Technology and surveillance

Does China’s digital police state have echoes in the West?

The state can gather more information, more easily, than ever before. Do not underestimate the risks





THEY’RE watching you. When you walk to work, CCTV cameras film you and, increasingly, recognise your face. Drive out of town, and number-plate-reading cameras capture your journey. The smartphone in your pocket leaves a constant digital trail. Browse the web in the privacy of your home, and your actions are logged and analysed. The resulting data can be crunched to create a minute-by-minute record of your life.

Under an authoritarian government such as China’s, digital monitoring is turning a nasty police state into a terrifying, all-knowing one. Especially in the western region of Xinjiang,

China is applying artificial intelligence (AI) and mass surveillance to create a 21st-century panopticon and impose total control over millions of Uighurs, a Turkic-language Muslim minority. In Western democracies, police and intelligence agencies are using the same surveillance tools to solve and deter crimes and prevent terrorism. The results are effective, yet deeply worrying.

Between freedom and oppression stands a system to seek the consent of citizens, maintain checks and balances on governments and, when it comes to surveillance, set rules to restrain those who collect and process information. But with data so plentiful and easy to gather, these protections are being eroded. Privacy rules designed for the landline phone, postbox and filing cabinet urgently need to be strengthened for the age of the smartphone, e-mail and cloud computing.

I spy with my many eyes

When East Germany collapsed in 1989, people marvelled at the store of information the Stasi security service had garnered on them, and the vast network of informants it took to compile it.

Since then the digital revolution has transformed surveillance, as it has so much else, by making it possible to collect and analyse data on an unprecedented scale. Smartphones, web browsers and sensors provide huge quantities of information that governments can hack or collect; data centres allow them to store it indefinitely; AI helps them find needles in the digital haystacks thus assembled. Technologies that once seemed a friend of freedom, allowing dissidents in dictatorships to communicate and organise more easily, now look more Orwellian, letting autocrats watch people even more closely than the Stasi did.

Xinjiang is the nightmarish extreme that the new technology makes possible: a racist police state. Fearing insurrection and separatism, China’s rulers have reinforced techniques of totalitarian control—including the mass detention of Uighurs for re-education—with digital technology. In parts of the province streets have poles bristling with CCTV cameras every 100-200 metres. They record each passing driver’s face and the car’s numberplate. Uighurs’ mobile phones must run government-issued spyware. The data associated with their ID cards include not just name, sex and occupation, but can contain relatives’ details, fingerprints, blood type, DNA information, detention record and “reliability status”. All this and more is fed into the Integrated Joint Operations Platform (IJOP), an AI-powered system, to generate lists of suspects for detention.

Totalitarianism on Xinjiang’s scale may be hard to replicate, even across most of China.

Repressing an easily identified minority is easier than ensuring absolute control over entire populations. But elements of China’s model of surveillance will surely inspire other autocracies—from Russia to Rwanda to Turkey—to which the necessary hardware will happily be sold. Liberal states have an obligation to expose and chastise this export of oppression, however limited their tools of suasion.

The West must look at itself, too. These days its police forces can also have access to a Stasi’s worth of data. Officers can set up bogus phone towers to track people’s movements and contacts. Data from numberplate-readers can track a person’s movements for years. Some American cities have predictive-policing programs akin to IJOP that analyse past crimes to predict future ones. All this allows the monitoring of possible attackers, but the potential for abuse is great. Hundreds of American police officers are known to have used confidential databases to dig dirt on journalists, ex-girlfriends and others.

Watching the detectives

How to balance freedom and safety? Start by ensuring that the digital world, like the real one, has places where law-abiding people can enjoy privacy. Citizens of liberal democracies do not expect to be frisked without good cause, or have their homes searched without a warrant.

Similarly, a mobile phone in a person’s pocket should be treated like a filing cabinet at home.

Just as filing cabinets can be locked, encryption should not be curtailed. A second priority is to limit how long information on citizens is kept, constrain who has access to it and penalise its misuse fittingly. In 2006 the European Union issued a directive requiring mobile-phone firms to keep customers’ metadata for up to two years. That law was struck down by the European Court of Justice in 2014. Misuse of police data should be a criminal offence for which people are punished, not a “mistake” absolved by a collective apology.

