From Italy: a very sensitive situation

The implications of Brexit for Italy should be evaluated from both the economic and political point of view.

From the economic point of view, the key word is ‘uncertainty’. In the medium term, the consequences of Brexit will ultimately depend on the (uncertain) final terms of the ‘divorce’ agreement between UK and the EU. But what this agreement will look like is very unclear. Options range from an association agreement with the European Union under art. 310 of the TFEU, thus having the UK ultimately continue participating, with distinctions, to the European single market policies (in particular the free movement of goods, services, capital and persons), to a ‘hard’ Brexit, in which the UK takes the status of a generic WTO country dealing with EU, i.e. facing the EU Common External Tariff on the trade of goods and services, with no provisions on the free circulation of capital and people, pretty much like the EU – China relations nowadays.

The first option will be almost equivalent to the preservation of the status quo, while the second option (the ‘hard’ Brexit) might lead to the relocation of economic activities from UK to Italy (there are currently around 500 affiliates of UK companies in Italy, with a total turnover in excess of 13Bln euros), as there will be an opportunity for ‘tariff jumping’ investments leaving the UK during the transition phase to reorient their activities on the mainland continental market. This, provided that Italy is able to offer conditions of political stability and adequate legal certainty.

In the short term, however, there are also consequences. Beyond a devaluation of the pound, the regulatory cost of reorganizing the British economic system with new rules defining the inter-relations with the EU, in particular with respect to the banking industry, brings about uncertainty in terms of future investment decisions. This scenario could imply for Great Britain a reduction of 2-4 points of GDP over the next couple of years, i.e. basically stalling economic growth in the country. The latter could have repercussions on Italy, as the UK is the fourth largest market for Italian exports, although the overall volume of transactions does not exceed 5% of the total Italian exports. Also, since the UK is not necessarily the final destination market for Italian exports (often Italian products go through Britain but are ultimately consumed in the United States), it is possible that Brexit might imply a reshape of the Italian Global Value Chains, which could reroute through other countries acting as ‘bridge’ to the US, with Ireland and Germany being the most likely candidates.

Beyond the economic impact, there are rather more delicate political implications. In the short term, the obvious risk is that the ‘Leave’ vote creates an emulation effect in which other Eurosceptic parties campaign in their national elections with similar requests. Indeed, the upcoming referendum on constitutional reforms in Italy (to be held by December this year) will be the first testing ground of this ‘Brexit-induced’ risk of domestic political instability.

In the medium term, precisely in order to minimize the risks of internal political instability, large European countries, including Italy, might have an incentive to make life complicated and difficult to Britain after its divorce request: maximizing the economic damage to the United Kingdom would in fact show to the euro-sceptic electorate the risks involved in campaigning against the EU, and would therefore enable governments in office to more easily preserve the status quo. Still, putting on the ropes a country which is a major nuclear power, a key member of NATO and European defense, and a permanent member of the UN Security Council does not seem a wise foreign policy for any EU country.