‘If populism means that the ruling class is listening
to the needs of the people, if anti-system means
introducing a new system that removes old privilege
and encrusted powers, well these political forces
deserve both these epithets…’
– Giuseppe Conte, Prime Minister of Italy
in his inaugural speech to the Italian Senate, June 2018
Political uncertainty has characterised 2018 for Italy.
In a general election that predictably produced no outright winner – few could have predicted the depths of division that would materialise in the wake of the result.
Two of Italy’s most prominent populist parties became the first and third largest parties in the Italian Parliament – the Five Star Movement and The League – with the previous ruling Democratic Party relegated to second and vehemently against working with either of the populist parties to form a government.
A ten-week standoff would follow, during which time it was entirely unclear who would see Italy through the next five years – a period certain to be trying both at home and internationally – as the competing factions failed to find anything remotely resembling a majority.
After 88 days of negotiations, law professor Giuseppe Conte was appointed Prime Minister – a newcomer to politics, having no experience whatsoever nor having even run for office – the goal being to bridge the two parties, with the leaders of the Five Star Movement and The League each holding the position of Deputy Prime Minister.
Despite both representing populist ideals, the Five Star Movement and The League are separated by a deep ideological chasm – making it all the more surprising when the two announced they were forming a coalition and that they would rule together, ushering in the self-titled ‘governo del cambiamento’ – ‘government of change’ – the first populist government in Western Europe.
But far from being the primary driver of uncertainty in Italy, the result of the March election and the formation of the ‘government of change’ is seemingly an inevitable result for a country struggling to regain its standing in the wake of the global financial crisis.
While the bulk of major economies in Europe have returned to – and in many cases exceeded – the levels at which they operated prior to the global financial crisis, Italy has experienced sustained sluggish growth amid battles with recession.
‘This is the real problem with Italy – we are still in a situation in which the growth level and recovery from the crisis has not been completed,’ says Antonio Villafranca, co-head of the Centre on Europe and Global Governance at the Italian Institute for International Political Studies.
The Stability and Growth Pact
The Stability and Growth Pact (SGP) is a rule-based framework instituted by the European Union in order to ensure fiscal sustainability through an early warning mechanism, and enforced by potential sanctions on non-compliant Eurozone countries. Its chief requirements are that government deficits should not exceed 3% of GDP, and that total government debt should not exceed 60% of GDP.
The present state of the Italian national debt leaves it with very few options to stimulate the economy without contravening SGP requirements. Italy’s inability to keep its head above water with regard to its deficit is, in large part, due to the Italian government’s enormous expenditure on interest owing on past debt, rather than the kind of fiscal recklessness that the SGP is aimed at discouraging. The requirements of the SGP make it difficult for Italy to ease the debt ratio without risking sanctions.
The coalition government argues that Italy should be allowed by the European Commission to exceed the thresholds dictated by the SGP, just as France and Germany were able to during and after the global financial crisis. Whereas both of those countries have now exceeded their pre-crisis GDP levels, Italy’s remains 7% lower.
‘So, this is now the request of the new government,’ says Villafranca. ‘They say that now it’s time to grow faster, and that’s why we should be allowed to do what the others did over the last eight years: which is spend more.’
In a joint manifesto, the new coalition government has made clear that it plans to renegotiate various EU treaties, including the Stability and Growth Pact. Amid this noise, the European Commission has made it clear that it will remain firm in its commitment to the Pact’s requirements. In May, when the manifesto was first released, European Commission vice-president for jobs, growth, investment and competitiveness, Jyrki Katainen, warned that ‘the rules of the Stability Pact apply to all member states and the Commission will grant no exceptions to anyone.’
GDP in Italy remains 7% lower than pre-crisis levels; in contrast, most other major European economies have been able to bounce back: Germany’s GDP is 11% higher than before the crisis, France’s is 7% and even Spain, one of the most severely impacted in Europe, has managed a 2% increase.
The result of the global financial crisis for Italy was adding to a debt-load that was already the largest total debt in the Eurozone, ballooning to €2.3tn – a figure which represented 132% of GDP – and the second highest rate of debt, behind only Greece. But as the third largest economy in the Eurozone (and eighth largest worldwide), the potential risk involved with Italy’s public debt poses catastrophic issues globally when considering the shockwaves the Greek crisis sent through the world – with an economy and debt-load magnitudes smaller than that of Italy.
‘Italian public debt is fully sustainable today. However, its reduction must be pursued, but with a view to economic growth,’ said Giuseppe Conte, in his inaugural speech to the Italian Senate, June 2018.