A third priority is to monitor the use of AI. Predictive-policing systems are imperfect, better at finding patterns of burglary than of, say, murder. Face-recognition may produce lots of “false positive” results. AI trained with biased data—eg, patterns of arrest that feature a disproportionate number of black people—may reproduce those biases. Some sentencing algorithms are more likely to label black defendants than white ones as being at high risk of reoffending. Such algorithms must be open to scrutiny, not protected as trade secrets.

Vigilance and transparency must be the watchwords. They may enhance the technology’s effectiveness: the routine wearing of bodycams by police, for instance, appears to reduce public complaints. Consultation matters, too. A bill recently proposed in California would compel police agencies to disclose what surveillance gear they have, publish data on its use and seek public input before buying any more. If that makes progress slower so be it. Police rightly watch citizens to keep them safe. Citizens must watch the police to remain free.


Brazil: A History of Military Interventions

Summary

The saying goes that those who can’t remember the past are doomed to repeat it. In Brazil, the country’s long history of military coups, dictatorships and interventions is far from forgotten, but that hasn’t stopped fears of a reoccurrence from taking hold. In January, President Michel Temer signed a decree ordering the military to take control of security in Rio de Janeiro, bringing the debate over civil-military relations to the forefront of Brazilian politics once again. The move was in response to escalating violence and drug-related crime in the state. Then, in April, Gen. Eduardo Villas Boas, commander of the Brazilian military, twice publicly criticized pervasive corruption in Brazilian politics. And in May, the government called in the army to help clear federal highways blocked by truckers protesting rising fuel prices.

Brazilians, it seems, have grown somewhat accustomed to having the military intervene to help solve the country’s problems. The Institute for Democracy and Media Democratization released a poll in May that revealed that about half the population would not oppose a larger role in government for the military under certain circumstances. With legislative and presidential elections approaching in October, the topic has come up more and more in political debates. The corruption scandal that led to President Dilma Rousseff’s impeachment and charges against many others has fueled calls for military intervention to put an end to the country’s political and economic struggles.

This Deep Dive will look at three important cases of military intervention in Brazil: the Proclamation of 1889, the 1930 revolution and the 1964 coup. Comparing these examples with what’s happening in Brazil today will help determine the likelihood that the military will intervene to help the country deal with the substantial challenges it is facing now.
 
Proclamation of the Republic, 1889
Brazil’s shift from a constitutional monarchy, which lasted from 1822 to 1889, to a federal republic has been officially called a proclamation, but it was initiated through a bloodless coup. The military essentially seized power from the monarchy and transferred it over time to civilian authorities.
 
The fall of the Brazilian monarchy began with the gradual erosion of its three historical pillars of support: the Catholic Church, the military and private-sector elites. Under the monarchy, Catholicism was the official religion of Brazil, and the church had strong ties to the government. But by the latter half of the 19th century, the Catholic Church’s political influence had declined. It still had an important social role, but its ties to the government had weakened.

As for the military, its main grievance with the monarchy was its lack of inclusion in national security planning and restrictions on military members publicly commenting on military issues. The government had close ties to business elites, leaving little room for military involvement even in matters directly related to security. The Paraguayan War (1864-1870), fought initially between Brazil and Paraguay, exacerbated the problem, creating a sense of solidarity among the armed forces and disaffection with the regime. The war also sparked a major economic crisis. The monarchy used extensive external credit to finance the conflict and keep the economy running after it ended. Government debt rose nearly sevenfold between 1871 and 1889.

In addition to these domestic issues, there were numerous international factors that ultimately led the monarchy to change its economic model. That Brazil was the only Portuguese-speaking country and the only country ruled by a monarchy in South America made it somewhat vulnerable. The rest of the major countries of the region were former Spanish colonies with wholly elected governments, and the monarchy was worried about the possibility of Spain once again conquering large parts of South America. It was also concerned about the United States’ Monroe Doctrine (fearing the U.S. might become more involved in South America and denounce Brazil’s ties with the U.K.) and the Catholic Church’s potential interference in political affairs.

