Matteo Salvini, leader of the eurosceptic party League, gestures during a news conference at the foreign press association in Rome, Italy. (Photographer: Alessia Pierdomenico/Bloomberg)

What Europe Should Do About Italy

(The Bloomberg View) -- The crisis in Italy is also a crisis for the European Union. The populist parties that won the last Italian election, and that hope to do even better next time, are united in little except blaming the EU for Italy’s setbacks. They’re wrong about this, and now Europe must be careful not to play into their hands.

The immediate political turmoil is no closer to resolution. Carlo Cottarelli, the premier-designate and former International Monetary Fund official, has been struggling to form a caretaker government. President Sergio Mattarella may soon be forced to dissolve parliament and call snap elections. Whether the next vote comes soon or after an interlude of technocratic rule (all but doomed to fail for lack of support in parliament), Italy’s future in the euro system will be in contention.

This is an argument that Europe needs to win — but winning will require a demanding mixture of flexibility and restraint.

On Tuesday Guenther Oettinger, a German EU commissioner, told an interviewer: “My concerns and expectations are that the coming weeks will show that developments in markets, government bonds and Italy’s economy could be so drastically impacted that they serve as a signal to voters not to vote for populists on the right and left.” He was also reported as having said something brisker — that financial markets would teach Italy’s voters a lesson. The Five Star Movement and the League were delighted. Matteo Salvini, head of the League, said: “They are shameless in Brussels.”

Oettinger was right, but unwise to say it. The European Union can’t expect to defeat the coalition in a battle for Italian public opinion — not like this, anyway.

Up to now, the European Central Bank has stayed prudently quiet, but Italy’s bond yields have surged, and there are signs of contagion in Portugal, Greece and Spain. What if the Italian populists campaign on a demand for special, rule-breaking assistance from the central bank? The ECB would feel obliged to say no — and Germany, for one, would insist. 

While it’s true that the EU’s rules on fiscal consolidation and ECB support should be exercised flexibly, and that the budget rules in particular need to be improved, they can’t be simply tossed aside, as the populists demand, without undermining the financial integrity of the entire European project.

At the same time, the EU ought to recognize that one of Italy’s biggest grievances is legitimate: The union’s handling of the refugee crisis has been lamentable. Its partners left Italy largely alone to deal with what should have been treated as a European problem. Italy should get more support for the costs of rescuing and processing migrants, and asylum seekers should be distributed more fairly across the EU. Had this been done earlier, the Italian election might have gone differently.

Rather than lecture — or surrender — EU leaders should acknowledge their failure on refugees, then remind Italy that it is a valued member of the euro system, that it benefits enormously as a result, and that membership confers both rights and obligations.

Italians will have to work out for themselves what’s at stake in their future with the EU. In the last election, the populists didn’t dare to explicitly propose quitting the euro system — and with reason, because such a course would be disastrous for Italy’s economy. Membership in the euro system is what keeps Italian interest rates low enough to support the country’s enormous debts. Fiscal control would be far harder, and far more urgent, outside the euro system.

This is the case that Italy’s mainstream politicians should be pressing. There’s only so much the EU’s leaders can do to help. Top of the list is denying the populist alliance more opportunities to point fingers in their direction.

©2018 Bloomberg L.P.