US embassy cable - 04ROME2653

UNCLAS SECTION 01 OF 04 ROME 002653 
 
SIPDIS 
 
 
DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA 
PARIS ALSO FOR USOECD 
TREAS FOR OASIA HARLOW, STUART 
FRANKFURT FOR WALLAR 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ELAB, PGOV, IT, ITALIAN POLITICS 
SUBJECT:  BERLUSCONOMICS - THE RECORD UNDER TREMONTI'S 
LEADERSHIP 
 
REF: A) ROME 2630 
B) ROME 2280 
C) ROME 2389 
D) ROME 791 
E) ROME 402 
F) 03 ROME 3679 
G) 03 ROME 2674 
1.  SUMMARY:  PRIME MINISTER BERLUSCONI HAS ANNOUNCED HIS 
INTENTION TO STAY AT THE HELM OF ITALIAN ECONOMIC DECISION- 
MAKING, FOLLOWING THE FORCED RESIGNATION OF FINANCE MINISTER 
GIULIO TREMONTI (REF A).  WHILE THERE IS PRESSURE FOR THE PM 
TO APPOINT A PERMANENT SUCCESSOR SOONER, BERLUSCONI HAS 
HINTED HE MAY RETAIN THE PORTFOLIO UNTIL THE END OF THE 
YEAR, IN ORDER TO SEE THROUGH THE CONTENTIOUS DEBATE OVER 
THE 2005 BUDGET.  WHOEVER REMAINS AT THE HELM OF THE 
MINISTRY OF ECONOMY AND FINANCE WILL FACE A SERIES OF 
DAUNTING CHALLENGES: REVIVING A STAGNANT ECONOMY AND 
DECLINING ITALIAN COMPETITIVENESS, MANAGING THE LARGEST 
NATIONAL PUBLIC DEBT IN THE EURO ZONE, AND TACKLING A HUGELY 
BURDENSOME, BUT POLITICALLY RADIOACTIVE, PENSION SYSTEM. 
2.  FINANCE MINISTER TREMONTI WAS ADEPT - SOME SAY TOO 
CLEVER -- AT FINDING WAYS TO CONTAIN ITALY'S BUDGET DEFICIT 
UNDER DIFFICULT INTERNATIONAL CIRCUMSTANCES.  HE TOOK SOME 
STEPS TO ENCOURAGE BUSINESS SECTOR INVESTMENT AND ENCOURAGE 
THE REPATRIATION OF PRIVATE CAPITAL.  DURING HIS WATCH, THE 
BERLUSCONI GOVERNMENT ALSO ENACTED SOME NOTEWORTHY LABOR 
MARKET REFORMS AND INTRODUCED A MODEST PENSION REFORM BILL 
(STILL TO BE ENACTED).  HOWEVER, ON THE MOST IMPORTANT 
ISSUES - SERIOUS REFORM OF THE PENSION SYSTEM AND TAX 
STRUCTURE - TREMONTI AND HIS ECONOMIC TEAM FAILED TO MAKE 
SIGNIFICANT PROGRESS.  THIS CABLE REVIEWS THE BERLUSCONI 
GOVERNMENT'S ECONOMIC RECORD UNDER TREMONTI'S TENURE AND 
EXAMINES THE CHALLENGES THAT FACE THE GOVERNING COALITION 
BETWEEN NOW AND THE NEXT NATIONAL ELECTIONS, WHICH MUST BE 
HELD NOT LATER THAN 2006.  END SUMMARY. 
 
