Can Italy survive its self-inflicted wounds?

Italy’s populist government has been keen to blame Brussels for its fiscal-policy constraint. But its own choice of crowd-pleasing spending over public investment and reform should be scrutinised.

Italy’s stand-off with Brussels over its 2019 budget deficit ended a few days before Christmas, after two months of intense negotiations, forcing the Italian Parliament hastily to approve the budget law on December 30th 2018. Many commentators spoke of a law ‘decided by the European Commission’ and the main opposition party—the Partito Democratico (PD)—filed a claim to the Constitutional Court against the government for rushing it through the Senate without allowing due time for debate. While the court eventually dismissed the claim, it warned that similar ‘law-making procedures should be abandoned as they may not survive future constitutional claims’.

The stalemate with the European Commission did not need to happen. After pushing back on the commission’s complaint that the draft budget was not in line with commitments made early in 2018­—the previous government having set an envelope for the deficit of 0.8 per cent of gross domestic product—Italy submitted a revised target of 2.4 per cent. With the commission openly calling for the opening of an excessive-deficit procedure, the two sides eventually settled on 2.04 per cent, as the government realised the risk of fines. Saving-face decimals and optics mattered.

The Italian crisis with Brussels was completely self-induced, created and pushed by the populist forces solidly at the helm of the government: the Five Stars Movement and the League. The commission’s preoccupations did not stem from the size of the Italian public debt (131.2 per cent of GDP, according to the Italian statistics institute, ISTAT) nor the extent of any target deficit (whether 0.8, 2.04 or 2.4 per cent of GDP)—think about Japan, which has a public debt of over 235 per cent of GDP, or France, which is running a deficit of 2.7 per cent of GDP (OECD data). Rather, Italy has been on the brink of losing the confidence of domestic and foreign investors, and the European Commission, because of the budget choices the government made in the budget law.

Despite political instability being part of its DNA, Italy is still the ninth biggest economy in the world. Since 1946, when the first republican government took power, there have been 65 administrations over 72 years, or about one government every 13 months. Nevertheless, the country has developed to become a rich, affluent part of the OECD and the third largest economy in the EU—if Brexit happens.

Worrisome indicators

During the budget negotiations, the commission took aim at the Italian government’s push for welfare-enhancing measures such as universal basic income, more favorable pension terms and benefits, new taxes imposed on the banking system and a general tax amnesty. It questioned whether these measures would help boost growth and create jobs.

According to the latest figures published by ISTAT on November 30th, economic indicators are worrisome: the country’s output shrank by 0.1 per cent in the third trimester of 2018—the only EU country where this happened. Unemployment has grown to 10.6 per cent and youth unemployment to 32.5 per cent. In October, Moody’s downgraded Italy’s credit rating to one notch above junk, while Standards and Poors revised its outlook from stable to negative. A recent Goldman Sachs report forecast the economy to ‘flirt with recession’. The Bank of Italy has cut its growth forecasts to 0.6 per cent for 2019 and 0.9 per cent for 2020, from prior estimates of 1 per cent and 1.1 per cent, respectively. And the International Monetary Fund has revised down its own forecasts to match those of the Bank of Italy, since ‘concerns about sovereign and financial risks have weighed on domestic demand’.

The commission pointedly doubted whether the key budget reforms proposed were mere political stunts devised by the populist government to cement its grip on the electorate—and not only domestic support. As the May 2019 elections to renew the European Parliament fast approach, the Italian populist coalition is increasingly seen as leading the ‘nationalist international’ rapidly organising across Europe.

Rather than welfare-enhancing reforms to patronise its electorate, Italy badly needs structural reforms to its economy. GDP per capita remains at about 90 per cent of the 2007 level, before the great recession. According to ISTAT, productivity during 1995-2017 increased on average by 0.4 per cent annually—about a quarter of the French or German performance. To get back on track, national and international think tanks and observers agree the country needs to increase public investment, lower pension spending, lower tax rates on labour and better target resources to reduce poverty and boost prosperity.

The business community knows too: during the first two weeks of December, business leaders staged protests in Turin and Milan over the government’s expansionary budget plans. Rather than proposing much-needed structural changes to raise productivity and attract investment, however, the populist government has made policies to boost its popularity the centrepiece. As the recent Nobel laureate Paul Romer said, ‘an economy grows … whenever people take resources and rearrange them in a way that makes them more valuable’—which universal basic income and more favorable pension benefits would certainly not do.

Savvy story-telling

Welfare-enhancing reforms have been at the heart of the political narrative which allowed the Five Star Movement and the League to rise to power. Both successfully scoped what people wanted—how they felt after the great recession—and the parties crafted a narrative, through savvy story-telling and captivating metaphors, which connected their proposed policies with popular values and needs.

For example, the League has created the perception that Italy today has a problem with immigration, when the numbers say otherwise. It connected its proposal to curb immigrant arrivals with values of fairness and a sense of identity, supposedly under threat by immigrants taking Italians’ jobs. Similarly, the Five Stars Movement campaigned for the introduction of universal basic income as a measure of equity, easily connecting with the public need for economic justice, but insufficient to create the conditions for more and better jobs, the real problem suffered by Italians. Those policies were powerful drivers of a populist narrative which won handily at the March 2018 general elections.

On the other side of the political spectrum, few countries show like Italy how much liberalism and progressive politics have lost their capacity to inspire at the expense of populist narratives. Nicknamed il Rottamatore (the Scrapper), the former Italian prime minister Matteo Renzi sought to renew the Italian political system and introduce structural reforms during his three years in office. He managed to modernise labour laws, introduce powerful measures against poverty and legalise same-sex marriage, among other key reforms, and similar measures were taken by his successor, Paolo Gentiloni. But they both failed to capitalise on the economic recovery following these reforms, and the government and its leading stakeholder, the PD, suffered a crushing defeat in March last year.

To get out of the stagnation which has persisted for a quarter of a century, Italy needs to elaborate a bird’s-eye view of its future in the form of a new political narrative, which should invigorate the citizenry and address its needs. The recent stalemate with the European Commission was a direct consequence of populist forces triumphing at the last elections. The liberal-democratic and progressive forces should roll up their sleeves and work hard on building an alternative political narrative which offers Italians a different vision, anchored in popular values, beliefs, needs and emotions.

Only then will the country truly muster the courage needed to implement essential socioeconomic reforms. As the European elections loom, this is the only way Italy can survive its self-inflicted wounds and move into the future with confidence.