Friday, February 27, 2015

The Commission’s energy union ‘strategy’: A rebranded work programme

The European Commission’s grandly-titled ‘Framework strategy for a resilient energy union with a forward-looking climate change policy’ was published on February 25th. It contains sensible proposals. If all were enacted, EU energy and climate policies would be significantly improved. But they will not all be enacted – at least not in the lifetime of this Commission. A credible strategy needs priorities, resources and a clear timetable. This publication identifies only one very general priority (‘obey the rules’) and one very specific one (extend the energy market in South-East Europe). A forward-looking climate policy initiative would contain some new proposals: this paper does not. This paper is essentially a restatement of the Commission’s existing work programme, now rebranded as an energy union.

European integration has always been rules-based. Yet the Commission identifies “the implementation and enforcement of existing EU legislation” as the first priority of its new strategy. Specifically, it promises to insist that member-states implement the third energy market package. This is sensible, but not new: the Commission has been insisting that national governments implement this package ever since it was adopted in 2009.

The paper reiterates the Commission’s desire to centralise regulation. “Today, the European Union has energy rules set at the European level, but in practice it has 28 national regulatory frameworks. This cannot continue.” Whatever the Commission thinks, this will continue. In the late 1980s the Commission proposed a European Environment Agency to regulate Europe-wide. When the agency was created in 1990, national governments had changed its role to one of collection and dissemination of information: more of an environmental Eurostat than a green policeman.

The Commission’s attempts to centralise energy regulation face the same strong opposition in the Council. In 2009, as part of the third energy package, the EU set up the Agency for the Co-operation of Energy Regulators (ACER). As the name suggests, this is a forum for discussion between national regulators, not a body that actually regulates EU markets. In the Energy Union paper the Commission says that ACER should “carry out regulatory functions at the European level”. The Council is not likely to agree.

Apart from the statement that obeying existing rules is its first concern, the Commission identifies only one other priority: the integration of Central and South-Eastern European energy markets into the wider European market. It promises that it “will take concrete initiatives in this regard as an urgent priority” – though does not reveal what these might be. Central and South-Eastern European countries are indeed very important for Europe’s energy and climate policies: CER will publish a paper on this subject next month. But a credible strategy for an energy union would have set priorities for shaping the whole of Europe’s energy market, not simply identified how that market should be enlarged. The strategy paper ends with a section called “the Energy Union in 15 action points”. Several of these have bullet points, so in total there are 27 items on the Commission’s ‘to do’ list. President Jean-Claude Juncker and his team have not said which of these it considers to be the most important. It is very unlikely to be able to do all of them.

So what should be the priorities for building an energy union? First should be energy efficiency. The Commission should propose that most new power stations must be combined heat and power. Heat that is produced when anything is burnt should be used rather than being wasted up cooling towers. The Commission suggested this as part of the 2012 ‘energy efficiency directive’, but the Council rejected the proposal. The Commission should try again.

The second priority should be the construction of an efficient Europe-wide electricity grid. An improved and extended grid would enable member-states to harness much more renewable energy, so increasing energy security and reducing carbon emissions. With a Europe-wide grid, the EU could generate wind and tidal power in the north of the continent, and wind and solar power in the south. Electricity could be transmitted north to south during nights, when solar panels do not generate, and south to north during days when the wind is not blowing. (However good the grid, it cannot cater for all scenarios. Electricity storage or gas power stations as back up capacity will be required to ensure that the lights stay on during calm nights.)

The third priority should be energy subsidy reform. In 2009 the G20 promised to end inefficient fossil fuel subsidies. Little progress has been made since then. The paper notes that “collectively, the EU spent over €120 billion per year – directly or indirectly – on energy subsidies, often not justified”. It declares that “environmentally harmful subsidies need to be phased out altogether”. But all it proposes to do on energy subsidies is an “analysis of energy prices and costs (including taxes and subsidies)”. This is just a delaying tactic. The International Energy Agency and the International Monetary Fund have both conducted this analysis, and published the results, in the last two years. There is no need for more analysis. There is a need for action. The Commission should use its state aid powers to reduce existing subsidies to coal power stations, and prevent new subsidies to coal (other than for carbon capture and storage demonstration projects). In July 2014, the Barroso Commission gave state aid clearance to the UK for new subsidies to existing coal fired power stations. London argued that this was necessary to provide a back up for intermittent renewables. Gas power stations are more economically efficient in this role, and much less polluting. The Juncker Commission should reverse the state aid clearance for new subsidies to old coal.

The fourth priority should be diversification of gas suppliers. On the day that the Commission published its paper, Russian president Vladimir Putin threatened to cut off gas supplies to Ukraine. This was predictable. The paper stresses the need for Europe to reduce energy imports and dependence on single suppliers of hydrocarbons. (Russia is not named in this context; it does not need to be named.) The suggestion that Council President Donald Tusk made when he was Polish prime minister – that member-states should club together to become single gas buyers when negotiating with the Kremlin – is given a polite nod but nothing more: it will be “assessed”.

Instead, the paper stresses the need to find alternative suppliers of gas. The Commission promises to work on gas interconnectors within the EU. These are necessary, particularly for countries which import most or all of their gas from Russia, and are likely to receive EU funds. The Commission will also work on the Southern Gas Corridor to bring gas from Central Asia to Europe. And it will “encourage” Central and Eastern European and Mediterranean countries to build liquefied natural gas (LNG) facilities, as Northern European countries have done. More LNG facilities would be good for energy security. They would also be good for climate action. The greenhouse gas footprint of LNG is higher than that of piped gas, because of the energy used during its transformation. But even when turned into liquid and then back into gas, natural gas is less bad for the climate than coal is. 

