Italy's Unlikely Allies Offer a Brief Respite From Crisis

(Bloomberg Opinion) -- After three weeks of turmoil, Italy’s political crisis seems over, for now. Giuseppe Conte, the resigning prime minister, will try to form a new government with a different coalition. Out goes the hard-right League led by Matteo Salvini, and in comes the center-left Democratic Party, which will team up with the anti-establishment Five Star Movement. Such are the differences between the two forces, however, that it’s hard to see how they can form a stable alliance.

Conte will need to lead from the front, if he is to make this coalition of very strange bedfellows work. In his first year in government, he was relegated to the role of a notary who was meant to ensure that the League and Five Star respected the government contract both had signed. This experiment has comprehensively failed, dragging Italy into an economic slowdown and political tumult. Conte should now understand that being prime minister really is the most important job in a country.

To be fair, Italy has few good alternatives at the moment. Salvini pulled the plug on the Five Star-League government as he hoped to cash in on his popularity, which had brought his party to win more than a third of the vote at the European Parliament elections in May. Had Italy held a new vote in the autumn, Salvini would almost certainly have won an absolute majority together with another hard-right party, Brothers of Italy. A victory would have paved the way to years of tense confrontation with Italy’s European partners, on issues ranging from immigration to public finances. The financial markets would continue to be roiled by the risk Italy might leave the euro – raising the cost of refinancing the country’s enormous public debt.

An election would have been a fairer choice given how popular Salvini seemed just a few weeks ago. It would have also tested his leadership capabilities. In his 14 months in government with Five Star, Salvini did precious little of what he had promised for the economy, while still managing to spook investors. As prime minister, he would have had no excuses.

The Democrats and the Five Star Movement had other plans, however. They sensed that a defeat was imminent and chose to put their differences aside to avoid going to the polls. This wasn’t easy: For years, Five Star has accused the Democrats of being part of the corrupt elite that ruined Italy. Meanwhile, the Democrats said Five Star had supported all the policies passed by the League, including its hard line on immigration. The two parties have plenty of disagreements, from their attitude on infrastructure building to labor market and welfare policies. It’s hard to see their coalition lasting for long.

They do have something to build on, though. The financial markets have taken the news of their possible alliance in stride, sending the yield on 10-year bonds below 1% for the first time. Traders are betting the new government won’t want to pick fights with Brussels, let alone leave the euro. It’s now possible that Italian bonds will rally further, narrowing the gap with Spain and Portugal. This will make it easier to put together a budget for 2020 and avoid a VAT increase worth 23 billion euros ($25 billion) which has already been penciled in. The risk of a recession in Europe will also make the European Commission less tough in applying the bloc’s fiscal rule, giving the coalition even greater leeway.

The two parties have also moved a bit closer over the years, since Nicola Zingaretti took over as party leader for the Democrats, pushing the party to the left. Finally, Salvini’s miscalculation appears to have cost him dearly: A poll published this week in Corriere della Sera, a daily paper, shows that his popularity has dropped by 15 percentage points. Italians may be starting to have enough of his brash and confrontational attitude.

The new government, if it is formed, could seize this opportunity to fulfill the two parties’ promise of making Italy fairer. They could start by cutting public spending, especially on pensions, to start reducing payroll taxes. This would help to address Italy’s enormous intergenerational inequality. They could also improve on Italy’s poor management of migrants and refugees, which offers little help to those who want to integrate into society. This is a far bigger problem than the number of people landing via sea, which has fallen sharply since 2015.

Unfortunately, such steps seem unlikely. The Five Star Movement is split, with a group that would have preferred to keep an alliance with the League. The Democrats are also divided, and former Prime Minister Matteo Renzi will look for possible excuses to replace the existing leadership. Any coalition will need to include other smaller parties, and will still be able to command only a slender majority in the Senate. Were the government to collapse prematurely, it seems likely that Salvini and a newly formed center-right coalition would scoop to victory, capitalizing on the failure.

Italy’s renewed calm should be celebrated, but we should be under no illusion. It’s only a matter of time before a political crisis strikes again.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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