THE STATE OF THE ECONOMY - THEN AND NOW 
--------------------------------------- 
 
3.  WHEN PRIME MINISTER BERLUSCONI TOOK OFFICE, HE INHERITED 
A CRUSHING PUBLIC DEBT OF 110.6 PERCENT OF GDP, A RIGID 
LABOR MARKET, TEN PERCENT UNEMPLOYMENT, A BLOATED PUBLQ4-QL|CH 
BETTER. ITALY'S PUBLIC DEBT, 106.2 OF GDP PERCENT IN 2003 
AND 105 PERCENT EXPECTED IN 2004, IS STILL THE HIGHEST IN 
THE EURO ZONE. GDP GROWTH IS EXPECTED TO BE ONLY 1.2 PERCENT 
THIS YEAR.  GROWTH RATES IN 2002 AND 2003 WERE A PALTRY 0.4 
AND 0.3 PERCENT, RESPECTIVELY.  ITALY'S DEFICIT/GDP RATIO IS 
CLIMBING, AND COULD BREACH THE THREE PERCENT CEILING OF THE 
EU STABILITY PACT IN 2004, UNLESS A SPENDING CUT PACKAGE IS 
PASSED.  ON A POSITIVE NOTE, UNEMPLOYMENT HAS FALLEN TO 
ABOUT NINE PERCENT.  HOWEVER,   REGIONAL DISPARITIES ARE 
STILL NOTABLE; WHILE NORTHERN ITALIAN FIRMS ARE DESPERATE 
FOR SKILLED LABOR, THE SOUTH'S UNEMPLOYMENT RATE IS NEARLY 
EIGHTEEN PERCENT (ADMITTEDLY SOFTENED BY A THRIVING 
UNDERGROUND ECONOMY). 
 
5.  THE BERLUSCONI GOVERNMENT CLAIMS THAT MACRO-ECONOMIC 
PERFORMANCE REMAINS POOR BECAUSE OF THE SLOW RECOVERY OF 
WORLD MARKETS, AND THE HUGE PUBLIC DEBT BURDEN IT INHERITED. 
CRITICS, HOWEVER, CHARGE THAT THE GOVERNMENT HAS FAILED TO 
ENACT MEANINGFUL STRUCTURAL REFORMS THAT WOULD HAVE HELPED 
TO TURN AROUND THE ECONOMY, POINTING SPECIFICALLY AT LABOR 
MARKET, TAX REFORM AND PENSION REFORM. 
 
LABOR MARKET FLEXIBILITY 
------------------------ 
 
6.  ITALY LONG HAD ONE OF THE MOST SCLEROTIC LEGAL LABOR 
MARKETS IN EUROPE, WITH SEVERE LEGAL OBSTACLES TO HIRING AND 
FIRING WORKERS.  EARLY ON, THE BERLUSCONI GOVERNMENT 
LIBERALIZED FIXED-TERM CONTRACTS, AND ANNOUNCED ITS 
INTENTION TO ABOLISH ARTICLE 18 OF THE LABOR CODE, WHICH 
ALLOWED THE REINSTATEMENT, USUALLY UNDER COURT ORDER, OF 
WORKERS DEEMED TO HAVE BEEN UNFAIRLY DISMISSED FROM 
COMPANIES WITH SIXTEEN OR MORE EMPLOYEES.  THE PROSPECT OF 
ABOLISHING ARTICLE 18 SPARKED A PROTRACTED BATTLE WITH UNION 
FEDERATIONS, AND LED TO GENERAL STRIKES AGAINST THE 
GOVERNMENT.  THE FIGHT WAS OVER MORE THAN JUST ARTICLE 18; 
AT STAKE APPEARED TO BE THE SOCIAL COMPACT - "CONCERTAZIONE" 
 
