Next week’s parliamentary election in Italy is a make-or-break vote for the country, which for several years has been teetering on the brink of a fiscal crisis.
If Italians choose a government that won’t push ahead with economic reform, or rolls back recent changes that were designed to make the economy more competitive, the country’s ability to repay its debt will be in question.
That would be terrible news for Italy and the euro area as a whole, which might not be willing or able to bail out its third-largest economy. With days to go before the vote on Feb. 24-25, only this much is certain about the outcome: The next government in Rome may be stable or reformist by Italian standards, but it will not be both.
An average of the latest opinion polls, which weren’t permitted after the week up to Feb. 8, put Pier Luigi Bersani’s center-left coalition in the lead, its margin over the center- right People of Freedom, led by Silvio Berlusconi, dwindling to fewer than five percentage points. Bersani should win the lower house, but you cannot rule out a Berlusconi upset -- already a three-time prime minister, he seems to have the political lives of a cat.
A Berlusconi-led victory in the Chamber of Deputies would result in an immediate market backlash. “Il Cavaliere” (the Knight), as Berlusconi is known, has a terrible track record for implementing the kinds of structural changes to the economy that Italy needs in order to boost growth and stabilize its mountain of public debt. Investors would immediately start to question whether Italy’s 127 percent debt-to-gross-domestic-product ratio is sustainable. They would dump Italian bonds, potentially forcing the government into a bailout.
A center-left victory in the Chamber of Deputies still looks more likely. Bersani’s coalition may have scored only an average 35 percent in the polls before Feb. 8, but under Italy’s election rules the party that attracts the most votes nationwide will get more than 50 percent of the seats in the lower house.
The composition of the upper house -- the Senate -- is much less clear, because there the majority-securing bonus for the winner is distributed not nationwide, but by region. And who controls the Senate matters, because it holds as much power as the Chamber of Deputies. Any law other than the budget can be drawn up in either house, and must be passed by both. A failure to control both houses in Italy can therefore mean gridlock and has led to the downfall of some governments.
Based on the (admittedly now out-of-date) polling data, it seems virtually impossible for the center-right to win a majority in the Senate. There is a chance that Bersani will win an outright majority in the upper house, too, though much will hinge on results in the Lombardy region, where the two traditional political groupings appear to be in a dead heat. To put it in U.S. terms, Lombardy is the Ohio of Italy’s election.
A victory for Bersani’s coalition in both chambers could make the process of making and implementing government decisions faster and easier. Italy has a history of political fragmentation and instability, averaging just less than a government a year since World War II. A coalition of a few like- minded parties could boost government effectiveness and stability.
However, even if a Bersani-led center-left government proved long-lived, it probably wouldn’t pass the reforms that are needed to make Italy more competitive. Bersani’s Democratic Party has close links with the country’s biggest labor union, the Italian General Confederation of Labor, which opposes many efforts to open up Italy’s labor market. Furthermore, his biggest potential coalition partner on the left -- Nichi Vendola’s Left Ecology Liberty party -- has talked about reversing the structural reforms that Prime Minister Mario Monti’s government of technocrats managed to pass.
The new government’s commitment to reform will be heavily scrutinized by investors, who will start to worry as soon as it appears that the process has stalled. A half-hearted agenda of changes to Italy’s labor and product markets would bode poorly for the economy. Structural reforms undermine growth in the short run before they eventually boost it. If implementation is drip-fed, the pain will stretch over more years than necessary and the boost to growth will be delayed.
For the bond markets and Italy’s economy alike, the best available election outcome would see the center-left failing to win an outright majority in the Senate and being forced, as a result, to pair with Monti’s centrist coalition. Monti’s participation in the new government would help to reassure investors, Italy’s euro-area partners and the European Central Bank that structural reform will stay on the menu.
Even a government with Monti won’t be cause for too much celebration, however, because it is only positive for Italy if the government can last. The more -- and more diverse -- parties there are in a governing coalition, the greater the opportunity for disagreement.
Monti and Vendola have diametrically opposed views on labor-market reform, the most important area where Italy needs to change. At times during the election campaign, the two men have declared that they will not work with each other. Monti is also at odds with some of the Democratic Party’s more left-wing politicians. Infighting and horse trading may result in a political impasse and topple the government.
This is an election in which the most politically likely outcomes are suboptimal. Voters will have to choose between a potentially stable government with insufficient commitment to reform, and a more pro-reform coalition with a greater likelihood of collapsing. I don’t envy Italians their choice, but of the two options a broader coalition involving Monti is preferable.
That’s because Italy has to change for its economy to grow, and there is a mechanism that might be able to keep the government together longer than the Italian average -- fear of the bond market.
At the first sign of a government collapse, investors would drive up Italy’s borrowing costs, forcing politicians either to risk pushing the country into a bailout program or to resolve their differences quickly. Snap elections are a euro cent a dozen in recent Italian history, but the potential cost of triggering one is much higher in the current environment.
Fear of incurring that cost may just be enough to keep a fractious coalition government together for long enough to deliver the changes that Italy’s economy so badly needs.
(Megan Greene is a Bloomberg View columnist and chief economist at Maverick Intelligence. She is also a senior fellow at the Atlantic Council in Washington. The opinions expressed are her own.)
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