by Tomas Valasek
When the EU's first 'foreign minister', Cathy Ashton, starts work on December 1st, she will find Iran on top of her 'to do' pile. Earlier this week, Tehran turned down a proposal from the International Atomic Energy Agency (IAEA) that would have seen a large part of the country's stock of uranium moved out of the country for further enrichment. Barring a last-minute change of heart in Tehran, the US, UK, France and Germany will soon move to tighten UN sanctions on Iran. This could set the scene for a confrontation with Russia and China, which are unconvinced that tough sanctions would work.
It will fall to Ashton to try to get Iran to reconsider. The country's government has not rejected the IAEA proposals outright; it has offered a counter-proposal, which US and European officials deem unacceptable. The Iranians may simply be buying time but there is a small hope that they are open to compromise. Before the UN Security Council imposes further sanctions, the EU needs to be absolutely sure that Iran does not want a deal.
The trouble is that the chances of a negotiating breakthrough with Iran, never high, have diminished since the fraudulent elections in Iran in June 2009 and their bloody aftermath. For the past five months, the country has been mired in twin crises: one within the regime (a band of clerics versus the former Revolutionary Guard commanders grouped around President Mahmoud Ahmadinejad) and another one between the regime and the people. The government appears to have become dysfunctional. Tehran wavered for weeks over the recent Western proposals before rejecting them. It is not obvious that in a country as unstable as Iran is today, any centre of power has the courage to push for a compromise with the West (though some Iran watchers have warned that Tehran could be faking indecision while it buys time to develop further its nuclear programme).
It had been hoped that Barack Obama's entry into the nuclear talks would strengthen the EU's negotiating hand. In the past Iran had made clear to EU diplomats that it would not accept any agreement that did not involve the US. But Obama's charm offensive has had a limited effect. True, it “empowered advocates of engagement inside Iran and transferred the onus of co-operation from the US to Iran”, one Iran expert told a recent gathering of foreign policy thinkers and officials convened by the CER and other think-tanks in Stockholm. Obama's efforts have also made it more likely that Russia will support sanctions. But even after the US had joined the Iran talks and Obama had offered “dialogue without preconditions”, Tehran decided to reject the recent IAEA package.
High Representative Ashton and other western diplomats have few effective tools left to pressure Iran into changing its position, so the world's attention is shifting towards negotiating a new sanctions regime. The EU used to be divided on further sanctions, with France and the UK strongly in favour and Germany more sceptical. But Chancellor Angela Merkel's recent tough language on Iran (in a speech to a joint session of the US Congress) suggests that the new centre right-liberal coalition views sanctions more favourably (this was confirmed by senior German diplomats at the Stockholm event).
The key critics of tighter sanctions are Russia and China, whose top officials have argued on many occasions not only that sanctions would fail to stop Iran's nuclear programme, but also that they would boost the position of radicals within the country. They are right that sanctions are a very blunt instrument. Tougher sanctions almost certainly would strengthen the Revolutionary Guards' stranglehold on the economy and thus, paradoxically, empower the most authoritarian of Iranian political forces and set back the cause of Iran's liberalisation. Sanctions could also prompt Iran to kick out the IAEA inspectors who monitor Iran's nuclear facilities; this would leave the world blind to Iranian nuclear intentions.
But the case for sanctions, on balance, seems somewhat stronger. They discourage other states in the region from following Iran down the nuclear path, and they give the US and - crucially - Israel an alternative to the use of force. Existing sanctions have worked to the extent that they have deprived Iran of some needed technology; the centrifuges used to enrich uranium are said to be crashing frequently. And contrary to what Russia and China say, precedents suggest that sanctions can, under the right circumstances, bring weapons programmes to halt. As one US participant at the Stockholm meeting pointed out, “sanctions against Iraq in the 1990s and early 2000s worked so well that they made the invasion of that country completely unnecessary”. It transpired after the war that Iraq had given up its nuclear and biological programmes years before the US invasion, in large part because it could not obtain the necessary technology.
The two European members of the UN Security Council, France and the UK, along with Germany and the US, will lead negotiations at the UN on further sanctions. But Ashton will still have an important role to play. Sanctions are not meant to replace talks but to complement them; the idea is to inflict hurt on Iran's economy and political classes in order to get the government to accept nuclear proposals from the IAEA. So Cathy Ashton, like Javier Solana before her, will be expected to keep up talks with Iran while the UN debates sanctions, and after the UNSC agrees a new regime. The UNSC is likely to do so: President Dmitri Medvedev has hinted that Russia will swallow somewhat tougher sanctions, while China rarely vetoes UNSC resolutions alone (unless they concern Tibet or Taiwan).
But one wonders if this is the EU's last hooray on Iran. If the combination of sanctions and talks fail, the remaining options would seem to leave little room for EU diplomacy. If Israel strikes Iran's nuclear facilities, Tehran will certainly call off the EU-led talks. The other choice before the world is to start preparing for a nuclear Iran. A strategy of containment would require western governments to focus on making Iran's neighbours feel secure, so as to discourage them from building nuclear weapons themselves. But this will almost certainly be a job mainly for the US, rather than the EU. So while Baroness Ashton will spend a lot of time on Iran at the beginning of her term, the EU may gradually lose its leading role.
Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
Wednesday, November 25, 2009
Wednesday, November 11, 2009
What Eastern Europe can learn from the crisis
by Katinka Barysch
It is 20 years since the Berlin Wall crumbled and political and economic freedom started spreading through Eastern Europe. Today, however, the region is mired in deep recession. The global economic and financial crisis has hit the Central and East European countries (CEECs) harder than any other emerging market region. In February 2009, I asked whether the savage downturn would make the new EU member-states question their entire transition model of trade opening, financial integration and EU-conforming reforms (‘New Europe and the economic crisis’ http://www.cer.org.uk/pdf/bnote_new_europe_feb09.pdf). This has not happened. Dire predictions did not come true: financial systems did not collapse, the steep fall in exports and industrial output has bottomed out and there has been no mass social unrest. Most people, inside and outside the region, seem to agree that the CEECs need to recalibrate their growth model, rather than ditch it. The crisis may harbour some valuable lessons on how to go forward after 20 years of transition.
The fact that the CEECs had sold almost their entire banking sectors to big finance houses from Austria, Belgium, Germany, Italy or Sweden turned out to be a mixed blessing. During the boom years, financial integration did help the CEECs to grow faster (which is not true of all emerging market regions). When the crisis hit, West European banks did not withdraw all funding from their CEE subsidiaries overnight or let them go bankrupt, as many had feared. These subsidiaries did stop lending, as their parent banks scrambled to rebuild capital – but so did local banks.
There were no big banking crises in Eastern Europe. The hastily assembled ‘Vienna initiative’ – a club consisting of pan-European banks, the regulators of the countries in which they operate and international organisations such as the EU and the World Bank – helped to prevent a run for the exit that could have resulted in financial meltdown. The €25 billion put up by three multilateral lenders in support of ailing CEE banks also helped.
The EBRD, in its latest ‘Transition Report’, claims that countries with a higher share of foreign bank ownership did relatively better in the crisis than those with shaky local institutions that relied on short-term liquidity from abroad. However, the EBRD report also admits that the presence of foreign banks fuelled unsustainable credit booms and brought shoddy lending practices to the CEECs, such as giving mortgages in euros or Swiss francs to people without thorough credit checks.
The crisis showed that home country supervision – the basic principle of EU financial market integration – needs to be improved. The authorities of say, Sweden and Austria, did not pay enough attention to what their banks were getting up to in Latvia or Hungary. Some economists think that this will change now that Swedish and Austrian taxpayers are footing the bills for bank bail-outs abroad. But others argue that only stronger cross-border banking regulation and supervision can prevent similar trouble in the future. At the same time, the governments and regulators of the CEE host countries need to work harder to strengthen local capital markets. For example, unhedged foreign-currency denominated loans are a lousy idea as long as exchange rates are not irrevocably fixed.
Eastern Europe’s exceptional openness to trade was a blessing while global growth was strong. But it also left the region vulnerable. No fiscal stimulus programme would have been big enough to compensate for the collapse of eurozone demand in countries where exports typically account for 50 to 80 per cent of GDP. What is more, the crisis highlighted that some of the new EU members had focused rather too much on one industrial sector – cars. Around half of export revenues and up to 20 per cent of value added is generated by the automotive industry in the Central European countries.
Several car factories in CEECs shut down in late 2008 and early 2009. For a while it looked as if the new members might be the losers from a subsidy race among the bigger, richer EU countries. In the end, however, countries such as the Czech Republic and Slovakia benefited from the scrappage schemes that Germany, Austria, France and other West European countries implemented to boost domestic demand. Single market rules held: these schemes did not discriminate in favour of vehicles made at home. The WIIW, a Vienna economic research outfit, even claims that those CEECs that rely most on exports of machinery and cars have suffered milder contractions.
Most countries are now phasing out their ‘cash for clunkers’ schemes, which will translate into lower demand for vehicles made in Eastern Europe. In the medium term, the need to cut costs and overcapacity in this sector worldwide could work in the CEECs' favour as the big car makers will continue to relocate production to countries with low unit labour costs.
Nevertheless, the economic crisis has served as a reminder that the CEECs need to diversify their industrial structures. Wedged between a high-tech Western Europe and a low-cost Far East, there is only one way to go for the CEECs: move up the value chain. To do this, these countries need to improve their education and training systems, make their markets work better and encourage innovation and entrepreneurship.
Such reforms are needed more urgently than ever now that global competition for capital and markets has become fiercer. The EBRD, which tracks economic change across Eastern Europe, finds that there have been few instances of reforms unravelling since the onset of the crisis; but it also finds that there has been little noticeable progress towards better-functioning market economies. So far, populism has been contained in Eastern Europe. But with lay-offs still rising fast, and governments too cash-strapped to do much about it, the elections due in many CEECs in 2010 and 2011 could result in governments promising protection rather than explaining the need for economic change. The risk remains that the CEECs will draw the wrong lessons from the crisis and endanger the economic success of the last 20 years of transition.
Katinka Barysch is deputy director of the Centre for European Reform.
