Friday, June 26, 2015

Britain’s EU referendum: Cameron cannot please two audiences any longer

David Cameron kicked off the renegotiation of Britain’s EU membership at the European Council in Brussels. The modesty of his demands for reform will inevitably lead him into a breach with Conservative eurosceptics.

For some time, David Cameron has been trying to satisfy two very different audiences on Britain’s renegotiation with the EU. One is the Conservative eurosceptics. Many of them argue that he cannot achieve radical reform without making ambitious demands and threatening to recommend a ‘No’ vote unless he is satisfied. The other audience, the EU’s leaders, say they will give Cameron more help if he speaks softly and keeps his demands within the realm of the possible.

When Cameron kicked off the renegotiation at the European Council in Brussels, over dinner on Thursday night, it became clear that he will work broadly within parameters that are acceptable to his fellow leaders. British officials briefed that the government understood the EU treaties cannot be changed before a referendum. That has been pretty obvious for a long time to anyone who understands the EU’s rules on treaty change, or who talks to other EU governments, but not to all Conservative eurosceptics. As more of them come to realise that Cameron’s ambitions on EU reform are in fact quite modest, they will prepare to attack him. He is reaching the stage where he can no longer appeal to both audiences.

At the European Council, there was not a lot of time to talk about the British question. The EU’s leaders were busy with Mediterranean boat-people and the increasing danger that Greece may leave the euro. But Cameron managed to outline the broad headings of his demands for reform, repeating much of what he had already said on a recent tour of European capitals. The others listened politely and there was no substantive discussion. EU leaders asked the secretariat of the Council of Ministers to work with UK officials on the details of their proposals. Cameron hopes to clinch a final deal in December – allowing a referendum on membership to be held in 2016, probably in the autumn.

Some governments grumble that Cameron has not yet been specific on his ideas for reform. The Germans, however, think this is tactically wise. As soon as his list of demands is known, eurosceptics will attack him for a lack of ambition, while integrationists in other capitals will cry “impossible”, and he will lay himself open to the prospect of failure. Cameron may say very little on specifics until shortly before the December summit.

In recent weeks I have spoken to some of those who met Cameron on his European tour. They told me they were concerned about Cameron’s ability to navigate the many obstacles that he will face between now and the referendum. In particular, they wondered whether he regards Conservative party unity as more important than winning the referendum. They noted his recent about-turns under pressure from anti-EU Tories – on whether ministers would have to support his line in the campaign, and whether the civil service could take sides. But Cameron has a justification for these shifts: if he can retain the support of moderate eurosceptics – so that no more than, say, 50 Tory MPs back ‘Brexit’ – he is more likely to win the referendum.

Other EU governments want to see Cameron make the case for membership, which to them means taking on the eurosceptics and making enemies in his party. Some of them told me that only when he does that will they believe he is determined to prevent Brexit, and therefore worth negotiating with on a serious basis. But Cameron will not want to make the case in Britain until he has struck a deal in Europe. In the meantime, if he can convince other leaders that he will – as he said in his 2013 Bloomberg speech – fight to keep Britain in the EU “with all my heart and soul”, they will probably do business with him.

EU leaders worry that domestic politics may blow Cameron off course. Will Conservative backbenchers push him to demand reforms that are unattainable, thereby making it hard for him to claim a successful outcome? So far he has not asked for much that his partners regard as ridiculous, except for the idea that EU migrants should be denied benefits until they have lived in the UK for four years. Will he carry the cut-and-thrust of Westminster politics – focused on victory and defeat – into EU councils, which usually work towards careful compromises that offer something for everybody? Other leaders claim that if Cameron threatens them they are less likely to help. But some of them are already resigned to the December summit being the scene of a ferocious battle from which Cameron plans to emerge blood-stained but victorious.

If Cameron wants to win the referendum, he will have to upset some Tories & admit that the EU is good for Britain

Cameron’s task is that much harder because he has few friends in other EU capitals. His peers view him as a ‘transactional’ politician who is a skilled negotiator on particular issues but fails to invest in long-term relationships. For example, some Italians thought it odd that when he met Prime Minister Matteo Renzi in Milan earlier this month, asking for help on EU reform, he would not offer to take a single Mediterranean refugee. But Cameron’s recent European tour suggests, at least, that he sees the need to deploy some gentlemanly charm on his peers.

Chancellor Angela Merkel of Germany, the most influential EU leader, likes Cameron, but they have several times misunderstood each other (as in December 2011, when he refused to sign a treaty on fiscal discipline because she rejected a Treasury protocol that would have given the City of London some extra protection). Her officials have warned the British not to assume that she can fix the rest of the EU; 26 other governments, plus the European Commission and Parliament, also matter. One senior German told me that, though he thought Brexit would be damaging, allowing the UK to undermine the EU’s core principles – for example by disregarding rules on freedom of movement or non-discrimination – would be even worse for Europe.

Though the Germans share Cameron’s desire for a more competitive EU economy, they disagree with many other UK priorities. They oppose turning the ‘yellow card’ procedure – through which national parliaments can club together to ask the Commission to withdraw a draft law – into a ‘red card’, because they do not want to make it harder for the EU to legislate. They are hostile to Cameron’s desire for mechanisms to protect the single market against the risk of the eurozone imposing decisions on it, pointing out that the eurozone has never caucused; they suggest that what the British are really after is a veto for the City of London over financial rules. As for Cameron’s priority of preventing EU migrants from claiming in-work benefits such as tax credits, the Germans cite treaty articles banning discrimination on grounds of nationality. They point out that not only Poland and the other Central European states, but also countries like Spain would never agree to amend these articles.

Merkel’s advisers predict that she will ‘lead from behind’ during the British renegotiation, allowing Donald Tusk, the president of the European Council, to broker agreements among governments, while Jean-Claude Juncker, the Commission president, prepares relevant legislation. In dealing with the crises in Ukraine and Greece, Merkel has kept France’s President François Hollande at her side – to minimise the impression of German dominance and ensure that he is supportive. She will similarly enlist Hollande on the British question.

The final deal that Cameron obtains will mix EU-wide reform with UK-specific provisions. The mechanisms for delivering change will be varied: declarations and decisions of the European Council, as well as legislation and promises to amend the EU treaties at some unspecified point in the future. Those amendments will not happen any time soon. Most leaders view re-opening the treaties as a mad idea – nobody knows where the process would end, and several countries would have to hold their own referendums.

As for substance, Cameron will probably win an accord on ‘competitiveness’ that covers extending the single market, negotiating more trade agreements with other parts of the world and curbing unnecessary EU red tape (in fact the Commission is already doing these). He may get something on restricting immigrants’ rights to unemployment benefits, but nothing on tax credits unless the UK changes its own rules (for example, by introducing a residency qualification that applies to everyone, Britons included). He might win a treaty article promising to protect the single market, and an ‘emergency brake’ enabling any government to delay – but not stop – a decision that it thought damaged the market. On the treaties’ commitment to ‘ever closer union’, the British are unlikely to gain a full opt out, but words will be found to reassure them. The yellow card procedure could be beefed up so that national parliaments can more easily object to draft EU laws.

None of this will change the fundamentals of how the EU works. If Cameron tries to claim the contrary he will sound unconvincing. Besides, the essence of the campaign will be about whether Britain is better off in or out. Cameron likes the mantra that Britain should stay “in a reformed EU”, as it helps him to keep much of his party together. But if he wants to win the referendum, he will have to upset some Tories and admit that the EU per se is good for Britain. If he tries to keep both audiences happy, he will fail.

Charles Grant is director of the Centre for European Reform. An earlier and shorter version of this article appeared in the Observer on June 21st.

Wednesday, June 24, 2015

The four horsemen circling the European Council summit

Simultaneous crises are the new normal. Europe’s leaders must confront a quartet of challenges if they want to prevent the European Union falling apart.

Four horsemen will be circling around this week’s European Council. They represent four crises that threaten the EU: ‘Grexit’; the Mediterranean migration crisis; Russian aggression; and Britain’s threat to leave if the club is not reformed. Any of these issues could dominate the European Council’s agenda: each could alter the fundamental character of the Union. While none of them is particularly new – Greece's economic and financial woes have troubled the EU for six years – they are circling together and affecting each other.

‘Grexit’ looms first. The risk of a Greek default and possible exit from the eurozone is the most acute of the four crises.  Over the past several months, Greece’s creditors and the government of Alexis Tsipras have played a dangerous game of chicken. As a deadline approaches for Greece to repay the IMF €1.6 billion, it seems Greece may give in. An emergency summit on Monday brought renewed hope for a deal, as Greece offered more cuts to pensions and higher taxes. Tsipras now faces an uphill battle in the European Council to convince sceptical creditors like Germany and Finland, or fellow debtors like Spain and Portugal. For a deal to stick, the Greek leader must persuade sceptical members of his own party that he is not caving in to demands from Brussels. But even if a deal is clinched, as CER’s Christian Odendahl recently pointed out, a lasting solution to Greece’s economic problems will remain elusive. And so, despite the brinkmanship of the past weeks, even if Europe’s leaders hammer out an accord with Greece they may simply buy more time rather than remove the risk of Grexit.

