Britain’s European debate is moving from process (referendum when? how?) to substance – the question of whether the costs of EU membership outweigh the benefits. This debate is healthy. What baffles me is that some of the most frequently made arguments in this debate are baseless yet enduring.
I have done a number of public debates with UKIP leader Nigel Farage and other zealous eurosceptics. Such debates are not part of my job: the Centre for European Reform is an independent think-tank, not a campaigning organisation. Yet as an analyst, I believe that the debate about Europe should be well informed.
Hard-core eurosceptics often base their arguments around claims that are simply not correct. Their pro-European counterparts are then left to protest lamely that the eurosceptics are economical with the truth. The eurosceptics have the initiative; the pro-Europeans have the moral high ground. As long as eurosceptics get away with telling the public that EU windmills are dangerous giants, the debate about Europe will be skewed.
One of the most frequently repeated arguments in the British EU debate is that “the Commission in Brussels dictates 75 per cent of our laws” (this is a quote from UKIP’s website but I have heard the number repeated in public debates and in the national media). The European Commission does not dictate laws; it is allowed to propose laws. But it is the ministers from the (elected) EU governments that negotiate and agree them, together with the (elected) European Parliament.
The 75 per cent figure comes from a statement that Hans-Gerhard Pöttering, then president of the European Parliament, made in 2009: "Today approximately 75 per cent of the European Union legislation is decided by the European Parliament together with the Council of Ministers and has a direct impact in our daily lives.” Note: Pöttering was talking about the share of EU legislation that is influenced by the European Parliament. He did not refer to national legislation.
So what is the true share of UK legislation linked to EU directives? There is no easy answer. First, EU laws and national laws cannot be compared like for like. EU regulations apply directly in the member-states. EU directives are implemented through national laws and regulations. Sometimes one national law implements four EU directives, sometimes four national laws implement one EU directive.
A lot of British business regulation is likely to be related in some way or another to the single market and hence to the EU. But the EU does not get much involved in setting British rules governing tax (other than VAT and excise duties), social security, pensions, education, policing (except cross-border operations), spatial planning or the health service. The House of Commons Library has tried to calculate the percentage of secondary legislation in the UK that results from EU requirements and concluded that "[t]his figure has fluctuated between 8 and 10 per cent in the last decade". OpenEurope, a eurosceptic think-tank, has spent a couple of years looking at the question of how much British law can be traced back to the EU. The researchers concluded that it was not possible to determine the share with any kind of accuracy.
Nor is it a straightforward question how much EU regulation costs the UK. The anti-EU Bruges Group claims that EU regulation costs the UK £28 billion a year, but it is not clear where this figure comes from. Some eurosceptics have also claimed that EU regulation cost the UK over £100 billion over the last decade. This figure is probably based on research that OpenEurope did in 2010. It should be used with great caution.
OpenEurope looked at the impact assessments attached to 2,000 UK business regulations since 1998. (Many national governments, as well as the EU, try to estimate the potential positive and negative impacts of planned pieces of legislation before they enact them.) OpenEurope’s researchers then added up the estimated costs of the proposed regulations as well as the estimated benefits. They found that the 2,000 pieces of regulation could have cost the economy a total of £176 billion since 1998, and that £124 billion of this could have come from regulation that was in some way related to EU policies. I say “could have” because the £176 billion and £124 billion figures are made up of ministerial estimates of potential costs, not actual costs.
The researchers also added up the estimated benefits of the regulations and found that they are significantly bigger (by 60 per cent) than the estimated costs. In other words, although regulations can be burdensome, their net effect on the economy is thought to be positive because they usually help business to trade with one another as well as making workers more productive and products safer. OpenEurope says that the positive net effect is smaller for EU-related regulations than for national regulations. But it admits that it is particularly hard to quantify the benefits of EU regulation since impact assessments do not usually take into account wider benefits, such as access to the single market or the price decreases resulting from stronger international competition.
The costs of EU regulation also depend on how it is implemented in the individual EU countries. Some governments go beyond what is required by the EU. A 2006 review found no evidence that the UK was doing more ‘gold plating’ than other EU countries. But any meaningful estimate of the burden of EU regulation would have to consider the share of costs added at the national level.
These costs would then have to be set against the benefits of being a member of the single market and the world’s largest trading bloc. These benefits are every bit as hard to calculate as the costs of EU membership. Therefore, when pro-Europeans use figures such as the 3.3 million jobs that directly depend on exports to the EU or the £3,300 that every British household gains from being inside the EU each year, they should also be taken with more than a pinch of salt.
Eurosceptics claim that access to the European market is no longer worth much since Britain now “mostly” trades with non-EU countries. It is true that the share of British exports that go to the other EU countries has fallen to just below 50 per cent and that sales to emerging markets are growing faster – that is exactly what you would expect, given that the eurozone is in recession while many emerging markets are still growing briskly.
But British exports to emerging economies are starting from a surprisingly low base: in 2007, 3.3 per cent of UK exports went to the BRIC countries; by 2012, that share had risen to 5.6 per cent. Britain still sells more to Germany than to Brazil, Russia, India, China and South Africa, Australia, New Zealand and Canada – combined. Another key export market for Britain is the US – with which the EU is currently negotiating a free trade and investment agreement.
