Wednesday, November 25, 2009

Last hooray for the EU on Iran?

by Tomas Valasek

When the EU's first 'foreign minister', Cathy Ashton, starts work on December 1st, she will find Iran on top of her 'to do' pile. Earlier this week, Tehran turned down a proposal from the International Atomic Energy Agency (IAEA) that would have seen a large part of the country's stock of uranium moved out of the country for further enrichment. Barring a last-minute change of heart in Tehran, the US, UK, France and Germany will soon move to tighten UN sanctions on Iran. This could set the scene for a confrontation with Russia and China, which are unconvinced that tough sanctions would work.

It will fall to Ashton to try to get Iran to reconsider. The country's government has not rejected the IAEA proposals outright; it has offered a counter-proposal, which US and European officials deem unacceptable. The Iranians may simply be buying time but there is a small hope that they are open to compromise. Before the UN Security Council imposes further sanctions, the EU needs to be absolutely sure that Iran does not want a deal.

The trouble is that the chances of a negotiating breakthrough with Iran, never high, have diminished since the fraudulent elections in Iran in June 2009 and their bloody aftermath. For the past five months, the country has been mired in twin crises: one within the regime (a band of clerics versus the former Revolutionary Guard commanders grouped around President Mahmoud Ahmadinejad) and another one between the regime and the people. The government appears to have become dysfunctional. Tehran wavered for weeks over the recent Western proposals before rejecting them. It is not obvious that in a country as unstable as Iran is today, any centre of power has the courage to push for a compromise with the West (though some Iran watchers have warned that Tehran could be faking indecision while it buys time to develop further its nuclear programme).

It had been hoped that Barack Obama's entry into the nuclear talks would strengthen the EU's negotiating hand. In the past Iran had made clear to EU diplomats that it would not accept any agreement that did not involve the US. But Obama's charm offensive has had a limited effect. True, it “empowered advocates of engagement inside Iran and transferred the onus of co-operation from the US to Iran”, one Iran expert told a recent gathering of foreign policy thinkers and officials convened by the CER and other think-tanks in Stockholm. Obama's efforts have also made it more likely that Russia will support sanctions. But even after the US had joined the Iran talks and Obama had offered “dialogue without preconditions”, Tehran decided to reject the recent IAEA package.

High Representative Ashton and other western diplomats have few effective tools left to pressure Iran into changing its position, so the world's attention is shifting towards negotiating a new sanctions regime. The EU used to be divided on further sanctions, with France and the UK strongly in favour and Germany more sceptical. But Chancellor Angela Merkel's recent tough language on Iran (in a speech to a joint session of the US Congress) suggests that the new centre right-liberal coalition views sanctions more favourably (this was confirmed by senior German diplomats at the Stockholm event).

The key critics of tighter sanctions are Russia and China, whose top officials have argued on many occasions not only that sanctions would fail to stop Iran's nuclear programme, but also that they would boost the position of radicals within the country. They are right that sanctions are a very blunt instrument. Tougher sanctions almost certainly would strengthen the Revolutionary Guards' stranglehold on the economy and thus, paradoxically, empower the most authoritarian of Iranian political forces and set back the cause of Iran's liberalisation. Sanctions could also prompt Iran to kick out the IAEA inspectors who monitor Iran's nuclear facilities; this would leave the world blind to Iranian nuclear intentions.

But the case for sanctions, on balance, seems somewhat stronger. They discourage other states in the region from following Iran down the nuclear path, and they give the US and - crucially - Israel an alternative to the use of force. Existing sanctions have worked to the extent that they have deprived Iran of some needed technology; the centrifuges used to enrich uranium are said to be crashing frequently. And contrary to what Russia and China say, precedents suggest that sanctions can, under the right circumstances, bring weapons programmes to halt. As one US participant at the Stockholm meeting pointed out, “sanctions against Iraq in the 1990s and early 2000s worked so well that they made the invasion of that country completely unnecessary”. It transpired after the war that Iraq had given up its nuclear and biological programmes years before the US invasion, in large part because it could not obtain the necessary technology.

