Centre for European Reform

Last hooray for the EU on Iran?

2009-11-25T15:19:00.001Z

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.

What Eastern Europe can learn from the crisis

2009-11-11T11:14:00.002Z

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’ http://www.cer.org.uk/pdf/bnote_new_europe_feb09.pdf). 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.

Is Turkey Iran's friend?

2009-11-04T17:27:00.001Z

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.

President Lamy?

2009-10-20T12:33:00.003Z

by Hugo Brady

EU leaders are racking their brains to come up with candidates for the future presidency of the European Council. The job, to be created by the nearly-ratified Lisbon treaty, will replace a system whereby the EU is 'led' by a different national leader every six months. Instead, the Union will have a full-time consensus builder who will also represent the EU to foreign heads of state, for a maximum five-year term. The man or woman who gets the job is banned from holding national office, but the assumption is that potential incumbents need to have served as a president or prime minister in a past life.

Strangely, suitable candidates are proving elusive, even though the post has the potential to be both prestigious and influential. Of those names that have been touted so far, some – like the former British prime minister, Tony Blair – are divisive figures that would inevitably bring much political baggage to the office. Others – like Jan Peter Balkenende, the current Dutch prime minister – are agreeable to most, but uninspiring. They lack the profile and international standing that is needed if the post is to be more than merely ceremonial.

In early 2008, I tried to imagine the qualities the successful candidate for European Council president should have, in a mock job advert published in CER's bi-monthly bulletin:

"As the first person to hold this post, you will enjoy enormous scope to shape its future potential. Second-rate candidates need not apply. You should be a formidable communicator, highly capable but not overly assertive. You need to be firm but conciliatory. Modesty would be an asset. Although this position offers prestige and influence, power and perks will be limited. With only a handful of staff and no presidential cavalcade, the job will resemble that of the UN secretary-general rather than that of US president. Beyond your right to assemble us for emergency meetings, your formal powers will be limited. We are counting on your ability to set the agenda and forge consensus through persuasion and quiet charisma."

('Applicants sought for EU council president', CER bulletin, April/May 2008).

These are virtuous attributes indeed but, even in the rarefied corps of past and present European leaders, they are hard to find. Moreover, the job appears to require its holder to be a walking paradox: charismatic but modest, highly effective but non-intimidating, a consensus builder but also a decision-maker. Most ex-leaders of national governments would struggle to adjust to the limitations and requirements of such a position. That is one reason why candidates are so scarce.

Hence the member-states would find more suitable candidates if they widened their search beyond former heads of government to heads of international organisations, former European Commissioners with a distinguished record and, perhaps, even prominent figures from the world of business with an international profile. Some potentials might be Dominique Strauss-Kahn, (although it is probably more important that he stay in his current position as head of the IMF), or Chris Patten, a former EU commissioner for external relations.

In an ideal world, the most promising candidate from the non-leaders category would probably be Pascal Lamy, the current head of the World Trade Organisation. Judged against the criteria quoted above, Lamy emerges as a front-runner for a number of reasons. First, as the current head of a complex but indispensible organisation that operates by consensus and moves at a slow pace, Lamy could argue that he has done this sort of work before. Second, he has no political baggage of the sort that would identify him as a tool of one particular camp of member-states or another. A French socialist who supports free trade, Lamy would be a prime candidate to bring the Union together on many issues, especially on further steps to hasten economic recovery.

Also, whilst chief of staff for Jacques Delors, a former president of the European Commission, Lamy was a highly effective consensus builder who managed to thrive amid often spectacular political infighting. That is a quality that would stand him in good stead in the power-sharing triumvirate established by the Lisbon treaty, where the Council President's responsibilities rub up against those of the president of the European Commission and a newly powerful High Representative for Foreign Policy.

Opponents could argue that Lamy has no foreign policy experience on big picture issues like the Middle East peace process or Iran's nuclear programme. But trade – along with enlargement – has long been the EU's most important foreign policy tool, and Lamy is a former EU trade commissioner. Furthermore, rising powers like China or India will sit up and take notice if the head of the WTO were to depart suddenly to take up the European Council job.

I have no idea if Lamy is interested in the EU presidency, or whether he would be willing to leave the WTO were it offered to him. But the member-states will have a bigger, better field of candidates to choose from if they can let go of the idea that the first incumbent - so important to the future success of the position - must first have been a member of their own club.

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

Greece: Nowhere to hide

2009-10-08T15:58:00.001Z

by Simon Tilford

The Greek economy is on a very dangerous course. Unless the government takes steps to boost productivity and strengthen public finances, Greece faces a bleak future. Many Greeks appear to believe that membership of the euro insulates their country from the threat of financial crisis. This is mistaken. Membership may free the country from the threat of a currency crisis, but not from a fiscal crisis.

Eurozone membership requires considerable discipline. The reason is obvious. A country that loses trade competitiveness within the currency union can only regain it by ensuring its costs rise less quickly than the rest of the eurozone. In short, it must engineer a real depreciation within economic and monetary union (EMU). It cannot rely on devaluation to restore competitiveness.

Costs can be held down by wage freezes, although this risks depressing domestic demand and exacerbating the weakness of the fiscal position. Only stronger productivity offers the chance of regaining competitiveness without hitting domestic demand and bringing on a fiscal crisis. Higher productivity requires reforms of labour markets and the opening of the domestic economy to more competition.

Greece only has a small window of opportunity. The government deficit is on course to exceed 8% of GDP this year – this despite the Greek economy having only just entered recession. With the economy set to contract next year and stagnate the following year, the debt to GDP ratio will rise dramatically. The IMF estimates that it will jump to 134% by 2014. In reality, it looks like being much higher than this. And once the deficit reaches such a level it is hard to prevent it rising further because of the rising burden of interest payments.

Greece cannot finance deficits of this size domestically. It has to attract funding from abroad. This will become increasingly difficult if investors believe that the economy will be stuck in a cycle of very weak economic growth and rising public debt. Investors will lose faith in the ability of the Greek government to service its debts.

Many Greeks appear to believe that the eurozone as a whole would step in to prevent a debt crisis. They are probably right, but this would not be cost free. Assistance would be provided only in return for a commitment to reform the economy and cut public spending. It would make much more sense to take steps now rather than having to take more painful steps later.

The election result suggests that there is little stomach for reform in Greece. But Greece has no choice but to reform. Delay will only make the eventual medicine more bitter.

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

The Czechs will probably ratify the Lisbon treaty this year

2009-10-02T13:48:00.003Z

by Charles Grant

Any prediction about the timing of the Czech Republic’s ratification of the Lisbon treaty must be heavily qualified; politics in Prague are so complex and opaque that many Czechs find it hard to understand what is going on. But having just spent a couple of days talking to politicians and officials in Prague, I think it likely that the Czechs will ratify this year.

The republic’s maverick president, Vaclav Klaus – who shares the passion of his idol, Margaret Thatcher, for free markets and bashing Brussels – is doing his best to delay the ratification of the Lisbon treaty. Last year a group of eurosceptic senators allied to Klaus challenged the treaty in the constitutional court, with six specific complaints about the document. After seven months the court approved the treaty and earlier this year the parliament voted for it, but Klaus has delayed signing the law of ratification. On September 29th the eurosceptic senators mounted a second challenge to the treaty in the constitutional court, thereby giving Klaus a good reason not to sign.

If the Irish approve the treaty in their October 2nd referendum, Poland’s president, Lech Kaczynski, is likely to sign his country’s law of ratification. The Czech Republic would then be the only EU member-state not to have ratified the document.

The general view in Prague is that the court, based in the Moravian town of Brno, will once again approve the treaty. It is an independent institution and nobody thinks its judges are particularly eurosceptic. But how quickly will it rule? Klaus has admitted receiving a hand-written letter from David Cameron, the leader of the British Conservatives, apparently stating that they are with the Czech president in his fight against the treaty. If Klaus can delay his signature till the Conservatives take office in Britain – after the general election that is due by next June – Cameron will hold a referendum on the treaty. The result would almost certainly be a No, and that would be the end of the Lisbon treaty.

Nobody knows how long the court will take to consider the treaty. Although it took only ten days to rule on a recent case concerning early parliamentary elections (the court insisted that the current parliament continue to the end of its term), it will need to give a full and considered response to the new challenge to the Lisbon treaty. However, one senior figure I spoke to was confident that the ruling would be “in weeks not months”. The case for a quick ruling is that the court has already spent time on the treaty, dealing with last year’s case, and that “the court does not exist in a political vacuum”. The judges understand, apparently, that there is much at stake for the whole of Europe. The chairman of the court has said that he and his judges will prioritise this case and that other matters will be put on hold. The predominant view of people I spoke to was that the court would rule by Christmas.

But could Klaus’s friends in the Senate seek to delay the treaty further, by mounting a third legal challenge? The leader of the eurosceptic senators, Jiri Oberfalzer, is reported to have said that they would not do so. Oberfalzer has also said it is unlikely that the president himself would start a new case before the court. Indeed, at a recent dinner of leaders of the Visegrad countries (the Czech Republic, Hungary, Poland and Slovakia), Klaus apparently said that ratification was like a train in motion that could not be stopped.

So long as Klaus jibs at signing the ratification, he will face mounting pressure from other EU governments. And he may face threats from France and/or Germany. In Paris there is talk of punishing the Czech Republic for delaying ratification, for example by making sure the next Czech commissioner gets a non-job or by blocking Czech participation in international bodies. In the Commission and the European Parliament some people say that the Czechs could lose their commissioner altogether: if the next Commission has to be appointed under the rules of the Nice treaty – so that the number of the commissioners must be less than the number of member-states – the Czechs should be the ones to lose out.

That kind of threat would probably be counter-productive. Klaus is famously stubborn and is never happier than when standing up for a little country against bullying by big member-states. Czech officials worry that France’s president, Nicolas Sarkozy – renowned for his impulsive comments – could put his foot in it with a stinging attack on the Czechs.

It would be wiser to let the Czech people themselves put pressure on their president. Klaus is out of tune with Czech public opinion, which is predominantly in favour of the Lisbon treaty. All the main parties except for the Communists support the treaty. The recent decision of President Barack Obama to scrap plans for an anti-missile radar in the Czech republic has weakened the hand of those Czech politicians who argue that the American alliance is more important than European integration. Indeed, since the US decision on missile defence there has been more talk in Prague of boosting the EU’s role in defence. The best course of action for Europe’s leaders is to wait patiently for the court to rule and keep their fingers crossed.

Charles Grant is director of the Centre for European Reform.

Westerwelle for finance minister

2009-09-29T09:11:00.000Z

by Katinka Barysch

Guido Westerwelle is the undisputed winner of Sunday’s election in Germany. His Liberal Democratic Party (FDP) attracted almost 15 per cent of the vote, its highest share ever. Angela Merkel will remain chancellor although her Christian Democratic Union (CDU) did slightly worse than in the 2005 election. The FDP’s gains allow Merkel to discard the cumbersome ‘grand coalition’ with the Social Democrats and start negotiating a deal with the more likeminded Liberals.

The haggling about posts and policies is likely to be swift this time, with Merkel promising to have her new cabinet in place in a couple of weeks. Traditionally, the leader of the junior coalition partner becomes foreign minister (and vice chancellor). So Westerwelle is almost certain to succeed SPD-leader Frank-Walter Steinmeier in the foreign ministry.

Since taking over as FDP leader eight years ago, Westerwelle has worked hard to make his party appeal more to young voters and those fed up with the two big Volksparteien, the SDP and the CDU. Sunday’s result shows that he has been successful. But party political manoeuvring and a relentless quest for media attention have not left him much time to travel the world.