Eurosceptics often imply that if Britain severed its ties with the EU, it would trade more with emerging markets. In a purely arithmetical sense this might well be true: if British business found it more difficult to access markets in France, Spain and Poland they might try harder to sell things in India and Indonesia. But the idea that the EU is holding Britain back is spurious. Germany sells six times as many goods and services to China as the UK does. If it is the EU holding Britain back, why is it not holding back Germany?
Another figure that the eurosceptics like to use is £50 million: that is supposed to be the daily British contribution to the EU budget. This number has some validity, although it is outdated. In 2011 the gross UK contribution to the EU budget was £13.83 billion, or £37 million a day. Is this a lot or a little? It depends how you look at it. As a share of GDP, the UK’s gross contribution is the lowest of any EU country, lower than those of poorer countries such as Poland or Bulgaria. And of course, Britain also gets money back from the EU for its farmers, universities and poorer regions. Once these revenues are factored in, Britain’s net contribution amounts to roughly 1 per cent of total government spending.
Even 1 per cent is a lot if, as many eurosceptics claim, the money is wasted. UKIP calls the European Union a “bureaucratic monster” and sometimes implies that most EU spending goes to meddlesome bureaucrats. In reality, around 5 per cent of the EU budget is spent on administration, and half of that on the European Commission. The European Commission has 23,000 employees, less than Birmingham City Council. It is true that EU officials are “unelected”, as are the 32,000 officials in the British Home Office and those of any other state administration around the world. No doubt, the EU’s bureaucracy could be streamlined and made more effective but the real potential for savings – as many British politicians have pointed out for years – is in the common agricultural policy and funds for poorer regions.
The latest figure that has crept into the European debate is £150 billion – that is supposed to be the sum that the UK could lose through the euro crisis, according to the Bruges Group. Among the heroic assumptions underlying this calculation is that all other 26 EU countries would go bankrupt simultaneously so that Britain would be lumbered with the entire £60 billion costs of a lending facility called the European Financial Stabilisation Mechanism; that the European Investment Bank (an AAA-rated infrastructure lender) would fold; and that Britain would be called upon to bail out the European Central Bank if the euro broke up.
The fundamental truth is that the European Union is an extremely complex undertaking that cannot easily be reduced to simple numbers – either on the positive or on the negative side. But perhaps by feeding random numbers, half-truth and fiction into the debate, the hard-core eurosceptics will force other politicians and journalists to do a better job of explaining what is really at stake in Britain’s EU membership.
Katinka Barysch is deputy director of the Centre for European Reform.
Wednesday, May 29, 2013
Thursday, May 16, 2013
A dose of inflation would help the eurozone medicine go down
Everyone accepts that persistently high inflation can damage economic growth and arbitrarily punish some groups in society while benefiting others. But in Europe at least, the risks of excessively low inflation are often ignored. In the face of chronically weak demand, the eurozone now faces the prospect of deflation. This promises to depress economic growth further and make it yet harder to pay down debt. Indeed, the role of higher inflation in helping to address the eurozone crisis is poorly understood. If the single currency is to survive, it needs much higher inflation than at present, especially in Germany.
Policy-makers are right to warn of the risks of losing control over inflation. Persistently high and volatile inflation can make it hard for firms to calculate prices and future profits, deterring them from investing. It can create wage spirals and, crucially, redistribute income from savers to borrowers. But eurozone policy-makers are dangerously sanguine about the risks of low inflation. When inflation falls very low, consumers and firms tend to sit on cash rather than spend it, in the case of consumers because they expect prices to fall further or in the case of firms because they fear a further weakening of demand. This is what economists mean by a ‘liquidity trap’: households do not want to spend and firms do not want to invest, making a prolonged recession self-fulfilling. Meanwhile, very weak growth and low inflation make it much harder to pay down debt. The US and most of Europe spent much of the 1930s in such a liquidity trap, and after spending the last 20 years in one, Japan is now desperately trying to escape it. If the eurozone is not to get caught in such a vicious circle, it will need to rapidly stimulate its economy.
Headline eurozone inflation turned negative over the second half of 2009, before rebounding and averaging almost 3 per cent over the second half 2011, and hence well above the ECB’s target of ‘close to 2 per cent’. The apparent strength of inflation was used to rebut those who argued that the eurozone needed lower interest rates and more fiscal stimulus to counter the downturn. Such policies, it was argued, would lead to unacceptably high inflation. For example, the ECB persistently used above target inflation to justify its refusal to cut interest rates further or launch unorthodox forms of monetary stimulus such as quantitative easing (QE). This refers to the practice of central banks purchasing financial assets from commercial banks and other private institutions. But much of the inflation over this period reflected higher energy (and food prices) and crucially, increases in administered prices and value-added-tax (as governments have attempted to get on top of fiscal deficits). In reality, the headline rate of inflation says little about underlying inflation pressures. For example, at no point has inflation excluding energy and food exceeded 2 per cent. And stripping out the impact of tax rises and increases in administered prices, inflation has been below 2 per cent throughout.
The argument for targeting headline (as opposed to core) inflation is that it is the headline rate which sets inflation expectations and wage settlements, and hence the future rate of inflation. But this has not been the case: the headline rate of eurozone inflation fell to 1.2 per cent in April 2013. Excluding energy and food, as well as rises in taxes and administered prices, it will have been just 0.4 per cent and hence perilously close to zero. In some countries this underlying measure of inflation is already well into negative territory. For example, in Spain prices are falling by between 0.5 per cent and 1 per cent. The headline rate of inflation will fall back rapidly, once the impact of tax rises and increases in administered prices fall out of the inflation indices. The reasons for the extreme weakness of underlying inflation are obvious. With economic activity so depressed, workers are having to accept whatever wage rises employers offer, while firms are having to cut prices because disposable income is falling.
