Friday, October 24, 2008

How a new Irish government might save Lisbon

by Hugo Brady

The financial crisis is challenging many of our assumptions about the course of politics and world affairs. Gordon Brown – only weeks ago portrayed as nearing the end of his time as UK prime minister – has been elevated to European, even global leadership status. After years of pan-European financial integration, the EU is heading back to national banking systems, with heavy state involvement. And the French desire for a different kind of globalisation – considered either hopelessly vague or a form of Gallic envy a short time ago – might well be realised in the coming months. Cliché or not, these are interesting times indeed.

The crisis may have another unlikely outcome: it may save the Lisbon treaty, rejected by Ireland in a referendum last June. The French government, and many others, want the Irish to hold a second referendum, preferably next spring. But they greatly under-estimate just how difficult reversing the June decision is going to be. (In fact, the chances of a second referendum before next autumn are very slim, despite the difficulties this poses for the 2009 European Parliament elections and the appointment of a new European Commission.) They also believe – rightly in a sense – that the current government of Brian Cowen, Ireland’s taoiseach, is part of the problem, not the solution.

Ireland is faring worse than most other countries in the current economic turmoil. Burst housing and credit bubbles have placed incredible strain on public finances. The approval ratings of the current coalition – led by Cowen's Fianna Fáil party – are in free fall after it unveiled a hugely unpopular budget that includes the removal of free medical benefits for the elderly. The opposition accuses the government of punishing the vulnerable for the bankers’ mistakes. With only a thin majority to rely on, the collapse of the government is a possibility.

In a previous CER Insight, I wrote about how challenging it was for the Irish government back in 2002 to hold and win a second referendum on the Nice treaty.
See: Tough choices to avoid euro-paralysis, June 2008. One important – and overlooked – component was the general election held between the two votes. Though the Nice treaty issue was not prominent in the campaign, the change of government wiped the political slate clean and provided some legitimacy for the previous decision to be re-visited.

The chances of this happening in the case of the Lisbon treaty have suddenly increased. If the present government falls, there will be three options. There may be a general election. Or Fianna Fáil may form a new coalition with new partners. More probable is the formation of an alternative government, led by the largest opposition party, Fine Gael, backed up by the Irish Labour party and others.

A Fine Gael-led coalition government would still have a mountain to climb to convince the Irish electorate to say yes to Lisbon. First the new government would have to find a way to make clear to voters that sticking with the Nice treaty means Ireland is about to lose its automatic right to be ‘represented’ on the European Commission. Second, it would have to give more power to the Oireachtas – the Irish Houses of Parliament – to decide how EU policy is decided at home. (One idea is to include a special ‘EU auditor’ post in the Irish constitution as a watchdog on European matters.) Third, the government would probably have to secure revamped promises on old bugbears in Ireland’s relationship with the EU such as abortion and defence, as well as new ones like tax harmonisation and, possibly, the Charter of Fundamental Rights.

I have argued that all such guarantees should be consolidated into one protocol on ‘Ireland in Europe’ to make them more visible to the public. The Irish government may also propose a clause to be added to the state’s constitution that no Irish citizen may be conscripted in the army of a foreign power, to address a spurious but widely believed claim from the June campaign. These would appear as separate questions on the ballot in a second referendum. Lastly, the new coalition should bring home a promise, probably from the June 2009 European Council, that the slimming down of the European Commission (as foreseen in the Nice and Lisbon treaties) will not happen. There will be more opposition to this concession from other member-states than the Irish imagine, but the difficulty in securing it should give extra impetus to any new campaign at home.

The course of Ireland’s EU debate would depend on all these things happening at the right time. Even then, there would be no certainty of success. The current leader of the pro-European Fine Gael, Enda Kenny, seems a poor alternative to lead the government. And the more impressive leader of the Labour Party, Eamon Gilmore, has grave misgivings about voting on the same treaty a second time. If they manage to agree, the government will still have to find positive arguments to make the main text of the treaty acceptable to voters.

