Friday, November 28, 2008

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.

Monday, November 24, 2008

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.

Monday, November 10, 2008

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.

Friday, November 07, 2008

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