Italy's fall: a catastrophe waiting to happen?

The first half of the 1990s was a traumatic period for Italy. During the previous decade the country had successfully followed the discipline of the European Monetary System (EMS), inflation had reduced and exchange rate parity, after several adjustments, had been constant for more than five years. Then, in 1992, the Maastricht Treaty was signed promising the arrival of the euro by the close of the decade.

The Maastricht Treaty required further decreases in Italy’s inflation rate and a major adjustment in the country's public deficit. The latter was much higher than the treaty limit of 3% of gross domestic product (GDP), especially because of the interest bill on the public debt accumulated in the 1970s and the 1980s. The bill was high because the debt was high, and also because the interest rates on Italian treasuries contained a high premium for inflation and exchange rate uncertainty.

The EMS crisis of 1992-93 that, paradoxically, came just after the treaty’s signature, numbered Italy among its victims. The lira was ousted from the system, suffering large depreciations. While the rest of the EMS stabilised after the summer of 1993, Italy’s currency remained an outsider for two more years. The markets cast doubt over whether some members of the coming monetary union would be able to comply with the convergence criteria dictated by the treaty; Italy was widely considered the member most at threat of failing to comply.

Besides monetary troubles, the first part of the 1990s saw great political turbulence in Italy. Many judges attacked the corruption that was rife in financing the country's political parties, which caused a meltdown in Italian politics where, since the 1940s, and despite the frequent changes of governments, a multitude of parties maintained the same alliances among each other, government after government. This gave some sort of stability to the political world. This judiciary action saw the removal of many of Italy's most established politicians, creating a vacuum that destabilised the governance of a country experiencing deep macroeconomic difficulties. At this point, meeting the criteria to join the eurozone seemed to be an impossibility.

Enter Berlusconi

It is during this difficult period that Silvio Berlusconi became a political leader and the country's premier. He filled the empty spaces of the political spectrum, brought with him a number of collaborators from his business activities and promised a new era of reform. His programme was characterised by economic liberalism with a strong emphasis on opposing the old-fashioned style of politics that had brought Italy to its knees. Liberalism was never truly implemented and his major contribution was not economic: it consisted in the introduction of a two-party political scene, with a simplification of the parties' policies, better fitted to the needs of the media.

Mr Berlusconi's populist approach appealed to the electorate, and seeded a suspicion over how independent the country's judiciary was, and also supported his desire to see a modern, Anglo-American-style two-party system. He quickly built his centre-right party and succeeded in creating a coalition that brought together parties with very different views, such as the former Fascist party and the Northern League.

Mr Berlusconi's centre-right position helped to instil a reformist spirit into the country's centre-left, which formed a similarly heterogeneous coalition. The emphasis on personal leadership was adopted by the left. These changes altered the mentality and culture of the whole spectrum of the Italian political landscape.

Stuttering start

The first Berlusconi government fell quickly, leaving the unenviable task of adjusting Italy’s macro-economy, and meeting the criteria to enable the country to enter the eurozone from its outset, to figures who also had not been professional politicians, such as Romano Prodi and Carlo Azeglio Ciampi, who were largely backed by the centre-left camp. Admission to the euro was based on Italy's credibility: the risk premium on the country's public debt descended rapidly, as soon as it appeared that Italy would gain admission to the eurozone; in a virtuous circle, the consequent large decrease in the government’s interest payments reinforced these optimistic predictions that Italy would be able to bring its deficit below the critical point of 3% of its GDP.

The success was brought about by a wave of national unity towards meeting the euro target, and involved some far-sighted behaviour by the unions, which helped to deliver reductions in real wages and labour costs while inflation was decreasing, in spite of the depreciations of the lira.

But after the adoption of the euro, Italy, like other European countries, barely attempted to increase productivity and keep fiscal discipline. There was a lack of appetite for structural reform and any political composure disappeared. The bipolar nature of Italy's political scene introduced by Mr Berlusconi showed its limits, descending into a myopic, wild and unprincipled fight. The country's government was blackmailed by extremist minorities on both sides of the political fence. Mr Berlusconi’s methods to keep the show going on were rough and artificial. To strengthen the unity of the right he insisted in singing the outdated song of anti-communism and accused the left of influencing the magistrates who targeted him with accusations, mostly related to his pre-political life as a businessman. He relied on his personal charisma and on the influence on the media, while taking insufficient care in constructing a well functioning centre-right organisation with autonomous, quality leaders.

The left responded with a similarly artificial unity, brought together only in their criticism of Mr Berlusconi, stressing his conflicts of interest and his scandalous private behaviour. Big differences of opinion and political styles characterised the left, thus limiting its credibility as a potential governing coalition.

However, the two-party political system in Italy remained popular. Electoral rules were changed to grant a disproportionate majority in the country's parliament to the winning party and to make it easier for leaders to choose their cabinets, which they often filled with low-quality politicians unlikely to stand up to their party's more powerful figures. Bitterly fought elections saw the left and right parties alternate in power twice, even though Mr Berlusconi’s coalition governed for more years. But neither the left nor the right had coherent political views that could effectively support a government. The growth rate of Italy remained low, public debt high and structural reform became impossible, as an inclement political climate prevented sufficient  convergence among parties needed to advance the country's cause.

Exit Berlusconi

The global recession and the European sovereign debt crisis saw the rapid fall of Mr Berlusconi’s premiership and government, who refused to admit the seriousness of the problems within Italy. There was also a weakening of the trust in the two-party political system, which, incidentally, was beginning to show its flaws elsewhere in Europe and in the US. After many years of insufficient attention being paid to risks being taken by the country and of excessive reliance on euro-induced convergence and fiscal discipline of European countries, financial markets started to speculate against the weaker members of the euro area, thus imposing adjustments and reforms. Italy’s treasury bonds soon became a target for speculation and Mr Berlusconi, as the country's premier, appeared responsible for the potential default of the country.

After months of confusion, with sky-rocketing yields on Italy’s bonds, in November 2011 Mario Monti succeeded Mr Berlusconi as Italy's premier, a personality that could hardly be more different from his predecessor. Mr Monti’s government is labelled 'technocrat' as it does not include professional politicians. To take the difficult measures required to fix Italy’s accounts and re-launch growth within the country, the new government has been granted a large majority involving the two political sides.

This ceasefire of Italy's left and right is only temporary, however, and will end, at the latest, with the elections of 2013. But some hope remains that, besides economic reforms, the technocrat government will result in a rethink of the ineffective bipolarisation of Italy’s politics. The optimal model of democratic political competition, in Italy and elsewhere, is still to be invented. But Mr Monti’s Italian experiment might leave a lasting improvement after its end: a scenario where general interests command a decent degree of competence, and greater integrity of politicians together with an adequate amount of convergence among the political parties, to cope with the acute problems of the country and not the interests of the few.   

Franco Bruni is professor of international monetary policy and theory at Bocconi University in Milan