Coronavirus could damage the euro zone

The coronavirus pandemic may claim an unexpected victim: a united euro zone. And if it does, Italy will have done much of the work.

The country has essentially shuttered its economy to fight its enormous health crisis. All retail establishments — restaurants, shops and entertainment — are closed throughout the entire country except for essential stores like groceries and pharmacies. Effectively, millions of Italians are out of work.

These actions would shock any economy. But Italy’s economy is already weak, and has been for decades. Its gross domestic product has barely grown over the past 20 years. Its unemployment rate, at 9.8 percent, is one of the highest in Europe. Worse still, Italy is one of the most heavily indebted nations in the world. Government debt stood at 138 percent of GDP before this crisis hit, and lenders were already demanding high interest rates for government bonds to account for the added risk of default. With this existing weakness as a backdrop, Italy will find it difficult to muster the fiscal response it would need to contain new economic distress — something its lockdown is sure to cause.

Italy’s economic crisis will ultimately put serious pressure on the euro. The currency’s value is largely set by healthier economies such as Germany, and makes it impossible for weaker, indebted economies to recover by letting currency depreciation make its goods cheaper in a global market. If Italy’s economic hit weakens its banks sufficiently, the European Central Bank could be forced to step in with a large bailout. The terms it imposed on Greece, another deeply indebted European Union country, after it slunk into default indicate that Italians would likely face years of depression and stagnation should a bailout be necessary.

That’s not something they are likely to stand for. Italy’s current government is extremely weak, a coalition between the populist Five Star Movement and the center-left Democratic Party that has trailed the opposition in the polls by substantial margins for over a year. That opposition coalition is dominated by the extreme populist League party and its bombastic leader Matteo Salvini.

Salvini has long raged against the E.U. While he has recently called for the very measures the Italian government is now undertaking, he has also called for a massive fiscal stimulus to offset the economic pain. It’s not inconceivable that the current government, unable to deliver such a stimulus and unwilling to flout the powers that be in the E.U., falls and thus brings Salvini to power. And a Salvini-led government would be a nightmare for the E.U. establishment.

If the past is any guide, Salvini will not hesitate to break with the E.U. His meteoric rise over the past few years has come as a result of strident nationalistic rhetoric. There is no problem, it seems, that cannot be solved by a decisive, aggressive and strong chief executive. It would be completely out of character for him to preach national defiance and then meekly accept whatever terms Brussels and Berlin impose.

The failure of another populist, former Greek prime minister Alexis Tsipras, will surely be foremost in Salvini’s mind should he gain power. Tsipras vocally opposed the austerity measures the European Union imposed as a condition of bailing the country out, only to flinch and accept nearly identical ones rather than leave the euro zone. Greece’s unemployment rate, while dropping, remains more than 16 percent, and its economy grew at only a 1 percent annual rate in the fourth quarter of 2019. Tsipras’ party, Syriza, was tossed from office in last year’s elections. Defeat is not a word in Salvini’s dictionary, and that means he will bite the bullet and leave the euro zone if he has to — no matter how much he denies it right now.

If Italy leaves the euro, then it’s likely only a matter of time before the euro zone itself either contracts to only stronger, northern countries or breaks up all together. As Nobel Prize winning economist Joseph Stiglitz pointed out, the euro was supposed to draw the member states closer together. Weaker economies such as Italy’s were supposed to make structural changes to be more like Germany’s and stronger economies were supposed to make sacrifices to support the weak. Neither set of changes has broadly occurred, and an Italian departure will make these facts crystal clear to markets and voters alike.

This doomsday scenario is speculative right now, but Italy’s economic lockdown is sending clear warning signs that a fiscal meltdown is coming. Let’s hope European leaders don’t ignore them.

Henry Olsen is a Washington Post columnist and a senior fellow at the Ethics and Public Policy Center.

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