His public statements about foreign policy have often been a little vague and sometimes contradictory. He has argued for continuity in German foreign policy, promising that there would be no sharp breaks with most of Steinmeier’s positions. As a strong Atlanticist he was critical of George W Bush’s war on terror but has applauded Barack Obama, in particular for his moves on disarmament. He has spoken out against Germany sending more troops to Afghanistan, or letting them fight in the south, but he wants Berlin to live up to its promises to train more Afghan policemen. He is a firm believer in the benefits of European integration, especially the single market, and he thinks Germany should pay more attention to the smaller EU members. But the smalls will not like his suggestion that European integration should become more flexible, allowing sub-groups of member-states to go ahead with particular policies. He says EU accession negotiations with Turkey should continue, which will put him at loggerheads with those in the CDU (and its smaller sister party, the CSU) who want to offer Turkey a privileged partnership. He has sometimes sounded rather conciliatory on Russia. But he also advocates keeping Germany’s nuclear power stations running beyond 2022, to make the country less dependent on Russian gas.

Westerwelle does not have a lot of experience with foreign policy and his public statements on international issues so far do not add up to a coherent Weltanschauung. That does not mean that he would not make a good foreign minister. Joschka Fischer had limited international credentials before he became foreign minister of the SPD / Green Party coalition in 1998. He turned out to be an effective and principled international operator. Like all foreign ministers before him, he quickly became one of Germany’s most popular politicians.

It is not Westerwelle (or Fischer or Steinmeier) that is the problem. It is the tradition of giving the foreign ministry to the leader of the junior coalition partner. Westerwelle may or may not agree with Merkel on foreign policy. He has little choice but to use his new job to sharpen his party’s profile. The SPD did so dismally in Sunday’s election partly because, after four years in the grand coalition, voters struggle to tell what it stands for. The lesson for the FDP will be to chart an independent course, especially after 11 years in opposition. It should: in economics, not in foreign policy.

Since the foreign minister and the chancellor always come from different parties, all vital foreign policy dossiers (relations with the US, Russia, China and so on) land directly on the chancellor’s desk. Not content with being in charge of secondary issues, Germany’s foreign ministers have often developed their own stance on the big issues of the day. Contradictory public statements and competing diplomatic initiatives have sometimes been the result. Such incoherence in foreign policy mattered little before reunification, when Germany’s low-key foreign policy mainly consisted of supporting European integration and the transatlantic alliance. But today, Germany claims international leadership and is expected to adopt regional and global responsibilities. Today, German foreign policy should not be a matter of coalition squabbles. Therefore, the foreign minister should come from Merkel’s own party.

Westerwelle should move into the finance ministry instead. While the foreign policy part of the FDP’s manifesto is weak, it has strong positions on economic policy: it advocates open markets, less stringent hiring and firing rules, an effective competition policy, help for small enterprises and, most importantly, lower and simpler taxes. Westerwelle insists that he will not sign a coalition agreement that does not contain tax reform. But he also knows that with € 1.6 trillion in public debt and a new law mandating a zero deficit by 2016, there is not much room for fiscal manoeuvre. The temptation to leave this balancing act to someone else and instead enjoy the international limelight will be strong. But if Westerwelle is serious about tax reform, he should install himself in the finance ministry and see it through as best he can. By helping to tackle some of Germany’s economic weaknesses, Westerwelle may even add more to his country’s international standing and credibility than by being its chief diplomat.

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

Talk of ‘exit’ is premature

2009-09-22T14:40:00.001Z

by Simon Tilford

The governor of the Bank of England (BoE), Mervyn King, has had a mixed financial crisis. He assumed that financial stability flowed from monetary stability – which we now know is not the case – and was very slow to recognize the extent of the crisis. He has also taken the UK into unchartered waters with the embrace of so-called quantitative easing (QE). QE involves the electronic creation of new money by the central bank in the form of purchases of government and private sector bonds. QE aims to drive down long-term interest rates and encourage bank lending. The BoE has now spent around £150bn, in the process buying not far short of a quarter of the UK’s entire outstanding stock of government debt. It is far from clear whether QE will work. It is possible that the banks will simply sit on the cash rather than lending it, as they did in the early 1990s when the Bank of Japan employed a similar strategy. But King is right to argue that dramatic action is warranted by the economic outlook, which is much worse (and not just in the UK) than the general consensus.

The BoE governor has repeatedly warned that commentators and economists are not paying sufficient attention to the difference between ‘growth and levels’, and that the threat of inflation is extremely remote. He is clearly right. A couple of quarters of modest economic growth following peak-to-trough contractions of around 5 per cent is neither here nor there. It certainly does not represent a return to business as usual. Of course, it is positive that the recession is over. But that the economy has been stabilized at all has been the result of massive monetary and fiscal stimulus. The underlying dynamic remains very weak. On most growth projections it will take the EU economy several years to return to pre-crisis levels of GDP.

No sooner has the recession ended than we are being overwhelmed with talk of a rapid bounceback in economic growth and hence for the need to craft ‘exit strategies’ to prevent an upsurge of inflation. This ignores what has happened. The gap between what we can produce and what we do produce is now enormous. With consumption and investment set to remain very weak, it will take many years to close this gap. To talk of exit strategies in such a situation is dangerous and potentially deflationary. It is going to feel like a recession for many years. Demand for labour will take a long time to recover, not only because it will take time to recoup the lost output but because labour productivity will also rise over this period. Fewer workers will be needed to produce a given amount of output. The result threatens to be mass unemployment. The outlook for investment is also very poor. The combination of excess capacity and undercapitalised banks will conspire to keep investment weak for quite some time.

Of course there are mighty long-term fiscal challenges facing most EU economies. If bond investors start to believe that governments have lost control of their public finances, long-term interest rates will rise, hitting growth. But a premature exit would do more harm than good, as it would almost certainly derail the recovery, in the process weakening fiscal positions. If no-one else is willing to spend, then the state has to. Any country exiting before a self-sustaining recovery has taken hold will essentially be guilty of free-riding on the demand being generated by deficit spending elsewhere. Germany has already indicated that it intends to tighten fiscal policy steadily following the election and is now constitutionally obliged to reduce its fiscal deficit to 0.35% of GDP by 2016. Such a move will only work if others keep spending and Germany can rely on rebuilding its trade surplus for economic growth. This is a zero-sum game. If everyone behaves in this way, the impact on Europe’s economy will be dire.

Similarly, a premature move to raise interest rates in an effort to head off a largely imaginary inflation bogeyman would risk scuppering the recovery by increasing the cost of capital and boosting the already excessive strength of the euro. The European economy needs very low interest rates for an extended period of time to keep capital cheap and to stimulate activity to close the output gap. The risk of snuffing out the recovery now (in the process exacerbating the weakness of public finances) is far greater than a spike in inflation later on. Stagnation and debt deflation pose greater risks to the European economy than inflation.

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

The dangers of Karzai’s re-election

2009-09-10T09:11:00.002Z

by Tomas Valasek

The final result of the Afghan election may not be known until the end of September, but it looks as if President Hamid Karzai will have done well enough to avoid a second round of voting. This is causing dismay in some western capitals, where some senior figures now view Karzai as a key obstacle to Afghanistan’s reconstruction. If he stays in power, people in many European countries are likely to become increasingly disenchanted with the ‘mission impossible’ that their soldiers are undertaking, and that would increase the probability of European forces being withdrawn.

A senior UK diplomat recently described the problems posed by Karzai’s government for western attempts to reconstruct Afghanistan. “Our game plan is to use foreign troops to create enough breathing room for the Afghan government to assert its authority throughout the country,” he said. “But if the government whose authority we help to assert is widely viewed as corrupt and incompetent, we have no chance of succeeding.”

Karzai’s government has earned its inglorious reputation for several reasons. Washington suspects that some of its top officials are involved in the drug trade, including the president’s brother, Ahmed Wali Karzai, as well as the defence minister, Karzai’s running mate and the potential future vice-president, Mohammad Fahim. Corruption extends downwards through the bureaucracy. Western troops say that many Afghan policemen steal valuables during searches of houses. Local leaders complain they have very little effort from the Kabul government to rebuild roads or resuscitate the economy; it is the western governments and NGOs that deliver the little progress that there is.

In his early years as president, Karzai offered hope for a new future and was genuinely popular. In 2005, 83 per cent of Afghans approved of president Karzai and 80 per cent approved of the national government overall. Today those figures have dropped to 52 and 49 per cent, respectively. Those are still solid numbers that some western leaders would envy. But the support has been on a constant slide for the past four years because more and more Afghans have given up hope that the current government will deliver stability or prosperity.

The US, the UK and other key troop-contributing governments worry that a Karzai victory heavily tainted by allegations of fraud will further disappoint the Afghans and embolden the Taliban. And in the western countries that send the troops his re-election could also fatally undermine public support for the mission. The latest opinion polls show that about two-thirds of Britons want UK troops out of the country – not only because of rising casualties, but also because of the perception that Afghan politicians are using their authority, which rests on the support of western troops, for self-enrichment.

The US, for now, has little choice but to stay put. The US public is as fidgety as that in Britain but President Obama has made success in Afghanistan a key plank of his foreign policy and he will not want to give up so soon. The US may send more troops if General Stanley McChrystal, the commander of US and NATO forces in Afghanistan, requests reinforcements.

The situation is different in other NATO allies. The Dutch are scheduled to leave next year, and the Canadians say they will withdraw in 2011, though NATO is working hard to get both governments to change their mind. That may prove impossible unless events in Afghanistan give the public some reason to believe that NATO is managing to turn around its flagging mission. Even the British presence cannot be taken as guaranteed, if public support for it continues to slide.

The prospect of European troops departing brings two risks. One is to the security of Afghanistan itself. Together, the UK, Canada and the Netherlands supply the bulk of the troops that keep a semblance of order in three of the volatile southern provinces (though the US is reinforcing its presence in the south). NATO and the EU are busy training new Afghan soldiers and police to replace the western troops. But on the evidence of the past few years, the central government is unlikely to have enough properly trained replacements to take over from the Europeans anytime soon. Some local Afghan leaders say that if the Europeans withdraw in the next year or two, they will leave the country too, or strike deals with the Taliban. Either way, the government in Kabul would lose out. The second risk is to NATO itself. Why should Washington take the alliance seriously if it finds itself manning the ramparts in Afghanistan alone?

To prevent European support for the war in Afghanistan from collapsing, the governments need to take two steps. First, those capitals that have done little to drum up public support for the mission need to step up. In the UK, Prime Minister Gordon Brown gave a major ‘why we fight’ speech on September 4th. More effort of this sort is needed. Second, assuming that Karzai is declared the victor, the West needs to find ways of making clear to is government that it needs to do more to fight corruption. This could include withholding EU and national aid from the most corrupt parts of the Afghan government.

Getting the Kabul government to change its ways will not be easy: when the US special representative, Richard Holbrooke, recently suggested that Afghanistan might have to deal with complaints of ballot-rigging by holding a second round of elections, Karzai walked out of the meeting; he later told a French newspaper that the US wanted him to be more “docile”. But the European governments and Washington are right to try. The government in Kabul and its western partners need to find ways of changing the perception that the Karzai government is failing, or public pressure may force European troops to withdraw sooner than is good for the country.

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

Anglo-Saxons and hedge funds: Culprits or scapegoats?

2009-08-07T10:05:00.001Z

by Philip Whyte

Disasters often provoke unseemly bouts of finger-pointing. This has certainly been true of the global financial crisis. In the Anglo-Saxon world, libertarians have blamed it on governments, and governments on ‘bankers’. But in continental Europe, many blame Anglo-Saxons for their supposed reluctance to regulate financial markets. The crisis, they believe, would never have happened if the British and the Americans had regulated and supervised their financial sectors like the French and the Germans. On this view, the UK needs to change, notably by clamping down on hedge funds. Does this narrative stack up? Or have some Europeans just turned Anglo-Saxons and hedge funds into their scapegoats of choice?

