Before the euro's arrival, Italy managed to kick the can down the road by depreciating the lira and generating inflation to contain rising public debt. Its high private savings rates kept the country afloat, compensating for an inefficient public sector.

But this devaluation strategy is no longer possible within the constraints of the common currency. And Italian consumers and entrepreneurs are now getting choked by the combination of a stronger currency and rising taxes. Even Italians' traditionally high savings rates have declined to below 9% from 16% pre-crisis.
To escape its debt trap, Italy must grow. And to create growth, the Italian government needs to implement a credible fiscal policy and a genuine reform plan to modernise its economy.
Monti can claim some successes on this front: controlling debt and deficits, cutting health and welfare spending and, to some degree, freeing up labour markets. As foreign investors dumped Italian bonds in 2011, Monti imposed emergency measures to restore market confidence.

These included new taxes on wealth and on first homes, which were painful for Italians and boosted support for anti-tax and anti-euro parties. But the populist quick-fix proposals from such parties are an economic illusion, and do nothing to address the structural causes of Italy's crisis.
A lot more needs to be done. Labour reforms so far lack the muscle to shake up a workforce where older employees have stable, well-paid contracts while young skilled workers survive on temporary, low-paid jobs – or leave the country. Opening up closed professions could boost productivity by 14% over a decade, says the OECD. The government must also address one of the lowest employment rates of any advanced economy in the world to protect the long-term health of public finances. Raising women's historically low participation in the workforce would be a good start.

Finally, Italy must support its weaker banks – including troubled Monte Paschi – but cannot afford to do so only using public funds. Like Holland, Spain and Ireland, it must spread the burden on equity and subordinated bond investors, not just taxpayers.
Italy does have strong foundations to build on. Its economy was less exposed than Ireland's or Spain's to the construction bubble. Its manufacturing base is stronger than many of its eurozone peers, counting on a tirelessly creative class of entrepreneurs. But it must act fast or risk losing that advantage. At the ballot box, Italians face a choice between another quick fix or a long-term strategy of reforms. Only the latter will restore their country to health.

*The author is Head of European Macro Credit Research at RBS. The views expressed are his own.

©RIPRODUZIONE RISERVATA