On Thursday, European Union leaders are holding a videoconference to plan their fight against the new coronavirus. They will also probably discuss the economic consequences of the pandemic. A group of nine member states have proposed that the European Union borrow money to finance the fight against coronavirus by issuing joint “coronabonds,” a move opposed by Germany and the Netherlands.
This decision will be made against the backdrop of a looming fiscal crisis in one of the E.U.’s founding members, and its third-largest economy. Italy was already in a financially precarious position before the pandemic. Its government has run a budget account surplus excluding interest payments (spending less money than it brings in), in 19 of the last 20 years.
Nonetheless, it has the highest level of public debt in the “eurozone” countries that participate in Europe’s common currency, and the third-highest level of debt in the world. This means that it may have a hard time raising more money in a period of crisis. Nor is this just Italy’s problem. If a core member of the eurozone gets into trouble, the E.U. may start to experience financial market instability, and challenges to its legitimacy, just as it did when Greece got into trouble – but potentially on a much larger scale.
There is an adage that when the U.S. economy sneezes, the rest of the world catches a cold. We may be about to see what happens to the E.U. when one of its core members has an untreated case of double pneumonia.
Covid 19 is creating serious fiscal strains
People have known for a long time that Italy has economic vulnerabilities, but they largely stopped paying attention to them. Now, the coronavirus emergency has highlighted Italy’s fiscal vulnerabilities. Even before coronavirus, Italy had low economic growth. Now, it is in the grips of a serious recession.
The worst-hit parts of Italy are in the industrial north, which is Italy’s economic powerhouse. As the country locks down to stop contagion, economic growth has fallen further, while the demands on Italy’s government have increased dramatically. If it is to keep hospitals going, help families deal with their mortgages, and keep businesses on life support, the government needs money.
However, the more that the government needs to spend, the higher its indebtedness will grow. Policy makers fear that Italy will soon reach a point where markets become skeptical of Italy’s ability to repay its debt and refuse to lend, except perhaps at very high interest rates. Last week saw an early sign of what this might look like, when Italy’s borrowing costs skyrocketed bringing back memories of the eurozone debt crisis.
If a crisis emerges, it is unlikely to stop with Italy. When the Greek debt crisis hit, European leaders believed they could limit the contagion, because the Greek economy was only a small part of the eurozone. They were more worried about what might happen if markets lost confidence in Spain, and very worried indeed about what might happen if Italian debt came under sustained attack. Italy’s size and importance meant that it would be extremely difficult to firewall it from the rest of the eurozone, creating the risk of a general loss of confidence in the eurozone, and perhaps even its possible collapse. These fears may be emerging again.
The E.U. is losing public support in Italy
Eurobarometer opinion poll data shows Italy used to have very high support for the E.U., both before and after it joined the single currency. Twenty years later, the situation is radically different.
Before the start of the coronavirus emergency, only around one third of Italians had a positive image of the E.U. and trusted it. As the emergency got worse, Italians’ frustration with the E.U. increased. First, Germany blocked the export of needed medical masks and other protective equipment to Italy, which was in dire need of help. Then, on March 12, the president of the European Central Bank, Christine Lagarde, made comments that suggested that the bank would not be prepared to do “whatever it takes” to support eurozone member states if they came under market attack. These comments triggered the worst stock market crash in Italian history.
This made it easier for Italian populists to rouse resentment against the E.U. Opposition to Europe was a hallmark of Five Star Movement- Northern League coalition that governed the country until last September. The pandemic has emboldened the anti-E.U. rhetoric. Matteo Salvini, the leader of the League, (the most popular party among Italian voters), was quick to blame European inaction. However, Salvini’s skepticism is now a mainstream position. The perceived lack of solidarity from E.U. countries is pushing all Italian parties to distance themselves the Union. Again, there is the possibility of contagion. If European solidarity among member states falls apart under the pressure of a crisis, it will call the underlying principles of the E.U. into question.
Italy faces stark economic and political problems. It has little fiscal room to cope with an extraordinary medical emergency. While it has committed 25 billion euros to support the economy over the coming months it will need far more than that. Anti-E.U. discontent is growing too. However, these aren’t just Italy’s problems. A collapse of confidence in Italian debt would very possibly undermine the eurozone. Likewise, the E.U.’s organizing principle of an “ever closer union” are coming under enormous strain. The coming days and weeks may have transformative consequences for E.U. politics.
Manuela Moschella is associate professor of International Political Economy at the Scuola Normale Superiore. Lucia Quaglia is Professor of Political Science at the University of Bologna.