(FORTUNE Magazine) – HEARD ABOUT the latest Italian fashion? It's called capitalism. Over the past 14 months share prices on the Milan Stock Exchange have charged ahead by more than 180% -- one of the world's biggest bull runs. Italy's debt-ridden industrial companies, which until recently didn't bother to publish audited annual statements, have tapped the stock market for more than $8.5 billion in new equity capital since 1983. Behind the borsa's boom are hundreds of thousands of individual investors who no longer park their savings in bank deposits or stuff them in suitcases bound for Switzerland. The new domestic mutual fund industry is growing at the rate of nearly $3 billion a month and generating the kind of newspaper hoopla normally devoted to Turin's famed soccer squad, Juventus. Italy still has plenty of economic problems. Its budget deficit makes the U.S. look like a model of fiscal conservatism, and the unemployment rate is stuck at around 10.5%. But after lagging behind the rest of Europe in recent years, the real growth rate of Italy's gross domestic product may exceed 3% in 1986, putting Italy near the top of the pack. ''This year the economy is coming to the market's rescue,'' says Roger Hornett, director of European research at the London brokerage house James Capel & Co. Soaring share prices have begun to tempt more of the fiercely private family-run companies that form the backbone of the Italian economy into going public. ''The typical Italian would still rather have 100% of a small company than 35% of a public company three times larger,'' complains Jody Vender, a Milan-based investment banker. But recently Benetton, the wildly successful $500-million-a-year clothing chain, announced plans to hold its first public offering later this year. Says Aldo Palmeri, the company's managing director: ''A year ago the Benetton family had no intention of doing this. But now they realize it is essential to building a true multinational.'' The market's new vigor is even helping revive Italy's sluggish state- controlled sector, which accounts for more than 30% of industrial production. By the end of 1986 government-owned companies will have raised some $4 billion in three years through public share offerings. Many of those companies belong to the Institute for Industrial Reconstruction (IRI), a sprawling holding company whose $24-billion-a-year empire includes numerous well-run operations, such as airframe-maker Aeritalia, as well as prodigious money losers like ; Finsider, one of the world's biggest steel companies, and carmaker Alfa Romeo. For three years IRI's new chairman, Romano Prodi, 46, has been pushing with some success to transform the company from a highly politicized ward for Italy's industrial basket cases into a professionally managed moneymaker. Says Prodi: ''Giving private shareholders a voice is critical. It is making it more and more difficult to fall back into the old, bad habits.'' Foreigners have been quick to respond to Italy's new look. Big British and American pension funds initially sparked last year's rally. Along with a lot of other international money managers who discovered the Milan market for the first time, they pumped more than $2 billion into Italian shares last year. In late February, Shearson Lehman Brothers had no trouble raising nearly $75 million to launch the first overseas mutual fund comprising exclusively Italian securities (see Personal Investing). About half the money came from individual U.S. investors. Direct investment by foreign companies in Italy is also up sharply after slumping in the 1970s. American companies, whose stake in Italy was nearly $5 billion at the end of 1984, have led the charge. Among the biggest corporate investors is telecommunications colossus AT&T, which bought 25% of Olivetti (1985 sales: $3.2 billion) for $254 million in 1983. Olivetti, led by world-class entrepreneur Carlo De Benedetti, 51, epitomizes Italy's industrial revival. When De Benedetti took the helm in 1978, Olivetti was a barely profitable typewriter company sinking rapidly under a $1-billion debt load many times larger than its equity base. By shedding nearly 20,000 employees, raising new capital and pouring it into electronics, and forging a host of cross-border agreements, he turned Olivetti into one of the world's leading manufacturers of personal computers and one of Europe's most profitable companies. De Benedetti has been one of the biggest winners in the bull market. He picked up 15% of Olivetti for $17 million when he became chief executive. Today his share is worth about $500 million. His personal business empire, ranging from food to financial services, merits comparison with those of the Agnellis of Fiat or the tiremaking Pirellis. With some $800 million in cash recently raised through Olivetti and his publically listed holding company, Cofide, De Benedetti is set for further expansion. Ever the man-in-a-hurry, he welcomes his countrymen's ''discovery of the stock market'' but wishes attitudes could change even faster. ''To create more jobs and become more competitive internationally,'' he says, ''Italians must continue making the cultural jump from family companies to public companies.'' Just a few years back Italy's economy seemed on the brink of bankruptcy. In 1978 Luigi