Thursday, April 30, 2015

Two cheers for Ukraine

Despite recent progress, Ukraine remains militarily, politically and economically fragile. The EU needs to do more to help.

There are plenty of reasons for those in Kyiv to be optimistic. The government, more competent and less corrupt than any since independence in 1991, is undertaking serious reform. But Ukraine’s success is far from assured: the political class is fractious, Russia may be preparing for more fighting in the Donbass and the economy is shrinking. Without sustained Western attention, the country’s attempt to become a Western-orientated democracy may once again fail, as happened after the ‘orange revolution’ of 2004.

President Petro Poroshenko claims there is now a committed majority for pro-EU policies throughout Ukrainian politics. Some impressive foreigners have taken Ukrainian citizenship in order to become ministers, including the Ukrainian-American finance minister, Natalie Jaresko, and the economy minister Aivaras Abromavičius, originally from Lithuania. Many of those recently elected to the Verkhovna Rada (parliament) are young, bright and not beholden to oligarchs. Vigorous NGOs monitor the government’s actions and make a fuss when standards slip.

Reform-minded officials report that serious efforts are being made to tackle corruption. A new prosecutor-general, appointed in February, has made a start on going after corrupt officials (his deputy is a Georgian who overhauled the prosecutor’s office in Georgia) and almost 500 anti-corruption cases are underway. So that ordinary people can see the benefits of the crackdown, the government has made a priority of police reform. And after a four-month delay, it has appointed a head to the new Anti-Corruption Bureau.

There is much talk in Kyiv of ‘de-oligarchisation’. The government has started to take back control of state-owned enterprises (SOEs) which the oligarchs have – till now – de facto controlled through minority shareholdings. In March, Poroshenko fired Ihor Kolomoisky, from his job as governor of Dnipropetrovsk: Kolomoisky had deployed a private militia to defend his business interests in a state-owned oil company against the state. Prosecutors are investigating the affairs of Rinat Akhmetov, Ukraine’s richest man. The Rada has passed several laws that hurt the business interests of one or other oligarch. But business and politics are still unhealthily mixed: Poroshenko himself has not yet fulfilled his promise to sell his own corporate assets, including media interests.

Both Poroshenko and Prime Minister Arseniy Yatsenyuk have links to rival camps of oligarchs. Though tensions between them are serious, they are under Western pressure to maintain a united front. Yatsenyuk may want to be president but is currently less popular than Poroshenko, not least because he gets much of the blame for the country’s economic woes.

Both men have flirted with Ukrainian nationalists in an effort to court popularity. Poroshenko appointed Dmytro Yarosh, the leader of the far-right ‘Praviy Sektor’ group, as an adviser to the chief of the general staff. Meanwhile the Rada passed a law making it a criminal offence to criticise the role of the extreme nationalist organisations which operated in Ukraine from the 1920s to the 1950s, even though some carried out atrocities against Poles and Jews (at the time of writing, Poroshenko has yet to sign this law). The Rada should not waste its time on laws which do nothing to modernise Ukraine but help to sustain the Russian narrative that fascists run Kyiv.

Ever since the birth of the Maidan movement in November 2013 – when the then president, Viktor Yanukovych, rejected the EU’s Deep and Comprehensive Free Trade Agreement (DCFTA) – Ukraine’s politicians have had to look over their shoulders. When things are going badly on the battlefield or in the economy, there are mutterings about 'another Maidan'. But Ukraine needs a period of stability, rather than more unrest, in order to build its strength.

The ceasefire agreed in February, as part of the ‘Minsk 2’ agreement, is fraying, with soldiers being killed nearly every day. Russian troops remain in the Donbass, training and equipping separatist forces. On April 23rd, NATO’s secretary-general, Jens Stoltenberg, reported a substantial Russian build-up along the border with Ukraine and also inside the country. Ukrainian forces are finally getting some Western training, from the US, the UK and Canada, and some non-lethal military equipment. But Kyiv’s politicians also want defensive weapons: they believe that the Russian president, Vladimir Putin, plans more territorial conquest. If Russia does grab more land, Western governments should step up military assistance and consider giving Ukraine the means to defend itself. Ukraine’s politicians also want NATO membership (though they know it is not on offer for now); opinion polls show that just over half the people agree, up from a small percentage before the war began.

