Ukraine: Edging towards the EU?

Ukraine, to its sorrow, has always been on the frontier between Russia and the rest of Europe. Its name even means “Borderlands”. For centuries it was partitioned between its neighbours. When it gained its independence from the collapsing Soviet Union it was politically and linguistically divided between the Ukrainian-speaking West and the Russian-speaking East. Many observers in the early 1990s expected it to fall apart sooner or later. The first line of its national anthem seemed grimly appropriate: "Ukraine has not yet died".

Twenty years on, its independence and national identity seem more solid, even if many Russian politicians, from President Vladimir Putin to his arch-opponent Aleksey Navalniy, still talk of Russians and Ukrainians as “one people”. But Ukraine, and the European Union, now face a moment of decision: will Ukraine be the Russosphere's border with the EU, or the Eurosphere's border with Russia?

Ukraine seemed for a long time to be dodging this choice: President Viktor Yanukovych tacked between Brussels and Moscow after his inauguration in 2010. Now, however, with the Vilnius Eastern Partnership Summit a month away, Ukraine seems to be turning decisively towards the EU – ironically, partly because of Moscow’s pressure on it (described in Charles Grant’s recent CER Insight 'Is Putin going soft?') to join the Russian-led Customs Union instead of signing an Association Agreement with the EU. Both government and opposition in Ukraine support closer integration with the EU, and opinion polls show that even in Russian-speaking eastern Ukraine there is a majority in favour of EU membership (though this is not on offer at this stage).

The deal is not yet done: the EU set a series of conditions for Ukraine to meet before the agreement could be signed. It has made some progress, for example on electoral reform, following EU criticism of the conduct of parliamentary elections in October 2012. The biggest obstacle remains, however: ending ‘selective justice’, and in particular pardoning former Prime Minister Yulia Tymoshenko, currently serving a seven-year sentence for abuse of office. Former Polish President Aleksander Kwasniewski and former European Parliament President Pat Cox have been working persistently on behalf of the European Parliament (where Tymoshenko has many supporters) to achieve this.

Up to now, this has remained too much for President Yanukovych to swallow. The Ukrainian government has a draft law prepared which would release her on humanitarian grounds and allow her to travel abroad for medical treatment; but it would not void her conviction. Yanukovych evidently still considers her a political threat, and hopes that his compromise offer will be enough for the EU. 

So far the EU has not blinked: Enlargement Commissioner Stefan Füle, Swedish Foreign Minister Carl Bildt and EP Foreign Affairs Committee Chair Elmar Brok all delivered the EU message to Yanukovych at the Yalta European Strategy meeting in September. The EP has extended the mandate of Kwasniewski and Cox for a few more weeks in the hope that they can still clear the way for Ukraine to sign the Association Agreement, which includes a Deep and Comprehensive Free Trade Agreement (DCFTA), in Vilnius. As an incentive, both the Parliament and the Council have supported provisional application of the trade aspects of the agreement as soon as possible after signature, prior to ratification.

Assuming that a solution is found, both Ukraine and the EU will face challenges in implementing the agreement and benefitting from it. For Ukraine, the immediate threat is that Russia will punish it for rejecting the Customs Union. Russia has repeatedly used gas deliveries to Ukraine and other neighbours as instruments of political pressure. When Deputy Prime Minister Dmitriy Rogozin recently warned the Moldovans against initialing their own Association Agreement with the EU, telling them that he hoped they would not freeze, Ukraine will have got the message.

Overall, Ukraine's trade is quite well balanced between Russia and the EU: in 2011, the last year for which WTO figures are available, 29 per cent of its exports went to Russia and 26 per cent to the EU; 35 per cent of its imports came from Russia and 31 per cent from the EU. But Ukraine is vulnerable to a Russian squeeze on its energy imports. Despite some domestic production, Ukraine relies on Russia for about 60 per cent of its gas; imports from other sources have historically been negligible. This year it has cut imports from Russia by about 30 per cent, and increased imports from Western and Central Europe (saving money in the process). Ukraine hopes to exploit its shale gas reserves (though international oil and gas majors have been slow to invest, deterred by the poor business climate). But in the short term, Russia can make life uncomfortable economically. It can also step up political pressure: Putin’s adviser Sergei Glazyev warned in September that Russia could no longer guarantee “Ukraine’s status as a state” if it signed the Association Agreement.

Russia's claim that it would need to take "defensive measures" against Ukrainian imports if Ukraine signed the Association Agreement is questionable. Suggestions either that EU goods will replace domestic production on the Ukrainian market, forcing Ukrainian goods onto Russia, or that EU agricultural products of dubious quality will reach Russia via Ukraine, seem fanciful. There is no reason why Russia could not continue to trade normally with neighbours who sign EU Association Agreements, rather than trying to force them inside the high and economically distorting tariff wall of the Customs Union. But Russia has so far paid more attention to geopolitics than economics in building its Customs Union. Ukrainian heavy industry might struggle to replace its markets in the former Soviet Union if Russia closed the door, but Russian customers would also suffer from the loss of familiar suppliers.

Whatever Russia does, Ukraine will have to accelerate its own reforms in order to benefit from the DCFTA. Research by the European Bank for Reconstruction and Development (EBRD) shows that among Eastern European states, Ukraine has made the least progress since 1989 in converging with the EU-15 in terms of GDP per capita. In the 33 countries in which the EBRD operates, real GDP has grown since 1989 by about 40 per cent; in Ukraine it is still almost 40 per cent below its 1989 level. The main reasons for this are weak institutions and rule of law; poor governance and high levels of corruption (in Transparency International's 2012 Corruption Perceptions Index, Ukraine was 144th - worse than Russia, Azerbaijan or Kazakhstan, among others); and a lack of modernisation in key sectors (for example steel and agricultural production). With or without an Association Agreement, Ukraine will have to tackle these problems if it wants to close the prosperity gap with the rest of Europe.

In addition, the Association Agreement will require Ukraine to incorporate several hundred EU directives into its domestic legislation, in areas from agriculture to transport. There are transitional periods of up to eight years for Kyiv to come fully into line with EU standards and regulations, but even so the capacity of Ukraine's public administration is likely to be stretched to its limit.

In the long run, meeting European standards will enable Ukraine to compete more effectively not only in EU markets but (perhaps even more importantly) in third countries. With some of the most fertile soil in Europe, for example, it should be well-placed to increase agricultural exports.

In the short term, however, there may be more pain than gain, even if the Russians refrain from imposing trade sanctions on Ukraine. Other countries in central Europe and the western Balkans going through a similar process of adjustment have had the incentive of eventual EU membership. This has spurred them to accept increased competition from the EU, and to invest political and economic resources in coming up to EU standards. But against a background of general enlargement fatigue and specific concern about Ukraine's size, poverty and institutional backwardness, and about the likely Russian response, support for offering Ukraine a membership perspective has been limited to a few central European countries. It may be objectively true, as the EU has often argued, that all the reforms sought by the EU are also in Ukraine's own long-term interest. But the political reality is that the downsides will be apparent sooner than the advantages. 

How much does it matter to the EU whether Ukraine leans west or east, or stays uncomfortably balanced between the two? It is the largest country with its territory wholly in Europe. But it lacks the hydrocarbons that have lured foreign investors to Azerbaijan, and the leaders of the Orange Revolution squandered the chance to join Georgia as darlings of the West with their dysfunctional, bickering rule. If Russia cares enough to want Ukraine in its camp, why not let it have it?

The EU could look at Ukraine in grand, geopolitical terms. The American statesman Zbigniew Brzezinski wrote in the early 1990s that "Russia can be either an empire or a democracy, but it cannot be both. ...Without Ukraine, Russia ceases to be an empire". But it would be a mistake for the EU to see Ukraine only through the prism of Russia.

Looked at in its own right, a prosperous Ukraine with functioning institutions and a modern economy would be a more attractive neighbour and partner than anything likely to emerge if it is left to its own devices, either joining the Customs Union or remaining in a no-man's land. 

Europe should therefore increase both its pressure on the Ukrainian government to reform and its practical support for the changes it seeks. Whatever their reservations about Yanukovych as an individual, European leaders should step up their engagement with him and his government. They should encourage Ukraine to make even more use of twinning arrangements and other forms of technical assistance offered by the European Commission to enable Ukraine to implement the necessary EU directives. They should maintain the Kwasniewski/Cox mission, which has proved its value over the last year as a means of strengthening the rule of law in Ukraine. Above all, they should offer Ukraine a membership perspective – certainly not in the short term, and with a list of reforms attached, but reflecting the fact that, for all its shortcomings in media freedom and rule of law, Ukraine has managed to remain a more or less democratic state for two decades. 

As they head for Vilnius, European leaders should remember that Tymoshenko and Yanukovych are not the only people in Ukraine who matter. And as he ponders how to respond to Kwasniewski and Cox, Yanukovych should remember it too. Forty-five million Ukrainians also have a stake in getting closer to the EU.

 Ian Bond is director of foreign policy at the Centre for European Reform.

Is Putin going soft?

