Europe

The Looming Crisis in Italy


With low growth, chronic unemployment, and crippling public debt, Italy checks all the boxes for a looming financial crisis. Yet, with its upcoming elections next year and the rise of new players in Italian politics, the country faces even greater political risks. Policy makers would do well to pay attention to the risks that Italy poses to the eurozone and global economies.

Image courtesy of Pava, © 2012.

Since the 2007-08 financial crisis, Italy’s economy has experienced a triple-dip recession, meaning that its economy is still below the pre-2008 output levels. According to the International Monetary Fund, Italy will not recover its 2008 level until 2025, representing an entire generation of lost economic growth.

As Italy’s economy and its companies struggled during the recession, Italy’s share of non-performing loans grew. Between 2000 and 2017, the share of non-performing loans rose from 5.8 percent to 17.1 percent of the total loans. In contrast, only 1.3 percent of all U.S. loans are non-performing. As Italian banks accumulated bad debts, investment and rate of job creation slowed down, contributing further to the lack of economic growth.

Amidst the economic crisis and banking difficulties, middle- and lower-class Italians have suffered. Today, 38 percent of Italians in the labor force are unemployed. The conditions are even worse for its youth: one out of every two young Italians are unemployed. This condition is worsened by Italy’s declining labor productivity relative to the eurozone economies, most notably Germany.

As Italy’s government attempted to address this crisis by borrowing more heavily, government debt soared. With a debt to GDP ratio of 133 percent, Italy is now the second most heavily indebted nation in the European Union, second only to Greece. This increase in debt has constrained the government’s ability to undertake further public investment projects. It also means that Italy now has one of the highest debt servicing costs in the developed world, making the country particularly sensitive to an increase in such costs as a result of political risks and lack of investor confidence.

Indeed, political uncertainties leave little room for investor optimism. In the 72 years since World War II, Italy has seen 62 governments. The next elections are scheduled to be held by May 2018, in which the anti-establishment Five Star Movement is projected to win over the Democratic Party, according to the recent polls. The most likely political scenario is that a weak coalition government comprising unlikely partners will emerge.

If the next elections lead to a coalition between the non-partisan, anti-establishment Five Star Movement and its right-leaning counterparts, Forza Italia and the Northern League, it will raise serious question about Italy’s commitment to economic reforms and its continuing membership in the eurozone. For instance, the Five Star Movement wants to introduce universal income support for the poor. Given Italy’s already high levels of public debt, this policy would jeopardize Italy’s finances.

The euro’s future also remains at stake. The Five Star Movement wants to organize a referendum on the euro. Given the rising Euroscepticism in Italy, with only 58 percent of Italians—the lowest of any EU nation—approving of the euro, it is possible that Italians would vote to leave the eurozone if a referendum were organized.

While the euro has been bad for Italy’s economy, leaving the euro might further damage its already poor economic prospects. Since the country already has one of the highest debt servicing costs, the ensuing political uncertainty would prompt rating agencies to downgrade Italy’s bond ratings. Such a development would certainly spiral Italy’s debt servicing costs and wreck its economy.

To make it even worse, the size of Italy is likely to magnify the impact of a potential crisis. Because Italy is the third largest economy in the eurozone and is ten times the size of Greece, Italy’s sheer size will amplify the magnitude of the crisis.

Given its poor economic performance in the last several years, Italy needs strong commitment to reforms that will set its economy on the proper track. With its slow growth, high debt levels, and chronic unemployment, the last thing that the country needs is yet another protracted period of uncertainty as a result of the upcoming elections. In light of the risks that Italy poses to the eurozone, policy makers would do well to keep an eye on Italy in the upcoming months.

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