It is 20 years since the Berlin Wall crumbled and political and economic freedom started spreading through Eastern Europe. Today, however, the region is mired in deep recession. The global economic and financial crisis has hit the Central and East European countries (CEECs) harder than any other emerging market region. In February 2009, I asked whether the savage downturn would make the new EU member-states question their entire transition model of trade opening, financial integration and EU-conforming reforms (‘New Europe and the economic crisis’ http://www.cer.org.uk/pdf/bnote_new_europe_feb09.pdf). This has not happened. Dire predictions did not come true: financial systems did not collapse, the steep fall in exports and industrial output has bottomed out and there has been no mass social unrest. Most people, inside and outside the region, seem to agree that the CEECs need to recalibrate their growth model, rather than ditch it. The crisis may harbour some valuable lessons on how to go forward after 20 years of transition.
The fact that the CEECs had sold almost their entire banking sectors to big finance houses from Austria, Belgium, Germany, Italy or Sweden turned out to be a mixed blessing. During the boom years, financial integration did help the CEECs to grow faster (which is not true of all emerging market regions). When the crisis hit, West European banks did not withdraw all funding from their CEE subsidiaries overnight or let them go bankrupt, as many had feared. These subsidiaries did stop lending, as their parent banks scrambled to rebuild capital – but so did local banks.
There were no big banking crises in Eastern Europe. The hastily assembled ‘Vienna initiative’ – a club consisting of pan-European banks, the regulators of the countries in which they operate and international organisations such as the EU and the World Bank – helped to prevent a run for the exit that could have resulted in financial meltdown. The €25 billion put up by three multilateral lenders in support of ailing CEE banks also helped.
The EBRD, in its latest ‘Transition Report’, claims that countries with a higher share of foreign bank ownership did relatively better in the crisis than those with shaky local institutions that relied on short-term liquidity from abroad. However, the EBRD report also admits that the presence of foreign banks fuelled unsustainable credit booms and brought shoddy lending practices to the CEECs, such as giving mortgages in euros or Swiss francs to people without thorough credit checks.
The crisis showed that home country supervision – the basic principle of EU financial market integration – needs to be improved. The authorities of say, Sweden and Austria, did not pay enough attention to what their banks were getting up to in Latvia or Hungary. Some economists think that this will change now that Swedish and Austrian taxpayers are footing the bills for bank bail-outs abroad. But others argue that only stronger cross-border banking regulation and supervision can prevent similar trouble in the future. At the same time, the governments and regulators of the CEE host countries need to work harder to strengthen local capital markets. For example, unhedged foreign-currency denominated loans are a lousy idea as long as exchange rates are not irrevocably fixed.
Eastern Europe’s exceptional openness to trade was a blessing while global growth was strong. But it also left the region vulnerable. No fiscal stimulus programme would have been big enough to compensate for the collapse of eurozone demand in countries where exports typically account for 50 to 80 per cent of GDP. What is more, the crisis highlighted that some of the new EU members had focused rather too much on one industrial sector – cars. Around half of export revenues and up to 20 per cent of value added is generated by the automotive industry in the Central European countries.
Several car factories in CEECs shut down in late 2008 and early 2009. For a while it looked as if the new members might be the losers from a subsidy race among the bigger, richer EU countries. In the end, however, countries such as the Czech Republic and Slovakia benefited from the scrappage schemes that Germany, Austria, France and other West European countries implemented to boost domestic demand. Single market rules held: these schemes did not discriminate in favour of vehicles made at home. The WIIW, a Vienna economic research outfit, even claims that those CEECs that rely most on exports of machinery and cars have suffered milder contractions.
Most countries are now phasing out their ‘cash for clunkers’ schemes, which will translate into lower demand for vehicles made in Eastern Europe. In the medium term, the need to cut costs and overcapacity in this sector worldwide could work in the CEECs' favour as the big car makers will continue to relocate production to countries with low unit labour costs.
Nevertheless, the economic crisis has served as a reminder that the CEECs need to diversify their industrial structures. Wedged between a high-tech Western Europe and a low-cost Far East, there is only one way to go for the CEECs: move up the value chain. To do this, these countries need to improve their education and training systems, make their markets work better and encourage innovation and entrepreneurship.
Such reforms are needed more urgently than ever now that global competition for capital and markets has become fiercer. The EBRD, which tracks economic change across Eastern Europe, finds that there have been few instances of reforms unravelling since the onset of the crisis; but it also finds that there has been little noticeable progress towards better-functioning market economies. So far, populism has been contained in Eastern Europe. But with lay-offs still rising fast, and governments too cash-strapped to do much about it, the elections due in many CEECs in 2010 and 2011 could result in governments promising protection rather than explaining the need for economic change. The risk remains that the CEECs will draw the wrong lessons from the crisis and endanger the economic success of the last 20 years of transition.
Katinka Barysch is deputy director of the Centre for European Reform.
Wednesday, November 04, 2009
Is Turkey Iran's friend?
by Katinka Barysch
Is Turkey really Iran’s “friend”, as Recep Tayyip Erdogan claimed in a recent interview with the Guardian newspaper? Erdogan’s visit last week to Tehran suggests so. He met not only President Mahmoud Ahmadinejad but also Supreme Leader Ayatollah Ali Khamenei, a rare honour. He announced plans for energy and commercial co-operation with Iran and defended the country’s right to civilian nuclear power, calling its energy programme “peaceful” and “humanitarian”. Ahmadinejad, meanwhile, thanked Erdogan for his critical stance on Israel.
Policymakers in the West are getting worried that Turkey’s growing ties with Iran – by lessening that country’s sense of isolation – may frustrate diplomatic efforts to prevent Tehran from building a nuclear bomb.
Turkey’s official line is that it fully supports international efforts to persuade Iran to stop its enrichment programme, backed by the threat of tougher sanctions. The Turkish government claims that it is using closer ties with Iran to pass on tough messages to the leadership there. However, Turkish political leaders and high officials have been very cautious in their public pronouncements about Iran. “Iran does not accept it is building a weapon”, Erdogan is quoted as saying by the Guardian. “They are working on nuclear power for the purposes of energy only."
Erdogan has often mentioned Iran in the same sentence as Israel, perhaps implying that if one country in the Middle East has nuclear weapons it might be unfair to prevent other ones from building them too. Following his Tehran trip, he referred to western pressure on Iran as ‘arrogant’ because it came from countries that themselves had nuclear weapons. It would be preferable, he said, to have a nuclear-free Middle East and a nuclear-free world.
Turkey’s rather friendly stance on Iran may be understandable and acceptable at a time when the West’s diplomatic efforts are making at least some progress. But what if current negotiations fail? Would Turkey support the tougher sanctions that the US and most EU countries are threatening?
When asked this question, a top Turkish diplomat (at a recent EDAM roundtable in Bodrum) was evasive: “We would have to first see the content of the resolution. And we would have to make sure that we bring Russia and China on board.” This answer implies that Turkey may support sanctions in the (unlikely) event that they are backed by the United Nations Security Council but not if they are unilaterally imposed by the Americans and the Europeans. Another Turkish diplomat (at the ‘Istanbul Forum’, a big conference focusing on Turkey and the Middle East in October) summed up Turkey’s stance on Iran’s nuclear programme as “diplomacy, more diplomacy and even more diplomacy”.
Many Turks fear the impact of tougher on their own economy. Turks say that the 1999 sanctions against Iraq resulted in the loss of what had then been their second most important trading relationship, and that European sanctions on Serbia in the 1990s cut off one of Turkey’s most important transport artery to the EU.
Trade between Turkey and Iran has been growing fast in recent years, to reach an estimated $ 6 billion in 2008. Politicians from both sides say they want to see that figure double or even triple over the next 5-10 years. Iran is also Turkey’s second biggest gas supplier after Russia. Many Turks think that Iranian gas will be essential if Turkey is to fulfil its ambition of becoming a regional energy hub. Further sanctions would therefore harm Turkey’s economic interests. Already, US pressure forced Turkey to put on ice a $3.5 billion investment deal in the Iranian gas sector signed in 2007 – although Erdogan confirmed that Turkey still wanted to go ahead with such energy deals during his recent Tehran visit.
More importantly, perhaps, Turkish support for tougher sanctions would end the recent rapprochement between Tehran and Ankara and could even lead to retaliation. “We have no choice but to have good relations with our big neighbours”, explained one Turkish parliamentarian at the Istanbul Forum. “This conviction stood behind our decision in 2003 not to allow the Americans to march into Iraq from our territory. We knew we would have to live with Iraq afterwards, no matter what the outcome of the war.”
The Erdogan government values its relationship with Iran as part of its ‘zero problem’ neighbourhood policy. Having been more or less isolated in the region only 20 years ago, Turkey now has flourishing political and trade links with most of its immediate neighbours, as well as many countries of the Middle East, the Caucasus and Central Asia. There are even plans to open the border to Armenia, closed since 1993. Ankara is proud that it is one of the few countries that ‘talks to everyone’. This strategy has entailed links with Hamas and, more recently, visa-free travel and trade liberalisation with Syria.
Iran is one of Turkey’s most important neighbours and therefore crucial for the perceived success of the ‘zero problem’ strategy. Turkish politicians like to point out that the current Turkish-Iranian border dates back to 1639 and that the two countries have not been at war since. Since the implosion of Iraq, the two countries have worked together more closely on security issues, in particular to prevent Kurdish separatism and terrorism, which threatens both countries.
As ties with Iran thicken, Turks see the country’s nuclear programme as less of a threat. A third of Turks now think that a nuclear armed Iran would be acceptable, according to the latest Transatlantic Trends survey from the German Marshall Fund. Two years ago, the share was half that, at 17 per cent. In the US, only 5 per cent say they could live with a nuclear armed Iran. Turkish leaders hardly ever say explicitly whether they consider a possible Iranian bomb as a threat. When asked whether he was worried about such a prospect, one official at the EDAM roundtable responded: “We are under Nato’s nuclear umbrella.”
This apparent confidence, however, hides some deep-seated anxiety and mistrust. Turkey and Iran may not have been to war with each other for centuries, but they are natural rivals in a volatile region. Arguably, much of Turkey’s recent regional diplomacy has been designed to contain Iran’s growing influence, from Turkish efforts to help stabilise Iraq to building closer links with Syria. Neither the Americans nor the Iranians took up Ankara’s offer to mediate between the two, preferring to deal with each other directly. At the Istanbul Forum – which devoted a lot of time to discussing Iran – not a single Iranian official showed up.