So, the energy union priorities should be energy efficiency through combined heat and power, an improved and expanded electricity grid, reform of energy subsidies and diversification of gas suppliers. What proposals should be added to achieve forward-looking climate policies? First, the Commission should propose an Emissions Performance Standard (EPS), to limit the amount of carbon dioxide that power stations and industrial plants are allowed to emit. The European Parliament tried to include an EPS in the 2010 ‘industrial emissions directive’. The Barroso Commission blocked Parliament’s effort on the grounds that a regulatory approach was inconsistent with the market-based approach of the Emissions Trading System (ETS). This line of reasoning is not convincing. It is perfectly possible to combine an EPS with emissions trading, as the Californian government shows. What is more, emissions trading in Europe has not delivered a significant or predictable carbon price, which is needed to channel investment into low-carbon energy. Rejecting a new measure because it is (allegedly) inconsistent with an unsuccessful existing policy is not sensible. Last month, the Juncker Commission agreed to consider an EPS. But the Energy Union strategy does not mention it.

Second, the Commission should propose financial support for modern nuclear power technologies which will be even safer than existing nuclear stations and which can use radioactive waste and plutonium (of which the UK and France have large stockpiles) as fuel. The Commission accepts that the EU should maintain technological leadership “in the nuclear domain”, but argues that this should include the International Thermonuclear Experimental Reactor (ITER), the nuclear fusion project in France. ITER is a partnership between the EU, China, India, Japan, Russia, South Korea and the United States. The EU is ‘leading’ in the sense that the money from the EU Budget covers 45 per cent of the total; the other six partners cover just 9 per cent each. Billions have already been spent, but the earliest date that nuclear fusion could generate electricity commercially is 2050. ITER is a waste of money, and should be abandoned. The EU should instead invest the money in nuclear technologies which could contribute to energy security and decarbonisation in the 2020s.

Third, the Commission should spend more of the EU Budget on innovative renewable energy technologies. Wave and tidal power could make a major contribution to European electricity. But these technologies are still at the development or demonstration stage, so need significant grants. The Commission should transfer money from the transport part of its Connecting Europe facility into research and development of new renewables. 

Fourth, the Commission should promote a price floor for the ETS. Carbon trading has two objectives: cap the total amount of greenhouse gas pollution, and put a price on carbon so that more investment goes into low-carbon energy sources and less into dirty coal. Greenhouse gas levels are below the cap which the ETS sets – though this is due more to the economic downturn than to the ETS. But the current carbon price (around €7 per tonne of carbon dioxide emitted) is far too low to have any significant impact on investment decisions. The Commission should propose a minimum price at which allowances can be traded. The price floor should be introduced at €30, and go up each year.

Juncker’s Commissioners regard energy as an issue on which ‘more Europe’ is needed. They are not alone in thinking this: Finnish prime minister Alexander Stubb made the same point at a CER event in October 2014. The energy union paper says that national policies provide insufficient predictability for potential investors. EU regulations are more stable than national regulations are, because they are difficult to change once agreed. However, attempts to alter the tier of government at which policy is made – from member-state to EU level or vice-versa – cause more unpredictability and so increase the cost of capital. The Commission estimates that “over €1 trillion needs to be invested into the energy sector in the EU by 2020”. This at a time when the European economy is weak. The Commission, Parliament and national governments must not allow inter-institutional arguments to increase the price tag. They should focus on energy and climate issues, not on constitutional squabbles.

President Juncker promised to lead a more political Commission. Sadly, the energy union framework strategy is not political enough. It is too bureaucratic and too timid, and needs more focus.

Stephen Tindale is a research fellow at the Centre for European Reform.

Monday, February 23, 2015

Reduced to rouble? An update on the Russian economy

Recent events in Ukraine have shown that Russia is determined to change the balance of power in Europe. Whether Vladimir Putin can be stopped by diplomacy or sanctions remains an open question (and is the subject of a forthcoming CER policy brief). Russia’s economy, however, is in deep trouble. Although the oil price and the rouble have stabilised, the Russian economy will go through a long, deep and painful recession as high interest rates and poor access to finance hits investment, inflation erodes customers’ disposable incomes and the government tightens fiscal policy. A renewed fall in the oil price and the rouble would be likely to lead to a severe crisis, as Russia’s foreign reserves are dwindling, and renewed capital flight could lead to the imposition of capital controls. The problem is that a collapse and subsequent bailout of Russia is not in the interest of the West.

Putin’s first decade in power was underpinned by rising oil prices, which allowed a rent-seeking elite to earn fortunes from Russia’s mineral wealth. As a result of the resource boom, the rouble’s real effective exchange rate (which takes Russia’s high inflation into account) rose strongly from 1999 to 2008. This made non-resource export industries uncompetitive – a common phenomenon of resource-rich countries called ‘Dutch disease’ (see chart 1).

Chart 1: The oil price and Russia’s exchange rate

Source: Federal Reserve Economic Data (FRED)
Notes: The nominal effective exchange rate weighs all the exchange rates of the rouble with other currencies by the share of Russian trade with these countries. The REER adjust these exchange rates for the difference in inflation between pairs of countries.

