Embattled Berlusconi Survives for Now, But Italy's Future is the Real Issue

Italians face an uncertain economic future no matter who is in power.

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Europe is about to show the world the difference between big news and important news.

In big news, the debt-saddled countries of Greece and Italy are making headlines with their crises of leadership. In a much-anticipated vote, the Italian parliament passed Prime Minister Silvio Berlusconi's budget Tuesday. The vote was seen as symbolic of lawmakers' support of Berlusconi. However, his fate is still in question; the budget did not win with an absolute majority, and the opposition has asked for Berlusocni's resignation.

Likewise, Greece is undergoing major power shifts. Prime Minister George Papandreou has agreed to resign as soon as the Hellenic Republic forms a unity government.

[See a translation guide to G-20 leaders' recent statements.]

New heads of state—or the potential for new heads of state—make for big news. But the real changes that could help save Europe from its sovereign debt crises will happen in ledgers and on balance sheets.

"If Italy wants to get its act together, it can," says Axel Merk, portfolio manager at Merk Funds. But that will involve massive changes to Italians' way of life. Italy's generous pension system is an example. "If you work for 35 years [in Italy], you can retire with a pension no matter how old you are. Italy just can't afford that anymore. Changing these things is, of course, extremely difficult."

More important, says Domenico Lombardi, a senior fellow at the Brookings Institution, is enhancing the Italian economy's growth. "When you have a very high public debt," as Italy does, he says, "potentially [low growth] creates an explosive mix." Reducing regulatory barriers and privatizing state enterprises could be steps in the right direction, he says, but as the United States and countless other economies have shown in recent years, boosting growth at will can be a near-impossible task, particularly for a large economy like Italy's—the third largest in the euro zone.

The pressure is particularly on Italy, as the European Union's plan to leverage its bailout fund, the EFSF, is still in question after the EU recently agreed to more than double its size to $1.4 trillion.

This is not to say that the actions of leaders like Papandreou and Berlusconi haven't had wide-ranging economic repercussions. Indeed, every development surrounding Berlusconi in recent days has affected yields on Italian bonds. Trepidation surrounding the prime minister's government was quantified in near 15-year high yields on Italian 10-year notes earlier this week, with interest rates reaching 6.78 percent on Monday. Some economists say that 7 percent or higher would be unsustainable territory.

[Read analysis of the latest U.S. jobs numbers.]

The markets have made their distrust of Berlusconi known, but there is no guarantee that a different government would be a better government. According to Merk, Berlusconi may simply be "the devil you know" to Italian voters and some lawmakers.

That devil is hanging on tightly; Berlusconi has insisted that he will refuse to resign, despite clear indications that he no longer holds a political majority. What happens from here is unclear; in one scenario, for example, Berlusconi could step down and leave the post to one of his close aides, says Lombardi, while still maintaining some influence. Merk also says that Berlusconi could use the current opportunity to "bully" Italian lawmakers, essentially telling them, "If you don't like me, then I'm going to call for snap elections. So if I lose my job, you guys are going to lose your jobs"—a move that Merk calls "very irresponsible."

Whether Berlusconi survives may ultimately be of no consequence. How Italy survives its economic plight will be of the greatest consequence to the rest of Europe.