Tirades against Anglo-Saxons long predated the crisis, but they have gathered in intensity since it began. In the run-up to the G20 summit in April, Luxembourg’s prime minister, Jean-Claude Juncker, stated that this crisis “started in the US. The Anglo-Saxon world has always refused to add the dose of regulation which financial markets needed.” At the end of the same summit, the French President, Nicolas Sarkozy, announced the death of “unregulated Anglo-Saxon finance”. And in July, Germany’s chancellor, Angela Merkel, told a political meeting in Nuremberg that “with us, dear friends, Wall Street or the City of London won’t dictate again how money should be made, only to let others pick up the bill.”

In any analysis of the causes of the crisis, the UK and the US clearly deserve a share of the blame. They tolerated unsustainable domestic credit booms which wreaked havoc on themselves and the rest of the world. But they were hardly the only countries to experience credit-fuelled housing booms. Denmark, France, Ireland and Spain did too. Nor were they the only countries which allowed ‘shadow banking’ entities to proliferate and banks’ exposures to complex financial instruments to grow. It was a funding crisis at two ‘special investment vehicles’ (SIVs) that brought the regulated German bank, IKB, to its knees. And German banks built massive exposures to collateralised debt obligations (CDOs).

What of hedge funds? Listen to French and German leaders, and you would think that hedge funds were central to the financial crisis. France and Germany have leaned on the European Commission to propose a directive that would regulate hedge funds; they have criticised the Commission’s resulting legislative proposal as too weak; and they have accused the British of dragging their heels. France and Germany are not entirely wrong: the example of Long Term Capital Management in 1998 shows that some hedge funds can pose a threat to financial stability. Even so, it is hard to avoid the conclusion that France and Germany have used the crisis as an opportunity to advance one of their hobby horses.

Both the EU’s de Larosière report and the UK’s Turner review agree that hedge funds did not cause the global financial crisis. They did not drive the growth in sub-prime lending. They did not cause house prices to fall. And they did not force regulated banks (such as Germany’s Hypo Real Estate) to hold CDOs on their balance sheets. So it is quite wrong to imply, as some French and German politicians do, that the crisis would not have occurred if hedge funds had been more tightly regulated. It is also wrong to suggest that the British are reluctant to regulate hedge funds. The British government has accepted the Turner review’s recommendation that “regulation should focus on economic substance, not legal form”.

The Turner and de Larosière reports point to a broad, technocratic cross-Channel consensus on the causes of the financial crisis and the lessons to be learned. Does it matter if this is not reflected in political rhetoric? Yes, for two reasons. First, political obsessions can often drag policy in undesirable directions. (Remember that when Germany chaired the G7 in the months leading up to the crisis in 2007, it was so fixated with regulating hedge funds that it was blind to what turned out to be the central problem: the excessive leverage and effective under-capitalisation of the regulated banking sector). Second, rhetoric can poison negotiations unnecessarily, making agreement more difficult to reach.

Populist broadsides against Anglo-Saxons and hedge funds are unlikely to help the prospect of pan-European regulatory reform. If French and German politicians are not careful, the scenario which they paint of a recalcitrant Britain at odds with the rest of Europe could become a self-fulfilling prophesy. It is no secret that sections of Britain’s media and political class are primed to detect sinister motives in anything emanating from Europe. More often than not, such fears are just paranoid fantasy. But for once, the British may be forgiven if they conclude that France and Germany are exploiting the crisis to promote some of their longstanding objectives and to weaken London’s position as a financial centre.

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

Can Europeans share a common security culture?

2009-07-27T09:35:00.003Z

by Clara Marina O'Donnell

European countries have long declared their ambition to turn the EU into a global player in security – in order to tackle common threats and strengthen their voice on the global stage. But they still cannot agree on the main threats to their security or the best way to tackle them. Their views are so diverse that it is a wonder EU countries have managed to agree on any common action at all. But member-states need to strengthen their efforts to develop a common approach to security if the EU is to become a serious player.

For the past two decades, the EU has been developing a profile in foreign and security policy. It has agreed common security strategies, deployed over 20 peacekeeping and crisis management missions, led negotiations with Iran on the latter’s nuclear programme and negotiated a ceasefire to the Russia-Georgia war. However, as was brought into focus at a recent EUISS seminar, EU countries do not always share the same threat perceptions, or agree how these should be tackled.

Some European countries, such as Ireland and Austria, do not believe they face any serious ‘hard’ threats. Others fear for their territorial integrity, including the Baltics, Poland and the Czech Republic. Greeks and Cypriots worry mainly about the prospect of renewed military conflict with Turkey. So while Cyprus is still partly militarily occupied and Greek and Turkish military aircraft tail each other on a daily basis, the Viennese worry mainly about the level of burglaries in their city.

While the UK considers the threat of transnational terrorism as the most pressing threat to Europe as a whole, and a key priority to be tackled at home and abroad, most other countries feel largely unaffected. Russia is seen as a close partner to some countries, including Italy and Germany, while the Baltic states see it as an existential threat. Some member-states believe it is important to have a global outlook on security, in particular France and the UK, while others, such as Malta, believe their main security challenge is managing migration flows.

Different views also exist on how to tackle security threats. For many member-states a UN mandate is essential in order to participate in a military mission abroad, while for others, like the UK, it is only desirable. Some believe the US and NATO are cornerstones of their security (in particular the UK and the eastern countries), while others view NATO with suspicion – and resent the UK for having sided with the US during the war in Iraq. Some EU member-states have long traditions of intervention in conflicts across the world and accept the possibility of casualties within their armed forces, in particular France and the UK. Others are averse to the use of military force, most notably Germany.

Various member-states (Sweden, Austria, Finland and Ireland) have a long history of neutrality and are grappling to make their stance compatible with growing EU co-operation in security and defence (Ireland is finding it the hardest to accept EU defence co-operation. Due to public concern, it will have its military neutrality enshrined in an EU treaty for the first time if the Lisbon treaty comes into force). For their part, the UK and France are insistent on the need to develop expeditionary capabilities to allow the EU to fulfil its ambitions abroad. Some member-states, such as Sweden, have transformed their military forces, but many others have so far resisted.

In light of their very different histories, traditions and cultures, it is no mean achievement that EU countries have agreed to work together to provide peacekeeping and crisis management to conflicts zones in need, and to cooperate on wider security issues such as Iran and the Arab-Israeli conflict. In addition, with time the EU is likely to become further involved in security, by tackling ‘soft’ threats (such as protective measures against cyber attacks), or certain aspects of ‘hard’ threats (such as monitoring the cross-border transfer of dangerous products which could be used in chemical or biological attacks).

But member-states’ different interests and approaches limit the EU’s effectiveness as an external actor, as demonstrated by the difficulties in finding helicopters for the EU’s peacekeeping mission to Chad, the UK’s refusal to send a battlegroup to the Democratic Republic of Congo in 2008, or the difficulties the EU has in agreeing a common position on Russia or energy security.

Perhaps the biggest problem for the EU is the division between its western and eastern members. While many member-states feel they cannot trust their partners to guarantee their security (within the EU or NATO), it is difficult to talk of a common security culture. If threat perceptions within eastern European countries worsened, their anxieties could define their foreign policies, hampering the EU’s work at home and abroad (and NATO). For the EU and NATO to remain credible security providers to their members, and for the EU to become a serious player in global security, European countries must overcome the current mistrust and strengthen their efforts to develop a stronger common strategic culture.

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

Carl Bildt and the cost of speaking plainly

2009-07-21T12:11:00.001Z

by Charles Grant

Carl Bildt is better known throughout the world than most of his fellow EU foreign ministers – and many of the prime ministers, too. That is not only because he has held some senior jobs (prime minister of Sweden, and Balkan envoy for both the United Nations and the EU), but also because he is actively engaged in, and knowledgeable about, a wide range of international issues.

Someone with Bildt’s skills and experience should be the front-runner to become the EU’s new High Representative – in effect its foreign policy chief – if, as is likely, the Lisbon treaty is finally implemented at the end of this year. That treaty would merge the roles currently played by Javier Solana, the current High Representative, and Benita Ferrero-Waldner, the commissioner for external relations, into a single post at the head of a new ‘external action service’ – an embryonic EU foreign ministry.

But Bildt’s chances of being appointed High Representative are slim. This is because he tends to say what he thinks and that is not always wise in politics or diplomacy. His frank and trenchant opinions appeal to think-tankers and journalists but not always to other foreign ministers. Some of them find his confidence and cleverness, and the length of his contact book, irritating. And sometimes he conducts his own solo diplomacy, particularly when Balkan problems hot up, which can be frustrating for the country holding the EU presidency.

I must declare an interest. Carl Bildt sat on the advisory board of the Centre for European Reform until he became Swedish foreign minister in October 2006, and still attends many CER conferences. He is very much a ‘think-tankers’ foreign minister’: he likes to argue and ask questions, and he brims with ideas. He also works very hard at his job: most weekends, this youthful-looking 60-year old is at some conference or other, debating the most pressing foreign policy issues of the day. And if he is not at a conference he is on a diplomatic mission or at a summit.

His critics view Bildt as an arrogant Mr Know-it-all. But in many ways he is modest. He takes the time to speak to people who are not ‘important’, like secretaries and conference organisers, and not all politicians do that. Furthermore, most politicians will only attend a conference if they are given a speaking slot. They go to give their speech and are not particularly interested in hearing what others have to say. But Bildt is not like that. Every six months the CER and other think-tanks organise a roundtable that brings together European and American diplomats and thinkers. Bildt always turns up, even though he seldom has a speaking slot. He sits at the back taking notes, because he is genuinely interested to hear what other experts have to say.

If Bildt was serious about running for the job of High Representative he would have manoeuvred to win the support of France and Germany. But he has not done that, with the result that both Berlin and Paris are likely to block his candidacy. Germany takes the view that the EU should maintain friendly relations with Russia. So in August 2008, when Russia invaded Georgia, the Germans disapproved of Bildt’s comparison of the Russian justification for the attack on Georgia to Adolf Hitler's rationale for invading parts of Central Europe – namely the need to protect a minority. Bildt’s comment was indeed over-the-top and unwise. In fact he has a good network of contacts inside Russia, including some of those in positions of power. Nevertheless as far as several EU governments are concerned, Bildt is simply too confrontational towards Russia.

France is an even bigger problem for Bildt. Just before the recent European elections he gave an interview to Le Figaro in which he contradicted the view of President Nicolas Sarkozy that Turkey is not in Europe. “If we judge Cyprus to be in Europe, although it is as in island along Syria's shores, it is hard not to consider that Turkey is in Europe," Bildt said. That interview made Sarkozy angry and he cancelled a visit to Stockholm. To make matters worse, Bildt does not speak French fluently.

Bildt has also been implicitly critical of Sarkozy’s protectionist rhetoric – he is a true believer in free markets, free trade and the ‘Lisbon agenda’ of economic reform. You know where you are with Bildt – he is a strong backer of human rights in authoritarian countries and he believes that the countries of Eastern Europe should be free to choose their own destinies. He is also an unstinting Atlanticist; if the decision was left to him, Sweden would join NATO. Bildt’s experience in Bosnia has made him passionate about the protection of minorities. At the end of the war in Sri Lanka, when government forces were killing many Tamil civilians, he tried to fly to Colombo to make his point to the country’s leaders. But he was refused a visa.

Many EU foreign ministers would probably prefer a High Representative in the mould of Javier Solana, the incumbent. The Spaniard’s style of operating is the opposite of Bildt’s: he avoids direct confrontations with people, preferring to build a consensus through discreet personal diplomacy. The ideal High Representative would be a figure who combined Bildt’s rigorous thinking and grand strategic vision with Solana’s subtle manner and feline operating skills. But there is probably no such person.

