Brendan O'Leary and Gemma Dipoppa discuss the fallout from the Italian referendum

Italy’s economy plunged into fresh uncertainty after voters on Sunday rejected a pro-reforms platform pushed by Prime Minister Matteo Renzi. The country’s banking system is in deep trouble with eight big banks nursing huge bad loans, and the referendum has diminished hopes of them getting recapitalized and saved. Italy’s economy has seen little growth over the past two decades, and with Renzi’s market-friendly policies now voted out, prospects of fresh investments, from both domestic and foreign sources, have also dimmed. The repercussions will be felt across Europe, particularly in the stability of the euro and efforts at economic integration across the continent, experts say.

Italy’s referendum vote is widely seen as a negative sign in the context of rising populist sentiment against immigration and globalization in Europe. Similar views contributed to Donald Trump’s being elected president in the U.S. and the Brexit vote in June that made way for the U.K. to leave the European Union. This week, the Supreme Court in the U.K. will hear a case to determine whether British Prime Minister Theresa May’s government or Parliament has the power to trigger Brexit negotiations with the E.U.

Right-wing populism could also influence elections coming up in France, Germany and the Netherlands. The populist movement was dealt a blow on Sunday, however, when elections in Austria resulted in the victory of left-leaning Alexander Van der Bellen over Norbert Hofer, a far-right candidate from the Freedom Party.

A Stricken Banking System

On the economic front, the overarching worry in Italy is the future of its banking system. Italy’s banks have about 360 billion euros or about $385 billion in suspect debt, according to a New York Times report. Prior to the election, the Financial Times reported that up to eight Italian banks were at risk of failure if the referendum failed. Among them is Banca Monte dei Paschi di Siena, the third largest Italian bank by assets, which is currently undergoing recapitalization and is in negotiations with Qatar’s sovereign wealth fund and others to fund it.

“Not having a government in Italy means that those actions that need to be undertaken to ensure that the banks don’t collapse will be delayed.” –Mauro Guillen

The recapitalization of Banca Monte dei Paschi di Siena would be crucial. “If that effort were to fail, it would trigger deep anxieties and questions about whether Italian taxpayers would have to help bail out the bank, or whether or not the bank’s troubles would see some orderly resolution,” said Brendan O’Leary, professor of political science at the University of Pennsylvania. He noted that the European Union’s new banking union is being put into place, and that under its rules, there would be no bailouts by taxpayers or the European Central Bank.

“Renzi was negotiating the transition of troubled banks to better health,” said Gemma Dipoppa, a Penn Ph.D. student in comparative politics and a native of Italy. Now, the absence of a government “would create a vacuum” and those negotiations would be stalled, she added. Few expected Renzi to win, she said, adding that she was surprised by the 68% turnout. She hoped for a quick and smooth transition to a new government in order to avoid any instability.

O’Leary and Dipoppa discussed the implications of the vote in Italy, the court challenge over Brexit and related matters on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

“Italy’s referendum comes at a bad moment,” said Wharton management professor Mauro Guillen. The country’s largest banks “need to do something” to extricate themselves from bad loans, as that affects the stability of the eurozone, he added. “Not having a government in Italy means that those actions that need to be undertaken to ensure that the banks don’t collapse will be delayed.” While Renzi has submitted his resignation, Italian President Sergio Mattarella has asked him to wait until a budget for 2017 is passed.

Guillen noted that Italy has had 63 governments in the last 70 years. Some of that is attributed to “a gridlock” in the country’s system of government where its Senate has “a lot of power on par with the Parliament.” Renzi’s platform contained proposals to change the Italian constitution and facilitate economic reforms and faster government decision-making. “European leaders in general liked Renzi,” he added. “They were thinking that at long last Italy would start to initiate reforms.” Now, it is not clear if the referendum was a vote against Renzi, against the government wanting to expand its powers or against the reforms agenda, Guillen said. “I suspect it is a mix of all three reasons.”

The only visible possibility for helping Italy’s banks is a eurozone-level bailout, said Guillen. That could come through the bond buying program of the European Central Bank, where it would purchase both government and corporate bonds. “The ECB does have enough firepower. But the problem is in spite of the monetary expansion, Italy’s economy doesn’t recover.” He noted two signs that hint at the future prospects for Europe — one positive and the other negative. The positive for Europe is that euro is losing value against the U.S. dollar, and that would help exports become more competitive and the region’s economies to recover. The negative is the likelihood of instability in emerging markets that would be impacted by an interest rate increase by the U.S. Federal Reserve. “Investors would go into pessimism and depress global demand,” he noted.

Miscalculated and Wrongly Packaged

Renzi’s referendum call is widely seen as a miscalculation of the public mood, much like when former British Prime Minister David Cameron called for the referendum on Brexit last June, said O’Leary. “[Renzi] deserved this. He stupidly put his own position on the line by offering to resign if voters didn’t support his proposals. He didn’t need to do that.”

“[Renzi] put his own position on the line by offering to resign if voters didn’t support his proposals. He didn’t need to do that.” –Brendan O’Leary

Renzi handed his opponents “a gift” when he said, ‘Back me or I’ll resign,’” said O’Leary. That allowed his opponents to mobilize themselves, even though many of them were not populist, he added. “[Renzi] maximized his number of potential enemies.”

