Animal spirits

Giulio Tremonti wants to unleash the animal spirits of Italian entrepreneurs. But first, we must climb the mountain.

By Tom Buerkle
September 2001
Institutional Investor Magazine

Here we are in the village of Lorenzago di Cadore, Tremonti's ancestral home. It is a beautiful warm morning in mid-August, and the jagged limestone peaks of the Dolomites float in dazzling sunshine. Tremonti is on holiday after a hectic two months as economy and finance minister in the new government of Silvio Berlusconi, and he is eager to discuss his plans for reinvigorating the economy. The 54-year-old tax lawyer has invited us to join him and his friends on a hike up Monte Lastroni, a midsize peak that sits near the border with Austria.

Swept into office after promising massive tax cuts and lavish infrastructure spending, Tremonti's boss, Berlusconi, has found the exercise of power trickier than its attainment. The violent crackdown on antiglobalization protesters at the Group of Eight meeting in Genoa in July has dented the government's popularity, while the gloom enveloping the European economy has overshadowed even the sunny optimism of il cavaliere, or the knight, as Berlusconi is known. Italy's growth has slowed to a near halt, casting doubt on the government's ability to afford its promises.

Still, it's easy to see why Berlusconi has entrusted Tremonti with Italy's economic reins. For one thing, he combines drive and determination with supreme self-confidence - critics say arrogance. He also shares his boss's populist touch. The evening before our hike, Tremonti stopped in at a local hotel to trade gossip with friends over a glass of grappa and to discuss plans for what he bills as a moderate, one-and-a-half-hour walk.

Since taking office in June, he has introduced a raft of measures under a "100 days" program designed to spur investment and job creation and to lure the country's legendary black economy into the open. The measures include the so-called Tremonti law, which grants hefty tax breaks to companies that increase investment; abolishes Italy's inheritance tax, which generated little revenue but drove capital offshore; greatly expands the ability of companies to hire workers on flexible, fixed-term contracts; scraps planning requirements for many building projects; and establishes a gradual, three-year program to encourage underground companies to become legal and pay taxes. All these measures should liberate the "animal spirits" that drive Italy's economy, he insists.

Tremonti knows a thing or two about entrepreneurial spirit. At the hotel he related how he and some friends backed the hotel owner, Gino, in his attempt to export the regional specialty - gelato - to Beijing. Gino returned from China with no deal and no money, but he did bring back a People's Liberation Army winter coat and hat, which he models with pride.

We begin our expedition in the nearby town of Sappada, where the Tyrolean architecture and German-language signs are evidence of the local population's roots. Tremonti's confidence is infectious as he explains his program during our ascent.

"The main part of our GDP is produced by small and medium-sized enterprises, where the person is confident, where the role played by the personality of the entrepreneur is relevant," Tremonti says. "This is an area in which our policy could work, transmitting a message of optimism."

He had better hope so, because Italy's worsening budget picture limits his room for maneuver on taxes. In a surprise television appearance in July, Tremonti warned that a pre-electoral spending binge by the previous center-left government of Giulio Amato had left a yawning budget gap. His cautioning note elicits a vigorous denial from Vicenzo Visco, Amato's Treasury minister, who insists that any deterioration is modest and stems from a slowing economy rather than left-wing profligacy. "They act like a revolutionary government, so they have to destroy everything" left by their predecessors, Visco says. Still, the move gave Tremonti a pretext for postponing a promise to slash taxes by 1 percentage point a year over five years. The government's five-year economic plan, released in July, suggested those cuts would not start until 2003, a timetable Tremonti confirms.

Halfway up 2,400-meter-high Monte Lastroni, it becomes clear that our walk will not be as moderate as advertised. Several members of our group cast a longing eye at some sunbathers stretched out near the edge of a mountain pond. But Carlo Jean, the retired Italian general who leads the group, keeps his gaze fixed firmly on the summit in the distance. "If we see something higher, we keep on going," he says. We don't want anything above us but God."

Tremonti's deficit tactics also raised fears among Italy's European Union partners that Rome might renege on its deficit-cutting commitments under the EU Stability Pact. Here Tremonti plays a canny game. He vows to respect the agreement, even though he acknowledges that Italy is likely to overshoot its deficit target this year. He also notes that Germany and France are facing similar budget woes and suggests a readiness to relax the pact's deficit limits if only Paris, Berlin and Brussels would see the light. "If you ask me, 'Is it correct this kind of rigidity in Europe?' I have other ideas," he says. "But they are personal ideas. Now I am not a professor, I am secretary of a ministry, and I am obliged to respect the treaties signed by my country."

As we work our way up the rocky path, Tremonti relates how he studied German as a university student because that was fundamental to understanding legal theory a generation ago. He hasn't maintained his proficiency, however. When he met with German finance minister Hans Eichel in Berlin in July, the two conversed through an interpreter, a barrier that could explain their lack of rapport. At that time, Eichel brushed off Tremonti's hints about relaxing the Stability Pact's restraints. But a comment last month by Eichel, in which he was quoted as saying that EU countries might do better during the current slowdown to focus on spending restraint rather than rigid deficit targets, suggested that Tremonti's strategy may be astute. Eichel later issued a statement saying he did not mean to question the Stability Pact, but it's clear that squaring the pact's strict guidelines with the worsening deficit picture across Euroland will tax ministers this autumn.

