Investment, Productivity and Employment in the Italian Economy

This paper analyzes the effect of institutional structure, regulations, technological progress, and labor market flexibility on productivity in the Italian economy within the framework of the representative agent model of Saltari and Travaglini (2007). The core model is shown to be too restrictive to provide a good representation of the Italian economy. Broadening the view of the way in which firms take account of the costs of changing the labor force and investment achieves a more satisfactory representation of the dynamics of the productive sector of the economy while still retaining the spirit of the core model. Institutional or market structures, regulations, and other factors are incorporated in the system through modifications to the production function, the demand and supply functions for labor. A full-information, Gaussian estimator of a differential equation system is used throughout. As the constraints on the system arise from both macro-economic theory and the institutional structure of the Italian economy, this estimator provides a much more stringent test of all the hypotheses embedded in the model than many other studies. The model provides a foundation for a study of the extent to which, over time, changes in regulations or market structure might allow firms to reallocate resources to take better advantage of the skills available in the labor force within the context of a segmented labor market with varying efficiencies. The model lends itself to a policy analysis of the effects of these changes on the workings of the labor market as the ease with which firms may change their labor force determine the dynamics of the interaction between firms and labor and the path over time of labor and capital themselves.