Wednesday, October 07, 2015

Beware cheap oil!

Europe’s economies welcome the collapse of oil prices. But serious foreign policy problems await if oil remains cheap.

When oil prices go up, governments of oil-importing countries worry. But when oil prices go down, there is a sigh of relief. Low oil prices give European economies a boost, but in terms of foreign and security policy, Europe’s neighbourhood faces more instability as oil-producing countries struggle with a fiscal crunch.

Between 2005 and 2014 there was an extended period of high oil prices. From 2011 to 2014, Brent oil averaged $107 per barrel. But in mid-2014 prices plummeted. Oversupply – booming US shale oil production in combination with unchanged levels of production in OPEC countries – met falling demand, particularly from a slowing Chinese economy. Supply disruptions, sanctions and conflicts – which removed more than 3 million barrels per day from the market in 2015 – had little effect on the downward trend in oil prices. On October 6, Brent oil was trading at around $52 per barrel.

Source: IMF, EIA

The period of high oil prices had negative consequences. It led to a massive transfer of wealth from Western economies to oil producing ones, which weighed on European recoveries and filled the state coffers of (mostly) less democratic states. Defence spending, repression and corruption increased in the Middle East and Russia. Since oil products are a key ingredient in fertilisers, high oil prices contributed to soaring food prices, putting extra strain on import-dependent emerging economies, like Egypt. This was one of the factors that led to the 2011 Arab Spring uprisings. Pirates and militant groups in the Gulf of Guinea specialised in stealing crude oil from pipelines and tankers.

Now, developments in both supply and demand are likely to depress prices for some time, perhaps until the end of the decade. The markets are bearish about prospects in the years ahead: oil futures contracts for early 2020 currently trade at less than 60 US dollars ($). On the supply side, American shale or ‘tight’ oil production can respond to price changes more quickly than conventional production can. Rystad Energy, a Norwegian energy consultancy, estimates that on average US shale oil becomes economic to produce at $58 per barrel; so increased US supply could slow global price rises above that level. In addition, in mid-2016 sanctions on Iran’s oil sector will end; as it attempts to win back market share it could soon add one million barrels per day to global output, increasing the world’s excess capacity.

On the demand side, China is slowly moving away from energy-intensive heavy manufacturing towards domestic and urban services, and its growth rates will inevitably fall from stellar to merely robust. The recovery in the eurozone is shaky, the IMF has corrected its global growth forecast downwards and overall energy efficiency gains mean the world confronts a depressed demand for oil, for now.

So, is the current price decline a good thing? Unfortunately a sustained period of low oil prices will create its own foreign and security policy problems. Low oil prices hurt the bottom line of oil-exporting countries. The IMF expects the export earnings of the Gulf states this year to decline by $287 billion due to the price collapse. Since 2011 governments across the Middle East have increased social spending to keep their populations happy in the wake of the Arab Spring uprisings. They may now struggle to maintain that spending.

In many oil-exporting states, those who control the oil wealth control most of the economy. If expected oil proceeds decrease in countries where ethnic, tribal or religious communities compete for political influence – as in many countries in the Middle East – this could become a cocktail for instability and conflict.  Jihadist groups in the region may find it easier to recruit disgruntled youth when economic problems rise. The risk of social unrest may lead governments to increase repression, resulting in human rights violations, terrorism and migratory pressures.

The chart below shows the depth of a country’s state coffers and the oil price at which oil-exporters can balance their books (called the ‘fiscal breakeven price’). The size of the bubble reflects the population that needs to be kept happy. An oil-exporter would prefer to be in the lower right-hand corner: able to balance the books with a low oil price, and with substantial government reserves to withstand years of low oil prices. Countries in the upper left-hand corner have breakeven prices in excess of the current oil price, and small financial buffers.

Source: IMF, Deutsche Bank, World Bank

Only Kuwait still earns money at current prices. Saudi Arabia can weather low oil prices for a long time due to its massive reserves, but others are not so fortunate. Bahrain has a high breakeven price, limited government reserves, large debts and a high rate of oil and natural gas extraction; only about ten years’ worth, at current rates. Under these difficult economic conditions, tensions between the ruling Sunni minority and the Shi’a majority could boil over, as they did during the Arab Spring. Despite its small financial buffer, Iraq sits on massive oil wealth and has a relatively low fiscal breakeven price. This suggests that if it is able to attract investment into its oil sector, it could prosper despite low oil prices. But the fight against the Islamic State terror group and Baghdad’s inability to reach a revenue-sharing agreement with the Kurds mean this may be difficult.
#SaudiArabia can weather low #oil prices due to its reserves - others however are not so fortunate
Outside the Middle East, crude oil, natural gas and oil products make up 90 per cent of Nigeria’s exports. It has limited reserves, a high breakeven price and a large and growing population that demands improved social services and economic opportunity. Groups like Boko Haram could exploit such grievances.

The Russian economy is heavily dependent on oil as Andrey Movchan from Carnegie’s Moscow centre explains. The chart above suggests that it has substantial reserves to deal with low oil prices, but Ian Bond and Christian Odendahl have argued that Russia’s state coffers may not be as full as the official statistics suggest. Russia has responded to low oil prices by pumping record quantities of crude, but Western sanctions against its financial and oil sectors as a result of its intervention in Ukraine are making it hard for Russia to replace depleted oil fields. If low oil prices persist, President Vladimir Putin will have to choose between maintaining social spending and pushing on with his expensive programme of defence modernisation. Although Russia’s vulnerability to oil price fluctuations should convince him to diversify the Russian economy, Putin may prefer to distract public opinion with military adventures abroad. It is worth remembering that Iraq’s president Saddam Hussein invaded neighbouring Kuwait in 1990 during a period of low oil prices.
If low #oil prices persist, #Putin faces a choice between social spending & #defence modernisation
Metal prices have fallen along with the oil price, and so developing countries that are dependent on mineral extraction face similar difficulties: copper accounts for 73 per cent of Zambia’s exports; 60 per cent of Mauritania’s exports comprise iron ore and copper; 90 per cent of the Democratic Republic of Congo’s exports consist of copper, cobalt and oil. The longer the price slump lasts, the more weak governments in these countries – many of which have a history of civil strife – will struggle.

The role of the US in both global oil markets and (potentially) Middle Eastern politics will change. American shale oil will continue to put downward pressure on prices. It makes the United States, not Saudi Arabia, the global swing-producer; and it challenges the cohesion of the OPEC oil cartel, as maintaining market share rather than high prices becomes the overriding concern for OPEC’s members.

In Europe, the impact of low oil price is mixed. The economic effects are clearly positive: low oil prices boost household incomes and reduce production costs. The impact of the Chinese slowdown, a negative for the European economy, is partially off-set by the subsequent fall in the oil price. But persistently low prices may complicate the EU’s efforts to reduce its dependence on Russian gas by delaying investment and production in some of Europe’s most important gas and oil suppliers, including Algeria and Azerbaijan. The Shah Deniz-2 gas project in the Caspian, bringing gas from Azerbaijan to Europe and a critical element in the EU’s efforts to increase its supply of non-Russian gas, loses money at current prices.

From a climate perspective, there is both good and bad news. The exploitation of high-cost energy sources will be delayed, including off-shore Arctic resources, complex ultra-deepwater fields and Canadian tar sands. Perhaps $200 billion in capital expenditures, mostly involving deepwater and oil sands projects, has been deferred due to the oil price bust, say energy consultants at WoodMackenzie. (Some Arctic projects and oil sands production could become economic again at $70 per barrel.) The controversial development of European shale resources might be unnecessary (and uneconomic) with the current oil and gas glut.

In the longer term, low oil prices should create an incentive for oil producers to modernise their economies to reduce their dependence on hydrocarbon exports – if they can afford the necessary investment and show the political will. If so, Europe should be prepared to assist them with the transition.

But low oil prices also challenge European climate policy, which rested on the assumption that oil prices would continue to rise, gradually making renewables and other low-carbon technologies more attractive. Low oil prices are linked to a drop in the carbon price. Meanwhile, coal has also become cheaper. Robust regulation rather than market forces will thus be needed to achieve Europe’s climate objectives. This also has consequences for the international climate conference in Paris in December. In a low oil-price environment, reaching binding decisions on climate targets becomes much harder. Though the US and China may push for an agreement in Paris, emerging economies like India and Turkey – which experience soaring energy demand  –  may be more reluctant to commit to costly emissions-reductions strategies.

Finally, and most urgently for European policy-makers, the arc of instability around Europe’s southern and eastern periphery, full of oil-exporting countries, will get more unstable if the oil slump lasts. This could lead to more regional conflict, an increased risk of terrorism, new refugee flows to Europe and more stress on EU countries struggling to cope with mass migration. European governments should consider this when debating spending priorities: a world of low oil prices will demand investment in development and humanitarian aid, security and in capable military forces.
The arc of instability around #Europe may get more unstable if cheap #oil lasts
Oil prices that are neither too high nor too low are good from a foreign policy perspective. But because the oil market tends to overshoot and undershoot, a ‘goldilocks’ oil price will remain elusive. For now, Europe should be ready for its neighbourhood to stay turbulent as long as cheap oil reigns.

Rem Korteweg is a senior research fellow at the Centre for European Reform.

Tuesday, September 29, 2015

With or without you: Will Catalonia be Europe’s next crisis?

Catalonia’s elections have caused more problems than they have solved. It is time for both Spain and Catalonia to start a national dialogue to reform Spain’s model of regional government. Otherwise, Catalonia will become Europe’s next crisis.

