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posted on 27 January 2018

Europe Braces For The Next Italian Election

from STRATFOR

-- this post authored by Adriano Bosoni

Italy's general election will be one of the most important political events for the European Union this year. Italian voters will head to the polls March 4 dissatisfied with their current leaders and with the state of the economy. What's more, they will find no shortage of anti-establishment candidates on the ballot. The rise of the Five Star Movement, a protest party made up mostly of political outsiders that lambastes Italy's traditional leaders, has pushed mainstream parties to espouse populist and Euroskeptic views. The right-wing Northern League, for example, has called for stronger immigration controls and proposed a referendum on Italy's membership in the eurozone. Former Prime Minister Silvio Berlusconi's center-right Forza Italia, meanwhile, has suggested introducing a parallel currency to coexist with the euro and ignoring EU rules that limit state intervention to rescue troubled banks. Even the center-left Democratic Party, while still pro-European Union, has criticized Brussels for its focus on austerity measures.

Considering the size of Italy's economy, the problems with its banking sector and the amount of Italian debt held by international banks, the country's withdrawal would probably bring about the end of the eurozone. But the fate of the currency area isn't the only thing at stake in Italy's general election. The greater risk in the upcoming vote is that the country could destabilize the alliance between France and Germany and hold back the process of reforming the European Union.

Looking for a Way Out?

Though Italy's gross domestic product is expected to expand this year by around 1.5 percent, the projected growth won't offset the country's prolonged economic decline. Italy's GDP growth stagnated between 2010 and 2017, having steadily dropped from an average annual rate of 1.4 percent in the 1990s because of a variety of factors, including high taxes, rigid labor laws, government corruption and an aging population. Whether the country's membership in the eurozone also contributed to its decadeslong slump is debatable, but the common currency at least deprived Italian leaders of a tool they had frequently used to bolster the Italian economy: monetary policy. Before the euro's introduction, Italy devalued its currency to deal with financial crisis. Now that it no longer has that option, Rome can only resort to fiscal policy - which, under the European Union's guidance, has largely taken the form of spending cuts and tax hikes. These unpopular measures have stoked antipathy among Italian voters toward the eurozone and toward the political establishment.

The Three Largest Economies in the Eurozone

Despite the Euroskeptic rhetoric so many Italian parties have adopted, an "Italexit" from the eurozone is unlikely for now. For one thing, holding a referendum on eurozone membership would require changes to the Italian Constitution that the next parliament will probably struggle to make, based on current opinion polls suggesting no party will win enough of the vote to govern alone. Coalition talks could drag on for months after the election and could lead to a new vote if lawmakers fail to appoint a government. For another, none of the parties flirting with the idea of leaving the eurozone has presented a concrete plan to do so. Most Italians, moreover, oppose leaving the currency area. Though many voters dislike the eurozone, they also understand the risks entailed in leaving it.

Withdrawing from the eurozone is not a priority for the parties competing in Italy's general election. The Five Star Movement, the Northern League and Forza Italia, in fact, have all backpedaled on the issue in recent weeks. Instead, their criticism of the euro is meant to ignite nationalism and woo the large portion of the electorate that is dissatisfied with the political and economic status quo in Italy. It is also meant as a bargaining chip that the parties can use to try to accomplish their true goal: revising the European Union's fiscal rules.

Italy's Main Political Parties

Renegotiating the Rules

Most Italian parties, including those that are on board with European integration, see the bloc's rules on deficit and debt as a legal straitjacket preventing Italy from introducing growth-oriented policies. They are particularly critical of the Fiscal Compact Treaty, an agreement that introduced stricter controls on EU members' fiscal policies, including the requirement to keep a balanced budget. Italy signed the treaty at the height of a financial crisis in 2012 under significant pressure from Germany. Although the European Union has been flexible in enforcing the treaty, Italian politicians are skeptical of a legal framework that reduces their government's room to maneuver on fiscal policies. The external constraints that many proponents of eurozone membership argued would help discipline Italian leaders two decades ago are now a nuisance for Italy's politicians.

