Can we learn from the “Italian Miracle” Formula?

Carlo Resta from RGE:

"In the 1960s, while the Italian economy was booming, such to talk of “The Italian Economic Miracle”, IRI - Istituto per la Ricostruzione Industriale S.p.A. - was among its most important factors[1]. The IRI, (Institute of Industrial Reconstruction) was a conglomerate owned by the Italian government and inherited by the Great Depression period. By the 1960's it was growing at rates that were more than double those of the national economy and it was once the largest non-oil producing company in the world outside the United States. It had stakes in a multitude of sectors of the Italian economy, ranging from infrastructure and manufacturing to telecommunications.
This experience of the IRI contains some valuable precedents and lessons for policy makers today in the midst of the extreme economic difficulties.
When the 1929 market crash initiated the worldwide depression of the 1930s, few countries were as adversely affected as Italy, even though this propagated with a certain delay. Italian banks had a history of purchasing substantial interests in Italian industry, and when those industries began to fail it appeared that the nation's banking system might well collapse. The Fascist government of Benito Mussolini created IRI in January 1933 to bail out Italy's three largest banks, Banco di Roma, Banca Commerciale, and Credito Italiano. As a result, wrote Stuart Holland in: The State as Entrepreneur. New Dimensions for Public Enterprise: The IRI State Shareholding Formula, “the new state holding company found itself responsible for major proportions of the main industrial and service sectors in the economy.”
During the years of its intense growth, IRI behaved unlike any corporation seen before. Because it served the interests of the state, it did not have to concern itself with short term profits. Thus IRI could sink millions of lire into enterprises, like steel and road building that private companies shied away from. The effect of such government investment was to create markets in which other companies could then compete, thereby expanding the economy as a whole. The U.S. government was using tax-breaks and incentives, but their situation was different, so Italy employed IRI. Not only did IRI create economic markets, it did so in areas thought to be most beneficial to the country as a whole or in areas of strategic importance.
It is crucial to remember that IRI avoided the pitfalls of most state-run businesses. The problem with most state-run businesses, especially in the formerly communist countries, was that there were few incentives to be productive or efficient. Thus, state-run companies often became notorious for mismanagement, creating unnecessary jobs and spending public money unwisely. IRI avoided these drawbacks by creating a level of distance between itself and its subsidiary holding companies. IRI's subsidiaries were put in a position to behave as if they were private enterprises; they were encouraged to be entrepreneurs, while the small core of IRI management acted as investors, backed by the financial might of the Italian government. While IRI was 100 percent government owned, the subholdings were not, and thus these subholdings could attract private investment as well. And so they did.
When IRI was working well, it combined the dynamism of entrepreneurial capitalism with some sort of social guardianship and long term forward looking common purpose. The success that IRI had in the 1950s and 1960s, during what was dubbed: “The Italian Economic Miracle”, made it the model for governmental involvement with industry around the world. In the 1960s, Great Britain, France, Australia, Canada, Sweden, and West Germany all initiated programs that were based at least in part on the IRI formula of mixed state/private investment formula.
Many European countries, particularly the UK, were looking at the “IRI’s formula” as a positive and effective example of a proper state participation in the economy. It was better than the straightforward “nationalization” because it allowed a direct cooperation between public and private capital. Many of the companies of IRIs’ group had mixed capital, partly from public government, partly from private investors. Many of IRI’s enterprises were listed and the bonds issued by IRI to finance its own companies were massively subscribed by savers.

Here are the main functions of the newly proposed Institutes for Economic Reconstruction:

1.Be of immediate support to companies in strategic sectors of the economy; prevent their collapse, avoiding catastrophic impacts by taking over preferred shares, (a midway instrument between shares and bonds with no voting rights), taking control only where strictly necessary.

2.Acquire stakes in small and medium size businesses (SMEs) to protect them for being indirect contagion casualties, facilitate their financing, their international development plans.

3.Acquire preferred stakes in new enterprises with strong growth prospects, to promote new technologies, new inventions, more exports to BRICs, vital sectors of the economy …

4.Act as a traditional institutional investor in search of long term returns, acquiring assets domestically but also abroad, restoring confidence and stabilizing markets in coordination with the necessary general economic reforms of each of the western countries.

5.Defy fears that external SWFs investment reasons are other than portfolio diversification and that by investing in other countries they could take control of crucial national interests, or could influence other sovereign states. Consider co-investments with SWFs with the aim of contributing to a globally coordinated stabilization effort.

Now, the big problem facing this depressionary period is that there is strong general reluctance to undertake any investment at all. There is widespread fear. The risks are perceived to be too high; a vicious “Trust Crunch” circle is generated, and that brings to a compression and ultimately to the freezing of any exchange in the economy. If the blood stops circulating even the healthiest individual will eventually die. The banks stop lending, even to themselves; consumer confidence plummets at its lowest, panic spreads across and creates damage to fundamentally sound businesses. The above curve gets flatter and it moves more and more to the extreme right of the graph. This deadly spiral must be “unlocked”!

