by Tomas Valasek
The future of the euro may not be secure, warned the CER’s Simon Tilford in a January 2009 essay. The current economic crisis threatens to exacerbate the tensions within the eurozone, and an insolvent member-state... could default and leave the eurozone. Since January, the economic crisis has deepened further, and the eurozone’s weakest economies have come under even greater strain. This does not make their exit from the eurozone inevitable there is a strong argument in favour of keeping the eurozone together at any cost. But what if it did happen? What would leaving the eurozone mean in practice? What happens to the physical currency in circulation in the afflicted country?
There is a considerable body of precedents. Most historical currency unions have broken up. The most recent examples come from Central and Eastern Europe. Since the end of the Cold War, three countries with national currencies the Soviet Union, Yugoslavia, and Czechoslovakia have fallen apart, forcing their constituent parts to hastily adopt national currencies. To find out what the separation entailed, the CER spoke to an architect of one of those transitions: the former member of the board of the Slovak National Bank, Ján Mathes.
We asked him what a country leaving the eurozone would use instead of the euro. Several options are possible, Mathes said. Members of the eurozone have not kept a stock of national currencies in reserve so they would need to print and mint replacements. But if a country is in a hurry to leave the euro, there may not be enough time. Minting a sufficient number of new coins takes months. Producing today's high-tech, secure banknotes, from design to the printing stage, took Slovakia nearly a year. Even though eurozone members would need less time they would presumably revert to the design they used before adopting the euro printing hundreds of millions of notes still takes many months.
If a country left the eurozone abruptly, it would need to find temporary ways to separate its share of the euros from the rest. In the early 1990s, the Czech Republic and Slovakia chose to stick distinguishing stamps on their banknotes. We had thousands of people working day and night, putting tiny stamps on nearly 80 million old Czechoslovak banknotes, Mathes said. The Czechs affixed different stamps to their portion of the old notes and the currency was thus divided. Each side eventually printed its own currency, and the stamped notes were withdrawn and destroyed.
But what worked for the Czechoslovak koruna may not work for the euro. Stamps are easy to remove and the temptation to remove them would be strong. The value of the currency of the country leaving the eurozone is certain to plunge vis-à-vis the euro, so its citizens would remove stamps en masse, thus converting them to the more valuable original euros. Another physical solution, Mathes says, it to laser-engrave distinguishing marks onto the portion of the euros, which would have been allocated to the country departing the eurozone. This can be done relatively quickly and would make the currencies irreversibly different, said Mathes, adding “but I suspect that the European Central Bank will not look kindly on a state burning holes in its currency.
In many ways, the birth of the new currency would only mark the beginning of its troubles. A country would only resort to leaving the eurozone if it was in deep economic crisis but this guarantees that its currency will inspire little confidence. There is a risk that the currency’s value would slide uncontrollably. To prevent such a scenario, the new money would have to be introduced in tandem with a thorough stabilisation and recovery programme overseen and financed by the IMF or the World Bank.
But the same reforms, if introduced early, would also reduce the chances of a country dropping out of the euro in the first place. And the rest of the eurozone members will have strong interest to prevent anyone from leaving, because of the risks to the rest: a member's departure would weaken the credibility of the euro, deepening the sense of crisis and possibly forcing other countries to drop out. Self-interest may drive the rest of the eurozone to prop up the ailing country’s economy at nearly any cost. It is probably too early for ordering replacement currencies or burning holes in the euro.
Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
Monday, March 23, 2009
Thursday, March 19, 2009
How serious is the threat to the single market?
by Simon Tilford
There has been a lot of anguished talk about how the EU’s single market is under threat. Much of this alarm has focused on government support for struggling car firms and public bail-outs of crisis-ridden banks. An erosion of the EU’s competition rules would be every bit as debilitating as the impact of the financial crisis and the resulting recession. But how serious is the risk to the single market?