Charles Grant is director of the Cente for European Reform

Iran, elections, and nuclear weapons

2009-07-10T15:57:00.002Z

by Tomas Valasek

What the future holds for Iran's theocratic regime is hard to read. True, the government has ensured its own survival by suppressing last month's protests there with brutal force. President Mahmoud Ahmadinejad will remain in power despite a contested election. But the authority of the regime has suffered. The president has lost legitimacy in the eyes of millions of Iranians. The country's supreme leader, Ayatollah Ali Khamenei, who urged force against the protestors, has lost much of his popularity. The events of June 2009 could turn out to be the beginning of a deeper challenge to the Islamic republic: Iran observers point out that the country's 1979 revolution was preceded by a long build up of low-level agitation.

What is clear is that the violence around the presidential election bodes ill for western diplomacy to end Iran's nuclear ambitions, in at least two ways. First, Barack Obama will be under pressure to rethink the offer of 'engagement grounded in mutual respect', which he extended to the government in Iran in April 2009. On the other hand, the US will now find it easier to convince the Europeans to toughen the sanctions regime on Iran, thanks to Tehran's heavy-handiness.

Iran's nuclear programme is run directly by the country's supreme leader, not the president. The recent political turmoil will have had little effect on it. Even if the challenger, Mir Hossein Mousavi had won the presidency, Iran would have almost certainly continued to enrich uranium. Mousavi said during the campaign that he would not abandon "Iran's right to nuclear technology". Some Iran watchers have speculated that Mousavi would build enrichment facilities but not nuclear weapons, lest he put Iran in even deeper isolation. In reality, the president's views have little bearing on the nature of the nuclear project.

The West has long been worried that Iran is building a nuclear bomb, or at least acquiring all the necessary ingredients. However the more immediate concern now is the prospect of an Israeli military strike on Iran. US officials say they fear that Israel may try to destroy Iran's nuclear facilities this autumn, before Russia delivers a batch of modern anti-aircraft missiles recently purchased by the Iranian regime.

To prevent Iran from acquiring nuclear weapons – and to keep Israel from attacking – Barack Obama launched a new diplomatic push in April 2009. He has promised to join the European-led talks with the government in Tehran. US negotiators are rumoured to be considering dropping a key western condition for the talks, namely that Iran shut down its enrichment programme before the negotiations start. Obama also recorded a video statement to the Iranian people, in which he has offered a partnership between the US and Iran. The idea was to win the Iranian regime's goodwill by showing it the respect it craves, and to spur the Iranians into pressuring the leadership to pursue a less confrontational line with the US.

The second pillar of the US strategy has worked very well. While most Iranians support the nuclear programme, many of the young ones are increasingly frustrated with the country's pariah status. Mir Hossein Mousavi, surged ahead in the polls after he accused president Ahmadinejad of leading Iran into the 'indignity' of international isolation.

But Mousavi failed to win – or was prevented from winning – and the post-election protests have undermined the overall strategy. Iran cannot negotiate because the government is 'too busy locking people up', said one EU official working on the Iran dossier. If Ahmadinejad and Khamenei do fully consolidate power, this will create another headache for the West: how can Barack Obama speak to a regime which has likely rigged elections and brutally suppressed democratic protests? Obama is already under fire for being "soft" and "naive" regarding Iran. Admiral Michael Mullen, the chairman of the US Joint Chiefs of Staff, recently urged him to take a harsher line, noting that Iran's nuclear programme was progressing whatever the domestic situation there. Even if Obama starts talks with Tehran, he may feel compelled to satisfy Mullen, and others, by employing tougher rethoric. This would likely cause the talks to collapse prematurely.

If, as is likely, engagement does not generate a generous response from Tehran, the US will want to tighten existing sanctions on Iran. Some governments like the German and Italian ones, have been known to be sceptical about the need for further sanctions; the Italian foreign minister published an article in early June calling for the West to be nice to Iran. But the violence in Tehran has made the doubters more inclined to penalise the Iranian government, EU officials say.

However, fresh UN sanctions may be blocked by Russia, and possibly China. Both are members of the UN Security Council and oppose a harsher line on Iran. If the US and the EU apply unilateral sanctions, these will be less effective. Meanwhile, Israel may decide to attack, or Iran may race to acquire a full nuclear weapon. So the furore over Iran's presidential election – by throwing up new obstacles to diplomacy – has made the job of resolving tensions over its nuclear programme harder. That may prove the deadliest legacy of the events of the last few weeks.

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

Russia: A tale of two crises

2009-07-03T09:30:00.002Z

by Katinka Barysch

Russia’s economy has been hit hard by a triple whammy of capital outflows, collapsing oil prices and falling global demand. In the first three months of the year, output was down by 10 per cent compared with a year earlier. The retail boom that had fuelled growth in recent years has turned into a slump. The output of the manufacturing sector is contracting at a rate of over 20 per cent year on year. Construction is in deep recession. The current-account surplus has melted away.

However, the latest economic indicators suggest that the economic contraction is at least slowing. The oil price has recovered to over $70 a barrel. Surveys show that credit conditions are easing and managers are a bit less gloomy. Capital outflows have slowed. So has inflation, which has allowed the central bank to finally cut rates. International reserves, although down from 2008 peaks, still stand at $410 billion. The government is making plans for recapitalising some of the country’s banks.

Investors still remember the rapid, V-shaped recovery that followed Russia’s last financial crash in 1998. In the following nine years, the Russian economy grew by an average of 7 per cent a year. Will Russia be able to pull out of trouble this quickly again?

On the plus side, Russia’s government finances are in incomparably better shape than they were ten years ago. Back then, it was short-term public borrowing that triggered the crisis, ultimately forcing the government into default. Since then, the budget has shown a healthy surplus, allowing the government to stash away $140 billion in a reserve fund. So although revenue has collapsed (half of it comes from the oil and gas sector), the authorities have room for fiscal manoeuvre. Public spending will also have a bigger impact on the economy, simply because the Russian state is much bigger than it used to be (federal budget revenue was 13 per cent of GDP back in 1998, today it is over 20 per cent, according to Erik Berglőf from the European Bank of Reconstruction and Development).

Also, in 1998 the Russian economy had only just returned to growth, following years of severe post-transition recession. Now, after ten years of uninterrupted expansion, fewer Russians are living hand to mouth and many should be able to draw on savings to tide them over the most difficult period.

However, there are also reasons to expect the current crisis to be more severe and drawn-out. The 1998 crisis mainly affected emerging markets. This time, the recession is global, which means that no country will be able to export its way out of trouble. (Russia exports mainly raw materials, as well as some metals, timber and heavy industrial goods. But it is the collapse in demand for non-oil exports, such as steel products, that is causing the most trouble since these are often produced in isolated one-industry towns.)

Depressed global demand also means that the rally in oil prices is likely to be short-lived. After 1998, the oil price climbed steadily from around $10 a barrel to a peak of $140 last summer. Many forecasters expect oil prices to linger around $50-60 this year and next – not disastrously low but not enough to fuel a strong Russian recovery either. Moreover, Russia’s economy today is much more dependent on oil and gas sales than it was in 1998. Back then, oil and gas sales accounted for 44 per cent of export revenue, now the share is over two-thirds. Many manufacturing and services industries are directly or indirectly linked to the resource sector.

Perhaps the biggest difference lies in the role of banking and borrowing. Although both crises originated in the financial sector, in 1998 this sector was still so small that its collapse barely affected the wider economy. Then, credit to firms and households stood at 9 per cent of GDP; today it is over 40 per cent.

In recent years, much more of that borrowing came from abroad so the drying up of global liquidity in 2008 hit Russia hard. The World Bank estimates that in 1998-99, the reversal in foreign capital flows amounted to less than 2 per cent of Russian GDP. In 2008-09, it was close to 12 per cent of GDP.

Domestic banks cannot take up the slack because a rising share of bad loans will constrain their ability to start lending again. The health of the banking sector is difficult to assess. Official numbers show that the share of non-performing loans has climbed from 1 per cent at the start of the year to 4 per cent today. Given the sorry state of Russian industries, this is still an implausibly low number. Independent assessments put the share of bad loans at anywhere between 10 and 20 per cent.

As a result of these factors, the Russian economy is likely to take longer to come out if its slump than it did ten years ago. The World Bank predicts a contraction of almost 8 per cent this year, but some forecasters thinks even this is too optimistic and they question whether Russia will be able to make even timid recovery in 2010. Most economists agree that Russia stands little or no chance of returning to the 7-8 per cent growth rate that it enjoyed before the crisis struck

The big question is what the changed growth outlook will mean for Russia’s internal stability and the government’s willingness to implement economic reforms. In 1998 Russians expected very little from their leaders in Moscow. They were positively surprised when the Putin administration after 2000 started to implement some useful reforms, such as simplifying the tax system and cleaning up regulations.

Since then, Putin’s muscular rhetoric, combined with Alexei Kudrin’s sound macro-economic management, have raised expectations. The people that took to the streets in Russian cities in recent weeks and months did not so much protest against government policies as demand government help. The government could react either by getting serious about modernising and diversifying the economy. Or it could resort to economic nationalism and populist spending increases. So far, there is more evidence of the latter than the former. Prime Minister Putin has personally instructed companies to clear wage arrears and criticised shops for overcharging struggling families. On June 29th, he told the managers of Russia’s biggest banks that they should not go on summer holiday before they have significantly increased lending to the corporate sector (he even gave them a numerical target of $16 billion). With this kind of crises response, Russia’s growth prospects could end up being lower not only in the short term, but for many years to come.

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

Britain’s eurosceptics need to come clean

2009-06-25T12:56:00.001Z

by Simon Tilford

Britain’s media and political class have a right to be sceptical about the EU, even hostile to it. But they also have an obligation to be honest about the economic implications of a retreat from full membership of the Union. Their failure to do so is dishonest and poses a serious risk to Britain’s prosperity. A newly ‘emancipated’ Britain would not remain part of the EU’s single market, at least not on the terms the eurosceptics claim. In fact, a retreat would achieve nothing but impotence. It would not reduce the regulatory and compliance costs facing UK business and it would end our ability to shape the EU’s single market.

Those calling for a renegotiation of the EU’s Lisbon treaty, or of the UK’s relationship with the EU more generally, ignore that this would inevitably lead to at best semi-detached membership of the EU, and more probably divorce. Eurosceptics appear to believe that a Britain outside the EU would remain part of the single market, but that it would be freed from the need to abide by EU regulation. In short, Britain could enjoy all the benefits of access to the single market but none of the costs.

This is incoherent. To remain a full member of the single market, British firms would have to abide by all its rules and regulations. A Britain that opted to withdraw from the EU would have no say over the drawing up of those rules and regulations. British interests would not be represented in Brussels and Britain would not be able to stymie regulatory drives that threaten UK prosperity. In short, British business would experience the worst of all worlds.

British manufacturers might not suffer too badly. Britain would have no say over EU product standards, which British firms would nevertheless have to comply with in order to sell their products in the EU. Nor would the costs of producing for the UK market fall – it would make no sense for British firms to make one set of products for the British market and another for the rest of Europe. But merchandise markets are at least already open. The real threat for the UK lies elsewhere.

Britain is by far the biggest exporter of commercial services in the EU. As such, it has a very strong interest in opening markets for those services. But a Britain that has no say over the future of the single market will not be able to use its influence to push for service sector liberalisation. It will not be able to challenge the self-serving idea put forward by other member-states that a single market in merchandise goods is one thing, but open markets in services are somehow beyond the pale. Nor will it be able to ensure that regulation of service industries is not inimical to the interests of British business. This would be a major own-goal.

One only has to look at the financial services industry to see the risks. If British-based providers of financial services wanted to do business in the single market, they would have to abide by whatever regulations the rest of the EU dreamt up. These would certainly be more restrictive in the absence of British involvement. At a time when other EU governments see an opportunity to cut London down to size, would it really make sense to be a bystander? How would Britain thwart the rather heavy-handed attack on the private equity and hedge fund industries operating in the EU if it had no seat at the table?

