Italy After Berlusconi

The Italians have a knack for pathos and tragedy. After all, Italy has given the world the gift of Giuseppe Verdi and Gioachino Rossini. No other culture has ever managed to match the drama and pomp of Italian opera.

What the world has witnessed in the months and weeks leading to Prime Minister Silvio Berlusconi’s last curtain has been nothing short of an “opera buffa,” Rossini-style. With all the gaffes and other missteps that “Il Cavaliere” (“The Knight”) had to account for over his years in power, his announcement to step down is much less of a surprise than his long tenure is a miracle.

Much as Bill Clinton survived impeachment stemming from his episode with Monica Lewinksi, Berlusconi survived his trysts with Ruby Rubacuori (what a name!) and Noemi Letizia. Italians will not put down a septuagenarian prime minister for his display of virility, no matter how misguided his actions may have been.

Mr. Berlusconi also easily survived allegations of being connected to organized crime, of engaging in dubious business practices with his media empire and of abusing his power as the occupant of Palazzo Chigi, the official residence of the Presidente del Consiglio. Corruption is not unfamiliar territory in Italian politics.

It is truly remarkable that a man whose persona and performance as a politician are mired with so much controversy was able to stay in power for so long, especially seeing as how we are talking about Italy here, with its history of short-lived coalition governments.

Since the end of World War II, Italy has had 13 legislatures with 60 governments, led by 24 prime ministers, many rotating in and out of Palazzo Chigi multiple times. The average duration of Italian governments is just about 13 months, and Berlusconi’s three stints as prime minister have all been above that mark. His last government so far lasted three-and-a-half years, making Italy seemingly as stable and orderly as the United Kingdom, France or Germany.

But now, at long last, Italy’s political system has reached its breaking point. Members of the governing coalition, even those in his own party, have abandoned Berlusconi in droves. His government no longer has the support of the Italian parliament, and elections will have to be called as soon as practical to ring in a post-Berlusconi era.

One would think that this would give rise to a big sigh of relief not only in Italy, but also on international markets. After all, Mr. Berlusconi’s stubborn reluctance to accept reality by implementing true austerity measures to deal with an astronomical sovereign debt load was seen as a major problem for Italy’s credibility.

Interestingly enough, global bond markets have reacted in the opposite fashion. The uncertainty created around Berlusconi’s announcement to resign has sent Italian bond yields past the critical 7% mark. Even in his disgraced exit, Il Cavaliere has yet again managed to create a stir.

As much as Berlusconi’s departure is a welcome event, markets seem to have realized that Italy’s political and economic future is just as shaky as it was before — maybe even more so.

While Italy had a somewhat unreasonable and sometimes comical prime minister before, at least it had a government, and one of the most long-lived in post-war history, at that. Now, Italians will have to find a new government — and nobody seems to dare make predictions as to where voters will look for leadership.

Markets hate nothing more than surprises and uncertainty. While Berlusconi’s exit from Palazzo Chigi is hardly a surprise at this point, there is lots of uncertainty. Will Italy be governed by pro-business and pro-austerity conservatives, or will the next election produce a stalemate between the left and right, and a variety of special interests?

What will be the strength and role of the Lega del Nord (Northern League), which represents the bedrock of Italy’s industry? And will the elected parties find a compromise quickly enough on forming a coalition government and giving it a political mandate to take the critical steps to actively deal with the crisis?

Nobody has the answers to these questions at this point, and no date has yet been set for an election. This raises the issue of what the Italian President, Giorgio Napolitano, will do to install an interim government that stays on task as the country braces itself for hitting rock bottom.

The most recent rumor is that Napolitano will ask Mario Monti to step in until an early election sometime in February 2012. Monti is a business professor at Bocconi University in Milan and a former ranking member of the EU commission. Napolitano may just pick the right person for the job.

Just a few days after the world has witnessed the great tragedy of a falling government in Greece, we are now faced with the world’s eighth-largest economy in free fall. Italy is simply too big to fail and too big to be bailed out. All the problems we have diagnosed in Greece are magnified in Italy: Rome’s public debt sits at over €2 trillion, a number that is significantly larger than the amounts that Germany, France and Italy (irony of all ironies) have committed to the European Financial Stability Facility.

Rome’s debt represents 120% of Italian GDP. This is an unhealthy and unsustainable number, regardless of how one looks at it. But the issue is exacerbated by the fact that Italy’s economy is shrinking, not growing. With austerity measures in the works, the decline of the Italian economy will be even faster, as the public sector will contribute less to the nation’s GDP.

The private sector is unlikely to pick up enough steam through the next recession to make up for the difference and lead Italy back to growth. There are simply not enough purchasers of Prada shoes, Ferraris and Zegna suits in the world. And Fiat is a shadow of its former self, leaving much of the Italian car market to Volkswagen and the other German carmakers while pumping money in its Chrysler division.

Italy can neither rely on the private sector, nor on 1980s-style inflation to help it dig out of the staggering mountain of debt that has been piled up over the past few decades to fund an explosion of government programs. Structural rebirth is unavoidable. The state will need to shrink while raising taxes — and the population will have to work longer while making do with reduced pensions.