Brookings: Topics - Italy

Beppe Grillo: Part of the Problem or Part of the Solution for Italy’s Democratic Party?

Ruth H. Santini — Mon, 04 Mar 2013 00:00:00 -0500

Many aspects of the recent Italian general elections surprised observers and commentators, from the extent to which established political parties such as the center-left Democratic Party and the center-right People of Freedom Party lost consensus across the country (receiving respectively 3.5 million and 6.2 million of votes less than in the previous elections), to the unforeseen success of Beppe Grillo’s Five Star Movement. Given the dearth of information and media coverage in the run up to the elections of the Five Star Movement, perhaps most surprising was its success. This movement, which is not a party, was only created at the end of 2009 and, running for the first time at the national level, gathered 8 Million votes, equaling one quarter of the electorate. The Five Star Movement is now the largest single group in the lower house.

The Italian establishment as a whole, from the political class, to the main media groups and the economic lobbies, had disregarded Grillo, and often depicted him as a populist, demagogue, enraged and dangerous political figure, without lending him any credibility. Yet the former comedian has in the past few years effectively transformed himself into a media-savvy political entrepreneur. The refusal to engage with Grillo on the personal level has translated into the inability to engage with the issues his movement has consistently waged for: formulating a law against corruption, reducing the costs of the political establishment, adopting models of environmentally sustainable development, defending public goods, creating a more transparent and more efficient public administration. More than anything else, the movement has battled for the moralization of political and economic life and for the primacy of politics vis-à-vis economics. However, rather than recognizing, both instrumentally but also existentially, the issues where convergence would be desirable in the interest of real reforms, the Democratic Party has often demonized Grillo and refrained from distinguishing him from the movement and its campaigns. The strategy of ignoring the wave of discontent, even when it came coupled with pragmatic proposals to deal with public affairs, has backfired and the Democratic Party is, once again, now in a difficult soul-searching phase.

Rather than seeing in such a protest movement (an anti-establishment, albeit not an anti-political movement) an antidote for post-democracy and its illnesses, the Democratic Party has retrenched. It failed to run an electoral campaign, falsely self-confident that the fear of a Berlusconi come-back or a renewal of painful austerity measures by Mario Monti would suffice to scare voters towards its ranks. The party failed to build any kind of narrative articulating the challenges Italy faces as well as pointing out what the light at the end of the tunnel might look like. It likely did so because it assumed that there is no autonomy for politics vis-à-vis economics and its constraints. The Democratic Party fell in the trap of believing that economic imperatives will dictate the pace of changes and reforms and that Italian political decisions will continue be taken elsewhere, be it Brussels or international financial markets.

In voting for Grillo, a quarter of the electorate has chosen a different approach. One where communication is simple, where proposals are advanced, where new ideas are tested, and where getting people involved, in some embryonic form of liquid democracy, is encouraged. Grillo’s voters feel that sovereignty should be exercised independently from Brussels and financial markets. Their starting point is the necessity to react to the rapid shrinking of the middle class which has accelerated since the global financial crisis hit Italy, exacerbating a stagnating political and economic system. The Five Star Movement aims for a resurgence of conscience and will to engage in political activities, at all levels. And therefore it should be an inspiration for traditional political parties, given its effective style of communication, innovative and truly interactive use of social media, the way in which it selects political personnel from civil society, and the issues it chooses to prioritize, emanating from local demands directly affecting civic and public life.

Grillo’s voters, like many other Italians, point to a desire for ”more” and not less politics, closer to them, which is able to listen rather than preach and lecture. They believe that professional politicians need to earn popular respect on the basis of what they deliver, a somehow revolutionary message in 2013 Italy.

Of course, one should not be fooled and forget that having a non-elected leader of a movement whose non-statute was written by only two people and never put to a vote is also not ideal. Yet while the Five Star logo is the property of Grillo and not the movement itself, one should not confuse the founder with its members.

The Five Star Movement has its contradictions, many of which remain to be discovered and brought to life. But much could be learned from the movement which could help revitalize the way in which politics is conducted in Italy. Italy’s traditional parties should embrace the Five Star Movement’s vitality, accepting and endorsing the idea and practice of citizens regularly expressing their dissent, and using protest and pressures to encourage change from within the party system.

Now the Five Star Movement’s “citizen-deputies” will be torn between two opposing objectives, the desire to realize some of the most pressing issues within their platform, and their goal of serving as an “outsider” watchdog designed to denounce the mistakes and corruption of the existing political elites. It is the tension between these two goals that will test the truly democratic nature of the Movement, and the autonomy of its elected representatives vis-à-vis their non-elected leader, Beppe Grillo.

Authors

Ruth H. Santini

Publication: Transatlantic Academy

Why Europe Should Not Worry About Italy

Ruth H. Santini and Francesco Giumelli — Mon, 04 Mar 2013 14:54:00 -0500

Contrary to what many think, the sick man of Europe is Europe itself, not Italy.

While seemingly a threat to EU stability and at the heart of possible contagion, Italy is historically used to navigating through uncertainty, short-lived governments and catastrophic economic forecasts.

Yet, the world continues to wonder where the Belpaese is heading to with a divided center-left, a never ending dawn of Berlusconi’s political influence, and with the impressive rise of the protest-driven party of a former comedian.

Undoubtedly, Italy’s elections have produced an uncertain political situation, but the world should be aware by now that uncertainty is the norm, not the exception for Italy.

Italy’s case has time and again struck foreign observers. How is it possible that such a dysfunctional system, ineffective institutions, widespread corruption and generalised limited care for rules would allow the country to become the eighth economy worldwide?

Italy has developed in a constant state of emergency, short-term planning and flexible interpretation of laws. However inexplicable, this is the way it works in the peninsula.

There are three elements that should reassure the markets and the international community that Italy will emerge from this crisis once again.

The first element is the strength of two key characteristic, which allow for the continuity of the country, namely its bureaucracy and its small and medium enterprises. Let’s try to understand why.

Ironically, Italy’s national bureaucracy has ensured the continuity of the country’s central authority in the past 60 years.

With a new government every 11 months, bureaucracy has helped to maintain the system together by ensuring that the high political turnover did not affect the institutional continuity of government. Moreover, despite being harshly struck by the economic crisis, Italy’s small and medium enterprises, which account for 70 percent of Italian GDP, continue to represent the backbone of the Italian economic and social structure.

Second, the political rise of Beppe Grillo, the comedian-politician-entrepreneur who has shaken Europe’s economic and political certainties, should not be considered as a more destabilising political figure - if not in his personal style - than French leader Francois Hollande or British PM David Cameron.

Grillo’s political programme is composed of several common sense points, many of which have been advanced by other political parties as well and would only help to strengthen the bond between the citizens and the state.

Other points are tailored to address popular concerns fueled by the growing inequalities and resentment towards EU policies. Grillo calls for an increase of taxes on the wealthy and has questioned, under the current circumstances and EU obligations, Italy's membership of the euro.

He nevertheless re-affirmed the importance of building a truly united European Union and sees the future of Italy firmly anchored within a fairer and more democratic Europe.

To what extent is this different from Hollande’s 75 percent wealth tax or Cameron’s proposal to have a referendum on whether the UK should remain in the EU?

Grillo’s agenda is not scarier than theirs, and his 25 percent of the votes does not grant him with the majority.

Finally, despite enormous limits in their leadership and their shared responsibility for lack of reforms in the past years, the Democratic Party (PD) and the People of Freedom Party (PdL) reacted to the deadlock reached by the country in late 2011 and jointly supported Mario Monti’s technocratic government.

This experience, mainly aimed at reassuring international financial markets about the solidity of Italy’s budget and institutions, could be repeated if conditions in the eurozone require it.

Italy indeed is a difficult beast to understand – let alone tame - for the other European countries, but it is an anchor, not an iceberg, for the European integration process.

Obviously, Italy’s economic troubles should not be underestimated, but they should not raise greater concerns than those in Spain and France.

Italy will deal with its domestic uncertainties. Europeans should be more concerned about the lack of progress, beyond a useful and yet scarcely revolutionary banking union, of an EU austerity package which has failed to be coupled with the necessary social and economic growth measures necessary to jumpstart renewed trust in European institutions. The greatest dangers for the EU come from this, not Italian party politics.

Authors

Ruth H. Santini
Francesco Giumelli

Publication: EUobserver

Italy’s Post-Election Chaos Isn’t What You Think

Carlo Bastasin — Fri, 01 Mar 2013 00:00:00 -0500

No parliament, no government, no president of the republic. And now not even a pope. The situation in Italy resembles a house of cards in a perfect storm.

It’s not just a matter of politicians, scenarios and furniture flying all over the place until the storm subsides. The problem is deeper than that. The new Italian Parliament has three minorities that are unable to form a majority. It is a power game in which Pier Luigi Bersani, the electoral winner, is the political loser, and the electoral losers, former Prime Minister Silvio Berlusconi and ex-comic Beppe Grillo, are the political winners.

Consider this. Almost half of those Italians who cast their ballots for one of the traditional parties switched their vote this time. You think Americans are fed up with Congress? In Italy, trust in the government stands at 5 percent, and trust in Parliament at 8 percent. The rate of abstentions is high. The party holding the majority of seats in the Chamber of Deputies -- 54 percent, as required by law -- won the support of just 20 percent of the electorate.

On top of all this, the timeline to form a new government is tight. The Parliament convenes for the first time March 15. Amid all the confusion, the parties must agree within 10 days on the leaders of the Chamber of Deputies and the Senate. Then they have to nominate a prime minister, who must form a government and take an oath in front of the president of the republic. All this before April 15, when the Parliament meets to elect a new president of the republic.

Against Everything

So I can sympathize with those who despair and say Italy has chosen nihilism, or who say, in effect, that Italians voted against everything -- including Europe and austerity, which they had come to believe in before the debt crisis. I understand why people are saying Italy could bring down the whole euro project. But I disagree with them.

Italians remain pro-European, and fewer people than you would suppose are seriously thinking of relinquishing either the euro or the economic-policy commitments that come with it.

Discontent is focused, above all, on taxes. They are among the highest in the euro area. Taxes on business are the highest of any euro member, and they are severely hurting a weakened economy. Italians see excessive taxes mainly as the consequence of bad political management. It’s not that they object to Europe and austerity. Rather, they are angry about the tax increases introduced under the banner of Europe and austerity.

If austerity means fiscal discipline, Italians actually want more of it. This is why New York Times columnist Paul Krugman is wrong to say Italians shunned an intelligent and credible man such as Prime Minister Mario Monti because he was “the proconsul installed by Germany to enforce fiscal austerity on an already ailing economy.”

In Italy’s case, however, the argument about fiscal stimulus just misses the point. A bigger budget deficit wouldn’t do much to stimulate demand, because the real problem is the breakdown in Italy’s supply of credit. From the beginning of the euro crisis three years ago, Italy has seen a faster shrinkage in total credit supply than most euro-area countries, as foreign banks have repatriated their loans. This widespread lack of credit has crushed the private economy. Businesses and households can’t get loans and are cutting investments and consumption at an unprecedented rate.

Effective Answers

Reviving the market for credit is the first job. This would be far more effective than delivering a new fiscal stimulus. In fact, continued budget discipline is vital in ending the credit crunch. The new government must negotiate a deal with the European Union and with the European Central Bank, so that the ECB can support the Italian banks. But this can’t happen unless the ECB is sure that it has a reliable partner in the Italian state and that Italy will remain as fiscally stable as possible.

Italians understand this, and so the political crisis may be a little easier to resolve than many think. Under the pressure of markets, Italian parties are likely to close ranks behind another technical prime minister, just as they did in November 2011 behind Monti. They will nominate someone familiar with financial issues -- some high official at the Bank of Italy, or maybe even Monti himself. They will call it an “institutional government” and ask it to make the political system more honest and functional, reining in the anger and recrimination of the citizens.

It’s a strange way to run a country -- but don’t write off Italy.

