Italy: Is there a way out of the woods?

Italy’s economic problems have been well documented: a gigantic public debt coupled with an embarrassingly low growth rate and an ageing population. These problems are not new - they are structural.

The current period of relief may prove short-lived since the ECB’s lifeline comes with a likely cut-off date. Italy is simply too big to bail. With its gigantic €1.8 trillion public debt, neither the ECB nor foreign governments can guarantee Italy’s finances in the long-term.

To shelter Italy from the markets, eurozone taxpayers would have to underwrite hundreds of billions of Italian public debt, either via the ECB or the EFSF (the eurozone’s bailout fund). An increase on that scale would face insurmountable opposition in the German, Dutch, Finnish and Slovakian parliaments.

This means that, for all the talk of European solidarity, Italy is left to its own devices. But it won’t be easy. Italy is stuck in the all too familiar situation of having an overvalued currency and inappropriate interest rates (ideally they should be close to zero now, not the ECB’s 1.5%) due to the single currency’s one-size-fits all monetary policy. Therefore, it needs to cut deeper and harder than, say, the UK to convince markets of the long-term viability of its debt burden – the unfortunate cost of sharing a currency with the likes of Germany.

So can Italy get back on the path to economic growth and show the world that it belongs inside the eurozone? Well, the game isn’t up for Palazzo Chigi quite yet - but time is quickly running out.

Pressured by both the ECB (who wanted some concrete austerity measures in return for buying Italian bonds) and the markets, Berlusconi and the Economy Minister Giulio Tremonti have committed to achieving a zero deficit by 2013 rather than 2014 as originally planned, through additional savings worth €45.5 billion. This is welcome, but now the key is to first get this new austerity package adopted by the Italian parliament and then, most importantly, implement it properly and push for pro-growth reforms. As we know all too well from Greece, it’s one thing to pass an austerity package - another to put it into practice.

Colossal challenges

If Italy is to get out of the woods, several things need to happen - and all of them throw up colossal challenges.

Berlusconi has to go: His premiership has descended into farce and his coalition government gets wobblier by the day, hostage to the sometimes ludicrous demands of the Lega Nord. When he addressed Italian MPs on the eurozone crisis, Berlusconi looked tired, powerless, sometimes disoriented. Unfortunately, Il Cavaliere seems determined to stay. Everyone will be the worse for it.

But Italy’s future is on the centre-right: Alas, the opposition is not in much better shape than Berlusconi’s rag tag coalition, with any centre-left government likely to have to rely on several small post-communist parties to get a majority in parliament - hardly a recipe for the successful labour market liberalisation that Italy so desperately needs.

Get the regions on board: The two austerity packages unveiled in less than a month have been with resistance from Italy’s regional administrations, which will be heavily affected by the proposed cuts to transfers from central government. As in Spain, a strategy needs to be put in place to convince the regions that these cuts are necessary.

Freeing up the labour market is essential: Radical reform of the labour market should be the top priority for any Italian government. Firing and hiring simply has to become far easier, which in turn lowers barriers to entering the job market. In addition, the tax burden on businesses should be reduced, particularly on SMEs where Italy’s economic strength lies. At the end of the day, Italy cannot live on austerity alone. It’s these kinds of reforms that will win investors’ confidence.

Stay the course: Having decided to bring forward the balanced budget target, the Italian government will most likely need to further dip into pensions. This is a huge challenge which will make the government even less popular. The opposition is now pushing the narrative that Italy is under the thumb of the EU, with key decisions being taken not in Rome, but in Berlin, Frankfurt and Brussels. As elsewhere in Europe, such a message is political dynamite. But the government needs to stay the course. If there’s one advantage to Berlusconi’s growing unpopularity, it’s that he can push through the necessary reforms.

There are a range of other things that need to happen. Not least, there needs to be a way to boost domestic demand, particularly with Italian exports losing ground on the world stage.

Will all these reforms take place? We shall see. But both Italy and Europe need to be fully aware of the consequences of Rome failing to deliver deep-rooted and necessary change. It’s time to finally bite the bullet or Berlusconi may soon have to add yet another, less than flattering point of note to his CV: bringing down the eurozone.

The author is a researcher at Open Europe, an independent think-tank based in London and Brussels, which calls for reform of the EU