To counter these threats, Brazil aligned itself with the United Kingdom, which also was an opponent of the Catholic Church, resented the U.S. for taking over some of its holdings in the Americas and was a historical rival of Spain. That the two countries had many adversaries in common made the U.K. the single most important foreign partner for Brazil, not only on a diplomatic level but also in terms of trade. In 1863, the U.K. accounted for 38 percent of Brazil’s exports and more than half its imports.

But this relationship came at a cost for Brazil. The U.K. abolished slavery in the West Indies in 1833, and shortly thereafter, it began to use its navy and economic ties with Brazil to pressure the country to do the same. From 1850 to 1888, the monarchy in Brazil passed laws that would lead to the gradual elimination of slavery in the country. Business elites were most affected by these legal changes because higher labor costs threatened to slash their profits from agricultural goods.

In 1889, a military official declared the end of colonial rule, and the monarchy put up little resistance. Within two days, the king and his family fled Brazil. The military assumed power and oversaw the transition to a democratic system known as the First Brazilian Republic.
 
Brazilian Revolution, 1930
The First Republic had a strong federal system and was governed through a power-sharing agreement among Brazil’s three richest states: Minas Gerais, Sao Paulo and Rio de Janeiro. The arrangement became known as “coffee with milk” politics because it divided power among three regions dominated by the coffee and dairy industries. During this time, agriculture became critical not just to Brazil’s economy but also to its politics – oligarchs who made their wealth through agriculture had a lot of influence over regional politics, and some academics and historians have even referred to the 1889-1930 government in Brazil as an oligarch republic.
 
World War I created an opportunity for Brazil to industrialize. Before the war, places like Europe and the United States could produce manufactured goods more efficiently and cost effectively than Brazil. But when German warships started greatly restricting trade between Brazil and Europe, Brazil needed to supply its own manufactured goods, and domestic industries, uninhibited by outside competition, were able to develop. Industrialization led to urbanization, as people moved to cities to find manufacturing jobs.
Many of those people flowing into the cities were of European origin. After Brazil eliminated slavery, it had turned to European immigration to fill the gaps in its labor force. Help wasn’t hard to find – many Europeans wanted to escape the intense political turmoil that would later culminate in the Bolshevik Revolution and World War I and start a new life elsewhere. Millions of Europeans, especially from southern Europe, settled in Brazil. They brought with them their beliefs in workers’ rights and communist ideology. Industrialization and European immigration thus set the stage for a political movement against the Brazilian ruling class.

Brazil’s young military officers were also exposed to European ideologies, since much of their military education was based on European models. Younger officers became sympathetic to broader social movements and critical of the oligarchical government, partly because the military was kept on the fringes of power during the First Republic. This culminated in a series of small rebellions throughout the 1920s carried out by lieutenants and captains in Rio de Janeiro, Sao Paulo and Rio Grande do Sul. The rebellions never managed to topple the government, but they were important precursors to future events.
Meanwhile, the ruling elite faced another challenge on the economic front. Brazil depended heavily on coffee exports for revenue, but economic instability in Europe, particularly related to the war, forced down prices for commodities such as coffee. It also restricted Brazil’s access to markets like Germany, which was among Brazil’s leading coffee buyers at the time. In the 1920s, the Brazilian government sought foreign credit to help stabilize domestic coffee prices – which would also help stabilize the political elite. Accessing credit proved increasingly difficult, however. Brazil’s traditional sources of credit in Europe were in no position to continue in that role. By this time, the U.S. had become Brazil’s largest trade and business partner, but Washington was starting to face some economic problems of its own, and U.S. demand for all goods – foreign and domestic – plummeted with the onset of the Great Depression. The fate of the coffee industry – and thus of Brazil’s ruling elite – was sealed with the 1929 stock market crash.

Aspiring political leaders who were not from the three states that had previously dominated Brazilian politics seized on the opportunity to organize a revolt. Getulio Vargas, whose base was the working class, led this movement. Vargas and his political partners started working closely with sympathetic military officials, who were easily identified after the rebellions in the 1920s. When Vargas lost the 1930 presidential election, his band of aspiring political leaders and disgruntled military officers refused to recognize the results and instead declared Vargas president. The First Republic was no more.
Coup d’Etat, 1964
Vargas became increasingly dictatorial from 1937 to 1945, a period referred to as the Estado Novo, or New State. The government during this time was modeled on European fascist regimes. Vargas abolished the constitution, declared a state of emergency (in response to a supposed communist plot to overthrow the government), and centralized power by eliminating the position of vice president and refusing to hold legislative elections. Throughout World War II, Brazil tried to remain neutral and maintain relations with both the U.S. and Germany, until it became clear that Germany would end up on the losing side of the war. With a clear victory for the Allies, there was strong international pressure, mainly from the U.S., for Brazil to return to a more democratic system – one that was staunchly anti-communist.