Authors

Carlo Bastasin

Publication: Bloomberg

Image Source: © Tony Gentile / Reuters

Italy's Election and the Euro Crisis

Domenico Lombardi — Wed, 27 Feb 2013 00:00:00 -0500

Italy’s election on Monday left the country in political chaos with no clear solution for managing its crippling fiscal crisis. Center-left party leader Pier Luigi Bersani is claiming the top post but will lack majority control in Parliament. Without the legislative body’s full support, Bersani’s push for continued austerity measures could falter. Senior Fellow Domenico Lombardi say this uncertainty is deeply troubling for the EU leadership.

Video

Italy's Election and the Euro Crisis

Authors

Domenico Lombardi

Italy’s Election Results Are Bad News for All of Us

Douglas J. Elliott — Tue, 26 Feb 2013 09:30:00 -0500

Let me be blunt. The Italian election result is a triumph for fantasy and irresponsibility. It is quite bad news and no one knows what will happen next. It is possible to lay out several potential outcomes, with various degrees of damage to Italy, Europe, and the U.S. We can even handicap the odds of the outcomes, but we simply cannot know what will happen in this unprecedented situation.

The best outcome would have been a majority in the Chamber of Deputies for the Democratic Party and the partners in its electoral coalition and a majority in the Senate when their seats were combined with those of the party built around the out-going Prime Minister, Mario Monti. Both groupings have real flaws, but they are at least serious about proposing solutions for Italy that might actually work and are in line with the advice of their key European partners and, in most cases, with the advice of academics and neutral analysts.

Instead, Italians predominantly voted against pain and austerity, while ignoring the lack of reality, and sometimes outright irresponsibility, of the parties they supported. It is hard to know whether to be more worried by the quarter of the vote that went to a new protest party formed by an Italian comic turned politician named Beppe Grillo, with its incoherent policies and lack of serious answers, or by the resurgence of Silvio Berlusconi. Berlusconi is at least a smart politician with a history as a leader, but he became a laughing stock in his disastrous last term as prime minister and he campaigned with promises of magic solutions that are clearly not realistic. He is held in contempt by many of the European leaders with whom the Italian government will have to work, which is crucial given the clear necessity of continued support from the stronger European nations.

The result of the election is that the Democratic party and its electoral coalition have a working majority in the Chamber of Deputies, but only because the current election law awards a bonus to guarantee 54% of the seats to the winner of the most votes, even if they receive less than a third of the actual votes, as was the case last night. The problem is that the law works differently for the Senate, which has co-equal powers with the Chamber. Here the result was a disaster. No one came close to a majority in the Senate. It would take a post-election coalition of two of the three major groupings to produce a majority and all of those potential coalitions are problematic. So what are the possibilities?

A grand coalition of the Democratic Party and Berlusconi. The likeliest result is probably that Berlusconi cuts a deal with the Democratic Party to form an unstable coalition government. (Monti’s group might be added, but its votes would not be needed and Berlusconi may not allow its inclusion.) It would be unstable despite holding a clear majority of seats in both houses, because the views and interests of Berlusconi and the Center-Left only partially overlap. Further, the Democratic Party is fairly committed to continuing on the economic path agreed with its European partners, while Berlusconi campaigned on the idea of rejecting that path. Finding a set of policies that both groups could support and that would not trigger a rupture with Germany and Brussels, spooking the markets, will be difficult. It will not be forgotten in Germany, which is facing its own election in the autumn, that Berlusconi demonized Merkel and Germany.

I nonetheless think this is the likeliest outcome because it could be less bad than the other choices and Berlusconi and the other politicians are pragmatists. For Berlusconi, it would be the opportunity to be back as part of the government, representing a triumphant resurgence for a man who was written off as dead politically. More importantly, it puts him in a position to protect his business and personal interests from the threat of further attack, including the ongoing criminal investigations. Berlusconi is very vulnerable when out of power, so being back has great attractions for him beyond all the usual reasons that politicians want power. It should be noted that he would not even have to take an office, but could operate behind the scenes through other members of his coalition.

For the Democratic party, it would let them stave off dangerous new elections and ensure that their leader, Bersani, would be prime minister. Their hope would be that surviving as a government for a year or so might allow enough time for tempers to cool among the protest voters and for the economic outlook to turn at least a little cheerier, improving their chances in any subsequent election. They might be able to obtain the agreement of Berlusconi to their key policy goals, as he has a very strong pragmatic streak.

New elections in a few months. On the other hand, the gaps in views between Berlusconi and the Democratic party may prove too great to bridge. The chances of a different coalition being able to form a government are very low, so an inability to form a Berlusconi-Democratic party coalition would very likely force new elections in the near term. It is also possible that one side or the other believes that a new election would work to their advantage and therefore would force one. The President of the Republic, a largely non-political figure in the Italian system, would arrange an interim government to hold the country together for a few months until a new election takes place. There would be attempts to change the election law to improve the chances of a stable government the next time around. It is unclear whether it would be possible to gain a broad enough consensus to pull this off, however, so something close to the current system might stay in place.

Scenario A. If we are lucky, we might get a kind of repeat of the experience of last year’s Greek elections, where the second election produced a somewhat stable government of relatively responsible parties. The reactions of the markets and the rest of the world to Italy’s election may be sufficient to scare some sense back into the country. Enough of those who did not vote, or voted out of anger, may switch and vote for the Democratic party or for Monti’s group, giving a coalition of those two groupings a majority in both houses of parliament. This would likely still not produce a strong government, but it could be good enough to get by for a critical year or two. A couple of percentage point swing in the Senate votes could produce this relatively benign result.

Scenario B. The nightmare is that Grillo’s party could be bolstered by the failure of the traditional politicians to pull together a coalition. Enough Italians may be ready for a radical change, and a rejection of European pressure, that Grillo would get the nod the second time around. This seems to me to be a less likely result, as it requires a significant further swing to an untested party, combined with a fairly even breakdown of the vote between Berlusconi, the Democratic party, and Monti’s grouping that gives neither Berlusconi nor a Democratic party-Monti coalition enough votes. It is quite possible that Monti would withdraw and implicitly or explicitly throw his support behind the Democratic party coalition, as the lesser of the evils. This could ensure a plurality for that grouping, even if only half of his voters followed his lead.

However, it is easily conceivable that Grillo could win a plurality in the Chamber of Deputies and thereby 54% of the seats, even if he is far from a majority of seats in the Senate. This would produce an even more chaotic outcome than yesterday’s results, with the possibility of a third election to follow.

Scenario C. It is also conceivable that Berlusconi would ride back to power in a new election, although this is the least likely of the outcomes. He could combine the political advantages of his attacks on European-imposed austerity with an image as the one politician strong enough to pull together a working government. However, he is not likely to pick up many Grillo voters, who seem quite disgusted with the existing politicians, nor many of those who voted for the Democratic party. He might pick up some Monti voters who are not comfortable voting for the Center-Left, however, and he might pick up some of the abstainers. Berlusconi came close to winning a plurality of votes for the Chamber, so it is certainly possible that Italy’s greatest living campaigner might pull off an even bigger victory next time.

A coalition with Grillo. A coalition of Grillo with the Democratic party grouping would have a majority of seats in the Chamber and the Senate. This might appear plausible, since Grillo seems to have gained most of his support from the left of the political spectrum. However, Grillo’s support is for a rejection of the traditional politicians, including the Democratic party, and for a rejection of the accomodations being made to the rest of Europe, and even for a potential withdrawal from the Euro.

Further, Grillo has come close enough to victory to taste it and is more likely to prefer to gamble on another round of elections rather than risk losing much of his support by being part of a government that will inevitably disappoint many of his followers. Protest parties often lose much of their base if they join in an actual government and thereby take on responsibility for real world decisions.

The prospects for a Berlusconi-Grillo government do not appear much better. Grillo’s voters are not natural allies of Berlusconi. For his part, Berlusconi would find it very hard to fit Grillo’s party into a government that he led. He would either have to follow through on rhetoric that would immediately pit him against the rest of Europe and against the markets, likely bringing his government down in short order, or would face a risk of losing Grillo’s support in the near-term.

Conclusions

In the end, we know we are facing a period of serious uncertainty for Italy, for Europe, and in consequence, for the U.S. Europe will very likely hold together, but an increased probability of a truly bad outcome could depress economic activity across the world, as businesses and families hold off on investments in the future and on spending while they wait for the uncertainty to be worked through.

Authors

Douglas J. Elliott

Image Source: © Max Rossi / Reuters

Italy and the Year of the Lowest Common Denominator

Carlo Bastasin — Mon, 25 Feb 2013 00:00:00 -0500

The next Italian government faces a double challenge. It is expected to keep order in public finance, as the other governments of the past 20 years, and to rekindle growth, as none of the past governments has succeeded in doing. Consequently its agenda will have to be gauged on the basis of three main elements: its adherence to the European fiscal compact; its ability to work with the EU institutions to solve the credit crunch underway; its reform plans aimed at helping Italian producers urgently achieve higher productivity and return to the export performances of the past.

In order to endorse and implement this ambitious as well as indispensable agenda, the political framework of the next legislature needs to grant a sense of urgency while ensuring stability. The outcome of today’s election is exactly the opposite. Given the provisional results on Monday evening, all three requisites are missed: There is no plausible majority in the Parliament; the parties more opposed to respect European commitments have become much stronger than at any time in the past; and the political stalemate does not bode well for economic reforms for which no majority has a mandate.

According to Monday night’s provisional results, the majority of the Chamber of Deputies will go to the left-of-the-center Partito Democratico, while the Senate will have no possible majority. Hence, there is no “governabilità” in the Italian Parliament. As a consequence, the new legislature will be uncertain and short. Its hallmark will be the “lowest common denominator” among inhomogeneous parties, both in the institutional and economic domains.

At a more profound level, the message delivered by the vote is a widespread popular protest against politics, similar to what happened in Greece in the last elections. The pillars of Italy’s politics of the last 20 years – a pro-European outlook and, fiscal austerity, in particular – have become negative qualities in this break with Italian post-war historical tradition.

Although Italy has to reconstruct a political narrative, just as Greece did, this does not mean that it will break free from Europe. The opposite is true. My estimate is that restoring normality in the credit market and lowering the cost of loans for the private economy is far more effective (the elasticity of the demand would be about three times higher) in stimulating the Italian economy than cutting taxes. In this light, European politics presiding over the solution of the crisis is more important than domestic policy.

Furthermore, the current political stalemate crystallizes the fact that the national Parliament is far from playing a central role in the management of the country. Executive preeminence over the legislative, the lack of political party credibility and the strong influence of European legislation have put the Parliament in a marginal institutional position. The same has happened over the past 15 months when a non-elected “technical” government, led by Mario Monti, brought the country out of its darkest hour. After the failure to achieve a clear parliamentarian majority, the outcome of the elections might be some form of non partisan “institutional” government that will be called on to conduct the country through a new electoral law and new elections. In this scenario, the political economy will be cautious, the European commitments will be observed and the new electoral law will be proportional. It will be the year of the lowest common denominator.

Voting in the midst of a recession

Today’s Italian election was not like any of the past elections. The reason is that Italians had never voted before in the midst of a recession as severe as the current one. Italian GDP has declined by about 9% since the beginning of 2008. In terms of purchasing power, the average disposable income of Italian households has plunged back to the level of 27 years ago. Consumptions have gone back to the levels of 1995. Unemployment is officially at 11%, up from 7% in 2008. But total underemployed labor force is around 21%. In terms of GDP losses, none of the larger European countries has been affected by the global financial crisis and by its European consequences as profoundly as Italy, not even Spain. Such a damaged economic context represents an unprecedented challenge for the democratic choice of legislative leadership.

