Economic Policy Challenges for the Next Italian Government
With low growth, crippling public debt, and chronic unemployment, Italy checks all the boxes for a major financial crisis. However, with the right economic policies, the next coalition government can turn Italy around and make the country more competitive in the global economy. To do so, the incoming Italian prime minister and the coalition government must commit to providing much-needed political stability and undertaking substantial fiscal and labor-market reforms.
Given the moribund state of Italy’s economy, the last thing that Italy needs is another protracted period of political uncertainty. Yet, despite having its elections on March 4, 2018, Italy has still not succeeded in selecting a new prime minister and forming a government. With the right-wing coalition, populist Five Star Movement, and the left-wing coalition gaining roughly 37 percent, 33 percent, and 23 percent respectively of the total votes, no single party has enough votes to form a majority government. Although who will lead Italy remains unclear, the incoming government must heed the economic challenges that the country faces.
Since the 2008 financial crisis, Italy has experienced a triple-dip recession, and its economy is one of the only two European Union (EU) economies still below the pre-2008 income levels. In comparison, per capita incomes of France and Germany have grown by over 18 percent since 2008. Unemployment remains high, especially for young Italians. With one in five youth unemployed, Italy has the highest youth unemployment rate in the EU.
As the economy struggled and policymakers attempted to stimulate growth by borrowing, the Italian government rapidly accumulated debt. As a result, public debt now accounts for nearly 135 percent of the country’s gross domestic product (GDP), the second-highest such ratio in the eurozone. Such a high debt burden significantly constrains the Italian government’s ability to enhance economic growth by undertaking public investments.
At the same time, due to the accumulation of bad loans, the country’s banks are on the brink of disaster. In the last several years, Italian banks accumulated more than €360 billion of non-performing loans. As a result, 17.1 percent of Italy’s banking loans are sour, which is nearly 10 times worse than the U.S. level at the height of the 2008 financial crisis.
Given the scale of its economic challenges and political uncertainties, the Italian government must ensure much-needed political stability. Since 1945, Italy experienced 62 governments, with an average tenure of only 1.2 years per government. The resulting political instability, along with relatively high levels of corruption and government regulations, means that the country is an unattractive location for foreign investment. In 2016, inward foreign direct investment stock in Italy accounted for only 19.5 percent of its GDP, the second-lowest such ratio in the European Union, after Greece. To attract foreign investment and help create jobs for ordinary Italians, the new government must reduce political risks for foreign investors in the country.
To assuage investor fears about political risks, Italy would have to strengthen its commitment to the euro. While the euro has been bad for Italy’s economy, leaving the euro will further damage its already poor economic prospects. Due to its high levels of public debt, Italy already has one of the highest debt servicing costs among the advanced economies. As a result, the country is particularly sensitive to a substantial increase in borrowing costs. Leaving the euro—as the leading Five Star Movement formerly advocated and the Brothers of Italy still advocates—would likely prompt rating agencies to downgrade Italy’s bond ratings. Such a development will spiral the country’s cumbersome debt servicing costs and wreck its economy.
Despite populist pressure to abandon fiscal discipline, the next Italian prime minister must also continue the last two Italian governments’ commitment to reducing public debt, which has helped Italy achieve modest growth since 2015. Labor market reforms—providing more flexibility to hire and lay off workers and increasing women’s participation in the labor force—will also help Italy improve its economic competitiveness and achieve stronger economic growth.
As Italy strengthens its commitment to such reforms, the government must not cave into pressure to introduce more generous employment benefits. It would also be a singularly bad idea to introduce a universal basic income of €1,000 ($1,222) for 59 million Italians as Forza Italia advocates. While such policy proposals might garner popular support, the country can ill-afford such expensive programs right now without jeopardizing its already precarious finances.
As the Eurozone’s third-largest economy, Italy has great potential. It now needs economic policy leadership that will pursue critical reforms and help its economy get back on the right track. As Italians brace for the new coalition government, the new prime minister must provide Italy the leadership that the country needs to thrive in the global economy.