Tuesday, September 29, 2009

Westerwelle for finance minister

by Katinka Barysch

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

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

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

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

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

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

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

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

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

Tuesday, September 22, 2009

Talk of ‘exit’ is premature

by Simon Tilford

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

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

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

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

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

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

Thursday, September 10, 2009

The dangers of Karzai’s re-election

by Tomas Valasek

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

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

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

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

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

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

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

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

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

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

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