There is no question about it. The Italian vote will make it much more difficult for Europe to manage its crisis. It also raises the probability that the common currency will fail. Such a disaster and the financial chaos that would follow it are not yet a likelihood, but they certainly are more likely than they seemed just a few weeks ago.

From the broad European perspective, the Italian election revolved around two critical points: First, would Italy continue to bow to the austerity demands attached to aid from the European Central Bank (ECB), the International Monetary Fund (IMF), and the European Stability Mechanism (ESM)? Second, would it continue with the pro-growth structural reforms initiated by Prime Minister Mario Monti during the past year or so? The center-left coalition, led by Pier Luigi Bersani and his Democratic Party, answered yes to both questions. The center-right, led by former prime minister Silvio Berlusconi, argued for a reconsideration.

Now these opposing views have garnered about equal numbers of votes in both the lower house of Italy’s parliament and in its Senate. The figures are so close that the country may have to hold a new election in just a few months, though Bersani, with a slight advantage in the lower house, might find a way to form a government. Especially since the anti-government Five Star Movement did surprisingly well, it is clear that even if the country can organize a government, Rome will have great difficulty moving legislation.

In any event, Premier Monti’s structural reform effort is a dead issue. He had pushed this agenda because he realized that an Italy would suffer under austerity alone. In particular, he saw the risk of a vicious cycle, in which the austerity slows economic growth enough to enlarge budget deficits, despite the tax hikes and spending restraint, eliciting still more fiscal austerity that then only compounds economic and deficit problems.

Monti believed Italy could pursue needed austerity and avoid this fate by also implementing growth-oriented structural reforms. His work focused initially on labor markets, aiming for economic flexibility and efficiency by loosening rules on hiring and firing and scaling back regulations to give firms more latitude in setting hours and production schedules. Though he made remarkable strides against long-standing powerful interests, all recognize that there is much left to do before Italy could regain the kind of competitiveness it needs. This divided government hardly seems capable of taking those additional steps, especially faced, as it is, with still powerful opposing interests.

The austerity question becomes still more complicated because any decision to soften its demands will likely affect Germany’s upcoming September elections. Chancellor Angela Merkel is running a campaign of European cooperation, aimed at securing Germany’s broader interests within the currency union and Europe generally. Her opposition has taken a narrower definition of German interests, worrying over the loss of German influence within Europe and the risk to the German taxpayer. Though Merkel remains popular, polls show that a large part of the public shares these narrower concerns. They will only likely intensify with an Italian rejection of austerity, since Germans will then naturally ask themselves why their country should extend itself when the Italians seem unwilling to change the policies that got the country into trouble in the first place. If the Italian vote swings the German election against cooperation, Merkel, even if she remains chancellor, could find her maneuvering room severely limited, taking from Europe and its periphery their main source of financial support.

Disappointing as this Italian muddle is, panic now would be premature. A second Italian vote might bring a more committed government to Rome. The divided government that seems to exist now may yet surprise and pursue more aggressive and cooperative policies. The German vote may turn out to be less vulnerable to an Italian disappointment than it seems at the moment.

But there should be no mistake: the outcome of the Italian elections lowers the probability of cooperation from all involved. As a consequence, it also suggests a less ordered European situation—and a greater reason to worry over the financial and economic hardship that would accompany such a failure.

Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. He writes frequently on economics and finance. His new book, Thirty Tomorrows, linking globalization to aging demographics, is forthcoming from Thomas Donne Books of Saint Martin’s Press.

Image: Wikimedia Commons/Etienne (Li). CC BY-SA 3.0.