Britain needs to step up its involvement in the EU, not leave the playing field in a huff. It needs to strive to ensure that EU financial regulation is – as far as possible – proportionate and reconcilable with the UK approach. More generally, it needs to make common cause with other economically liberal member-states to ensure that the EU evolves in a direction that serves British interests.

Britain’s conversation about its relationship with the EU is devoid of the pragmatism and empiricism with which it is traditionally associated. Some British eurosceptics genuinely believe that the UK can have its cake and eat it. That it could reduce the cost of EU membership while retaining all the existing and potential benefits. Others know exactly what they are doing. Their ultimate objective is for Britain to withdraw from the EU. This is a perfectly defensible aim, but those for whom this is the objective need to explain how it would be in the UK’s strategic and commercial interests.

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

Can Russia contribute to global governance?

2009-06-17T10:49:00.002Z

by Charles Grant

Like the US, China and India, Russia has never been a big enthusiast for multilateral global governance. When the Russians believe that working through multilateral institutions will suit their interests, they will do so. But Russia’s history, size and traditions make it sceptical of multilateralism. Only with great reluctance did then President Vladimir Putin sign the Kyoto protocol on climate change – when he realised that Russia would benefit financially through the sale of unused carbon allowances.

Russia has never shown a lot of interest in multilateral institutions, other than the privileged clubs it is a member of, such as the G8 and the UN Security Council (UNSC). Presidents Yeltsin and Putin have had similar views on global governance, both preferring to talk of multipolarity rather than multilateralism.

As a G8 member, Russia has not been in favour of broadening the membership to include countries like China. But now that the G20 has become an important group, in some ways replacing the G8, Russia willingly takes part. Russia evidently likes the UNSC, being one of five veto-wielding members. But it has shown less interest in the UN as a whole and stayed on the sidelines during the discussion of UN reform at the end of Kofi Annan’s tenure as UN secretary-general. When Russia does take part in global bodies, it often seems more interested in the status of membership than in active participation.

Russia is ambiguous on whether it wants to join the World Trade Organisation – its membership talks with the WTO have dragged on since 1993. Earlier this month Russian trade officials told EU negotiators that they hoped to join the WTO this year – but then Prime Minister Putin said that Russia would want to join only as part of a grouping with Belarus and Kazakhstan. That is likely to delay membership.

Russia is more comfortable with regional organisations than global bodies, perhaps because it can play a leading role in them. It likes the Collective Security Treaty Organisation, which links a number of former Soviet countries, and the Shanghai Co-operation Organisation, which brings together most of the Central Asian countries and is dominated by Russia and China. There has been talk in the Kremlin of a ‘gas OPEC’, hooking together Russia, Iran and other producers such as Turkmenistan.

Russia strongly dislikes NATO for several reasons: the US leads the alliance, Russia believes the West would not allow it to join, and NATO’s expansion symbolises Russia’s strategic retreat since the Cold War. In recent years Moscow has taken against the Organisation for Security and Co-operation in Europe, whose observers have criticised the conduct of elections in former Soviet states. That is one reason why President Dmitri Medvedev came up with the idea of ‘a new European security architecture’ last year. Medvedev has said this should bring together Russia, the US, European countries and European security organisations. But his government has not yet produced any specific proposals.

The economic crisis is spurring governments around the world to think seriously about reform of global governance. For example the membership of the Financial Stability Forum is being broadened to include the leading developing economies. The IMF and World Bank are preparing for another round of reform. The effort to combat climate change is likely to lead to new global institutions. Yet Russia has been reluctant to put forward its own proposals on global governance. Why?

Russian foreign policy is hyper-realist. Russian diplomats tend to believe that countries are most likely to achieve their objectives through being tough and unyielding rather than by compromising or working things out in international organisations. Their worldview focuses on power rather than rules. It is natural for large and strong countries to be realist; it tends to be smaller and weaker states that see multilateral institutions as a bulwark against bullying by the powerful. And perhaps Russia’s difficult history – it has never had defined frontiers and has usually got on badly with its neighbours – has encouraged the realism.

The fact that Russia is big makes it reluctant to cede much authority to multilateral bodies. For in international organisations small countries can wield disproportionate influence. One thing that Russian diplomats find infuriating about the EU is that small countries can veto its decisions – for a while Lithuania blocked the negotiation of an EU-Russia trade agreement. Tiny Georgia could, if it really insisted, stop Russia joining the WTO. Seeing itself as a great power, Russia has – ever since the Congress of Vienna, almost two hundred years ago – liked the idea of a concert of powers. Thus it enjoys its role in the ‘quartet’ that is supposed to handle the Middle East peace process: Russia sits alongside the US, the UN and the EU.

Russians should rethink their scepticism towards multilateral institutions. The Russian economy is globalising. Sberbank’s recent purchase of a major stake in General Motors Europe is just one indication of this trend. Gazprom is buying energy infrastructure in many EU member-states. Russia’s leading metals companies are building global networks. The long-term prosperity of the top Russian firms depends on their buying companies and raising money in the world’s major financial centres.

Russia is developing global economic interests and will need to defend them. This is best done through strong multilateral institutions. If Russia joined the WTO it would be harder for other countries to impose anti-dumping duties on Russian exports. As a leading exporter of energy, Russia has an interest in joining the International Energy Agency, and helping it to develop into a body that can smooth out volatility in oil and gas prices. Russia should also take more interest in the future of the IMF and the World Bank, and in the emerging institutional framework for regulating global financial markets.

The Europeans – who, unlike the Russians, Indians, Chinese and Americans are instinctively multilateralist – should encourage the Russians to view multilateral institutions as a tool for promoting their national interests. The WTO is the prime example of an organisation that would deliver tangible benefits to Russia, and the EU – as Russia’s biggest trading partner – should urge the Russians to made up their minds to join it.

Charles Grant is director of the Centre for European Reform.

EU politics after the elections

2009-06-10T12:36:00.007Z

by Hugo Brady

EU policies were not the issue that guided most voters in last week’s elections to the European Parliament. The economic crisis and job safety were uppermost in people’s minds. It is therefore surprising that in the EU’s six largest member-states, socialist parties – whether in government or opposition – either did poorly or were routed. It was the centre-right, liberal and green parties that triumphed, gaining the majority of the assembly’s 736 seats. The far-right picked up a few extra seats as did single-issue, eurosceptic parties.

How to explain the centre-left’s eclipse? To suggest a single, pan-European explanation would be a little dubious. Election campaigns were, almost without exception, based on local and national issues. Nevertheless, European electorates appear to trust conservative or liberal parties to get them out of the current crisis in better shape than the left. In countries like Italy or France, where socialist parties are not in power, the centre-left was too complacent that the crisis would mean an automatic increase in their share of the vote. Also, sterner language by centre-right parties on immigration issues over the last year probably served to shore up their votes in some countries.

For the next five years, the European Parliament will be dominated, but not controlled, by the European People’s Party (EPP, the group of centre-right parties), which won 264 seats. New MEPs are already haggling over which committee chairmanships each political group will get and who will be the parliament’s next president. More importantly, the EPP is attempting to cobble together the majority (369 votes) needed to approve current European Commission president, José Manuel Barroso, for a second term. EU governments are likely to approve Barroso’s reappointment at a summit in Brussels next week. If the EPP’s leader, Joseph Daul, can get the Liberals, the anti-federalist European Conservatives and some independents on board, Barroso, a liberal-leaning conservative, will be re-appointed. That will mean that future EU policies – in critical areas like the environment, financial regulation, migration and energy policy – should continue to be governed by the same centre-right consensus that has prevailed since 2004. However, France’s president, Nicolas Sarkozy, might support Barroso’s reappointment only on the understanding that a major economic portfolio such as trade, internal market or competition will go to a French nominee in the next Commission.

The election results have affected Europe’s political landscape in other ways, too. First, the parliament’s credibility is under threat from an ever-decreasing electoral turnout. At just over 43 per cent, average turnout was higher than expected (some polls predicted participation as low as 35 per cent). But the trend towards voter apathy that has been apparent since direct elections to the assembly began 30 years ago continues. This trend is in stark contrast to the European Parliament’s rising powers and relevance. Almost ten years ago, Oxford academic Larry Siedentop argued that an indirectly elected ‘European senate’ of national parliamentarians would be a better way to give voters a proper say over European integration, an idea revisited in The Economist this week. If turnout in the next two elections falls below 40 per cent, Siedentop’s idea should be dusted off.

Second, Libertas, the group that led the campaign against the Lisbon treaty in last year’s Irish referendum, fielded over 500 candidates in various EU countries. But it failed to make an impact in any, despite spending some €30 million. Declan Ganley, Libertas’ leader, failed to win a seat in Ireland. His retirement from politics makes a Yes vote in Ireland’s second treaty referendum, expected in early October, more likely. He was a key factor in swaying undecided, mildly pro-European voters whose support is critical if the treaty is to pass. However, the amount of media attention heaped on Ganley partially obscured the utter failure of pro-European parties to give voters strong arguments as to why the treaty matters. If this failure is repeated, other member-states can expect a second No, whatever Ireland’s economic circumstances or perceived reliance on the EU.

Third, the elections highlighted that popular anti-EU feeling in Britain is at an all-time high. Well over 50 per cent of the British vote went to eurosceptics of various hues. The Conservative party and UKIP, both staunch opponents of the Lisbon treaty and of further EU integration, gained seats, while the ruling Labour party received an historically low share of the vote. That suggests a future British government will face fresh calls for a referendum on Britain’s place in Europe, whether linked to the Lisbon treaty or not. Conservative leader David Cameron, if and when he becomes prime minister, will be haunted by Britain’s 20-year EU debate as much as his predecessors were. In the end, the Tories might be relaxed about fundamentally re-defining Britain’s relationship with France and Germany. But Britain’s ally, the US, wants it to remain a fully engaged EU member-state. The Obama administration will be dismayed if Britain chooses to relinquish or renegotiate its status.

Lastly, victories for the far-right, including the Dutch Freedom Party, British National Party, Hungarian Jobbik and Greater Romania Party, have caused anguish among Europe’s political mainstream. Although far-right parties gained no more than eight extra seats, they look likely to have enough seats to form a separate group in the next European Parliament. Under new rules, groups can be formed by a minimum of 25 MEPs from seven different countries. Being a member of such a group gives parties access to significant funds and the right to chair or steer committees. Whether such a far-right grouping would have a lot of political influence remains to be seen, however. In the 2004-2009 parliament, the far-right ‘Identity, Tradition, Sovereignty’ group quickly dissolved due to irreconcilable differences between the parties. The Parliament’s new cohort of extreme nationalists and anti-immigration parties may soon realise what those in the political mainstream have long known: working with foreigners can be tough.

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

What the economic crisis will mean for European defence

2009-06-05T16:07:00.002Z

by Tomas Valasek

There are mounting indications that defence budgets across Europe, not very high in the first place, could fall further because of the economic crisis. This will have a three-fold impact on European militaries and missions. Some governments will be tempted to cut operations – but if done haphazardly, this risks leaving parts of the world exposed to insecurity. Multinational weapons programmes may suffer a disproportionate share of the budget cuts. And while all defence ministries will have to rationalise (and most already have) governments will need to decide whether it is worth keeping the rumps of their national militaries. Many should form joint units with neighbours instead.