On the face of it, there is plenty to worry those who see the single market as key to Europe’s future prosperity. First, any hope that the impact of the financial crisis on the ‘real economy’ would be limited has ended. In the face of huge falls in industrial output this year and the prospect of several years of very weak economic growth, many European industrial firms will go bankrupt. Wage subsidies and short-time working, and all the other strategies currently being employed to cope with the collapse of demand, can only be sustained for so long. Many of the firms that go bust will be fundamentally competitive, or at least appear so. EU governments will be under huge pressure to intervene to protect such companies. The way in which they intervene will be crucial. The Commission will have a real fight on its hands to ensure that competition is not distorted. It should be strong enough to enforce the rules. But much will depend on whether member-state governments support the Commission and on who is appointed to be the next EU commissioners for competition and the internal market.
Second, the landscape of European banking has changed fundamentally over the past year and competition policy in this sector has effectively been suspended. A number of the biggest EU banks have been nationalised in all but name and governments have moved to provide public guarantees for bank loans. The shot gun marriage of Britain’s Lloyds TSB with another high street British bank, Halifax Bank of Scotland (HBOS), has left the combined group controlling around a third of the entire UK market for consumer banking services. The German, Dutch and Belgian governments have bailed out financial institutions, while governments across the EU have recapitalised banks.
The dramatic increase in government influence over the lending process will need to be reversed if potentially serious distortions are to be avoided. There is a risk that pressure will be put on banks to maintain funding for national champions and to avoid lending to companies based in other EU states. Such politicised lending would undermine the efficient allocation of capital throughout the EU by protecting inefficient companies and reducing available funds for more competitive firms. Once the financial sector has stabilised and normal levels of financial intermediation have been restored, the Commission will have to get serious about ensuring that the EU does not retreat into such ‘capital protectionism’.
Third, a further deepening of the single market can be ruled out. Crucially, faster action to liberalise and integrate service sectors across the EU now looks out of the question. It was hard enough to gain consensus in favour of radical moves to dismantle obstacles to the integration of service sectors before the crisis, but it will be impossible in the face of the backlash against liberalisation. This is bad news. Service sectors account for around two-thirds of economic activity across the EU. Service sector productivity has been extremely weak for a number of years now, holding back economic growth. More competition at both national and European level would do much to change this, and boost economic growth.
The lack of service sector integration will be particularly damaging for the eurozone. Countries that decide to forego exchange rate flexibility as a tool of economic adjustment need to ensure that their economies can be flexible in other ways. If countries such as Spain and Italy are to recover their competitiveness within the currency union, they will have to boost their productivity. This, in turn, requires more competition in service industries. The alternative route to greater competitiveness – wage cuts – would condemn their economies to stagnation. And such wage deflation might not be possible in any case, as Germany is heading for deflation. It will be extremely difficult to cut costs relative to Germany, if German costs are falling.
The legal underpinnings of the single market appear robust. But there are real reasons for concern. The steady progress in reducing state-aid has been halted and is likely to be put into reverse. The partial renationalisation of bank lending is inimical to the emergence of a single capital market. And progress towards deepening the single market in services has ground to a halt. All this bodes ill for Europe’s growth prospects and the stability of the eurozone. All EU governments profess to be committed to upholding the single market. The next couple of years will determine the strength of that commitment. If member-states do not respect the Commission’s right to enforce those rules, the single market could indeed come under threat.
Simon Tilford is chief economist at the Centre for European Reform.
There has been a lot of anguished talk about how the EU’s single market is under threat. Much of this alarm has focused on government support for struggling car firms and public bail-outs of crisis-ridden banks. An erosion of the EU’s competition rules would be every bit as debilitating as the impact of the financial crisis and the resulting recession. But how serious is the risk to the single market?
On the face of it, there is plenty to worry those who see the single market as key to Europe’s future prosperity. First, any hope that the impact of the financial crisis on the ‘real economy’ would be limited has ended. In the face of huge falls in industrial output this year and the prospect of several years of very weak economic growth, many European industrial firms will go bankrupt. Wage subsidies and short-time working, and all the other strategies currently being employed to cope with the collapse of demand, can only be sustained for so long. Many of the firms that go bust will be fundamentally competitive, or at least appear so. EU governments will be under huge pressure to intervene to protect such companies. The way in which they intervene will be crucial. The Commission will have a real fight on its hands to ensure that competition is not distorted. It should be strong enough to enforce the rules. But much will depend on whether member-state governments support the Commission and on who is appointed to be the next EU commissioners for competition and the internal market.
