Thursday, January 25, 2007

The wrong benchmark for Eastern Europe
by Katinka Barysch

In November last year, Anders Aslund, a long-time observer of transition economies, rang the alarm bells over Eastern Europe. In an FT article he talked about “Central Europe’s political malaise” and warned that budget profligacy and reform fatigue would keep the new members from catching up with the West.

The tone was very different at last week’s Euromoney’s East European investment conference in Vienna. Bankers and politicians extolled the virtues of a fast-growing, open and stable region. The tenure of most speeches was: “We may have problems in the East, but on many fronts were are already better than the ‘old’ EU (or at least bits of it)”.

That’s certainly true for growth. In the last five years, the 12 new members recorded an average growth rate of 4.5 per cent, well above the EU-15’s 1.6 per cent. But the comparisons go further. “We are much faster reformers than the West Europeans” beamed one Serbian representative in Vienna. Romanians and Croatians were proud that the World Bank – in its annual ‘Doing business in 2007’ survey – put them into the group of fastest-reforming countries. Only one of the ‘old’ EU countries (France) made it into the list.

Romanians and Bulgarians also stressed that they came far ahead of long-standing EU members Italy and Greece in the World Bank’s overall ranking (which assesses the ease of starting a business, getting a loan, paying taxes and so on). Czechs and Slovenes have less unemployment than France, taxes in Slovakia are lower than in Germany …

Stop! These comparisons may be uplifting for countries that have struggled for more than a decade to join the EU club. But they miss the point. Eastern Europe gains nothing by benchmarking itself against the worst-performing EU-15 countries. This breeds complacency, which is not something that Romania, Poland or even the booming Baltics can afford.

The new members are doing well now. But they are in a rather uncomfortable spot between a high-tech Western Europe and low-cost emerging Asia. When it comes to skills, innovation and flexibility, the new members are miles away from the top EU performers. When it comes to wages, they cannot (and should not) endeavour to compete with China. The average Chinese worker earns $1.60 an hour, according to estimates from the Economist Intelligence Unit, while Chinese productivity has grown by 5 per cent a year over the last half-decade. In Hungary, wages are 5-6 times higher while productivity growth is half that of China. Further east, wages are still lower, but they are rising fast: Romania’s real wage growth exceeds 10 per cent.

China’s current export success rests largely on labour-intensive, mass-manufactured goods and consumer electronics. Most of the ‘old’ EU (perhaps with the exception of Portugal and Greece) has long moved out of the production of T-shirts or television sets, and into sophisticated manufacturing and services that do not directly compete with China. But the new member-states rely on the kind of low value-added goods and consumer electronics that China is specialising in.

There is no need to panic. The East European countries retain many advantages over China: geographical proximity, million of highly skilled, relatively low-cost workers, a business environment that is very similar to that in the ‘old’ EU, and full integration into the EU’s single market.

But competition from China and other emerging economies will force the new member-states to run ever faster just to stand still. They will have to move quickly into higher-value added goods and services. For this, they need vastly better education and training systems, more flexible labour markets and a truly entrepreneur-friendly business environment. In other words, it is Europe’s best performers – Denmark, Sweden, Ireland – that they need to compare themselves too, not the laggards.

Katinka Barysch is chief economist at the Centre for European Reform.

Tuesday, January 23, 2007

The world in 2020
by Mark Leonard

By 2020, according to the Economist Intelligence Unit, the Chinese economy could overtake the US to become the largest in the world, at least when measured using purchasing power parity (PPP) exchange rates. India is expected to grow rapidly to become the third biggest economy. Alongside these Asian giants, a series of smaller powers – such as Iran and Russia – will increasingly be able to exploit their nuclear weapons and energy to increase their say in world affairs.

This shift in economic power could be all the more significant, as it is overlaid with an ideological struggle over the shape of world order. Many of the new poles of 2020 will not simply be great powers pursuing their national interest, but networks of countries united by ideas about how the world should be run. In the 1990s it seemed prophetic to talk of the ‘end of history’. Francis Fukuyama’s famous thesis was not that power struggles or even wars would end (in fact, he thought they would continue), but that the great ideological battles of the 20th century would end with “the universalisation of western liberal-democracy”. However, although the differences between major powers are less stark today than during the Cold War, the big story in international relations seems to be history’s dramatic return.

By 2020 we will most likely not see a new world order, but at least four. Already the contours of a new ideological map are emerging that splits the world across two axes. One is domestic: between democracy and autocracy. The other is about philosophies of global order: between those who want to see the world governed by law and international institutions and those who want to see it governed by power. These divisions could give rise to a quadripolar world.

To Europe’s west, the most powerful bloc will continue to be the American World, underpinned by the dollar, popular culture, and the prevalence of the Washington consensus. The goal of US foreign policy is to build a ‘balance of power that favours democracy’. Instead of seeing international institutions as the ultimate foundation of a liberal order, US foreign policy will increasingly seek to maintain US primacy, and the power of key democratic allies such as Japan and India in East Asia.