'The Valdai Club' is an annual public relations exercise for the Russian leadership. A group of international think-tankers, academics and journalists gathers in a Russian region and then meets President Vladimir Putin and his senior ministers. This forum has not been particularly successful PR: in recent years much of the world’s press has written critically about the Kremlin. Last month, however, when the club gathered for the tenth time, by the shores of Lake Valdai in Northern Russia, some of the discussions were positive for Russia’s image.

Putin had a clear message for the outside world: Russia’s political system is starting to open up, at least at the local level. He also spoke gently about the US. Only on the fraught question of Russia’s relations with neighbouring Ukraine and Moldova did Putin appear – to a western audience – somewhat harsh.

What accounts for Putin’s softer approach to domestic politics and to Washington? Russia’s mounting economic problems, the opposition’s surprisingly strong showing in September’s local elections and the emerging US-Russian consensus over Syria’s chemical weapons are probably relevant.

In the final session of the Valdai Club, broadcast live on Russian TV, a relaxed and confident Putin sat on a panel with three European grandees: François Fillon (former French prime minister), Romano Prodi (former Italian prime minister) and Volker Rühe (former German defence minister). They urged him to listen to young Russian protestors and to take seriously ‘the responsibility to protect’ Syrians. In the audience were opposition leaders who questioned Putin on electoral fraud and the imprisonment of activists. He answered calmly that Russia was “on the way to democracy” and reminded everyone that the recent elections in Moscow, where Alexei Navalny scored 27 per cent, and in Yekaterinburg, where Yevgeny Roizman (another opposition politician) became mayor, had been free and fair.

Given Putin’s track record, one should treat his words with scepticism. But an earlier session with one of his chief advisers had surprised participants. “The trend for fair elections will be more pronounced; there will be more political competition in future”, said the adviser. “Yekaterinburg and Moscow were successes that should be repeated elsewhere.” The adviser urged opposition parties to focus on municipalities, hinting that it was too soon for them to win regional governorships or national elections. I asked opposition politicians what they made of all this. Vladimir Ryzhkov (a liberal) and Ilya Ponamarev (a leftist) told me that the Kremlin really had taken a new approach – though it could still use the courts to clobber anyone considered a threat.

One reason for this modest political opening may be the economic slowdown, which is likely to fuel unrest. Perhaps Putin and his advisers want to create channels for peaceful protest that they can control. Having grown at about 4 per cent a year in the previous three years, the Russian economy may not achieve 2 per cent growth in 2013, despite a favourable oil price. Foreigners and Russians are investing less. The brain drain and capital flight continue. The technocrats running the economy know that politics is holding it back. One former minister told the Valdai Club that “the keys to improving the economy are independent courts and the protection of property.” Investment would suffer so long as the courts remained subject to the whim of the executive, he said.

Putin and his ministers were uncharacteristically polite about Obama, welcoming co-operation with him over Syria’s chemical weapons. Yet very recently their relations with Washington had been toxic, with rows over the Syrian civil war, Russia’s granting of asylum to Edward Snowden and US plans for missile defence. Obama cancelled a summit that had been due in September.

The reasons for the Kremlin’s shift of tone towards the US are unclear. The Russians worry a lot about their citizens fighting in Syria and Afghanistan, and then returning to infect Russia’s Muslim regions with Islamic extremism. They want the Americans to help to manage the situation in both war-zones. Perhaps the Russians think they can be magnanimous to those who misread the Middle East: they always said that the Western response to the Arab spring was naïve, that Arab countries were incapable of democracy and that it would all end in tears. They feel vindicated by events in Egypt, Libya and Syria.

Notwithstanding the politeness, Putin’s entourage can still be hostile, if not paranoid towards the US. I asked one minister if NATO remained a threat to Russia’s security. “Of course, why else does it try to creep as close as possible to our borders?” he answered. “It has punished regimes it dislikes – Yugoslavia, Iraq and Libya – without any regard to the UN Security Council.” He accused NATO of deceiving Russia by enlarging after promising it would not (which is partly true) and said that Russia could not be a friend of NATO unless it renounced further enlargement.

Most Russians share this suspicion of NATO. And they believe that NATO wants to absorb Ukraine – though in fact that idea that has virtually no support in Kiev or the major western capitals. It is true that the EU hopes Ukraine will sign both a ‘deep and comprehensive free trade agreement’ and an ‘association agreement’ in Vilnius in November, as part of its ‘Eastern Partnership’. The EU also hopes that Moldova, Georgia and Armenia will sign similar deals. Putin wants to stop these countries signing as they could then not join the Customs Union established by Russia, Belarus and Kazakhstan. Putin is keen for the Customs Union to expand into much of the former Soviet Union and to evolve into a more powerful ‘Eurasian Union’.

Russia is using bully-boy tactics to prise countries away from the Eastern Partnership. In August it blocked imports from Ukraine for several days, saying this was a ‘dress rehearsal’ for the measures it would have to take if Kiev went with the EU. And it told the Moldovans that they would have their gas cut off, their exports blocked and their migrant workers expelled from Russia (Moldovan exports of wine to Russia were stopped in September, but the EU, to its credit, said that it would import an equivalent number of bottles). What the Russians told Armenia is unclear, but in September it decided to join the Customs Union rather than the Eastern Partnership. Countries in the EU have also been targeted by Russia: earlier this month, Lithuania – presumably because it is hosting the Vilnius summit – found its dairy products excluded from the Russian market for a week.

The Russians have genuine concerns about the Eastern Partnership, since it will affect their trade with their neighbours. Putin told the Valdai Club that EU goods would flood into the countries of the Eastern Partnership; Ukraine and Moldova would therefore have to dump the goods that they produced on the Russian market; and then Moscow would be forced to take protective action. The Russians may have a point that the EU should have made more effort to talk to them about the impact of the Eastern Partnership. Nevertheless Ukrainian and Moldovan participants in the Valdai Club reported that Russian bullying is damaging the appeal of the Customs Union in their countries. Armenia is a special case: it dare not cross Moscow, since only Russian troops prevent Azerbaijan from invading the territory of Nagorno-Karabakh, currently occupied by Armenian forces.

Besides Armenia, Russia cannot count any neighbour as a true friend. It has been slow to understand that ‘soft power’ – the appeal of a country’s social, economic and political system, and of its behaviour – may achieve as much as machismo. Russia’s leaders appear to see the value of treating the opposition, and possibly the Americans, with a little more courtesy. They should try the same with their neighbours.

Charles Grant is director of the CER. A different and shorter version of this article appeared in the print edition of the New Statesman of October 11th to 17th.

Eurozone recovery: The world is not enough

The end of the eurozone’s long recession has been met with relief by its policy-makers, with some jumping on the news to justify their management of the eurozone crisis. They argue that the eurozone economy is on the mend, and the recovery will gain momentum over the coming quarter. If they are right, then the outlook for the euro has indeed improved: faster growth will make it easier for countries to service their debt, bring down unemployment and help contain political populism. Unfortunately, their optimism is almost certainly misplaced. The basic problem is that the world cannot accommodate a Europe refashioned in Germany’s image.

Economists should always be wary of extrapolating from a period of exceptionally bad economic performance. Economies do recover, as the sudden jump in the UK’s growth rate over the course of 2013 shows. But there are reasons to doubt that the eurozone’s return to growth in the second quarter of 2013 (ending six consecutive quarters of contraction) is the start of an economic rebound strong enough to get on top of debt ratios and bring down unemployment.

First, so far the recovery is not worthy of the name. The eurozone expanded by just 0.3 per cent, and will have grown at best by a similar amount in the third quarter. At that pace it will take two and a half years for the eurozone to regain its pre-crisis size.

Second, the return to growth hardly vindicates the eurozone’s austerity strategy; growth in the second quarter was boosted by an easing of fiscal austerity. Investment did pick up marginally, bringing to a close eight consecutive quarterly declines. However, investment was still down almost 4 per cent compared with the previous year. Private consumption, meanwhile, was lower in the second quarter of 2013 than the first. The biggest contribution to growth came from net exports (growth of exports outpaced that of imports).

This is not the basis of a sustainable recovery. It is highly unlikely that fiscal policy will continue to make a positive contribution to growth beyond the third quarter of 2013. Many eurozone economies are falling behind on their deficit reduction targets, and will therefore come under pressure to tighten policy. Germany has indicated that it has no intention of imparting any fiscal stimulus, despite running a budget surplus and the German economy barely expanding (the Deutsches Institute für Wirtschaftsforschung, for example, expects growth of just 0.2 per cent in the third quarter). Fiscal policy may not act as a major drag on economic activity across the eurozone over the next few years but neither will it be a source of economic growth.

Net exports have kept the eurozone economy afloat. Between the trough of the crisis in the second quarter of 2009 and the second quarter of 2013, the eurozone economy expanded by 3 per cent. Over this period domestic demand fell by 0.7 per cent. Put another way, all the growth the eurozone enjoyed was dependent on demand generated outside of the currency union; without it the eurozone would have continued to shrink.

