Italy's growth performance has been lacklustre in the last two decades. The economy has low R&D intensity; firms are smaller and less likely to grow or exit than firms in other advanced countries; the shadow economy is large. I show how these features arise simultaneously in a Schumpeterian growth model with heterogeneous firms where the tax auditing probability increases with firm size. Tax evasion confers a cost advantage over competitors. In equilibrium, small firms invest less in innovation because growing entails a (shadow) cost of fiscal regularization. Unfair competition forces other firms to lower the mark-up they charge for their new products, reducing the incentive to innovate. Market selection is hampered, further lowering the aggregate growth rate along the extensive margin. I calibrate the model on Italian firm-level data for the period 1995-2006 and find that enforcing taxes would have increased the longrun growth rate from 0.9% to 1.1%. The market share of high type firms would have been 8 percentage points higher and average firm size 25% higher. Also, I find that lowering the tax burden can have a significant impact on growth when the shadow economy is large, while the effect is negligible when taxes are enforced.

Aggregate wages display little cyclicality compared with what a standard model would predict. Wage rigidities are an obvious candidate, but a recent strand of the literature has emphasized the need to take into account the growing importance of worker composition effects during downturns. With reference to the Italian case we document that firm composition effects also matter increasingly in explaining aggregate wage dynamics, i.e. aggregate wage growth has been raised by the increase in the employment weight of highwage firms. To the extent that this reallocation occurs towards more productive firms, the composition effects may also reflect an efficiency enhancing mechanism. We use a newly available dataset based on social security records covering the universe of Italian employers from 1990 to 2013 and employ a standard measure of allocative efficiency on wages paid across firms. We show that this measure has improved progressively since before the recent downturn, being aligned at the sectoral level with measures of productivity growth and market openness to competition. We then focus on the recent downturn and find that large firms were able to adjust wages more than small firms and that small firms instead adjusted employment to a larger extent. Finally, we document that the continued improvement in the measure of allocative efficiency over this period correlates positively with measures of economic activity (evolution of employment and value added) across sectors.

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This paper analyses wage dynamics in Italy in the last 25 years with special focus on the recent recession. Using linked employer-employee data we document the presence of a trade-off between wage and employment adjustments: firms experiencing more wage rigidities exhibit more employment adjustments. Over time, the average amount of nominal wage rigidities was subdued during the recession years. Most of the adjustments took place through the part of wages that is not negotiated at the national level. In a rather rigid institutional context, a larger share of temporary workers, whose contractual relationship may be terminated without cost and whose wages are more frequently renegotiated, served instead as a significant flexibility enhancing margin. More broadly, we find that larger firms, with a greater share of blue-collar workers or belonging to a sector in which firm bonuses represent a large part of annual earnings, were the ones displaying a higher level of wage flexibility.

This paper analyses wage dynamics in Italy in the last 25 years with a special focus on the recent recession. Despite the rather rigid Italian institutional setting, using linked employer-employee data we find that wage rigidities, albeit always present, have been subdued during the recessionary years. Using complementary data, we verify that, although we only observe daily and not hourly wages, overtime hours are not the main mechanism behind this enhanced wage flexibility. We document the presence of a trade-off between wage and employment adjustments: firms historically displaying higher levels of wage rigidities were less able to modify wages but exhibited higher turnover. A higher share of temporary workers, whose contractual relationship may be costlessly terminated and whose wages are therefore more frequently negotiated, served instead as a significant wage flexibility enhancing margin. More broadly, we find that firms of larger dimension, with a higher share of blue collar workers, or belonging to a sector where bonuses represent a large part of annual earnings were the ones displaying a higher level of wage flexibility.JEL Classification: J31, J33