Italy Has a Very Serious Problem

(Bloomberg Opinion) -- Italy’s populist coalition government has a major problem. It’s called recession. The Five Star Movement and the League sold their voters the dream of an economic rebound after a decade of stagnation and sluggish recovery. But barely eight months after they took power, the economy is back in recession — its first since 2013.

The slowdown is part of a broader deceleration in the euro zone, including Germany. The economic difficulties in China and the return of protectionism didn’t help the country’s exporters. But Italy’s statistical agency said net exports went up in the fourth quarter, while domestic demand contracted. This raises severe doubts over the government’s economic strategy, which has pushed up borrowing costs and made businesses more uncertain.

Giuseppe Conte, Italy’s prime minister, said on Thursday that the economy would strengthen in the second half of the year. He is confident that Italy will meet the official growth forecasts of a 1 percent expansion in 2019. Last week, in an interview with Bloomberg News, he said he was even hopeful for a 1.5 percent expansion, which is what the government penciled in before being rebuked by the European Commission.

This is all fantasy thinking. The Bank of Italy and the International Monetary Fund believe that Italy will grow by 0.6 percent. Even that seems optimistic. The government has decided to use up the little firepower it had on handouts, including a generous early retirement plan and an income support scheme. The latter might help boost domestic demand, but that may not be enough to make up for what’s happening to investment. The government estimates that Italy’s investment growth will fall sharply, from 3.8 percent in 2018 to 0.6 percent this year. Add the slowing global economy, and it’s clear that the GDP growth forecasts are at risk.

This leaves Italy’s rulers with an economic and political dilemma. As growth plummets, the fiscal targets — for a budget deficit of 2 percent of gross domestic product this year — are in danger. The government has set aside 2 billion euros ($2.3 billion) of extra spending, which will only be available if the deficit is on target. But this would look pretty paltry if the economy keeps slowing. Anyway, the more pertinent question is whether Brussels will ask for another budget adjustment.

A round of spending cuts and tax hikes would do more harm than good, so long as the bond markets remain sanguine. But there’s a strong case for the populists to rethink their most damaging policies, such as the early retirement scheme. That money would be far better used to spur investment, as Germany is considering doing to fight its own slowdown. The alternative is arriving at the next budget in the autumn and finding out there’s no money left for giveaways.

The situation is especially acute for the League. Unlike Five Star, which is plummeting in the polls, the League is getting stronger thanks to its more focused message, particularly on immigration. The longer it stays in power, though, the more it risks being blamed for the economy. The League’s traditional heartlands are in the richer north, which would lose badly from a downturn. Voters would also question its support for an income support scheme, which will mainly target citizens in the poorer south.

Matteo Salvini, the League’s leader, is coming under pressure from his party to pull the plug on the populist coalition. He could then fight a new election as leader of a reunited center-right coalition, allowing him to focus on pledges such as tax cuts. This might happen after the European Parliament elections in May, which may give Salvini greater certainty about his popularity in the polls.

A center-right government would maybe be more reassuring for investors. After all, one populist agenda is better than trying to straddle two. But Italy’s problems wouldn’t disappear. The country faces formidable fiscal challenges, as its plans to cut the deficit and keep the enormous public debt in check rely on unrealistic hikes to VAT. Meanwhile, an aging population and weak productivity will constrain growth.

It’s taken Italy’s rulers just a few months to discover the problems with their policies. Don’t expect a solution any time soon.

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

Ferdinando Giugliano writes columns and editorials 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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