There are two strong reasons to believe that defence budgets will fall dramatically. First, all European governments will see their public debts rise over the next few years. Some – like that of Latvia – are beginning to have serious trouble raising funds. Even the more sturdy economies, like the UK, have been warned by rating agencies to bring their debt under control or risk losing their gold-plated credit rating. Most European governments will have to increase taxes and cut spending in order to rebalance the books. Second, those cuts will hit defence harder than other parts of the budget. This is because many forms of government spending – like the cost of paying interest on public debt – cannot be reduced by decree. Some non-mandatory expenditures like healthcare tend to be politically explosive: no government wants to be seen to be taking risks with people’s health. So defence budgets are an obvious target for ax-wielding finance ministers. George Osborne, the UK shadow chancellor of the exchequer, warned recently that he would cut defence spending if the Conservatives won the election (which they are widely expected to do this year or next).

The looming military budget cuts will have many salutary effects. Defence establishments, with their resistance to civilian oversight and emphasis on continuity, tend to get bloated in times of relative plenty. It often takes a crisis to force meaningful reforms. France – which suffered a defence budget meltdown in 2007, even before the economic crisis unfolded in full – at last shut many of its African bases, a legacy of its colonial years. Slovakia recently cut the number of military commands from eight to three – a long overdue step that will reduce unnecessary overheads. Other European militaries, too, will come out of the crisis with more sensible structures and budgets.

But the economic crisis presents several serious risks to European defences. The easiest portion of the defence budget to cut is the part that pays for operations. Withdrawing soldiers from faraway places plays well at home (it removes young men and women from harm’s way) and is politically easier than restructuring the militaries (no one is laid off). But European governments should resist the urge to pull back their soldiers indiscriminately; this could cause conflicts to re-flare and leave vulnerable people at risk. Instead, they should stop sending overlapping missions to the same trouble spots. Because international institutions compete to fly their flag in missions abroad, it is not unusual for western governments to have multiple operations in the same place. For example, three different forces are currently fighting piracy off the coast of Somalia. That is a wasteful use of taxpayer money. The EU, NATO, and the US should roll their Somalia operations into one or two.

The budgetary crisis will force many defence ministries to cancel planned weapon buys. Their instinct will be to cut multinational programmes and protect those purchases that generate jobs at home. That could be a mistake. While much of the needed equipment can be made nationally, the truly complex systems are so expensive that defence ministries can only afford them if they share the development costs with other countries. As defence budgets shrink, such multinational approaches will only become more important. Granted, many of the collaborative programmes to date have been a disaster. The seven-nation plan to develop a new generation of military transport aircraft, the A400M, is the most glaring example. The airplane cannot fly because the engines, made by a four-nation European consortium, lack the proper certification; the plane is also said to be too heavy.

But the answer lies not in abandoning collaborative programmes. Instead, European governments need to rethink their approach to collaboration. The trouble with the A400M is not that the plane’s manufacture, EADS, lacks technical expertise (it builds one of the finest civilian aircraft in existence, the Airbus) but that participating governments have been more concerned with securing production jobs than with obtaining a good product. In return for investing in the aircraft, they have demanded that a commensurate number of production jobs to go to their country. As a result, bits of the aircraft are being built in different countries, and not necessarily in the ones most qualified to do the job. In case of the A400M, EADS executives say they wanted a US company to build the engine, but were told by participating governments to keep the jobs in Europe. European governments should accept that it makes more sense to order the needed parts from the plant with the most relevant technical expertise, no matter where it is located. The governments also need to be more ready to buy off-the-shelf components, rather than try to generate jobs by manufacturing parts from scratch.

Cuts in personnel and equipment risk turning some European militaries into ‘showcase’ forces: incapable of deploying abroad and thus irrelevant to most EU and NATO operations. It makes little sense, for example, for most European militaries to maintain supersonic air forces without access to air-to-air refueling; or to have infantry without the support units needed to feed and re-supply the soldiers in faraway places. As an excellent new study commissioned by the Nordic governments concluded, “the size of certain units may fall below a critical limit… and small and medium-sized countries [could] lose their ability to maintain a credible defence. The result could be a Europe where only countries like France, Russia, the UK and Germany have their own modern defence forces.”

There are two ways to avoid such outcome while cutting budgets. Some of the key equipment that makes modern warfare possible – like planes providing air-to-ground surveillance or military transport – needs to be jointly owned. NATO owns a common fleet of aircraft that co-ordinate air traffic, and the alliance plans to buy transport airplanes for its members to use. This allows militaries of the smaller and poorer European states that cannot afford such specialist equipment to take part in complex operations in distant places.

But joint ownership of critical resources alone may not save enough money. The time has come for European governments to consider abandoning parts of their national forces and infrastructure, and to form joint units with neighbours. It is becoming increasingly hard to justify why the 25 European members of NATO should maintain 25 separate air forces with own commands and bases, when between them they could only find a handful of much-needed helicopters for Afghanistan (most did not have any, and those who did, did not want to send them). Modern militaries do virtually all their fighting abroad, and in coalition with others. If they lack the money to equip and deploy their soldiers overseas, they need to consider radical cost-saving measures. More governments should do as Belgium, Holland and Luxembourg do (they merged parts of their air forces) or emulate the Nordic countries (which are thinking of forming joint amphibious forces).

Such ‘pooling’ is not a new idea; it has been talked about on and off for nearly a decade, but to little effect. Most European governments have found it too difficult to part with the cherished symbol of national sovereignty that is a proper army or an air force. They have held on to them as symbols even though the practical value of some military services in Europe is negligible. The US has stopped asking Europe for more forces for Afghanistan, partly because politicians do not want to send forces into harm’s way but also because few have any useful forces to deploy. The economic crisis may at last force more countries to pool their militaries. This would enable them to take part in NATO and EU operations whilst saving money. If so, the crisis will have turned out to be a blessing in disguise.

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

Why the European elections matter

2009-05-29T09:39:00.001Z

by Hugo Brady

Between June 4th and June 7th, Europeans will cast their votes to elect a new European Parliament (EP). Recent opinion polls indicate that they will do so without much enthusiasm. Indeed, there is every chance that the average turnout will be the lowest ever – it has fallen at every election since the first time that Europeans directly elected their MEPs in 1979, and sank to 45.6 per cent in 2004. But despite the prevailing apathy, this election matters. During its next five-year term, the EP will influence what the EU decides in areas as diverse as financial services, trade, climate change, energy security and immigration.

Why do European elections so often struggle to capture the public imagination? Evidently, voters think the stakes are lower than in national elections – or at any rate less clear. Unlike legislative elections in a member-state, European elections do not, strictly speaking, lead to the formation of a new government. Moreover, the EP can often seem distant because few voters know what it actually does. And even if they do, the areas where the EP exercises most influence seem technical and dull. Voters tend to be less interested in arguments such as home versus host regulation of service companies, or the pros and cons of ‘unbundling’ vertically-integrated energy companies, than in the subjects which dominate domestic elections – tax and spending, health and education policy, foreign and defence policy and so on. And on those issues the EP has no say.

MEPs are remote from most voters. The party list system used in most countries means that few electors know the names of their MEPs. European constituencies are huge, making it difficult for any voter to meet an MEP; in national politics members of parliament can more easily hold ‘surgeries’ to meet constituents. Furthermore, the process-heavy, non-adversarial way in which the Parliament operates attracts little media, and voter, attention. Political groups in the EP stand out less clearly than in most national assemblies. Although they are organised on a conventional left-right spectrum, they are composed of MEPs from very different national traditions, which makes them less monolithic. And there is not a great difference between the policies proposed by the three biggest groups, the centre-right European People’s Party (EPP), the centre-left Party of European Socialists (PES) and the Alliance of Liberals and Democrats for Europe (ALDE). Finally, the parliament lacks political theatre. Many of its proceedings revolve around consensus-building and horse-trading in specialist committees.

Eurosceptics sometimes argue that these flaws weaken the legitimacy of the EP as a representative institution. That argument is unfair for two reasons. The first is that the EP’s job is not to replace national assemblies but to complement them, by providing an additional layer of democratic representation in EU policy. The second is that the EP has become a serious actor. During its 2004-2009 term, it influenced EU policy in areas as diverse as climate change, energy, the cross-border provision of services, telecoms regulation and the authorisation of chemicals. This trend is set to continue, especially if – depending on Ireland’s autumn referendum – the Lisbon treaty enters into force. The EP would then have the power of ‘co-decision’ – an equal say to the Council of Ministers – over virtually all legislation, instead of around 70 per cent as is now the case. In particular, the Lisbon treaty would give the EP much more legislative power on justice and home affairs.

The future political balance of the EP will be largely determined by the outcome of voting in the big six member-states: Britain, France, Germany, Italy, Poland and Spain. The EPP seems likely to remain the largest political group in the Parliament, albeit with a reduced majority, despite the fact that Britain’s Conservatives are due to leave it. The Party of European Socialists (PES), for its part, should increase its representation, but only a little. When other groupings are taken into account – including the new group that the British Conservatives plan to lead – the centre-right is likely to dominate the EP.

If current opinion polls are to be believed, the mainstream centre-left will fail to draw much advantage from the current ‘crisis of capitalism’. In the largest member-states, centre-left parties are either unpopular incumbents (as in Britain, Germany and Spain), or in opposition and disarray (as in France, Italy and Poland). The great unknown is how well populist fringe groups of the left and right – those who are really opposed to the current political and economic system – will perform. It would still be a major surprise if fringe parties won much more than 50 seats in the 736-seat EP.

The balance of the parties matters for the leadership of the European Commission. In June the European Council is due to nominate the Commission’s next president. EU leaders are likely to offer José Manuel Barroso, who is affiliated with the EPP, a second five-year term. But if the PES becomes the largest group in the EP, they will try and insist on one of their own. The newly elected Parliament is due to approve the European Council’s nominee for Commission president in July. Assuming that the centre-right dominates the Parliament, Barroso will be voted in.

In the autumn the EP will hold hearings on the individual commissioners proposed by governments. These hearings matter. Five years ago, the EP did not like the look of Silvio Berlusconi’s nominee, Rocco Buttiglione, on account of his views on gays and women – and it forced Berlusconi to withdraw him. In January the Parliament will vote to invest the entire team of commissioners. If it is implemented, the Lisbon treaty will make more explicit the need for the appointment of the Commission president to ‘take into account’ the results of the European elections. In the long run, whatever happens to that treaty, the Commission is likely to become more directly accountable to the Parliament. But whether that makes Europeans any more willing to vote for MEPs is another matter.

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

Making a success of the EAS

2009-05-21T15:02:00.002Z

by Charles Grant

If the Irish people vote yes to the Lisbon treaty at the second attempt, and the Czechs, Germans and Poles also ratify, the EU will set up an ‘external action service’ or EAS. This new institution promises to make the Union’s common foreign and security policy more effective. But of course an EAS will not mean that the EU suddenly develops a single foreign policy on every issue. The EU’s inability to develop a coherent approach to Russia, for example, would probably not be very different if an EAS was in place. Different member-states believe that they have different interests in Russia and so disagree on how to handle it.

That said, some of the EU’s incoherence in foreign policy can be put down to its often dysfunctional institutions, notably the rotating presidency; the split between both the High Representative (currently Javier Solana) and the external relations commissioner (currently Benita Ferrero-Waldner), and their respective bureaucracies; and the fact that the current institutions do not provide EU foreign ministers with high quality analysis on a number of important subjects.

The EAS should solve some of those problems. It will be a single bureaucracy made up of the merged foreign desks of the Commission and the Council of Ministers secretariat, as well as secondees from member-states. It will be led by the new High Representative or HR, fusing the Solana and Ferrero-Waldner jobs. That individual plus the EAS will take on the tasks currently performed by the rotating presidency, in terms of external representation and foreign policy.

If the member-states get the design of the EAS right – and give it the budget it needs – it should improve EU foreign policy in four ways.