Russia hovers over the ‘Grexit’ talks too. Should Greece leave the eurozone, it will need to attract credit, loans and investment from elsewhere, and Russia has shown an interest. This has strengthened Tsipras’ hand in the negotiations with Brussels. On Friday June 19th, the day after the Eurogroup failed to reach a Greek bailout agreement, Tsipras flew to Saint Petersburg for a meeting with Russia’s president Vladimir Putin and Alexei Miller, the head of Gazprom. The Greek leader signed a preliminary agreement to build a $2 billion pipeline across Greece, as part of Gazprom’s ‘Turkish stream’ project. The agreement is non-binding, but pokes a finger at the Commission’s plans to reduce the EU’s dependence on Russian gas imports. Tsipras’ flirtation with Moscow, at a time of high stakes negotiations with Brussels, has raised eyebrows. An increasingly Russia-friendly Greece would make it more difficult for the EU to maintain a unified position against Russian assertive behaviour in Ukraine and Eastern Europe.

Meanwhile, people continue to die on a daily basis in Ukraine’s ongoing conflict, though at less alarming rates than before. The ‘Minsk-II’ ceasefire is flawed, but most European governments are unwilling to give up on it. They think Russian help is needed elsewhere, such as the Iran nuclear talks and the Syrian civil war. As long as the fighting does not escalate dramatically, European leaders will not step up pressure on Russia to change its behaviour. Some leaders worry about the impact of sanctions on business (though statistics show the effect is limited), and argue that the current lull warrants a thaw in relations with Moscow. While France has cancelled the controversial sale of the Mistral amphibious ships, three European oil and gas companies have recently struck new commercial deals in Russia.

For now, however, the EU remains politically unified: most of the sanctions have been extended until January 2016, while those specific sanctions linked to the annexation of Crimea have been rolled over for a year. That unity may not endure, however. Regardless of what happens in the Donbass, by the end of the year, investigators will have published their official findings into the shooting down of flight MH17, which killed 298 people. One potential finding of the report could point to Russian complicity, either in delivering the missile system, or in the chain of command that led to the missile’s firing. European leaders will then need to decide whether to punish this crime or do nothing. A push for new sanctions could strain today’s delicate unity on Russia, while inaction would be a sign of weakness and an insult to the victims. The creation of an international tribunal to persecute the culprits may offer a sensible, but unsatisfying, middle road.

The desire to avoid ruffling Russian feathers means that Ukraine will not figure prominently at the European Council meeting either. But that is a mistake. Ukraine needs money: earlier this year Kyiv said that it required some $40 billion over the next five years, to avoid economic collapse, but with the economy continuing to deteriorate that sum now looks inadequate. As Charles Grant and Ian Bond have highlighted, some of that money is coming from the IMF, and some may eventually come via debt restructuring, but most of the money will need to come from the EU and the US. If Ukraine’s economy collapses, the ensuing political chaos would threaten the pro-Western leadership in Kyiv, handing Vladimir Putin the victory he has not been able to achieve through military force.

4 horsemen will be circling this week’s EU summit: Grexit, migration, Russia and Brexit

The third horseman circling is the migration crisis in the Mediterranean. In the first six months of 2015, 1,868 migrants have died trying to cross from North Africa. According to the International Organisation for Migration (IOM), some 114,000 migrants have reached Europe, mostly landing in Greece and Italy. In summer the weather is calmest and crossings increase, so both numbers are likely to rise. In response, the EU is trying to look tough. On June 22nd, it launched an Italian-led mission to monitor the maritime movements of smugglers. A subsequent stage of the operation would see European navies board and seize migrant ships, including in Libyan waters. Diplomats in New York are currently drafting the necessary United Nations mandate. The EU also wants the permission to destroy ships used by traffickers, although this is not likely to get international or Libyan support.

None of these measures will solve the migration crisis. The EU should take a broad approach, in terms of geography and reach. It will not be enough to track smugglers’ movements at sea, although it is a start. Gathering accurate intelligence on smuggling networks requires a presence on land or a credible Libyan counterpart with which to co-operate. And a focus on Libya makes sense at first, but smugglers could soon exploit the route of least resistance by shifting their activities to other parts of the North African coast. Many migrants are Syrian refugees, but a solution to Syria’s civil war remains out of reach. The EU must also review its development and humanitarian policies in transit countries like Libya, and in source countries across the African continent. A humanitarian tragedy cannot be reduced to a mere security challenge.

The tough debate in the European Council will, however, be less about the military mission or the EU’s foreign policy response, and more about migration’s ramifications within the EU. In May, the European Commission proposed a quota system, which would alleviate the burden on countries such as Italy and Greece, and redistribute 40,000 asylum seekers across the EU. Many, including the Central and Eastern European countries, object to this mandatory system. Under quotas, they would receive many more migrants than would otherwise be expected to make their way to them. Northern member-states also object because they ultimately feel these asylum seekers should be processed in southern Europe. Italy feels abandoned by the rest of the EU and has threatened to give migrants temporary visas so they can travel to other member-states. France has retorted that this might trigger the re-imposition of French border controls. The Schengen border code allows temporary border controls in exceptional circumstances, such as in the event of a serious threat to the internal security of a member-state. But in this case its invocation would not be the result of an acute threat to internal security, but of the breakdown of European solidarity. All this could cause a serious Schengen crisis, and draw into question one of the foundations of the EU – the free movement of people.

That leads to the fourth issue, which although not a crisis (yet) will preoccupy European leaders for the coming year. Britain’s prime minister, David Cameron, will outline his EU reform agenda at the summit meeting. He hopes to get results before an in-out referendum on EU membership, which may well take place in autumn 2016.

Among other things, Cameron wants to cut EU migrants’ access to benefits (particularly those going to people in work), in the hope that this would deter people from coming to the UK. This puts him on a collision course with several member-states, including Germany and Poland, which point out that this would violate EU treaty articles banning discrimination on grounds of nationality. The other member-states are very reluctant to open up the treaties to accommodate British reforms. They fear that one or other member-state would grab the opportunity to make special demands themselves. In some countries, like France, Ireland and the Netherlands, treaty change would trigger risky referendums. Cameron’s dilemma, however, is that a lot of Conservative backbenchers will not support his effort to keep Britain in the EU unless he achieves radical change.

Other British ideas may go down better in Europe, such as strengthening the EU’s ‘competitiveness’ by trimming cumbersome regulation, negotiating free-trade agreements and deepening the single market. The forthcoming European Council gives Cameron a platform to launch his renegotiation campaign, though for now he will avoid going into the details of what he wants. The secretariat of the Council of Ministers will be tasked with taking forward the detailed work, together with British officials. Cameron will find it hard to convince his European colleagues that they need to change EU policies and institutions in order to help him. As Charles Grant wrote recently, member-states fear that Eurosceptic backbenchers will push Cameron into demanding reforms that are unobtainable. The fewer allies Cameron has in the Europe, the tougher the negotiations will be, and the more the ‘British question’ will become an irritant in European politics.

The EU’s leaders will find it hard to tame these four horsemen. No country can afford to pick and choose which of these issues to take seriously and which not. All four are dangerous, and they all require a coherent European response. The four horsemen threaten the EU precisely because they raise issues that can only be solved if governments prioritise a European solution over narrow national agendas. If a European answer cannot be found, the horsemen will continue to promote chaos, instability and mutual recrimination within the EU.

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

Monday, June 22, 2015

The eurozone’s ‘five presidents’ report’: An assessment

The long-awaited report rightly aims to complete a financial union in the eurozone, but over-emphasises structural reforms and underplays the need for stronger counter-cyclical policies.

The eurozone in its current institutional setup may not survive the next severe political or economic crisis, and needs reform. The presidents of the European Commission, the European Central Bank (ECB), the European Council, the European Parliament and the Eurogroup have now presented their widely anticipated report – the ‘five presidents’ report’ – on how to complete the monetary union. It contains some important proposals, such as a strong emphasis on completing the banking and capital markets unions. But two key aspects are missing: a more activist ECB in order to prevent future shortfalls in demand, and strongly counter-cyclical fiscal policies at the national level. What is more, the case for a convergence of structural policies in the eurozone is less strong than the report assumes.

The report contains four sections, devoted to the economic, financial, fiscal, and political union respectively. Each of these unions is divided into two stages, the first to be completed by June 2017 and the second by 2025. The economic union concerns the co-ordination and implementation of economic policies such as labour market reforms, and aims to foster structural convergence among eurozone countries towards common standards (formalised as a ‘Maastricht’ for structural policies in stage two, similar to the original convergence criteria before the introduction of the euro). It also seeks to strengthen the implementation of the macroeconomic imbalance procedure (MIP, the eurozone’s monitoring system to prevent crises), and to introduce national ‘competitiveness authorities’ to monitor wage developments.

The financial union aims to complete the banking union, including common deposit insurance and a full and common backstop for the banking union’s resolution capacity. It also seeks to speed up the creation of the capital markets union, and the report suggests a proper European securities market regulator in the future. The fiscal union focuses on strengthening and streamlining the current rule-based setup, as well as the creation of a ‘fiscal stabilisation function’ at the eurozone level in stage two which tries to tie European investments to the business cycle. The political union seeks to better integrate the European semester (the coordination of economic policies) into national and European democratic processes.

