Thursday, December 21, 2006

Has Germany been Finlandised (and has Britain)?
by Charles Grant

During the Cold War, Finland was a prosperous, liberal democracy. But its leaders felt unable to criticise the Soviet Union, particularly on questions of foreign policy. They were scared of what their big neighbour might do to them, especially since it had invaded them in the Second World War. People living further from the Soviet Union, in comfortable Western Europe, sneered about ‘Finlandisation’ – the inability of a small and relatively weak country to criticise a big and potentially hostile neighbour. But maybe the Finns were the best judge of how to handle the Soviets.

Under Chancellor Gerhard Schröder, German foreign policy became very pro-Russian. Schröder is proud of his friendship with President Vladimir Putin, and has refused to criticise the roll-back of democratic freedoms in Russia during the past few years. Chancellor Angela Merkel, from the CDU party, takes a slightly different line: when she has met Putin, she has made a point of raising concerns over human rights in Russia. But overall German policy remains very pro-Russian. The SPD-controlled foreign ministry, in particular, is very reluctant to criticise Russia.

Germany has good reasons for wanting close relations with the Russian government. Much of its gas comes from Russia, which is also an important export market. Germany’s big businesses lobby hard, and effectively, to deter the government from becoming too critical of the Putin regime. And of course, given the Second World War, and the many millions of Germans and Russians who died fighting each other, there will always be a special relationship between these two countries. There are very many reasons why Germany and Russia should be friends, and co-operate together on dealing with a whole host of common problems.

But a strange event earlier this month suggests that the ‘Finlandisation’ of Germany may be going too far. Sabine Christiansen presents the most influential television programme in Germany, and has interviewed everybody from Bill Clinton to Tony Blair to George Bush. In one recent programme she interviewed half a dozen studio guests about the situation in Russia, in the light of the murder of Alexander Litvinenko, and other recent news. She had invited Garry Kasparov, former world chess champion, and now a leader of the liberal opposition in Russia, to take part. Then the invitation was withdrawn at the last minute. The reason, according to the Financial Times of December 16th, was that the Russian ambassador to Germany said that he would not take part in the show if Kasparov was there. According to the FT piece, two people who work on the Sabine Christiansen programme confirmed the story. However, both the presenter herself and the Russian embassy in Berlin deny that Kasparov was cancelled because of Russian government pressure.

If the FT piece is true, it is alarming that an influential TV programme seems so unwilling to annoy the Russian government. But Germany may not be the only country to be have been Finlandised. Britain has not been so uncritical of events in Russia as has Germany. However, the British government is very nervous about what happens in Russia, mainly because of the massive investments made by Shell and BP. If British-Russian relations took a major turn for the worse – and with the Litvinenko affair, they have already deteriorated in recent months – the security of those investments would be called into question. That is why the British government has handled the Litvinenko affair with kid gloves. Ministers are loath to suggest that anyone linked to the Russian state could be involved in the murder of Litvinenko. They wish the affair would just go away.

Smaller EU countries tend to be more outspoken on human rights questions in places like Russia and China. It is easier for them to be outspoken, for they often have fewer commercial interests at stake. Foreign policy is inevitably a messy business, in which principles have to be balanced against the national interest. So if a government refrains from criticising malpractice in countries such as Russia or China, it may be understandable. But if a top television programme in a leading EU country tries to limit debate on a controversial current affairs topic, for fear of annoying a foreign government, it is surely unacceptable.

Charles Grant is director of the Centre for European Reform.

Friday, December 08, 2006

Beware a weak dollar!
by Simon Tilford

When Claude Trichet, president of the European Central Bank, announced yesterday’s increase in eurozone interest rates, he did not even mention the threat a weaker dollar could pose to the outlook for the eurozone economy. At the current exchange rate between the euro and the dollar, his apparent complacency may be right. In trade weighted terms, the euro has only strengthened very gradually over the last 12 months. However, European policy-makers are being too sanguine about the implication for Europe of a sustained fall in the dollar. As a result, they risk repeating the mistakes of early 2001, when they dismissed the threat posed to the European economy from a weaker dollar.

