What the summit says about the EU

by Katinka Barysch

The EU summit on December 10th-11th was a success in so far as EU leaders managed to agree on all major agenda items. The fact that there was a lot of bitter wrangling and a big dose of compromise was only to be expected against the backdrop of a rapidly worsening European economy. However, the longer-term consequences of these compromises are worrying.

* Lisbon treaty

The most unequivocally positive but least noticed deal of the summit concerned the future of the Lisbon treaty. Under quite a bit of pressure from their European colleagues, the Irish government eventually agreed to attempt a repeat referendum in the second half of 2009. Ireland obtained the pledge of legally binding guarantees that the Lisbon treaty would not affect their country’s tax system, neutrality and laws on abortion and gay marriage (since the other EU countries do not want to re-ratify the Lisbon treaty, these clauses will be tacked on to Croatia’s accession treaty which EU countries will need to ratify around 2010-11). EU leaders also agreed that each country would keep its ‘own’ commissioner, abandoning the unworkable and unpopular (in particular among smaller countries such as Ireland) plan to move towards a rotation system.

The outcome of a second referendum is still hard to call. Acute economic worries could turn the Irish against any initiative put forward by their unpopular government. On the other hand, pro-treaty campaigners will raise the spectre of Ireland being marginalised in, or even pushed out of, the EU in case of a second No – an uncomfortable thought at a time of extreme uncertainty.

If the Irish say Yes next year, the treaty could come into force at the start of 2010. If more evidence was needed, the war in Georgia and the struggle to find a concerted response to the financial crisis confirmed that the institutional changes contained in the Lisbon treaty are needed, in particular the streamlining of the EU’s foreign policy machinery and the abolition of the rotating presidency.

* Economic stimulus

Most media attention ahead of the summit had focused on the EU governments disagreeing about the Commission’s proposal for a €200 billion economic stimulus programme. Since the EU’s own central budget is both small and mostly tied up in farm aid and regional spending, €170 billion would have to come from the member-states. The UK and France in particular had criticised Germany for not doing enough to revive its economy, especially since years of prudence had left the country with a sound budget and big external surplus. Chancellor Angela Merkel pointed to the €12 billion worth of measures already passed by the German Bundestag (which the government expects to lead to investment of €50 billion), while her finance minister, Peer Steinbrueck, accused the UK of moving towards “crass Keynesianism” in a newspaper interview. The impression that Germany was isolated in Europe was reinforced when Gordon Brown invited Nicolas Sarkozy and Commission President Jose Manuel Barroso to an economics summit on December 8th but not Merkel.

In the end, EU leaders backed a somewhat watered down stimulus package amounting to “about” 1.5 per cent of EU GDP. However, since this so-called package consists of vastly different national efforts – some already passed, some still under discussion, and many containing spending items that had in any case been planned – it is hard to predict the impact on Europe’s contracting economy. Bruegel, a Brussels-based think-tank, has calculated that the tax cuts and additional spending announced by Europe’s 13 biggest economies for 2009 would amount to only 0.53 per cent of their GDP. The bulk of the planned measures (amounting to 1.16 per cent of GDP) consist of additional credit and spending brought forward, which will have a much more limited impact on demand.

* Climate change

The most important deal of the summit did not concern economics but the EU’s long-term commitment to fight climate change. The French presidency was determined to forge an agreement on how to implement the EU’s 20-20-20 targets from March 2007 before the Czechs – not necessarily known for their green credentials – take over the EU’s rotating presidency in January 2009. To the relief of many – and in particular the 10,000 delegates at the UN conference on climate change that was taking place at the same time in Poznan, Poland – EU leaders managed to clinch a deal, albeit at a price.

EU states kept their commitment to increase the share of renewable sources to 20 per cent and to cut total greenhouse gas emissions by 20 per cent compared with 1990 levels, both by 2020. An agreement on the (non-binding) target of achieving energy savings of 20 per cent was left to later. However, following heavy lobbying from Austria, Italy, Germany and the new member-states, a gradual move towards auctioning all emissions permits from 2013 onwards was delayed. Making energy generators and manufacturers pay for their emissions permits provides greater up-front incentives for investments in energy-savings technologies, it eliminates opportunities for windfall profits and it generates additional revenue that can be used for investments in environmental technology, such as carbon capture and storage.

Under the EU’s summit compromise, power generators in Western Europe will have to pay for all their emission rights from 2013 but those in Central and Eastern Europe will still get most of them for free until 2020. Poland in particular, which still relies on coal for more than 90 per cent of its electricity, had argued that full auctioning would at least double its power prices. Germany had led the group of those countries that had warned that saddling European producers with the cost of pollution permits would force them to relocate to countries with lax environmental standards, such as Ukraine or China. This sounds credible for energy-intensive industries, such as cement and aluminium but not for other manufacturing sectors, which could gain long-term competitiveness if forced to invest in new, energy-efficient production technologies. Now all industries that face cost increases of 5 per cent or more from being part of the emissions trading scheme will continue to get their pollution permits for free – which is more than 90 per cent of all EU industries. Equally controversial is a clause that allows EU countries to achieve a significant part of their emission reduction targets by investing in environmental projects in developing countries. Such offset projects are a lot more difficult to verify and they take the pressure off EU countries to invest in green technologies at home.

Despite an immediate outcry from Green MEPs (calling the compromise a “free for all”), the European Parliament is likely to adopt the package on December 17th. In case it does not, Sarkozy has already said he would call an emergency EU summit before year-end.

Troubling outlook

The December summit has shown that the EU can act even under very difficult circumstance. However, some of the longer-term implications are troubling. First, the fact that EU countries found it so hard to agree on what is little more than a rag-bag of national economic measures shows that the scope for economic policy co-ordination in the EU, and even within the eurozone, is limited. Given that the euro may yet come under pressure (spreads between German government bonds and those issued by Greece, Italy and Spain are still widening), the EU needs to overcome this handicap.

Second, although the EU has in principle stuck to its 20-20-20 targets – still the most ambitious in the world – its role as global leader in climate change has been weakened. The argument that the current economic downturn would make it impossible for European companies to shoulder the costs of emission rights is not convincing: the move to full auctioning would in any case not have started until 2013, a couple of years after even the most pessimistic forecasters say growth will return. By putting the interests of business lobbies first, the EU has weakened its hand in the crucial 2009 Copenhagen summit. How will the Europeans respond when China and India argue that economic development takes priority over fighting climate change?

Thirdly, the summit showed the limits of EU solidarity. EU governments – all EU governments – will put the interests of their own taxpayers and business lobbies first. What came as a surprise to many was that Germany – traditionally seen as the “good European” – is now just as willing to fight for its national interest as traditionally more assertive countries such as France and the UK.

Katinka Barysch is deputy director of the Centre for European Reform.

The Irish send out good vibrations on Lisbon

by Hugo Brady

Ireland’s parliament – the Oireachtas – recently published a lengthy report on where the country’s relationship with the EU stands after the country’s rejection of the Lisbon treaty by referendum. Initially, I feared the study might be heavy on clichéd pieties about Ireland’s relationship with the EU without really dealing with the difficult political situation created by voting down the treaty or suggesting concrete ways out of the mess. In fact - while it fails to completely avoid the clichés (“Ireland’s position at the heart of Europe” etc) – the analysis, compiled by the parliament’s EU committee, is impressively clear, thoughtful and, in places, prescriptive.

The report sets down some sensible parameters for the debate to come:

• Saying no to the Lisbon treaty automatically implies that some further action must be taken. Legally, the EU can continue as it is with the current treaties. In reality, if the treaty is declared dead, other member-states will find ways of working together more closely. Ireland would become increasingly isolated.

• Ireland’s rejection of the treaty is affecting its ability to “promote and defend” its national interests. This is true across a range of policy areas including the EU’s climate change package, the future allocation of money from the common agricultural policy, and responses to the economic crisis. The report also maintains that over-harsh criticism of Ireland’s moves to shore up confidence in its banks and its exclusion from recently established EU discussion bodies points to its near-pariah status amongst other member-states.

• One of the assumptions underpinning investment by multinational companies in Ireland is that the country is and will remain a full member of the EU. Foreign companies which invest in Ireland are worried about the uncertainty thrown up by the current situation but are sticking with the view that the country will ultimately resolve the issue.

The report then ruled out two options Ireland might take to move on from the Lisbon rejection. First, that the country should accept a self-imposed exile from core European policies to allow the rest of the EU to go ahead. This was the cumbersome and unsustainable option taken by Denmark in the early 1990s when the Danes opted-out of EU foreign policy, citizenship, justice co-operation and the single currency.) The other is to attempt to pass the Lisbon treaty – or even parts of it – by parliamentary ratification alone. Even if legally possible and well-intentioned, the committee rightly concluded this deliberate circumvention of a democratic decision would be ill-advised.

Hence the solution, strongly implied by the report’s analysis, is a second referendum on the treaty. The committee also points out the ways in which Ireland’s conduct of its EU policy can be improved to address public perceptions of a lack of control over law-making in Brussels. One is to give Ireland’s parliament powers to prevent the government signing up to EU legislation it disagrees with. Many national parliaments in the EU have this power. Ireland’s – surprisingly – does not. A second is to create a special EU ‘panel’ in the parliament’s upper house, the Seanad. This would be a sort of ‘wise persons’ committee, nominated on the basis of their familiarity with EU matters, to scrutinise legislation and co-ordinate with Ireland’s MEPs. What is striking about these proposed reforms is that they are both inspired by Ireland's eurosceptic neighbour, Britain, where the scrutiny reserve has existed for decades and the House of Lord’s EU affairs committee is considered an authoritative source of reasoned analysis on EU issues.