The result has been a big swing in the eurozone’s current account position. In 2008 the eurozone had a deficit of around €85 billion (less than 1 per cent of GDP); it is on course to have a surplus of close to 2.5 per cent of GDP in 2013. Eurozone policy-makers cite this shift as evidence of improved competitiveness. The truth is simpler: falling eurozone domestic demand hit demand for imports, whereas rising demand around the world boosted demand for eurozone exports.

It is a moot point whether the external surplus can continue rising. Leaving aside the fact that the eurozone is flouting its G20 commitments to prevent the growth of large trade imbalances, it is probably already hitting the limits of the possible. The eurozone is simply too big an economy for the rest the world to keep it afloat. A surplus of 2.5 per cent of eurozone GDP already comprises a big drag on the global economy, which the eurozone in turn is increasingly dependent upon.

Much of the growth in eurozone exports over the last ten years has come from emerging markets. For example, between 2002 and 2012 eurozone exports to China rose fourfold. But that growth has now slowed rapidly – over the first six months of 2013 exports to China were less than 1 per cent higher than a year earlier. It is a similar story with exports to Latin America and Central and Eastern Europe. The share of the eurozone’s total exports accounted for by the US and UK has fallen to less than a quarter, so modest economic recoveries in those two countries will not boost eurozone exports that much.

Nor will it be easy for eurozone economies to boost net exports by increasing their shares of global markets (or even maintain their shares of growing global trade volumes). Germany managed this from 2002 onwards, building up a huge external surplus in the process. But Germany had an undervalued real exchange rate – both relative to other members of the eurozone and relative to the rest of the world (because of the weakness of the euro). The euro remained weak because Germany’s surplus was offset by the deficits of the other member-states. That is now changing as all eurozone economies have current account surpluses or are close to having them. An economy with a big trade surplus tends to experience currency appreciation, because demand for its currency outstrips the supply of it. Eurozone policy-makers bemoan the strength of the euro, but it is a product of their strategy. A strong euro will hit demand for eurozone exports, especially the more price sensitive ones of the southern European member-states.

Rising exports are not going to trigger a substantial recovery in investment demand and hence employment and consumption. True, some rebound in investment is inevitable. Economic recoveries tend to be driven by investment because it falls by more than any other component of GDP in a recession. The eurozone is no exception: investment is down around 20 per cent relative to the pre-crisis period. Machinery and equipment will wear out and need to be replaced. Some firms will get round to making the investment which they had put on ice. But there is little chance of spending returning to pre-crisis levels in the foreseeable future for a number of reasons.

First, a big recovery in investment across the eurozone requires debt relief for the struggling member-states. Relief will happen but it will inevitably be drawn out. The strategy towards Greece gives a good indication of how the issue is likely to be managed. Policy-makers will eschew the big write-offs that could kick-start a recovery in confidence, preferring instead to lengthen pay-back periods. One reason for this is that much of the debt is now held by public institutions; it is much harder to write-off debt when it is tax-payers rather than private investors who face losses.

Second, the weakness of bank balance sheets means that credit is expensive and scarce; eurozone bank loans were down almost 4 per cent in August compared to a year earlier, and by much more in the hardest-hit economies. Banks will remain undercapitalised and confidence in them weak due to the likely failure to put in place a sufficient pan-eurozone fiscal backstop.

Moreover, even if the eurozone were to move aggressively to reduce the debts of the struggling member-states and to recapitalise their banks, investment is unlikely to rebound to pre-crisis levels, because some of the investment in the south and elsewhere was unsustainable. For investment to return to pre-crisis levels over the eurozone as a whole, it must rise in Germany. But there is no indication of this happening. In the second quarter of 2013, German investment was still 5 per cent lower than five years ago, and lower as a proportion of GDP than 10 years ago.

A rebound in private consumption requires a mixture of lower unemployment, rising real wages and a fall in the proportion of household income saved. In light of the weakness of investment, it is hardly surprising that unemployment remains high across the eurozone as a whole. Against a backdrop of exceptionally weak domestic demand, the bargaining power of labour is feeble and real incomes are under pressure; small gains in Germany are being more than offset by falls elsewhere in the currency union. Wage restraint could price people back into work, as it did in Germany. But if Germany is anything to go by, that will have little impact on consumption or investment. Private consumption fell from 59 per cent of German GDP in 2002 to 56 per cent in 2012. It is now growing but not by enough to raise its proportion of GDP. With the language of austerity still dominating politics, and public services being cut in most eurozone economies, it is hardly surprising that households are reluctant to spend money.

Implicitly or explicitly, Germany is the benchmark for the eurozone. Its experience should worry advocates of the current strategy. German policy-makers like to argue that domestic demand is now contributing as much to economic growth as net exports. But net exports are still positive, which means the country is becoming more, not less, dependent on foreign demand. And although domestic demand is expanding, it is doing so at an anaemic pace. Unlike Germany, the eurozone will not be able to rely on an undervalued currency and net exports to boost economic growth.

The eurozone needs policies suited to a large continental economy which cannot rely on exports for economic growth. First, countries with large trade surpluses should not be allowed to tighten fiscal policy; instead they should be trying to boost demand and rebalance their economies. The European Commission should be as concerned about excessively low wage growth and large structural trade surpluses as it is about excessive rapid wage growth and trade deficits. Second, the institutional fault lines cannot be fudged indefinitely. The eurozone does not need to become the United States of Europe, with a large federal budget and fiscal transfers of the kind present within existing member-states of the EU. This would be politically impossible and of uncertain economic merit. But it does need a functioning banking system. And member-states’ debt burdens have to be reduced to a level which are consistent with a return to sustained economic growth. The end of the eurozone’s recession may do more harm than good if it emboldens policy-makers to persevere with the current strategy.

Simon Tilford is deputy director of the Centre for European Reform.

What would a Brexit mean for EU competition policy?

The debate over Britain’s future in the EU has to date failed to highlight the threat posed to EU competition policy and enforcement, which both play a critical role in underpinning the single market. Yet a British exit from the EU could have important repercussions for competition policy.

Several dangers present themselves. The first is the risk that the ground-rules for EU competition policy could be weakened in any future treaty renegotiation without the British at the table. Secondly, even absent such an explicit renegotiation, removing Britain’s input into policy and enforcement might encourage some drift in the way existing rules are applied. Thirdly, and regardless of the possibility of renegotiation or drift, there would be heavy additional costs for both government and for business. Lastly, a British exit could harm the global dialogue between competition authorities.

The threat of a tectonic shift in competition policy if the UK left the EU cannot be ruled out. It was, after all, the UK that led the counter-attack against President Sarkozy’s attempts to demote the principle of “undistorted competition” during the 2007 negotiations that led to the Lisbon treaty. Some crafty drafting in a new protocol, added to the Treaty at Britain’s behest, somehow did enough to allow the European Commission to maintain that nothing had changed. But the Sarkozy tendency, present even before today’s economic crisis, is far from a spent force: the forces of protectionism are alive and well, in France and elsewhere. A future treaty renegotiation could witness renewed calls to promote European champions, protect strategic national industries and slacken state aid disciplines.

Even without a change in the ground rules, a British exit from the EU might still weaken EU competition policy. National competition authorities together form the European Competition Network (ECN). The ECN co-ordinates policy with the European Commission, and national authorities are consulted on individual decisions via an advisory committee. The UK is an active voice in all these fora. Over time, Britain’s absence from them would probably lead to policy drift, as other voices became more prominent in the debate. British companies active across Europe would remain subject to EU competition rules, regardless of Brexit. But the UK would have voted itself off the committee that sets and applies the rules.

A British exit from the EU would also impose instant additional costs. Since Britain would no longer be part of the one-stop shop for reviewing mergers, these would need to be separately reviewed by the UK’s future Competition and Markets Authority (CMA). This would place extra costs on businesses, as well as an increased burden on the CMA, which would need more staff (and a budget to match). The same would apply to action against cartels and cases involving abuses of dominant market positions: complainants and defendants would have to meet in an additional and unnecessary forum. Of course, the UK could, like Norway, allow the Commission in Brussels to adjudicate on its cases. But with no British officials left in the Commission, and with policy possibly veering away from the UK’s attachment to free competition, this seems unlikely.

Finally, a British exit from the EU could harm the dialogue between competition authorities. Competition laws have proliferated around the globe. When the UK joined the EEC in 1973, there were only a handful of active jurisdictions, with the US far out in the lead, both in policy thinking and in enforcement. Today’s club of anti-trust authorities, the International Competition Network (ICN), counts members from 111 countries. Chinese policy is now a major pre-occupation, with India’s new law also starting to be felt. The spreading burden of compliance should bring its own reward, with markets becoming more open and competitive around the globe. But aligning these systems is also becoming a real challenge. The EU has been a key mover in the ICN, and has long since been recognised as a twin motor of global anti-trust action and advocacy alongside the US. Indeed, in recent years the EU has been much the more vigorous enforcer of the two. But a British exit from the EU would weaken the EU’s standing in the international anti-trust dialogue, and exclude the UK from the collective clout that goes with being part of the EU. It would also deprive the US of an interlocutor within the EU camp that shares its common law heritage. Worse, if the EU falls prey to protectionism, there could be more fundamental damage to the dynamic of anti-trust enforcement around the globe.