Poroshenko wants UN peacekeepers on the border between Russia and Ukraine to prevent further aggression, but Russia rejects that as contrary to the Minsk 2 agreement. Ukraine's problem is that this text (analysed in a recent CER insight) is ambiguous and impossible to implement. It says "a dialogue is to start on modalities of conducting local elections in accordance with Ukrainian legislation", including an interim law on "special status" – meaning greater decentralisation of power than in the rest of Ukraine – for the conflict areas; it does not specify with whom the dialogue should be conducted. It also calls for Ukraine to enact constitutional change, decentralisation and a permanent law on special status, all by the end of 2015, but is unclear on the sequencing of all these requirements.

The Ukrainians say that there must be free and fair elections in the conflict areas first, so that they have interlocutors with democratic legitimacy to deal with; the Russians say that the Ukrainians should negotiate the constitutional changes with the de facto authorities of the so-called Donetsk and Luhansk People's Republics and then hold elections later. Diplomats from Germany and some other EU countries think the Russian interpretation of the Minsk 2 agreement is correct, but US diplomats take Kyiv’s side.

Whatever the text was intended to mean, the reality on the ground is that elections cannot be held unless the Russians and their allies agree; and they will not agree until they have the autonomy they want. But if Ukraine accepts elections on Russian terms, and the current separatist leaders are confirmed in office, all hope of free and fair elections and the possibility of changing the region’s leadership in future elections will be lost; the Minsk agreement says that once elections have been held, the Kyiv government cannot sack the local authorities.

Somehow, the constitutional changes and the elections need to be synchronised. One possibility would be for the Ukrainian government to accept the separatist leaders as provisional interlocutors and negotiate a deal with them on special status for their territory. A referendum on the special status and local elections could be held simultaneously, according to Ukrainian law and subject to OSCE monitoring; and the separatist leaders would become legitimate if voters chose them and approved the new status.

But even if the timetable can be fixed, Ukraine and Russia disagree on the nature of decentralisation. Poroshenko emphasises that most Ukrainians do not want a federal constitution with broad regional autonomy. Russia wants the Donbass to have an effective veto over Ukraine's membership of the EU and NATO (as Republika Srpska has over Bosnia's big decisions). There is no obvious way of preserving the unitary state wanted by most Ukrainians while giving the rebel entities the blocking power desired by Russia. The West should avoid endorsing any arrangement likely to produce Bosnia-style paralysis.

The biggest reason for worrying about Ukraine, however, is neither the politics nor the military situation, but the economy. In the first quarter of this year, Ukraine’s GDP was 15 per cent lower than a year earlier, and it is still shrinking. Foreign currency reserves are only $10 billion, and that is after a recent $5 billion IMF disbursement. Putin's game may be to wait until Ukraine defaults, and economic woes push impoverished people onto the streets – and then offer assistance in return for the installation of a new, more Russia-friendly regime.

Senior officials in Kyiv claim that Ukraine will not undergo a disorderly default, even though at least $40 billion is needed over the next five years to balance the budget. They reckon it will come from the IMF ($17.5 billion) and the restructuring of debts ($15.3 billion), with the balance provided by friendly governments and the EU.

But the Ukrainian authorities know they need still more cash to stabilise the economy and then to generate growth. Speaking at the Lennart Meri conference in Tallinn, on April 26th, Anders Aslund of the Peterson Institute urged European central banks to make $10 billion in currency swap credits available to Ukraine, to strengthen its foreign currency reserves (and thus make a speculative attack on the hryvnia less likely). They could do so with policy conditions attached, thereby reducing the likelihood that the reserves would need to be used.

The government needs to create an environment that is attractive to foreign investors. Improving the rule of law is crucial. The government has plans for bringing more of the grey economy into the legitimate sector so that it pays tax. The measures demanded by the IMF, such as cutting pensions and phasing out energy subsidies (to reduce wastage of energy), are essential – but will be painful and unpopular.

The Rada took a crucial step on April 9th when it passed a law to break up the state gas company, Naftohaz, into transit, storage, supply and production businesses. This should bring Ukraine's gas market into line with the 'unbundling' prescribed by the EU's 'third energy package' (which Ukraine’s agreements with the EU oblige it to implement). Ukraine has managed to reduce its dependence on Russian gas, thanks to 'reverse flow' arrangements with EU neighbours.

Reformers in Kyiv want the EU to increase its role in Ukraine. If Russia will not allow UN peacekeepers, many Ukrainian politicians would like an EU police mission on the Russian border; and they would like more support for police reform. Poroshenko wants the EU to do more to fight Russian propaganda and to help broadcasters compete with Russia's output. One idea mooted is for the EU to help establish a Russian-language news agency that could operate throughout former Soviet countries.

