Thursday, June 24, 2010

EU JHA co-operation: After Lisbon, reality bites

By Hugo Brady

EU policies on policing, justice and immigration were widely expected to take a big leap forward after the ratification of the Lisbon treaty. But interested outsiders should not assume that new powers for the EU’s institutions will translate automatically into more coherent European action in security and migration matters. In fact, the EU’s governments and its institutions face serious challenges in justice and home affairs (JHA) co-operation in the years ahead.

First, JHA policy-making is becoming more fractious and politically divided under the new treaty. Sensitive issues like terrorism or organised crime are now subject to the same rules as the EU's single market, meaning that the European Parliament can amend or block such decisions for the first time. This may not sound very radical. But for the EU's conservative interior and justice ministries – as well as key partners like the US – it is a brave new world.

Take terrorism. Last February, the European Parliament shocked both EU governments and the Obama administration alike by rapidly using its new powers to vote down the so-called Swift agreement. (This arrangement allowed US intelligence services to comb European financial transactions en masse for counter-terror purposes.) The parliament has since signalled that it will also vote down a modified version of the agreement which officials had hoped might soothe concerns over data privacy. Furthermore, EU officials worry that MEPs may reject any new security-related law on principle. There is an urgent need for EU governments and the parliament to find a new modus vivendi that allows them to work together constructively on such matters.

Second, EU countries complain that it is now harder under Lisbon to project a single voice in international fora when law and order and immigration issues are discussed. Officials are currently at a loss to know who takes the lead on terrorism or corruption issues in, say, the UN or OSCE. Is it the EU's six-month rotating presidency, the European Commission or the embryonic external action service? Although the Commission would bitterly oppose such a move, it should be up to the High Representative for foreign policy to decide in future who is best placed to lead the EU's external representation in these areas.

Third, the Commission's justice and security directorate, which has drafted most JHA legislation since 1999, is set to be divided in two. The split – into separate home affairs and justice departments – is largely at the behest of Viviane Reding, the EU's firebrand justice commissioner. Reding wants to use her new directorate to re-balance the JHA policy area which she believes has been hitherto too pro-American and too security-focused.

The decision to split up the Commission's JHA directorate is probably a mistake. Part of its added value in security and migration matters was the ability to bring all the relevant policy elements – policing, justice, immigration – together under one roof. There is also a danger that the split could result in more in-fighting and a loss of shared purpose. Better checks and balances were needed in EU internal security co-operation. But these have now been provided in the guise of a more powerful parliament and the extension of the jurisdiction of the EU's Court of Justice over all JHA legislation.

Lastly, despite new powers under the treaty, there is a dearth of really strong ideas from either the governments or the institutions about how the EU's JHA agenda should develop over the next five years. EU governments have recently agreed both an 82-page list of proposals for improving JHA co-operation (known as the Stockholm programme) and a wide-ranging ‘internal security strategy’. But the fact that these largely lack substance hints that the future of European co-operation on security and migration issues will centre on consolidating existing achievements rather than launching bold new initiatives.

One priority is to safeguard the EU’s Schengen area of passport-free travel. Schengen ranks alongside the euro as one of the EU's most tangible achievements. Like the euro, each Schengen country relies largely on assurances of good faith from others in the club, in this case that the common border is being maintained properly. But not all Schengen members are trusted equally. French police are increasing their spot-checks on cars crossing the border from Spain, for example, while Finnish border guards routinely check passports of non-EU travellers en route from Greece. To make the passport-free zone work properly, EU countries must agree a more transparent system for verifying border standards. They must also ensure that Romania and Bulgaria – both chomping at the bit to join – are not allowed in prematurely until they have carried out thoroughgoing reform of their police and judiciaries.

The gap between rhetoric and reality in the Schengen area should serve as a warning against future hubris. The EU’s new powers in policing, justice and immigration will only be a success if they result in the member-states adopting policies that seriously address current security and migration challenges. We will soon know whether a vague new treaty, a divided Brussels bureaucracy and a truculent European Parliament will help or hinder that ambition.

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

Tuesday, June 15, 2010

The eurozone retreats into a beggar-thy-neighbour cul-de-sac

by Simon Tilford

Almost every member of the eurozone is rushing to slash public spending. While there is no doubting the scale of the fiscal challenge, the eurozone economy is not strong enough to cope with the contractionary effects of a generalised budgetary tightening. And if the eurozone falls back into recession, there will be no chance of putting public finances on a sustainable footing. Furthermore, excessive austerity in Europe will make it even harder to bring about the necessary rebalancing of the global economy, risking a protectionist backlash in the US. Unfortunately, these risks will receive scant attention when European leaders come together for this week's summit in Brussels.