Barzini, the late author and social critic, told a New York Times interviewer that Italy was ''going down the drain to Bangladesh.'' Italy would be the first developed nation, he said, to ''turn itself back into an underdeveloped nation.'' Inflation threatened to reach South American heights. Red Brigade terrorists ruled the streets, while union leaders, backed by the politicians in Rome, exercised veto power over management decisions. Says Giorgio Porta, managing director of chemical giant Montedison: ''If anything you wanted to do cost even one job, the unions' answer was no.'' Drowning in debt and unable to cut costs, company after company fell into the arms of the government. An unprecedented power-sharing agreement with the country's powerful Communist party appeared imminent. The stock market itself verged on becoming just another Italian ruin. Says Giovanni Palladino, managing director of Studi Finanziari, a Rome-based economic research company: ''For two decades the politicians all believed that the economy could be financed by bank lending alone. Of course, since the government owns the banks, that was also a fantastic way to increase their own power.'' In the early 1960s, the market capitalization of the companies listed on Italy's borsas equaled nearly 50% of the country's gross domestic product (GDP), comparable to the level that prevails today on the U.S. exchanges. By 1976 that percentage had shriveled to just 4% of GDP -- the steepest decline and fall in any industrialized country. Unable to raise money elsewhere that year, Fiat, Italy's largest private sector company (1985 sales: $14 billion), sold $400 million of new shares and bonds to the state-owned Libyan Arab Foreign Bank.

Colonel Qaddafi's boys still own 14% of Fiat, but much of the rest of Italy's dismal legacy from the 1970s has been swept aside. A rigorous antiterrorist campaign, capped in January 1982 by the successful rescue of American General James Dozier from Red Brigade kidnappers, has restored confidence in Italy's political stability. Though the Communist party still claims the loyalty of some 30% of the voters, its influence, particularly among the young, is & clearly waning. Says Olivetti's De Benedetti: ''I'd put the chances of the Communists coming to power in Italy now at zero.'' Prime Minister Bettino Craxi's nearly three-year-old coalition of Christian Democrats and Socialists is the longest-running Italian government since the fall of Mussolini. More fundamentally, the economic disasters of the 1970s have prompted a profound shift in the attitudes of the general public and the political elite. The old faith in featherbedding and governmental guidance of the economy is being supplanted by growing acceptance of the need for a more deregulated, profit-driven, competitive economy. Says Paolo Azzoni, a Milan stockbroker: ''Italy, like the rest of the world, has gone back to the market.'' DRAMATIC EVIDENCE of this new attitude first surfaced at Fiat in the fall of 1980. Fiat Chairman Giovanni Agnelli's new management team confronted the company's unions with a rigorous recovery plan that called for cutting employment by more than 30%. The unions promptly called a strike. But five weeks later some 40,000 Fiat workers marched through the streets of Turin expressing support for Fiat's management and demanding the chance to return to work. Chastened by the realism of their rank and file, the union leadership quickly capitulated. In the wake of that now legendary march, a new breed of tough-minded managers launched a tidal wave of corporate restructuring. Within months of taking over perennial money loser Montedison (1985 sales: $7.4 billion), Chief Executive Mario Schimberni laid off 10,000 employees, including most of the old management. Marisa Bellisario, then the new chief executive of Italtel (1985 sales: an estimated $640 million), prescribed similar medicine for the state-owned telecommunications equipment maker. Recalls Bellisario: ''I arrived here one month before the Fiat strike and immediately discovered that we had too many people. Rome's reaction was that a state company could never lay off employees, but I had a simple reply. First, it's the only way we're going to survive; second, look at what happened at Fiat.'' More recently Italian industry has begun an impressive modernization drive. Fiat, for example, has bought more than 1,000 robots from its subsidiary Comau, doubling the productivity of its assembly lines. Last year corporate capital spending in Italy rose by 12%, the largest increase among Europe's major economies. Investment should continue at a similarly torrid pace in 1986. ) The government has contributed to the recovery with a more determined assault on inflation. Devaluing the lira to keep exports competitive is now a last resort rather than a first line of defense. In an even bolder move, the politicians have dared to tinker with Italy's sacred scala mobile (literally ''escalator''), which for nearly 30 years indexed all wages and pensions quarterly against inflation. The scala now lifts labor costs at a rate below the actual inflation rate. Last May, in an extraordinary display of enlightened self-interest, Italian voters rejected a Communist party-inspired referendum that would have restored the scala's higher rate. Marvels