Political economy of Italy, Slide di Politica Economica

Scarica Political economy of Italy e più Slide in PDF di Politica Economica solo su Docsity! POLITICAL ECONOMY OF ITALY: WHAT IS POLITICAL ECONOMY OF ITALY? LECTURE OUTLINE:  From Political Economy to Economics and Beyond  The Political Economy of National Economies: Italy FROM POLITICAL ECONOMY TO ECONOMICS AND BEYOND: The key issue of our time: How to Run the World (and Europe)? How to Reconcile National Interests and International Order?  This is the subject of several disciplines including Economics (International Economics and International Political Economy or IPE). The challenge of our time is to managing cultural diversity and how to reconciliate national interests and international order. If a country wants to maximize only its own national interest, we will have international disorder. We have to find a solution by balancing the right national interest with the right international order. In the history of Economics we can identify some paradigms: CLASSICAL ECONOMICS (1776-1874): The main idea of this economists was that Economics was originally POLITICAL ECONOMY defined as the science of wealth of nations (Adam Smith treaty), then as an enquiry into production, distribution and consumption of goods and services (wealth: subject of economics). The key points were:  Methodological Holism (social classes mainly three: land-owners, workers and entrepreneurs);  Labour Theory of Value = tool to explain the exchange value of goods and services in the market that is the cost of production (Exchange economy/market economy, the relevance of specialization);  Principle of Comparative Advantage: David Ricardo in the 19th century distinguishes between national market (the exchange value of goods and services is the ABSOLUTE COST OF PRODUCTION in the internal market, free movement of input and output) and international market (where there is the imperfect mobility of capital and labour, the key principle is the theory of COMPARATIVE COST ADVANTAGE). In a world with imperfect international mobility of capital (saving) and labour, it is sufficient to guarantee free trade to maximize and reconcile national interests: “One Economic Freedom” = free trade of goods, is enough because a country tends to specialize into something that can done relatively better than competitors (the other countries). THE DECLINE OF CLASSICAL ECONOMICS: In the beginning of the 70s a scientific revolution happened favoured by some limits of the classical political economy: 1- The limits of the labour theory of value  there are things that don’t require a high cost of production and nevertheless they have a high value and vice versa, so the principle of marginal utility was introduced; 2- The lack of distinction between absolute and relative gains of international trade  international trade brings benefits but nations are interested in relative power, topic that don’t matter for classical economists; 3- The class struggle and the fear of Marxism  Classical economics in the hands of Karl Marx became a powerful tool to predict the collapse of capitalism (classical economists wanted market economy and capitalism with collaboration between classes). NEOCLASSICAL ECONOMICS (1870-1935): Alfred Marshall (1890) the father of macroeconomics, Principles of Economics: “Political economy or Economics is a study of mankind in the ordinary business of life” (title of his treaty, first time of the appearance of Economics). Economics as the science of rational choices under conditions of scarcity  Lord Lionel Robbins (1935): “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. Economics is the social science that investigates the rational choices of humans when they face conditions of scarcity (Robbinson Crusoe – cast way: he is alone and has to identify its constraints and its resources). The key points are:  Methodological individualism  analysing the agents of the economy behaviours from the bottom to the top (consumers, entrepreneurs, managers, firms, governments, markets and their networks, ect);  New theory of value  marginal utility theory of value (marginalists);  Economic equilibrium  determinants of economic development in the long-run by analysing and identify the best allocation of scarce resources (they look at the short run rather than the long run). The period is known as the 1st globalization or Belle epoque because there is an increasing movement of labour and capital  one economic freedom is not enough, there is the need to guarantee the 3 economic freedoms (Economic freedom remains the way to reconcile national interests and to ensure the best allocation of resources). KEYNESIAN REVOLUTION (1936): The masterpiece publication (scientific revolution) The General Theory of Employment, Interest and Money. Keynes is the founder of modern macroeconomics. affected by the clash between growing international economy space and persistent international polity space fragmented in nation-states (International Political Economy or IPE).  A governance without a government (the gap). IN BRIEF: Economics was born as Political Economy, then it becomes the science of rational choices under conditions of scarcity applying its method to several fields. The rediscovery of Political Economy originates to the need to combine economic theory with history and politics. A variety of approaches to International Political Economy. THE MAIN APPROACHES TO IPE: International Political Economy is the study of how economics and politics interact in the global system. The main approaches are: Liberalism; Marxism, Realism: Robert G. Gilpin (1930-2018). We consider only the Gilpin’s Realism (4 points to stress on): A) The international system is anarchic (not necessarily conflictual): “Anarchy means rather that there is no higher authority to which a state can appeal for succour in times of trouble.” B) The nation-state is the primary actor in international affairs, but there are also non-state actors such as multinational firms, international institutions, NGOs. C) Ideas and values play an important role in determining behaviour and choices. D) One of the dominant issue is the relationships between interdependence and national sovereignty: Gilpin defined IPE: “I define ‘global political economy’ as the interaction of the market and such powerful actors as states, multinational firms, and international organizations” In a previous book, Gilpin (1975) had defined IPE as “the reciprocal and dynamic interaction in international relations of the pursuit of wealth and pursuit of power”. MEASURING THE ECONOMY: INTRODUCTION: The manifesto said that econometric society (1933) “science is measurement”. Peter Druker father of modern management said “you can’t manage what you can’t measure” We can measure & manage something if we have clear targets. We usually look at: Income & wealth to measure individual welfare, Income statement & balance sheet for firm profit  Is it sufficient? The role of relational goods. What are the main desirable targets of an entire economy? How can we measure its performance? Macroeconomics studies the working of economic systems (local, regional, national, international) Problems & Goals: An economic system is well working when it can solve a set of problems by reaching a set of targets  Macroeconomic Problems: growth, business cycle, unemployment, inflation, public debt, external debt. Macroeconomic Targets: Happiness? Wellbeing? Human Development? We usually say: high growth, full-employment, price stability. Europe states: A Sustainable, Smart and Inclusive Growth. I prefer to say a “Good Growth” (sustainable, fair and inclusive). LECTURE OUTLINE: How to measure the performance of an economy? (How to measure growth, employment and stable prices). GROWTH – ECONOMIC GROWTH INDICATORS: There are several macroeconomic accounts, the most important (and useful) is the “Resources and Uses Account” (of a nation). Statistical identity and GDP: The Fundamental Statistical Identity: Y + M = C + I + E; Y = C + I + NX where NX = E - M It is a statistical identity because the unsold goods are considered unplanned inventories that is goods bought by the firms themself. Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. There are 3 way to calculate it: A) Expenditure Approach: GDP = C + I + NX B) Value-Added Approach: GDP = Sum of VA. The value added by a firm is the value of its production (1 car = $200) minus the value of the intermediate goods used (steel = $100). C) Income Approach: GDP = Sum of Factor  Payments = wages + interest + rent + profit. GDP as Value of Final Goods (Demand Side)  We can calculate GDP (Y) as total expenditure of goods and services = Consumption (C), Investment (I), Government Purchases (G), Net Exports (NX) = Y = C + I + G + NX, Where G includes Government Consumption and Investment The Components of GDP are:  Consumption (C): The spending by households on goods and services, with the exception of purchases of new housing.  Investment (I): The spending on capital equipment, inventories, and structures, including new housing.  Government Purchases (G): The spending on goods and services by local and central governments. It does not include transfer payments because they are not made in exchange for currently produced goods or services.  Net Exports (NX): Exports minus imports. Real vs Nominal GDP:  Nominal GDP values the production of goods and services at current prices. It may change if prices change and quantities are constant.  Real GDP values the production of goods and services at constant prices (base year). Since real GDP uses base year prices, real GDP only changes when the country produces more output. Actual and Potential GDP:  Actual GDP is the value of all final goods really produced in a given period of time.  Potential GDP is an estimate of the maximum sustainable output of the economy. The Output Gap is the difference between actual and potential GDP expressed as a percentage of potential GDP  (actual GDP – potential GDP)/ potential GDP. The most important growth indicator is Real GDP per capita = Real GDP/Population. The final target should be a “Good Growth”: Sustainable, Fair, Inclusive. EMPLOYMENT – HIG OR FULL EMPLOYMENT: But first we have to define some key concepts:  Working Age Population : The working age population is defined as those aged 15 to 64  Labour Force or active population , comprises all persons who fulfil the requirements for inclusion among the employed or the unemployed: Employed + Unemployed. If a person is not seeking work, she is not counted in the labour force. The main indicators are the Employment Rate and Age Dependency Ratio and the Unemployment Rate:  Employment Rate is defined as a measure of the extent to which available labour resources (people available to work) are being used. It is calculated as the ratio of the Employed to the Working Age Population (WAP) = (employed/WAP) * 100  Age Dependency Ratio is the ratio of dependents D (people younger than 15 or older than 64) to the Working Age Population (WAP) = ADR = (D / WAP) * 100  Unemployment Rate (UR) is the number of unemployed people (U) as a percentage of the Labour Force (LF) = UR = (U/LF) *100 PRICE STABILITY: It means a “low” inflation = very small rates of increase in consumer prices. Maintaining price stability is the primary objective of the euro-area central banks and a fundamental goal of the main central banks as well. In pursuing price stability, the ECB seeks to hold inflation below but close to 2% over a medium-term horizon. Inflation = a situation in which the economy’s overall price level is rising. The inflation rate is the percentage change in the price level from the previous period. If (C + I + G) > GDP then NX = <0 and I = 1> Sn , Where Sn = Y – C – G  The region has to attract foreign saving (Sw) in order to finance the trade deficit: -NX = Sw If C + I + G < GDP then NX = > 0 and I < Sn The region has to export national saving (Sn) in order to maintain macroeconomic equilibrium: NX = -Sw IN BRIEF: The (static) condition of macroeconomic equilibrium is the balance between Investment (I) and Saving (S = Sn + Sw). When I = S then a country can sustain (= finance with foreign saving) a trade deficit spending more than it produces, that is Domestic Demand (C + I + G) exceeds Domestic Production (and vice versa it can sustain a trade surplus). THE AS-AD MODEL: Short and long run equilibrium:  In the short-run AD determines output, employment and inflation.  In the long-run economy moves toward its potential GDP. SUPPLY SIDE: SHORT AND LONG RUN The Aggregate Production Function shows the total output the economy can produce with different quantities of labour, given constant amounts of capital and natural resources and the current state of technology: Y = F (L, K, N) The AGGREGATE-SUPPLY CURVE shows the quantity of goods and services that firms choose to produce and sell at each price level. It tells us the price level consistent with firms’ unit costs and their percentage markups at any level of output over the short run. We have to distinguish between movement along and shift of the entire curve: Movements along the AS curve  When a change in output causes price level to change, we move along economy’s AS curve. It increases of real GDP, input requirements per unit of output, price of nonlabour inputs, unit costs, price level. When a change in real GDP causes the price level to change it is a movement along the curve. Shifts of the AS curve  when anything than a change in real GDP causes price level to change. What can cause unit costs to change at any given level of output? Changes in world oil prices, Changes in the weather, Technological change, Nominal wage, etc. Long-run AS curve: In the long run, an economy’s production of goods and services depends on its supplies of labour, capital, and natural resources and on the available technology used to turn these factors of production into goods and services. The price level does not affect these variables in the long run. This level of production is also referred as POTENTIAL OUTPUT OR FULL-EMPLOYMENT OUTPUT. The AGGREGATE DEMAND – AD CURVE  it shows the quantity of goods and services that households, firms ad the government want to buy at each price level. GDP = C + I + G + NX, where: Consumption Spending  Household spending on consumer goods is about 2/3 of total spending in the economy. What determines the total amount of consumption spending?  Disposable Income: the income of the household sector after taxes = Total Income – Net Taxes;  Wealth  The Interest Rate  Expectations  Marginal propensity to consume Investment spending  It consists of three components: Business spending on plant and equipment, Purchases of new homes and the Accumulation of unsold inventories. Investments depends primarily on two factors: 1- The expected profit connected to the level of sales: a firm facing an increase in sales and needing to increase production. To do so, it may need to buy additional machines, i.e. to invest. 2- The interest rate. Government purchases  include all of the goods and services that government agencies buy during the year. When analysing total spending in the economy, they are treated as a given value determined by forces that are outside of our analysis. Net exports  they depend on: 1- Model of specialization 2- Domestic and foreign income: The higher the (domestic) income, the higher imports 3- Domestic and foreign prices: The higher the (domestic) price, the lower exports HOW THE INTEREST RATE AFFECTS SPENDING:  When Fed increases money supply, interest rate falls, and spending on several categories of goods increases: Plant and equipment, New housing, Consumer durables especially automobiles, export.  When Fed decrease money supply, interest rate rises and these categories of spending fall. WHY THE AGGREGATE DEMAND CURVE IS DOWNWARD SLOPING? 3 effects: 1- Price Level and Consumption: The Wealth Effect  A decrease in the price level makes consumers feel wealthier, which in turn encourages them to spend more. This increase in consumer spending means larger quantities of goods and services demanded. 2- Price Level and Investment: The Interest Rate Effect  A lower price level reduces the interest rate, which encourages greater spending on investment goods. This increase in investment spending means a larger quantity of goods and services demanded. 