Italy: crisis postponed

Italy: a storm is brewing beyond the horizon

“And breathe,” says Stephen King in the Evening Standard. That’s what markets have done after a turbulent week in Rome – even by Italian standards – saw the first run on Italian government bonds in six years.

Early last week the president vetoed the populist government’s choice of finance minister because of his euroscepticism, triggering a collapse of coalition talks between the Five Star movement and the Northern League. An autumn election, likely to turn into a referendum on euro membership, seemed on the cards.

Now, however, the populist coalition is back on, with the controversial eurosceptic Paola Savona moved to the ministry for Europe. That shows the government has not “given up [its] objections to the operation of the single currency”, notes The Economist. Nor is the economics professor replacing Savona, Giovanni Tria, “an obliging europhile”. Still, a collision between Brussels and Rome has been postponed.

Hostility to the euro will grow

This merely means, however, that it could be all the more dangerous for the single currency when it does arrive; it certainly can’t be avoided. Italy remains a “slow-motion catastrophe”, as Matthew Klein puts it in Barron’s. The economy has barely grown in the past 20 years. Productivity has been stagnant for the same stretch of time. The key culprits are inefficient and uncompetitive product markets; an inflexible labour market; an inefficient banking system riddled with bad loans; and a poor education system.

Italy’s membership of the euro means it can’t cut interest rates or let the currency slide to juice growth. Nor can the government spend much due to EU budget-deficit rules. With none of the pre-euro means of tempering downturns available, the only way to raise the economy’s speed limit is through difficult structural reforms to tackle the problems hampering productivity, says The Economist. But the populists “have little idea how to deal with” these. Instead, their ragbag of measures will add another 6% of GDP or so to Italy’s already horrendous debt pile of over 130% of GDP.

The upshot is that unlike elsewhere in the eurozone, the odds of structural reform giving growth a fillip are minuscule. Resentment against the straitjacket imposed by the euro will surely rise, shrewdly fuelled by the populist government. In the meantime, Brussels and Berlin are loath to let Italy spend more and offer it debt relief.

Nor is it likely that the Germans will accept significant moves towards a eurozone budget or a bailout fund that spreads the risk of an Italian default. This imbroglio looks highly unlikely to end well. “Inadequate reform and incompatible visions of the euro’s future are a poisonous and unstable combination.”

The major design flaw in the euro

There has never been a successful single currency without a single government standing behind it. The euro looks unlikely to prove an exception to this historical rule. At the outset, Germany was reluctant to impose potential burdens on its taxpayers by supplementing the single currency with elements of statehood– a huge centralised budget, for instance. It hoped trouble would be avoided, assuming “its own enthusiasm for monetary discipline would spread elsewhere”, says Stephen King in the London Evening Standard.

In Italy’s case, though, this was always a bit of a stretch. Tough domestic reforms to bolster competitiveness were far harder to achieve than elsewhere “in a nation that changes its prime ministers with such frequency”. It hardly helped that Italian politicians never explained that taking part in this prestigious project would require some painful sacrifices.

This message was also rarely heard in the other southern European countries with poor track records on spending and debt, but who were admitted anyway. As ever in Europe, economic difficulties were subordinated to political symbolism. Everything seemed fine in the boom of the late 1990s and early 2000s. Once the tide went out after the global crisis, however, the structure almost fell apart. When the next downturn or crisis arrives and worries over how Italy can possibly service its debt resurface, the end will be nigh.

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