Many Turks fear that a nuclear armed Iran would change the regional balance of power and trigger an arms race in this unstable part of the world. One Turkish politician, when asked what Turkey would do if efforts to stop the Iranian weapons programme failed, said: “We will have to build our own bomb.” It is statements like this that make some people suspect that the reason why Turkey is now starting its own nuclear programme is not only to improve energy security but also to be prepared in case of a nuclear arms race in the Middle East.
Turkish officials deny this categorically. They insist that their country needs nuclear power to satisfy fast-growing energy demand, reduce reliance on imported gas and cut CO2 emissions. Moreover, it could take Turkey a decade to build up a nuclear capacity. Already, the first tender to build a nuclear plant is being reviewed after only one company (from Russia) submitted a bid.
Meanwhile, Turkey is in talks with Washington about buying a missile defence system against short and medium-range missiles. The claim of Turkey’s foreign minister, Ahmet Davutoglu, that this system would have “nothing to do with Iran or any other country” just begs the question.
Turkey’s ambiguous stance towards Iran is symptomatic of the difficulties that Turkey faces in trying to combine its growing regional ties with its traditional orientation towards the West. As a long-standing NATO member and a country negotiating for EU membership, Turkey is expected to align itself with the US and Europe – or at least not do anything that undermines the West’s political objectives in the Middle East. As a regional power, Turkey will want to act independently and avoid antagonising its neighbours. It is not clear how long Ankara will be able to avoid tough choices.
Katinka Barysch is deputy director of the Centre for European Reform.
Is Turkey really Iran’s “friend”, as Recep Tayyip Erdogan claimed in a recent interview with the Guardian newspaper? Erdogan’s visit last week to Tehran suggests so. He met not only President Mahmoud Ahmadinejad but also Supreme Leader Ayatollah Ali Khamenei, a rare honour. He announced plans for energy and commercial co-operation with Iran and defended the country’s right to civilian nuclear power, calling its energy programme “peaceful” and “humanitarian”. Ahmadinejad, meanwhile, thanked Erdogan for his critical stance on Israel.
Policymakers in the West are getting worried that Turkey’s growing ties with Iran – by lessening that country’s sense of isolation – may frustrate diplomatic efforts to prevent Tehran from building a nuclear bomb.
Turkey’s official line is that it fully supports international efforts to persuade Iran to stop its enrichment programme, backed by the threat of tougher sanctions. The Turkish government claims that it is using closer ties with Iran to pass on tough messages to the leadership there. However, Turkish political leaders and high officials have been very cautious in their public pronouncements about Iran. “Iran does not accept it is building a weapon”, Erdogan is quoted as saying by the Guardian. “They are working on nuclear power for the purposes of energy only."
Erdogan has often mentioned Iran in the same sentence as Israel, perhaps implying that if one country in the Middle East has nuclear weapons it might be unfair to prevent other ones from building them too. Following his Tehran trip, he referred to western pressure on Iran as ‘arrogant’ because it came from countries that themselves had nuclear weapons. It would be preferable, he said, to have a nuclear-free Middle East and a nuclear-free world.
Turkey’s rather friendly stance on Iran may be understandable and acceptable at a time when the West’s diplomatic efforts are making at least some progress. But what if current negotiations fail? Would Turkey support the tougher sanctions that the US and most EU countries are threatening?
When asked this question, a top Turkish diplomat (at a recent EDAM roundtable in Bodrum) was evasive: “We would have to first see the content of the resolution. And we would have to make sure that we bring Russia and China on board.” This answer implies that Turkey may support sanctions in the (unlikely) event that they are backed by the United Nations Security Council but not if they are unilaterally imposed by the Americans and the Europeans. Another Turkish diplomat (at the ‘Istanbul Forum’, a big conference focusing on Turkey and the Middle East in October) summed up Turkey’s stance on Iran’s nuclear programme as “diplomacy, more diplomacy and even more diplomacy”.
Many Turks fear the impact of tougher on their own economy. Turks say that the 1999 sanctions against Iraq resulted in the loss of what had then been their second most important trading relationship, and that European sanctions on Serbia in the 1990s cut off one of Turkey’s most important transport artery to the EU.
Trade between Turkey and Iran has been growing fast in recent years, to reach an estimated $ 6 billion in 2008. Politicians from both sides say they want to see that figure double or even triple over the next 5-10 years. Iran is also Turkey’s second biggest gas supplier after Russia. Many Turks think that Iranian gas will be essential if Turkey is to fulfil its ambition of becoming a regional energy hub. Further sanctions would therefore harm Turkey’s economic interests. Already, US pressure forced Turkey to put on ice a $3.5 billion investment deal in the Iranian gas sector signed in 2007 – although Erdogan confirmed that Turkey still wanted to go ahead with such energy deals during his recent Tehran visit.
More importantly, perhaps, Turkish support for tougher sanctions would end the recent rapprochement between Tehran and Ankara and could even lead to retaliation. “We have no choice but to have good relations with our big neighbours”, explained one Turkish parliamentarian at the Istanbul Forum. “This conviction stood behind our decision in 2003 not to allow the Americans to march into Iraq from our territory. We knew we would have to live with Iraq afterwards, no matter what the outcome of the war.”
The Erdogan government values its relationship with Iran as part of its ‘zero problem’ neighbourhood policy. Having been more or less isolated in the region only 20 years ago, Turkey now has flourishing political and trade links with most of its immediate neighbours, as well as many countries of the Middle East, the Caucasus and Central Asia. There are even plans to open the border to Armenia, closed since 1993. Ankara is proud that it is one of the few countries that ‘talks to everyone’. This strategy has entailed links with Hamas and, more recently, visa-free travel and trade liberalisation with Syria.
Iran is one of Turkey’s most important neighbours and therefore crucial for the perceived success of the ‘zero problem’ strategy. Turkish politicians like to point out that the current Turkish-Iranian border dates back to 1639 and that the two countries have not been at war since. Since the implosion of Iraq, the two countries have worked together more closely on security issues, in particular to prevent Kurdish separatism and terrorism, which threatens both countries.
As ties with Iran thicken, Turks see the country’s nuclear programme as less of a threat. A third of Turks now think that a nuclear armed Iran would be acceptable, according to the latest Transatlantic Trends survey from the German Marshall Fund. Two years ago, the share was half that, at 17 per cent. In the US, only 5 per cent say they could live with a nuclear armed Iran. Turkish leaders hardly ever say explicitly whether they consider a possible Iranian bomb as a threat. When asked whether he was worried about such a prospect, one official at the EDAM roundtable responded: “We are under Nato’s nuclear umbrella.”
This apparent confidence, however, hides some deep-seated anxiety and mistrust. Turkey and Iran may not have been to war with each other for centuries, but they are natural rivals in a volatile region. Arguably, much of Turkey’s recent regional diplomacy has been designed to contain Iran’s growing influence, from Turkish efforts to help stabilise Iraq to building closer links with Syria. Neither the Americans nor the Iranians took up Ankara’s offer to mediate between the two, preferring to deal with each other directly. At the Istanbul Forum – which devoted a lot of time to discussing Iran – not a single Iranian official showed up.
Many Turks fear that a nuclear armed Iran would change the regional balance of power and trigger an arms race in this unstable part of the world. One Turkish politician, when asked what Turkey would do if efforts to stop the Iranian weapons programme failed, said: “We will have to build our own bomb.” It is statements like this that make some people suspect that the reason why Turkey is now starting its own nuclear programme is not only to improve energy security but also to be prepared in case of a nuclear arms race in the Middle East.
Turkish officials deny this categorically. They insist that their country needs nuclear power to satisfy fast-growing energy demand, reduce reliance on imported gas and cut CO2 emissions. Moreover, it could take Turkey a decade to build up a nuclear capacity. Already, the first tender to build a nuclear plant is being reviewed after only one company (from Russia) submitted a bid.
Meanwhile, Turkey is in talks with Washington about buying a missile defence system against short and medium-range missiles. The claim of Turkey’s foreign minister, Ahmet Davutoglu, that this system would have “nothing to do with Iran or any other country” just begs the question.
Turkey’s ambiguous stance towards Iran is symptomatic of the difficulties that Turkey faces in trying to combine its growing regional ties with its traditional orientation towards the West. As a long-standing NATO member and a country negotiating for EU membership, Turkey is expected to align itself with the US and Europe – or at least not do anything that undermines the West’s political objectives in the Middle East. As a regional power, Turkey will want to act independently and avoid antagonising its neighbours. It is not clear how long Ankara will be able to avoid tough choices.
Katinka Barysch is deputy director of the Centre for European Reform.
Tuesday, October 20, 2009
President Lamy?
by Hugo Brady
EU leaders are racking their brains to come up with candidates for the future presidency of the European Council. The job, to be created by the nearly-ratified Lisbon treaty, will replace a system whereby the EU is 'led' by a different national leader every six months. Instead, the Union will have a full-time consensus builder who will also represent the EU to foreign heads of state, for a maximum five-year term. The man or woman who gets the job is banned from holding national office, but the assumption is that potential incumbents need to have served as a president or prime minister in a past life.
Strangely, suitable candidates are proving elusive, even though the post has the potential to be both prestigious and influential. Of those names that have been touted so far, some – like the former British prime minister, Tony Blair – are divisive figures that would inevitably bring much political baggage to the office. Others – like Jan Peter Balkenende, the current Dutch prime minister – are agreeable to most, but uninspiring. They lack the profile and international standing that is needed if the post is to be more than merely ceremonial.
In early 2008, I tried to imagine the qualities the successful candidate for European Council president should have, in a mock job advert published in CER's bi-monthly bulletin:
"As the first person to hold this post, you will enjoy enormous scope to shape its future potential. Second-rate candidates need not apply. You should be a formidable communicator, highly capable but not overly assertive. You need to be firm but conciliatory. Modesty would be an asset. Although this position offers prestige and influence, power and perks will be limited. With only a handful of staff and no presidential cavalcade, the job will resemble that of the UN secretary-general rather than that of US president. Beyond your right to assemble us for emergency meetings, your formal powers will be limited. We are counting on your ability to set the agenda and forge consensus through persuasion and quiet charisma."
('Applicants sought for EU council president', CER bulletin, April/May 2008).