The fundamental weakness of Italy’s fiscal position has caused Italian citizens to be more critical of the State and policymakers. In fact, this weakness, mainly derived by irresponsible policymaking in the 80’s, has prevented the State from addressing the collapse of GDP through stimulative demand policies. Given the fiscal nature of the crisis in other euro-zone countries – and the risk of contagion arising from those countries - Italy’s governments have been forced to implement austere fiscal policies during a recession. Between 2007 and 2012 the debt/GDP ratio in the 27 EU countries increased from 59% to 87% of GDP, while it increased from 103% to 126% in Italy. The difference, amounting to 5% of GDP, explains a large part of the growth differential accumulated by Italy relative to the other countries. Between 2011 and 2013 the Italian fiscal correction will amount to 5% of GDP. Italy is now the second country in the euro area with the highest tax on GDP ratio. Before 2008 Italy had seen its public debt decline from 126% to 103%. As a consequence of the global financial crisis and of its European consequences the public debt has returned to 126%. Italy’s banking system entered the crisis as the most solid in the euro area, but the procrastination of the crisis has now weakened it. The lack of an honest narrative for the euro crisis at the European level has left the painful policies caused by the worsening of the economic situation unexplained. This lack of consistency between causes and consequences of the crisis has stoked sentiments of frustration among the citizens. Furthermore the relation between Italian taxpayers and the State representatives was damaged by the pain caused by the austerity measures that had been implemented, more or less consistently, during the past 20 years. The fact that “fiscal sacrifices” have not brought Italy out of the crisis has produced further potential for political dissatisfaction.

In the past two decades, unsuccessful policymaking and austerity have fostered the success of political factions that feed on anti-political feelings and populism. In fact, Silvio Berlusconi has emerged as an anti-political leader since the early ‘90s. As such he has often found himself in a paradoxical win-win situation: he could reap benefit from his voters’ dissatisfaction with politics despite – or sometimes just because of – his poor performance as a politician.

However, this time the political framework was different from those of the past elections, and not only as a consequence of the current economic recession. In fact, Italians have never voted while facing more recession down the road, as it is the case now, with an expected decline of GDP by 1% in 2013. While Germany projects a stable economy this year, Italy faces more recession. The bleak perspectives have political consequences. If we define populism as “overpromising”, then there is no reason for rosy perspectives to be credible. In other words, traditional populism is not on fertile ground when a country faces the certainty of more recession.

Recrimination and Anger

In this environment the main sentiments are those of recrimination and anger. Indeed radical feelings about politics and dishonesty have been affecting the electoral contest in both destructive and constructive ways. On the one hand, political leaders have not easily advanced their visions of the future, but have preferred dwelling instead on the past (blaming Berlusconi or Monti or both); on the other hand, parties have finally taken stock of popular anti-political feelings in a rational way, for instance the lists of candidates have been purged and more than 50% of the new MPs will have never had public office before.

At the beginning of the electoral campaign, recession and widespread popular dissatisfaction produced a political environment that was indisputably favorable to the Left and to the anti-establishment parties. Before February 9, when electoral law imposed a suspension of polls’ publication, the last surveys showed Bersani’s Left Coalition (Partito Democratico and SEL) at 34%; Berlusconi’s Right coalition (PDL, Lega and others) at 23%; Monti’s Center at 15%; the two radical anti-establishment leftist parties, led by Grillo and Ingroia, respectively at 15% and 5%.

However, since the beginning of February, the Italian electoral campaign has been hit by what an American political analyst would call a string of “October surprises”. The first bit of unexpected news concerned the solidity of the third largest credit institution of the country, Monte dei Paschi di Siena, which is now jeopardized by a crass case of mismanagement in its derivative operations. The bank became the symbol of murky relations between financial interests and political personnel close to the Partito Democratico (PD). In the first ten days of February the news about the scandal-prone bank moved 5% of the electorate. Overall the impact has still to be gauged properly in the light of successive scandals emerging day after day and involving different parties and also private industries. A familiar unease emerged in the Italian public opinion as business scandals appeared intertwined with abuses in national, regional and municipal politics.

Monte dei Paschi caused a shockwave because it touched exactly on the raw nerves of the electorate: anti-political feelings and economic mismanagement. It was immediately clear that Monte dei Paschi was going to have a long lasting effect on the polls – eroding consensus for PD, which was directly involved in the bank’s management – and more indirectly on Prime Minister Mario Monti, given his assumed familiarity with financial milieus. In 2005-6 a similar case (Unipol) changed the electoral tide in favor of Berlusconi. In fact Berlusconi immediately tried to profit from the weakness of his opponents, resorting to generous promises of tax reimbursements. Berlusconi’s party staged a resurgence that brought it from the meagre levels of the beginning of the campaign (13%) to 20%. However, after the first wave of media reactions, Berlusconi’s comeback seemed to slow down, while anger remained up and rising, but looking for new political expressions.

The last two weeks of electoral campaign also staged the emergence of the “Movimento 5 stelle” led by the famous entertainer Beppe Grillo, who has voiced strong social criticism against the traditional parties and the establishment. Mario Monti, the incumbent Prime Minister, whose surprising decision to run was based on the expectation that Berlusconi’s party had disintegrated, found himself in a very inconvenient position as target of all dissatisfactions: social hardships, voiced by the Partito Democratico and by the radical Left; fiscal populism and anti-Europeanism provoked by Berlusconi; anti-establishment sentiments and juvenile protests bandied about by Grillo. Grillo in particular has been able to tap the unprecedented reservoir of undecided electors, many of whom had been tempted by abstention.

On February 9, 43% of the electors were still undecided. The dispersion of party support across the polls was noticeable. In the following weeks even the hierarchy among the major parties seemed to be in question. Although the Democratic Party was unanimously seen as the winner, getting the majority at the Chamber of Deputies, the second place was seen as a matter of contention between Grillo and Berlusconi. Given the peculiarities of the electoral law, the run for the Senate, the upper Chamber in the bicameral system, was even more uncertain. Control of both chambers is essential for implementing reforms and for the stability of the government.

The current electoral law was designed by Berlusconi in 2005 to avoid stable majorities at a time when the Left seemed close to winning the elections. In fact the law is designed to avoid the formation of a clear majority in the Senate where each of the 315 senators is elected through a regional vote, with the 20 regions as constituencies. In order to control the Senate, the Partito Democratico should have won at least 158 seats and specifically it needed to win at least three of the four uncertain regions of Lombardy, Veneto, Campania and Sicily. It lost all of them to Berlusconi allowing him to become the first party at the Senate.

This time there is no margin for Grand Coalition

In order to understand how critical the multi-party negotiations are, one needs to dive into some details of Italy’s required economic restructuring. During the crisis, Italy lost 25% of its industrial capacity in the past 4.5 years. After such a long period of idleness, those jobs are gone forever. The loss of “potential capacity” will not be restored even if a more benign economic cycle is restarted. In other words, due to the length of the crisis Italy has suffered a structural loss in its potential GDP. On the other hand Italy has 3000-4000 firms that are still performing amazingly well on the global markets. They are keeping the country afloat, but they urgently need easier access to credit and more labor flexibility. In particular, labor flexibility is needed to encourage the 3000-4000 firms to hire hundreds of thousands of unemployed Italian workers and not to move production elsewhere. Labor flexibility of this kind runs against the agenda of Partito Democratico. Bersani owes his nomination as party leader to the support of the most popular and conservative trade union, the CGIL. This union is a bastion against more radical leftwing parties. So even if Bersani is a moderate and open minded leader, he has little room of maneuver: he will be hard pressed from the Left and threatened by a new generation inside his party. Berlusconi did not manage to find a solution to the crisis when he governed the country. Although he has governed for at least ten of the last 18 years, he has never been able to implement the tax cuts that were the cornerstone of his electoral programs. On the other side, Monti has been adamant during the electoral campaign in saying that he will not join a government under the auspices of the CGIL and a euro-skeptic Berlusconi.

While the GDP gap between Italy and the other euro partners has widened since the crisis started, the brunt has been born by industrial manufacturers that in 2008 were on the verge of a technological transformation similar to the one that had proven so successful in Germany in the Nineties. It was by no means a sure thing that the transformation would succeed, given the fact that the delay in productivity was getting bigger year by year. Not only had the Italian GDP increased by a mere 4.2% between 2000 and 2011, against 16.5% in the rest of the EU, but hourly productivity in 2011 was only 1.6% higher than in 2000, against an increase of 13.9% in the rest of the EU. Italy actually posted the lowest increase in productivity among the 27 EU countries.

Essentially, Italy’s capitalism has faced a double challenge that it has never been able to fully address. The first has been the reshuffling of European - and particularly German - industrial supply chains to Eastern Europe after the fall of the Berlin Wall and the enlargement of the EU. This historical change has shifted industrial production away from Italy, the second largest manufacturing powerhouse in the EU, to the new member states. The second challenge is that Italian producers never really adjusted to the era of a fixed exchange rate created by the European Monetary Union. Starting in 1994, Italy’s exports - that were more ebullient than in the other European countries during the period between 1950 and 1990 – lost touch with the rest of the euro area and started declining. Currency devaluations had benefitted mainly producers of low added value goods, whose demand has a higher elasticity to the price and consequently to its currency denomination The productive structure in Italy struggled to move upscale on a range of products with higher added value. In fact probably the opposite happened between 2005 and 2008 when the so called “unobserved economy” – part of which is outright illegal – increased by an astonishing 6.4% of GDP, showing probably that the structure of costs of production in Italy was too heavy and “needed” to avoid taxation and bureaucratic costs to survive.

The loss in productivity is well explained by the modest level of investment in tangible capital that was lower in Italy than in the rest of the EU. Particularly disappointing is the level of expenditure, both private and public, in research and development. The contribution of Total Factor Productivity – labor organization, labor formation, innovation of the productive process, quality of investments and most importantly economies of scale, given the small size of Italian firms - has even been negative. Labor force employment has remained almost 5 points lower that the European average at 56.9% due to the very weak contribution by female workers (46.9% of the total female labor force). Youth unemployment is at almost 20%, still lower than in 2004 (24.4%).

The growth problem of the Italian economy is clearly rooted in its low productivity. Hence it is likely to need urgent reforms on the supply side - in the use of capital and labor – that should emerge in the political context of a wide program of reforms involving a multitude of social partners and political parties driven by the priority of competitiveness. This is exactly the bone of contention between Monti who is in favor of a grand coalition for all-round structural reform, Bersani who is preeminently sensitive to the reasons of trade unions and of employment and Berlusconi whose focus is entirely on the level of taxation on firms. The electoral campaign has indeed focused on taxation.

First priority is to end the suffocating credit crunch

Good relations with the European partners are essential because of a specific problem of the Italian economy – credit crunch – that can be solved only through an innovation in the cooperation with the EU institutions. In fact, the persistence of the crisis in Italy, and possibly in the euro-zone, has been significantly underestimated in the last six months. In focusing exclusively on the fiscal nature of the crisis, it was generally assumed that strengthening fiscal rules and letting local banks buy government bonds with financing from the European Central Bank (ECB), would have been sufficient to bring the crisis under control and rekindle the economy.

The idea was that once fiscal fears had been assuaged, the whole structure of interest rates would fall in line with the declining cost of servicing the public debt. Ultimately, the economy would benefit from renewed credit supply and demand. Unfortunately, this simple scheme, dictated by the fiscal rhetoric on the causes of the crisis and by the avoidance of mutualization, has not worked.

The political project behind the euro has been substantially weakened by the prolonged crisis. So, without a strong and tangible political commitment, the economies – and particularly the financial systems – have remained fragmented, forcing new cracks in the European foundation. In the twelve months before June 2012, when Mario Draghi announced that the ECB would do “whatever it takes” to save the euro, Spain experienced a capital outflow equivalent to more than a quarter of its GDP. In Italy, outflows amounted to almost one-sixth of its aggregate income. The departure of foreign investors from periphery bond markets caused a large share of these flows, especially in Italy in late 2011 when the government, then led by Silvio Berlusconi, seemed paralyzed and dysfunctional.