What the eurozone needs

Four main shortcomings of the eurozone architecture contributed to the current crisis. First, the ECB allowed demand in the eurozone to fall below trend by conducting less aggressive monetary policies than was needed. Second, national fiscal policies were not counter-cyclical enough, both before and during the crisis. That means, policy did not lean against the wind when too much or too little demand forced wages and prices to veer off course before the crisis; and spending and tax policies were pro-cyclical during the downturn, aggravating the recession. Third, sovereign debt in some countries was allowed to reach critical levels; and because no lender-of-last-resort to governments existed, liquidity problems became insolvency crises. Finally, the banking sectors of many member-states grew too large and took on too much risk. While this also happened outside the eurozone, the lack of a common backstop meant that eurozone governments were tasked with supporting their national banking system, which destabilised government finances, too. It also meant that banks in some regions were unable to provide financing for the economy, and capital markets were to underdeveloped to pick up the slack. If the eurozone had been a true monetary union, like the US, banks and capital markets would instead have helped to spread economic shocks across the whole monetary union.

The five presidents’ report does not address the first issue at all – despite the severe fall in inflation and inflation expectations in the last two years, and the ECB’s hesitation to implement more aggressive steps such as ‘quantitative easing’ to pre-empt such a fall. There are political reasons for not touching the ECB and its mandate: the ECB is the most reliable and unconstrained institution in the eurozone. Opening a Pandora’s box of changes to its mandate or its institutional role could unsettle a delicate political balance. But at least an acknowledgement that the ECB needs to do its utmost to keep demand in the eurozone stable – something it has persistently failed to do during the current crisis – should have been included.

“It is a mistake to leave out the ECB’s monetary policy from the report.”

The second issue, counter-cyclical fiscal policy, is addressed half-heartedly. The report emphasises that fiscal policy needs to be set counter-cyclically, at both national and eurozone levels. But the five presidents aim to strengthen the existing fiscal rules that emphasise debt reduction and for which counter-cyclical policy is an afterthought. The IMF has recently shown how strongly counter-cyclical policy contributes to stronger and more robust economic growth. This applies with added urgency to members of a monetary union that by definition lack independent monetary policies and currencies to cushion economic swings. The urgency is increased still further if the monetary union concerned has trouble exiting a long economic slump, as the eurozone does.

The report should have put counter-cyclical national fiscal policy at the centre of its recommendations on fiscal matters, and urged policy-makers to review the eurozone’s fiscal rulebook in that light. Of course, the five presidents do want to strengthen the MIP. However, correcting imbalances once they appear is not the same as preventing them. Moreover, the MIP in its current form is of little use during the downturn. The report does call for the aggregate fiscal stance of the eurozone (the combined fiscal policies of eurozone countries) to be appropriate for the eurozone business cycle. This is a welcome contribution to the eurozone governance, if it can be agreed – not least because it would force a country like Germany to invest more for its own sake. But the emphasis on a eurozone fiscal stance also makes the omission of monetary policy (which serves essentially the same purpose as the aggregate fiscal stance: to stabilise the eurozone business cycle) all the more striking.

The ECB’s lender-of-last-resort function to governments is rightfully excluded entirely from the report. While such a function is of fundamental importance for the stability of a monetary union, the ECB’s OMT programme has so far been remarkably successful in arresting panic in bonds markets. Given how controversial this programme is in countries like Germany, policy-makers should not waste precious political capital on trying to formalise the ECB’s role as the eurozone’s lender-of-last-resort.

The report urges the eurozone to complete the banking union, and make significant progress on the capital markets union, by 2017. This is a laudable and ambitious agenda. In a more complete monetary union like the United States, private financial connections across state borders help to cushion regional economic developments. For example, if a business in Florida is owned by investors in Boston, both a boom and a recession in Florida will be felt in Boston, too, thereby spreading both gain and pain. Such a ‘private risk-sharing’ across states has been shown to be just as important as fiscal risk sharing in smoothing the business cycle. In the eurozone, such private cross-border risk sharing is underdeveloped, both because cross-border ownership and capital flows are underdeveloped. Banks, in addition, are so closely tied to their sovereign and to their regional economy that in a crisis, they destabilise rather than stabilise the government and the economy. De-coupling banks as much as possible from their sovereign, and making sure that capital markets and banks are diversified across the monetary union, is a crucial step toward making the monetary union more resilient, and the report is rightly setting ambitious goals both in scope and in timeline.

“Completing the financial union is a laudable and ambitious agenda.”

Why the focus on structural reform and ‘competitiveness’?

The report puts a strong emphasis on ‘competitiveness’ and structural convergence between countries, under the headline ‘economic union’ – which not coincidentally is the first chapter. And yet, the four issues outlined above were much bigger reasons for the crisis in the eurozone than the lack of structural reforms. Divergence in wages and prices, for example, was mostly a symptom of the weakness of counter-cyclical policy. Of course, the right mix of structural policies may well help countries to grow faster. But the problem is that economists do not understand very well which combination of structural policies in what sequence is most conducive to economic growth. The best hope for finding the right mix of structural policies is not an outside actor that moves a country closer to some defined benchmark; rather, it is the constant bargaining and local problem-solving that democracy is still best-placed to deliver.

Can the emphasis on economic union be explained politically? There is a political case for structural convergence. If there is ever going to be a true fiscal union, including risk sharing and temporary fiscal transfers, it needs political legitimacy, especially in the currently stronger countries. Such legitimacy is easier to establish if the public of a stronger country does not have the impression that it subsidies a more generous welfare state or laxer labour markets policies elsewhere. This is implicitly the argument that the report makes. But there is also the opposite political case. Since a true fiscal union is not on the cards, the outside meddling in domestic policy issues (and that is how the aim for structural convergence will be perceived in most countries) will delegitimise the eurozone, especially if the focus on structural policies does not improve the citizens’ economic well-being. The proposed measures to create a political union – for example to strengthen parliaments’ involvement in the European semester – are well-intentioned but unlikely to create the European polity that could overcome such national categories of thought and allegiance.

The five presidents’ report is a welcome attempt to focus the discussion on the institutional setup needed to make the euro a success. However, given the limited political appetite for further integration, it is important to focus reform efforts on where they are needed the most: to complete the banking and capital markets unions, as the report rightly recommends; to make the ECB a more activist central bank; and to make national fiscal policy strongly counter-cyclical. Such a policy mix would also be the best hope for escaping the eurozone’s current economic slump. The main obstacle to the implementation of the report will be Germany: neither common deposit insurance nor a common backstop for the banking resolution fund, nor an aggregate eurozone fiscal function and a strengthened MIP (which would target Germany’s current account surplus) will be to the Germans’ liking. If forced to make a choice, Jean-Claude Juncker should focus his political capital on completing the financial union first.

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

Thursday, June 11, 2015

Greece: After a deal, work on a solution

A deal between Greece and its creditors is still likely. But what the country really needs is a Greece-led, cross-party plan to transform its institutions – and less restrictive fiscal policies. 

The current negotiations between Greece and its creditors are entering the final stages – cue the involvement of Angela Merkel and François Hollande. The positions are still far apart – mostly on labour market and pension reforms that not only Syriza but also the previous Greek government refused to implement. The crucial deadline is now June 30th, when Greece promises to pay €1.6 billion to the IMF, after bundling repayments at the end of the month, followed by a €3.4 billion repayment to the ECB in July.

A deal on these reforms and fiscal targets will probably be reached in the end: neither Alexis Tsipras and Syriza, nor Merkel and the eurozone have an interest in Grexit. However, a deal will be a short-term fix rather than a long-term solution. Instead, Greece must formulate a long-term, cross-party package that addresses its institutional problems and is supported across Greek civil society. The creditors, on the other hand, need to back such a long-term plan, and put more sensible fiscal targets and debt relief on the table. If both come together, we may move toward a solution, not just a deal.

The politics of a deal

The key political question is: can Tsipras, Merkel and the leaders of other wary eurozone governments sell a deal to their own parliaments and electorates?

If Syriza were to reject a deal along the lines currently discussed, the party would probably split, opening the way for new elections, and excluding the more radical part of Syriza from power. While the polls currently suggest that Syriza has a comfortable lead, the consequences of rejecting a deal – which could result in bank closures and capital controls – might convince voters to give more moderate voices another chance. After all, polls still suggest that a majority of Greeks want to keep the euro, and want a deal in the end. Syriza is therefore likely to back Tsipras when he decides to put a deal to a vote.

Merkel frets about the wider risks of Grexit – the stability of the euro, the EU’s standing, but also the geopolitical implications of weakening a state at Europe’s crucial south-eastern border. She will not let it happen unless something forces her hand. Could that something be her finance minister, Wolfgang Schäuble, alongside CDU rebels? The answer has to be no: reports of a Schäuble-Merkel split are overblown. Schäuble can play the hawkish finance minister, which boosts his domestic popularity, because he knows that Merkel will step in to broker the compromise needed to prevent Grexit. The CDU is with reason dubbed the Kanzlerwahlverein – the “Chancellor’s supporters’ club” – by the German press. In the end, they will back Merkel, minus a few rebels.

