The dangerous part

Background: I always believed that Italy's payroll taxes are so incredibly high that they are one of the main causes hampering the country's growth. Similarly, people in Italy always complain about how expensive goods are (but probably this is due to the fact that we have the lowest after tax wages in Western Europe). Hence, I thought, the "Bel Paese" may experience both higher inflation and lower growth than other EMU countries.

Now, I write this post because some of our readers are taking the De Haan course and I am looking forward to comments. Moreover, Matteo studied OCA theory for a while and may contribute to the discussion. I am still not able to rationalize completely what's going on.

Take the first figure about the labour wedge in a few European countries including Italy in 2008. Well, it's large, larger than average but, still, lower than in Germany and France, which grow usually at a higher pace (1st. puzzle).

Now take the second figure, which shows the yearly change in the HICP for the same countries. I haven't found data on changes on wages in the same years, yet. So you have to trust me when I report that nominal wages in Italy increased in 2009, say by around 3%. If so, with 0.8% inflation we had an increase of real wages of about 2% during a recession! (2nd puzzle). So the correction hardly occurred on the cost side, or did it? Rather than reducing labour costs through lower wages, the adjustment occurred quantitatively (firms jumped on the train and finally could fire people that usually they could not!). Unemployment grew and the insiders increased their real income. For me this is evidence of a dangerous development that further promotes inflation differentials (and, worse, lower growth in Italy). Not surprisingly, prices reacted much steeper in Spain, Germany and even in France! This is a World of flexible prices, sticky wages and silly unions (and governments).

A. B.