The two European members of the UN Security Council, France and the UK, along with Germany and the US, will lead negotiations at the UN on further sanctions. But Ashton will still have an important role to play. Sanctions are not meant to replace talks but to complement them; the idea is to inflict hurt on Iran's economy and political classes in order to get the government to accept nuclear proposals from the IAEA. So Cathy Ashton, like Javier Solana before her, will be expected to keep up talks with Iran while the UN debates sanctions, and after the UNSC agrees a new regime. The UNSC is likely to do so: President Dmitri Medvedev has hinted that Russia will swallow somewhat tougher sanctions, while China rarely vetoes UNSC resolutions alone (unless they concern Tibet or Taiwan).

But one wonders if this is the EU's last hooray on Iran. If the combination of sanctions and talks fail, the remaining options would seem to leave little room for EU diplomacy. If Israel strikes Iran's nuclear facilities, Tehran will certainly call off the EU-led talks. The other choice before the world is to start preparing for a nuclear Iran. A strategy of containment would require western governments to focus on making Iran's neighbours feel secure, so as to discourage them from building nuclear weapons themselves. But this will almost certainly be a job mainly for the US, rather than the EU. So while Baroness Ashton will spend a lot of time on Iran at the beginning of her term, the EU may gradually lose its leading role.

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

Wednesday, November 11, 2009

What Eastern Europe can learn from the crisis

by Katinka Barysch

It is 20 years since the Berlin Wall crumbled and political and economic freedom started spreading through Eastern Europe. Today, however, the region is mired in deep recession. The global economic and financial crisis has hit the Central and East European countries (CEECs) harder than any other emerging market region. In February 2009, I asked whether the savage downturn would make the new EU member-states question their entire transition model of trade opening, financial integration and EU-conforming reforms (‘New Europe and the economic crisis’ This has not happened. Dire predictions did not come true: financial systems did not collapse, the steep fall in exports and industrial output has bottomed out and there has been no mass social unrest. Most people, inside and outside the region, seem to agree that the CEECs need to recalibrate their growth model, rather than ditch it. The crisis may harbour some valuable lessons on how to go forward after 20 years of transition.

The fact that the CEECs had sold almost their entire banking sectors to big finance houses from Austria, Belgium, Germany, Italy or Sweden turned out to be a mixed blessing. During the boom years, financial integration did help the CEECs to grow faster (which is not true of all emerging market regions). When the crisis hit, West European banks did not withdraw all funding from their CEE subsidiaries overnight or let them go bankrupt, as many had feared. These subsidiaries did stop lending, as their parent banks scrambled to rebuild capital – but so did local banks.

There were no big banking crises in Eastern Europe. The hastily assembled ‘Vienna initiative’ – a club consisting of pan-European banks, the regulators of the countries in which they operate and international organisations such as the EU and the World Bank – helped to prevent a run for the exit that could have resulted in financial meltdown. The €25 billion put up by three multilateral lenders in support of ailing CEE banks also helped.

The EBRD, in its latest ‘Transition Report’, claims that countries with a higher share of foreign bank ownership did relatively better in the crisis than those with shaky local institutions that relied on short-term liquidity from abroad. However, the EBRD report also admits that the presence of foreign banks fuelled unsustainable credit booms and brought shoddy lending practices to the CEECs, such as giving mortgages in euros or Swiss francs to people without thorough credit checks.

The crisis showed that home country supervision – the basic principle of EU financial market integration – needs to be improved. The authorities of say, Sweden and Austria, did not pay enough attention to what their banks were getting up to in Latvia or Hungary. Some economists think that this will change now that Swedish and Austrian taxpayers are footing the bills for bank bail-outs abroad. But others argue that only stronger cross-border banking regulation and supervision can prevent similar trouble in the future. At the same time, the governments and regulators of the CEE host countries need to work harder to strengthen local capital markets. For example, unhedged foreign-currency denominated loans are a lousy idea as long as exchange rates are not irrevocably fixed.

Eastern Europe’s exceptional openness to trade was a blessing while global growth was strong. But it also left the region vulnerable. No fiscal stimulus programme would have been big enough to compensate for the collapse of eurozone demand in countries where exports typically account for 50 to 80 per cent of GDP. What is more, the crisis highlighted that some of the new EU members had focused rather too much on one industrial sector – cars. Around half of export revenues and up to 20 per cent of value added is generated by the automotive industry in the Central European countries.

Several car factories in CEECs shut down in late 2008 and early 2009. For a while it looked as if the new members might be the losers from a subsidy race among the bigger, richer EU countries. In the end, however, countries such as the Czech Republic and Slovakia benefited from the scrappage schemes that Germany, Austria, France and other West European countries implemented to boost domestic demand. Single market rules held: these schemes did not discriminate in favour of vehicles made at home. The WIIW, a Vienna economic research outfit, even claims that those CEECs that rely most on exports of machinery and cars have suffered milder contractions.

