ROME, Italy — In a small workroom whose window overlooks the Umbrian countryside, women hold gray silk-linen cardigan sweaters up to light tables one-by-one, checking every knot and seam. When a worker finds a hole, she puts the sweater in a bag destined for repair or recycling.

This is how Brunello Cucinelli's fashion company tapped demand for quality Italian goods to lift sales of its $1,280 sweaters and other products by 15 percent last year. It's a bright spot in a country where unemployment yesterday reached a record, industrial production is down 25 percent from 2007 and the longest slump in more than 20 years isn't abating.

With three-quarters of his sales from overseas, Cucinelli says the rest of Italy should follow his model: produce quality goods and sell them everywhere -- especially outside Italy. The formula has worked for shoemaker Tod’s SpA, eyewear maker Luxoticca Group SpA and luxury-goods company Prada SpA, among others. It’s worked especially well for Brunello Cucinelli SpA, whose shares have risen 162 percent since last year’s offering.

“Italian companies need to re-convert themselves and such a re-conversion must be toward a better, higher standard,” Cucinelli said at company headquarters in Solomeo, a village he helped restore. “If you have a company that doesn’t sell its goods or services abroad and focuses only on the domestic market, it will keep paying a price.” Businesses that think internationally, he says, can enjoy a “Renaissance.”

Debt Effect

Italy faces considerable hurdles in following his dream. Sales abroad of apparel, textiles, leather and related products rose only 2.6 percent last year, barely more than the 2.3 percent increase for all exports. Luxury goods account for only 15.5 percent of exported manufactured goods, according to business lobby Confindustria. That’s not enough to drive an economic recovery.

At the same time, the austerity measures and economic reforms passed under pressure from the European Union haven’t produced the gains in competitiveness registered in other countries hit hard by the region’s debt crisis.

“We are a little bit over-regulated as a state,” Impregilo SpA Chief Executive Officer Pietro Salini said an interview on Bloomberg Television’s “On the Move” with Francine Lacqua on June 27. “The enormous quantity of laws and legislation -- nobody even knows how many we have in reality. I think we need some clear paths in order to have simplicity.”

Portugal Club?

Whether the euro region’s third-largest economy can join countries like Ireland and Portugal, which are showing signs of pulling out of the crisis, may determine European leaders’ course as they seek to guide the 17-nation group back to health. The alternative is spiraling further into the economic malaise that has thrown Greece into depression.

Recent investor concern has already pushed up yields on Italian 10-year bonds, which reached a four-month high of 4.93 percent on June 26. That was up from a seven-year low of 3.68 percent set on May 3 amid a global selloff in fixed-income assets triggered by speculation the Federal Reserve would start to slow monetary stimulus.

To follow Cucinelli’s example, Italian companies must reshape how they do business, according to an April report by Goldman Sachs Group Inc. They need to enhance competitiveness via higher productivity, focus more on exports and integrate themselves into the “global supply chain.”

“The underperformance of the Italian economy vis-a-vis the rest of the euro area is not a new phenomenon -- it pre-dates the introduction of the euro,” said the author, Frankfurt-based Dirk Schumacher. “Such prolonged weakness is indicative of underlying structural problems in the economy, problems that are particularly evident in the slow growth of Italian exports.”

Small Size

A major impediment to competitiveness is the size of Italian companies, which tend to be smaller than their European counterparts. That makes it harder for them to achieve the economies of scale needed to penetrate foreign markets.

Labor laws guaranteeing stronger protection for workers once a company reaches 15 employees are one explanation, Schumacher wrote. Almost 47 percent of Italian workers are employed by companies with fewer than 10 staff, figures from European statistics office Eurostat show. That compares with about 19 percent in Germany.

“The size factor is very important,” said Nerio Alessandri, CEO of Technogym SpA, a designer of fitness equipment. “The small-is-beautiful, small-is-quality approach does not work. You need to be big and beautiful, big and high quality, big and competitive. In a global economy, competition can change its players in a short amount of time. Size is key.”

Olympic Contract

Alessandri built the 30-year-old company, which now has 2,200 employees, into a world leader in its industry. It became an official supplier to the Olympic Games, including in 2012. Exports account for 90 percent of Cesena-based Technogym’s sales, up from 80 percent five years ago.

“For us Italy is the worst market at present, even worse than Spain, which still shows some vitality,” he said.

Unlike southern neighbors Spain and Portugal, Italy failed to profit from the boom in the run-up to the debt crisis. Gross domestic product has exceeded 2 percent a year just twice since 1998, while expansion in Spain has topped 3 percent in 10 of the past 15 years.

Nor has Italy, which has averaged almost one government per year since World War II, known consistent leadership. Former Prime Minister Silvio Berlusconi, who governed for more than eight years after entering politics in 1994, failed to tackle economic rigidities. His attempt to overhaul labor laws was scuttled after union protests and attempts to tame Europe’s second-biggest debt left him unable to lift competitiveness through corporate tax cuts.

