Italy’s Populists Aren’t the Only Ones to Blame

(Bloomberg Opinion) -- The fight between Italy and Brussels over Rome’s budget is blamed widely on Italy’s populist leaders, Matteo Salvini and Luigi Di Maio. The two deputy prime ministers have insisted that Rome should run much higher budget deficits over the next three years, in a bid to fulfill their electoral pledges and kick-start growth.

A different government would almost certainly have sought a compromise with the European Commission to avoid the risk of a so-called “excessive deficit procedure,” which might lead to financial sanctions. But Italy’s problems didn’t start this year. The country has lived with an enormous public debt for more than two decades. In a sense, it’s more surprising that several successive Italian governments managed to avoid a confrontation with the rest of the EU.

Italy was allowed to join the euro in May 1998 even though its public debt stood just below 120 percent of gross domestic product. The so-called “Maastrich criteria” — which EU members must meet to enter the single currency — stated that government debt shouldn’t exceed 60 percent of GDP. Failing that, the ratio should at least be approaching the target at a satisfactory pace. Italy and other countries, such as Belgium, were admitted into the monetary union under this more relaxed rule.

Yet Italy never managed to get rid of this enormous burden. True, Rome has run primary surpluses in most years since 2000. But even this hasn’t been enough to cut sovereign debt, which has risen to more than 130 percent. The trouble was a combination of lackluster growth and insufficient fiscal restraint, especially when compared to Belgium. Andre Sapir, an economist at the Bruegel think tank, speaks of Belgium’s “absolute commitment to debt sustainability and to euro membership that was at times lacking in Italy.”

Still, even though Italy’s leaders have failed to reduce public debt, they’ve done just about enough to keep the burden sustainable. They were helped by the European Central Bank gifting Italy and the euro zone with a prolonged era of low interest rates to end the 2011-2012 sovereign debt crisis. Quantitative easing brought Italian bond yields to a low of just above 1 percent in December 2016. That combination of an ultra-expansionary monetary policy and a credible central bank helped Italy cut its interest payments substantially. But while this money could have been used to lower debt more aggressively, successive center-left governments used it to cut taxes and lift spending instead.

The end of QE, which the ECB is planning for the end of this year, was always going to be a challenge for Italy. And it has coincided with the formation of an arch-populist government that thrives on confrontation with Brussels. Salvini and Di Maio decided to press on with an expansionary budget, even though they knew it risked rejection. While the Commission would have been open to concessions, as it has been in the recent past, the magnitude of the deviation was such that it had no choice. If Rome doesn’t change its mind, it risks years of intrusive monitoring by Brussels, including a demand to cut debt by up to one-twentieth of the difference between its debt levels and the “Maastricht criterion” each year.

There’s no doubt that this is the consequence of Salvini and Di Maio’s provocation. But the two leaders enjoy a strong popular mandate, which they won by promising to disobey the euro zone’s fiscal rules. Italians knew what they were getting.

This isn’t a justification to forget fiscal discipline. It’s not just Brussels, but the financial markets too, that have given the Italian government a sharp reminder of what it means to abandon prudence. But it was perhaps inevitable that voters would eventually back fiscally irresponsible leaders, given all the leeway that was extended before — and the lack of real consequence. Italy’s excessive deficit procedure really has been a long time coming.

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.

©2018 Bloomberg L.P.