Italian General Election – A Populist Government Would Increase the Risk of Insolvency

After Greece, Italy is the Eurozone country most likely to face sovereign insolvency over the next few years. At the same time, the nation is “too big to fail”, meaning that from a European perspective, a disorderly financial collapse of Italy must be averted at almost any cost. A combative new government could therefore try to force the EU, or the ECB, to provide the country with additional financial resources. This is the conclusion of an analysis conducted by the Centre for European Economic Research (ZEW) on the Italian debt situation in the run-up to the parliamentary elections.

At 2.3 trillion euros, Italy’s absolute debt is the highest in the Eurozone, representing 23 per cent of total euro sovereign debt. At the same time, the country only contributes around 15 per cent of the EU’s total economic output. The associated risks are further fuelled by unfavourable debt dynamics. Despite historically low interest rates, the country’s debt ratio has been rising fairly steadily since 2007 and currently stands at 132 per cent of the national GDP.

However, ZEW’s analysis also highlights some of Italy’s strengths, including the current account surpluses and the fact that, on balance, Italy has no foreign debt. Furthermore, the country has no significant implicit debt, which usually arises from governments making generous benefit promises to future generations. A reform-oriented government would thus stand a good chance of stabilising public finances by implementing reforms of the labour market, tax system and public administration.

“A populist government in Rome could cause substantial damage“

A look at the election manifestos of the various parties, however, gives reason to doubt that these necessary reforms will be introduced. Instead, the Italian political parties largely focus on glowing promises of increased government spending while rejecting the possibility of structural reforms. The ZEW analysis also found that voting for a populist party could indeed be an economically rational choice for Italians. Friedrich Heinemann, the author of the study and head of the ZEW Research Department “Corporate Taxation and Public Finance”, explains: “The fact that Europe has so far failed to set up an insolvency procedure for euro countries is now taking its toll, as this makes the Eurozone vulnerable to blackmail. It is perfectly understandable that Italians would prefer to receive external financial transfers than to face reforms involving budget cuts as a solution to the Italian debt problem.” If the Italians elect a government which seeks out confrontation with the Eurozone, as was the case with the Greek government back in 2015, there is no way of knowing what the outcome of this will be. “A populist government in Rome could cause substantial political and economic damage as it would usher in a new period of economic and political uncertainty, putting the survival of the Eurozone and the EU as a whole at risk,” says Heinemann.

For more information please contact:

Prof. Dr. Friedrich Heinemann, Phone +49 (0)621/1235-149, E-mail friedrich.heinemann@zew.de