1) The EAS should help the EU to join up its foreign policies. The EU has the potential to play a powerful international role because it has such a broad range of instruments at its disposal, such as aid, trade, soldiers, policemen, humanitarian aid, rules on asylum and visas, and so on. Neither NATO nor the UN can draw on such wide-ranging capacities. But in practice the EU rarely joins up its external policies. Within the Commission there is seldom much co-operation between the various directorates-general, let alone between those directorates and the Council of Ministers. By merging parts of the Commission and the Council into a single institution, the EAS should help to join up EU foreign policy. But it will still be a challenge to ensure that other parts of those bodies – such as the trade, enlargement, justice and energy directorates of the Commission – work in harmony with the EAS.

2) The EAS should be able to provide more high quality and common analysis to EU ministers. If the 27 governments view a problem in a similar way, they are more likely to be able to hammer out a common approach to it. The current institutions sometimes succeed in encouraging common thinking. For example the EU has taken a single line on Iran’s nuclear programme in recent years, partly because of the quality of the analysis provided by the Situation Centre (which gathers intelligence from the member-states) in the Council of Ministers. The EAS will have more resources and expertise than the current array of Brussels institutions. National diplomats seconded to it should help to feed in the best analysis from national capitals.

3) The integration of the Commission’s 120-odd overseas representations into the EAS should increase the EU’s clout. At the moment they focus (naturally) on the Commission’s priorities and are of little help to Solana and his team in Brussels, or to EU foreign ministers. In order to improve their performance and enhance their expertise in areas like political reporting and hard security, senior figures from national governments should be given prominent roles in some missions. These offices will need to have positions to represent in their part of the world, which will probably encourage the EAS to develop common policies. They will play a role in co-ordinating (though not managing) the work of member-state embassies. They will represent the smaller member-states that have no embassy in the country concerned. Even large member-states such as Britain or Germany do not have embassies everywhere and may find EU missions useful. In the longer run, small and large member-states may start to rely on missions as a way of saving money: if and when a government trusts the quality of the EAS’s work, it may decide to close embassies in countries that it considers relatively unimportant.

4) The EAS will eliminate the problem that a weak presidency can undermine EU foreign policy. The Czech presidency has, by general consent, been one of the worst in memory, and not only because the government collapsed half way through. When the EU is represented by the High Representative and the EAS it will, one may hope, be spared the embarrassments it has faced in the first half of 2009.

It is inevitable that the creation of the EAS will be a bureaucratic nightmare. Each of the existing bureaucracies, as well as the member-states, will fight to protect its specific interests. The EAS will need to be shaped by men and women of vision who can look beyond those interests. Whether or not the EAS is a success will depend, in part, on how well it meets four challenges.

1) Will the EAS attract very good people to work for it? National governments must send their best and brightest. It is not self evident that they will: the UK, for example, has not always sent its top diplomats to work in the Council of Ministers secretariat. The High Representative must be the kind of politician who inspires and whom bright young people will want to work for. And he or she will need to get on well with the president of the European Council (a new post) and the Commission president. The effectiveness of both the Commission and the Council of Ministers is marred by national flags being imposed on particular jobs. The High Representative must have the freedom to appoint the best people to the key jobs (of course, every member-state must have people in the EAS). He or she will also need deputies. Solana works about 100 hours a week, but the new HR will have extra responsibilities in the Commission and in chairing the meetings of EU foreign ministers. The HR will need at least five senior deputies: for traditional diplomacy, managing military missions, generating civilian capabilities, working with the various Commission directorates, and ensuring that justice and home affairs (JHA) is integrated into external policies. Other deputies may be needed to focus on specific regions.

2) Will the EAS succeed in stitching together policy on JHA with the EU’s foreign policies? A lot of the things the EU does that matter to the rest of the world are in areas like visas, asylum, illegal immigration, organised crime, counter-terrorism, police and judicial co-operation and border controls. At the moment the EU seldom joins up policies in these areas with other external policies. For example, when the JHA directorate general negotiates an agreement on the repatriation of illegal immigrants with a third country, it can offer to discuss visa rules, but not trade, aid or non-proliferation, which are handled by other parts of the EU. The EAS needs to find a way of integrating the EU’s work on JHA with other external policies.

3) When several parts of the EU are operating in the same problem country, will the EAS manage to co-ordinate their work? When there are several EU missions in the same country they tend not to work together. For example, when the EU peacekeeping mission arrived in Bosnia it found that the EU police mission, the Commission office and the EU special representative’s office had different objectives and did not want to work with it. There was little co-ordination from Brussels. There have been similar problems in Congo and Afghanistan. In order to ensure that the various EU agencies work together in such important places, the EAS should deploy a special representative to each of them. He or she should have the authority to co-ordinate the work of the various missions on the ground.

4) Will the 27 member-states identify with the EAS and trust it to promote their interests? Most small countries will see the value of a body that can represent them in places where they lack embassies. But there is a real danger that the foreign ministries of Britain, France or Germany could see the EAS as a rival source of power and as a competitor for money and the best people. They would then work round or against the EAS. The High Representative should therefore ensure that the big countries are given the chance to send good people to fill some of the top posts in the EAS. If the HR can establish an efficient bureaucracy that produces high-quality analysis, national foreign ministries will, hopefully, learn to respect it.

Charles Grant is director of the Centre for European Reform.

Are the British the new French?

2009-05-05T09:56:00.002Z

by Simon Tilford

The British tend to deride France as a hopelessly statist, anti-entrepreneurial country full of bolshie workers intent on extracting disproportionate rewards for their labour and a state too weak to resist them. This characterisation is not wholly inaccurate. But the implicit (and sometimes explicit) assumption is that the UK is everything that France is not. This is not the case.

In some respects, Britain now looks worse than France. For all its faults, France produces good public services and decent social outcomes, such as relatively low levels of poverty and high overall skills levels. Britain, by contrast, now combines a very big state, patchy public services, generally poor social outcomes and increasing barriers to wealth creation. This is a poisonous mixture. The situation can be rescued, but not without breaking some eggs.

The figures are arresting. Britain has gone from having one of the smallest states in the EU to one of the largest. In 2000, public spending accounted for 37% of GDP in the UK, just three percentage points above the US and a full 15 percentage points below France. By 2010 the OECD estimates that state spending will account for 49% of GDP in Britain, against 53% in France (52% in famously high-spending Sweden). Britain has already overtaken Germany and the Netherlands (44% and 46% respectively).

This unprecedented expansion of the British state would be less of problem if the UK now had Scandinavian (or even French) levels of public services or first-rate physical infrastructure. But improvements in British public services over the last ten years have been nowhere near big enough to justify the increase in expenditure. Most of the money has gone on increased employment and wages, rather than improvements in services. Perhaps unsurprisingly, given the stranglehold that the unions have on the public sector, productivity has stagnated.

It is also notable that Britain’s welfare-state is not comparable to that of Germany or the Netherlands, let alone France or Sweden. Unlike in these countries, many of the ordinary Britons currently losing their jobs will receive only derisory sums in unemployment benefits because these are means-tested. And only a forensic scientist could spot significant improvements in the country’s physical infrastructure. Britain’s roads remain as congested as ever and its railways expensive and unreliable.

Of course, the tax burden in the UK is still lower than in France. In 2008, taxes accounted for 49% of GDP in France compared to just 42% in Britain. But the gap between tax and expenditure in Britain is completely unsustainable, given the parlous state of the country’s public finances. How it is closed will to a large extent determine Britain’s economic prospects. If the gap is bridged by cutting expenditure, the UK stands a chance of returning to a relatively strong growth path. But if it is closed primarily through increased taxes, Britain will have a bleak future. The tax burden will be among the highest in the OECD, but public services (and the country’s social outcomes) will be nowhere near good enough to justify the tax take. In short, Britain will have Scandinavian levels of taxation and American levels of public services and social welfare.

The Labour party is poorly placed to sort out this mess because of its close links to the public sector unions. Under Labour the public sector has become a privileged class that is impervious to change and reform. By way of illustration, public sector wages are currently rising by close to 4% a year at a time of economic crisis. And this despite the fact that public workers are on average better paid than their private sector counterparts and enjoy generous pension entitlements. What about the country’s physical infrastructure? On the government’s forecasts, public investment will halve over the next 4 years. In fact, the only significant cuts the government intends to make are to investment.

The Tories stand a better chance of taking on entrenched public sector vested interests, but it will be a battle. Moreover, they will need to avoid the mistakes of the 1980s when they reduced spending by cutting services and investment rather than by increasing public sector efficiency. If they do this again, UK taxes will remain very high relative to what those taxes deliver in terms of services.

Britain still has strengths, of course. It is straightforward to set up a business in the UK and the labour market remains flexible. But overall Britain looks increasingly like one of the sick men of Europe, and certainly as sick as France. The French state is an efficient provider of services and quasi-state institutions construct and manage first-rate physical infrastructure. France, unlike Britain, has bitten the bullet on public pensions, increasing the retirement age to 65. The French have no qualms about allowing private companies to provide healthcare. Even the Tories do not appear to have the stomach for dismantling the NHS’s near monopoly on the provision of public healthcare.

The British need to get over the idea that they took all the difficult decisions in the 1980s and that Britain is an example for others to follow. It has a huge state, yet has poor social outcomes. Much of its growth in recent years has been down to a turbo-charged financial services industry and an unsustainable expansion of the public sector. Both trends have now run their course and the public sector has become a dead weight on the economy. Britain needs to concentrate on improving the climate for wealth creation. This will require much better public sector productivity and high levels of investment in human capital and physical infrastructure.

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

Towards a new system of financial regulation

2009-04-23T09:17:00.002Z

by Philip Whyte

The financial crisis is often portrayed as the product of weak regulation in the Anglosphere. But it is more accurate to think of it as the result of flawed thinking (and policy) across the global financial system as a whole. One reason is that countries outside the Anglosphere have also experienced unsustainable credit and housing market booms. Another is that differences in regulatory systems are smaller than is often supposed. The lesson of the crisis is not, as Nicolas Sarkozy and Jean-Claude Juncker seem to think, that Anglo-Saxons must move in a European direction. It is that all countries must converge on a new regulatory model.

It is not hard to see why the attention of European politicians should have zeroed in on regulatory flaws in the US – it is, after all, where the financial crisis broke out. There are unquestionably important lessons to be learned from the US experience – particularly in relation to the ‘shadow banking system’ and securitisation (the process of originating loans, then packaging them up as securities and selling them on to the market). But the financial crisis has done more than simply expose flaws in the US’s regulatory model. It has also called into question the very principles on which institutions the world over have been supervised.

The first flaw that the crisis has exposed is the ‘pro-cyclicality’ of financial regulation. Regulation did nothing to mitigate the expansion of leverage, credit and house prices. Capital adequacy rules did not become more constraining during the upswing, while accountancy rules exacerbated the downswing by forcing firms to sell assets at distressed prices. So the regulatory framework did not provide enough of a check on banks at the top of the credit cycle – but compounded their problems when the cycle turned. Lesson: the regulatory framework must be redesigned so that it mitigates, rather than exacerbates, the credit cycle.

A second problem brought to light by the crisis is that regulators were not paying enough attention to liquidity. For the past twenty years or so, international discussions between regulators have concentrated overwhelmingly on solvency – that is, how much capital financial institutions should hold to cushion themselves against losses on their banking and trading books. But many of the institutions that were brought low by the crisis (such as Northern Rock and Lehman Brothers) ran into trouble because their sources of funding dried up. In effect, regulators had spent the past twenty years preparing for a right hook, but ended up being floored by an upper cut. Liquidity will loom larger in regulation than it has done to date.

A final flaw that the crisis exposed is the belief that the stability of a financial system follows inexorably from the soundness of its individual constituents. What this belief ignored was that institutions were more interconnected (and hence vulnerable) than was previously realised; and that actions by individual institutions to maintain their own stability could, when copied by all their peers, push the system itself to collapse. In short, regulatory regimes paid too much attention to the supervision of individual institutions (micro-prudential regulation) and not enough to the system as a whole (macro-prudential regulation). Macro-prudential supervision will be one of the key innovations to emerge from the crisis.