Many eurozone policy-makers appear to welcome the fact that inflation is now so low in the struggling eurozone countries. After all, only by ensuring that their costs rise less slowly than Germany’s can they hope to rebuild their trade competitiveness. But they also need some inflation in order to gradually erode the real value of their debts and ensure their debt burdens are sustainable. Were German inflation running at 3-4 per cent, the struggling eurozone economies might be able to reconcile these conflicting pressures. But German inflation stood at just 1.1 per cent in April, making the adjustment very difficult.
The European Commission likes to laud the narrowing of current account deficits in the peripheral countries as evidence of the progress these countries are making in boosting their competitiveness. But this is largely down to collapsing demand for imports, not wage restraint or structural reforms. For example, Spanish imports were 20 per cent lower in 2012 than in 2007, Italy’s fell 12 per cent over the same period. This, in turn reflects the weakness of domestic demand – down by 13 per cent and 9 per cent respectively over this period. Were domestic demand to recover in Spain and Italy, their current account deficits would quickly widen again. As the Commission’s own data illustrate, real exchange rates remain hugely out of kilter across the eurozone. The ‘German euro’ is strongly undervalued, whereas in Italy and Spain the reverse is the case.
Normally, when faced with such pervasive economic weakness and mounting deflation pressures, central banks would be doing whatever it took to raise inflation expectations. Only in that way can they hope to bring about the negative real interest rates needed to persuade firms and business to invest: when real interest rates are negative, it is expensive to sit on cash. If interest rates were close to zero, this would mean unconventional measures aimed at loosening monetary policy, such as QE, and committing to run a very loose monetary stance for a prolonged period of time.
The ECB reduced interest rates by 0.25 of a percentage point to 0.5 per cent at its May meeting, but there is little indication that it is planning an aggressive monetary relaxation. The ECB could also launch QE so long as it concentrated its asset purchases on the eurozone assets as a whole rather than on particular member-states. Crucially, it could attempt to boost inflation expectations by committing to keep interest rates at their current lows until 2015 (as the US Federal Reserve has done). At present, the impact of low eurozone interest rates on inflation expectations is limited by the fear that the ECB will tighten as soon as inflation starts to rise. If households and businesses are confident that policy will remain loose even once inflation has started to rise, it could make them readier to spend rather than sit on cash.
There are essentially two reasons why this is not happening. First, Europe’s policy-makers continue to deny that Europe is in a liquidity trap. They believe that eurozone economies are so weak because growth potential has fallen steeply, rather than because demand has fallen far short of supply. The solution therefore lies in structural reforms; monetary stimulus and a drive to raise inflation expectations would achieve little. There is no doubting that the rate of potential output growth across the eurozone has fallen as a result of structural problems. But there is also no doubt that output gaps (the difference between actual and potential output) remain huge, as acknowledged by the IMF, and are getting bigger as households are not spending and firms are not investing.
Second, although the eurozone as a whole needs higher inflation, some countries are much more in need of it than others. The Bundesbank has acknowledged that higher German inflation could be necessary to facilitate adjustment, but concern that it could erode the real value of savings means that Germany continues to stand in the way of monetary stimulus. Although Jens Weidmann voted in favour of cutting interest rates at the ECB’s meeting earlier this month, he has warned that the eurozone must avoid negative interest rates.
However, the choice for Germany is not between the status quo or higher inflation but between large debt defaults across the eurozone (and a possible dismantling of the eurozone) on the one hand or higher inflation on the other. The least painful of these would be higher inflation, even if it were unpopular with German savers. Default was manageable in Greece, but defaults by Italy and Spain would pose an incomparably sterner test for the eurozone. The collapse of the euro, even ignoring the political fall-out, would be very painful for Germany: the country’s real exchange rate would rise very strongly.
Faced with such unpalatable alternatives, the new German government (whatever its composition) will probably not stand in the way of the ECB loosening monetary policy further, perhaps by launching QE. But the Germans are almost certain to oppose any ECB commitment to maintain a loose stance until the recovery is underway and inflation is rising, as this would imply robust inflation in Germany. If so, the central bank could struggle to raise inflation expectations. And the eurozone will struggle to escape its liquidity trap.
Simon Tilford is chief economist at the Centre for European Reform.
Policy-makers are right to warn of the risks of losing control over inflation. Persistently high and volatile inflation can make it hard for firms to calculate prices and future profits, deterring them from investing. It can create wage spirals and, crucially, redistribute income from savers to borrowers. But eurozone policy-makers are dangerously sanguine about the risks of low inflation. When inflation falls very low, consumers and firms tend to sit on cash rather than spend it, in the case of consumers because they expect prices to fall further or in the case of firms because they fear a further weakening of demand. This is what economists mean by a ‘liquidity trap’: households do not want to spend and firms do not want to invest, making a prolonged recession self-fulfilling. Meanwhile, very weak growth and low inflation make it much harder to pay down debt. The US and most of Europe spent much of the 1930s in such a liquidity trap, and after spending the last 20 years in one, Japan is now desperately trying to escape it. If the eurozone is not to get caught in such a vicious circle, it will need to rapidly stimulate its economy.