These are virtuous attributes indeed but, even in the rarefied corps of past and present European leaders, they are hard to find. Moreover, the job appears to require its holder to be a walking paradox: charismatic but modest, highly effective but non-intimidating, a consensus builder but also a decision-maker. Most ex-leaders of national governments would struggle to adjust to the limitations and requirements of such a position. That is one reason why candidates are so scarce.
Hence the member-states would find more suitable candidates if they widened their search beyond former heads of government to heads of international organisations, former European Commissioners with a distinguished record and, perhaps, even prominent figures from the world of business with an international profile. Some potentials might be Dominique Strauss-Kahn, (although it is probably more important that he stay in his current position as head of the IMF), or Chris Patten, a former EU commissioner for external relations.
In an ideal world, the most promising candidate from the non-leaders category would probably be Pascal Lamy, the current head of the World Trade Organisation. Judged against the criteria quoted above, Lamy emerges as a front-runner for a number of reasons. First, as the current head of a complex but indispensible organisation that operates by consensus and moves at a slow pace, Lamy could argue that he has done this sort of work before. Second, he has no political baggage of the sort that would identify him as a tool of one particular camp of member-states or another. A French socialist who supports free trade, Lamy would be a prime candidate to bring the Union together on many issues, especially on further steps to hasten economic recovery.
Also, whilst chief of staff for Jacques Delors, a former president of the European Commission, Lamy was a highly effective consensus builder who managed to thrive amid often spectacular political infighting. That is a quality that would stand him in good stead in the power-sharing triumvirate established by the Lisbon treaty, where the Council President's responsibilities rub up against those of the president of the European Commission and a newly powerful High Representative for Foreign Policy.
Opponents could argue that Lamy has no foreign policy experience on big picture issues like the Middle East peace process or Iran's nuclear programme. But trade – along with enlargement – has long been the EU's most important foreign policy tool, and Lamy is a former EU trade commissioner. Furthermore, rising powers like China or India will sit up and take notice if the head of the WTO were to depart suddenly to take up the European Council job.
I have no idea if Lamy is interested in the EU presidency, or whether he would be willing to leave the WTO were it offered to him. But the member-states will have a bigger, better field of candidates to choose from if they can let go of the idea that the first incumbent - so important to the future success of the position - must first have been a member of their own club.
Hugo Brady is a senior research fellow at the Centre for European Reform.
EU leaders are racking their brains to come up with candidates for the future presidency of the European Council. The job, to be created by the nearly-ratified Lisbon treaty, will replace a system whereby the EU is 'led' by a different national leader every six months. Instead, the Union will have a full-time consensus builder who will also represent the EU to foreign heads of state, for a maximum five-year term. The man or woman who gets the job is banned from holding national office, but the assumption is that potential incumbents need to have served as a president or prime minister in a past life.
Strangely, suitable candidates are proving elusive, even though the post has the potential to be both prestigious and influential. Of those names that have been touted so far, some – like the former British prime minister, Tony Blair – are divisive figures that would inevitably bring much political baggage to the office. Others – like Jan Peter Balkenende, the current Dutch prime minister – are agreeable to most, but uninspiring. They lack the profile and international standing that is needed if the post is to be more than merely ceremonial.
In early 2008, I tried to imagine the qualities the successful candidate for European Council president should have, in a mock job advert published in CER's bi-monthly bulletin:
"As the first person to hold this post, you will enjoy enormous scope to shape its future potential. Second-rate candidates need not apply. You should be a formidable communicator, highly capable but not overly assertive. You need to be firm but conciliatory. Modesty would be an asset. Although this position offers prestige and influence, power and perks will be limited. With only a handful of staff and no presidential cavalcade, the job will resemble that of the UN secretary-general rather than that of US president. Beyond your right to assemble us for emergency meetings, your formal powers will be limited. We are counting on your ability to set the agenda and forge consensus through persuasion and quiet charisma."
('Applicants sought for EU council president', CER bulletin, April/May 2008).
These are virtuous attributes indeed but, even in the rarefied corps of past and present European leaders, they are hard to find. Moreover, the job appears to require its holder to be a walking paradox: charismatic but modest, highly effective but non-intimidating, a consensus builder but also a decision-maker. Most ex-leaders of national governments would struggle to adjust to the limitations and requirements of such a position. That is one reason why candidates are so scarce.
Hence the member-states would find more suitable candidates if they widened their search beyond former heads of government to heads of international organisations, former European Commissioners with a distinguished record and, perhaps, even prominent figures from the world of business with an international profile. Some potentials might be Dominique Strauss-Kahn, (although it is probably more important that he stay in his current position as head of the IMF), or Chris Patten, a former EU commissioner for external relations.
In an ideal world, the most promising candidate from the non-leaders category would probably be Pascal Lamy, the current head of the World Trade Organisation. Judged against the criteria quoted above, Lamy emerges as a front-runner for a number of reasons. First, as the current head of a complex but indispensible organisation that operates by consensus and moves at a slow pace, Lamy could argue that he has done this sort of work before. Second, he has no political baggage of the sort that would identify him as a tool of one particular camp of member-states or another. A French socialist who supports free trade, Lamy would be a prime candidate to bring the Union together on many issues, especially on further steps to hasten economic recovery.
Also, whilst chief of staff for Jacques Delors, a former president of the European Commission, Lamy was a highly effective consensus builder who managed to thrive amid often spectacular political infighting. That is a quality that would stand him in good stead in the power-sharing triumvirate established by the Lisbon treaty, where the Council President's responsibilities rub up against those of the president of the European Commission and a newly powerful High Representative for Foreign Policy.
Opponents could argue that Lamy has no foreign policy experience on big picture issues like the Middle East peace process or Iran's nuclear programme. But trade – along with enlargement – has long been the EU's most important foreign policy tool, and Lamy is a former EU trade commissioner. Furthermore, rising powers like China or India will sit up and take notice if the head of the WTO were to depart suddenly to take up the European Council job.
I have no idea if Lamy is interested in the EU presidency, or whether he would be willing to leave the WTO were it offered to him. But the member-states will have a bigger, better field of candidates to choose from if they can let go of the idea that the first incumbent - so important to the future success of the position - must first have been a member of their own club.
Hugo Brady is a senior research fellow at the Centre for European Reform.
Thursday, October 08, 2009
Greece: Nowhere to hide
by Simon Tilford
The Greek economy is on a very dangerous course. Unless the government takes steps to boost productivity and strengthen public finances, Greece faces a bleak future. Many Greeks appear to believe that membership of the euro insulates their country from the threat of financial crisis. This is mistaken. Membership may free the country from the threat of a currency crisis, but not from a fiscal crisis.
Eurozone membership requires considerable discipline. The reason is obvious. A country that loses trade competitiveness within the currency union can only regain it by ensuring its costs rise less quickly than the rest of the eurozone. In short, it must engineer a real depreciation within economic and monetary union (EMU). It cannot rely on devaluation to restore competitiveness.
Costs can be held down by wage freezes, although this risks depressing domestic demand and exacerbating the weakness of the fiscal position. Only stronger productivity offers the chance of regaining competitiveness without hitting domestic demand and bringing on a fiscal crisis. Higher productivity requires reforms of labour markets and the opening of the domestic economy to more competition.
Greece only has a small window of opportunity. The government deficit is on course to exceed 8% of GDP this year – this despite the Greek economy having only just entered recession. With the economy set to contract next year and stagnate the following year, the debt to GDP ratio will rise dramatically. The IMF estimates that it will jump to 134% by 2014. In reality, it looks like being much higher than this. And once the deficit reaches such a level it is hard to prevent it rising further because of the rising burden of interest payments.
Greece cannot finance deficits of this size domestically. It has to attract funding from abroad. This will become increasingly difficult if investors believe that the economy will be stuck in a cycle of very weak economic growth and rising public debt. Investors will lose faith in the ability of the Greek government to service its debts.
Many Greeks appear to believe that the eurozone as a whole would step in to prevent a debt crisis. They are probably right, but this would not be cost free. Assistance would be provided only in return for a commitment to reform the economy and cut public spending. It would make much more sense to take steps now rather than having to take more painful steps later.
The election result suggests that there is little stomach for reform in Greece. But Greece has no choice but to reform. Delay will only make the eventual medicine more bitter.
Simon Tilford is chief economist at the Centre for European Reform.
The Greek economy is on a very dangerous course. Unless the government takes steps to boost productivity and strengthen public finances, Greece faces a bleak future. Many Greeks appear to believe that membership of the euro insulates their country from the threat of financial crisis. This is mistaken. Membership may free the country from the threat of a currency crisis, but not from a fiscal crisis.
Eurozone membership requires considerable discipline. The reason is obvious. A country that loses trade competitiveness within the currency union can only regain it by ensuring its costs rise less quickly than the rest of the eurozone. In short, it must engineer a real depreciation within economic and monetary union (EMU). It cannot rely on devaluation to restore competitiveness.
Costs can be held down by wage freezes, although this risks depressing domestic demand and exacerbating the weakness of the fiscal position. Only stronger productivity offers the chance of regaining competitiveness without hitting domestic demand and bringing on a fiscal crisis. Higher productivity requires reforms of labour markets and the opening of the domestic economy to more competition.
Greece only has a small window of opportunity. The government deficit is on course to exceed 8% of GDP this year – this despite the Greek economy having only just entered recession. With the economy set to contract next year and stagnate the following year, the debt to GDP ratio will rise dramatically. The IMF estimates that it will jump to 134% by 2014. In reality, it looks like being much higher than this. And once the deficit reaches such a level it is hard to prevent it rising further because of the rising burden of interest payments.
Greece cannot finance deficits of this size domestically. It has to attract funding from abroad. This will become increasingly difficult if investors believe that the economy will be stuck in a cycle of very weak economic growth and rising public debt. Investors will lose faith in the ability of the Greek government to service its debts.
Many Greeks appear to believe that the eurozone as a whole would step in to prevent a debt crisis. They are probably right, but this would not be cost free. Assistance would be provided only in return for a commitment to reform the economy and cut public spending. It would make much more sense to take steps now rather than having to take more painful steps later.
The election result suggests that there is little stomach for reform in Greece. But Greece has no choice but to reform. Delay will only make the eventual medicine more bitter.
Simon Tilford is chief economist at the Centre for European Reform.