To Europe’s East, Russia and China. Although they will continue to be suspicious of each other, they are united by their autocratic systems of government, and they will increasingly use international law and institutions to protect the sovereignty of states from western interference. Together, China and Russia could turn the Shanghai Co-operation Organisation into an anti-NATO of countries that are repressive. They will also use their seats in multilateral institutions such as the United Nations to contain the United States.

To Europe’s south will be a stateless world of faith – defined neither by democracy nor the rule of law. While some countries in the Middle East – Lebanon, Palestine, and Turkey – may develop a new strain of ‘Muslim Democracy’, many won’t manage to change their politics quickly enough to keep up with social demands.

And that leaves the fourth zone. An expanded EU will share a belief in democracy with the Americans – but be alienated from them because of its belief in multilateralism and international law. Around its core, the ‘Eurosphere’ will include another 70 countries that are deeply dependent on the Eurosphere for trade, aid, investment. These will gradually be drawn into the European way of doing things, through the European neighbourhood policy that links market access to compliance with European standards on human rights, the rule of law, migration and proliferation.

Not all countries will fit neatly into one sphere or another. This will lead to a global battle to co-opt ‘swing countries’ in South-East Asia, Central Asia, the Caucasus and the Middle East. The biggest swing-state will be India.

The shift from a unipolar to a multipolar world could be almost as significant for global politics as the end of the Cold War. Like the events of 1989, it will force European strategists to change their mental maps of the world, and develop relations with countries that were outside the EU’s sphere of influence.

So what should European leaders do?
Their most urgent challenge should be to prove my predictions wrong. By pursuing a ‘disaggregation strategy’ of engaging the relevant forces in each of the other blocs, they could prevent the ‘quadripolar world’ from coming into being. For example, there are strong forces in favour of the international rule of law and international co-operation at a federal and state level in the United States, that the EU could engage with on climate change and international trade. Russia and China have major differences on energy and proliferation that could be exploited, in order to prevent these great powers from becoming a cohesive force. And in the Middle East, the EU should do all it can to play off the differences between Iran and Syria, and Hamas and Hizbollah, through policies of conditional engagement. The alternative to breaking down these emerging blocs could be a permanent sense of frustration, and a gradual shrinking of European influence in the world.

Mark Leonard was director of foreign policy at the Centre for European Reform until November 2006. In early 2007 he will set up and direct a new pan-European initiative of the Soros foundations network, to promote the EU as a model for an open society.

Friday, January 12, 2007

Why the UK needs to back Commission energy plans
by Katinka Barysch

The reactions to the Commission’s energy package – widely leaked before its official publication date on January 10th – were predictable. Environmental campaigners deplored a lack of ambition while the big eurozone countries recoiled at the Commission’s call to break-up national energy champions.

The package offers little that is fundamentally new: the EU has had targets for energy market liberalisation, renewable energy use, CO2 emissions and so on for years. The Commission wants the member-states to become more ambitious in some areas (for example in saving energy), but in others it is just reinforcing objectives that EU countries have signed up to a long time ago. Energy market liberalisation is a case in point.

It is ten years since the EU decided to create a single European market for energy. EU countries were supposed to liberalise wholesale markets by 2004 and those for consumers by mid-2007. Yet the reality is very different.

In the gas sector, the incumbents still controls more than 80 per cent of the national gas market in Germany and France, as well as Denmark, Italy, Hungary and Poland. In the UK, the country that has gone furthest with gas sector liberalisation, the share is just one-quarter.

Power markets look similarly closed. Electricite de France has three-quarters of the French electricity market; Spain has just two dominant operators; and Germany’s lucrative power market has been carved up between five big companies. In the UK, nine companies compete on relatively even terms.

Cross-border competition remains severely limited. In the gas sector, the big European companies tend to sign long-term bilateral deals with gas producers, most notably Russia’s Gazprom. In the electricity sector there are still very few interconnectors between national grids, and those that do exist are chronically congested. Partly as a result of this, wholesale gas and power prices vary widely between the different EU countries.

Neelie Kroes, the EU’s competition commissioner, has spent the last two years trying to find out why competition has remained so limited. She has launched dawn raids on various European power companies suspected of collusion, and she promises closer scrutiny of future energy mergers. But, as the energy paper rightly points out, competition policy alone cannot create a well-functioning European energy market. National governments and European energy companies need to play ball.

The Commission says that the fact that Europe’s big energy companies still control both production and distribution of energy is a serious impediment to competition. It therefore wants gas and electricity companies to sell their networks and pipelines. Knowing that this is controversial, it suggests an alternative option: a legal and de facto separation that actually works (unlike the current weak legal controls). Since regulation is key to making this second option work (and since a number of national regulators are rather too cosy with their clients), the Commission wants to shift regulatory powers to Brussels.

The comments from Paris and Berlin ranged from “unnecessary complications” to “expropriation”. So what are the chances that EU leaders will adopt the Commission’s package, or parts of it, at their March summit?