3- Price Level and Net Exports: The Exchange rate effect  When a fall in the Euroland price level causes Euroland interest rates to fall, the exchange rate depreciates, which stimulates Euroland net exports. The increase in net export spending means a larger quantity of goods and services demanded. WHY THE AGGREGATE DEMAND CURVE MIGHT SHIFT? Other factors affect the quantity of goods and services demanded at any given price level. When one of these other factors changes, the aggregate demand curve shifts. These shifts arising from a change in exogenous variables concerning: Consumption, Investment, Government Purchases (Fiscal policy), Net Exports, Money Supply (Monetary policy). SHORT RUN MACROECONOMIC EQUILIBRIUM: The short run equilibrium will change when either AD curve, AS curve or both shift:  An event that causes AD curve to shift is a DEMAND SHOCK.  An event that causes AS curve shift is a SUPPLY SHOCK. ADJUSTING TO THE LONG RUN: We can summarize economy’s self-correcting mechanism as follows  Whenever a demand or a supply shock pulls economy away from full employment, self-correcting mechanism will eventually bring it back  When output exceeds its full-employment level, wages will eventually rise causing a rise in price level and a drop in GDP until full employment is restored  When output is less than its full employment level wages will eventually fall causing a drop in price level and a rise in GDP until full employment is restored. CONCLUSIONS: The AS-AD can be used to explain the working of an economy in the short and in the long run:  In the short-run AD determines output, employment and inflation  In the long-run economy moves toward its potential GDP basically determined by labour productivity. SHORT RUN AS-AD MODEL: LECTURE OUTLINE: Which are the main causes and consequences of business cycles, inflation and unemployment? Outline: 1. Business Cycles 2. Inflation 3. Unemployment BUSINESS CYCLES: Structural unemployment is the unemployment that results because the number of jobs available in some labour markets is insufficient to provide a job for everyone who wants one (point A). Cyclical unemployment due to insufficiency aggregate demand (point B). When the economy goes into a recession and total output falls, the unemployment rate rises from conditions in the overall economy, cyclical unemployment is a problem for macroeconomic policy. Macroeconomists say we have reached full employment when cyclical unemployment is reduced to zero but the overall unemployment rate at full employment is greater than zero because there are still positive levels of frictional, seasonal, and structural unemployment. How do we tell how much of our unemployment is cyclical? Many economists believe that normal amount of frictional, seasonal and structural unemployment account for an unemployment rate of between 4 and 4.5% in the United States. The natural rate of unemployment is the unemployment rate at which GDP is at its full- employment level (Potential GDP):  When unemployment rate is below natural rate, GDP is greater than the potential output (inflationary gap) and so economy’s self-correcting mechanism will then create inflation.  When unemployment rate is above natural rate, GDP is below than the potential output (deflationary gap) and so self-correcting mechanism will then put downward pressure on price level. The Economic Costs of Unemployment  Chief economic cost of unemployment is the opportunity cost of lost output. Goods and services the jobless would produce if they were working but do not produce because they cannot find work and the unemployed are often given government assistance so costs are spread among citizens in general. However, when there is cyclical unemployment, nation produces less output and some groups within society must consume less output  In other words: we also have an economic cost of unemployment due to less output and the cost of assistance. THE TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT: PHILLIPS CURVE Society faces a short-run trade-off between unemployment and inflation. Policymakers can choose the best combination of inflation and unemployment using a Keynesian approach  The idea here is that: according to Keynesian model, policy makers could choose between high inflation and low unemployment or low inflation and high unemployment:  If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation.  If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment. According to Philips (with a typical Keynesian way of thinking): sometimes the government tries to reduce unemployment expanding the aggregate demand and the result is lower unemployment and higher inflation, in other period they persuade different combination and the result is the opposite. The Keynesian approach is: you must manage the economy from the demand side, closing the gap. When you are in a deflationary gap you expand the demand, when you are in an inflationary gap you contract the demand. In the first case you will have more inflation and less unemployment and vice versa. A twofold limit:  Labour market flexibility : in order to restore the long run equilibrium, wages may have to be reduced too much.  Demand management policy : in order to reduce the unemployment rate, the inflation rate cold increase too much. CONCLUSION: The AS-AD model can be used for explaining business cycles, inflation and unemployment. In the short run Aggregate Demand determines output, employment and inflation due to sticky wages and prices. The main consequences of short run fluctuation around potential GDP are: waste of resources, price instability and under/over employment. In search of the best policy: the twofold limit of labour market flexibility and Keynesian demand management policy. LONG RUN AS-AD MODEL: LECTURE OUTLINE: Which are the main determinants of growth in the long run? Outline: 1. What happens in the long run 2. The determinants of growth 3. The model of specialization WHAT HAPPENS? In the long-run the economy tends to reach the full employment equilibrium with actual GDP equals to potential GDP, unemployment rate equals to natural rate of unemployment, inflation rate determined by the interplay between AS-AD. The speed of adjustment depends on wages and price flexibility. POLITICAL ECONOMY OF ITALY: WHAT IS POLITICAL ECONOMY OF ITALY? LECTURE OUTLINE:  From Political Economy to Economics and Beyond  The Political Economy of National Economies: Italy FROM POLITICAL ECONOMY TO ECONOMICS AND BEYOND: The key issue of our time: How to Run the World (and Europe)? How to Reconcile National Interests and International Order?  This is the subject of several disciplines including Economics (International Economics and International Political Economy or IPE). The challenge of our time is to managing cultural diversity and how to reconciliate national interests and international order. If a country wants to maximize only its own national interest, we will have international disorder. We have to find a solution by balancing the right national interest with the right international order. In the history of Economics we can identify some paradigms: CLASSICAL ECONOMICS (1776-1874): The main idea of this economists was that Economics was originally POLITICAL ECONOMY defined as the science of wealth of nations (Adam Smith treaty), then as an enquiry into production, distribution and consumption of goods and services (wealth: subject of economics). The key points were:  Methodological Holism (social classes mainly three: land-owners, workers and entrepreneurs);  Labour Theory of Value = tool to explain the exchange value of goods and services in the market that is the cost of production (Exchange economy/market economy, the relevance of specialization);  Principle of Comparative Advantage: David Ricardo in the 19th century distinguishes between national market (the exchange value of goods and services is the ABSOLUTE COST OF PRODUCTION in the internal market, free movement of input and output) and international market (where there is the imperfect mobility of capital and labour, the key principle is the theory of COMPARATIVE COST ADVANTAGE). In a world with imperfect international mobility of capital (saving) and labour, it is sufficient to guarantee free trade to maximize and reconcile national interests: “One Economic Freedom” = free trade of goods, is enough because a country tends to specialize into something that can done relatively better than competitors (the other countries). THE DECLINE OF CLASSICAL ECONOMICS: In the beginning of the 70s a scientific revolution happened favoured by some limits of the classical political economy: 1- The limits of the labour theory of value  there are things that don’t require a high cost of production and nevertheless they have a high value and vice versa, so the principle of marginal utility was introduced; 2- The lack of distinction between absolute and relative gains of international trade  international trade brings benefits but nations are interested in relative power, topic that don’t matter for classical economists; 3- The class struggle and the fear of Marxism  Classical economics in the hands of Karl Marx became a powerful tool to predict the collapse of capitalism (classical economists wanted market economy and capitalism with collaboration between classes). NEOCLASSICAL ECONOMICS (1870-1935): Alfred Marshall (1890) the father of macroeconomics, Principles of Economics: “Political economy or Economics is a study of mankind in the ordinary business of life” (title of his treaty, first time of the appearance of Economics). Economics as the science of rational choices under conditions of scarcity  Lord Lionel Robbins (1935): “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. Economics is the social science that investigates the rational choices of humans when they face conditions of scarcity (Robbinson Crusoe – cast way: he is alone and has to identify its constraints and its resources). The key points are:  Methodological individualism  analysing the agents of the economy behaviours from the bottom to the top (consumers, entrepreneurs, managers, firms, governments, markets and their networks, ect);  New theory of value  marginal utility theory of value (marginalists);  Economic equilibrium  determinants of economic development in the long-run by analysing and identify the best allocation of scarce resources (they look at the short run rather than the long run). The period is known as the 1st globalization or Belle epoque because there is an increasing movement of labour and capital  one economic freedom is not enough, there is the need to guarantee the 3 economic freedoms (Economic freedom remains the way to reconcile national interests and to ensure the best allocation of resources). KEYNESIAN REVOLUTION (1936): The masterpiece publication (scientific revolution) The General Theory of Employment, Interest and Money. Keynes is the founder of modern macroeconomics. affected by the clash between growing international economy space and persistent international polity space fragmented in nation-states (International Political Economy or IPE).  A governance without a government (the gap). IN BRIEF: Economics was born as Political Economy, then it becomes the science of rational choices under conditions of scarcity applying its method to several fields. The rediscovery of Political Economy originates to the need to combine economic theory with history and politics. A variety of approaches to International Political Economy. THE MAIN APPROACHES TO IPE: International Political Economy is the study of how economics and politics interact in the global system. The main approaches are: Liberalism; Marxism, Realism: Robert G. Gilpin (1930-2018). We consider only the Gilpin’s Realism (4 points to stress on): A) The international system is anarchic (not necessarily conflictual): “Anarchy means rather that there is no higher authority to which a state can appeal for succour in times of trouble.” B) The nation-state is the primary actor in international affairs, but there are also non-state actors such as multinational firms, international institutions, NGOs. C) Ideas and values play an important role in determining behaviour and choices. D) One of the dominant issue is the relationships between interdependence and national sovereignty: Gilpin defined IPE: “I define ‘global political economy’ as the interaction of the market and such powerful actors as states, multinational firms, and international organizations” In a previous book, Gilpin (1975) had defined IPE as “the reciprocal and dynamic interaction in international relations of the pursuit of wealth and pursuit of power”. MEASURING THE ECONOMY: INTRODUCTION: The manifesto said that econometric society (1933) “science is measurement”. Peter Druker father of modern management said “you can’t manage what you can’t measure” We can measure & manage something if we have clear targets. We usually look at: Income & wealth to measure individual welfare, Income statement & balance sheet for firm profit  Is it sufficient? The role of relational goods. What are the main desirable targets of an entire economy? How can we measure its performance? Macroeconomics studies the working of economic systems (local, regional, national, international) Problems & Goals: An economic system is well working when it can solve a set of problems by reaching a set of targets  Macroeconomic Problems: growth, business cycle, unemployment, inflation, public debt, external debt. Macroeconomic Targets: Happiness? Wellbeing? Human Development? We usually say: high growth, full-employment, price stability. Europe states: A Sustainable, Smart and Inclusive Growth. I prefer to say a “Good Growth” (sustainable, fair and inclusive). LECTURE OUTLINE: How to measure the performance of an economy? (How to measure growth, employment and stable prices). GROWTH – ECONOMIC GROWTH INDICATORS: There are several macroeconomic accounts, the most important (and useful) is the “Resources and Uses Account” (of a nation). Statistical identity and GDP: The Fundamental Statistical Identity: Y + M = C + I + E; Y = C + I + NX where NX = E - M It is a statistical identity because the unsold goods are considered unplanned inventories that is goods bought by the firms themself. Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. There are 3 way to calculate it: A) Expenditure Approach: GDP = C + I + NX B) Value-Added Approach: GDP = Sum of VA. The value added by a firm is the value of its production (1 car = $200) minus the value of the intermediate goods used (steel = $100). C) Income Approach: GDP = Sum of Factor  Payments = wages + interest + rent + profit. GDP as Value of Final Goods (Demand Side)  We can calculate GDP (Y) as total expenditure of goods and services = Consumption (C), Investment (I), Government Purchases (G), Net Exports (NX) = Y = C + I + G + NX, Where G includes Government Consumption and Investment The Components of GDP are:  Consumption (C): The spending by households on goods and services, with the exception of purchases of new housing.  Investment (I): The spending on capital equipment, inventories, and structures, including new housing.  Government Purchases (G): The spending on goods and services by local and central governments. It does not include transfer payments because they are not made in exchange for currently produced goods or services.  Net Exports (NX): Exports minus imports. Real vs Nominal GDP:  Nominal GDP values the production of goods and services at current prices. It may change if prices change and quantities are constant.  Real GDP values the production of goods and services at constant prices (base year). Since real GDP uses base year prices, real GDP only changes when the country produces more output. Actual and Potential GDP:  Actual GDP is the value of all final goods really produced in a given period of time.  