Italy's elections on Sunday might not solve its economic woes
Italy's fragile economy an even bigger concern than the outcome of this weekend's general election
Ahead of Italy's election on March 4, investors are most afraid of political change.
They worry that the government may succumb to the populist forces that France and the Netherlands dodged last year. Such fears are misplaced.
Italian political risk is overhyped. By contrast, there is undue complacency about Italy's vulnerable economy, the third biggest in the euro area.
It is possible to predict a political horror story because the ruling centre-left Democratic Party, which is pro-European and broadly reformist, has fallen out of favour.
One rising force in Italian politics promises disruption.
Many Italians will back the insurgent Five Star Movement, which is noisily anti-establishment.
A reviving political force will be scarcely more palatable, as Mr Silvio Berlusconi, forced out as prime minister in 2011, makes an unexpected comeback.
Though Mr Berlusconi is barred from seeking public office, his party is part of an alliance that includes the eurosceptic Northern League.
This right-of-centre coalition has been polling strongly on a programme that would loosen the budgetary reins and dial back on reforms.
Yet the risks posed by politics in Italy are usually exaggerated. The governing class is adept at extricating the Italian state from tight spots.
Sunday's vote is more likely to result in political paralysis arising from a hung parliament than either a disruptive new government or a further resort to the technocrats.
A parliamentary stalemate would be undesirable but it should be manageable.
But if there is too much angst about Italian politics, there is too little about the economy.
Investors are placing excessive faith in the current business upswing. That strengthened last year as GDP grew at its fastest clip since 2010.
Yet the growth was only 1.4 per cent, below even Britain's Brexit-battered 1.7 per cent and well short of the euro area's 2.5 per cent.
Unemployment fell from 11.8 per cent of the labour force at the end of 2016 to 10.8 in December last year.
That still leaves it well above the euro area's average of 8.7 per cent, let alone Germany's 3.6 per cent.
Whatever the strength of the current upturn, it comes after a dismal decade for the Italian economy, which still bears scars from the deep recessions arising from first the financial crisis and then the euro crisis, followed by a weak recovery.
Italy has not simply lost ground over the past decade. Its poor economic performance over so long a period has left two unwelcome legacies.
First, Italian public debt has risen from an already high 100 per cent of GDP at the end of 2007 to over 130 per cent, a burden on the economy exceeded in Europe only by Greece.
Second, bad loans have built up in the banking system as businesses hurt by the ailing economy have been unable to service them.
Italy's pile of non-performing loans is the biggest of any country in Europe, making up almost a quarter of the total in the EU.
These twin burdens hobble the economy and make it susceptible to any setback.
Banks weighed down by bad loans are reluctant to lend, stifling the flow of credit to new enterprises and projects.
Italy's huge public debt means that it simply cannot afford a big rise in long-term interest rates, which are currently at a benign 2 per cent.
This is largely thanks to the European Central Bank's (ECB) massive program of quantitative easing that has created new money to buy bonds.
Banks are now making progress in reducing their bad loans, but further inroads depend crucially upon an extended period of strong growth.
That is also vital in order to bring down the public debt burden.
Yet even before the financial crisis, Italy's underlying growth rate was sluggish, held back by limping productivity.
That is why, remarkably, living standards measured by real GDP per person were 5 per cent lower in 2016 than in 2000.
By comparison, they were nearly 20 per cent higher in Germany.
For the moment, the Italian economy can enjoy its spell in the sun of the ECB's easy-money policies.But the ECB is already starting to turn the heat down by reducing the scale of its asset purchases.
The cyclical upswing has masked the underlying fragility of the Italian economy and public finances. That vulnerability will persist whatever the outcome of the election. - REUTERS
The writer is a London-based writer and a former European economics editor of The Economist.