What has changed since 2001 to make European policy-makers such as Mr Trichet so relaxed about the impact of a fall in the dollar on the European economy? One argument is that the eurozone economy has become less dependent on exports for growth. There are at last signs that the German economy could start growing under its own steam rather than depending on exports for external stimulus. However, it is far from clear that the recovery would remain on track if exports took a big hit.

In fact, the trade dependence of most EU economies has, if anything increased since 2001. For example, German exports as a percentage of GDP have risen rapidly in recent years. The proportion of total exports accounted for by the US may have declined, but that ignores the fact that a sizeable proportion of the growth has been accounted for by rising exports to countries whose currencies are effectively tied to the dollar, notably China.

Another argument is that the reforms made by European economies over the last five years have boosted their competitiveness and left them better able to cope with a weaker dollar. The competitiveness (and profitability) of German industry in particular has certainly improved, with the result that German companies will be relatively better able to cope with a weak dollar than five years ago. The same cannot be said of other eurozone economies. The competitiveness of the Italian and Spanish economies has deteriorated very sharply since 2001.

If the Chinese and the other East Asian central banks were to allow their currencies to rise in response to a fall in the dollar, then the European economy would not have to bear the full cost of adjustment of a decline in the value of the dollar. So far, there is no indication the East Asians intend to allow their currencies to rise against the dollar. In the event of a run on the dollar, European companies are likely to experience a loss of competitiveness not just in the US, but in fast growing Asian markets as well as in third markets, where US and Asian companies will be much more competitive.

In any event, a focus on the direct trade impact risks underestimating the scale of the threat. When measuring the vulnerability of the EU economy to a fall in the dollar and downturn in the US economy direct trade flows are a relatively small part of the story. The importance of the direct trade with the US is far outweighed by indirect links. For example, the sales of British and Dutch-owned companies in the US outweigh exports from the Netherlands to the UK many times over. Even in export-dependent Germany, sales from German-owned companies in the US are five times higher than the value of German export to the US. Declining profits from the US affiliates of European businesses would hit business confidence and investment in Europe hard.

The ECB should not rush to raise interest rates further. Of course, a stronger euro will present benefits as well as impose costs. Import prices will fall, especially those of commodities priced in dollars, such as oil. This will lower inflation pressures in Europe and reduce the likelihood of further interest rate rises. However, the European economy is not as resilient as many are assuming. A rise in the value of the euro to €1.50:$1 or €1.60:$1 – a very plausible assumption – would not just be shrugged off. Indeed, it would in all likelihood put an end to the long-awaited eurozone recovery, which is currently not powerful enough to absorb the shock of a much weaker dollar.

Simon Tilford is head of the business unit at the Centre for European Reform.

Friday, November 24, 2006

Segolene's crushing victory: Good or bad news?
by Aurore Wanlin

Segolene Royal’s victory in the socialist party’s (PS) presidential primary last week was widely expected. The scale of her triumph, however, came as a surprise. With 61 per cent of the votes, her popularity can no longer be dismissed as a mediatic bubble. There is more behind Ms Royal’s success than most of her opponents have recognised so far.What does her victory say about the way French politics and her party are changing?

To start with the PS, the process that led to Segolene Royal’s victory marks the beginning of a renewal. The primary has provided the party with both new blood and a new intellectual dynamic. Over the last months, the PS has gained many new members, eager to choose their candidate. The contest between the three main contenders – Laurent Fabius, Segolene Royal and Dominique Strauss-Kahn – has revived the internal debate on a wide range of issues, from education to security or the 35 hour week. Each of them, although relying on the same official programme, has managed to define a specific political line. Although there is a risk that the PS has difficulties to mend its divisions, Segolene now benefits from an indisputable legitimacy. On the other side of the spectrum, some in the UMP regret that they have not had a similar opportunity to discuss the party’s line and choose its champion.