Potential GDP is an estimate of the maximum sustainable output of the economy. The Output Gap is the difference between actual and potential GDP expressed as a percentage of potential GDP  (actual GDP – potential GDP)/ potential GDP. The most important growth indicator is Real GDP per capita = Real GDP/Population. The final target should be a “Good Growth”: Sustainable, Fair, Inclusive. EMPLOYMENT – HIG OR FULL EMPLOYMENT: But first we have to define some key concepts:  Working Age Population : The working age population is defined as those aged 15 to 64  Labour Force or active population , comprises all persons who fulfil the requirements for inclusion among the employed or the unemployed: Employed + Unemployed. If a person is not seeking work, she is not counted in the labour force. The main indicators are the Employment Rate and Age Dependency Ratio and the Unemployment Rate:  Employment Rate is defined as a measure of the extent to which available labour resources (people available to work) are being used. It is calculated as the ratio of the Employed to the Working Age Population (WAP) = (employed/WAP) * 100  Age Dependency Ratio is the ratio of dependents D (people younger than 15 or older than 64) to the Working Age Population (WAP) = ADR = (D / WAP) * 100  Unemployment Rate (UR) is the number of unemployed people (U) as a percentage of the Labour Force (LF) = UR = (U/LF) *100 PRICE STABILITY: It means a “low” inflation = very small rates of increase in consumer prices. Maintaining price stability is the primary objective of the euro-area central banks and a fundamental goal of the main central banks as well. In pursuing price stability, the ECB seeks to hold inflation below but close to 2% over a medium-term horizon. Inflation = a situation in which the economy’s overall price level is rising. The inflation rate is the percentage change in the price level from the previous period. If (C + I + G) > GDP then NX = <0 and I = 1> Sn , Where Sn = Y – C – G  The region has to attract foreign saving (Sw) in order to finance the trade deficit: -NX = Sw If C + I + G < GDP then NX = > 0 and I < Sn The region has to export national saving (Sn) in order to maintain macroeconomic equilibrium: NX = -Sw IN BRIEF: The (static) condition of macroeconomic equilibrium is the balance between Investment (I) and Saving (S = Sn + Sw). When I = S then a country can sustain (= finance with foreign saving) a trade deficit spending more than it produces, that is Domestic Demand (C + I + G) exceeds Domestic Production (and vice versa it can sustain a trade surplus). THE AS-AD MODEL: Short and long run equilibrium:  In the short-run AD determines output, employment and inflation.  In the long-run economy moves toward its potential GDP. SUPPLY SIDE: SHORT AND LONG RUN The Aggregate Production Function shows the total output the economy can produce with different quantities of labour, given constant amounts of capital and natural resources and the current state of technology: Y = F (L, K, N) The AGGREGATE-SUPPLY CURVE shows the quantity of goods and services that firms choose to produce and sell at each price level. It tells us the price level consistent with firms’ unit costs and their percentage markups at any level of output over the short run. We have to distinguish between movement along and shift of the entire curve: Movements along the AS curve  When a change in output causes price level to change, we move along economy’s AS curve. It increases of real GDP, input requirements per unit of output, price of nonlabour inputs, unit costs, price level. When a change in real GDP causes the price level to change it is a movement along the curve. Shifts of the AS curve  when anything than a change in real GDP causes price level to change. What can cause unit costs to change at any given level of output? Changes in world oil prices, Changes in the weather, Technological change, Nominal wage, etc. Long-run AS curve: In the long run, an economy’s production of goods and services depends on its supplies of labour, capital, and natural resources and on the available technology used to turn these factors of production into goods and services. The price level does not affect these variables in the long run. This level of production is also referred as POTENTIAL OUTPUT OR FULL-EMPLOYMENT OUTPUT. The AGGREGATE DEMAND – AD CURVE  it shows the quantity of goods and services that households, firms ad the government want to buy at each price level. GDP = C + I + G + NX, where: Consumption Spending  Household spending on consumer goods is about 2/3 of total spending in the economy. What determines the total amount of consumption spending?  Disposable Income: the income of the household sector after taxes = Total Income – Net Taxes;  Wealth  The Interest Rate  Expectations  Marginal propensity to consume Investment spending  It consists of three components: Business spending on plant and equipment, Purchases of new homes and the Accumulation of unsold inventories. Investments depends primarily on two factors: 1- The expected profit connected to the level of sales: a firm facing an increase in sales and needing to increase production. To do so, it may need to buy additional machines, i.e. to invest. 2- The interest rate. Government purchases  include all of the goods and services that government agencies buy during the year. When analysing total spending in the economy, they are treated as a given value determined by forces that are outside of our analysis. Net exports  they depend on: 1- Model of specialization 2- Domestic and foreign income: The higher the (domestic) income, the higher imports 3- Domestic and foreign prices: The higher the (domestic) price, the lower exports HOW THE INTEREST RATE AFFECTS SPENDING:  When Fed increases money supply, interest rate falls, and spending on several categories of goods increases: Plant and equipment, New housing, Consumer durables especially automobiles, export.  When Fed decrease money supply, interest rate rises and these categories of spending fall. WHY THE AGGREGATE DEMAND CURVE IS DOWNWARD SLOPING? 3 effects: 1- Price Level and Consumption: The Wealth Effect  A decrease in the price level makes consumers feel wealthier, which in turn encourages them to spend more. This increase in consumer spending means larger quantities of goods and services demanded. 2- Price Level and Investment: The Interest Rate Effect  A lower price level reduces the interest rate, which encourages greater spending on investment goods. This increase in investment spending means a larger quantity of goods and services demanded. 3- Price Level and Net Exports: The Exchange rate effect  When a fall in the Euroland price level causes Euroland interest rates to fall, the exchange rate depreciates, which stimulates Euroland net exports. The increase in net export spending means a larger quantity of goods and services demanded. WHY THE AGGREGATE DEMAND CURVE MIGHT SHIFT? Other factors affect the quantity of goods and services demanded at any given price level. When one of these other factors changes, the aggregate demand curve shifts. These shifts arising from a change in exogenous variables concerning: Consumption, Investment, Government Purchases (Fiscal policy), Net Exports, Money Supply (Monetary policy). SHORT RUN MACROECONOMIC EQUILIBRIUM: The short run equilibrium will change when either AD curve, AS curve or both shift:  An event that causes AD curve to shift is a DEMAND SHOCK.  An event that causes AS curve shift is a SUPPLY SHOCK. ADJUSTING TO THE LONG RUN: We can summarize economy’s self-correcting mechanism as follows  Whenever a demand or a supply shock pulls economy away from full employment, self-correcting mechanism will eventually bring it back  When output exceeds its full-employment level, wages will eventually rise causing a rise in price level and a drop in GDP until full employment is restored  When output is less than its full employment level wages will eventually fall causing a drop in price level and a rise in GDP until full employment is restored. CONCLUSIONS: The AS-AD can be used to explain the working of an economy in the short and in the long run:  In the short-run AD determines output, employment and inflation  In the long-run economy moves toward its potential GDP basically determined by labour productivity. SHORT RUN AS-AD MODEL: LECTURE OUTLINE: Which are the main causes and consequences of business cycles, inflation and unemployment? Outline: 1. Business Cycles 2. Inflation 3. Unemployment BUSINESS CYCLES: Structural unemployment is the unemployment that results because the number of jobs available in some labour markets is insufficient to provide a job for everyone who wants one (point A). Cyclical unemployment due to insufficiency aggregate demand (point B). When the economy goes into a recession and total output falls, the unemployment rate rises from conditions in the overall economy, cyclical unemployment is a problem for macroeconomic policy. Macroeconomists say we have reached full employment when cyclical unemployment is reduced to zero but the overall unemployment rate at full employment is greater than zero because there are still positive levels of frictional, seasonal, and structural unemployment. How do we tell how much of our unemployment is cyclical? Many economists believe that normal amount of frictional, seasonal and structural unemployment account for an unemployment rate of between 4 and 4.5% in the United States. The natural rate of unemployment is the unemployment rate at which GDP is at its full- employment level (Potential GDP):  When unemployment rate is below natural rate, GDP is greater than the potential output (inflationary gap) and so economy’s self-correcting mechanism will then create inflation.  When unemployment rate is above natural rate, GDP is below than the potential output (deflationary gap) and so self-correcting mechanism will then put downward pressure on price level. The Economic Costs of Unemployment  Chief economic cost of unemployment is the opportunity cost of lost output. Goods and services the jobless would produce if they were working but do not produce because they cannot find work and the unemployed are often given government assistance so costs are spread among citizens in general. However, when there is cyclical unemployment, nation produces less output and some groups within society must consume less output  In other words: we also have an economic cost of unemployment due to less output and the cost of assistance. THE TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT: PHILLIPS CURVE Society faces a short-run trade-off between unemployment and inflation. Policymakers can choose the best combination of inflation and unemployment using a Keynesian approach  The idea here is that: according to Keynesian model, policy makers could choose between high inflation and low unemployment or low inflation and high unemployment:  If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation.  If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment. According to Philips (with a typical Keynesian way of thinking): sometimes the government tries to reduce unemployment expanding the aggregate demand and the result is lower unemployment and higher inflation, in other period they persuade different combination and the result is the opposite. The Keynesian approach is: you must manage the economy from the demand side, closing the gap. When you are in a deflationary gap you expand the demand, when you are in an inflationary gap you contract the demand. In the first case you will have more inflation and less unemployment and vice versa. A twofold limit:  Labour market flexibility : in order to restore the long run equilibrium, wages may have to be reduced too much.  Demand management policy : in order to reduce the unemployment rate, the inflation rate cold increase too much. CONCLUSION: The AS-AD model can be used for explaining business cycles, inflation and unemployment. In the short run Aggregate Demand determines output, employment and inflation due to sticky wages and prices. The main consequences of short run fluctuation around potential GDP are: waste of resources, price instability and under/over employment. In search of the best policy: the twofold limit of labour market flexibility and Keynesian demand management policy. LONG RUN AS-AD MODEL: LECTURE OUTLINE: Which are the main determinants of growth in the long run? Outline: 1. What happens in the long run 2. The determinants of growth 3. The model of specialization WHAT HAPPENS? In the long-run the economy tends to reach the full employment equilibrium with actual GDP equals to potential GDP, unemployment rate equals to natural rate of unemployment, inflation rate determined by the interplay between AS-AD. The speed of adjustment depends on wages and price flexibility. For income per capita to rise, either labour productivity must rise or the number of hours worked must grow faster than the population. The major sources of labour productivity are:  Accumulation of capital goods (investment);  Qualitative improvements in the labour forces (human capital);  Greater efficiency in allocating resources (TFP) but there is competition as reallocation of resources from low to high productivity sectors;  Technological change and innovations. The key role of productivity  GDP per capita depends on labour productivity (output per hour worked) and the number of hours worked (connected to employment rate). We can imagine a growth basically based on productivity or employment rate. In the long run the key variable affecting economic growth is labour productivity (due to ageing population and robots). THE MODEL OF SPECIALIZATION: Finally, labour productivity depends on the international division of labour based on the principle of comparative advantages: with the same amount of inputs one can obtain a greater output (gains from trade). Economists use the Rule of 70 to determine the number of years it takes for income to double  Time to double = 70/g, where g is the average growth rate. If g = 2%, then Time to double = 70/2 = 35 years. If g = 3%, then time to double = 23 years and 4 months. CONCLUSIONS: In the long-run economy moves towards its Potential GDP (vertical line of Aggregate Supply). The key variable of the adjustment is wages & prices. We assume that in the long run wages & prices have time to adjust to bring supply and demand into balance. In the short run, however, wages & prices are sticky and therefore Aggregate Demand determines output, employment and inflation. In the long-run the main drivers of growth are labour productivity and employment rate. However, the true determinant of output is LABOUR PRODUCTIVITY. MARKET DEMAND AND SUPPLY: DEMAND: Firms reveal consumer needs by analysing market demand that depends on price and other variables (mainly income), demand is inversely proportionated to the price. Price and income elasticity measure the sensibility of demand to price and income. SUPPLY: Firms face a twofold constraint: law of diminishing demand (or price-takers) and law of increasing costs (in the short and in the long run). And they must make a twofold decision concerning level of Output (Q) and Price (P), and methods of production (labour intensive or capital intensive). Firms maximize profit by producing the quantity at which marginal cost equals marginal revenue. The break-even point - BEP is a technique to determine the best level of price and quantity. Firms maximize profit by choosing the best combination between price and quantity and between labour and capital. In order to maximize profit, they have to manage supply chains able to satisfy consumer needs. Market Supply depends on price and other variables (mainly cost of inputs). Price elasticity measure the sensibility of supply to price. THE ROLE OF MARKETS: COMPETITION AND MONOPOLY LECTURE OUTLINE: How do Markets Work? Outline: 1. Market Forms 2. Perfect Competition 3. Monopoly MARKET FORMS: Market is any place where buyers and sellers meet to exchange goods or services (were physical spaces or cyberspaces). Markets tend toward equilibrium, and in equilibrium total surplus is maximized. MARKETS NOT IN EQUILIBRIUM: SURPLUS  When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium. SHORTAGE  When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium. EQUILIBRIUM  law of supply and demand: the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. How to determine the market forms  we have to look at:  The number of buyers and sellers  The nature of the product (standardized or differentiated)  The existence of barriers to entry or exit  The type of information (perfect or imperfect) In a competitive market, economic profit and loss are the forces driving long-run change. Expectation of continued economic profit (losses) causes outsiders (insiders) to enter (exit) the market. In real world entry and exit occur literally every day, in some cases, we see entry occur through formation of an entirely new firm or it also occurs when an existing firm adds a new product to its line. Exit can occur in different ways:  Firm may go out of business entirely, selling off its assets and freeing itself once and for all from all costs.  Firm switches out of a particular product line, even as it continues to produce other things. IN BRIEF: Competitive firm:  In the short run, when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost.  