Is Italy a weak link in Europe? Such fears have been often expressed in the past – witness Italy’s many changes of government and strong communist party in the Cold War era – yet nothing approaching a collapse occurred. Far from being a Trojan horse, Italy was one of the more solid members of the Western alliance, for all the surface turbulence of its political scene.

Today the Italian experiment with a left-right populist government, formed from an unlikely alliance between the leftist Five Star Movement (M5S) and the anti-immigrant, nationalist Lega (formerly the Northern League), is raising similar concerns, sending “ripples throughout the European Union and financial markets,” as GIS expert Enrico Colombatto wrote in an October 2018 report.

Abortive reforms

Italy’s current political predicament began with the leftist government of Prime Minister Matteo Renzi (2014-2016). Mr. Renzi and his Democratic Party, to their credit, promised to address Italy’s economic malaise – especially restrictive labor laws that kept workforce participation the lowest in the EU (36.4 percent) – via deregulation and revamping the country’s inefficient government.

However, the Renzi government’s trademark Jobs Act (2015), while simplifying employment contracts and making hiring and firing easier, was too limited to make an impact. As Professor Colombatto noted in a February 2016 report, such tinkering reflected “a self-delusion common in Europe” that the unemployment problem would simply “vanish due to faster economic growth and demographic trends.” What was needed was a more radical overhaul – sweeping away regulations and shaking up the educational and pension systems – to restore business confidence and create jobs.

But even that modest start showed something important, as Professor Colombatto pointed out. The lack of widespread public hostility toward the Jobs Act showed that many Italians – perhaps out of desperation – were ready to consider deregulation and even bolder measures. But Mr. Renzi did not follow through. Instead, he proposed a self-interested constitutional reform, which as GIS expert Dr. Alberto Mingardi noted in a June 2017 report, tried to streamline Italy’s governance without restructuring the country’s dysfunctional political system. Failure to pass it in December 2016 ended Mr. Renzi’s two-year premiership.

‘Populist’ majority

This loss of nerve accelerated the erosion of Italy’s mainstream parties and opened the way for antiestablishment movements – especially comedian Beppe Grillo’s idiosyncratic M5S, which tapped 31-year-old Luigi Di Maio as its new leader in late 2017, and Matteo Salvini’s Lega, whose euroskeptic, anti-immigrant line turned it from a regional party to a national force on the right.

Unlike most European countries, where such movements were doomed to the political margins or to junior partnerships with established parties, widespread disillusionment with the self-serving nature of Italy’s political elite – reinforced by the 18-month “technical” government of Prime Minister Paolo Gentiloni (2016-2018) – allowed M5S and Lega to harbor larger ambitions. By mid-2017, Dr. Mingardi predicted that it was entirely possible for the next election to produce a “populist majority” in parliament backed by more than 45 percent of the vote – adding that this total could be an understatement. (His prediction was spot-on, as M5S and Lega ended up polling 32.7 percent and 17.4 percent, respectively, in the March 2018 elections.)

Ties that bind

The ability of two counter-systemic movements to eject the established parties from government is what makes Italy unique among the EU’s major countries. Just as surprising is how two parties with such disparate ideological origins and constituencies could manage to cohere.

At bottom, M5S and Lega owe their success to a revolt against EU management – of the eurozone’s financial and debt crisis, which both parties refer to as “austerity” policies, and of the failure to protect against and share the burden of illegal immigration. This euroskeptic alliance of the left and right was cemented by a shared sense of grievance, and – at least on the part of Mr. Salvini – ambitions to overturn the alleged Franco-German domination of EU power structures.

Once in power, the M5S-Lega government – led by Prime Minister Giuseppe Conte, a Florentine law professor – dropped all talk about taking Italy out of the eurozone. But the migrant crisis provided more durable political fuel, especially for Mr. Salvini, who took the post of interior minister and promptly closed his country’s ports to rescued migrants. Partly this represented weariness with the almost 600,000 migrant arrivals via the Mediterranean in 2015-2017 (though this pales beside Germany’s 1.54 million arrivals in 2015 alone). Yet most of these migrants viewed Italy as a transit country, not a destination, while they represent perhaps the only way to plug the country’s negative demographic balance and provide new workers to support the social security system.

Even so, 42 percent of Italians polled in 2016 saw immigration as the country’s biggest challenge (second to unemployment, at 47 percent), and it was clear early on that the issue would decide the 2018 elections, GIS expert Alberto Mingardi noted in October 2017. Particularly telling was an increasing tolerance by the traditional hard-left M5S of crackdowns on migrants by the local authorities, which anticipated the party’s later decision to ally with the anti-immigrant Lega.