Mariano Rajoy, Spain’s conservative prime minister, comes from Galicia, on the north-western coast. By reputation, Galicians are so vague and elusive that – according to a Spanish joke – if you meet one on a staircase you cannot tell whether he is going up or down. Rajoy’s handling of the Catalonian problem has epitomised this uncertainty. His belief that the problem would simply disappear if he ignored it for long enough has led to a pseudo referendum that broke more things than it fixed. It is now time for him to face an uncomfortable truth; he should start a dialogue on Spain’s model of regional government.

The results of Sunday’s elections (with pro-independence parties winning the most seats, but non-secessionist ones having the most votes) have divided Catalonia’s public opinion and made the region virtually ungovernable. In the run up to the election, a heated debate, with threats and ultimatums from both sides, has increased the deep political divisions in Spanish society. Politicians in both camps have sadly succeeded in convincing Europe that Spain and Catalonia are mutually exclusive concepts. The reality is much more complex.

Support for Catalonia’s independence has surged in recent times. For the last four years, each September 11th (which marks the ‘Diada’, Catalonia’s ‘national’ day) has seen millions of Catalonians take to the streets to support independence. And each time, Artur Mas, Catalonia’s regional president, has called on the Spanish government to allow the region to hold a referendum. The response of Madrid has always been the same: the Spanish constitution protects the country’s territorial integrity and, as such, forbids such referendums. The 1978 constitution, agreed during Spain’s transition to democracy, represents in the eyes of many Spaniards the country’s success in reaching a political consensus after a bloody civil war which tore the country apart. This explains why mainstream political parties are so attached to it, and regard any separatist claim as an attack on Spain’s sovereign values.

After 1.8 million Catalonians voted in favour of independence in a non-binding consultation held on November 9th, 2014, Mas decided to dissolve the Catalonian parliament and call for early elections. Now he is facing prosecution before the Spanish courts for organising the consultation. After dissolving the parliament, Mas declared that given Rajoy’s refusal to grant Catalonians the right to hold a referendum, the regional elections should be interpreted as a vote on independence. To ensure a clear link between the elections and a potential declaration of independence, most pro-independence parties rallied under the same umbrella: ‘Junts pel Si’ (‘Together for a Yes’).

There are very different political forces in Junts pel Si: on the one hand, Catalonia’s republican party (Republican Left of Catalonia-ERC), known for its radical pro-independence stance and its leftist, anti-monarchical policies; on the other, Mas’ Convergència Democràtica de Catalunya, a centre-right liberal party, which ruled Catalonia together with the non-separatist Unió Democràtica de Catalunya until they parted ways at the beginning of 2015 because of their diverging views on independence. Junts pel Si also represents a number of independent associations and individuals, all pro-independence. Junts pel Si is not a cohesive party and has no electoral programme, besides promising to withdraw Catalonia from Spain. For that, they have given themselves a deadline: 18 months to establish a roadmap, culminating in a declaration of independence.

Mas’ attempt to present these elections as a referendum led to the creation of two main political blocs: on one side is the pro-independence camp, with Junts pel Si and the so-called Candidacy for Popular Unity (CUP – a radical, left-wing populist party); on the other, the regional branches of Spain’s mainstream parties: the conservative PP; the socialist PSC; the liberal Ciudadanos; and, perhaps surprisingly, Podemos, Spain’s new left party – which defends Catalonia’s right to decide, but opposes a referendum under the current constitution.

Junts pel Si won the elections, with 62 seats out of 135, but nine fewer than the combined total of Convergència and ERC won in 2012. Ciudadanos came second, with 25 seats. The socialists obtained 16 seats, and both PP and Podemos, 11. CUP won 10 seats (see Chart 1).

Chart 1: Pro-independence parties won the most seats, but did not reach 50 per cent of the votes

If these were regular elections, seats would be everything that mattered. But they are not. Mas and his partners did not fight the elections to win seats. They fought them to gain legitimacy to pursue and eventually declare independence. For that, they needed to win the majority of the votes, regardless of the seats. And they did not achieve that: together, the pro-independence camp (CUP and Junts pel Si) got less than half of the vote (47.8 per cent).

Mas is in a difficult position – and so is Catalonia. He presented Catalonians with a false choice: vote for me, and you will be voting for independence; vote for the others, and Catalonia’s voice will not be heard in Spain – or Europe. Whatever the outcome, the election would not have given Mas a legal mandate to withdraw Catalonia from Spain. But since he did not get 50 per cent of the votes, he has no moral mandate to push for independence, either.
The election would not have given #Mas a legal mandate to withdraw #Catalonia from #Spain
The pro-independence camp is now splintering. The CUP has announced that it will not back Mas, thereby depriving him of the majority he needs to form a government. It is not clear whether the ERC, his partner in Junts pel Si, will support him either. These splits among the supporters of independence could make Catalonia ungovernable, leading to new elections, the fourth in five years.

Spain as a whole is now on the brink of a constitutional crisis. And this is everybody’s fault. The government should understand that almost half of Catalonians want to revisit the region’s relationship with Spain. Madrid should be open to a constructive and comprehensive dialogue that includes not only Catalonia, but also the other Spanish regions. As much as Spaniards love their hard-fought constitution, it is time to change it.
#Spain as a whole is now on the brink of a constitutional crisis: and this is everybody's fault
The constitution is based on the asymmetric devolution of competences: regions such as Catalonia, the Basque Country or Navarra have more powers devolved to them than others such as Extremadura, Murcia and Asturias. The asymmetry creates resentments, and if the government tries to deal with the Catalan problem on its own, potentially increasing the differences between different regions, it risks making the tensions between the central government and other regions still worse. Spain is a country of strong regional identities, and most Spanish regions have separatist movements of some sort. The government’s aim should be to reform Spain’s outdated model of regional government, including rethinking the role of the Senate. As in other federal or quasi-federal countries Spain’s upper chamber was designed to represent the regions in the law-making process. But the constitution did not give it enough competences to play this role effectively. So the Spanish Senate has become a virtually defunct institution, and regional representatives have to channel their claims through other fora – not least the Congress, Spanish lower chamber. This accentuates regional divergences and exacerbates secessionism; as in many cases, the country’s political debate falls hostage to regional quarrels that do not find their place elsewhere. If Spain reformed its Senate to make it a fully-fledged chamber of regional representation, some of these issues could be resolved.

Catalonia’s pro-independence parties should end their confrontational rhetoric. They should stop picturing Catalonia as the victim of the Spanish central government, whose only real option is to leave. Pro-independence parties should start by engaging in a sober public debate about Catalonia’s relationship with Spain and Spain’s approach to its autonomous regions, based on facts, not on myths and emotions. Otherwise, the independents will fail to impress Madrid but also their European partners. As John Kerr warned before the Scottish referendum in 2014, the road to the EU for a seceded region would be long and painful. If Catalonia was to leave Spain, it would de facto leave the EU. There is currently no legal possibility for enjoying the rights attached to EU citizenship without having the citizenship of a member-state. Catalonia would then need to re-apply to the EU, and would need the support of all member-states. This would create an unprecedented constitutional challenge for the EU. Currently, Europe is dealing with its fair share of problems. If Catalonia wants its international partners to take its claims seriously, it needs to rethink its hostile strategy and be willing to be part of a more inclusive debate on Spain’s regional configuration. Otherwise Catalonia may indeed become Europe’s next crisis.

Camino Mortera-Martinez is a research fellow and Brussels representative at the Centre for European Reform.

The insoluble Syrian problem: Only wrong answers?

Syria is the origin of many of Europe’s current security problems. Four years after the war there started, the West has no strategy for ending it; but neither does anyone else, including Russia.

It is understandable that Western leaders who have failed to end the war in Syria over the last four years should now be clutching at straws. They still need to clutch at the right straws, however. There are more ways to make things worse in Syria (and neighbouring countries) than to make them better. The EU needs to re-examine what it is doing, and have achievable objectives rather than lofty aspirations; and it should understand that all the other players in the conflict have their own objectives, most of which are incompatible with the West's.

As world heads of government meet in New York for the UN General Assembly’s annual session, Europe's refugee crisis has given the EU a new incentive to search for peace in Syria. Though British prime minister David Cameron was wrong to imply recently that the EU should stop taking in Syrian refugees and instead wait for a peace deal, he is right to think that the flood of refugees from the region cannot be stemmed unless the conflict in Syria ends. The problem is that neither he nor anyone else has a plan for that.

In March 2015 the EU's Foreign Affairs Council endorsed 'Elements for an EU regional Strategy for Syria and Iraq as well as the Daesh  threat'. (Daesh is the Arabic abbreviation for the so-called ‘Islamic State’ (IS) terror group). The overall objectives of the strategy were "to counter the threat posed by Daesh and other terrorist groups to regional and international stability, and simultaneously to create the conditions for an inclusive political transition in Syria and Iraq as well as in refugee-hosting countries in the region, while alleviating the human suffering caused by the ongoing violence and displacement".

Taking these three points in turn, the West and its regional allies have been conducting an air campaign against Daesh for more than a year now. While there have been some successes (Kurdish groups drove them out of Kobane, near the Turkish border, with the help of coalition airstrikes), Daesh has also advanced in some areas, taking the Iraqi city of Ramadi and the Syrian city of Palmyra. Local forces cannot defeat them decisively without help.

The chaos that followed Western interventions in Iraq and Libya has made the British and American governments cautious about stepping up their involvement in the Syrian conflict. But without those two countries, it is inconceivable that any Western-led coalition would send big enough forces for long enough to destroy Daesh militarily and then to create a stable framework for political progress. The EU therefore needs to set itself more realistic goals for combating Daesh.