‘We want to reduce the public debt, but we want to do it by increasing our wealth, not with austerity that, in recent years, has helped to make it (public debt) grow.’
La Nuova Italia
If the onus for Italy moving forward is centred on the need for increasing wealth in the absence of austerity measures, significant reform to its business sector and environment are necessary – with the ‘government of change’ eying overhauls that would do just that.
‘We will have to work on simplifying the regulatory framework. Regulatory hypertrophy contributes to legal uncertainty, which ends up benefitting dishonest people and penalising citizens and businesses operating legally,’ said Conte.
‘We will be sure to reorganise entire sectors of the legal system, repealing unnecessary laws, and favouring the reorganisation of existing legislation, also through the adoption of codes by business sectors.’
Like much of the change and reform promised under the new regime, Conte has been heavy on discourse, but scarce on details. Major reform though, even for heavily embattled sectors such as retail and institutional banking, will be met with caution – in large part due to the uncertain environment.
‘The business environment is very complex – the financial crises have increased levels of litigation everywhere and the courts in general are appearing more and more inclined to favour customers over financial institutions,’ opined the GC of a major Italian commercial bank.
‘Any changes need to be carefully considered and should look to bring Italy more closely aligned with the rest of Europe and homogenised globally, at least where the banking sector is concerned.’
Stoking business on one side is the flat tax, proposed by The League.
‘The goal is the “flat tax”, which is a reform with fixed tax brackets and a system of deductions that guarantees the progressiveness of the levy in full harmony with the principles of the constitution,’ explained Conte.
‘This is the only way to bring about a drastic reduction in tax evasion, which will have benefits in terms of greater tax savings, greater consumer spending and investments, and increasing the tax base.’
The proposal will take Italy from a system of five tax brackets to one of only two – 15 and 20%. Rather than greatly cut into tax revenue, as critics claim, it is hoped the system will instead cut into tax evasion, a long-standing problem in Italy. A report published this year by the Italian Senate put the ‘tax gap’ caused by evasion at anywhere between €16.5bn and €28.6bn per year.
‘The government are hoping to have additional revenues coming in from the fact that they will collect more taxes,’ explains one general counsel working in financial services.
‘Even if they lower tax rates through the flat rates, they will collect more taxes, in their opinion, because the economy is running faster. In addition, they think this will also help discourage tax evasion, which is really very high in Italy.’
The goal, then – as always – is more money flowing into government.
This will be sorely needed if the government is to deliver on the lofty promises made before the election – among them the Five Star Movement’s universal basic income proposal. The cost of implementing this depends on who you ask – the Five Star Movement has claimed it will cost as little as €15bn a year, while former Prime Minister Matteo Renzi estimated via tweet that it would cost as much as €84bn a year.
In any case, so hefty a bill will be a big ask for Europe’s second most indebted nation.
An increasing disparity between Italy’s traditional commercial centres and the outlying provinces has led to demands for drastic change. Within Italy, this is known as the north/south divide.
Italy as a whole posted 1% annual GDP growth between 2001 and 2016. Over that same period, the southern part of Italy saw its output shrink 7.2%. Unemployment – and particularly youth unemployment – is leagues higher in the south than in the north. Whereas the overall unemployment rate stands at 11.2%, it is nearly 19.3% in the south, compared to 6.9% in the north.
‘It is Milan and then nothing,’ explains a general counsel from the manufacturing sector. ‘Even then, the top young talent in Italy is studying here and then going abroad. If they’re not leaving the south to come to Milan, then they’re going out to wider Europe or further – and they’re not coming back.’
Youth unemployment in Italy is a long-standing problem, but again, those in the south are particularly hard done by: a devastating 46.6% are unemployed.
The uniqueness of Italy’s election drama means that it cannot be boiled down to a simple case of regional disparity leading to a protest vote in favour of the country’s populist parties. Again, the two halves of the coalition are distinctly different – perhaps best illustrated by the difference in approach: flat tax vs UBI.
The Five Star Movement can certainly be said to be fuelled by the angst of the forgotten south. These are the voters hit hard by globalisation and feeling the pressures of being on the wrong side of the north-south divide. They are the citizens for whom policies such as universal basic income are designed.
EU’s Regional Development and Cohesion Policy: 2021-2027
A focus on key investment priorities, where the EU is best placed to deliver. The majority of the fund will go toward innovation, support to small businesses, digital technologies and industrial modernisation, as well as the shift toward a low-carbon economy.