Poroshenko also hopes that at the forthcoming Eastern Partnership summit in Riga, the EU will offer visa free travel to Ukrainians, as it has done for Moldovans. Though Ukraine has made some progress on meeting EU standards for border control, there are still technical obstacles to lifting visa requirements, so he is likely to be disappointed. The Union will have to reassure Ukrainians that the delay on visa waivers is not a political signal that Ukraine should be kept at arm's length.

The DCFTA between Ukraine and the EU is important for the country’s future, providing a roadmap for creating a more competitive economy. But although the EU has unilaterally opened its markets to Ukraine, in line with the agreement, Kyiv announced in September 2014 that it was postponing the implementation of its side of the DCFTA. This was mainly because of Russian pressure (though some Ukrainian oligarchs were happy to maintain protection from EU competition). Moscow claimed that the DCFTA would damage its economic interests, and called for trilateral discussions with the European Commission and Ukraine over how the agreement was applied. These technical talks started last autumn. The Commission reckons that none of Russia’s complaints stand up but Germany has chided Brussels for not doing more to reassure the Russians.

Poroshenko now says he hopes for implementation by the start of next year. The sooner the better: once Ukraine meets EU standards, its industries will be able to export more easily not only to the Union but also to anywhere else that recognises EU standards. That way, if Russia responds to DCFTA implementation by blocking Ukrainian exports, as it threatens, Kyiv will have other options. The EU should do all it can through technical assistance and twinning arrangements to ensure that Ukraine’s administration has the capacity to make the DCFTA work.

European unity over the sanctions regime against Russia has been, so far, impressive. But EU leaders have not yet shown a similar determination to support the government in Kyiv. At an EU-Ukraine summit and related donors’ conference, on April 27th and 28th, EU leaders failed to come up with any fresh money. The EU should unlock its vaults, while making further money conditional on the continuation of reform.The government in Kyiv is doing enough of the right things to deserve support.

Charles Grant is director of the CER, and was recently in Kyiv on an ECFR study trip. Ian Bond is director of foreign policy at the CER.

Thursday, April 23, 2015

Dead in the water: Fixing the EU’s failed approach to Mediterranean migrants

Europe can no longer ignore the humanitarian crisis in the Mediterranean. If it wants to avoid the death of more refugees, it should fix its asylum policy, increase its naval presence, and play a stronger role in Libya.

There is something deeply wrong with Europe’s approach to irregular migrants. After the Mediterranean boat tragedy, which left more than 700 migrants dead, the European Commission has unveiled a ten-point action plan on migration. It has several good points, but it can only be the beginning.

On migration and asylum policy, a north-south divide runs through the EU. Under the Schengen treaty (to which the UK and Ireland are not parties), all members are responsible for securing the external borders of the Union. The premise is simple: in an area of free movement without borders, the migration problems of one member-state are the problems of the Union as a whole. But the EU has not had a common migration policy for twenty years.

Europe’s asylum system, known as the 'Dublin system', has caused friction within the Union. Under it, the EU member-state where a migrant first arrives is primarily responsible for processing an asylum application. This places an unreasonable burden on countries bordering conflict zones, such as Italy, Greece or Malta. These countries, overloaded with applications, turn down the overwhelming majority of them. So asylum seekers travel to other countries, such as Germany or Sweden. Here they have better chances of a successful application; but locals resent them as an increasing burden on social services. The system has created two different zones in Europe with two different interests: Northern member-states want an asylum policy that keeps migrants in the South but treats them humanely, while Southern member-states want the North to share the burden by accepting more migrants. The Mediterranean refugee crisis shows that this system is unsustainable.

When popular uprisings in Libya and Syria turned into bloody conflicts, tens of thousands of people started risking their lives on leaky boats to cross the Mediterranean rather than face an uncertain fate at home. Problems were compounded as smuggling networks exploited Libya’s lawlessness to create a new, lucrative path by which they could bring African migrants to the EU. The rickety smuggling ships often got into problems on the high seas, whether by accident or by design.

In October 2013, three years after the Arab uprisings started, the Italian government of then-prime minister Enrico Letta decided to launch a search-and-rescue operation called ‘Mare Nostrum’. With a budget of 9 million euros per month, the Italian authorities patrolled both Italian and Libyan waters. Between October 2013 and October 2014 (when the operation was replaced by the EU-led ‘Triton’ mission), ‘Mare Nostrum’ helped save an estimated 150,000 lives and detained 351 smugglers. Still, the flow of migrants continued and scenes of overcrowded boats reaching Lampedusa became a symbol of Europe’s failed migration policies. According to the International Organisation for Migration, more than 170,000 migrants reached Italy by sea in 2014.