Headline eurozone inflation turned negative over the second half of 2009, before rebounding and averaging almost 3 per cent over the second half 2011, and hence well above the ECB’s target of ‘close to 2 per cent’. The apparent strength of inflation was used to rebut those who argued that the eurozone needed lower interest rates and more fiscal stimulus to counter the downturn. Such policies, it was argued, would lead to unacceptably high inflation. For example, the ECB persistently used above target inflation to justify its refusal to cut interest rates further or launch unorthodox forms of monetary stimulus such as quantitative easing (QE). This refers to the practice of central banks purchasing financial assets from commercial banks and other private institutions. But much of the inflation over this period reflected higher energy (and food prices) and crucially, increases in administered prices and value-added-tax (as governments have attempted to get on top of fiscal deficits). In reality, the headline rate of inflation says little about underlying inflation pressures. For example, at no point has inflation excluding energy and food exceeded 2 per cent. And stripping out the impact of tax rises and increases in administered prices, inflation has been below 2 per cent throughout.
The argument for targeting headline (as opposed to core) inflation is that it is the headline rate which sets inflation expectations and wage settlements, and hence the future rate of inflation. But this has not been the case: the headline rate of eurozone inflation fell to 1.2 per cent in April 2013. Excluding energy and food, as well as rises in taxes and administered prices, it will have been just 0.4 per cent and hence perilously close to zero. In some countries this underlying measure of inflation is already well into negative territory. For example, in Spain prices are falling by between 0.5 per cent and 1 per cent. The headline rate of inflation will fall back rapidly, once the impact of tax rises and increases in administered prices fall out of the inflation indices. The reasons for the extreme weakness of underlying inflation are obvious. With economic activity so depressed, workers are having to accept whatever wage rises employers offer, while firms are having to cut prices because disposable income is falling.
Many eurozone policy-makers appear to welcome the fact that inflation is now so low in the struggling eurozone countries. After all, only by ensuring that their costs rise less slowly than Germany’s can they hope to rebuild their trade competitiveness. But they also need some inflation in order to gradually erode the real value of their debts and ensure their debt burdens are sustainable. Were German inflation running at 3-4 per cent, the struggling eurozone economies might be able to reconcile these conflicting pressures. But German inflation stood at just 1.1 per cent in April, making the adjustment very difficult.
The European Commission likes to laud the narrowing of current account deficits in the peripheral countries as evidence of the progress these countries are making in boosting their competitiveness. But this is largely down to collapsing demand for imports, not wage restraint or structural reforms. For example, Spanish imports were 20 per cent lower in 2012 than in 2007, Italy’s fell 12 per cent over the same period. This, in turn reflects the weakness of domestic demand – down by 13 per cent and 9 per cent respectively over this period. Were domestic demand to recover in Spain and Italy, their current account deficits would quickly widen again. As the Commission’s own data illustrate, real exchange rates remain hugely out of kilter across the eurozone. The ‘German euro’ is strongly undervalued, whereas in Italy and Spain the reverse is the case.
Normally, when faced with such pervasive economic weakness and mounting deflation pressures, central banks would be doing whatever it took to raise inflation expectations. Only in that way can they hope to bring about the negative real interest rates needed to persuade firms and business to invest: when real interest rates are negative, it is expensive to sit on cash. If interest rates were close to zero, this would mean unconventional measures aimed at loosening monetary policy, such as QE, and committing to run a very loose monetary stance for a prolonged period of time.
The ECB reduced interest rates by 0.25 of a percentage point to 0.5 per cent at its May meeting, but there is little indication that it is planning an aggressive monetary relaxation. The ECB could also launch QE so long as it concentrated its asset purchases on the eurozone assets as a whole rather than on particular member-states. Crucially, it could attempt to boost inflation expectations by committing to keep interest rates at their current lows until 2015 (as the US Federal Reserve has done). At present, the impact of low eurozone interest rates on inflation expectations is limited by the fear that the ECB will tighten as soon as inflation starts to rise. If households and businesses are confident that policy will remain loose even once inflation has started to rise, it could make them readier to spend rather than sit on cash.
There are essentially two reasons why this is not happening. First, Europe’s policy-makers continue to deny that Europe is in a liquidity trap. They believe that eurozone economies are so weak because growth potential has fallen steeply, rather than because demand has fallen far short of supply. The solution therefore lies in structural reforms; monetary stimulus and a drive to raise inflation expectations would achieve little. There is no doubting that the rate of potential output growth across the eurozone has fallen as a result of structural problems. But there is also no doubt that output gaps (the difference between actual and potential output) remain huge, as acknowledged by the IMF, and are getting bigger as households are not spending and firms are not investing.
Second, although the eurozone as a whole needs higher inflation, some countries are much more in need of it than others. The Bundesbank has acknowledged that higher German inflation could be necessary to facilitate adjustment, but concern that it could erode the real value of savings means that Germany continues to stand in the way of monetary stimulus. Although Jens Weidmann voted in favour of cutting interest rates at the ECB’s meeting earlier this month, he has warned that the eurozone must avoid negative interest rates.