The committee also heard evidence from key players involved in the most controversial aspects of the debate last June. (The list includes defence, taxation, public services, ethical issues like abortion, and the size of the European Commission.) The committee conclusively dismissed the fear that the treaty could increase EU powers to set national tax rates. But it did agree that it would be desirable for Ireland to have a European commissioner all the time, to “offer legitimacy to the proposals made by the Commission”. It also recommended that Ireland’s already very strict rules for committing troops to peacekeeping operations be made even more explicit by requiring the approval of a two-thirds parliamentary vote.

The positive and constructive tone struck by the report is very welcome, but it should be borne in mind that almost all political parties in the Oireachtas support the Lisbon treaty. This did not prevent its rejection in June in a popular vote and will not – on its own – prevent a second rejection next year. But the report shows how the moderate centre in Ireland is trying to take back control of the debate from well organised populists of the left and right that have wreaked havoc on the country’s foreign policy and its interests abroad. That damage was neatly summed up by Catherine Day, an Irishwoman, and secretary general of the European Commission. "Ireland's image in the European Union has been tarnished by the 'no' vote”, she told the committee. “I can see every day that it has reduced our ability to shape and influence events in the European Union. Other Member States tend to view us now only through the prism of the Lisbon Treaty.”

See: http://www.oireachtas.ie

Hugo Brady is a research fellow at the Centre for European Reform.

The EU takes on defence procurement

by Clara Marina O'Donnell

The EU is in the middle of a little noticed – but potentially important – debate about defence markets. For the first time, the European Commission could be authorised to help reduce barriers amongst the EU’s segmented national defence markets.

European defence markets remain drawn along national lines. Defence-related goods are exempt from EU single market rules. These exclusions were designed for only the most sensitive components of weapons, material and related technology. The trouble is that governments have used the national security argument to exclude everything, from bullets to uniforms, from open competition. And often national security has been little more than a cloak for protectionism.

Moreover, it is difficult to move defence goods from one member-state to another. Each country has cumbersome administrative procedures for export controls. As a result, defence companies with plants in several member-states have to negotiate different sets of national requirements when they want to move their components from one plant to another. The Commission has estimated that, within the EU, the direct and indirect costs of such barriers to transferring military goods amount to €3.16 billion a year. Since requests to move goods within the EU are hardly ever rejected, the value of such extensive and diverging national checks is questionable.

As Europe's paltry defence budgets are barely adequate to maintain today’s spending programmes, the current system makes little sense. So the Commission has proposed two new directives. The first is designed to open a substantial amount of defence procurement to EU competition. The Commission suggests new procurement procedures, specially tailored for defence needs (while recognising that some goods, like nuclear technology and cryptology, will always have to be exempted due to national security). The second proposed law aims to simplify procedures to move goods around the EU. It would encourage member-states to use so-called general licences. (Broadly speaking, goods which benefit from a general licence can move across borders without importers having to ask for specific licences to do so.)

The two draft directives have the potential to bring about significant improvements. Defence companies would get access to previously closed markets, while ministries of defence, and European taxpayers, would benefit from cheaper defence goods. Easier transfer of goods across the EU would make life a lot easier for defence companies. And delays in importing new kit needed by national militaries would be reduced.

In practice it remains to be seen what difference the directives, if agreed, would make. Member-states are trying to maintain maximum control of the initiatives. They get to decide what military goods are considered safe for general licences, and it is likely that only the least sensitive goods will qualify at the outset. In addition the cut-off point for military goods that are considered too sensitive to be subject to open procurement procedures has been left very vague. Here, too, member-states are likely to be very conservative for the foreseeable future.

The impact of the proposals, and particularly the procurement directive, will depend on the willingness of defence companies and the European Commission to contest decisions by member-states, and take them to the European Court of Justice. It is unlikely that large high-tech defence programmes will be open to competition for many years to come. Large defence companies will probably be unwilling to contest decisions made by their biggest customers: national defence ministries. But it is not unreasonable to foresee that in the medium term the directive could have a substantial impact on less sensitive defence sectors, low-value, high-volume goods such as rifles, tanks or even military catering. Defence ministries will have stronger incentives to open up such non-sensitive sectors as a way to cut costs. In addition, such goods are produced by a multitude of smaller companies across the EU that are not always dependent on one defence ministry. Some might conclude they have less to lose and be more willing to take a ministry of defence to court.

The most important impact of the directives would be the cultural shift they would represent. By adopting the initiatives, member-states would be accepting the Commission's oversight in an area they have hitherto jealously guarded. Defence ministries would no longer have the final say in their defence procurement.

The directives would be a minor but incremental step towards improving Europe's defence market. But it is far from certain that they will come into force. The timetable is tight. (The directives need to be agreed before the European Parliament’s term ends in spring 2009, otherwise the turnover of experts in the Commission and Parliament could postpone an agreement by several years.) In addition there are still serious stumbling blocks which member-states and the European Parliament need to agree on. Amongst other things some smaller member-states fear local industry might lose out from more open markets. The big defence companies are concerned about the impact on national research budgets and large-member states, in particular the UK, are trying to defend their case. Some member-states have admitted they will shed no tears if the whole package collapses. But it would be a mistake not to agree the package. With current defence budgets, Europeans cannot hope to maintain a proper defence industrial base without a new approach to their defence market. And if the EU really wants to reinforce its global role, it has no choice but to improve its military muscle.

Clara Marina O'Donnell is a research fellow at the Centre for European Reform.

PCA? The EU needs a real Russia debate

by Katinka Barysch

Was the EU right to resume negotiations on a new partnership and co-operation agreement (PCA) with Russia despite Moscow not fully complying with the Georgia ceasefire plan? Probably not. But the real problem with the EU’s decision is that it has not been accompanied by a more strategic debate about EU-Russia relations.

The last EU-Russia summit on November 14th in Nice was remarkable not only because of the EU’s apparent U-turn with regard to the PCA talks. It was also exceptionally brief (with only two hours for discussion) and largely free of the antagonistic exchanges that have come to characterise these six-monthly meetings. In one respect, however, the summit felt familiar: it was preceded by much disagreement among the EU members. In the end it was only Lithuania that held out against a resumption of PCA talks, with the Commission and the other 26 EU governments supporting it – some more grudgingly than others. Germany, France and Italy were keen to demonstrate that the EU still considers Russia a partner. Many of the Central and East European members supported the PCA talks simply because they feared the alternative: if EU-Russia relations remained blocked, bilateral relations between Moscow and the big EU member-states would inevitably grow stronger and the interests and concerns of the smaller ones would be sidelined.

When European leaders decided to “postpone” the PCA talks at their emergency summit on September 1st, they said they would only revisit that decision if and when Russia complied with the six-point ceasefire plan that Nicolas Sarkozy had brokered in the midst of the Georgia war. Russia has pulled troops out of Georgia proper, it has allowed EU monitors to work in Georgia (albeit not in Abkhazia and South Ossetia) and it has embarked on multilateral peace talks with the Georgians in Geneva, all as promised. What Russia has not done is withdraw all its troops to the positions they held before August 7th, another condition of the six-point plan. Observers think that Russia has three times as many troops in South Ossetia and Abkhazia as before the war and that it is building up military installations there. President Medvedev says that Russia’s recognition of South Ossetia and Abkhazia is “irreversible”, so troop strengths are a matter of negotiations between Moscow and the “sovereign governments” there.

The Europeans know that holding up PCA talks – the conclusion of which is in any case several years away – will not make Russia compromise on something that it considers so close to its national interest. But they already knew that the suspension was of predominantly symbolic value when they decided on it on September 1st (while rejecting other possible sanctions). They could at least have asked Russia to do something symbolic in return, for example expressing a commitment to strengthening the arms control regime in Europe.

The signal the EU has sent now is that it is prepared to accept new realities in the Caucasus and return to business as usual. In fact, the EU did so long before the November 14th summit. After a lull in September, EU-Russia co-operation restarted in October, with several EU-Russia ministerial councils (on energy, foreign affairs and justice and home affairs) and various technical working groups getting together that month. It makes little sense for the EU to continue co-operation at all levels, from expert meetings to summits, while keeping the PCA talks on hold. So unfreezing the talks was consistent, if not exactly brave.

EU politicians do have a point when they say that the Europeans need to continue to engage with Russia in areas ranging from energy security to preventing Iran’s nuclear bomb. What is troubling, however, is that the decision on the PCA was not accompanied by a more thorough debate on the future of the EU’s Russia policy. EU leaders did ask the Commission to conduct an “audit” of the different policy areas that matter for the EU and Russia, such as energy, trade, foreign policy, research and visas. The result is an anodyne, technical document that does little more than illustrate the fact that the EU and Russia depend on each other in many ways. The implicit conclusion is: let’s continue working together. But the document does not answer the question why. Is co-operation a means to an end (it was once seen as a way towards a “strategic partnership” and “common values”)? Is it meant to further the EU’s interests? If so, which ones and how? Or does the EU proceed with the dozens of co-operation and support programmes simply because it cannot agree on an alternative?

The Europeans need a more political, strategic debate about what they want and need from Russia. This will take time. The Georgia war has not narrowed the gap between the different national positions as much as many people had initially predicted. But this gap makes a political debate on Russia all the more urgent. By next year the Europeans will have to forge a coherent response to Medvedev’s proposal for a new European security architecture. Sarkozy told Medvedev at the Nice summit that the idea would be discussed within the framework of the OSCE in 2009. But Sarkozy did not necessarily speak on behalf of his EU colleagues, many of whom suspect strongly that Russia simply wants to split the Europeans and drive a wedge between Europe and the US. Nor did all EU governments welcome Sarkozy’s idea of a ‘deal’ on missiles under which the US would suspend the deployment of missile defences in Poland and the Czech Republic while Russia would withdraw the threat of putting Iskander missiles into Kaliningrad.

The PCA negotiations – which will be conducted mainly by the European Commission – will not provide the answer to such questions.