In October 2014, the Italian government appealed for EU support. The Italian demand to strengthen ‘Mare Nostrum’ was met with criticism from Northern member-states, including the UK, Germany and the Netherlands. They argued that Italy had created a ‘pull effect’ by establishing a search-and-rescue operation. In their view, the prospect of being rescued at sea needlessly encouraged more migrants to attempt the crossing. Germany, France, Sweden and the UK are the top destinations for asylum seekers, and their governments face increasing domestic pressure to cut back on the numbers. The compromise that emerged from this north-south disagreement was operation ‘Triton’. This is an EU-led operation, with a more restricted mandate, budget and area of operations than ‘Mare Nostrum’. It has no mandate to proactively search and rescue boats in danger; it has a monthly budget of 2.9 million euros with a limited fleet of two aircraft, one helicopter, and six patrol vessels, and it only patrols Italian waters.

During the first three months of operation ‘Triton’ (end of October to end of December 2014), Frontex, the EU’s border agency, observed an increase in migrants of 160 per cent, compared with the same period of 2013, when the Italian rescue operation was still in place. Meanwhile, deaths in the Mediterranean have soared: more than 1,750 migrants have perished since the beginning of 2015, in comparison with 56 reported deaths in the same period of 2014. Since ‘Triton’ was established, more migrants have attempted to reach European soil, and many more have died trying. This suggests that other factors besides the ‘pull effect’ are leading migrants to board the ships.

These factors are mostly linked to foreign, not migration, policy. Since October 2014, the conflict in Libya has worsened; the country has fallen apart and the Islamic State terrorist group has joined the fight. Refugees en route to Europe have to run a lethal gauntlet in Libya: they are harassed, mistreated and sometimes killed by the warring factions. Yet the country’s chaos and its proximity to Europe make it a smuggler’s dream. The Boko Haram terrorist group in Nigeria, repression in Eritrea, and continued violence in Somalia create a steady flow of refugees from further afield. The flood of refugees from Syria’s civil war continues unabated, and many of them now reach Europe through Libya. Not all irregular migrants are refugees. Some are merely economic migrants. But Europe’s inability to manage these crises has prompted an increase in the number of irregular migrants. The possibility of potential terrorists hiding among legitimate refugees is another reason for the EU to take a serious, end-to-end view of the migration issue.

The Commission’s ten-point action plan is a step in the right direction. The Commission is right to push for an increase in Triton’s resources. European leaders should agree to a substantial increase not only of the operation’s budget but also its logistical resources. The mounting death toll shows that the available fleet and manpower are not enough. More helicopters, ships and surveillance assets are needed. Since there is no meaningful Libyan coast guard or navy, European governments should agree to expand the mandate of the operation and to allow it to patrol Libyan waters, as ‘Mare Nostrum’ did.  Beyond increasing Triton’s capabilities, its mandate should be broadened to include assisting boats in trouble. This cannot be done within the existing mandate of Frontex, as the Commission suggests, since this is purely a border control agency. Reluctant governments should realise that over-emphasising the ‘pull effect’ is not only factually incorrect, but also morally indefensible.

The Commission has proposed capturing and destroying smuggling vessels, taking its cue from the EU’s counter-piracy mission Atalanta, which operates off the Horn of Africa and in the Gulf of Aden. But migrant flows will not stop if the EU starts sinking old fishing boats. Such action will only increase the price a migrant has to pay to a smuggler for his passage to Europe.

Smugglers and pirates are not the same and cannot be defeated in the same way. While a military show of force may deter pirates, the prospect of special forces abseiling onto, or firing warning shots at, boats filled with desperate civilians is not one we should welcome. Part of the success of operation Atalanta was a result of attacking pirate hideouts on shore in Somalia. Smuggling networks, by contrast, are dispersed; those in charge may be in an internet-café in Bamako, Benghazi or Bari. Shutting them down requires effective intelligence and law-enforcement operations, not military intimidation.

The EU has suggested destroying boats before they are used for smuggling. This sounds tough, but how can one differentiate between a smuggling vessel and a legitimate trawler or merchant ship? Not every Libyan fisherman doubles as a people smuggler. And many smuggling boats embark from Turkey, Egypt, Tunisia or elsewhere; the EU cannot sink them all. The EU should certainly pre-empt imminent acts of smuggling – for instance, when it is clear that people are being loaded onto a boat – but getting the information in real time to enable such an operation would present a tremendous intelligence challenge.

There is a market for people smuggling, and European leaders must appreciate the dynamics of supply and demand. Europe should focus on the demand-side problems onshore; those factors that lead people to risk their lives on rusty boats in the first place. This means Europe should address Libya’s lawlessness and Syria’s civil war. In the absence of a functioning central government in Libya, the EU should establish a civil-military mission on the ground and create a safe zone where migrants could be processed. It should be set up initially in an area controlled by Libya’s internationally-recognised government, currently in exile in the east of the country. The Mediterranean crisis should force Europe to take more responsibility for preventing Libya's collapse.

