On a cold, foggy day in Milan last winter, 10 plainclothes carabini-eri barged in on Mario Chiesa, a political hack who headed the city's biggest public charity for the elderly. It uas a sting designed to nab Chiesa just as he was pocketing a $5,000 kickback from a businessman. That evening, Paolo Pillitteri, a Socialist Party politician in Milan, noted the arrest in his personal diary: "I don't think there will be a domino effect."

Those words spoken by Pillitteri, a former Milan mayor now facing multiple corruption charges, will probably go down as one of the bigger misjudgments of the year. That first arrest 12 months ago, in what became known as Operation Clean Hands, has snowballed into the biggest criminal investigation in modern Italy. Scores of politicians are under investigation for corruption, including 34 members of Parliament and three Cabinet ministers.It's not only politicians who are under fire. Also implicated are more than 200 businessmen, from officials of state-controlled ENI, Europe's No. 2 energy group, to dozens of top managers at blue-chip companies that form the very heart of Italian capitalism--auto giant Fiat, chemical group Montedison, the Ferruzzi agricultural empire, and others. Judges are warning that this may be only the beginning. The companies declined to comment.

SYMBOLIC END. The outlines of a new Italy are uncertain at best. But beyond the drama of the nightly television news, now watched by millions of Italians with the same fascination and anger with which Americans once followed Watergate, a profound transformation is taking place. The tight collusion between politics and business that has set Italy apart from its European neighbors for almost four decades looks as if it has been shattered permanently. "An entire system, a Mafia-style system, is ending, and it is ending rapidly," says Luciano Benetton, the managing director of $1.6 billion Benetton fashion group. "It's a system in which you had to pay the political parties to get work."

The symbolic end of that system came on Feb. 11, when former Prime Minister Bettino Craxi was forced to step down as Socialist Party chief in the face of more than 50 charges of alleged corruption and abuse of office. The autocratic politician had been at the epicenter of Italian political life for some 20 years. He denies any personal wrongdoing. Gianni Di Michelis, former Foreign Minister and Socialist Party official, is also suspected of kickback scheming. He also denies any wrongdoing. Now, dozens of businessmen are testifying how party aides negotiated multimillion-dollar kickbacks on contracts from street cleaning to nuclear power plant construction.

Craxi personified the immense power wielded by Italian politicians over almost every aspect of the postwar Italian economy. The Italian government, after all, controls a greater chunk of the economy--more than 50% of output--than any other big Western industrial power. In Rome's web are most of commercial banking, steel, telecommunications, and energy--even ice-cream plants, groceries, and vineyards.

For Italian political parties, such activities were giant spoils machines. Much of the private sector--from Fiat, the country's largest industrial group, to small construction outfits--had no choice but to come to terms with what Italians call la partitocrazia, or rule by the political parties. Even though business groups would regularly criticize government policy, many were in collusion with politicians to cut deals. "It's all been pure theater when Italian companies attack the government," says Paolo Bernasconi, a leading Swiss criminal lawyer who is an expert on Italian money-laundering in Switzerland.

COSTLY GAME. The system that kept the national machinery oiled also cost it dearly. Indirectly, of course, Italy's weakened moral climate has helped to cultivate organized crime. But the direct tab for a country already burdened with huge public deficits is enormous, too. Just running Italy's parties costs about $1 billion a year. Actual corruption adds vastly more. A Turin-based think tank estimates that kickbacks since 1980 have added as much as $73 billion to Italy's enormous public debt.

Nothing better illustrates how business Italian style has worked than recent revelations about ENEL, the state-owned national electricity authority. The second-largest utility in Europe, Rome-based ENEL is also the largest single purchaser of natural gas in the world. It employs 107,000 people and wields a juicy $6 billion-a-year annual capital investment budget.

It is also, as Operation Clean Hands is now alleging, a deep pit of corruption. Testimony of Valerio Bitetto, a Milanese Socialist Party organizer who was a leading figure in ENEL from 1980 to 1992, alleges that as a company board member, he worked out alleged kickback schemes with some of the biggest engineering groups in Europe on billions of dollars' worth of power-station construction. State-owned Ansaldo, Fiat, Belleli--a prominent Mantua-based contractor--and Franco Tosi, now a unit of Swiss-Swedish group ABB Asea Brown Boveri (Holding) Ltd., are all alleged to have paid out millions of dollarsto Bitetto and officials from other parties.Fiat's engineering managing director confessed to making kickback payments. The other companies declined to comment. According to police records, the kickbacks were often paid by foreign subsidiaries of the companies concerned to confuse the money trail, and proceeds allegedly went into numbered bank accounts held abroad by party officials (chart). The testimony of Bitetto and other ENEL officials has now led to multiple arrests.

It's a similar story with dozens of big public-works projects. Roman and Milanese magistrates now believe that almost all the contracts comprising the $11 billion in Italian road construction between 1989 and 1992 included kickbacks of 7% to 8%.

Why has Italy Inc.'s dirty secret emerged now? There have been myriad scandals in Italy before Operation Clean Hands. This time, things are different. During the four decades of the cold war, Italy, with its homegrown Communist Party the largest in the West, was on the ideological front line. A majority of Italian voters supported a coalition of parties led by the anti-Communist Christian Democrats and Socialists. Now, with no communist threat, voters are deserting the traditional corruption-ridden parties in droves.

Paradoxically, the decapitation of Italy's traditional postwar leaders has allowed the eight-month-old government of law professor Giuliano Amato to pass some of the most far-reaching legislation in decades. Without interference from the parties, Amato is privatizing huge industrial and financial properties. His deficit-slashing budget is one of the toughest ever passed.

The next step will be the touchiest. Amato is a kind of Gorbachev figure, an innovator still attached to the old system. The Columbia University-trained Prime Minister is a member, after all, of the discredited Socialist Party and has been a key Craxi aide for a decade. Most agree Rome will now try to modernize Italy's outmoded electoral laws and then face voters in new elections in the next few months.

HARSH LESSONS. Meanwhile, the revelations about the extent mf corruption will no doubt harm the country's image. Fiat, for example, is already fighting to resist increasingly tough competition from rival auto makers. Its future now depends on a high-stakes, $27 billion investment on new models due to roll off assembly lines by yearend. Now, says one senior Fiat executive in Turin: "I'm really worried by the fact that countries and products are usually identified. If your country is corrupt, then somehow your products are, too."

But cleaning up the mess will ultimately make Italy a more open, and probably tougher, international competitor. That's why many in the Italian industrial world applaud the spreading investigation. True, it's a difficult time. Because of the political paralysis caused by Clean Hands, government spending has all but dried up, just as the worst recession in 20 years batters the country. Industrial unemployment has slumped by more than 6% in the past year, while consumption is falling drastically. And the political transition barely under way promises to be bruising. "But whatever the cost," says Stefano Micossi, a leading economist, "these investigations must go on." Italy can only benefit.

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