WITH the European debt crisis shrouded in a cloud of uncertainty, the departure of Silvio Berlusconi, Italy’s colourful former prime minister, has been welcomed but does not quite constitute the silver lining many are hoping for.

His departure follows the addition of a new chapter to Europe’s spiralling debt saga. The latest crisis in Italy, the world’s third largest bond market, occurred when LCH Clearnet, a clearing house, raised margin calls, requiring more capital to be set aside against possible defaults, causing panicked investors to flee the market.

As with Greece, the impact of a failed economy in Italy will have devastating effects on the European Union, the global economy and the euro, and will increase the likelihood of contagion. Unlike Greece, the stakes with Italy are much higher due to its size.

Berlusconi, who governed Italy for the past decade, stubbornly clung to power through the recent global financial crisis and amid serious scandals. Even as it became clear that he would step down, some doubted his sincerity as his precondition was the approval of a package of economic reforms endorsed by European institutions.

To the relief of international investors, the Italian Senate and lower house passed the legislation, a package of austerity measures, with uncharacteristic swiftness last weekend, paving the way for Mario Monti to take his place.

Monti, who has served twice as EU commissioner in Brussels, is a prudent economist and Italy’s best shot at restoring its credibility. Though he is inarguably capable, he and ultimately the government that is elected following his interim term face a daunting task ahead.

To start with, Berlusconi has left a legacy of patronage, monopolies and cronyism that will take time and a united reformist government to dismantle. Monti, acting as a caretaker technocrat, will have to work with political parties vying for power in the next elections which may try to distance themselves from unpopular austerity measures.Monti will also inherit an economy in desperate need of structural reforms. Berlusconi resisted reform that could potentially have prevented the current crisis. Under his governance, Italy has been among the slowest-growing economies in the world over the past decade. Productivity has been abysmal and unit wage costs have soared.

At the root of these problems is Italy’s job market which protects aging workers in old, inefficient industries and leaves only temporary jobs for the youth. This has caused a mismatch in wages to productivity which has resulted in less efficient industries, thus creating an environment that is not conducive to innovation.

After years of promoting an archaic economy plagued with patronage and interference by the government, Italy sank to 87th position on the World Bank’s Ease of Doing Business list. Though the thought of small businesses — the family-owned pasta place round the corner or the small gelato store — are endearing, in reality what drives economic growth in most countries are large firms that can take advantage of economies of scale.

Though Italy has a few world renowned large companies, it does not have enough of them. Given the current business climate, this will not change unless the government creates an environment that makes it worth the investors’ while; one where monopolies and vested interests take a back seat to competition and innovation.

Not all is as bad as it seems, though; there are a few things that Monti can work with. Italy’s public debt will stabilise at 120 per cent of the GDP, which is much better than Greece which at one point was expected to increase to 190 per cent of the GDP. Italy’s overall net international debt is 24 per cent, lower than other troubled countries in Europe.

Italian households have been saving and by some estimates the country’s interest costs would rise by only one per cent next year, a manageable number. The budget deficit is also relatively low thanks to Finance Minister Giulio Tremonti, and the country came out relatively unscathed from the real estate bust that triggered the banking crisis in 2008.

Monti, if he is able to get a majority in parliament, may be able to pass effective laws that could serve as a foundation for reforming the current economy. It remains to be seen, however, whether he will be able to do this. The Northern League, a coalition partner in Berlusconi’s government, has not warmed to the idea of a technocratic government and Italy’s political parties are more divided now than ever.

In order for the euro to survive, Italy will have to succeed in its implementation of austerity measures and reforms, such as making the labour market more flexible and creating a more efficient tax collection system.

The caretaker technocrats will have to gain a majority to pass bills in a divided political landscape, while Italians will have to stomach austerity measures. The government will have to take on wealthy and powerful Italians to weed out vested interests and corruption. It will also have to break up monopolies and encourage competition and productivity.

This will all have to be done while Italy struggles with its debt crisis ($2.6tr), with the extra margin call in place, and the likelihood that rating agencies will downgrade them in the future.

Italy’s predicament might be less precarious if a strong EU could put forward a united and executable strategy to rescue the euro — which thus far has eluded them. There are also rumours that some eurozone members are considering forming an inner group with their own rules, further diminishing investor confidence in the currency.

If Italy manages to get its act together — and that is a very big if — the eurozone will gain some breathing room. Given the mess left by Berlusconi’s legacy and the inability of eurozone members to agree on a remedy, it looks as though things will get a lot worse before they get better.

For countries such as Italy and Greece, investors need to be patient and give the new administrations a chance. Unfortunately, patience is wearing thin and with the real threat of contagion, the whole world is waiting for the other shoe to drop.

The writer is a development economist and is currently working as a freelance journalist in New York.