In the long run, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost. Competitive market: In a market with free entry and exit, profits are driven to zero in the long run, i.e. firms must charge a minimum price = Marginal cost = minimum ATC. In a market economy, price changes act as market signals, ensuring that pattern of production matches pattern of consumer demands:  When demand increases, a rise in price signals firms to enter market, increasing industry output  When demand decreases, a fall in price signals firms to exit market, decreasing industry output An Increase in Demand in S An Increase in Demand in Short and Long Run THE REQUIREMENTS OF MONOPOLY:  Numbers of buyers and sellers: One seller  Product: There aren’t close substitutes  Barriers: There are some barriers to entry A monopoly firm is the only seller of a good or service with no close substitutes, the market in which the monopoly firm operates is called a monopoly market. The fundamental cause of monopoly is barriers to entry that have several sources:  Ownership of a key resource (DeBeers Diamond).  The government gives a single firm the exclusive right to produce some good (patent and copyright).  Costs of production make a single producer more efficient than a large number of producers  Entry is impeded by incumbent Natural monopolies  An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. It arises when there are economies of scale over the relevant range of output. COMPARING MONOPOLY AND COMPETITION: In perfect competition, economic profit is relentlessly reduced to zero by entry of other firms In monopoly, economic profit can continue indefinitely But monopoly differs from perfect competition in another way, we can expect a monopoly market to have a higher price and lower output than an otherwise similar perfectly competitive market. By raising price and restricting output, new monopoly earns economic profit. Consumers lose in two ways: they pay more for output they buy and due to higher prices they buy less output. Monopolist firm Competitive firm Is the sole producer Is one of many producers Faces a downward-sloping demand curve Faces a horizontal demand curve Is a price maker Is a price taker Reduces price to increase sales Sells as much or as little at same price TOURISM RENT: Economic rent is an extra income. In monopoly the maximum price that consumers are willing to pay is higher than the minimum price producer is willing to accept. The difference is a rent earned by producers and the cause is a lack of supply. We can distinguish between Natural and Artificial Rents: In the first case the supply cannot be increased (due to “natural” barriers or factors like in tourism), in the second case the producer do not want to increase the supply (in order to maximize profit). CONTESTABLE MARKET: A contestable market is one with firms facing zero entry and exit costs. A market with a single firm (incumbent) but without barriers works like a competitive market: in the long run the incumbent will be only able to earn a normal profit (zero economic profit). Therefore, the key feature of market is the absence of barriers (free to entry/exit = liberalization policies). CONCLUSION: Specific  Markets work as places where buyers and sellers meet to exchange goods or services. The best form of market is perfect competition. The worst form is monopoly (according to some economists and politicians, it is just a temporary situation useful to incentive innovations). But the real difference depends on the existence of barriers. General  In a planned economy, the government decides where, what and how to produce. Who makes these decisions in a market economy? In 1776 Adam Smith answered: “an invisible hand” = Market economy is an invisible mechanism for coordinating decisions taken by millions of consumers and producers. Markets promote growth fostering an efficient In Monopoly quantity is lower and price higher compared with Competition because the monopolistic firm prefers to sell less quantity at a higher price in order to maximize profit. Without barriers we would have a competitive equilibrium. allocation of scarce resources. Competitive markets reinforce Total Factor Productivity – TFP. MARKET FAILURES AND MICROECONOMIC POLICY: INTRODUCTION: General Question: What Is the Role of Economic Policy? Politics is the art of governing society. Economic policy is the art of governing the economy: Combining different tools to achieve particular targets, distinguish between final and intermediate goals and tools, taking into consideration trade-offs and alternative choices. According to Richard Musgrave (1959), the government has three economic functions, which include (macroeconomic) stabilization, (fair) distribution and (efficient) allocation of resources. We assume that the final target is a sustainable, fair (or smart) and inclusive growth (it requires economic efficiency). We distinguish between Micro and Macro Economic Policy. The former affects single markets (i.e. anti-trust’s decision), the latter affects the entire economic system (i.e. changes in interest rates or taxes). Outline: 1. Microeconomic policies: goals and tools 2. Macroeconomic policies: goals and tools LECTURE OUTLINE: What is the Role of Microeconomic Policy? Outline: 1. Economic efficiency, market failures and innovation 2. Goals and Tools of Microeconomic policy ECONOMIC EFFICENCY: MANAGEMENT MICROECONOMICS Effectiveness refers to doing the right things. It measures if the actual output meets the desired output. It focuses on ends. it means “producing a result that is wanted” Economic efficiency is a state of allocation of resources in which it is impossible to make any one individual better off without making at least one individual worse off (Pareto efficiency) Efficiency refers to doing things in a right manner. It focuses on getting the maximum output with minimum resources. It focuses on means. It means “capable of producing desired results without wasting materials, Basic condition: all markets should have the form of perfect competition EQUILIBRIUM AND INNOVATION: According to Schumpeter, innovation is the engine of economic development because it breaks the economy out of its static mode (“circular low”) and sets it on a dynamic path triggering a process of “creative destruction”  he introduced a new theme, innovation that triggers the optimal equilibrium. Innovation is a new combination of inputs aimed at producing both “new things” and “old things” by a different method of production. This idea covers five main cases: – Introduction of a new good (playstation and Olivetti vs Steve Jobs) – Introduction of new methods of production (ICT revolution: a journey in a smart city) – Opening of a new market (music downloaded) – Conquest of a new source of raw materials (oil) – Carrying out of the new organization of any industry (empowerment) Disruptive and sustaining innovations – disruptive innovation vs incremental innovation  The theory of disruptive innovation was invented by Clayton Christensen, of Harvard Business School, in his book “The Innovator’s Dilemma”. Christensen used the term to describe innovations that create new markets by discovering new categories of customers. He contrasted disruptive innovation with sustaining innovation, which simply improves existing products. Personal computers, for example, were disruptive innovations because they created a new mass market for computers; previously, expensive mainframe computers had been sold only to big companies and research universities. The result is either a reduction in the average total cost or an increase in the demand of the firm. The main function of the entrepreneur is to introduce innovations in the economy. Temporary monopoly  The innovative entrepreneur can both reduce the price of old goods and to increase the price of new goods. The innovative entrepreneur is followed by a swarm of imitative entrepreneurs who erode the extra-profit = The innovation provides a temporary benefit to the entrepreneur because imitators after a short period of time produce a similar good. GOALS OF MICROECONOMIC POLICY: We need to distinguish between:  Intermediate : reducing market failures to improve economic efficiency  Final : contributing to a sustainable, smart and inclusive growth The tools are: COMPETITION LAW  is known in the USA as anti-trust law with Sherman Act (1890) that reduced the market power of the large and powerful “trusts” of that period, and the Clayton Act (1914) that strengthened the government’s powers and authorized private lawsuits. In the EU, the European commission monitors:  agreements between companies which restrict competition, like cartels  abuses of a dominant position, where a major player tries to squeeze competitors out of the market  mergers, when companies join forces permanently or temporarily  financial support (State aid) for companies paid by EU governments CORRECTING EXTERNALITIES  Negative: the government should impose taxes. This raises the supply curve to the level of private cost plus external cost (e.g. Environment, City arts). Positive: the government should offer subsidies (e.g. Education, Culture, creativity and innovation – COSME). PROVIDING PUBLIC GOODS AND REGULATING COMMON RESOURCES   Providing public goods: The importance of physical and cyber security, culture as merit good  Regulating common resources : Tourist accommodation tax, to limit visitor numbers CONCLUSION: The main (intermediate) target of microeconomic policy is to improve markets economic efficiency reducing the phenomena of market failures. The main tools are competition law and regulation policy. MACROECONOMIC FAILURES AND POLICIES: LECTURE OUTLINE: What is the Role of Macroeconomic Policy? Outline: 1. The European Final Target 2. Monetary Policy: Goals and Tools 3. Fiscal Policy: Goals and Tools MONETARY POLICY: GOALS AND TOOLS  The most important target of the long run is to increase Potential GDP (that is productivity): a supply-side policy  The most important goal of the short run is to stabilize Actual GDP around Potential GDP: a demand-side policy A free economy is not able to ensure a sustainable, fair and inclusive growth (macroeconomic failures) In the short run, the role of macroeconomic policy is to manage Aggregate Demand (AD) Y = C + I + G + NX Tools: monetary and fiscal policy (affecting AD and therefore the entire economy) Targets: final and intermediate Consumption, Investment and Net Exports depend negatively on interest rate that is determined in the money market Monetary Tools are:  Open-market operations  Changing the reserve requirement  Changing the discount rate Monetary policy is the set of actions taken by the central bank in order to affect the money supply and interest rate. A central bank is an institution designed to oversee the banking system and regulate the quantity of money in the economy. The primary objective of the ECB is to promote price stability throughout the euro area. Fed is more interested in macroeconomic stabilization. OPERN-MARKET OPERATIONS  When the FED or ECB buys a government bond it pays for the bond with a check, when this check is deposited in the seller's bank, the Fed credits that bank's reserves the amount of the check. The bank now has more deposits and excess reserves = This is how the Fed creates new reserves: The money multiplier then goes to work creating more and more deposits, that is, more money.  Expansionary monetary policy (money supply increases): the central bank buys government bonds on the secondary market and injects liquidity into the economy.  Restrictive monetary policy (money supply decreases): the central bank sells government bonds on the secondary market and reduces liquidity in the economy. RESERVE REQUIREMENTS  they are regulations on the minimum amount of reserves that banks must hold against deposits.  Increasing the reserve requirement decreases the money supply.  Decreasing the reserve requirement increases the money supply. Central banks have tended to change reserve requirements only rarely. It is a percentage of deposits, established by the ECB, that a bank cannot invest because it is necessary to guarantee the liquidity of deposits. It is a mechanism that the central bank can control by changing the percentage of it:  if the coefficient increases, the amount of deposits drops;  if the coefficient decreases, the amount of deposits increases. DISCOUNT RATE (Fed) and REFINANCING RATE (ECB)  The refinancing rate is the interest rate the ECB lends on a short-term basis to the euro area banking sector. It is the interest rate at which the European Central Bank is willing to lend short-term to other banks.  Increasing the refinancing rate decreases the money supply.  Decreasing the refinancing rate increases the money supply In the USA, the refinancing rate is called the discount rate. It affects the Federal Funds Rate is the nominal interest rate on overnight loans between commercial banks. The interest rate on interbank loans. The federal funds market: Where banks lend reserves overnight. CHANGES IN THE MONEY SUPPLY: AD SHIFT The central bank can shift the aggregate demand curve when it changes monetary policy  An increase in the money supply shifts the money supply curve to the right.  A decrease in the money supply shifts the money supply curve to the left. Without a change in the money demand curve, the interest rate falls and increase the quantity of goods and services demanded. How the Interest Rate Affects Spending  When Fed increases money supply, interest rate falls, and spending on several categories of goods (Plant and equipment, new housing, Consumer durables especially automobiles, Export) increases. When Fed decreases money supply, interest rate rises, and these categories of spending fall. An expansionary monetary policy increases money supply and decreases interest rates (and vice versa). FISCAL POLICY: GOALS AND TOOLS Fiscal policies: changes in government purchases (G), taxes (T) and Debt (D)  Deficit spending : when government spending exceeds government revenue  Automatic stabilizers are expenditures that automatically increase, or taxes that automatically decrease, when economic conditions change. The most important automatic fiscal stabilizer is the income tax. When income increases, tax collections increase (and vice versa). Fiscal policies are policies of taxation and government spending:  Expansionary fiscal policy refers to an increase in government spending and/or a cut in taxes. Both increase the overall spending in the economy.  