Ordinary Russians also saw their incomes grow, but the rule of law weakened and corruption flourished: Russia ranked 136th out of 172 countries surveyed by Transparency International in 2014. Long before the hammer blows of sanctions, falling oil prices and a collapsing currency, the Russian economy was stagnating. Now Russia is in recession. In January, confidence indicators in the service and manufacturing sectors dropped to new five-year lows, pointing to a large contraction in activity. The IMF predicts a contraction of 3 per cent of GDP in 2015, but it could be much worse. 

The two main reasons for the recession are the fall in the oil price and the decline in the value of the rouble (see chart 1), which are closely connected. Lower oil revenues (in US dollars) mean less demand for the Russian currency. In addition, the loss of confidence in the Russian economy, combined with financial sanctions and political uncertainty, has led to capital flight as wealthy Russians and foreign investors dump rouble assets. That is not only leading to a collapse in investment, which further weakens the economy, but also exacerbating the fall in the currency. Overall, $151.5 billion of private capital left Russia in 2014. To put that figure into perspective, foreigners held direct and portfolio investments in Russia in the order of $477 billion and $225 billion respectively (at the end of September).

The Russian central bank has intervened heavily to defend the rouble (see chart 2). At the end of January 2015, Russia had $376 billion in reserves, down from $499 billion a year earlier. Nearly half of the remaining reserves, however, are not under the full control of the central bank. Two sovereign wealth funds, the Reserve Fund (current foreign and domestic assets of roughly $88 billion) and the National Wealth Fund of the Russian Federation ($78 billion, down from $89 billion a year ago), hold large reserves and are under the control of the Kremlin. 

In recent weeks, the oil price, and as a result the rouble, have stabilised and somewhat recovered from their lows. But the risk of a further fall in the rouble is still large. If investors expect that currency reserves will run out and that the central bank will have to impose strict capital controls to stop outflows, investors and Russians might opt to reduce their exposure to rouble assets quickly. And any capital controls would be a major obstacle to foreign investment in Russia.

Chart 2: Currency interventions by the Russian central bank
Source: Bank of Russia

One negative impact of a falling rouble is inflation. Food prices in particular have risen dramatically in recent months, in part because of Russian counter-sanctions on food imports, which were imposed on August 6th 2014 (see chart 3). Such imported inflation lowers the real incomes of households; as a consequence, they are spending less on Russian goods, hurting the economy.

Chart 3: Inflation in Russia
Source: Federal Reserve Economic Data (FRED)

Another negative effect of a falling rouble is high interest rates. In an attempt to stabilise the currency in mid-December, the Bank of Russia raised its key rate to 17 per cent. With non-food inflation at 9 per cent, that means that real interest rates are prohibitively high at around 8 per cent, which is depressing consumption and investment. This is a classic dilemma of emerging markets in crisis: the central bank is trapped between having to stabilise the currency by means of higher interest rates and helping the wider economy, which would benefit from lower rates. The central bank cut interest to 15 per cent in late January, but this will only marginally lower the negative impact on the domestic economy.

The final problem of a falling rouble is that it causes the value of debt in foreign currency to balloon. The current external debt of banks and firms stands at $600 billion. It has fallen by $130 billion over the past six months, as international investors were unwilling to roll over maturing debt. But calculated in roubles, the foreign debt increased from 24.9 trillion to 33.8 trillion over that period. In 2015, these banks and firms have to repay $110 billion in 2015, and another $53 billion in the first nine months of 2016 (see chart, late 2015 and 2016 data quarterly). Russia’s current account surplus, from which that external debt could be repaid, is just below $60 billion a year – and bound to fall because of the decline in the oil price. This means that Russia will need to run down foreign currency assets in 2015 to cover the difference.

Chart 4: Repayment schedule of Russian external debt
Source: Bank of Russia

Chart 5: Russia’s current account surplus in million USD
Source: Bank of Russia

There could be one silver lining: a weaker currency benefits exporters. But business surveys find that manufacturers have suffered from declining export orders for their products for 17 months in a row – including the last couple of months during which the fall in the rouble would be expected to have some positive effect on export orders. One reason is that Russian manufacturers often supply investment goods to the global energy sector, which is suffering from falling energy prices. Another reason is years of under-investment in other sectors of the economy. 

Falling oil prices have hit the state budget hard. Although President Putin has said lower oil prices are not “a tragedy”, Russia relies on fossil fuel revenues to finance half its budget. Russia’s 2015 budget was originally based on oil prices of $100 a barrel, but the government currently expects an average price of just $50, which given average market forecasts of around $55 for 2015 is reasonable. Since military spending is forecast to increase, the government must make big cuts elsewhere. Such fiscal retrenchment will further depress economic activity. The Russian government will struggle to borrow from abroad: one of the three main rating agencies, Standard & Poor’s, has already downgraded Russian government bonds to non-investment grade status (also known as ‘junk’), and the rating of the other two, Moody’s and Fitch, are just a whisker above the threshold. 

EU and US sanctions have cut off some Russian banks and companies from direct access to western financing. Some key companies and banks now need to turn to the central bank and the government for funding, putting further strain on Russia’s foreign exchange reserves. But western finance is also hard to tap for those firms and banks that are not among the sanctioned, as western banks are afraid to fund them, fearing that Russia’s deteriorating economic situation or potential further sanctions will lead to future losses. Even if sanctions are eventually lifted, fear of a repeat scenario could impair Russia’s access to international capital markets for years to come. 

The downgrade of government bonds also has knock-on effects for banks and firms in Russia, as a weaker sovereign rating usually leads to lower ratings for banks and firms as well. This further impairs their access to funding. Fitch, for example, downgraded 13 firms in mid-January, following the downgrade of the Russian government. The strained funding of banks will induce them to tighten lending conditions for companies and households. The most recent bank survey shows that credit standards tightened considerably across the board in the third quarter of 2014, and will have tightened further since then.