Competition policy in Europe has always been about more than just free competition: it also serves the goal of breaking down barriers between countries. Single market legislation removes legislative barriers, and competition policy ensures that firms do not erect private barriers in their place. Believers in the single market should pause to reflect whether the UK is better on the inside of EU competition policy, or on the outside looking in.

Alec Burnside is Managing Partner in the Brussels office of Cadwalader, Wickersham & Taft LLP.

Division and indecision over Syria

The deal on chemical weapons reached by Russia and the United States marks the latest chapter in the West’s effort to stay out of Syria’s civil war. After Russia’s diplomatic initiative, a military strike has been avoided. The White House says that diplomacy backed by a credible military threat has succeeded, and European leaders claim that their appeal for a UN process was heard. Obama’s wish to avoid military solutions may have created new momentum for negotiations with Iran. But this moment of jubilation could be short-lived: a daunting task at the UN awaits; military action may still be needed; and transatlantic cohesion has been damaged.

For more than two years, US and European governments have successfully navigated developments that could otherwise have formed a casus belli and led to Western entanglement in Syria. In the summer of 2012, the Syrian military shot down a Turkish air force jet, and was accused by Ankara of lobbing mortars over the Turkish-Syrian border and staging car bombings in southern Turkish towns. The attack on a NATO member-state could have triggered military action against Syria, but instead the alliance showed restraint and sent German, Dutch and US air defence batteries to southern Turkey.

In November 2012, France and the UK – followed a month later by the US  –  stated that President Assad no longer represented the Syrian people, but no action was taken to force a change of regime. The US and Europe have also long resisted arming the rebel groups. When it became clear in early 2013 that Assad was winning, the European Union – under French and British leadership – and the United States lifted the arms embargo. But the subsequent flow of arms to rebels has been limited, reflecting concerns that the weapons might end up with Al Qaeda affiliates. The US, UK and France have been providing jeeps and communications technology, and possibly small arms, but most heavier material, mortars and anti-tank weapons, are sent by Qatar and Saudi Arabia.

The aftermath of the chemical weapons attack on August 21st is the closest the US and its allies have come to military intervention in Syria. If it were not for the use of poison gas, the US and others would have remained on the side-lines, but moral imperatives and presidential credibility required action, however reluctant. European division and US foot-dragging followed.

What makes the current crisis so uncomfortable and damaging for the West is that it is largely self-inflicted; Obama’s red lines on the use of chemical weapons, when crossed, forced his hand. European divisions have made matters worse, particularly when Britain’s prime minister David Cameron – initially in favour of a strike – deferred to the House of Commons and lost, while the French president remained committed to military action. Without a united Franco-British front, Germany, the Netherlands and others continued to prevaricate and say they had not been asked to support a military strike, or – like Poland – did not have relevant military capabilities. Other European states, including Italy, Spain and Belgium, believed the UN should act. Only Denmark backed the French.

Meanwhile, more than two weeks of intense diplomacy passed before the EU’s High Representative Catherine Ashton was able to forge a common European position. A carefully-worded statement agreed on September 7th said that “a clear and strong response is crucial” to the poison gas attack, but it fell short of calling for military action. Instead it urged the Security Council to push for a political solution.

A divided West was inching towards a military intervention for which there was little political appetite and even less public support. President Putin’s initiative to get rid of Syria’s chemical weapons could be the ‘deus ex machina’ to avoid an unwanted military campaign.

While it is impossible to know for sure, Putin’s diplomacy may be informed by the fear that any US military involvement could decisively turn the tables on Assad. A shift in the military balance would cause Moscow to lose an ally in the region and perhaps its Mediterranean naval base, but Putin’s support for Assad is fuelled by the concern that Al Qaeda-linked groups might take over in Syria and could eventually spread to Russia.

In spite of comments by President Obama that a strike would be limited – or in Secretary Kerry’s words “unbelievably small” – any military action has unpredictable consequences. A strike was meant to ‘deter and degrade’ Assad’s capability to use chemical weapons. The US was aiming for a ‘Goldilocks’ intervention; too soft, and it would only be a symbolic punishment; too hard, and it might topple Assad, strengthening jihadist rebel groups. But reality is never so straightforward, and the adversary always has a vote in a conflict. Assad could make life difficult for any US-led coalition, for instance by using chemical weapons again; placing human shields around potential targets; or using Syrian-sponsored Hezbollah to strike Western assets or Israel. US credibility would then demand further escalation. By regaining diplomatic momentum, Putin was able to protect his interests, and his client in Damascus. Whatever the outcome, Moscow will have bought time for Assad, and Russia will step up its arms shipments to Syria, hoping to tilt the military balance in favour of Assad. The US, UK and France should consider balancing this by increasing their efforts to arm moderate rebels.

The agreement between Russia and the US will have to be enshrined in a UN Security Council resolution. France, the US and UK prefer a resolution under chapter 7 of the UN charter, which could allow the use of force in the event of non-compliance. But Russia has said an explicit reference to military action is unacceptable.

If the Russians stand firm, Obama will face a choice between a resolution without ‘teeth’, or circumventing the gridlocked Security Council. In the first case, the Russians and the Syrian regime will claim that UN-backed military enforcement is off the table; and Obama will be criticised by US hawks in Congress for weakness. But the outcome could be more ambiguous. During the Iraq crisis ten years ago, the UN Security Council adopted resolution 1441, pushing Iraq to fulfil its disarmament obligations. It was adopted under chapter 7, but did not explicitly mention the use of force. The Security Council could pass a similar resolution now.

Washington and Moscow have an interest in agreeing a resolution because the alternatives are less palatable. But given the distance between the Russian and US positions, a face-saving compromise would leave the enforcement mechanism deliberately vague. In 2003, as Saddam Hussein continued to defy the UN weapons inspectors, this clause – and its lack of specificity – became the focus of a dispute in the Security Council. Unfortunately, a similar resolution on Syria will sow the seeds for future US-Russian disagreement. The technical obstacles associated with a verification mechanism in a war zone are plentiful, and if Syria breached the resolution, a fractured West could still end up being drawn into the conflict.

Nevertheless, if a resolution is adopted and the Syrians carry out their side of the bargain, this may do more than just prevent Syria’s future use of chemical weapons. Iran’s new moderate president, Hassan Rouhani – strengthened by a policy of US restraint in Syria – has signalled a willingness to talk to Obama. This positive momentum offers the best hope for some time to move diplomacy on Iran’s nuclear programme forward, and should be embraced by the US and Europe.

Progress on chemical weapons could also create some momentum for a general ceasefire and the start of a peace process. The EU ought to be able to unite around this goal, at least. It should now start working with Russia, the US, Iran as well as the groups in Syria to get the Geneva 2 negotiations underway in the hope of moving towards a political solution.

A stalemate at the UN would be damaging; Putin could say he produced an olive branch that the US was unwilling to accept, and paint Obama as a warmonger; while members of Obama’s own party and isolationist Republicans will accuse him of risking US entanglement in another war. The EU would find itself in an uncomfortable position. Fundamental to the EU’s foreign policy is support for international norms, of which the prohibition on chemical weapons is one (the 2003 EU security strategy describes the proliferation of weapons of mass destruction as “potentially the greatest threat to our security”) and support for the United Nations is another. These conflicting norms would ensure that Europe remained divided.

The worst option for US credibility is if a resolution is not agreed and the United States shies away from military action. Credibility is an important currency in international relations. It would be seen as a victory in Damascus, Tehran and Moscow, it would sap the morale of Syria’s rebels and it would send a message that the use of chemical weapons may go unpunished. It would make Israel and Saudi Arabia uncertain about US assistance on Iran’s nuclear programme. Pyongyang’s hand would be strengthened, and among allies in the Asia-Pacific – where US security guarantees are considered crucial to check the rise of China – signs of US weakness would make leaders nervous. Western impotence in Syria will reduce America’s – and by extension the West’s – international standing, strengthening those that believe Western decline creates opportunities to expand their influence.

Deal or no deal, the crisis has negatively affected transatlantic relations. In 2011, then-Secretary of Defense Robert Gates complained publicly that Europe was not equitably sharing the burden of military risks and expenses. Not much has improved since then. In Libya, eight out of twenty-eight NATO allies participated in the bombing phase of the air campaign. Now an even smaller number of Europeans would stand by the US. Washington has not drawn upon NATO’s command headquarters or common surveillance assets (as happened in Libya) or even mentioned NATO. The US probably wanted to avoid bringing Europe’s division into the North Atlantic Council, where unanimous support would be needed. While much has been made of the US rebalance towards Asia and the consequent need for Europe to bear a greater burden for security in its neighbourhood, most of Europe is still passing the buck to Washington. Once again, the US and Russia get to sort out a security issue in Europe’s neighbourhood without Europe being at the table.

Rem Korteweg is a senior research fellow at the Centre for European Reform.

Continuity and change in Germany's EU policy

However the Germans vote on September 22^nd, Berlin’s attitude to the EU is not going to change much. The opposition Social Democrats call for a bit less austerity in Southern Europe but otherwise support most of Chancellor Angela Merkel’s policies. Nonetheless German policy on Europe is evolving – independently of the elections – in some important respects.

