After the resignation of Silvio Berlusconi, polls show that most Italians seem to be relieved by the sober competence of Mario Monti, who was invited by the president in November to form a government. As Monti noted drily to reporters earlier this year, his popularity suggests “a hidden demand for a boring government that would try to tell the truth in non-political jargon.”

Despite the new government’s initial popularity, experts on Italy and Europe caution that Monti still has his work cut out for him. His performance has earned high marks so far from Italian voters and European policymakers, but Europe’s fourth-largest economy is far from well, they say. Low tax compliance and a restrictive labor structure that keeps unemployment high are holding Italy back.

To make matters more challenging, experts from Wharton and elsewhere believe that improvement may be years away. Yet Monti, former president of Bocconi, Italy’s leading business school, doesn’t have much time: His initial mandate expires in 2013. “He faces a very difficult task, and he’s doing as well as you could expect anyone to do,” says Franklin Allen , a professor of finance at Wharton.

Still, Monti also has a few advantages. First, the problems Italy faces are less dire than those that confront Greece, Spain or Portugal. “There’s a tendency to see all the problems through the same lens of public finance, which is simply wrong,” says Iain Begg, a professor at the London School of Economics and an analyst for Chatham House, a British think tank for international affairs.

Meanwhile, investors are no doubt seeing a mixed bag when comparing Italy to the rest of southern Europe in terms of absolute debt levels. At 119% of GDP, the country’s absolute debt levels may be lower than those of Greece (160%) but higher than Spain (68%) or Portugal (106%), according to the latest IMF figures. On the plus side, the debt is still held largely by Italians, which also makes the situation less urgent than if anxious foreigners held all of Italy’s bonds. In addition, the European Central Bank “firewalls” have helped reduce market anxiety.

A Silver Lining

Mostly, however, prospects are better because Italy is a wealthier country than Greece, Spain or Portugal. Italy’s per capita GDP stands at $35,545, higher than Spain’s $31,946 and Greece’s $29,635, and significantly higher than Portugal’s $21,408, according to 2010 IMF figures.

Moreover, the budget deficit — 4% of GDP — is not too bad, Begg notes. “I think [U.S. Treasury Secretary] Timothy Geithner would kill for that.” Just as a wealthier household can sustain more debt, Italy’s debt level may not be as unsustainable as it might seem. “At that level, the debt is high but stable, because 4% of GDP means that with a little inflation and growth, it’s level-pegging,” he says.

Second, Monti may not be a politician, but he evidently learned something about politics in his years with the European Union. An economist and civil servant, Monti has extensive experience with European Union governing bodies, having spent nine years as a European commissioner in the 1990s.

From the start, Monti dealt himself a few better cards than his Greek counterpart, according to Begg. He insisted on having the power to nominate his entire 15-person cabinet, which doesn’t always happen in a parliamentary system. Across the Adriatic, Greek Prime Minister Lucas Papademos did not have the authority to name his cabinet. Instead, 50 politicians, only some of whom are allied to him, were put in place. Monti’s second savvy move had to do with his choice of finance minister. In contrast to Berlusconi, who had public feuds with his finance minister, Monti chose someone he could trust: himself.

Despite these advantages, Monti faces an uphill battle. The Italian economy appears to be improving under his care, but is hardly immune to the economic storms that assail the rest of the continent. “Italy is on the right path, but it cannot be taken for granted that everything that is in the strategy will be achieved painlessly – and that is where the principal challenges lie,” Begg says. Already, debate is heating up over Monti’s attempt to revise Article 18 of Italian labor law, which makes most workers almost impossible to fire. Since its passage in 1970, attempts to overturn these rules have been met by stiff and sometimes violent opposition: Some opponents have even been assassinated.

Monti’s non-political background may also make it hard for him to perform certain highly political tasks. Passage of the labor reforms may require considerable ability to negotiate, but in his stint as European Commissioner for Competition, he was often criticized for being inflexible in his review of proposed mergers. On the other hand, the unions seem to be in no mood to negotiate; concessions by the government seem to have been read as signs of weakness. Some union leaders have charged that Monti has blood on his hands because of several suicides that followed the imposition of austerity measures.

Europe’s common currency also complicates matters. Before the introduction of the eruo, countries in financial difficulties could scramble back to growth by devaluing their currency and attempting to make their exports more competitive. But now that the troubled southern European economies are locked into a common currency, that option no longer exists unless the country decides to leave the eurozone. And concern abounds that if some countries – such as Greece or Italy – were to leave the eurozone, it might lead to the break-up of the eurozone itself.

Structural and Political Reform

Beyond structural reforms, observers caution that political reform is needed as well. Berlusconi may be gone, but his legacy is still alive. Italy has been rocked by repeated corruption scandals in the past 20 years, and some observers say that ties between business and politicians remain too cozy. “The political system needs to be transformed, and that’s going to be a very difficult thing for Monti to achieve,” says Wharton’s Allen. Yet one measure of the degree to which the political class has been discredited, adds Begg, is that Monti seems to have more legitimacy precisely because he was not elected.

But Begg also points out that strong reform-minded political leadership has yet to emerge in Italy. “There’s clearly discontent among the voters, who were conveying the message that [they have] had enough.” The Italian electorate is hardly alone; the defeat of the Sarkozy government at the hand of Francois Hollande in France demonstrates how angry Europeans are with policies based on austerity.

Reforms are required before Italy and Europe see a revival in their fortunes, but Mauro Guillen, a professor of management at Wharton, questions whether reforms that were pushed through by a government that wasn’t directly elected will actually stick. He cautions against placing too much faith in technocrats. People assume technocrats have the solution to problems, but they often don’t. In fact, technocrats have no better track record historically than elected politicians. “It’s not the right way to initiate reform,” Guillen says.

However, the situation may not be as desperate as it seems, according to Begg. For one thing, Italians are used to politics that are chaotic by most countries’ standards. The stability of the Berlusconi era was the exception to the rule of quick turnover in parliament – there have been more than 60 governments in the post-war era. The Berlusconi administration, which remained in power for a decade, was a rare period of stability.

Moreover, Italy always has functioned mostly through the efforts of non-elected officials. “They have quite a high caliber of public administration,” Begg notes. The Central Bank and the Ministry of Finance, in particular, have some “pretty impressive people” working for them.

Finally, the economy may be more competitive than it appears: A large share of the economy is completely off government radar. In 2010, World Bank economists estimate, the informal economy, out of reach of the tax authorities, was equal to 27% of the official GDP. If they’re right, this means that instead of being 9% smaller than the United Kingdom, the true Italian economy may actually be 3% larger. That, among other factors, may allow Monti to lead Italy out of the doldrums.