Parliamentary dynamics are crucial as populists make up 60 per cent of MPs and senators
Italy is not the only potential source of future economic instability for the eurozone, but it is the most foreseeable. Other possible triggers are a trade war and a global economic downturn — or more likely both. A trade war remains a clear and present danger. The EU has secured a reprieve from US steel and aluminium tariffs. But the European trading bloc is dangerously dependent on the export of manufactured goods. And we should be careful not to misinterpret the announcement of a short delay as a sign of appeasement by Donald Trump. The US president took a tactical decision not to fight the EU and China at the same time.
So the threat to the EU has not gone away and the concessions that he will extract for a permanent exemption are going to be formidable. A trade war or another geopolitical accident have become more probable. Both have the potential to end the current trend of global economic expansion. A downturn, even one short of a recession, would be poisonous for the eurozone — and for Italy. The eurozone crisis left Italy with only one improbable pathway to put itself on a sustainable footing: permanent fiscal restraint and economic reform (coupled with a prayer that this dream combination from conservative economics would ensure everlasting debt sustainability).
Five Star leader, Luigi di Maio (l.) and the League's leader, Matteo Salvini
Back in the real world, no Italian political parties have promised serious reforms, and the two winning parties in the recent general election, Five Star Movement and the anti-immigrant League, have threatened to unleash the very opposite of fiscal restraint. So if the global economy turns down, it will take Italy with it. A critical moment to watch is the 2019 budget, which will have to be passed by this autumn. Italy may well have a new government by then. But the political dynamics of the parliament will be more important. Populist parties account for some 60 per cent of Italian MPs and senators. Their priority will not be to follow the fiscal rules of the EU.
When governments are weak, parliaments are strong. The majority in the Italian parliament does not look as though it will approve yet another austerity budget. So why are financial markets so calm? I think they are making two misjudgments.
The first is that Mario Draghi is a guarantor of stability until his term ends in October next year. I would not bet that the president of the European Central Bank would come to the aid of a member state that deliberately flouts the fiscal rules. When he gave his whatever-it-takes pledge in 2012, Italy was led by Mario Monti, a Europhile prime minister in charge of a government of technocrats. Naturally, Mr Monti stuck to the rules.
The second misjudgment is that the Italian establishment will always find a way to keep extremists away from power. I have lost count of the number of times I have been assured that electoral reforms would guarantee the victory of centrist parties. Electoral systems matter, of course, but they cannot miraculously produce majorities where none exist.
What we see in Italy now is the predictable response to two decades of economic policy that failed to produce jobs for young people. Many of the victims of this policy are now the backbone of support for the two triumphant populist parties.
No country, not even a paternalistic one such as Italy, can maintain a pro-European consensus in the presence of permanent economic calamity. Unless Five Star or the League agree to self-destruct, they cannot afford to let go of their election promises.
Five Star promised a universal basic income; the League wants a flat income tax. Both intend to reverse pension reforms. These promises are simply inconsistent with adherence to the EU’s fiscal rules. New elections would not solve the problem. They might produce the same result or an even larger share of the vote for extreme parties. There will still be no majority for economic reform and fiscal restraint.
In other words: of all the feasible constellations it is hard to see one that offers compliance with the fiscal rules of the EU. It has been the tragedy of the eurozone that Italy is too big to save and too big to fail. The eurozone has no instruments to deal with the crisis of a large country effectively.
The Franco-German talks about eurozone reform belong in the nice-to-have-category — new rules of engagement for the European Stability Mechanism, the rescue umbrella, and the next steps towards banking union. But if Paris and Berlin were serious about crisis prevention, they would need to talk about a single safe asset as a backstop for financial markets and a funding instrument to create fiscal capacity to revive the eurozone’s economic wastelands. The political chances of such reforms are zero. For as along as this remains so, we are safe to define a time of economic stability as the period between two crises.