Italy on the Brink

Will a debt crisis force Italy to go the way of Greece?

An embattled prime minister struggling to hold the government together. Rocketing public debt. An economy on the brink of collapse. That may sound like a description of Greece, the most recent sick man of Europe, but it sums up equally well the dire political and fiscal realities facing Italy, where the government of Silvio Berlusconi this week was clinging to power as the country’s debt crisis spiraled out of control.

It would be difficult to overstate the extent of Italy’s problems. Although the third largest member of the Eurozone, Europe’s 17-member economic and monetary union, Italy appears headed for a Greek-style financial calamity. Weighed down with a runway public debt of $2.6 trillion, a figure more than 120 percent of GDP, Italy has indulged in a massive borrowing spree. Now the borrowing has reached danger levels. Borrowing costs, as measured by Italy’s interest rates, rose to 6.67 percent this week, the highest since the euro was established in 1999. For some perspective on that number, consider that it is around the same level that forced Greece, Ireland, and Portugal to seek bailouts from the European Union and the International Monetary Fund. Alarm is growing that Italy could be the next country to need rescuing – a strain that, given the size of Italy’s economy, would almost certainly overwhelm the other Eurozone countries and send shockwaves throughout global markets.

Italy’s current troubles are a long time in the making. Financial analysts have long urged the country to overhaul its rigid labor market, which makes it difficult to hire and fire workers. That in turn contributes to high unemployment, particularly among the country’s youth, and stalls economic growth. Combined with Italy’s plunging birth rates, the effect is to tilt the ratio of pensioners to workers heavily toward the former. By some estimates, Italy’s retirees will actually outnumber its active workers by 2030. The future looks as bleak as the present.

Resolute action does not seem forthcoming, however. Partly out of fear of the country’s powerful government labor unions and partly out of a refusal to undertake unpopular reforms, successive Italian governments have done little to change the status quo. Berlusconi has been no exception. Forced by market pressures, his government passed a modest austerity package in August, but there is no evidence that it has the will or the political support to implement it. Due to defections in his party, Berlusconi does not have the backing needed to pursue reforms. It is not even certain that Berlusconi will be around to see them through. This week he barely survived a no-confidence vote in the Italian parliament, and it is now clear that he does not command a majority. With his control slipping, Berlusconi is largely powerless to enact required reforms quickly.

Even if a durable political coalition existed to enact austerity measures, there is concern that they will trigger the kind of fierce public backlash that has swept Greece in recent months. Kindling those concerns are Italy’s labor unions, who for years have threatened to thwart any attempt to reform Italy’s labor laws or to trim the country’s bloated welfare state. It is not an idle threat. Back in September, the Italian General Confederation of Labor, Italy’s largest trade union, organized a nationwide strike to protest the government’s passage of an austerity package. Thousands of protestors poured into the streets and effectively shut down the country, disrupting everything from public transportation to hospitals and schools, along with other government services. The prospect of violent Greek clashes replaying themselves on the streets of Rome and Milan may be enough to keep any Italian government from pushing ahead with the kind of reforms that the country so urgently needs.

Ultimately, that inaction is the greater worry. Unaddressed, Italy’s massive debt will trigger a fresh round of panic through Europe’s already fragile markets. In the worst-case scenario, Italy will seek a bailout. Europe would then struggle to come up with a rescue package that large, leading to the possibility of a default that could break up the 17-nation Eurozone and drag down the global economy. Both scenarios are terrifying. As one analyst recently put it: “Italy is too big to fail, too big to save.”

There is still a chance that it may not come to that. For the time being, Italy has been placed on a kind of fiscal probation. The International Monetary Fund is monitoring to make sure that the country puts in place reforms to balance the budget by 2013 and encourage economic growth. Still, there is little immediate cause for optimism. The high-profile showdown over Berlusconi’s government notwithstanding, Italy’s problems are not only political. They are also cultural and structural. In the long run, only a far-reaching economic reform agenda and a government willing to see it through in the face of popular discontent will bring the country out of its debt crisis. Neither has emerged to date.

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