Italy’s Fateful Choice

With Mario Monti as prime minister and Giorgio Napolitano as president, Italy probably has its finest political leadership in generations. And, unless things change profoundly in Italian politics, it could also be the finest for the next 25 years or so. That is a rare asset that should not go to waste.

While Italians are beginning to have second thoughts on the path to reform, the world’s financial markets are wondering, in the words of Primo Levi’s famous book, if not now, when?

And if not the current prime minister and president, then who will be able to reset Italy in such a manner that the country can realize its true potential? These questions were the subject of intense debate at the annual meeting of the Council on the United States and Italy, held in Venice in early June.

Mr. Monti and his team have certainly labored hard to get Italy back on the right track. They have imposed pension reform, curtailed spending and, most recently, passed an investment package to stimulate growth. So far, so good.

But all of a sudden, Mr. Monti is seeing the political tide turning against him in the media and among Italy’s professional politicians. Voters are disgruntled about the spending cuts, and the reality of pension reform is sinking in as well. And now, Mr. Berlusconi, the buffoonish ex-prime minister, has spoken out that his party may try to pull the rug out from under Mr. Monti’s government at any time.

The world feels like it has seen this movie before. Over the past 50 years, whenever there was a rare moment when Italy seemed to be getting its act together, the domestic political landscape changed suddenly. Not only was further progress halted, but Italy has often marched two steps backward, giving back whatever progress it had already achieved.

Thus, beyond the markets’ inherent sense of alarmism, it is this fear of regression that haunts the sentiment toward Italy. At the same time, many other nations actually wish the country, and the highly-regarded Mr. Monti, well. This includes Germany.

Yet one wonders whether Italy’s politicians realize that they are liable to score an own goal if they now rear their heads too early and too assertively. The markets, in part resentful of their earlier laxity toward Italy, leave no doubt about their judgment that Italy still needs quite a bit of reform.

If Italy’s politicians don’t want to let Mr. Monti administer the medicine, then the odds are they will have to do so themselves — and likely under excruciating pressure from the markets. Knowing the often self-absorbed practices of Italian parliamentarians, one wonders whether they can recognize their self-interest in time.

It is certainly preferable to sit back and have Mr. Monti do it. That would leave the politicians in the enviable position of being able to blame the Monti technocrats — as well as the Germans and the eurocrats in Brussels — for the inevitable pains, strains and glitches along the reform path.

Symbolic failures

And if that doesn’t happen? Then count on a cascade of negative events raining down on Italy. There is a whole bunch of unfortunate parallels that the markets, justified or not, short-sighted or not, have already drawn up. These parallels, no doubt, greatly upset the Italians, who feel that these reactions belittle the depth of their own positive actions in areas such as pension reform.

For example, Mr. Monti’s government has failed so far to reform the professions. Italian analysts are right to point out that, in the bigger scheme of things, issues such as deregulating cab driver licenses and pharmacists’ locations have no appreciable macroeconomic significance.

Still, this failure is potentially devastating on a purely symbolic level. And it is precisely on the symbolic level that markets, in these fast-moving, reflexive times, base their judgments. Didn’t the Greek government also fail in its efforts to liberalize the professions? And doesn’t Italy, like Greece, also have severe problems with tax collections in the upper-income and wealthy strata of society?

Et voila, the parallel is constructed and the global media will not only eat it up, but play it up to the fullest possible extent. The trouble for debtor countries in this age of fast global communications is that not a lot of thorough analysis goes into market-moving judgments.

Italians are almost as sensitive to perceived parallels between their country and Spain as between Italy and Greece. They are quick to point out that Italian banks are more solid than Spain’s. But once again, in the potent politics of symbolism and in the knee-jerk drawing of comparisons, it is the issue of labor market reforms that will be seized on by the markets.

No doubt, Spain’s unemployment is far higher than Italy’s. But Spain, in the markets’ view, has undertaken significant labor market reforms, including stringent cutbacks on severance pay.

In contrast, in the heat of the battle over Italy’s labor law, Mr. Monti decided to give in to Susanna Camusso, the leader of the country’s most radical labor union, CGIL, which opposes virtually any change in layoff practices. The fact remains that there is still an excessive amount of legal procedures involved in any conceivable layoff measure, whether at the individual or group level.

A comparison to Germany is particularly telling in this context. Like Italy, Germany is not a country of weak unions. And both countries’ industrial structure is very similar, in that they both rely on a large number of family-owned, small- and medium-sized companies.

The crucial difference is that in Germany, when business turns down, there are virtually no restrictions on individual dismissals at smaller firms and clear-cut procedures for group dismissals at larger firms. In Germany, what is at issue is not the question of reinstatement or continued employment, but the right to receive severance pay and how much that pay will be.

In other words, entrepreneurial freedom in times of business downturns is basically not impeded in Germany, while this is at the core of the issue in Italy. If one adds in the Italian reality of living, as they describe it themselves, in a very legalistic and quite combative society, it dents the case that Italy has achieved any significant reforms.

Spain is in. Will Italy be out?

What all countries in the West have had to learn, at considerable pain, is that in the era of globalization, referring to national customs isn’t such a convincing excuse anymore. Conditionality, as things stand, doesn’t just apply to Latin Americans, Asians and Africans nowadays.

Why does this matter so much? Spain — under an elected, “non-technocratic” government — has more progress on labor market reforms to show for than Italy. Spain’s economic situation may well be worse than Italy’s, but from the perspective of the German government, Spain has a considerable credibility advantage.

Spain has committed to a profound consolidation/structural reform formula. Thus, in Germany’s and its partners’ eyes, Spain is now deemed worthy of protection under a European umbrella in its struggle with the markets.

By the same measure, Italy is not. There is plenty of resentment in Italy over that determination. But with the specter of a return of Berlusconi, the insistence by the markets and the Germans — as the ones most on the hook for providing the umbrella — on continued reforms is only getting stronger.

It is certainly true that reinventing Italy will involve far more than fiscal consolidation and labor market/structural reforms. In particular, Italy’s vast group of small- and medium-sized companies, as well as many of the country’s large corporations, must all do a lot more.

They must move beyond their often remarkably feudalistic structures. They cannot go on portraying themselves as victims of an overregulating government, globalization and a heartless Europe.

At the same time, one can only feel for the Italian people, who are caught in the middle of all these titanic forces. An economy — any economy — will only be successful if there is a realistic plan for creating economic growth, and if there is faith that there will be growth tomorrow, and the next quarter and next year.

This is lacking in Italy today. But eurobonds, even if they were to come to pass, are no cure for what ails Italy either. As Glenn Hubbard has pointed out, over the past decade Europe’s periphery has experienced the extremely low bond spreads that eurobonds would promise — with results that the entire world is now struggling with.

The challenge for Italy’s reformers is to make the reforms solid enough that a return of Silvio Berlusconi and his ilk could not undo them. That is a tall order indeed. But absent that, the markets won’t buy it — no matter what the Germans are thinking or doing — or not doing.