Between late July and mid-September 2012, when Mario Draghi announced the OMT program, Spanish and Italian 10-year government bond spreads fell by about 130 basis points, the euro appreciated 7 percent against the U.S. dollar, and periphery equities rose by 30 percent. The intensity of the crisis, reflected by the government bond spreads, had weakened markedly as capital outflows from the periphery to the core stopped and even inverted direction, albeit moderately. In fact, except for the positive signs exhibited by the government bond market, the fragmentation in financial markets continued across the euro area.

In the context of intense deleveraging pressures, most European banks have kept trying to limit their exposure in the most fragile countries of the periphery. The consequence has been painful: the decline in credit supply has generated a dangerous and vicious cycle of continued credit crunches and economic recession. The protracted character of the 4-5 year-long crisis has given strength to destructive forces that go far beyond the stability of public budgets and affect the destruction of industrial capacity, the functionality of the banking system and the supply of credit to the economy.

The destructive elements of political inertia, banking instability and weak growth proved to be inextricably connected. As soon as Draghi announced the ECB plan for OMTs, political complacency set in. In October of last year, a proposed banking union was put on the backburner while strong opposition emerged against allowing the ESM to fund Spanish banks. The supply of credit in the periphery declined and the recessionary dynamic was implicitly accepted as a necessary cost of repairing the competitiveness of countries showing deficits in their balance of payments.

Month after month, although the spreads on government bonds were declining, a feedback loop started again: the recessionary forces remained intact and the lack of growth reverberated not only in the dubious solidity of many banks, but also in the shaky political stability of the countries that were most affected by the crisis.

As it affects the functionality of the interbank market, uncertainty about the status of the banking system is a critical component of the mistrust that prevents capital flows from spreading across the euro zone. If foreign investors continue to reduce their exposure in the periphery, several governments could face serious problems in funding their budgets, alternatively, lending to the private sector may be crowded out, making current recessions even more severe. According to the IMF, “The pullback of foreign investors has indeed been mirrored by falling credit to the private sector and a simultaneous significant increase in local banks holdings of local government bonds. Credit dynamics are the best indicators that the government bond crisis is changing its nature and becoming an economic crisis, potentially even more difficult to contrast.

The decrease in credit supply to the periphery is substantial and affects perhaps one-sixth of the total credit available to those countries. This means that unless the ECB channel for banking refinance remains open indefinitely, interest rates in the periphery will remain at levels that are ultimately incompatible with the sustainability of public debt in a weak economy. The contagion stemming from the periphery would spread to the rest of the euro area.

The only way to restore the flow of funds from the core to the periphery is to repair stressed balance sheets, including through bank resolution and recapitalization, and by making credible down payments on the fiscal and banking union. In order to achieve that, the next Italian government needs to be credible for its domestic policies and effective in designing a European solution encompassing the interests of all other countries. It is a tall order that probably requires a very experienced leader.

All scenarios are associated with instability

No matter how it will take shape and which nature it will have - political or, more likely, “institutional” - the government that emerges from the vote of 24-25 February would have a less defined political identity than a one-party government and would require long preliminary negotiations. It is reasonable to foresee that the coalition would absorb part of its personality by keeping the commitment to the European agenda. In fact, even after the painful compliance with European fiscal rules, Italians still look favorably to the European Union and the European Monetary Union. Confidence in the European institutions actually increased by 2% last year and is regularly higher than confidence in the national parliament and the national government.

The adherence to the European agenda is a significant indicator of the future policies given the extraordinary increment in surveillance and coordination required by the Treaty on Stability which will be applied starting next year. (As explained in “What Italy Can Expect after Monti”, Carlo Bastasin, November 26, 2012, Brookings Up Front Blog).

From a European point of view, the defeat of Berlusconi was generally regarded as highly important because it would stave off what is seen as one of the greatest threats to the euro and a real paradox of democracy in the euro system. Berlusconi has been fighting his campaign on the basis of a harsh critique of the European fiscal straitjacketing, or “German austerity” as he calls it. He has also been relentlessly and personally attacking German Chancellor Angela Merkel. A victory by Berlusconi and a departure from austerity would obviously be observed with fear and criticism by investors, and thereby push Italy closer to requesting an assistance program by the euro partners. In such an assistance program, the lion share would be provided by German tax payers. The paradox, therefore, is that due to Berlusconi’s campaign against Germany and Europe, the Germans would be called upon to be more sympathetic to Italy and show tangible solidarity with someone who has been bashing Berlin all the time. Not only would this be illogical in general, but all the more so if it happens at the height of the German electoral campaign ahead of the federal election on September 22, 2013. Inevitably Italy would become an electoral issue, and German voters would vote against a European policy of solidarity. Assistance to Berlusconi would be denied. Italy may then wind up on the verge of a default.

The election shows that any responsibility that Berlusconi may have in the new government will not be exclusive, substantially reduces the danger of a German-Italian showdown. Nevertheless the new government will be subject to scrutiny by the other partners in Brussels and by investors throughout the world. Skepticism by creditors - both public and private - could produce pressure on Italy’s financing of its public debt and request the new government to comply with a program of reforms different from the one that Bersani or Berlusconi prefer. If the challenge is not taken up, the government could wind up requesting an Outright Monetary Transactions (OMT) program sooner rather than later. However the required conditionality and terms set out in a future MoU in connection with an OMT request would put severe strains in the coalitions both of left and right. A European program of assistance would hardly be acceptable for the Partito Democratico and for the Popolo della Liberta’ that would find themselves again in the middle of a new electoral campaign. For all these reasons it is highly probable that in the next weeks all major parties will negotiate to agree on a new technical or institutional government. In fact, by doing so, they will stave off the political costs of managing a painful phase, just as they did with Mario Monti in November 2011.

In this “lowest common denominator” legislature, the way Italian legislative and executive powers will work depends also on the role that Grillo’s party assumes with its strong parliamentary representation. The “Movimento cinque stelle” is generally considered to be a source of political instability that could throw more sand in the wheels of the painstakingly laborious Italian legislative process. But this still needs to be seen. However, Grillo’s party could also represent an unprecedented innovation in European political culture with potentially profound consequences, even to the point of redefining democracy. The movement’s roughly 100 MPs, elected by a sentiment of profound skepticism against policymakers, will scrutinize all the political activity of the parliament and the government inside and out. They are likely to request full transparency on any legislative act. They will put enormous pressure on their colleagues, embracing a language that knows no respect for the usual parliamentarian doctrines of privacy and, on the contrary, is extremely advanced in using the internet as a platform to inform citizens. For all the grave problems that Grillo’s non dialectic language and tribunician attitude create for democracy, Italian electors may have invented a new stratagem to make parliamentary life more transparent in the age of the new media technology.

Authors

Carlo Bastasin

Image Source: © Max Rossi / Reuters

The Rise of Anti-Politics

Carlo Bastasin — Sun, 24 Feb 2013 00:00:00 -0500

Editor's Note: As Italian voters make their way to the polls on February 25, Carlo Bastasin discusses the rise of ‘anti-politics’ and whether the election will be determined by those who vote based on economics or by those who pay greater attention to the personalities of the individual candidates. A translation of the exchange from with Spanish news outlet La Razón appears below. The original article in Spanish is available on the La Razón website.

Q: Do Italians base their votes on economics or are they directed by the images of the candidates?

A: My perception is that economics are going to be decisive. It is a very critical issue that has become an emotional one. The leadership and personalities of the candidates are connected to the economy. Italians have never before voted in the context of a profound economic recession like the one that we have now. GDP has fallen by 7 percent since 2008, industrial capacity by 25 percent and over half a million jobs have been permanently lost. This economic debacle has a high emotional potential to provide motives for indignation and protest. For that reason, the leaders that that express their anger (Grillo) or their optimism (Berlusconi) can benefit more than more rational candidates (Monti).

Q: Why has ‘anti-politics’ emerged so strongly?

A: Berlusconi represents both realities: politics and anti-politics. When he fails as a politician, he promotes anti-political sentiments that he then collects. Thus, he is in a position to “always win,” even when he loses. In any case, considering that his/their resurgence is more fiction than reality. The latest polls do not give a realistic picture of the situation. I am not even sure that Berlusconi will place second after Bersani; he could even be third after Grillo. What is real is the wave of anti-politics.

Authors

Carlo Bastasin

Publication: La Razón

Image Source: © Stringer . / Reuters

Time to Bite the Bullet on European Defense

Clara M. O'Donnell — Fri, 01 Feb 2013 00:00:00 -0500

Europe’s military spending is in free fall. As highlighted during a seminar organised by the CER in December as part of the FR-UK Defence Forum, the EU countries combined have reduced defence spending from €200 to €170 billion since the start of the economic crisis in 2008. In response, governments have signed up to a variety of new bilateral and multilateral initiatives. These are designed to limit the impact of budget cuts on their armed forces. But so far, the savings incurred pale in comparison. At the December discussions, participants estimated them at €200 to €300 million. Many sensitivities relating to national security make it hard for governments to implement collaborative defence efforts. But at a time when Europe’s neighbourhood is replete with instability and the United States is scaling back its own armed forces, Europeans need to do more to stem the damage to their militaries.

Notwithstanding their budget cuts, taken together EU states are still the second largest defence spenders in the world. And not all European countries are reducing the level of funding to their armed forces. According to a 2011 study for the European Parliament, Finland and Denmark have maintained military spending steady in recent years. Poland and Sweden have increased it.

But even prior to the economic crisis, most European countries spent less than 2 per cent of their GDP on defence – even though NATO members are in theory committed to devote at least that much to their militaries. And, according to the European Parliament study, most middle-sized European countries have cut their defence spending by 10 to 15 per cent since 2009. Some of the smaller EU states, including Latvia and Lithuania, have cut by more than 20 per cent. Britain is reducing its military budget by 7.5 per cent over four years. And according to Andrew Dorman from Chatham House, the actual reduction is nearly 25 per cent because the ministry of defence has many unfunded liabilities and has to unexpectedly pay for the replacement of the UK’s nuclear deterrent. France is expected to scale back its military once it announces its new defence priorities this year. As a result, US officials warn that Europeans will soon be incapable of deploying a mission like the one they sent to Libya in 2011.

European governments have acknowledged that closer co-operation between their armed forces could offset – at least partly – the impact of such large spending cuts. They have introduced some welcome measures. For example, last year, 14 countries agreed to buy surveillance drones for a joint NATO-run squadron. Eighteen states now take part in an EU network to facilitate maritime surveillance through information exchanges. Last April, Belgium and the Netherlands decided to co-operate in helicopter maintenance. In September, Bulgaria and Romania agreed terms to make it easier to police each other’s airspace. Britain and France are training together to develop a new joint expeditionary force. And the UK and other Europeans are providing logistical support to France’s deployment in Mali.

But governments remain wary of pooling military capabilities. They still fear that their partners may block their access to shared equipment if they disapprove of a particular operation. States also disagree on the best way to develop new military technologies. For example, the UK wants to acquire defence equipment with France bilaterally. But since President François Hollande has been in office, France has become increasingly keen to allow other European countries to take part in Franco-British procurement projects. Many countries are averse to committing to ambitious initiatives because they know that these can be costly in the short term – last year Britain notably abandoned its plans to adapt its aircraft carrier so that French planes could land on it, after realising how expensive the adjustments would be. Several EU states are loath to integrate their defence companies with those of other countries, as Germany illustrated when it refused to support the merger between BAE and EADS. Finally, governments do not want their defence firms to lose out on contracts. Many in France worry that several of the cost-saving projects proposed by NATO, including missile defence and the joint purchases of surveillance drones, favour US defence companies.

Europeans need to overcome some of these continued aversions to co-operation. Even though governments would prefer to avoid using military force, they might not have a choice. Several conflicts risk undermining stability in Europe’s southern periphery over the next few years – not least the partial take-over of Mali by Islamist militants, where French forces have already felt compelled to intervene, the civil war in Syria and a possible standoff with Iran. And Washington, struggling with its own budgetary constraints, wants its allies across the world to take more responsibility for their regional security.