Friday, October 02, 2009
The Czechs will probably ratify the Lisbon treaty this year
by Charles Grant
Any prediction about the timing of the Czech Republic’s ratification of the Lisbon treaty must be heavily qualified; politics in Prague are so complex and opaque that many Czechs find it hard to understand what is going on. But having just spent a couple of days talking to politicians and officials in Prague, I think it likely that the Czechs will ratify this year.
The republic’s maverick president, Vaclav Klaus – who shares the passion of his idol, Margaret Thatcher, for free markets and bashing Brussels – is doing his best to delay the ratification of the Lisbon treaty. Last year a group of eurosceptic senators allied to Klaus challenged the treaty in the constitutional court, with six specific complaints about the document. After seven months the court approved the treaty and earlier this year the parliament voted for it, but Klaus has delayed signing the law of ratification. On September 29th the eurosceptic senators mounted a second challenge to the treaty in the constitutional court, thereby giving Klaus a good reason not to sign.
If the Irish approve the treaty in their October 2nd referendum, Poland’s president, Lech Kaczynski, is likely to sign his country’s law of ratification. The Czech Republic would then be the only EU member-state not to have ratified the document.
The general view in Prague is that the court, based in the Moravian town of Brno, will once again approve the treaty. It is an independent institution and nobody thinks its judges are particularly eurosceptic. But how quickly will it rule? Klaus has admitted receiving a hand-written letter from David Cameron, the leader of the British Conservatives, apparently stating that they are with the Czech president in his fight against the treaty. If Klaus can delay his signature till the Conservatives take office in Britain – after the general election that is due by next June – Cameron will hold a referendum on the treaty. The result would almost certainly be a No, and that would be the end of the Lisbon treaty.
Nobody knows how long the court will take to consider the treaty. Although it took only ten days to rule on a recent case concerning early parliamentary elections (the court insisted that the current parliament continue to the end of its term), it will need to give a full and considered response to the new challenge to the Lisbon treaty. However, one senior figure I spoke to was confident that the ruling would be “in weeks not months”. The case for a quick ruling is that the court has already spent time on the treaty, dealing with last year’s case, and that “the court does not exist in a political vacuum”. The judges understand, apparently, that there is much at stake for the whole of Europe. The chairman of the court has said that he and his judges will prioritise this case and that other matters will be put on hold. The predominant view of people I spoke to was that the court would rule by Christmas.
But could Klaus’s friends in the Senate seek to delay the treaty further, by mounting a third legal challenge? The leader of the eurosceptic senators, Jiri Oberfalzer, is reported to have said that they would not do so. Oberfalzer has also said it is unlikely that the president himself would start a new case before the court. Indeed, at a recent dinner of leaders of the Visegrad countries (the Czech Republic, Hungary, Poland and Slovakia), Klaus apparently said that ratification was like a train in motion that could not be stopped.
So long as Klaus jibs at signing the ratification, he will face mounting pressure from other EU governments. And he may face threats from France and/or Germany. In Paris there is talk of punishing the Czech Republic for delaying ratification, for example by making sure the next Czech commissioner gets a non-job or by blocking Czech participation in international bodies. In the Commission and the European Parliament some people say that the Czechs could lose their commissioner altogether: if the next Commission has to be appointed under the rules of the Nice treaty – so that the number of the commissioners must be less than the number of member-states – the Czechs should be the ones to lose out.
That kind of threat would probably be counter-productive. Klaus is famously stubborn and is never happier than when standing up for a little country against bullying by big member-states. Czech officials worry that France’s president, Nicolas Sarkozy – renowned for his impulsive comments – could put his foot in it with a stinging attack on the Czechs.
It would be wiser to let the Czech people themselves put pressure on their president. Klaus is out of tune with Czech public opinion, which is predominantly in favour of the Lisbon treaty. All the main parties except for the Communists support the treaty. The recent decision of President Barack Obama to scrap plans for an anti-missile radar in the Czech republic has weakened the hand of those Czech politicians who argue that the American alliance is more important than European integration. Indeed, since the US decision on missile defence there has been more talk in Prague of boosting the EU’s role in defence. The best course of action for Europe’s leaders is to wait patiently for the court to rule and keep their fingers crossed.
Charles Grant is director of the Centre for European Reform.
Any prediction about the timing of the Czech Republic’s ratification of the Lisbon treaty must be heavily qualified; politics in Prague are so complex and opaque that many Czechs find it hard to understand what is going on. But having just spent a couple of days talking to politicians and officials in Prague, I think it likely that the Czechs will ratify this year.
The republic’s maverick president, Vaclav Klaus – who shares the passion of his idol, Margaret Thatcher, for free markets and bashing Brussels – is doing his best to delay the ratification of the Lisbon treaty. Last year a group of eurosceptic senators allied to Klaus challenged the treaty in the constitutional court, with six specific complaints about the document. After seven months the court approved the treaty and earlier this year the parliament voted for it, but Klaus has delayed signing the law of ratification. On September 29th the eurosceptic senators mounted a second challenge to the treaty in the constitutional court, thereby giving Klaus a good reason not to sign.
If the Irish approve the treaty in their October 2nd referendum, Poland’s president, Lech Kaczynski, is likely to sign his country’s law of ratification. The Czech Republic would then be the only EU member-state not to have ratified the document.
The general view in Prague is that the court, based in the Moravian town of Brno, will once again approve the treaty. It is an independent institution and nobody thinks its judges are particularly eurosceptic. But how quickly will it rule? Klaus has admitted receiving a hand-written letter from David Cameron, the leader of the British Conservatives, apparently stating that they are with the Czech president in his fight against the treaty. If Klaus can delay his signature till the Conservatives take office in Britain – after the general election that is due by next June – Cameron will hold a referendum on the treaty. The result would almost certainly be a No, and that would be the end of the Lisbon treaty.
Nobody knows how long the court will take to consider the treaty. Although it took only ten days to rule on a recent case concerning early parliamentary elections (the court insisted that the current parliament continue to the end of its term), it will need to give a full and considered response to the new challenge to the Lisbon treaty. However, one senior figure I spoke to was confident that the ruling would be “in weeks not months”. The case for a quick ruling is that the court has already spent time on the treaty, dealing with last year’s case, and that “the court does not exist in a political vacuum”. The judges understand, apparently, that there is much at stake for the whole of Europe. The chairman of the court has said that he and his judges will prioritise this case and that other matters will be put on hold. The predominant view of people I spoke to was that the court would rule by Christmas.
But could Klaus’s friends in the Senate seek to delay the treaty further, by mounting a third legal challenge? The leader of the eurosceptic senators, Jiri Oberfalzer, is reported to have said that they would not do so. Oberfalzer has also said it is unlikely that the president himself would start a new case before the court. Indeed, at a recent dinner of leaders of the Visegrad countries (the Czech Republic, Hungary, Poland and Slovakia), Klaus apparently said that ratification was like a train in motion that could not be stopped.
So long as Klaus jibs at signing the ratification, he will face mounting pressure from other EU governments. And he may face threats from France and/or Germany. In Paris there is talk of punishing the Czech Republic for delaying ratification, for example by making sure the next Czech commissioner gets a non-job or by blocking Czech participation in international bodies. In the Commission and the European Parliament some people say that the Czechs could lose their commissioner altogether: if the next Commission has to be appointed under the rules of the Nice treaty – so that the number of the commissioners must be less than the number of member-states – the Czechs should be the ones to lose out.
That kind of threat would probably be counter-productive. Klaus is famously stubborn and is never happier than when standing up for a little country against bullying by big member-states. Czech officials worry that France’s president, Nicolas Sarkozy – renowned for his impulsive comments – could put his foot in it with a stinging attack on the Czechs.
It would be wiser to let the Czech people themselves put pressure on their president. Klaus is out of tune with Czech public opinion, which is predominantly in favour of the Lisbon treaty. All the main parties except for the Communists support the treaty. The recent decision of President Barack Obama to scrap plans for an anti-missile radar in the Czech republic has weakened the hand of those Czech politicians who argue that the American alliance is more important than European integration. Indeed, since the US decision on missile defence there has been more talk in Prague of boosting the EU’s role in defence. The best course of action for Europe’s leaders is to wait patiently for the court to rule and keep their fingers crossed.
Charles Grant is director of the Centre for European Reform.
Tuesday, September 29, 2009
Westerwelle for finance minister
by Katinka Barysch
Guido Westerwelle is the undisputed winner of Sunday’s election in Germany. His Liberal Democratic Party (FDP) attracted almost 15 per cent of the vote, its highest share ever. Angela Merkel will remain chancellor although her Christian Democratic Union (CDU) did slightly worse than in the 2005 election. The FDP’s gains allow Merkel to discard the cumbersome ‘grand coalition’ with the Social Democrats and start negotiating a deal with the more likeminded Liberals.
The haggling about posts and policies is likely to be swift this time, with Merkel promising to have her new cabinet in place in a couple of weeks. Traditionally, the leader of the junior coalition partner becomes foreign minister (and vice chancellor). So Westerwelle is almost certain to succeed SPD-leader Frank-Walter Steinmeier in the foreign ministry.
Since taking over as FDP leader eight years ago, Westerwelle has worked hard to make his party appeal more to young voters and those fed up with the two big Volksparteien, the SDP and the CDU. Sunday’s result shows that he has been successful. But party political manoeuvring and a relentless quest for media attention have not left him much time to travel the world.
His public statements about foreign policy have often been a little vague and sometimes contradictory. He has argued for continuity in German foreign policy, promising that there would be no sharp breaks with most of Steinmeier’s positions. As a strong Atlanticist he was critical of George W Bush’s war on terror but has applauded Barack Obama, in particular for his moves on disarmament. He has spoken out against Germany sending more troops to Afghanistan, or letting them fight in the south, but he wants Berlin to live up to its promises to train more Afghan policemen. He is a firm believer in the benefits of European integration, especially the single market, and he thinks Germany should pay more attention to the smaller EU members. But the smalls will not like his suggestion that European integration should become more flexible, allowing sub-groups of member-states to go ahead with particular policies. He says EU accession negotiations with Turkey should continue, which will put him at loggerheads with those in the CDU (and its smaller sister party, the CSU) who want to offer Turkey a privileged partnership. He has sometimes sounded rather conciliatory on Russia. But he also advocates keeping Germany’s nuclear power stations running beyond 2022, to make the country less dependent on Russian gas.
