Italy's future government promises to break with the past. The incoming coalition, made up of the anti-establishment Five Star Movement and the right-wing League party, has plans to reverse years of austerity measures, reassess Italy's foreign policy priorities and renegotiate its links with the European Union. Many of the items on its agenda are expensive. Initiatives such as reducing the income tax, increasing subsidies for poor families and abolishing a recent reform that raised the retirement age, for example, stand to drive up public spending while diminishing state revenue. These measures could also deepen Italy's deficit — not a minor concern for a country whose public debt exceeds 130 percent of gross domestic product. More important, the Five Star Movement and League want to revise the EU economic governance framework, including the rules that establish debt and deficit limits for member states. Some of the proposals included in the coalition agreement could lead to the eurozone's disintegration if implemented.
Proposing policies and putting them into action, however, are two different things. To implement its agenda, the Italian government will have to overcome formidable challenges, not least of all the differences between the ruling coalition's constituent parties. But even if it doesn't bring about the end of the eurozone, Italy's new administration will force EU governments and institutions to make difficult choices.
Stratfor has long asserted that Italy is an important country to watch for the rise of populist and Euroskeptic political forces. The country's recent general election was a victory for these forces, and now Italy is close to having a government that opposes EU fiscal rules. In our 2018 Annual Forecast we said that the next administration in Rome would push to renegotiate the European Union's economic governance. Now the first signs of that initiative are starting to emerge.
Will It Work?
To some extent, whether Italy's new government can realize its policy goals will depend on whether the coalition can stay together. The two parties that make up the alliance answer to different electorates, after all, and have different priorities. The League is ideological, with clear stances on issues such as immigration and national sovereignty. The Five Star Movement, by contrast, is more pragmatic and willing to adapt its platform based on which way the political wind is blowing. The League has experience with power, governing wealthy regions such as Lombardy and Veneto, whereas the Five Star Movement consists mainly of people with little or no history in politics. And although the League has recently dropped the word "Northern" from its name, it still maintains its ties to Italy's industrial region in the north, its electoral stronghold. Many of the party's supporters have negative views of the country's relatively poorer south — where the Five Star Movement and its promises of new subsidies are popular.
Further complicating their partnership is the fact that both the League and the Five Star Movement aspire to govern Italy alone someday, and to absorb the disenchanted voters from the country's moribund traditional parties. This ambition means that the two parties will make policy decisions in the current government with an eye to the next general election, which could happen well before the end of the legislature in 2023. The Five Star Movement's advantage in the Chamber of Deputies, where it controls 222 seats compared with the League's 124, is misleading because the League sees this as a government of equals. As a result, each party can just as easily threaten to bring down the government in the event of a major rift over policy. Even the election for the next European Parliament, scheduled for mid-2019, could stir up trouble between the two parties, since they will probably run separately.
Merely staying together won't necessarily be enough to let the government achieve its goals, though. Many Italian leaders have come to power with lofty promises of reform only to hit a wall thanks to a political system designed to make governments weak and the policymaking process complex in an effort to prevent the rise of another authoritarian regime. The heads of Italy's new government may be sincere in their intentions to shake things up. But the country's massive bureaucracy, vested interests and parallel centers of power (including unions, business lobbies, the Roman Catholic Church and the Mafia) will be as difficult as ever to overcome.
Words Not to Be Taken Lightly
Nevertheless, for the European Union, Italy's government is a source of concern. The Five Star Movement and the League have pledged to return to what they call "a pre-Maastricht Europe," referring to the 1992 treaty that created the European Union. Given all the Maastricht Treaty accomplished on the Continent, deepening the process of integration and laying the foundation for the eurozone, the promise carries a lot of weight. The Five Star Movement and the League see the euro, and even more so the fiscal targets attached to it, as a straitjacket that confines the Italian economy and undermines growth. From their standpoint, the euro has deprived Rome of the option to apply monetary policy to cope with crises, while EU fiscal rules have hindered countries from using public spending to generate growth. The League and the Five Star Movement have also described the European Union as an undemocratic entity whose ability to interfere with the domestic affairs of member states must be curtailed.