Lamberto Dini, deputy governor of the Bank of Italy: ''Until it happened, almost no one believed the referendum would fail.'' Italy's inflation rate, stuck in the high teens from 1973 to 1983, averaged 8.6% in 1985. Almost as surprising, at least to the politicians in Rome, has been the public's exuberant response to a bill creating a domestic mutual fund industry in Italy. Passed in 1983 after 25 years of debate, this legislation gives Italy's small savers, whose household savings rate of around 20% is the highest in the world, their first real shot at having their money professionally managed. After 20 months, Italy's 43 domestic funds have collected more than $19 billion. Some 25% to 30% of their portfolios are invested in stocks. ''This job involves door-to-door purchases, not sales,'' jokes a fund salesman. By injecting such large amounts of institutional money into the borsa, the mutual funds reassured foreign and domestic investors that the Milan exchange was no longer a casino fit only for speculators. PROPELLED BY the combination of falling inflation and interest rates, soaring productivity, and a born-again stock market, corporate profits have exploded. According to Roger Hornett of James Capel, Italian industry's earnings rose more than 40% on average last year and should be up more than 45% in 1986 -- an increase unparalleled in the industrialized world. From 1981 to 1985, for example, Fiat's earnings climbed from $85 million to more than $520 million. After years of big losses, Montedison, Italy's second- largest private company, finally pumped out an estimated $50 million in profits last year and should more than double that performance in 1986. Like most Italian companies, Montedison has reaped an earnings windfall from its financial restructuring. Some $400 million in new equity helped the company < slash its stiff debt-servicing bill from nearly 11% of sales in 1981 to about half that last year. Italy's multinationals have generally been a woefully provincial lot compared with their peers in the rest of Europe, the U.S., and Japan. But with their balance sheets in better shape, many have begun to expand internationally. One of Montedison's biggest moneymakers, for example, is the pharmaceutical company Farmitalia, whose Adriamycin is one of the fastest- selling anticancer drugs on the U.S. market. Notable among a recent string of Italian joint ventures was a European marketing deal struck between AT&T and the state-owned semiconductor company SGS, one of IRI's offspring. Says IRI Chairman Prodi: ''We have stopped thinking defensively and convinced our people that the future of the Italian economy is to be among the first in the world.'' Despite Italy's recent progress, that lofty goal remains far off. Italy is still plagued by an excess of corrupt politicians and hamfisted bureaucrats. Labor markets remain rigid, which helps keep the official unemployment rate at 10.5%. The rate is somewhat overstated since the thriving underground economy may amount to 20% to 30% of GDP. Still, says Herman Burdick, general secretary of the American Chamber of Commerce in Italy: ''Italian business is working with one hand tied behind its back.'' Foreign investors in the stock market are complaining about delays caused by the exchange's cumbersome registration rules for non-Italians. Says Paul Horne, a Paris-based economist with Smith Barney: ''When I visit our clients in New York, first they roll their eyes at the profits they've made in Italy. Then they roll them at the settlement delays.'' BUT THE REAL NOOSE around the neck of the Italian economy is runaway government spending. Late last year Italy's national debt of some $400 billion crept above 100% of its gross domestic product. Interest payments alone account for roughly two-thirds of the government's annual budget deficit, which last year equaled around 16% of GDP -- three times the size of the much maligned U.S. deficit. As long as this fiscal nightmare persists -- and no one holds out hope for a quick solution -- Italy's inflation and interest rates will hang well above those of its chief trading partners, inevitably handicapping industry's ability to compete. For now the good times are likely to keep rolling on the Milan Stock Exchange. Among the leading industrialized nations, Italy's dependence on imported oil is second only to Japan, and nearly 70% of its imports are denominated in dollars. With both oil prices and the dollar dropping, Italy's inflation rate should fall to around 6% this year. The balance of payments -- a negative $4.6 billion last year -- could swing back into surplus. Falling interest rates alone could slice 20% off the projected $70-billion budget deficit. On balance, Italy hasn't looked so healthy since the mid-1960s, when its long post-World War II expansion first began to falter. During its miracolo economico, as that era was known, Italy grew faster than every other European country, including West Germany. To Georgetown University historian Walter Laqueur, an expert on postwar Europe, Italy's remarkable rebound from the chaos of the 1970s already qualifies as ''a second miracle.'' With a little more luck, a lot more political courage, and continued faith in its new pro- market path, Italy seems capable of working still more economic wonders.