Italy’s Referendum Could Result In The Death Of The Euro by John Mauldin, Mauldin Economics
An important election is coming up, and I’m not talking about the US presidential election. The upcoming referendum in Italy this fall will have a major macroeconomic impact on the world. But hardly anyone outside of Italy is paying much attention to it—yet.
I’ve been saying for some time in interviews around the country that the referendum in Italy could have even more of an impact than the Brexit vote did in the UK. And like the Brexit vote, it is rife with emotion and political turmoil, making the outcome too close to call.
The current prime minister, Matteo Renzi, has basically bet his career on this referendum, which would allow him to enact much-needed reforms. In fact, they’re the same reforms that I have written about in my letters over the past five years and that I talked about in my previous two books.
Italy has about as sclerotic a governmental process as any country in Europe. And that is saying something. There is no end to corruption and crony politics. Each faction wants to keep the status quo and keep its perks but wants everybody else to give theirs up. If you’re a voter in Italy, your frustration is understandable.
This vote in Italy needs to go on your economic radar screen. If the “no” vote wins, Renzi has promised to resign. This would throw Italy into a political crisis. Then there would be a real potential to elect parties that would call for a vote on whether to stay in the European Union. And at this point, it is not clear what the Italians would decide to do.
Know this: The European Monetary Union does not work very well, if at all, without Italy. A “no” vote would be the death knell of the euro.
Nick Andrews, who writes for my friends at Gavekal, gives an excellent summary of the situation in Italy. And, it is worth every bit of your attention.
Renzi’s Great Gamble
By Nick Andrews and Stefano Capacci
Prime ministers come and go in Italy—four since the financial crisis—but precious little seems to change. The latest incumbent, Matteo Renzi, has pursued structural reform more energetically than his predecessors. But for all the progress he has made, he might as well have been wading through molasses. Now, in a bid to secure a popular mandate for his restructuring program, Renzi has bet his premiership on a referendum over badly-needed constitutional reforms. It is a high stakes gamble. If Renzi wins the vote, which is due in either October or November, his proposed measures will streamline Italy’s legislative process, breaking the parliamentary gridlock which has crippled successive governments, and opening the way to far-reaching economic reforms. If he loses, Renzi has promised to step down—a pledge that has turned the referendum into a popular vote of confidence in the unelected prime minister, his Europhile policies, and—by extension—Italy’s membership of the eurozone itself. As a result, a “no” vote in October will not just precipitate the fall of Renzi’s government; it could throw Italy’s long-term membership of the eurozone into doubt, plunging the single currency area once again into crisis.
Policy no man’s land
Italy’s fundamental problem is that it’s stuck in a policy no man’s land. Its old economic model, in place for much of the last three decades of the 20th century, relied on a combination of currency devaluation to maintain international competitiveness together with fiscal spending to support the poorer regions of the country’s south.
Signing up to the euro put an end to all that, preventing devaluations and prohibiting budget deficits at 10% of gross domestic product. However, the design of Italy’s bicameral parliamentary system, in which the upper and lower house—the Senate and the Chamber of Deputies—wield equal legislative power, made it almost impossible for any government to push through the structural reforms necessary for Italy to compete and prosper within the eurozone. The result has not just been depressed growth and relative impoverishment, but an outright decline in living standards as Italy’s real GDP per capita has slumped to a 20-year low.
Such a below-par economic performance has led to a build-up of bad assets on the balance sheets of Italy’s banks, where 18% of all loans are now classed as non-performing. In turn, this bad loan overhang has eroded the ability of the banking sector to extend new credit to the thousands of small businesses which are the engine of Italy’s economy and which normally power employment growth. The result is stagnation.
To stand any chance of escaping this low growth trap, Italy needs to enact wholesale structural reforms to enhance its competitiveness relative to its eurozone neighbors. Notably, it needs to make the labor market more flexible to encourage job creation, it needs to lower the barriers to entry that protect much of the country’s service sector, it needs to overhaul a judicial system so sclerotic that bankruptcy proceedings can last 10 years or more, and it needs to restructure its fragmented and dysfunctional banking system.
The prescription might be clear, but Italy’s political system makes enacting reform all but impossible. Renzi has already tried to overhaul Italy’s labor market by attempting to dismantle the generous protections that make it difficult and expensive for companies to dismiss staff, and which therefore encourage businesses to hire only temporary workers, heightening economic insecurity among the young.
But Renzi’s attempt ran into bruising opposition from Italy’s powerful and well-subscribed trade unions. The results were a watered-down reform package that entitles existing permanent staff to a near-guarantee of lifetime employment, and a severe dent in Renzi’s popularity from which he is yet to recover. It’s a familiar story in Italy. Entrenched interests—whether represented by local and regional political leaders, unions, protected professions, or established private sector companies—exert enormous influence over the political process. All profit from the status quo, which promises they will continue to benefit from special protections and payouts. And because of the equal balance of power in Italy’s parliament, which means the Senate can block government legislation indefinitely, the consequence is political—and economic—stagnation.
Bloated and wasteful
Renzi’s referendum aims to change that. The prime minister is seeking popular approval for constitutional reforms that promise to cut the size of the upper house from 315 to 100 senators. Under his proposals, senators will no longer be directly elected, but will instead be chosen by regional councils, nominated by the mayors of big cities, or—in the case of five—be appointed by the Italian president. The reform will cut the costs of the notoriously bloated and wasteful upper house, where senators have traditionally enjoyed lavish expenses and generous pensions. Most importantly, it will downgrade the political power of the Senate so that it will no longer be able to obstruct government legislation entirely, but only to propose amendments that will be adopted at the discretion of the lower house (although the Senate will retain a say on