As former European Central Bank (ECB) president Mario Draghi prepares to take over as Italy’s prime minister, the choice by the country’s president of a man widely seen as a ‘technocrat’ has been warmly welcomed in financial markets and European policymaking circles.
Since the January collapse of the previous government which was mainly supported by a political coalition between the Five Star Movement (M5S) and centre-left Partito Democratico (PD), inconclusive negotiations among the political parties over forming a new cabinet has left Italy stuck in a political and economic stalemate.
But even when the prospects of Draghi, a former governor of the Bank of Italy, leading a new cabinet seemed bleak, the markets still sent a unanimous verdict – they effectively blessed the new government by sending Italian government bond yields down.
Draghi’s return is also welcomed in Brussels where his strong European resumé relieves concerns Italy might not be able to effectively tap into the economic recovery money available, and raises hopes the country can institute the kind of reform programme many have called for.
Parliamentary support is crucial
However, although Draghi’s economic competence is not in question, the markets and Brussels’ honeymoon with Italy might prove short-lived. Draghi will find it a challenge to maintain the parliamentary support he has secured, but this support is crucial for the new government to effectively tackle long-standing challenges which have impaired Italy’s economic trajectory, as well as new social and economic challenges brought by the pandemic.
If history is any guide, political stability is far from being Italy’s best suit, and even ‘Super Mario’ is likely to find maintaining his majority difficult in Italy’s fragmented parliament. Support for the new partially technocratic government – both within the parliament and among Italians – is only partially assured by the economic expansion expected to take place under Draghi’s watch as the economy recovers from COVID-19.
The popular narrative is that Draghi’s government will be significantly different from the technocratic government led by Mario Monti in the wake of the sovereign debt crisis because the latter was formed to implement an austerity agenda, but this new government will be called on to use more than €200 billion in European recovery funds.
While the differences in the economic context are undeniable, important policy challenges exist even under the current favourable conditions. Any positive effects of the reforms and investments financed under the recovery fund will play out in the future but, in the short to medium term, Italy’s economic prospects are more uncertain.
The European Commission (EC) estimates Italy’s economy has been among the worst hit by the COVID-19 crisis and does not expect it to return to pre-crisis levels of output before 2023 at the earliest. Draghi’s government will not just be tasked to plan long-term recovery, but also to address the social and economic vulnerabilities exposed right now by the pandemic.
Unless a sustained recovery materializes well in advance of the implementation of the European Union (EU) Recovery Plan, a government which takes distributive decisions without a formal electoral mandate is an easy target for political opponents seeking to channel public discontent – exactly what happened with the Monti government.
Although the new government’s economic orientations are likely to be expansionary, Italy’s economic choices must continue to take place within the framework of the EU fiscal rules which have been frozen rather than changed in the wake of the pandemic.
Public finances under scrutiny
Voices from Brussels have left few doubts about what it is expected of Italy – that any reform and investment policies must be compatible with the state of the country’s public finances – particularly its high debt burden.
Even the money allocated to Italy under the EU Recovery and Resilience Facility is not a ‘free lunch’, because accessing the funds requires Italy to undertake long overdue reforms to the country’s burdensome public bureaucracy and judicial system, in line with timelines and milestones set in conjunction with the European Commission.
So, although austerity will not necessarily be back on the agenda soon, making spending decisions under an unchanged European fiscal rulebook is likely to raise tensions among the political forces which support the new government, potentially threatening its stability.
Italian political parties will soon realize their new or renewed positive orientation towards Europe needs to be proven – not only by declaring support to Draghi’s new cabinet, but also by complying with rules not entirely of the country’s own making.
The saying goes that short honeymoons are better than no honeymoons, and there are good reasons to think this is the case with Mario Draghi. The real question is going to be which partner – the markets, Brussels, or Italian citizens and their elected representatives – will be the one to call an end to the honeymoon first.