In memory of Dr. Andreas Höfert

Italian lessons for Europe

It was not the worst-case scenario for the markets or the euro – that would have been Silvio Berlusconi returning to power. But it was the second-worst: a hung parliament, no clear majority in the senate, and therefore months of political instability ahead for Italy. It is now more likely that the euro crisis, which has already proved so difficult to control, will reignite.

Politics has always been a little bit more complicated in Italy than elsewhere. From the civil wars that ended the Roman Republic and gave birth to the Empire, to the clashes between the Guelphs and Ghibellines in Dante’s Florence, from the condottieri and popes of the Renaissance to Don Camillo and Peppone, Italian politics has always been dramatic, sometimes with a flair for the comic but much more often for the tragic.

Italy has had more than 60 governments since World War II – an average of almost one per year. In fact, “cabinet instability” has characterized the peninsula so strongly that essayist Nassim Nicholas Taleb went so far as to state that “Italy’s [economic and political] stability is because of these switches of government” (emphasis added). I am not so sure that this will provide any comfort for Italians – and for the rest of Europe, I am quite certain that it will not.

The current constellation of no clear majority in the Italian senate is likely to create a short-lived government, soon triggering new elections. Procedural constraints and political reasons mean those elections will likely occur in fall 2013 at the earliest, if not in early 2014. Until then, the markets will price in some sort of risk premium, which might last all the way until a new, broad-based political majority emerges. This premium is more likely to fall if election law is reformed in the meantime, but this will be a daunting task given the lack of majority in the senate.

The fact that Italians didn’t vote the way market participants wanted them to will likely prolong uncertain times for the markets and bring back harder times for Italy in the form of higher interest on its government debt. Rates have already increased by almost half a percentage point since the election results came in.

Those considerations aside, the Italian elections should serve as a lesson for Europe in dealing with the euro crisis. In the last couple of years, Italians have been forced to accept austerity, recession and ever-increasing unemployment all for the sake of remaining in the euro. It seems normal for them to start questioning why they have to go through such hardship. Therefore it should come as no surprise that a comedian – and even a buffoonish former prime minister making unrealistic promises – have had far more appeal than an austere professore considered by many of his compatriots to be no more than a proconsul appointed by Brussels or a steward imposed by the markets.

And this is not only an Italian issue. In Greece, a “grand coalition” between the two traditional parties barely holds a majority in parliament. Should Mariano Rajoy’s government in Spain fall over alleged corruption, resulting in new general elections, finding a majority to rule the country might become a daunting task. Everywhere in Europe, from the extreme left to the extreme right, populist parties are gaining traction.

This stems in my view from a variant of the globalization trilemma first expressed by Harvard Professor Dani Rodrik, and which we can name the euro trilemma: sovereign nation-states, the euro and political democracy cannot all flourish simultaneously. At least one of those three concepts will have to give way.

If nation-states were forced to give way, we would see a Federal Republic of Europe: a democratic, integrated Europe with common fiscal, economic and social policies. If the euro were to give way – something that Beppe Grillo, the comedian, Five Star party leader, and de-facto winner of the Italian elections wants to put to referendum – the Eurozone could ultimately break up, with all the disruption such a scenario would entail.

What we have so far experienced in the euro crisis is in my view the worst case of the trilemma: independent nation-states trying to share the euro as a common currency and doing this more and more against the will of the people through austerity. In the long run, this will undermine political democracy: either by forcing countries to accept leaders imposed by Europe and the markets instead of the ones chosen by the people, or by paving the way for more and more populist, anti-establishment and ultimately undemocratic parties. As The Telegraph’s Ambrose Evans-Pritchard astutely wrote two years ago in the aftermath of the first Greek crisis, “no democracy will immolate itself on the altar of monetary union for long” – a fact that remains of the utmost importance.