Contractionary fiscal policy, also called austerity, refers to a decrease in government spending and/or an increase in taxes. Both reduce the overall spending in the economy. The multiplier effect  An increase in G stimulates additional spending by consumers determining a multiple increase in aggregate demand. trade surplus. It showed that a country did not spend the available resources: domestic demand was below internal supply, investment below savings, imports below exports. Creditor countries, living beneath their means, were considered by Keynes the culprits of the global imbalances: they committed the sin of greed. The cure was a demand management policy oriented to stabilizing the economy. The international order should have allowed individual national governments to implement, when necessary, a deficit spending policy to raise the aggregate demand and consequently the level of production and employment. In Bretton Woods, Keynes proposed a combination of adjustable exchange rates and stable prices that would have allowed national governments to run a demand management policy oriented to full employment equilibrium. Moreover, he projected an International Clearing Union to force creditor countries to reduce their trade surplus. THE NOBLE COMPROMISE The Bretton Woods System was a gold-exchange standard = A regime of adjustable exchange rates pegged to the dollar (the only currency convertible in gold at $35 per ounce) while national governments retained a margin of flexibility and could count on the help of the new international institutions in order to attain external equilibrium. They could change their par value by less than 10% without IMF approval, could adopt temporary capital controls and other measures to reduce external deficit. Otherwise, they had to trigger the classic deflationary process (stable exchange rate was considered an external constraint). The member states, together with the twin international institutions (IMF and WB), were willing to seek a shared management of the global imbalances. GATT – GENERAL AGREEMENT ON TARIFF AND TRADE 1947: The General Agreement on Tariffs and Trade (GATT) was an international organization, created in 1947 devoted to the promotion of freer trade through multilateral trade negotiations . It rested on three basic principles: 1. Non-discrimination : This principle refers to the unconditional acceptance of the most- favoured-nation principle 2. Elimination of nontariff trade barriers (such as quotas), except for agricultural products and for nations in balance-of-payments difficulties 3. Consultation among nations in solving trade disputes within the GATT framework. IN BRIEF: The new world order was built on the two ancient pillars of gold (exchange) standard and free trade managed with a new spirit of cooperation between national governments and international institutions. NEW EUROPEAN ORDER: THE MARSHALL PLAN The ancient idea of a unified Europe re-emerged during WWII as an attempt to prevent a new Great War. After the war, the key question became: how can we unify Europe? The debate between federalists and internationalists (1941-48): Federalists  They share a basic idea: the first step should have been to set up a federate state (weak or strong). Only a European government would have been able to manage a complex process of economic integration. Policy first, economy later. However: Altiero Spinelli: Federalism as negation and overcome of nation-state and way for building a strong European government; Robbins, Hayek, Einaudi: Federalism as a way for reducing the power of politics restoring a great and free market; De Gasperi & Catholics: Federalism inspired to subsidiarity & solidarity principles. Internationalists  They argued that it was sufficient to restore the old economic order based on free trade and gold standard in order to rebuild a unified Europe within a unified world economy. Actually, it was sufficient to sign Bretton Woods and GATT agreements. Functionalism  In the end, it prevailed a third doctrine, the so-called “functionalism”, elaborated by the Rumanian economist David Mitrany and followed by the politicians Robert Schuman and Jean Monnet. They believed that the first step towards a unified Europe was meant to be opening the markets. A progressive economic integration would have ultimately called for a model of political unification. Economy first, politics later. Schuman: “Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity.” Monnet: “Europe will be forged in crises, and will be the sum of the solutions adopted for those crises”. AN OBSTACLE COURSE RACE STARTED WITH MARSHALL PLAN European journey would have been some sort of obstacle course race. And so it was, at least in part. The starting point in the long road to Europe can be considered April 16th, 1948 when in Paris the Organization for European Economic Cooperation (OEEC) was established in order to manage the aid of the so-called Marshall Plan (loans and grants). The discussion concerning the political model (which type of federation) was postponed to make room to the process of economic integration. We will identify 3 great steps in the European journey. IN BRIEF After WWII, Europe choose the functionalist approach in the awareness that one day it would be necessary to establish a type of political union. ITALY: STRUCTURAL PROBLEMS & STRATEGIC DECISIONS When WWII ended in May 1945, all the anti-Fascist parties formed a predominantly northern government led by the Resistance hero and Action Party leader Ferruccio Parri. In November 1945 Parri was forced to resign and was replaced by the Christian Democratic leader, Alcide De Gasperi who led a coalition that until May 1947 also included the Left. After the general election of 18 April 1948, De Gasperi formed a series of governments during the Years of Centrism. WAR AS NEGATIVE SUPPLY SHOCK: In 1945 national income returned to 1911 level, with a decrease of 40% compared to 1938. Firms faced a paradox: they have more plants and lower production capacity due to the shortage of raw materials. There were about 9 million unemployed. Unemployment was cyclical and above all structural. Between May 1946 and summer of 1947 the inflation rate exceeded 100%. The cause was the fall in supply or the scarcity of resources. After the end of war controls on prices and wages, too much money circulated compared to available goods. THE RECONSTRUCTION PROBLEM: Italian economy regresses to a new macroeconomic balance with lower output (actual and potential), higher inflation, higher structural unemployment and twin deficits. The fundamental problem of reconstruction is to increase potential and actual GDP. Italy suffers for a shortage of capital and raw materials. It is forced to import many goods and has to export or attract foreign capital in order to obtain the necessary foreign currency (Dollar Gap). THE STRATEGIC CHOICE In the years 1961-63, inflation rate rose to 3.3, 4.8 and 7.6% while full employment reinforced the bargaining power of trade unions that managed to achieve wage increases above labour productivity. CLUP increased changing the distribution of income between wages and profits. Investment and consumption continued to grow: therefore aggregate demand grew and the trade deficit reappeared. Cost inflation triggered demand inflation: the negative shock of AS was followed by a positive shock of AD. The result is a new macroeconomic equilibrium with higher inflation and negative net exports. “One essential component of the 'miracle' was exports, which increased at a yearly rate of 12.5%. Private consumption grew at a more moderate, albeit considerable, 5.9% per year. Apparently, the exceptional expansion of the 1950s had not affected the mercantilist model of development. However, there was another interesting trend in those years that of wage shares on industrial products. This passed from 62.7% in 1951 to 48.8% in 1962. In practice, the largest part of the huge increase in productivity which took place during the decade went to the benefit of profit. In the 1950s, the position of force enjoyed by employers in industrial relations prevented workers from acting effectively to contrast this trend.” IN BRIEF: From 1953 to 1962 the Italian economy grows at high rates driven by investment and exports. THE CRISIS OF 1963-64: The situation of foreign accounts is aggravated by a capital flight triggered by the symbolic measure of the first organic Centre-Left: the nationalization of the electricity industry. The Bank of Italy is uncertain: It fears to break the spell of miraculous growth. Then it implements a credit crunch: inflation and investments fall. FULL EMPLOYMENT AND INFLATION: “As a result, wages rose substantially: in two years, raises for employees grew by 43%. For the first time, they surpassed productivity growth and the wage share climbed back to 52% in 1963 … the immediate consequence of the workers’ unrest had been soaring inflation. This was alimented by employers’ attempts to defend their profits, passing the increase in labour costs to prices”. “Since 1947 the Bank of Italy had successfully pursued a policy mix of monetary stability, balanced current accounts and non-inflationary growth. In order to achieve this growth, the key variable in the eyes of the Central Bank was profitability. Only adequately high profits (given the scarcity of endogenous credit) could ensure the investments necessary to absorb the chronic manpower surplus without recurring to foreign capital. Conversely, due to the fact that workers’ marginal propensity to consume was higher than that of their employers, in the Bank's view, a wage rise would result in a greater demand for consumer goods, thus feeding inflation, higher imports and current account imbalances and, lastly, causing an arrest in growth.” THE MONETARY POLICY: First, an easy monetary policy: “Yet the centrality of profits in guaranteeing capital accumulation did not translate, in the Bank’s policy, into a dogmatic concept. Its attitude had always been characterised by policy flexibility and theoretical eclecticism. So, in the period immediately before the 1962-63 inflationary crisis, it adopted an easy monetary policy to sustain the price increases which defended profit levels.” Then, a restrictive manoeuvre: “However, this policy could not long continue in the Bretton Woods system of semi-fixed exchange rates. In the light of the rapid deterioration of the Italian balance of payments, Italy's monetary and political authorities were faced with a choice: either to devalue the lira or to apply a strict deflationary policy. Devaluation of the lira encountered the opposition of the USA, concerned about the stability of the whole system, and of the European partners, threatened by the competitiveness of Italian exports. It was rejected by the Banca d'Italia itself, for reasons of prestige and credibility. Thus, between the second half of 1963 and early 1964, the Bank reversed its policy of monetary expansion and applied a very restrictive one”. MORE EXPORTS AND LESS INVESTMENTS: “The restrictive manoeuvre achieved its objectives. Inflation returned under control. The abrupt slowing-down of the economy caused a surge in unemployment-the number of jobless returned to over a million but order was restored on the factory floor. With labour costs again under control, the previous conditions of capital accumulation were also restored. From 1966, the GDP had been rising again at a very sustained pace. But this growth had a very different quality from that of the 'miracle' years: it began-to use Riccardo Bellofiore's words – a phase of ‘accumulation without investments'. Capitalists reacted to the social turmoil of the early part of the decade with a 'strike' in investments, preferring to transfer capital abroad, legally or illegally. Thus, growth became even more dependent on exports.” IN BRIEF: The 1964 decision was consistent with the choice to participate in the Bretton Woods System. According to Petrini (Reading L, p. 141): “In sum the 1964 crisis marked a pivotal change in Italian history: in response to the exposure of the contradictions of the ‘economic miracle’, the country's establishment decided to remain on the path of ‘low-consumption-low salaries export push’, rather than accept the new realities brought about by modernisation, and to accommodate workers’ demands with a move to more internally oriented growth and efforts towards higher value-added production.” THE END OF THE MIRACLE: 1969 turning point: “Wage as independent variable” Until then no one had questioned, at least theoretically, the CLUP rule. In the Hot Autumn of 1969 the idea that wages should be predetermined on the basis of ethical-political parameters was affirmed. In 1970 CLUP increases significantly and in 1971 the Italian economy goes into crisis. On 15 August 1971 Nixon declares the end of Bretton Woods. THE END OF BRETTON WOODS: At the end of the sixties, America and West Germany were running opposite monetary policies. America, in order to finance the war in Vietnam, was increasing the money supply, while West Germany continued to run a traditional policy oriented to monetary stability. The expectation of a strong revaluation of the Mark compared to the Dollar triggered an outflow of capital from America to Europe. The Bundesbank was forced to buy Dollars against Marks, until a twofold fear prevailed: America was worried for the outflow of capital (and gold), and West Germany for the risk of inflation associated with the increasing supply of Marks. The historical decision to (temporary) suspend the convertibility of Dollar into Gold was taken by President Richard Nixon on 15 August 1971. A CASE OF ECONOMIC TRILEMMA: There exist three desirable goals: stable exchange rates, free flow of capital and autonomous monetary policy. Unfortunately, they are unable to coexist. In fact, with the free flow of capital, in order to maintain a stable exchange rate, it becomes necessary to coordinate monetary policies. Under the Bretton Woods Order, the member states chose the combination between stable exchange rate and national monetary policies coordination. After the wave of nationalism, they preferred a different combination: floating exchange rate and independent monetary policy. TRADE UNIONS AND MONETARY POLICY: “At the end of the 1960s, when the labour market approached again a situation of full employment, industrial workers' discontent with their poor job conditions exploded again, setting in motion a cycle of industrial conflict which was to last until the end of the 1970s. The workers won significant advances in terms of wages, as in the early 1960s, but this time also in terms of increased control over production processes, directly questioning power hierarchies on the factory floor.” “Again, as in the early 1960s, the immediate consequence of the worsened social conflict was an upsurge in inflation, in an attempt to alleviate the profit squeeze which had followed the workers' victories. The great difference with respect to 1963 was that the ensuing deflationary move, carried out in 1970 by the Bank of Italy, still under the guidance of Carli, in collaboration with a centre-right government presided by Emilio Colombo, did not work. This time deflation did not bring back order to the shop floor, stopping wage increases and thus restoring external competitiveness. The reason for this different outcome mainly lay in the increased strength of the trade unions.” THE (FAILED) EXTRAORDINARY MAINTENANCE: Carli’s attempt to reinforce private big business after the nationalization of electricity. DEVALUATION, PROFIT, INFLATION AND CRISIS: “The devaluation of the lira turned out to be quite effective in terms of GDP growth and defence of profits. In 1973-74, the economy grew at rates similar to those of the ‘economic miracle’, with an average yearly GDP growth (in real terms) of 6.3%. However, the sudden rise in imports produced by the booming economy, the ‘skyrocketing’ of the cost of imported energy due to the oil shock, and worsening of terms of trade caused a drastic worsening in the balance of payments. During 1974, the government was therefore forced to ask for international financial assistance. In return, it pledged to contain inflation. The Central Bank and the government implemented a very restrictive fiscal and monetary manoeuvre. The result was a slump in 1975”. THE CRISIS OF 1975: 1975 is the worst year. The dual adverse AS: production falls, unemployment and inflation rise and the composition of aggregate demand changes, with more public spending and fewer imports and exports. The positive AD shock does not offset the dual adverse AS shock. The Italian economy falls into stagflation associated with twin deficits. THE RECOVERY OF 1976-79: Governments of national solidarities (Andreotti). The recovery begins in 1976 thanks to the growth of exports, sustained by the progressive devaluation of the Lira and the parallel and gradual reduction of Clup. On 24 January 1978 the trade union leader Luciano Lama states: “in an open economy, variables are all dependent on each other”. In February, an assembly of 1500 trade union delegates ratified the return to wage moderation. The independent variable salary season ends. Devaluation is still the way to gain competitiveness. THE PERVERSE SPIRAL: It is just a short-term solution. Competitive devaluations trigger a trade war in Europe shrinking the volume of trade. In Italy starts a perverse spiral: lira devaluation is followed by an increase in price of imported goods, rise in inflation, automatic adjustment of wages, which causes a new rise in prices and induces entrepreneurs to ask for a further devaluation. External loss of value is followed by internal loss of value In 1970, 1$ = 627 lire and 1 mark = 172 Lire In 1979, 1$ = 831 lire and 1 mark = 453 Lire In 1970 the inflation rate was 5.2%, in 1979 it was 15.7%. RECOVERY FUELLED BY DEVALUATION RATHER THAN PRODUCTIVITY: “This opened a five-year spell of sustained GDP growth on average 4.7% between 1976 and 1980 - analogous to Japan’s and higher than that of Italy’s European partners. It was, once again, export- led growth. However, although between 1964 and 1972 expansion of exports was founded on the gains in productivity obtained by greater exploitation of the workforce, after 1973 the key factors became devaluation and transfer of resources from employees to enterprises. In effect, the operation of a massive fiscal drag, that is, an