Katinka Barysch is deputy director of the Centre for European Reform.

What 'Obama effect' for transatlantic relations?

by Tomas Valasek

Europe got the president it wanted on November 4th. Obama will have Europe's goodwill and with it, a window of opportunity to restore transatlantic co-operation on key security issues. The list of common challenges includes, but is not limited to, Afghanistan, Iran and Russia.

Whether Obama succeeds or not depends in part on how willing he will be to try out new approaches. Europe will expect the next president to change the substance of US foreign policy as much as its style. On some issues like Iran and Afghanistan, Obama plans changes; on other like Russia he offered few new ideas during the campaign. He will have to think creatively on all fronts.

Afghanistan will be on top of the US priorities for Europe. Obama will put more troops in the country and expect Europe to do the same. And even though all European governments are short on troops and money, many will respond in kind.

But while a 'surge' worked in Iraq, more troops will not automatically be the right approach to Afghanistan. Western soldiers act like a magnet for terrorists from across the region, mainly Pakistan. Obama will need a Pakistan strategy more than an Afghanistan surge. In fact, he should consider talking to some of the current enemies from among the Taliban in Afghanistan, to build local alliances against the most radical insurgents coming from Pakistan.

On Iran, Obama said he was willing to speak directly to the Tehran government. This would be a much welcome change. The EU has been talking to Iran since 2003 but senior EU diplomats involved in negotiations say the talks cannot succeed without the US joining in. They may not succeed anyway; Iran may be far too determined to acquire nuclear weapons. But even so, a US participation in the talks would help build transatlantic consensus on further steps like a tighter embargo.

It is important that Obama does not just talk to Iran without getting something back - he is the last card the West has to play. Talking to Ahmadinejad now could also strenghten him in presidential elections, which is not in the US or European interest. So Obama should show he is willing to talk, but only at the right moment and under the right conditions.

On Russia, Obama will have a delicate task on his hands. Moscow appears determined to divide the EU member-states. It also wants to drive a wedge between the more Moscow-friendly European capitals and the United States. Obama's victory does not appear to have changed Russian policy: on the day US election results were announced the Russian president Dmitry Medvedev gave a speech criticising US 'aggression' and 'unilateralism'.

Obama's immediate priority should be to help to strengthen the EU consensus on Russia, and to bring Europe's and America's policies closer to one another. This requires two things. First, Obama will need to convince Berlin, Paris, Rome and other capitals that Washington will not gratuitously provoke Moscow. So the US should stop pushing for a Membership Action Plan (MAP) for Ukraine and Georgia. Instead of MAP, which has become a red flag to not only Moscow but also to Berlin and Paris, NATO should use its special Ukraine and Georgia councils to expand security assistance to the two countries, and to give them a clear set of criteria for future membership.

At the same time, Obama needs to re-assure NATO allies on Russian borders that Washington would not abandon them in case of a Russian aggression. To that end, Obama should work with other allies to organise 'table top' military exercises assessing NATO's readiness to defend the Baltic states against a military attack.

Bosnia is on neither Obama's nor Europe's list of priorities but it should be. Years of 'hands-off' Western policy allowed nationalists to once again flourish there. The US and Europe must urgently re-engage. The office of high representative (HR, usually a senior European diplomat) will close soon, under Russian pressure. Instead, EU governments and the US should use the full power of traditional diplomatic tools like the prospect of EU membership, and the implied threat of military intervention, to keep nationalist politicians from tearing the country apart. Above all, Obama and the EU need to pay more attention to Bosnia; the country is vulnerable and could collapse.

There are other areas, where Europe and the US will need to re-think their policies. For example, Turkey's relations with the US and Europe are at their lowest point in decades. The ideas put forth above are therefore not meant to be read as an exhaustive list but rather as a sample.

President Obama will find that dealing with Europe is not easy. Eight years of the George Bush government left Europe distrustful of the US. But Obama is surrounded by an excellent team of advisors, who understand Europe and are well positioned to guide Obama through European sensitivities. Most importantly, candidate Obama has shown tremendous empathy and intellectual curiosity on the campaign trail. And he has a first-rate mind. He seems well aware of the need for course correction in places like Iran. This bodes well for the transatlantic relationship.

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.

The Commission’s economic forecasts are still too complacent

By Simon Tilford

On the face of it, it appears churlish to accuse the Commission of complacency when it is forecasting no growth in the eurozone economy in 2009 and a deep recession in the UK. But the Commission has a tendency to be slow to downgrade its forecasts and its latest forecasting round is no exception. The Commission’s forecasts of economic stagnation next year – 0.2 per cent in the EU and 0.1 per cent in eurozone – already looks out of date. It is hard to conceive how either the EU or the eurozone will escape deep recessions in 2009. The indications of an unprecedented slump in economic activity are multiplying all the time.

Of the EU-15 economies, the Commission is probably right to be most pessimistic about Britain and Ireland, forecasting economic contractions of 1 per cent and 0.9 per cent respectively in 2009. There is no doubt that these two economies will be among the hardest hit within the EU. Both are experiencing huge falls in house prices, and their credit markets have effectively seized up. British consumers are easily the most indebted in the EU. The UK’s household savings rate was actually negative in the first half of 2008. If it were to rise back to its long-term average of 8 per cent over the next three years, the British economy would experience a deep slump.

But it is the Commission’s forecasts for a number of other member-states that stand out. Its forecasts for Germany and Spain look least credible, at zero and -0.2 in 2009 respectively. Germany’s economic strategy in recent years has been based almost entirely on export success combined with high domestic savings rates and low consumption. This leaves it hugely vulnerable to the unfolding economic crisis. The IMF expects world trade volumes to rise by just 2.1 per cent in 2009 and trade between the advanced economies to decline by 0.1 per cent. After appearing to hold up relatively well over the early part of 2009, German industrial orders are now in free-fall (falling 8 per cent in October), as most of the country’s key export markets are either in recession, or growing much less rapidly. Business expectations have fallen to their lowest levels since 1992. Germany’s specialisation in capital goods, chemicals and premium cars stood the country in good stead during the cyclical upturn in 2004-06, but with demand for all three in reverse, Germany has become very vulnerable.

Nor will the domestic economy come to the rescue. Germany has avoided the house price boom entirely and German households are not that indebted. But a recovery in domestic consumption has proved elusive. After falling steadily for over two years, unemployment is about to start rising, which will no doubt prompt Germany’s risk-averse households to further increase the proportion of their incomes that they save.

The EU’s forecast for Spain is also too sanguine. Spanish unemployment is rising very rapidly, industrial production is falling (by 8.8% in October), the pace of decline in house prices is accelerating and demand for Spanish exports is under severe pressure. The collapse in construction sector activity will impose a severe drag on the Spanish economy next year. In the circumstances, it is hard to see how the decline in output could be held down to as little as 0.2 per cent.

The Commission expects zero growth in both Italy and France. Italy and France have not experienced house price booms of the scale seen in Spain or the UK, but in both countries industrial production is under huge pressure, as a result of collapse in consumer sentiment and a big fall in export orders. Consumer and business surveys point clearly to recessions next year, rather than economic stagnation.

The IMF’s forecasts look more realistic than those of the Commission. It is forecasting a decline in EU output of 0.2 per cent and 0.5 per cent for the eurozone. This means recessions in Germany (0.8 per cent), Spain (0.7 per cent) and France and Italy (0.5 per cent and 0.6 per cent respectively.) The IMF was heavily criticised earlier in the year for allegedly being too pessimistic about Europe’s economy’s outlook, but it has been vindicated as the European economy slowed dramatically even before the intensification of the financial crisis in September.

The aggressive cuts in interest rates by the ECB and the Bank of England (BoE) over the last six weeks have come too late to have that much impact on next year’s economic growth. Interest rate reductions normally work with a lag of about 18 months. Some governments are at the limits of their borrowing capacity and can do little to directly stimulate economic activity by cutting taxes or boosting expenditure. But others have scope to offset the severity of the downturn. The EU urgently needs member-states that have run-up huge current account surpluses and which have strong fiscal positions to boost demand. Germany and the Netherlands are the obvious candidates. Their current account surpluses are not sustainable in the present climate, and they need to rebalance their economies. Germany, in particular, requires a far more significant stimulus package than the one put together by the German government, which will have a marginal impact. If the governments of big surplus countries fail to take concerted action, their surplus savings will condemn themselves and Europe as a whole to an even deeper recession.


Simon Tilford is chief economist at the Centre for European Reform

How a new Irish government might save Lisbon

by Hugo Brady

The financial crisis is challenging many of our assumptions about the course of politics and world affairs. Gordon Brown – only weeks ago portrayed as nearing the end of his time as UK prime minister – has been elevated to European, even global leadership status. After years of pan-European financial integration, the EU is heading back to national banking systems, with heavy state involvement. And the French desire for a different kind of globalisation – considered either hopelessly vague or a form of Gallic envy a short time ago – might well be realised in the coming months. Cliché or not, these are interesting times indeed.

The crisis may have another unlikely outcome: it may save the Lisbon treaty, rejected by Ireland in a referendum last June. The French government, and many others, want the Irish to hold a second referendum, preferably next spring. But they greatly under-estimate just how difficult reversing the June decision is going to be. (In fact, the chances of a second referendum before next autumn are very slim, despite the difficulties this poses for the 2009 European Parliament elections and the appointment of a new European Commission.) They also believe – rightly in a sense – that the current government of Brian Cowen, Ireland’s taoiseach, is part of the problem, not the solution.

Ireland is faring worse than most other countries in the current economic turmoil. Burst housing and credit bubbles have placed incredible strain on public finances. The approval ratings of the current coalition – led by Cowen's Fianna Fáil party – are in free fall after it unveiled a hugely unpopular budget that includes the removal of free medical benefits for the elderly. The opposition accuses the government of punishing the vulnerable for the bankers’ mistakes. With only a thin majority to rely on, the collapse of the government is a possibility.