Renzi would have managed to secure adequate support for each of his proposals had he not bundled them into one package but sold them individually, O’Leary noted. He attributed Renzi’s failure to “overconfidence [and] a belief that centralization of power was necessary to impose certain reforms and the fear that his government and its popularity were stagnating.”

O’Leary recalled that Renzi came to power on an agenda that challenged the European Union’s austerity programs and tried to restore Italy’s autonomy in policy-making, especially fiscal policy. “I suspect he feared that time was running out and he had to do it in a quick package.” Still, he noted that Renzi’s proposals were on the table before Cameron’s defeat in the Brexit vote in June. “He should have taken Cameron’s defeat as a signal, and perhaps could have chosen a way of retreating at that juncture, but he didn’t do so.”

Guillen blamed Renzi’s loss on “the failure of the established parties to control the situation and opportunistic politicians who drummed up support.” In Austria, that populist pressure came from the Freedom party, which is mostly anti-immigrant, he said. “What happened in Austria is a good thing from the point of view that they have avoided having a populist elected. But it is very discouraging to see this in Italy.”

Ripples across Europe

European Union leaders were happy that Renzi sought a referendum on his proposals, said Dipoppa. “Italy in general is a strongly pro-European country and its people do not want to leave the euro,” she added. While the effects of globalization were a concern in Italy, they were not the drivers behind the latest vote, she noted.

According to O’Leary, the more destabilizing prospect comes from Italy’s leading populist movement, the Five Star Movement, which has said that if it gets to form a government, it will hold a referendum on leaving the euro and returning to the lira as the country’s currency. That will pose a serious choice for Italians, he said. “Most Italians like the euro compared to the lira, but they don’t like the ‘medicine’ that comes with the euro.” If the Five Star Movement were to come to power in the near term and proposes a referendum on Italy’s membership in the euro, “it would be a nightmare scenario for the rest of Europe,” he added.

“Italy in general is a strongly pro-European country and its people do not want to leave the euro.” –Gemma Dipoppa

Immediately in Italy, the pressing question is who might replace Renzi. According to Dipoppa, the top candidates for the prime minister’s job include Pier Carlo Padoan, former finance minister in the Renzi cabinet, and Pietro Grasso, the former head of Italy’s Anti-Mafia Commission. The markets would favor Padoan, she said, adding that he and Renzi have advocated loosening of the extent to which the European Commission oversees the budgets and fiscal policies of member states.

O’Leary said the German and French elections in 2017 could further the populism trend. In France, he expected Marine Le Pen, president of the National Front and “an undoubted opponent of the EU” to get into the second round, although he didn’t expect her to win in the final round. In Germany, he said support for populism has been on the rise, but he expected it to “paradoxically increase the power of the center-left parties” because of the coalition between its Chancellor Angela Merkel’s Christian Democrats and the Social Democrats. He foresaw a reduction in the size of the Christian Democrats in the coalition.

Dominating the issues in Germany is Merkel’s decision to allow a million refugees into the country, which some have described as “brave and courageous” and others as “unconstitutional and done with the least degree of adequate preparation,” O’Leary noted. Germany has recorded superior economic growth relative to its neighbors, but that has been uneven, he pointed out. “Also, German growth hasn’t been terrific, and not everybody has prospered under a period of significant, but not extensive, economic growth in the country.”

Europe is also grappling with the uncertainty over Brexit. On Monday, the U.K. Supreme Court began a four-day session of hearing submissions from the British government, which favors Brexit, and others that want to block Brexit. The question at stake is whether the government or Parliament has the right to launch Brexit negotiations with the EU. The latest case follows a ruling in November by the British High Court that Theresa May’s government must consult with Parliament before proceeding on the Brexit — a decision that put a brake on May’s plans to begin the process of withdrawing from the EU.

O’Leary expected the U.K. Supreme Court to require the British government to consult with its Parliament on Brexit negotiations, and also secure consents from the Scottish parliament and the assemblies in Wales and Northern Ireland.The easiest way out for May is to keep the U.K. in the [European] single market, which would satisfy the Scots who would retain their European benefits and rights,” he said. Such a move would also satisfy Northern Ireland, he added.

“If things go bad in Italy, it is a big deal.” –Mauro Guillen

Why Italy Matters

Guillen said the defeat of populist platforms in Austria’s presidential election “is a good sign,” but noted that it is a small country with limited impact across the region. What happens in Italy is so much more important, he said. “If things go bad in Italy, it is a big deal. It is another episode in this whole saga in Europe since 2009 with the sovereign debt crisis, and it comes at a bad moment because it gives the anti-reform populist parties more support. This is a trend — Brexit, the Trump election and now this in Italy. The next big test is the French election.”

To advance Italy’s growth, Dipoppa argued that the government must invest more in innovation and education, and introduce measures to improve the competitiveness of small businesses. Also, reforms begun by the Renzi government to improve the competitiveness of the country and to expedite government bureaucratic processes must continue, she added.

O’Leary said the Italian political class knows that its economic policy making is “deeply constrained” by European policy. “They have the mother and father of a banking crisis emerging in front of them,” he added. “How are they going to cope with that? How are they going to interact with Europe to solve that in a credible fashion?”

Image by Francesco Pierantoni –, CC BY 2.0,