Europe Should Let Italy Win

It’s time for Brussels to grab the wheel in the game of chicken over Rome’s budget.

talian Interior Minister Matteo Salvini attends a press conference at the Italian Embassy in Bucharest, Romania, on Oct. 23. (Daniel Mihailescu/AFP/Getty Images)
talian Interior Minister Matteo Salvini attends a press conference at the Italian Embassy in Bucharest, Romania, on Oct. 23. (Daniel Mihailescu/AFP/Getty Images)

The current standoff between the Italian government and the European Commission in Brussels—in which Italy is pushing for greater spending resulting in a larger deficit, which the commission claims violates its rules—seems at first glance like a replay of the game of chicken that drove the Greek debt crisis in 2015. Then, like now, debt and politics were intimately intertwined, with an indebted nation trying by any means necessary to gain leverage on the eurozone institutions that have a say over its economy. On the one hand, Italy has been emphasizing its geopolitical importance, arguing that it has a critical role to play in maintaining Libya’s stability. On the other, it is sending a subtle message that, if placed under pressure, it has the power to blow up the eurozone.

Who will flinch first? The answer will likely turn on two differences that distinguish the current case from that of Greece. First, Italy is a much larger country, and thus a runaway financial crisis would pose a far graver problem, because an international rescue package would be much harder to design. Secondly, the new game of chicken is occurring in a rather different international environment, with U.S. President Donald Trump shaping international as well as American politics.

It is not difficult to see how a compromise might be found in which Italy and Europe could agree on infrastructure investment financed through deficit spending, but the escalation of the political conflict means that as time passes any productive outcome becomes less and less likely. The European Union must find a solution before the politics become completely poisonous.

On the face of it, the budget dispute, which turns on Italy’s proposal for a 2.4 percent deficit, looks puzzling. Isn’t 2.4 percent less than 3 percent, the (admittedly overly simple) deficit to GDP ratio rule stipulated in the EU’s Maastricht Treaty and its Stability and Growth Pact? In truth, the dispute is fundamentally about the link between fiscal positions and growth. Italy’s budget proposal treats the 2.4 percent as viable because it will lead to higher growth, which will then increase the denominator in the debt to GDP calculations and thus ensure viability and success. Over the past years, after decades of low growth and then a fierce double-dip recession, Italy has staged a modest recovery, with about 1.5 percent GDP growth in 2017. But the growth rate is slipping again, and the new proposal is designed to give a needed temporary boost. It is an attempt to pull the country up by the bootstraps.

The problem is that everyone knows that Italy’s bootstraps narrative doesn’t fully describe its motives. The importance of the budget for the Italian government goes far beyond its numbers: Its basic purpose is political. The fiscal package represents not only an overall stimulus for the Italian economy but also an attempt to tie together the two quite disparate parties in the government coalition. The right-wing party, the Lega, wanted a simplification (and reduction) of tax rates, and ultimately a standard rate, hoping that that would reduce the problem of tax evasion and avoidance. It got a low 15 percent basic tax for artisans and the self-employed who earn less than 65,000 euros (about $75,000), and a tax amnesty. The left party, the Five Star Movement, got a basic minimum income—means-tested, as opposed to the party’s sometimes rather utopian suggestions for a universal income as a way of responding to unemployment generated by technology and globalization. Both sides wanted to boost consumption and so canceled a planned rise in value-added tax. And both wanted to reduce the pensionable age—a move that has no immediate fiscal consequences but will impose a longer-term burden on young people.

There is also a very obvious national, not to say nationalist, element. This is a budget designed to defy Europe and to make the point that in a democracy people should, in voting for their government, have a say over their tax rates and their fiscal regime. The budget also includes some savings, in part from reduced spending on the housing and management of migrants.