A cohesion policy for all regions and a more tailored approach to regional development. The policy will focus on all regions that are lagging behind in terms of growth or income, including those belonging to richer member states. Additionally, new funding criteria will be introduced to ‘better reflect the reality on the ground’ – specifically, youth unemployment, low education level, climate change and the reception and integration of migrants. It will also aim to support locally-led development strategies and involve local authorities in the management of the relevant funds.
Fewer, clearer, shorter routes and a more flexible framework. The rules will be less complex, create less red tape and have lighter control procedures for businesses and entrepreneurs benefitting from EU support. There will also now be one set of rules, which now cover seven different EU funds. Further, they will combine the stability necessary for long-term investment planning with the right level of flexibility in order to cope with unforeseen events. A mid-term review will be conducted to gauge whether changes are needed for the final two years of the funding period.
A strengthened link with the European Semester to improve the investment environment in Europe. The Commission proposes to strengthen the link between the Cohesion Policy and the European Semester, to create a growth- and business-friendly environment in Europe.
The League represents an entirely different sector of Italian society. These voters are primarily in the north of Italy, and for whom international competitiveness is a real concern. Despite the north being the wealthy half of the country, they argue that their tax burden is so high that they cannot compete with the likes of China and Germany on the international stage. It is from these voters that the coalition’s flat 15% and 20% taxes are being motioned.
‘In any case, as time has gone on, the coalition still says they want to do both of these things, even if they are articulating it in a more cautious way,’ says Villafranca.
The rifts of regional disparity have been recognised and addressed – with varying degrees of success – by Brussels over the years, but the nature of the Union appears to make this phenomenon somewhat of an inevitability.
‘There is larger literature now explaining how European economic integration contributes to these regional disparities. If you look at what the European Union has been doing over the last decade, trying to push towards more integration, more open markets, you are basically supporting the regions and the provinces in which you have the best human capital, the best infrastructure and the most competitive enterprises,’ says Villafranca.
‘You can see everywhere in Europe, including the United Kingdom, regional disparities growing. It is a by-product, a side-effect, of economic integration and openness to international trade.’
The EU has dedicated considerable money to accelerating the growth of the provinces of member states via what is called the Regional Policy of the European Union – or Cohesion Policy, for short. In May, the EU announced the shape of the policy for the period spanning 2020 to 2027, with a headline goal of modernising the Cohesion Policy.
There is an abundance of examples of EU money going into the regions of its member states under the Policy, going back at least 15 years. And still, areas such as Italy’s south remain underserved.
‘The Cohesion Policy is just a small percentage of the EU budget. It’s just a percent of the EU GDP. It’s peanuts. If you are serious that you want to face social inequalities, regional disparity, you need a lot of money to do so,’ says Villafranca.
As with any other EU member state, Italy is going to have to weather whatever storm is roused by an impending Brexit. Whether the coalition is ready or not, change is coming.
According to the Ministry of Economic Development in Italy, the United Kingdom is Italy’s fifth biggest export destination, valued at €23.1bn in 2017. Still, Italy is relatively insulated from the UK for Brexit’s direct impact to be too dramatic.
‘One of the biggest issues will certainly be what is going to happen after Brexit in terms of English law and the jurisdiction of the English courts – which is one issue that the industry is now deeply and extensively considering as negotiations continue,’ explains a prominent Italian GC from the financial services sector.
Though the specifics have yet to be negotiated, decisions will need to be made by international corporates with a large presence in the UK. Some are waiting, others are acting now.
‘It’s a process which takes months and months, which means that in my view – not speaking for AIG – a transitional period leaves a lot of question marks,’ says Diego Manzetti, head of legal South European Zone for AIG.
‘How long can you really wait before you start your process and before you move ahead? I think banks and insurance companies don’t have as much time to act.’
For Italy, the Brexit effect will be felt in more indirect ways. While Italy is not so entangled with the British economy that their fates are linked, the country does depend on stability within the EU as a whole, thanks to the national debt.
‘The biggest impact on Italy will not be felt in trade or investment, but rather that instability in Europe will translate to an increasingly destabilised Italy and, consequently, higher interest rates,’ says Villafranca.
‘Any phenomenon which has a potentially negative impact on Europe, has a disproportionate effect on countries which have the highest levels of debt – Italy among them – because of this. Look at the independence movement in Catalonia. What is incredible is that when there was a peak in the turmoil in Catalonia, the Italian spread was growing even faster than the Spanish spread, which is absurd because Italy has nothing to do with the Catalonian situation – it’s absolutely a Spanish problem.’