In 1945, Vargas was overthrown in a coup, marking the start of the Second Brazilian Republic. His removal from office, however, did not stabilize politics in Brazil. During the turbulent times from 1945 to 1964, only two of 11 presidential terms were completed.
It was also a tumultuous time on the economic front. Throughout the 1950s, the Brazilian government pursued an import substitution policy to boost growth in important areas such as machinery, the chemicals industry and the auto industry. Though the policy spurred growth, it also had some negative consequences. Tariffs were imposed on imported goods, making them more expensive relative to domestically produced goods. They were more lenient, however, on input materials that Brazil couldn’t produce on its own and that were necessary for production. Foreign capital was used to help finance this policy, and a series of exchange rate measures were imposed to help further regulate trade. By the early 1960s, Brazil’s economic problems could no longer be ignored.
What’s more, the Cold War and pressure from the United States to reject any communist influence encouraged the military to take action. Maintaining a good relationship with the United States – Brazil’s largest trade partner and an important source of foreign funding – was critical to Brazil’s economic well being. Then-President Joao Goulart planned to make significant reforms, some of which had communist undertones. They included land redistribution, controls for urban housing and increased regulation in areas like banking, education and government administration. The U.S. encouraged Goulart to adopt more moderate policies, but it also curried favor with the Brazilian military in case Goulart refused to moderate his positions. Brazil could not risk economic isolation from the U.S. or some type of U.S. military intervention. Recognizing these constraints, the military took over with support from opposition political forces and ran a dictatorship until 1985, when civilian control over the government was restored.
Common Characteristics
All three of these military interventions occurred in different periods of Brazil’s history and under different circumstances, but they nonetheless have some things in common. First, they all occurred with the support of an organized civilian population that opposed the government. The civilian groups involved were often driven to support drastic political and social change at times when the government pursued policies that favored one group at the expense of another, usually one that was already disadvantaged to begin with. The justification for the military response was usually that the civilian leadership was no longer competent enough to run the state’s affairs. These conditions threatened economic development and, in turn, weakened national security.
The three examples above also reveal that successful military takeovers in Brazil have four main qualities. First, a political crisis results in an extremely weak government that has little or no backing from historical pillars of support. Second, an economic crisis threatens core components of the economy. Third, a large portion of the military, particularly officers, is frustrated with the government, often because the military has been excluded from state affairs. Fourth, foreign forces play some role.
The first two qualities are applicable to Brazil today. The military regime ended in 1985, marking the start of the Third Republic, and 22 years later, the country again finds itself in the midst of political and economic turmoil. President Michel Temer, who took over after Dilma Rousseff’s impeachment, has been a weak leader, unable to push through major economic reforms. Many political and business elites have been implicated in a series of high-profile corruption scandals. The scandals, along with high government spending, declining commodity prices, and lower global demand and investment, resulted in two years of severe economic hardship followed by a very slow recovery.