Germany is making a new effort to revive its damaged relationship with France. It is moving towards accepting a full banking union, including a resolution regime, though not, for now, on terms acceptable to most of its partners. It is recognising – with some regret – that there will not be a significant revision of the EU treaties in the coming years. And it is increasingly critical of the European Commission and the European Parliament.

The big strategic decisions on Germany and the EU are taken by politicians like Guido Westerwelle, the foreign minister, and Wolfgang Schäuble, the finance minister, and, above all, Merkel. But the key officials in the Chancellor’s office, the foreign ministry and the finance ministry are hugely influential on EU policy. That is not surprising, given that they – unlike most politicians – understand the technicalities of the EU’s inner workings.

These officials are more relaxed about the euro than they were six months ago. They think that modest progress in Ireland, Portugal and Spain is vindicating their insistence on austerity in these countries. They regard Greece as a hopeless case, but too small to threaten the euro’s survival. Italy is a much bigger worry, because its political system seems to make structural economic reform impossible.

As for the Official Monetary Transactions (OMT) – the bond-buying scheme unveiled by the European Central Bank a year ago, which reduced the cost of borrowing for the Southern Europeans – it should be “a bazooka that is left in the cupboard”, according to one official. If ever used, the ECB’s independence could be compromised: politicians would put pressure on the bank to deploy the OMT to achieve a particular spread for a country’s bonds, he says. And what would the ECB do if, once an OMT programme had started, its beneficiary stopped reforming? This official thinks that if a country applies the right policies, as Spain has done recently, it does not need OMT. And if a country chooses the wrong policies, OMT cannot save it.

Germany’s constitutional court in Karlsruhe is due to rule on the legality of the OMT this autumn. The view in Berlin is that court is unlikely to ban the OMT outright, though it may set conditions for its use.

German officials think that France, unlike Italy, is capable of reform. But in his first year as president, President François Hollande infuriated German officials: he tried teaming up with Spain’s and Italy’s leaders to oppose Merkel at summits, and did very little to revitalise France’s economy. The Germans talked of moving ahead without France. The French found the Germans’ tone patronising.

But this summer the atmosphere between Paris and Berlin has improved a little.  The Germans understand that they cannot lead Europe on their own. They say they have learned that lecturing France will not persuade it to reform. Only if France believes that it is an equal partner of Germany’s, they think, is there a chance if it reforming. Meanwhile Hollande has not tried to manoeuvre against Merkel in the European Council since February (when he was in a minority of one over the EU budget). At the end of May, a joint Hollande-Merkel letter floated ideas such as a eurozone budget, a bank resolution regime, contracts for economic reform and a permanent president for the Eurogroup (which brings together the countries in the euro).

German officials hope that after the general election they can restart the Franco-German motor with a grand bargain. France would accept Merkel’s idea of contracts – it would have to negotiate structural reforms with the Commission – and Germany would agree to a modest eurozone budget, to reward countries that undertake painful reforms. Some Germans believe that these contracts would be the most effective means of getting France to reform. The bargain would also cover a bank resolution regime, which France is keen to see implemented. None of these steps would require treaty change.

Despite their new, softer line on France, some Germans still worry that the French will exploit Germany’s willingness – in the event of a serious crisis – to do whatever is necessary to keep it in the euro, and that they will therefore shy away from difficult reforms. France would then slowly drift into Southern Europe and Germany would find it hard to lead the EU on its own.

Banking union is currently a major bone of contention between Berlin and Paris. Schäuble wants a resolution regime with a first phase “based on effective co-ordination between national authorities; and effective fiscal backstops, also including the European Stability Mechanism (ESM) as last resort.” (see FT article by Schäuble). The Commission, however – backed by most member-states, including France – wants to run a centralised system that draws on a new resolution fund. The Germans think the Commission would not be capable of acting quickly to resolve a bank, and that, given the fund’s initial small size, they might end up having to pay to clean up others’ banks. They also argue that the Commission is abusing the treaties by using a single market article as the legal base for its proposal.

At the moment, the two camps are far apart. But German officials are convinced that the EU needs a viable resolution regime. A possible compromise, one suggests, could involve Germany accepting the Commission as the resolution authority, provided the ESM is the backstop. Germany likes the ESM because it is run by a German and it has an effective veto over its money being spent.

Many German politicians, being committed to a federal Europe, retain some affection for the Commission and the European Parliament. But the key officials have become very critical of both bodies. They say that the Parliament has too much power and is out of touch. So when it comes to the proposed ‘new’ method of choosing the Commission president – the idea is that after the 2014 European elections, the party with the most MEPs would appoint its designated candidate – German officials are wary. They fear that this method could lead to a powerful Commission-Parliament alliance against the Council of Ministers (in which Germany is a dominant force). This wariness extends to senior German politicians. Without the co-operation of Angela Merkel and her European People’s Party, MEPs may struggle to impose the president of their dreams on the European Council.

Officials complain that the Commission lacks economic expertise, that it produces too many meddlesome rules, and that it spends too much time worrying about its own power. It annoyed them recently by pushing ahead with a directive banning certain greenhouse-gas coolants that are used in Mercedes air conditioners. And they are frustrated that the Commission gave France extra time to meet the 3 per cent budget rule, without first extracting commitments on structural reform.

Some German officials are keen to build up the ESM as an alternative to the Commission for eurozone governance. They admit that the ESM currently lacks economic expertise but think that in the long run it could evolve into a European Monetary Fund. They believe that in contrast to the Commission it is not subject to political pressure. However, some foreign ministry officials understand that Germany is rather isolated in its desire to bash the Commission. For example, Poland – an important German ally – is usually supportive of the Commission. These officials therefore believe that any German attempt to promote the ESM as an alternative will not get very far.

Another source of tension between Berlin and Warsaw is the Eurogroup. The Poles – like the British – want the key body for taking decisions in the EU to remain the 28-member Council of Ministers. They worry that building up the Eurogroup could hurt countries outside the euro, as well as the single market. Some German officials are ready to go along with France’s wish to develop eurozone-specific institutions. Merkel, however, is keen to maintain the importance of the 28, partly because of her warm relations with the Polish and British prime ministers.

Twelve months ago, German officials were all for treaty change; six months ago, they really hoped it would be possible, but recognised that it might not be. Now they think that in an ideal world, treaty change would be desirable, but they are mostly reconciled to its postponement for a long time. The reason is simple: the only other member-state that wants treaty change is the UK, which means that the chances of the whole EU adopting a new treaty are zero.

The top officials say that if there is to be a new EU treaty, it would have to be negotiated in 2016, as the various election and referendum calendars allow no other possibility. Any new treaty would be a small, “surgical” change that would not require a convention (a suitable model may be the fiscal compact, last year’s non-EU treaty that did not require ratification by all signatories before entering into force). But these officials acknowledge that there may well be no new treaty of any sort, and they say that the EU can cope perfectly well with the existing ones. (The finance ministry would still like a treaty amendment to strengthen the independence of the EU’s new banking supervisory mechanism, but that is a long-term objective. Its own plans for a resolution regime would not require an amendment in their first phase.)

Germany’s recoiling from treaty change will be unwelcome news to some British Conservatives. They have been counting on the EU needing a new treaty, and thus a British signature, in order to extract concessions – such as the repatriation of powers – from Britain’s partners. It seems unlikely that the British government will enjoy that kind of leverage before the referendum that David Cameron has promised in 2017.

Charles Grant is director of the Centre for European Reform

The Commons vote on Syria:The world turned upside down

Prime Minister David Cameron made a strong case for taking military action to punish the Syrian regime for using chemical weapons. Labour leader Ed Miliband said that he was willing to consider it. It took a combination of party political manoeuvring and a rebellion by Conservative isolationists to defeat the government on August 29th, ensuring that Britain would not join in any operation. The vote is already affecting the UK’s relationship with the US. It may also reduce still further Europe’s willingness to equip and train for conflicts outside its borders. It does not (yet) mean that Britain has pulled up the drawbridge, but it will make it harder for future governments to get involved in wars, even for noble causes.

The vote in the Commons did not necessarily reflect a majority against the principle of military action. Four hundred and ninety MPs voted to start a process that could lead to military action. But they were split: the government, with no support from Labour MPs, put forward one set of conditions that would have to be met; the Labour Party, with no support from the coalition’s MPs, proposed a slightly different set. Only 52 MPs voted against the use of force in any circumstances by opposing both the government and opposition proposals.

The main reason that the government lost was that 30 Conservative and 9 Liberal Democrat MPs voted against the government motion (with many others absent or not voting). There was a sense among the Conservative rebels that this was not Britain’s fight: comments included "Our job in this parliament is to look after our own people" and "The world needs to act. The world, however, does not equal the UK". There was a striking amount of criticism of the US, occasionally bordering on hostility, from some Conservatives.

