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(Anatole Kaletsky is a Reuters columnist but his opinions are his own.)
By Anatole Kaletsky
Feb 21 (Reuters) - We don't yet know the winner of Sunday's election in Italy, but the losers are already clear. And in this election, who loses may be much more important than who wins.
The obvious loser is Mario Monti, the charming and eloquent economics professor who is widely credited with saving Italy from a Greek-style debt crisis during his one-year term as Italy's unelected prime minister.
Monti could have gone down in history as the most effective and intelligent Italian leader of his generation, had he decided to opt out of this weekend's election and instead sought appointment as Italy's president. That is a mainly ceremonial role that can become very important in times of constitutional crisis (which in Italy occur all too often), and Monti could almost certainly have won strong endorsements from Italian politicians on the left and right.
Instead, Monti surprised everyone by founding a political party and running for Parliament at the head of a center-right grouping. This now looks like a big mistake. According to the last pre-election polls, Monti's group is running a humiliating fourth, after the Italian Socialist Party, Silvio Berlusconi's resurrected personal party, and stand-up comedian Beppe Grillo's anarchic Five Star Movement. Worse still for Monti, he seems to have helped his arch-enemy Berlusconi by splitting the opposition to the scandal-ridden former prime minister. If Monti's party performs as badly as expected, it will be all too easy for his opponents to present the election as a clear rejection of the painful economic reforms he imposed on his long-suffering countrymen at the behest of the German government and the European Central Bank.
Germany's key role in shaping the Monti reform program points to a second and even more important potential loser on Sunday: Angela Merkel, the German chancellor. Merkel was almost as enthusiastic in her friendship and admiration for Monti as she was in her contempt for Berlusconi. If Monti is humiliated on Sunday, the Italian election will be seen as a dangerous defeat for the European Union's political establishment and for the German approach to the euro crisis.
Whatever coalition emerges to govern Italy and whatever role in it Monti might play, two implications will follow if his party suffers the thrashing suggested by the polls. Monti's reform program, and his perceived kowtowing to Merkel, will lose legitimacy. And the new governing coalition will be deeply divided and weak.
As a result, further fiscal austerity efforts or moves to impose unpopular labor reforms will be off the agenda - at least until the next election or another financial crisis. That will, in turn, create big political problems for Germany and the ECB.
Merkel and the ECB have famously promised to do whatever it takes to support Italy and other euro members in the event of a systemic euro crisis. But Merkel was able to overcome German public opposition to this guarantee only by promising to match any financial support with tough conditions for reform. If the new Italian government is unable to implement such conditions, doubts will surely arise about Germany's willingness to provide support in a financial crisis, especially in the months before Merkel herself faces German voters in September. Such doubts, in turn, will make a financial crisis much more likely, not only in Italy but also in other struggling economies of the euro zone.
Paradoxically, Sunday's election could prove more disruptive to the rest of Europe than to Italy itself. This is because Monti managed to implement push through an extraordinary reform agenda during his year in office. The structural budget deficit was reduced to 0.5 percent of gross domestic product last year, exactly the same as Germany's. Labor markets were substantially deregulated, even if much more still could be done. The state pension system has been largely protected against demographic changes and is better funded than in Germany, France, Britain or the United States.
Even the loss of competitiveness caused by the strong euro may be less daunting than generally believed. Italy's current account deficit was only 1.5 percent of GDP last year, slightly smaller than that of France and half the size of Britain's. And plenty of Italian companies have remained successful in global markets - and not just in familiar sectors such as fashion, textiles and luxury cars. For example, the aerospace company Finmeccanica, now embroiled in a scandal in India, has won much bigger markets in the developed world. It is Britain's third-biggest defense supplier and the second-largest foreign contractor to the Pentagon. It also accounts for roughly 25 percent of the value of the Boeing 787. Energy giant ENI has the biggest share in Brazil's enormous offshore oil exploration. And Unicredit is the dominant bank in much of central Europe.
In short, it is quite possible that Italy has done enough reforming to stabilize its financial situation. It must now restore economic growth, and further fiscal austerity is the last thing it needs. The problem is that the financial markets may not believe the first of these propositions, about Italian financial stability, and Merkel certainly does not believe the second proposition, that fiscal easing is now necessary for Italy's economic growth.
Sunday's election will therefore raise questions in the markets about promises to defend financial stability in Italy that ultimately depend on Merkel's acquiescence. Whether investors start to probe Italy's financial defenses immediately after the election or months later is anyone's guess. But sooner or later the promises of support from Germany and the ECB are bound to be tested. With further Monti-style reforms disavowed by Italian voters, Merkel will face a terrible quandary: whether to support an Italian government that refuses further austerity and Germany-inspired reforms or allow a breakup of the euro. Whichever option she chooses, Merkel could end up the biggest loser in Sunday's election.
(Anatole Kaletsky is an award-winning journalist and financial economist who has written since 1976 for The Economist, the Financial Times and The Times of London before joining Reuters. His recent book, "Capitalism 4.0," about the reinvention of global capitalism after the 2008 crisis, was nominated for the BBC's Samuel Johnson Prize, and has been translated into Chinese, Korean, German and Portuguese. Anatole is also chief economist of GaveKal Dragonomics, a Hong Kong-based group that provides investment analysis to 800 investment institutions around the world. ) (Anatole Kaletsky)