di Harold James
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.
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