The worst of the economic and political upheaval seems to have passed, but it will still be a while before average Brazilians see any improvements in their living conditions, as employment and wages remain low and the government seeks opportunities to cut social spending. But the government, with the help of the judiciary, is making an effort to police itself and prove to the public that it doesn’t need the military to take over. The corruption investigations continue, and the government is trying to tackle the problem through reforms and prosecuting those who were allegedly involved in the scandals, rather than overhauling the system entirely. Some high-profile politicians such as former President Luiz Inacio Lula da Silva, former President of the Chamber of Deputies Eduardo Cunha and Sen. Aecio Neves have even been charged, showing that no one is above the law. And throughout the scandal, the government has remained functional and the military has not intervened, which may not have been the case in the past.
But Brazil does not appear to have the latter two qualities. The military is not being neglected or undermined by the government today. In fact, over the past 25 years, the government has included military officers in national defense planning, debates and policy. Gen. Eduardo Villas Boas’ comments about corruption among Brazilian politicians sparked concerns that Brazil was moving backward, but that he was able to speak out about a political issue itself indicates that military officials are not merely observers of Brazilian politics but can also have some political influence. He has subsequently said the military respects state institutions and the constitution. Moreover, there are 71 candidates with military backgrounds running in the 2018 general elections, including one candidate running for president. Even if all are elected, they will represent a small minority of the public representatives in Brazil, but this is nevertheless an opportunity for former members of the military to participate in the political system and represent the military’s point of view on political and security matters.
On the international level, there are no signs that any foreign countries would support a military solution to the crisis in Brazil. All governments in South America are hesitant to become militarily involved in other countries in the region. Even in the case of Venezuela, which is experiencing a political and economic crisis of its own, countries in the region have been slow to take any concrete action (like cutting trade ties) against Nicolas Maduro’s government and are applying only moderate sanctions. Countries outside of South America, particularly the United States, want stability in Brazil. With ongoing NAFTA and Chinese trade talks and military operations in the Middle East, the U.S. is already overextended and would be unlikely to support a military intervention in Brazil. Outside of the Western Hemisphere, one of Brazil’s strongest relationships is with China, which imports natural resources from Brazil. If the Brazilian government were overthrown, it could destabilize the country and strain trade ties, making Beijing unlikely to support any move in that direction.
The recent suggestions that the military should become more involved in internal security may have raised some eyebrows, but this should not be seen as a prelude to another military dictatorship. In this case, at least, history is not repeating itself.


Argentina and the IMF

The IMF hands Mauricio Macri a vote of confidence

But Argentines are more sceptical



THE timing took many by surprise. On June 7th, just four weeks after negotiations began, Argentina’s government declared that it had secured a three-year credit line with the IMF worth $50bn. The deal’s size is likely to reassure investors of Argentina’s solvency. Its speed is a sign of the fund’s confidence in Mauricio Macri, Argentina’s business-friendly president. But for ordinary Argentines, many of whom blame the IMF for the country’s disastrous $82bn default in 2001, the announcement carries echoes of a painful past.

An acute currency crisis meant Mr Macri had little alternative but to seek the IMF’s help. In April the yield on American ten-year Treasury bonds rose to 3% for the first time since January 2014. That prompted a widespread sell-off in emerging markets. The currencies of Turkey, Russia and Mexico were all battered; Argentina’s was particularly badly hit. Investors were spooked by the country’s large fiscal and current-account deficits, and a rapidly growing pile of foreign-currency debt. They also doubted the independence of the central bank, which in January had cut interest rates at the behest of the government, despite inflation of 21%.

As investors pulled their money out of Argentine assets, the peso plunged by one-fifth against the dollar. Between April 23rd and May 4th the central bank raised interest rates by 12.75 percentage points to 40% and sold $5bn of its currency reserves in an effort to arrest the decline. Nicolás Dujovne, the treasury minister, tried to win back investor confidence by cutting the target for this year’s primary budget deficit (ie, before interest payments) from 3.2% to 2.7%. None of that worked. As the peso continued to slide, Mr Macri appeared on television on May 8th to announce the country had approached the IMF for a credit line.

The details of the “standby arrangement” should help soothe investors’ nerves. The first tranche of credit, worth $15bn, will be disbursed shortly after the IMF’s executive board approves the deal on June 20th. Further disbursements will be at the discretion of Argentina’s government. The interest rate will vary between 1.96% and 4.96%, depending on how much money the government chooses to use. After a three-year grace period, each disbursement must be repaid in eight quarterly instalments. The arrangement “reduces the reliance on more expensive and less stable private market sources,” said Alberto Ramos of Goldman Sachs in a note.

So far, so generous. But the IMF has demanded new commitments from Argentina on fiscal and monetary policy. The government must eradicate its primary deficit by 2020, a year earlier than it had planned, and run an overall surplus in 2021. While the fiscal targets have been tightened, inflation targets have been loosened. With markets expecting inflation of 27% this year, the central bank has been persuaded to abandon its wildly optimistic target of 15% for 2018 and will instead aim for 17% in 2019, falling to 9% in 2021. The new figures “are demanding but not unrealistic”, says Mr Ramos. The central bank will also stop its partial financing of the fiscal deficit and will have its independence enshrined in law. The government is expected to send a proposal to congress to strengthen the bank’s charter.