Other eurozone countries will probably agree if Germany agrees, as they either tend to align with Germany, such as Finland, or have a less hawkish stance than Germany, such as France and Italy. For Portugal and Spain, it is important that the deal is not seen as an easy way out for Greece, as the governments in Lisbon and Madrid, which both have pushed through harsh adjustments and reform packages, are up for re-elections later this year.

The economics of a deal

The most controversial issues in the negotiations are labour market and pension reforms, and the pace of fiscal consolidation. Greece has liberalised its labour market considerably since 2011, and it is now more flexible than Germany’s, according to the OECD. Partly as a result, Greek labour costs and prices have fallen considerably (see Chart 1). And yet, exports other than tourism have largely failed to grow – contrary to those of other countries in southern Europe. Labour market inflexibility is thus unlikely to be holding back the Greek economy.

Greece’s labour market is already more flexible than Germany’s

Chart 1: Unit labour costs and GDP deflator in Greece and the eurozone
Source: Eurostat, Haver
Notes: Q1 2000 = 100. Unit labour costs measure labour costs per unit of output; the GDP deflator is a price index for the whole economy, not just consumption, as measured by the consumer price index.

The formerly very generous Greek pension system has already been substantially reformed. Further adjustments are necessary, but mainly because pension funds lost assets in the 2012 restructuring of Greek public debt, and the economy has collapsed, depriving the system of revenues. To make the system sustainable in the long term, further adjustments will have to be made, even more so with the recent court ruling against part of the cuts. However, the key to making the pension system sustainable is economic growth, not more cuts in entitlements. The political capital that could be wasted on another pension reform – with 45 per cent of pensioners already below the poverty line – would be better spent on measures to promote growth and employment.

The fiscal adjustment of Greece has been massive. The IMF calculates that spending cutbacks and tax increases amounted to 16.5 per cent of GDP between 2008 and 2013, roughly twice as much as Portugal or Ireland. The impact on the Greek economy has been devastating, increasing rather than decreasing the ratio of public debt to GDP. That the creditors still argue, despite overwhelming evidence to the contrary, that fiscal consolidation in an economic crisis reduces debt levels can only be explained by their huge investment in this false narrative. Even Sweden failed to consolidate its public finances in the early 1990s before economic growth resumed. The focus on fiscal consolidation in Greece is economically misguided.
Even Sweden failed to consolidate its public finances in the early 1990s before economic growth resumed.

What Greece really needs

What stands between Greece and prosperity is not another labour reform or wage cuts to make the economy more ‘competitive’, nor further fiscal consolidation or a pension reform to instil confidence in investors. The real issues are deeper than that. In order to unlock the potential of Greece, its entrepreneurial skills and underused natural resources, Greece needs to improve the institutions that govern its economy. 

First, Greece needs to reform its public bureaucracy, which has been opaque, inefficient, and clientelistic for decades. Successive reform attempts have largely failed, and the Greek public bureaucracy remains subject to heavy political influence. Since the crisis, Greece has made some progress, for example in tackling corruption, but the momentum for change was fading even before Syriza came to power. The problem is that institutional reform cannot happen without broad support from Greek society, politicians and bureaucrats themselves – and even then it will not happen easily, and take time.

Second, Greece needs decisive reform to its judicial system. A functioning legal system is at the heart of a market economy; it benefits entrepreneurs, investors, exporters, and lowers inequality. It currently takes 1,580 days to enforce a contract in Greece, according to the World Bank’s ’ease of doing business’ survey (the OECD average is 540 days). This places Greece 155th of 189 countries in the world, right alongside Chad, Pakistan and Italy. The broader rule of law index of the World Justice Project puts Greece at the bottom of high income countries, just above Russia. Justice reform usually takes a long time, and hence needs broad political and public support to be sustainable.

Third, Greece needs to cut unnecessary regulation and state involvement in product markets. Regulation serves the purpose of making product markets work better and minimising legal costs, but can also enable incumbents to stifle competition. The regulated therefore have an incentive to influence policy-makers to tweak regulation in their favour. State control of the economy, while useful in some areas, needs to be limited for the same reason: price controls and state companies are potential breeding grounds for clientelism. Greece uses more product market restrictions and state control of the economy than other eurozone countries, according to the OECD, although it should be noted that it has made progress in recent years and is now where Germany was in the not-so-distant past (see Chart 2). The OECD has compiled a list of 329 recommendations to improve competition in various Greek sectors, and those recommendations are part of the current negotiations. However, such liberalisation could prove short-lived if not complemented by judicial and bureaucracy reform.

Chart 2: Regulation and state control of product markets
Source: OECD
Notes: A high number indicates more regulation and higher state control.

Tackling these problems will take Greek ideas, Greek resolve, Greek perseverance – and not outside pressure. Support for reform will always be grudging if it is done at the barrel of a gun. Greek civil society and a broad coalition of political parties need to join forces and agree on a package to change these institutions sustainably, such that it is implemented regardless of the outcomes of future elections. The progress of the reform process should not be monitored by an outside actor, micromanaging Greek policies, but by a council consisting of Greek experts, Greek civil society and media, and the major political parties in parliament. Only with full ownership of the reform process can the institutions of the country be reformed.

If Greece puts together such a cross-party council and programme, the creditors should embrace it enthusiastically – and offer support in the form of less restrictive fiscal targets and the explicit and binding promise of debt relief upon the successful implementation of such a genuinely Greek package. At the very least, Greece needs fiscal policy to be neutral: that is, neither expansionary nor contractionary. Ideally, fiscal policy would be expansionary until the economy has recovered its lost output and unemployment has come down sharply. Fiscal policy is also the reason why debt relief matters: not only would a lower debt level reduce the need for further consolidation under the eurozone’s fiscal rules; lower debt levels would also increase the shock absorption capacity of the Greek economy in a future downturn by enabling the Greek government to avoid the pro-cyclical fiscal policies that it was forced to implement over the last five years.

Of course, Greece would need time to put such a package together, which is why a short-term deal at the current juncture seems necessary. After the deal, however, Greece and its creditors should start working on a solution, not just a deal.

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

Wednesday, June 03, 2015

Know your enemy: How to break the EU’s gridlock on security measures

Terrorism and organised crime are serious threats to Europe. The EU is better placed than the member-states to deal with the transnational aspects of these threats. But disagreements between the Council and the Parliament result in gridlock over security measures. One reason is that sensitive information cannot be shared with MEPs, leaving them in the dark about both the threats and the means to deal with them. If the EU wants to tackle the threat of terrorism effectively, MEPs should be given adequate access to confidential information.

In February 2010, three months after the Lisbon treaty entered into force, the European Parliament rejected, for the first time, an international agreement concluded by the EU. The Lisbon treaty gave the European Parliament powers in the field of Justice and Home Affairs, including the power to ratify international agreements on security and counter-terrorism. The Parliament refused to ratify an agreement with the US on a Terrorist Finance Tracking Program (TFTP). The Council of Ministers and the US had spent the previous three years negotiating this agreement to trace the financial data of potential terrorists. TFTP used data provided by SWIFT, a Belgium-based company that processes international bank transfers. After the Council and the administration of George W Bush managed to reach an understanding, the European Parliament posed an unexpected obstacle. Amongst other things, the Parliament claimed that the Council had not provided MEPs with the necessary security information to show why the TFTP system was needed. The Council, however, was reluctant to disclose too much sensitive information on threats and foiled plots. And so the EU’s struggles in the area of privacy and security started.

Five years later, these struggles are far from over: institutional rows between the European Parliament and the Council have stopped the passage of several pieces of legislation (such as the EU Passenger Name Records directive (EU PNR), Europe’s system for exchanging information about airline passengers departing for or arriving from third countries). Revelations by former US National Security Administration contractor Edward Snowden on the breadth of US spying programme have eroded support for transatlantic data-sharing and other forms of co-operation (like the Transatlantic Trade and Investment Partnership, TTIP). For the first time ever, the European Court of Justice has annulled a directive (the data retention directive, which required telecoms companies to retain certain data for a period of up to two years and was championed by the UK). And international partners have definitely not figured out who to call in Europe to discuss security issues. The EU is suffering from a worrying paralysis on security measures.

This gridlock is risky: as exemplified by the recent attacks in Brussels, Paris and Copenhagen, terrorism and organised crime are, more than ever, international phenomena that require supranational responses; if the institutions do not manage to sort out the problems derived from the post-Lisbon arrangements, the EU’s security could be endangered.

When facing cross-border criminal activities, such as terrorism, having 28 different systems and legal frameworks in place is inefficient and expensive. Different standards in data sharing systems, for example, can lead to situations where information is not transmitted quickly enough between member-states. This can result in suspects being able to cross borders without being detected and make it harder to foil transnational plots. It also means more costs for the companies that need to implement the various standards (such as banks or aviation companies). Despite recent events, however, the current tendency seems to be towards less, rather than more Europe. Member-states retain many competences in the field of internal security. Unlike in other areas, such as Schengen, EU action is not compulsory. The blocking of the EU PNR directive, which has been under discussion since 2011, has prompted the adoption of national PNR systems, funded by the European Commission. While however, some member-states (like Germany) are very sensitive to data protection issues, others (like the UK) are not. Having several PNR systems in place, with different sets of safeguards and protections, will make the system less efficient and more expensive. An EU PNR system would ensure, in absolute terms, a more effective system with a higher level of data protection that would apply uniformly across the EU.