However, the choice for Germany is not between the status quo or higher inflation but between large debt defaults across the eurozone (and a possible dismantling of the eurozone) on the one hand or higher inflation on the other. The least painful of these would be higher inflation, even if it were unpopular with German savers. Default was manageable in Greece, but defaults by Italy and Spain would pose an incomparably sterner test for the eurozone. The collapse of the euro, even ignoring the political fall-out, would be very painful for Germany: the country’s real exchange rate would rise very strongly.
Faced with such unpalatable alternatives, the new German government (whatever its composition) will probably not stand in the way of the ECB loosening monetary policy further, perhaps by launching QE. But the Germans are almost certain to oppose any ECB commitment to maintain a loose stance until the recovery is underway and inflation is rising, as this would imply robust inflation in Germany. If so, the central bank could struggle to raise inflation expectations. And the eurozone will struggle to escape its liquidity trap.
Simon Tilford is chief economist at the Centre for European Reform.
Thursday, May 09, 2013
Commission should move to structural reform of the ETS
The EU regularly describes the ETS as the centrepiece of its climate policy. This centrepiece is currently a failure. Climate change is already killing hundreds of thousands of people each year, and costing the global economy hundreds of billions of dollars. Yet European efforts to strengthen the ETS are moving at a snail’s pace.
Last month the European Parliament rejected Commission proposals to postpone the auction of carbon allowances under the Emissions Trading System (ETS). The Commission had proposed this in an attempt to stop the carbon price falling even further, but Parliament’s rejection of such ‘backloading’ means that the carbon price is now down to about €3 per tonne. This is far too low to encourage firms to invest in low-carbon technologies.
In June 2012 I argued in a CER policy brief 'Saving emissions trading from irrelevance' that withdrawing allowances from the market - which could be done either temporarily, as the Commission proposed, or permanently - was necessary to prevent the ETS becoming irrelevant. I assumed that allowance withdrawal was the approach that had the best chance of being agreed quickly. Nearly a year later, allowance withdrawal has still not been agreed. A second vote in Parliament is scheduled for early July. MEPs ought to pass the Commission proposal.
However, allowance withdrawal will not be enough to rescue the ETS. It needs to be combined with structural reform. I argued last year that the EU should also set an ETS price floor, to provide price stability and make the carbon price high enough to attract investment to low-carbon options. I concluded that the Commission should make these proposals as soon as possible.
In November 2012 the Commission did suggest structural reform. In its report ‘The state of the European carbon market in 2012’ it wrote: “A carbon price floor would create more certainty about the minimum price, giving a better signal for investors.” But it went on to repeat long-standing objections to price intervention. Price-based mechanisms would “alter the very nature of the current EU ETS being a quantity-based market instrument. They require governance arrangements, including a process to decide on the level of the price floor”.
A price floor would indeed alter the nature of the ETS. It would turn the ETS from a quantity-based instrument into a price-based instrument. But it would also turn the ETS from an irrelevant instrument into an effective one. The Commission’s concerns about governance (with their implicit worries about political interference) are greatly overstated. Governance arrangements already exist to decide the quantity of allowances. Similar arrangements could be created to decide the price level.
On 7th May 2013 nine energy and environment ministers, from Germany, France, the Netherlands, Sweden, Denmark, Portugal, Finland, Slovenia and the UK, signed a statement urging the European Parliament to support the postponement of auctions and the Commission to “bring forward, by the end of the year at the latest, proposals to perform a proper structural reform of the EU ETS”. This statement is welcome. But the Commission should not wait until the end of the year before making its structural reform proposals. The backloading proposal was only ever a small first step. The Commission should not be distracted by continuing exchanges with Parliament on allowance withdrawal from the much more important task of proposing structural reforms.
Germany’s Peter Altmaier, environment minister, signed the statement. However, this does not mean that the German government is fully behind either backloading or ETS structural reform. Different lines have been taken by the German economic and environmental ministries. Chancellor Angela Merkel has spoken of the need for reform of the ETS, but is yet to take a clear position on what that reform should be. She probably will not do so before the federal elections in September.
The UK House of Lords European Union Committee issued a report on 2nd May calling for an ETS price floor. The Committee argues that this “would simultaneously increase investor confidence and help to stabilise possible financing for infrastructure, low carbon innovation and related applications.” The UK government has introduced its own ETS floor price, which may attract low-carbon investment to the UK but will not help the global climate, because fewer allowances bought in the UK will lead to more allowances being available elsewhere. And the UK government has said in the past that it opposes a Europe-wide price floor because it vehemently opposes EU involvement in revenue raising.
This is not a sensible position for any government to take. EU measures are not imposed by ‘Brussels bureaucrats’ – despite what parts of the British media like to claim – but negotiated by European institutions, including national governments in the Council.
Last month the European Parliament rejected Commission proposals to postpone the auction of carbon allowances under the Emissions Trading System (ETS). The Commission had proposed this in an attempt to stop the carbon price falling even further, but Parliament’s rejection of such ‘backloading’ means that the carbon price is now down to about €3 per tonne. This is far too low to encourage firms to invest in low-carbon technologies.
In June 2012 I argued in a CER policy brief 'Saving emissions trading from irrelevance' that withdrawing allowances from the market - which could be done either temporarily, as the Commission proposed, or permanently - was necessary to prevent the ETS becoming irrelevant. I assumed that allowance withdrawal was the approach that had the best chance of being agreed quickly. Nearly a year later, allowance withdrawal has still not been agreed. A second vote in Parliament is scheduled for early July. MEPs ought to pass the Commission proposal.