Westerwelle does not have a lot of experience with foreign policy and his public statements on international issues so far do not add up to a coherent Weltanschauung. That does not mean that he would not make a good foreign minister. Joschka Fischer had limited international credentials before he became foreign minister of the SPD / Green Party coalition in 1998. He turned out to be an effective and principled international operator. Like all foreign ministers before him, he quickly became one of Germany’s most popular politicians.
It is not Westerwelle (or Fischer or Steinmeier) that is the problem. It is the tradition of giving the foreign ministry to the leader of the junior coalition partner. Westerwelle may or may not agree with Merkel on foreign policy. He has little choice but to use his new job to sharpen his party’s profile. The SPD did so dismally in Sunday’s election partly because, after four years in the grand coalition, voters struggle to tell what it stands for. The lesson for the FDP will be to chart an independent course, especially after 11 years in opposition. It should: in economics, not in foreign policy.
Since the foreign minister and the chancellor always come from different parties, all vital foreign policy dossiers (relations with the US, Russia, China and so on) land directly on the chancellor’s desk. Not content with being in charge of secondary issues, Germany’s foreign ministers have often developed their own stance on the big issues of the day. Contradictory public statements and competing diplomatic initiatives have sometimes been the result. Such incoherence in foreign policy mattered little before reunification, when Germany’s low-key foreign policy mainly consisted of supporting European integration and the transatlantic alliance. But today, Germany claims international leadership and is expected to adopt regional and global responsibilities. Today, German foreign policy should not be a matter of coalition squabbles. Therefore, the foreign minister should come from Merkel’s own party.
Westerwelle should move into the finance ministry instead. While the foreign policy part of the FDP’s manifesto is weak, it has strong positions on economic policy: it advocates open markets, less stringent hiring and firing rules, an effective competition policy, help for small enterprises and, most importantly, lower and simpler taxes. Westerwelle insists that he will not sign a coalition agreement that does not contain tax reform. But he also knows that with € 1.6 trillion in public debt and a new law mandating a zero deficit by 2016, there is not much room for fiscal manoeuvre. The temptation to leave this balancing act to someone else and instead enjoy the international limelight will be strong. But if Westerwelle is serious about tax reform, he should install himself in the finance ministry and see it through as best he can. By helping to tackle some of Germany’s economic weaknesses, Westerwelle may even add more to his country’s international standing and credibility than by being its chief diplomat.
Katinka Barysch is deputy director of the Centre for European Reform.
Guido Westerwelle is the undisputed winner of Sunday’s election in Germany. His Liberal Democratic Party (FDP) attracted almost 15 per cent of the vote, its highest share ever. Angela Merkel will remain chancellor although her Christian Democratic Union (CDU) did slightly worse than in the 2005 election. The FDP’s gains allow Merkel to discard the cumbersome ‘grand coalition’ with the Social Democrats and start negotiating a deal with the more likeminded Liberals.
The haggling about posts and policies is likely to be swift this time, with Merkel promising to have her new cabinet in place in a couple of weeks. Traditionally, the leader of the junior coalition partner becomes foreign minister (and vice chancellor). So Westerwelle is almost certain to succeed SPD-leader Frank-Walter Steinmeier in the foreign ministry.
Since taking over as FDP leader eight years ago, Westerwelle has worked hard to make his party appeal more to young voters and those fed up with the two big Volksparteien, the SDP and the CDU. Sunday’s result shows that he has been successful. But party political manoeuvring and a relentless quest for media attention have not left him much time to travel the world.
His public statements about foreign policy have often been a little vague and sometimes contradictory. He has argued for continuity in German foreign policy, promising that there would be no sharp breaks with most of Steinmeier’s positions. As a strong Atlanticist he was critical of George W Bush’s war on terror but has applauded Barack Obama, in particular for his moves on disarmament. He has spoken out against Germany sending more troops to Afghanistan, or letting them fight in the south, but he wants Berlin to live up to its promises to train more Afghan policemen. He is a firm believer in the benefits of European integration, especially the single market, and he thinks Germany should pay more attention to the smaller EU members. But the smalls will not like his suggestion that European integration should become more flexible, allowing sub-groups of member-states to go ahead with particular policies. He says EU accession negotiations with Turkey should continue, which will put him at loggerheads with those in the CDU (and its smaller sister party, the CSU) who want to offer Turkey a privileged partnership. He has sometimes sounded rather conciliatory on Russia. But he also advocates keeping Germany’s nuclear power stations running beyond 2022, to make the country less dependent on Russian gas.
Westerwelle does not have a lot of experience with foreign policy and his public statements on international issues so far do not add up to a coherent Weltanschauung. That does not mean that he would not make a good foreign minister. Joschka Fischer had limited international credentials before he became foreign minister of the SPD / Green Party coalition in 1998. He turned out to be an effective and principled international operator. Like all foreign ministers before him, he quickly became one of Germany’s most popular politicians.
It is not Westerwelle (or Fischer or Steinmeier) that is the problem. It is the tradition of giving the foreign ministry to the leader of the junior coalition partner. Westerwelle may or may not agree with Merkel on foreign policy. He has little choice but to use his new job to sharpen his party’s profile. The SPD did so dismally in Sunday’s election partly because, after four years in the grand coalition, voters struggle to tell what it stands for. The lesson for the FDP will be to chart an independent course, especially after 11 years in opposition. It should: in economics, not in foreign policy.
Since the foreign minister and the chancellor always come from different parties, all vital foreign policy dossiers (relations with the US, Russia, China and so on) land directly on the chancellor’s desk. Not content with being in charge of secondary issues, Germany’s foreign ministers have often developed their own stance on the big issues of the day. Contradictory public statements and competing diplomatic initiatives have sometimes been the result. Such incoherence in foreign policy mattered little before reunification, when Germany’s low-key foreign policy mainly consisted of supporting European integration and the transatlantic alliance. But today, Germany claims international leadership and is expected to adopt regional and global responsibilities. Today, German foreign policy should not be a matter of coalition squabbles. Therefore, the foreign minister should come from Merkel’s own party.
Westerwelle should move into the finance ministry instead. While the foreign policy part of the FDP’s manifesto is weak, it has strong positions on economic policy: it advocates open markets, less stringent hiring and firing rules, an effective competition policy, help for small enterprises and, most importantly, lower and simpler taxes. Westerwelle insists that he will not sign a coalition agreement that does not contain tax reform. But he also knows that with € 1.6 trillion in public debt and a new law mandating a zero deficit by 2016, there is not much room for fiscal manoeuvre. The temptation to leave this balancing act to someone else and instead enjoy the international limelight will be strong. But if Westerwelle is serious about tax reform, he should install himself in the finance ministry and see it through as best he can. By helping to tackle some of Germany’s economic weaknesses, Westerwelle may even add more to his country’s international standing and credibility than by being its chief diplomat.
Katinka Barysch is deputy director of the Centre for European Reform.
Tuesday, September 22, 2009
Talk of ‘exit’ is premature
by Simon Tilford
The governor of the Bank of England (BoE), Mervyn King, has had a mixed financial crisis. He assumed that financial stability flowed from monetary stability – which we now know is not the case – and was very slow to recognize the extent of the crisis. He has also taken the UK into unchartered waters with the embrace of so-called quantitative easing (QE). QE involves the electronic creation of new money by the central bank in the form of purchases of government and private sector bonds. QE aims to drive down long-term interest rates and encourage bank lending. The BoE has now spent around £150bn, in the process buying not far short of a quarter of the UK’s entire outstanding stock of government debt. It is far from clear whether QE will work. It is possible that the banks will simply sit on the cash rather than lending it, as they did in the early 1990s when the Bank of Japan employed a similar strategy. But King is right to argue that dramatic action is warranted by the economic outlook, which is much worse (and not just in the UK) than the general consensus.
The BoE governor has repeatedly warned that commentators and economists are not paying sufficient attention to the difference between ‘growth and levels’, and that the threat of inflation is extremely remote. He is clearly right. A couple of quarters of modest economic growth following peak-to-trough contractions of around 5 per cent is neither here nor there. It certainly does not represent a return to business as usual. Of course, it is positive that the recession is over. But that the economy has been stabilized at all has been the result of massive monetary and fiscal stimulus. The underlying dynamic remains very weak. On most growth projections it will take the EU economy several years to return to pre-crisis levels of GDP.
No sooner has the recession ended than we are being overwhelmed with talk of a rapid bounceback in economic growth and hence for the need to craft ‘exit strategies’ to prevent an upsurge of inflation. This ignores what has happened. The gap between what we can produce and what we do produce is now enormous. With consumption and investment set to remain very weak, it will take many years to close this gap. To talk of exit strategies in such a situation is dangerous and potentially deflationary. It is going to feel like a recession for many years. Demand for labour will take a long time to recover, not only because it will take time to recoup the lost output but because labour productivity will also rise over this period. Fewer workers will be needed to produce a given amount of output. The result threatens to be mass unemployment. The outlook for investment is also very poor. The combination of excess capacity and undercapitalised banks will conspire to keep investment weak for quite some time.
Of course there are mighty long-term fiscal challenges facing most EU economies. If bond investors start to believe that governments have lost control of their public finances, long-term interest rates will rise, hitting growth. But a premature exit would do more harm than good, as it would almost certainly derail the recovery, in the process weakening fiscal positions. If no-one else is willing to spend, then the state has to. Any country exiting before a self-sustaining recovery has taken hold will essentially be guilty of free-riding on the demand being generated by deficit spending elsewhere. Germany has already indicated that it intends to tighten fiscal policy steadily following the election and is now constitutionally obliged to reduce its fiscal deficit to 0.35% of GDP by 2016. Such a move will only work if others keep spending and Germany can rely on rebuilding its trade surplus for economic growth. This is a zero-sum game. If everyone behaves in this way, the impact on Europe’s economy will be dire.
Similarly, a premature move to raise interest rates in an effort to head off a largely imaginary inflation bogeyman would risk scuppering the recovery by increasing the cost of capital and boosting the already excessive strength of the euro. The European economy needs very low interest rates for an extended period of time to keep capital cheap and to stimulate activity to close the output gap. The risk of snuffing out the recovery now (in the process exacerbating the weakness of public finances) is far greater than a spike in inflation later on. Stagnation and debt deflation pose greater risks to the European economy than inflation.