The deal obliges Mr Macri to inflict further austerity on Argentines. After taking office in 2015 he sought to repair gradually the economic imbalances bequeathed by his predecessor, Cristina Fernández de Kirchner. That required his government to borrow billions of dollars on international credit markets to plug the budget shortfall. That strategy came to an abrupt end in April, when interest rates rose and investors lost patience with the slow pace of his reforms. The credit line provides him with some breathing space. Mr Macri will hope to use it to recover his approval ratings, his lowest since taking office, in time for elections in October 2019.

It will be no easy task. Argentines are weary of austerity and are unlikely to thank Mr Macri for providing them with more of it, particularly at the behest of the IMF. In 2001 the IMF offered loans in exchange for commitments to cut spending. When the government reneged, the fund pulled the plug and the country defaulted. Although the politicians were chiefly to blame, the IMF’s reputation has never recovered. A poll conducted in May found that three-quarters of Argentines were opposed to any sort of arrangement with the fund. If Mr Macri is to stand a chance of re-election next year, he must convince voters that the alternative would have been far worse.


China Won’t Save Global Growth

The surge in factory activity since the lifting of seasonal pollution controls is likely to be a one-off boost

By Nathaniel Taplin



RED HERRING
Change from a year earlier

Source: CEIC*Average of output growth in steel, cement, glass, non-ferrous metals and electricity.



Amid the sturm und drang in global markets, an apparent ray of light from China’s latest monthly purchasing managers index: the healthiest factory activity in eight months, with both total orders and new export orders quickening.

The key factor lifting China’s PMI from barely 50—the line between contraction and expansion—as recently as February to a rosy 52.9 in May was domestic. Industrial activity has surged since seasonal pollution restrictions ended in March, releasing winter’s pent-up demand. That’s one reason that global commodity prices haven’t suffered more from the recent strong dollar.


The bad news is that this is likely to be a one-off boost. That could spell trouble for some commodity-dependent emerging markets like Indonesia, particularly if the dollar also keeps strengthening.


Pollution controls: off. Photo: Qilai Shen/Bloomberg News 



The impact of China’s pollution restrictions, a pet project of President Xi Jinping’s , is clear in the odd shape of Chinese data since the fourth quarter. As the winter curbs on heavy industry rolled through the country’s north starting last October, industrial production and real-estate investment nose-dived. Both began bouncing back between February and April as the restrictions eased. Credit growth, which usually leads industry and investment, slowed gradually throughout.

Spring fling aside, the fundamental forces driving Chinese real estate now look weaker than a few months ago. Residential floor space sold in April was down 4% from a year earlier, the first drop in half a year. More important, property inventories, whose decline has been a key driver of the long upturn since 2015, look close to leveling off. After roughly halving from mid-2015 to late 2017, they have been stable since December at about 18 months of sales, according to Rosealea Yao, senior analyst at Gavekal Dragonomics in Beijing.




House prices are still rising—for now—meaning the second-half slowdown is unlikely to be overly severe, unless trade tensions or the eurozone’s incipient relapse into crisis really damage external demand.

Still, investors shouldn’t look to China to save the day either. For now, global growth rests firmly on the shoulders of that old workhouse, the U.S.


What Italy’s Crisis Means for Europe

Lucrezia Reichlin

 European Union (EU) and Italian national flag banners hang in central Rome


MILAN – Since the populist Five Star Movement and the right-wing League captured a combined parliamentary majority in Italy’s March 4th election, Italian politics has been at an impasse, with the two parties struggling to form a government. But now, with President Sergio Mattarella having rejected a M5S/League proposal to appoint the staunchly Euroskeptic economist Paolo Savona as Minister of Economy and Finance, the situation has taken a dramatic turn.

