Events, dear boy, events. Europeans went on holiday this year more cheerful about their economic prospects than some of them had been for years. With luck, they are reading Harry Potter on the beach, not the financial pages of their newspapers. Consumer confidence is a creature with a fragile digestion, calculated to be upset by plunging stock markets and emergency injections of liquidity by central banks. The Ode to Joy has abruptly been replaced by Noël Coward: “There are bad times just around the corner, And the outlook is absolutely vile . . .”

In the calm of a sustained global boom, it has been too easily assumed that, particularly in Germany, Europe’s return to healthy growth is reform-driven and therefore durable, rather than merely cyclical. Whether the European Central Bank’s unaccustomed activism was needed to calm financial market jitters, or was over the top and panic-inducing, the robustness of the eurozone’s vaunted recovery may now face its first serious test.

Italy, the weakest link in the euro-chain, is on course to fail that test. The Mad Hatter’s tea party that passes for Italy’s Government has blown the opportunity to get its house in better financial order while the good times lasted, demonstrating yet again that self-preservation is the only game that Italy’s venal politicians play well. That ought to concern the ECB as much as the sub-prime fallout: Italy’s profligacy is no longer only Italy’s business.

Luck attended the birth of the Prodi coalition just over a year ago. After five static years, growth had picked up along with business confidence and export orders — not least from Germany, Italy’s biggest market. Tax revenues in 2006 unexpectedly surged by € 6.5 billion, a windfall that Italy’s two most credible public figures, the Bank of Italy Governor Mario Draghi and Tommaso Padoa-Schioppa, the Economy Minister, insisted should go on trimming Italy’s monstrous public debt, currently 107 per cent of GDP. Unemployment had dropped to about 6.4 per cent (although in Italy, where 27 per cent of economic activity is “underground”, official employment statistics are pretty meaningless).

Best of all, although voters had rightly punished the outgoing Berlusconi Government for doing too little, two of its braver reforms made the Centre Left’s task easier.

The first, known as the Biagi law in honour of a reformer murdered by the Red Brigades, had liberalised the job market by easing absurdly rigid restrictions on flexible contracts. The second reform tackled Italy’s worst financial headache, a pension bill that absorbs a bankrupting 15.4 per cent of GDP and, with a rapidly ageing population, could equal all of Italy’s earned income by 2020. The Maroni law intended to hold spending steady by increasing the minimum retirement age from — wait for it — 57, to 60 in 2008 and 62 in 2014. Given that one Italian in five is over 80 and there are already only 1.5 adult children per retired parent, adjustment was urgent.

Romano “Mortadella” Prodi bores the Italians, but they were half convinced by his promises to close the gaping budget deficit, cut the tax burden on employers, and expand Italy’s backward services economy by ending restrictive practices in commerce and the professions. Boredom has now become infuriated contempt. The man and his minions are seen as interested in one thing only — power.

Prodi’s fractious nine-party “team” has been held hostage by the hard left fringe. He could have called the Communists’ bluff. They no more want fresh elections than he does. Instead he has appeased them; first, with a tax-and-spend first budget — predictably followed by demands for even higher public spending to “compensate” for stiffer taxes. So, in the five-year spending plan approved in June this year, he postponed half the spending cuts needed to put budgets in the black by 2011, the theoretical end of this do-nothing government’s term. Finally, in a vote of confidence this month, Parliament blew the tax windfall on € 6.5 billion of extra welfare spending.

Market and labour reforms have fared little better. The assault on restrictive practices has hit small fry — cab drivers, hairdressers, bakers — far harder than richer professions. The unions are chipping away at the Biagi employment law. And last month, in a craven deal with unions that froze out employers, the Maroni law was effectively gutted.

The minimum retirement age will now rise by only one year in 2008, to 58, and even by 2013 a 61-year-old will be able to retire on full pension. Workers with “strenuous” jobs, a category expanded on union insistence to assembly-line workers, bus drivers and even night shifts, can still draw pensions at 57. The estimated financial cost of this sell-out to the hard left is € 10 billion — 0.7 per cent of GDP — a third met by raising employers’ contributions on temporary contracts, and any shortfall, under a “safeguard clause”, by yet higher taxes. The cost in political credibility is far higher.

Never mind, there is always the Pope.

Prodi has publicly challenged the Vatican to back the Government’s blitz on tax evasion by exhorting Italians to “render unto Caesar”. Tax evasion is endemic, no question. Of Italy’s 40 million taxpayers, 10 million report less than € 6,000 a year, only 5 per cent admit to € 40,000 and a nugatory 0.8 per cent own up to more than € 100,000. The gap is at least € 100 billion a year, 7 per cent of GDP. But honesty would cost Italians serious money. Corporation taxes are 37 per cent, payroll taxes are crippling, personal taxation is punitively high, and the tax code is a monster. The obvious way to widen the tax base — and shrink the black economy — is to reduce and simplify taxes. The Prodi solution is 3,000 extra tax inspectors, and a new wealth tax that the seriously rich will avoid and the middle classes resent. At bottom, rotted politics makes for rotten taxpayers. Italians do not pay taxes because they despise the politicians who would spend their earnings. The Caste, an exposé of Italy’s parasitic and corrupt political class, is this summer’s runaway bestseller. It makes Harry Potter look tame.

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