Italy needs markets to keep the pressure up. Mario Monti's liberalization reforms are already producing a backlash from vested interests. Opposition will be even tougher when he tackles labour rules. Eventually, Italy needs lower bond yields. But for now, 6-per-cent yields are just what are needed to scare Italians into backing change.
Mr. Monti's biggest test to date has come from a decree announced on Jan. 20 to promote competition in service sectors and open up closed professions, such as notaries and pharmacists. The Bank of Italy reckons greater competition could boost the country's GDP by 11 per cent over the long term, but that won't placate many Italians who stand to lose from the reforms today. Strikes by taxi drivers and truckers (who are also complaining about hikes in fuel prices) have blocked roads across Italy. A wave of further action is planned in coming weeks by lawyers, pharmacists and gas-station owners. The strikes could sap Italian's reform zeal, or worse, spark unrest. Battles on the streets aren't the only challenge; the decree must be approved by parliament within 60 days. Any suggestion that it is being watered down would spook markets.
The government faces an even stiffer challenge in coming weeks as it seeks to tackle Italy's lopsided labour market. The current system crimps productivity by penalizing employees on short-term contracts, who are easier to fire and have fewer benefits than permanent employees. Mr. Monti needs to strike a deal with Italy's unions, whose members are keen to protect their privileges. The unions' political links give them an edge: The largest union, CGIL, is linked to the centre-left Democratic Party, whose support Mr. Monti needs to keep a parliamentary majority.
Mr. Monti has one big ally – bond markets. Ten-year bond yields have narrowed by a full percentage point since he took office in mid-November. They fell 20 basis points after the liberalization decree was announced on Jan. 20. Over time, Italians will need to see yields come down further to believe their sacrifices are worth it, particularly as the country enters a recession. But for the moment, they are probably at just about the right level to keep the pressure up.