Segolene’s victory also means that the party might shift back to the centre, distancing itself from a more radical rhetoric, hostile to the liberal economy. Unlike most other European left-wing parties, the French socialists have never done their so-called 'Bad Godesberg'. After each electoral failure, the PS, far from choosing a more liberal line, has tended to go back to what it saw as true socialism. Last year’s popular rejection of the EU constitution brought into light the depth of the socialists’ hostility to a liberal Europe. Ms Royal’s victory over Laurent Fabius, former leader of the No camp, as well as her desire to look at what other countries such as Spain or the UK have done, might signal that change is on the way.

But a lot will depend on Ms Royal herself. Key to her success is that she seems different. Not only because she is a woman, nor because she does not belong to the establishment – she does. But because she has a different approach to politics. Her main concern is to reconcile the French with politics, by giving them a say. Take her position on Turkey’s accession to the European Union: the French will decide. Her website, the citizens’ jurys all have a similar objective: give the people the sense that she listens to them. That pragmatic approach has its advantages. Ms Royal knows to talk concretely on issues that matter most to the French.

However, there is a danger that Ms Royal appears as an anti-party candidate. Her success carries a certain vote of sanction. Segolene Royal is right to try to address France’s democratic malaise: populism has been on the rise for several years, social frustrations run high and the French distrust their political class. As a democartic leader whose main concern is to increase citizens’ participation in the political game, she appeals to the French. But as an anti-party candidate, Ms Royal will find it much harder to bring her party back to the centre by giving up the anticapitalist and antiliberal rhetoric that has been so detrimental to it. Her biggest challenge will be to combine her concerns for more direct democracy with an audacious political programme palatable both to the traditional socialist supporters and to voters in the centre. This will not be easy to achieve; but Ms Royal has already shown that she should be not underestimated.

Aurore Wanlin is a reasearch fellow at the Centre for European Reform.

Friday, November 17, 2006

Climate change:
Western business can help China and India
by Katinka Barysch

We Europeans are proud pioneers in combating climate change. But what we do at home is almost irrelevant unless we persuade and help China and India to limit emissions.

European countries are doing more than most to reduce emissions at home, according to report presented to the UN’s climate change conference in Nairobi this week: 15 of the world’s ‘greenest’ countries are in Europe. And the EU wants to go further. The European Commission has just published a plan to extend the EU’s pioneering emissions rights trading (ETS) scheme to cover more sectors and pollutants.

European climate policies matter – as examples for the rest of the world and as a testing ground for new technologies and policies. But to stop global warming we need a global approach.

In the US – the single biggest source of greenhouse gas emissions – the consensus is slowly shifting in favour of tougher policies. While the Bush administration has ruled out ratifying the Kyoto Protocol, a large number of State governments have adopted emission reduction targets or joined regional ‘cap and trade’ schemes.

Whether the US supports a post-Kyoto regime will critically depend on whether China and India come on board. China is already the second biggest emitter of greenhouse gases, mainly because it relies on coal – the dirtiest of fuels – for two-thirds of its power generation. Coal in China is cheap and plentiful. The country still has reserves to last it about 200 years, and the price of producing energy with coal is a fraction of any alternatives. India is a similar story: it relies on coal for more than half of its energy needs and is the fourth biggest source of CO2 emissions in the world. The International Energy Agency assumes that 70 per cent of additional coal demand until 2030 will come from India and China.

The Kyoto protocol almost pales into insignificance in comparison. In 2004, the Christian Science Monitor reported that China was on course to build 562 additional coal-fired power plants by 2012, more than half of the world’s total. Together with planned new plants in India (213) and the US (70 or so), these will emit 2.7 billion additional tons of carbon dioxide. Compare that with the (maximum) 480 million tons that Kyoto countries have promised to cut from their CO2 emissions by 2012.