increase in workers’ tax burden due to nominal wage rises, allowed a system of generous subsidies to enterprises to be financed (mainly through cuts in social security contributions paid by employers and passed on to the state).” TOWARDS EMS: The spiral begins to break with the decision of some countries to establish a European Monetary System (EMS) which provides for a return to a stable exchange rate regime and the construction of a European area of free movement of capital. In January 1979 the government of national solidarity resigned for disagreements on the EMS and in March 1979 Italy joined the new European monetary system. In the elections of June 1979 the Communist Party suffers a hard defeat. The experience of the governments of national solidarity definitively ends.  post-bretton woods world: characterized by competitive devaluations to safeguard profit margins BANK OF ITALY AND COMMUNISTS AGAINST EMS: The fear of losses of reserves or deflationary policies: “In spite of the opposition of both the Bank of Italy and the PCI, the government headed by Giulio Andreotti decided to follow the Schmidt- Giscard proposal. The Bank of Italy was doubtful about the asymmetric character of the new system and feared possible losses of reserves while trying to remain within the fluctuation band and the ultimate loss of credibility if the lira could not fulfil its commitments … The asymmetric character of the exchange mechanism, which assigned the burden of adjustment to the debtor countries, and the lack of any real commitment in support of the weaker countries, induced the PCI and other voices on the left to criticise the predictable social effects of an agreement which appeared to be tailored to Germany’s deflationary bias. Ultimately, the PCI voted against entry into the EMS, thus terminating its participation in the governmental majority”. THE OIL SHOCK OF 1979: Another adverse AS shock occurs during 1979 with the oil price rising from $12 to $32 a barrel. The Fed decides to cut inflation by raising interest rates: capital flows into the U.S. from all over the world and the Dollar appreciated. For Italy, the season of the weak Dollar, i.e. cheap imports, also ends. The spiral becomes unsustainable. In Autumn of 1979 the new governor of the Bank of Italy, Carlo Azeglio Ciampi, followed the restrictive turn of the Fed and raised interest rates. The economic cycle of the 1970s ends. IN BRIEF: The business cycle of the 1970s was characterized by a first phase of stagflation and devaluation (1970-74) followed by a severe crisis (1975) and a recovery (1976-79) fuelled by the “perverse spiral” wages-inflation-devaluation. FROM BIG BUSINESS TO DISTRICTS: During the 1970s the “Second Industrial Divide” occurs: from mass production to flexible production. In Italy several factors – oil prices, demand for differentiated products, class struggles – contributed to the decline of large enterprises and the rise of industrial districts . In 1979 Giacomo Becattini retrieved the concept of the industrial district, originally shaped by Alfred Marshall, to explain the agglomerations of small firms that flourished in the Italy of the late 70s. Becattini would later define the industrial district as “a socio-territorial entity which is characterised by the active presence of both a community of people and a population of firms in one naturally and historically bounded area.” THE DISTRICT EFFECT: Are the district firms (DF) more productive and/or efficient than their competitors due to the particular context in which they operate? Both theories and evidence show that DF are able to create a higher value added as they can exploit various external economies of scale: economies of organization, knowledge, transaction, adaptation to change, training. Moreover, DF show a high propensity to incremental innovations. DISTRICTS AND SIZES: European Firm size: four sizes European classification of micro enterprise  Micro: up to 9 persons employed  Small: 10-49  Medium: 50-249  Large: over 250 persons employed Istat (2011): Made in Italy industrial districts are 130, that is 92.2% of total industrial districts in Italy; they are mainly focused on mechanical sectors (27.0%), textiles and clothing (22.7%), personal goods (17.0%) and leather and foot-wear (12.1%). ONE REASON FOR IDS SUCCESS: Decentralize to reduce labour costs and social conflict: “On a more structural plan, the manufacturing sector underwent deep restructuring, aimed at containing labour costs, which had tripled since 1969. First and foremost, production outside the large Ford-style factories was “The 'St. Valentine's decree' of 1984 by the government, with the assent of the non-communist trade unions, which reduced the wage index system in an attempt to break what was seen as a vicious circle between wage indexes and inflation. This measure, attacking one of the main union achievements of the 1970s, caused the collapse of the trade unions' unitary federation. The communist sections of the CGIL and the PCI called for a referendum against the measure. Their defeat in the polls one year later definitely marked the opening of a new epoch. The electorate had embraced the promises of growth which monetarist stabilisation seemed to reveal”. A THIRD CHOICE AND THE RECOVERY: A third crucial choice, after devaluation and reduction of sliding scale, was the expansion of public debt. In 1980 the Debt/GDP ratio was 59%, in 1990 it rose to 100.5%. The increase was mainly due to the payment of interest on the growing stock of accumulated debt (i.e. financial rents). Lira realignments and Clup reduction stimulated exports. The growth in financial rents supported consumption while high real interest rates - negative in 1979 and over 5% in 1985 - caused investment to collapse. Inflation reduced sensibly although it remained higher than in partner countries mainly because of the strong dollar which weighed on the energy bill. The recovery of the Italian economy was driven, until 1987, by consumption and exports. THE TURNING POINT OF 1987: In 1987 the realignments of the lira ended and shortly afterwards Confindustria withdrew from the 1985 agreement: companies, once again tightened between fixed exchange rates and high inflation tackled any increase in the Clup. The end of realignments and inflation led both real exchange rate appreciation and expansion of foreign debt. In Italy, as in the United States, growth was now driven by public and private consumption financed with twin deficits. November 9, 1989: Berlin Wall Falls.  Twin deficit: the government deficit, an expenditure that increases more than tax revenues and the trade deficit, a volume of imports higher than the volume of exports. INCREASE IN REAL EXCHANGE RATE: “In spite of lower prices, the diverging inflation rate with respect to the more 'virtuous' European countries remained significant, and this led to an increase in the exchange rate of the lira in real terms. The frequent re-alignments of the exchange rates which took place in the first phase of the EMS were not sufficient to compensate the inflationary spread. In addition, after the Basel-Nyborg agreement of 1987, the EMS in practice became a system of fixed exchange rates, thus accentuating the problem of competitiveness for the Italian economy.” THE CRISIS OF 1990-91: Expansion stopped in 1990: Gulf War transformed the climate of general optimism into a dark season of uncertainty and pessimism stopping the movement of goods and people around the world. In America the insolvency of families and businesses led to the bankruptcy of over 100 banks. In Japan the stock market collapsed. Three adverse AD shocks: the AD first expanded, then collapsed. DIVERGENT ECONOMIC POLICY CHOICES: Fed runs an expansive manoeuvre to reduce interest rates. Germany follows an opposite strategy. It raises interest rates in order to tackle inflation (and to attract foreign capital) connected to country's reunification process. The EMS countries are forced to follow it in order to avoid capital flight and currencies depreciation. They have to implement a restrictive policy during a crisis. Italy is in trouble. In 1991 it achieved “primary budget balance” (the budget balance net of interest payments on general government debt). However, the deficit/GDP ratio was 11.3% due to the payments of interests. ECONOMIC AND MONETARY UNION – EMU: The Single European Act was the first major revision of the 1957 Treaty of Rome. It was signed at Luxembourg on 17 February 1986 establishing a single market by 31 December 1992. A single market seeks to guarantee the free movement of goods, services, capital and people (the four freedoms) – The free movement of capital was brought forward to 1990. The first obstacle, already announced by the functionalists: a single market does not work without a monetary union. The reason is (again) the “economic trilemma.” A NEW ECONOMIC TRILEMMA: There exist three desirable goals: stable exchange rates, free flow of capital and autonomous monetary policy. Unfortunately, they are unable to coexist. In fact, with the free flow of capital, in order to maintain a stable exchange rate, it becomes necessary to coordinate monetary policies. European countries renounce monetary sovereignty in order to enjoy free trade/flow of capital and exchange rate stability. MAASTRICHT TREATY AND EMS CRISIS: The Maastricht Treaty was signed on 7 February 1992 by 12 members of the European Communities. In the summer of the same year the EMS goes into crisis. The crisis confirms the validity of the “economic trilemma” theory. The Bundesbank independently raises interest rates. Italy and Great Britain, in order to curb the flight of capital and prevent the devaluation of their currencies, are forced to pursue Germany’s policy of raising interest rates. The restrictive manoeuvre exacerbated the crisis: in September 1992 the two countries have to devalue their currencies and exit the EMS. Rapidly mark appreciated by more than 50% against lira: 1 mark, that was exchanged for 750 lire, reaches about 1100 lire, touching in some moments the quota of 1200 lire. A SINGLE CURRENCY FOR A SINGLE MARKET: The European Monetary System went into crisis and was formally rescued in August 1993 with the decision to widen the exchange rate fluctuation margins from 2.25% to 15%. In fact, one can no longer speak of a quasi-fixed exchange rate regime. The EMS crisis, like the previous crisis of the Bretton Woods agreements, shows that in a fixed exchange rate regime, with perfect mobility of capital, independent monetary policies do not work. A Single Market requires a Monetary Union. In Maastricht it was decided to constitute the most solid of the forms of Monetary Unions: a single currency managed by a single European Central Bank. A DIFFERENT INTEREPRETATION: During the 1980s Italian economy did not suffer a lack of productivity and therefore competitiveness. The problems arose with the rigidity of the exchange rate (EMS) that forced entrepreneurs to look for competitiveness in the low cost of labour rather than in technological innovations. After the exit from the EMS and the consequent devaluation of the lira, Italy had another opportunity but was unable to take it: the income policy agreed in July 1992 reduced the bargaining power of the trade union, pushing employers to seek again competitiveness based on low labour costs (disappearance of Internal Constraint). According to Petrini, it was a mistake. EMS AND LOW CLUP VS INNOVATIONS: “It is therefore evident that, in these years, the troubles of the Italian economy had less to do with the non-productivity of Italian workers than with the constraints imposed by entry into the EMS. In the second half of the 1980s, the increasing rigidity of the EMS, the weakness of the US dollar, which reduced possibilities of finding alternative outlets for Italian exports and, lastly, the 1990 decision to adopt the stricter fluctuation band of ±2.25% for the lira, further exacerbated the problem for the Italian economy. Inflation, after having fallen to its lowest level in 1987, started to rise again, as a result of the increase of prices in the services sector and, paradoxically, of the capital influx caused by the newly acquired credibility of the lira and high interest rates.” THE DISAPPEARANCE OF THE INTERNAL CONSTRAINT: “But, again, the respite due to devaluation was not used to obviate the most evident weaknesses of the Italian industrial system. On the contrary, in July 1992, the agreement between Confindustria and the unions definitively ended the wage index system and, a year later, the new agreement on the cost of labour, which linked wage bargaining to the programmed rate of inflation, definitely marked the end of the 'internal constraint' for the Italian productive system, with the disappearance of a strong labour movement capable of making employers follow a strategy of growth different from pure containment of the cost of manpower. At the same time, the onset of a vast programme of privatisation, the largest ever achieved in an advanced capitalist country, carried out under the TWO GROWTH PATHS: In theory (and practice) we could have both a growth without increase in productivity and a growth without increase in employment. Both are second best solutions. The former allows to enjoy greater richness but leaving many people unemployed. The latter hinders technological advancements and encounters the limit to substitute capital with labour. In 1954 the Italian government approved the Vanoni’s Plan in the attempt to promote an annual GDP growth rate of 5% due to increase both in productivity (3%) and employment rate (2%). ITALY TAKES THE SECOND PATH AT THE BEGINNING OF 2000S: THE BEST WAY: Productivity increases so that both wages and profits can increase. Profits are invested in production fuelling economic growth while high wages improve middle class wellbeing. High productivity may also lead to higher demand of new goods and services rising new jobs (the controversial issue concerning employment & productivity). On the contrary, low productivity compresses both wages and profits. If labour costs increase more than labour productivity then CLUP and prices increase and competitiveness falls. THE ITALIAN WAY: The growth was driven by higher employment and lower productivity. The main consequences of a low growth were: low wages and profits, high CLUP, low competitiveness, decline in market share, fall in investments (and potential GDP). What was the structural cause of a prolonged slowdown? The answer of Faini and Sapir. AN OBSOLETE MODEL? The Great Convergence: in 30 years, from 1950 to 1980, Italy closes the gap with Europe and reduces the gap with America. The New Divergence: over the next 25 years, from 1980 to 2004, the gaps reopen. - Indicators: GDP per capita, productivity, market share - Causes: not euro but an obsolete model of specialization - Cure: renew the model of specialization by increasing the human capital endowment PAVITT’S TAXONOMY: 1- Science-based (high-tech firms which requires high investment in R&D: electronics, pharmaceuticals, aviation, chemicals. It is dominated by large firms) 2- Scale-intensive where innovations are mainly derived from the exploitation of economies of scale (large firms: automotive sectors) 3- Specialized -suppliers: (B2B: specialized machinery for office, medical, optical) 4- Supplier-dominated (traditional manifacturing such as textiles, furniture, footwear, food & beverages, wood, paper). CONCLUSIONS: Specific  How Did the Italian Economy Change from 1993 to 2007? Italy experienced a partial economic regeneration but also a worrying slowdown, which raises doubts about the model of specialization: is it obsolete? General  How did the Italian economy change from 1945 to 2007? We can identify three great stages: 1. A phase of sustainable growth based on increased productivity, capital accumulation, big companies and export propensity (1945-71) 2. A phase of unsustainable growth based on devaluation, public debt and many SMEs (1972- 92) 3. A phase of partial regeneration and worrying slowdown which raises doubts about the model of specialization (1993-2007) It is always a dominant outward-oriented strategy: what unites all this period of time, however, and therefore the evolution of the Italian economy in the second post-war period is an outward strategy. The fate of the Italian economy is in international markets, without the Euro and the economic and monetary union it would have been more difficult for Italy to remain competitive in the global