Simon Tilford is chief economist at the Centre for European Reform.
The governor of the Bank of England (BoE), Mervyn King, has had a mixed financial crisis. He assumed that financial stability flowed from monetary stability – which we now know is not the case – and was very slow to recognize the extent of the crisis. He has also taken the UK into unchartered waters with the embrace of so-called quantitative easing (QE). QE involves the electronic creation of new money by the central bank in the form of purchases of government and private sector bonds. QE aims to drive down long-term interest rates and encourage bank lending. The BoE has now spent around £150bn, in the process buying not far short of a quarter of the UK’s entire outstanding stock of government debt. It is far from clear whether QE will work. It is possible that the banks will simply sit on the cash rather than lending it, as they did in the early 1990s when the Bank of Japan employed a similar strategy. But King is right to argue that dramatic action is warranted by the economic outlook, which is much worse (and not just in the UK) than the general consensus.
The BoE governor has repeatedly warned that commentators and economists are not paying sufficient attention to the difference between ‘growth and levels’, and that the threat of inflation is extremely remote. He is clearly right. A couple of quarters of modest economic growth following peak-to-trough contractions of around 5 per cent is neither here nor there. It certainly does not represent a return to business as usual. Of course, it is positive that the recession is over. But that the economy has been stabilized at all has been the result of massive monetary and fiscal stimulus. The underlying dynamic remains very weak. On most growth projections it will take the EU economy several years to return to pre-crisis levels of GDP.
No sooner has the recession ended than we are being overwhelmed with talk of a rapid bounceback in economic growth and hence for the need to craft ‘exit strategies’ to prevent an upsurge of inflation. This ignores what has happened. The gap between what we can produce and what we do produce is now enormous. With consumption and investment set to remain very weak, it will take many years to close this gap. To talk of exit strategies in such a situation is dangerous and potentially deflationary. It is going to feel like a recession for many years. Demand for labour will take a long time to recover, not only because it will take time to recoup the lost output but because labour productivity will also rise over this period. Fewer workers will be needed to produce a given amount of output. The result threatens to be mass unemployment. The outlook for investment is also very poor. The combination of excess capacity and undercapitalised banks will conspire to keep investment weak for quite some time.
Of course there are mighty long-term fiscal challenges facing most EU economies. If bond investors start to believe that governments have lost control of their public finances, long-term interest rates will rise, hitting growth. But a premature exit would do more harm than good, as it would almost certainly derail the recovery, in the process weakening fiscal positions. If no-one else is willing to spend, then the state has to. Any country exiting before a self-sustaining recovery has taken hold will essentially be guilty of free-riding on the demand being generated by deficit spending elsewhere. Germany has already indicated that it intends to tighten fiscal policy steadily following the election and is now constitutionally obliged to reduce its fiscal deficit to 0.35% of GDP by 2016. Such a move will only work if others keep spending and Germany can rely on rebuilding its trade surplus for economic growth. This is a zero-sum game. If everyone behaves in this way, the impact on Europe’s economy will be dire.
Similarly, a premature move to raise interest rates in an effort to head off a largely imaginary inflation bogeyman would risk scuppering the recovery by increasing the cost of capital and boosting the already excessive strength of the euro. The European economy needs very low interest rates for an extended period of time to keep capital cheap and to stimulate activity to close the output gap. The risk of snuffing out the recovery now (in the process exacerbating the weakness of public finances) is far greater than a spike in inflation later on. Stagnation and debt deflation pose greater risks to the European economy than inflation.
Simon Tilford is chief economist at the Centre for European Reform.
Thursday, September 10, 2009
The dangers of Karzai’s re-election
by Tomas Valasek
The final result of the Afghan election may not be known until the end of September, but it looks as if President Hamid Karzai will have done well enough to avoid a second round of voting. This is causing dismay in some western capitals, where some senior figures now view Karzai as a key obstacle to Afghanistan’s reconstruction. If he stays in power, people in many European countries are likely to become increasingly disenchanted with the ‘mission impossible’ that their soldiers are undertaking, and that would increase the probability of European forces being withdrawn.
A senior UK diplomat recently described the problems posed by Karzai’s government for western attempts to reconstruct Afghanistan. “Our game plan is to use foreign troops to create enough breathing room for the Afghan government to assert its authority throughout the country,” he said. “But if the government whose authority we help to assert is widely viewed as corrupt and incompetent, we have no chance of succeeding.”
Karzai’s government has earned its inglorious reputation for several reasons. Washington suspects that some of its top officials are involved in the drug trade, including the president’s brother, Ahmed Wali Karzai, as well as the defence minister, Karzai’s running mate and the potential future vice-president, Mohammad Fahim. Corruption extends downwards through the bureaucracy. Western troops say that many Afghan policemen steal valuables during searches of houses. Local leaders complain they have very little effort from the Kabul government to rebuild roads or resuscitate the economy; it is the western governments and NGOs that deliver the little progress that there is.
In his early years as president, Karzai offered hope for a new future and was genuinely popular. In 2005, 83 per cent of Afghans approved of president Karzai and 80 per cent approved of the national government overall. Today those figures have dropped to 52 and 49 per cent, respectively. Those are still solid numbers that some western leaders would envy. But the support has been on a constant slide for the past four years because more and more Afghans have given up hope that the current government will deliver stability or prosperity.
The US, the UK and other key troop-contributing governments worry that a Karzai victory heavily tainted by allegations of fraud will further disappoint the Afghans and embolden the Taliban. And in the western countries that send the troops his re-election could also fatally undermine public support for the mission. The latest opinion polls show that about two-thirds of Britons want UK troops out of the country – not only because of rising casualties, but also because of the perception that Afghan politicians are using their authority, which rests on the support of western troops, for self-enrichment.
The US, for now, has little choice but to stay put. The US public is as fidgety as that in Britain but President Obama has made success in Afghanistan a key plank of his foreign policy and he will not want to give up so soon. The US may send more troops if General Stanley McChrystal, the commander of US and NATO forces in Afghanistan, requests reinforcements.
The situation is different in other NATO allies. The Dutch are scheduled to leave next year, and the Canadians say they will withdraw in 2011, though NATO is working hard to get both governments to change their mind. That may prove impossible unless events in Afghanistan give the public some reason to believe that NATO is managing to turn around its flagging mission. Even the British presence cannot be taken as guaranteed, if public support for it continues to slide.
The prospect of European troops departing brings two risks. One is to the security of Afghanistan itself. Together, the UK, Canada and the Netherlands supply the bulk of the troops that keep a semblance of order in three of the volatile southern provinces (though the US is reinforcing its presence in the south). NATO and the EU are busy training new Afghan soldiers and police to replace the western troops. But on the evidence of the past few years, the central government is unlikely to have enough properly trained replacements to take over from the Europeans anytime soon. Some local Afghan leaders say that if the Europeans withdraw in the next year or two, they will leave the country too, or strike deals with the Taliban. Either way, the government in Kabul would lose out. The second risk is to NATO itself. Why should Washington take the alliance seriously if it finds itself manning the ramparts in Afghanistan alone?
To prevent European support for the war in Afghanistan from collapsing, the governments need to take two steps. First, those capitals that have done little to drum up public support for the mission need to step up. In the UK, Prime Minister Gordon Brown gave a major ‘why we fight’ speech on September 4th. More effort of this sort is needed. Second, assuming that Karzai is declared the victor, the West needs to find ways of making clear to is government that it needs to do more to fight corruption. This could include withholding EU and national aid from the most corrupt parts of the Afghan government.
Getting the Kabul government to change its ways will not be easy: when the US special representative, Richard Holbrooke, recently suggested that Afghanistan might have to deal with complaints of ballot-rigging by holding a second round of elections, Karzai walked out of the meeting; he later told a French newspaper that the US wanted him to be more “docile”. But the European governments and Washington are right to try. The government in Kabul and its western partners need to find ways of changing the perception that the Karzai government is failing, or public pressure may force European troops to withdraw sooner than is good for the country.
Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
The final result of the Afghan election may not be known until the end of September, but it looks as if President Hamid Karzai will have done well enough to avoid a second round of voting. This is causing dismay in some western capitals, where some senior figures now view Karzai as a key obstacle to Afghanistan’s reconstruction. If he stays in power, people in many European countries are likely to become increasingly disenchanted with the ‘mission impossible’ that their soldiers are undertaking, and that would increase the probability of European forces being withdrawn.
A senior UK diplomat recently described the problems posed by Karzai’s government for western attempts to reconstruct Afghanistan. “Our game plan is to use foreign troops to create enough breathing room for the Afghan government to assert its authority throughout the country,” he said. “But if the government whose authority we help to assert is widely viewed as corrupt and incompetent, we have no chance of succeeding.”
Karzai’s government has earned its inglorious reputation for several reasons. Washington suspects that some of its top officials are involved in the drug trade, including the president’s brother, Ahmed Wali Karzai, as well as the defence minister, Karzai’s running mate and the potential future vice-president, Mohammad Fahim. Corruption extends downwards through the bureaucracy. Western troops say that many Afghan policemen steal valuables during searches of houses. Local leaders complain they have very little effort from the Kabul government to rebuild roads or resuscitate the economy; it is the western governments and NGOs that deliver the little progress that there is.
In his early years as president, Karzai offered hope for a new future and was genuinely popular. In 2005, 83 per cent of Afghans approved of president Karzai and 80 per cent approved of the national government overall. Today those figures have dropped to 52 and 49 per cent, respectively. Those are still solid numbers that some western leaders would envy. But the support has been on a constant slide for the past four years because more and more Afghans have given up hope that the current government will deliver stability or prosperity.
The US, the UK and other key troop-contributing governments worry that a Karzai victory heavily tainted by allegations of fraud will further disappoint the Afghans and embolden the Taliban. And in the western countries that send the troops his re-election could also fatally undermine public support for the mission. The latest opinion polls show that about two-thirds of Britons want UK troops out of the country – not only because of rising casualties, but also because of the perception that Afghan politicians are using their authority, which rests on the support of western troops, for self-enrichment.
The US, for now, has little choice but to stay put. The US public is as fidgety as that in Britain but President Obama has made success in Afghanistan a key plank of his foreign policy and he will not want to give up so soon. The US may send more troops if General Stanley McChrystal, the commander of US and NATO forces in Afghanistan, requests reinforcements.
