DURING the worst days of the euro-zone debt crisis, the fear was that bond-market turmoil in places such as Greece and Spain would spread to Italy. The biggest debtor in Europe would be too big to bail out, so Grexit might lead to Italexit and the break-up of the euro. Now the attention is focused directly on Italy itself.
In March half of Italian voters plumped for two populist parties that until recently favoured leaving the euro: the maverick Five Star Movement, which triumphed in the poorer south; and the xenophobic Northern League, which scored well in the richer north. Neither had fought the election campaign on a promise to leave the euro (the opposite, in fact). And as the two tried to form an all-populist cabinet, investors hoped that the sobering prospect of power, together with EU deficit rules and the behind-the-scenes influence of the Italian president, would allow Italy to keep muddling along.
Such hopes took a nasty jolt on May 27th. The populists named as finance minister Paolo Savona, an economist who does indeed think that Italy should quit the euro. President Sergio Mattarella vetoed Mr Savona (see article). The populists threatened for a moment to impeach him and even hinted at a march on Rome—an allusion to Benito Mussolini’s blackshirts in 1922. Amid talk of a political, constitutional and economic crisis, bond yields spiked and global stockmarkets shuddered (see article).
In the short term such fears are overblown. Italy is less vulnerable to panicky investors than many realise. Its economy, let alone its democracy, is nowhere near collapse. But deep-rooted weaknesses are worsening and becoming harder to fix. To avoid an eventual explosion, Italy needs careful handling and a change in mindset—of its and Europe’s politicians alike. The worry is that neither seems likely.
Panic, but not yet
Whatever the outcome of closed-door scheming in Rome this week, Italy is likely to get its first all-populist government—if not now, then soon, after another election. That could lead to spendthrift policies. The populists’ plans include a flat tax that would lower revenues and a universal basic income that would raise expenditure; both parties want to wind back previous pension reforms. This could cost as much as 6% of GDP annually—largesse that Italy cannot afford with its public debt at 132% of GDP, the highest in the world after Japan and Greece.
Yet Italy is not Greece. In 2017 the government ran a budget surplus before interest payments of 1.7% of GDP. The average maturity of its debt is about seven years. Given that much of its borrowing is from its own residents, and that the current account is in surplus, Italy is not particularly vulnerable to a run on its bonds by foreign investors. The ECB is still buying its bonds under the quantitative-easing programme, albeit at a reduced rate. Short of a large and prolonged risk premium on its bonds, Italy’s debts are serviceable.
Italy’s real problem is the debilitating combination of chronically low growth and high public debt. Low growth means living standards are stagnant and Italy cannot work off its debt easily; high debt means it cannot use fiscal stimulus to boost the economy, especially if there is another downturn. Even with the global upswing of recent years, Italy remains one of Europe’s worst-performing economies.
Though populists rail against austerity, years of budgetary restraint give them a bit of room to introduce their policies. But doing so at any scale requires them to shift the burden of taxes and expenditure, not add to it. Italy already spends more on cash transfers, 20% of GDP, than any other rich country. If it wants to introduce a universal basic income, it needs to cut pensions, not increase them. Its tax wedge, the gap between what employers pay and what employees take home, is one of the highest in the OECD. This contributes to joblessness. Just 69% of Italian 25- to 54-year-olds are in work, compared with 74% in Spain and 81% in France. Cutting taxes on income and labour, though, will require Italy to raise them elsewhere, ideally on property and consumption.
Quitaly
A bigger problem is that the populists have little idea how to deal with the myriad causes of Italy’s stagnant productivity: a rigid, dual labour market; uncompetitive product markets; the proliferation of family-owned firms that do not grow; a banking system hobbled by bad loans; an underperforming education system; and, more recently, a brain-drain. London is now a sizeable Italian city.
Fixing all this requires years of difficult structural reforms, now all the more difficult after successive governments have wasted the time and opportunity provided by the global recovery and the ECB’s ultra-low interest rates.
The same is true of the euro zone as a whole. Its “banking union” is incomplete; its capital markets are underdeveloped. And all ideas for a substantial budget to help countries in the straitjacket of the euro adjust to shocks have been rejected. Creditor countries, led by Germany, have said that they will not accept greater risk-sharing without greater risk-reduction. Italian populists’ call to do away with budgetary restraint only deepens Germany’s belief that Italy cannot be trusted.
A founder of the EU, Italy was long one of the most Europhile members; it is now among the most Eurosceptic. But the populists know that most Italians, even those who voted for them, do not want to see their savings slashed and their jobs destroyed by leaving the single currency. That is why they have toned down their anti-euro rhetoric. But they do not understand that living in a single currency requires a flexible economy. Similarly, Germany has yet to accept that, if it is to thrive, the euro zone must have more risk-sharing.
Inadequate reform and incompatible visions of the euro’s future are a poisonous and unsustainable combination. If the turmoil in Italy and the markets’ fright have served as a reminder of such dangers, and spur reform both in Rome and Brussels, then some good may come of the mess. The risk is that it will make any reform harder, if not impossible.