One area to focus on is limiting the flow of foreign fighters to Daesh and al Qaeda affiliates such as Jabhat al-Nusra. A UN expert panel suggested in March 2015 that in total there were more than 20,000 foreign fighters in Syria and Iraq. Apart from stepping up intelligence and border co-operation in Europe to prevent Europeans joining jihadist fighters, the EU should do more with source and transit countries. The International Centre for the Study of Radicalisation and Political Violence at King's College London assessed in January 2015 that between 3,800 and 7,000 of the foreign fighters came from three countries: Russia, Saudi Arabia and Tunisia. In addition, the British government says that thousands of foreign fighters have used Turkey as a transit route for joining jihadist groups.

The question is whether the EU can help or persuade any of these countries to stop the flow. Research by the Russian investigative newspaper Novaya Gazeta strongly suggests that the FSB (Russian security service) created a 'green channel' to enable jihadists to leave areas in Russia where they were fighting the Russian state and to travel instead to Syria, presumably on the basis that they were less of a threat to Russia as long as they were fighting (and dying) in Syria.

Saudi Arabia has cracked down on the Daesh threat within the kingdom, but its own religious ideology and the economic and social pressures caused by low oil prices (including youth unemployment of almost 30 per cent) suggest that it will remain a source of willing ‘martyrs’ in Syria. Saudi individuals also continue to finance various jihadi groups in Syria and Iraq, including Daesh. The West has long been reluctant to criticise Saudi Arabia’s export of wahhabist fundamentalism, but it needs to make clear that Western support for Riyadh cannot be unconditional: the Saudis have to do a better job of cutting off the human and financial jihadi pipeline to Syria and Iraq.

Tunisia's democratic government may be a more promising partner. The EU has started a dialogue with Tunisia on security and counter-terrorism, and has agreed to help the government develop an anti-radicalisation strategy which would prevent the recruitment and manage the return of foreign fighters. Work on this strategy should be pushed forward urgently, and the EU should then commit funds and personnel to support implementation: reducing radicalisation in Tunisia would address both the terrorist threat to European interests in the country, and the role of Tunisian jihadists elsewhere.

After initially waving anyone willing to fight against Assad through the Turkish border, Turkey's president Recep Tayyip Erdoğan has recently been doing more to control the border. Turkey and the EU should have a shared interest in ensuring that Daesh cannot use Turkish territory to smuggle in weapons and fighters, or to smuggle out oil from Iraq and Syria to fund its 'caliphate'. Turkey has long lobbied for a ‘safe zone’ and a no-fly area on the Syrian side of the border, to be maintained by Western forces. Turkish prime minister Ahmet Davutoğlu repeated the message in a letter to EU leaders before the EU's emergency summit on the refugee crisis, on September 23rd. A safe zone is an unrealistic goal as long as Europeans – and Americans – are unwilling to fly air defence missions in Syrian airspace or put forces on the ground to defend one; but the EU could offer Turkey other forms of assistance with border control.

Clearly, Europe has failed to create "the conditions for an inclusive political transition in Syria and Iraq as well as in refugee-hosting countries in the region". The EU has to decide how President Bashar al Assad fits into any transition. His regime has been responsible for far more deaths and displacement than any of its opponents, including Daesh. In October 2011 the EU Foreign Affairs Council stated that Assad "must step aside to allow a political transition to take place". But Europe is now wavering: German chancellor Angela Merkel thinks Assad should be included in peace talks; David Cameron thinks Assad could have a role in a transitional government, but should then step down. As long as the West lacks the will to force Assad from power, however, he will have a seat at any negotiating table, just as war criminals like Slobodan Milosevic were at the Dayton peace conference which ended the Bosnian war; and his fate will depend on the outcome of the negotiations.
If West can’t force #Assad out, he’ll have a seat at the negotiating table like #Milosevic at Dayton
With or without Assad, political progress (as the March 2015 EU strategy recognised) is "heavily dependent...on the willingness of national and regional players to act in accordance with the stated objectives". Unfortunately, none of the influential players share the EU's objectives. The Syrian government is not interested in political transition, and nor are its backers in Tehran and Moscow. Iran and Saudi Arabia seem happy to carry on fighting a proxy war in Syria and Iraq whatever the cost to the local populations. Neither Daesh nor Jabhat al-Nusra are interested in inclusivity – both are Sunni sectarian organisations. For the Turkish government, weakening Kurdish forces for internal Turkish reasons is more important than helping them to defeat Daesh in northern Iraq and Syria.

Russian president Vladimir Putin is not an honest broker in the conflict. Assad and Putin are spinning a seductive tale in which they and the West share an interest in defeating terrorism in Syria, so all well-intentioned countries should now be on the same side: this was the message of Putin’s speech to the UN General Assembly on September 28th. In reality, Assad played an important role in strengthening Islamist radicals at the expense of the moderate opposition, and IHS Janes showed in December 2014 that the Syrian armed forces and Daesh fought other rebel groups more often than they fought each other. The Syrian government and Daesh have even worked together on oil sales, according to the EU.

Putin himself has two aims: first, he wants to keep Assad in power, regardless of how many more Syrians die in the process, thereby keeping Russia’s bridgehead in the Middle East and frustrating (as he sees it) an American plot against his ally. German foreign minister Frank-Walter Steinmeier could not have been more wrong, therefore, when he "strongly welcomed...the growing military engagement of Russia in the region": the most likely result of Russia's intervention will be more fighting and an even greater flow of refugees to Europe. The Russian military will solve neither Syria's problems nor the West's.
The #Russian military will solve neither #Syria's problems nor the West's
Second, Putin wants to use Russia’s supposed help in the fight against terrorism to persuade the West to drop its Ukraine-related sanctions against Moscow. The West should not fall for this ploy: if Putin wants sanctions lifted, he needs to get out of Crimea and stop interfering in eastern Ukraine. Ukraine should not be sacrificed for the promise of Russian support in Syria.

If progress towards a political solution remains out of reach, that leaves the EU's final objective, "alleviating the human suffering caused by the ongoing violence and displacement". This is the objective most directly relevant to tackling the refugee crisis; it is the area in which regional players are least likely to try to obstruct European action; and it is the problem which a big injection of EU (and other countries’) assistance would do most to address.

UN agencies are running out of money to support refugees in camps in Jordan, Lebanon and Turkey. And the camps themselves are not a long-term solution to a long-term problem. Given the bleak prospects for a political settlement, both the West and the countries of the Middle East need to do more than simply accommodate and feed these millions of people; they need to provide them with sustainable livelihoods, education and other tools to ensure that they do not become permanently marginalised minorities. Resettling larger numbers of Syrian refugees in the prosperous West rather than in fragile states like Jordan and Lebanon will have to be part of the solution.
Peace won’t come to #Syria due to #Russia fighting but because combatants are dead or tired of war
It is depressing to admit that after four and a half years of war and 250,000 deaths, there is no path to peace in sight. Whatever Putin said in New York, peace will not come to Syria because Russia has joined the fight, or because the rest of the world has given up trying to remove Assad; it will come when all the combatants are dead or tired of war. Meanwhile, if Europe is unwilling to bribe or coerce the parties to the negotiating table, its best course is to concentrate on helping their victims.

Ian Bond is director of foreign policy at the Centre for European Reform.

Monday, September 21, 2015

Eastern mess: The EU’s partners need attention

Georgia, Moldova and Ukraine signed EU association agreements in 2014, but reforms are now stalling. The EU needs to push the three governments to do more.

Europe’s southern neighbourhood is in such a state of chaos, with civil war in Syria and anarchy in Libya driving migrants and refugees onto European shores, that few EU leaders are paying attention to the Eastern neighbourhood. But Europe cannot ignore the challenges and opportunities there. There are limits to what it can do with Armenia, Belarus and Azerbaijan: it should encourage improved relations with the first two; and do its best to respond to repression and corruption in the third. But its priority should be to re-energise reform processes in Georgia, Moldova and Ukraine, in alliance with populations desperate for better governance and an end to crony capitalism.

In Armenia, progress in relations with the EU stalled in 2013 when Moscow leant on Yerevan to join the Russian-led Eurasian Economic Union rather than signing an association agreement with the EU. Since then, however, the EU and Armenia have started negotiating a new deal, designed to preserve as much of the draft association agreement as possible. Armenia depends on Russia for its security, but the EU should help it to keep what freedom of manoeuvre it can in foreign policy and trade relations.

In Belarus, President Aleksandr Lukashenko will go through the formality of being re-elected in rigged elections on October 11th. In the past, the EU would probably have responded with another round of sanctions, but Lukashenko has been on his best behaviour, releasing all Belarus’s political prisoners; and he has played the international statesman, hosting talks on the war in Ukraine. He wants to show Russian president Vladimir Putin that Belarus has European as well as Eurasian options. The EU should respond positively, though without illusions: Lukashenko has a long history of hedging his bets between Moscow and Brussels.

Belarus is no longer ‘Europe’s last dictatorship’. Azerbaijan under President Ilham Aliyev is the unquestioned champion now, locking up journalists and human rights activists and accusing the West of using a ‘fifth column’ to destabilise the country. Azerbaijan poses a dilemma: on the one hand, it is a crucial element in Europe’s strategy of energy diversification; on the other, it is an increasingly paranoid and corrupt dictatorship. The EU is a major purchaser of Azerbaijan’s oil and gas, which ought to give it some leverage. Russia, however, has its own levers: it can offer Azerbaijan more support in its conflict with Armenia (which has occupied almost 14 per cent of Azerbaijan’s territory since their 1988-94 war); and it will not raise inconvenient human rights issues. Europe is likely to continue an awkwardly balanced policy of buying Baku’s oil and gas while doing the bare minimum to support Azerbaijan’s battered civil society.