Most countries are now phasing out their ‘cash for clunkers’ schemes, which will translate into lower demand for vehicles made in Eastern Europe. In the medium term, the need to cut costs and overcapacity in this sector worldwide could work in the CEECs' favour as the big car makers will continue to relocate production to countries with low unit labour costs.

Nevertheless, the economic crisis has served as a reminder that the CEECs need to diversify their industrial structures. Wedged between a high-tech Western Europe and a low-cost Far East, there is only one way to go for the CEECs: move up the value chain. To do this, these countries need to improve their education and training systems, make their markets work better and encourage innovation and entrepreneurship.

Such reforms are needed more urgently than ever now that global competition for capital and markets has become fiercer. The EBRD, which tracks economic change across Eastern Europe, finds that there have been few instances of reforms unravelling since the onset of the crisis; but it also finds that there has been little noticeable progress towards better-functioning market economies. So far, populism has been contained in Eastern Europe. But with lay-offs still rising fast, and governments too cash-strapped to do much about it, the elections due in many CEECs in 2010 and 2011 could result in governments promising protection rather than explaining the need for economic change. The risk remains that the CEECs will draw the wrong lessons from the crisis and endanger the economic success of the last 20 years of transition.

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

Wednesday, November 04, 2009

Is Turkey Iran's friend?

by Katinka Barysch

Is Turkey really Iran’s “friend”, as Recep Tayyip Erdogan claimed in a recent interview with the Guardian newspaper? Erdogan’s visit last week to Tehran suggests so. He met not only President Mahmoud Ahmadinejad but also Supreme Leader Ayatollah Ali Khamenei, a rare honour. He announced plans for energy and commercial co-operation with Iran and defended the country’s right to civilian nuclear power, calling its energy programme “peaceful” and “humanitarian”. Ahmadinejad, meanwhile, thanked Erdogan for his critical stance on Israel.

Policymakers in the West are getting worried that Turkey’s growing ties with Iran – by lessening that country’s sense of isolation – may frustrate diplomatic efforts to prevent Tehran from building a nuclear bomb.

Turkey’s official line is that it fully supports international efforts to persuade Iran to stop its enrichment programme, backed by the threat of tougher sanctions. The Turkish government claims that it is using closer ties with Iran to pass on tough messages to the leadership there. However, Turkish political leaders and high officials have been very cautious in their public pronouncements about Iran. “Iran does not accept it is building a weapon”, Erdogan is quoted as saying by the Guardian. “They are working on nuclear power for the purposes of energy only."

Erdogan has often mentioned Iran in the same sentence as Israel, perhaps implying that if one country in the Middle East has nuclear weapons it might be unfair to prevent other ones from building them too. Following his Tehran trip, he referred to western pressure on Iran as ‘arrogant’ because it came from countries that themselves had nuclear weapons. It would be preferable, he said, to have a nuclear-free Middle East and a nuclear-free world.

Turkey’s rather friendly stance on Iran may be understandable and acceptable at a time when the West’s diplomatic efforts are making at least some progress. But what if current negotiations fail? Would Turkey support the tougher sanctions that the US and most EU countries are threatening?

When asked this question, a top Turkish diplomat (at a recent EDAM roundtable in Bodrum) was evasive: “We would have to first see the content of the resolution. And we would have to make sure that we bring Russia and China on board.” This answer implies that Turkey may support sanctions in the (unlikely) event that they are backed by the United Nations Security Council but not if they are unilaterally imposed by the Americans and the Europeans. Another Turkish diplomat (at the ‘Istanbul Forum’, a big conference focusing on Turkey and the Middle East in October) summed up Turkey’s stance on Iran’s nuclear programme as “diplomacy, more diplomacy and even more diplomacy”.

Many Turks fear the impact of tougher on their own economy. Turks say that the 1999 sanctions against Iraq resulted in the loss of what had then been their second most important trading relationship, and that European sanctions on Serbia in the 1990s cut off one of Turkey’s most important transport artery to the EU.

