Is Mario Monti going to Be the Next Italian Prime Minister?

Investors and political leaders around the world are considerably worried that the new government that will emerge from the next Italian elections in April 2013 will not be headed by Mario Monti nor will purse the “Monti Agenda” of structural reform and fiscal discipline. The worries are well founded, for several reasons.
Economics.. On one hand it is hard to conceive that the ECB plus ESM bazooka of bond purchases in the secondary and primary sovereign debt markets may be sufficient to prevent a breakup on the Eurozone, should investors perceive that the new Italian government lacks a strong commitment to reforms (see Manasse and Zavalloni (1), Manasse and Trigilia (2)), and that it may revert to the old path of low productivity growth and high deficits. Spreads would sky-rocket until the bazooka becomes politically useless. The Euro would not stand the pressure.
On the other hand, the Monti’s “agenda” (Latin for “things to be done”) is far being a Monti’s’ “acta” (“things that have been done”). So far the Government has managed to push through Parliament seven Reforms: Budget Consolidation and Pension Reform (“Save Italy”), Competition (“Grow Italy”), Administrative and Fiscal Simplification, Labor Market Reform, Spending Review, Growth. Yet in a recent inquiry the Sole 24 ore, a business daily newspaper, found that as of August 31st, about 86.6 percent (!) of the decrees required to implement the reforms remained to be approved, with implementation lags particularly serious in the crucial labor and spending review reforms. In other words, the job is far from finished.
Finally, while the tax increase and the pension reforms have already displayed their negative impact on consumption and output (according to my rule-of-thumb evaluation, they may have depressed GDP growth by up to -2%), the much hoped-for positive effects on medium term growth (+1.5 according to me) of the other reforms have not yet materialized and may be dissipated if interest rate rise back. Thus should the reform drive fade away, only the negative impact effects would be left.
…And Politics. Hence the crucial question, for Italy and Europe, is: What is the probability that Monti will be appointed for a second term and/or that the new government will adhere strictly to the Monti agenda (MM2)? My answer is that Monti (or the pursuit of his agenda) stands less than 50% of a chance. Let’s see why.
In order to give a coherent answer to the question one needs to evaluate at least two aspects of the Italian uncertain political landscape.
Voting Rules (V): the main political parties are trying to reach an agreement on how to reform the electoral system before the 2013 election. To simplify, an agreement could either be reached on a “proportional”-type system (P), resulting in a hung-up Parliament, or on a “majoritarian”-type (M), from which a clear-cut majority may emerge. So V could take values V={P,M} with some probabilities attached.
Front Runners: the two main parties, Democrats on the left (L) and Freedom Party o the right (R) have yet to decide, possibly by primary elections, their candidate prime minister. This choice could produce either moderate leaderships/coalitions (right-centre, RC, or left-centre, LC) or radical leaderships/coalitions (RR, LL). So that R={RC,RR} and L={LC,LL}. An example of RR is Berlusconi. An example of LC is the Mayor of Florence, Renzi, a sort of Tony-Blair-Wanna-Be.
The presumption is that the likelihood of MM2 depends on the realizations of these uncertain events. A more hung parliament (P) would be more conducive to MM2 than a clear-cut victory of either party, since as Monti would be a reasonable compromise between two weak opponents. Furthermore, radical front runners/coalitions would be less conducive to a middle-of-the road man such as Mario Monti (3). Now all we need to do is to assign probabilities for these events, and calculate the resulting expected likelihood of MM2.

Reasonable priors are as follows: as to the electoral reform, an agreement on a somewhat proportional system (P) is more likely that the alternative (M), say 0.6 to 0.4, given that the two largest parties have fallen substantially in voting intentions (25% the Democrats, and 20% the Freedom party) and no one wants to risk a large electoral defeat. As it concerns the candidates, the competition of radical parties (particularly the anti-system M5S party of the comedian-turned-politician, Beppe Grillo, and the IDV party of ex Mani-pulite persecutor Di Pietro) is likely to favor radical coalitions on both sides (RR, LL), so that I assign 0.6 to radical leader/coalitions (RR,LL), and 0.4 to the moderate ones (RC, LC).

With these priors (4), it turns out that the likelihood of MM2, is less than one half, namely 0.43. There are two opposite forces at play: the proportional system favoring Monti, and the emergence of radical coalitions, hindering him. Unfortunately for Europe, the latter is likely to prevail.

Notes

(1) Paolo Manasse, Luca Zavalloni, Contagion in Europe, voxeu.org, http://www.voxeu.org/article/contagion-europe-evidence-sovereign-debt-crisis
(2) Paolo Manasse, Giulio Trigilia, Welcome to Euritaly, http://www.voxeu.org/article/welcome-eurotaly-if-italy-falls-so-does-europe
(3) In a formula, the probability of MM2, p, depends the realizations of (V, R, L): p = F(V, R, L) with some obvious properties : F(P,*) > F(M,*), which means that a proportional system favors Monti, and F(*, sC) > F(*, ss) for s=R,L, which means that moderate leaders favor Monti.
(4) I assume a simple step function F(*) that declines from a maximum value of 1, when the system is proportional and both candidates/coalitions are moderate, to zero when the system is majoritarian and the leader/coalitions radical.

F(P, RC, LC)
1
F(P, RC,LL)
0.6
F(P,RR,LC)
0.6
F(P,RR,LL)
0.3
F(M, RC, LC)
0.6
F(M, RC,LL)
0.3
F(M,RR,LC)
0.3
F(M,RR,LL)
0
With this specification, and denoting by p(x) the probability of x=V,R,L,  assuming that the events V, R, L are independent, the expected likelihood of MM2 is
calculated as                                 


    =0.43