Italy’s economic woes present opportunity for EU

It has arrived as a result of the budget proposed by Italy’s populist coalition, which would raise borrowing to 2.4% of GDP – triple the 0.8% to which Rome had previously committed itself – in a country whose debt already stands at 2.3 trillion euros.

The rejection of these initial proposals by the EU has sparked fears of a renewed euro crisis and raised the prospect of a political and economic reckoning for Rome and for Brussels.

The departure – if it goes ahead – of a large member state like Britain from the EU would be a blow, but not a fatal one for the Union. Britain was a latecomer to the organisation and has often been a peripheral and reluctant partner since it joined in 1973. Italy, by contrast, has been one of the EU’s most committed members from the start. Its estrangement would create an existential crisis for Europe.

Equally, Italy’s economy is far too substantial to allow it to be endlessly clobbered with austerity like poor Greece. Persisting to the point of Italy’s economic collapse would seriously damage the countries wielding the sticks too.

Contrary to the popular perception in northern Europe, Italy’s current economic woes are not caused by careless spending.

Italy is the only eurozone member, along with Germany, to have recorded a primary budget surplus almost every year since the euro’s inception in 1999. This means it brings more revenue in to its government treasury than it spends, before interest payments are taken into account.

And it is those interest payments that are the key to Italy’s issues. The real root of the country’s economic problems is the large debt burden stacked up during the decades before the euro existed. In those years, successive Italian governments often relied on devaluing the currency, the lira, to get themselves out of trouble – an option that is no longer available as a euro member.

Italy’s attempts over the last few years to use spending cuts to reduce its crippling inherited debts have failed. Worse still, they have contributed to creating an economic and political crisis in the process.

Italy’s economic output is now less than it was in 2000 (when measured by GDP per head and adjusted for inflation). Unemployment has doubled over the past decade to more than 10%. The impact falls disproportionately on the young and the true jobless figure is probably higher, once those scraping by informally are taken into account. Meanwhile, prices have risen markedly and the wages of those in employment have failed to keep pace.

There are, of course, numerous other causes for Italy’s economic stagnation, most of which are its own responsibility. Its education system is badly outdated and its pension costs are too high. Inefficient public administration and legal systems drastically increase the cost and difficulty of doing business.

But reforms to tackle these structural problems are difficult to implement while also pursuing debt-driven austerity. And, given the timeline, the inevitable conclusion drawn by many Italians is that the EU and the euro are at least partly responsible for their struggles.

This situation has caused Italian voters to lose faith with the traditional political parties. Earlier this year they elected an unstable coalition of populists. The ensuing battle for leadership of the coalition between the erratic, inexperienced Five Star Movement and the far-right Lega led by Matteo Salvini, has resulted in them presenting a budget to the EU that deliberately defies eurozone rules on overspending.

Their motivations for doing so are as much political as economic. In particular, the eurosceptic and deeply cynical Salvini sees great personal political advantage in stirring up nationalism by provoking a public row with the EU.

The rest of the EU would be well-advised not to give him one. Heated rhetoric in response to Salvini’s attempts at provocation should be avoided. The EU cannot afford to play into his populist hands by allowing itself to be portrayed, however unfairly, as an adversary of the Italian people.

Instead, the EU would be wiser to deal calmly with the Italian coalition’s economic proposals on their merits.

The coalition claims its budget is designed to kick-start the economy by putting more money in people’s pockets. Generating dramatic economic growth, they say, is the only way it will eventually be able to bring down Italy’s debts.

Unfortunately, the governing parties have diametrically opposing ideas for doing so. Five Star wants to implement its expensive promise to the electorate of a universal basic minimum income. The Lega favours a hefty tax cut. Putting both in the proposed budget adds up to an enormous deficit.

Nonetheless, it is possible to construct a deal on the Italian budget that would benefit all concerned. While the Italian government’s current proposals are unreasonable, there is some leeway to allow the government to spend more to stimulate the economy without wildly overshooting the deficit rules.

Preserving the euro’s economic credibility depends upon adhering to these rules as closely as possible. But they have been stretched before – notably by France and Germany – when the overriding circumstances demanded it and without bringing the system crashing down.

As the German economist David Folkerts-Landau proposed in the 
Financial Times, the eurozone’s European Stability Mechanism could acquire some of Italy’s historic debt at much lower interest rates. This would reduce the burden on Italy and allow its economy to grow, without imposing huge costs on other Europeans.

Such a solution is essential to move forward. The Italian governments of the 1980s which caused these difficulties cannot now be punished and futilely perpetuating Italy’s debt problem fuels the anti-EU populists.

In exchange for this support Italy must, of course, agree to strict conditions on stimulating its economy sensibly and to reform its malfunctioning public sector.

The EU would also be helping itself by compromising on the Italian budget proposal and cooperating to resolve Italy’s long-term debt problems. Such steps would directly address a widespread criticism of the EU – that it is insufficiently responsive to the democratically-expressed concerns and economic needs of its citizens.

None of this will be easy. The partners in government in Rome are far from ideal. And sceptical voters in some other EU countries will need to be reassured that the debt relief arrangements will not impose significant costs on them.

But allowing the Italian people, who have always been consistently amongst the most committed supporters of the EU, to become irretrievably alienated from it would be a catastrophic failure for the whole continent.

As the old adage goes, one should never let a crisis go to waste. The Italian budget dispute offers an ideal way for the EU to prove anew that it has the interests of all Europeans at heart.