Italy presents one of the great puzzles of post-war European economic development. From the 1950s through the 1980s, it was one of the most successful catching-up economies in the developed world. Rapid industrialisation, productivity growth and structural transformation brought Italian living standards progressively closer to those of the leading European economies. Then, around the beginning of the 1990s, something changed. Productivity growth collapsed, investment weakened, real wages stagnated and Italy gradually transformed from one of Europe’s most dynamic industrial economies into its most conspicuous case of long-term stagnation.

The reasons for Italian secular stagnation

The conventional explanation is reassuringly simple. Italy had been living beyond its means. Its growth was supported by fiscal deficits, rising public debt, inflation and periodic currency devaluations. By the early 1990s, with public debt above 100% of GDP and the lira under pressure, this model had supposedly reached its macroeconomic limits. Fiscal consolidation, structural reforms and eventually the euro were therefore not the causes of Italy’s decline, but the unavoidable correction of an unsustainable development model.

But the timing raises an uncomfortable question. Italy’s economic performance deteriorated precisely when its old policy regime was replaced by a fundamentally different institutional framework: the Maastricht Treaty in 1992, completion of the Single Market in 1993, fiscal and monetary convergence during the remainder of the decade, and finally the Stability and Growth Pact and monetary union. The crucial question, therefore, is whether Italian growth was undermined by the exhaustion of its previous development model, or by the new constraints imposed by deeper European integration?

This question comes remarkably close to the interpretation proposed by Guarascio, Heimberger and Zezza (2025), who analyse Italy as a failed experiment in “modernisation by external constraint”. Their argument does not romanticise Italy’s previous development model. Italy had substantial structural weaknesses. But many of them — small firms, regional dualism, institutional weaknesses, relatively low educational attainment and strong state involvement — had also existed during the decades in which Italy had grown extraordinarily rapidly. What changed was the institutional environment within which these characteristics operated.

Debt, growth and the wrong diagnosis

One obvious candidate for explaining this structural break is public debt. Italy did accumulate substantial public debt before Maastricht. But the coexistence of relatively strong growth and rising debt does not establish that growth was simply “financed by debt”. Before 1990 Italy combined high growth with primary deficits; subsequently it combined very weak growth with persistent primary surpluses. The first correlation can be interpreted as evidence that deficits artificially sustained economic activity. But the second is equally consistent with the proposition that prolonged fiscal restraint weakened aggregate demand, public investment and private investment incentives.

The empirical literature provides little support for the existence of a universal debt threshold beyond which growth necessarily collapses. Reinhart and Rogoff (2010) famously suggested that growth falls sharply when public debt exceeds 90% of GDP. Herndon, Ash and Pollin (2014) subsequently showed that this result depended on a spreadsheet error, excluded observations and an unconventional weighting procedure. After correcting these problems, the apparent 90% threshold largely disappeared.

Pescatori, Sandri and Simon (2014) reached an even more important conclusion. Using a broader historical sample, they found no “magic threshold” beyond which medium-term growth suddenly collapses. The negative relationship between debt and growth is considerably stronger over a one-year horizon but weakens markedly over longer periods. Panizza and Presbitero (2014) and Lof and Malinen (2014) similarly questioned the direction of causality: weak growth itself increases debt-to-GDP ratios, meaning that the familiar correlation between high debt and low growth cannot simply be interpreted as evidence that debt causes stagnation.

This distinction is crucial for Italy. After Maastricht, it became one of Europe’s most fiscally restrictive major economies when measured by its primary balance, yet persistent primary surpluses neither restored growth nor eliminated the debt problem. The reason follows from standard debt arithmetic: when nominal growth remains chronically weak, even large primary surpluses may fail to reduce the debt ratio. Italy’s post-1990 problem was therefore not merely its inherited debt. It was the collapse of growth itself.

Single Market, Maastricht and monetary union: a new restrictive development regime

The fiscal story must consequently be placed within a much broader institutional transformation. The Single Market, Maastricht and monetary union did not merely deepen trade and financial integration. They progressively changed the instruments available to national governments. Competition rules and state-aid disciplines constrained traditional industrial policies; Maastricht and the Stability and Growth Pact restricted discretionary fiscal policy; and monetary union eliminated national monetary policy and exchange-rate adjustment.