market. PRESENT AND FUTURE OF ITALIAN ECONOMY - THE GREAT RECESSION OF 2008: INTRODUCTION: What Are the Main Structural Features of the Italian Economy Nowadays? • The 2010s (before the great shock) • The Great Shock • The Recovery Plan Specific Question: The Great Recession of 2008: causes & cures Outline: 1. The American Origin 2. The Impact in Europe (and Italy) 3. A dual cure THE AMERICAN ORIGIN: The main causes of business cycles (Lecture 4) are:  The structural divergence between saving (S) and investment (I)  Various shocks (positive and negative) affecting AS-AD  Sticky wages and prices Recession is a phase of a business cycle (expansion, crisis, recession, recovery). Sometimes we say “peak” (the point where the economy moves from expansion to recession) and “trough” (the point where the economy moves from recession to expansion). In order to understand the great recession of 2008 we have to consider the business cycles of 2000s. THE REACTION TO THE 2001 ATTACK: After 9/2001: expansionary fiscal policy (tax cuts and wars) and expansionary monetary policy (reducing interest rates). Ownership society and subprime mortgages (the myth that houses never lose value). The result was: – Higher aggregate demand and higher American GDP – But also greater debts by households, companies, government, country: AD > Y; G > T; Imports > Exports; I > S Y = C + I + NX Sn + Sw = I GLOBAL IMBALANCES: - Europe: A policy mix aimed both at impeding the fall of aggregate demand and to expand the aggregate supply via austerity strategy: Draghi Quantitative Easing and Fiscal Pact. - Italy: the austerity policy of Mario Monti to save Italy The paradox of a restrictive fiscal policy during a great recession justified by the need to close spreads. While America implements an expansionary policy on the aggregate demand side, Europe seeks through austerity to bring the short-run supply curve back to the level of full employment. CONCLUSION: The main explanations of the great recession focus on overinvestment (the crisis as the inevitable outcome of an unsustainable boom) vs oversaving (the crisis as a dramatic fall in investment). Consequently, the main responses focus on the alternative between a “do nothing policy” (austerity) and a Keynesian stimulus package. According to me the great recession shows above all the existence of a political trilemma and the need of a global governance. ITALY IN 2019: AN ECONOMIC SURVEY LECTURE OUTLINE: What was the economic situation of Italy in 2019? Outline: 1. The Italian Economy in 2019 2. The Determinants of Growth 3. The European Commission Assessment THE ITALIAN ECONOMY IN 2019: A great economy characterized by low growth, high unemployment, huge public debt, large social and territorial divides. THE REASONS WHY ITALY DID NOT GROW: Potential economic growth depends on two great forces: labour productivity and employment rate. Actual economic growth depends on an appropriate level of Aggregate Demand able to drive actual Aggregate Supply to potential Aggregate Supply. Italy was experiencing a low level of potential growth due to low employment rate and low labour productivity:  Employment rate was low due to inefficiencies in labour market  Productivity was low due to a drop in investment and TFP At the same time AD was squeezed by vast public debt. The result was an output gap around zero (The car moved slowly but at full speed). THE FUTURE SCENARIO: A shrinking and aging population. Without radical changes, in 2061 GDP will drop of 24,4% and GDP per capita of 16,2%. In order to compensate the fall in labour force, labour productivity should strongly increase. THE DETERMINANTS OF ECONOMIC GROWTH: This last variable is called demographic dividend: it is the contribution that the demographic variable gives to the wealth of the country. The Age Dependency Ratio (ADR) is the ratio of dependents D (people younger than 15 or older than 64) to the Working Age Population (WAP) = ADR = (D / WAP) × 100 Italy 2061: According to Istat, the population should be 53,7 millions in 2065 (- 11%). Therefore Italy should suffer a decline in WAP and a rise in ADR. IN BRIEF: In any case productivity is the key variable and the real challenge for the Italian economy. THE COUNTRY REPORT OF EC (2019): The thesis: Italy has fallen in a vicious circle: the country is suffering a situation of low growth that impede to increase investment and therefore productivity. The result is still low potential (and actual) growth, low wages and profit, low employment, and again low consumption and investment. The government should run structural reforms on the supply side. On the contrary it tried to implement weak measure to support domestic demand. LOW ACTUAL (AND POTENTIAL) GROWTH: After solid real GDP growth in 2017 at 1.6 %, economic activity slowed down over 2018. Household consumption downshifted sizeably in 2018. Despite rising disposable income and relatively high consumer confidence, consumer spending only grew moderately. The investment recovery is vulnerable to worsening financing conditions. Gross fixed capital formation, at 18.1 % of GDP in Q3-2018, is still markedly below both the latest peak of 2007 (22 %) and the EU average (20.6 %). No reduction in government debt is expected over the coming years. Italy’s current account surplus remained broadly stable in 2018. The export performance deteriorated and Italian exports lost market shares, due to an appreciation of the euro in nominally effective terms, the slowdown in particular export markets and political uncertainty about global trade policy. LOW INVESTMENTS LEADS LOW PRODUCTIVITY (AND LOW POTENTIAL GROWTH): Potential growth is projected to rise moderately but continues to lag behind peer countries. On the back of low investment and weak productivity growth, potential output has been declining since the onset of the global financial crisis. Weak productivity growth is a major constraint on economic expansion. The productivity gap between Italy and the rest of the EU remains substantial. Labour productivity (measured as real gross value added divided by hours worked) increased on average by 0.5 % per year between 2010 and 2017, compared with an EU average of 1.3 %. Growth in total factor productivity (TFP) is lagging behind the EU average. In 2010-17, annual TFP growth rates averaged a mere 0.3 %, which is 0.5 pp. less than the EU average. LOW EMPLOYMENT AND GAPS: After hitting new records, job growth slowed amid weak economic activity. Headcount employment reached a historical record by mid-2018 but dropped slightly in Q3 2018, the first quarterly decline since 2013. Job growth has been driven by temporary contracts. The share of temporary employees has risen to 17.5 % in Q3 2018 and is above the EU average. The median duration of temporary contracts is less than 12 months. Gender and regional employment gaps remain substantial. CLUP AND WAGES: Weak wage growth reflects the labour market slack. In 2017, compensation per employee grew by 0.3 % in nominal terms, but dropped by 0.8 % when adjusted for inflation. Due to subdued wage growth, the increase in Unit Labour Costs (CLUP) remains contained. The expected slow growth in productivity implies that wage moderation is likely to continue as it limits the scope for wage We define competitiveness as the set of institutions, policies, and factors that determine the level of productivity of a country. The level of productivity, in turn, sets the level of prosperity that can be earned by an economy. The productivity level also determines the rates of return obtained by investments in an economy, which in turn are the fundamental drivers of its growth rates. In other words, a more competitive economy is one that is likely to grow faster over time. The concept of competitiveness thus involves static and dynamic components: although the productivity of a country determines its ability to sustain a high level of income, it is also one of the central determinants of its returns to investment, which is one of the key factors explaining an economy’s growth potential.” 12 Pillars of competitiveness, the logic behind it is that the mix of these 12 factors make one country more competitive than another, but something is missing. IN BRIEF: We could say: Competitiveness as environment promoting productivity, namely Total Factor Productivity (TFP). It is a (broad) measure of production factors efficiency, labour and capital. It depends on many aspects: firms size and governance, quality of management, digitization and ICT diffusion, North-South divide, public administration efficiency and of the legislative-judicial apparatus, education, quality of capital, meritocracy, quantity and quality of infrastructures, etc.” THE FRENCH APPROACH: The basic idea is: having Germany as a reference. Germany has a huge surplus, this according to the French represents a sign of strong imbalance, of weakness. Germany by accumulating this huge trade surplus, thus manifesting this national competitiveness, is misusing the resources at its disposal. Because the underlying reasoning is that a country uses its resources well when it achieves both internal and external equilibrium:  The internal balance is the potential GDP,  the external equilibrium is the balance of payments balance. A country can have both a deficit and a surplus. If it has a surplus it exports savings (China, which with domestic saving bought American bonds, which in itself is fine because China had a huge domestic saving that it did not know how to employ and used it abroad). So basically according to the French you have to have both an internal balance and an external balance. It may be convenient for a country to have a surplus or a deficit. If it needs to attract capital or savings, then that country may have convenience in running a deficit. It is an idea of the relationship between internal equilibrium and external equilibrium that goes beyond the simple (mercantilist) idea that one should increase the trade surplus indefinitely, export more than one imports, and so on. Germany would therefore do better to implement an expansionary policy at home, increase wages, public spending, domestic demand by reducing the trade surplus. So the point is: in the relationship French there is an idea of competitiveness as a simultaneous internal and external balance that may require a smaller or greater trade surplus. 2. The French Approach (Reading N2) * The Council of the European Union: Recommendation of 20 Sept 2016 on the establishment of National Productivity Boards: * “Potential growth in the curo area and in the Union as a whole has slowed down considerably since 2000. The downward trend in potential output growth is notably due to a steady decline in the contribution of total factor productivity. Since 2008, economie growth has been further weakened by a fall in investment. Looking forward, economie growth will ultimately depend on increasing productivity. Raising productivity is a multi-faceted challenge which requires a set of well-balanced policies aimed, in particular, at supporting innovation, increasing skills, reducing rigidities in the labour and product markets, as well as allowing a better allocation of resources.” * We are waiting the Italian Board ... The First Report of the French Board «_ Productivity and competitiveness: where does France stand în the Euro zune? - First report — July 2019 (just a few pages) * “Productivity is often confused with compcetitiveness. In this sense, a productivity slowdown would then explain why France”s trade performance is relatively poor. Yet this equivalence is of limited relevance. AII other things being equal, it is true that productivity improvements reduce unit costs of production and may then result in increased market shares However, if production costs (e.g. wages) were to follow productivity gains (which should be the case in the long run), these gains would not necessarily translate into competitiveness gains through lower prices. Likewise, a country”s trade "performance" depends on a variety of factors that go beyond productivity, such as sectoral specialisation or the level of domestic demand.” In Italy, price-based competitiveness measures are not always an accurate predictor of trade outcomes. Overall, Italy maintains a high-quality export mix, and the adaptability of small-scale specialized firms is still a source of strength. But, small firm size is becoming less of an asset, and even the most innovative sectors are weighed down by the structural barriers that have depressed productivity more broadly. Italy’s future competitiveness will depend on full implementation of a comprehensive structural-reform agenda. FORTIS’ THESIS: "It is rather surprising that the European Commission does not is still aware that Italy is no longer what it was 20 years ago, when fashion and furniture actually represented the three quarters of our external manufacturing surplus: the weight of these traditional sectors have in fact greatly decreased, passing from the 74 percent of 1994 to 30 percent of our assets in 2013 manufacturing and this 30 percent is now composed, as it is said, of productions with higher added value than the past. The predominant part of our trading assets manufacturing is instead today generated by the mechanical and means of transport sectors other than motor vehicles, packaged medicinal products, cosmetics, niche chemicals. Without with what we intend to deny the importance they still have in the our production system the typical productions of fashion and of furniture – which remain cornerstones of Made in Italy –Brussels should take note that compared to the beginnings of the nineties the Italian export of mechanics is now in value almost twice that of textile clothing-leather- footwear, as well as the export of drugs is more than double that of that of furniture".  In Italy there is a problem of austerity: the slowdown of the Italian economy is all due to the austerity policies imposed by the European Commission.  A comparison between the 4 largest European countries and their companies (Italy, France, Spain and Germany). From this comparison it emerges that the small ones are less competitive than the competitors, the medium ones are more productive than the competitors. In Italy there are many smaller companies. The basic question is: In Italy how easy is it to move capital and workers from one sector to another? Legislation and credit encourage or slow down displacement. In Italy, mobility is certainly not facilitated. Often innovation passes through the "death" and "rebirth" of the company (therefore entry and exit). So productivity can grow either because the productivity of existing enterprises grows or because there is a reallocation to more productive sectors or because there is closure, the exit of less efficient enterprises and the entry of more efficient enterprises. So this can be traced back to internal factors (innovation, human capital and ownership) and external factors (location). The problem lies in the dwarfism (nanismo) of enterprises (highly polarized structure, many small businesses) and management and management at the family level. A LACK OF DOMESTIC DEMAND: “What actually slowed Italy’s growth, in addition to the myriad of country’s institutional and infrastructural system constraints that for years have impeded companies and discouraged foreign investment (bureaucracy, fiscal pressure, the high cost of energy, the uncertain legal framework and infrastructure deficit) was the prolonged austerity that the country was subjected to in an effort to reduce the public debt: while on the one hand the process of deleveraging public finances, based on continuously increasing taxes for households and companies, allowed Italy from 1992 to 2014 to remain in primary surplus for 22 out of 23 years (no other EU country, nor the US or Japan has been able to achieve this!), on the other hand this led to excessive fiscal pressure on the private sector, a reduction in households’ disposable incomes with consequent low growth of consumption and a similar negative impact on industrial production and investment. The situation became even more critical in 2011 when excessive austerity policies (with no growth) imposed from Europe dealt a further blow to Italian households’ purchasing power. All these factors drastically slowed Italian domestic demand, and important driving of economic growth in any developed economy, especially if the country is a major producer of manufactured goods as is the case of Italy. Thus the absence of