Second, the landscape of European banking has changed fundamentally over the past year and competition policy in this sector has effectively been suspended. A number of the biggest EU banks have been nationalised in all but name and governments have moved to provide public guarantees for bank loans. The shot gun marriage of Britain’s Lloyds TSB with another high street British bank, Halifax Bank of Scotland (HBOS), has left the combined group controlling around a third of the entire UK market for consumer banking services. The German, Dutch and Belgian governments have bailed out financial institutions, while governments across the EU have recapitalised banks.
The dramatic increase in government influence over the lending process will need to be reversed if potentially serious distortions are to be avoided. There is a risk that pressure will be put on banks to maintain funding for national champions and to avoid lending to companies based in other EU states. Such politicised lending would undermine the efficient allocation of capital throughout the EU by protecting inefficient companies and reducing available funds for more competitive firms. Once the financial sector has stabilised and normal levels of financial intermediation have been restored, the Commission will have to get serious about ensuring that the EU does not retreat into such ‘capital protectionism’.
Third, a further deepening of the single market can be ruled out. Crucially, faster action to liberalise and integrate service sectors across the EU now looks out of the question. It was hard enough to gain consensus in favour of radical moves to dismantle obstacles to the integration of service sectors before the crisis, but it will be impossible in the face of the backlash against liberalisation. This is bad news. Service sectors account for around two-thirds of economic activity across the EU. Service sector productivity has been extremely weak for a number of years now, holding back economic growth. More competition at both national and European level would do much to change this, and boost economic growth.
The lack of service sector integration will be particularly damaging for the eurozone. Countries that decide to forego exchange rate flexibility as a tool of economic adjustment need to ensure that their economies can be flexible in other ways. If countries such as Spain and Italy are to recover their competitiveness within the currency union, they will have to boost their productivity. This, in turn, requires more competition in service industries. The alternative route to greater competitiveness – wage cuts – would condemn their economies to stagnation. And such wage deflation might not be possible in any case, as Germany is heading for deflation. It will be extremely difficult to cut costs relative to Germany, if German costs are falling.
The legal underpinnings of the single market appear robust. But there are real reasons for concern. The steady progress in reducing state-aid has been halted and is likely to be put into reverse. The partial renationalisation of bank lending is inimical to the emergence of a single capital market. And progress towards deepening the single market in services has ground to a halt. All this bodes ill for Europe’s growth prospects and the stability of the eurozone. All EU governments profess to be committed to upholding the single market. The next couple of years will determine the strength of that commitment. If member-states do not respect the Commission’s right to enforce those rules, the single market could indeed come under threat.
Simon Tilford is chief economist at the Centre for European Reform.
Friday, March 13, 2009
The real G20 agenda
by Katinka Barysch
Finance ministers from the G20 countries are meeting in London this weekend to prepare for the global economic summit at the start of April. Expectations are high. But what will the summit be about? Judging by recent comments from European leaders, the agenda will include clamping down on tax havens, regulating hedge funds and cutting bankers’ bonuses. Most commentators agree that these questions are not the most pressing for restoring financial stability and economic growth. Martin Broughton, president of the UK employers’ federation CBI, rightly dismissed them as “red herring issues”.
World leaders must focus two things: how best to work together to prevent an even deeper global recession; and how to avoid future crises of such magnitude.
The first issue is as pressing as it is divisive. While the US administration is pushing for more fiscal spending, the Europeans are reluctant, and most emerging powers are keeping quiet. Many countries are loath to commit to more budget spending before they know whether and how their existing emergency packages are working. The second part of the agenda is longer term and fiendishly complicated. No-one should expect an unwieldy group of 25 or so (G20 has become a misnomer) heads of state to discuss the minutiae of capital adequacy ratios or cross-border supervision. The G20 is a process, not an event, and this summit is a political exercise, not a technical one.