However, allowance withdrawal will not be enough to rescue the ETS. It needs to be combined with structural reform. I argued last year that the EU should also set an ETS price floor, to provide price stability and make the carbon price high enough to attract investment to low-carbon options. I concluded that the Commission should make these proposals as soon as possible.
In November 2012 the Commission did suggest structural reform. In its report ‘The state of the European carbon market in 2012’ it wrote: “A carbon price floor would create more certainty about the minimum price, giving a better signal for investors.” But it went on to repeat long-standing objections to price intervention. Price-based mechanisms would “alter the very nature of the current EU ETS being a quantity-based market instrument. They require governance arrangements, including a process to decide on the level of the price floor”.
A price floor would indeed alter the nature of the ETS. It would turn the ETS from a quantity-based instrument into a price-based instrument. But it would also turn the ETS from an irrelevant instrument into an effective one. The Commission’s concerns about governance (with their implicit worries about political interference) are greatly overstated. Governance arrangements already exist to decide the quantity of allowances. Similar arrangements could be created to decide the price level.
On 7th May 2013 nine energy and environment ministers, from Germany, France, the Netherlands, Sweden, Denmark, Portugal, Finland, Slovenia and the UK, signed a statement urging the European Parliament to support the postponement of auctions and the Commission to “bring forward, by the end of the year at the latest, proposals to perform a proper structural reform of the EU ETS”. This statement is welcome. But the Commission should not wait until the end of the year before making its structural reform proposals. The backloading proposal was only ever a small first step. The Commission should not be distracted by continuing exchanges with Parliament on allowance withdrawal from the much more important task of proposing structural reforms.
Germany’s Peter Altmaier, environment minister, signed the statement. However, this does not mean that the German government is fully behind either backloading or ETS structural reform. Different lines have been taken by the German economic and environmental ministries. Chancellor Angela Merkel has spoken of the need for reform of the ETS, but is yet to take a clear position on what that reform should be. She probably will not do so before the federal elections in September.
The UK House of Lords European Union Committee issued a report on 2nd May calling for an ETS price floor. The Committee argues that this “would simultaneously increase investor confidence and help to stabilise possible financing for infrastructure, low carbon innovation and related applications.” The UK government has introduced its own ETS floor price, which may attract low-carbon investment to the UK but will not help the global climate, because fewer allowances bought in the UK will lead to more allowances being available elsewhere. And the UK government has said in the past that it opposes a Europe-wide price floor because it vehemently opposes EU involvement in revenue raising.
This is not a sensible position for any government to take. EU measures are not imposed by ‘Brussels bureaucrats’ – despite what parts of the British media like to claim – but negotiated by European institutions, including national governments in the Council.
So the Commission should be ambitious and press ahead with structural reform proposals, including a price floor. The ETS was a creditable experiment. But the experiment has not worked. The ETS must be transformed or abolished. Otherwise it is just a fig leaf, hiding Europe’s tardiness on climate change.
Stephen Tindale is an associate fellow at the Centre for European Reform.
Wednesday, May 01, 2013
NATO and the costs of star wars
Over the last decade, the US has spent tens of billions of dollars constructing a shield to stop nuclear missiles from North Korea or Iran reaching its soil. So far, the shield does not work. Fortunately for the Americans, neither Pyongyang nor Tehran has nuclear missiles that could hit the US. Unfortunately, however, America's missile defence programme has upset China and Russia, two countries that do have nuclear arsenals that could reach its homeland. America's European partners in NATO should try to convince Washington to scale back its missile defence ambitions for the next few years. Not only would this allow the US government to spend its shrinking defence budget on more pressing military needs. It would also improve European security by reducing tensions between NATO and Russia.
Since the collapse of the Soviet Union, the US has been increasingly worried about nuclear attacks by 'rogue' states. In 1998, a study group chaired by Donald Rumsfeld predicted that North Korea and Iran could field intercontinental ballistic missiles within five years. Today, however, Iran has neither intercontinental missiles nor a nuclear bomb. In March of this year, a report from the Pentagon's intelligence agency (erroneously declassified) assessed "with moderate confidence" that Pyongyang could build a nuclear device that fits on a missile. But there is still no evidence that North Korean missiles are sophisticated enough to reach the US.
Although the American mainland is not currently under threat, every president since George H.W. Bush has sought to deploy nation-wide defences against a limited attack by ballistic missiles. Reviving some of President Ronald Reagan's 'star wars' ambitions, the US has had missile interceptors deployed in Alaska and California since 2004. Both the George W Bush and Obama administrations have also had various plans to deploy interceptors against intercontinental missiles at bases in Europe. (The Obama administration, working with NATO, has also been deploying interceptors in Europe to protect Europeans and US troops in the region against shorter-range missiles from Iran – a threat which does exist.) In March, Secretary of Defence Chuck Hagel announced that because of technical problems and budgetary constraints, the US is suspending its efforts to build Europe-based strategic interceptors. He also said that in response to the bellicose attitude of North Korea's new leader, the US will add 14 missile interceptors in on its West Coast, and perhaps deploy a few more on the East Coast, too.
