Italy’s new government has a loose collection of contradictory policies that, if implemented, will quickly unravel.
That is the view of the senior economist who, until Friday, was on track to become Italy’s finance minister in the government of experts commissioned by the country’s president.
Marcello Messori, the director of the School of European Political Economy at Luiss University in Rome, stepped aside after the Five Star Movement (M5S) and the League – the winners in Italy’s recent general election – succeeded at the second attempt in hammering out a coalition deal.
As a quiet weekend beckoned, Messori was contemplating the list of ministers put forward by the coalition’s pick for prime minister, Giuseppe Conte – a little-known law professor who belongs to neither of the main parties and is not a member of parliament.
Conte was blocked earlier in the week by Italy’s president, Sergio Mattarella, from appointing a Eurosceptic economy minister – a decision that provoked the anti-immigration, far-right League and the anti-establishment M5S to walk away from the talks.
With emotions raw, Conte agreed to look elsewhere for an economy minister, and alighted on Professor Giovanni Tria, whose main claim to prominence was as president of the Italian National School of Public Administration, the main training ground for senior civil servants.
Messori fears that Tria and Conte will struggle to reconcile tax and spending policies that together could send the public deficit spiralling out of control. “We have a joke in Italy about having a friend who is a drunk and yet carries around a full bottle of wine. It’s a joke because it is impossible,” he says.
“The current contractual arrangement between the two parties is not only incompatible with European Union rules, but with economic stability,” he adds. “Smashing together their policies when they were not only very different but contradictory is a disastrous way to go about politics.”
The coalition is seeking to increase public spending on welfare and infrastructure while introducing a flat tax on individuals of 15% and on companies of 20%.
“The coalition is aiming to redistribute income to poorer households, but if you do it through the tax system in this way, the government will run out of money and the welfare payments they rely on will be cut, leaving them worse off,” he says.
Flat taxes are well known to offer huge benefits to those who pay the most tax, while households on low incomes gain only slightly. Initially, the government would also suffer a huge drop in income.
But difficult times deserve radical policies, says the coalition, which has even proposed creating a parallel electronic currency as a backdoor attempt to reduce the cost of Italian exports. The ratings agency Standard & Poor’s describes the use of such “mini-BoTs” – named after Italian Treasury bills, known as BoTs – as calling into question the survival of Europe’s monetary union and a “red alert” to international investors.
But there is plenty of economic data that shows the coalition can take its time before making any radical decisions. For one thing, it inherits an economy that in some ways is in better shape than at any time since the 2008 crash.
The country exports more than it imports, with the result that it had a balance-of-payments surplus of $46bn last year. The government runs a budget deficit that is low at 2.3% and falling. And its nominal growth rate – before inflation is taken into account – is faster than the rate at which it is borrowing, which means that Rome’s debt-to-GDP ratio is declining.
In its latest assessment, the Organisation for Economic Co-operation and Development (OECD) says that exports and business investment are increasingly driving a solid recovery. However, the report also gives the coalition plenty of ammunition if it wishes to assert that the economy needs radical medicine.
Italy’s GDP growth rate matched that of France and the UK last year, hitting 1.6%. But it is expected to fall to 1.4% this year and 1.1% the next. This arc of decline is partly explained by a decline in global growth. But it is also the result of structural problems that have dogged Italy’s economy for decades.
Low productivity is commonplace in regions outside the north-eastern powerhouse that runs from Milan across to Venice. Public investment is low and has been hampered in recent years as much by new public procurement rules as by tough spending limits.
The level of female employment remains low by OECD standards, and results in overall employment of 58%. By contrast, the UK’s employment rate is above 72%.
Tax rules remain byzantine, even by European standards, and mean that a start-up company can sometimes be told to pay crippling levels of tax, even amounting to 120% of its income. It’s no wonder thousands of business people try to hide their incomes until they have reached a size that takes them into a lower tax bracket.
Cronyism in public life, and nepotism in the private sector, remain rife despite the efforts of Matteo Renzi’s short-lived social democrat government to push through vital reforms to employment contracts.
Italy’s banks are stuffed with bad loans that the government has sought to alleviate, not by forcing them to write off debts, but by pumping more cash into their reserves. Last year, the government accepted an increase in its budget deficit from 1.9% to 2.3% as the price of boosting the banks’ balance sheets.
Unfortunately many of these institutions went back to their bad old ways and used the cash to buy Italian government debt. This can be justified only as long as the government is stable and the European Central Bank (ECB) acts as a guarantor.
Dhaval Joshi, chief European investment analyst at BCA Research, says that, as a rule of thumb, investors start to get nervous about a bank’s solvency when share capital – the funds held by shareholders – no longer covers net non-performing loans.
“On this rule, the largest Italian banks now have €165bn of equity capital against €130bn of net non-performing loans, implying excess capital of €35bn,” he said.
It follows that there would be fresh doubts about Italian banks’ solvency, Joshi says, if the bank’s own borrowings, which amount to €350bn, become more expensive to service. They could quickly find that €35bn is whittled away by extra borrowing costs, and that would trigger a further flight of investors.
The delicate state of Italian banks and public spending shows, Messori says, how carefully any Italian government must steer its course.
It’s a lesson that appears lost on M5S’s leader, Luigi di Maio, and the League’s Matteo Salvini, who is set to be sworn in as interior minister.
Within hours of their second attempt at forming a government receiving the green light, they were locked in a war of words with European commission president Jean-Claude Juncker, who told the new administration to fund its own spending programme for the poor south rather than look to the EU.
His comments followed those of European Central Bank vice president Vítor Constâncio, who said any extra funding by the central bank would come with the same set of strings attached as those offered to Greece.
It was a hard line that leaves the coalition on a collision course with its creditors. For a country with the third largest debt mountain after the US and Japan, the risks of a Greece-style debacle – only multiplied by 10 – cannot be discounted.