The credibility of the EU's policy in Eastern Europe, however, depends ultimately on the progress of reforms in Georgia, Moldova and Ukraine, the countries that claim to want to integrate more closely with the EU.

Charles Grant has recently set out the obstacles to Ukraine’s transformation. Progress in Ukraine was bound to be slower than people hoped, even without Russia’s meddling. The authorities could have used the war to justify more radical reforms, while blaming Russia for the associated pain. Instead, the unpopular coalition government is now fraying as different factions try to blame each other for setbacks. Reformist MPs (including from President Petro Poroshenko’s party) are frustrated, and worry that the oligarchs are digging in to defend Ukraine’s corrupt old system. The recruitment of new police forces is cutting the level of petty graft; but the new anti-corruption bureau is moving at a snail’s pace in the fight against high-level corruption.

Georgia’s parliamentary elections are not due until October 2016, but the political situation is already tense. Prime Minister Irakli Garibashvili told a recent international conference that the association agreement with the EU was a “masterplan for Georgia’s modernisation”, but President Giorgi Margvelashvili warned the same audience that a growing number of people opposed Georgia’s pro-Western course. The failure of the EU and NATO to offer Georgia a firm commitment to membership supports Russia's argument that Georgia would do better to accept its place in Moscow’s orbit than pursue the mirage of Western integration.

Behind the scenes, oligarch and former prime minister Bidzina Ivanishvili seems to influence every political decision in Georgia. His rhetoric is pro-Western, but many local commentators fear that his major financial interests in Russia affect his real views. The ‘Georgian Dream’ coalition which he led to power in 2012 is losing support, and there are hints that he is putting together a more pro-Moscow coalition for the next elections, built around conservative and religious groups; that way, even if ‘Georgian Dream’ lost power, Ivanishvili could retain influence. The EU and the US worry about the erosion of media freedom in Georgia, and prosecution of Ivanishvili’s political enemies, particularly former president Mikheil Saakashvili (now the governor of Odessa in Ukraine).

Meanwhile Moldova is in chaos. The country has had four prime ministers so far this year. Thousands of protesters have been on the streets of the capital, Chișinău, following a banking fraud which led to the collapse of three banks and a government bail-out which has cost Moldova $1 billion, about 16 per cent of its GDP. The pro-EU coalition barely held onto power in parliamentary elections in November 2014, when it had the association agreement and visa liberalisation agreement with the EU to its credit; if, as seems likely, early elections take place, there is a high probability that the (more pro-Russian) Communist Party will take over.
The issues of #Georgia, #Moldova & #Ukraine all link to the persistence of corrupt oligarchic systems
The persistence of corrupt oligarchic systems is the golden thread that links the problems of Georgia, Moldova and Ukraine. The EU has to bear some responsibility for the continued strength of crony capitalism in Eastern Europe: perhaps for fear of being accused of interfering in internal affairs, it has allowed oligarchs to pretend to be ‘pro-EU’, even while their actions have given the concept of ‘European values’ a bad name. Some EU member-states have even facilitated the corruption: the Moldovan banking scandal involved 48 UK-registered shell companies, many with bank accounts in Latvia. The result is that the EU is being discredited in the eyes of ordinary people.
The #EU's eastern flank needs well-governed stable countries - not #Russian influenced basket-cases
It does not have to be like this. If the EU made a serious effort to put pressure on the three governments to clean up their acts (and if it put more barriers in the way of dirty money from the region), it would have widespread backing from their populations: the Ukrainian revolution in 2014 showed that people are hungry for good governance. The EU needs well-governed, stable countries on its eastern flank, able to provide prosperity for their citizens; it does not need corrupt, Russian-influenced basket cases whose citizens will join the flow of migrants to Europe.

Ian Bond is director of foreign policy at the Centre for European Reform.

Global slowdown: The eurozone to reap what it has sown?

The slowdown in emerging markets leaves the eurozone even more reliant on exports to the US and UK to compensate for its feeble domestic economy. 

The eurozone is banking on a weak euro and strong global growth to boost exports and inflation and offset the weakness of domestic demand. How likely is this? China might yet avoid a recession, but there is no doubt that it is set for a period of much slower growth. At the same time, pretty much every emerging market is weakening, partly because of their dependence on China, and partly because of sluggish productivity growth. The US Federal Reserve’s decision not to increase official interest rates is welcome: a rise would have prompted further capital outflows from emerging markets. But there is no doubt that the global economy is labouring, and that this poses a threat to the eurozone’s anaemic recovery.

The eurozone ran a trade surplus of €125 billion over the first six months of 2015. Over the same period of 2011, it had a deficit of €17 billion. Over the last four years, exports have risen 18 per cent; imports just 2 per cent. The data for net exports (exports minus imports), which measures the impact of foreign trade on economic growth, is striking. Between the first half of 2011 and the first half of 2015, the eurozone economy expanded by 1 per cent. Without rising net exports, it would have shrunk by 1.3 per cent. In short, without global demand, there would have been no eurozone recovery at all.
Without global demand, there would have been no #eurozone recovery at all
The eurozone’s rising surplus is down to trade with developed countries, especially English-speaking ones, and commodity producers, not China or other emerging markets. Just 7 per cent of the increase in eurozone exports over the last four years was to China, whereas nearly half of the increase was with the US, the UK and Canada. Moreover, these countries accounted for over 40 per cent of the rise in the eurozone’s net exports (as imports from these countries barely rose). Most of the rest of the increase in eurozone net exports was with commodity producers, as falling oil and other raw material prices reduced the value of eurozone imports from these countries. By contrast, net exports to China fell over this period, as the value of eurozone exports to China rose by less than the value of imports from China.

The eurozone will certainly be hit by the slowdown in China and elsewhere. Emerging markets buy over a quarter of eurozone exports, and these are set to come under pressure, while the competitiveness of emerging market manufactured goods will increase as the value of their currencies falls. Eurozone net exports to these economies, especially China’s, could weaken substantially. Can the Anglo-Saxons continue to act as the eurozone’s ‘consumer of last resort’ and offset the impact on the currency union of the slowdown in emerging markets?
Nearly half of the increase in #eurozone exports since 2011 was to the US & UK; just 7% to #China
Both the US and UK economies are growing relatively robustly and investors are currently sanguine about their rising trade deficits. This may well persist for a while, especially as capital flows out of emerging markets into developed ones. But it leaves the eurozone vulnerable to a slowdown in the US and UK, which are themselves not immune to weakening global growth, especially the UK which is more dependent on foreign trade than the US. They will not be able to sustain a big drag on their economies from negative net exports indefinitely. So far, the US dollar and sterling have been rising in value against the euro, just as US and UK trade deficits with the eurozone have been widening. But this positive sentiment could easily reverse if investors turn bearish about the growth prospects of the US and UK.

Meanwhile, there is little to suggest that domestic demand in the eurozone will be strong enough to deliver robust GDP growth. Domestic demand has picked up over the last year as lower inflation and energy prices have temporarily boosted household incomes. But this is largely a one-off boost to growth. There is no sign of a pick-up in investment in the eurozone as a whole. Fiscal policy has become mildly expansionary, and should remain so, but there is no prospect of a major programme of fiscal stimulus.
The #currencyunion cant rely on a weak € & strong global economy to offset economic weakness at home
The eurozone’s need to focus on boosting domestic demand is as pressing as ever. The currency union cannot rely on a weak euro and strong global economy to offset economic fragility at home. Aside from leaving it highly vulnerable to external events, the eurozone has become a major drag on the global economy itself. Unfortunately, the European Commission is powerless to do anything about the biggest obstacle to stronger growth in eurozone domestic demand: excessive savings in Germany and the Netherlands. Germany’s current account surplus is on course to exceed 8 per cent of GDP this year and the Netherlands’ 11 per cent. In all likelihood, the eurozone will only adopt the aggressive monetary and fiscal measures needed to raise domestic demand when it can no longer rely on external demand. That time might not be too far off.

Simon Tilford is deputy director at the Centre for European Reform.

Friday, September 18, 2015

Jeremy Corbyn and the rise of groupthink

Jeremy Corbyn’s rise to the Labour leadership heralds an era of ideological contest that threatens Britain’s membership of the EU – and the United Kingdom itself.

When does cosy consensus become groupthink? According to the social psychologist, Irving Janis, it is when the desire for conformity becomes so strong that alternative courses of action are not even considered, let alone taken.

Jeremy Corbyn, the uncompromising left-winger who has never held ministerial office, surfed from Labour’s backwaters to party leader on a wave of groupthink. The British left never fully accepted Blair’s Third Way – and his greatest mistake, the Iraq war, provided the pretext for its demonisation of him. Corbynistas disparage the party’s centrists as “red Tories” – a process Janis defined as 'stereotyping' opponents as spiteful and biased. The British left has always seen itself as the guardian of political morality, leading to a state of total certainty in which the risks flowing from the group’s decisions – withdrawal from NATO might endanger the country’s security, for example – are reflexively dismissed. And Janis also pointed out that moral certainty encourages excessive optimism: the British left imagines that the surge of Corbyn backers signing up to vote will be replicated in the broader electorate, despite the fact that no leader from Labour’s left has ever won a general election.