In a previous CER Insight, I wrote about how challenging it was for the Irish government back in 2002 to hold and win a second referendum on the Nice treaty.
See: Tough choices to avoid euro-paralysis, June 2008. One important – and overlooked – component was the general election held between the two votes. Though the Nice treaty issue was not prominent in the campaign, the change of government wiped the political slate clean and provided some legitimacy for the previous decision to be re-visited.

The chances of this happening in the case of the Lisbon treaty have suddenly increased. If the present government falls, there will be three options. There may be a general election. Or Fianna Fáil may form a new coalition with new partners. More probable is the formation of an alternative government, led by the largest opposition party, Fine Gael, backed up by the Irish Labour party and others.

A Fine Gael-led coalition government would still have a mountain to climb to convince the Irish electorate to say yes to Lisbon. First the new government would have to find a way to make clear to voters that sticking with the Nice treaty means Ireland is about to lose its automatic right to be ‘represented’ on the European Commission. Second, it would have to give more power to the Oireachtas – the Irish Houses of Parliament – to decide how EU policy is decided at home. (One idea is to include a special ‘EU auditor’ post in the Irish constitution as a watchdog on European matters.) Third, the government would probably have to secure revamped promises on old bugbears in Ireland’s relationship with the EU such as abortion and defence, as well as new ones like tax harmonisation and, possibly, the Charter of Fundamental Rights.

I have argued that all such guarantees should be consolidated into one protocol on ‘Ireland in Europe’ to make them more visible to the public. The Irish government may also propose a clause to be added to the state’s constitution that no Irish citizen may be conscripted in the army of a foreign power, to address a spurious but widely believed claim from the June campaign. These would appear as separate questions on the ballot in a second referendum. Lastly, the new coalition should bring home a promise, probably from the June 2009 European Council, that the slimming down of the European Commission (as foreseen in the Nice and Lisbon treaties) will not happen. There will be more opposition to this concession from other member-states than the Irish imagine, but the difficulty in securing it should give extra impetus to any new campaign at home.

The course of Ireland’s EU debate would depend on all these things happening at the right time. Even then, there would be no certainty of success. The current leader of the pro-European Fine Gael, Enda Kenny, seems a poor alternative to lead the government. And the more impressive leader of the Labour Party, Eamon Gilmore, has grave misgivings about voting on the same treaty a second time. If they manage to agree, the government will still have to find positive arguments to make the main text of the treaty acceptable to voters.

Ironically, the events of the past few months may help to build such a case. The Georgian war and financial crisis have shown the EU needs capable, coherent leadership more than ever. The treaty’s reforms to the presidency system – to make leadership of the EU longer-term and more stable – would go some way towards achieving this. Second, and more importantly, the crisis has underlined Ireland’s reliance on its membership of the EU and the eurozone; outside the euro, Ireland would have faced a run on its currency. Even though the country cannot be forced to leave the Union, a second referendum will inevitably raise questions over its future in the EU. On the other hand, a yes vote could presage a speedier economic recovery and a return to the good times.

Hugo Brady is a research fellow at the Centre for European Reform.

Another Great Depression?

by Katinka Barysh

Many observers have drawn parallels between the current economic crisis and the Great Depression of the 1930s. However, the stock market collapse of 1929 did not directly cause what turned out to be the deepest and most prolonged recession of modern times, ultimately ending in the Second World War. The blame lies with misguided macro-economic policies and protectionist reactions, such as the infamous Smoot-Hawley tariff of June 1930, which contributed to a collapse in international trade. The downturn that is now hitting the US and EU economies will fuel protectionist reflexes. But unless western countries are prepared to tear up the rulebook of the World Trade Organisation, their room for manoeuvre is in fact limited.

Trade flows will of course be affected by the current crisis: domestic demand in the US, UK and other big economies is falling, companies cannot get the credit needed to finance exports and imports, and high energy prices have been pushing up shipping costs (although pressures are abating as oil prices fall). The Economist Intelligence Unit predicts that world trade will grow by only 4-5 per cent next year. That is a lot less than the average of 8 per cent recorded in the previous five years. But it is nothing compared with the Great Depression when real world trade flows contracted by around 14 per cent.

Surveys show that support for free trade among Europeans has been in decline for a couple of years, as people have become more concerned about globalisation, and in particular the rise of China. But overall, Europeans still hold rather benign views on international trade: over 80 per cent of Germans, French, Italians, Poles and Spaniards think that growing trade ties are, on balance, good for their country. Remarkably, in the traditionally more liberal UK the share is lower, at 77 per cent, and in the US barely over half, according to a Pew Global Attitudes Survey published earlier this year.

With many EU economies descending into recession and unemployment rising, enthusiasm for foreign trade will of course diminish. People fearing for their jobs and incomes are often happy to blame outside competition. The worry is that protectionist voices are growing louder around the world at a time when the multilateral trading system is severely weakened by the collapse of the Doha trade talks in July. However, while there is little chance of Doha – or any other ambitious trade deals – being concluded before economic conditions improve, the risk of a full-scale protectionist backlash appears small.

Most European countries trade more with their EU neighbours than with the rest of the world. Intra-EU trade is governed by the strict rules of the acquis, which does not allow any tariff or non-tariff barriers. The current recession will weaken EU countries’ commitment to state-aid rules, competition policy, as well as the liberalisation of services sectors and network industries such as energy. But the economic downturn would have to become truly catastrophic for trade barriers to re-appear within the EU.

The EU’s hands are also bound when it comes to trade with the outside world. Since the Great Depression, the world’s trading powers have conducted eight rounds of multilateral trade negotiations. As a result, tariffs on almost all manufacturing imports into the EU are low. And there are strict rules governing the use of ‘safeguard’ measures (to guard against surges in imports) and anti-dumping and anti-subsidy duties (to punish overseas producers that sell at artificially low prices). The EU could of course stretch, bend or even breach these rules to give temporary reprieve to, say, car companies, steel makers or clothing manufacturers (until a WTO court ruling resolves the issue). But such actions would probably only affect EU trade at the margins.

The failure of the Doha round does not substantially alter the trade regime of developed countries. However, unlike in the EU (and the US and Japan), developing countries are applying tariffs that are a lot lower (in some cases 20-30 per cent) than what they legally agreed to in previous trade rounds. Countries such as Mexico, India, South Africa or Korea could ramp up their tariff protection without breaching WTO rules. European politicians, and the Commission, could then come under pressure to retaliate. Moreover, a heavily Democrat-controlled US Congress could be a lot more hawkish on international trade. The main risk then is not that the rich countries will abandon their WTO commitments on a grand scale. It is that angry exchanges about economics poison the political atmosphere and make it more difficult for countries to work together on other issues, such as climate change.

Katinka Barysch is deputy director of the Centre for European Reform.

Scapegoating the US lets others off too easily

by Simon Tilford

Huge amounts have been said about the consequences of the credit crunch for the US and UK economies. They undoubtedly face major adjustments, and several years of very weak economic growth. There has also been trenchant criticism of spendthrift ‘Anglo-Saxons’ living beyond their means, derailing the global economy in the process. The US is a convenient scapegoat for politicians confronted with economic uncertainty, but it needs to be remembered that a number of European and East Asian economies benefited enormously from the credit boom. Indeed, it could not have happened without excess savings generated by the likes of China, Germany and Japan.

The credit booms in the US and UK, as well as in other countries such Spain and Australia, were not simply the result of poor commercial practices and policies in those countries. They were also the by-product of imbalances in the global economy. The US is regularly pilloried for running a large external (current account) deficit, for playing fast and loose with its currency, and hence for destabilising the global economy. This is misleading. The US did not cause the current problems all on its own. Those governments that believe a rising current account surplus is a symbol of national economic virility and competitiveness played a major role too. Indeed, their surpluses are the underlying cause of instability.

If some countries routinely run huge current account surpluses, others must run huge deficits. German and East Asian surpluses have to be invested somewhere and they got invested in housing and other assets in the US, UK and elsewhere. Criticism of the US Federal Reserve for pursuing an excessively weak monetary policy, and hence inflating asset prices is fine as far as it goes. But low interest rates were needed to encourage enough borrowing to soak up the excess liquidity produced by rising current accounts surpluses. Those condemning the US need to ask themselves where the global economy would have been without the demand generated by the US and other big deficit countries. China would certainly have grown much less rapidly and Germany and Japan would probably still be mired in economic stagnation.

Many in Germany, Japan and China argue that their dependence on the US is declining because the US accounts for a falling share of their respective current account surpluses. What they fail to notice is that the US has still been absorbing much of the liquidity that China, Japan and Germany have generated by running external surpluses with other economies. Furthermore, US demand has stimulated trade between other countries (for example, Chinese purchases of Japanese components or German machinery).

With credit conditions now tight and employment growth very weak, there will be a progressive narrowing of the US current account deficit (along with those of the UK, Spain etc). The governments that regularly criticise the US for the destabilising impact of its imbalances might not like the implications of this process. This unwinding poses a big problem for export-dependent economies. It exposes their domestic imbalances, which are just as much of a ‘problem’ as those of the US. An external surplus suggests that there are inadequate investment opportunities in an economy.

In a European context, it is imperative that the German government takes steps to rebalance the German economy. Domestic savings need to fall and investment needs to rise. Much is made of the competitive ‘gains’ the Germans have made in recent years and how this stands their country in good stead. Improved price competitiveness could help German firms to gain market share in the downturn, but collapsing export orders demonstrate that it will provide only so much support. Steep falls in investment in machinery and equipment and in purchases of cars in most of the country’s key export markets will hit the Germany economy hard next year.

