Matteo Salvini is Europe’s hottest populist. He is the leader of Italy’s League party, Deputy Prime Minister and a social-media star. But he’s really the boss − Prime Minister Giuseppe Conte is a non-entity. Mr. Salvini’s party placed first last weekend in the European Union parliamentary elections and he’s about to use his power to play a dangerous game that could amplify Italy’s status into the Western world’s biggest sovereign risk.
Under him, the League has been a juggernaut. In the 2013 Italian election, the right-wing, anti-migrant party, then called the Northern League, won a mere 4 per cent of the vote. That year, Mr. Salvini was elected party secretary and launched a rescue mission. He removed “Northern” from the name and reinvented it as a national – and nationalist − Euroskeptic party with a mission to pry Italy loose from the fiscal restraints imposed by the EU.
The overhaul worked. In the 2018 Italian election, the League won more than 17 per cent of the vote, placing third overall. In the EU election, the League hit 34 per cent, placing first and burying its coalition partner, the anti-establishment Five Star Movement. While M5S is still the biggest party in the Italian parliament, Mr. Salvini is on the upswing and, through sheer force of personality, boosted by endless selfies with adoring voters, is calling the shots. He has become the public face of Europe’s third-largest economy and the EU’s tormentor-in-chief.
What will he do with power? There is ample speculation that he will pull the plug on the coalition and persuade Italy’s President (who is head of state) to call an election. Based on his soaring popularity ratings, the League would win and install Mr. Salvini as prime minister. Then watch out.
Italy’s coalition government had few friends in Brussels even before Mr. Salvini triumphed in the EU poll and vowed to assemble a right-wing, anti-Europe alliance − known as the Salvini bloc − within the EU Parliament. Since the coalition government was formed a year ago, Rome and Brussels have been fighting over the size of Italy’s budget deficit and debt, with Mr. Salvini vowing to run up both, in violation of the EU’s fiscal rules. The tiff sent Italian sovereign bond yields shooting up to scary levels last autumn.
The yields matter because Italy is one of the most indebted countries in the world, measured by both total debt and debt as a per cent of gross domestic product. This year, its debt-to-GDP is expected to reach 133 per cent, the second highest in Europe, after Greece, and the second highest among the Group of Seven countries, after Japan (Canada’s is about 84 per cent, Germany’s about 56 per cent).
Italy’s debt is clearly unsustainable, all the more since it has been an economic zombie for two decades. Italy had the worst per-capita growth rate in the world in the decade ending in 2010 and the longest economic downturn after the 2008 financial crisis. It has just emerged from its third recession since then, but growth is so weak that it’s hard to tell. Istat, the Italian statistics agency, forecasts growth of only 0.3 per cent this year. Youth unemployment, at 33 per cent, is the second highest in Europe and as high as Tunisia’s.
Brussels and Rome are positioning themselves for a new clash over Italy’s rising debt. This week, the European Commission (the EU’s executive arm) delivered a warning letter to Italy’s finance ministry, saying “Italy is confirmed not to have made sufficient progress towards compliance with the debt criterion for 2018.” Unless Italy reins in the debt, Brussels could hit the government with a hefty non-compliance fine.
The United States is also concerned about the poor health of the Italian economy, even if Italy is running fairly hefty current-account surpluses. The U.S. Treasury Department this week placed Italy on the list of countries it is monitoring for macroeconomic policies and potential currency manipulation. Its report said that “Italy’s competitiveness continues to suffer from stagnant productivity and rising labour costs. The country needs to undertake fundamental structural reforms to raise long-term growth.”
Perhaps the ultimate indictment of Italy’s dire financial state is the spread between 10-year Greek and Italian bonds – they’re converging. On Friday, the Italian yield was 2.72 per cent, by far the highest among the big European economies. Greece’s was 2.98 per cent. Italy seems to be replacing Greece as the sick man of Europe.
Mr. Salvini vows to deliver a “fiscal shock” to Italy in the form of Donald Trump-style tax cuts. He wants a flat, 15-per-cent income-tax rate that would cost €30-billion ($45-billion) and painfully expensive pension reforms that would effectively bring down the retirement age. He seems to have the support of Italian voters to launch a war with Brussels.
Indeed, Italians know that the previous governments’ economic plans, which centred on fiscal contraction – austerity – did not work. The jobless rate kept rising and the manufacturing sector got hollowed out. Italians didn’t elect the League and M5S merely to keep failed economic policies intact.
But Mr. Salvini appears to forget two big things. The first is that a spending spree without deep reforms, from prying open closed professional shops to taking the scalpel to Italy’s soul-crushing bureaucracy, won’t make the economy more competitive, and Italy seems eternally allergic to reforms. The second is that bond investors might not let Mr. Salvini spend with abandon. If the hedge funds pile into the market and drive Italian yields back up to the danger levels seen in 2011 and 2012, before the European Central Bank came to the rescue, Italy could enter another debt crisis.
We all saw the damage little Greece inflicted on Europe. Italy is Greece times 10. There would be no way to contain an Italian crisis. The country is way too big and contagion would set in with alarming speed. Mr. Salvini might win his battle with Brussels, but at what cost to Italy and to Europe?