The gridlock over security measures in the EU is also detrimental to Europe’s transatlantic relations. The EU is currently negotiating a ‘Data Protection Umbrella’ agreement with the US. This deal will establish a general data protection framework applicable to all transatlantic data transfers for law enforcement purposes. With this agreement, the EU and the US hope to avoid having to negotiate data protection clauses every time a deal on information sharing is on the table.

The EU and the US are considering including transatlantic ‘data flows’ as part of the negotiations for a Transatlantic Trade and Investment Partnership (TTIP). In the wake of the Snowden revelations, there has been a public backlash against this move, due to concerns about the US framework for protecting private data. Dialogue between the EU and the US has become more constructive, but America is still unsure of who would be at the end of the line when it calls Europe to discuss security matters. And the US is getting frustrated by the institutional rows that break out every time security is at stake. The US may eventually bypass the EU as an institution and negotiate bilateral agreements directly with the member-states. This would be detrimental to the EU’s role in promoting global security, and to the efficiency of the fight against security threats in Europe.

There is a way to overcome this stand-off in the field of security. At present, the European Parliament is left in the dark about both the nature of the threats Europe faces and the kinds of tools law enforcement agencies and intelligence services need to combat them. The result is suspicion and misunderstanding. The Parliament should receive enough information to assess the real utility of security measures. This would help it to take informed decisions in the security field and contribute to a more productive dialogue between the Parliament, the Council and third parties, such as the US.

Under the current framework, the Council can only give access to confidential information to MEPs if they already have the necessary security clearances. Because security clearances are a matter of national competence, the process for obtaining them differs greatly from country to country. Some MEPs may find it easier to obtain their clearance than others. Some national administrations may not even want to issue clearances to their MEPs at all: in Ireland, for example, national MPs are not given access to any sort of confidential information. It would be difficult for the Irish administration to justify why its own national MPs do not get to access such documents while their European peers do. Moreover, many MEPs regard national vetting processes (which may include interviewing and researching friends and relatives) as highly intrusive. For these or other reasons, few MEPs are currently security vetted.

An EU security clearance system would help solve some of these issues. But such a system is currently out of the question: the EU does not have either the competence or a security agency of its own to conduct the investigations. One way to solve the problem of access to confidential information would be to set up a small group of MEPs with the necessary security clearances from their own states. The security-cleared body would have to have long-term, fixed membership. This group of MEPs would be responsible for evaluating the usefulness of tools such as PNR or TFTP on the basis of the confidential information it received. Such a group would facilitate communication between the Parliament and the Council, and would help to break the institutional gridlock, both within Europe and in the EU’s international agreements with partners such as the US.

For this system to work, both the Parliament and the Council would need to make concessions. The Council should step up its efforts to explain sensitive internal security matters to parliamentarians. It should also encourage national administrations, which may be reluctant to issue clearances for their MEPs, to do so. MEPs (and, specifically, members of the proposed security-cleared group) should accept that they will have to undergo the same security clearance procedure as any EU or national official who has access to confidential information.

The European Parliament is no angel, nor is the Council the devil. They represent different interests but they are both equally necessary for ensuring the EU’s security. They should put aside their differences over the Lisbon treaty division of labour and start working together. Europe’s security and transatlantic relations depend on this.

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

Wednesday, May 27, 2015

How will the eurozone cope with the next downturn?

Spring brought a burst of sunshine over the eurozone economy. The French economy expanded rapidly in the first quarter of 2015 and even the Italian one managed respectable growth. Fiscal policy is no longer contractionary across the eurozone as a whole. Cheaper oil is boosting consumption. A weaker euro is boosting exports. And the ECB's quantitative easing appears to be working: money supply growth is picking up, suggesting deflationary pressures are easing.

But it would be risky for eurozone policy-makers to mistake a modest cyclical upturn after years of stagnation for something more than that. First, business cycles are getting shorter and downturns deeper. The reasons for this are complicated but globalisation and increasingly complex financial linkages between countries appear to be playing a part. Nobody knows how long this eurozone cycle will last but it is probably fair to assume that we are already some way into it.

Second, when the next downturn comes, the eurozone is going to be poorly placed to handle it. There is little to suggest that the current upturn will be strong enough to undo the damage caused by the crisis. Eurozone growth is unlikely to exceed 2 per cent even at the peak of the cycle, with growth in the weaker economies much lower. This will not be enough to render debt sustainable (whether public or private). Given the amount of slack in the eurozone economy, unemployment will remain high and inflation pressures weak. Against this backdrop the ECB is unlikely to raise interest rates, meaning that it will have no room to cut them in an effort to counter the next downturn.

Furthermore, the eurozone has largely failed to address the underlying institutional weaknesses of the currency union. The reforms that have been made basically comprise crisis management tools and rules, whereas the crisis has demonstrated that monetary union without fiscal and financial integration is unstable. Unfortunately, there is little appetite for this integration, especially now that the eurozone is growing. Meanwhile debt burdens continue to grow in the weaker economies and the eurozone governments refuse to acknowledge the need for debt write-downs.

The eurozone needs further fiscal and financial integration to prevent its members from having to pursue precisely the opposite macroeconomic policies to the ones they need. Eurozone countries have given up the safety valve of an independent currency and monetary policy, hence need an even larger shock absorber in the form of fiscal policy.
Not only does the eurozone lack any fiscal transfer mechanism, but the rules of the fiscal compact tightly circumscribe the ability of member-states to impart counter-cylical fiscal stimulus.
As it stands, the eurozone is a mechanism for divergence among its members, not convergence: real interest rates are highest in the weakest countries, lowest in the strongest. This almost guarantees divergence as capital and the more productive labour become concentrated in the core. This state of affairs persists in currency unions such as the US, the UK or Germany, but the negative effects of it are offset by fiscal transfers between the participating regions or states. The banking union is work in progress: regulation has been federalised but risk not mutualised; banks are still largely back-stopped at national rather than federal level.

What happens regarding Greece will have a bearing on how the eurozone copes with the next downturn. If Greece leaves the eurozone, the ECB might well be able to contain the immediate financial fall-out. But a Greek exit will end the irreversibility of membership. Unless it acts as a catalyst for closer integration, the risk is that the eurozone will come to look like an exchange rate mechanism rather than a currency union. This will increase the likelihood of speculative attacks on the weaker members come the next recession.

The eurozone is all but certain to go into the next downturn with interest rates close to, or at, zero, high levels of public and private sector indebtedness and unemployment still well above pre-crisis levels. The ECB will be able to employ quantitative easing, but its effects will probably be exhausted by then. Critically, there will be little scope for fiscal policy to counter the weakness of private sector demand, especially in the countries most in need of it. And weak banks in struggling countries will essentially still be back-stopped by fiscally constrained governments.

In short, many eurozone governments could face the prospect of further deep recessions despite having barely recovered pre-crisis levels of activity, amid persistently strong support for populist parties. The politics of this is likely to be combustible. At this point it could be make-or-break regarding the bigger institutional questions hanging over the eurozone. It is possible eurozone governments will bite the bullet and agree a fiscal union including a degree of risk mutualisation and transfers between participating economies. But this could prove politically impossible.

The euro is not out of the woods. Eurozone reforms have not abolished the business cycle and the need for counter-cyclical fiscal policy. There is little to suggest that the current upturn will be strong enough to bring down debt levels or enable the ECB to raise interest rates in any meaningful way. But there is much to suggest that the upturn will be used as a justification for further delaying the adoption of the federal structures needed to make the euro a success.

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

Don't mention Beijing: The EU and Asia's maritime security

The security challenges facing EU member-states and south-east Asian countries are strikingly similar. Both regions have difficulties with their neighbours: assertive Chinese claims in the South China Sea are a less dramatic version of Russia's annexation of Crimea; refugees in boats and illegal migration are creating humanitarian and security challenges, and piracy threatens sea-borne commerce. More co-operation between the EU and ASEAN (the Association of South East Asian Nations) on maritime security could help both of them, but it could especially contribute to south-east Asian security.   

Mention maritime security at an ASEAN meeting and the conversation quickly turns to China and the South China Sea. Five of its six littoral states are members of ASEAN. But China claims 80 per cent of the South China Sea, including its islands, rocks and reefs and the natural resources it contains. That does not go down well in the region. The most recent spat arose when satellite photos showed China reclaiming land, erecting infrastructure and even building a runway on Mischief Reef and Fiery Cross Reef. These semi-submerged reefs are part of the Spratly island group, some or all of which is claimed by Vietnam, the Philippines, Taiwan, Malaysia, Brunei and China. In this tangled mess of maritime disputes, China’s construction work creates new brick-and-mortar facts and further weakens prospects for international dispute settlement. On April 28th, increasingly alarmed by Chinese moves, ASEAN's ten member-states adopted an uncharacteristically unified position, saying that the land reclamations "eroded trust and confidence and may undermine peace, security and stability in the South China Sea." South-east Asian officials next expect China to declare an air-defence zone over a major part of the South China Sea, in a further step to bring the sea under de facto Chinese control. Not surprisingly, all littoral states have been investing in submarines, ships or other capabilities as part of a naval arms race.