Guarascio et al. (2025) interpret this transformation as “modernisation by external constraint”. European rules were expected to discipline governments, force firms to restructure and raise productivity. Italy embraced this strategy and undertook extensive privatisation, financial deregulation, product-market reform and labour-market liberalisation. Yet productivity growth did not accelerate. It collapsed. This creates a fundamental reform paradox: if Italy’s stagnation reflected an insufficient willingness to liberalise and reform, why did the period of most intensive structural reform coincide with the most dramatic deterioration in productivity performance?

The loss of exchange-rate autonomy further changed the adjustment mechanism. Before monetary union, Italy could periodically restore competitiveness through depreciation of the lira. With the euro, adjustment increasingly had to occur through internal devaluation — wage moderation, labour-market flexibility and restraint of domestic demand. But prolonged wage restraint weakens consumption, while weaker demand reduces incentives for investment. Cheaper and more flexible labour may also reduce incentives for labour-saving capital investment and technological upgrading. A cumulative mechanism can therefore emerge: weak wages restrain demand, weak demand discourages investment, lower investment slows productivity growth, and weak productivity is then invoked to justify further wage restraint.

Italy as an early symptom of a European problem

The significance of this mechanism extends beyond Italy. This is where the Italian story becomes much more than an Italian story. The mid-1990s approximately coincide not only with Italy’s structural break but also with the end of Europe’s long post-war productivity convergence towards the United States. During the earlier decades of European integration, trade barriers fell and markets became increasingly integrated while national governments retained substantial control over fiscal policy, industrial policy, exchange rates, public ownership and public investment. The institutional architecture emerging from the 1990s was qualitatively different.

This distinction is crucial. European integration as such cannot plausibly explain Europe’s subsequent stagnation. The first phase of integration, beginning with the Treaty of Rome in 1957 and extending through the customs union and the expansion of intra-European trade, coincided with exceptionally rapid growth and convergence. The relevant hypothesis concerns instead the deepening and institutional transformation of European integration from the early 1990s onwards. The Single Market strengthened competition rules and restrictions on national state aid. Maastricht imposed fiscal and monetary convergence requirements. The Stability and Growth Pact institutionalised fiscal constraints, while the euro removed national monetary and exchange-rate adjustment. After 2010, fiscal surveillance and the Fiscal Compact further reinforced this architecture. Considered separately and isolated, each of these reforms mighy have had an economic rationale. Considered jointly, however, they created something qualitatively different: a development regime increasingly organised around constraints on national economic policy. Taken together, they progressively reduced the policy space available to national governments for macroeconomic stabilisation, industrial transformation and strategic investment.

The crucial problem was the asymmetry of this process. National policy instruments were progressively constrained without creating equivalent instruments at the European level. Europe created a common central bank but not a federal fiscal authority of comparable macroeconomic importance. National fiscal space was restricted without establishing a permanent common fiscal capacity capable of large-scale stabilisation and investment. National industrial policies were constrained long before Europe developed anything resembling a common industrial strategy of comparable scale. Exchange-rate adjustment disappeared without the creation of sufficiently powerful fiscal-transfer or risk-sharing mechanisms.

Has the deepening of European integration become a development trap?

It is precisely this asymmetry that lies at the heart of the proposition that deep European integration has become a development trap. The problem is not primarily the loss of national sovereignty as such. It is that economic functions previously performed by national fiscal, monetary and industrial policies were constrained or transferred upwards without creating equally powerful European development capacities.

More fundamentally, the post-1990 European model was based on the assumption that constraints themselves would generate efficiency. Fiscal discipline would enhance credibility, competition would improve resource allocation, monetary rigidity would impose discipline, and structural reforms would raise productivity. Yet development requires more than the efficient allocation of existing resources. It requires the creation of new technological capabilities, infrastructure, skills, industrial ecosystems and strategic complementarities.

The contrast with the United States and China is instructive. Both retained — and more recently dramatically expanded — public procurement, subsidies, tax incentives, strategic investment and industrial policy. Europe instead spent much of the past three decades constructing an institutional framework designed to constrain discretionary fiscal expansion, state aid and national industrial intervention. The question is therefore whether Europe entered the technological transformation of the past three decades with an institutional framework systematically biased against the scale and coordination of investment required for structural change.

