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Italy Is Opening the New Season of the Euro Area Crisis

Published on , , Twitter: @euinside

A really hard beginning is awaiting the new European Commission. Not only that it will have to work in an environment of growing tensions along the external borders, especially to the east, but it will have to tackle a possible return of the eurozone crisis with all the consequences that stem from it. Therefore, it will be essential who will take the post of the powerful EU commissioner for economic and financial affairs. Claims for it have not only certain member states, like France, but the Party of European Socialists as well, especially after the outcome of the European elections perceived as a signal for a radical change of the EU economic policies. A possibility which saw also the 39-year old Italian Prime Minister Matteo Renzi after the Democratic Party he took over in a coup last year won a massive victory at the European elections.

Matteo Renzi's happy days are over (and also of the leftist forces)

Even before his champagne had turned flat after his victory, though, came the moment of sobriety when on 6 August the Italian national statistical institute released the data that the country is falling back into recession. The Italian gross domestic product shrank by 0.2% a second quarter in a row. Matteo Renzi headed the government of Italy in the end of February which means that his entire rule so far has been accompanied by a shrinking economy against the backdrop of his stated large-scale programme for reforms. It envisaged the GDP to bubble up by 0.8% which is a little bit more optimistic than the European Commission's spring forecast for an economic growth of 0.6%.

The bad news about the return of the recession in the EU's third biggest economy will be a huge test not only for the new Commission but also for the European semester because nothing is the same anymore as it was in the beginning of the crisis in 2009 when there was, though painfully achieved, unanimity about the path ahead.

Now the division in the Union is great which means that the debate in the euro area and the EU at large will no longer be whether but how countries, like Italy, that reject doing reforms or where the resistance to reforms is very strong should be rescued. In an interview with The Financial Times, Mr Renzi firmly stated that not the Troika, the ECB or the European Commission but he himself will decide what reforms should need to be undertaken. "I will do the reforms myself because Italy does not need someone else to explain what to do", the Italian prime minister states with his typical boyish arrogance. He claims that already many things have been done with a speed unknown by far in Italy. "Not even dictators managed to get things done as fast as this", he adds knowingly. This, for itself, is a very odd statement which forces one to think that Renzi does, may be not as much as Victor Orban, sympathise with dictatorships. This is a very worrying trend, especially when it comes from a founding member of the EU.

The European Commission's reforms

One of the fundamentals of the European semester, which was established for closer coordination of the member states' economic policies, is the country-specific recommendations. The European Commission formulates them after a thorough analysis of the countries' economic situation and their mid-term programmes for reforms. In this year's set for Italy are visible the Commission's efforts to give the new Italian government a lead which, in the same time, reflects also the trend from last year of "mitigating" the austerian zeal. In the analysis that accompanies the recommendations for reforms, the European Commission outlines a very serious problem and it is that the Italian reforms programme had not been adopted by an independent body as the two-pack foresees (the establishment of an independent fiscal council that should monitor the government's fiscal policies). This is one of the recommendations to the Italian government which also has a deadline - "no later than in September 2014" to be ensured the complete independence and operationalisation of the fiscal council.

 According to the Commission, the macro economic scenario which the programme is based upon, is "slightly optimistic". The recommendations to the Italian government are eight and practically repeat last year's set but the tone is definitely different compared to the 2013 cycle. The first recommendation is more efforts to be invested in respecting the debt reduction rule which is over 130% of GDP. The reduction of the debt is at the centre also of the recommendations related to Italy's budget policy. The quality of public spending must be improved significantly at all levels by in the same time keeping the expenditures for education, innovation, research&development and key infrastructure projects.

Italy is one of the countries with very high tax burden, especially on labour. That is why the Commission recommends shifting that burden to other areas like consumption, property and environment. The tax reform, too, has a deadline - it should be launched by March 2015. Improvement of the efficiency of public administration, transparency, fight against corruption, enhancing the resilience of the banking system and a large-scale reform of the labour market are the other key recommendations to the Italian government. The national reforms programme is definitely ambitious and envisages serious structural reforms, focused on three strategic areas: institutions, economy and employment. The institutional reform foresees the adoption of a new election law which is supposed to ensure good governance, abolishing provinces and improving the Senate's functions.

This reform was started by Enrico Letta's government last year after the early elections in February led to a complete deadlock of governance. As if to counterbalance the bad news about Italy's economic performance, the last week ended with the adoption at first reading of one of the key reforms concerning the two-chamber parliament. It reduces the number of senators by two thirds - from 315 to 100 - and abolishes all their additional payments. This is expected to secure 50 million euro in savings monthly. Their powers will also be slashed. The Senate will no longer be able of a confidence vote for the government, but will have supervisory functions over the governance. It will be able to hear ministers and will pass amendments to the Constitution, constitutional laws and laws for national referenda.

The draft passed through the Senate after really tough debates, disputes and rows but it is still far from adoption. It is yet to be debated in the House of Deputies and then it will be subjected to a referendum. Even if it passes, this reform is the least of Renzi's problems because it affects mainly the political forces. The economic reforms, however, like liberalisation of the labour market, tax reform, and the changes in the public administration will affect voters themselves and will cause resistance among public officials. But the stakes, too, are huge. Italy has been dragging along for decades with very weak growth and the Commission constantly points to the main problem - the very complicated taxation system, corruption, the sluggish and dependent on vested interests public administration.

Will Matteo Renzi take on this task, which will for sure melt his huge support, is a question that Brussels will seek an answer to in the coming months. ECB President Mario Draghi, however, is certain - Italy is not Germany and the reasons for the low gross domestic product are different than those in other countries that have temporary problems. At his regular weekly news conference in Frankfurt last week Mr Draghi said that the reason for Italy's bad performance is the lack of structural reforms. "I keep on saying the same thing, really – reforms in the labour market, in the product markets, in the competition, in the judiciary and so on and so forth. These would be the reforms which actually have and have shown to have a short-term benefit".

"Our model is Germany"

In his interview with The Financial Times Matteo Renzi points out that he pursues Germany's economic model. However, he demonstrated strong opposition against Angela Merkel's economic views which was quite evident during the 26-27 June EU summit in Brussels when he fought for "more flexibility" in the approach toward countries that implement structural reforms. This autumn, he has to convince Brussels and his peers in the European Council that Italy, indeed, does work on the announced reforms and that it will not deviate from the drawn path. But if it continues with the rebellious tone, this will encourage even more French President Francois Hollande to insist on loosening the discipline. This will practically mean a recant of all commitments, whose main purpose was to calm the financial markets down, and will practically mark the return of the euro area crisis.

But the scale this time will be different and, indeed, will put into question the capabilities of the monetary union to survive under the weight of huge and non-reforming economies like France and Italy. Certainly, this will be another great opportunity for David Cameron to seek allies for further loosening of the Union. So far, reforms in Italy were impeded by the typical Italian politics - frequent government changes or rule of media dictators like Berlusconi. That is why, Enrico Letta and now Matteo Renzi decided to first deal with the political reform. If it passes, then the road to all the other reforms will be cleared. Then we will know if the Italian premier has the courage to implement them or everything was just populism. But will markets have the patience to wait and see the denouement in the second season of the crisis?

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