Renzi’s EU Challenges and U.S. Interests

The umpteenth change of government in Italy (the third since late 2011 and the 63rd in 68 years) should arouse more than mere curiosity in Washington. Matteo Renzi, the newly appointed prime minister, has promised to work towards the relaxation of the austerity course that has dominated the EU economic policy during the crisis. The Obama administration, which has consistently argued for the EU to accord preference to growth-oriented policies over austerity, cannot but welcome any move in that direction.

But can Renzi really make a difference and tilt the balance in favor of more flexible fiscal rules?

Over the last few years, upon the insistence of a German-led coalition of ‘thrifty’ countries (e.g., with public finances more or less under control), the EU has adopted a set of rules to prevent deficit spending as an instrument of fiscal policy and to empower the European Commission with greater authority to oversee, assess and sanction national budgetary policies deemed too lax. These are binding commitments which cannot be changed at will, but only via intra-EU negotiation.

Beset by chronic political instability, and with a poor record of economic reform and a huge public debt (over 133 percent of the GDP), Italy is hardly in a position to demand re-negotiation of EU rules. In fact, given its gigantic debt-to-GDP ratio (second only to Greece’s in the EU), Italy is subject to even stricter budgetary constraints.

To its credit, Italy did achieve a remarkable degree of fiscal consolidation under Renzi’s immediate predecessors, Mario Monti and Enrico Letta, and managed to keep its budget deficit within the EU-set 3 percent threshold in both 2012 and 2013. But fiscal restraint has come at the cost of negative-to-zero growth and a dramatic rise in unemployment. As a consequence, public debt has risen, not diminished. Renzi and Pier Carlo Padoan, Italy’s new Economy Minister, will certainly insist on this simple fact when they seek more leeway from the EU. However, their attempt is unlikely to succeed if they fail to reform Italy’s institutional and economic systems.

A key step would be to enact an electoral and constitutional overhaul to avoid continuous changes of government and streamline the decision-making process. Even though the changes would not enter into force until the next electoral cycle, this would be a strong signal that Italy is serious about reform. More importantly, Renzi must commit Italy to a mid- to long-term agenda to stimulate the economy, which has constantly underperformed since the introduction of the euro in 1999. The tax burden should be reduced (particularly for companies and families), labor market regulations made more flexible but also more supportive of the young and the unemployed and the efficiency of the public sector and the judiciary increased.

Italy’s government had best start implementing reforms before it takes on the EU six-month presidency next July. Renzi would then be in a far better position to get the help he needs from the EU and Germany because he could argue that his reforms can only be brought forward if Italy is accorded more lenient terms.

It is critical that Renzi avoid requesting ad hoc moves, as Germany and other austerity champions would see this as potentially undermining EU rules. The Italian government should instead use the EU presidency’s agenda-setting power to shape the debate about the so-called ‘contractual arrangements.’ These are meant to be binding mechanisms by which an EU member state commits to structural reforms in return for as yet unspecified ‘compensation measures.’ Their actual shape should be defined later this year. If the Italian government had already started to implement its agenda, it would have more credibility to insist on a balanced trade-off: reforms in exchange for greater flexibility in the application of the EU budgetary constraints.

Even if Renzi can succeed in keeping his fractious left-right coalition united and overcome domestic opposition to his reform agenda (admittedly, a big ‘if’), there are limits to what he can reasonably achieve. Supporters of austerity command the higher ground in the EU and are likely to agree only to small adjustments. But small adjustments would be better than nothing due not only to their economic impact but also their political value EU governments that are struggling with economic and social problems, such as Italy’s, could point to such adjustments as evidence that the austerity course is being stemmed.

Renzi seems determined to fight off against the wave of popular resentment against the EU that is mounting all across Europe, including in traditionally Europhile Italy, and that is widely expected to favor anti-EU forces at next May’s European Parliament (EP) elections. The Italian electorate, while disillusioned, still sees continued membership in the currency union as a safer bet than the other way round, but is also unwilling to make further sacrifices for the euro’s sake. Renzi’s room for political maneuver is therefore limited: his pro-EU stance can only hold if he is able to de-emphasize the public opinion’s growing association of membership in the eurozone (and, by extension, in the EU) with austerity policies.

Here lies another reason for which the United States should pay attention to Italy. The growth of anti-EU sentiments risks poisoning national debates about the merit of European integration, which could in turn make the EU more difficult to manage economically and also more inward-looking. Such an outcome should be a source of concern for the United States. Renzi’s chance to reverse the austerity course in the EU is minimal. Nevertheless, were he to win some real concessions from his European partners which he could sell to the public, Renzi would contribute to reinvigorating popular support for the EU. In the long-run, this achievement would be far more significant than shaping the EU economic debate, for Italy, Europe and ultimately also for the United States.