President Hollande’s government can allay some of the French concerns about the lack of European industrial participation within NATO cost-saving initiatives. To do so, Paris could suggest projects to the alliance which involve equipment made in Europe. As a participant from the CER seminar has proposed, Berlin, London, Paris or Rome could sell some of their old fighter jets to countries in Central Europe which want to strengthen their arsenals cheaply.

As suggested by another participant at the December discussions, Europeans should buy cutting edge military capabilities only when it is necessary. Over the last few decades, the cost of defence equipment has grown exponentially. Even when their economies are stronger, European governments will increasingly struggle to arm their militaries. In some cases, national security will require governments to continue acquiring the most technologically sophisticated capabilities. But for less sensitive tasks, governments should explore cheaper equipment options and a greater use of civilian suppliers, for example in communications.

Finally, European governments must ensure that they do not duplicate their efforts to build the next generation of drones. European governments have long argued that it has been very inefficient for Europe to have three manned fighter jets programmes (Rafale, Eurofighter and Gripen). The duplication has prevented the various programs from benefiting from economies of scale, it has curtailed interoperability amongst European armed forces, and it has led Europeans to compete against each other in export markets.

Over the next few years, Europeans will decide how to develop unmanned combat aircraft and other sophisticated drones. It is still unclear how governments will proceed. France and Britain have announced plans to develop next generation drones bilaterally. EADS and Finmeccanica, Italy’s largest defence company, have floated intentions to do the same. And France has agreed to work on unmanned aircraft with Germany, too.

Under current spending trends, there is insufficient demand in Europe to support several competitive next generation large unmanned aircraft programmes. So Europeans must avoid several unco-ordinated efforts taking place simultaneously. EU countries could barely afford duplicating expensive aerospace programmes prior to the economic crisis. They definitely cannot afford it now.

Authors

Clara M. O'Donnell

Publication: Centre for European Reform

What Italy Can Expect after Monti

Carlo Bastasin — Mon, 26 Nov 2012 15:30:00 -0500

Most observers hold Italy as the make-or-break case of the eurocrisis and look anxiously at what will happen in Italian politics once the current government ends its mandate. The coming election, presumably in March of 2013, may indeed be critical, although not for the kind of political uncertainty that we generally associate with high-stake elections, but for the opposite reason. What the ballots may actually reveal is how limited the scope is for national politics in the new European institutional setting forged by the crisis.

Twelve months have now passed since Mario Monti took the responsibility of a non-partisan, or “technical”, government, and Italy has become reassuringly boring. In that time Prime Minister Monti has advanced in his rather severe mission of lending some credibility to Italian policymaking and has been a very influential player in the European negotiations. Further financial turmoil in the euro area has been averted also through Monti's policies that have proved more credible and consistent than those of his predecessors. Recently the drain of capital has reversed and foreign investments are flowing back to Italy, albeit moderately.

Nevertheless, the economy has continued to fall faster than expected. After four years of crisis, the loss of almost 30% of Italian industrial capacity has become structural. Consequently, if growth is not restored rapidly, the persistent recession will put the fiscal position of the country at risk. Not because fiscal policy is out of line, but because the GDP--the denominator in the debt-GDP ratio--is declining.

A lack of understanding of the new European arrangements and of how intrusive they can be in national politics has left foreign analysts scared by the fiscal policy uncertainty following the next election and after Monti. In many cases, both in the US and across Europe, policymakers look at the end of the current Italian government with outright angst. The country is too big to be saved and in the recent past it has indulged in financial and political instability. Although the doubts surrounding Italian fiscal probity are widely exaggerated, the fears of its economic collapse, unfortunately, are not.

The new European fiscal rules, carved into the "fiscal compact" treaty now being adopted by most EU countries, in fact, are enough to keep any "non-Monti" government on the track of fiscal discipline. A subsequent government may be more inclined to spend or more inclined to reduce taxes, more prone to European rhetoric or rather more nationalistic, but eventually the structural budget balance--net of the ups and downs of the economic cycle--will have a lower limit for the structural deficit of 0.5% of GDP, as mandated by the "reinforced golden rule" contained in the treaty. And this, along with an external balance close to equilibrium, is all that matters to partner countries that want primarily to avoid paying the Italian public debt bill in the near future.

But, what happens if the elections change the character of the government radically? In recent years incumbent governments in the eurozone have been persistently thrashed at the polls. According to recent opinion polls, Italian electors have a mixed judgment on the current government and have cultivated a sense of rebellion towards the political establishment at large. But the fact remains that the financial decisions of the next government have already been made. The double imperative of balancing the budget and reducing the ratio of government debt to GDP (annual cut of 5% of the debt exceeding 60% of GDP) has been approved by the Italian Parliament and by those of the other countries, becoming part of an international treaty – the fiscal compact.

This treaty provides that “in the event of a significant observed deviation from the medium-term objective of the adjustment path” a correction mechanism shall be triggered automatically. Controls and sanctions, up to the appeal to the Court of Justice of the European Union, will enforce the imposition of lump sums or penalty payments in a much more stringent way than in the past.

Wiggling out of this legal construction is not only difficult, but even discussing such an eventuality can be problematic. Once a “non-Monti” government reveals any intention not to comply with the fiscal agreements, or as soon as the Parliament expresses the wish to denounce the Treaty, the country's fiscal position will deteriorate. In fact, investors will be afraid to buy the government bonds of a country whose future fiscal soundness is questioned by its own institutions.

Furthermore, the fiscal compact was introduced as a counterpart for the creditor countries to convince them to share more resources in the common funds that give financial assistance to the ailing countries. The text of the Treaty clearly states that "the granting of financial assistance in the framework of new Programmes under the European Stability Mechanism will be conditional, as of 1 March 2013 (10 days before the most likely date for the Italian election) on the ratification of this Treaty”.

If the “fiscal compact” loses an important country like Italy, the fund in question (the ESM) would most likely be canceled. It would be the end of the single currency. Those Italian fringe parties that are vocally critical of both budgetary rigor and the euro have a tragic consistency. But this corners them in a very difficult position as they are characterized as extreme political formations that are not offering a realistic program.

If the next Italian Parliament does not want to leave the euro, then the "non-Monti" government’s room for maneuver in public finance is rather low, if not nonexistent. It remains, however, to discuss instead the quality and structure of the budget. In fact, every time the current “technical” ministers make awkward or wrong decisions (significant mistakes were made in one aspect of the pension reform, while serious problems emerged in the labor market reform, in the proposed reform of the school system and in the initial design of the Budget Law), they justify them in their hope that more political choices in the future can improve the understanding of the reality of Italian society by those who govern it. But even in the case of a rehabilitation of the political parties, the degree of freedom that the new government will enjoy is smaller than generally assumed and relates mainly to the quality of decisions (paradoxically to their "technical" nature) rather than the ideological footprint.

Parties will still campaign and reap votes by promising a revolution in the ratio between taxes and public spending, particularly if they tell their electors only the benevolent half of the story, promising only tax cuts. Alternatively, they can defend the newly fashionable "balanced budget theorem" (growth by an equal increase in spending and taxes) and promise a more generous welfare package. However, the Budget law of a "non-Monti" government must still be submitted, first of all, to the judgment of the partner countries and EU institutions, even before it is discussed and voted by the Italian Parliament. The Law will need to be considered credible by the EU institutions in terms of its compliance with the annual target toward a balanced budget. In respect of the application of the fiscal balance rule , set out in article 3 of the Treaty, the EU Commission will monitor the compliance through country-specific medium term objectives and a calendar of convergence.

Moreover, according to the fiscal compact, all major economic policy reforms in one country must be discussed ex-ante with the other member states and the Brussels institutions and, where possible, coordinated among the countries of the euro area. This is particularly interesting because any radical revision, politically inspired, should manage to collect the support of the other EU partners. However, given the diversity of political orientation among the partners, it is highly unlikely that they will agree on a very radical agenda in one of the member states.

Furthermore, in order not to violate the annual targets, radical policy strategies need to be smoothed out as gradual processes, consistent and continued over long periods. Necessarily they would need to last multiple years, perhaps longer than a single legislature. This is a serious constraint for any ideological overtone, because, by increasing the likelihood that the law would be revoked at the first change of majority or electoral appointment, ideological policies would be less stable and therefore less credible. This is the main rationale behind the current vogue pushing for “grand coalitions” across Europe.

Finally, should radical political change occur and bring a country's budgetary position out of line, the EU would put in place a suavely named "budgetary and economic partnership program". The mechanism would actually put the diverging country under strict surveillance and require a detailed description of the structural reforms that the government would have to implement--all of this carried out under constant EU monitoring.
But wasn't this control already in place in the past, and didn't it prove blatantly ineffective? Yes, but now, markets are no longer anesthetisized, and partner governments are once again alive and kicking as well. And the Treaty offers them a powerful new weapon: Any country adhering to the Treaty can bring another country that is supposedly violating the Treaty in front of the EU Court of Justice and request the imposition of financial sanctions. This is possible independently from the initiatives of the European Commission. In the deteriorated diplomatic environment caused by the European crisis, it is not difficult to imagine one of the creditor countries moving its legal armies to the Court in Luxembourg. In fact there is a lot of populistic potential behind fiscal rigor (in other countries).

So, strong control from abroad, no fiscal leeway and no ideological leverage. Deprived of room for maneuver both in its theory and its practice, the "non-Monti" government should wager everything on forging "a different climate in Europe," denouncing the failure of austerity policies in all countries and the lack of economic and fiscal coordination among the 17 member states. In the past, a request for less austerity might have worked, and actually did work, but now investors are ready to jump ships that are massively loaded. In the past weeks it was enough for Berlin to put just a little informal public pressure on French President Hollande to let France become a target for speculation.

Yet, a questioning of the European status quo will be inescapable for the coming government, and necessary not only for Italy. The balance of power between those countries that enjoy the confidence of markets and those countries that do not is so out of line that it has caused a new form of democratic deficit in Europe. In the meantime the European public discourse has been damaged so severely that the historical truth of the crisis and its causes has been disregarded and needs now to be restored if we want to give back to the citizens a positive sense of Europe.

From a more pragmatic point of view, the new Italian government needs to develop a European strategy to avoid a deeper recession and avert the dangerous debt-deflation spiral that is underway. Since fiscal policy cannot be used, monetary policy is not available at a national level and structural reforms are not helping stop the economy’s decline, Italy needs an external stimulus coming from a growth initiative in Europe. The export oriented industrial sector is still thriving and would profit from an increase in the economic activity abroad. Consequently, in order to restore growth, Italy needs to change the nature of the current economic cooperation in the euro area that is based solely on preventive distrust and fiscal austerity. This has clearly proved not to work and is deepening--not alleviating--the fiscal crisis. Furthermore the spiral of austerity is drawing in all of Europe. Even the stronger economies, from the Netherlands to Germany, are now balking. So a new Italian government will have to reconsider the way the euro area deals, or does not deal, with its depressed level of activity.

However, to renegotiate the European framework, a government must be credible in Brussels. And in order to be credible there it needs to conduct credible policies at home. In the current juncture, for instance, if President Hollande had a balanced budget, he would be politically stronger than Chancellor Merkel. In order to be effective in Brussels, a "non-Monti" government in Italy would wind up behaving more or less the same way as the real Monti government. Perhaps it would enjoy even less wiggle room, as it will have to build its own credibility from scratch. For this reason, political analysts in Italy believe that no matter the government “post-Monti”, it actually means Monti.

Authors

Carlo Bastasin

Image Source: © Miguel Vidal / Reuters

Will Spain’s Debt Crisis Impact Italy?

Domenico Lombardi — Wed, 10 Oct 2012 00:00:00 -0400

Spain’s reticence to ask for help in managing its escalating debt crisis continues. In the face of protests against austerity measures, a shrinking GDP and one of the highest unemployment rates in the industrialized world, Spanish authorities will likely hold off asking for a bailout package. And, despite modest gains from its austerity plan, Italy harbors fears of contagion from the crisis in Spain. This is a defining moment, notes Senior Fellow Domenico Lombardi.

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Will Spain’s Debt Crisis Impact Italy?

