TO ITS MARKET SHARES IN EXPORTS, GIVEN
THEIR LIMITED ABILITY TO COMPETE ON PRICE. A MORE
FAVORABLE EXCHANGE RATE WOULD HELP, BUT LONG-TERM TRENDS
ARE NOT ENCOURAGING, HE CONCLUDED.


NOTE: MISSING SIGNATURE.

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2003ROME04923 - Classification: UNCLASSIFIED