All roads lead to Berlusconi’s Rome. For now.

By Hugo Dixon
October 31, 2011

The euro zone’s future hangs on Italy – and Italy’s future hangs on its politics. The best way forward would be a grand coalition replacing Silvio Berlusconi’s discredited government. But after the prime minister’s Houdini act last week, that doesn’t seem likely and other scenarios aren’t as attractive.

Until recently, investors didn’t pay too much attention to the multi-dimensional chess game that is Italian politics. The state may have nearly 2 trillion euros of debt, equal to 120 percent of GDP,  but the country is rich: Net household wealth was 8.6 trillion euros in 2009, according to the Bank of Italy. The deal-making and back-stabbing in Rome – or for that matter, Berlusconi’s bunga-bunga sex parties – didn’t seem to matter. True, the country has virtually stopped growing in recent years. But there was even a view that Italy benefited from having politicians that were so concerned with their elaborate games that they couldn’t interfere with the business of business.

All that changed in early July. As the euro crisis gathered pace, scandals and wrangling in Rome unsettled markets. The 10-year bond yield, which had been a relatively comfortable 4.8 percent, shot up to 6 percent in two weeks. Berlusconi and Giulio Tremonti, his previously respected finance minister, fell out. The center-right government, which survives on a wafer-thin majority, was able to pass austerity measures to cut the deficit. But the actions were seen as too little, too late. Investors became hyper-sensitive to Italian politics and were no longer willing to take things on trust.

The rot was only stopped by the European Central Bank wading into the market in August and buying Italian bonds. But even this bought only temporary respite. Despite two European summits last week designed to provide a comprehensive solution to the euro crisis, Italian yields ended the week back at 6 percent. The country is on the edge of a debt spiral as investors’ concerns about the country become self-fulfilling. If borrowing costs rise further, the country’s debts won’t seem sustainable, meaning yields could shoot still higher.

The best way of breaking the vicious spiral would be to have a positive political shock – to counter the negative one delivered over the summer.  And the best way of achieving that would be to have a temporary grand coalition led by a technocrat such as Mario Monti, the former European Commissioner. Its mission would be to take harsh actions needed to solve Italy’s two big problems: debt and low growth. Labor markets would be liberalized; the bloated public sector would be cut down to size; and the over-generous pension system would be reformed. It might even be possible to reduce debt to below the psychologically important 100 percent mark by privatizing assets and instituting a one-off property tax.

Such an outcome doesn’t look likely. Although Berlusconi’s government has come close to collapsing several times in recent months, he has so far managed to pull it back from the brink. The latest crisis was caused by pressure last week from Germany and France to produce a stronger reform program. The Northern League, Berlusconi’s main coalition partner, balked at this. In the end, a compromise was struck which was just enough to satisfy the European allies but not too strong to bring the government down.

This was a pity. If the government had collapsed President Giorgio Napolitano would have been free to call on Monti or somebody else to form a technocratic government. As it is, Berlusconi will now limp on with a lackluster reform program which will struggle to secure the support of the market.

Even worse, the government may not be able to implement its program. The decisive vote in parliament probably won’t occur until January by which time another three months will have been wasted. What’s more, if the government falls at that point, the consensus in Rome — where I spent a few days last week — is that it will be hard for Napolitano to call on a technocrat to take charge and will instead be under pressure to agree to new elections. This is partly because Italy traditionally votes in the spring time and partly because the next elections have to be held anyway by mid-2013, meaning that a new technocratic government wouldn’t have much time to achieve anything.

New elections in, say, March might not be so bad if they delivered a decisive outcome. But Italy’s Byzantine politics make this far from certain. There are three blocs: the right, the left and the center. Current opinion polls show that the left would be the leading bloc but that it might not be able to form a majority without the support of the center. The center, though, is ideologically closer to the right – although it would be loath to join them in a coalition if Berlusconi was still around. Further complicating the picture is that fact that each of the blocks is made up of several parties each with its own agenda.

What all this means is that new elections could easily produce a messy outcome. Even a clear victory by the left wouldn’t necessarily be good. Pier Luigi Bersani, leader of Italy’s Democratic Party, the main left-wing group, hasn’t yet set out a clear agenda. Given that the party relies on support from unions, it might not be able to embrace the free-market reforms Italy needs.

There are, of course, other scenarios: Berlusconi may get his diluted program through parliament; his government may collapse before the end of the year, allowing a grand coalition to take over; even if it collapses in January, Napolitano may find a way of bringing in a technocratic government. Meanwhile, the euro zone last week agreed ways to leverage the European Financial Stability Facility, its bailout fund. This means it should soon have a much bigger war-chest with which to support Italy if its bond yields climb higher. But the EFSF’s resources are not limitless. If Italian politics remains dysfunctional, Europe could soon be back in crisis mode.

5 comments

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will you replace him w Italy’s communist politicians? then it will totally be the second Greece case… communists and socialists killed EU… what a sad story for our arrogant friends…

Posted by Ocala123456789 | Report as abusive

If saving Europe depends on Italy getting a functional government, then tough luck. It is a truism in Italy that they haven’t had one for 2000 years.

Posted by Jim1648 | Report as abusive

From the article: “But the EFSF’s resources are not limitless. If Italian politics remains dysfunctional, Europe could soon be back in crisis mode.” What do you mean “could soon be back in crisis mode”??

The blind could see that they already are.

Posted by r.felder | Report as abusive

The BBC article points to an interesting case: The USG’s ability to tax other states and fund Michigan did not result in solutions to the Michigan problem, it simply led to a series of increasingly corrupt politicians and an aggravated downward spiral. Now the corrupt politicians are still in place, the problem is no closer to solution, and the other states don’t have money as well.

Posted by ARJTurgot2 | Report as abusive

I’d Like to know why italian pensions are generally called “generous”.

the vast majority of pensions are 1000-1200 euro/month earned after life long contributions ending at 65 years.

sure we have such scandals as members of parliament obtaining 3000 euro/month for having hold the charge for just one day, while the hard-working ones (the two Parliament chambers works two days per week) enjoy 9000 euro/month after some years of “service”.

but these pensions, and other quite high ones earned by well positioned high ranks civil servants remain unknown by reforms an debates.

what the government really want is to leave their retirement privileges untouched (as well as those of their friends) and compress the already low levels for the common people with the excuse that “the bad guys in Europe ask us”.

I see also some superficiality from the foreign press (usually so accurate and lucid in describing italian politics) when they depict the italian pensions as generically “over-generous”. the common italian person pension is more or less the same as other europeans ones, minus the fact that services for elderly people (hospitals etc.) are practically non existant.

Posted by lbo_it_rm | Report as abusive