Germany, as the EU president in the first half of 2007, is chiefly responsible for brokering a deal. But Germany – with its big and powerful energy companies – is hardly suited to play the role of an ‘honest broker’. Worse still, Germany itself is divided about what to do. The environment ministry wants tough targets for emissions of greenhouse gases. Chancellor Angela Merkel backs this stance, not least because an intra-EU agreement would allow her to shine when the issue comes up at the G8 summit in June. The economics minister, Michael Glos, fears that higher environmental standards could erode German industrial competitiveness. But he will compromise – provided that German power producers can retain their cosy national oligopoly.

In an FT interview on January 12th, Glos said he would not completely rule out the Commission’s suggestions of ‘ownership unbundling’ and centralised regulatory powers – but only after all other options have been exhausted. So he is effectively defending the current system of (weak) legal unbundling and co-operation between national regulators. Germany is also having fierce internal debates about most other aspects of the EU energy agenda, ranging from the ‘right’ stance towards Russia to energy saving targets for cars and buildings. Chances are that Merkel will arrive at the EU spring summit perched precariously on a fragile national compromise.

But even if her hands were not tied, she would struggle to persuade pre-election France that energy market opening is a good idea. The merger between Gaz de France and Suez is still one of Paris’ pet projects. Unlike other big European gas companies, Gaz de France owns few production assets. Stripping out the French gas pipe network would make Gaz de France unattractive to Suez. EdF is one of Europe’s more efficient power producers, and with its strong home base it would do well in a more liberalised European market. However, EdF also provides pensions and welfare to several hundred thousand workers. It is highly unlikely that either of the big parties would risk a blow to national prestige and / or a showdown with the trade unions just ahead of presidential and parliamentary elections.

This leaves the UK as the only big country that could push hard for the Commission’s package – provided the British government can overcome its traditional dislike for the Commission. The UK is in a strong position since it has already done its homework on opening local power and gas markets, and since most Brits want tougher action climate change. Yet, London will face an uphill struggle to persuade the Germans and the French that open and flexible markets, rather than national champions, are the best guarantee for secure energy supplies.

Katinka Barysch is chief economist at the Centre for European Reform.

Tuesday, January 09, 2007

The Tories and human trafficking: Don’t play politics
by Hugo Brady

The British Conservative party kicked off the New Year saying they wanted to sign Britain up to a 2005 European convention that grants rights to the victims of human trafficking. Odd that the Conservatives should suddenly develop such a concern for humanity: only a few months before they wanted to scrap UK legislation giving effect to a related European convention on human rights for all British citizens.

Both conventions are products of the Council of Europe, a 46-country assembly that promotes democracy and human rights in Europe but does not have the EU’s legal and institutional muscle. The human trafficking convention calls for better national laws to prosecute the criminal gangs that engage in this modern form of slavery, and to protect the victims. So how come Britain is not already signed up? The reason is a clause in the convention requiring signatory countries to let the victims of trafficking stay in the country for 30 days, to recover from their ordeal and decide whether they will help police prosecute offenders.

British officials worry that some immigrants will falsely claim to be the victims of traffickers (the same way some file bogus asylum claims) so they can stay in the country. They worry this will create an immigration pull factor towards Britain. The Conservatives say such fears are exaggerated. Hardly a typical Conservative stance: illegal immigration is a subject of great concern amongst core Tory voters. The Tories want their support for the convention to help convince mainstream UK voters that they are the ‘nasty party’ no longer nor against international co-operation in principle.

The Conservative party should resist any temptation to play politics with this issue. Human trafficking is a savage form of modern slavery that generates massive profits for international criminal gangs. In Europe alone, over 100,000 victims are trafficked each year, mostly to where thriving markets in sexual exploitation exist in Austria, Belgium, Britain, France, Germany, Greece, Italy, the Netherlands and Spain. Gangs deceive, pressure or abduct their victims (mainly young girls) in their home countries and sell them on to be sexually exploited or, at best, used as slave labour abroad. The most unfortunate are raped, tortured or demeaned by various methods of disorientation such as being passed between several ‘owners’ to break their resistance to prostitution. And business is depressingly good. Human trafficking is the fastest growing criminal activity on the planet. A recent estimate from the UN Office on Drugs and Crime estimates that traffickers make annual profits of $7-$10 billion worldwide.

If the Tories are really serious about cracking down on this crime, they should support the more substantial work of the EU as it develops its crime-fighting role (which they oppose on instinct). In 2005, for example, Europol – the EU’s police office – helped to smash the biggest ever people-smuggling ring in the UK, led by ‘untouchable’ gang leaders Ramazan Zorlu and Ali Riza Gun. This gang smuggled tens of thousands of Turks and Iraqis into the UK. In 2006, a year later, phone tap evidence secured by Eurojust, the EU’s unit of prosecutors, from Belgium, Italy, the Netherlands and Austria, helped to put Zorla, Gun and the other big gang leader behind bars for a very long time. The Conservatives concern about the victims of trafficking is laudable. But they should have the courage and honesty to acknowledge where the real progress is made: in the EU.

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