Chart 6: Bank lending conditions for Russian firms and households
Source: Bank of Russia
Notes: The chart shows the balance of answers of banks to the question of whether they have loosened or tightened credit standards.

The recent stabilisation of the oil price and the rouble gives Russia temporary relief from the acute economic and financial pressures at the end of 2014. But the country’s considerable foreign debt, high inflation and real interest rates, restrictive access to finance for businesses and cuts in public spending, will lead to a long and deep recession. A renewed fall in the oil price and the rouble could lead to intensifying capital flight and the imposition of capital controls. What is more, a further fall in oil revenues for the Russian government and higher inflation, especially in food prices, would lead to steep falls in living standards of ordinary Russians, of whom more than 15 million already live below the poverty line.

A Russian economic collapse on the scale of the late 1980s (also a time of low oil prices and high defence expenditure), would give the West a difficult dilemma. On the one hand, the world cannot afford a failed state with nuclear weapons; and political leaders in the West will be susceptible to arguments that Russia is ‘too big (and dangerous) to fail’. On the other hand, bailing out Russia under any version of its current leadership and system looks very unattractive: as in the 1990s, much of the bail-out money would end up helping the elite both to stay in power and further enrich itself. European policy-makers should be prepared to target support on those parts of the Russian economy that might at some point become the backbone of a stable middle class in Russia – and they should hope that the oil price does not take another deep dive.

Jennifer Rankin contributed to an earlier version of this insight. I am grateful to Ian Bond for guidance on Russian politics.

Christian Odendahl is chief economist at the Centre for European Reform.

Friday, February 20, 2015

No, we can’t: Why Podemos is not Syriza

2015 will be a hectic year for the Spanish electorate. Over the next few months, Spain, a decentralised state with 17 different regional parliaments, will hold four different elections: to the Andalusian Parliament in March; regional and local elections in the rest of Spain in May; to the Catalonian Parliament in September; and a general election no later than December. All eyes are set on one party: Podemos (‘We can’), the rising star of the Spanish political landscape. Does Podemos stand a real chance of taking power? And what does Podemos really want?

Podemos’ origins are rooted in the 2011 indignado (indignant ones) movement which conveyed some citizens’ weariness with the Spanish political and economic situation and prompted many to vent their outrage on the streets. These protestors did not represent any particular political force. Critics accused them of not having a clear message, of lacking leadership and of staying out of formal politics. It gradually became clear that, without an organised structure and leadership, the movement would not succeed in addressing Spain’s most urgent problems. In January 2014, some of the most active people behind the movement (including university professors, economists and trade unionists) founded a new party to try to use indignation to achieve political change.

Podemos channels the anger of the many Spaniards who have been hit hard by the crisis and feel that the two main parties – the conservative Popular Party (PP) and the Socialist Party (PSOE) – no longer represent their interests. Its leadership comes mainly from the faculty of political sciences of the Complutense University in Madrid, an institution known for its long-standing commitment to far-left ideology. Media and social networks have been crucial for the rise of the party: its leader, Pablo Iglesias (who, ironically, was named after the founder of the social-democratic PSOE), is a regular participant in political talk-shows and very active on social media.

In the last six months, Podemos has risen in the opinion polls so that it is now at the very least the second most popular party. The Spanish National Centre for Social Research (CIS), a publicly funded research institute, has Podemos on 23 per cent (see Chart 1). But another survey, the latest barometer published by Metroscopia, a leading private polling company, estimates that, if elections were held now, Podemos would receive 28 per cent, beating both PP and PSOE.

Chart 1

Source: Spanish National Centre for Social Research

Will Podemos reallly finish second – or even first – in the general election? There are three reasons why one should be sceptical. First, the fact that Podemos was founded one year ago and its future development is unpredictable. Second, the evidence that citizens are mainly drawn to Podemos by disenchantment with the two major parties, rather than affinity with the party’s ideas. Third, the peculiarities of the Spanish electoral system, which rewards or punishes parties according to the regional concentration of their votes.

Podemos is a new party with no government experience, even at the local level. So far, it has received little negative exposure. It capitalises on discontent with the Spanish political system, so its popular support is dependent on current issues and events. Podemos’ recent jump in the polls coincided with police action against major corruption networks, resulting in the prosecution and incarceration of several public figures from both PP and PSOE. Podemos received extensive and positive media coverage of its first general assembly, in October, which confirmed the media-savvy Iglesias as the party leader. But it is difficult to predict the behaviour of Spanish voters if corruption scandals fade away and when the time comes to elect a government. A stable two-party system has been in place since the first post-Franco democratic elections in 1982. Although Spaniards are worn out by the long-lasting economic crisis, fear of the unknown still plays a major role in the collective conscience of a society strongly attached to its institutions. Many voters will shy away from major shifts of power, anxious that a change might bring about political instability and a re-opening of old wounds from pre-democratic times.

The rules of the electoral system in Spain are often ignored when analysing opinion polls, but they are vital for an accurate prediction of the election results. Spain is a quasi-federal state with strong regional identities. The electoral system is designed to avoid the fragmentation of power and to ensure political stability and governability. A complex formula ensures that any party that does not reach 25 per cent of the votes will be under-represented in parliament. Meanwhile, the rules ensure that regionalist parties are well represented at the national level. The votes won in smaller, rural electoral districts are more valuable to parties than those won over in bigger, more urban hubs. Both features derive from Spain’s political history, when the Parliament collapsed on several occasions due to the combination of both the proliferation of many smaller parties and rising regional tensions. These traits help to explain why Spain’s two-party system has endured (both PP and PSOE have traditionally obtained more than 25 per cent of the votes each) and why smaller, nationwide parties, generally from the left, have been under-represented vis-à-vis their regional counterparts (such as nationalist parties in Catalonia, Galicia or the Canary Islands).

