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Traditional economic policy prescriptions proposed to address the Italian North-South divide mainly suggest that, in order to reduce unemployment and stimulate productivity, downwards wage flexibility should be guaranteed and the wage-setting model decentralised to sub-national labour markets. Contrarily, the Keynesian view suggests that higher wages and demand stimuli can engender positive effects on productivity and employment.

Applying panel structural VAR modelling to Italian regional data (1995–2019), we evaluate how wages and government expenditure impact productivity and employment dynamics.

We find that a rise in both government spending and real wages has long-lasting, positive effects on productivity and employment, even when considering centre-northern and southern regions separately.

To the best of our knowledge, this research provides new insights, particularly in the Italian context, by explicitly examining the effects of wage and fiscal policies on two significant macroeconomic variables—employment and productivity—using a novel and integrated approach. Additionally, our findings suggest that conventional policy recommendations warrant reconsideration.