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 Then the invitation was withdrawn at the last minute.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.