Italy’s approach—both its emphasis on growth and its national and anti-EU rhetoric—have earned the support of Trump and Russian President Vladimir Putin. Both leaders have reportedly mentioned the possibility of extending fiscal as well as political support to Italy, including through buying Italian government bonds. Legally, it is entirely possible for the U.S. Treasury to buy foreign assets, and it has done that as part of cooperatively designed rescue packages in the past.

But were the United States to take a deliberate action to support one European government that is challenging the EU, it would rightly be interpreted in Europe as overtly aggressive diplomacy. It would also look as if Trump is trying to construct a new internationalism—a nationalist internationalism—in place of the “globalism” he attacks and thinks the EU embodies. This would produce a backlash and would likely harden Europe’s current position.

In the meantime, Italian ministers seem to be imitating Trump in attacking the European Central Bank as the institution chiefly responsible for lower future growth. Italy is worried about the running down of the bank’s quantitative easing program, which allowed for extensive purchases of Italian government bonds. Luigi Di Maio, the leader of the Five Star Movement, accused ECB President Mario Draghi of poisoning the atmosphere against Italy simply by mentioning the end of Europe’s extraordinary central banking measures.

The discussion of the budget and responses to it has become a blame game—but it’s one that Italy suffers from most of all. The most obvious immediate financial problem affects Italy’s banks rather than the government. The perception of an increased risk to Italian government debt pushes yields up and brings down the price of the government bonds—most of which are held on the books of the banks. The banks themselves need funding and have a large quantity of bonds that need refinancing soon. The consequence of falling asset values reduces bank capitalization, and new capitalization is required, perhaps from the government—but that would run up against another set of EU rules, this time on state rescues.

The Italian government is signaling its opposition to the EU on a range of measures, from fiscal arrangements to the treatment of migrants—it aims to save money by spending less on medical and administrative arrangements for refugees. It is ostentatiously appealing to ideological affinities with Trump and Putin in a struggle against the EU. It is also signaling solidarity with other anti-EU movements in other countries. But, absent some change in the organization, Italy will soon see that pulling on these political bootstraps will only result in the country hauling itself onto a minefield. Brussels could—and will—respond by insisting that rules are rules and need to be obeyed. The commission has already threatened a fine of 0.2 percent of GDP, around 3.5 billion euros (nearly $4 billion).

But on its own, that response will not be convincing to Italians and will do nothing to heal Europe’s growing political rifts. Disapproval of Italy needs to be accompanied by measures that both show a true European commitment to economic recovery and defuse the narrative of a threat posed by mass migration. European leaders need to explain why national or nationalist strategies are less likely to produce sustained well-being than a course in which Europe generates collective security and genuine public goods. The increasing instability in German politics, after a string of disappointing regional elections for the country’s two largest parties and Chancellor Angela Merkel’s announcement of her intention to step down as party leader, may play an important part in giving Europe this new orientation; the most conservative of the likely successors to Merkel and the current front-runner, Friedrich Merz, consistently emphasizes his commitment to the European idea.

Politically, however, neither side in the standoff with Italy can afford to be seen flinching. The Italian government would discredit itself in the eyes of its voters if it abandoned its current budget; the Europeans fear that they would have to give up on the consistency of its fiscal rules and their application to all member states.

But all Europeans are used to the art of finagling impossibilities. The way around the present impasse is to reformulate the issue as a general one of European growth, but also European security. Infrastructure investment, especially in energy and notably in environmentally sustainable energy, is essential to solving Europe’s security dilemma and countering fears about dependence on the Middle East or Russia for oil. The integration of refugees into society, and into employment, is also a security issue. There is, in short, an overriding case for the provision of resources to tackle problems that are genuinely European and whose solution would provide a European common good. If Italy were to try to limit its deficit spending to such measures, the EU could, and should, permit it to do so.

Harold James is Professor of History and International Affairs and the Claude and Lore Kelly Professor of European Studies at Princeton University. His latest book (with Markus Brunnermeier and Jean-Pierre Landau) is The Euro and the Battle of Ideas (Princeton University Press).