Rather than explore more moderate alternatives, the coalition has abandoned negotiations and called for a new election. An attempt to form an interim technocratic administration chosen by Mattarella was followed by a clash with the populists, which could have led to a constitutional crisis and spooked the markets. Now the situation seems to have changed again, and a coalition government is back on the table. But the situation remains highly fluid – and volatile.

This is the first time in Italy’s postwar history that a coalition of parties from the political extremes has attempted to form a government without any input from centrist forces. For their part, M5S and the League represent two different, but possibly overlapping, constituencies. Whereas M5S’s stronghold is in Italy’s poorer south, the League’s is in the country’s prosperous north, where a large small-business community harbors fears of immigration, globalization, and high taxes.

Neither party represents Italians who want change but still support Italy’s membership in the European Monetary Union (EMU). These voters’ voice has been relatively subdued, but now Mattarella is tenaciously channeling it.

A new election could take place as soon as this fall, or early in 2019. Either way, it will now essentially be a referendum on the euro. The campaign will be bitter and divisive, and the outcome will not generate greater certainty about the future. Elections to the European Parliament will be held in May 2019, and the situation in Italy will no doubt mobilize nationalist and Euroskeptic parties hoping to change the European Union’s political equilibrium.

Given that Italy is a founding EU member state with a long pro-European tradition, it is worth asking how we arrived at this point, and how the EU should respond.

Italy’s economic problems are rooted in low productivity, unfavorable demographics, and weak governance in many parts of the country – all of which pre-date the introduction of the euro in 1999. While Italy’s mainstream political leaders hoped that eurozone membership would create the conditions for far-reaching economic reform, the euro has instead deprived Italy of the means to engage in competitive devaluation.

With the exception of Greece, Italy has fared worse than any other euro member state since the 2008 financial crisis. But there is no use playing the blame game. Responsibility lies partly with the EU and its pro-cyclical policy rules, but mainly with Italy’s past leaders, all of whom failed to address its structural problems.

The Italian story is different from the Irish, Spanish, and Portuguese boom-bust narrative of recent years. Italy experienced neither a credit-fueled boom during its first decade of euro membership, nor a traditional bust. The country’s problems are structural and will require a creative reform program that addresses the deep causes of its dismal economic performance over the past 20-plus years.

Unfortunately, neither EU-recommended fiscal discipline nor populist-style fiscal profligacy will fix this fundamental problem.

Instead, Italy needs aggressive action to help the truly productive parts of the economy grow faster and exploit potential external demand. Rather than designing industrial policies to subsidize the losers, Italy should be providing opportunities for new market entrants, to reverse the high rate of emigration by skilled young people. Italy also needs more public investment in infrastructure and education, which will require addressing corruption, inefficient judicial processes, and ineffective local institutions – problems that have dogged Southern Italy, in particular.

Beyond this domestic agenda, Italy also needs to pursue reforms vis-à-vis the EU, starting with a relaxation of constraints on public spending for pro-growth investments and new partnerships. More investment will require additional fiscal space. But, more importantly, Italy and the EU both need new ideas, and more trust on each side.

Of course, whether the EU would even engage in such a discussion in the absence of credible Italian leadership remains an open question. EU rules cannot easily accommodate the problems of a country that is unable to consolidate its debt as a result of structurally weak growth – even if it has run large primary surpluses for years.5

More broadly, whereas the discussion about reforming eurozone economic governance has long focused on enhancing risk-sharing mechanisms to strengthen resilience against economic shocks and financial crises, that emphasis is somewhat beside the point in Italy’s case, because it offers no cure for structural weakness. Addressing the latter will require deeper EU-level cooperation on a growth agenda, which presupposes a formal deal on the timing and schedule of fiscal consolidation.

The economic agenda proposed by Italy’s populist parties is fanciful and unconvincing. But that is no excuse for the EU to maintain the status quo. It is time for EU leaders to start thinking outside the box to formulate a growth strategy for the bloc’s fourth-largest member state. At this point, Italy looks more like Japan than Spain or Portugal, and policies need to reflect that fact.

Italy and the EU are at an inflection point. In the absence of concerted action, we may well be sleepwalking toward another euro crisis – one that would be much harder to overcome than the last, and which could threaten the current composition of the EU itself.


Lucrezia Reichlin, a former director of research at the European Central Bank, is Professor of Economics at the London Business School.