Spiralling Italian debt - a political and economic 'monster'

Washington

JUST when it seemed safe not to worry about the next financial crisis, up pops Italy. In Italy, lavish plans may propel next crisis, warned The New York Times. Or, Italy's budget rattles financial markets on debt crisis fears, said Sky News.

Exactly how a crisis might emerge isn't clear. Would Italian interest rates soar, reflecting fears that the country can't service its colossal debt? Would Italian banks weaken because their bonds lose value? Would there be spillover effects on other countries? Might Italy abandon the euro?

What is clear is that the new Italian government is flirting with trouble. All the ingredients of a crisis are present.

Consider:

At the least, Italy and the European Commission - the Brussels-based bureaucracy that oversees the European Union's laws and regulations - seem destined to collide, because the proposed 2019 budget violates European Union rules calling for much lower debt levels. The question is whether the dispute ends in an acceptable compromise or triggers a major confrontation.

"This budget doesn't make the Italian debt sustainable," says Jeromin Zettelmeyer, a former top German economic official now at the Peterson Institute in Washington. "The worry is about a political stand-off. The government could ignore requests of the European Commission [for budget changes]." But so far, he notes, "there is no panic in the markets", suggesting that investors believe an accommodation will be reached.

The larger issue is why the Italian economy has been bogged down in recent decades. As Bill Emmott, a former editor of The Economist, noted in his book Good Italy, Bad Italy, this wasn't always the case. From 1950 to 1970, Italy's GDP grew an average of 5.8 per cent a year - a rate that, even if halved now, would still make sizeable debt reduction possible.

To some extent, an economic slowdown was inevitable. There was a long period after World War II of "economic catch-up" as Italy and many countries rebuilt and adopted existing technologies. But more recently, Emmott argues, over-regulation and chronic budget deficits have sapped Italy's economic vitality.

Italy's debt has become an economic and political monster. What's ultimately at stake is whether the monster can be controlled inside of Italy or whether it breaks out, spreading havoc across global economies and financial markets. THE WASHINGTON POST WRITERS GROUP