Eurozone policy-makers appear to believe that fiscal policy has no impact on levels of economic activity, even when private demand is as weak as it is in Europe. Of course, some eurozone economies – Greece, Portugal and Spain, for example – have little option but to cut now. However, those member-states running big trade surpluses with the rest of the currency bloc need to hold off tightening fiscal policy until their domestic economies are growing sustainably. The German government believes it is leading by example in embarking on a severe round of budget cuts. But this is the last thing the eurozone needs at this point and demonstrates an alarming parochialism. The fiscal crisis cannot be solved without economic growth. And the eurozone will only return to decent economic growth if the bloc's surplus economies, in particular Germany, start to consume more.

The German economy is very unbalanced. The weakness of domestic demand (a reflection of an extremely high savings rate and years of eye-watering wage restraint) means the country is running a massive current account surplus with the rest of the eurozone. This surplus is a drag on the eurozone economy. Germany's austerity programme all but guarantees very weak domestic demand in the country and effectively ends any chance of narrowing its trade surplus with the rest of the currency union. But unless this surplus narrows substantially, it will be very hard to get the eurozone economy growing, and all but impossible to address the eurozone's fiscal crisis.

Germany's Chancellor Merkel argues that her government's cuts will make Germany more competitive (and hence boost its export sector). In short, Germany's economic growth strategy is predicated on a further increase in its exports relative to its imports. For a country with a huge external surplus and a relatively sound fiscal position to be cutting public spending at this point is highly irresponsible. Germany is defining its economic policy purely in national terms without consideration for the impact on the sustainability of the common currency or the outlook for the broader international economy.

After years of relying on demand generated elsewhere in Europe, Germany now needs to become a source of it. The country is sending a damaging signal to the financial markets – it does not care about economic growth. No-one should be surprised that bond spreads (the difference in government borrowing costs) within the eurozone have widened sharply since Germany announced its budget plan. Instead of some masochistic rush to see who can cut by most, the eurozone needs a co-ordinated response. Germany, whose borrowing costs have fallen to just 2.5 per cent, should be doing all it can to boost its domestic demand, not depress it further.

The Netherlands' external surplus – relative to the size of its economy – is as large as Germany's, and the Dutch rely even more than the Germans on trade with other eurozone economies. But assuming that the conservative People's Party for Freedom and Democracy (VVD) succeeds in forming a coalition government with Geert Wilders' Freedom Party (PVV) and the centre-right Christian Democratic Appeal (CDA), Holland will adopt the same beggar-thy-neighbour strategy as Germany. It is possible that fiscal austerity and further wage restraint will work for Germany and the Netherlands, on the assumption that their firms can take further market share within the eurozone. But this is a zero-sum game: it is not as if every economy can allow domestic demand to stagnate and rely on exports. One country's surplus is another's deficit. They are banking on being able to export the consequences of their austerity to others.

Nor are the Europeans giving any thought to how their austerity (and neglect of economic growth) will impact on the rest of the world. An uncoordinated and premature fiscal contraction against the backdrop of a stagnant eurozone economy will prove contractionary for the world as a whole. The weakness of economic growth will prevent a rise in eurozone interest rates, which will keep the euro weak and boost the exports of those member-states, such as Germany, that trade a lot internationally. As a result, it will throw a further obstacle in the way of the urgently needed rebalancing of the global economy away from its excessive reliance on the US consumer. This reliance can only be reduced if surplus economies in Europe and Asia consume more, not less.

With China resolutely refusing to reduce its export dependence and Europe retreating into a destructive beggar-thy-neighbour cul-de-sac, it will not be long before protectionist sentiment in the US rises. And this will be understandable, despite the inevitable condemnations by European governments.

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

Friday, June 11, 2010

Shale gas and EU energy security

by Katinka Barysch

Will unconventional gas solve Europe’s energy security problem? Many EU member-states rely a lot on Russian gas; in the case of some Central and East European countries the dependence is total. What if these countries suddenly discovered that they themselves sit on huge gas reserves? They should not hold their breath. Unconventional gas will make a big difference to the EU’s energy security – but perhaps not in the way that shale gas enthusiasts expect.

Unconventional gas (UG) is gas trapped in rock formations. The technology now exists to get this gas out. It involves drilling into the rocks and then blasting in water mixed with chemicals to extract the gas. In the US, the new technology has been a ‘game changer’. US production of shale gas (one form of UG) tripled in 2004-08, allowing America to overtake Russia as the world’s biggest gas producer. The US is now self-sufficient – which has enabled it to mothball its terminals for importing liquefied natural gas (LNG, gas that is frozen to liquid form and transported by tankers).

