LONDON, June 24 (Reuters Breakingviews) - Italy's new prime minister, Enrico Letta, is making the best of a bad job. After February's inconclusive election, it looked like Italy's dysfunctional political system might drag the country further into the abyss. There was a risk that nobody would be able to form a government, new elections would be called and that even these would end in a stalemate.
In the end, a grand coalition was formed involving Letta's center-left Democrats, Silvio Berlusconi's center-right PDL and Mario Monti's centrist group. Putting together such a coalition was itself an achievement - given that the Democrats and Berlusconi hate one another and that the Five Star Movement, led by comedian Beppe Grillo, refused to make deals with anybody.
Even after the coalition was formed - largely as a result of pressure from Giorgio Napolitano, Italy's respected octogenarian president - there wasn't much hope that it could achieve anything. But Letta has been quietly getting on with reform, as I discovered when I spent a few days in Italy last week. Part of the explanation is that he is an intelligent, modest, consensus-builder rather than a charismatic figure with a big ego.
Moreover, none of the big beasts of Italian politics, notably Berlusconi, is in Letta's cabinet. The prime minister, who is not even leader of his own party, keeps a fairly arms-length relationship with the political leaders. This gives his government a semi-technocratic flavor, not vastly dissimilar from the Monti government it replaced.
The worry is that these qualities could be a source of Letta's ultimate undoing. Although he is popular now, the same was true of Monti in his honeymoon period. Letta has yet to prove he can push through, let alone sell, any real tough reforms.
That said, Letta's first steps have been promising. He has started to clean up the corrupt political system. Ministers, including Letta himself, now only receive a single MP's salary rather than the double salary they used to get. The state will also stop funding political parties: in the past decade, it gave them 2.5 billion euros, of which only 500 million was documented.
Letta has also begun to unblock Italy's civil justice system, which has been a blight on business and deterred foreign investment. Cases get gummed up in the courts for years on end. This gives the offending party in a dispute a perverse incentive to threaten to call in the courts. A week ago, Letta passed a decree that aims to cut the backlog of 4 million cases by hiring assistant magistrates and forcing mediation.
Tougher challenges lie ahead. The most immediate is how to square Berlusconi's insistence on scrapping a property tax and a planned increase in VAT with the need to keep the deficit below 3 percent of GDP, as agreed with the European Commission.
These taxes shouldn't be scrapped at all. Insofar as Rome can cobble together any money, it should be cutting high taxes on labor in order to bring down Italy's youth unemployment rate, which has shot up to 40 percent as a result of the recession. Italy faces a lost generation: some of the most talented young people are quitting the country; many of the rest are stuck at home with few prospects.
To be fair, Letta is trying to combat youth unemployment by cutting labor taxes for youngsters and is badgering other European leaders to fast-track a European-wide scheme to fund jobs for those leaving education. He also plans to remedy one of the mistakes in Monti's labor reform, under which companies can't offer people more than one fixed-term contract. This led to lots of people being kicked out of work.
That said, Letta's hope of creating 100,000 jobs from these measures seems too modest given unemployment of 3.1 million. Bolder measures are needed to cut wages and make Italy more competitive.
Letta should have two other priorities. First, he should kick off Italy's long-stalled privatization program. The state's debt is expected to end the year at over 130 percent of GDP and may jump higher if Rome needs to plug a capital shortfall in some of the country's banks as part of the European Central Bank's push to clean up lenders' balance sheets. Liquidating Italy's vast asset portfolio is one of the few ways of bringing debt down.
Second, Letta must reform the defective electoral system. He has already secured preliminary agreement on solving the biggest problem - the need for governments to secure majorities in both houses of parliaments - by downgrading the Senate's power. This is what made forming a government after February's election so hard. But there isn't agreement yet on another defect: the ability of party leaders rather than the people to pick which individuals are chosen as MPs.
The risk is that Berlusconi's judicial problems could trigger another political explosion before Letta makes much progress. The former prime minister has only one appeal left in a tax evasion case. If he loses that appeal, scheduled for early next year, he would no longer be able to be an MP. He might then force a snap election in the hope of winning it and so provoking a constitutional crisis.
Letta might, therefore, be tempted to steer clear of any reforms that antagonize Berlusconi. But there's no point in continuing as prime minister if he reaches the point when he can't make progress in tackling Italy's deep-seated problems. That was Monti's error. Letta should have the courage to be different.
(Hugo Dixon is Editor-at-Large, Reuters News. The opinions expressed are his own.)
Editing by Sarah Bailey