What the April meeting is really about is maintaining faith in multilateral solutions at a time when the temptation for go-it-alone and beggar-thy-neighbour policies is growing. If leaning on Liechtenstein or forcing disclosure onto hedge funds helps this cause then so be it. But in terms of confidence building two issues appear paramount: the role of the International Monetary Fund and governments’ commitment to avoid protectionism.
Since September 2008, the IMF has lent over $50 billion to countries ranging from Pakistan to Ukraine. It urgently needs more cash. The US and EU governments are supporting a doubling of the Fund’s resources to $500 billion. They appear less willing, however, to redress their own over-representation in international financial institutions. This would be a precondition for emerging powers such as China to contribute significantly to an increase in IMF resources, and – perhaps more importantly – accept its legitimacy at the heart of the global financial system.
The IMF needs enhanced legitimacy to fulfil other functions that will be equally essential for future financial stability. First, the world needs better surveillance of national macro-economic and exchange rate policies to address the kind of global imbalances that have contributed to the current crisis. The IMF already has such mechanisms in place but they need to be strengthened. Second, the Fund needs to expand its new, $100 billion short-term, conditionality-light lending facility for emerging markets that are well run. It could also encourage such countries to pool their foreign exchange reserves to make them available for emergency lending.
Without easily available emergency finance, emerging markets will conclude that the best insurance against future pain is to accumulate more reserves. They will do this by keeping their currencies down and running big external surpluses. This kind of policy, as practiced by China, has already caused lots of friction. In an environment where global trade is shrinking, it would fuel a nasty protectionist backlash in the West. That is why the G20 summit needs to produce a firm commitment to increasing the IMF’s role and resources while setting in train a thorough reform of its governance structures.
There are already some signs that protectionism is rising. World Bank economists have counted 47 new trade restrictions since late 2008. More than a third have been put in place by the G20 countries that pledged to avoid such measures at their November 2008 summit. But the real risk is not a return to a 1930s-style tariff war but what Richard Baldwin and Simon Evenett (in a recent CEPR paper) call “murky protectionism”: industrial subsidies, requests that banks lend to only local companies, or the use of environmental arguments to discriminate against foreign goods and services. Examples abound, such as the ‘buy American’ provisions in the US stimulus programme or Nicolas Sarkozy’s idea that French car companies should make cars only in France. Encouragingly, in these instances international outrage ensued and the governments in question backtracked. The risks, however, remain high.
Therefore, G20 leaders need to broaden the ‘no protectionism’ pledge from last November to cover non-tariff measures. And they need to task international organisations such as the OECD and the WTO with alerting the world to national measures that could be harmful for that country’s trading partners.
Katinka Barysch is deputy director of the Centre for European Reform.
Finance ministers from the G20 countries are meeting in London this weekend to prepare for the global economic summit at the start of April. Expectations are high. But what will the summit be about? Judging by recent comments from European leaders, the agenda will include clamping down on tax havens, regulating hedge funds and cutting bankers’ bonuses. Most commentators agree that these questions are not the most pressing for restoring financial stability and economic growth. Martin Broughton, president of the UK employers’ federation CBI, rightly dismissed them as “red herring issues”.
World leaders must focus two things: how best to work together to prevent an even deeper global recession; and how to avoid future crises of such magnitude.
The first issue is as pressing as it is divisive. While the US administration is pushing for more fiscal spending, the Europeans are reluctant, and most emerging powers are keeping quiet. Many countries are loath to commit to more budget spending before they know whether and how their existing emergency packages are working. The second part of the agenda is longer term and fiendishly complicated. No-one should expect an unwieldy group of 25 or so (G20 has become a misnomer) heads of state to discuss the minutiae of capital adequacy ratios or cross-border supervision. The G20 is a process, not an event, and this summit is a political exercise, not a technical one.
