Italy really hasn't mattered much to the Western world since the war-mongering fascist era. That's about to change.
On Dec. 4, Italy will hold a referendum on constitutional reform that, in its sterile essence, would see the abolition of the Senate, leaving the Chamber of Deputies (equivalent to the U.S. House of Representatives) as the dominant legislative body. But only a few erudite lawmakers and scholars see the vote in those narrow terms. Calling it a vote on the future of the European Union and the euro zone in the era of resurgent populism might be a more accurate description. Coming shortly after Brexit – Britain's decision in June to exit the EU – and the victory of Donald Trump in the U.S. election, it is seen as populism's next great test.
The three main opposition parties – the anti-establishment 5 Star Movement (M5S), the separatist Northern League and Mr. Berlusconi's Forza Italia (Go Italy) – each of them populist in their own way, oppose the reforms and are urging a No vote. Recent polls give the No side a narrow lead over the Yes forces, led by Prime Minister Matteo Renzi. (A poll blackout went into effect two weeks ahead of the vote.)
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Read more (for subscribers): Will Italy's referendum become the next Brexit?
A win by the No side would also embolden other populist parties just as the election cycle rolls across Europe. Austria, France, the Netherlands and Germany all face parliamentary or presidential elections in the next 11 months (Germany's federal election must be held no later than Oct. 22). Marco Buti, the European Commission's director general for economic and financial affairs, used a Rome speech on Nov. 17 to say that the coming election cycle "gives me the shivers."
If the vote goes against Mr. Renzi, who heads the centre-left Democratic Party, M5S and its leader, former comedian Beppe Grillo, will claim moral victory. This will put Mr. Renzi and his pro-European centrists on the run and set up M5S for possible victory in the next election.
M5S is already Italy's main opposition party, the biggest elected anti-establishment party among the major European countries; it placed second at the national level in the 2014 EU elections. It wants to hold a referendum on the euro and embark on an Italian-style "drain the swamp" campaign if it forms the next government. A No vote would embolden M5S and its supporters, who are already fired up by the success of Brexit and Mr. Trump.
Mr. Renzi, the 41-year-old former Florence mayor who has been Prime Minister since 2014, has said he would resign if he loses the referendum. If he calls an election next year – one must happen no later than mid-2018 – the polls suggest M5S could come out on top. Its victory would put the euro zone's third-largest economy in the hands of Eurosceptic populists who vow to rip up the system and install their peculiar, if ill-defined, policies that include direct digital democracy, an anti-consumerist and ecological "de-growth" agenda and controls on immigration (even if it would be a stretch to call Mr. Grillo a racist).
Economists and market strategists are chilled by the political prospects. In a Nov. 16 report, Holger Schmieding, chief economist at Germany's Berenberg Bank, said it looks like Mr. Renzi was heading for narrow defeat in the referendum. "We see a potential political crisis in Italy as the top tail risk in Europe in 2017," he said. "Taken together, [Italian] political parties that either demand a referendum on the euro or have an unclear position might command more than 50 per cent of the vote in case of early elections."
Investors are already spooked, too, by the inevitable political chaos that might follow a No vote.
On Nov. 24 – 10 days before the referendum – the European Central Bank predicted especially volatile market conditions to come. "Elevated geopolitical tensions and heightened political uncertainty amid busy electoral calendars in major advanced economies have the potential to reignite global risk aversion and to trigger a major confidence shock," the ECB said in its semi-annual financial stability report.
The potential instability is reflected in Italian bond prices (the Italian sovereign bond market is the world's third largest). By Nov. 30, the yield on benchmark 10-year bonds reached 1.98 per cent, the biggest rise among the largest euro-zone countries, after gaining 32 basis points in a month (100 basis points equals one percentage point). Bond prices and yields have an inverse relationship. The rising yield means that investors are dumping the bonds, no doubt for fear the referendum's outcome will trigger a ratings downgrade as Italy's risk profile rises. Italy is generally seen to be locked in tradition, resistant to change, conservative to its Latin core. The image is worse than a cliché; it's wrong. Political change often sweeps through Italy, sometimes inspiring movements in other countries, and may do so again.