A closer look at the 30 Conservative rebels is revealing: 26 of them also rebelled against the government and voted in favour of a referendum on the UK's EU membership in October 2011. In the past, many Conservative eurosceptics have favoured an Atlantic alternative of closer partnership with the US rather than the EU. There is now a significant group, however, for whom the choice is not between Europe and the open sea, but between (as they see it) the illusion of "punching above our weight" and the reality of being a medium-sized power with domestic problems to fix. Their position resembles that of the populist UK Independence Party, which – to quote their website – opposes "needless foreign adventures that don't directly affect us as a nation".

To judge from opinion polls, this scepticism about UK involvement in distant conflicts reflects the popular mood; but in the past national politicians have been more willing to ignore such sentiments in favour of maintaining Britain's status as a leading world power and defender of international norms. If the Prime Minister and Ed Miliband had been more confident that taking action was the right thing to do, they might have found it easier to agree on a motion that government and opposition could both back. As it was, the Prime Minister had no hesitation in confirming on the night of the vote that the government would abide by what he considered to be the will of Parliament: Britain would not take part in any military action against Syria. Ministers have been surprisingly ready to say that there will not be another vote unless circumstances change very significantly – almost as though defeat had come as something of a relief to them. It is not clear how bad things would have to get in Syria before they would revisit the issue.

While publicly the US administration has expressed understanding for the situation, in his speech on August 30th Secretary of State John Kerry pointedly left the UK out of a list of US allies in dealing with Syria. British military staff attached to US Central Command headquarters (from which any Syria operation will be run) are reportedly being excluded from discussions. It is certainly an exaggeration to speak of the demise of the special relationship – not least because the unique intelligence relationship between the UK and US will certainly continue. But at least since the invasion of Iraq in 2003, Britain's willingness to turn up has been more important to the US than any practical military contribution it could make. If the UK loses the political will even to play a symbolic role in operations, that will certainly erode the basis of the relationship.

There is also a question of why President Obama has now decided to consult Congress before taking military action – something which clearly was not envisaged before the British vote. Was the President's position weakened by David Cameron’s defeat, so that he felt he had to give in to pressure from Congressional Republicans to offer them the same chance that British MPs had had to debate military action? Comments by White House officials suggest a degree of irritation with the British for starting down this road. If (as is possible) Obama fails to get the support of at least the House of Representatives, the administration may well put part of the blame on the British. Another CER Insight in the coming days will deal with other international implications of a possible strike on Syria.

Within Europe, the Commons vote threatens to undermine improving Franco-British ties on defence and security. David Cameron and Francois Hollande are not natural soul-mates, and Hollande did not initially share Nicolas Sarkozy's enthusiasm for defence co-operation with the UK. But Britain's willingness to provide modest logistical help in the initial stages of France's Mali operation earlier this year, and subsequent shared views on Syria (including on the question of partially lifting the EU's arms embargo to allow weapons deliveries to the opposition) had started to turn things round. This renewed alignment between the UK and France, and the embarrassment of failing to back them in Libya in 2011, seemed to be nudging Germany in the direction of supporting action in Syria (Foreign Minister Guido Westerwelle said on August 26th that if the use of chemical weapons were confirmed by UN inspectors, then Germany would "be among those who think that some consequence will have to be drawn"). After the British vote, and probably not by coincidence, Chancellor Merkel's spokesman seemed to rule out any German involvement, leaving France isolated as the only European country likely to join the US in military operations.

The British vote comes at an inconvenient time in the preparations for the December European Council discussion on European security and defence policy. The UK has been a keen promoter of increased European defence capabilities, particularly those such as strategic airlift which would enable European countries to play a more active part in expeditionary operations. But if reluctant partners believe, rightly or not, that the UK itself is losing the political will to undertake such operations, they are unlikely to respond to British pressure to spend more on such capabilities (though they may be relieved that the UK will no longer try to push them into wars at the behest of the US).

In NATO the vote may have an impact on the unresolved division between allies who believe that the alliance's main focus should be on territorial defence, and those who see the main threats to transatlantic security as global, not European, and want NATO to be able to act beyond its borders. Again, the UK's credibility as a strong supporter of an expeditionary outlook for NATO is likely to be reduced, while the position of countries like Poland (which has ruled out taking part in action against Syria and is more focused on security issues in its immediate neighbourhood) may be strengthened.

The Commons vote may turn out to have little long-term impact on the UK’s world view. Any response to Assad’s use of chemical weapons is hedged with uncertainty. If a limited strike fails to prevent the future use of nerve gas, what would the Western reaction be? What impact would a strike have on regional security? Would it destroy any hope of improving the West’s relations with the new president of Iran, making conflict more likely? Perhaps in other circumstances, with more clarity about the ramifications of action, a parliamentary majority could be found. Perhaps next time the government would do a better job of rounding up its members to vote. Perhaps next time the Labour Party, having exorcised the demons of 2003 and the decision to invade Iraq, could vote on the merits of the case when an atrocity needs to be punished.

But equally, the vote could turn out to be the signal for a strategic shift in favour of insularity. By voting – almost by accident – against even a modest military gesture, British MPs risk sending the message that in future the UK will be content to stay on the side-lines, regardless of what is happening in distant lands. For all the expressions of dismay from veteran statesmen like Tony Blair, former Foreign Secretary Sir Malcolm Rifkind and former Liberal Democrat leader Lord Ashdown, public opinion seems happy with that; and current political leaders seem disinclined to court unpopularity by reiterating the case for interventionism. For a country with global economic and security interests, that is a risky position to take, and a bad example to set.

Ian Bond is director of foreign policy at the Centre for European Reform.

Europe's struggle for influence in Egypt

Egypt tests Europe’s ability to influence events in its southern neighbourhood. In January 2011, the protestors in Tahrir Square brought down President Mubarak, despite lukewarm support from Western countries. After Mubarak’s removal from power, the EU adopted a new policy based on the ‘more for more’ principle; the more a country enacts democratic reforms, the more EU aid it can expect. In November 2012, after the elections that led to Mohamed Morsi’s brief presidency, the European Union announced a package of grants and loans totalling nearly €4.2 billion. The following week President Morsi announced his autocratic grab for Egypt’s constitutional powers. When European officials complained about the violation of religious or women’s rights in Egypt, Muslim Brotherhood officials would retort by pointing at rising Islamophobia in Europe. Now, in spite of intense American and European diplomatic pressure, the interim government has used disproportionate force to disperse the pro-Morsi sit-ins, killing more than 800. A cycle of violence has ensued as dozens of policemen and security officers have been killed in response. Egypt now balances on the precipice of further violent conflict.

Europe’s diplomatic relations with Morsi’s government were troubled, but things are no easier now. The liberals and the moderates in the current government  ‒ those that the EU and Washington considered allies  ‒  have either been co-opted or outflanked by the hardliners. Prime minister Hazem el-Beblawi, a liberal economist, supported the crackdown against the sit-ins and has suggested the Muslim Brotherhood’s licence to operate as a political party could be revoked. Another moderate and key interlocutor of the West, Mohamed ElBaradei, is no longer influential after he resigned in protest at the violence and even faces legal charges over that decision. Meanwhile, Tamarod, a grass roots protest movement which appeared to share Western values, is becoming more nationalist and has called for tearing up Egypt’s peace treaty with Israel and an end to American military aid.

Following last week’s violence, the EU has decided to stop the sale of all ‘arms that can be used internally’. In practice the EU measure is likely to halt the export of small arms, munitions and possibly armoured personnel carriers. The army and police are too powerful for the EU’s decision to influence the internal balance of power. And if the Egyptian military run out of guns and bullets, there are many more suppliers able to replenish its stocks. Given the proliferation of arms from places like Libya, the same also holds true for the Islamists. And so, the EU’s decision will do little to bring the parties back to the table. It seems calculated to make clear that Europe disapproves of the violence, but not of the new regime.

If it had wanted to make a stronger point, the EU could have suspended aid, withdrawn its ambassadors, made a common demarche on the Egyptian ministry of foreign affairs or slapped economic sanctions on the assets and movements of senior government or military officials. Of course, the EU could still do all these things, but it seems unwilling to antagonise the Egyptian government. Egypt is too important for several European interests; a secure Suez Canal, enduring Arab peace with Israel and the fight against militant Islam.

Behind closed doors US and European security and intelligence communities will have welcomed Morsi’s replacement by General Abdel Fattah al-Sisi. Morsi’s government looked the other way while lawlessness flourished in the Sinai peninsula. Militants have bombed the natural gas pipeline to Israel and Jordan thirteen times in the past two years. The peninsula has become a conduit for Libyan arms to Hamas and Syria’s rebel groups (intelligence agencies have been particularly concerned about the spread of shoulder-fired missiles that can shoot down helicopters and planes). In the Sinai, there are nearly daily attacks against the police and army (in mid-August 24 police officers were killed in an ambush). Despite their restrictions on arms exports, most European governments probably hope that Egyptian security forces have enough weapons to reimpose order in Sinai.

But the overthrow of Morsi is unlikely to bring peace. Al Qaeda’s chief, Ayman al-Zawahiri, has called on his followers to resist the interim government in Cairo. The Egyptian economy is on life support. Sectarian attacks on Coptic Christians and their churches have increased. The Suez Canal – a maritime chokepoint that carries roughly 8 per cent of global seaborne trade  ‒  is at risk. This puts Europe in the uncomfortable position of giving preference to its security interests over its liberal values, without being sure that it can protect either.