The German finance minister, Peer Steinbruck, needs to spend more time thinking about how to address the country’s exceptionally weak domestic demand. Tax cuts would be a good first step. The German government needs to get over its obsession with fiscal probity. In the long-term, of course, fiscal discipline is a necessity, but at present it risks aggravating an already serious situation. China and Japan faces different challenges, but the underlying problem is one of excessive dependence on exports.

Unfortunately, there is little sign of any rethinking of economic strategy in these three economies. If anything, the problems experienced by the US have confirmed the belief that a competitive economy is one with a big external surplus and rising international reserves. This is bad news for everyone. Unless China, Germany and Japan make a net contribution to global demand, the world really could face a slump. Instead of gloating about the US’s comeuppance they should be considering what will drive their own and others’ economic growth.

Simon Tilford is chief economist at the Centre for European Reform.

In defence of Anglo-Saxon capitalism

by Charles Grant

Those who never liked ‘Anglo-Saxon’ capitalism are feeling smug. Marxists, fans of ‘Rhineland’ capitalism and those who simply cannot stand American power are crowing. “The US will lose its status as the superpower of the world financial system,” says Peer Steinbruck, Germany’s finance minister. “Self-regulation is finished, laisser faire is finished, the idea of an all powerful market which is always right is finished,” says France’s president, Nicolas Sarkozy. The British academic (and sometime fan of Margaret Thatcher) John Gray proclaims that “in a change as far-reaching in its implications as the fall of the Soviet Union, an entire model of the government and the economy has collapsed.”

All this hyperbolic froth and windy rhetoric conceals a real danger for the European economy. The perceived failure of one model of capitalism, combined with growing protectionist pressure from all continents, could push EU governments to ban or discourage a whole range of ‘Anglo-Saxon’ practices and institutions. Cross-border takeovers and equity issues, the private equity and hedge fund industries, and even privatisations – all of which can help to make economies more efficient – may come under threat. Furthermore, some governments may think that because the EU’s ‘Lisbon agenda’ of economic reform is British-inspired, they can relax their efforts to carry out its painful but essential prescriptions.

Of course, the credit crisis has exposed huge weaknesses in the American and British financial systems. The so-called phantom banking industry of institutions and instruments that focused on fiendishly complex off-balance sheet financing was poorly regulated. Those in charge of many leading banks appear to have had no idea about the risks they were taking on. Their pay packages were ridiculous and unjustified, especially when those who had failed received tens of millions of dollars of ‘compensation’ for being fired. The property and credit booms in the US, the UK, Spain and Ireland were excessive. And the British decision to allow the building societies (mutuals) to turn themselves into banks – and their subsequent move into risky financial instruments and models of funding – may have been an error.

But politicians such as Steinbruck should not indulge in too much Schadenfreude. For the next few years, some of the core euroland economies may be lucky enough to escape some of the pain that will afflict the Anglo-Saxons. But the continental banks are certainly not immune from the crisis, as the rescue of the Dutch-Belgian Fortis shows. The capital ratios of some of the top continental banks are inferior to those of their American peers. And if a European bank involved in several members-states did head for the rocks, could the EU’s ramshackle regulatory system – with national authorities holding many of the key powers – move as quickly as Treasury Secretary Hank Paulson, Federal Reserve Governor Ben Bernanke and the Congress have done?

Many of today’s Cassandras mistakenly assume that financial crises are a uniquely Anglo-Saxon phenomenon. Very different sorts of financial system – such as those of Japan and Sweden in the early 1990s – have ended up being bailed out by governments. Financial crises are inherent in the nature of capitalism, rather than one particular brand of it.

However the current crisis turns out, many continental European governments will have to tackle serious structural flaws in their economies. They are held back by a lack of competition and restrictive practices in a host of sectors, especially services. Their universities cannot compete with the world’s best. In many of these countries, old-fashioned trade unions block reform and modernisation (look at the pitiful saga of Alitalia). Excessive state aid distorts the allocation of capital and may deter new entrants. Over the past 20 years, France, Germany and Italy have performed poorly on economic growth and job creation. Europe as a whole has a poor record on innovation and the adoption of new technologies.

Among the EU-27, the UK has not been the star of the class. In recent years the Nordic economies and the Netherlands have had the best record of combining on the one hand high employment and active labour market policies, and on the other generous welfare and high-quality public services. But the UK has many strengths (as well as notable weaknesses like infrastructure). Its liberal labour markets have helped to push the employment rate above 70 per cent of the workforce – the only other EU countries above 70 per cent are Denmark, Sweden and the Netherlands. And of the EU’s large economies Britain is the most open to foreign investment, which is one reason why it has a good record of adopting new technologies.

Moreover, the City of London remains a big British strength – despite everything that has happened. Much of what the City does is valuable not only to the UK, but also to Europe and indeed the world economy. If properly regulated, mergers and acquisitions, corporate advice, City law firms, hedge funds, private equity, the euromarkets, the fund managers, the Lloyds insurance market, the currency markets, the international equity markets, and much else, add value. The City is in for a lean few years, but it will come back – after some consolidation and regulatory reform – because the world needs a centre of expertise for international finance.

Nobody should write off the American economy. Compared to its European peers, its history of recovering rapidly from recession is impressive. Its track record on innovation and start-ups is the envy of the world. Where are the European Googles, Microsofts, Ciscos and Intels? The US has most of the world’s best universities. It consistently out-performs the EU on productivity. Despite the rise of the BRIC economies, at market exchange rates the US will remain the world’s leading economy for many decades. China’s leaders know this very well and have not resorted to the kind of hubris that we have heard from certain continental politicians.

Some European leaders may view the Lisbon agenda of economic reform as ‘Anglo-Saxon’, but they should not abandon it. Parts of the agenda are rather Anglo-Saxon, such as the emphasis on creating employment, liberalising utilities and enhancing competition. But much of the agenda has a broader scope: boosting innovation, improving R&D, reforming pensions and helping start-ups. All the European economies need the Lisbon agenda, whether they are Anglo-Saxon, Rhineland, Nordic, East European or Mediterranean. At some point the financial turmoil will settle down. Then EU leaders will need to return to two key questions: why is the trend growth rate of the EU economy about one percentage point less than that of the US, and what can Europe do to catch up?

Charles Grant is director of the Centre for European Reform.

Can the next US president heal the transatlantic rift?

by Tomas Valasek

There are two schools of thought on what the election of a new US president will mean for transatlantic relations. The optimists argue that relations will improve significantly. They assume that much of the anger Europe feels towards the US is aimed at George W Bush rather than the country as a whole, and that once he leaves, US-European ties will revert to their normal, friendly terms. The pessimists disagree: they say that US and European outlooks on security are fundamentally different, that the next US president, whoever he is, will pursue a foreign policy similar to that of George W Bush, and that the relations may well worsen post-US elections as the Europeans, disappointed that president Obama or McCain does not turn out to be a multilateralist European liberal, turn their backs on the United States with a vengeance.

So when the German Marshall Fund released its annual Transatlantic trends survey last week, both the optimists and pessimists poured through the numbers in search of evidence for their respective hypotheses. On balance, the results tend to slightly favour the optimists, but much depends on who the Americans elect on November 4th.

The German Marshall Fund asked the Europeans directly whether they think that relations with the US would improve after the elections. Fourty-seven per cent of Europeans said ‘yes’ assuming Obama is the president. The reverse held true for McCain: only 11 per cent thought transatlantic relations would improve with him in the White House. But this reflects Europe’s strong preference for Obama rather than a dislike of McCain. Only 13 per cent of Europeans think that relations would worsen under McCain while a significant plurality - 49 per cent - expect them to remain the same. This suggests that Europe is adopting a ‘wait-and-see’ attitude on the Republican candidate.

Another useful way of gauging the impact of elections is to compare perceptions of the United States in Europe with attitudes towards George W Bush personally. Thirty-six per cent of Europeans support US leadership role in the world but only 19 per cent approve of George W Bush’s conduct in the office. This suggests that the 'Bush' factor reduces the Europeans’ support for the US by 17 percentage points – a percentage that Obama would certainly (and McCain possibly) pick up just by getting elected.

At this point the pessimists would point out that it does not matter what the Europeans think now. A pessimist would say that the Europeans do not understand how much continuity there is in US foreign policy. And that once Europe finds out that Obama or McCain’s foreign policy is more similar to George W Bush’s foreign policy than Europe’s - which it will be - even the most hardened Euro-optimists will feel disappointed.

That is a valid point. Obama’s victory in particular would be bound to generate expectations that no president could fulfil. So after an initial spike in European support for the US, there would come an inevitable decline. (With McCain, the Transatlantic Trends suggest, there would be little excitement in Europe initially, and hence less room for disappointment later if he turns out to be similar to the current president).

But none of this rules out the possibility of a long-term improvement in relations. It all depends on how the new president conducts himself in office. Past US presidents have managed to combine the US foreign policy tradition of assertive leadership with the Europeans’ preference for multilateral solutions and diplomacy. And so, presumably, could Obama and McCain.

Here are a few supporting numbers: in 2002, 64 per cent of Europeans approved of US leadership. (That number, as pointed out earlier, has dropped to 36 per cent today.) The major change since 2002, which accounts for the chill in transatlantic relations, was the war in Iraq. But six years on, Iraq has become a lot more stable and less salient as a political issue in Europe. It could largely disappear from transatlantic debates if Obama wins the presidency: he opposed the war all along, and has promised to withdraw US forces speedily if elected.

European support for US leadership stood at 64 per cent six years ago because previous US presidents have used US military power more delicately than George W Bush, and listened to the European allies a lot more attentively than the current president. That is precisely what Obama promises to do. (McCain says he will listen to Europe more but on some issues like Russia he sounds more aggressive than George W Bush.)