In the meantime, Tremonti will have to focus his attention on structural reform. In Italy that means pensions and health care. Just before the August recess, Tremonti signed a deal with regional governments aimed at capping health spending for the next three years. Fundamental pension reform could prove more difficult. Tremonti believes he can get more Italians to work by giving them the option of raising their retirement age. He also promises to push ahead this fall with a plan to allow workers to invest their company-held severance payments - the trattamento di fine rapporto, or TFR, which amounts to more than E12 billion ($11 billion) a year but currently pays almost no interest - into private pension plans. But the left-wing Confederazione Generale Italiana del Lavoro, Italy's biggest union, has vowed to oppose the reform, and analysts question Tremonti's resolve, noting that a general strike over pension reforms contributed to the downfall of the first Berlusconi government in 1994.

"The issue is how prepared they are to fight the unions the first day they go on strike," says Francesco Giavazzi, an economics professor at Bocconi University in Milan. "There has to be a confrontation with the unions - the sooner the better."

Our hike takes us along the old World War I Italian-Austrian front and passes by a string of Italian fortifications built into a mountain ridge. Tremonti, whose face is youthful but whose stocky build suggests too much time spent behind a desk, soldiers on with his walking stick.

Then there is always the question of potential conflicts of interest involving Berlusconi, who also happens to be Italy's richest man. Just before the August parliamentary recess, the Chamber of Deputies, the lower house, approved a bill that would prevent prosecutors from bringing charges of false accounting against companies unless shareholders or creditors claim damages and shorten the statute of limitations for the crime by half. If it is signed into law in September, it would effectively halt two criminal trials in which Berlusconi is a defendant, involving allegations of accounting irregularities at his soccer club AC Milan and at his Fininvest holding company. "Not having a crime of false accounting in Italian law is bad," says Guido Rossi, former head of the Commissione Nazionale per le Societö e la Borsa, Italy's stock market regulator. "It's against an efficient market."

Tremonti is unapologetic, though. He contends that the old law had been abused by Italy's aggressive magistrates and needed reform, something even the previous center-left government discussed. A good law is still a good law, he says, even if it happens to benefit Berlusconi.

All in all, Tremonti is playing aggressively with the hand he has been dealt. But there is a lurking suspicion that Italy's best hope is hope itself. It's an impression that Tremonti, with his effervescent faith in Italian entrepreneurs, does nothing to dispel.

In addition to their breathtaking beauty, the Dolomites are home to countless marmots, a plump rodent that burrows readily in mountain meadows, pervasive and yet rarely visible, just like Italy's underground economy. At one break during the walk, Tremonti stoops over a marmot hole, whistles and taps his walking stick, but nothing emerges from the blackness. Is it an omen, or does Tremonti know his countrymen better than his wildlife?

We reach the summit, with stunning views of Antelao, "the king of the Dolomites," to the west and, immediately below, the lush, wooded valleys that drew Tremonti's timber-trading ancestors to the region. After descending to a mountainside lodge for a beer to cool down from the four-hour hike, the minister and Institutional Investor return to Tremonti's summer home to discuss his plans in more detail.

Institutional Investor: There was some surprise at the European Commission in Brussels and in Italy when you announced in July that the deficit could be as much as 2.6 percent of GDP, compared with an initial target of 0.8 percent. Did you do that to get out of your campaign promises to cut taxes, to change public expectations?

Tremonti: No. Reading the newspapers the week before [the announcement], you find a lot of news contrasting the numbers and creating an absolutely negative atmosphere. And so our decision was to interrupt this kind of show and to block this tendency.

Our message was, the deficit target is 0.8. What we find now is a tendency toward 1.8. And considering the cash effect introduced by the electoral cycle, there is a risk of more than 2. Starting with 0.8 is obviously better than starting with 1.8. Starting from 0.8, we could try to organize our tax reform. Now we are obliged to postpone it.

For how long?

Now, to 2003. It could be before, but we are sure in 2003 it could be possible, considering the flexibility inside the tax system - if you reduce income taxes, you recover revenue among other taxes, for example, value-added tax or corporate tax.

In the 2002 budget we are going to set up a commission on tax reform. Our strategy is [to have] zero to L20 million ($9,500) in income excluded from taxation. From L20 million to L200 million, the tax rate should be 23 percent. And from L200 million, 33 percent. This is our design.

It could be that we anticipate a corporate tax reform [in the 2002 budget] because the present system is based on a quite complex tax base and on six rates. For example, you can realize capital gains abroad and you can import capital losses. Absolutely illogical. In my opinion, transforming the present base into a more neutral base, you can finance a dramatic reduction in the tax rate.

In the absence of tax cuts, what is the pro-growth element of your program?

