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Italy isn't quite on the verge of its own Brexit. But its Sunday referendum still matters a lot for Europe.

It could cause chaos in Europe’s political and economic scene.

Thousands of people take to the streets to say 'NO' at the upcoming constitutional referendum and to protest against Prime Minister Matteo Renzi's government politics.
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Brexit. Trump. An Italian referendum?

Political and economic leaders across Europe will be paying very close attention to a high-stakes Italian ballot measure coming up for a vote on Sunday that is so confusing, nine out of 10 Italians have admitted they don't understand it and an Italian startup is offering classes on the referendum’s finer points.

The measure consists of a package of reforms that would drastically shrink the size and power of one of Italy’s two houses of parliament in an effort to reform the country’s famously corrupt and inefficient system of government.

Italian Prime Minister Matteo Renzi has been lobbying aggressively for the set of changes and has said he’ll resign if voters reject the measure. A “no” vote — that is, a vote to leave Italy’s government exactly as it is right now — would give the country’s opposition movement a significant boost.

The primary beneficiary of that bounce would be the Five Star Movement, an insurgent populist party led by a former comedian who wants Italy to abandon the euro. Which means that Sunday’s vote is not merely a domestic political matter — it’s also an important symbolic vote about Italy’s relationship with the European community as a whole.

The most recent polls we have to go off of suggest that a “no” vote is likely, and that’s causing some panic in Europe. For advocates of the eurozone — the group of European countries that use the euro as their national currency — this raises the haunting prospect of another Brexit scenario, as well as the specter of a domino effect in which other countries follow the UK and Italy’s lead, and the eurozone breaks up. That nightmare scenario would wreak havoc on the global financial system and international trade.

The upheaval in the Italian government caused by a “no” vote also would spook investors and could cause a crisis in Italy’s massively indebted banks, an issue that could spread to other European countries with similarly ailing financial sectors.

It would be wrong to interpret a “no” vote as Italy’s Brexit — both because there’s several reasons that Italians might vote against the reforms, and because the Five Star Movement would still be many steps away from power. But it could still cause some chaos and open the door for Italy to reconsider its relationship with Europe.

Italy will be deciding whether it wants to reform its constitution — and whether to keep the prime minister in power

Italian Prime Minister Matteo Renzi speaks during a demonstration to support the “Yes” (“Sì”) vote to the constitutional referendum.
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Italians will be voting for or against a bundle of adjustments to the constitution designed primarily to streamline the way Italy’s national government passes laws.

But at its core, the reforms are meant to upend Italy’s “perfect bicameralism” in its legislative branch. Currently, both the lower and upper chambers of their parliament are elected directly and have virtually identical power, which makes passing legislation a slow and arduous process.

Italy’s unusual parliamentary system was drawn up with care to prevent the recurrence of a fascist like Benito Mussolini, who ruled the country from 1922 to 1943; it’s difficult to form a majority, and the chambers can check each other’s power with ease. But that principle of balance can also make it very difficult to get things done in parliament.

The reforms, then, would reduce the senate from 315 to 100 members, strip it of most of its powers, and, with some notable exceptions, make it more of a consultative body instead of an equal partner in forging new laws. The composition of the senate body would also change, and be composed primarily of local government officials — mainly regional council members and mayors.

When Prime Minister Matteo Renzi and his center-left Democratic Party initially proposed the constitutional reforms in 2014, they were faring well in the polls and pursuing the reforms seemed like a good idea. After the reforms failed to garner enough votes in parliament to become law, Renzi moved to put it up for a referendum.

But this year a major development altered the way Italians perceive the measure: Renzi said he would resign if the referendum failed. In other words, he personalized it — now, Italians aren’t just voting on the referendum, they’re also voting on whether or not they want Renzi to remain in office.

“No” voters will be motivated by an anemic economy and concerns about corruption

For many, opposition to the ballot measure is more about opposition to Renzi than the ballot measure itself. Renzi, who came to power as a fresh-faced reformer just to two years ago at the age of 39, has plenty stacked against him. He is overseeing a weak economy: Unemployment is over 11 percent; economic growth is incredibly sluggish and seems destined to remain near the bottom of the eurozone; and Italy’s major banks are brimming with bad loans and desperate for capital.