Ironically, the events of the past few months may help to build such a case. The Georgian war and financial crisis have shown the EU needs capable, coherent leadership more than ever. The treaty’s reforms to the presidency system – to make leadership of the EU longer-term and more stable – would go some way towards achieving this. Second, and more importantly, the crisis has underlined Ireland’s reliance on its membership of the EU and the eurozone; outside the euro, Ireland would have faced a run on its currency. Even though the country cannot be forced to leave the Union, a second referendum will inevitably raise questions over its future in the EU. On the other hand, a yes vote could presage a speedier economic recovery and a return to the good times.

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

Wednesday, October 15, 2008

Another Great Depression?

by Katinka Barysh

Many observers have drawn parallels between the current economic crisis and the Great Depression of the 1930s. However, the stock market collapse of 1929 did not directly cause what turned out to be the deepest and most prolonged recession of modern times, ultimately ending in the Second World War. The blame lies with misguided macro-economic policies and protectionist reactions, such as the infamous Smoot-Hawley tariff of June 1930, which contributed to a collapse in international trade. The downturn that is now hitting the US and EU economies will fuel protectionist reflexes. But unless western countries are prepared to tear up the rulebook of the World Trade Organisation, their room for manoeuvre is in fact limited.

Trade flows will of course be affected by the current crisis: domestic demand in the US, UK and other big economies is falling, companies cannot get the credit needed to finance exports and imports, and high energy prices have been pushing up shipping costs (although pressures are abating as oil prices fall). The Economist Intelligence Unit predicts that world trade will grow by only 4-5 per cent next year. That is a lot less than the average of 8 per cent recorded in the previous five years. But it is nothing compared with the Great Depression when real world trade flows contracted by around 14 per cent.

Surveys show that support for free trade among Europeans has been in decline for a couple of years, as people have become more concerned about globalisation, and in particular the rise of China. But overall, Europeans still hold rather benign views on international trade: over 80 per cent of Germans, French, Italians, Poles and Spaniards think that growing trade ties are, on balance, good for their country. Remarkably, in the traditionally more liberal UK the share is lower, at 77 per cent, and in the US barely over half, according to a Pew Global Attitudes Survey published earlier this year.

With many EU economies descending into recession and unemployment rising, enthusiasm for foreign trade will of course diminish. People fearing for their jobs and incomes are often happy to blame outside competition. The worry is that protectionist voices are growing louder around the world at a time when the multilateral trading system is severely weakened by the collapse of the Doha trade talks in July. However, while there is little chance of Doha – or any other ambitious trade deals – being concluded before economic conditions improve, the risk of a full-scale protectionist backlash appears small.

Most European countries trade more with their EU neighbours than with the rest of the world. Intra-EU trade is governed by the strict rules of the acquis, which does not allow any tariff or non-tariff barriers. The current recession will weaken EU countries’ commitment to state-aid rules, competition policy, as well as the liberalisation of services sectors and network industries such as energy. But the economic downturn would have to become truly catastrophic for trade barriers to re-appear within the EU.

The EU’s hands are also bound when it comes to trade with the outside world. Since the Great Depression, the world’s trading powers have conducted eight rounds of multilateral trade negotiations. As a result, tariffs on almost all manufacturing imports into the EU are low. And there are strict rules governing the use of ‘safeguard’ measures (to guard against surges in imports) and anti-dumping and anti-subsidy duties (to punish overseas producers that sell at artificially low prices). The EU could of course stretch, bend or even breach these rules to give temporary reprieve to, say, car companies, steel makers or clothing manufacturers (until a WTO court ruling resolves the issue). But such actions would probably only affect EU trade at the margins.

The failure of the Doha round does not substantially alter the trade regime of developed countries. However, unlike in the EU (and the US and Japan), developing countries are applying tariffs that are a lot lower (in some cases 20-30 per cent) than what they legally agreed to in previous trade rounds. Countries such as Mexico, India, South Africa or Korea could ramp up their tariff protection without breaching WTO rules. European politicians, and the Commission, could then come under pressure to retaliate. Moreover, a heavily Democrat-controlled US Congress could be a lot more hawkish on international trade. The main risk then is not that the rich countries will abandon their WTO commitments on a grand scale. It is that angry exchanges about economics poison the political atmosphere and make it more difficult for countries to work together on other issues, such as climate change.

