Whisper it softly, but the age of government austerity is ending. It may seem an odd week to say this, what with the U.S. government preparing for indiscriminate budget cuts, a new fiscal crisis apparently brewing in Europe after the Italian election and David Cameron promising to “go further and faster in reducing the deficit” after the downgrade of Britain’s credit. But politics is sometimes a looking-glass world, in which things are the opposite of what they seem.
Discussing the outcome of Friday’s “sequestration” of U.S. government spending is best left to the month ahead, when we see how the public reacts to government cutbacks. But in Italy, Britain and the rest of Europe, this week’s events should help convince politicians and voters that efforts to reduce government borrowing, whether through public spending cuts or through tax hikes, are both politically suicidal and economically counterproductive.
In Italy, and therefore the entire euro zone, this shift is now almost certain. After the clear majority voted for politicians explicitly campaigning against austerity and what they presented as German economic bullying, further budget cuts or labor reforms in Italy are now off the agenda, if only because they would be literally impossible to implement. If Angela Merkel demands further budget cuts, tax hikes or labor reforms as a condition for supporting Italy’s membership of the euro, a majority of voters have given an unequivocal clear answer: Basta, enough is enough. Most Italians would rather leave the euro than accept any further austerity – and if Italy left the euro, total breakup of the single currency would follow with an inevitability that might not apply if the country exiting were Greece, Portugal or even Spain.
Merkel surely understands this, and she is determined to avoid a catastrophic euro crisis just before her own election in Germany on Sept. 22. She is therefore almost certain to heed Italian voters’ refusal to accept further tax hikes, budget cuts or labor reforms. From now on, the European Central Bank will have to offer its support to Italy without any tough pre-conditions. In fact, Italy can realistically be expected to make only one economic promise: to maintain the existing taxes and reform laws already legislated under Monti. That promise should be easy enough to keep, since Italy’s new parliament will be no more able to muster a majority for repealing old laws than for introducing new ones.
The European Commission, meanwhile, can move the fiscal goalposts in Italy’s favor. Once that precedent is set for Italy, similar flexibility should spread across the euro zone – and at that point the ECB would be able to offer effectively unconditional guarantees of financial support for all members of the euro zone, while Merkel and German voters turn a blind eye. Once investors work all this out, European financial markets can be expected to calm down and Italian politicians to return to what they know and love: plotting, backstabbing and Machiavellian intrigue.