Authors

Domenico Lombardi

The European Central Bank’s New Bond-Buying Program: Implications for Italy

Domenico Lombardi — Tue, 11 Sep 2012 10:17:00 -0400

Editor's note: This piece is translated and adapted from Domenico Lombardi’s bimonthly column “Pennsylvania Avenue” in the Italian daily Il Foglio.

Today’s meeting between Greek Prime Minister Antonis Samaras and European Central Bank President Mario Draghi is a further sign of the increasingly important role of the Eurotower in dealing with the crisis in Europe. Leveraging on the ECB’s announcement last week of a bond-buying program to stabilize financial markets in Europe, Prime Minister Samaras will likely ask that the ECB apply a similar criterion for the Greek bonds in its portfolio by giving up its privileged creditor status.

A favorable response would pave the way for a new restructuring of the Greek debt now held almost exclusively by the official sector. Such restructuring represents, in the medium term, one of the conditions necessary to jump-start the economy and, in the short term, would encourage a re-engagement of the International Monetary Fund in Greece. In fact, the IMF is bound to fund “sustainable policies” in any borrowing country and the current outlook in Greece—with GDP in freefall and the debt-to-GDP ratio skyrocketing—looks anything but sustainable.

While today’s meeting may not have any concrete resolutions, the bond purchasing plan announced by the ECB last week may have important implications for Italy—the third largest eurozone economy with a public debt worth €2 trillion or 5 percent of the global bond market. In fact, the institutional framework that has been set up for the new ECB bond-buying program, or as it is officially called the Outright Monetary Transactions (OMT) program, is new and unprecedented. However, the framework’s apparent complexities mask some potentially problematic aspects of the program.

First, the purchase of short-term bonds alone risks creating problems for the management of Italy’s public debt. One of the reasons why the country was able to resist escalating speculative pressures is because of the relatively high duration of its debt, which hovers at about seven years. Thus, an OMT program for Italy, which may be quite protracted if ever activated, will reduce that duration since new issuances will be primarily in the form of shorter-term bonds purchasable by the ECB. Notably, the choice of the ECB goes in the opposite direction of the approach adopted by the U.S. Federal Reserve, which has favored the purchase of longer-term bonds through the recent “Operation Twist”.

For a country with high debt like Italy, the purchase of longer-term bonds by the ECB would not significantly affect the incentive to fulfill its agreed-upon commitment. If Italy were to renege on its commitments, then the ECB would put an end to its purchases and the spreads would instantly climb, taking the bond yields to considerably higher levels. Given the enormous amount of debt to refinance, the incentive to follow through would be significant in any case.

In contrast, under the current setup, since the program would last for quite some time, the debt duration would be reduced, paradoxically creating a condition of greater vulnerability to future speculative attacks. This prospect would make Italy more and more dependent on forms of supranational assistance and on countries like Germany which have heavy influence over institutions like the ECB.

As for the role of the European Financial Stability Facility (EFSF), it can purchase only up to half of the bond issuances in the primary market under the current guidelines. In the case of Italy, this limit is purely theoretical. In fact, the fund has available—net of existing obligations— €150 billion in its coffers, which would barely cover half of the primary net issuances that the Italian Treasury carries out, on average, in any given year. And this is based on the highly unrealistic assumption that no other eurozone country would request help from the fund.

Really the EFSF’s role is to introduce the requirement whereby beneficiary countries must agree to a program of formal policy conditions and therefore help the ECB avoid the serious embarrassment of imposing on its member countries conditionality. And yet, the EFSF does not have the in-house skills to design and monitor stabilization programs.

For this reason, the OMT framework foresees the intervention of the IMF to design the program conditions and to verify their implementation by the beneficiary country. The question is: what kind of conditionality will the IMF introduce? Based on the programs already in existence in the eurozone, it is likely to cover structural and competitiveness policies.

In the case of Italy, it is difficult to imagine fiscal conditionality beyond any of the obligations already taken by the Monti government. Moreover, the enforcement of fiscal policy falls under the Fiscal Compact Treaty and the broader EU legal framework. However, the presence of the IMF would be helpful. On the one hand, it would alleviate the problem of the scarce financial resources of the EFSF and offer a less embarrassing way to apply to IMF financing in the context of what is officially a tripartite program led by EU institutions. On the other hand, it would offer an exit strategy to the ECB, whereby once bond purchases were ended through mutual consent, the country in question would spend a post-program period of “convalescence” monitored by the IMF.

It is not clear yet if and when the Italian authorities will request assistance under the newly-established OMT program. For the time being, their plan is to benefit for as long as possible from the dampening effect on yields that have resulted from the simple announcement of the new program.

Authors

Domenico Lombardi

Puntate Sull'unione Politica

Robert Kagan — Sat, 14 Jul 2012 00:00:00 -0400

Editor's Note: In this interview with Angelo Aquaro of La Repubblica, Robert Kagan discusses his views on the European Union and the financial crisis, American and European roles in Syria and Iran, and perceptions of Mario Monti both in Italy and abroad.

Angelo Aquaro: Scusi, professore, ma se gli americani vengono ancora da Marte e gli europei da Venere, allora da dove viene Mario Monti, l'uomo che il settimanale Time ha definito "il più importante d'Europa ", l'italiano che qui in America è una superstar, invitato di lusso tra i big della new economy nella Sun Valley? Robert Kagan, l'autore di Paradiso e potere, il pensatore di destra che oggi, a sorpresa, piace a Barack Obama, sorride. Il suo nuovo libro, The World America Made, è già uno scandalo.

Perché di fronte alle tesi liberal del declino - da Fareed Zakaria, L'era post-americana, a Thomas Friedman, Il mondo è piatto - sostiene che l'America resta una grande potenza: pur sempre, s'intende, nel mito guerresco di Marte. "Beh, non credo che per Mario Monti sia importante venire da Venere o da Marte. Non è lì per fare la guerra o la pace: e davvero non saprei qual è il pianeta dei problemi finanziari. Ma per quello che so sta facendo un gran lavoro. Qui c'è molta ammirazione. E spero che l'Italia prosegua su questa direzione".

Ecco, proprio questo è il problema. Il Wall Street Journal si chiede se senza di lui l'Italia rispetterà gli impegni. Mentre l'ex premier Silvio Berlusconi è pronto a tornare in campo.

Robert Kagan: Non vorrei entrare nel merito...

Aquaro: È un discorso più generale: fino a che punto un disastro economico di tali dimensioni può richiedere soluzioni eccezionali.

Kagan: È davvero un tipo di decisione che spetta al popolo italiano: trovare un equilibrio tra la necessità di affrontare la crisi e non avere, invece, un approccio politico alla crisi stessa. Però, ecco, la democrazia è democrazia: e la sospensione della politica generalmente non dura a lungo.

Aquaro: Ma lei la vede o no l'uscita dal tunnel per l'Italia e l'Europa?

Kagan: Il mio ottimismo è messo alla prova. Però se credo che l'Unione, alla fine, troverà una via d'uscita è perché credo che il suo significato ultimo non sia meramente economico: è politico. E l'idea che l'Unione si dissolva politicamente è più che un rischio per gli europei. La Grecia resterà dentro o fuori? Io credo che l'Unione resterà comunque in piedi. Provate a porvi la domanda: che Europa sarebbe se finisse la Ue? Già questo può aiutarvi a tenerla unita.

Aquaro: In Spagna siamo arrivati agli scontri per l'austerity. Un'Europa unita aiuterebbe a gestire queste crisi?

Kagan: Prendersela con Bruxelles invece che con Madrid? No: in questo gli stati nazionali, che poi devono rispondere agli elettori, continuerebbero ad avere un bel da fare.

Aquaro: Il suo saggio sull'Europa-Venere e l'America-Marte compie dieci anni.

Kagan: E dovrei sorprendermi che è ancora più attuale. Chiariamo: oggi come allora non vedo in bianco o nero. Inghilterra e Francia, per esempio, hanno spinto per la forza in Libia proprio quando gli Usa sembravano riluttanti. Ma l'Europa è l'unica che diminuisce le spese militari. Al contrario di Cina, Brasile, India, Turchia.

Aquaro: Lei spiega che l'economia non basta: senza capacità militare non ci sarà mai vera influenza.

Kagan: Guardate alla Germania e alla sua ritrosia a impegnarsi sempre in Libia. E se penso all'Europa mi è difficile pensare a un'Europa senza la Germania. Ecco perché America ed Europa hanno mentalità differenti. Prendete Barack Obama.

Aquaro: A cosa si riferisce?

Kagan: Sta impostando tutta la campagna elettorale come il presidente che sa come uccidere: lui ha ucciso Osama Bin Laden, lui ha ordinato i blitz con i droni. In Europa pensavano che sarebbe stato un presidente più "europeo": ha dimostrato di essere un vero presidente americano.

Aquaro: L'idea del suo libro, che non è vero - come dicono invece a destra - che l'America sia in declino, è finita nel discorso sullo Stato dell'Unione. Avrebbe mai pensato di diventare ispirazione per Obama?

Kagan: Guardi" dice ridendo "io ho sempre ritenuto che la politica estera dovesse essere bipartisan. Sono contento che il presidente abbia trovato il libro utile.

Aquaro: L'ha cercata?

Kagan: Abbiamo avuto alcuni incontri: non a tu per tu. Washington è piccola. E poi non io non scrivo per questo o quel partito.

Aquaro: Veramente è tra i più importanti consiglieri dell'uomo che sfida Obama, Mitt Romney. Che si è già distinto per i suoi attacchi all'Europa.

Kagan: È stato davvero spiacevole che le sue dichiarazioni siano state prese come antieuropee: voleva soltanto dire che non permetterebbe mai che l'America adotti un sistema di welfare europeo.

Aquaro: Anche Obama accolla all'Europa le responsabilità per la crisi: non è che siamo diventati il vostro capro espiatorio?

Kagan: Che ironia: in Europa pensano che la responsabilità della "loro" crisi sia dell'America. Tutti cercano un capro espiatorio.

Aquaro: Lei scrive: non è vero che l'America è in declino. Però nel libro non cita mai chi l'ha guidata negli ultimi anni.

Kagan: Il libro ha una prospettiva storica. Però no, non credo che Obama stia spingendo l'America verso il declino. Sì, mi ha deluso la lentezza di reazione verso la Primavera araba. Ma se è per questo negli Anni '90 mi aveva deluso la lentezza nei Balcani di George H. W. Bush. E poi di Bill Clinton.

Aquaro: E adesso la Siria.

Kagan: Non fossimo sotto elezioni vedremmo un'America molto più attiva. Ma non credo che Obama voglia rischiare. Anche se alla fine Assad cadrà.

Aquaro: Ha ragione John McCain a chiedere un intervento?

Kagan: Non intervento diretto. Ma costruire zone sicure per l'opposizione usando la forza aerea di Stati Uniti e Nato: come in Libia.

Aquaro: E l'Iran? L'US Navy prepara le grandi manovre nel Golfo.

Kagan: Le possibilità di un'azione militare non sono poche. Siamo lì per mandare un segnale o perché temiamo che possano passare all'azione? L'arrivo di una dragamine fa pensare alla seconda ipotesi. Le sanzioni sempre più stringenti potrebbero spingere l'Iran a un'exploit militare.

Aquaro: Dica la verità - parlando di Europa, Siria, Iran e adesso tornando all'Italia: come ha vissuto, da osservatore internazionale, il passaggio da Berlusconi a Monti?

Kagan: Mi sta chiedendo se l'Italia, oggi, viene presa molto più seriamente come paese? La risposta è sì. A un'analisi oggettiva non c'è dubbio che sia considerata molto più seriamente. E questo giusto per rovinare le mie prospettive per quando Berlusconi tornerà: non potrò più rimettere piede in Italia.

Aquaro: Crede davvero che tornerà?

Kagan: Ma non posso saperlo! E la prego: non scriva anche questo.

Aquaro: Il professore ci perdonerà: ma per noi che veniamo da Venere come resistere alla tentazione?

