The Eurocrisis Redux, or why Italy won’t leave the Euro
To avoid a long Twitter thread, a quick blog.
I make no claim to have an in-depth understanding of Italian politics but I do think the basic application of some straight forward political economy principles, coupled with applying the lessons of the last two Euro standoffs, is useful when trying to work out how the current Italian crisis will end.
The short answer is this: Italy will neither exit the Euro nor default on its debt.
This wouldn’t be a real Eurocrisis redux blog if it didn’t include a statement of the geographically obvious, so let’s get that out of the way now:
Italy is not Greece.
Italy is not Greece in this case in three key ways:
- The scale is very different. Italy is a G7 economy, a major player in the Eurozone and with an outstanding debt stock (€2.3 trillion or 130% of GDP) which is simply in a different league. Greece may have been containable, Italy wouldn’t be.
- But the nature of that debt stock is rather different. It’s primarily held domestically rather than abroad. In other words the primary losers from any default would Italians. An anti-Euro/populist default in Italy is a very different proposition to a Greek default in 2015 – rather than imposing direct costs on foreign creditors (mainly official ones in the Greek case), it would impose direct losses on Italian citizens.
3. Italy may have experienced the best part of two lost decades of growth but unlike Greece, it hasn’t experienced an actual depression with 20–25% declines in GDP, huge falls in real incomes and unemployment peaking at almost 30%. In Greece it was at least plausible for the government to argue that “things couldn’t get any worse” (although they were wrong on that), this isn’t a case open to any new Italian government.
Point 2 is the key here. The direct domestic political costs of Euro exit/default would be simply too high for any Italian government to bear. They’d be much higher on day one for an Italian government than they’d have been on day one for the Greek government in 2015.
One could make the case that Euro exit and the redenomination of debt into new Lira for existing holders could be sold to Italian voters as effectively cost-less to them. Well, good luck with that. The Harold Wilson “the pound in your pocket” approach was tricky enough in a relatively insular Britain in 1967, I don’t think it could be sold in an internationalised member of a currency union with free flowing capital markets. It would obviously be a cost and a high one that.
Italy is similar to Greece in 2015 in one key regard though: despite a primary budget surplus and a current account surplus it is vulnerable to external economic pressure and the real Achilles Heel is the banking system. There are plenty of routes open to the Eurozone authorise to gradually apply financial pressure if they feel the need to go down that road.
In any stand-off between a new government and the Eurozone, I’d expect the Italian side to blink first.
So what to expect if some form of anti-Euro/populist government takes charge?*
Much shouting, some unnecessary damage to the Italian economy, a lot of political drama, a half dozen or so “crunch/crucial/key” summits in Brussels and then ultimately no Italian exit or default.
*For what it’s worth, I can’t see how such a government being formed now, or after new elections, is really avoidable. President Mattarella may have acted in accordance with the constitution but politically this feels like a huge mis-step – he’s handed anti-establishment politicians exactly the card they’d like for new elections and potentially added a constitutional stand off to an already fraught situation.