Tapping into these fears helped overcome what many saw as the ideological incompatibility of the two parties. The Italian case also shows migration’s transformative effect on European politics, as GIS expert Teresa Nogueira Pinto pointed out in a February 2019 report, because it is “fostering new political alliances based on euroskeptic and nationalist principles.”

Backward looking

At the same time, Italy’s “populist” parties nicely illustrate a feature of similar movements around the world – a yearning to preserve prized elements of the past. This gives the appeal of these ostensibly radical parties, even the left-leaning M5S, a distinctly status quo tinge, as Dr. Mingardi explained:

Widespread dissatisfaction with the Italian political class, perceived as self-referential and corrupt, has been feeding the M5S’s growth. The movement is sharply critical of the EU and what it calls its “austerity” policies. Its political program resembles an extreme left platform, with a touch of skepticism about the benefits of economic growth. In day-by-day political practice, however, Five Star tends to side with Italy’s established interest groups, from powerful trade unions all the way to taxi drivers. Somehow, its vociferous denunciations of the powers that be do not seem to apply to organized labor and public servants – groups that are part and parcel of this establishment.

This led the GIS expert to conclude in a July 2018 report that the experiment of a “left-right populist government could end up as a disguised version of more business as usual, or in an utter disaster.” Now that relative fiscal responsibility of Prime Minister Conte and his economic team have taken an immediate financial crisis off the table, the business-as-usual option seems even more likely.

But while that might sound vaguely reassuring, it only perpetuates the practice that got Italy in trouble in the first place. Forming governments at the cost of constant haggling and bargaining, including with the bureaucracy, traditionally led to “higher spending and, ultimately, the crushing public debt that still oppresses Italian taxpayers,” as Dr. Mingardi noted in June 2017. Even the short-term tax relief proposed by the Conte government is no substitute for structural reforms that leaders like Silvio Berlusconi failed to deliver over the past quarter-century.

European template

Italy’s antiestablishment alliance of left and right could become a template for European Parliament elections this year. The combination has already been tested in Greece (though the Independent Greeks are just an add-on to the radical left Syriza alliance) and in few other countries.

A more typical pattern is Spain, where alternative parties of the left (Podemos) and center-right (Ciudadanos) have been willing to form alliances with mainstream partners. Even so, the erosion of establishment parties has prevented the formation of durable governments – as the recent collapse of Prime Minister Pedro Sanchez’s Socialist-led coalition shows.

The Italian case shows the possibility of a different path – especially as its ruling coalition defies predictions that it would fly apart. After nine months in office, Prime Minister Conte’s government is more popular with voters than the six previous Italian cabinets at equivalent stages in their terms. This creates a pan-European opportunity for antiestablishment parties this year, with the European Parliament holding new elections in May and nearly all the EU’s leading institutions – the European Commission, the European Council and the European Central Bank – set to renew their leadership.

As GIS expert Dr. Michael Leigh noted in a January 2019 report, the “grand coalition of conservatives and socialists that has dominated EU institutions since the 1980s might lose its majority,” leaving an opening for a more exotic alliance of liberals, French President Macron’s “Europe on the Move” and Spanish conservatives in Cuidadanos. The euroskeptics and nationalists are poised to make even bigger gains, which could give them a seat at the table to allocate top EU posts and shape policies.

A grander vision has been presented by Matteo Salvini, who over the past year has managed to double Lega’s popular support (eclipsing M5S in several polls) and is emerging as the government’s leading strategist and power broker. He envisages a broader disruption of the EU institutions – a new “European spring” that sweeps out the old bureaucrats and ways of doing business. At the very least, judging by the growing antagonism between Rome and Paris over migration that recently led to the recall of the French ambassador, the political changes in store this year may result in an even more fractious Europe.

‘Necessary disruption’

Italy is a precursor in part because it was among the first of Western Europe’s countries – in the 1990s – to experience a crisis of the political parties that shared power after World War II: the Christian Democrats and the Social Democrats (or in Italy’s case, the communists). Increasingly hidebound and trapped in a program of welfare handouts to buy the favor of their clienteles, these parties failed to address Europe’s underlying problems. Voters were rightly fed up with this establishment, as Prince Michael of Liechtenstein noted in a March 2018 comment.

GIS’s founder expanded on this point in June 2018, regarding market fears that an inexperienced new government could trigger a sovereign debt crisis: “Experienced politicians put Italy into these dire straits. It is hard to imagine that a newcomer would make matters any worse.” Instead, the lesson to be drawn is that Italy “needed to shake up its usual political process. … It may prove painful or even dangerous, but disruption is its only chance for eventual improvement.”

According to this argument, what the Italian case exposes is not national weaknesses but those of the EU’s leadership. The rule of so-called populists in Rome is less of a threat to Europe’s security than to its conventional wisdom – political, financial and strategic.