US foreign policy, contrary to the pessimists’ assumptions, is not bound to remain jingoistic - in fact, it has become a lot less belligerent in the last three-four years, during which the US opened talks with North Korea and endorsed Europe's nuclear diplomacy with Iran (for which president Bush, wrongly but understandably, has received no credit in Europe).

To win the Europeans’ hearts, the new president will have to show appreciation for the EU’s new role. As McCain or Obama will find out, Europe has changed much since George W Bush came to power. It no longer instinctively turns to the US when a crisis breaks out on or near the continent. The EU now takes care of most security problems on its own (except for large-scale crises, which still require NATO involvement). This new EU is not anti-American: 67 per cent of Europeans think that Europe should seek to work with the US rather than independently, say the Transatlantic Trends. So if the next US president seeks to work with his allies in Europe, he is likely to be received positively. Support for US’s leadership role would eventually inch up. And optimists among the Europeans would feel vindicated.

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.

The EU’s toolbox for Russia

by Katinka Barysch

Last week, Russia belatedly signed up to a timetable for pulling back its troops from the ‘buffer’ zone in Georgia. The EU, and its current president, Nicolas Sarkozy, deserve credit for having brokered the initial ceasefire and then pushing hard for Russia to follow the terms. The important question now is how the EU will respond in case tensions do not ease, or even grow further.

At its emergency summit on September 1st, the Europeans managed to stick together in an unprecedented condemnation of Russian aggression. To signal their willingness to act, they froze negotiations on their new Partnership Agreement with Russia. This decision did not sway Russia’s plans. But, being used to a squabbling and uncritical EU, Moscow will have taken note of the Europeans’ relatively strong reaction – relative because compared with the tough rhetoric of some US politicians the EU’s reaction looked measured. Those who criticise the EU for this miss the point. The EU cannot be a mediator in the conflict and take sides at the same time. The EU’s mediating role was all the more effective because it was backed by an angrily growling America that openly backed Saakashvili. The Americans found it easier to be firm because they could rely on the EU to do the negotiations.

The latest ceasefire agreement, of course, will not end the tensions. Already, there are new disagreements about how many Russian soldiers should remain in Abkhazia and South Ossetia, and where EU monitors will be allowed to go. Moreover, many people, and not only in Ukraine, Poland or Estonia, predict that Russian efforts to control its neighbourhood will not stop at the border of South Ossetia.

So the EU needs to continue its debate about what kind of tools it has available to ratchet up the pressure if necessary.

Most of the measures that politicians and commentators have discussed since August 8th are more likely to harm European interests without making Russia change its ways. Moreover, any panicky over-reaction would make Russia look scarier than it is, which Russian leaders may secretly enjoy.

Economic sanctions are almost a non-starter. Almost 30 per cent of the gas consumed in the EU comes from Russia, and the EU is in no position to replace these supplies in the foreseeable future. Acutely aware that this dependence is mutual, Russian leaders have been notably careful not to mention energy in their angry exchanges with the West. The EU could try to limit Russian sales of non-energy goods or Russian investments in EU countries. But in the absence of a UN mandate, such steps would violate the EU’s own rules for openness and non-discrimination. Economic sanctions risk undermining the principles on which the EU is based. And they could stunt Russia's diversification away from oil and gas, which is good for its long-term stability.

As for Russia’s WTO application, the EU is keen on getting Russia to respect international trade rules and submit to the WTO dispute settlement procedures while Moscow seems in no rush to finish the accession negotiations. Russia’s membership is in any case a long way off, because of Moscow’s erratic trade policy, the US’ refusal to repeal the Jackson-Vanik amendment and vetoes from Georgia and, possibly, Ukraine (both WTO members). The EU should not use the WTO to make a political point at a time when the organisation is already weakened by the break-down of the Doha trade talks.

Nor would it be a good idea to ban Russians from visiting or working in EU countries. If Russians cannot travel, they may be more prone to believing their government’s propaganda about a West that is hostile and hypocritical. And the EU needs to think very carefully about targeted visa sanctions. A ban on Russian leaders and top officials would signal a new world in which the Europeans no longer believe that engagement can achieve anything. We are a long way from there. The EU could make it harder for Russia’s big businessmen to holiday at the Cote d’Azur or do business in London, hoping that they would put pressure on their leaders to change their ways. But many rich Russians have acquired foreign passports and few will risk falling out with a regime that seems to enjoy a bit of oligarch bashing from time to time.

The EU’s decision to continue doing business with Russia does not mean that it will be business as usual. The EU could stop preparations for a trade agreement for nuclear fuels, something that Russia wants badly to grab a bigger share of the European market. The same applies for Russia’s participation in EU research projects.

More fundamentally, the EU’s response should not start by asking how to punish Russia or change its course. It should start within the EU, with a set of well-defined objectives. The tricky part is to figure out how to achieve these objectives in the face of Russian opposition or obstruction. After Georgia, the EU can no longer pretend that its goals do not clash with Russia’s. That is good because it forces the Europeans to have a more open and realistic debate about its ties with Russia and to set clearer priorities (a slimming down the bloated EU-Russia agenda in reaction to Georgia would help with this). The EU’s priorities should be: stability beyond the EU’s eastern borders, energy security, and international tasks that require some sort of Russian involvement, such a preventing Iran from building a nuclear bomb. Russia would have to take the Union a lot more seriously if it beefed up its neighbourhood policy, made some tangible progress towards a common energy policy and streamlined its foreign policy-making.

Katinka Barysch is deputy director at the Centre for European Reform.

The Arab-Israeli conflict: France's dashed hopes

by Clara Marina O'Donnell

During a trip to Israel in August, the only optimists I met were French diplomats. The reason for their upbeat mood? Ambitious plans by President Sarkozy for the EU to advance the Middle East peace process – including a controversial proposal that the EU should take the lead in creating an international peacekeeping force which could replace the Israeli army in the West Bank as part of a peace deal. But in the current inauspicious environment, can France, which currently holds the EU presidency, really help to move things forward and allow the EU to play a bigger role in the peace process?

Probably not. Already, it looks as if the French plans are becoming victims of circumstance. The Gymnich, an informal meeting of EU foreign ministers, that will take place on September 5th and 6th, had been flagged up as vital in developing a new EU strategy. The EU was to reflect on ways it could increase its support for the peace process, including the offer of new security guarantees to Israel. But the Georgian war has changed EU priorities, and talks on the Middle East have been seriously scaled down.

But even if the EU’s agenda had not been thrown off course, the situation in Israel and the Palestinian territories is so bad that there is little Europe can do to assist the current peace process. The prospects for the US-sponsored Annapolis peace effort, always bleak, have almost entirely faded. With just over three months to the December deadline for a deal, not only are Palestinians still divided and feuding, but Israel has also plunged into a political crisis. Prime Minister Olmert, the main force behind the peace talks, has been forced to resign over corruption allegations. In the current environment, any efforts by the EU, a minor player, are condemned to frustration.

Yet Sarkozy’s ideas are interesting. The CER has long argued that the EU should offer more security guarantees to Israel, including peacekeepers, in order to prove its credibility as a valuable partner to Israel, and to strengthen its role in the peace process (‘The EU, Israel and Hamas’, CER working paper, April 2008). So while it might not be possible to debate these ideas at the upcoming Gymnich, and still less put them into practice in the near future, the EU should still reflect on them.

Sarkozy’s general approach to Israel is also interesting. The EU has always found it hard to influence Israel. Two tactics have been tried, both – so far – unsuccessfully. The EU used to voice loud public criticism of Israeli actions it disapproved of, for example the expansion of settlements in the Palestinian territories. But Israel would simply ignore this, and accuse the EU of megaphone diplomacy. More recently, the EU has trodden more softly, in the hope of increasing its influence. Relations have, as a result, significantly improved – but on issues such as settlements the EU is still mostly ignored.

Sarkozy has adopted something of a middle ground approach – ‘tough love’ – with Israel. He presents himself as a true friend of Israel but he is also publicly critical about sensitive issues. His approach seems to have had some success. Despite declaring that settlement activity must stop and that Jerusalem must become a shared capital of Israel and a future Palestinian state, Sarkozy received a standing ovation when he addressed the Israeli parliament in June. And I encountered generally positive assessments of him from local and foreign officials in the region.

France may not be able to deliver the ambitious and radical ideas it was envisaging to strengthen the Middle East peace process (it would be unkind to suggest that scaling back ambitious agendas might be a recurrent theme of the current French administration). Neither has Paris found a magic solution to the EU’s conundrum of how to increase its influence with Israel (the continued growth in settlements over the last year clearly shows the limit of EU influence), but Sarkozy’s new approach does offers a potentially useful path forward for EU-Israel relations.

Clara Marina O'Donnell is a research fellow at the Centre for European Reform.

Farewell, Polish plumber

by Philip Whyte

When the EU expanded its membership in 2004, the UK was one of only three EU countries – Ireland and Sweden were the others – fully to open its borders to migrants from the ten new member states. The decision resulted in an unexpectedly large influx of migrants from central and eastern Europe. Ever since, the debate in the host countries has focused on the domestic impact of this wave of immigration. But it is time the debate moved on. For there is strong evidence that few of these migrants have any intention of settling permanently.

The host countries’ initial focus on migratory inflows is entirely understandable. When the EU enlarged its membership in 2004, the British government projected that the annual inflow of central and eastern Europeans to the UK would average between 5,000 and 13,000 through to 2010. It was being too modest. British statistics on migration are a mess, but most estimates suggest that official projections were out by a factor of twenty. Close to a million central and eastern Europeans are thought to have migrated to the UK since 2004.

The conservatism of the government’s initial projections was not unreasonable. By and large, Europeans are a sedentary bunch: they are disinclined to move within their own countries, let alone across national borders (with all the attendant difficulties of adapting to new languages and cultures). Previous enlargements – including the Iberian one in 1986 – had not provoked a dramatic increase in migration across national borders. So why expect the admission of the former Communist-bloc countries to produce different effects?

