Italians this year are bragging about what they call il sorpasso: the phenomenon of Italy surging to surpass Britain as the world's fifth-largest economy. A recent revaluation of the national gross domestic product (GDP) by Istat, the Italian government's statistical agency, to take into account Italy's huge, untaxed ``black'' market economy, shows that Italy is ahead of the much more legal Britain.

One look at Milan's smart cars and flashy clothes, and a visitor can see that many Italians are living quite well indeed.

At this point, cautious economists shake their heads. Italy's success rests on a mountain of public debt, they warn. London is stronger than Milan as an international financial center, sterling stronger than the lira as an international currency, and Britain's north-south gap, large as it is, narrower than Italy's.

But the sorpasso debate is important to the Italians not for proving they are better off than the British, but as a benchmark underlining a remarkable economic comeback.

Only a decade ago, Italy was called the sick man of Europe, wracked by rampant labor unrest, chronic balance of payment deficits, inefficiency, and mismangement. Today, inflation has fallen to 4.5 percent, entrepreneurs are starting small businesses at an unprecedented pace, and the country's large companies are rolling in profits. Fiat's Giovanni Agnelli, Ferruzzi's Raul Gardini, and Olivetti's Carlo De Benedetti are hailed as the new titans of European commerce.

``All of a sudden we're waking up and discovering that we're richer and better than we thought,'' says Massimo Esposito, an editor of Il Sole-24 Ore, Italy's leading business daily. The paper has taken advantage of the new climate to double sales in each of the past two years. ``It's a true boom,'' he says.

At the Confindustria employers' association, research director Innocenzo Cipolletta points to 1979 as the boom's beginning. In that year, Italy joined the European monetary system, a move that began to steady the lira.

``The move delivered a clear message,'' Mr. Cipolletta says. ``Improve productivity, invest, and become competitive - or die.''

Businessmen responded. At Olivetti, for example, Mr. De Benedetti installed new management, reduced the workforce, and improved its line of office equipment and computers.

The results are visible in the firm's ultramodern Scarmagno plant near Turin in northern Italy. Workers tap commands into computers and watch closely as robots move around the 2.2 million sq. foot plant, assembling M24 personal computers to be sold under the AT&T label in the United States. Between 1981 and 1985, Olivetti's revenues doubled and profits increased fivefold.

New mood in the workplace

Key to this success was worker cooperation. Like many other Italian companies, Olivetti was stymied by militant labor unions during the 1970s. The company lost more than 40 work days annually to strikes, ``sick'' leaves, and assorted worker protests. Last year, the company only lost three days.

``De Benedetti motivates us,'' says Franco Gallini, an Olivetti worker at the Scarmagno plant for 25 years. ``He doesn't put his money in Switzerland and just live nicely. He puts it here.''

``We made much more than a simple economic turnaround,'' says Bruno Lamborghini, Olivett's vice president of corporate, economic and market research. ``We also made a psychological turnaround.''

Mr. Lamborghini refers to the Olivetti's shift from an inward, family-dominated company relying on its home market to an outward-looking, professionally-run conglomerate sprinting after exports.

In an effort to gain sufficient size to compete with the American and Japanese computer giants, Olivetti has pursued foreign links, first teaming up with AT&T, before last year buying West German officemaker Triumph-Adler. Now Olivetti does two-thirds of its business abroad.

``British and French businessmen often are defensive, satisfied with what they have achieved,'' Lamborghini says. ``We're less nationalistic and more aggressive.''

Achievements marred by inequalities

Aggressive as they are, Italians know all too well that their achievements are marred by inequalities. Unemployment stubbornly refuses to come down from a high 11 percent, and is much higher in the impoverished south. Naples, with its sprawling slums, seems to exist in a different universe from Milan.

``We talk about overtaking Britain,'' says Professor Enrico Pugliere of the University of Naples, ``and yet half our country remains in the third world.''

Just as alarming as this massive inequality is the country's massive budget deficit, which last year equaled nearly 15 percent of the nation's gross national product and pushed its total national debt to more than one year's GNP. On paper, the solution is simple: cut government expenditures. In reality, that task proves impossible for Italy's politicians.

Weak governments are the culprit. Parties cobble together in coalitions that then flaunt hiring freezes and spending limits as they scramble for patronage. The ensuing corrupt and bloated bureaucracy forces many entrepreneurs into thriving black market. Worse yet, it fails to provide basic services.

``The health system stinks, the universities are overflowing, city traffic jams are incredible because there are not enough highways, even the telephones don't work well,'' says Carla Collicelli of the CENSIS institute, the country's most prestigious center for sociology research. ``It's inefficient. It's outrageous.''

Public sector goes private

In recent years, the public sector became such an embarrassment that the government put professional managers in charge of some of its industrial holdings. At the huge IRI holding company, for example, Harvard-trained Romano Prodi has sold some of the state's weak subsidiaries - including automaker Alfa Romeo - and streamlined many of the other operations - including air carrier Alitalia.

``IRI is different,'' Ms. Collicelli says. ``It now acts like a private enterprise.''

That is the key. While other Europeans - from class-conscious Britons to cautious Germans to state-directed Frenchmen - remain hesitant to embrace laissez-faire economics, the Italians seem to have a natural knack for free-for-all capitalism.

Impressive as Olivetti and the other industrial giants are, what really hits a visitor is the vitality of the country's small and medium-sized businesses - a leathermaker employing six or seven workers in his garage, a machine-tool maker with 100 to 150 employees. These firms use flexibile management, upmarket design, and top-flight quality, to stay competitive in traditional industries against stiff Asian competition.

Anyway one counts it, the results are impressive. Even in the face of a gradually strengthening lira, Italy last year accounted for 8.1 percent of the world's manufactured exports - a dramatic improvement from the 3.3 percent that the country posted in the 1950s. Britain's share of manufactured exports, by contrast, has fallen from about 20 percent to just 7.7 percent. Despite the danger of becoming embroiled once again in the sorpasso debate, such statistics make many Italians sound cocky and conceited.

``Who wants to be compared with a poor country like Great Britain?'' asks Francesco Alberoni, one of the country's leading social commentators. ``We want to compare ourselves with rich countries: Sweden, Denmark, France.''