Coal is not the only problem. China is already the second biggest oil consumer in the world, after the US. It used up 5.5 million barrels of oil a day in 2005, and India an additional 2 million. Both countries’ needs will continue to grow fast as people get wealthier and more mobile. More than three million new passenger cars were registered in China last year. But still only 11 out of 1,000 people have their own vehicle. In a developed country like the UK, more than half of all people have a car.

Improving the EU’s ETS is important. But our priority must be to persuade and help China and India to limit greenhouse gas emissions.

The Chinese and Indian authorities say they take climate change seriously. But they insist that economic growth has priority and only rich countries can afford to combat climate change. China and India account for only 10 per cent of the fossil fuel CO2 accumulated in 1850-2004. The EU, the US and Russia together account for 70 per cent. Getting Beijing and Delhi to sign up to a tough post-Kyoto regime will be as difficult as it will be essential. In the meantime, are there other things we in Europe can do?

At a workshop on India, China and climate change – which the CER ran together with the German-British Forum on November 14th – we explored how the private sector could help China and India to become greener.

The transfer of Western technology is helping to make these countries more energy efficient. But change is slow: 15 years ago, Chinese power plants typically operated at a level of efficiency that was 35-50 per cent of that of German plants. Since then that share has crept up to 50-60 per cent. A step change is needed.

Many people put their hopes into clean coal technologies. These capture the CO2 produced by coal burning and bury it under ground. So far there are only a few pilot plants in places such as Norway and the UK. But even if the West managed to make the technology commercially viable, it would remain too expensive for China to roll it out on a grand scale.

Western governments and the EU give China some money to encourage the adoption of clean technologies. But it is not enough to make a difference. Perhaps market mechanisms are more promising. Business is certainly interested. There are now 80 environmental companies listed in London’s AIM (alternative investment market) alone. Mainstream companies from Goldman Sachs to Virgin have earmarked billions of dollars for green investment schemes. There are now more than 100 funds that solely invest in clean energy and other environmental technologies.

Under Kyoto’s ‘clean development mechanism’, rich-world polluters can keep within their target by investing in environmental projects in those developing countries that have no targets themselves. In theory, therefore, Western businesses have an incentive to invest in energy savings technologies, clean coal plants and renewables in China. In practice, however, the clean development mechanism is clunky and complicated. Its effectiveness also suffers from Kyoto’s limited lifespan. Most green investments, such as new power station or windfarms, have long lifespans. So investors have to make an assumption about long-term trends in carbon prices. At the moment, they don’t even know whether there will be a carbon market after Kyoto runs out in 2012.

China itself is not exactly making it easy for Western companies. Widespread disregard for intellectual property rights makes investors reluctant to transfer the cutting edge technologies that are often needed in environmental projects. Moreover, regulatory frameworks are uncertain or badly enforced. Take renewables as an example. Both India and China have ambitious targets but since burning coal is cheaper than building dams or erecting wind turbines, regulation is needed to encourage investment. In 2004, the Chinese authorities announced that 30 Giga-watts should come from wind power by 2020 (a modest target: experts assume that China’s potential for wind-powered energy is at least ten times that). However, when the government finally released the relevant regulation in 2006, potential investors withdrew in frustration: local content requirements of 70 per cent and an overly competitive market framework would make it almost impossible for western companies to turn a profit. The big winners would be incumbent Chinese energy giants.

Western investment can help China and India to limit their greenhouse gas emissions. But these countries also need to help themselves by building an attractive regulatory and business environment for green investments.

Thursday, November 09, 2006

On November 8th, the European Commission published its new strategy report on enlargement. A non-event: drafts had been widely leaked to the press; and the most explosive question – whether accession negotiations with Turkey should by wholly or partly suspended because of Cyprus – has been put off until December.

The Commission tries to be upbeat. It talks about progress in the candidates and the EU’s will to keep its enlargement promises. But it cannot paper over the fact that today enlargement fatigue on the part of the EU meets accession pessimism on the part of the member-states.