What the April meeting is really about is maintaining faith in multilateral solutions at a time when the temptation for go-it-alone and beggar-thy-neighbour policies is growing. If leaning on Liechtenstein or forcing disclosure onto hedge funds helps this cause then so be it. But in terms of confidence building two issues appear paramount: the role of the International Monetary Fund and governments’ commitment to avoid protectionism.
Since September 2008, the IMF has lent over $50 billion to countries ranging from Pakistan to Ukraine. It urgently needs more cash. The US and EU governments are supporting a doubling of the Fund’s resources to $500 billion. They appear less willing, however, to redress their own over-representation in international financial institutions. This would be a precondition for emerging powers such as China to contribute significantly to an increase in IMF resources, and – perhaps more importantly – accept its legitimacy at the heart of the global financial system.
The IMF needs enhanced legitimacy to fulfil other functions that will be equally essential for future financial stability. First, the world needs better surveillance of national macro-economic and exchange rate policies to address the kind of global imbalances that have contributed to the current crisis. The IMF already has such mechanisms in place but they need to be strengthened. Second, the Fund needs to expand its new, $100 billion short-term, conditionality-light lending facility for emerging markets that are well run. It could also encourage such countries to pool their foreign exchange reserves to make them available for emergency lending.
Without easily available emergency finance, emerging markets will conclude that the best insurance against future pain is to accumulate more reserves. They will do this by keeping their currencies down and running big external surpluses. This kind of policy, as practiced by China, has already caused lots of friction. In an environment where global trade is shrinking, it would fuel a nasty protectionist backlash in the West. That is why the G20 summit needs to produce a firm commitment to increasing the IMF’s role and resources while setting in train a thorough reform of its governance structures.
There are already some signs that protectionism is rising. World Bank economists have counted 47 new trade restrictions since late 2008. More than a third have been put in place by the G20 countries that pledged to avoid such measures at their November 2008 summit. But the real risk is not a return to a 1930s-style tariff war but what Richard Baldwin and Simon Evenett (in a recent CEPR paper) call “murky protectionism”: industrial subsidies, requests that banks lend to only local companies, or the use of environmental arguments to discriminate against foreign goods and services. Examples abound, such as the ‘buy American’ provisions in the US stimulus programme or Nicolas Sarkozy’s idea that French car companies should make cars only in France. Encouragingly, in these instances international outrage ensued and the governments in question backtracked. The risks, however, remain high.
Therefore, G20 leaders need to broaden the ‘no protectionism’ pledge from last November to cover non-tariff measures. And they need to task international organisations such as the OECD and the WTO with alerting the world to national measures that could be harmful for that country’s trading partners.
Katinka Barysch is deputy director of the Centre for European Reform.
Tuesday, March 10, 2009
Economic crisis and the 'eastern partnership'
by Tomas Valasek
In two months, at a summit in Prague on May 7th, the European Union will launch a new policy for Eastern Europe – an 'eastern partnership'. It will increase EU assistance to the region, open the EU’s markets to the neighbours’ goods and gradually remove visa requirements, among other things. The idea is to give the neighbouring countries stronger incentives to adopt European norms and rules, to integrate their economies with the EU's, and thus to make the region more prosperous and stable. The concept is sound – but the initiative as well as the EU’s overall policy for Eastern Europe will suffer unless the EU takes more visible steps to assist its neighbours through the economic crisis.
The crisis hit Eastern Europe hard. Ukraine’s currency, the hryvnia, lost over 50 per cent of its value, and economists warn of a possible default. Belarus, too, is in trouble. Much of the economy is driven by exports of machinery to Russia, where demand has collapsed. Armenia, another member of the eastern partnership, is in equal difficulty, and will probably need an IMF emergency loan soon.
The economic crisis poses a three-fold challenge to the EU's eastern policy. The first risk is that of rising nationalism and protectionism on both sides of the EU’s borders, which is hampering economic integration. The European Union and Ukraine are negotiating a new free trade agreement but senior EU officials say that Ukraine has become more protectionist since the crisis broke out. It insists on keeping a number of controversial tariffs, which has caused the talks to stall. The EU, too, is far less open to eastern workers and visitors these days. The member-states are unwilling to ease visa requirements for the partner states, fearing an influx of illegal workers. If the EU and its partners fail to deepen economic integration and make travel to the EU easier, the eastern partnership’s main goal – a gradual alignment of the partner states with the EU – will be in trouble.
