Former President of the European Central Bank (ECB) Mario Draghi has been appointed as Prime Minister of Italy. “Super Mario,” as it is known, faces vast expectations. He is responsible for reviving an Italian economy in stagnation. His appointment also has implications for the future of European leadership.
Following its formula “whatever the cost” proclaimed in July 2012, Mr. Draghi is considered the savior of the euro. One commentator even calls it “the last hope” for Italy. He became the fourth technocratic Italian prime minister since 1994, after another former central banker Carlo Azeglio Ciampi, economist Lamberto Dini and former European commissioner and economist Mario Monti.
At 73, he enjoys wide support from all political parties, including his rivals from the Five Star Movement and Lega. Former Prime Minister Matteo Renzi withdrew from the previous government the support of his “Italia Viva” party, forcing President Sergio Mattarella to turn to Mr. Draghi to form an alternative coalition. If only to avoid the health problems posed by general elections in the midst of a pandemic.
The markets welcomed the appointment of Mr. Draghi. In response to Mr. Mattarella’s call to form a government on February 3, the spread between Italian and German 10-year rates fell from 113.8 basis points on February 2 to 91.2 basis points on February 12, its narrowest margin in five years. The spread between Italian and German sovereign debt is used as a measure of political risk for the euro area. The Italian stock market reacted strongly, with the benchmark FTSE MIB gaining 2.1% on February 3.
This week, the Italian parliament is expected to approve the Draghi government, which includes representatives of the main parties as well as technocrats, and plans to roll out a program of much-needed structural reforms in many areas ranging from education, to public administration in through justice, infrastructure, acceleration of the vaccination program, support to households and businesses during the pandemic and a stimulus spending plan. Mr. Draghi also sees climate change as a strategic focus for his government and has already created a new ministry to oversee the transition to a sustainable economy.
Italy was the most impacted EU country during the first phase of the Covid-19 crisis and the first to impose strict regional lockdowns. With 2.7 million cases, the country now has a lower absolute number of infections than the UK, France and Spain, but it remains the second country in Europe after the UK in terms of mortality, with more than 93,500 recorded deaths. Like its European neighbors, Italy is facing vaccine supply difficulties. Some 4.9% of the population has already been vaccinated (according to data from February 13), a proportion higher than the European average of 4.7% and that of Germany, France and Austria, but lower than the 5.2% of Spain.
As a result, Italy is struggling to emerge from a recession that sent the economy down by 8.8% in 2020, a record since the end of World War II. Depending on the sanitary measures that will be needed in the weeks and months to come, the economy may not return to growth until the second quarter of this year. In addition, next month Italy will end the pandemic moratorium on layoffs, which is expected to lead to higher unemployment, which is invariably stagnant around 10%. We expect Italy’s gross domestic product (GDP) to grow by 4.8% this year and the consumer price index to rise by 1%.
Italian economic activity is currently around 80% of its pre-pandemic level. To date, the country’s economic recovery largely reflects that of its neighbors (see graph).
The time is right for the recovery of the Italian economy. In the past, the mission of technocratic prime ministers was to implement austerity measures. This tended to quickly undermine the political support they enjoyed. Since 1993, their political life expectancy has been only 16 months. In contrast, Mr. Draghi enjoys a window of opportunity in the form of lower borrowing costs and political support for budget spending.
In July 2020, the European Union agreed on a pandemic stimulus fund worth 750 billion euros. For the first time, this agreement gave its executive, the European Commission, the power to issue debt on behalf of member states. Italy and Spain are the main beneficiaries of this recovery plan.
By the end of April, the new Italian government should present to the European Commission a spending plan for the 209 billion euros coming from the stimulus fund and allocated in the form of grants and loans. This amount is equivalent to 10% of the national GDP. In response to the crisis, the country has already taken budgetary measures representing around 5% of GDP in 2019. These initiatives to contain the pandemic are expected to reduce public debt to around 160% of GDP in 2021.
Other member states, including the governments of the ‘four frugal’, namely Austria, Denmark, the Netherlands and Sweden, which last year resisted more generous support, will be on the lookout for signs let Italy spend the money wisely. In their eyes, this would involve spending on infrastructure and efforts to develop an economy that has stagnated for more than two decades, going so far as to occasionally threaten the stability of the single currency.
A new European leadership?
In August 2020, Mr Draghi presented the pandemic as an opportunity to use the EU budget of € 1.1 trillion over seven years and the recovery fund, both at national and EU level. , in order to stabilize and strengthen economies. He added that high debt levels would only be sustainable if they were “used for productive purposes”, such as public investments in “human capital” and “critical infrastructure for production”.
During the euro zone sovereign debt crisis in 2012, Mr. Draghi required the support of German Chancellor Angela Merkel to save the euro. Germany is now in transition to new leadership, with Ms Merkel set to step down as chancellor in September. This could allow Mr. Draghi to position Italy closer to the center of European strategic leadership, in line with French President Emmanuel Macron’s vision for a more federalized European Union.
Last year, Mr. Draghi’s speech went even further. He proposed strengthening European federalism, suggesting that the common debt and budget “formed the basis for the development of a common treasury ministry”. Italy’s leadership in terms of structural reforms, ahead of the changes in France or Germany, would lend legitimacy to the EU’s recovery plan. This could in turn have permanent consequences for the Union’s fiscal architecture.
Political and economic expectations for the new Italian Prime Minister are high. Mr. Draghi has the opportunity to chart a long-term growth path for Italy and consolidate the European project at a historic moment.
It remains to be seen whether his leadership will be more than just an acting appointment. It may also be that in accordance with the ‘great man theory’ pioneered by 19th century historian Thomas Carlyle, which emphasizes the impact of individuals, observers expect too much of a technocrat who attacks a pandemic recession and a complex political landscape.