Worrisome Italy

In the past, Italy was able to maintain its position as a major industrial economy because of three factors. First, its domestic markets remained closed to foreign competition; second, it could devalue the lira against the German mark in order to maintain competitiveness; and, finally, it had highly flexible, entrepreneurial family-owned firms.

All three factors have now changed. The highly protected domestic market, for example, gave Fiat an automatic 60 percent share of Italian car sales, which allowed the company to compete with Volkswagen for the title of Europe's largest automaker as recently as in the late 1980s. But the Italian market was gradually opened to competition — first, from other European carmakers, and then from Japanese and Korean ones, as well. As a result, Fiat nearly went bankrupt in the 1990s. It has sorted out some of its problems, but its market share in Italy is now only slightly more than half of what it once was.

The adoption of the euro in the late 1990s was another blow to the traditional way of doing business in Italy. When the euro came into being, the lira was devalued one last time, and the German mark was fixed in the monetary union at a severely overvalued level. German manufacturers complained bitterly at the time, but by now they have been able to cut costs and increase their competitiveness. They are once again beating their Italian competitors both in Italy and in various export markets. Yet, the euro is permanently fixed and no devaluation is now possible.

Revenge on Marco Polo

The great 13th-century Venetian merchant Marco Polo is credited with introducing China to Western Europeans. Some historians also believe he brought back from his travels Chinese noodles and meat-filled wontons, which Italians then perfected into spaghetti, macaroni, tortellini and other pasta, now far better known around the world. Huge profits were made over the centuries by food companies founded by Italians in Italy, the U.S., Argentina and other parts of the world.

Now, the Chinese are ready to pay Italians back. Small, family-owned Italian companies, based mainly in northern and central Italy, have long been renowned around the world for producing high-quality engineering products, machinery and equipment, clothing, leather accessories, paper and a variety of other goods. They have the flexibility and managerial acumen to follow changing fashions, provide great quality and excellent design and even do what Italians are not traditionally good at — keep their costs down.

But all of a sudden they find that the Chinese are beating them at their own game. Chinese companies are able to knock off their designs, closely match their quality and handily beat their prices. In Veneto, the prosperous province around Venice, Chinese products are not only seen as a threat to local exports, but have now started to inundate local markets as well. Even in Venice, world-famous glassware makers have to warn shoppers against far cheaper Chinese-made knock-offs available at some Venetian shops.

These factors are cutting into Italy's ability to grow and, ultimately, to fund its massive public debt. Italy is a big economy, with GDP that exceeds $2 trillion. But this is one of those cases when size doesn't really matter — or at least doesn't matter all that much. Italy is a member of the Group of Seven, an exclusive club of the world's richest and most influential industrial nations. If Italy wobbles, it will mean that the bell is tolling for the industrial world as a whole — a frightening vision of things to come for other rich economies.

Alexei Bayer is an economist and author based in New York City.