Trade between Turkey and Iran has been growing fast in recent years, to reach an estimated $ 6 billion in 2008. Politicians from both sides say they want to see that figure double or even triple over the next 5-10 years. Iran is also Turkey’s second biggest gas supplier after Russia. Many Turks think that Iranian gas will be essential if Turkey is to fulfil its ambition of becoming a regional energy hub. Further sanctions would therefore harm Turkey’s economic interests. Already, US pressure forced Turkey to put on ice a $3.5 billion investment deal in the Iranian gas sector signed in 2007 – although Erdogan confirmed that Turkey still wanted to go ahead with such energy deals during his recent Tehran visit.

More importantly, perhaps, Turkish support for tougher sanctions would end the recent rapprochement between Tehran and Ankara and could even lead to retaliation. “We have no choice but to have good relations with our big neighbours”, explained one Turkish parliamentarian at the Istanbul Forum. “This conviction stood behind our decision in 2003 not to allow the Americans to march into Iraq from our territory. We knew we would have to live with Iraq afterwards, no matter what the outcome of the war.”

The Erdogan government values its relationship with Iran as part of its ‘zero problem’ neighbourhood policy. Having been more or less isolated in the region only 20 years ago, Turkey now has flourishing political and trade links with most of its immediate neighbours, as well as many countries of the Middle East, the Caucasus and Central Asia. There are even plans to open the border to Armenia, closed since 1993. Ankara is proud that it is one of the few countries that ‘talks to everyone’. This strategy has entailed links with Hamas and, more recently, visa-free travel and trade liberalisation with Syria.

Iran is one of Turkey’s most important neighbours and therefore crucial for the perceived success of the ‘zero problem’ strategy. Turkish politicians like to point out that the current Turkish-Iranian border dates back to 1639 and that the two countries have not been at war since. Since the implosion of Iraq, the two countries have worked together more closely on security issues, in particular to prevent Kurdish separatism and terrorism, which threatens both countries.

As ties with Iran thicken, Turks see the country’s nuclear programme as less of a threat. A third of Turks now think that a nuclear armed Iran would be acceptable, according to the latest Transatlantic Trends survey from the German Marshall Fund. Two years ago, the share was half that, at 17 per cent. In the US, only 5 per cent say they could live with a nuclear armed Iran. Turkish leaders hardly ever say explicitly whether they consider a possible Iranian bomb as a threat. When asked whether he was worried about such a prospect, one official at the EDAM roundtable responded: “We are under Nato’s nuclear umbrella.”

This apparent confidence, however, hides some deep-seated anxiety and mistrust. Turkey and Iran may not have been to war with each other for centuries, but they are natural rivals in a volatile region. Arguably, much of Turkey’s recent regional diplomacy has been designed to contain Iran’s growing influence, from Turkish efforts to help stabilise Iraq to building closer links with Syria. Neither the Americans nor the Iranians took up Ankara’s offer to mediate between the two, preferring to deal with each other directly. At the Istanbul Forum – which devoted a lot of time to discussing Iran – not a single Iranian official showed up.

Many Turks fear that a nuclear armed Iran would change the regional balance of power and trigger an arms race in this unstable part of the world. One Turkish politician, when asked what Turkey would do if efforts to stop the Iranian weapons programme failed, said: “We will have to build our own bomb.” It is statements like this that make some people suspect that the reason why Turkey is now starting its own nuclear programme is not only to improve energy security but also to be prepared in case of a nuclear arms race in the Middle East.

Turkish officials deny this categorically. They insist that their country needs nuclear power to satisfy fast-growing energy demand, reduce reliance on imported gas and cut CO2 emissions. Moreover, it could take Turkey a decade to build up a nuclear capacity. Already, the first tender to build a nuclear plant is being reviewed after only one company (from Russia) submitted a bid.

Meanwhile, Turkey is in talks with Washington about buying a missile defence system against short and medium-range missiles. The claim of Turkey’s foreign minister, Ahmet Davutoglu, that this system would have “nothing to do with Iran or any other country” just begs the question.

Turkey’s ambiguous stance towards Iran is symptomatic of the difficulties that Turkey faces in trying to combine its growing regional ties with its traditional orientation towards the West. As a long-standing NATO member and a country negotiating for EU membership, Turkey is expected to align itself with the US and Europe – or at least not do anything that undermines the West’s political objectives in the Middle East. As a regional power, Turkey will want to act independently and avoid antagonising its neighbours. It is not clear how long Ankara will be able to avoid tough choices.

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