The stable liberalism of the pre-2008 period is crumbling, giving way to ideological contest between three political tribes – a Corbynite left, the Conservatives and the Scottish nationalists – which imperils Britain’s membership of the EU, and the future of the UK.

Between 1992 and 2008 there was consensus over the big policy questions of the age: that the state should reflect and nurture the country’s social liberalism, and provide more rights and opportunities for minorities and women; that it should intervene in markets only to correct obvious failures; that pro-work redistribution through tax credits and a minimum wage should counter poverty and inequality; and that more should be spent on improving public services. Now, Britain’s parties are retreating into ideological comfort zones, ignoring or attacking evidence that contradicts their prior beliefs, and choosing policies less on a careful analysis of outcomes than on tribal orthodoxies.

Corbyn’s policies engage in a debate with a spectral Margaret Thatcher: re-open the coal mines that she closed; subordinate monetary to fiscal policy; unpick the privatisation programme that she started. He has no programme of progressive structural reforms – to property, land and retail finance markets, or to the tax system – which would be efficient ways of reducing Britain’s troublingly high level of inequality and raise its weak level of productivity. Confronting past enemies, the left does not notice the alternative roads it might travel.
#Corbyn’s victory heralds renewed ideological contest in #Britain – with some serious attendant risks 
Labour is not alone. The Conservative policy programme follows party ideology over a careful analysis of the country’s problems. The EU referendum will define Cameron’s second term, even though Britons still rank Europe below immigration, the economy, health, welfare and housing in importance. They are right to do so: it is hard to find a major problem facing the country that would be solved by leaving the EU. Meanwhile, George Osborne’s decision to move towards a budget surplus, reached predominantly by cuts to government consumption and capital spending, is ideological small-statism: higher public investment in infrastructure and housing is needed to cope with a growing population, and investment finance is currently cheap as interest rates are low. The Conservatives’ proposed laws to make industrial action harder are simply a political trap for Labour, since Britain’s days lost to strikes are half the EU average, and are hardly a major drag on the economy.

As for the third force in British politics, the Scottish National Party’s rise lies in the fact that Scots have come to define their political identity against the Tories. The SNP has a tendency to make eye-catching policies to maximise the contrast with those south of the border, irrespective of whether the policies work. Abolishing university tuition fees was a canny political move, since they are hated by the predominantly middle-class students that pay them, and fees in England have risen to £9,000 a year. But abolishing fees led the SNP to cut bursaries for poorer students, to the extent that they are worse off under the new system. The SNP’s decision to make medical prescriptions free costs 7.5 per cent of the Scottish health budget – money that could be better spent on hospital and social care, given that Scotland’s population is ageing rapidly.

Britain’s tribal warfare threatens to undermine the country’s political and economic settlement. Jeremy Corbyn is at best equivocal about Britain’s membership of the EU: he sees it as an agent of international capitalism. Under pressure from Labour moderates, many of whom said they would quit the shadow cabinet if he did not support EU membership, Corbyn has said that Labour will campaign to remain in the EU. But he also said he would try to reverse any “damaging” reforms David Cameron negotiates, citing an opt-out from EU employment rules as an example – and criticised the EU’s proposed trade deal with the US, the Transatlantic Trade and Investment Partnership.
#Britain’s tribal warfare threatens to undermine the country's political and economic settlement
But the threat Corbyn’s leadership poses to the UK’s EU membership arises mostly in the internal dynamics of the Conservative party. The Tory right, knowing that Labour has little hope of winning the 2020 general election under such a left-wing leader, has less incentive to maintain party discipline. Eurosceptics will be tempted to follow their gut feeling, since a split over Europe will not be hugely damaging with the electorate.

The pro-EU coalition on the centre ground of British politics is shrinking, as is the opinion poll lead for the In camp. And since the EU’s member-states face intractable problems – refugees and the euro's flaws – which aggravate British euroscepticism, the referendum could hardly be held in worse circumstances.

As for Scotland, Corbyn’s supporters say a left-wing Labour party will draw voters lost to the SNP back to the fold, and make Scottish independence less likely. There are two reasons why this is doubtful. First, there are not enough left-wing voters in England and Wales for Labour to win the 106 seats needed for a majority in 2020. Scots will have little faith that Corbyn will deliver them from Toryism. Second, Nicola Sturgeon, the SNP leader, has popularity ratings in Scotland that are matched only by Angela Merkel in Germany.

The SNP has drawn up a list of ‘triggers’ that it says should prompt a second independence referendum. Some of the mooted triggers are unlikely to work – a renewal of Trident, Britain’s nuclear deterrent, because a majority of Scots support a deterrent; or if the Conservatives take Britain into an illegal war, because illegality is difficult to prove. But if the majority of Brits vote to leave the EU, with a Scottish majority voting to stay in, Sturgeon would justifiably argue that the constitutional settlement that Scots approved in the first independence referendum was no longer in place. And Scotland would probably vote to leave in a second vote.

Britain’s move towards the international margins and its inability to confront underlying social and economic problems are the result of its widening political fault-lines. If the country does break up, its failure to rise above groupthink will be to blame.

John Springford is a senior research fellow at the Centre for European Reform.

Wednesday, September 16, 2015

The battle for reform in Kyiv

Ukraine’s reformist government is achieving results. But vested interests are blocking many key reforms, and corruption remains a major problem. Mikheil Saakashvili, the controversial governor of Odessa, is dividing the reformers in Kyiv, as I discovered on my recent visit.

Ukraine’s pro-EU, pro-reform coalition has made real progress since taking office nearly a year ago. The current lull in fighting in the Donbass makes it easier for the government to work on reform. So does slightly better economic news: the government has struck a deal with its creditors to reschedule debt, while the economy may soon stop shrinking.

But the obstacles to reform remain huge, as became evident during a recent trip to Kyiv which included the Yalta European Strategy conference (YES is an annual event which can no longer take place in Russian-occupied Yalta). The problems include corruption, the erosion of public support for the reformers, the government’s political weakness and the excessively centralised nature of Ukraine’s state. And now the ambitions of Mikheil Saakashvili – once the reforming president of Georgia, now the reforming governor of Ukraine’s Odessa region – threaten to destabilise the political system.
Mikheil Saakashvili's ambitions as governor of #Odessa threaten to destabilise the political system
The governing coalition, which includes the parties of both President Petro Poroshenko and Prime Minister Arseniy Yatsenyuk, has several achievements to its credit. A new police force has started to patrol in four large cities and is apparently uncorrupt. Energy markets have been liberalised and the price of gas is rising (though Naftogaz, the state gas monopoly, still needs reform and privatisation). The bloated civil service lost 20 per cent of its staff last year and will lose a similar proportion this year. After much delay, an anti-corruption bureau has been established – though it cannot start work until a special anti-corruption prosecutor is appointed. The banking sector has been reformed, with a third of the country’s banks being wound up. Private militias are being integrated into the official armed forces.

But there is massive resistance to change. As Saakashvili explained to the YES conference, parallel to the official government is a shadow government, consisting of oligarchs and the officials and the MPs they control, which stymies reform. The key ministries are now clean at the top, but not further down. Many judges, prosecutors, bosses of state-owned enterprises, customs officials and politicians are corrupt.

The most passionate reformers in the government say that corruption is Ukraine’s number one problem. They complain that both the president and the prime minister are too cautious in confronting vested interests, and they argue that unless leaders go for a radical break with the past, the opportunity to clean up the country will be lost. So the reformers argue that all the judges and prosecutors should be sacked. The state-owned enterprises, which lost €6-7 billion last year according to Saakashvili, resist reform and privatisation; ministers often find it impossible to fire their senior executives.

Serhiy Leshchenko, a reformist member of the Rada (Parliament), and of Poroshenko's party, says that one significant problem is corrupt judges letting crooks go free. He estimates that about half the members of the Rada are corrupt or controlled by oligarchs. His personal priority is to push through an act of parliament that would provide for state funding of political parties.

Despite the reforms that have been achieved, opinion polls suggest that the public gives the government virtually no credit. Citizens and businesses still encounter corruption, red tape and customs problems. And they know little about the government’s successes because it is hopeless at communications. For example, prosecutors pursuing corrupt individuals do not explain their work to the public. Television programmes seldom feature anything about reform.

So it is not surprising that support for the governing parties is eroding. The Opposition Bloc party, made up of those aligned with former President Viktor Yanukovych, has more support than it did. Two new parties have recently been formed. UKROP, close to the oligarch Igor Kolomoyskyi and to Right Sector, a far-right nationalist group, is strongly anti-Poroshenko. The other new party is Responsible Citizen, led by Boryslav Bereza, who is running for mayor of Kyiv. Though he used to be close to Right Sector his party’s focus is on anti-corruption and encouraging an open society.

The government’s growing unpopularity means that in recent months fewer MPs have been willing to vote for key reforms. It is not even certain that the Rada will pass the recent debt restructuring package, which is essential for economic stability. Tensions between Poroshenko and Yatsenyuk, always present, are worsening. This rivalry is about power and differences of style as much as clashes over policy: Poroshenko, an oligarch who became known as the ‘chocolate king’, is a more consensual figure, while Yatsenyuk, a lifelong politician, has sharper edges. Yatsenyuk’s own party is so unpopular that it has decided not to compete in next month’s local elections.
The government’s growing unpopularity means MPs are less willing to vote for key reforms in #Ukraine
Poroshenko appointed Saakashvili as governor of Odessa in May, hoping that he would tackle corruption with as much energy as he had done when he was president of Georgia. But the appointment is causing ructions among Ukraine’s reformists. Saakashvili is one of several foreigners recently appointed to top jobs in Ukraine, but he is the only one to attack the prime minister in public. He has accused Yatsenyuk of delaying reforms (such as the introduction of an e-customs system in Odessa) and of protecting Kolomoyskyi (whom Poroshenko sacked as governor of Dnipropretovsk in March) and says that he should go.

