Italy’s December referendum vote could help solve certain structural issues hindering the country’s economic growth. We look at the implications of either a yes or no vote.

We have entered a period where political uncertainty is on the rise and election results can be surprising. The Brexit vote in the U.K. and the election of Donald Trump are just the most obvious examples. Europe is bracing for a spate of important political events, including Brexit negotiations and major elections in Austria, France and Germany. The first such event takes place December 4, when Italy votes on a referendum intended to stabilize the government and reduce political gridlock.

Over the longer term, reform in Italy is critical for increased economic growth and the ultimate well-being of the Italian people. It is also important to Europe's economy and the political stability of the European Union (EU). It’s encouraging that Italy is working toward these goals, but it may be a rocky road ahead. The referendum is increasingly seen as a way for Italians to air their discontent with the establishment, much like the U.K. referendum. Philip Dicken, Head of European Equities, notes that Italy is one of the largest economies in the eurozone and uses the euro as its official currency — so any discontent in Italy could have far-reaching consequences. Investors should be aware of the implications and political risks involved.

Why does Italy need reforming?

Italy has struggled with low growth and political instability for a long time. Matteo Renzi is the third prime minister in four years, and his government is the country’s 63rd in the past 70 years. If the referendum passes, the hope is that Italy will have more stability in its political structure, which should open the way to economic reforms. This, in turn, could allow the government to tackle three structural issues that are hindering economic growth:

  1. Labor and demographics: An aging population and a high unemployment rate among the young
  2. Productivity: Persistently low growth and productivity
  3. Debt and leverage: High public sector debt and a poorly capitalized banking system

What are the proposed changes to the Italian government?

The referendum bundles together a number of proposals, but the key changes involve greatly reduced powers for Italy’s senate and an overhaul of the state to strengthen central institutions. The proposed reform, strongly supported by Prime Minister Renzi, would transform the country’s senate into a “Senate of Regions” composed of 100 senators mainly made up of regional councilors and mayors. The changes would cut the number of senators by two-thirds, strip the senate of its ability to bring down a government and sharply limit its scope to block legislation.

This referendum is happening concurrently with the rise of the Five Star Movement, a populist anti-EU and anti-Euro political party. A new electoral law gives the political party with the largest share of the vote an automatic majority in Italy’s lower house of parliament. It was designed to give more power to the clear winner and overcome the stasis of coalition governments that has slowed decision making in the past. But with the rise of the Five Star Movement it has effectively made a populist government more likely than before. So whatever the result of the referendum, the new law will likely be called into question to stave off a Five Star Movement majority in future general elections.

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