Both factors may constrain Podemos’ electoral performance. If Podemos stays at around the 23 per cent mark, as consistently shown by official polls, it will receive fewer than 23 per cent of the seats in parliament. Podemos’ supporters mostly live in big cities, and the party’s poll ratings in smaller, more rural areas are modest. If Podemos cannot boost its rural vote, and that does not seem likely, it will do much worse at the general election than current polls suggest.

Over the past year, analysts have been struggling to understand what Podemos’ main objectives really are. The party itself is being deliberately vague. This has lead many commentators (and a large part of the public) to wonder whether Podemos has any political programme at all. The party’s rethoric on the need for transparency, honesty and political integrity is attractive to many Spaniards after the corruption scandals and the long-running slump. Podemos seems to believe that a renewal of Spain’s political class will, by itself, help the country to navigate its way out of the crisis. Unlike Syriza, which blames Greece’s problems on external decisions taken by the ‘troika’, Iglesias’ party denounces Spain’s internal enemies: the corrupt ‘caste’ – the governing elites. Mirroring Spanish society, Podemos is fairly pro-European. The party supports EU membership and advocates a reformed eurozone. Its leaders, from a generation which greatly enjoyed the benefits of Spain’s accession to the Union, fear the impact of a hostile relationship with Brussels. In their call for reform, Podemos’ leaders are unlikely to follow Syriza’s confrontational strategy with the European institutions.

Over time, the party’s economic programme has become more mainstream, very much in line with traditional social democracy. Podemos advocates reforming the mandate of the European Central Bank to introduce growth and employment objectives, reforming the institutions and the structure of the currency union and reconsidering austerity policies. The Spanish socialist party included very similar ideas in their programme for the 2014 European Parliament elections. However, Podemos has been more vocal about the need for reform.

Although some of Podemos’ proposals fall under the classic definition of populism, its dissonant voice could help to generate a more serious debate on the need for reform of the EU’s economic and fiscal policies. Podemos’ growing influence may help to push PSOE to take a tougher line on reforming eurozone governance. Pedro Sanchez, the socialists’ newly elected leader, has already started (albeit timidly) to advocate changing Europe’s economic policies. He has recently began publicly to criticise the austerity measures that his party helped to implement, calling for the EU institutions to introduce growth and employment objectives.

Podemos will almost certainly not win the 2015 Spanish general election. Its irruption onto the Spanish political scene will push PSOE to the left, and could change the socialists’ euro policy. But PSOE is also unlikely to win the elections. Podemos’ approach to Europe is more moderate than that of Syriza, since it focuses primarily on internal issues. Whether Podemos comes second or third, it is unlikely to put Spain on collision course with the EU institutions.

Camino Mortera-Martinez is a research fellow at the Centre for European Reform.

Friday, February 13, 2015

Russia's war in Ukraine: Is Minsk the end, or just the start?

There is no doubt who gained most from the deal reached in Minsk on February 12th to end the conflict in Ukraine: Russian President Vladimir Putin. At a minimum, a frozen conflict will block Ukraine’s progress towards NATO and the EU; and if fighting resumes, the terms of the ceasefire will leave Ukrainian forces in a weaker position than now. The only questions are why German Chancellor Angela Merkel and French President Francois Hollande were prepared to give Putin so much, after a year of Russian aggression and lies; and what the West can do now to buttress European security.

The Minsk deal includes two documents. The first, entitled ‘a package of measures for the implementation of the Minsk agreements’ was signed by representatives of Russia, Ukraine, the Organisation for Security and Co-operation in Europe (OSCE) and the separatist entities in Donetsk and Luhansk. This contains 13 points, modifying the original Minsk agreements of September 5th and 19th; and an annex outlining a special status for the Russian-controlled areas of Donetsk and Luhansk. The second document is a declaration by Hollande, Merkel, Poroshenko and Putin “in support of” the package of measures.

According to the package, a ceasefire will start at midnight on February 15th (Kyiv time), giving Russian forces and their proxies time to take more territory. Early indications are that fighting around strategic points is intensifying. After the Minsk talks, Putin said that the separatist forces claimed to have surrounded 6,000 to 8,000 Ukrainian forces in Debaltseve and “assumed that they would lay down their arms”.

Gaining territory before the ceasefire matters, because the line of contact at that time will become the boundary between Kyiv and ‘separatist’ controlled territory. Ukrainian forces will have to withdraw heavy weapons (artillery and missiles of a calibre greater than 100mm) to distances of up to 140 kilometres from that line. Heavy weapons on the Russian side are supposed to withdraw by the same distance, but from the ceasefire line agreed in Minsk in September.

To monitor the ceasefire and withdrawal of weapons, the OSCE will have (at least initially) its current team of 250 unarmed monitors and one drone to cover an area of more than 20,000 square kilometres. By comparison, the UN peacekeeping force on the Israel-Lebanon border, UNIFIL, has 10,000 multinational troops to cover an area of under 1,000 square kilometres, and still cannot prevent Hizbollah deploying thousands of missiles there. The OSCE may not need the same force density as UNIFIL, but trust between the parties is low; the resources and mandate of the OSCE mission will need to be significantly strengthened if it is to play an effective stabilising role.

