Italy's game of euro chicken

The Greek crisis is only a few years in the rearview mirror, and Brexit is still in the process of negotiation, but the European Union is already face to face with a new crisis. Italy, having finally formed a government composed of left- and right-wing populists, saw that government collapse after its president, Sergio Mattarella, rejected the coalition's finance minister over his pronounced euroscepticism. Mattarella's extraordinary intervention in vetoing the choice of a democratically-elected government has only inflamed populist passions. New elections are likely, and the markets have followed political events into turmoil. Even Britain has reason to worry about the impact of the crisis on the course of their own exit from the European Union.

The chief populist complaint is that the euro operates for the benefit of Germany, and at the expense of countries like Italy. And with Italian unemployment still in the double-digits years after the end of the Great Recession, they have a point. But German domination of the European Union — particularly in monetary policy — was not only predictable; it was explicit. Why, then, was Italy so determined to adopt the euro in the first place?

Then Prime-Minister Romano Prodi provided one answer back in 1997, when Italy was struggling to meet the Maastricht criteria for inclusion in the eurozone: "Europe is not just about a currency. It is impossible to think of Europe cut off from its great Latin culture." Italy is where the Roman Empire was founded, and the bulk of the peninsula was part of Charlemagne's domains, and of the Holy Roman Empire for centuries thereafter. A "Europe" that rejected Italy over fears about budget deficits or optimal currency areas would be selling its birthright for a mess of potage.

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In the same speech, though, Prodi gave another, less elevated rationale for doing everything and anything to get into the currency union: "If we are not in the first group, our currency would come under assault, our economy would be defenseless, our international credibility would be diminished." From the beginning, Italy had reason to worry that if it were left out of the core European club, it would fall prey to the vultures of international finance, as Britain had on Black Wednesday, 1992, when it was forced to withdraw from the European Exchange Rate Mechanism.

It was quite a cautionary tale. Yet, during the 1990s, after its recovery from the pound crisis, Britain thrived. Leaving the ERM made it possible for Britain to adopt a monetary policy appropriate to its own inflationary environment, rather than Germany's. Refusal to adopt the euro did not even impede London from expanding its role as the European financial capital. Why, then, would the Italians have drawn the opposite conclusion from the ERM crisis — in which, it should be remembered, the Lira also breached its prescribed trading bands — and show so much determination to get into the euro by hook or by crook?

Prodi did not articulate the deepest reason why Italy wanted so badly to be a member of the club, because it would have been politically catastrophic to do so. In truth, both Italy's political and economic elites and its people were eager to ditch each other, and hand sovereignty over to a supranational body that they knew would be dominated by Germans.

Italy's postwar politics were notoriously unstable for decades, with 52 changes of government between 1946 and 1993, more than one per year. In 1998, on the eve of the adoption of the euro, Transparency International rated Italy as the most corrupt country in Western Europe. In response to economic difficulties, the Italian lira was devalued repeatedly against the deutschmark, but evidence that the devaluations facilitated structural readjustment of the economy is limited. Rather, devaluation was part of a way of life, cleaning the slate just so it could be dirtied again, a fact reflected in persistently high borrowing costs for Italians and difficulty attracting foreign capital.

This is what the Italians were trying to escape when they joined the euro. The people would escape from a corrupt, self-dealing political class to be governed by more efficient bureaucrats in Brussels, themselves being watched by German bankers. Permanently lower interest rates would enable Italian business to finally compete with German, French and Dutch ones. And Italian political elites would have the chance to play a perhaps smaller role in a much bigger European game, while being relieved of the responsibility for much macroeconomic management of their own country. It was win-win.

Until it became lose-lose. The Italians and the Germans both undoubtedly hoped that the discipline of the euro would inculcate German political culture and fiscal prudence into Italy. But it turns out that volunteering to surrender your sovereignty is no way to improve self-government. Italy certainly has made some important economic and political reforms over the years, and has perforce managed their budget to suit the requirements of Brussels. But reform at the command of foreign bureaucrats has proved extraordinarily unpopular, and for good reason: Under conditions that have obtained since the late 2000s, this has meant a grinding misery for the Italian people, particularly its young people, and within the Euro there is no obvious way for the Italian government to provide substantial relief.

The populists promise to change this. But they can't actually change anything substantial without either permission from Brussels, or leaving the euro. Leaving would immediately spark a massive economic contraction, and would surely be political suicide for any Italian government. But without a credible threat to leave, there is very little reason for Brussels to agree to the kind of structural changes that would be necessary to make the European Union work: either by making it directly responsive to democratic accountability, or by devolving far greater power to national governments and effectively reverting to little more than a free trade zone.

Freedom isn't free, and sovereignty isn't cheap — but don't expect populists to admit that. Matteo Salvini, leader of the right-wing eurosceptic League party, hopes to take the case for leaving to voters. He will undoubtedly make that case in a thoroughly dishonest fashion, promising relief and prosperity when, in fact, if the markets see any sign that Italy might actually try to leave, they will punish it mercilessly. He'll have an uphill climb; for all their populist fury, Italians still significantly favor the euro. But even if Italians truly want to stay in, to force change they have few other options than playing a game of chicken. And to win a game of chicken, you have to convince the other driver that you really won't swerve, even though he's in an Audi Q7 and you're in a Fiat 500.