The Economy, But Not Economic Reform, Begins

UNCLAS ROME 000996

SIPDIS

SIPDIS
SENSITIVE

E.O. 12356: N/A
TAGS: ECON IT ITALY NATIONAL ELECTIONS
SUBJECT: The Economy, But Not Economic Reform, Begins
to Dominate Italian Election Campaign

Ref: A. ROME 725


B. ROME 798

C. NAPLES 102

D. ROME 864

E. ROME 863

This cable is Sensitive But Unclassified. Please
protect accordingly, not for distribution outside the
U.S. Government or on the Internet.


1. (SBU) Summary and Comment: Italy's electoral
campaign has begun to focus almost exclusively on
incumbent Prime Minister Silvio Berlusconi's Achilles
heel: the economy. Center-left challenger Romano Prodi
threw Berlusconi on the defensive during a nationally
televised debate March 14 that focused almost
exclusively on economic issues. Berlusconi delivered a
weak performance in which he tried, unconvincingly, to
paint a rosy picture of his accomplishments and of the
Italian economy. In turn, the center-left has offered
a series of populist proposals to capture voters
disillusioned by the poor economy. What is missing
from this campaign, however, are serious proposals for
structural economic reform necessary for Italy to
remain a strong and reliable ally actively engaged
abroad. End summary and comment.

E l'Economia, Stupido.
--------------


2. (SBU) Italy's poor economic health has emerged as
the key issue in its national elections April 9-10.
Throughout January and February, incumbent Prime
Minister Silvio Berlusconi and his Forza Italia party
kept the debate focused on the appropriateness of his
campaign tactics and other issues favorable to him (Ref
A) to avoid a meaningful discussion of economic issues.
Berlusconi's handlers recognize that economic themes
are his weak point, since most Italians polled consider
themselves worse off now than five years ago. However,
the moderators in the first Prodi-Berlusconi debate on
March 14 limited the discussion almost entirely to
economic themes in a format that did not permit
Berlusconi to change the subject. Since then, the
debate has almost entirely shifted to economic issues,
and Berlusconi's occasional gaffes.

Berlusconi: The Economic Record
--------------


3. (SBU) Berlusconi has the difficult task of defending
his management of Italy's dismal economy. The Italian
business community expected great things from
Berlusconi following his election in 2001. They have
been disappointed. Italy's economy has stagnated over
the last five years, averaging just 0.6 percent GDP
growth per year since 2001, compared with 1.5 percent
for the euro area, 1.6 percent for France, and 2.3
percent for the UK.


4. (SBU) The center-right government, however, has not
been a complete wash for the Italian economy, as
Berlusconi's critics charge. The coalition improved
labor flexibility with the 2003 "Biagi Law" (which made
it much easier to hire workers on temporary contracts)
and regularized 700,000 formerly illegal immigrant
workers. The Biagi Law and the legalization helped
lower Italy's nominal unemployment rate from 9.1
percent in 2001 to 7.7 percent in 2005. The center-
right also enacted modest pension reforms, gradually
raising the retirement age for most male workers from
57 to 60 starting in 2008, and eventually to 62 in

2014. Finally, Berlusconi's coalition passed income tax
cuts in 2003 and 2005 that amount to 350-500 euro per
year for the average Italian family.

Half Measures Frustrate Business.
--------------


5. (SBU) While Berlusconi has attempted to grapple with
some of Italy's fundamental problems, the fixes he has
managed to implement have been the kind of half
measures that please no one. The pension reform, by
raising the retirement age only modestly over such a
long period, does little to ensure the long-term
sustainability of the system; yet, it has cost the
center-right support among working Italians. The tax
cuts, aimed at Italy's struggling middle class, have
been offset by price increases for utilities and other
government services. Our business contacts frequently
grumble that Berlusconi only uses his political capital
for the things--such as decriminalization of false
accounting or relaxation of media regulation--that
benefit his personal legal and business interests.


6. (U) As a result, Italy's business leaders--led by
FIAT Chairman Luca Cordero di Montezemolo, who also
heads Italy's main employer association, Confindustria-
-have become Berlusconi's harshest critics. Relations
between Berlusconi and Confindustria reached a nadir at
the associations' annual meeting March 18 when the
Prime Minister lashed out at Montezemolo and other
association leaders, by saying their negativity was
undermining his campaign. Forza Italia campaigners
claim this confrontation helped Berlusconi with small
business owners unrepresented by Confindustria. True
or not, it certainly made it clear that Berlusconi does
not have the strong backing of industry that he once
enjoyed.

The Optimist Versus the Cassandra
--------------


7. (U) Berlusconi's primary tactic, one that worked
successfully for him in the 2001 election, is to exude
confidence and optimism on the economy. Berlusconi's
campaign slogan, "The left says everything is going
badly, let them lose!", sums up his approach to this
election.


8. (U) The left is using growing economic anxiety to
attack the Berlusconi administration for increasing job
insecurity and for presiding over a drop in household
spending power that coincided with the switch to euro
coins and banknotes. Prodi has embraced the
"Cassandra" label given to him by Berlusconi's
supporters. "They forget that Cassandra always told
the truth," Prodi commented to the Corriere della Sera
newspaper March 7, "even if she was condemned by the
gods never to be heard."