Monti’s Austerity

Berlusconi resigned from his third stint as premier in November 2011 when the country was on the verge of becoming engulfed by the debt crisis, with 10-year bond yields topping 7 percent.

His successor, Mario Monti, implemented austerity measures that helped bring the country’s deficit within EU limits. Yields plummeted, though the recession deepened. Current Prime Minister Enrico Letta has pushed for a more expansive policy and suspended the payment of a property tax due last month. Last week the government said it would spend 1.5 billion euros ($2 billion) to create jobs for youth and postponed a planned sales- tax increase for three months, until Oct. 1.

The Organization for Economic Cooperation and Development says Italy needs to continue the “structural reforms” implemented by Monti that included easing labor-market rules and partially opening closed professions.

Two Recessions

“Future reforms, in carefully planned and coordinated legislation, will need to remove remaining restrictions in professional and public services and promote a more inclusive labor market,” the Paris-based OECD said in a May report.

More than 15 percent of the nation’s manufacturing capacity has vanished in the last five years, a period that saw two recessions, Confindustria said in a June 5 report. In the same period Germany’s capacity rose by 2.2 percent.

Between 2007 and 2012, about 32,000 Italian companies closed down, most of them small- and medium-sized, according to a presentation by Luca Paolazzi, chief economist of Confindustria. Joblessness reached 12.2 percent in May, the highest rate in at least 36 years.

Of 23 categories monitored by the business lobby, only the pharmaceutical industry has higher output now than in the autumn of 2007, the group said. Textiles are down 34.7 percent and automotive has fallen 45.1 percent, according to the report.

Productivity Gap

Unit labor costs, a measure of productivity, rose every year save one from 2005 to 2011 and reached an index level of 112.4 in 2011, according to the OECD. Germany’s level, by contrast, fell to 96.1 in 2007 before rising to 104 in 2011.

“The productivity gap with main competitors abroad has widened” in the last five years, Paolazzi wrote. “Unit labor costs kept rising and competitiveness weakened further.”

In the three months through March, Italy’s exports fell for the first time in almost four years as the economy shrank more than initially reported. Sales abroad dropped 1.9 percent from 2012’s fourth quarter, statistics agency Istat said June 10.

Industrial output unexpectedly declined in April, signaling that the country’s recession probably extended to an eighth quarter.

Still, exports may be the best hope for the future. In the two years through 2014, Istat says, overseas sales should rise at close to a double-digit pace, or about 40 billion euros. Such an increase will help generate a recovery next year, Istat said in a separate report in May.

Asia Markets

“An increasing number of companies will benefit from successfully repositioning the core of their sales out of Europe and into the emerging countries of Asia and South America,” said Emanuele Baldacci, head of integration and quality development department at Istat, in an interview.

Sales abroad of Italian goods and services will rise 9.7 percent in the 2013-2014 period, the institute forecast. Exports of manufactured goods will advance 10 percent, with sales of services forecast to rise 7.5 percent. The report was based on projections by Sace SpA, Italy’s trade-credit insurer.

“Cucinelli’s success in markets like Asia prompts us to be hopeful,” said Marco Tarica, who heads the international unit of trade association Unimpresa. “It shows that the history and the culture behind Made in Italy, be it food, clothes or machinery, are seen as guarantees of quality from Russia to Far East and South America and that means we could sell there much more than we do.”

Sweater Sales

Back in Solomeo, at Cucinelli’s headquarters, the founder says Italian executives have made a virtue of necessity and that his industry may lead an economic pickup.

Cucinelli sells only 25 percent of its output of sweaters, leather bags and belts in Italy. Reaching out internationally is working: Sales jumped to 280 million euros last year and the company pulled off a stock-market listing as it successfully expanded in Asia and other foreign markets.

The soaring shares since the April 2012 IPO -- the benchmark FTSE MIB index is up 6.5 percent in the same period -- have made the founder a billionaire. That helped him give his current and past employees a Christmas bonus totaling 5 million euros. He says he urged them not to overspend and to avoid debt, even as he predicts a shining future for his country.

“The time we are living in reminds me a lot of the Italian Renaissance, when merchants returned from the Americas with potatoes, corn and tomatoes and thus broke all the old equilibriums in the European production,” Cucinelli said. He spoke in an office with four bookshelves filled with history and philosophy books and about 400 cashmere spools of every color except black.

“There is a huge demand out there, and in Europe we are just 250 million people. How can we fear that there won’t be any room for us and our products in the future?”

By: Lorenzo Totaro, with assistance from Flavia Rotondi in Rome, Giovanni Salzano in Rome and Francine Lacqua in London. Editors: Andrew Davis, Anne Swardson, Fergal O’Brien