Europe’s fate hangs—more than it should—on Italy’s February 24 election. So does the stability of global financial markets.

If the vote goes the wrong way, toward former Prime Minister Silvio Berlusconi’s People of Freedom Party or the antiestablishment Five Star Movement, the strains on Europe’s common currency will stretch to the breaking point and the odds of financial panic will rise on both sides of the Atlantic. Such a result will also raise the risks of a prolonged recession, both in Italy and in Europe generally.

Right now, the polls and the electoral maneuvering point to an acceptable, if not an especially encouraging election outcome, one that could avoid the worst of these risks. But, as ever with politics, most especially Italian politics, matters are far from certain.

At issue in this vote is Italy’s willingness to cooperate with the rest of Europe. During the last 13 months, Prime Minister Mario Monti has accepted as necessary the budget austerity demanded by Germany and the Eurozone in return for financial support. If the election brings in a government that rejects such cooperation, Italy would almost certainly lose the support of the European Stability Mechanism as well as that of the International Monetary Fund (IMF). With these monies withdrawn, Italian borrowing costs would rise immediately, so quickly, in all likelihood, and so high, that in short order the government in Rome would find itself unable to finance its own operations.

The resulting default would likely force Italy out of the common currency. Worse, it would drive investors away from the bonds of other nations in Europe’s beleaguered periphery, forcing up their borrowing costs and possibly driving them into default, however otherwise committed they might have been to cooperation and austerity. Such a chain reaction of failures could destroy the euro and precipitate a financial panic that would strain the resources of any government or central bank, in Europe, America and possibly further afield.

Also hanging on this vote is Italy’s recent, important embrace of progrowth, structural reform. Faced with the need for austerity, Monti turned to such reforms as the only way to promote growth without burdening the national budget. In the absence of such a strategy, Monti quite reasonably saw the real possibility of a vicious economic cycle, one in which otherwise essential budget restraint deepens recessions, widens budget deficits, and elicits still more austerity that creates still deeper recessions. Accordingly, he led Rome’s parliament to liberalize the nation’s regulatory structures to improve business efficiency, dynamism and competitiveness.

In particular, Italy has altered its once highly restrictive labor laws to make it easier and less costly for firms to hire and fire workers, set work rules, and negotiate with unions locally instead of only on a national basis. Such efforts will, admittedly, generate growth only gradually, but in these circumstances, the approach is all the country has available to moderate the ill effects of otherwise essential budget austerity.

If the February election shuts down the reforms, Italy would suffer still more recessionary pressure. Since Italy’s promotion of such liberalizing reform has served as a guide for the rest of Europe’s periphery, backsliding by Rome could easily have an unfortunate echo elsewhere.

Current polls suggest that the vote will save Monti’s efforts on both European cooperation and structural reform. Italy’s Democratic Party supports them, and it currently leads in the polls, with almost 38 percent of the indicated vote. Though described as left-leaning and led by an ex-Communist, Pier Luigi Bersani, the Democrats nonetheless have vowed very publicly to stick to the austerity program. Bersani has said that he would keep Monti’s pension cuts and tax increases in place. He has even embraced the proposal, put forward by German Finance Minister Wolfgang Schäuble, to institute a “currency commission” that would govern the budgets of nations participating in the common currency. Equally important, Bersani has vowed to keep Monti’s more liberal regulatory and labor laws intact, claiming credibility in such a commitment by pointing out how in the late 2000s he, as minister of economic development, worked to advance pro-competition measures.

This strong support no doubt contributed to Monti’s decision late last December to abandon political neutrality and seek office. Of course, Monti has no party of his own. He was appointed. But there is talk of a centrist group forming around him. Franco Frattini, former foreign minister under the old Berlusconi government, has endorsed such an effort. Support has begun to emerge from the centrist UDC Party and a centrist civic group launched by Luca Cordero di Montezemolo, entrepreneur and head of Ferrari.

Support of this kind could help defeat Berlusconi’s People of Freedom Party, whose attacks on Monti precipitated this election. Berlusconi’s party is already trailing in the polls, with only 18 percent of the electorate. Even the rumored alliance with the Northern League would gain him only 4 percent more of the electorate.

Perhaps even more importantly, postelection support of this kind in Italy’s Senate (where Monti is already a member for life) could help a victorious Bersani in the lower house stay the course. In particular, it could help him resist pressure from his own party’s left wing to unwind Monti’s structural reforms, especially from the trade unions and his likely coalition partner, the Left, Ecology and Freedom Party.

Though prospects for a continuation of Monti’s crucial policies look reasonably good, it is also clear that much remains in play. If, for instance, a Bersani government would retain the progrowth structural reforms already advanced by Monti, it is not at all clear that it would improve economic prospects still more by extending them—or even if it wants to do so.

Europe’s common currency could survive an adverse vote or even an Italian disaster. Important as Italy is at this juncture, it still is not the whole story. But it would make matters a lot easier for Italy and Europe, and reduce the risk of financial panic, if the election allows the country to continue down the path set by Monti.

Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. and an affiliate of the Center for the Study of Human Capital at the State University of New York at Buffalo. His most recent book, Thirty Tomorrows, linking demographic change and globalization, is due out next year from Thomas Dunne Books of St. Martin’s Press.

Image: Wikimedia Commons/Pava. CC BY-SA 3.0.