Why Italy Could Leave the Eurozone

Scott B. MacDonald

Politics, Europe

Economic and political reform isn't on the menu.

The Italian referendum has come and gone – and so has Italian Prime Minister Matteo Renzi, whose reform referendum suffered a major rejection at the polls. Close to sixty percent of Italians said No to proposed changes that would have reduced the power of the Senate and streamlined the legislative process to move ahead on badly needed economic reforms. The downfall of the Renzi administration leaves the third largest debtor among advanced economies without a government and the country’s banks in a precarious position. Once again Italy is heading toward the brink – this time a looming crisis in the financial system which has the potential to rapidly spread from the country’s creaky banks to the rest of the eurozone.

Renzi made a gallant effort to restructure Italian politics and reduce its inherent instability, thus setting the stage for badly needed economic reforms. He was thwarted by a combination of populist right-left forces, regional resistance to what was correctly perceived as a centralization of power in Rome and a degree of anti-EU sentiment. Since 1945, Italy has had 65 different prime ministers, not a great track record and certainly a difficult environment for economic policymakers.

What is called for is both economic and political reform; sadly this does not appear to be on the menu any time soon. Instead Italy faces the likelihood of an interim government and elections early in 2017. Even then it is not clear who will form the next government. The big winner of the December vote is Beppe Grillo, the leader of the populist Five Star Movement. A former comedian, Grillo wants another referendum to pull Italy out of the eurozone, an end to EU-mandated government spending limits, income guarantees for all citizens, and possibly a default on the country’s massive €2.3 trillion public sector debt burden (equal to 135 percent of GDP.)

In recent opinion polls, the Five Star Movement is just behind Renzi’s Democratic Party, which indicates that Grillo could win enough seats to lead the next government in Italy. Such a development would certainly be a major shakeup in European politics as it would put an anti-eurozone populist at the helm of the eurozone’s third largest economy. Although a Five Star Movement victory remains a big if at this point, chances have improved for a Prime Minister Grillo.