Benito Mussolini came to power in the 1920s, a decade before the rise of Adolf Hitler's fascists. In the 1960s and 1970s, the Americans feared that the Italian Communist party, then the biggest of its kind in the capitalist world, would form a government (in the 1976 election, it won 34 per cent of the vote). Italy did not invent populism but Donald Trump seems to have memorized the playbook of Silvio Berlusconi, the billionaire businessman who was prime minister in four governments, starting in 1994, and campaigned as an outsider who pledged to scrap the old political machine.
Mr. Grillo, one of Europe's most popular bloggers, expertly tapped into the rage building up in Italy when he launched M5S in 2009. At the time, Italy seemed ripe for a populist movement.
The Berlusconi era, which inflicted enormous damage on the Italian economy, was nearing its inglorious end and the country was in deep recession. A bailout was not out of the question. Unemployment soared (and kept soaring; the youth jobless rate today is almost 40 per cent). The country lost a quarter of its manufacturing base, and non-performing loans hobbled the Italian banks, which are still in deep crisis. Italian bond yields were in danger territory and were saved from probable default by the ECB's firefighting efforts, which were ostensibly designed to help all of the ailing euro-zone countries but, in reality, were aimed largely at Italy.
The collapse of Italy, whose economy is still considerably larger than Canada's, would have destroyed both the EU and the euro zone. Consider the damage that little Greece inflicted on the EU and multiply it by 10.
The rise of M5S and Mr. Grillo's throw-the-bastards-out rhetoric resonated with Italians, who were weary of the corruption and the expense of the ineffectual and bloated Italian government (Italy has 945 elected parliamentarians, Britain 650 and Canada 338). In the general election of 2013, a year before Mr. Renzi came out of nowhere to seize control of the Democratic Party, M5S picked up 25 per cent of the vote. But a year later, in the 2014 EU parliamentary elections, its vote haul slipped to 21 per cent – no breakthrough – while Mr. Renzi's Democrats took 41 per cent.
That's when Mr. Renzi, sensing he could bury M5S, decided to strike. He pushed forward with the overhaul of the electoral law, called the Italicum, which would guarantee a solid majority to the leading party through the award of bonus seats. But today, with the populists coming on strong and M5S polling more or less equally with the Democrats, at 30 per cent, that decision looks foolhardy. M5S could nab those bonus seats, ensuring an unchallenged majority for four years, punting Mr. Renzi into the political wilderness.
Mr. Renzi also pushed ahead with constitutional reform, which was not originally his idea and, in itself, cannot be considered politically reckless, as the Brexit vote was under former British prime minister David Cameron. "The Brexit proved to be a Cameron wrong political bet in what was an unnecessary and consultative referendum," analysts led by Antonio Guglielmi of Mediobanca Securities said in a recent note. "The Italian referendum is not a Renzi idea, but rather a mandatory step to approve constitutional reforms."
But Mr. Renzi did make a mistake – a biggie – in the way he promoted the reforms: He personalized the referendum by vowing to resign if it were to go against him, transforming the Dec. 4 vote into a popularity contest.
The broad and complex constitutional reforms amount to the biggest changes to the constitution since it was designed, in 1946, the year after Mussolini's execution, to prevent the rise of power-mad strongmen.
If passed, the reforms would end Italy's perfectly symmetrical bicameral system by downgrading the upper house, the Senate, into a regional talking shop with no power to pass laws. The Senate's effective elimination would, in theory, speed up Italy's notoriously slow lawmaking process. The reforms would also centralize power in Rome over key budget areas, including energy, infrastructure and transport, but not health, which are now under the control of local authorities.
By the end of November, Italy was divided, not on traditional left-right lines but on whether to gut the constitution and whether to punish Mr. Renzi for promoting the electoral and constitutional reforms. Andrea Barzini, a film producer in Rome, is voting Yes. "I want the powers taken away from the regions because they are corrupt," he said. Rome lawyer Anna Falcone urges a No vote. "The problem is not the constitution, it's incapable politicians," she said.
But while Italians squabble, a bigger story is unfolding in the country, one that will influence the direction of the EU at the most fragile time since its predecessor's inception with the 1957 Treaty of Rome. Centrist politicians and bureaucrats in Brussels, Berlin, Paris and London know what's at stake. So do bond investors. They fear that a No vote in the Italian referendum, followed by an election that could sweep the already surging Eurosceptic M5S party to power, could deepen the cracks in the apparently failing EU integration project.
Eric Reguly