Italy’s Populists Are Picking a Fight With Brussels Over Austerity

(Bloomberg Businessweek) -- Italy’s populists are getting ready to uncork the prosecco. Only four months after taking power, unlikely allies Luigi Di Maio of the anti-Establishment Five Star Movement and Matteo Salvini of the anti-migrant League have picked a fight with Brussels that they could well win.

Italy and the 18 other countries that use the euro as their currency have until Oct. 15 to submit their 2019 spending plans to the European Commission for approval. The “people’s budget” Di Maio and Salvini are drafting seeks to make good on costly election promises, while flying in the face of European Union rules that set limits on government deficits and debt. If the EC blinks, Rome gets away with new-style Keynesian stimulus, defying the prevailing austerity. If it’s thumbs down, the Italians get a reprimand, which they can exploit to cement their hold on power by rallying their base and revving up their offensive against the Brussels elite. “For the populist government, it’s a win-win,” says Giovanni Orsina, head of the School of Government at Rome’s Luiss-Guido Carli University. “If the EU says no to the budget, that’s a godsend—they’ll fight their campaign for the European Parliament elections next May on that.”

On paper, the fight is over money to start paying for campaign pledges. Five Star stumped for a basic income for the poor of €780 ($895) a month, while the League promised to cut taxes and lower the retirement age. The government’s fiscal outline contemplates a deficit of 2.4 percent of gross domestic product for 2019, three times the gap targeted by the previous administration. Despite pressure from the EU and from investors, who have repeatedly pushed yields on Italian government bonds to multiyear highs, the ruling coalition has refused to budge on that number, though it’s agreed to lower deficit targets for subsequent years.

Italy’s Populists Are Picking a Fight With Brussels Over Austerity

Italy is rebelling against austerity, following in the footsteps of Portugal’s Socialist government, which raised the minimum wage and boosted public-sector salaries, flouting the spirit of the €78 billion bailout package the country obtained from the EU and the International Monetary Fund in 2011. France and Spain have also played fast and loose with EU budget rules, without incurring the fines of up to 0.2 percent of GDP that Brussels can levy on countries that persistently exceed the limits.

Guntram Wolff, director of the Bruegel think tank in Brussels, calls this the biggest test of wills over an EU country’s budget since the euro-area debt crisis that began in Greece, then spread to Spain and Portugal. “France always cooperated with Brussels, Portugal too, there was a dialogue,” he says. “What’s more important is that Italy has higher debt and lower productivity growth than France”—which means its situation is more “fragile.”

At more than 130 percent, Italy’s debt-to-GDP ratio is the second-highest in the euro area after Greece. “We have to do everything to avoid a new Greece—this time an Italy—crisis,” said European Commission President Jean-Claude Juncker on Oct. 1.

For Italy’s populists, the battle over the budget is symbolic of their quest to wrest control from Juncker and his army of Eurocrats and return it to governments in European capitals, a theme calculated to resonate across the Continent in the approach to next year’s European Parliament elections. “We’ve handed over too much power to Brussels. We have to be a leading country, not a country that is led,” says Michele Geraci, undersecretary at the Ministry of Economic Development. “We want to make sure that European regulations on trade, migration, and other issues look after Italian interests.”

Five Star and the League rose to power on a wave of discontent from voters who have endured a string of unpopular prime ministers installed in power after political negotiations—including economist Mario Monti, who stepped in from 2011 to 2013 to steer the country through the height of the debt crisis. “Voters are rebelling against the loss of sovereignty to powers which imposed austerity and told them nothing could be done to limit immigration,” says Orsina. “That’s why Italy’s traditional ruling class is paying a heavier price than in other countries.” The frustration built up over years of belt-tightening has achieved what seemed politically unfeasible: uniting the rightist League, whose power base is the rich industrial north, with Five Star, a web-savvy movement that draws most of its strength from the depressed south.

Members of the Italian Establishment are mounting a quiet resistance. President Sergio Mattarella, a 77-year-old former constitutional court judge, has forged an alliance with Finance Minister Giovanni Tria in a bid to impose spending restraint on the government. If moral suasion isn’t enough, Mattarella could exercise powers accorded him under the 1948 constitution and refuse to sign the budget into law—although he can only send it back to Parliament once.

More than Brussels, it’s the financial markets that have the power to thwart the Italian populists’ ambitions, especially at a time when the European Central Bank is tapering off its bond purchases. Salvini regularly makes a show of taunting investors. “I’ll eat the spread for breakfast,” he said with typical bombast on Sept. 30—a reference to the 10-year yield spread over German bunds, a barometer of market sentiment.

Despite all the posturing and tough talk, Carsten Brzeski, a former European Commission official, expects the impasse between Rome and Brussels to be resolved amicably. “It’s a bit of give and take, in the end they will find a compromise, a deal,” says Brzeski, who’s now chief economist of ING-DiBa AG, the German branch of the Dutch banking company ING Group.

In the meantime, expect plenty more verbal pyrotechnics. Sitting alongside French nationalist Marine Le Pen at a Rome event on Oct. 8, Salvini launched a broadside against Juncker and Pierre Moscovici, the EU’s economic policy chief. “We are against the enemies of Europe—Juncker and Moscovici—shut away in the Brussels bunker,” he said.

©2018 Bloomberg L.P.