Is something similar about to happen in Europe? Some energy experts estimate that Europe’s UG reserves could be several times bigger than its conventional gas reserves. The likes of Exxon, Chevron, Shell and ConocoPhilips have already snapped up land plots in places that look promising for UG exploration, most notably in Poland, Sweden and Germany.

Should the EU scrap expensive and complicated diversification plans, such as the proposed Nabucco pipeline to import Caspian gas, and simply wait for the UG boom to happen in Europe? At a recent energy security conference in Vienna, gas experts, geologists and industry representatives urged caution.

* Estimates of European UG reserves are based on geological surveys that were not carried out with UG in mind. Only drilling holes in the ground will show whether the geology is indeed suitable for producing and commercially exploiting UG. So far, there has been very little drilling in Europe. A couple of wells in Hungary have been abandoned as unpromising. In southern Sweden, environmental concerns may make gas extraction impossible irrespective of whether the geology proves suitable. In Poland, the country considered most promising, not a single well has been drilled so far.

* In the US, it was small, technology-savvy energy companies that made the shale gas boom possible. The giant international oil companies have only recently joined the fray by buying up smaller companies with the right technology and know-how. Europe’s energy markets are still dominated by national champions. There are few nimble, innovative players. Expertise and infrastructure for UG development is scarce. Engineers are being flown in from Texas or Pennsylvania. In the whole of Europe, there are only 67 land rigs (the structures used in drilling for UG), compared with thousands in the US.

* US legislation tends to be rather kind to oil and gas companies. For example, the law that regulates the safety of drinking water has an intentional loophole that excludes ‘fracking’, the technology used to blast water and chemicals into rocks. Only now, with the shale gas boom in full swing, are environmental concerns mounting in the US. In Europe, by contrast, exploration starts with these concerns already being widely discussed. UG production needs huge amounts of water and, more importantly, uses chemicals that seep into the ground (usually at a depth of several thousand metres but that could store up problems in later years). Some UG drillings have made the earth shake near-by.

* Big UG sites require lots of space (they consist of scores of rigs close together), as well as new roads, reservoirs and pipelines. Planning restrictions in Europe are often tight, partly because the continent is more densely populated: typically 250-400 people live on each square kilometre in EU countries compared with 80 in the US.

* In the US, whoever owns a plot of land owns the resources beneath it. In EU countries, the resources below surface usually belong to the state. There will be no ‘poor farmers to shale gas millionaires’ stories in Europe. If only big energy companies gain, UG production could be less socially acceptable. Moreover, those companies looking for UG in Europe complain that local regulators and environment ministries have no experience with awarding the necessary licenses. Progress can be frustratingly slow.

* The US shale gas boom happened at a time when gas prices were rising and most analysts predicted steadily growing gas demand for years ahead. The situation is very different now. The European market is over-supplied at the moment, prices on the 'spot' market for short-term gas contracts have fallen significantly, and the medium-term outlook is highly uncertain. “High prices allowed us to make lots of mistakes when building up the US shale gas industry,” says one gas expert. “With depressed prices and demand in Europe, we have to be profitable straight away.” Because of the smaller scale of production and the dearth of infrastructure and expertise, it will probably cost two to three times as much to produce UG in Europe than in the US. So it is not clear whether European UG will be able to compete with LNG and pipeline gas.

Whether and when Europe’s first UG projects will become profitable is still anyone’s guess. One manager who runs a UG project in Poland says that in a best case scenario his company would need around three years to drill exploratory wells, another three to determine whether resources are commercially viable and yet more time to figure out how to get supplies to customers. One person involved in the Swedish exploration says he would expect commercialisation in around ten years.

“In Europe, unconventional gas is not a game changer,” concludes one executive of a big EU gas company. UG will most likely develop in Europe, but a repeat of the US shale gas boom is doubtful. The good news is that regardless of UG developments in Europe, the shale gas boom in the US is changing the global, and European, gas market.

Scores of new LNG terminals are being constructed in the Gulf, Africa and elsewhere. But the US LNG market has disappeared almost overnight. Other than Asia, that only leaves Europe as a destination for rapidly growing amounts of LNG. Already, market prices for LNG have collapsed in Europe, which, in turn, has forced pipeline gas suppliers such as Norway’s Statoil and Russia’s Gazprom to re-negotiate contracts with their biggest European customers. LNG imports mean more competition in a market hitherto dominated by 30-year contracts with fixed volumes and prices linked to the international oil price. That system is crumbling. Gazprom and other suppliers will have to make a bigger effort to be cheap and reliable – and that before even a single molecule of unconventional gas has been produced on the European continent.

