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The end of La Dolce Vita

The euro crisis has claimed its biggest scalp to date in the form of Italian prime minister Silvio Berlusconi. Speaking in the early hours of 9 November, the country’s largely symbolic president, Giorgio Napolitano, announced that Berlusconi would step down “within a few days”. Having survived countless legal actions against him, claims of corruption and tabloid tales of his relationships with young girls, the Italian leader has finally been felled by a combination of crumbling support from his multi-party coalition and the country’s dire economic circumstances. 

Given that this was Berlusconi’s third term of office, his removal from the political stage may not be permanent. Yet a fourth term seems unlikely, given his age and the scale of the personal, political and legal challenges against him. Once government bond yields broke the 7% barrier, something had to give at the heart of the Italian political economy to reassure the markets. Bond yields continued to rise even after the planned resignation was announced, suggesting that more is needed to convince investors that Italy can put its economic house in order. 

Napolitano pledged that the fiscal and structural reforms demanded by Berlin and Paris would be passed as soon as possible. This would be difficult to guarantee because a new government must be formed either now or after an election. Either way, a range of different parties, each with their own priorities, must quickly coalesce around a reform agenda. If this is achieved, then Brussels will enforce deep-seated cuts that will increase unemployment and tear at the fabric of an already deeply divided nation. The alternative is even more daunting: a national debt of €1.9 trillion, equivalent to 118% of GDP, coupled with torturous rates of interest, spell economic collapse for the country and most of its inhabitants.

However, the national debt ratio has topped 100% for all of the past 20 years and the government has largely balanced its books over that period. It has merely borrowed in order to service the debts built up during the boom years, but if the loans dry up then the economy is in real trouble. In many ways, Italy is paying the price for its past, not current, economic performance. After the boom years of the 1950s and 60s, growth has slowed dramatically, averaging just 0.75% a year since 1996. The root causes include a poor regulatory environment that protects established business interests at the expense of new entrepreneurs. 

It has long been argued that Italy has prospered economically in spite of its political fragility. Successive weak central governments have had less influence than their counterparts elsewhere in Europe, allowing private enterprise to prosper. Yet Italy’s implied libertarian formula will not answer on this occasion. Prolonged instability will deter investors, depress revenues and inflate the national debt. A strong government is needed and needed quickly.