For Europe the main concern is that trade disruptions resulting from tensions in the South China Sea affect European companies and consumers. The EU is ASEAN's second largest trading partner; the largest source of foreign direct investment, and main development aid donor. The EU has concluded, or is negotiating, free-trade agreements with nearly all ASEAN members. Thus, Europe shares south-east Asia's interest in maritime security.

That security is not only jeopardised by Chinese assertiveness; boatloads of migrants from Bangladesh and refugees from Myanmar pose a challenge to the Thai, Malaysian and Indonesian authorities. European states are also grappling with the migration issue. In April, the European Council held an emergency meeting after more than 800 migrants died when their boat capsized in the Mediterranean. The European Commission now wants to disrupt the smuggling networks. Some ASEAN governments, controversially, opt to turn the boats around, leaving the refugees to face uncertainty and peril. The symmetry of the threat posed by illegal migration, and the diversity of their responses, should convince the EU and ASEAN at least to share their experiences of approaches that work.

Piracy is another area where the two regions share interests. Since 2008 European navies have co-ordinated a multinational anti-piracy mission off the Horn of Africa, to which some Asian navies have contributed, including those of Singapore and Malaysia. In the Straits of Malacca, since 2004, four littoral states have organised a patrol with aircraft and naval vessels to increase security in the strategic waterway. Both operations have had success, as piracy rates have dropped, although the threat remains and the two organisations should share lessons learnt.

ASEAN's main geopolitical challenge, however, is the rise of China. The organisation is too divided and weak to balance China's growing influence. Individual states, such as Thailand, the Philippines and increasingly Vietnam, look to Washington for help. Simultaneously, these and other governments express concern at being caught in the middle of a Sino-American 'great power' clash. Stronger relations with the EU could offer a way for south-east Asian states to hedge; to avoid being overly dependent on either Washington or Beijing. In a region of intense geopolitical competition, the EU is welcomed as a non-threatening party that promotes multilateral, not zero-sum, solutions.  Meanwhile Europe, reluctant to play the part of America’s junior partner but increasingly aware of its economic and security interests in Asia, is slowly finding its voice.

In 2013, the EU and ASEAN set up a high-level dialogue focused on maritime security. This dialogue could eventually contribute to resolving South China Sea disputes by encouraging ASEAN to act coherently on maritime issues, although this is not its official objective. For now, the question of how to handle China is too controversial for ASEAN. And so, the EU and ASEAN talk about a response to China's actions, without actually mentioning the big neighbour: after all, many of the things ASEAN could do to counter piracy, illegal migration or smuggling would also improve the region's ability to monitor, respond to and possibly discourage Chinese moves in disputed areas of the South China Sea.

The EU should offer its support and expertise on maritime security – drawing on its own experiences. By focusing on issues like people smuggling or piracy, Europe's involvement in south-east Asian security affairs will increase; it will build trust between the two organisations, and, by making maritime security about more than just China, it will invite the involvement of all members of ASEAN, not just those who have problems with Beijing.

As part of its dialogue with ASEAN, the EU should launch practical and political initiatives. On the practical side, resolving technical issues related to data sharing and analysis between coast guards and other regional agencies would improve maritime awareness. The EU could also help ASEAN member-states identify shortfalls in their maritime assets and develop ways to resolve them. On the operational side, the EU and ASEAN should organise joint exercises and training, for instance in the field of search and rescue operations. European navies, coast guards and Frontex – the EU’s border agency – should share experiences (whether positive or negative) from Operation Triton, the EU’s border security mission in the Mediterranean. The EU could give advice on how to organise civil-military missions with a group of 28 diverse member-states. At the political level, the EU should help ASEAN develop common norms for policing its maritime zone. This could result in a code of conduct that respects international maritime law and the freedom of navigation. This would help countries in the region to defuse tensions and avoid misunderstandings.

These measures will not easily change the security dynamic in the region, but they would better equip south-east Asian nations to respond to maritime challenges. They may be designed to address non-traditional security issues like piracy or illegal migration, but a more coherent and capable ASEAN would also offer the best chance of deterring risky Chinese manoeuvres. Sometimes it is best to pretend that the elephant is not in the room.

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

Five ways to win a referendum, and five potential pitfalls

David Cameron's new Conservative government is committed to a referendum on EU membership in 2016 or 2017. Many commentators assume that he will negotiate a package of EU reforms, cajole much of his party to back the result, and then cruise to victory in the referendum. And so he might. But there’s many a slip twixt cup and lip. How can Cameron maximise his chances of winning? And what are the chief obstacles that lie in his path?

Here are five pieces of advice for Cameron. First, he should not over-bid. Many Conservatives will urge him to ask for the moon. But if he tries to make fundamental changes to the EU, he will fail. Britain’s partners have no appetite for a new treaty, which would need ratification in 28 member-states, in some of them by referendum. Most capitals, including Berlin, fear that the lengthy process of changing the treaties would be like opening Pandora's box. There is no chance of a new treaty being ratified before the end of 2017. The best that Cameron can hope for is an agreement on minor treaty changes, to be ratified at some point in the future.

Second, Cameron must start making the case for EU membership. He did so with his Bloomberg speech of January 2013 – but never followed up, for fear of annoying Conservative eurosceptics and potential UKIP voters. Britain's partners will not take Cameron seriously until he is willing to explain to the British the benefits of EU membership – and thus to make enemies in his own party. Cameron must grasp the nettle that at some point in the campaign his party will split into two hostile camps, perhaps undermining its long-term cohesion.

Third, Cameron should take initiatives in the EU and seek to lead in areas where Britain has expertise. One reason why Britain's influence has waned in recent years is that it has often sat on the sidelines and appeared happy for others to lead. Britain's EU partners would listen to it with more respect if it made concrete proposals in areas such as foreign and defence policy, climate and energy, trade and the single market or co-operation on policing and counter-terrorism. They would welcome a more pro-active Britain.

Fourth, he must work hard at building alliances in the EU, where he has few good friends. When the European Council chose the new Commission president last June, only Hungary's Viktor Orban joined Cameron in voting against Jean-Claude Juncker. Angela Merkel is a friend on a good day, but she and Cameron are prone to misunderstand each other (as they did over Juncker's appointment). Other leaders sometimes complain that Cameron is a very transactional politician who does not invest sufficient time in building relationships. Britain's ties to the Central Europeans have frayed in recent years, partly because of the Conservatives' anti-immigration rhetoric. But the problem is not just the Conservatives. Under the last Labour government, too, many of the EU’s smaller members complained that British ministers and officials seldom took them seriously, for example by making the effort to visit them to discuss areas where they could work together.

Fifth and finally, clubs have not only rules but also mores. British politicians tend to forget that their rambunctious style of domestic politics – involving confrontation, bluntness and a win-or-lose psychology – goes down badly in Brussels. The EU works through long negotiations and compromises that end in everyone feeling that they have got something. Sometimes Cameron gets this: two years ago he worked patiently with Germany and other partners to forge a deal that shrank the EU budget. Sometimes he does not: during talks over the Commission presidency, Cameron told one leader that Juncker's appointment could prompt him to campaign to take Britain out of the EU. Such threats alienate potential allies.

Cameron is an intelligent, successful and – so far – lucky politician, who will probably get some of these things right. But as the last few decades of European history show, governments often lose control during referendum campaigns on EU issues. Here are five things that could go wrong.

First, Britain’s highly-charged debate on Europe may not only spur Conservative eurosceptics to demand reforms that are unattainable, but also damage the already tarnished British brand, and so make it harder for Cameron to clinch a good deal with his partners. In recent years, for example, sometimes hysterical press reports on EU immigrants have led many people on the continent to view Britain as a nasty country. The government's current refusal to take any North African boat people, and the prospect of Britain quitting the European Convention on Human Rights (so that it would join Belarus as the only European non-signatory) do nothing to help. The worse Britain’s reputation, the less likely are other governments – who all have their own domestic politics to worry about – to give Cameron what he wants.

The second reason to worry is that other EU leaders may not make significant efforts to help Cameron. True, they hope Britain stays in the EU. But Cameron has nothing to offer them in exchange for their concessions. Several governments have indicated that they will not agree to his probable demands and that if the British choose to leave, that is their problem. Madrid, Paris and Vienna are three capitals where there is not much sign of a willingness to accommodate British desires.

The third worry is that a flaming row over migration during the renegotiation may energise the get-out campaign. For Cameron, and many Britons, the priority will be to restrict EU immigrants' access to in-work and out-of-work benefits. Some of Cameron's demands challenge the fundamental EU principle of non-discrimination and thus require treaty change. But as my colleagues Camino Mortera and John Springford have written, Britain's partners are in no mood to indulge Britain on this. The danger is that Cameron raises the expectations of the British people on what can be achieved and then disappoints them.