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

Thursday, October 02, 2008

Scapegoating the US lets others off too easily

by Simon Tilford

Huge amounts have been said about the consequences of the credit crunch for the US and UK economies. They undoubtedly face major adjustments, and several years of very weak economic growth. There has also been trenchant criticism of spendthrift ‘Anglo-Saxons’ living beyond their means, derailing the global economy in the process. The US is a convenient scapegoat for politicians confronted with economic uncertainty, but it needs to be remembered that a number of European and East Asian economies benefited enormously from the credit boom. Indeed, it could not have happened without excess savings generated by the likes of China, Germany and Japan.

The credit booms in the US and UK, as well as in other countries such Spain and Australia, were not simply the result of poor commercial practices and policies in those countries. They were also the by-product of imbalances in the global economy. The US is regularly pilloried for running a large external (current account) deficit, for playing fast and loose with its currency, and hence for destabilising the global economy. This is misleading. The US did not cause the current problems all on its own. Those governments that believe a rising current account surplus is a symbol of national economic virility and competitiveness played a major role too. Indeed, their surpluses are the underlying cause of instability.

If some countries routinely run huge current account surpluses, others must run huge deficits. German and East Asian surpluses have to be invested somewhere and they got invested in housing and other assets in the US, UK and elsewhere. Criticism of the US Federal Reserve for pursuing an excessively weak monetary policy, and hence inflating asset prices is fine as far as it goes. But low interest rates were needed to encourage enough borrowing to soak up the excess liquidity produced by rising current accounts surpluses. Those condemning the US need to ask themselves where the global economy would have been without the demand generated by the US and other big deficit countries. China would certainly have grown much less rapidly and Germany and Japan would probably still be mired in economic stagnation.

Many in Germany, Japan and China argue that their dependence on the US is declining because the US accounts for a falling share of their respective current account surpluses. What they fail to notice is that the US has still been absorbing much of the liquidity that China, Japan and Germany have generated by running external surpluses with other economies. Furthermore, US demand has stimulated trade between other countries (for example, Chinese purchases of Japanese components or German machinery).

With credit conditions now tight and employment growth very weak, there will be a progressive narrowing of the US current account deficit (along with those of the UK, Spain etc). The governments that regularly criticise the US for the destabilising impact of its imbalances might not like the implications of this process. This unwinding poses a big problem for export-dependent economies. It exposes their domestic imbalances, which are just as much of a ‘problem’ as those of the US. An external surplus suggests that there are inadequate investment opportunities in an economy.

In a European context, it is imperative that the German government takes steps to rebalance the German economy. Domestic savings need to fall and investment needs to rise. Much is made of the competitive ‘gains’ the Germans have made in recent years and how this stands their country in good stead. Improved price competitiveness could help German firms to gain market share in the downturn, but collapsing export orders demonstrate that it will provide only so much support. Steep falls in investment in machinery and equipment and in purchases of cars in most of the country’s key export markets will hit the Germany economy hard next year.

The German finance minister, Peer Steinbruck, needs to spend more time thinking about how to address the country’s exceptionally weak domestic demand. Tax cuts would be a good first step. The German government needs to get over its obsession with fiscal probity. In the long-term, of course, fiscal discipline is a necessity, but at present it risks aggravating an already serious situation. China and Japan faces different challenges, but the underlying problem is one of excessive dependence on exports.

Unfortunately, there is little sign of any rethinking of economic strategy in these three economies. If anything, the problems experienced by the US have confirmed the belief that a competitive economy is one with a big external surplus and rising international reserves. This is bad news for everyone. Unless China, Germany and Japan make a net contribution to global demand, the world really could face a slump. Instead of gloating about the US’s comeuppance they should be considering what will drive their own and others’ economic growth.

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