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Has Europe Returned to the Brink? Not Yet



The recent election and political confusion in Italy indicate that political risk is back in Europe. Yet what is the real scope of the danger, and where do we go from here? To answer, it is worth noting that there were two elections in Europe, one in Cyprus and one in Italy, and in many ways they produced opposite results. In Cyprus, the center-right leader Nicos Anastasiades, who was endorsed by Chancellor Angela Merkel of Germany, cruised to victory with 57 percent of the vote, the biggest margin in 30 years. In Italy, there were strong performances of both the old (former Prime Minister Silvio Berlusconi) and new (the comedian-turned-politician Beppe Grillo), both appealing to unhappiness with the status quo technocrats and their fiscal medicine of high taxes and austerity.

In Nicosia, Anastasiades has a strong mandate to negotiate a bailout for Cyprus with the Troika of the European Union, the European Central Bank (ECB), and the International Monetary Fund (IMF). His victory signals the strength of the political center. His toughest challenge will be to decide how to get a form of Russian assistance as part of the deal. Numerous options are available, each with different political and economic implications, from forcing debt restructuring on Russian lenders and creditors, to arranging swaps, to carrying out privatizations of state-owned companies and selling them to Russians. Negotiations on this matter will likely conclude at the end of March, and I will have more to say about this is another posting.

Italy, with its rebuke to the status quo, departs from the political trajectory in the euro area periphery, where centrist pro-reform governments have won. Admittedly, the result also goes against this author's prediction at the end of 2012. I contended that the combined anti-austerity vote in Italy would rise above 30 to 35 percent. Instead Berlusconi and Grillo got a combined vote of nearly 55 percent. Mario Draghi, president of the ECB, may well have been too successful with the official monetary transaction (OMT) safety net, which eased the sense of crisis in Italy. The lesson of Cyprus (and earlier euro area elections) may be that reformers are elected when voters are haunted by crisis. What did I get wrong and where does Italy go from here?

Has Italy Doomed Europe's Austerity Strategy?

Invariably after a huge electoral surprise, commentators will claim that the unforeseen result validates their own prior positions. Consequently, it is no surprise that many anti-austerity advocates are now claiming that Italy proves that the current austerity strategy in Europe has failed. The usual euro-doomsters, whose business model relies on selling bad news to Anglo-Saxon financial markets, will warn Grillo will take Italy out of the euro. Unsurprisingly, this author disagrees with both statements.

Looked at closely, the electoral result in Italy was a near perfect three-way split by the center-left (Pier Luigi Bersani), the demagogic right (Berlusconi), and the anti-establishment (Grillo), with each getting 25 to 30 percent. Prime Minister Mario Monti's new centrist party garnered only an embarrassing 10 percent.

Monti's humiliation will be lamented in Brussels, Frankfurt, Berlin, London, and elsewhere. But his political demise may well backfire in the anti-austerity camp, because he was probably the only European leader with the stature to stand up to Merkel and the "northern block" of countries that dictate current strategy on such matters as the shape of an evolving European Banking Union. Not to be overlooked is the fact that Merkel and her allies have exhibited more flexibility toward the troubled countries of southern Europe than is often acknowledged. The euro area has considerable leeway in its new fiscal surveillance framework on structural deficits and medium-term balances. Spain, for example, can probably avoid sanctions, no matter what its 2012 deficit is. Both Ireland and Portugal will get more time to repay their bailout loans. Would an obstreperous new Italian government that nonetheless implemented some structural reforms be given the same latitude on the deficit? Probably.

The bottom line for Italy, however, is that the ongoing fiscal consolidation is unlikely to be reversed, except maybe on the margins. The future of economic structural reforms remains in serious doubt, but Monti in any case left with an unfinished agenda here.

Monti: The Unbearable Lightness of Being a Technocrat

Monti's fate recalls the quip by former euro group president Jean-Claude Juncker: "EU leaders know what to do, just not how to get elected after having done it." Thrust on to the political stage as a technocratic leader with a commitment to take necessary but unpopular steps to stabilize Italy in late 2011, he bombed with voters. But even a natural political salesman like Bill Clinton would have struggled to sell the policies he had to implement. His poor showing also illustrates the dangers of technocrats trying to leap from governing into real politics. For example, his policy mix was probably wrong, possibly because he was trying to be too political. By relying too heavily on tax increases—especially on an unpopular property tax rather than spending cuts—he galvanized Berlusconi and his conservative constituency.

Monti's technocratic government evidently judged that this mix was the only one politically possible, just as for political reasons he watered down several of his structural reforms because of his failure to get cross-party support. If Monti was also shaping his program to improve his chances in a future election, the results have been doubly disappointing—he failed in his goal and his tax increases cost him center-right votes, opening the door for Berlusconi's unwelcome comeback.

Berlusconi has again proven that he is a master of media performances and opportunism. His showing reflects anti-tax movement among voters as much as a rejection of austerity.