Election Issue #1: Jobs and Income
--------------


9. (U) The heart of both the center-right and center-
left economic platforms is reducing labor costs to
boost income, spur greater employment, and counter
declining worker productivity. Prodi has pledged to
reduce social security contributions by five percent--
three percent from the share paid by workers themselves
and two percent from the share paid by employers.
Prodi would pay for these reductions (and for his
proposed increases in social spending outlined below)
by raising the capital gains tax rate from 12.5 to 20
percent.


10. (SBU) Berlusconi's platform, meanwhile, calls for a
three-percent cut in contributions--one percent for
workers, two percent for firms. Unlike the center-
left, the center-right alliance has not explained how
they would pay for their proposed reduction in social
security contributions. Furthermore, the center-right
is attacking Prodi's plan to raise taxes, by saying
this will hurt average Italians, stifle Italy's
economic recovery, and lead to capital flight.
(Berlusconi's tax amnesties may have coaxed some off-
shore money back to Italy, but they create a moral
hazard and stimulate further tax evasion.)


11. (SBU) Comment: A capital gains tax increase may
prove politically risky for the center-left. Though
falling, Italy's savings rate remains at 12.7 percent,
meaning many average citizens hold bonds and other
investments that would be subject to these higher
taxes. Also, some economists warn that a higher
capital gains tax will force the GOI to raise returns
on government bonds, potentially gobbling up any
revenue gain in higher debt service. End comment.

...And More Welfare.
--------------


12. (U) As part of its platform for boosting family
income, the center left promises additional assistance
for child care and government payments of euro 2,500
per year for each child under three. This is many
times more generous than childbearing subsidies enacted
under the center-right government, which included an
income-dependant, one-time-only lump sum payment of
euro 1,000 for each newborn.

13. (U) Berlusconi's social platform, meanwhile,
focuses on retirees. The center-right promises that it
will raise the minimum state pension from euro 600 per
month to 800 for Italy's least-well-off senior
citizens. This measure is expected to produce a
further (unfunded) burden of up to euro 7.2 billion per
year on the national budget. Promising pension
increases worked for Berlusconi in 2001, and the Prime
Minister delivered by increasing minimum rates to euro
600/month, though the increase was limited to
pensioners over 70 with no other source of income--a
group that included 1.4 million of the 7.2 million
people then receiving minimum state pensions. Future
pension increases will likely carry similar
limitations.
How and How Much to Help the South
--------------


14. (U) Many of the key swing regions in this
elections, including Puglia, are located in the South
(the "Mezzogiorno"); and the center-left hopes to
convince voters there that it will be more generous
than Berlusconi. The center-left promises a slew of
aid for government services, anti-mafia campaigns,
infrastructure, education, research and development,
transportation, and support to low-income families.
The center-left also pledges additional tax incentives
for companies willing to invest in the Mezzogiorno.
Berlusconi's southern strategy is hobbled by the
presence in his coalition of the Northern League, which
has vociferously opposed government hand-outs for the
South. The center-right platform focuses primarily on
improving southern infrastructure, specifically by
constructing the Straits of Messina Bridge to connect
Sicily with mainland Italy. (See Refs B, C.)

Dancing Around Reform
--------------


15. (SBU) While economic issues have taken center stage
in this campaign, the question of structural reform has
not. In a recent conversation with Econoff, Marcello
Messori, an economic advisor to the center-left, was
highly critical of the lack of straight talk in the
current campaign. Both sides, he observed, are
focusing on relatively minor economic issues, such as
social security contributions and child care, rather
than addressing the need for fundamental economic
reform. Neither candidate, he said, is honestly
telling voters that Italy, faced with growing
competition from China and other low-cost producers,
must make a painful shift from manufacturing to a
service-based economy. The center-left's unstated
goal, Messori said, is to improve Italy's welfare
system as a way of easing this transition. Messori
acknowledged, however, that Prodi's coalition is far
from united, with the hard-left coalition members, such
as the Rifondazione Comunista, stubbornly hostile to
economic liberalization.

Comment
--------------


16. (SBU) As Italy's richest businessman, Berlusconi
was swept into office in 2001 under the promise to
return Italy to its former status as a first-tier
economy. Five years later, Italians are openly
speaking about becoming the "next Argentina"--i.e., a
once-great economic power that slid into third-world
status through persistent debt, corruption, and
mismanagement.


17. (SBU) The reluctance of both sides to directly
address Italy's fundamental economic problems is, in
our view, a defining characteristic of this campaign.
Though Italy is falling further behind the rest of
Europe (not to mention East Asia and the United
States),both the center-left and center-right have
concluded that tough talk about Italy's economic ills
is no way to win an election.


18. (SBU) At every opportunity, the Embassy stresses to
Italian audiences the need for the next GOI, whether
led by Berlusconi or Prodi, to improve Italy's economic
performance and competitiveness. Without a more
dynamic economy, Italy will have increasing difficulty
playing a strategic, active role in the G/8, meeting
its international commitments, and remaining an active
partner with the United States in Iraq, NATO,
Afghanistan, and future world challenges. End comment.

Spogli