Whatever government Italy's next election (eventually) brings into power will doubtless take on the challenge of trying to revise the EU fiscal rules. The Continental bloc's constituent governments and institutions will then have three options. They could renegotiate or even abolish the Fiscal Compact, in keeping with Italy's wishes. EU member states in Northern Europe, however, probably would resist this effort because they want to maintain oversight over their southern counterparts' fiscal policies. The European Union may instead choose to ignore Italy's calls to overhaul the treaty, but doing so could alienate the Italian government and encourage it to pursue unilateral measures, perhaps at the peril of the entire eurozone. The third, and most likely, option would be a compromise: The European Union could agree to tolerate deviations in Italy's fiscal targets if the country promised not to cause too much trouble.

This option - an approach Rome and Brussels have tried in the past - would prevent a political crisis from erupting in the bloc, at least in the short term. But the deal could come at a high price for European integration as EU member states and institutions look for ways to make the eurozone more resilient.

In Between France and Germany

Many of the measures under consideration to fortify the currency area against future financial upheaval are controversial. EU members, for example, have differing views on proposals such as the creation of a European Monetary Fund to deal with financial crises and the introduction of a separate budget to pay for infrastructure projects in the eurozone. Even so, these measures stand a chance of passing because they increase spending across the currency area, but not risk. The proposals Italy is most interested in, on the other hand - such as a common insurance for deposits in eurozone banks - will distribute risk over the currency area's members. This is where the country could become a problem for the rest of the European Union.

As it pushes for greater risk-sharing, higher public spending and more flexible fiscal rules, Italy will turn to France as a natural ally. Paris and Rome tend to have similar views on the eurozone, after all. But France will have its own priorities to consider. The country often has to find a balance between its natural sphere of influence in the Mediterranean and its crucial partnership with Germany. The future of the Continental bloc itself will depend in part on how France navigates this dilemma.

France's ties to Southern Europe give it leverage in negotiations with Germany and its Northern European peers. Still, Paris can only go so far in advocating measures that contradict Berlin's interests without jeopardizing its alliance with Germany. And though negotiations over eurozone reform have yet to begin, German politicians already have drawn a line in the sand: Germany's main political parties recently signed a draft coalition agreement that expressed their reservations about increasing risk-sharing in the eurozone. France will be willing to listen to Italy, and even to side with it in some cases. It will probably refrain, however, from taking any action that would endanger its partnership with Germany. Aware of its weakness, meanwhile, Italy has offered to sign a strategic pact with France, inspired by the Paris-Berlin alliance, to try to avoid being sidelined in discussions over the eurozone's future. The agreement will be ready by the end of the year and will create a framework for more intense cooperation between Italy and France.

The Limits of Gattopardismo

The debate over what to do with the eurozone will tie into another debate over Italy's role in it. EU members could decide to include the country in the next phase of eurozone integration, hoping that a combination of pressure, controls and flexibility will help it introduce economic and institutional reforms. But this strategy could plant the seeds for future financial crises. Just look at what happened with Greece: The eurozone admitted it despite the many risks it brought to the currency area, and today the bloc is still dealing with the fallout of that decision. Alternatively, Italy's fellow EU states could try to exclude Rome from some of the future eurozone reforms - and perhaps spark a political catastrophe along the way by breaking the allegedly sacrosanct unity of the currency area.

Here again, a third option is the most likely. EU members could use Italy as an excuse to hold off on substantive reforms and go for the low-hanging fruit - cooperation on security and defense, for instance, or superficial changes to the eurozone - making timid advances and presenting them as a success. The accomplishment would constitute a victory, albeit a modest one. Considering how politically fragmented the European Union is these days, any show of unity, however small, is a triumph for the bloc. But at the same time, a failure to solve the eurozone's shortcomings through meaningful economic and financial reform could lead to new problems and stronger, more radical Euroskeptic movements down the line.

Politicians in Italy and in the European Union as a whole have long relied on a strategy of gattopardismo to manage the difficulties of day-to-day operation. The term - derived from the title of one of the best-known Italian novels of the 20th century, Il Gattopardo - describes the introduction of political and economic reforms that are purely cosmetic. So far, gattopardismo has served Italy and the bloc well enough to keep them from disaster. In that strategy, though, lies the germ of new and perhaps more serious problems that one day may take root.

"Europe Braces for the Next Italian Election" is republished with permission of Stratfor.

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