Katinka Barysch is deputy director of the Centre for European Reform

Friday, June 04, 2010

Eurozone governance: Why the Commission is right

By Philip Whyte

The collapse of market confidence sparked by the parlous state of Greece’s public finances is forcing the EU to review how the eurozone is run. This is entirely welcome. The crisis has cruelly exposed fault-lines in the system of governance – and confidence is unlikely to be restored unless these flaws are rectified. There are profound disagreements, however, about what these flaws are. Broadly speaking, there is a narrow view and a broader one. If the eurozone is to extricate itself from its current mess, it is essential that the broader prevail.

The narrow view – advanced by Germany – holds that the eurozone’s difficulties are the result of government irresponsibility. The way to restore market confidence, then, is to force wayward governments, starting with Greece’s, to mend their ways by repairing their public finances. Errant behaviour, moreover, must be discouraged by strengthening fiscal rules and imposing tougher penalties on miscreants – for example, by withholding EU structural funds, suspending countries’ voting rights, or, in extremis, expelling rogue states from the eurozone.

Germany’s view is not totally wrong. Greece’s behaviour has been egregious and the incontinence of its government has played a key part in the country’s difficulties. The eurozone’s budgetary rules have been repeatedly flouted by member-states (including Germany). Public finances are weak and need to be strengthened over the medium term. Eurozone governments have to reassure markets that they are not profligates. In short, crafting a more credible framework for fiscal policy in the eurozone must form part of the task of reconstruction.

The problem with Germany’s position, however, is that it is one-eyed. The eurozone’s problems are not reducible to budgetary indiscipline alone. In the years leading up to the global financial crisis, Spain was running a budget surplus, not a deficit. The weakening of the country’s public finances since 2008 is not, therefore, connected to government irresponsibility before the crisis. Nor will budgetary austerity solve Spain’s underlying economic problems, which are high levels of private-sector debt and a dramatic a loss of trade competitiveness.

The Commission is therefore right to argue for a much broader reform of the way the eurozone is run. The proposals that it published on May 12th do not neglect the need for strengthening the weakened Stability and Growth Pact, or for deepening fiscal policy co-ordination. But the Commission also wants to beef up the Eurogroup’s surveillance of macroeconomic imbalances. This surely makes sense. Imbalances between members cannot simply be ignored – particularly in the absence of a fiscal union to transfer funds to depressed areas.

Nevertheless, some countries – Germany among them – are reluctant to allow the question of imbalances to get more airtime in the Eurogroup. Not coincidentally, enthusiasm for discussing imbalances is weakest among the countries that run large trade and current-account surpluses. This reticence is as easy to understand as it is impossible to justify. The countries believe their surpluses are badges of their ‘competitiveness’. As they see it, it is for deficit countries to become fitter, not for surplus countries to become flabbier.

The position of the surplus countries, however, is misguided. To start with, trade surpluses tell us nothing about economic dynamism. German politicians often liken their country to a toned athlete who is trouncing the international competition. They should think again. Yes, Germany has world class companies producing first-rate products. But productivity growth in recent years has been so weak that output per head is now below the eurozone average. The only reason German unit labour costs have fallen is that real wages have too.

The surplus countries are also incoherent. They condemn irresponsibility in the deficit countries, yet remain wedded to their own surpluses. This makes no sense. Deficits and surpluses are umbilically linked: one entails the other. Only in an Alice in Wonderland world would it be possible for the trade gap in ‘Deficit-land’ to decline without an offsetting adjustment in ‘Surplus-land’. Why do surplus countries struggle to accept this? The answer must be that they have grown reliant on the foreign irresponsibility that they like to decry.

If European policy-makers are to restore the financial markets’ flagging faith in the eurozone, they must persuade investors that the region is not heading for a prolonged economic slump. The Commission’s proposals on eurozone governance rightly identify many of the key elements that would provide such reassurance: a rebalancing of demand within the eurozone from the deficit to the surplus countries; supply-side reforms to raise the region’s long-term growth potential; and credible plans for fiscal consolidation over the medium term.

The danger, however, is that the minimalist German view will prevail, with reforms to eurozone governance focusing primarily on fiscal policy, the Commission’s proposals on macroeconomic surveillance being emasculated, and supply-side reforms being taken as seriously as they were under the Lisbon agenda (that is, not very). Should this scenario transpire, the eurozone could find itself condemned to permanent crisis, with chronically weak growth across the region as a whole, and politically destabilising debt-deflation in the south.