The implementation of a proper “State/Private Co-Investment” formula allows reducing enterprise risks, guarantees a long term view horizon, reestablishes trust and confidence in the markets for investments to take place, gives a positive boost to all of the firm’s constituents, and thus decreases risks. The presence of such a ‘Strong hand’, enhances the value of a company for all the parties involved: employees, management, suppliers, customers, shareholders, bondholders, financing banks, insurers, regulators, local administrators. The positive impact reverberates also into other companies of the same sector, creates a compounding positive virtual circle, a psychologically positive impact into the entire system.

... The impact of the “State/Private Co-Investment Formula” is obviously of superior significance in periods of deep dislocation and depression like those we are currently going through. Historical examples show also that where there is a public presence, growth is even faster than the market average at times of expansion. Last but not least, history reminds us that the most important element will be, much further down the line, a proper ‘exit strategy’ for the public money. This is a relevant aspect but it can be addressed later on.

Furthermore, a renewed formula of the Italian I.R.I., a new breed of western Sovereign Fund which I call Institutes of Economic Reconstruction (IER), can be viewed exactly as a portfolio manager, having to allocate capital among different selection of enterprises and industrial sectors.

...The IER holding company can also be viewed as a fund manager and similarly, if successful in allocating its asset among best performers and diversifying risks accordingly, generating return higher than the market. ...The value generated by these asset allocation strategies will also improve because the allocation process itself is made easier by the presence of a “strong hand” that reduces fears and uncertainties. And we know that asset allocation is the most important factor in successful value creation and preservation. From the case study of IRI, we see that when the Italian economy was growing 8%, IRI was growing more than double that.
The stronger the depression, the higher is value of the “State/Private Co-Investment Theory”. Same was for the Great Depression and for other similar historical periods. After all the creation of “Sovereign Alpha” does not just come automatically, but it is also be the result of a selection and an enhancement process; the enterprise will have to improve its values and standards, requirements, conditions, and keep them that way.

If IRI chemistry allowed to flourish the unstoppable Italian art of making do with what available; if that formula allowed the unfolding of the fantastic creativity of the Italians and their relentless ‘trial and error’ mentality that brought to life world icons like Ferrari or Espresso, Versace and Armani,… up to the helicopters currently used by the USA President and much more, think what a similar formula could do to revamp a United America and the western economies today. Not only the historical comparables match, but the advantage of available technology and knowledge make possible a more effective and controlled use of the “State/Private Co-Investment” formula. Yet, time is of the essence.

A new breed of Sovereign Wealth Funds, the Institutes for Economic Reconstruction (IER), based on the “State/Private Co-Investment” formula with the crucial goal of reestablishing confidence in each of the national markets, and restarting the much needed economic growth, appears to be the only way forward and a viable one. Not Von Hayek but not really Keynes either. It is going to be a balanced, comprehensive approach, a real generator of modern value.
This approach not only will benefit the individual enterprises which receive the participation from the State, but it will also generate a positive crucial impulse to the global economy, increasing overall market returns and reducing risks. Last but not least, ethical and sustainable growth considerations will be able to receive a reasonable place in a much needed restructuring of the world order. Markets will come out different from this crisis but ultimately stronger.
We have the means, the expertise, and now a good impending necessity to make it happen.

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty”. Winston Churchill




Carlo Resta is the founding Partner and President of Oraculum Advisors Limited, an investment banking boutique consultant to global financial services institutions for their business development, marketing, partnerships andalliances activities.
As a wealth manager, Carlo was the Managing Director of Global Investment advisory at Chase Manhattan Bank, for Europe, Africa and the Middle East from 1999-2001. The group was responsible for all client-directed investment business in this region within Chase’s Private Bank. As a start-up and product specialist in equities, Carlo was formerly a Director of the Client Strategies Group for the Merrill Lynch International Private Bank from 1997 to 1999. From 1995 to 1997 he was a Director, Global EquityDerivatives, at Merrill Lynch where he developed and expanded the derivatives business of Merrill Lynch in Southern Europe. He was also responsible for marketing Merrill’s entire range of financial products and services to his client-base. Carlo’s team launched the first Equity Linked Capital Protected Investment Product for the Italian,Portuguese and Spanish markets. Most recently in 2002 and 2003, Carlo worked for the Old Mutual Group on projects dealing with their expansioninto new financial products and services. Prior to joining Merrill Lynch in 1993, Carlo spent eight years at San Paolo Bank in their headquarters in Turin and in New York. Carlo holds a degree in Economics and Banking Sciences from the University of Siena, Italy, and an MBA in Finance and International Business from New York University, Leonard Stern School of Business.