ROME 00002653  002 OF 004 
 
NCERTAZIONE DESCRIBES 
THE 1993 TRIPARTITE AGREEMENT AMONG UNIONS, EMPLOYERS AND 
THE GOI, WHEREBY UNIONS ACCEPTED WAGE MODER!RQ"QLQ*V  AFTER NEARLY TWO YEARS OF FIGHTING, THE GOVERNMENT 
SETTLED FOR A COMPROMISE SOLUTION THAT ALL THREE PARTIES 
(WITH THE EXCEPTION OF ITALY'S LARGEST TRADE UNION 
FEDERATION CGIL) ACCEPTED: ARTICLE 18 WOULD BE SUSPENDED FOR 
THREE YEARS, BUT THE THREE-YEAR PERIOD WOULD ONLY START WHEN 
A PENSION REFORM BILL WAS PASSED.  (MORE ON PENSIONS BELOW.) 
ALTHOUGH APPROVING THE AGREEMENT, PARLIAMENT WILL HOLD A 
HEARING ON HOW THIS AGREEMENT WOULD AFFECDDQ>NZ)MITICS WITHIN AND OUTSIDE OF THE COALITION ARGUED THAT 
THE BERLUSCONI GOVERNMENT WASTED TIME AND POLITICAL CAPITAL 
OVER ARTICLE 18, WHEN MORE PRESSING LABOR MARKET REFORM WAS 
REQUIRED.  WHILE PROBABLY ACCURATE, THIS CRITICISM FAILS TO 
ACKNOWLEDGE THAT THE CENTER-RIGHT GOVERNMENT HAS ENACTED 
OTHER MEASURES THAT HAVE MADE THE LABOR MARKET MORE 
FLEXIBLE. 
 
9.  THE MOST NOTABLE OF THESE WAS THE SO-CALLED BIAGI LAW, 
WHICH ENCOURAGES MORE PART-TIME EMPLOYMENT BY REDUCING 
EMPLOYER SOCIAL SECURITY CONTRIBUTIONS FOR THESE WORKERS. 
THE BIAGI LAW ALSO CREATED OPPORTUNITIES FOR OUTSOURCING, 
JOB-SHARING AND THE USE OF PRIVATE EMPLOYMENT SERVICES. 
U.S. COMPANIES HERE REPEATEDLY TELL US THEY ARE QUITE 
SATISFIED WITH THE FLEXIBILITIES THEY HAVE FOR HIRING 
EMPLOYEES.  HOWEVER, THE "EXIT" OR FIRING OF WORKERS REMAINS 
AN IMPORTANT OBSTACLE FOR EMPLOYERS. 

10.  OVERALL, THEREFORE, THE GOVERNMENT RATES A B-MINUS IN 
TERMS OF LABOR MARKET REFORM: SOME PROGRESS, BUT MUCH STILL 
NEEDS TO BE DONE. 
 
PENSION REFORM 
-------------- 
 
11.  ITALY'S PENSION SYSTEM IS EXTRAORDINARILY GENEROUS: 
MANY ITALIANS QUALIFY FOR A FULL STATE PENSION AT AGE 57. 
AS A RESULT, THE GOVERNMENT IS HEMORRHAGING MONEY TO FUND 
PENSIONS, SPENDING ABOUT FOURTEEN PERCENT OF GDP (ALMOST 30 
PERCENT OF THE ITALIAN BUDGET).  WITHOUT MEANINGFUL REFORM, 
THE PERCENTAGE IS EXPECTED TO CLIMB TO SIXTEEN PERCENT IN 
2020, AND PERHAPS AS HIGH AS 20 PERCENT IN 2030. 
 
12.  THE BERLUSCONI ADMINISTRATION IS TREADING LIGHTLY ON 
PENSION REFORM, FOR FEAR OF ALIENATING VOTERS AND TO KEEP 
THE COALITION INTACT.  (THE 1994 BERLUSCONI GOVERNMENT FELL 
PRIMARILY OVER BATTLES WITHIN THE COALITION OVER PENSION 
REFORM.)  IN 2003, THE GOVERNMENT INTRODUCED LEGISLATION TO 
RAISE THE RETIREMENT AGE FOR STATE PENSIONS TO 60 YEARS OF 
AGE BEGINNING IN 2008, AND TO PROVIDE INCENTIVES FOR THOSE 
WORKING PAST RETIREMENT AGE.  ACCORDING TO GOVERNMENT 
ESTIMATES, SPENDING ON PENSIONS WOULD INITIALLY INCREASE 
BECAUSE OF THESE INCENTIVES; BUT BEGINNING IN 2008, OVERALL 
EXPENDITURES WOULD FALL BY 0.5 TO 1 PERCENT.  LABOR MINISTER 
MARONI HAS ARGUED, HOWEVER, THAT SAVINGS WOULD BE GREATER, 
AS GOVERNMENT ESTIMATES ABOVE DO NOT FACTOR IN SAVINGS FROM 
INCENTIVES TO EMPLOYEES TO REMAIN IN THE WORKFORCE. 
 
