At the recent Leaders’ Climate Summit, Italian Prime Minister Mario Draghi described his own country as “beautiful but fragile. His commitment to devote a large part of the common European financial resources, known as the “Next Generation EU”, to finance Italy’s transition to a more sustainable economy is a big gamble. Prime Minister Draghi is trying to replicate in Italy what he did for the European Monetary Union during his tenure as President of the European Central Bank: make it more resilient.
The goal is ambitious. Officially, the recovery funds agreed to in response to the COVID-19 pandemic are one-off measures. In reality, they could become permanent features of a greatly expanded toolkit. If Italy can be put back on track, Europe will have to agree to further integrate.
A Hamiltonian moment for the EU
Is the EU’s common fiscal response to the pandemic the Hamiltonian moment many analysts have been talking about EU leaders have agreed to pool 750 billion euros, now largely depends on how Italy will do in the next few years.
Most common European funds – around 200 billion euros – will go to Italy.
The combination of grants and loans will be largely devoted to accelerating the green transition and the digitization of the Italian economy and public administration. Prime Minister Draghi’s plans also include an ambitious overhaul of the judicial system, whose slowness is seen as an obstacle to foreign direct investment.
The Prime Minister ensures that it is he and his closest allies in the government who will manage interactions with the European Commission in Brussels. In the EU capital, Prime Minister Draghi has a credibility that traditional Italian politicians simply lack.
Europe looks at the former central banker with hope and anxiety. If Italy fails to reform, Europe will likely be stuck in a bad balance for many years: too big to disintegrate, but too timid and cumbersome to be able to respond with the pragmatic agility and ambition needed. to the economic and geopolitical challenges it faces.
Prime Minister Draghi’s plan is therefore not only to save Italy, but also to build on the work he started while he was at the head of the ECB: to push Europe and in especially the euro zone to integrate more – and to make it more resilient. and less fragile.
Is Italy reformable?
Italy is known for unnecessary expenses, dysfunctional politics and Byzantine bureaucracy. Rather than being at the forefront of reform, the country is too often associated with the dead weight of Europe – too big to fail, but impossible to reform. For decades, EU partners have pressed governments in Rome to introduce structural reforms.
However, no one wanted to be at the mercy of a stagnant economy – before the pandemic, the economy had a debt-to-GDP ratio of around 130%. But the timid changes made by Rome have been used by EU partners like Germany to justify their reluctance to agree to additional burden-sharing measures at European level.
Prime Minister Draghi’s main goal is to get Italy to start spending European public funds well and ultimately push for a more ambitious European agenda.
Paradoxically, with Prime Minister Draghi’s spending plans, the public debt will initially rise to 160%, if not slightly higher than under the previous government’s spending plans.
In reality, there are only three ways to reduce this ratio over time: more growth, more inflation, or austerity. Prime Minister Draghi is a Keynesian economist with little patience for an ideological attachment to austerity. Since cutting public spending can push economies into a deflationary spiral and thus become self-defeating, Prime Minister Draghi is betting on good debt and good debt – money dedicated to investment rather than unnecessary spending.
The big question now is whether the country can deliver? If not, European governments will likely revert to mutual finger pointing, behavior that has been brought under control even during the worst months of the COVID-19 pandemic.
A lot depends on Germany
Much will also depend on the direction Germany takes once Chancellor Angela Merkel steps down in early fall. German conservatives are divided on the way forward for Europe. Many are weary of the big public spending plans – European and national – that emerged during the pandemic.
The temptation to return to belt tightening measures is very present. If this becomes the policy of the German government, it could quickly put a new conservative German government on a collision course with Prime Minister Draghi and his closest European allies, like France. It would be a repeat of the North-South split experienced during the so-called euro crisis.
However, this is not a given because even in Germany, the political discourse is changing. Polls show that a majority of voters currently support parties that are more open-minded about debt spending and a more active role for governments in market economies. Loud efforts by Prime Minister Draghi and President Macron to protect European assets from foreign (mainly Chinese) takeovers also enjoy broad political support in Germany. Europe as a whole is asserting itself more and more in its industrial policies thanks to an alignment of German, French and Italian positions.
Fractional parts of Italy can abandon Draghi
Concrete progress could be expected soon on some legacy projects that Draghi helped launch as a central banker, such as the banking union, and here too, Germany’s position has softened. The debate on the reform of common European budgetary rules will probably gain some ground. Tax rules are currently on hold due to COVID-19.
But for now, Prime Minister Draghi’s main goal is to make sure Italy starts spending EU public funds well. This would give him the additional political capital needed to start phase two and push for a more ambitious European agenda. It is a multi-year project.
However, it is not clear whether the Italian political parties currently supporting the government are willing to engage in such a scenario in the medium to long term. The clear and current temptation for professional politicians will always be to use Prime Minister Draghi for as long as necessary and then find a convenient excuse to withdraw parliamentary support and replace him with one of their own.