Italian referendum could lead to ‘existential crisis’ for the Euro

European equities face a significant referendum‐related challenge – no, not that one but rather the one called by Italian prime minister Matteo Renzi for October/November this year.

For those suffering from referendum overload, this might have passed unnoticed, and indeed it has so far received very little public attention. However, in the context of Italy’s future trajectory, it is potentially hugely more significant for that country than Brexit will be for the UK, and by extension therefore, of critical importance to Europe and European equities.

The backdrop to the referendum is that Italy requires serious reform. For that reform to take place, Italy needs a stable government capable of commanding a majority in both upper and lower houses. The problem is that for this to occur, Italy must first have serious reform of its political system, an objective that could only be achieved by a stable government… and so on.

The solution to this paradox has so far eluded Italy, to the extent that it has enjoyed over 60 governments since the end of World War II, and remains largely unreformed.

Renzi has therefore attempted to resolve the situation by forcing through radical political reforms, including the reduction of the Senate from 315 elected individuals to just 100 appointees from regional governments, without an ultimate power of veto over legislation from the Lower House.

Although this legislation has in fact already been passed, it did not reach the required majority for constitutional reform and is therefore now placed before the Italian public in a referendum. A vote for Yes would give Italy the chance to pass those vital reforms that have eluded it for so long.

Italy is running out of time in which to update its economy, and as it falls further behind other major European nations, there is a risk it misdiagnoses the problem as membership of the euro. That has exacerbated the situation, for sure, but it is a symptom rather than the underlying problem.

Incredibly, Italian industrial production is still even now below where it was in 1990, seeing almost no recovery so far from a devastating drop of 26% in the financial crisis.

Italy is an exporting nation, and as such needs to maintain international competitiveness. However, an unreformed labour market dominated by unions has led to constantly rising wages, even at a time of high cyclical unemployment.

This is in direct contrast to Germany, where wages were kept flat for a considerable length of time after euro membership, improving German competitiveness dramatically.

To quote The Economist: “As economic growth stalls yet again, the country is being branded the sick man (or even the Japan) of Europe”. While this may perhaps sound a familiar description of Italy, it in fact dates to 3 June 1999, and refers to Germany. At that time however, Germany was completing the Hertz reforms of the labour market.

Since then, the German economic machine has reached new levels of power, driven by ever‐falling unemployment and, crucially, an export‐driven economy within the confines of the euro.

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