Behind the Clash Over Italy’s Budget, a Fear of Populism

https://www.nytimes.com/2018/10/26/world/europe/italy-budget-european-union.html

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BRUSSELS — Just a few years ago, the European Union faced down a populist Greek government whose debts threatened the common currency, the euro, and the very integrity of the bloc.

But if the European Union thought the problem was behind it, it is now back — and bigger and more dangerous than ever — in Italy, whose populist government is also insisting on breaching bloc rules for fiscal discipline in order to keep faith with its voters.

The European Union rejected Italy’s draft 2019 budget this week and demanded revisions; Italian leaders, like the Greeks before them, say that they will ignore those demands.

This clash between an elected government that ran on increasing public spending and the technocrats of Brussels encapsulates the dilemma at the heart of the European Union — its democratic deficit as it tries to manage a currency shared by differing sovereign states without a common budget or finance minister.

But looming behind the current clash over the budget lies a much deeper fear in the European Union: that it will give more fuel to a populist, euroskeptic wave across the Continent before elections for a new European Parliament in May.

So far, European populism has played out on national stages. But a major showing by populists in the European elections would sharply change the balance of power in the European Parliament, affecting the makeup of the European Commission — the executive branch of the bloc — and potentially rendering European Union institutions even more ineffective.

This larger political anxiety is part of the real debate over how to handle Italy and its defiant budget, European officials say.

As the Italian deputy prime minister Matteo Salvini, a right-wing populist from the League, has used the migration issue to bash Brussels and increase his popularity, his coalition partner and rival, Luigi Di Maio, a left-wing populist from the Five Star Movement, is expected to use the clash over the budget to raise his own standing at home.

If divisions in the Greek and Portuguese governments undercut their challenges to Brussels, “the divisions in the Italian coalition all serve to reinforce the need to stick it to Brussels and stand firm both on fiscal policy and migration,” said Mujtaba Rahman, chief European analyst for the Eurasia Group, a consultancy.

Mr. Salvini has vowed to cut taxes, while Mr. Di Maio has pledged a guaranteed income for the unemployed and the poor. Both want to keep their promises.

The fear in Brussels is that if the technocrats are too tough on the Italians, they could galvanize support for Mr. Salvini and the rest of Europe’s populists and create institutional challenges for the bloc for the next five years at least.

“Greece is no longer the only European country with crazy politicians,” said Maria Demertzis, deputy director of Bruegel, an economic research institution in Brussels.

“The current Italian government has its own dose of preposterousness,’’ she said. ‘‘But it’s still elected. They have signed agreements with Brussels and should honor them, but elected governments also have the ability to change their minds. And there’s no good answer on how you punish a country.”

The European Union enforced its will on tiny Greece, which was in desperate straits, Ms. Demertzis said. “The way that 27 nations imposed themselves on a sovereign nation is still something we haven’t gotten our heads around. This is where the E.U. attempts to square a circle and the democratic deficit comes in.”

The result is that “Greece is no longer a sovereign country, but exists in a debtor-creditor relationship with Brussels,” Ms. Demertzis said. “It creates a lot of resentment and anger.”

Bruno Maçães, a former secretary of state for European affairs in Portugal, sees the contradiction. In a Twitter message, he wrote: “I look at what is happening with Italy and can only think: what insanity allows people to think that a fiscal union will lead to anything but the end of the EU? Think what would happen if Brussels had the actual power to draft or permanently veto a national budget?”

Of course, Italy is not Greece, and it has much more room to maneuver. Italy is still able to finance itself, and the markets — which had forced Greece and Portugal to concede — are ambivalent, seeing more of a political crisis today than an economic one.

A serious debt crisis for Italy is still only hypothetical, if more plausible now than before. But given Italy’s size and its status as a core country of the bloc, a crisis, should it come, could be unmanageable and have consequences not just for the European economy but also for the world.

Italy is the eurozone’s third-largest economy, and it has a cumulative debt of some $2.6 trillion — among the world’s top five debt loads, and at nearly 132 percent of gross domestic product, more than twice the maximum of 60 percent allowed under European rules

The debt is so large that even though some 70 percent of it is held domestically, there is significant exposure for German, French and American banks. But a crisis would badly hurt Italians first of all, including small-business leaders who voted for this government, so it is unlikely that Rome wants to throw itself over the cliff.

Still, if investors get really frightened and the cost of Italian borrowing spikes down the road, Italy’s debt payments could get out of control. The Greek bailout cost about $300 billion, and Greece is tiny compared with Italy, whose economy is nearly 10 times as large.

Furthermore, the structures that the European Union set up to deal with debt crises, like the European Stability Mechanism, are small and would require Italy to agree to a restructuring plan, which this government would be highly unlikely to accept.

Then the European Central Bank would have to decide whether Italy really is too big to fail, especially if the stakes include the very existence of the euro currency. “Would European countries really be prepared to break the euro?” asked Ms. Demertzis of Bruegel.

So the nightmare is out there, distant on the horizon. And that, of course, is another part of the balance that Brussels is seeking, as officials emphasize that they are open to dialogue with Italy over its budget, and some economists suggest that given Italy’s essentially stagnant growth — under 1 percent a year — some fiscal expansion might be beneficial. Still, in the longer run, the message goes, what Italy is doing is incompatible with membership in the euro and the single market.

Italy has three weeks to respond to the European Commission, but it probably would not pass a budget until the end of the year. The commission could then put Italy into something called the “excess deficit procedure,” which could eventually lead to fines and sanctions.

But all that will take time — and the May elections are not so far away.

“It’s all about timing,” Mr. Rahman said. “But it’s also about democracy and membership. And this is the issue that policymakers in France, Germany and Brussels are most concerned about.”