The second risk stems from the perception that the EU is not doing enough to help the eastern partners through the crisis. President Vladimir Voronin of Moldova recently dismissed the eastern partnership-related grants as “candy”, suggesting they were not serious enough to warrant attention. He is unfair to the EU: it is not the eastern partnership's purpose to bail out the partners' economies. It has only a modest financial component; its grants amount to a few hundred million euro, and are meant mainly to help improve governance and expand people-to-people contacts. There are other tools the EU can use to assist its eastern neighbours through the crisis, like the International Monetary Fund, which recently made a $15 billion emergency loan to Ukraine. But Voronin’s words signal a broader problem for the EU’s eastern policy: the EU is not perceived to be helping its eastern neighbours; they see the IMF but not Europe. And perceptions are important: if the EU’s eastern partners think that the EU is failing them at the time of their greatest need, most of the goals of the eastern partnership will come to nought.
The third risk relates to the economic weakness of many new EU member-states in Central Europe. It is they who, along with Sweden, have most strongly advocated greater EU engagement with its eastern neighbours. And in the EU, which has many diverse members and interests, an initiative only succeeds when a strong state or a group of states devote serious time and attention to winning EU-wide support for it. But will the new member-states push for more financial assistance for Eastern Europe? It could mean keeping less of the much-needed money for themselves, and that is a tough political decision to make. Will they have the energy to fight the political battles in Brussels with EU governments less interested in Eastern Europe? Some new member-states like Latvia are reducing diplomatic staffs across Europe, and they will find it difficult to pursue multiple foreign policy goals simultaneously. Also at risk are the myriad of small grants which the new member-states' governments give to non-governmental groups in the neighbouring countries, and the training programmes they organise for East European administrators or journalists. These programmes are just as important as the eastern partnership itself: they expand the circle of people in the Eastern Europe who have a vested interest in closer relationship with the EU. So it matters that these activities are now at risk because of recession-related budget cuts.
The economic crisis represents a crisis of sorts for the EU's eastern policy. But there are ways of minimising the damage or even turning a problem into an opportunity.
Some EU government-financed initiatives for eastern neighbours will no doubt fall victim to the economic crisis. But instead of all Central European governments cutting all their training or advisory programmes, they should pool some of the initiatives. For example, rather than recalling advisors who are helping to reform key Ukrainian ministries, the new member-states could agree to withdraw some and co-finance the remaining ones. The same should apply to training programmes in the EU for East European administrators and to the very useful conferences organised in Latvia and Estonia to raise the profile of the EU’s eastern initiatives: some will be cut but there ought to be ways to share resources to save the remaining ones.
The top priority for the EU’s eastern policy, however, must be to take steps to more visibly help its eastern neighbours through the economic crisis. It is simply not true, as president Voronin suggested, that European aid to the east is peanuts – the IMF, in which EU member-states play a strong role, gave a $15 billion loan to Ukraine, and a further $2 billion loan to Belarus. The trouble is that the EU as such is not getting the credit. And in the eyes of the Eastern Europeans, the EU’s perceived stinginess compares unfavourably with the far greater amounts which Russia is willing to spend on bailing out Eastern Europe (it set aside $7.5 billion for the task).
The situation calls for creative solutions. The EU should not compete with the IMF in providing balance-of-payment loans directly to governments: the IMF has a better capacity to raise the necessary funds and to oversee the reforms, which the recipient states undertake in order to qualify for IMF loans. But the EU could expand its €25 billion emergency fund for the new member-states to include the eastern neighbours as well. And it should use the money to co-finance IMF assistance with targeted loans or grants to soften the social impact of the economic crisis. For example, it could finance job retraining programmes in Belarus or Ukraine.
