A newly populist Italy tests Europe's bonds

The European Union, the alliance of nearly 30 countries stretching across the continent, is facing its most serious political crisis for years.

And here’s what is truly extraordinary. The main challenge may not be the unraveling of Europe’s decades-old partnership with the United States, so dramatically on show at last weekend’s Group of Seven meeting of the world’s major democratic economies. Nor even Brexit: the decision by Britain, with the EU’s second-largest economy, to leave the union over the next couple of years. Both issues will surely figure at an EU summit this month hosted by French President Emmanuel Macron, not least because the Trump administration followed its broadside on the G7 host nation, Canada, with a further hint at possible new tariffs on Germany’s car exporters. But neither poses a structural threat to the EU.

Instead, the key danger signal comes from Italy, where a combination of economic stagnation and the influx of hundreds of thousands of refugees in the past few years has led to a new, unabashedly Euroskeptic government.

Italy is the EU’s fourth-largest economy. Unlike Britain, a latecomer and always a more reluctant member, it was a co-founder of the European Economic Community, the precursor of the EU. It was also a founding member of the euro – the shared EU currency introduced in 2002 and now used by 19 of the 28 member states. But as the latest election results made clear, many Italians have become persuaded that their country has been getting a raw deal from the EU.

The EU is not about to fall apart. It is the world’s largest tariff-free trading area, a key not just to frictionless trade but to the operation of a complex web of supply and manufacturing chains crossing Europe’s borders. Some members – especially the main economic power, Germany – have benefited from it more than others. But none can make a credible argument they’d be better off outside.

The challenge from Italy, however, is part of growing pressure for a looser form of union, in opposition to the EU’s defining, Franco-German vision of an ever more closely integrated bloc in which centrally mandated policies – whether on accepting refugees, or framing national budgets – are binding on all member states regardless of their circumstances.

The economic constraints have been felt especially by countries that are part of the single currency: the eurozone. When it was created, in the image of the German mark, the political impetus to do so was so great that little heed was paid to the starkly different economic conditions in member states. In effect, all of them have had to follow Germany’s tight fiscal and monetary policy model, even if hit with market shocks like the 2007-08 financial crisis.

In Italy, the EU has run into a perfect storm. Not only has the country had to absorb one of the largest number of arrivals during a surge of refugees beginning in 2015 – more than 600,000. It has been among the last major EU economies to begin growing since the financial crisis. It also needs to manage a major divide between its relatively prosperous north and southern regions where unemployment among young people is stuck at well over 30 percent. 

At least for now, the new Italian government has shelved talk of pulling out of the European currency and reinstating the old lira. Though that would restore its control over the levers of monetary and economic policy, it would also invite a run on its banking system and risk killing the still-fragile shoots of recovery. But remaining on the agenda are major increases in social welfare spending and tax cuts, in defiance of the eurozone’s financial rules. If the government does go ahead with those policies, depending on the EU response, Italy could still end up with a banking crisis and crash out of the currency zone anyway.

President Macron is keenly alert to the potential impact of the Italian political shift, as well as a surge of populist Euroskepticism in newer, East European member states such as Poland and Hungary, where the main driver has been the arrival of refugees from the Middle East.

He has been seeking to persuade German Chancellor Angela Merkel to join him in a major reform initiative to address both the pressures of immigration and the economic disparities within the union. He wants a far better funded EU currency system, with a centrally run budget sufficient to provide support for less economically robust states on the southern rim of the EU.

Mrs. Merkel has come around to the idea of some form of Franco-German reform plan. She has signaled openness to allowing countries like Hungary and Poland to opt out of accepting further refugees by contributing to other forms of EU support for them. Yet it remains unclear whether she will be ready to accept anywhere near the scale of money Macron has said will be needed for effective eurozone reforms. That would mean taking on a longstanding reluctance within Germany to commit a major chunk of money to helping what it views as the less economically self-disciplined member states in the south.

What still seems to be a taboo is a significant loosening of the union – the suggestion by more radical reformers to allow individual countries greater financial and monetary leeway, and greater autonomy in other policy areas as well. This kind of “multispeed” EU was what the then-British Prime Minister, David Cameron, tried and failed to sell to fellow EU leaders before the referendum that decided on Brexit, convinced that it would help take the wind out of anti-EU campaigners’ sails.