The larger story of Europe’s pursuit of influence in Egypt relates to the changing balance of power in its southern neighbourhood. With America unwilling to get involved, European countries have tried, with mixed success, to take the lead on issues in Libya, Mali and Syria. In Egypt the EU now finds itself competing with the Gulf countries for influence. Saudi Arabia, Kuwait and the UAE – primarily concerned with domestic support for the Muslim Brotherhood – have welcomed the assault on the Brotherhood and have given the interim government a cheque worth $12 billion, almost €9 billion.  Reasoning that Cairo, if it wanted, could simply ignore Europe and rely on the Gulf states, the EU has decided to keep its aid and trade relationship intact. It is betting that by denouncing the violence, stopping arms sales but maintaining other ties, Brussels will be able to keep doors in Cairo open.

One positive for the EU in the Egyptian crisis is that member-states are allowing Catherine Ashton to coordinate EU policy. She was the first European leader to visit Egypt after the fall of Mubarak, and the only senior foreign official to have visited Morsi after his detention. This gives her credibility in Europe and in the region. European governments should mandate Ashton, and the EU’s Special Representative for the region, Bernardino Leon, to coordinate efforts with the Gulf states and the US and reach out to the interim government to help establish a national political dialogue.

Europe’s influence also relies on the power of its markets. Europe’s aid package is less than half of the Gulf states’ financial commitment, but Egypt needs foreign investment and deeper trade relations, rather than a line of credit. Once stability has been restored, the EU should be prepared to help the country deal with its vicious cycle of unemployment, inflation, capital flight, rising debts, falling currency reserves and increasing budget deficit (running at roughly 12 per cent of GDP) by further opening its markets to Egyptian goods. In time, the Egyptian government will have to reduce its subsidies on fuel and bread – actions that could spark popular unrest. The EU has also made macro-financial assistance to Egypt – worth €500 million – conditional on the successful negotiation of an IMF loan. European leaders should continue to push the interim government to strike a deal even though the political environment is not ready for this yet.

While the Brotherhood is suppressed, the military is the most organised political institution in the country. Under current conditions, a rush to the ballot box would almost certainly mean victory for the military’s candidate, perhaps al-Sisi himself, and enrage the Brotherhood’s supporters. At a conference in Cairo in March, one of the speakers, since elevated to a very senior position in government, said that if Morsi’s government failed, it would mean the bankruptcy of political Islam in Egypt. His words now read like a policy prescription. The interim government has detained 75 senior members of the Muslim Brotherhood, including Morsi himself. Under the existing electoral law, given their criminal indictments, many of the Brotherhood’s leadership would not be eligible to participate in the elections. By purging the Brotherhood, General al-Sisi hopes to stop his opponents from playing a meaningful role in Egypt’s politics.

The EU has an interest in a pluralist democracy, not in military rule sanctioned through quick elections. However difficult it may be, to give the opposition parties a fair chance it would be sensible to gather all parties (including the Brotherhood) in a process that lets them determine the timing of the elections. The recently created European Endowment for Democracy could also use its admittedly limited funds to support some of Egypt’s nascent political parties.

If the military insist on pushing the Brotherhood underground, however, this is likely to create security problems of its own. As avenues for democratic participation are closed to the Brotherhood, the likelihood increases that its supporters will resort to violence (as happened in Algeria in 1991 when the military intervened to deprive Islamists of their election victory, sparking civil war). The Brotherhood’s hardliners will gain influence, condemning the US and Europe as anti-Islamic and hypocritical for condoning the overthrow of a democratically elected government. The Brotherhood could also reverse its earlier renunciation of violence. Political Islam in Egypt would become more anti-Western and less amenable to democratic ideas, opening the way for a rise in violent extremism, including against Western interests, in a region that is rife with conflict. Tragically, Europe’s access to Cairo’s powerbrokers would then become even more important, even as its policy choices become more unpalatable.

Rem Korteweg is a senior research fellow at the Centre for European Reform.

How the EU can help Kerry with Israeli and Palestinian peace talks

As soon as US Secretary of State John Kerry announced the resumption of peace talks between Israel and the Palestinians, the EU promised to do everything it could to support the new American initiative. The Middle East peace process has been a top EU priority for years. But Europeans are conscious that they lack the diplomatic clout to be a major player. Palestinians and Israelis think that EU member-states are too frequently divided among themselves. Many Israelis also argue that even though the EU and Israel have close ties, the Union does not give sufficient importance to their security concerns. Nevertheless, Europeans played a modest role in helping the US convince Israelis and Palestinians to sign up to new talks. And the EU can make further contributions to the peace process.

In July, as Secretary Kerry negotiated assiduously with Israeli Prime Minister Benjamin Netanyahu and Palestinian President Mahmoud Abbas to give peace talks another chance, the EU high representative for foreign affairs Catherine Ashton announced that the EU would no longer give grants and scholarships to companies and educational institutions based in Israeli settlements. In addition, a leaked letter from Ashton detailed EU plans to require products from settlements to be labelled as such when sold in the EU. The Union, which has long argued that Israeli settlements are illegal under international law, had been working on both initiatives for a while. But the timing of the announcement and the leaked letter helped in a small way to convince both President Abbas and Prime Minister Netanyahu to agree to peace talks.

Of course, the Obama administration was the key driver behind Abbas and Netanyahu’s endorsements of new negotiations. But according to European officials, the Palestinian president felt emboldened by the fact that the EU was willing to put international pressure on Israel. Israel, for its part, is always worried about being isolated. Netanyahu asked Kerry to convince the EU to revisit the decisions on the settlements. But Kerry told Netanyahu that he would not ask the EU to back down, and that unless Israel took part in peace talks, Tel Aviv risked similar action by other countries in the future. According to officials, the exchange between Kerry and Netanyahu weighed on the Israeli prime minister’s decision to support negotiations.

The EU helped the Americans coax the parties to the negotiating table because it has some economic leverage over them. Israel has an association agreement with the EU, and so many of its exports to Europe benefit from preferential trade terms. The Union disburses research funds and scholarships to Israeli industry and universities. And the EU is the largest donor to the Palestinians. In recent years, the European Commission and member-states have together provided €500 million a year. Amongst other things, this money has helped Palestinians develop the institutions required to function as an independent state – though more Palestinian nation-building will be needed before a two-state solution can be viable. The EU’s economic weight could be of significant help to both Israelis and Palestinians if they reached a peace deal. European states could help stabilise the region through further aid and trade concessions. The EU is already reflecting on how it could deepen bilateral ties with Israel in response to the progress in the peace process, a move the Israeli authorities greatly welcome.

Europe could also help the negotiations by making clear that if a deal was reached it would offer peacekeepers to prevent violence. Over the years, a number of European politicians have raised this possibility. Europeans already provide peacekeepers to UN monitoring missions along the Lebanese and Israeli border, and the Golan Heights. But if Europeans want their offer to be credible, they need to reassure Israelis and Palestinians that their peacekeepers would not be passive observers. Instead European troops would be given a mandate to use force if necessary to stop outbreaks of violence. EU states have sometimes imposed limitations on what troops or police forces can do when deployed, for a variety of reasons including minimising the risks to personnel. This was the case for example during an EU police monitoring mission along the border between Gaza and Egypt between 2005 and 2007. As a result, Israel never felt the mission was credible.

Finally, and controversially, the EU can support the peace effort by helping to bring Hamas into the process. The militant group, regarded by the EU, US, Israel and many other countries as a terrorist organisation, has been in sole control of Gaza for six years. Hamas, which frequently clashes militarily with Israel, is popular among Palestinians in the West Bank as well as in Gaza. Without its endorsement President Abbas will be incapable of reaching a durable peace settlement with Israel. In recent years, Egypt, Qatar and several EU governments have grudgingly reached this conclusion. Qatar and Egypt – even under former President Hosni Mubarak – have tried unsuccessfully to reconcile the warring Palestinian factions. The EU has made clear that it would be willing to work with a Palestinian unity government which included Hamas, if President Abbas were comfortable with the deal and Hamas renounced violence.

The need to include Hamas in a peace deal is also recognised by some Israeli officials, including former heads of Mossad – the Israeli national intelligence agency – and by some in the US government. During her last year in office, former Secretary of State Hillary Clinton asked her department to work out how to engage with the militant group. But the US government is unlikely to stop boycotting Hamas, given strong Congressional opposition to the organisation.

If the talks between Netanyahu and Abbas develop into something meaningful, Secretary Kerry should make use of Europe’s willingness to engage with Hamas. With the consent of President Abbas and the Israeli government, the US should discreetly encourage the EU to make the public case for including Hamas in the peace negotiations.

