By Michael Stott
ROME (Reuters) - Regardless of who wins next weekend's parliamentary election, Italy's long economic decline is likely to continue because the next government won't be strong enough to pursue the tough reforms needed to make its economy competitive again.
Bankers, diplomats and industrialists in Rome and Milan despair at how Italians are shifting allegiances ahead of the February 24-25 vote to favor anti-establishment upstarts and show disgust with the established parties.
That makes it more likely that no bloc will have the political strength to tackle Italy's deep-rooted economic crisis, which has made it Europe's most sluggish large economy for the past two decades.
Final opinion polls predict that the vote will deliver a working majority in both houses for a centre-left coalition governing in alliance with technocrat former prime minister Mario Monti. Political risk consultancy Eurasia assigns this scenario a 50-60 percent probability.
But Italy's election for both chambers of parliament has the potential to tip the euro zone back into instability if the outcome does not produce that result.
The colorful cast of candidates includes disgraced media tycoon Silvio Berlusconi, one of the world's richest men, the bespectacled academic Monti, anti-establishment comedian Beppe Grillo who campaigns from a camper van, and Nichi Vendola, a former communist poet who is the governor of Puglia.
Investors have so far taken a relaxed view, relying on polls produced until the legal deadline for surveys of Feb 10.
One of the best indicators that they are not worried: Italian benchmark 10-year bond yields, which topped six percent during the country's worst political moments in 2011, are now trading around 4.4 percent, almost a full percentage point lower than those of Spain.
Italian stocks have performed broadly in line with the wider European market since January, despite the election and a wave of scandals which has engulfed several leading Italian groups.
But observers in Italy are increasingly nervous that the rosy election scenario favored by investors may not work out.
A jaded electorate, angry about political corruption, economic mismanagement and a national crisis that has impoverished a once-wealthy member of the G7 club of rich nations, could produce a surprise.
Pier Luigi Bersani, the standard-bearer for the centre-left, is a worthy but lackluster former minister whose party has been linked to a banking scandal in the mediaeval Tuscan town of Siena. Support for his party now seems to be fading.
Opponents have latched on to the fact that the ailing bank, Monte dei Paschi, was run by a foundation dominated by political appointees from the centre-left and accused Bersani's party of presiding over a debacle that will cost taxpayers hundreds of millions of euros.
CAMPER VAN POLITICS
Monti, dubbed "Rigor Montis" by one opponent for his austerity policies which critics say hurt growth, is stuck in fourth place and slipping. Detractors say he comes across poorly on the hustings and has been hurt because he formed an election alliance with two discredited centrist politicians who are emblematic of the traditional politics which Monti disavows.
The big gainer in the final days before the election, according to private surveys quoted by experts, is stand-up comedian Beppe Grillo and his anti-establishment 5-Star Movement. Grillo has been on a "tsunami tour" of Italy in a camper van, filling piazzas with his ringing denunciations of the country's political class. He campaigns mainly on the Internet, where his widely read blog features a list of Italy's parliamentarians convicted of a crime (it features 24 names).
"The big question is: what happens to Grillo?" said one senior banker in Milan, speaking on condition of anonymity. "He won't win but he could stop Bersani and Monti from getting enough seats to form an effective government."
Under the electoral law in force for this poll, which almost all Italians agree is in need of reform, voters cast ballots for a party list. The coalition with the most votes is awarded top-up seats in the lower house to give it a 55 percent majority. But in the Senate, the top-up premium applies by region.
Pollsters say the race is too close to call in a few battleground regions but there is a good chance the centre-left will fall short of a majority in the Senate, which has equal law-making powers to the lower house.
A substantial vote for Grillo's movement - and some experts suggest he could top 20 percent - could mean the new parliament is filled with new, inexperienced, anti-establishment deputies who may refuse to do deals with other politicians and block legislation. Bersani and Monti could find themselves without a workable majority in the Senate even in alliance - a scenario which Eurasia believe has a 20-30 percent probability.
"It's hard to see Grillo's movement as a source of stability," said one diplomat, speaking off the record. "There is no chance they would be part of a coalition."
Ironically Grillo himself will not be entering parliament regardless of how well his movement does. The shaggy-haired 63-year-old was convicted of manslaughter after three passengers died when a jeep he was driving crashed in 1981, making him ineligible for election under his own party's rules barring convicted criminals from parliament.
"Grillo's agenda is just silly," said one leading Italian columnist, speaking anonymously because his publication did not allow him to be quoted in other media before the vote.
"It's a fuck off policy. He wants to leave Europe, set up people's tribunals, halve public employees. It's the most visible symptom of Italy's political crisis."