A fourth risk is that the euro crisis turns nasty. Despite the eurozone economy's modest improvement this year, Greece's place in the currency union remains precarious. A Grexit could trigger panic in the financial markets and thus the need for emergency summits and improvised institutional repairs. If eurozone leaders – who are the same as EU leaders – are once again seen as economically incompetent, the EU's image in Britain will suffer. A new eurozone crisis would also divert leaders' time and energy from addressing British concerns.

A final concern is whether Britain's pro-Europeans can run an effective keep-Britain-in campaign. As in the EU referendum of 1975, much of the establishment is likely to support staying in. But the country has become less deferential since then. In Britain, as in much of Europe, the EU is disliked because it is seen as a project of the rich, successful, cosmopolitan and well-travelled elite. Pro-EU forces must marshal arguments that appeal to people who never went to university. A top-down, 'we know what is good for you' campaign could easily fail. But if Cameron keeps his demands modest, works on his relationships with other leaders and uses his fine skills as a salesman to make the case for the EU, the referendum is winnable.

Charles Grant is director of the Centre for European Reform.

Friday, May 22, 2015

After a deal: How to keep Iran honest?

A nuclear deal with Iran may be concluded before the deadline of June 30th. But the deal could undermine stability in the region, not promote it, unless the US and Europe are willing to contain Iran and reassure its neighbours.

Western and Iranian negotiators say an agreement on Iran’s nuclear programme is within reach. A deal that puts a brake on Iran’s nuclear programme would be a momentous achievement, but only if it can be verified and enforced.  It may not be. The prospect that an agreement could bring Iran in from the cold – after lifting international sanctions and restoring trade and diplomatic relations –   yet still leave room for it to cheat, is making Tehran’s neighbours nervous. Without Western willingness to contain Iranian influence, a deal will make the region more volatile.

There are two reasons why a comprehensive deal might fall short. The negotiators on both sides still have hard work to do. On April 2nd, the United States, France, the UK, Germany, China and Russia (otherwise known as the EU3+3), and Iran announced that an accord had been reached on the political contours of a final, comprehensive deal. This political framework, however, has many loose ends. Iran says an agreement will expire after 10 years, but the US says some restrictions on its nuclear programme should apply for up to 25 years. Iran says research and development on advanced uranium centrifuges can continue under a deal. The US disagrees. Iran does not want to give inspectors access to military sites. The US, and the International Atomic Energy Agency (IAEA), the UN’s nuclear watchdog, insist it should. They also say that Tehran must be more transparent about the possible military dimensions of its nuclear programme. If these issues are not resolved, a deal would either have little value or collapse.

Another reason for pessimism is that the deal may be skewed in Iran’s favour. The political framework agreed on April 2nd says Iran will freeze – not dismantle – its enrichment capability and reduce – not remove – its uranium stockpile. In return the UN, US and Europe will cancel most sanctions (except some proliferation-related sanctions and those linked to its missile programme and sponsorship of terrorism).

The problem is that those sanctions worked; they brought Iran to the negotiating table. But once sanctions are lifted US and European leverage will vanish. Any Iranian violation of the agreement will be difficult to detect, and even more difficult to respond to through a concerted international effort. US officials are overconfident when they suggest that it will be possible to create a reliable system to ensure that sanctions could reactivate, or ‘snap back’, automatically. The negotiators will have trouble devising a procedure that is immune to a Chinese or Russian veto in the United Nations Security Council – a necessary condition to put the sanctions back in place. The Security Council is more divided than five years ago as relations between Russia and the West have soured. The Russian ambassador to the UN, Vitaly Churkin, said on May 13th that there could be "no automaticity, none whatsoever" about re-imposing sanctions. In short, the West will have to compromise at the UN to get a deal.

The West could still re-impose its own sanctions, but once a nuclear deal has been reached, it may also be difficult to maintain transatlantic unity. Iran has the fourth-largest oil reserves and the second-largest reserves of natural gas in the world. It is actively promoting a bright economic future – fuelled by its ample hydrocarbon reserves – that European firms can be a part of. And a future pipeline connecting Iran’s gas fields to Turkey’s trans-Anatolian pipeline would contribute to the EU’s energy security. As more European firms enter the Iranian market, and in the absence of blatant Iranian violations of the nuclear agreement, European governments might favour protecting their commercial and energy interests over a unified transatlantic response to an ambiguous violation of the deal.

Ultimately, however, the US and Europe hope that their concessions during the negotiations will encourage Tehran to help stabilise the Middle East. The EU’s foreign policy chief, Federica Mogherini, said on April 28th that she was convinced a deal could “open the way to a different role of Iran in the region”. The West hopes a nuclear deal turns Iran into a helpful partner – but hope is not a strategy.

The US and Europe are right that Iran is needed to fight the Islamic State terror group, reach a solution in Yemen, and bring Syria’s civil war to an end. But it is risky to assume that Iran will suddenly change its colours after a nuclear agreement and become more helpful on all regional security issues. Why would it? Despite years of tough sanctions and economic stagnation, Iran is now a rising power in the Middle East. Its population is young, well-educated and large; second only to Egypt in the region. It has a strong sense of national identity and culture; huge hydrocarbon reserves, and a regional network of allies and militant groups, such as Hezbollah. Iran’s influence in the region has increased since the fall of Saddam Hussein. With a hand in Lebanon, Syria, Iraq, and Yemen, its reach stretches from the Eastern Mediterranean to the southern entrance of the Red Sea and the Straits of Hormuz. Riyadh, highly insecure and deeply suspicious of Iranian intent, feels encircled. Even in the Persian Gulf, a vital international waterway, Iran is flexing its muscles: on April 28th the Iranian navy forced a Danish container ship to divert its course and two weeks later it fired warning shots at a Singaporean cargo ship. The Sunni Arab world and Israel are rightly concerned about Iran unshackled from its sanctions; it will make Iranian assertiveness in the region more likely.

Viewed from the region, the nuclear deal is another sign of US withdrawal from the Middle East. Just as in Syria, where the West pushed to rid Syria of chemical weapons but did little to end the civil war, Sunni Arab states – including Saudi Arabia, the UAE and Kuwait – think that the West is negotiating with Iran about weapons, while doing little to challenge Tehran’s ambitions. Over the past two years, countries around the world have sought assurances from Washington. In areas of intensive geopolitical competition from East Asia to Eastern Europe, countries like Japan and Poland have asked questions about US commitment to their security, and received some reassuring answers from the US. Now it should be the turn of America's allies in the Middle East. At a Camp David summit on May 14th, President Obama made his case for an Iran nuclear deal to several Gulf leaders. The success of his efforts remains uncertain.

Paradoxically, an agreement that was meant to avoid another war in the Middle East may add to the region’s turbulence, unless a balance of power can be maintained. The Gulf countries and Israel primarily look to the United States to deter Iran. Washington will most likely give them some security assurances and sell them more sophisticated military equipment. But Europe has a role to play too.

European countries should help make sure Iran keeps its end of a nuclear deal by taking a tough line on sanctions; providing enough resources to spy on Iranian nuclear facilities, and improving the ability of Gulf countries to stand up to Iran. The EU should insist on gradually phasing out the sanctions, not removing them instantaneously. Measures such as those that blocked Iranian shipping companies from accessing the European reinsurance market and underwriters have been central to the sanctions’ overall success. The EU should only remove these measures if Iran meets clear commitments; for instance on reducing its uranium stockpile or disabling its enrichment cycle. Importantly, if needed, the EU should be willing to reactivate the sanctions unilaterally (or with the US), even without a UN resolution.

Paris, London and Berlin will actively promote their defence exports, seeking to persuade countries in the Middle East that stronger forces are necessary to keep Iran at bay. In May, France announced the sale of fighter jets to Qatar, and negotiations on a similar military package continue with the UAE. Germany has sold four advanced submarines to Israel. Saudi Arabia is the UK’s largest defence technology export market. But alongside selling more kit, Europe should help improve the ability of Arab militaries to counter threats from Iran by improving their professionalism and skills.

The UK, in co-operation with allies, should continue to use its intelligence capacities to monitor Iran’s nuclear supply chain. This would help to verify Iranian nuclear commitments. If the West is to keep Iran honest, Tehran has to know that its activities will be very closely scrutinised. The UK and other European governments should also direct more intelligence resources to disrupt Hezbollah’s military wing; that organisation has been on the EU’s list of terrorist organisations since 2013.

France, more than any other European country, has stood up for Arab interests during the Iran talks. It has also gained Arab credit for showing its resolve against Islamist terrorists in places like the Sahel. On May 5th, President Francois Hollande became the first foreign head of state to attend the summit of the Gulf Co-operation Council (GCC), a political and economic forum for Arab Gulf countries. Paris should use that diplomatic credit to persuade Arab Gulf countries not to over-react to a nuclear deal, and to make clear that they should end support for Sunni militant and terrorist groups: the prospects for stability in the Middle East will not be helped by continuing sectarian violence.

