The Italian Economy’s Moment of Truth

Alessandro Bianchi/Reuters

Now that a new anti-establishment government is taking power in Italy, it remains to be seen if the economy will be remade, or broken further.

Originally published at Project Syndicate

June 7, 2018

Alessandro Bianchi/Reuters
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Current political and economic issues succinctly explained.

MILAN — Italy and Europe are at an inflection point. After an election in March in which the anti-establishment Five Star Movement (M5S) and the far-right League party captured a combined parliamentary majority, followed by months of uncertainty, Italy has become the first major EU member state to be governed by a populist coalition.

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M5S and the League both openly question the benefits of eurozone membership, though neither party made leaving the euro a specific commitment of their governing program in the election campaign, a failure that Italian President Sergio Mattarella seized upon in vetoing key cabinet pick. They also disdain globalization more generally. The League, in particular, is obsessed with cracking down on immigration. On the domestic front, both parties have promised to tackle corruption and topple what they see as a self-serving political establishment, while introducing radical policies to reduce unemployment and redistribute incomes.

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Still, we won’t know the precise dimensions of the M5S/League agenda until the populist coalition begins governing in earnest. There are rumors that the parties want to write down Italy’s sovereign debt, which currently stands at a relatively stable level of just over 130% of GDP. If they did, a Greek-style confrontation with the European Union would seem certain to follow, with interest rates and spreads on Italian sovereign debt increasing rapidly, especially if the European Central Bank decided that its mandate precluded it from intervening.

In such a scenario, Italian banks currently holding considerable amounts of government debt would suffer substantial balance-sheet damage. The risk of deposit flight could not be excluded.

Unlike most eurozone countries, Italy’s nominal (non-inflation-adjusted) growth is too weak to produce substantial deleveraging, even at today’s low interest rates. Other things being equal, a rise in nominal interest rates would thus produce rising debt ratios and further constrain the government’s fiscal space, with adverse knock-on effects for growth and employment. And, unlike most of the rest of Europe, Italy’s real per capitaGDP remains well below its 2007 pre-crisis peak, indicating that the restoration of growth remains a key challenge.

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Whether any of the risks Italy now faces will materialize depends on whether the incoming government accepts reality and pursues prudent action and policies to spur more inclusive growth.

The outcome in Italy resonates beyond Europe, because political developments there are consistent with a worldwide retreat from globalization and growing demands for national governments to reassert control over the flow of goods and services, capital, people, and information/data. Looking back, this worldwide trend seems to have been inevitable. For years, global market forces and powerful new technologies have plainly outstripped governments’ capacity to adapt to economic change.

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Broadly speaking, then, Italy’s situation is not unique. And yet, more than many other countries, it desperately needs an agenda that ensures macroeconomic stability and encourages inclusiveness growth. That means more employment, more equitably distributed incomes and wealth, and more entrepreneurial opportunities.

Without greater economic inclusiveness, Italy could soon find that its leading export is talented young people. Mobile workers in their prime will seek outlets for their skills, creativity, and entrepreneurial impulses elsewhere, and Italy will have lost one of the principal engines of economic dynamism, growth, and adaptability.

Outside of financial and economic circles, foreigners tend to see a different and important side of Italy. They see a country of stunning beauty that is rich in intangible assets, culture, and creative industries, and home to many of the world’s most sought-after travel destinations. Those in academia or certain business sectors know about its centers of excellence in biomedical science, robotics, and artificial intelligence, and that Italian researchers, technologists, and entrepreneurs figure prominently in innovation hubs worldwide. And others are no doubt aware that Italian governments tend to come and go rather frequently, and that the economy and society have rarely suffered undue disruptions as a result.

In fact, international observers and Italians would all agree: Italy has enormous economic potential. But the challenge lies in unlocking it, which will require several things to happen.

For starters, the Italian government needs to root out corruption and self-dealing, and demonstrate a much stronger commitment to the public interest. The populists are probably right about these problems. And they are probably right that a reassertion of greater sovereignty over the key flows of globalization is necessary to counter the centrifugal political, social, and technological forces sweeping across advanced countries.

Moreover, Italy needs to develop the entrepreneurial ecosystems that underpin dynamism and innovation. As matters stand, the financial sector is too closed, and it provides too little funding and support for new ventures. There are major opportunities in e-commerce, mobile-payment systems, and social-media platforms to lower entry barriers and promote innovation. China, for its part, is rapidly advancing in these areas, creating significant opportunities for young people in the process.

Of course, with any digital technology, there are justifiable concerns about data security, privacy, and bad actors bent on manipulating information to undermine social cohesion and democratic institutions. But these issues should not stand in the way of realizing digital technology’s tremendous potential as an engine of inclusive growth.

Finally, it is worth noting that collaboration between government, business, and labor has played a key role in the countries that have adapted better to globalization and technology-induced structural change. To be sure, collaboration requires trust, and trust is established gradually over time. But without it, economic structures ossify, productivity lags, competitiveness suffers, and activity in tradable goods and services migrates elsewhere.

At this stage, uncertainty about the future is inevitable. But unless a country is prepared to accept long-term stagnation, failing to adapt to the coming changes is not an option. With a clear mandate for change, Italy’s new government could implement a vigorous, pragmatic, long-term policy agenda to produce inclusive growth. Otherwise, the country’s great potential will continue to fall short of being fully realized.

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