By Cyrus Sanati
FORTUNE -- The potential ouster of Silvio Berlusconi and subsequent collapse of the Italian government may not be such a bad thing for Italy. While the uncertainty from the resulting political chaos has the markets on edge, the fact is that the current left/right coalition government is a dysfunctional mess and needs to go. If it were to continue in power, Italy would be on a direct course to insolvency and fiscal default.
It's clear that Italy's issues cannot be solved by its clownish politicians. The best scenario out of all this mess would be for the resurrection of a technocratic-led government, such as the one that ruled Italy throughout 2012, as it could push through much needed reforms to get the nation's stalled economy back on the road to recovery. The worst scenario is for Italy to go through another election cycle that leads to another deadlocked government. This could easily cause investors to lose hope and once again pull their money out of the Italian debt markets. That may be all that is needed to resurrect the dormant European sovereign debt crisis, which is still a major threat to the integrity of the euro and the soundness of the world economy.
Italy's left and right coalition government was born out of the political chaos of the last election. The government led by Prime Minister Enrico Letta's leftist Democratic Party has disappointed Italian political watchers who had hoped that he would continue the reforms of the preceding technocratic government led by Mario Monti.
But Letta's tenuous coalition with Silvio Berlusconi's right-leaning PDL party is on the brink, spooking investors in European debt. Last week, Italian lawmakers from Letta's party began proceedings to oust Berlusconi from the Senate after an Italian court found him guilty of tax evasion last month. The courts bounced the decision to the Senate as to whether or not Berlusconi would be banned from holding political office.
Getting rid of Berlusconi would be a positive change for Italian politics. His inaction and political pandering over the last decade is one of the main reasons why Italy is in such an economic mess. His ouster would free Italy to close a dark chapter in its political history.
But being that Berlusconi's party remains the critical link in Letta's left-right coalition government, his departure now would up the uncertainty and increase the risk for investors in Italian debt -- at least in the short term. That's because Berlusconi's party is most likely going to withdraw from the current government if the Senate votes in favor of ousting the 76-year old billionaire. This would lead to an immediate collapse of the Italian government, resulting in political chaos in Italy and the possible calling of a new election, which could be even more destabilizing for the Italian economy.
Given all of this, it may seem that Berlusconi's presence in Italian politics is the best thing for the country right now. But that would be terribly short-sighted. Berlusconi has made life difficult for the ruling party to get anything accomplished since the coalition was formed last spring. It uses the threat of withdrawing from the coalition when it comes to raising revenue and paying down the country's massive 2 trillion euro debt pile. With one hand tied behind its back due to the devil's bargain it made with Berlusconi's right-leaning conservative party, Letta's government has been unable to take on the tough reforms needed to get Italy's economy back on track.
For example, Letta was recently forced to cancel a controversial property tax on first homes, or risk having Berlusconi's party pull out of the coalition. The loss of this sensible revenue source will leave a massive, 3 billion-euro hole in the Italian budget. The EU and IMF are concerned that Italy will not be able to meet its fiscal targets for the year as a result of this move and are imploring Rome to reconsider.
But the property tax debacle is just a drop in the bucket. While it would be nice for Italy to recoup that lost revenue, it will hardly move the needle when it comes to fixing Italy's debt problems. Nevertheless, by withdrawing it, Italy is sending a signal that it doesn't really give a damn about getting back on fiscal targets as the move makes it that much harder to balance the budget and begin the long march to paying down its debt.
On the flip side, Letta's left-leaning party counts on the nation's various unions for a great deal of support, so any chance of meaningful labor reform seems doubtful as long as Letta is at the helm. Reforming Italy's terrible labor laws is seen as a necessary component to getting the country back on the road to fiscal soundness -- without it, it will just be a matter of time before the country faces yet another fiscal crisis.
But out of the political chaos, Italy could emerge stronger if an unelected technocrat government is allowed to take control -- at least until necessary reforms are put in place. This occurred when the last Italian government fell at the end of 2011. Economist Mario Monti was given the reins and he was able to put in place a number of tough reforms needed to stabilize Italy. While they weren't as strong as some of the more conservative economists would have liked, they still gave the market hope that the country was on its way to someday paying down its debt.
Monti has since morphed into a politician with the founding of his own centrist Civic Choice party earlier this year and remains one of the lone sane voices in Italian politics. When asked what he thought of Letta's decision to withdraw the property tax, Monti said it was, "gutless and spineless." That is the sort of leadership Italy needs right now. Good riddance to Mr. Berlusconi and this dysfunctional coalition.
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