Authors

Robert Kagan

Publication: La Repubblica

Image Source: Eric Vidal / Reuters

Europe's Economy: Moving Out of Intensive Care, but Not Out of Danger

Douglas J. Elliott — Wed, 15 Feb 2012 17:30:00 -0500

Europe does seem to be healing, with substantially more good news than bad, assuming agreements to deal with Greece's immediate financial needs are indeed reached shortly.

And European leaders deserve credit for taking key steps in recent months.

They have moved slowly but steadily to create the infrastructure of the financial "firewall" intended to defend against potential disaster, while also agreeing on budget restraints to help protect against a repeat of the profligacy that led to this debt crisis.

For its part, the European Central Bank has flooded the banking system with liquidity to substantially reduce the chance that a major bank failure would trigger a more dangerous phase of the Euro Crisis.

The new leaders in Italy, Spain, and Greece have also been taking brave and necessary steps to sort out their own excessively rigid and inefficient economies.

As we see from the riots in Greece, it is not easy to clean away the barnacles of privilege and outdated tradition that accumulated over the years.

Nonetheless, Europe is not remotely out of peril. Here is a partial list of dangers to worry about:

Greek bailout. There is still the possibility that the multi-sided deal being worked out between the Greeks, European governments, the ECB, the IMF, and private sector creditors could fail.

This is unlikely, but it could do a great deal of damage, as Europe is not really ready yet to deal with a disorderly Greek default.

Give Europe another year, or perhaps even half a year, and Greece will be much less important to the future of the eurozone. Right now, though, it could make things very messy.

Portugal's mounting debt. European leaders are very supportive of the Portuguese, who are seen as trying hard to do the right things and making progress. However, Portugal's economy is in a serious recession, debt levels remain very high, deficits are adding to it, and the long-term competitive position of the nation is weak.

The main danger is that we could find that it, like Greece, is in such a bad situation that debt reductions are needed.

Another possibility is that a worsening economy may lead the people to demand debt reduction, a la Greece, even if economists believe it not to be necessary.

Spain's shaky economy. The Spanish economy is not in as bad shape as Portugal's is, but it's awful enough, particularly when viewed in terms of unemployment, especially of youth.

Spain is a big enough country that failures to meet economic targets could spook the financial markets into another round of pullbacks from European debt.

Italian politics. There will come a time when the politicians tire of technocrats running the country and judge that the current government has inflicted so much pain that it will be acceptable to the public to remove it.

Right now, Prime Minister Monti is still known as "Super Mario," but this will not last forever. There are few things more painful than watching Italian politicians at work, so there are plenty of ways that they could scare the financial markets into a new crisis.

European recession. Europe's economy shrank last quarter and it may well shrink again this quarter. Most economists believe the recession will be mild and relatively short, barring a policy disaster.

Unfortunately, economists are not actually all that good at predicting the course of recessions. There is the danger that an external factor, such as a move by Iran, could shock the European economy into a deeper recession.

There is also the chance that a recession spirals downward on its own as bad times breed pessimism, which leads to a pullback in consumption and investment, and a worse recession.

Banking crisis. Flooding the banks with cheap money makes it unlikely that any major banks will fail in the short-run. But, it is not impossible.

First, they do have to come up with acceptable collateral in order to borrow from the Eurosystem and some banks could run out.

Second, if hidden losses come to view, it may become apparent that one or more banks are dead men walking, in which case all the liquidity in the world is unlikely to stop disaster.

Backlash in Germany or France. There remains the risk that voters in some of the stronger countries of the eurozone rebel in a serious way against what they perceive as bailouts of the weaker nations using their money.

This is not likely without something else going wrong in the eurozone first, but it is a risk that is simply hard to quantify.

Certainly there are many worries about the potential for Marine Le Pen, a representative of the nationalistic hard right, to make it to the second round of the French presidential elections, although it would be very hard for her to win that round and become president.

Nonetheless, a strong showing by her might make it considerably more difficult for the next French president to do what needs to be done.

I still believe that Europe will most likely muddle through, but it would be a mistake to assume the patient is healed yet

Authors

Douglas J. Elliott

Publication: CNNMoney

Previewing Italian Prime Minister Monti's White House Visit

Carlo Bastasin and Cesare Merlini — Tue, 07 Feb 2012 17:39:00 -0500

In his meeting with President Obama on February 9, the new Italian Prime Minister Mario Monti will be in a position to present his counterpart with details of Italy’s dramatic turnaround—one that has a reasonably good chance of transforming the country from a euro area basket case into the potential keystone of a solution for Europe’s crisis. In less than three months, Monti has actually remodeled the political environment and the economic fabric of his country. In doing so, he has also become a major actor on the European stage.

As announced by the White House, the two leaders will discuss not only Italy’s situation, but also Europe’s policies including “the prospect of an expansion of Europe’s financial firewall.” The broadening of the discussion to Europe should not come as a surprise. As a policymaker Monti is unusual, having gained his governance experience not in national politics, but mainly in the European institutions, as a two-term EU Commissioner. Accordingly, his chief feature as Prime Minister seems to be a combination of national and supranational priorities that favor each other. His role and expertise could therefore represent a game-changer for the euro area, with implications extending beyond Europe.

Mario Monti was nominated Prime Minister on November 16, 2011, at arguably the most dramatic juncture of the euro area crisis. At the time, the White House branded his mandate as a “significant responsibility at a critical time." An internationally renowned economist, Monti was chosen after Silvio Berlusconi’s troubled government finally unraveled, threatening to bring Italy into default. Despite being parachuted into the position from outside the political arena, he and his ministers were granted unprecedented political backing by the Italian Parliament. The proposed government received a vote of confidence of 556 to 61 in the Chamber of Deputies and 281to 41 in the Senate. All three major political groupings, ranging from the right, center, and left of the center (including Berlusconi’s party), voted in favor of the new executive, giving it full democratic legitimacy.

In his first weeks as head of government, Monti introduced a massive fiscal package and got the Parliament to approve an ambitious pension reform. The sum of fiscal corrections deliberated in 2011 amounts to some 6% of GDP. The pension reform has also already been implemented. The austerity package shocked most political observers and economic analysts by its severity, but it sailed through Parliament with an overwhelming majority of about seven in ten MPs. Although Monti’s popularity in the Italian public opinion declined after the fiscal package, it climbed back in January and is currently between 60 and 70%—three times as popular as his predecessor was just before his resignation.

By implementing the requirements spelled out by the European institutions, Italy is now on track to balance its budget in 2013. After that, the famously high public debt (about 120% of Italy’s GDP) should decline more or less automatically, given the forthcoming constitutional provision for a balanced budget as required by the “fiscal compact” that was approved at the EU Summit on January 30. Moreover, in the first weeks of 2012, the Prime Minister, who also holds the Treasury portfolio, introduced a set of liberalizations aimed at increasing the depressingly low level of potential growth of the Italian economy and is now preparing an extensive reform of the labor market.

With these credentials, Monti has been able to join Merkel and Sarkozy in the frequent series of consultations among the leaders of the larger EU countries. However, rather than just taking a third seat at the table, the Italian leader aims to add a communitarian and integrative perspective to the Franco-German directorate. A widely noted Financial Times article went as far as saying that the euro’s destiny depends on Monti’s success, and vice-versa, while a number of observers in the media find that he seems to speak as president of the EU Commission as well as Italy’s Prime Minister.

In fact, one could even talk of a “Monti method”, with reference to his habit of employing the perspective of the interlocutor in order to prove his own points. His defense of central bank autonomy and of fiscal rigor, which puts him in a special relationship with Germany, is a case in point. As an EU Commissioner, he could use the German Ordoliberal arguments (on the virtues of a well-regulated market economy) to force that country to advance the liberalization of its tightly protected national service sector. Back in 2000 he pointed the EU Commission’s finger against the special status of the Landesbanken, which would later play a key role in the euro crisis.

Something similar happened vis-à-vis the United States. A staunch Atlanticist as well as a believer in the virtues of market economy, Commissioner Monti imposed from Brussels the respect of competition rules on such American corporate giants, as Microsoft, General Electric and Honeywell, hence earning the famous brand of Super-Mario (now occasionally extended to another Italian—Mario Draghi).

Prime Minister Monti, after setting Italian fiscal policy on the right course in compliance with the tight schedule and strict rulebook imposed by the creditor countries, is now in position to call for a more ambitious economic policy for the euro area, and for the entire Union, including also the full implementation of the internal market of goods and services, Monti’s favorite objective. The EU Council’s recent commitment on the issue of growth to complement fiscal rigor, reflects Monti’s influence.

Moreover, a policy course supporting the economic growth of the euro area is fully shared by Washington. As such, it could even appear in the common statement issued at the end of the meeting, along with the aforementioned “firewall” provision the EU should put in place to counter market instability in the euro area. This has been a sensitive issue in the United States, where it has been previously difficult to consider providing any financial support—either directly or indirectly via the IMF—for a troubled Europe, despite the fact that even China may be taking it into consideration. The results of the February 9 meeting will also be scrutinized for suggestions of possible U.S. participation in a financial backstop for the euro area.

The risk that Italy will not be able to refinance its debt is considered the make-or-break case for the eurozone. Italy is commonly considered too big to be saved even for those euro-partners that have stronger fiscal positions. Consequently, it is essential for the euro area as a whole that Italy manages to refinance its huge obligations in the next months. More specifically, between February and April, Italy will have to roll over 140bn euro of government bonds that are coming to maturity, almost half of the total for the full year. From this perspective one can easily understand Monti’s urgency for a stronger European “firewall” behind the debt of the euro area countries. A stronger financial backstop, which would have to be topped off by Germany and the other surplus countries, would de facto provide the symmetrical argument for him to maintain parliament’s support at home and the necessary popular backing for the reforms that are modernizing the country.

Mario Monti is branded a “tecnico” in Italy, meaning that he is not elected. The President of the Republic, Giorgio Napolitano, used his prerogative to make him a member of Parliament before appointing him as prime minister. However, the technical label remains, both domestically and internationally, often with an implicitly negative overtone. This reflects a recent peculiar development, at a time of spreading populism, to disparagingly downgrade as bureaucrats and technocrats certain effective policy makers who were once respectfully called "civil servants"—or in French, “commis de l'Etat”. It is conveniently forgotten by populists today that the European Community, now the Union, was a brainchild delivered by a technocrat named Jean Monnet.

The talks between the economist and technocrat Italian PM and the U.S. President will not be confined to the current economic challenge for Europe and the West at large, however central it will be. Italy's policies in its near neighborhood will be on the agenda as well, starting with the Balkans, but focusing on North Africa, where Italy’s restored role and the right combinations of bilateral channels and joint western approaches are needed to stem a failure of the Arab awakening. Such a failure may affect stability as well as jeopardize development and cross-cultural dialogue in the Mediterranean. Mario Monti, who will be accompanied by the former ambassador to the U.S. and now foreign minister, Giulio Terzi di Sant’Agata, will likely be in favor of reinforcing EU communitarian initiatives on the basin’s southern shores and in the Middle East at large, including Syria, rather than the intergovernmental French-inspired Union for the Mediterranean that failed to play a useful role following the uprisings of 2011.

Rome’s perspective, however, is bound to focus also on more distant geo-political areas such Russia and the Gulf, as a consequence of its acute interest for energy supplies. A greater transparency in these two sets of relations is desirable, along with a more integrated approach by the Europeans and a closer consultation across the Atlantic, ahead of possible crisis situations.

Finally, NATO. In the light of the uncertain outcome of its action in Afghanistan, where Italy is actively engaged, the organization may find itself in search not only of a strategy, whether "smart" or else, but also of a purpose, as was the case at the end of the cold war. The European-led operation in Libya, benefiting from a decisive Italian contribution more than it was perceived, was smaller and yet more successful and infinitely less costly than those in western Asia. Thus some lessons may possibly be drawn from it. The summit scheduled for next May in Chicago may provide an opportunity for an assessment and possibly for a reappraisal. Going back to the Monti government’s domestic standing, it is worth noting that the parties opposed to Monti in the Italian parliament also happen to be against the country’s participation in NATO missions and even against UN peace-keeping operations having an Italian contingent.

