Company profits in Italy

We provide insights into the macro and microeconomic underpinnings of company profitability developments in Italy. We show that the average ROA (returns on assets) of Italian companies declined slightly between 1993 and 2005 and then contracted sharply during the economic crisis before starting a slow recovery in 2013. While the pattern in Italy before 2009 was very similar to the pattern in Germany; during the crisis it became more similar to the pattern in Spain, with both countries performing relatively worse than Germany and France. This decline appears to be attributable to a fall in productivity, rather than a rise in labour costs. Indeed, notwithstanding the substantial deterioration that began in 2000, unit labour costs (labour costs over value added) in Italy are still lower than in Germany, France and Spain. Within Italy, we document large cross-sectional differences. Micro firms and firms located in the South are tend to exhibit the lowest ROA, while the ROA of firms from the North-West dropped dramatically between the mid-1990s and 2010. Interestingly, firms with the highest innovation intensity (measured by intangibles over total assets) tend not to have the highest ROA, particularly if they are small and operating in low-tech and/or low competition sectors. We interpret our results in terms of ‘active’ (based on innovation and higher expenditure on intermediate goods and labour) and ‘passive’ (based on cost control) business models, with the latter exemplified by domestic and usually small-sized and family-owned firms. From this perspective, subsidising innovation could treat the symptom rather than the disease. Instead, medium-tolong term policies should focus on increasing the share of firms with ‘active’ business models. Our econometric analysis suggests possible instruments: increasing the efficiency of the market for corporate control; reducing the government ownership of firms; increasing the degree of competition in sectors where barriers are still present; and improving the effectiveness of the education system to raise the human capital endowment available to businesses.