But the UK under-estimated the strength of the ‘push’ and ‘pull’ factors at play. Low income per heads, allied to housing shortages and high rates of joblessness (particularly among the young), encouraged many central and eastern Europeans of prime working age to seek their fortunes abroad. And by a happy coincidence, the EU countries that had thrown their borders open to them were enjoying buoyant economic growth and had numerous job vacancies to be filled. Migration was lubricated by low-cost airlines and Skype.

The scale of the influx did not go unnoticed in the host countries. Nor was it universally welcomed. Elements of the UK’s notoriously noisy press spoke of being ‘flooded’ and went out of their way to cast the new entrants as ‘benefit tourists’ – a scurrilous charge, given their exceptionally high rates of employment. Nevertheless, government policy was forced to adapt to this new context. When Bulgaria and Romania were admitted to the EU in 2007, the UK did not feel politically able fully to open its borders to nationals of these countries.

The irony, however, is that government policy has hardened at precisely the moment when the factors that drove migration to the UK in 2004-07 are going into reverse. The over-leveraged UK economy faces a nasty economic downturn and rising joblessness. Sterling has weakened markedly against most European currencies (reducing the relative wage that migrants earn in the UK). Meanwhile, unemployment in central and eastern Europe has been falling while incomes have risen. Against this backdrop, half of the 1 million central and eastern Europeans who came to the UK have returned to their home countries.

In other words, few migrants from the new member states have been escaping their home countries to settle in the wealthier EU member states. Instead, most have been using host countries as revolving doors through which they can enter and exit. Their aim is not to build a new life abroad, but a better one at home. The debate and policy response in the host countries needs to adjust to this reality – particularly as migratory flows will become more evenly distributed across the EU as restrictions on labour movement are gradually relaxed.

Philip Whyte is a senior research fellow at the Centre for European Reform.

Should Europeans care about Doha?

by Katinka Barysch

Are the Doha trade talks finally dead? Following the failure of the latest ministerial meeting in Geneva on July 29th, there will be little appetite for another big push to resolve disputes over farm subsidies and manufacturing tariffs. But unless the 150-odd WTO members agree on the outline of a deal in 2008, the new US administration (and the new EU Commission) would pretty much start from scratch in 2009. A final deal could then take another five years or more. Perhaps it would be better to give up on Doha?

Europeans do not seem to care very much. They worry more about the impact of the global downturn on their mortgage, job and pension. Many EU governments have also appeared distinctly unenthusiastic about trade liberalisation lately. French President Sarkozy blamed the Irish No to the Lisbon treaty on the ‘overly liberal’ trade policies of Trade Commissioner Peter Mandelson. During the Geneva talks, eight other EU countries lined up behind France (including Italy, Greece, Poland and Hungary). They argued that Mandelson’s first responsibility was to protect European jobs and incomes – in particular in the farm sector – not to finish a round of trade talks of dubious economic value.

Would the failure of Doha be a disaster for Europe? Not on the face of it. Calculations of the direct economic benefits from finishing the round have gradually been reduced (and most estimates are now well below 1 per cent of global GDP). With many of its biggest trading partners – China, Russia, ASEAN, the EFTA countries – the EU has special agreements on trade and investment, or is in the process of negotiating them (albeit with limited success). And many poorer countries may be more willing to grant the EU better access to their markets on a bilateral basis – without having to extend the same privileges to China.

So should the EU just let Doha die? Is reviving the round worth the risk of internal EU divisions and grumpy European farmers? Yes, because the costs of its failure could be huge. Here are just four of the issues to take into account.

* While Sarkozy and Berlusconi are wrong to claim that Mandelson is ‘selling out’ European farmers, the EU’s offer on agriculture is not negligible. It includes a complete abolition of export subsidies and a considerable reduction in both domestic farm support and import tariffs. Many development experts say the offer does not go far enough. But at least it would lock in some progress on CAP reform. That matters since the EU is conducting its own ‘health check’ on the CAP this year. And the issue of farm-sector reform will come up again by 2012, when EU countries will haggle about the EU’s new long-term budget. Accelerated CAP reform would free up billions of euros that would be better spent on innovation, climate protection or development. To keep CAP reform going is particularly important now that some EU politicians use the global food crisis as a phoney argument for more, not less, farm support.

* It is true that Doha would not result in drastic new tariff cuts for manufactured goods. But business in Europe and elsewhere is wrong to conclude that the current trade round doesn’t matter for them. As Patrick Messerlin, a French trade economist, has convincingly argued, the Doha round is hugely important for locking in the progress that has been made over the last 15 years. Most countries around the world now apply tariffs that are much lower than the ceilings fixed in the Uruguay round in 1993 (so-called bound tariffs). They could push them up to their bound levels without penalty at any time. Some emerging markets, such as Brazil, have already responded to slowing growth by nudging up their tariff protection. Binding manufacturing tariffs nearer their currently applied levels would reduce that risk, and give companies the certainty that they need to trade and invest abroad.

* If Doha fails, the WTO could lose much of its credibility, and the trend towards bilateral and regional trade agreements would accelerate further (200 of those are already in place, another 200 are being negotiated or planned). Economists disagree over whether this bilateralism is a good thing (a push for market opening while global talks remain stuck) or a bad thing (leading to a dangerous and costly fragmentation of the international economy). It certainly weakens the multilateral trading system. With only half of all Americans now believing that international trade is good for them, protectionist sentiment rising in Europe, and many emerging economies becoming more assertive in their trade policy, the world needs stronger global trade rules and dispute settlement mechanisms, not weaker ones.

* Finally, as Charles Grant and I have argued in our recent report ‘Can Europe and China shape a new world order?’, this is a critical time for persuading emerging powers that multilateralism actually works for them. They should work through international rules and organisations, not follow narrow-minded power politics. The WTO (and its predecessor, the GATT) is one of the cornerstones of the post-war multilateral system and the one that arguably matters most for China, India, Brazil and other rising economies. If the WTO does not deliver, how can we persuade these countries that the UN, the World Bank or the Kyoto regime on climate change matter for them?

Katinka Barysch is deputy director of the Centre for European Reform.

The EU will want more from Serbia than arrests

by Tomas Valasek

On July 21st, Serbian security agents hauled Radovan Karadzic off a bus in Belgrade and took him into custody. The long-wanted wartime leader of the Bosnian Serbs now awaits extradition to the International War Crimes Tribunal (ICTY) in The Hague, where he stands accused of crimes against humanity for his role in the 1992-95 Bosnia war. My conversations with analysts, journalists and diplomats in Belgrade this week suggest that his arrest could signal the beginning of Serbia’s full reconciliation with its role in the Yugoslav wars. It also opens the door to improved relations with the EU. However, Serbia’s application for EU membership will remain on hold until Belgrade and Brussels can agree on a better way of co-operating over Kosovo.

Karadzic had been hiding in Serbia for much of his 13-year run from the law. There are two schools of thought among local and Western observers in Belgrade on why the Serbian security forces moved to arrest Karadzic. Both assume that Serbia has known for a while that Karadzic had been hiding on its territory, rather than in Bosnia, where he committed his crimes. And both acknowledge that Serbia’s co-operation with the Hague Tribunal has been half-hearted of late.

Belgrade did arrest some accused war criminals, most notably Serbia’s former leader, Slobodan Milosevic. But shortly after Milosevic’s arrest – and largely because of it – elements in the security forces assassinated the then-prime minister Zoran Djindjic. Subsequent governments have been far more cautious. Belgrade would occasionally arrest smaller fish, usually right before important EU summits. This allowed Serbian governments to claim compliance with The Hague’s demands, without really dealing with Serbia’s role in the Yugoslav wars. All along, security forces loyal to the Milosevic regime were allowed to protect the most wanted criminals, like Karadzic and General Ratko Mladic, the wartime commander of the Bosnian Serb military.

So when the news of Karadzic’s arrest broke, some in Belgrade and Brussels – the first school of thought – saw it as a half-hearted attempt to improve Serbia’s image and win kudos with the European Union, which Serbia would like to join as soon as possible. But this time, things may be different. The second school of thought, to which I subscribe, argues that domestic politics played a crucial role in the arrest.

Karadzic’s arrest comes shortly after Serbia voted in what is arguably the most pro-EU government since Djindjic’s assassination. All recent Serbian governments had combined openly pro-Western parties with more nationalist voices, and so does the current coalition. But in this government the roles have been reversed. President Boris Tadic’s party ousted the nationalist prime minister, Vojislav Kostunica, who had been seen in Belgrade as the main obstacle to arrests of Karadzic and Mladic. Pro-EU parties now dominate, and they have gained a tighter control over the security apparatus. Right after forming a government, Tadic removed the head of secret service, who had helped protect indicted war criminals. The arrest of Karadzic came just two days later. People close to Tadic believe that the other remaining ‘big fish’, like Ratko Mladic, will be arrested soon as well.

Tadic won the election on a platform of bringing Serbia into the EU and attracting Western investment, both of which should improve Serbs’ poor living standards. But the EU wanted (and still wants) to see more arrests of war criminals before it moves Serbia’s application forward. No arrests, no EU integration, no foreign investment, no economic recovery. So Tadic decided that there were strong domestic reasons to move forward on the war crimes issue. The arrest of Karadzic, Serbian analysts say, has also helped boost Tadic’s image – he had a reputation for vacillating but this bold step has made him look like a leader. And he seems to have rightly calculated that the Serbian public would support him. There were precious few demonstrators in the streets of Belgrade after Karadzic’s arrest. This, in turn, made the nationalist opposition look out of touch.

