Not all that long ago, I wrote that the Eurozone would not last much longer. The formation of a new government in Italy is yet another hazard it must now face. The coalition of populists from both left and right are united by Euroscepticism. Though neither have called for exiting the EU, left wingers M5S have flirted with leaving the Euro. There are factions within the far-right League with similar ideas.
Yet the biggest danger to the Eurozone from this coalition does not come from outright opposition. The two parties appear to be attempting to combine the ideal of low taxes of the right with that of big spending from the left. It does not take an economist to explain that low taxes and high spending means heavy borrowing.
Eurozone fiscal credibility rules specify that the budget deficits of member states must be under 3% of GDP. The two parties do not seem to be too concerned by such rules. But Italy’s debt is already sky high – similar as a proportion of GDP than Greece’s at the point of their bail-out. The unlikely partners have even discussed asking the ECB to write off a significant proportion of the national debt. Such a measure would have severe consequences and the fact it is even considered shows the gravity of the situation.
Beyond breaking the EU’s rules with domestic policy, M5S and League seek deep changes to the EU itself. This includes not only a rethink of immigration policy, but reform to the entire single market. What makes Italy so dangerous is its population’s lack of desire to leave the EU. If it does not get what it wants, it will be a thorn in the side of the project from the inside. Unlike Greece, Italy is one of the Eurozone’s largest economies and cannot be ignored or bullied. The votes for this government were driven by a sense that EU policies were deeply unfair on Italy and, if the EU does not change the sentiment will only be reinforced.
What is remarkable is that financial markets are still relatively calm. If Italian government bond yields begin to skyrocket, it could represent the beginning of a new financial crisis. Any such crisis would not be contained in Italy alone, but would affect the entire Eurozone. At a time when the single currency is already fragile, a financial crisis is the last thing it needs. Indeed, some countries have not recovered from the last crisis. This list includes Italy, where GDP per capita is lower than it was before 2008.
There are two causes for the EU to remain hopeful. The first is the Italian presidency, the current occupant of which is strongly opposed to the new government. The position wields fairly extensive power and will cause the coalition to struggle to achieve controversial elements of its program.
Secondly, the EU can look to Italy’s history of less than long-lasting governments. It is possible that the alliance between two parties who hated each other during the election campaign will prove fragile. In this case, Italy may even end up with a new set of elections. The issue is, though, that the results may not be dissimilar. In fact, since the last elections the popularity of the populists has only increased in polling.
The extent of the damage to the Eurozone and EU project remains to be seen, then. But Italy’s government represents another setback. If the EU does not do something about the issues causing the popularity of Eurosceptics, it will not be the last.