Kolomoyskyi hit back, saying that the governor of Odessa was a “snotty addict” and that, as a “snapping dog without a muzzle”, he should be put down and returned to Georgia. Yatsenyuk defended himself at the YES conference by saying that his job was to run the government, not the judiciary and the prosecutors, and that he could not prevent their releasing senior figures whose arrest he had ordered. He also pointed out that the government had taken over companies controlled by Kolomoyskyi, such as UkrTransNafta, the state pipeline operator.

Many reform-minded officials and politicians say that Saakashvili has merely told the truth: Kolomoyskyi was guilty of abusing his position as a governor and Yatsenyuk has stalled on certain reforms. Serhiy Leshchenko says that Saakashvili’s focus on using the media is exactly what the country needs; the Georgian understands that the government should do a better job of selling its reforms.

But other reformers are sceptical about Saakashvili. A senior figure in the finance ministry says that he is difficult to work with because whatever one says to him immediately appears in the press. The critics wish he would focus on real work in Odessa rather than media stunts; they say he should not speak out on national issues when he is just a regional governor. They complain that his priority is to advance his own career – whether in Ukraine, possibly as prime minister, or back in Georgia, or on the world stage. But the critics admit that he is popular with many Ukrainians.

In a western country, either Yatsenyuk or Saakashvili would have to go after such a public row. But when I put this to a senior aide of Poroshenko he indicated that this might not be the case in Ukraine. He said there was truth in what Saakashvili had said but that he exaggerated, and that he needed to remember that he was not a national politician.

The situation in South-East Ukraine – which though militarily quiet is diplomatically blocked – constantly threatens to weaken the reformers in Kyiv. Poroshenko told YES that he was fully committed to the Minsk agreements between Ukraine and Russia and that they were the only route to peace. Yatsenyuk told the same conference that he was more sceptical of the agreements but accepted that for the time being there was no alternative.

A few days before the conference, a nationalist demonstration outside the Rada ended with the throwing of a grenade and the death of three policemen. The demonstrators opposed the government’s plan to amend the constitution to allow a ‘special status’ for the rebel-held areas of the Donbass. Such a status, demanded by Russia and the rebels, is a key provision of the Minsk agreements. Ukraine’s nationalists oppose the special status and may be able to block the constitutional amendment in the Rada, since it requires a two-thirds majority to pass.

Distinct from the argument about a special status for parts of the Donbass, decentralisation for the whole country is another major challenge for the political class. The extreme centralisation of the state is a major constraint on both economic growth and reform. In Odessa, the many permits required for foreign direct investment require complex approvals from the authorities in Kyiv, often involving bribes. In Ukraine’s 700-odd district governments, a deputy head cannot be sacked without the approval of the central government in Kyiv. The Mayor of Kyiv, Vitali Klitschko, complains that he cannot change parking rules in his city, to allow vehicle clamping, without the Rada’s permission.

There is much talk of decentralisation but so far it has not happened. Though desirable, it would be no panacea: if it happened too fast, it could merely entrench the positions of regionally-based oligarchs. So a precondition for decentralisation should be progress on ‘de-oligarchisation’ and the rule of law.

If the ceasefire continues to hold in the Donbass, the economy will benefit – as will, probably, the fortunes of the reformist government. The (Ukrainian American) finance minister, Natalie Jaresko, and the (Lithuanian) economy minister, Aivaras Abromavicius, have done a fair job of stabilising the economy. Inflation is around 50 per cent but falling. The economy shrank 7.5 per cent last year and may shrink a further 10 per cent this year, but modest growth is forecast for 2016. The debt restructuring will help, assuming the Rada passes it: government debt will drop by $4 billion, annual interest payments by $1.5 billion and maturities will be extended by four years.

The deep and comprehensive free trade agreement (DCFTA) between Ukraine and the EU will be fully implemented on January 1st 2016, according to Poroshenko. Implementation had been postponed because of pressure from Russia (which claimed that the agreement would harm its economy). Russia has threatened to retaliate against trade with Ukraine, if the DCFTA is implemented. I asked Jaresko how damaging such retaliation could be. She said it would hurt but that Ukraine could cope; Russia’s sanctions, border blockages, health controls and so on had already cut
Ukraine’s exports to it by 80 per cent. She thought the DCFTA would encourage foreign investors to treat Ukraine as a base from which they could export to Europe.

President Poroshenko had a clear message for the West at the YES conference: he urged both the EU itself, and the EU and the US, to remain united vis-à-vis Russia, so that they can more effectively protect Ukraine’s interests. Conversely, however, the West is counting on Poroshenko to hold together his country’s reformers, so that they can tackle vested interests, strengthen the economy and improve the lot of ordinary Ukrainians. The more the reformers fight each other, the more likely they are to fail.

Charles Grant is director at the Centre for European Reform.

Tuesday, September 08, 2015

Europe’s refugee crisis: Chronicle of a death foretold

The forces driving refugees towards the EU will not disappear in the foreseeable future. Europe needs a comprehensive long-term strategy to improve the political and security situation in its neighbourhood. And whatever else it does, it needs to take urgent steps to accommodate and integrate refugees already in Europe. The European Commission is on the right track and the member-states should follow its lead.

The response of European leaders to the scale and urgency of the refugee crisis has been inadequate. Stronger fences have not stopped migrants at Calais from regularly disrupting train services to the UK; or those in Serbia from walking along train tracks into Hungary. People still climb on board rickety boats along the Turkish and Libyan coasts. Germany’s interior minister, Thomas de Maizière, has suggested that the Schengen agreement could be suspended, allowing EU member-states to reimpose border controls between them – but that would only leave even greater numbers of refugees stuck in ‘frontline’ EU states like Greece.

David Cameron, the British prime minister, has said that the solution lies in stabilising countries of origin and “trying to make sure there are worthwhile jobs and stronger economies there”. Of course. But nobody suggests that such a goal is achievable in the foreseeable future in Syria (now the source of the largest contingent of refugees) or Libya (a transit state mired in civil war that cannot prevent people-smuggling). Huge numbers of refugees will continue to head for Europe as long as the conflicts and chaos they are fleeing endure.

#Refugees will continue to head to Europe as long as the conflicts & chaos they are fleeing endure

Europe is doing very little to try to stabilise not only Syria and Libya, but also Eritrea and Afghanistan, which are also sources of significant numbers of refugees (though in recent years it has expended much blood and treasure in the last of those countries). The EU’s efforts have been focused on supporting the moribund UN-led peace process in Libya, and on helping Syria’s neighbours to shelter refugees.

In Syria, neither the EU nor its member-states have been willing either to compel the warring parties to stop fighting or to create incentives for them to do so. Russia has stepped up its support for President Bashar al-Assad, to the extent of sending some Russian forces. The Islamic State terrorist organisation, despite being on the receiving end of airstrikes by the US, some EU countries and several Gulf states, continues to control much territory and attract many recruits. A rare glimmer of hope is that the nuclear deal with Iran might make Tehran a more co-operative partner in seeking a solution. But even in the unlikely event of a Syrian peace deal, it is doubtful that refugees will return home quickly.

The EU is a major donor in Afghanistan, particularly in supporting institution-building. But since the EU is involved neither in improving security nor in promoting a political settlement between Kabul and the Taliban, it can do little to stem the flow of refugees. Eritrea, a poor country with an appalling human rights record, will remain a source of refugees and economic migrants. Its government is unco-operative and the EU has few levers to pull. And in Libya, where there is no effective government, the EU is dependent on UN-led efforts to find a political solution. Even if the UN was able to put Libya back together again, there would still be some time before the country had a government capable of controlling porous borders and cracking down on people-smuggling.

So the flows of people will continue. How should the EU respond? Europe is a large donor to programmes that seek to keep refugees close to their countries of origin (and has provided more than €3.9 billion for Syrian refugees in Jordan, Lebanon and Turkey, in particular). But those inside the camps face unpleasant living conditions and meagre hopes of being accepted as an asylum seeker. This encourages them to seek a better life in Europe. The EU needs to step up its efforts to improve standards in these camps, support refugees in the region and enable them to resettle elsewhere. The EU may be able to persuade some other countries in the Middle East to take Syrian refugees (most have taken very few), but many more will still want to come to Europe.

The European Commission is now proposing a scheme for relocating 160,000 refugees already within the EU (in May it had already proposed a system of quotas for 40,000 refugees). This would be the first step towards a more permanent relocation system, and a far-reaching reform of the Dublin regulation, the system governing the management of asylum claims in Europe. Under the Dublin system, asylum seekers must apply in the first EU member-state they enter.

Among the most vocal critics of the Commission’s initial proposal for quotas were Spain and the Visegrad countries (Czech Republic, Hungary, Poland and Slovakia). The UK has been clear that it will not take part, and it is not legally obliged to, since it has the right to opt-out of EU measures related to Justice and Home Affairs (including asylum). But, even though the Commission is seeking to quadruple the number of refugees that it wants distributed among the member-states, public opinion in several member-states has shifted in its favour over the past week. Some governments are softening their opposition to quotas. For his part, David Cameron has announced that the UK will take 20,000 Syrians from camps near Syria over the next four years, but none of those already in the EU. Given that the Commission’s plans have strong backing from Germany and France, there may well be enough support among governments for them to pass.