Even if the ceasefire holds temporarily, Ukrainian defences will be weakened. The port of Mariupol, less than 10 kilometres from the line of contact, will be unprotected by tanks or artillery if fighting resumes. Meanwhile, Russian forces will keep control of the Ukraine-Russia border in the separatist areas until the end of the year, and until Ukraine has made constitutional changes guaranteeing the special status of the separatist areas. Unlike the first Minsk agreement, there is no provision for OSCE monitoring of the Russian-Ukrainian border, which means that Russia is free to move more weapons and other supplies into the separatist areas for at least the next ten months.

The constitutional changes sketched out at Minsk show how limited Kyiv’s influence will be in separatist-controlled areas. The local authorities there will have a role in appointing public prosecutors and judges and can create “people’s militias” (an ambiguous term, which might or might not be limited to a police force). The central government in Kyiv will have to pay for social and other services, without having control over them.

The Minsk package also foresees an amnesty for “events that took place in the particular districts of Donetsk and Luhansk regions”. MPs in the Netherlands are already asking whether this means that those responsible for the shooting down of Malaysian Airlines flight MH17 will also be amnestied; though Ukrainian President Petro Poroshenko has told the Dutch prime minister that they will not, the text itself makes no exception for them.

In the accompanying declaration, Hollande, Merkel, Poroshenko and Putin reaffirm their “full respect for the sovereignty and territorial integrity of Ukraine”. Given the involvement of Russia, it is not surprising that this is not further defined; but it is disappointing that neither Merkel nor Hollande appears to have said the word “Crimea” even in comments to the media after the talks.

Worse, the four leaders backed talks between the EU, Russia and Ukraine “to find practical solutions to the concerns raised by Russia about the implementation” of the EU-Ukraine Deep and Comprehensive Free Trade Agreement (DCFTA). The DCFTA will force Ukraine to make painful reforms; but it also offers a long-term route to a successful European economy.

Putin wants to deprive Ukraine of the benefits of the DCFTA. Russian proposals to exclude whole categories of EU goods from tariff reductions, in order to keep Russian goods competitive on the Ukrainian market, are contrary to WTO principles and economically damaging both for EU exporters and Ukrainian consumers. The European Commission delayed implementation of the DCFTA last September, in an effort to support the last Minsk deal. Putin wrote to Poroshenko at the time, warning that any move by Kyiv to implement the DCFTA would bring immediate retaliation from Russia. Now Hollande and Merkel appear to have offered Putin another opportunity to influence implementation of the DCFTA to suit Russia.

Poroshenko must have felt he had no choice but to accept the Minsk deal: his troops have been losing ground since the New Year, as more Russian regular forces and equipment have joined the fight; and the West has offered rhetorical but not practical support. France, Germany and the UK have all come out against supplying lethal weapons to Ukraine (the UK with the caveat, according to Foreign Secretary Philip Hammond, that “we could not allow the Ukrainian armed forces to collapse”). President Barack Obama has said only that he has asked his team to look at all the options, including supplying arms, if diplomacy failed.

On the positive side, the deal may give Poroshenko time to focus on economic and political reform, instead of concentrating on the war. The IMF announced on February 12th that it had agreed a $17.5 billion loan for Ukraine, as part of a package of bilateral and multilateral loans of about $40 billion to support reforms; without that, Ukraine would soon run out of money.

On the other hand, the Minsk deal may have weakened Poroshenko’s political position: Prime Minister Arseniy Yatsenyuk has been consistently more hawkish than Poroshenko, and may see an opportunity to undermine him. Western leaders will need to stay engaged with both men to keep them working towards the same goals of cleansing Ukraine of its pervasive corruption and reforming its Soviet-legacy economy. Whatever comes out of talking to Russia about the DCFTA, the EU should ensure that Ukraine is as ready as it can be to start full implementation of the agreement on January 1st 2016.

Why have European leaders conceded so much to Russia, despite its failure to implement the September agreement? Despite Russia’s serious economic woes, President Vladimir Putin has once again exploited Western divisions and disguised his own vulnerability.

The EU is divided between a small group of countries who want to arm Ukraine; those, led by Merkel, who think arming Ukraine would make things worse, but support the use of sanctions and diplomacy to persuade Putin to move; and those who want to get back to business as usual with Russia as soon as possible. Merkel leads the second group; Hollande seems uncomfortably balanced between the second and the third: he told journalists on February 13th that while the conditions were not yet right, he hoped that France would eventually be able to deliver the ‘Mistral’ warships ordered by Russia. Meanwhile across the Atlantic, Congressional Republicans like John McCain and members of the Obama administration are encouraging the president to reconsider his opposition to arming Ukraine. Putin has skilfully used European fears that giving weapons to Ukraine will escalate the war, and has offered peace, but at a high price.

What can the West now do to rescue something from the Minsk mess? First and without fanfare, those countries willing to do so should start training and equipping Ukrainian forces to ensure that they can defend the rest of their territory if fighting resumes. There will be no Western consensus on this; but the argument that helping a victim is ‘provocative’ to an aggressor does not stand up, either in international relations or in life: despite the West’s efforts not to provoke Putin, he now controls a significant portion of Ukrainian territory. Given the shortcomings in the new Minsk agreement, strong Ukrainian defences are likely to be needed sooner rather than later. The West cannot stop Putin escalating the conflict again if he chooses to, but it can raise the cost to him.