The 5-Star Movement is not the only anti-establishment force threatening to make Italy ungovernable. The federalist Northern League, which favors greater autonomy for northern Italy, is polling around five percent nationally. Its leader Roberto Maroni told Reuters last week he would use his seats in parliament in alliance with the centre-right to block a centre-left coalition and prevent it from governing.
The League is particularly important in the Senate as its home region of Lombardy, where the party polls about 15 percent, returns by far the most senators - 49 out of a chamber of 319.
Should Grillo's movement and the Northern League win enough seats to deprive a centre-left coalition with Monti of an overall majority, the most likely outcome is a "grand coalition" of left and right, experts say.
Such a result would unsettle investors because it would be likely to bring centre-right leader former premier Berlusconi, 76, back into government in a key role and Monti would be unlikely to join it.
Berlusconi's own party has boosted its standing in polls over the past month, helped by the former premier's veteran campaigning skill and his dominance of the country's private TV channels. But nobody apart from his own supporters believes he is likely to win this time.
Pope Benedict's unexpected resignation this month has pushed the parliamentary election off the front pages in Italy, giving Berlusconi less print space and TV air time to press his populist message. The main beneficiary appears to be Grillo, whose strategy of ignoring mainstream media and campaigning on the Internet has been unaffected by the news from the Vatican.
Investors above all want a government which will tackle the reasons for Italy's lackluster performance. Italy has hardly grown since the birth of the euro in 1999 and its economy has slumped faster since the 2007 financial crisis than any other in Europe except Greece. Last year, Italy contracted by 2.2 percent, according to official statistics.
Businessmen complain of three main obstacles: stifling bureaucracy, labor laws which offer workers so much protection that they encourage slack performance, and a dysfunctional court system which makes it hard to enforce contracts and collect debts. All are deep-rooted problems and none is likely to be tackled effectively by a weak and divided government.
"Nobody in Italy is ready to make the reforms our country needs right now," said the chief executive of a major Italian company, speaking off the record.
"I am deeply convinced that without a major change in labor flexibility, we will not be able to increase productivity. My personal experience is that Italian labor is fantastic. But if you take a very good worker and tell him his job is completely safe, you will turn him into a slacker."
Italy's byzantine court system - where cases can languish for years - and its legendary bureaucracy are major obstacles to foreign investment and competitiveness, business people and diplomats say. "Foreign companies are surprised by how hard it is to get things done here which we all thought had been agreed in Brussels 20 years ago," said one senior European diplomat.
Monti's technocratic government won plaudits from business for reforming Italy's pension system but its efforts to reform labor laws did not enjoy similar success. Monti's government lasted 13 months until Berlusconi's bloc triggered its collapse by withdrawing support. Some observers in Italy don't believe that the next parliament's make-up will be nearly as conducive to reform as the outgoing one.
"I want to be optimistic but my best guess is that they will keep to this muddle-through scenario in the next parliament with lackluster results for the economy," said a second senior diplomat. "This country needs a new generation of political leaders."
Key among the concerns of diplomats and business people is the disparate nature of the centre-left coalition leading in polls.
Bersani's election alliance is made up of four main parties, stretching from the former communist Vendola through the Christian left to socialists and centrists. If it is unable to govern alone, as most polls predict, it will need the support of Monti's bloc - itself made up of three parties.
Bankers fear that a government made up of seven different groups of widely varying political hues is highly unlikely to agree on the tough, radical reform measures the country needs.
"If we have a government made up of Bersani, Monti and Vendola, they will argue all the time," said the chief executive. "Bersani and Vendola's capacity for reform is almost zero." Comparing the present Italian centre-left candidate to the former German chancellor whose successful labor reforms belied his socialist roots, he added: "Bersani is no Schroeder".
Bersani's economic spokesman Stefano Fassina insists that the centre-left fully understands the urgency of Italy's economic plight and is committed to deliver on measures to stop the rot. But he puts the emphasis on making the public sector more efficient and persuading Berlin to tone down budget austerity at a European level rather than pursuing labor reform in Italy. Fassina insists that public commitments by Bersani and Vendola on an agreed program will minimize disagreements but he does admit to concern about how a centre-left administration could work with Grillo's unpredictable forces.
"It's impossible to have any discussions with Grillo as a party," he said. "We hope that in parliament some of his MPs will be pragmatic enough to agree on reasonable measures."
With so much uncertainty about the election and the chances fading of it returning a strong, stable reformist government, it is hard to avoid the conclusion that Italy's slow, steady economic decline will continue regardless of the result.
"We've seen a steady economic decline in Italy over the past 20 years and it's very hard to see any outcome from this election which will reverse that. The reforms which would really get the country going again are out of reach," concluded the European diplomat.
(Editing by Peter Millership and Giles Elgood)