Though Italy has a tradition of petitioning the European Commission for flexibility in its budgetary rules, the new government's enmity toward the European Union is a departure for a country that co-founded the European project seven decades ago. Public spending has long been important to Italy as one of the factors keeping the country together while geography, history and culture constantly threaten to break it apart. Even so, Italian leaders for the most part have presented European integration to voters as a project worth fighting for. Some even saw the EU fiscal rules as a necessary check on Italian politicians' tendency to overspend. That political consensus now seems to be over, after years of low growth and high unemployment have eroded trust in the European Union and in the political parties that back it.
Italy's massive bureaucracy, vested interests and parallel centers of power (including unions, business lobbies, the Roman Catholic Church and the Mafia) will be as difficult as ever for the government to overcome.
Over the past few months, the Five Star Movement and the League have toned down their anti-euro rhetoric, pledging to keep Italy in the currency area. The final coalition agreement also eliminated some controversial proposals that appeared in earlier drafts, such as a call for the European Central Bank to forgive part of Italy's sovereign debt and a request that the European Union establish a road map for exiting the eurozone. The omissions are probably due to the fact that most Italians are worried about the consequences of abandoning the currency area, whatever their criticisms of the euro. Still, the Five Star Movement and the League probably will use the threat of taking unilateral action on issues related to the eurozone as a bargaining chip as they push for more spending room.
A Familiar Story
In its promises and objectives, Italy's new government resembles that of Greece, which took over in early 2015 with a vow to end austerity and to renegotiate their country's debt. (The Greek government, of course, not only failed to get what it wanted, but it also had to ask its creditors for another bailout — hardly a performance for Italy's leaders to aspire to.) But Italy has a much larger economy than Greece does. As a result, the prospect of its departure from the eurozone poses a much bigger threat to the currency area's continuity than does the possibility of a Greek exit. And the real danger for the eurozone is that Italian leaders know their country's weight and could use it in their negotiating strategy. The problem with threats, however — especially those involving a country's financial future — is that they could spiral out of control and cause unintended consequences.
Italy's Euroskepticism is not an isolated case, either. In countries such as Poland and Hungary, the governing parties also support turning the European Union into more or less a club of sovereign nations that cooperate on issues of their choosing. The difference for Italy is that Euroskepticism has finally reached a core member of the eurozone, raising the stakes for the currency area higher than ever before. For France, which for the past year has been trying to reform the eurozone to make it more resilient to future crises, this development is bad news. Paris will have a hard time selling Northern European governments on its measures to increase financial risk sharing in the eurozone, including proposals to create a European Monetary Fund and to introduce a common deposit guarantee for eurozone banks, with Italy's government publicly denouncing EU fiscal rules.
For the European Commission, the news is even worse. Renegotiating EU economic governance structures as the Italian government has demanded would be almost impossible, since it would endanger the eurozone's continuity. A more realistic scenario would be Brussels' turning a blind eye to Italy's economic policies, at least for a while. But doing so would anger governments in Northern Europe and fuel Euroskepticism in the region, which mistrusts the south as it is. If the situation deteriorated enough, Northern European countries could even leave the currency area out of fear. At the same time, remaining inflexible to Rome's requests could escalate the conflict and lead Italy to take action that also would hurt the eurozone.
The third option is scarcely better, though it's one the European Union could live with: an unstable government in Italy that fails to get anything done because of the country's internal contradictions and institutional constraints. This outcome would temporarily neutralize Italy's threat to the bloc and to the eurozone, but it would also weaken Italy's ability to influence EU affairs, prolong the country's economic malaise and do little to appease Italian voters disillusioned with the status quo at home and in Europe.
If the next Italian government manages to implement every item on its agenda, the eurozone will be in danger. If it fails, a disappointed electorate could return to the traditional parties in the next election — or choose more radical leaders who are more willing to take unilateral action regardless of the effect on the eurozone. Either way, one thing is clear: Despite the reprieve that Emmanuel Macron's victory in last year's French presidential election and Angela Merkel's reappointment as German chancellor this year brought the European Union, the forces of Euroskepticism are alive and well in the Continent's political and economic core.