Second, France and Germany must do more to show that they are taking account of the interests of other EU member-states as well as the EU’s institutions. EU views are not united: the new Greek government is clearly a lot closer to Putin’s Russia than its predecessor, while the Lithuanian President, Dalia Grybauskaitė, has openly criticised the February 12th agreement as weak. Merkel may be doing her best to represent the EU’s ‘centre of gravity’, but in doing so she risks sidelining others. The Commission has never accepted the validity of Putin’s objections to the DCFTA with Ukraine, yet has now been committed by the Minsk deal to holding talks on how to accommodate them. Poland, despite having borders with Ukraine and Russia, no longer has a voice in negotiations. The UK has been invisible in the diplomatic arena, though it is contributing to NATO efforts to reassure Central European allies.

Third, the West should tighten implementation of its existing sanctions and start preparing new ones. It is time the European External Action Service (EEAS) had the resources to examine how sanctioned individuals and entities can circumvent the rules in particular member-states. Encouragingly, Merkel said after the European Council on February 13th that further sanctions were possible if the new agreement was violated. As a last resort, the EU could block Russia from SWIFT, the international financial transfer system, thereby inflicting considerable damage on Russia’s economy. But short of that drastic step, there are many senior Russians, including Putin himself, with financial interests in the West which have yet to be targeted.

Finally, the EU should let go of its illusions. A brilliant recent analysis by BBC Monitoring showed how Russian state media is successfully stirring up hatred and war fever in the population. Confrontation, not an idyllic pan-European zone of co-operation, is likely to be the norm for the foreseeable future. The EU has spent two decades trying to develop a mutually beneficial, rules-based contractual relationship with Russia. It is time to accept that its efforts have failed; now the West has to invest in protecting itself. Merkel was right to say at the Munich Security Conference on February 7th that a policy of forcibly altering borders in Europe should have no place in the 21st century, and that Russia’s actions in Ukraine had violated international law. It is a pity that the Minsk agreement rewards such behaviour.

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

Wednesday, February 11, 2015

Juncker’s three steps to improve the Commission’s standing in the EU

When Jean-Claude Juncker became European Commission president he pledged to do his best to restore citizens’ trust in the European project. Juncker thinks that improving the Commission’s standing in the EU is pivotal to delivering on this promise. In his first hundred days in office he has taken three important steps to strengthen the Commission’s hand but he still has to prove that he can avoid repeating the mistakes of his predecessor, José Manuel Barroso.

Juncker did not have an easy start in Brussels. He took over the Commission’s reins when public trust in the EU was plummeting and support for eurosceptic parties was on the rise. The Commission’s institutional power was also in decline. During the financial and euro crises, despite the Commission’s monopoly on proposing EU laws, the European Council became the primary forum for EU decision-making in the area of economic governance. The Commission was left to rubber-stamp the decisions of EU leaders and turn them into EU legislation.

While failing to provide leadership in responding to the economic crisis, the Commission attempted to expand its responsibilities in other policy areas (often described by British officials as ‘competence creep’). This has irritated quite a few member-states. Poland, though strongly pro-European, has for example felt uneasy with the idea of the Commission using strict environmental rules to limit shale gas exploitation.

Juncker wants to transform the Commission’s unfavourable image through three steps: setting the EU agenda rather than letting others do it for him; doing a few key things well, rather than doing a lot of things badly; and reconnecting the Commission to the citizens of Europe.

Juncker’s first step was to reassert the Commission’s power to set the EU agenda. He knew it would be a tall order: he became Commission president through the new Spitzenkandidaten process, whereby the candidate nominated by the largest party group in the European Parliament becomes Commission president. This process helped the Parliament strengthen its political control over the Commission and its president. But Juncker, though perceived by many as a staunch supporter of European integration, wants the Commission to be more equidistant between the European Parliament and EU capitals. He hopes that First Vice-President Frans Timmermans, who as Dutch foreign minister called for a better balance of power between member-states, the Commission and the European Parliament, will help him to achieve this objective.

Timmermans has so far tried to practise what he preaches. He presented the major objectives of the Commission’s action plan for 2015 both to MEPs and to the Council of Ministers before it was published, but he did not allow either side to fiddle with the content. In a letter to the president of the Parliament and to the Italian presidency, he also declared a willingness to co-operate more systematically with both EU ministers and MEPs over subsequent Commission action plans. He suggested that all three institutions jointly identify strategic EU priorities for each new legislative cycle (so called multiannual programming). The Commission would provide more information on its intended actions but in return, Timmermans would like both the Council and the European Parliament to fast-track key Commission legislative initiatives. This approach is a welcome departure from the second Barroso Commission. In 2010 it concluded an agreement with the Parliament which significantly enhanced MEPs’ influence on the Commission’s daily business, including its work programme. This came at the expense of the role of member-states, which were not a party to it.

Getting both MEPs and ministers around the same table to discuss the Commission’s future plans will not be easy. Member-states would like to enter into tripartite co-operation but the European Parliament will not like sharing hard-won powers. Timmermans should try to convince MEPs that greater Council engagement also helps them: when EU governments considered legislative proposals in the Council, it would be hard for them to backtrack on commitments previously made to the Commission and MEPs.

Greater collaboration on the Commission’s multiannual work programme could also speed up the adoption of EU laws. Although the European Parliament and the Council of Ministers have tried to shorten the process, it still takes them on average 19 months to reach consensus on a piece of EU legislation. They should prioritise speedier agreement on legislation which would help the EU economy recover.