The situation is different in other NATO allies. The Dutch are scheduled to leave next year, and the Canadians say they will withdraw in 2011, though NATO is working hard to get both governments to change their mind. That may prove impossible unless events in Afghanistan give the public some reason to believe that NATO is managing to turn around its flagging mission. Even the British presence cannot be taken as guaranteed, if public support for it continues to slide.
The prospect of European troops departing brings two risks. One is to the security of Afghanistan itself. Together, the UK, Canada and the Netherlands supply the bulk of the troops that keep a semblance of order in three of the volatile southern provinces (though the US is reinforcing its presence in the south). NATO and the EU are busy training new Afghan soldiers and police to replace the western troops. But on the evidence of the past few years, the central government is unlikely to have enough properly trained replacements to take over from the Europeans anytime soon. Some local Afghan leaders say that if the Europeans withdraw in the next year or two, they will leave the country too, or strike deals with the Taliban. Either way, the government in Kabul would lose out. The second risk is to NATO itself. Why should Washington take the alliance seriously if it finds itself manning the ramparts in Afghanistan alone?
To prevent European support for the war in Afghanistan from collapsing, the governments need to take two steps. First, those capitals that have done little to drum up public support for the mission need to step up. In the UK, Prime Minister Gordon Brown gave a major ‘why we fight’ speech on September 4th. More effort of this sort is needed. Second, assuming that Karzai is declared the victor, the West needs to find ways of making clear to is government that it needs to do more to fight corruption. This could include withholding EU and national aid from the most corrupt parts of the Afghan government.
Getting the Kabul government to change its ways will not be easy: when the US special representative, Richard Holbrooke, recently suggested that Afghanistan might have to deal with complaints of ballot-rigging by holding a second round of elections, Karzai walked out of the meeting; he later told a French newspaper that the US wanted him to be more “docile”. But the European governments and Washington are right to try. The government in Kabul and its western partners need to find ways of changing the perception that the Karzai government is failing, or public pressure may force European troops to withdraw sooner than is good for the country.
Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
Friday, August 07, 2009
Anglo-Saxons and hedge funds: Culprits or scapegoats?
by Philip Whyte
Disasters often provoke unseemly bouts of finger-pointing. This has certainly been true of the global financial crisis. In the Anglo-Saxon world, libertarians have blamed it on governments, and governments on ‘bankers’. But in continental Europe, many blame Anglo-Saxons for their supposed reluctance to regulate financial markets. The crisis, they believe, would never have happened if the British and the Americans had regulated and supervised their financial sectors like the French and the Germans. On this view, the UK needs to change, notably by clamping down on hedge funds. Does this narrative stack up? Or have some Europeans just turned Anglo-Saxons and hedge funds into their scapegoats of choice?
Tirades against Anglo-Saxons long predated the crisis, but they have gathered in intensity since it began. In the run-up to the G20 summit in April, Luxembourg’s prime minister, Jean-Claude Juncker, stated that this crisis “started in the US. The Anglo-Saxon world has always refused to add the dose of regulation which financial markets needed.” At the end of the same summit, the French President, Nicolas Sarkozy, announced the death of “unregulated Anglo-Saxon finance”. And in July, Germany’s chancellor, Angela Merkel, told a political meeting in Nuremberg that “with us, dear friends, Wall Street or the City of London won’t dictate again how money should be made, only to let others pick up the bill.”
In any analysis of the causes of the crisis, the UK and the US clearly deserve a share of the blame. They tolerated unsustainable domestic credit booms which wreaked havoc on themselves and the rest of the world. But they were hardly the only countries to experience credit-fuelled housing booms. Denmark, France, Ireland and Spain did too. Nor were they the only countries which allowed ‘shadow banking’ entities to proliferate and banks’ exposures to complex financial instruments to grow. It was a funding crisis at two ‘special investment vehicles’ (SIVs) that brought the regulated German bank, IKB, to its knees. And German banks built massive exposures to collateralised debt obligations (CDOs).
What of hedge funds? Listen to French and German leaders, and you would think that hedge funds were central to the financial crisis. France and Germany have leaned on the European Commission to propose a directive that would regulate hedge funds; they have criticised the Commission’s resulting legislative proposal as too weak; and they have accused the British of dragging their heels. France and Germany are not entirely wrong: the example of Long Term Capital Management in 1998 shows that some hedge funds can pose a threat to financial stability. Even so, it is hard to avoid the conclusion that France and Germany have used the crisis as an opportunity to advance one of their hobby horses.
Both the EU’s de Larosière report and the UK’s Turner review agree that hedge funds did not cause the global financial crisis. They did not drive the growth in sub-prime lending. They did not cause house prices to fall. And they did not force regulated banks (such as Germany’s Hypo Real Estate) to hold CDOs on their balance sheets. So it is quite wrong to imply, as some French and German politicians do, that the crisis would not have occurred if hedge funds had been more tightly regulated. It is also wrong to suggest that the British are reluctant to regulate hedge funds. The British government has accepted the Turner review’s recommendation that “regulation should focus on economic substance, not legal form”.
The Turner and de Larosière reports point to a broad, technocratic cross-Channel consensus on the causes of the financial crisis and the lessons to be learned. Does it matter if this is not reflected in political rhetoric? Yes, for two reasons. First, political obsessions can often drag policy in undesirable directions. (Remember that when Germany chaired the G7 in the months leading up to the crisis in 2007, it was so fixated with regulating hedge funds that it was blind to what turned out to be the central problem: the excessive leverage and effective under-capitalisation of the regulated banking sector). Second, rhetoric can poison negotiations unnecessarily, making agreement more difficult to reach.
Populist broadsides against Anglo-Saxons and hedge funds are unlikely to help the prospect of pan-European regulatory reform. If French and German politicians are not careful, the scenario which they paint of a recalcitrant Britain at odds with the rest of Europe could become a self-fulfilling prophesy. It is no secret that sections of Britain’s media and political class are primed to detect sinister motives in anything emanating from Europe. More often than not, such fears are just paranoid fantasy. But for once, the British may be forgiven if they conclude that France and Germany are exploiting the crisis to promote some of their longstanding objectives and to weaken London’s position as a financial centre.
Philip Whyte is a senior research fellow at the Centre for European Reform.
Disasters often provoke unseemly bouts of finger-pointing. This has certainly been true of the global financial crisis. In the Anglo-Saxon world, libertarians have blamed it on governments, and governments on ‘bankers’. But in continental Europe, many blame Anglo-Saxons for their supposed reluctance to regulate financial markets. The crisis, they believe, would never have happened if the British and the Americans had regulated and supervised their financial sectors like the French and the Germans. On this view, the UK needs to change, notably by clamping down on hedge funds. Does this narrative stack up? Or have some Europeans just turned Anglo-Saxons and hedge funds into their scapegoats of choice?
Tirades against Anglo-Saxons long predated the crisis, but they have gathered in intensity since it began. In the run-up to the G20 summit in April, Luxembourg’s prime minister, Jean-Claude Juncker, stated that this crisis “started in the US. The Anglo-Saxon world has always refused to add the dose of regulation which financial markets needed.” At the end of the same summit, the French President, Nicolas Sarkozy, announced the death of “unregulated Anglo-Saxon finance”. And in July, Germany’s chancellor, Angela Merkel, told a political meeting in Nuremberg that “with us, dear friends, Wall Street or the City of London won’t dictate again how money should be made, only to let others pick up the bill.”
In any analysis of the causes of the crisis, the UK and the US clearly deserve a share of the blame. They tolerated unsustainable domestic credit booms which wreaked havoc on themselves and the rest of the world. But they were hardly the only countries to experience credit-fuelled housing booms. Denmark, France, Ireland and Spain did too. Nor were they the only countries which allowed ‘shadow banking’ entities to proliferate and banks’ exposures to complex financial instruments to grow. It was a funding crisis at two ‘special investment vehicles’ (SIVs) that brought the regulated German bank, IKB, to its knees. And German banks built massive exposures to collateralised debt obligations (CDOs).
What of hedge funds? Listen to French and German leaders, and you would think that hedge funds were central to the financial crisis. France and Germany have leaned on the European Commission to propose a directive that would regulate hedge funds; they have criticised the Commission’s resulting legislative proposal as too weak; and they have accused the British of dragging their heels. France and Germany are not entirely wrong: the example of Long Term Capital Management in 1998 shows that some hedge funds can pose a threat to financial stability. Even so, it is hard to avoid the conclusion that France and Germany have used the crisis as an opportunity to advance one of their hobby horses.
Both the EU’s de Larosière report and the UK’s Turner review agree that hedge funds did not cause the global financial crisis. They did not drive the growth in sub-prime lending. They did not cause house prices to fall. And they did not force regulated banks (such as Germany’s Hypo Real Estate) to hold CDOs on their balance sheets. So it is quite wrong to imply, as some French and German politicians do, that the crisis would not have occurred if hedge funds had been more tightly regulated. It is also wrong to suggest that the British are reluctant to regulate hedge funds. The British government has accepted the Turner review’s recommendation that “regulation should focus on economic substance, not legal form”.
The Turner and de Larosière reports point to a broad, technocratic cross-Channel consensus on the causes of the financial crisis and the lessons to be learned. Does it matter if this is not reflected in political rhetoric? Yes, for two reasons. First, political obsessions can often drag policy in undesirable directions. (Remember that when Germany chaired the G7 in the months leading up to the crisis in 2007, it was so fixated with regulating hedge funds that it was blind to what turned out to be the central problem: the excessive leverage and effective under-capitalisation of the regulated banking sector). Second, rhetoric can poison negotiations unnecessarily, making agreement more difficult to reach.
Populist broadsides against Anglo-Saxons and hedge funds are unlikely to help the prospect of pan-European regulatory reform. If French and German politicians are not careful, the scenario which they paint of a recalcitrant Britain at odds with the rest of Europe could become a self-fulfilling prophesy. It is no secret that sections of Britain’s media and political class are primed to detect sinister motives in anything emanating from Europe. More often than not, such fears are just paranoid fantasy. But for once, the British may be forgiven if they conclude that France and Germany are exploiting the crisis to promote some of their longstanding objectives and to weaken London’s position as a financial centre.
Philip Whyte is a senior research fellow at the Centre for European Reform.
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