A major overhaul of financial regulation is in prospect, both in the Anglosphere and Europe. It will not involve the supposedly unregulated Anglo-Saxon systems converging on existing European models, but Anglo-Saxon and European models converging on an entirely new model, with novel rules and institutional structures. Will the new system regulate future crises out of existence? Almost certainly not. Financial systems will always be prone to periodic crises because of the nature of their function – borrowing short and lending long – and because they rely on fickle human traits such as confidence and trust. But if the new system can limit the scale of future crises, it will have done its job.

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

Towards a better EU migration policy

2009-04-08T16:01:00.003Z

by Hugo Brady

Over the last decade, EU countries have experienced a rapid rise in both legal and illegal migration, mostly from Turkey, Morocco, Albania, Algeria and Serbia. Each spring and summer, Mediterranean member-states struggle to cope as migrants perish attempting to reach Europe from North Africa in unseaworthy and over-crowded boats. The deaths of 300 people, who drowned while trying to reach Italy from Libya, marked a particularly grim beginning to this year’s ‘smuggling season’.

Unsurprisingly, then, migration has supplanted terrorism and crime as the top priority for European interior ministers. Ministers think that collective EU action is essential if migration is to be managed better. That includes making European border management more effective and technologically advanced; integrating migration issues – visas, border controls, the resettlement of refugees and the return of illegal immigrants – into EU foreign policy; and helping Europe to fill the 50 million skilled vacancies that Europe’s retiring baby boomers will leave behind by 2060.

European policies to tackle these challenges are in their infancy, such as the Union's rather weak scheme to attract more skilled workers with an EU working visa or 'blue card'. One reason for this is that ministers have to work around major knowledge gaps about the specific foreign labour needs of the single market and about the movement of migrants into and around the EU, a free movement area. Governments have little idea where migrants go next after entering the UK from Pakistan, Spain from Ecuador or Poland from Brazil. For example, how many move to other EU countries; how many go back home; and how many are granted residency? Similarly, policy-makers are not yet certain about how good the EU’s border controls are. How many visas to the EU’s passport-free area result in illegal overstays or how many travellers are allowed in, refused at the border or returned home? Officials say they need to properly understand such movements before they can agree serious migration policies.

In many cases, such data is available but the patterns have not yet been analysed to draw concrete conclusions. The European Commission, which might be expected to have such information readily to hand, is over-burdened. Its directorate-general dealing with migration issues also has a plethora of other responsibilities, ranging from commercial law to terrorism. To overcome this lack of analytical capability, Commission officials often emphasise technological solutions such as biometric databases for visas and law enforcement. But these have tended to be subject to long development delays and will not, in any case, cut out the need to synthesise vast amounts of information.

One idea to help address such knowledge gaps would be to create national ‘immigration profiles’. The idea – already floated by the Commission – would be to maintain a precise and detailed picture of migration and border management in each member-state at any given moment. The Commission would also be able to ascertain the foreign labour needs of each member-state, by identifying skill shortages by sector and occupation, though member-states would still control the issuance of work visas. Similar profiles of non-EU countries could help identify the skills composition of different migrant communities and to provide analysis to EU policy-makers negotiating with migrants’ home governments on visa facilitation, border controls and the return of illegal immigrants. The member-states think that the EU speaking with one voice in such negotiations would be a significant improvement on national efforts.

The compilation of national immigration profiles is not a panacea for solving all of Europe's migration challenges. But if implemented effectively, the profiles could help to ensure that future migration policies are properly evidence-based and, therefore, more effective. However, if the Commission wants the job of providing such analysis, it will need to create a separate department for migration or to boost the resources of its current directorate-general for justice, liberty and security.

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

The G20 summit – a distraction?

2009-04-03T13:24:00.003Z

By Simon Tilford

The good news first. The summit delivered more than expected. The trebling of the funds available to the IMF goes well beyond anything expected and is very welcome. From a European perspective it increases the likelihood of further crises in central and Eastern Europe being handled through the IMF, rather than the EU having to get involved in the politically fraught business of setting conditionality. A renewed commitment to resist protectionism, together with an additional $250 billion for trade finance and $250 billion in special drawing rights are positive moves, as is the agreement to use the proceeds from IMF gold sales to help the poorest countries.

The agreements to extend financial regulation to all systemically important financial institutions and to establish a Financial Stability Board (FSB) to replace the existing Financial Stability Forum (FSF) also represent progress. The FSB will include FSF members along with G20 countries that are not FSF members, Spain and the European Commission. It will be in charge of identifying systemic risks and will collaborate with the IMF to provide an early warning system for future crises. The FSB will also implement FSF principles on bankers' pay and insure appropriate capital adequacy ratios. The deal represents a necessary democratisation of the international financial system.

Now the bad news. The agreement does little to address the immediate challenges facing the global economy – dealing with toxic debt and the contraction of aggregate demand. In this respect, the summit and the grandiose statements accompanying it were probably a distraction. There is little in the agreement that will help "restore confidence, growth and jobs" or "repair the financial system and restore lending", as claimed by the summit communiqué. Over time, the agreement might help to “strengthen financial regulation and rebuild trust” and could help to ‘prevent future crises’. But it is unlikely to help "overcome this crisis."

The absence of additional national measures to stimulate demand comes as no surprise, but it is no less disappointing. Perhaps the most important moment at the summit was when President Obama reminded the world that it can no longer expect the US to provide a disproportionate share of the growth in global demand. While condemning the US for its profligacy and talking about the advent of a fairer, more multilateral world, many countries seem to be relying on the US continuing to perform the role of 'consumer of last report'. This is either hypocritical or parochial or both.

Across much of Europe, the summit agreement is being portrayed as victory over the 'Anglo-Saxons'. This is rather puzzling. The agreement will not lessen the economic crisis facing Europe. Listening to French and German criticism of US proposals for a co-ordinated stimulus, anyone would be forgiven for thinking that the US would have had most to gain from such a package. In fact, the countries that stand to lose most from the collapse in global trade and the prospect of several years of exceptionally weak growth in global demand are the countries running big trade surpluses. The Japanese understand this and the need for stimulus; the German government does not. Europe as a whole will pay the price.

Similarly, the G20 agreement will do very little to address the problem of frozen credit markets. The Europeans are right to stress that strengthened regulatory oversight will be needed in order to put the financial sector on a more stable long-term footing. Indeed, everyone recognises this. But the more immediate problem is dealing with toxic debt. Agreeing to tighten regulation once the recession is over will not persuade financial institutions to lend now. The agreement to "provide significant and comprehensive support to our banking systems to provide liquidity, recapitalise financial institutions, and access address decisively the problem of impaired assets" means little. Too many European governments remain in denial over the extent of the problem, and will not take the necessary action to remove toxic debt from their banking systems.

The deal will not prevent the economic slump in Europe from deepening. This will lead to the further weakening of public finances that many European governments are anxious to prevent. Moreover, even the strengthening of multilateral control over the global financial system might have unintended consequences for some European countries. One systemic risk the FSB is almost certain to flag up is the persistence of huge, structural current account deficits, and the destabilising impact these have on the global financial system. A more regulated global financial system will involve more obligations for the big surplus countries, such as Germany.

Simon Tilford is chief economist at the Centre for European Reform

The Europeans at the London summit

2009-04-01T15:31:00.002Z

by Katinka Barysch

Christine Lagarde, the French finance minister, threatens to walk out of the London G20 summit unless France gets its way on tougher financial regulation. The toppled Czech Prime Minister, Mirek Topolanek, who happens to hold the EU presidency, describes the US fiscal stimulus as “the road to hell”. Not one EU leader deems it necessary to support Gordon Brown publicly when he tries to drum up support for a more concerted international effort to revive the global economy. The Dutch and the Spaniards are turning the G20 itself into a misnomer by insisting on their own place at the table, and raising the number of the already over-represented Europeans (The fact that there will be six European governments represented, plus the Czech presidency, plus the European Commission, not counting the European heads of the World Trade Organisation and the International Monetary Fund, attracts deserved ridicule from other countries).

So is the G20 just another opportunity for the Europeans to show how weak, divided and status-conscious they are?

In fact, the Europeans have not done as badly in the run-up to the summit as some media reports (and occasional outbursts by stressed prime ministers) suggest.

EU leaders managed to thrash out a reasonably coherent position at their spring summit on 20th -21st March. The meeting’s final communiqué has a special section on the agreed line for the London summit. The words in this section are vague but represent a workable compromise which could allow the Europeans to speak with one voice at the G20.

G20 finance ministers had already reached a kind of truce on the issue of more fiscal stimuli at their meeting on March 14th. Not surprisingly, EU leaders, at their spring summit a week later, also rejected calls for an immediate increase in budgetary spending. So why some commentators are still speculating whether the G20 may come up with a new, co-ordinated package is a bit of a mystery. There needs to be a firm pledge from all G20 countries to assess critically the fiscal efforts they have made so far, and then to revisit the issue of a co-ordinated stimulus at their next summit, probably later this year.

At the March 20th–21st summit, EU leaders called only for swift implementation of those packages already announced. This, and the fact that the communiqué also calls on the EU countries to prepare for “an orderly reversal of macro-economic stimuli” and to “ensure consistency with longer term objectives such as sustainable public finances” represents a victory for Berlin and other capitals worried about inflationary pressures and the stability of the euro.

The Europeans supported global efforts to make more money available for the poorer and more vulnerable countries around the world. They started at home, by doubling the size of the EU’s own emergency fund for Central and Eastern Europe to €50 billion. The Europeans also agreed to raise an additional €75 billion as their contribution to a significant increase in the IMF’s war chest, to at least $500 billion. Since Japan had already pledged $100 billion, the onus is now on the US and China to chip in.

China, of course, will be cautious about committing money to an unreformed IMF. Here the EU’s position is lame. The communiqué only calls for a “reform of the IMF so that it reflects more adequately relative economic weights in the world economy”. The Europeans should have made it clearer that they are prepared to decrease their own voting shares and representation on the IMF’s management board. But diplomats say that the strongest opposition to thorough IMF reforms currently comes from the US – reluctant to give up its de facto ability to veto IMF decisions – rather than Europe.

On financial market regulation, the EU’s position is quite far advanced, much more so than the American one. The EU summit communiqué list all the measures that the EU wants to take – on regulating credit agencies, hedge funds, credit default swaps and so forth – and attaches deadlines to each. There has been a great deal of convergence within Europe, chiefly between Germany, France and others that want to see tighter rules and supervision of financial markets, and the UK, which has abandoned its belief in ‘light touch’ regulation. There are a lot of similarities between the recommendations of the recent reports from Jacques de Larosiere, which the EU wants to use as a basis for its legislative programme, and Adair Turner, head of the UK’s Financial Services Authority. Both, for example, call for more co-ordination between the supervision of individual banks and the monitoring of the stability of the financial system as a whole. The emerging US position as presented by US Treasury Secretary Timothy Geithner on March 26th also calls for more centralised supervision of US financial services, as well as a reform of capital adequacy and accountancy rules (in line with EU demands). Geithner for the first time acknowledged that hedge funds and other hitherto lightly regulated but systemically important finance vehicles need at least some supervision.

Of course the devil is in the detail and the London summit cannot and will not agree on more than the broad principles of further regulation and supervision. The debate about a new supervisory system in the US is only just beginning. It will be long and politicised. The EU’s deadlines for new legislation run from May until the end of 2009. Since the European Parliament will be re-elected in June and the European Commission will step down in October (although it could be extended to the end of the year), comprehensive new rules are unlikely before 2010.

The EU has looked weak and divided in the run-up to the G20 summit. Its reluctance to make more commitments to increase fiscal stimuli is rightly open to criticism. But the Europeans have actually managed to agree a reasonably coherent position and in many respects, their positions are as, or more, polished than the US ones.

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