Italy: Welcome to the Bungle

The Italian vote is a bungle—for Italy and for Europe. It will make it much more difficult for the Continent to manage its ongoing crisis, and it raises the probability that the eurozone will break apart. While, such a disaster and the financial chaos that it would cause are not yet a likelihood they certainly are more likely than they once seemed.

As far as Europe and the rest of the world were concerned, the Italian election revolved around two critical questions: First, would Italy continue to bow to the austerity demands attached to aid from the European Central Bank (ECB), the International Monetary Fund (IMF), and the European Stability Mechanism (ESM)? And second, would Italy continue with the pro-growth structural reforms initiated by the outgoing prime minister, Mario Monti? The center-left coalition, led by Pier Luigi Bersani and his Democratic Party, answered "yes" to both questions. The center-right, led by former prime minister Silvio Berlusconi, argued for a reconsideration. Now these opposing views have garnered about equal numbers of votes in both the lower house of Italy's parliament and in its Senate. The figures are so close that the country may have to hold a new election in just a few months, though Bersani, with a slight advantage in the lower house, might find a way to form a government. Especially since the anti-government Five Star Movement did surprisingly well, it is clear that even if the country can organize a government, Rome will have great difficulty moving legislation.1

This result pretty much kills Prime Minister Monti's structural reform effort. He had pushed this agenda because he realized that Italy would suffer under austerity alone. In particular, he saw the risk of a vicious cycle, in which austerity slows economic growth enough to enlarge budget deficits, despite the tax hikes and spending restraint, eliciting still more fiscal austerity that then only compounds economic and deficit problems. He believed Italy could pursue needed austerity and avoid this fate by also implementing growth-oriented structural reforms. His work focused initially on labor markets, aiming for economic flexibility and efficiency by loosening rules on hiring and firing and scaling back regulations to give firms more latitude in setting hours and production schedules. Though he made remarkable strides against long-standing and powerful interests, all recognize that there is much more to do before Italy could regain the kind of competitiveness it needs. This divided government hardly seems capable of taking those additional steps, especially because it is faced with still-powerful opposing interests.2

Even more important is the question of whether Italy will continue with its austerity program. This is notable because any decision to soften austerity in Italy will likely affect Germany's upcoming September elections, and, subsequently, it can alter the whole balance of influence in Europe. German chancellor Angela Merkel is running a campaign of European cooperation, aimed at securing Germany's broader interests within the currency union and Europe in general. Her opposition has taken a narrower definition of German interests, worrying over the loss of German influence within Europe and the risk to the German taxpayer. Though Merkel personally remains popular, polls show that a large part of the public shares these narrower concerns. These worries will only intensify with an Italian rejection of austerity, since Germans will then, naturally, ask themselves why their county should extend itself when the Italians seem unwilling to change the policies that got their country into trouble in the first place. If the Italian vote swings the German election against cooperation, Merkel, even if she remains chancellor, could find her maneuvering room severely limited, taking from Europe and its periphery their main source of financial support.

Disappointing as this Italian bungle is, panic is not an appropriate response. A second Italian vote might bring a more committed government to Rome. The divided government that seems to exist now may yet surprise and pursue more aggressive and cooperative policies. The German vote may turn out to be less vulnerable to an Italian disappointment than it might seem at the moment. But still, there is no mistaking how the outcome of the Italian elections lowers the probability of cooperation from all involved. The outcome, as a consequence, also gives reason to expect a less ordered European situation and, accordingly, a greater reason to worry over the financial and economic hardship that would befall the Continent if there were such failure.

1 Alessandra Galloni and Giada Zampano, "Messy Italian Election Shakes World Markets," The Wall Street Journal, February 26, 2013.

2 Klaus C. Engelen, "The Rising Tide of German Anger," The International Economy (Fall 2012).

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