The EU’s high representative, Federica Mogherini, has an important role to play too. She chaired the nuclear talks and her shuttle diplomacy was essential to agreeing the political framework in April. But her triumph will only last as long as an agreement holds. Her diplomatic access with the Iranians should allow her to push Tehran to stick to a deal. But perhaps her biggest challenge is that she should convince Iran to play a constructive role in places like Syria, Iraq and Yemen.

An ugly consequence of a nuclear deal is that it may encourage Arab countries to seek the same nuclear technology that Iran has. A nuclear agreement will most probably legitimise Tehran’s right to uranium enrichment, so Saudi Arabia has said it wants a nuclear fuel cycle too. This poses a serious problem to the West: an agreement meant to avoid the spread of nuclear technologies, may do just that. Riyadh could get the technology from Pakistan, which is widely believed to have developed nuclear weapons with Saudi financial assistance, and has a poor record on nuclear non-proliferation. But Laurent Fabius, the French foreign minister, also discussed nuclear power projects when he visited Riyadh in April. So the West faces a choice: it could decline Saudi requests and push Riyadh towards Islamabad, or it could help Saudi Arabia develop civilian nuclear technology and keep an eye on its nuclear programme. The latter option is preferable.

A nuclear deal may still collapse. But if a deal is reached, Europe should engage with Iran, but be willing to contain it too.

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

Monday, May 18, 2015

The Riga Summit: Enter, pursued by a bear

The Eastern Partnership summit in Riga on May 21st-22nd will be a gloomy affair. Russia’s aggressive behaviour has put EU member-states on the defensive. Enthusiasm for further integration between the EU and its Eastern neighbours is on the wane. But Europe should be bolder: a grey zone to its east is not in the EU's interests.

The Latvian Foreign Minister, Edgars Rinkēvičs, said in February that the EU’s meeting with its eastern partners would be a “survival summit”. The run-up to the meeting suggests that the Eastern Partnership will still be in a critical condition after Riga. The six partners (Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine) are a disparate group, and EU member-states are divided in their views of the partnership’s future. Here are five steps to save the Eastern Partnership.

First, decide what the goal of the partnership is. The EU has never seemed sure. Within the EU, some countries, primarily in Central Europe, have wanted to give the Eastern partners a perspective of eventual EU membership; others have not. Partners are equally divided: Georgia, Moldova and Ukraine have been more or less enthusiastically pro-EU; Ukrainian presidents (even Viktor Yanukovych) have been talking publicly about Ukraine’s long-term intention to join the EU since at least 1996.

President Aleksandr Lukashenko of Belarus, on the other hand, has been under some form of EU sanctions since 1997. Azerbaijan, with its large hydrocarbon reserves, has little interest in the trade privileges offered by the Eastern Partnership and still less in good governance, human rights and democracy. Armenia is balanced uncomfortably: too dependent on Russia for defence against Azerbaijan to sign an association agreement against Moscow’s will, but keen to benefit from any EU assistance available.

There has been protracted wrangling ahead of Riga over how to refer (or to avoid referring) to the possibility of enlargement. At the last summit, in Vilnius in 2013, the EU and its partners acknowledged “the European choice of some partners” and said that the partnership had a particular role in supporting “those who seek an ever closer relationship with the EU”. At the time of writing, even this vague wording seems to be in question.

The Treaty on European Union says clearly that any European state which respects EU values “and is committed to promoting them may apply to become a member of the Union”. By refusing to refer to this language, even indirectly, the EU reinforces two Russian arguments: that the EU does not want the Eastern Europeans as members under any circumstances; and that Eastern Europe is a region of “privileged interests” for Russia, in the phrase used by then-President Dmitri Medvedev in 2008. The EU should come off the fence, and say that it will keep the door to membership open, however long it takes partners to get through it; and that Russia has no right to close it.

Second, differentiate clearly between the partners. The pre-summit press release talks confusingly of the EU’s “determination to pursue closer, differentiated relations”. But there is no point in wasting limited EU resources on countries which are not committed to the partnership’s principles of democracy, the rule of law and good governance. Georgia, Moldova and Ukraine are at least making efforts to improve. Georgia and Ukraine will be disappointed that one of the most attractive elements of the partnership, visa-free access to the Schengen area, is still out of reach, for technical reasons. The principle of ‘more for more’ should be more than a slogan: EU programmes and funding should flow to the countries that have made the most progress.

There are good reasons for the EU to want a strong relationship with a major energy producer like Azerbaijan, but the Union should not behave as though Azerbaijan is gradually converging with European norms and values. The 2014-2015 progress report on Azerbaijan presented by the European Commission and the European External Action Service is stark. It talks of deteriorating conditions for civil society, the detention of human rights defenders and restrictions on freedom of expression and association. Notwithstanding the EU sanctions against it, Belarus is in fact a better performer on human rights than Azerbaijan, and should get a little more love from Brussels.

Where a government is a difficult or uncooperative interlocutor, the EU should focus more attention on civil society organisations – including through increasing the resources available to the European Endowment for Democracy. Support for civil society does not have to mean support for the political opposition or confrontation with the existing regime: it can cover help and advice for environmental groups or groups working to protect the rights of vulnerable minorities; all help to increase the resilience of society, and to prepare for the possibility of political evolution.

Third, communicate better. The then-foreign minister of Sweden Carl Bildt said in Vilnius in 2013 “Putin makes you an offer you can’t refuse; the EU makes you an offer you can’t understand”. The EU’s public diplomacy effort in Eastern Partnership countries needs to be turbo-charged. The Union has to do a much better job of countering ignorance, misunderstanding and misinformation and telling the positive story of the benefits co-operation with the EU will bring. Eighteen months after the first Maidan demonstrations, the EU delegation in Kyiv still has a website with information in English and Ukrainian only. It was left to the British Embassy in Kyiv to produce a Russian-language pamphlet setting out the advantages to Ukraine of its association agreement with the EU. The Ukrainian President’s website is in Ukrainian and Russian; if Petro Poroshenko thinks it is politically acceptable to speak to Russian-speaking Ukrainians in their native language, why does the EU not do the same?

Russian anti-EU propaganda has had the field almost to itself throughout the Eastern Partnership region, and it shows in the opinion polls. In Moldova, a poll in April showed 58 per cent in favour of joining the Russian-led Eurasian Economic Union (with 26 per cent against) and only 40 per cent in favour of joining the EU, with 42 per cent against. That is a remarkable statistic, considering that Russia has blocked Moldovan agricultural exports since July 2014, while the EU has increased Moldova’s access to European markets and given Moldovans visa-free access to the Schengen area.

Fourth, stop thinking that the Eastern Partnership is a purely technical exercise. For the countries that have signed association agreements, the process of harmonising local laws and regulations with European law is indeed a complex, tedious, legalistic marathon; and only a handful of people will ever read the whole text of the agreements, or need to. But Putin is right to think that if the EU’s partners implement the new laws and regulations and live up to their commitments under the agreements something dramatic will change in Europe.

The Eastern Partnership was never intended as a geopolitical project, but if it results in some of its members adopting the vast majority of the EU acquis communautaire, it will produce a decisive break between them and their Soviet past. The EU needs to understand that Putin sees the adoption by Russia’s neighbours of EU standards, open markets and above all the rule of law as inherently threatening to his interests.

Fifth, ensure that Ukraine succeeds. Ukraine's population is around 50 per cent greater than the other five partners combined; its GDP is almost equal to that of the other five. While it would certainly not be good if reforms stalled in Georgia or Moldova, failure in Ukraine would be fatal to the Eastern Partnership and deeply damaging to the EU itself.

The EU's interests lie in having neighbours that share its values and its ways of doing business. It needs to be ready to react to Russian moves to destabilise the countries of the region with much more speed and determination than it showed in Ukraine in 2014.Then, its sanctions were initially too weak to make Russia rethink its aggression, and its support for Ukraine too modest to match the scale of the economic, political and military challenges Kyiv faced.

Though in 2004 Putin said that Russia would welcome Ukrainian membership of the EU, since 2013 he has exerted enormous, destabilising efforts to ensure that Ukraine cannot benefit from its association agreement with the Union, let alone make progress towards membership.

German chancellor Angela Merkel and French president François Hollande made a serious error in Minsk: they supported the idea of talks between the EU, Russia and Ukraine “to find practical solutions to the concerns raised by Russia about the implementation” of the EU-Ukraine Deep and Comprehensive Free Trade Agreement (DCFTA). The DCFTA will force Ukraine to make painful reforms; but it also offers a long-term route to a better-managed, open and ultimately more successful economy.

Russian intentions towards the DCFTA are neither reasonable nor honourable. If Russia wants to ensure that its goods remain competitive on the Ukrainian market, it should negotiate its own free trade agreement with Kyiv; it has no more right to seek amendments to the DCFTA than the EU has to demand changes to the arrangements for the Eurasian Economic Union. But the proposed amendments put forward by Russia go further. They are clearly intended to wreck the DCFTA and to ensure that Ukraine cannot profit from it; they would damage both EU exporters and Ukrainian consumers. The EU should make clear that it will not postpone the implementation of the DCFTA any further: it will start on December 31st 2015. And the EU and its partners should be prepared to stand up to any Russian retaliation. As wildlife experts advise, “if a bear approaches or charges you, do not run”.

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