Mario Monti’s bilateral with Barack Obama on February 9 is the first such face-to-face meeting at the White House with an Italian top official since the May 2010 visit by the head of state Giorgio Napolitano. After the meeting, Napolitano went to Capitol Hill to address a bipartisan group of congressmen. His message at the time was that the euro was not about to crumble, as several American observers were predicting, and that Italy would do its homework to help prevent the collapse from happening. The remarks sounded rather optimistic to many. In effect this week the new Italian Prime Minister will be in Washington and New York to tell his American interlocutors that Italy’s homework is actually being done and that the euro, however shaken, will overcome the crisis.

A durable solution to the financial instability in the euro area, however, still remains to be found and depends on the success of the EU negotiations on the “firewall”.

Authors

Italian Prime Minister Monti's Visit to the White House

Domenico Lombardi — Mon, 06 Feb 2012 09:55:00 -0500

Prime Minister Monti has shown increasing international leadership through his exchanges with his European counterparts as part of his proactive engagement on the European crisis. Following his recent visits to various European capitals, on Thursday, Monti will go to the White House for a meeting with President Obama and the euro crisis will be the first item they are going to discuss.

Monti’s new proactive international approach to engaging other countries on the euro crisis is in line with the new Italian government’s policy. Shortly after taking office, it became evident to his Cabinet that stabilizing the Italian economy and the larger euro area can only come from concerted efforts that include, but are in no way limited to, the reforms efforts in Rome.

Such concerted efforts first and foremost involve the establishment of a convincing policy framework in Europe that would create expectations that ballooning fiscal deficits and debt will be credibly reigned in the medium term. The new Inter-Governmental Treaty that 25 European Union countries are expected to sign at the next European Summit in March would aim to do exactly that.

However, the treaty in its current draft form poses for highly-indebted economies a potentially-deflationary drag by imposing to Italy, for instance, a reduction of “excessive” debt of some 3 percent of GDP each year, on top on the adjustment needed to attain a balanced budget.

To put that into context, the Italian Treasury would need to gather additional resources for €40 to 50 billion on an annual basis to comply with the debt-reduction clause—an amount that is at least double the correction to the annual budget balance that the prime minister enacted days following his appointment through the “Save-Italy” decree last December.

The challenge is to strike the right balance in terms of a steady but feasible reduction in the debt-to-GDP ratio of the indebted economies without jeopardizing their growth prospects. A protracted period of flat growth, if not outright contraction, would undo any potential improvement in the debt sustainability that one would hope to achieve.

Aware of the need of containing the potential harm from this provision, Monti has been meeting persistently with the European Commission, the chair of the European Council, and his counterparts in Paris, Berlin and London. He does not underestimate the potential strength that a benevolent support from the White House could add to his position.

Europe is the most important market for the U.S. exports and thus the prospect of a prolonged period of economic stagnation in Europe will almost surely exact a toll on American jobs and corporate profits.

There is a further element that could prompt the White House to exert its leverage on Berlin. While the euro area crisis appears to have stabilized, the possibility that an adverse shock would trigger a further escalation cannot be ruled out. This is why Washington sees the strengthening of financial safety nets for Europe as an important element in containing the spillover effects to the rest of the global economy.

This would entail a much bigger European financial safety net and a step up in the International Monetary Fund’s own credit capacity, which currently stands at approximately $400 billion—too little for the institution to be a potentially-stabilizing actor in the crisis. In fact, the IMF managing director recently requested an additional half a trillion dollar top up.

The emerging economies as well as Japan, Saudi Arabia and other IMF member countries who may be available to provide additional resources to the IMF have requested that the Europeans make the first move by pledging themselves some $250 billion and by stepping up the financial capacity of their own regional financial safety net.

In response, European leaders agreed to bring forward the establishment of the European Stability Mechanism (ESM), a permanent rescue fund for Europe. In addition, the ESM is likely to provide financial resources in parallel with the European Financial Stability Facility, the current rescue fund. Once the ESM is up and running, it will be able to mobilize an additional €500 billion on top of the current net credit capacity of €250 billion from the EFSF. The challenge is, however, that euro area countries have to find €80 billion to fund the paid-in capital injection to the soon-to-be-established ESM in order for the permanent rescue fund to mobilize half a trillion of loanable resources.

The strengthening of the financial safety nets is a policy issue of particular importance to the U.S. and the international community. Coupled with the strengthening of the euro area policymaking framework, in fact, these two issues could go a long way in stabilizing the crisis in Europe.

But there is another issue that the United States should be worried about: the need to solidly anchor Germany to its regional, European dimension. Many would see a broader cooperative stance in Berlin as key in order to successfully shape an effective policy response to the crisis.

Reflecting the “Berlin consensus” on the crisis, however, the previously-mentioned treaty focuses overwhelmingly on budgetary discipline but offers almost no insights on fostering growth-enhancing measures or on building (even a very embryonic form of) a fiscal union. The only coordination that will be taking place in the fiscal domain is that euro area countries will have to simultaneously retrench their fiscal positions at the national level.

All in all, this will result in a prolonged period of very weak economic performance of the euro area. Thus, Germany is likely to increase its penetration efforts in the emerging economies to compensate for the flagging demand in its “natural” euro area exports markets where German businesses currently sell roughly 40 percent of their exports.

It is not a coincidence that German Chancellor Angela Merkel has just been to China and the Chinese Premier Wen Jiabao will reciprocate the visit in a few weeks when the Hannover’s industrial fair opens this April. Inevitably, this will escalate competitive pressures that American businesses will be facing in the most dynamic markets.

Authors

Domenico Lombardi

Argentina's 2001 Default Has Lessons for Greece and Italy

Mario I. Blejer and Eduardo Levy-Yeyati — Mon, 05 Dec 2011 00:00:00 -0500

The inevitable is finally happening. Although new uncertainties tend to replace old ones -- the focus has shifted to Italy’s troubles in the past few weeks -- Greece is going through a default.

It’s likely that this process will be guided by the broad outlines of an agreement reached between the European Union and Greece in October, although the details are probably subject to change.

As part of that accord, Greece and its private creditors have been invited to implement a bond exchange with a nominal discount, or haircut, of 50 percent of face value. Even though acceptance of the invitation is portrayed as voluntary, this agreement is, in all but name, a default, and for practical purposes should be consider as such.

Many comparisons have been made between Greece and Argentina, and now that default will be another common feature, we believe there are two distinct -- often overlooked or misconstrued -- lessons from the Argentine precedent.

Read the full piece on Bloomberg »

Authors

Mario I. Blejer
Eduardo Levy-Yeyati

Publication: Bloomberg

Berlusconi: End of an Empire in Italy

Ruth H. Santini — Wed, 16 Nov 2011 00:00:00 -0500

Editor's Note: In an interview with Bloomberg, Ruth Hanau Santini discusses former Prime Minister Silvio Berlusconi, his impact on Italy's economy and political environment, and the outlook for the European debt crisis.

BLOOMBERG: How did Berlusconi manage to stay in power for so long given all of the scandals?

RUTH SANTINI: Thanks for having me, first of all. So that’s a very interesting question. Berlusconi managed to win enormous public approval from the very beginning because he was jumping a situation of huge political and moral crisis at the beginning of the 90s, whereby the Italian political system was basically crumbling on the weight of huge political scandals in all the main political parties—from the Christian democrats to the socialist party, which basically then disappeared from the political scene. When these political scandals erupted, Berlusconi, by criticizing these politicians for their perceived lack of touch with reality and with the Italian public, managed to create an aura of being a self-made man, someone that was very down-to-earth, capable of turning situations around with an enormous gut instinct able to lead through a very complex political system, which then he was really able to shape. He was the main creator of the Italian bi-polar system, which never really existed before.

[...]

SANTINI: If we were talking about Berlusconi’s legacy, we are talking about the system that he created and put in place. He was the main stakeholder and he profited from that system he created. Let’s remember that he also reformed the electoral law, making a much less democratic electoral law. Of course he was able to get very different political parties together; he was a very shrewd politician. But he profited from that system he managed to create. One of the three main legacies that he will leave Italy is the political culture of tax evasion, corruption, ambiguity in terms of not being transparent, that is exactly one of the main legacies that will remain. Together with more structural legacies—the reforms he implemented. Wrong reforms, like the reform of education and of the university, and the reforms he promised and didn’t deliver on, like the reform of the public administration and the reform of the job market.

Watch the full interview »

Authors

Ruth H. Santini

Publication: Bloomberg

Italy Must Secure IMF Help to Stave off Further Crisis

Domenico Lombardi — Thu, 10 Nov 2011 15:03:00 -0500

As Italian yields skyrocketed and stock markets tumbled, the worst nightmare since the euro area crisis began has come true. The fallout of one of the most-indebted nations in the world, with euro1.9 trillion ($2.6 trillion) of public debt, is impossible to handle through conventional instruments such as a joint program with the International Monetary Fund and the European Financial Stability Facility.

In 2012 alone, the Italian Treasury will have to rollover some euro286 billion (a bit less than $400 billion) of bonds coming to maturity, equivalent to the IMF’s current financial firepower and in excess of that of the EFSF.

The IMF’s Intensive Surveillance

The unprecedented request from a G-7 country for the IMF’s “intensive surveillance,” made by the outgoing Italian prime minister, Silvio Berlusconi, in the midst of the G-20 Summit last week, has had virtually no effect in improving the credibility gap facing the Italian authorities that have unduly delayed any serious action since the crisis began to escalate.

Italy would greatly benefit from the credibility provided by a third party like the IMF. Under intensive surveillance, the IMF would monitor—almost on a continuous basis—the implementation of an agreed reform program. Such a program will be an operational version of the stabilization plan that the Italian Parliament will have to approve by the end of the week.

The IMF’s contribution will be to establish the intermediate policy targets and their respective timeframe in close cooperation with the Italian authorities. But it will also highlight trade-offs, complementarities and risks among competing policy measures. An IMF team due to fly to Rome as early as next week has reportedly been put on hold until a new government will take office.

This intensive surveillance will feature quarterly validations by the IMF’s staff, who will formulate its own independent appraisal in a report to be discussed then by the IMF’s executive board, which presumably will then be made public. Mechanisms of this sort provide a better signal of commitment than the statutory surveillance that the IMF obligated to conduct typically on an annual cycle.

An IMF Lending Program

Yet, intensive surveillance is less binding than that of a full-fledged IMF lending program, which is typically thought of as the most binding—and, thus, most credible—device.

If some of the agreed policy measures are not fulfilled by the borrower in the context of an IMF’s lending program, the executive board can either waive them or withhold the disbursement of the remaining funds. In so doing, it offers a much clearer signal of where the country stands in terms of the implementation of the agreed reform agenda.

Moreover, as the IMF’s own resources are at stake, market participants would typically attach a greater weight to the IMF’s pronouncements, since the fund would be “putting its money where its mouth is.” In appraising program implementation, in fact, the executive board must safeguard the institution’s funds in fulfilling a crucial fiduciary role.

What’s Next?

In light of the current political turmoil, there would be merit in exploring a financial arrangement with the IMF for the following reasons:

It would provide a stronger backstop to the Italian authorities’ low credibility.
It would insulate, to some extent, the implementation of the reform agenda from the country’s unstable political outlook.
It would establish a reassuring framework for the ECB to step in by announcing potentially-large scale interventions, should market pressures not recede upon successful implementation of the program.
By containing the Italian problem, the prospect of a systemic collapse of the euro area would hopefully subside.

The possibility that a new government in Italy with a short-term mandate could take office ahead of snap elections in the next few months provides a unique opportunity for the Italian authorities to securely anchor their own reform agenda by seizing the benefits of a full-fledged IMF program.

Authors

Domenico Lombardi