Berlusconi Redux: A Kingmaker Trying to Stay Out of Jail

So now we have an aging Lothario, media tycoon, and failed prime minister as the biggest single winner and kingmaker in the Italian election, with about 30 percent of the vote. His electoral pact with the Northern League ruled out his candidacy for prime minister, leaving him with more modest goals. At age 77, Berlusconi was recently sentenced to four years in prison (pending appeal), so what he wants is to be politically relevant and stay out of jail—and to try somehow to salvage his legacy.

These motivations dictate what he does next. He might, for example, lead his party into a grand coalition, even if he personally does not play a leading role. Were Italy's economy to deteriorate, he would not want to split his party over the terms required to get help from the official monetary transaction (OMT) lifeline. He may have campaigned against "German diktats," but he would likely favor assistance from the OMT, if necessary. Desiring to remain a player means Berlusconi will be flexible and pragmatic.

Considering how well he did at the polls, Berlusconi would likely resist new elections and oppose major changes to Italy's current electoral law, which has given him much of his political influence.

Like Mitt Romney, Bersani lost an election he should have won big-time. After turning back a pre-election primary challenge from the younger and more dynamic Matteo Renzi, Bersani will be desperate to form almost any kind of government under his leadership. He needs to become prime minister to wipe away the stain of his sluggish electoral result and reestablish his authority over the center-left. Expect him to try first to form a minority government or, if necessary, pursue a potential grand coalition.

Beppe Grillo: La Commedia e Finita?

Having garnered 25 percent of the vote, Grillo leads Italy's biggest single party. (Both Bersani and Berlusconi preside over coalitions of several parties.) The remarkable rise of the Five Star Movement (M5S) resulted from widespread popular dissatisfaction, even revulsion, with the Italian political class, its corruption, and general costs to the public. The M5S movement is a classic anti-establishment protest vote, which like the 2012 Obama campaign relied on social media to mobilize disparate supporters. Its success heralds the arrival of this type of social-media-driven campaigning in Europe.

To what extent Grillo and the movement represent a genuine repudiation of many of the policies—and austerity in particular—of the Monti government is much less certain than it was for the voters backing Berlusconi. If you voted for Silvio, it is a good bet that you want your real estate tax refund! It is easy to know what Grillo and M5S are s against, but difficult to see what they favor.

Instead of listing what it wants to achieve, Grillo's blog, in a classical case of populist messaging, has a negative list of 30 "not in my name" items: "Not in my name will Italy remain in the euro without a referendum,"1 "not in my name will the Italian welfare state be dismantled,"2 and "not in my name will SMEs [small and medium enterprises] be destroyed."3

But the M5S movement has dozens of parliamentarians ready to take office, while Grillo himself remains outside. To what extent he will speak for them is uncertain. What seems clear, however, is that the M5S is not a uniform and well-disciplined policy-oriented entity with specific goals. Will it remain an outside political protest movement, risking its own relevance, or will it use its phenomenal success to make a difference?

Will it, in another words, be an Italian version of the Occupy Wall Street movement and end up with little real impact, or an Italian version of the Tea Party, successfully organizing around specific goals (shrinking the political class and fighting corruption ) with lasting impact. Grillo's refusal to sully himself by governing seems to point toward the Occupy precedent.

However, the lack of a coherent M5S policy platform or even party leadership also suggests that at least parts of the party's parliamentarians will—in the event of an economic crisis—vote in favor of Italy's application for an OMT program. In other words, whatever Grillo might think, M5S parliamentarians (like others in the leadership class) are not likely to want responsibility for a collapse.

The emergence of M5S movement can be misinterpreted. Its spectacular success cannot necessarily be repeated. Circumstances will dictate the results of any new election. It is a mistake to assume that the M5S movement will automatically refuse to enter into any kind of government negotiations, or even be the regular parliamentary foundation of a minority government. Minority governments are a regular feature of many European countries, after all.

In fact, M5S risks a lot if it refuses to play ball with the other factions in parliament. Many voters will see that with 25 percent of the vote, it has a democratic duty to engage constructively in the political process and do something with its influence, if it wants to be taken seriously and show its supporters that they got something in return for their votes. When you are suddenly the biggest single party, you cannot escape responsibility! Italian voters may not take kindly to M5S sulking in its tent and turn against the movement next time. Some say that M5S wants to force another round of elections soon, but doing that would also be risky and cause a split of the movement.

Whatever happens, another period of a weak government is in the offing. It can be a weak Bersani-led minority government, propped up by the M5S movement on a case-by-case basis, or it can be a constantly squabbling grand coalition between Bersani and Berlusconi. But a new government will try to hang on rather than call imminent new elections. The betting here is that such a government will be free to apply for an OMT rescue if an emergency arises. Italy's voters ended the trend of centrist electoral victories in the euro area, but the ensuing weak Italian government will fail to alter the policy consensus in Europe or threaten the OMT safety net from the ECB.


1. Not in my name rimarremo nell'euro senza una consultazione popolare.

2. Not in my name verrà smantellato lo Stato Sociale.

3. Not in my name saranno distrutte le piccole e medie imprese.

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