13.  THE GOVERNMENT'S INITIAL PROPOSAL WOULD HAVE BROADENED 
THE CATEGORY OF WORKERS WHO MUST WORK UNTIL 60.  HOWEVER, 
BECAUSE OF OPPOSITION WITHIN THE COALITION, THE PROPOSAL WAS 
WATERED DOWN, AND ONLY A SMALL CATEGORY OF WORKERS NOW WOULD 
HAVE TO WORK UNTIL 60. 
 
14.  PROSPECTS FOR TIMELY PASSAGE ARE UNCLEAR. THE SENATE 
AND THE CHAMBER OF DEPUTIES HAVE PASSED THE PLAN, BUT THE 
DIFFERENCES IN BILLS MUST BE RECONCILED.  MARONI ASSERTED 
THAT THE CENTER-RIGHT CHAMBER LEADERS WORKED WITH SENATE 
COUNTERPARTS AS THE CHANGES WERE NEGOTIATED TO ENSURE THAT 
EXPEDITIOUS PASSAGE.  LIKEWISE, THE PRIME MINISTER AND 
FORMER FINANCE MINISTER TREMONTI EXPRESSED OPTIMISM THAT 
PARLIAMENT WILL PASS THE REVISED MEASURE THIS SUMMER. 
 
15.   THE GOVERNMENT'S PENSION REFORM PROPOSAL IS NOT FAR- 
 
ROME 00002653  003 OF 004 
 
ESS, ITS PASSAGE WOULD 
BE A MODEST AND HELPFUL STEP IN THE RIGHT DIRECTION.  GIVEN 
THE DIFFICULTY OF ENACTING PENSION REFORM FOR ANY 
GOVERNMENT, THE BERLUSCONI ADMINISTRATION WILL DESERVE A C- 
PLUS ON PENSION REFORM - IF THE GOVERNMENT SUCCEEDS IN 
PASSING ITS PLAN THIS SUMMER. 
 
FINANCIAL MARKET REGULATORY REFORM 
---------------------------------- 
 
16.  IN THE WAKE OF PARMALAT'S 18 BILLION DOLLAR FRAUD, 
WHICH FOLLOWED ON THE HEELS OF MISMANAGEMENT AND MALFEASANCE 
BY ITALIAN FOOD COMPANY CIRIO, THE GOVERNMENT IN JANUARY 
DRAFTED MEASURES TO STRENGTHEN THE OVERSIGHT POWERS AND 
PUNITIVE AUTHORITY OF CONSOB, ITALY'S SEC-EQUIVALENT, AND TO 
REVOKE THE CENTRAL BANK GOVERNOR'S LIFETIME MANDATE.  (THE 
CENTRAL BANK HAS BEEN HIGHLY CRITICIZED FOR NOT BEING MORE 
VIGILANT IN ITS MARKET SUPERVISION.)  MANY CONSIDER GREATER 
MARKET OVERSIGHT ESSENTIAL TO CALM CONCERNS OF JITTERY 
INVESTORS, BOTH DOMESTIC AND FOREIGN.  THE LEGISLATION WAS 
DRAFTED BY THE FINANCE MINISTRY IN RECORD TIME, BUT HAS 
SINCE LANGUISHED.  WITHIN THE COALITION, POLITICAL LEADERS 
ARE ARGUING OVER WHETHER CONSOB AND THE ANTI-TRUST 
AUTHORITY, WHOSE AUTHORITY WOULD ALSO INCREASE, SHOULD HAVE 
SUCH POWERS, AND WHETHER CENTRAL BANK GOVERNOR FAZIO SHOULD 
HAVE HIS LIFETIME MANDATE REVOKED AND REPLACED BY AN EIGHT 
YEARS MANDATE.  PRIVATE SECTOR ENTITIES, INCLUDING THE 
ITALIAN BANKERS' ASSOCIATION, HAVE CONCERNS ABOUT THE 
POTENTIAL FOR INTERFERENCE IN THE MARKETS BY THE INTER- 
MINISTERIAL COMMITTEE ON SAVINGS, WHICH ALSO WOULD BE GIVEN 
NEW OVERSIGHT AUTHORITY UNDER THE DRAFT MEASURE. 
 
