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Interview iwd 6. December 2016

"Italy is a different caliber"

Italian voters decided against a constitutional reform, Minister President Matteo Renzi resigned. In the interview Jürgen Matthes, Head of Research Unit International Economics and Economic Outlook at the Cologne Institute for Economic Research, talks about the election result and its consequences.

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Mr Matthes, the Italians have decided against a parliamentary reform by a large majority. Did you expect this result?

The polls anticipated a lead of the opponents of Renzis constitutional reform proposals, so it comes not with a big surprise. After the presidential election in Austria had been positive, however, the hope was that the people will back the political reform. For what was on the table - a reform that would have made the Italian government more effective - would have been important steps, which would have helped Italians in the long run. The clear result of the referendum obviously dismisses Renzi and his reform efforts. Unfortunately, this is not really a good omen for the near future.

Was it a mistake of Prime Minister Renzi to tie his political future up with the outcome of the referendum?

In retrospection it seems to be so. We have often seen in the past that in many countries significant decisions were linked to the political fate of a government or a leading person. In France, for example, an important reform of the labor market was decided upon along a vote of confidence in Parliament. By doing so, Renzi has tried to push the reform through. At the time he took the decision, probably did not expect, that his approval in the country would alter so substantially.

What will happen next in Italy?

There will be some kind of transitional government. Possibly, parliamentary elections will take place as planned in 2018, because there is still a governing coalition of the middle-left and the remnants of the Berlusconi party left. It is also possible that pressures for snap elections already next year will rise. At the moment, it is difficult to predict what will happen next.

"The short-term reactions in the financial markets were surprisingly benign".

What is the country's current economic situation?

Italy is currently experiencing a slight recovery. The reforms of Renzi have not yet taken full effect. This is mainly due to the fact that many companies, and thus also the Italian banks are burdened by high debt. Renzi should have addressed this issue earlier. Investment driven growth, which could have kicked off as a result of the economic reforms, has stalled due to the private debt burden. In principle, structural reforms show less effect in recessions, but more so in the next upswing. We see this in Spain, where labor and product market reforms have led to strong growth. But this happened only after the banking system was cleaned up consistently with the help of an ESM rescue package.

What kind of reaction of the financial markets do you expect?

The short-term reactions were surprisingly benign for Italy and even positive for the euro. In the medium term, one has to wait and see how Italy's economic situation will develop. In a worst case scenario, if the country slips into recession, the situation could become problematic. The financial markets could lose confidence in Italy’s high government debts. For such a situation the euro area has powerful new crisis mechanisms which might, however, need a certain change of rules in order to be able to cope with Italy. In the best case, the situation could turn out similar to Spain. The economy simply carried on with the same dynamic, although there was no government for a long period of time. This however happened on the basis of a self-sustained recovery.

What does the Italian result mean for the EU as a whole?

It is necessary to clarify whether the vote was directed primarily against Renzi or if Euroscepticism of the electorate played a major role. The upcoming elections will raise the question of whether the right-wing and left-wing populists will be as successful as many observers fear. Then the situation will become challenging for Europe. Italy is a different caliber than Greece, as regards political and economic relevance. The hope was that Renzi's reforms would take effect and people would notice that they are doing better. Then the voters would have most likely allowed the government to continue to cooperate constructively with Europe. Unfortunately, it did not work out that way.

Will the Italian referendum also have an effect on elections in other European countries?

The problem of Europe is that the debates in the member states only reflect national perspectives. They rarely take the bigger picture into account. This disadvantage for the European spirit could turn out to be an advantage here, however: Political Contagion effects are not very likely due to the separated national debates.

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