Being in Europe, we cannot be supply side because the Stability Pact excludes a policy based on the supply side. So we must try to organize something outside of the supply side. First, development, then tax reform. First, cuts in public spending, then tax reform.

We start with the 100-days measures. Our objective is to boost the economy. From new labor contracts to infrastructure, from freedom in building to the emergence of the black economy, from the taxation of investments to inventions, the spectrum is quite large, and in our opinion, the effect could be very strong.

If you want to finance tax reform, you are obliged to cut expenses. We started cutting expenses of the ministries by 10 percent and blocking the cash flows [the processing of tax refunds and government spending that the Amato government accelerated before the May election].

This government won on a supply-side, tax-cutting program, and you say the Stability Pact precludes you from having a supply-side policy. Should Europe reconsider the Stability Pact?

No. The Stability Pact is an important part of an important treaty, and our philosophy is to respect treaties. In my opinion, in larger terms, the European policy must be reconsidered. But I repeat, having treaties, you must respect them. So we are trying to reduce the deficit.

Which suggests you would love to persuade your EU colleagues to allow more flexibility, to change the Stability Pact. Will you raise this issue with your French and German colleagues?

In my opinion, the discussion on this issue could start this autumn. It would not be positive to discuss this issue now. We are too late. So what could be good for Europe is to respect the program [for the 2002 budget year].

What is a realistic deficit target this year? The International Monetary Fund said it would be difficult just to reach 1.5 percent.

Being a member of the government, I must respect the treaty, so I'm obliged to say 0.8. But I read, and I consider that it's a very good paper, the paper produced by the IMF, and they are speaking of another number.

Will the unfavorable global economic environment derail your program?

We know obviously the global scenario, but we understand that the structure of our economy is quite flexible. We have 5 million value-added tax positions. That means 5 million entrepreneurs, professionals and other people. That is quite important. It makes the difference between our country and the others. Our capital is represented by entrepreneurs. Our policy is especially targeted to the mentality and to the possibilities of these kind of people.

Many economists believe your projections for growth of 3 percent a year are too optimistic. Is it wishful thinking?

It's thinking, not wishful thinking. During the last decade, the policy was based on a scheme characterized by an excess of rigidity. You know that the main indicators of the oppression exercised by the state are represented by taxes and by laws. The tax pressure increased during the entire decade, and the quantity of laws last year was 12 kilometers, measured on the official journal. And so everything is regulated, and the effect transmitted to the economy is negative.

What we are trying to do is to stop or reduce the tax pressure, for example, reducing the taxation of new investments. And we are trying to stop the regulation and transmit a message of freedom. For example, now you are free to define a labor contract, you are free to rebuild your laboratory or your home. These issues could seem symbolic, but in policy the symbols are important.

The IMF forecast growth of 2.4 percent next year. That's still not enough to achieve all of your plans, is it?

I am more optimistic than the IMF. In my opinion, the boosting of the economy produced by labor contracts, the starting of infrastructure, the starting of rebuilding, the taxation of investments and other measures could be more than 2.5 percent. They were cautious; we are more ambitious.

You wrote a decade ago that the state can't choose how to tax wealth; it's for wealth to choose where to go and how much to be taxed. What does that imply for government policy?

The theory of von Clausewitz was that war is the continuation of policy by other means. Now war has been substituted by competition, and the competition is attractive competition. It's not necessary to conquer others' territories. It's sufficient to attract wealth on your territory or to conserve your wealth.

And so, we are trying to become attractive. A new corporate system that we are planning when we can go to tax reform should be a system based on a very simple tax base with a low tax rate of 33 percent. And this is to be competitive.

The recent takeovers of Montedison and Telecom Italia appeared to many outsiders to be anything but transparent and fair. Do those two deals send a bad signal?

We are starting a reform of the law after these cases. But in my opinion, a change in the law is necessary but not sufficient. What is necessary is the market, and our market is much too limited. The real reform of the market should be represented by pension funds. You know that a large part of our pension system is composed of a public pensions system. Without a second pillar [namely, private pensions], it's difficult to have an efficient market. And so I know the relevance of the law. But even if the law is perfect, without the market it would be difficult to have transparency and efficiency.

When will you move on pensions, and how much will you reform?

Starting from September, [we will have] a discussion with the unions. At the end, we must formalize our conclusions in the budget. What is important is the medium-term target. Immediate, drastic effects are not good.

At the moment, if you are retired, you cannot work. Our idea is to eliminate this kind of rigidity because it's inefficient. We are studying the idea of increasing the age of retirement but asking for flexibility on a voluntary basis - if you want, you can work.

Will you allow workers to use their company-held severance funds, known as TFR, to establish pension funds?

We do not have in Italy a real and efficient pension fund because the strategy of the unions is to reserve the system to the so-called closed pension fund they control. Our strategy is to make the worker free to choose where to invest his TFR. The TFR could be conserved in the enterprise; it could be invested in so-called closed funds controlled by the unions. The alternative is to invest the TFR in open pension funds controlled by the market. You know the tendency to save in our country is very high, and this kind of instrument should open a large and interesting market area for operators, a fantastic opportunity.