The EU has 500 million inhabitants so should not find it unmanageable to settle 160,000 refugees. But countries that have a strong record of integrating immigrants, and of cultural and religious tolerance, will be more effective in absorbing refugees than those that have experienced less immigration. The EU therefore needs its richer and more ethnically and culturally diverse member-states to do the heavy-lifting. Germany already is, but France and the UK must pull their weight, too. These are countries with very substantial immigrant populations from outside the EU, which also have the social infrastructure needed to integrate sizable numbers of refugees.

The #EU has 500 million inhabitants - so should not find it unmanageable to settle 160,000 #refugees

This is not to say that other member-states, notably the Central Europeans, should reject refugees. But with the exception of Poland they are small countries that could not accommodate huge numbers. In any case, only if the EU’s wealthier and more open societies pull their weight will they have the moral authority to cajole the Central European member-states to do more.

Beyond relocation and integration, the EU must also take action to prevent asylum-seekers travelling to Europe. An ‘open doors’ policy for asylum-seekers would be irresponsible, encouraging people to risk their lives with people-smugglers. That is why member-states (and the European Parliament) should agree, in the shortest possible time, to a common list of countries of origin that are ‘safe’, so that no asylum should be granted to their nationals. The Commission’s proposal will include such a list, which would have a deterrent effect – and help to ease the procedures when reviewing claims.

A functioning asylum system should also ensure that those not qualifying as refugees are effectively returned to their countries of origin. That is why the Commission’s proposal will also focus on improving the EU’s poorly-functioning return system. The EU needs to make sure that the readmission agreements with neighbouring countries that are already in place are enforced, while pushing ahead with negotiations on new deals with other relevant countries. The EU should also provide more funds and equipment both for its frontline member-states, and for the countries where refugees come from and travel through. This should include development aid to improve living conditions in source countries, as well as experts and technology to strengthen the key borders.

People fleeing conflicts or political persecution should expect their asylum claims to be reviewed within a reasonable period of time, under fair and humane conditions. The EU should create safe processing centres in countries closer to the refugees’ countries of origin: this would reduce both the need for improvised refugee camps on European soil, and the incentives for refugees to risk their lives by trying to reach Europe. In the Middle East, the most obvious candidate would be Turkey: a bridge between Europe and Asia, it already hosts 1.6 million refugees, according to the UN High Commissioner for Refugees. Legally, the EU can only set up a processing centre in Turkey if Ankara agrees to become a full member of the UN’s Geneva convention on the status of refugees. Currently, although a signatory, Turkey maintains a territorial exception that specifies it will only accept refugees from European countries. In return for Turkey agreeing to host the centres, the EU could expedite the talks on visa liberalisation, and offer financial support. In North Africa the EU should be ready – as soon as a viable government is installed – to set up safe processing centres in Libya.

The EU must also rethink the mandate of Frontex, the EU Borders Agency. Frontex can currently deploy Rapid Border Action Teams (RABITs) to help a member-state that is under exceptional pressure, as is currently the case for Hungary and the UK. If the EU wants to prevent Schengen from falling apart, it should reinforce the control over, and the management of, its external border, rather than rely on ad-hoc co-operation during crises. A permanent European Border Guard, with a strong mandate and budget, would ease the burden on the member-states struggling to cope with refugees, and would help to stop human traffickers.

Europe’s response to the refugee crisis has been painfully slow, but the Commission is now giving some sensible pointers on the way forward. Nothing that the EU’s institutions and governments can do in the near future will stop flows into the continent. The member-states will have to work out a fair system for processing and resettling asylum-seekers. But in the longer run a more pro-active EU foreign and development policy can help to reduce the incentives for people to travel to Europe.

Camino Mortera-Martinez is a research fellow, Ian Bond is director of foreign policy and Simon Tilford is deputy director at the Centre for European Reform.

Wednesday, August 26, 2015

Lighten the load

Greece’s debt burden needs to be reduced, but maturity extensions on existing loans are not enough for Greece to return to the markets.

The IMF says that Greece’s debt burden is unsustainable. That is why the IMF will not contribute to the third assistance package (recently agreed by Europe and Greece) unless Greek debt is reduced. The problem is that an outright cut in the value of the debt – a haircut – is politically unacceptable, especially to Germany. The other option – extending the maturity of existing official loans further and lowering interest payments – is not enough for Greece to return to the markets. In order for this to be possible, the eurozone needs to refrain from threats of Grexit in case of a renewed crisis; to commit to making Greek debt sustainable even if economic growth comes in below expectations; and to make new government bonds issued to the market senior to existing official loans, such that new government bonds are serviced before official debt. These measures would also be in the interest of the creditors themselves: only if investors, businesses and consumers feel confident about Greece’s euro membership, can Greece grow and repay its debt.

Greece’s public debt will reach 200 per cent of GDP next year, according to the European Commission. This puts Greece just behind Japan as the most indebted country in the world, and in 2022, Greek public debt will still be 160 per cent of GDP – even with ambitious assumptions about economic growth and budget surpluses. Pre-2008 government deficits are not the only reason debt has spiralled out of control: the economic collapse since 2008 is also to blame. Before the debt restructuring in early 2012, both rising debt and the economic collapse raised the Greek debt-to-GDP ratio (see chart 1). Since mid-2012, however, Greek debt measured in euros has hardly increased. Only when measured against the shrinking economy has it grown. Greek growth is hence crucial to making Greek debt sustainable.

Chart 1: Greek debt in euros and as a share of GDP

Source: Haver

The largest chunk of Greece’s public debt is owed to other European governments and institutions. The maturities of these loans are long, the interest rates low and the interest payments already partially deferred. As a result, Greece only pays 4 per cent of its GDP in debt servicing costs – less than Italy and Portugal, despite their lower debt burdens (see chart 2). Much of Greece’s debt will not be repaid for a generation: the average maturity of loans from the EFSF, the predecessor of the permanent rescue fund ESM, is 31 years, and the last repayment is due in 2053, when German finance minister Wolfgang Schäuble would celebrate his 111th birthday. For critics of a debt haircut, these numbers suggest that the burden is sustainable and debt relief therefore unnecessary.

Chart 2: Government interest expenditure as a share of GDP

Source: Haver

But is Greece’s debt really sustainable? For countries that finance their debt on markets, the debt-GDP ratio helps investors to gauge sustainability, though it is far from perfect. For a country overwhelmingly financed by official creditors, and which enjoys low interest rate loans with long maturities, the ratio is not very informative. A different indicator is needed, and the IMF uses a country’s yearly gross financing needs, which comprise the government budget deficit and the maturing bonds that must be refinanced. This measure helps because it can be used to compare Greece to countries whose debts are financed by the market. And it is the stated goal of the new ESM programme that Greece should return to the markets. But private investors will only lend to Greece if they deem Greece’s debt to be sustainable. Only then will Athens be able to replace official creditors’ loans with private funds borrowed on the markets. And only then will official creditors get their money back.

In Greece’s case, the IMF argues from experience with other highly indebted countries that yearly gross financing needs should not be more than 15 per cent of GDP over the next decades for public debt to be deemed sustainable by markets. Greece’s annual financing needs currently stand at 25 per cent, down from 29 per cent last year. They are predicted to decline at first because many official loans have initial grace periods and repayment of the EFSF loans only starts in 2023, but they will increase thereafter to 20 per cent or more, depending on economic growth performance and the size of primary budget surpluses.

By the measure of gross financing needs, Greece is miles away from returning to the markets at sustainable interest rates. This is why the Greek debt burden needs to be significantly reduced even if Athens manages to deliver on the long-term primary budget surpluses of 3.5 per cent of GDP from 2018 and the economy grows as currently projected (around 3 per cent per year in 2017 and 2018, and 1.75 per cent in the long run).

A haircut would be the cleanest solution, since Greece would then be on its own and could return to the market. However, the eurozone does not want to give up control over Greece’s economic policies just yet. As long as Greece depends on official funding to roll over mostly official debt, it must abide by the conditions set out by the creditors. While current EU treaties do not foresee a haircut, Schäuble’s argument that such a step is legally impossible is mostly an attempt to hide these political motives. Moreover, governments in core countries such as Germany shy away from presenting their voters with the final bill.
However, lowering interest rates and extending maturities is not enough for a Greek return to the markets.
However, the option that remains – lowering interest rates and extending maturities – is not enough for a Greek return to the markets. The political uncertainty unleashed by the rise of Syriza and the creditors’ harsh response has undermined private investors’ confidence that Greece will remain part of the eurozone, grow and repay its creditors. If official creditors deem a haircut to be politically impossible, three other ingredients are necessary to resolve Greece’s debt burden.

First, policy-makers in Europe need to ensure that another debt crisis in Greece, sparked by a new recession or political crisis, will not put Grexit back on the table. Not only is it false to argue that Greece needs to leave the euro if it cannot repay its debts; the lingering threat of a Greek exit also hurts the economy and reduces the chances of the debt being repaid.