The EU should also speed up the payment of its eastern partnership grants. They are small compared to the amounts disbursed through loans but if targeted well, could have real impact. The EU should direct them towards helping the most vulnerable parts of East European societies and towards regions hardest hit by the crisis. There is a real risk that some of the money could be misdirected or stolen – the ability of East European government to properly ‘absorb’ EU aid is in question. But EU officials have worked with the eastern neighbours for many years now; they have a good idea which parts of their administrations are competent and which are corrupt, and can reduce the risk of theft by targeting the aid carefully.
Building EU-wide support for these proposals will not be easy. All EU governments, including the most prosperous ones, are going to run up massive debt in the coming years. Money will be in very short supply, so the member-states will be reluctant to expand assistance to Eastern Europe. Also, the EU is getting fed up with Ukraine in particular, because the leadership is so weak and divided – the IMF even halted the disbursement of its loan because the government in Kyiv failed to agree the necessary reforms. And because Ukraine has been at the heart of the eastern partnership, its woes undermine support among EU member-states for the whole region.
But the EU has no choice but work with Ukraine; it is the largest and most important country in the eastern partnership. And while the economic crisis will consume most European effort and attention; the EU must be able to pursue different objectives simultaneously. The economic crisis creates an opportunity for the EU's eastern policy. Ukraine and other neighbours will be looking for help to stave off the crisis and lessen the social tensions it will create. The EU should become 'the friend in need', and built lasting loyalties.
Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
In two months, at a summit in Prague on May 7th, the European Union will launch a new policy for Eastern Europe – an 'eastern partnership'. It will increase EU assistance to the region, open the EU’s markets to the neighbours’ goods and gradually remove visa requirements, among other things. The idea is to give the neighbouring countries stronger incentives to adopt European norms and rules, to integrate their economies with the EU's, and thus to make the region more prosperous and stable. The concept is sound – but the initiative as well as the EU’s overall policy for Eastern Europe will suffer unless the EU takes more visible steps to assist its neighbours through the economic crisis.
The crisis hit Eastern Europe hard. Ukraine’s currency, the hryvnia, lost over 50 per cent of its value, and economists warn of a possible default. Belarus, too, is in trouble. Much of the economy is driven by exports of machinery to Russia, where demand has collapsed. Armenia, another member of the eastern partnership, is in equal difficulty, and will probably need an IMF emergency loan soon.
The economic crisis poses a three-fold challenge to the EU's eastern policy. The first risk is that of rising nationalism and protectionism on both sides of the EU’s borders, which is hampering economic integration. The European Union and Ukraine are negotiating a new free trade agreement but senior EU officials say that Ukraine has become more protectionist since the crisis broke out. It insists on keeping a number of controversial tariffs, which has caused the talks to stall. The EU, too, is far less open to eastern workers and visitors these days. The member-states are unwilling to ease visa requirements for the partner states, fearing an influx of illegal workers. If the EU and its partners fail to deepen economic integration and make travel to the EU easier, the eastern partnership’s main goal – a gradual alignment of the partner states with the EU – will be in trouble.
The second risk stems from the perception that the EU is not doing enough to help the eastern partners through the crisis. President Vladimir Voronin of Moldova recently dismissed the eastern partnership-related grants as “candy”, suggesting they were not serious enough to warrant attention. He is unfair to the EU: it is not the eastern partnership's purpose to bail out the partners' economies. It has only a modest financial component; its grants amount to a few hundred million euro, and are meant mainly to help improve governance and expand people-to-people contacts. There are other tools the EU can use to assist its eastern neighbours through the crisis, like the International Monetary Fund, which recently made a $15 billion emergency loan to Ukraine. But Voronin’s words signal a broader problem for the EU’s eastern policy: the EU is not perceived to be helping its eastern neighbours; they see the IMF but not Europe. And perceptions are important: if the EU’s eastern partners think that the EU is failing them at the time of their greatest need, most of the goals of the eastern partnership will come to nought.
