Italy’s Greatest Economic Threat: Italian Politicians

Italian ex-Prime Minister Silvio Berlusconi told news sources last week that his party — Popolo della Libertà — would soon decide whether or not to revoke support for the current technocrat government headed by Prime Minister Mario Monti. Berlusconi’s threat against the Monti government represents why implementation of his polices won’t induce Italian recovery and why financial markets forced him out of office in the first place. His condemnation of Monti’s policies is also indicative of the broader reform-cowardice problem within the entire Italian political establishment.

Silvio’s guns are cocked and loaded to shoot down reform.

At the heart of Berlusconi’s dismay with the Monti government is the implementation of “German-style” austerity. He claims that government spending cuts and structural reforms “lead just to recession and pain.” While he is correct in assessing the short-term effects of austerity, he is incorrect in assuming that the long-term effects are the same.

The Baltic States, such as Estonia, are the paragons of austerity. To restore competitiveness, Estonia slashed deeply into public wages and government expenditure in 2009. Flexible labor laws allowed for private sector workers and employers to agree upon wage cuts too. Estonian GDP sharply declined by 14 percent in 2009. Unemployment shot up to 17 percent. But Estonia recorded positive 2 percent growth by the very next year, and unemployment had also declined by 5 percentage points. Growth has since continued to increase and unemployment has since continued to decline. Moreover, Estonian industry has been growing over twice as fast as that of Germany for the past two years, according to Eurostat data. Further, Estonian industrial growth has outperformed that of Italy by threefold in 2010 and by 16-fold 2011. Austerity, done quickly and severely, leads to growth and prosperity in the long run — not recession and pain.

Berlusconi must suffer from amnesia, because he forgets that it was exactly his failure to implement proper austerity measures that forced him from office in November 2011 and put Monti in his place. As the spread between Italian and German bonds soared last fall, markets expressed their rejection of Berlusconi’s cowardice in implementing bold reform.

Market fears were rightly founded. Italy is badly in need of coliseum-sized economic repairs.

The Italian labor market, in which firing an employee for poor performance is illegal and rehiring said employee is mandatory, is the most inflexible labor market in Europe. According to numbers from Datagiovani, these protections cover over half of all private sector workers. But stringent employment protections cover a whopping 87 percent of the entire private workforce upon accounting for regulations stipulating that smaller firms can choose between rehiring a dismissed employee or paying up to 14 months of severance.  Italy needs employment flexibility so that hiring a new employee is not so risky and businesses aren’t afraid to grow.

Italy’s legal system needs an overhaul too. On average, it takes roughly 3.5 years to adjudicate a single lawsuit, giving property rights a shaky foundation. Of all OECD high-income countries, Italy ranks dead last in contract enforcement according to the World Bank.

Government corruption compounds the problems of an economically destructive regulatory state and a court system lacking in the protection of property rights. According to Transparency International’s 2011 Corruption Perceptions Index, Italy is the most corrupt country in Western Europe. Ironically, a Milan court just convicted Berlusconi last week for having evaded €270 million euro in taxes — a fraud from which he undoubtedly hid for years because of his position within the government and the Italian political system. It’s no surprise he wants to boot Monti from government and return to business-as-usual.

As “Il Caviliere” threatens the revocation of his party’s support for the Monti government, he threatens the small progress that Monti has already made in repairing Italy’s fundamental economic issues and he imperils the potential for future reform. The Italian political class—which relies on buying votes through corrupt public contracts, state employment, and regulation catered to special interests—is beholden to the unsustainable status quo.

Berlusconi’s rejection of austerity is a broader rejection of change. In ousting him from government last November, markets proved how seriously they take reform as a condition for financing Italy’s sky-high debt pile.

Italy needs rapid and significant market-oriented changes, not more spending to prop up an impossible economic structure. The return of Italian politicians to Italian government is a proposition that Italy simply can’t afford.