Italy’s Populist Path Ahead

(The Bloomberg View) -- Two and a half months after an inconclusive general election, Italy looks as if it will soon have a government — a populist coalition between two anti-establishment parties, the Five Star Movement and the League. Having won a clear popular mandate, the two parties must be given a chance to govern. But the program they have in mind is extravagantly expensive. If they stick with it, Italy stands to suffer — and to run into conflict with Europe.

The coalition’s many pledges, ranging from steep income tax cuts to a generous income support scheme for the poor, add up to more than 100 billion euros in new spending, according to an independent estimate. And the coalition has given no sign of how it might pay for its plans. Note that Italy already holds one of the largest public debts in the world.

The lavish spending Five Star and League envision could violate the Italian constitution, which compels the government to balance its budget taking into account the economic cycle. And it would make a mockery of the euro-zone budget rules. At the moment, Italy is enjoying a modest recovery from a double-dip recession between 2008 and 2013. EU rules say Rome should spend this time reducing its deficit and debt, not adding to it. 

Yet it remains unclear exactly what steps the new government will actually take. The parties have not yet named a prime minister, or met with President Sergio Mattarella to receive their mandate to govern. Even then, their small majority in parliament will make it very difficult to pass controversial legislation. And Mattarella will be able to veto any measures that breach the Italian constitution.

And Europe? Authorities in Brussels are left to see whether the new government will go ahead with its spending plans. The European Central Bank, for its part, will have noticed how the Italian coalition has already spooked the bond market, with the yield on Italy's benchmark 10-year bond hitting a 10-month high. There may be a hope within the new government that at some stage the ECB might come to the rescue. The ECB should resist being distracted by the political developments in Italy, and set its monetary policy as it sees fit for the euro-zone economy as a whole.

Clearly, the League and Five Star Movement face a steep learning curve. Their leaders have no experience at governing, or even working with each other. Yet they have raised voters’ expectations high. For the sake of Italy and Europe, one can only hope they trim their most exorbitant ambitions, keep Italy on the road to recovery, and allow Europe to breathe a sigh of relief.

©2018 Bloomberg L.P.