an adequate level of domestic consumption, not weak external competitiveness, has been the main cause of Italy’s low GDP growth over the last twenty years.” BUGAMELLI (BANK OF ITALY): Bugamelli’s thesis: The main cause of the Italian growth deficit is the slowdown in productivity since the second half of the 1990s. The dynamics of productivity differed across macro sectors. Until 2003 productivity was stagnant both in manufacturing and in private non-financial service sectors, with a negative growth gap with respect to France, Germany and Spain. Thereafter, manufacturing productivity picked up, displaying, since 2010, higher growth than in France and Spain. The main reason of the slowdown in productivity is a very polarized productive system dominated in any sector by micro and small firms. A SUPPLY-SIDE APPROACH: “The focus of this paper is on structural and supply-side issues. This does not mean that demand is not important for productivity developments. Demand surely played an important role during the recent double recession: the negative figures we reported above are the result of an abrupt collapse in foreign demand in 2008-09 and in domestic demand after 2011. In particular, demand issues (both levels and uncertainty) have determined a prolonged weakness in investment by private firms, thereby delaying supply responses. However, we think that structural features play an important role as proved by the persistently sluggish growth independently of the cyclical phase and in comparison with the other main euro-area economies. FIRMS HETEROGENEITY WITHIN A SECTOR: Firm heterogeneity within a sector is more important than that across sectors in explaining the underperformance of Italy’s aggregate productivity. This is the consequence of a very polarized productive system. On the one hand, there are many micro and small enterprises, which are on average old, have a limited attitude to innovation, to the adoption of advanced technology and to internationalization, are ineffective in their management skills and practices and have a vulnerable financial structure; these firms were severely hit first by globalization (the entry of China and emerging economies into global markets) and then, during the Great Recession, by the collapse of demand and the credit crunch. Such a large share of micro and small firms restrains aggregate productivity growth not only via a composition effect (given the typical correlation between size and productivity), but also because in Italy these firms are on average less productive and dynamic than their euro-area counterparts (an observation that does not apply to medium and large enterprises). On the other hand, there is a small set of firms, mostly medium- and large-sized, whose efficiency, performance and strategies (in terms of innovation, technology and exports) are comparable to their most successful European competitors; these firms have been able to react to the shocks that have hit the Italian economy in recent years and to cope with the many institutional frictions by strengthening innovation, investing in new technologies, upgrading product quality, and opening up the financial structure to equity capital. It is these firms that are currently supporting growth. Still, these high- performance firms’ average size and share of value added are smaller in Italy than in other countries.” THE KEY FACTOR: FIRM SIZE: “It is well known that Italy is the country with the most fragmented productive system as compared to other EU economies. In Italy microenterprises, i.e. those with less than 10 employees, account for 95 percent of the total number of firms, for 29 percent of total value added. On the other tail of the distribution, large companies, with more than 250 employees, do not reach 0.1 per cent in terms of number of firms, against 0.5 and 0.2 in Germany and France, respectively. This feature does not reflect Italy’s productive specialization in the so called “traditional” sectors, like textile, leather, shoes, and clothing, where economies of scale matter less. A standard shift-share decomposition shows how the main contribution to such a different market structure originates within sector, that is to say that in any sector Italian firms are on average smaller than foreign ones” WHAT IS THE PROBLEM WITH THIS STRUCTURE? “By simply looking at productivity, both levels and dynamics, across firm size classes and countries, it is quite clear that Italy’s peculiarity is a serious drag on aggregate productivity. On one side, in all countries and for reasonable technological reasons the correlation between productivity and size is positive: in Italy the productivity level in larger firms more than doubles that of companies with fewer than 10 employees. This implies that the predominance of small and micro firms in Italy negatively affect aggregate figures for a simple composition effect. But there is more. Comparing productivity levels and dynamics across countries but within size class, it emerges that Italian smaller firms are relatively less efficient than their European counterparts: the same gap between larger and smaller firms in Germany is only 48 per cent. IGNAZIO VISCO (BANK OF ITALY): A) Italy is back to the 1980s  By mid-2020, GDP had returned to the level observed in early 1993. In per capita terms, GDP dropped down to values recorded in the late 1980s.The reason for this huge jump of about 30 years back in the past is twofold. The first is, of course, the striking extent of the collapse of the economy due to the pandemic. The second reason why we went so far back in the past is that, since the 1990s, Italy’s GDP growth has been extremely weak. B) The main cause of the decline is the productivity slowdown  GDP per capita has slowed down since the mid-1990s and, after the double-dip recession due to the global financial crisis and the euro-area sovereign debt crises, has never been fully recovered. Labour productivity (measured by GDP per hour worked) started to stagnate in the mid-1990s and its weakness persists today. The key variable underlying the dynamics of GDP per capita and labour productivity is the so-called ITALY IN GVCS: Italy mainly exports intermediate goods. IN BRIEF: GVCs represent the new face of international trade and models of specialization. They also represent great opportunity for Italian firms. ITALIAN IDS IN THE GVC: The Italian Model: Some refinements A) Goods and/with services: In the traditional approach goods (tangible) are divided by services (intangible), but nowadays many goods include many services (i.e. smartphone). B) Global Value Chain C) The New Industrial Districts THE FADING OF THE DISTRICT EFFECT: IDs have been at the centre of a lively economic and political debate in which the widespread enthusiasm of the past was replaced by increasing and diffused criticism. According to many scholars, districts are one of the main culprits of Italy’s industrial decline, unfitted to face the challenges of globalization and the information and communication technology (ICT) revolution, due mainly to the dwarfism of their manufacturing firms, and their specialization in traditional industries. A consequence of this finding of decreasing importance of the district effect is increased diversity of performance (i.e. employment and firm profitability) both within and between clusters. DIVERSITY AMONG DISTRICT FIRMS: According to Confindustria (2013), in Italy 55,000 manufacturing companies closed between 2009 and 2012, with small enterprises in the Northeast where many districts are located, being the most affected in the country. The increasing importance of medium-large firms is also made evident by the emergence of leading firms in some districts, such as Tod’s in the footwear sector, Luxottica in the optical industry, Zegna in the luxury wool sector and Riello, which is specialized in heating equipment. Thus, the available empirical evidence shows there is wide diversity among cluster firms depending on their size, performance, and patterns of local and global involvement described in details below, which has consequences for the distribution of capital, knowledge, and market power in the district. A number of Italian districts have experienced a spontaneous shift in specialization from final goods such as clothing and shoes, which often are characterized by cost-based competition, to capital goods such as clothing and footwear industry machinery. In this case, technological capabilities provide competitive advantage over competitors in emerging markets. Between 1991 and 2001, 21 Italian IDs changed their industry specialization with one-third moving into the mechanical industry. Diversification in a related field is common. Some examples of specialization shifts include Schio and San Bonifacio (Veneto) previously specialized in textiles are now producers of textiles machinery, and Canelli which is located in the core wine region of Piedmont is now a center for the production of machinery for the wine industry, while Mirandola (Emilia Romagna) has which shifted from textiles to the mechanical and biomedical industries. IDS IN GVCS: The involvement in GVCs of Italian clusters differs depending on the characteristics of their firms, and their competitiveness strategies. Based on these differences, we propose three stylized models of ID-GVC involvement which we consider to characterize Italian IDs: Low-road IDs  Firms in low-road IDs have reacted to international pressures mainly by outsourcing large parts of their production to countries with comparative advantage in labour costs. The pressure of cost-based international competition has caused these districts to suffer a general decline the numbers of both employees and firms. In some cases, this has resulted in a crisis that has threatened the survival of the district. For instance in Barletta (Apulia) domestic production has been dismantled and transferred to lower labour cost countries on the other side of the Adriatic Sea as well as Vicenza’s district is competing on cost. In general, involvement in GVCs by low- road clusters has been less than successful, and resulted only in specialization in low value added manufacturing. Locally-rooted GVC-led IDs  This model is characterized by a concentration of medium to large sized firms, which are highly embedded in their districts via backward and forward linkages with other local firms and organizations. Several local ID firms have ceased to undertake high value-added activities related to design/product development, or branding and marketing (or both), and have opted to become manufacturing suppliers to larger Italian and/or international luxury brands which retain most of these high value added activities. An example here is Riviera del Brenta district where several local companies have become subcontractors of Italian and international luxury brands that offer a relatively safe high-end final market for these district firms. Outward-oriented GVC led IDs  This model of ID-GVC connection is characterized mainly by the presence of medium to large sized firms, which are strongly outward oriented. In these types of districts, firms compete in high end, specialized, or niche markets, they globally outsource most of their manufacturing activities but they keep the high value-added activities such as R&D, product development, design, branding, and marketing, within the district boundary. A case that nicely describes this model is Montebelluna (Veneto), a district focusing on production of sportswear including ski boots. Similarly, the Belluno eyewear district includes in Luxottica which has become the world’s largest eyewear group. IN BRIEF: The empirical evidence on recent developments in Italian IDs shows that they have reorganized their activities strategically and in different ways. They are very different from the 1970s and1980s IDs. Many districts have chosen the route of downgrading of their activities and searching for ways to reduce costs. However, these strategies are unlikely to be successful since the global competition scenario is becoming stronger. The strategy of escaping the low cost-low value-added trap seems a more promising development strategy, and firms in outward oriented GVC-led IDs are exploiting their GVC connections to favour their long- term development. They have responded to the uncertainty of a rapidly changing global production and innovation landscape, by devoting resources to activities –such as R&D, or design – which rarely yield immediate results, and need constant, steady firm-level commitment. They have challenged the dwarfism characterizing ID firms, and have grown , in some cases, for example Luxottica, they have become the international leader in their industry. CONCLUSION: Is the stagnant productivity related to the international model of specialization? No, it depends on several factors and mainly TFP and small firms size. The structural problem of the Italian economy is a stagnant productivity caused by a polarized productive system dominated in any sector by micro and small firms as well as by a lack of “national competitiveness” (low TFP). The model of specialization is now connected to the GVCs: it is no longer sufficient to look at the Pavitt Taxonomy. Firms and IDs have the opportunity to take part in the GVCs and they should try to extract the highest value-added. THE ECONOMY OF MADE IN ITALY: LECTURE OUTLINE: Can the model of specialization be still focused on Made in Italy? Graph B BBF: consumer goods of excellence exported by Italy (Hypothetical frequency distribution of car exporters by level of average unit values) Humber of countries exporting cars ata given AU The BBF covrsall'he consumer goods that Italy ecporis athighprices, But hat re fighi price? To answer this for all categoriesofgondswe trace the distribution of the average unit values applied by each county and look only at the goods for which Italy is above the 75% percentile To give an example, we assume that this graph traces te Sti te cap unit values applied by ll of 80 carexporting countries: cars will effectivly qualify asBBF only if Italy esporis them at AUVS inthe highest quartile Average unit values of cars Graph 1.1 Outlining the perimeter o460F (eni ani lente) | RE | sco: | BI (Number of the product categories exgorted by ta) The starting pont is Italan —Theperimeteris narowed Goods classified BBF axports asa whole to final goods, which arefinal goods exported (intermediate goods, are divided into Broad by Italy that havehigh average investment goods Economic Categories (BEL), unit valies and final goods). the classification used (equaltoor overthe 75th Just over 5000 preducts by the United Nations. percentie ofthedistrbution are traded worldwide, almost. The analysis looks only afallthe countries exporting. all'of which are also exported atthose exported by Italy. a particular g00€). by tly 4,577 PRODUCTS 881 PRODUCTS 467 PRODUCTS Sauro calentatari hu PAN hacer an |IN-Parmtrado data The Key Role of Exports *. Exports play a crucial role in Italy in supporting demand levels: in 2018 they totalled 555 billion current euros, equal to about one third of GDP. This indicates that Italy occupies an important position on international scenario in terms ot market share (Graph 1.2): in fact, with a share of just under 4 per cent, Italy is seventh in the world ranking of manutactures cxporters, bchind South Korea (4.1 per cent) and in front of the Netherlands (3.6 per cent). * A very varied mix of products. The basket of goods exported by Italy is therefore extremely diverse and in 2017 (latest available data) covered 90 per cent of the products appearing in the UN- Comtrade database, which has by far the most sectorially disaggregated data on world trade. Graph1.2 Tubi 20 gapoting countries Jlars 0 PIOLILOLLISI PISA dé ELI PIPPI SU É Scuro: calce by CSC bsec on UN-Co rire dt. The Main Destination Markets * More than half of Italy's export of goods go to the single European market (51 per cent, Graph 1.4). Within Europe, Germany is the leading destination market (11.9 per cent), followed by France (9.9 per cent). The United States remain the largest non-EU market with a share of 9.9 per cent, while first place among the emerging markets goes to China (3.3 per cent). * Although the advanced markets, Italy?s traditional trading partners, continue to play a lcading role in terms of weight, since the mid-1990s, the import of the emerging countries has been expanding at a considerably faster pace in terms of growth, especially since 2001, when China joined the WTO.