Italy will have a new government. Enrico Letta, Italy’s prime minister for the last ten months, has resigned. A young reformer, Matteo Renzi, takes his place. To the extent that Renzi has stressed the need for structural economic reform, many see the change as reason for hope, not just for Italy but for Europe generally in this crisis. But experience also advises that observers and participants also prepare themselves for despair. Renzi, after all, is relatively inexperienced, with few ties to Italy’s powerful interest groups, most particularly organized labor, and it is on these shoals that reform plans have foundered in the past.
It is largely impatience with Letta’s cumbersome coalition that enabled Renzi to rise. When Letta took office ten months ago, he had to cope with a highly Balkanized political situation and a widely divided electorate. The coalition he formed between his socialist Democratic Party and Silvio Berlusconi’s center-right People of Liberty Party aimed to span what may well have been an unbridgeable divide. He said that his government would continue both budget restraint and pursue the structural reforms outlined and partially instituted by former prime minister Mario Monti. At the same time, he set out to mollify the intense opposition to many of the reforms and to austerity. The ungainly mix accomplished little. Renzi for months had ratcheted up pressure on the government, threatening to bring it down unless it advanced a more active reform agenda. When, earlier in February, Renzi rejected the government’s revamped reform agenda. Letta resigned. Now Renzi has formed a government.
Renzi’s rhetoric certainly sounds encouraging to pro-reform elements in Italy and elsewhere in Europe. He has hit on well-known elements advanced by Monti, recommended by the Organization for Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF), and successfully implemented in Germany a decade ago. His program would: (1) improve the competitiveness of Italian business and encourage hiring as well as business expansion by cutting payroll and business taxes, the so-called tax wedge between the cost to business of an employee and a workers’ take-home pay; (2) cut wasteful public spending and rationalize work incentives by consolidating welfare and unemployment benefits; (3) encourage business to hire more freely by easing stringent hiring and firing rules; and (4) increase efficiency and competitiveness by encouraging company-by-company instead of national wage negotiations. He has at times also alluded to judicial reform to shorten the time it takes to enforce a contract, currently more than twice as long in Italy as the average of developed economies. And he has spoken of political reform to stop the revolving door of governments that have typified Italian politics since 1945. On these last two matters, however, he has remained vague.
His stump speech casts reform as an alternative to budget austerity. The implication is that Italy needs to abandon the latter in order to reach for the former. To a great extent, this is a false choice. Provided that government can cut spending, presumably of the wasteful sort, to offset the effects of payroll and business tax relief, it should have the ability to pursue both agendas simultaneously. Still, couching things as a choice might aim at the European Union’s strict budget rules. Since reform steps cannot be expected to have all their effects simultaneously, any nation working on such a program can expect to exceed strict deficit targets occasionally. Even Germany’s reforms of some ten years ago required grace from the EU’s strict rule that no nation’s budget deficit can exceed 3 percent of its gross domestic product (GDP). With just such needs in mind, Dutch finance minister Jeroen Dijsselbloem recently proposed that the EU grant latitude from its budget rules to nations that can show that they have implemented structural reforms. Renzi may be thinking along such lines, or perhaps he is just reaching, understandably in Italy’s political climate, for a way to sell reform to a skeptical public.
Whatever the ambiguity here, financial markets so far have treated Italy well. A recent large auction of Italian government debt, while Letta’s government struggled but had not yet resigned, sold €3.0 billion of ten-year bonds at a borrowing rate of only 4.11 percent, a mere 2.5 percentage points above in the rate Germany pays. Some might see this behavior as a vote of confidence. If it is, it concerns Italy’s prospects less than it does the promises of the European Central Bank (ECB) to support Italian borrowing with its own purchases if necessary. After all, ECB president Mario Draghi stated that under him the bank would do “whatever it takes” to protect the euro. It also no doubt reflects the growing consensus that Germany will, if necessary, back such periphery countries as Italy because of its own exposure to their debt and the benefits if derives from the union and the common currency. Whatever the reason, however, the low rates can help Italian recovery efforts and the associated reforms.
Unless Renzi is a magician, his new government will need all the help it can get. His relative inexperience, as mentioned, and his lack of connection to Italy’s powerful interest groups almost assures that his ambitious program will fail, at least in part, as structural reform has so many times in the past. The best a reasonable person can hope for is a partial implementation of reform. Partial reform is, however, worth something. It would improve Italy’s economic prospects, at least marginally, and perhaps lay the groundwork for future, more complete efforts. But though a partial solution would help, it would still leave Italy dependent on EU and ECB support—that is, on German support—and so still subject to Berlin.
Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. He is the author of Kawari, a book about Japan’s economic and financial challenges. His new book, Thirty Tomorrows, linking globalization to aging demographics, is forthcoming from Thomas Dunne Books of Saint Martin’s Press.
Image: Flickr/Ed Yourdon. CC BY-SA 2.0.