The third risk relates to the economic weakness of many new EU member-states in Central Europe. It is they who, along with Sweden, have most strongly advocated greater EU engagement with its eastern neighbours. And in the EU, which has many diverse members and interests, an initiative only succeeds when a strong state or a group of states devote serious time and attention to winning EU-wide support for it. But will the new member-states push for more financial assistance for Eastern Europe? It could mean keeping less of the much-needed money for themselves, and that is a tough political decision to make. Will they have the energy to fight the political battles in Brussels with EU governments less interested in Eastern Europe? Some new member-states like Latvia are reducing diplomatic staffs across Europe, and they will find it difficult to pursue multiple foreign policy goals simultaneously. Also at risk are the myriad of small grants which the new member-states' governments give to non-governmental groups in the neighbouring countries, and the training programmes they organise for East European administrators or journalists. These programmes are just as important as the eastern partnership itself: they expand the circle of people in the Eastern Europe who have a vested interest in closer relationship with the EU. So it matters that these activities are now at risk because of recession-related budget cuts.
The economic crisis represents a crisis of sorts for the EU's eastern policy. But there are ways of minimising the damage or even turning a problem into an opportunity.
Some EU government-financed initiatives for eastern neighbours will no doubt fall victim to the economic crisis. But instead of all Central European governments cutting all their training or advisory programmes, they should pool some of the initiatives. For example, rather than recalling advisors who are helping to reform key Ukrainian ministries, the new member-states could agree to withdraw some and co-finance the remaining ones. The same should apply to training programmes in the EU for East European administrators and to the very useful conferences organised in Latvia and Estonia to raise the profile of the EU’s eastern initiatives: some will be cut but there ought to be ways to share resources to save the remaining ones.
The top priority for the EU’s eastern policy, however, must be to take steps to more visibly help its eastern neighbours through the economic crisis. It is simply not true, as president Voronin suggested, that European aid to the east is peanuts – the IMF, in which EU member-states play a strong role, gave a $15 billion loan to Ukraine, and a further $2 billion loan to Belarus. The trouble is that the EU as such is not getting the credit. And in the eyes of the Eastern Europeans, the EU’s perceived stinginess compares unfavourably with the far greater amounts which Russia is willing to spend on bailing out Eastern Europe (it set aside $7.5 billion for the task).
The situation calls for creative solutions. The EU should not compete with the IMF in providing balance-of-payment loans directly to governments: the IMF has a better capacity to raise the necessary funds and to oversee the reforms, which the recipient states undertake in order to qualify for IMF loans. But the EU could expand its €25 billion emergency fund for the new member-states to include the eastern neighbours as well. And it should use the money to co-finance IMF assistance with targeted loans or grants to soften the social impact of the economic crisis. For example, it could finance job retraining programmes in Belarus or Ukraine.
The EU should also speed up the payment of its eastern partnership grants. They are small compared to the amounts disbursed through loans but if targeted well, could have real impact. The EU should direct them towards helping the most vulnerable parts of East European societies and towards regions hardest hit by the crisis. There is a real risk that some of the money could be misdirected or stolen – the ability of East European government to properly ‘absorb’ EU aid is in question. But EU officials have worked with the eastern neighbours for many years now; they have a good idea which parts of their administrations are competent and which are corrupt, and can reduce the risk of theft by targeting the aid carefully.
Building EU-wide support for these proposals will not be easy. All EU governments, including the most prosperous ones, are going to run up massive debt in the coming years. Money will be in very short supply, so the member-states will be reluctant to expand assistance to Eastern Europe. Also, the EU is getting fed up with Ukraine in particular, because the leadership is so weak and divided – the IMF even halted the disbursement of its loan because the government in Kyiv failed to agree the necessary reforms. And because Ukraine has been at the heart of the eastern partnership, its woes undermine support among EU member-states for the whole region.
But the EU has no choice but work with Ukraine; it is the largest and most important country in the eastern partnership. And while the economic crisis will consume most European effort and attention; the EU must be able to pursue different objectives simultaneously. The economic crisis creates an opportunity for the EU's eastern policy. Ukraine and other neighbours will be looking for help to stave off the crisis and lessen the social tensions it will create. The EU should become 'the friend in need', and built lasting loyalties.
Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
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