Italy sums up a lot of what's wrong with the Eurozone economy. Growth has returned, but it's anaemic. Unemployment is falling, but it's still a long way from normal levels.
Bloomberg Intelligence (BI) Economics sees underutilised resources approaching 4pc of GDP over 2015 in Italy, leaving plenty of scope for above-trend growth in years to come.
The speed at which spare capacity comes to be absorbed depends partly on the boldness of the ECB but also on whether the external outlook holds up - it could take years to be soaked up completely. Italy's biggest medium-term problem remains fostering efficiency gains.
Like much of southern Europe, Italy's recovery has been held back by tight credit, tight fiscal policy and an inadequate monetary policy response. Some of those influences have faded, and the economy is growing again. Yet the costs appear to have been substantial. Compared with what Italians might reasonably have expected their aggregate incomes and spending to be before the crisis broke, GDP is currently about 16pc lower. The chart below plots the path of GDP had the average growth rate from 2002 to 2008 been sustained, uninterrupted.
Some of that shortfall undoubtedly reflects unsustainable activity before the crisis. In other words, incomes should not have been expected to continue rising at the same pace because they were partly supported by growing imbalances within the euro-area economy. Still, the question remains, can any of that shortfall be made up?
BI Economics uses a range of methods to answer that, taking into account information from the path of GDP, wages, unemployment, inflation and surveys of capacity utilisation. Each says something about the degree to which resources are underutilised and can be combined to estimate what is known as the output gap - it captures the scope for above-trend growth as spare capacity is put back to use.
The results of applying those methods point to slack of close to 4pc in Italy's economy over 2015. The permanent loss of annual output looks, therefore, to have been substantial.
How quickly might that slack be taken up? BI uses a production function to decompose slack into its constituent parts. Doing so reveals that a substantial chunk of spare capacity remains in the labour market. As the recovery gradually continues in the euro-area and Italy, unemployment is likely to keep falling and average hours worked rising, but it could be a long process. The remaining part of the gap reflects productivity remaining below where it might be expected to be if there were no shortfall of demand. That too should recover in time, but it is probably the greatest source of uncertainty.
Productivity is Italy's biggest problem. The efficiency with which outputs have been combined there is now roughly what it was before the introduction of the euro.
On the assumption that the recovery continues uninterrupted by external developments and that productivity begins gradually to rise, the economy might expand by about 1pc this year and 1.4pc next. That's well above trend and reflects the boost to growth from ongoing declines in cyclical unemployment. (Bloomberg)