Timmermans should, however, ensure that fast-tracking key proposals does not compromise the quality or transparency of EU law-making. Today, the Commission conducts impact assessments to evaluate how planned legislation will affect citizens, the economy and the environment before deciding whether to make a proposal. In negotiations on the initial draft, member-states and MEPs often introduce substantial changes. Under time pressure, the Council and Parliament may not always consider how changes may affect the regulatory burden on citizens and industry. Additional impact assessments of these amendments, an idea supported by Timmermans, could help to deliver Juncker’s promise to cut red tape in the EU.

Juncker’s second step was to challenge the Commission’s reputation for producing unnecessary laws. In December 2014 he presented a lean but concrete action plan for the year to come. To the relief of many European capitals, it consisted of only 23 proposals, including Juncker’s flagship projects like the European Fund for Strategic Investments, which aims to deliver up to €315 billion in public and private investment in Europe. By contrast, the Barroso Commission tabled around 130 proposals per annum in its last five years.

Juncker decided to copy the practice in member-states, whereby a newly elected government can drop the unfinished business of its predecessor. This was a first test of the effectiveness of the new college structure. Timmermans, who co-ordinated preparation of the work programme, urged other vice-presidents to ditch any of Barroso’s proposals which did not coincide with Juncker’s priorities. The new college reviewed around 450 pending proposals and set out a list of 80 to be scrapped, or withdrawn and then resubmitted in a modified form.

Juncker’s approach deserves some credit. The Commission is right to drop proposals which do not contribute to boosting growth, jobs and investment. The European Commission decided, for example, to withdraw a proposal on the tax treatment of motor vehicles belonging to EU migrants who change their residence permanently, tabled in 1998 and stuck ever since. The Commission should instead focus on more pressing dossiers like the digital single market package, designed to ease access to cross-border digital services.

But Timmermans included among the 80 proposals to be withdrawn some on which member-states and MEPs have only recently started working. For example, he decided to ditch the so-called ‘circular economy package’, which aims to encourage recycling and efficient use of resources. He promised to come up with new, “more ambitious” proposals. Timmermans may thereby have pleased business representatives, who complained that the package hindered competitiveness, but he has annoyed MEPs and environment ministers. They are worried that the Commission’s better regulation agenda boils down to deregulation, and that environment and climate protection aims will become victims of Timmermans’ crusade to cut red tape.

But member-states and the European Parliament also fear that Timmermans may have just set a dangerous precedent: if an incoming Commission asserted the right to drop any unfinished legislation inherited from its predecessor, regardless of what stage it had reached, it would effectively gain a right to veto legislative negotiations. Timmermans should table new proposals on recycling and resource efficiency as soon as possible. If he can reconcile the divergent interests of business and environmentalists, he will give more substance to his ‘better regulation’ portfolio.

Juncker’s third and perhaps most important step was to challenge EU citizens’ preconceptions about the Commission. His other steps will mean little if the institution he runs does not restore its standing in the eyes of the public. EU citizens are more openly contesting the new powers given to the Commission by member-states, including the right to review the draft budgets of eurozone countries. Anti-establishment movements are gaining popularity by promising to block the ‘diktats of Brussels’. The recent electoral victory of the left-wing Syriza party in Greece could fuel similar movements across Europe.

Juncker hopes that making the Commission less technocratic and more political in the way it acts will help him improve the Commission’s image. He wants his commissioners to stand up to EU leaders, who under pressure from Eurosceptic voices at home, criticise EU decisions to which they had previously agreed. One of the first manifestations of this approach was Timmermans’ announcement of a new partnership with national parliaments. National parliamentarians have often complained that their concerns about unnecessary laws fall on deaf ears in Brussels. When in 2013, 14 parliamentary chambers raised a ‘yellow card’ to object to the proposed creation of a European Public Prosecutor’s Office, the Barroso Commission did not discuss parliamentarians’ concerns about the proposal and pushed ahead with legislation. Timmermans has urged his fellow commissioners to engage more actively in debate with national MPs. This would mean listening to parliaments’ doubts about Commission proposals and taking on board constructive ideas on how to improve EU action. Commissioners should also visit the parliaments of eurozone countries to discuss the Commission’s opinions on draft national budgets. After all, it is up to parliamentarians whether they take the Commission’s suggestions on board when they adopt the budgets.

Juncker also hopes that more direct interaction between his college and the press will narrow the gap between Brussels and EU citizens. He has therefore put communication policy under his direct supervision and reduced the number of spokespersons, who will now have responsibility for briefing on the Commission’s policies rather than speaking on behalf of individual commissioners. In Barroso’s time, it looked as if spokespersons represented individual commissioners rather than the institution as a whole, and when commissioners disagreed, the result was confusion. Juncker wants his Commission to speak in public with one voice. He also believes that since the commissioners are “the best advocates of Commission policies”, they should talk more often to the media themselves.

Building a more ‘political’ Commission may at times be difficult to reconcile with the Commission’s responsibility to represent the general interest of the European Union. Given growing tensions between creditor and debtor countries on how the eurozone should be governed, the Juncker college should make every effort to strike the right balance between the interests of different member-states. The determination of Greece’s Syriza-led government to walk away from previous agreements, and the equal insistence of Germany and its northern allies that Greece should stick to its obligations, will make it hard for the Commission to find common ground. If Juncker can help to reconcile feuding EU members-states without leaning towards any of them, he will have taken an important step towards restoring the Commission’s credibility in the eyes of all EU citizens.

Agata Gostyńska is a research fellow at the Centre for European Reform.