Project Syndicate

Meloni’s Choice Nov 11, 2022 |LUCREZIA REICHLIN

The adoption of an anti-EU stance by Italy's government would threaten the future of the European project by undercutting efforts to advance the institutional reforms that are needed to support further integration. And such integration is essential to enable Europe to confront the biggest challenges facing its citizens.

LONDON – The rise of Italian Prime Minister Giorgia Meloni and her Fratelli d’Italia (“Brothers of Italy”), a party with roots in Mussolini’s Fascist movement, has raised more than a few concerns. For markets and Italy’s international partners, particularly in Europe, the primary worry seems to be that weak public finances and growing political instability will result in a new fiscal crisis. But the far bigger danger is a potential rupture in Italy’s longstanding tradition of support for European integration. While Meloni views herself as America’s most faithful friend in Europe, her European policy is less clear. We know that she strongly opposes the pursuit of “ever-closer union” that the Italian establishment has long backed, instead supporting a minimalist design for the European Union, based on loose coordination of national policies.

For now, Meloni will most likely exercise caution in challenging European integration. She knows that the EU’s future is far from certain, and that Italy will be dependent on its economic support for the foreseeable future.

But Meloni’s balancing act could fail in several areas, including the negotiations on energyrelated fiscal-support measures, the approval of a reformed European Stability Mechanism (which neither Germany nor Italy has signed), the reform of the Stability and Growth Pact, and migration policy. It is worth noting that Meloni struck a moderate tone on economic issues during her campaign, but employed plenty of racist dog-whistling on issues like migration.

In the short run, much depends on the evolution of the economic situation. Italy has surprised everyone with a strong performance in the third quarter of 2022, which implies that growth for the year will be higher than expected, providing some helpful fiscal space.

If Italy achieves its official forecast of 0.6% GDP growth in 2023 – based partly on the predicted multiplier effect of money provided by the EU-financed NextGenerationEU (NGEU) program, which Italy will begin to spend next year – Meloni’s options will expand further. Higher nominal GDP growth could lead to a slight decline in the debt ratio. In this scenario, Meloni’s government could in principle spend some €20 billion ($20.6 billion) on support for families and companies hit by high energy prices, and deliver a minimalist version of the tax and pension reform that she promised during the campaign, without major consequences for Italy’s public finances. She may free up more fiscal space for such a scheme by rolling back the minimum-guaranteed-income scheme implemented in 2019 by Giuseppe Conte’s government. Her government is targeting a 4.5% deficit for 2023.

All of this sounds perfectly reasonable. But the official targets depend on gas prices continuing their recent downward trend, the public administration spending NGEU funds effectively, and GDP growth meeting the government’s rather optimistic forecast. None of this is guaranteed.

If gas prices were to rise again, Meloni’s government would be forced to introduce new support measures, which would not be funded by taxes. While a strong tourism season has bolstered Italy’s economy, it will soon become clear just how hard households and corporates have been hit by the energy crisis. This helps to explain why the International Monetary Fund has issued a less optimistic forecast of just -0.2% growth in 2023, and the European Commission has published a forecast of 0.3%.

Monetary-policy tightening raises further risks, as it affects both credit and debt-refinancing costs. The test of Italy’s ability to withstand these risks will come in the spring, when the 2024 budget is discussed. By then, we will also have a clearer idea about the persistence of inflation, and thus the European Central Bank’s policy trajectory.

If Italy’s fiscal position does become untenable (again), Meloni’s government will have to hope that its European partners will show solidarity, both by allowing for flexibility in the application of common fiscal rules and by implementing fiscal backstops. In other words, an Italian government that believes the EU should be defined by subsidiarity will be forced to advocate more risk-sharing.

With all of Europe facing an energy crisis, many EU countries will be reluctant to share risks. Overcoming resistance will require a high level of political alignment among the Union’s biggest players, together with a credible Italian commitment to reform as a basis for greater integration.

If the EU refused to provide the needed support, Meloni’s government would most likely blame it for Italy’s woes and its own failures. This would have serious domestic consequences, especially if the Meloni government also strayed from the reform path to which its predecessor, led by Mario Draghi, committed. Meloni already has incentive to do so: some of the reforms hurt the core of the ruling coalition’s electoral base. But Italy cannot access its grants and concessionary loans under NGEU without them.

Beyond its impact on Italy, the adoption of an anti-EU stance by the Union’s third-largest member would threaten the future of the European project, by undercutting efforts – spearheaded by figures like French President Emmanuel Macron – to advance the institutional reforms needed to support greater political and economic integration. Make no mistake: such integration is essential to enable the EU to confront the biggest challenges facing Europeans. The forces of division in the EU are growing stronger. The war in Ukraine has strengthened the position of the Eastern European and Baltic countries, which view strong ties with the United States as an alternative to deepening European integration. If Italy joins this camp, it could spell doom for the EU.

Without a shared vision, the EU will remain inherently unstable. But formulating such a vision, as Macron is attempting to do, takes work, such as forging consensus on thorny questions and implementing difficult governance reforms. Acting as a spoiler is much easier: simply thwart progress, and the edifice’s collapse will practically take care of itself. This – not another fiscal crisis – is the real danger posed by Meloni’s government.

LUCREZIA REICHLIN Lucrezia Reichlin, a former director of research at the European Central Bank, is Professor of Economics at the London Business School and a trustee of the International Financial Reporting Standards Foundation.