Even with a co-ordinated transatlantic effort, the prospects for the nascent peace initiative are not good. Not only must Hamas and President Abbas’ Fatah party be reconciled for any Palestinian state to work, but Netanyahu will also have to ensure his coalition supports a deal (and he would then probably have to win a referendum on withdrawal from many of the West Bank settlements); meanwhile many of the Arab countries whose support will be essential, above all Egypt, are in turmoil. Hezbollah could seek to re-establish its credibility in the Middle East – damaged by its support for Syrian President Bashar Assad – through a new military confrontation with Israel. More generally, spill-over from the Syrian conflict could destabilise both Lebanon and an increasingly fragile Jordan. But the talks are worth pursuing, with strong EU backing: if they fail, it is unclear how long Mahmoud Abbas can remain Palestinian president, and few other Palestinian politicians are as supportive of a negotiated peace. Secretary Kerry would probably have preferred a better hand of cards on taking office. But the next hand could be even worse.

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

Putin's Russia: Stability and stagnation

After a week in Russia I concluded that Russia is very stable – perhaps too stable. President Vladimir Putin appears to want little political or economic reform, lest it lead to instability. Nevertheless, divisions are appearing in his entourage: some favour clamping down hard on the opposition, while others counsel softer tactics. Sometimes Putin backs one group, sometimes the other. On foreign policy, too, Putin seems to have two faces. The pragmatic Putin wants to work with the US in dealing with common problems. But another Putin views the US as a hostile power that is trying to destabilise Russia, and is happy to do things – like sheltering the fugitive Edward Snowden – that infuriate it.

In Moscow, both opposition leaders and the more liberal government officials agree that the need for political and economic change is greater than ever, but that the chances of serious reform are close to zero. After mass demonstrations in the winter of 2011-12, optimists thought the regime would attempt to win back the support of the middle classes by modernising the country’s governance. But these days nobody expects much to change.

Russia’s leaders worry that big economic or political reforms could upset vested interests, create losers and perhaps strengthen the opposition. The government has in fact attempted some reforms of the university, school and healthcare systems, in order to save money, but these have been unpopular. Reform of the pension system – which would mean curbing pension rights – has been mooted for over a decade but frequently put off. There always seems to be an excuse for postponing major reform.

The slowdown of the economy has come as a shock to Russia’s rulers. In 2010, 2011 and 2012, Russia grew at close to 4 per cent. This year growth may be less than 2 per cent. The government initially blamed the slow-down of the world economy: demand for Russia’s natural resources was diminishing. But in April, when Putin gathered key ministers and experts to discuss the economy at the Black Sea resort of Sochi, they concluded that some of the problems were home-grown.

Officials list the structural problems: the absence of spare industrial capacity (in the 2000s the economy could grow quickly by turning on Soviet-era plants); the lack of labour mobility in Russia (old Soviet ‘mono-towns’ are propped up by the state); an ageing population; and, especially, the falling rate of private sector investment. Net capital outflow of $40 billion in the first half of the year did not help, but inadequate rule of law is perhaps the major deterrent to investment. Not much is being done about it. “The leaders put too much emphasis on stability,” said a former senior official. “There is a lack of energy at the federal level”.

More sustainable and less volatile growth requires Russia to wean itself off dependency on natural resources. One official admitted that though diversification remained a political objective, achieving it would be extremely difficult. Russia had to respect its natural strengths, which were raw materials, ‘mathematically-intense services’ (like data processing and computing) and land, said the official – who noted that Australia did quite well despite depending on exports of natural resources.

A high oil price provides cash for the government to satisfy vested interests and undermine potential opponents. But even a lower oil price would not necessarily trigger much reform, officials warn. “Everyone understands we need a crisis before you get institutional reform”, said one. “But they hope you can escape the crisis. Nobody in government or opposition has a really good plan for implementing reforms.” Even opposition leaders doubt that a drop in the oil price would spur reform. “There are no examples in Russian history since the USSR of bad economic performance provoking political unrest,” said one. “And if there are more demonstrations, so what?”

But if reform driven by bottom-up protests seems unlikely, for the time being, could splits in the ruling elite lead to top-down change? There is no longer a division between Putinites and followers of Prime Minister Dmitri Medvedev, because he is no longer a significant player. But the Putinites seem to be dividing between siloviki (those linked to the security establishment) and pragmatists. The battle between them is not yet dangerous to the stability of the regime, because Putin is clearly in charge.

The siloviki, led by, among others, Alexander Bastrykin (the head of the ‘investigative committee’) want to crush dissent. The siloviki ensured that Alexei Navalny, an opposition leader, was sentenced to five years’ hard labour in July. They do not want him to compete in September’s Moscow mayoral election.

But after one night in prison, Navalny was released. This means that he can – while his appeal is pending – run for mayor of Moscow. He can thank the pragmatists, who include Sergei Sobyanin, the current mayor of Moscow, for his release. Sobyanin, it seems, wants to run against Navalny in a free and fair election, as he knows this would enhance his legitimacy and that he would win easily. The Navalny affair is a reminder of the degree to which the courts are controlled by the executive.

Many oligarchs, liberals and moderates see Sobyanin as a possible successor to Putin. A former governor of Tyumen region, deputy prime minister and head of the presidential administration, he is a grey, Chernomyrdin-like figure. Sobyanin is very loyal to Putin and said to be effective. One former official who has worked with him said that if Sobyanin was in charge he would try to make moderate improvements to the system.

Navalny, who began as an anti-corruption campaigner, is emerging as the most credible opponent of Putin, though he lacks large-scale support (opinion polls suggest that he would be lucky to win 10 per cent of the votes in Moscow) and his own party has not been registered. The most liberal opposition leaders do not trust him to be a real democrat.

The Republican Party seeks to bring together all the liberals but has very little money and too many leaders. One of the party’s four co-leaders, Vladimir Milov, recently walked out to found his own party. Of the others, Vladimir Ryzhkov voted against the Republicans backing Navalny for mayor of Moscow, but Mikhail Kasianov and Boris Nemtsov voted in favour and so the party will support him. The opposition looks like remaining weak – and Russian politics are on course to remain stable.

Russia’s relations with the US, however, are in flux. The ‘reset’ – the warm tone that prevailed between Presidents Barack Obama and Dmitri Medvedev – had disappeared before Putin returned to the presidency in May 2012. This year the atmosphere has gradually soured.

Fathoming Putin’s intentions towards the Americans is difficult. Ask senior Russians how Putin sees the US and you get two different answers. One is that Putin would like a business-like relationship in which the two sides can deal with common challenges, like terrorism, Afghanistan, Iran, Syria and so on – even though they will often criticise each other. Putin understands that the US is the pre-eminent superpower and that he must work with it on some of these issues. Thus Putin personally backed last year’s Exxon-Rosneft deal – perhaps worth up to $500 billion – to develop hydrocarbon resources in the Black and Arctic Seas.

The other answer is that Putin really is paranoid about the US. He takes at face value the often insincere rhetoric of American politicians about the importance of spreading democracy and human rights. He thinks that the US will inevitably try to intervene to overturn regimes it dislikes, as it did in Afghanistan, Iraq, Libya and Serbia. Putin does not distinguish between Republicans and Democrats, believing them all to be interventionist (this upsets some of Obama’s people, since Obama and Secretary of State John Kerry opposed the Iraq war). This hostility to the US explains the clampdown on Russian NGOs that get foreign (and notably American) funding.

Both these views of Putin are probably true. He switches from one face to the other, which makes him a difficult partner for the Americans.

Obama has two priorities with Russia but is making little progress with either. One is arms control. Speaking in Berlin in June, Obama proposed new cuts to nuclear arsenals. For several years Russia has complained that American plans for missile defence could affect its strategic nuclear capability and therefore limit its enthusiasm for cutting warheads. In March the US said it was scrapping the fourth and final phase of its planned missile defence system in Europe. But Russia has not responded to that move or to the Berlin speech. One reason may be its desire to maintain a significant nuclear superiority vis-à-vis China.

Obama’s other priority is Syria. Putin has gone along with the idea of a ‘Geneva II’ peace conference, but this has been stymied by the West’s inability to deliver the opposition (though this is because the opposition is losing, which – in the view of US officials – is partly because of Russia’s support for President Assad). Most Russians believe that events in Syria are proving them right: they always warned that much of the opposition would turn out to be nastier than Assad’s regime. Syria will remain a source of discord for the foreseeable future.

There are other irritants in the US-Russia relationship. Russia has banned American exports of pigs and cattle, because the meat contains the chemical ractopamine. Meanwhile the ‘Magnitsky list’ annoys the Russian government: Congress has passed an act that enables the administration to impose visa bans and asset freezes on officials linked to the death in custody of Sergei Magnitsky, a lawyer and whistle-blower.

And now Russia has granted temporary asylum to another whistle-blower, Snowden. American officials think that Putin under-estimates how much Snowden matters to the Obama administration, which sees him as a serious criminal, and therefore how much the affair can damage the Moscow-Washington relationship. Obama may now be unwilling to meet Putin in Moscow in September, after the G20 summit in St Petersburg, as had been envisaged.

Those who know Obama well say that he is unwilling to spend time on subjects that do not deliver results. So the lack of progress on arms control and Syria, plus the Snowden affair, may lead to Obama minimising the time that he spends on Russia. Not that that is likely to upset Russia’s leaders a great deal. What they care most about is stability within Russia, an objective that they are – for now – achieving.

Charles Grant is director of the Centre for European Reform