The Obama administration has been wise to cancel the European leg of its strategic missile defence plans. Several recent studies had highlighted significant shortcomings in the programme. For example, a 2012 report by the National Academy of Sciences concluded that the interceptors planned for Europe would have been too slow to stop an incoming missile. But the US would be ill advised to increase the number of interceptors on the West – and possibly East – Coast. Studies have shown that the interceptors in Alaska and California do not work well either. According to Congress' Government Accountability Office, ten out of the 30 interceptors rely on technology which has never intercepted a missile during tests. The GAO estimates that it will take several years to repair this technology, costing the US taxpayer an additional $700 million. Hagel has promised to fix these glitches before the new interceptors are deployed. But the Pentagon does not yet have a solution to another big problem. None of its interceptors can distinguish between an incoming warhead and debris or decoys. (Ballistic missiles can easily carry decoys in addition to warheads.)
America's strategic missile defence efforts have made the US taxpayer fund a weapon that does not work to tackle a threat that does not exist. They have also antagonised China and Russia. Both countries worry that US technological breakthroughs could undermine their strategic deterrents. Moscow has been most displeased. The Kremlin has been asking for legal guarantees that the US would not direct its missile defences against Russia's strategic nuclear weapons. To reassure Russia, the Obama administration has encouraged Moscow to co-operate with NATO's defence programme against Iranian short and long-range missiles. (Moscow is less worried about NATO's defences against Iranian short-range missiles because the interceptors used would be too slow to stop a Russian strategic missile.) Washington has also been willing to provide Moscow political guarantees that its nuclear deterrent is not under threat.
But so far, the Obama administration has refused to give Russia legal guarantees. The US has made such commitments in the past. The Anti-Ballistic Missile Treaty established limits on what Moscow and Washington could do in this area from the 1970s until 2002. President George W Bush then withdrew from the agreement in order to pursue America’s missile defence ambitions unhindered. The Obama administration fears that Republican senators – who are keen on missile defence – would not ratify a treaty that would constrain the US. As a result, missile defence has become one of the most contentious issues in a troubled US-Russia relationship. Moscow has refused to negotiate further cuts in its nuclear arsenal until the issue is resolved. Last year, the chief of the General Staff of the Russian armed forces threatened to attack the European NATO countries hosting US missile defences. And according to press reports, Russian bombers have been simulating strikes against American missile defence installations.
Now that Hagel has cancelled the European leg of US strategic missile defences, there is a chance that NATO and Russia could end their dispute. Senior American and Russian officials have resumed talks about Russia co-operating with NATO's missile defence efforts. US policy-makers have also been encouraging Moscow to negotiate new bilateral nuclear reductions – a top priority for President Barack Obama. According to some Russian officials, President Vladimir Putin may be open to an agreement when he meets President Obama at the G8 in June or at their bilateral summit in September. But the Russians still want legal guarantees on strategic missile defences.
Europeans welcome the possibility of improved NATO-Russia ties. Most of them have never been convinced of the need for, or feasibility of, strategic missile defences and many disliked Washington's decision to leave the ABM treaty. Germany and others have been keen for Russia to co-operate with NATO's missile defence programme as a way to alleviate tensions. To maximise the chances of a deal between Washington and Moscow, Europeans should now encourage their American allies to include legal guarantees on missile defence in a new nuclear arms reduction treaty with Russia. Steven Pifer and Michael O'Hanlon from the Brookings Institution point out in their book 'The opportunity' that treaty limits could still allow the US to deploy all its planned defences against North Korea and Iran: the US and Russia could for example agree to each having a maximum of 125 interceptors capable of engaging intercontinental missiles. (The ABM treaty initially allowed for 200.) The treaty could also be limited to ten years, so that both sides could reconsider its ceilings in light of how the threats from North Korea and Iran evolve.
The White House, and Europeans, would struggle to convince some Republican senators to ratify such a treaty. But without it, Russia is unlikely to reduce its numerous tactical nuclear weapons – an arsenal that worries both Democrats and Republicans. Europeans should also discourage their US counterparts from deploying additional interceptors against strategic missiles until tests have shown them to be effective. The risk of wasting large sums of money at a time of savage defence cuts should help senators to reassess their views on missile defence.
As Greg Thielmann, a former senior US state department intelligence official, remarks, Europeans have "tamed ill-considered American instincts" in the past: in the 1980s, Europeans encouraged a reluctant Reagan administration to negotiate the Intermediate-Range Nuclear Forces Treaty. For the benefit of NATO-Russia relations and global arms control, the Europeans should encourage their ally to reassess its stance again.
Clara Marina O'Donnell is a senior research fellow at the Centre for European Reform and a non-resident fellow at the Brookings Institution.
Since the collapse of the Soviet Union, the US has been increasingly worried about nuclear attacks by 'rogue' states. In 1998, a study group chaired by Donald Rumsfeld predicted that North Korea and Iran could field intercontinental ballistic missiles within five years. Today, however, Iran has neither intercontinental missiles nor a nuclear bomb. In March of this year, a report from the Pentagon's intelligence agency (erroneously declassified) assessed "with moderate confidence" that Pyongyang could build a nuclear device that fits on a missile. But there is still no evidence that North Korean missiles are sophisticated enough to reach the US.