On balance, Tadic’s pursuit of war criminals seems genuine. It strengthens his domestic political position, and it improves Serbia’s standing in the eyes of the EU. But Kosovo will continue to plague the Brussels-Belgrade relationship. Serbia is a candidate for EU membership, and it recently signed a new partnership agreement with the EU, the ‘stability and association agreement’, or SAA. But the EU has held up the agreement’s entry into force, in order to pressure Belgrade to apprehend war criminals. The EU also has a second reason for being reluctant to speed up Serbia’s integration process: it wants co-operation from Serbia on Kosovo. And there has been very little progress on the latter point.

Most EU states have recognised an independent Kosovo. But Serbia, even under its current government, remains categorically opposed. Instead, it has effectively divided Kosovo by taking administrative control of the country’s north where much of the population are ethnic Serbs. Belgrade now finances health workers and policemen serving local Serbs in Kosovo. It is also preventing the EU rule of law mission, EULEX, from fully deploying. Tadic has hinted at wanting to improve co-operation with the EU – for example, he is sending back Serbian ambassadors to those EU countries that have recognised Kosovo (Kostunica had recalled them). But more needs to be done; Serbia needs to allow the EU police to operate in all of Kosovo. Until then, its ties with the EU, even after Karadzic’s arrest, will remain strained.

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform

Ukraine needs new politicians

by Charles Grant

Ukraine is heading for an economic crash. At least that was the message I picked up in the Crimean resort of Yalta earlier this month, at the 'Yalta European Strategy' conference. The point of this annual event is to bring Ukraine closer to the European Union. At last year's conference Gerhard Schröder and Bill Clinton dropped in; this year, Tony Blair and Mikheil Saakashvili urged Ukraine's leaders to push ahead with reforms that would speed up European integration.

But Ukraine's politicians are not listening. The two parties in the governing coalition, President Viktor Yushchenko's Our Ukraine, and the Bloc Yulia Tymoshenko (BYuT), are at daggers drawn with each other. The presidential election due in 2009 dominates politics. Yushchenko fears a challenge from Tymoshenko, who is more popular than him, and each seems to be focused on damaging the image of the other. Meanwhile, the economy is on the brink of collapse but neither politician is prepared to take the unpopular measures that would be required to stabilise it.

The political system is deeply corrupt and there are virtually no neutral state institutions: the electoral commission and the supreme court are packed with party nominees. One of Ukraine's brighter and younger politicians, Rada speaker Arseniy Yatsenyuk, was blunt in Yalta: "Our problem is a lack of political maturity, we have no standards, we don't have a clear idea how to enforce laws or penalise people, we have no strong prosecutor's office, and the judicial system is deteriorating."

Meanwhile the economy, which had picked up in the past few years, with growth of 7 per cent in 2007, faces huge problems. Inflation, at 30 per cent, is the third highest in the world, after Zimbabwe and Venezuela. The government is boosting transfer payments and public sector wages in an effort to buy political support. The trade deficit is running at 12 per cent of GDP. The government has foolishly tied the hryvnia to the dollar, which encourages hot money to flow in and fuel inflation. Ukraine's industries – predominantly metals, chemicals and food processing – are losing competitiveness. Another problem is that Ukraine is locked into one of its regular rows with Russia over the price of gas imports. If, as is likely, Ukraine ends up having to pay a significantly higher price, its gas-dependent heavy industries will suffer.

The question of NATO membership is exacerbating divisions among the political elite. The opposition Regions party, led by Viktor Yanukovich, is strongly against, while Our Ukraine is strongly for. BYuT would in theory like to join NATO in the long term, but does not want to push this for now on the grounds that it would divide the country.

In Yalta, Sergei Glaziev, a senior Russian economist and a former minister, described how Russia would react if Ukraine entered NATO: "Ukraine would lose its free trade area with Russia, we would raise gas prices, Russian companies would cut off co-operation with Ukrainian ones on high technology, and we would impose visa restrictions." That was quite moderate. Last month, at a conference in Moscow, I heard foreign minister Sergei Lavrov say that if Ukraine joined NATO, some Russians would question Ukraine's borders. Yuri Luzhkov, the mayor of Moscow, has explained what that means: Crimea should be chopped off Ukraine and given to Russia.

Such threats show that the Russians are failing to overcome their historic inability to make friends with their neighbours. Ukrainians do not like being bullied. As it happens, only about 20 per cent of them want to join NATO. But Russian threats tarnish the attractiveness of the big eastern neighbour, even in Ukraine's east, where people are naturally sympathetic to Russia. The Russians are wasting their energy when they threaten Ukraine, since there is no chance of it joining NATO in the foreseeable future. The pro-NATO Yushchenko is likely to be out of office in a couple of years, while France and Germany are determined to veto American efforts to give Ukraine a 'membership action plan.'

The question of the EU membership, by contrast, generally unites Ukrainians: easterners and westerners all want to join (Russia does not mind Ukraine joining the EU). The EU and Ukraine are negotiating a 'deep free trade' agreement, meaning one that would remove non-tariff as well as tariff barriers, and foster regulatory convergence. But many Ukrainians worry about the cost of implementing such an agreement. In order to comply with EU standards and therefore be able to export to EU markets, Ukraine would need to spend billions of dollars, say government officials. Yet EU aid to Ukraine totals only €200 million a year. Furthermore, some of Ukraine's oligarchs may resist free trade with the EU; they fear that outside competition could disrupt their cosy cartels.

Given that the EU is not offering Ukraine the carrot of a membership perspective, the political and business elites may be reluctant to embrace the – sometimes painful – reforms that would bring Ukraine closer to the Union. To his credit, France's President Nicolas Sarkozy is trying to get the EU to offer closer political links. Ukraine's deputy prime minister in charge of EU integration, Hrihoriy Nemyria, spelt out in Yalta what Ukraine wanted: "The long term goal of visa-free travel, money from the European Investment Bank, and integration into all EU agencies and programmes."

Fine ideas. But if Ukraine’s political class continues to perform abysmally, and if the economy crashes, there is little chance of the EU wanting to embrace Ukraine. Yatsenyuk told the truth in Yalta: "We're not ready for EU, we should wait five years before we try to get in. In five years there will be a new political elite in charge in Ukraine." Let us hope he is right on that last point.

Charles Grant is Director of the Centre for European Reform

The latest Euro-Med jamboree

By Clara Marina O'Donnell

On July 13th, President Sarkozy, surrounded by 42 EU and Mediterranean leaders, launched his pet project, the Union for the Mediterranean. The Paris summit was a success. The turnout was impressive and the mood constructive. Israel declared that peace with the Palestinians was closer than ever, while Syria and Lebanon announced they will open embassies in their respective countries. But many of the positive steps are the result of peace efforts unrelated to the new Union. And it doesn’t look like the French initiative addresses the obstacles that have limited the success of past EU policies in the region.

Because of its proximity, the stability and prosperity of the Mediterranean is of crucial importance to the EU. For many years, the EU has been working with the region, trying to replicate the soft power approach which proved so successful in Eastern Europe – it has encouraged regional cooperation and domestic reforms in exchange for deeper relations with the EU. In 1995, at a summit as ambitious as Sarkozy’s recent jamboree, the EU launched the so-called Barcelona Process – a multilateral framework designed to encourage peace, democracy and economic development through regional integration. In 2004, to the confusion of many Mediterranean partners, the EU introduced an additional policy, the European Neighbourhood Policy (ENP), designed to deepen bilateral cooperation between the EU and the Mediterranean partners, and to give an additional impetus to reform.

The Barcelona Process has created the only regional forum with Arab and Israeli participants. But Barcelona and the ENP have failed to fulfil expectations. Democratic reforms and economic development have not materialised, and the various conflicts remain unresolved.

Two main challenges have hampered EU efforts in the Mediterranean. First, the benefits that the EU can offer Mediterranean governments are limited, so the EU has little leverage to encourage reforms. The EU’s most effective incentive, membership, is not on the cards, and with the exception of Morocco, most countries are not interested in joining in any case. EU leverage is further reduced by its reluctance to offer things which are attractive to the region’s governments, such as greater access to the EU’s labour market and free trade for agriculture.

Secondly the EU is trying to encourage cooperation across a region riddled with conflicts. The Arab-Israeli conflict is the most intractable dispute, but serious tensions also exist between Morocco and Algeria, and Cyprus, Turkey and Greece. The different tensions obstruct most efforts to cooperate and have seriously undermined the Barcelona Process.

The Union for the Mediterranean has the merit of putting the region at the top of the political agenda and giving badly needed impetus to Euro-Mediterranean relations. The Union aims to strengthen the Barcelona Process by focusing on projects of regional cooperation (such as cleaning up the Mediterranean and building motorways). But it risks getting stuck in the same quagmire as previous EU initiatives. Regional projects were already part of the Barcelona Process and are therefore unlikely to provide a breakthrough. In addition the Union doesn’t address either of the main challenges. There are no new incentives to encourage Mediterranean leaders to reform. The EU will not even provide additional funding for the new projects. And while the different Mediterranean partners might have seemed constructive at the recent summit, it is largely because several difficult questions were put off until November. Among other things there is still no agreement on how to staff the Union’s new independent secretariat (which in principle should have officials from all the countries involved). Many officials think it will be unfeasible to have Israelis and Syrians working side by side, and many Arab governments have made clear they do not want the Union to lead to a normalisation of relations with Israel.

New institutions are not the answer to the region’s problems. If the EU wants to have a bigger impact on the Mediterranean it must offer its partners some of the things they care about – greater financial assistance and freer trade in agricultural goods would be a good start. Even then, the EU should lower its expectations and acknowledge that it is dealing with partners who have a very different analysis of the costs and benefits of reform than Eastern Europe had.

The EU should also increase its diplomatic efforts towards the different conflicts across the region. It should build on the momentum of the Paris summit so that the following summits of the Union no longer merely benefit from steps towards peace but contribute to them as well.

Clara Marina O'Donnell is a research fellow at the Centre for European Reform