Debt: fragile equilibrium

While the euro area’s overall public debt ratio declined to 86.1 percent in the third quarter of 2018 (the latest period for which figures are available) from its 2014 peak of 92, that of Italy has remained stuck at 133 percent, the second-highest in Europe after Greece’s (182 percent).

Yet the new government has not dramatically widened the budget deficit – targeted at 2.4 percent of gross domestic product this year, falling to 2.1 percent in 2020 and 1.8 percent in 2021. Economy and Finance Minister Giovanni Tria is a rather prudent Keynesian, not an extremist.

The key risk is rising interest rates; for now, as Professor Colombatto pointed out in October 2018, almost all EU economies “can refinance their long-term debts at fire-sale prices.” (Italy even managed to sell a 50-year bond in 2016, showing how investors saw the chances of a euro area sovereign default as minimal.) This could change if euro-area borrowing costs started to climb to U.S. levels or higher, something the ECB has done everything in its power to avoid.

The real problem, as Professor Colombatto explained, is that European governments have tried to stave off political challenges by accessing “the euro printing machines” and bailouts – the old ambition of an extended welfare state. “Advocates of irresponsible economic policymaking have found increasingly receptive audiences, while the EU authorities have failed to react,” he concluded.

The debt burden and current policies are sustainable as long as the economy and markets muddle through. But once they weaken, as must eventually happen, “the outcome is trouble, possibly disaster,” Professor Colombatto wrote.

Systemic failure

A tough, no-bailout policy from the central EU authorities might have a cleansing effect on Italy, forcing politicians to take responsibility for the government’s fiscal reputation and its impact on Italians’ financial well-being. But the trial run of the EU’s restrictive bail-in policy for commercial banks – the rescue of Italy’s Monte dei Paschi di Siena (MPS) – ended in failure, showing the streak of “protectionism and anticompetitive attitudes” that underlie regulators’ thinking.

Here the interests of Brussels and Europe’s rising populist movements could come “ominously close,” as Professor Colombatto notes. EU bureaucrats may be emboldened to build “even wider and more credible safety nets in exchange for greater power of national fiscal policies,” which spineless governments may be tempted to grant. Here Italy could influence policy much more powerfully than smaller “Club Med” countries like Greece or Portugal. Quite simply, its economy is large enough to drag down the whole euro area.

Southern exposure

The strains are also showing in foreign policy, where France and Italy – the main pillars of the EU’s southern flank – are working at cross-purposes. This is especially apparent in Libya, examined by GIS expert Dr. Federica Saini Fasanotti in a September 2018 report. France has taken the diplomatic lead in trying to install a national government through elections, even though Italian skepticism about this feasibility of this goal – buttressed by its colonial experience and contacts on the ground – may be more justified.

As Rome and Paris squabble (with each country’s substantial oil and gas interests in Libya playing a role), Moscow is providing military assistance to the Tobruk government and Field Marshal Khalifa Haftar. This is part of a wider Russian push to extend its reach in global energy through national champions like Rosneft and Rosatom. China is also lurking in the background, intent on its own strategy of securing access to raw materials in Africa.

‘Harmless dalliance’

Mr. Salvini’s outspoken praise of Vladimir Putin, along with M5S’s own pro-Russian sympathies, have led some to worry “that Italy could turn out to be the weakest link in the Western alliance’s resistance to Russian misconduct,” Dr. Leigh wrote in a May 2018 report. Yet for the past half century, as he noted, Italian leaders have always fancied their country as a bridge between East and West.

This goes well beyond the prominence of the Italian Communist Party (PCI) in the 1970s. It is a long-standing fact, based in part on geography, that most Italians do not perceive Russia as a threat, Dr. Leigh observed. Even as mainstream a figure as Romano Prodi, the former European Commission president and Italian prime minister, called for the immediate lifting of sanctions against Russia.

“Successive Italian governments have sought closer links with Moscow, mainly to advance business and/or personal interests,” Dr. Leigh wrote. “But whoever governs in Rome, Italy will continue to be subject to numerous political, institutional, financial, business and security constraints that bind it to the Western alliance.”

This jibes with Professor Colombatto’s assessment from May 2018:

Over the past decades, Italy has never played a major international role but has always remained loyal to the Western alliance. This will not change. Mr. Di Maio, once a self-proclaimed anti-Westerner, has already flipped and paid homage to NATO. Mr. Salvini of Lega still insists on being Vladimir Putin’s friend. Yet the dalliance is fundamentally harmless, serving only to confirm that he (much like Italy) is a foreign policy lightweight. … Italian leaders may perhaps drag their feet to appease some voters, but they will not tune out Brussels or Washington. With no idea of what would constitute a genuinely Italian raison d’etat or geopolitical view, they cannot afford to do so.

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