17.  GIVEN ITS INABILITY TO REACH CONSENSUS AND ADOPT 
MEASURES CRITICAL TO RESTORING TRUST IN THE MARKETS, THE 
GOVERNMENT SO FAR DESERVES A FAILING GRADE IN FINANCIAL 
MARKET REGULATORY REFORM. 
 
TAX REFORM 
---------- 
 
18.  AS SOON AS EUROPEAN PARLIAMENTARY ELECTIONS WERE OVER, 
THE BERLUSCONI GOVERNMENT RENEWED CALLS FOR FAR-REACHING TAX 
MEASURES (AN UNFILLED BERLUSCONI CAMPAIGN PROMISE DATING 
FROM THE 2001 ELECTION), INCLUDING BOTH LOWERING OF TAX 
RATES AND A REDUCTION IN THE NUMBER OF TAX BRACKETS.    THE 
CUTS COULD AMOUNT TO AS MUCH AS TWELVE BILLION EURO. 
 
19.  LONG SIMMERING DIFFERENCES OVER FISCAL POLICY AMONG 
COALITION PARTNERS QUICKLY CAME TO THE SURFACE, HOWEVER, AND 
WERE A MAJOR FACTOR IN THE CONFRONTATION THAT LED TO 
TREMONTI'S OUSTER.  SIMPLY PUT, FORZA ITALIA AND THE 
NORTHERN LEAGUE SUPPORTED SOME BREAKS FOR LOW-INCOME 
EARNERS, BUT LARGE REDUCTIONS FOR TAXPAYERS WITH INCOMES 
BETWEEN 80,000 AND 1,000,000 EUROS.  THE ALLEANZA NAZIONALE 
AND THE UDC, IN CONTRAST, OPPOSED A TAX BREAK FOR "THE 
RICH," BOTH FOR THE POLITICAL MESSAGE IT WOULD SEND AND FOR 
THE CONSTRAINTS REDUCED REVENUES WOULD PLACE ON THE 
GOVERNMENT'S ABILITY TO FUND AN-FAVORED PROJECTS, ESPECIALLY 
IN SOUTHERN ITALY. 
 
20.  THE DETAILS OF BOTH FURTHER FY 2004 SPENDING CUTS TO 
KEEP ITALY BELOW THE EU'S THREE PERCENT DEFICIT/GDP RATIO, 
AS WELL AS TAX AND SPENDING PLANS FOR THE FY 2005 BUDGET, 
ARE STILL TO EMERGE.  HOWEVER, BASED ON ITS PERFORMANCE 
SINCE 2001, IT IS HARD TO CREDIT THE GOVERNMENT WITH MORE 
THAN STAVING OFF FISCAL DISASTER IN A DIFFICULT 
INTERNATIONAL ENVIRONMENT.  POLITICALLY CHALLENGING BUT 
ECONOMICALLY ESSENTIAL STRUCTURAL REFORMS HAVE BEEN AVOIDED. 
THE TAX AND SPENDING PRIORITIEQQIQI>QLD ACTION IN THE MONTHS AHEAD.  WE THEREFORE FIND 
IT HARD TO GIVE THE GOVERNMENT MORE THAN A C-MINUS ON FISCAL 
POLICY. 
 
 
TH5RBQ