How Draghi lost Italy

Intervista ad Alberto Mingardi

1 Giugno 2018

Argomenti / Teoria e scienze sociali

Mario Draghi was meant to save the eurozone and in particular the troubled Italian economy. He now risks being remembered as the man who helped propel it over the cliff.

As president of the European Central Bank, the 70-year-old Italian economist is one of the most powerful authorities in the financial world, responsible for setting monetary policy for the entire eurozone. He is also one of the authors of a 2011 letter to the Italian government, prescribing a series of painful reforms intended to put the country back on the path to economic growth.

But as Italy teeters on the brink once again, critics from a wide range of political positions point to Draghi’s policies as the root of the political — and financial — instability the country finds itself in today.

After months of post-election turmoil, the political situation in the country remains unstable, with two populist parties — the anti-establishment 5Star Movement and the far-right League — struggling to form what would be Western Europe’s first Euroskeptic populist government.

The country could also be headed for a new election, perhaps as soon as this summer, that would be widely seen as a referendum on the Italy’s membership in the eurozone.

“His recipe for Italy was catastrophic,” said Giulio Sapelli, a Milan University economist, who has known Draghi since his time as director general at the Italian Treasury in the 1990s.

For Sapelli, it was the austerity measures championed by Draghi — put in place at a time when Italy’s economy was in deep trouble — that aggravated the economic crisis and facilitated the rise of the country’s populist parties.

“His approach has produced a fall in economic growth,” said Sapelli, whose name was briefly floated as a potential prime minister at the head of a populist government. “His policies have laid the ground for the success of these forces.”

Secret letter
A native of Rome, Europe’s top central banker is known to those close to him as a tough man, a leading economist with broad intellectual scope. Orphaned as a teenager, Draghi arrived at Rome’s La Sapienza University as a fully responsible adult, according to his friends in the Italian capital.

In 1976, he became the first Italian to earn a doctorate at the prestigious Massachusetts Institute of Technology, under the tutelage of the economist Franco Modigliani, a Nobel Laureate. He then went on to work at the World Bank and the Italian Treasury before joining Goldman Sachs, where he was a managing director, before being appointed governor of the Bank of Italy in 2005.

It was in his role as incoming ECB president that Draghi sent his letter to the Italian government listing the reforms he believed needed “to be implemented as soon as possible” to prevent the collapse of the economy — and possibly the entire eurozone.

The letter was co-authored with the outgoing ECB President Jean-Claude Trichet in August 2011 at the peak of the euro crisis, when the difference between Italy’s and Germany’s costs of borrowing — a key measure of investor confidence — was skyrocketing.

It was intended to be confidential, but news of it soon leaked to the press, helping to spark a political crisis that eventually led to the resignation of Prime Minister Silvio Berlusconi later that year.

Many of the reforms suggested by Draghi and Trichet were quickly passed into law, beginning with an overhaul of the pension system by Berlusconi’s technocratic successor Mario Monti.

Known as the Fornero law — after then-Labor Minister Elsa Fornero, who had to struggle to contain her tears as she announced it — the reform raised the minimum age of retirement and changed the way pensions are calculated.

It also immediately became a political flash point. Both the League and 5Stars made its reversal a central part of their political platforms ahead of last March’s election.

‘Whatever it takes’
One of the central themes of Draghi’s philosophy as a regulator is that while monetary policy can lay a foundation for economic prosperity, politicians also need to play their part.

“Actions by national governments are needed to unleash growth, reduce unemployment and empower individuals, while offering essential protections for the most vulnerable,” is how he put it in an address to the European Parliament in 2016.

Another thing political action did was allow Draghi to roll out an ambitious intervention in the economy of the eurozone.

With Italy and other troubled European economies seemingly on the path to reforms, Draghi was able to secure support for what would become a €2.55 trillion bond-buying program, helping to prop up struggling European economies by flooding them with money from the central bank.

Combined with his 2012 pledge to do “whatever it takes” to preserve the euro, the program calmed jittery markets, lowered the cost of public borrowing and brought to an end a crisis that had threatened to unravel the EU’s common currency era.

In Italy, however, Draghi’s policies also had an unintended effect, said Alberto Mingardi, director at the Bruno Leoni, a free-market think tank.

By removing the boot of the markets from the government’s neck, it gave the country’s politicians and its electorate a false sense of having room to breathe.

Even as Italy’s debt continued to climb (to more than 130 percent of GDP today), the country’s reform effort quickly lost its teeth. “Unfortunately, without pressure from the markets, Italian governments don’t do real reforms,” said Mingardi.

In a 2017 report on Italy’s labor market and education reforms, the OECD wrote that the efforts “go in the right direction, but more progress is needed to ensure their full and effective implementation. A whole-of-government approach will be needed to advance these reforms.”

The Draghi effect was particularly evident during last winter’s election season, when the markets shrugged off ever more extravagant campaign promises.

Rather than proposing reforms or efforts to tackle Italy’s mountainous public debt, political parties competed to propose the biggest spending increases.

Combined, the 5Stars’ and League’s electoral promises — from rolling back the Fornero reform to slashing taxes and introducing a guaranteed minimum income of about €800 a month — could cost as much as €125 billion, nearly 8 percent of GDP.

“Draghi has created the conditions for the success of populists,” Mingardi said.

“All of their proposals are predicated upon the assumption that the European Central Bank won’t rein in its unconventional monetary policies in the foreseeable future, thereby keeping the cost of debt financing very low,” he added.

And yet, investors seemed unconcerned. In the second half of 2017, during the height of the campaign, the difference between Italy’s and Germany’s costs of borrowing narrowed.

Draghi’s “whatever it takes” had become “do whatever you want.”

Today, as Italy’s political players struggle to form a government, the country seems to be headed back toward the precipice.

The political crisis — and the sudden realization that the winners of the election intend to keep their promises — caused Italy’s cost of borrowing to spike this week. It remains far from its peak at the height of the euro crisis, held down in part by Draghi’s bond-buying program.

But investors are carefully watching the country’s political developments, and weighing the risk that a populist government could roll back reforms, undermine Italy’s fiscal footing or even crash the country out of the eurozone.

That has serious implications for the Italian economy, as well as the rest of the eurozone. Italy is at “very serious risk of losing the irreplaceable asset of trust,” is how Ignazio Visco, Draghi’s successor as governor of the Bank of Italy, put it Tuesday.

Draghi’s name is often floated in the Italian press as a potential prime minister or president — a technocratic savior dropped in to put the economy back on its feet. (Draghi, for his part, denies any political ambition — “he’s not even thinking about it,” said a source close to the ECB president.)

But the recent developments put his reputation — and his legacy — at risk.

“Draghi will probably end up being remembered like [former U.S. central banker Alan] Greenspan, who at first was considered a maestro but then the opinion changed,” said Mingardi. “If we’ll have rising populism or even an Italexit, the same thing could happen to him.”

Da, 30 maggio 2018

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