Perhaps the most interesting part of the strategy paper is hidden in an annex on “absorption capacity”. The EU’s nappy test, Nick Watt of the Guardian calls it half-jokingly. But the question of absorption capacity is dead-serious. It is not only, as the Commission paper argues, a question of how many interpreters we need in Brussels or how much Turkish farmers could cost the EU budget. It is the question of whether enlargement helps the EU to become stronger and more prosperous.

The EU’s concern about absorption capacity is neatly summed up in the following quote:

“The prospect of further enlargement at a time when the full consequences of the preceding one have not yet been absorbed must give rise to concern. The Commission considers therefore that any further enlargement must be accompanied by a substantial improvement in the efficiency of the Community s decision-making processes and strengthening of its common institutions.”

This is not from the 2006 strategy paper. It’s from the Commission’s 1976 opinion on Greece’s membership applications. The EU has always been worried about the effect that newcomers would have on its institutions, its budget and policies, its identity and standing in the world. This is legitimate. An overstretched, gridlocked or internally divided EU would be bad for its existing members and unattractive for newcomers.

However, absorption capacity is a vague and politically charged term. A new House of Lords report on enlargement (to be released on Novmeber 23rd) argues that it could become a dangerous tool in the hands of those who want to keep out Turkey or stop enlargement altogether.

The Austrian EU presidency used the term to sever the link between the Western Balkan applicants (all small, so presumably “easy to absorb”) and Turkey (“too big, too poor, too different”). But this attempt backfired. When EU foreign ministers met their counterparts from the Western Balkans in Salzburg earlier this year, they stressed that absorption capacity was key to all future enlargements. The European Parliament followed with similar statements, as did the Council and a number of politicians from EU capitals. Enlargement Commissioner Olli Rehn tried to limit the damage by explaining that absorption capacity was not a new criterion for enlargement. But not all EU politicians agreed. Bavaria’s minister-president, Edmund Stoiber, for example, insists that the EU’s absorption capacity is more important than a candidate’s state of preparedness.

People and politicians in candidate countries are worried: “Does it matter whether we work hard?” they ask, “The EU will not let us in anyway.” The debate about absorption capacity could weaken the leverage the EU has over countries wishing to join. Given how much trouble looms in the EU’s immediate neighbourhood, that is a big risk.

The Commission report is a laudable attempt to deconstruct the term, and render it less politically explosive. To start with, the Commission insists that integration capacity is a better term: no country wants be “absorbed” by the EU. Then it breaks up the term into three questions:

1) Is the EU able to take in new members? Here the Commission promises to analyse the potential impact of each newcomer on EU institutions, policies and the budget.

2) Are the candidates well prepared enough to fit in neatly? To make sure they are, the Commission promises tougher conditions, closer monitoring and more help during future accession negotiations.

3) Are the people in the EU ready to accept more countries? The Commission rightly says that the main responsibility for explaining enlargements – past and future – lies with EU governments. But it promises to help by producing more comprehensible information.

Neatly divided into its different elements, absorption capacity becomes a to-do list for the EU rather than a threat to the candidates. After all, says the Commission, it is “first and foremost a functional concept”.

But this implies that the EU is a static construct that needs a few technical fixes before it can take in more countries. In reality, the EU is adjusting constantly in response to new challenges, such as fighting terrorism, securing energy or coping with globalisation. Successive enlargements have helped the EU in that process.

The accession of Turkey and the countries of the Western Balkans would spread democracy and wealth further across the European continent; it would strengthen the EU’s hands in volatile Middle East and Black Sea regions; it would add young, eager workers to an ageing EU economy; and it would encourage West European countries to find a way of living harmoniously with Muslim immigrants and neighbours (not only Turkey but also parts of Bosnia and Albania are predominantly Muslim).

New members are not just a burden to be “absorbed”. They are an asset too. Future enlargements will make the EU stronger, more tolerant and more competitive. The debate about absorption capacity cannot capture this because it only looks at one side of the enlargement balance sheet.

Katinka Barysch is chief economist at the Centre for European Reform