Second, debt relief by means of interest rate reductions and maturity extensions needs to be clearly and predictably tied to Greek growth. So far, the IMF and the Eurogroup of eurozone finance ministers have mostly blamed Greece for failing to reform when economic growth did not meet their unrealistic projections. Yet the projections themselves, as well as the counter-productive austerity policies implemented at the creditors’ behest, are to blame, too. A debt reduction plan must include provisions that automatically increase debt relief if growth disappoints, or investors will have good reason to question debt sustainability. Since such provisions could also reduce the Greek government’s reforming zeal, debt relief should equally be tied to the implementation of key reform projects. In practice, as long as the reform progress is deemed sufficient by an independent body such as the OECD, Greek debt would be made sustainable at every programme review by means of maturity extensions or further deferral of interest payments.
New private claims should be made senior to existing official and private claims on the Greek government.
Finally, in order to convince private investors to lend money to the Greek government, new private claims should be made senior to existing official and private claims on the Greek government – that means, Greece would prioritise the service of newly issued bonds over other loans. That would limit the risk of default for new private lenders, and signal that official creditors accept responsibility for the failure of past programmes. The amount of such new, senior debt should be clearly limited and agreed with the official creditors. The sustainability of the overall debt burden would be unaffected, but this plan has two crucial advantages. Greece could access markets a lot sooner than otherwise, freeing itself from the influence of the troika (now ‘quadriga’) of the European Commission, ECB, IMF and ESM. On the other side, the quadriga would have a new ally – the market – that would help to discipline Greek governments. Such an arrangement might also, depending on market appetite, reduce future official financing – something that creditors could sell as a political win back home.

Meaningful debt relief for Greece needs to happen: without it, the Greek drama cannot end. And it is in the interest of creditors, since the better Greece’s growth prospects inside the eurozone and the lower the risk of a renewed crisis, the greater the amount that will eventually be repaid. The IMF should not let the Europeans off the hook, and stand firm on its demands for debt relief.

Christian Odendahl is chief economist at the Centre for European Reform.

Thursday, August 06, 2015

Cameron's renegotiation plans: The view from Warsaw

David Cameron aims to get a quick agreement on the EU’s reform agenda but parliamentary elections in Poland on 25 October may complicate his plans. Although Law and Justice, the party leading in the opinion polls, belongs to the same political group as the Tories in the European Parliament, it may prove a tough negotiating partner in the European Council.

Soon after his election victory in May, British prime minister David Cameron toured Europe to discuss his plans to renegotiate the UK’s relationship with the EU. By making Warsaw one of the first stops on his trip Cameron hoped to improve relations with Poland, which deteriorated as his anti-migration rhetoric hardened. During his first term as prime minister, Cameron did not visit Warsaw at all.

But Cameron’s first meeting with prime minister Ewa Kopacz in Warsaw may well have been his last. The Civic Platform, which she runs and which has been in power for the last eight years (in coalition with the Polish Peasant Party), lost the presidential election on 24 May to the right-wing Law and Justice party. The victory of Andrzej Duda, who was sworn in on 6 August, has helped Law and Justice to catch the wind: it is now leading in the public opinion polls ahead of the October’s parliamentary elections, and stands a very good chance of winning them. If this is the case, Cameron will face a new prime minister at the renegotiation table.

What would this mean for Cameron’s EU reform agenda? Like the Conservatives, Law and Justice opposes transforming the EU into a fully-fledged political union, shares Cameron’s concerns about the current balance of power between member-states and EU’s institutions, and is wary of further eurozone integration and its impact on ‘euro-outs’. At first glance this makes the party a convenient partner for Cameron. But in the past, Law and Justice proved to be a difficult negotiating partner. During the 2007 negotiations on the Lisbon treaty, prime minister and party leader Jarosław Kaczyński opposed the new voting system in the Council of Ministers, which favoured the largest member-states. Kaczyński said that were it not for the Second World War Poland would now have a population of 66 million, and voting weights should reflect that. His comments caused bewilderment in Germany and elsewhere. The party is now positioning itself as more liberal, and nominated a woman, Beata Szydło, rather than Kaczyński, as its candidate for prime minister to appeal to more moderate voters. But Cameron has no guarantee that the party’s politics have changed. It could as easily confront Cameron as appease him.

Whether Cameron finds himself dealing with a prickly Law and Justice or a more emollient Civic Platform government after the elections, he will still need Poland (like all other member-states) to agree to his package of reforms. This insight sheds light on what Warsaw’s position might be on five issues Cameron has identified as central to the renegotiation.

First, Cameron wants to make the EU more competitive. He thinks that one way to do this is by cutting red tape and further liberalising the single market. This is one of the reform areas in which Cameron should find support in Warsaw. Poland is a clear beneficiary of the single market (between 2004 and 2013 its exports to the rest of the EU grew by almost three-fold, to reach a value of €114 billion in 2013). The current government shares Cameron’s view that the EU should serve its entrepreneurs and consumers. Law and Justice would probably also help Cameron on cutting red tape. The party wants to prevent the Commission from expanding its powers, and Cameron’s drive to reduce superfluous legislation fits this narrative neatly. But the party’s sympathy for deregulation does not mean that Law and Justice believes in Adam Smith’s ‘invisible hand’ in all circumstances. It has promised to impose a special tax on large retail companies, many of which are foreign owned. In doing so, Law and Justice is copying the hostile approach to foreign investors of Hungary’s prime minister Viktor Orban.

Second, Cameron wants to obtain an opt-out from the objective of ‘ever closer union’ set out in the Treaty on European Union. In June 2014 the European Council noted that the notion “allows for different paths of integration for different countries”, thereby leaning in Cameron’s direction. Poland did not oppose that wording. But what if Cameron demands that the treaty itself be amended to reflect the idea of “different paths”? Should the Civic Platform remain in power, it will probably oppose any immediate treaty change. If Law and Justice returns to power, it would perhaps be more sympathetic to Cameron’s arguments but the risk is that the party may use discussions on ‘ever closer union’ to argue for its own opt-outs. Its representatives have already hinted they would attempt to secure exemptions from the EU’s climate policy. If the party decides to use Cameron’s reform agenda to unpick what it does not like about the European project, other EU capitals will follow suit, delaying the renegotiation process.

Third, Cameron thinks that national parliaments should have a greater say in EU decision-making. Both Polish parties would show some understanding of Cameron’s concerns and might agree to a strengthening of the ‘yellow card’ procedure. But they would probably oppose collective veto rights for national parliaments. Ewa Kopacz is a former speaker of the lower chamber of the Polish parliament and recognises the need to engage parliaments better in EU matters. In 2012 she proved to be a skilful negotiator and broke a two-year stalemate between MPs and MEPs to set up the inter-parliamentary conference on EU foreign policy issues. If she remains in office, she will try to convince Cameron that there are ways to connect parliaments to the EU without giving them veto powers and hence without changing the treaties. Law and Justice would support a stronger role for national parliaments too. In an interview with the Polish daily Rzeczpospolita, Krzysztof Szczerski, the party’s leading expert on European affairs, complained that parliamentarians were not sufficiently involved in adopting EU laws and implementing measures. He acknowledged however that providing MPs with veto power would cause the EU’s institutional order to break down.

Fourth, Cameron wants to ask his partners for ‘safeguards’ for the single market. He worries that deeper eurozone integration in the area of financial services would damage Britain’s interests. This is one of the renegotiation areas where Civic Platform and Law and Justice are like to have completely different views. If Kopacz remains in power Cameron will find it difficult to convince her to help him negotiate more permanent safeguards for countries outside the eurozone. This is because Civic Platform want Poland to join the euro once it meets the convergence criteria and once the economic turmoil in the eurozone is over. In contrast with Britain, the Polish government has been more interested in participating in eurozone deliberations and its decision-making than in securing safeguards for ‘euro-outs’. The government has often pointed to Poland’s ‘pre-in’ status to justify being involved in talks about the eurozone’s future. In negotiations over the fiscal compact (the treaty introducing stricter eurozone budget rules) Warsaw won a provision giving not only ‘euro-ins’ but also other signatories of the compact the right to participate in euro summits whenever the architecture of eurozone or the implementation of the compact is discussed. For its part, Law and Justice dismissed this policy as too submissive to Brussels. Beata Szydło pledged that if she became prime minister she would put off any discussion of adopting the euro until the wages of Poles were similar to those of their Western European colleagues and she would abolish the post of the official in charge of euro adoption. Her mistrust of the euro makes her a natural ally of Cameron’s.
Cameron should realise that Poles see free movement as one of the EU's successes, not problems
Finally, in an attempt to please a more eurosceptic audience Cameron wants to limit access to unemployment and in-work benefits for EU citizens for the first four years after their arrival in the UK. But the British prime minister previously opted to discuss his concerns about the freedom of movement of people with Berlin rather than with Warsaw. He thought that putting his negotiation eggs in the Anglo-German basket would help him deliver reform - despite the fact that Poles are the largest group of EU migrants living in the UK (Poles constituted 8.7 per cent of all foreign citizens in Britain in 2013). This dismissive approach weakened Cameron’s hand in negotiations with Warsaw. As the elections near both parties are likely to harden their stance on Cameron’s free movement demands. In 2014, 80,000 Poles living in the UK registered to vote in the Polish presidential elections. This is not an enormous number, but if the parties are neck-and-neck, these votes will matter.

But Warsaw’s opposition to Cameron’s ideas is not merely a political calculation. He should realise that Poles see free movement of people as one of Europe’s greatest achievements, not a problem. The country was separated from Western Europe by the Iron Curtain for too long to sympathise with ideas putting freedom of movement at risk. If Cameron can focus on improving the EU for everyone, whether in Western or Central Europe, he may be able to get the support he needs from Warsaw, no matter which party forms the next government.

Agata Gostyńska-Jakubowska is a research fellow at the Centre for European Reform.