Rather than correcting this problem, the post-2010 response to the sovereign-debt crisis reinforced the same institutional logic. Fiscal consolidation was intensified even as subsequent research showed that its contractionary effects had been underestimated. Guajardo, Leigh and Pescatori (2014) found that fiscal consolidation generally reduces domestic demand and output, while Blanchard and Leigh (2013) showed that countries undertaking larger planned consolidations experienced systematically larger-than-expected output losses. Yet the crisis produced tighter fiscal surveillance and the Fiscal Compact, further institutionalising fiscal constraint as an organising principle of European macroeconomic policy.

The result is a striking historical paradox. European integration was extraordinarily successful while it enlarged markets without eliminating national development strategies, but became substantially less successful when deeper integration increasingly subordinated those strategies to a common framework of constraints. Italy may simply have been the first large economy in which the consequences became impossible to ignore. Its stagnation should therefore be understood not merely as an idiosyncratic Italian failure, but as an early and particularly severe manifestation of a broader European development problem.

Is There a Way Out of the European Development Trap?

If this diagnosis is correct, the European problem can no longer simply be described as one of an “incomplete” monetary union awaiting further integration. It may instead be one of over-integration in some policy dimensions combined with insufficient room for national economic adjustment and development. This distinction is crucial because it leads to a very different policy conclusion.

The conventional prescription is to complete the European architecture through ever deeper integration. In theory, some of the deficiencies of monetary union could be compensated for by a fully fledged fiscal union, a large permanent federal budget, extensive cross-country transfers and a genuinely federal industrial and investment policy. In political terms, however, such an arrangement appears extremely difficult to reconcile with a union of 27 sovereign states characterised by profound differences in economic structures, levels of development, national preferences and political interests.

More importantly, even if such a degree of integration were politically feasible, it would not necessarily solve the underlying development problem. Deeper economic integration can itself reinforce agglomeration forces and economies of scale, concentrating high-productivity activities, investment, skills and technological capabilities in the most competitive regions while progressively weakening the productive base of more vulnerable economies. Without extraordinarily powerful and politically sustainable redistribution mechanisms, a fully integrated economic union could therefore intensify regional divergence rather than eliminate it.

A more realistic alternative may consequently be to reconsider how far European integration needs to extend beyond the areas in which it has demonstrably generated common benefits. Historically, the most successful phase of European integration combined trade liberalisation and expanding economic exchange with substantial national autonomy over fiscal policy, industrial policy, public investment and development strategy. This suggests a different institutional counterfactual: not completing the existing architecture through further centralisation, but returning part of European economic governance towards its last broadly successful configuration — before the Single Market, Maastricht and monetary union progressively transformed integration from market opening into a comprehensive system of constraints on national economic policy.

Such an institutional reversal would not necessarily require dismantling the Single Market or even abandoning the euro. A politically more feasible approach would be to preserve their principal benefits while substantially relaxing those common rules that restrict national development policies. This would imply greater national discretion over productive public investment, industrial policy, state aid, strategic public ownership and other instruments of structural transformation. If the euro is retained, the case for restoring fiscal and industrial-policy autonomy becomes even stronger, precisely because member states have already surrendered monetary and exchange-rate instruments.

The objective should therefore be neither disintegration nor an unattainable federal union, but a less restrictive form of European integration that restores sufficient national policy space for countries to pursue development strategies consistent with their different productive structures and stages of development.

Yet this institutional reorientation currently appears unlikely. Europe increasingly seems to be caught in the same development trap that Italy entered earlier. The technological and industrial challenge from the United States and China has forced the EU to rediscover industrial policy, but the European Commission’s response has so far consisted largely of ambitious-sounding but essentially toothless strategies that are not backed by adequate centralised financial resources, while simultaneously adding new layers of regulation to an already highly restrictive framework.

Given the Commission’s apparent inability to provide an adequate response to Europe’s fundamental development challenges, it is therefore up to the member states themselves to fundamentally reconsider the institutional paradigm established since the 1990s. They should reassess whether the progressive centralisation of economic governance and the corresponding constraints on national development policies continue to serve their long-term economic interests and, if not, demand a redesign of the European institutional framework that restores substantially greater national policy space for investment, industrial policy and structural transformation.

But one thing seems increasingly clear: if European policymakers continue to interpret the symptoms of this development trap through the same institutional paradigm that helped create it, Europe’s ability to escape from it appears increasingly doubtful.