Italy’s coalition government, comprising the anti-establishment Five Star Movement (M5S) and the far-right League party, made headlines recently for its new draft budget, which violates European Union rules.
But this is hardly the first Italian government to make over-the-top promises and squander public money to pay for them. In fact, when all is said and done, Italy’s new populism is not new at all.
The government’s proposed budget promises to increase borrowing to finance a 2.4 per cent-of-GDP deficit in 2019 and the following two years. While this would not cross the EU’s 3 per cent-of-GDP ceiling on budget deficits, it is considerably more than the 1.6 per cent that the finance minister informally agreed with the EU over the summer.
For Italy, which suffers from deep structural issues and chronically anemic growth, increasing the target for the 2019 budget deficit is imprudent, to say the least. By worsening Italy’s already fragile fiscal position, the higher deficit will limit the scope for adjustment in the event of future shocks.
Italy’s sovereign debt already totals more than 130 per cent of its GDP – the second-highest ratio in the EU (after Greece). To put the country on a path toward public-debt sustainability, the country should be increasing its primary surplus (the difference between revenues and expenditures net of interest payments), to 3.5-4 per cent of GDP, according to the Bank of Italy. Instead, the primary surplus is due to drop to 1.3 per cent of GDP in 2019, from the projected 1.9 per cent this year, making it difficult, if not impossible, to achieve the planned debt reduction.
Long-term economic and social considerations almost inevitably collide with short-term political objectives, particularly for populists. Increasing spending today is the only way Italy’s coalition parties can deliver on their grand campaign promises.
Whereas M5S has pledged a form of “citizens’ income” for the poor and the League is committed to tax cuts, both want to repeal the 2011 pension reform that, among other things, raised the retirement age.
For the League, delivering on its electoral pledges is particularly urgent, as it is eager to cement its lead against its former center-right allies – notably, Silvio Berlusconi’s Forza Italia – and even M5S before next year’s European Parliament elections.
To be sure, Italy’s ruling coalition is responding, at least partly, to real and serious concerns. The global financial crisis and ensuing eurozone crisis lowered many households’ living standards considerably, and some five million people now in absolute poverty.
Real disposable income per capita dropped precipitously in 2009-2012, and remains below pre-crisis levels, which were already below the prevailing levels prior to Italy’s adoption of the euro. And with older households’ real income (and wealth) well above those levels, aggregate data do not capture how grim the situation has become for younger and middle-age households.
But simply throwing €10 billion ($11.5 billion) at the problem will not fix it. M5S’s “citizen’s income” will not be sufficient to lift people out of poverty, and it could actually worsen their plight to the extent that it distracts attention from the fragmented and poorly targeted welfare system, not to mention the need for broader structural reforms.
As it stands, Italy lags behind other large European economies in terms of output, employment, and income growth, with wages failing to keep up even with the country’s abysmally low productivity gains. Rather than offering Band-Aids, the ruling coalition should be working to boost Italy’s competitiveness, which has been undermined since the crisis by the weak recovery of real exports and low investment, which, at under 9 per cent of GDP, remains significantly below the eurozone average.
Even the League’s own voters are unlikely to buy into the citizen’s income program, owing to the perception that it would feed a culture of dependency and entitlement that many of them oppose. And, in fact, the coalition’s fissures are beginning to show.
For now, the League and M5S remain united by their determination to defend Italy’s sovereignty against EU efforts to undermine it. After spending weeks arguing with EU leaders about migration, the government is now challenging the Maastricht Treaty’s rules, all in an effort to maintain popular support.
But here, again, short-term political interests are at odds with long-term economic imperatives. In a world where capital flows across borders instantly, rigid notions of sovereignty are not only inappropriate, but also dangerous, not least because they stoke fears among international investors.
As Argentina’s experience starkly demonstrates, international investors’ mistrust of populist governments can result in upheaval: as they withdraw their funds, a sovereign-debt crisis becomes a self-fulfilling prophecy.
Italy is not there yet, but since the end of May, yields on its ten-year sovereign bonds have increased by about 210 basis points, bringing the differential with the German bund to over 270 basis points.
And all the ingredients for a crisis are there: a weak growth outlook, a poor and deteriorating fiscal position, a vulnerable banking sector with substantial sovereign-debt exposure, and no credible plan for needed structural reform.
If those in Italy’s government who advocate a departure from the eurozone get their way, the situation will become even more explosive, owing to widespread economic destabilization and the destruction of confidence.
After all, membership in the EU and the eurozone has been the main force pushing Italy away from irresponsible short-termism and toward greater fiscal discipline.
Historically, Italians trusted the EU more than their own governments. But that may no longer be true, meaning that the risks of a harder push toward the exit are mounting. Even if Italy remains in the eurozone, however, the ruling coalition is likely to behave much like its predecessors. The only novelty may be the extent of the damage it causes. - Project Syndicate