Italian president Sergio Mattarella’s veto of the incoming populist government’s choice of finance minister — an inveterate critic of the euro — may have been intended to prevent a repeat of the financial market run on Italian bonds seen in 2011-12. If so, the move has backfired. Investors reacted this morning by selling Italian bonds en masse.
The reason is straightforward. As the Five Star Movement and League parties refused to change their choice for finance minister, Italy is now heading for new elections, with former IMF economist Carlo Cottarelli appointed the technocratic prime minister of a caretaker government. Clearly, markets are more worried about a new campaign along pro and anti-euro lines, and the likelihood of the populists doing even better than in the March ballot.
Investors are right and all friends of Italy and of Europe should find the next campaign scarier than the prospect of a Eurosceptic finance minister. The latest development writes the populist parties’ campaign script for them: it is now hard to resist the charge that pro-European technocratic elites have blocked the people’s choice of more Eurosceptic policies. One view is that this was all along the plan of Matteo Salvini, leader of the League, by far the most virulent anti-euro party of the two. The League has soared in the polls, and will feel emboldened to run on a more explicitly anti-euro platform.
If Cottarelli wants to do the best he can for the Italian economy, he should do his best to defuse this political chain reaction. Hard as it must seem, he should go against what are no doubt his instincts and propose to implement the best of the agenda the two parties had agreed before the presidential veto.
Concretely, that means the following four things. First, commit to welfare reform in the direction of Five Star’s ideas for a sort of universal basic income. The current Italian benefits system is perverse in that it gives much bigger benefits to people on high incomes than on low incomes. This can be corrected and improved — to the benefit of the poorest voters — at reasonable cost.
Second, lower the taxation of labour income in a way that pays homage to the League’s flagship flat-tax policy. Payroll or social security taxes may be a better target for reducing Italy’s high cost of employment (the “tax wedge” on labour) than the income tax, but a simplification combined with a cut could be presented as meeting the League’s political priorities in this area.
Third, fund some of this with a moderate increase in the fiscal deficit. Cottarelli, as a public finance expert and former head of a public spending review, knows where to find the least damaging cuts to pay for new priorities — but he should allow for some increased borrowing to fund the two policies above. The deficit was only 2.3 per cent of economic output last year, and both it and the (admittedly huge!) debt stock are on a downward trend. This is a good time to give the Italian economy the stimulus boost it needs: unemployment is still 5 percentage points above where it was before the financial crisis a decade ago. A fiscal stimulus would accelerate growth, which in turn would lighten the debt burden — potentially more than the greater deficit would add given how debt arithmetic works at high debt levels.
Fourth, this would of course have to be justified against the EU fiscal rules. It can be: the European Commission has tolerated higher and more persistent deficits in other countries such as Spain. While debt was somewhat lower in those cases, the effect on growth (and therefore on the debt burden) would be stronger in Italy, which would start from a lower deficit. Rome must also continue its longstanding and correct opposition to Brussels’ method for calculating structural deficits and economic potential, which penalises long-stagnant countries such as Italy. There are good arguments for a more Keynesian interpretation of Europe’s Treaty rules.
But beyond the technical points, this is a political priority. It is late in the day, but Rome must contribute to the debate on eurozone reform — theoretically to be settled at a summit in one month’s time. Representing Italy, Cottarelli should push for more fiscal flexibility at the national level, in line with what Five Star and the League have pushed for. He could demand this in return for a more aggressive approach to bad loans on Italian banks’ balance sheet, a problem that has bedevilled progress on other eurozone reforms. A definitive purging of the banking system, with necessary restructuring and compensation for “little people” but not large investors, is right for Europe and Italy and should satisfy populist voters as well.
None of this is likely to happen, in part because the populist parties would see it for what it is: a defusing of the political rift over Europe. But just that — and the policies themselves — would be good for Italy, and for Europe. Cottarelli would be wise to give them his best shot.
- Noah Smith does a good job of explaining why the mounting evidence on minimum wages (they do not seem to reduce employment) means we should change our standard model of the labour market. Employer market power seems to be the rule, not the exception.
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