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Europe,s Unending Berlusconi Problem

LONDON – Silvio Berlusconi, Italy’s three-time prime minister and the country’s dominant politician for two decades, has now been convicted and sentenced to four years in prison – a sentence since reduced to one year. But few people in Italy – or in Europe – believe that Berlusconi will fade from Italian, or European, politics anytime soon. Just a few days ago, he declared his intention to remain involved in politics, though not to run for prime minister a fourth time.

Whatever role Berlusconi chooses to play, it is unlikely to be a marginal one. He may not wish to be king again, but he certainly can be a kingmaker, owing to his control of Mediaset, Italy’s largest media group. And, given his abysmal popularity ratings, he may decide to play the wild card, embrace a euro-skeptic and anti-government stance, and try to bring down Prime Minister Mario Monti’s technocratic administration.

Monti’s government took over from Berlusconi in November 2011, arriving with a clear mandate, and full parliamentary support, to implement the measures needed to restore market confidence and reassure Italy’s eurozone partners and the International Monetary Fund that the country was not going down the path taken by Greece. At the time of the G-20 summit in Cannes that month, Italy – and Europe – was dangerously close to collapse, with Berlusconi’s government deeply divided about the fiscal measures needed to bring down the country’s debt-service costs. Domestic political deadlock, and Berlusconi’s inability to engage with Germany and France resulted in spiraling refinancing costs, with the spread relative to German bunds consistently over 500 basis points between July and November 2011.

The Monti government has restored market confidence and Italy’s international credibility. But the overall picture remains fragile. The interest-rate spread has stabilized around a more manageable 300 basis points, but is still higher than it was three years ago. In addition, Italy’s economic outlook remains highly uncertain.

Indeed, the modest economic recovery that should benefit many countries in 2013 seems to be eluding Italy. According to the IMF, the economy will remain in recession next year, and, though the rate of contraction will be less severe than in 2012 (-0.7% in 2013, compared to -2.3% this year), the unemployment rate is expected to rise further, from 10.6% to 11.1%.

More needs to be done in order to support economic growth in the short term, improve the country’s fiscal position in the medium term, and implement the structural reforms needed to make the Italian economy more robust and internationally competitive in the long term. Italy is ranked 43rd in the World Economic Forum’s global competitiveness index, well below the main eurozone countries, owing to lack of investment – especially in human capital – and structural rigidities that have constrained growth for many years.

The answer to Italy’s economic problems is not, as Berlusconi advocates, an exit from the eurozone and a return to the flexibility of its own currency, which in the past allowed policymakers to boost competitiveness through irresponsible devaluations. Italy needs to learn how to live with the euro and within the eurozone, which means adopting policies that ensure that productivity growth and innovation, not currency devaluation, are the main drivers of competitiveness.

A stable, competent, and responsible government with a comfortable parliamentary majority is essential to continue what Monti’s government has initiated. While the odds still favor a relatively smooth transition, many uncertainties could derail the reform process. In particular, whether Italy will be able to move beyond technocratic politics to a “normal” government remains the outstanding question both at home and for the other eurozone member states.

From this perspective, what Berlusconi advocates for Italy, and the consequences of his agenda for the eurozone, is not good news. Any hint that the country may be locked again in parliamentary inertia, as in the final months of Berlusconi’s last government, would push the markets to question the credibility of Italy’s fiscal-consolidation plan, jeopardizing the country’s ability to refinance its debt. That debt is the largest in the eurozone – at roughly €2 trillion ($2.6 trillion), or 120% of the country’s GDP – which means that Italy can be helped, but not rescued.

With potential instability looming, Monti should ensure that Italy is not defenseless in the event of another round of market instability. Unlike some months ago, now the European Central Bank can intervene and buy troubled countries’ debt. But this mechanism can be activated only by formal request. Italy should follow this route without delay. It is better to have a powerful weapon that may gather dust than to be unarmed in a time of need.
Paola Subacchi is Research Director of International Economics at Chatham House.

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