Although the American mainland is not currently under threat, every president since George H.W. Bush has sought to deploy nation-wide defences against a limited attack by ballistic missiles. Reviving some of President Ronald Reagan's 'star wars' ambitions, the US has had missile interceptors deployed in Alaska and California since 2004. Both the George W Bush and Obama administrations have also had various plans to deploy interceptors against intercontinental missiles at bases in Europe. (The Obama administration, working with NATO, has also been deploying interceptors in Europe to protect Europeans and US troops in the region against shorter-range missiles from Iran – a threat which does exist.) In March, Secretary of Defence Chuck Hagel announced that because of technical problems and budgetary constraints, the US is suspending its efforts to build Europe-based strategic interceptors. He also said that in response to the bellicose attitude of North Korea's new leader, the US will add 14 missile interceptors in on its West Coast, and perhaps deploy a few more on the East Coast, too.
The Obama administration has been wise to cancel the European leg of its strategic missile defence plans. Several recent studies had highlighted significant shortcomings in the programme. For example, a 2012 report by the National Academy of Sciences concluded that the interceptors planned for Europe would have been too slow to stop an incoming missile. But the US would be ill advised to increase the number of interceptors on the West – and possibly East – Coast. Studies have shown that the interceptors in Alaska and California do not work well either. According to Congress' Government Accountability Office, ten out of the 30 interceptors rely on technology which has never intercepted a missile during tests. The GAO estimates that it will take several years to repair this technology, costing the US taxpayer an additional $700 million. Hagel has promised to fix these glitches before the new interceptors are deployed. But the Pentagon does not yet have a solution to another big problem. None of its interceptors can distinguish between an incoming warhead and debris or decoys. (Ballistic missiles can easily carry decoys in addition to warheads.)
America's strategic missile defence efforts have made the US taxpayer fund a weapon that does not work to tackle a threat that does not exist. They have also antagonised China and Russia. Both countries worry that US technological breakthroughs could undermine their strategic deterrents. Moscow has been most displeased. The Kremlin has been asking for legal guarantees that the US would not direct its missile defences against Russia's strategic nuclear weapons. To reassure Russia, the Obama administration has encouraged Moscow to co-operate with NATO's defence programme against Iranian short and long-range missiles. (Moscow is less worried about NATO's defences against Iranian short-range missiles because the interceptors used would be too slow to stop a Russian strategic missile.) Washington has also been willing to provide Moscow political guarantees that its nuclear deterrent is not under threat.
But so far, the Obama administration has refused to give Russia legal guarantees. The US has made such commitments in the past. The Anti-Ballistic Missile Treaty established limits on what Moscow and Washington could do in this area from the 1970s until 2002. President George W Bush then withdrew from the agreement in order to pursue America’s missile defence ambitions unhindered. The Obama administration fears that Republican senators – who are keen on missile defence – would not ratify a treaty that would constrain the US. As a result, missile defence has become one of the most contentious issues in a troubled US-Russia relationship. Moscow has refused to negotiate further cuts in its nuclear arsenal until the issue is resolved. Last year, the chief of the General Staff of the Russian armed forces threatened to attack the European NATO countries hosting US missile defences. And according to press reports, Russian bombers have been simulating strikes against American missile defence installations.
Now that Hagel has cancelled the European leg of US strategic missile defences, there is a chance that NATO and Russia could end their dispute. Senior American and Russian officials have resumed talks about Russia co-operating with NATO's missile defence efforts. US policy-makers have also been encouraging Moscow to negotiate new bilateral nuclear reductions – a top priority for President Barack Obama. According to some Russian officials, President Vladimir Putin may be open to an agreement when he meets President Obama at the G8 in June or at their bilateral summit in September. But the Russians still want legal guarantees on strategic missile defences.
Europeans welcome the possibility of improved NATO-Russia ties. Most of them have never been convinced of the need for, or feasibility of, strategic missile defences and many disliked Washington's decision to leave the ABM treaty. Germany and others have been keen for Russia to co-operate with NATO's missile defence programme as a way to alleviate tensions. To maximise the chances of a deal between Washington and Moscow, Europeans should now encourage their American allies to include legal guarantees on missile defence in a new nuclear arms reduction treaty with Russia. Steven Pifer and Michael O'Hanlon from the Brookings Institution point out in their book 'The opportunity' that treaty limits could still allow the US to deploy all its planned defences against North Korea and Iran: the US and Russia could for example agree to each having a maximum of 125 interceptors capable of engaging intercontinental missiles. (The ABM treaty initially allowed for 200.) The treaty could also be limited to ten years, so that both sides could reconsider its ceilings in light of how the threats from North Korea and Iran evolve.
The White House, and Europeans, would struggle to convince some Republican senators to ratify such a treaty. But without it, Russia is unlikely to reduce its numerous tactical nuclear weapons – an arsenal that worries both Democrats and Republicans. Europeans should also discourage their US counterparts from deploying additional interceptors against strategic missiles until tests have shown them to be effective. The risk of wasting large sums of money at a time of savage defence cuts should help senators to reassess their views on missile defence.
As Greg Thielmann, a former senior US state department intelligence official, remarks, Europeans have "tamed ill-considered American instincts" in the past: in the 1980s, Europeans encouraged a reluctant Reagan administration to negotiate the Intermediate-Range Nuclear Forces Treaty. For the benefit of NATO-Russia relations and global arms control, the Europeans should encourage their ally to reassess its stance again.
Clara Marina O'Donnell is a senior research fellow at the Centre for European Reform and a non-resident fellow at the Brookings Institution.
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