Renzi has also done little to alleviate many Italians’ concerns about systemic corruption among the country’s political class. Plenty of people will be voting based on whether he’s delivered on the bold promises he made when he was appointed prime minister.

But there’s also concern about how the proposed constitutional reforms to the Senate would interact with an electoral law that came into effect this year that makes it far easier for a party to gain a majority of seats in the Chamber of Deputies, the lower house of Italy’s parliament. Since the proposed reforms would basically make the Chamber of Deputies the dominant legislative chamber, to many of Renzi’s critics, this looks like a major opportunity for a power grab.

A loss for Renzi would be a blow to the euro and to Italy’s financial stability

Beppe Grillo, leader of the Five Star Movement, riling up a crowd.
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Renzi won’t necessarily step down if the referendum fails. In recent months he has hedged a bit, and analysts of Italian politics think that if the margin of loss on the referendum is slim enough, his party could decide that it doesn’t amount to a strong vote of no-confidence, and choose to keep him in power.

But if he loses by a large margin, there will be plenty of pressure for him to follow through on the pledge. If that happens, that’s a huge blow to his political clout. A caretaker government would likely take over, and another election could be held in the next six to nine months.

The Five Star Movement stands to gain the most from Renzi’s downfall. It’s an enigmatic party, identifying as post-ideological and garnering support from across the political spectrum. But it does have two clear convictions: The Italian government is intolerably corrupt, and the country should leave the euro. The latter is what makes its rise so significant for the rest of Europe.

The Five Star movement would be primed to do fairly well in an early election after Renzi’s loss. But it is still proving its mettle as a political party, and its continued rise is far from guaranteed.

“The Five Star Movement’s future electoral success also hinges on whether some of its newly elected politicians — particularly the mayor of Rome, Virginia Raggi — can turn things around,” Tom Pavone, a PhD candidate at Princeton University specializing in law and politics in the European Union, says. “Raggi has been the subject of tons of criticism from all sides of the political spectrum, because of her struggles to form a city council and because of her reluctance to distance herself from a local official who is being investigated for mafia collusion.”

“This is the problem that anti-system parties always face: How to govern when your political brand has been based on railing against those who do,” he says.

If the Five Star Movement does manage to eventually make it to Palazzo Chigi, the prime minister’s residence, there are still many more steps before it can affect policy on the currency Italy uses. As the Guardian reports, in order to abandon the euro, the party would have to usher in a constitutional amendment and hold another referendum.

Italy’s banks are the main concern at the moment

The real reason for worry in the immediate future is the way that a “no” vote could potentially affect Italy’s struggling banks.

“The real problem of Italy in this moment is the banking sector is near a collapse — think of the US in September 2008 [prior to the fall of Lehman Brothers],” explains Luigi Zingales, an economist at the University of Chicago.

The banks need to be shored up, but if the referendum fails, it will cast doubt on the direction of Italy’s economy and the government’s ability to manage or reform it effectively.

“In the short run, this matters because Italian banks currently hold an estimated 300 billion Euros in loans that may not be repaid and several banks may not be able to remain solvent without recapitalization,” Peter Hall, professor of European Studies at Harvard University, says. “However, their ability to secure the funds this recapitalization requires depends, at least partly, on general confidence in the future of the Italian economy. “

In other words, a “no” vote would rob Italy of the very thing it needs to stabilize its banks — confidence from investors. If Italian banks aren’t able to raise the capital they need and the government is forced to swoop in to rescue them, things will get messy.

European Union rules say that the Italian government can’t bail out banks before creditors take losses. But it’s estimated that nearly half of those creditors are ordinary Italians. Which means that many Italian citizens could have to take huge financial losses due to events precipitated by the “no” vote.

“That would likely inspire renewed conflict between the Italian government and the EU authorities, which is likely to inspire further fears about whether the monetary union in its current form remains viable,” Hall says.

The Sunday referendum is far too complex and far too many steps away from abandoning the euro to be considered comparable to Brexit. Nonetheless, a great deal is at stake for Italy and Europe in the long run.

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