The Commission’s action plan offers some timid ideas for the unsolved question of better burden- sharing in the EU’s asylum system: the Commission promises to “consider options for an emergency relocation mechanism”. This measure shows that the EU is slowly considering how to tackle the flaws in the Dublin system. Its latest reform, termed ‘Dublin-III’, has clearly not gone far enough. Europe’s leaders should be bolder. They should rethink the rule of first entry and ensure the effective implementation of all existing EU directives on asylum seekers. This would contribute to harmonising national asylum standards and distributing refugees more evenly across the EU.

Finally, the Commission’s action plan promises to “establish a new return programme for rapid return of irregular migrants”. This sounds good, but such a programme will not work without a functioning Libyan government that can negotiate the conditions of the return of migrants.

As the conflicts in Europe’s backyard continue, or intensify, more and more people will risk their lives to flee their countries. Turning a blind eye to the EU’s obligation to help those in need would neither be moral, nor coherent with the EU’s foreign policy interests. The domestic politics of migration are difficult for many member states, including the UK. Migration is a unifying issue for Europe's right-wing populist parties. But the current system, which creates problems and tension in many countries, does nothing to reduce the level of anti-migrant sentiment. As the EU’s migration commissioner, Dimitris Avramopolous, puts it “if Europe does not present a united front to stop tragedies like this from happening, there will only be one winner: the populists.”

Camino Mortera-Martinez is a research fellow and Rem Korteweg is a senior research fellow at the Centre for European Reform.

Friday, April 17, 2015

Vorsprung durch Grexit?

The German political and bureaucratic class is preparing for Grexit, and thinks the risks are containable. Angela Merkel should resist this emerging consensus in Berlin, and make every effort to keep Greece in the euro.

The brinkmanship between Greece and the euro group is entering a decisive phase. Amidst escalating threats – default by Greece, financial cut-off by the eurozone – the most pressing issue is whether Germany would allow a Greek exit from the eurozone, either on purpose (‘Grexit’) or by accident (‘Greccident’). Most of the key decision-makers in Berlin say that unless Greece starts implementing real reforms, it should leave the euro. But Chancellor Angela Merkel needs to consider the geopolitical dimension, as well as pressure from the US and the ECB to keep Greece in – in addition to the unwillingness of the Greek people to leave. For Europe’s sake, she should go the extra mile to avoid Greece departing the eurozone. But the odds of Grexit happening are rising.

Until the Greek government comes up with a serious plan for structural reform, Germany will continue to block further money for Athens. Given that Greece is finding it increasingly difficult to repay debts, and pay salaries and pensions, a Greek default and possibly exit from the euro is looking more likely with every passing week. “We have never been closer to Grexit, and we are close,” said one senior official in Berlin. Officials say they cannot detect any desire from the Greek government to commit to reforming labour markets, fighting corruption, improving tax collection, strengthening fiscal discipline or attacking vested interests. “Faced with Grexit, Tsipras might do a U-turn, and perhaps change his coalition partner. But we have no idea what he’ll do,” said an official. The German government does not know whether Tsipras is playing chicken and waiting for Germany to blink, or simply unable to control the many factions in his government. Or even whether he really wants to keep Greece in the euro.

Germans who favour Grexit argue that it would be good for the Greek economy. Greece currently has an output gap of around 13 per cent of GDP, according to the OECD; the economy is running at well below its economic potential. Autonomous Greek monetary policy and a weaker currency could therefore speed up the recovery, and avoid the further harm to the economy that a long depression would inflict. But a prerequisite for such a successful outcome would be that the exit be properly managed, with the help of the ECB, and with bridge financing for the Greek government from European institutions, to limit short-term disruptions. What is more, the new Greek monetary policy authorities would need to build up trust quickly, to avoid continued instability and high inflation.

Proponents of Grexit tend to underplay the potential downsides. Leaving the euro is more difficult than giving up a currency peg: millions of contracts would need to be rewritten, and foreign debt (in euros or dollars) would balloon when measured in new drachma, forcing companies and especially banks into default. Inflationary pressure would be strong, hurting consumers. It is not a given that, post-Grexit, the Greek financial system would be stable and inflation manageable. The deeper institutional and structural problems of the Greek state and economy would remain unresolved, leading to slow growth after the economy had returned to its potential output.

Some German officials predict that Grexit could be a gradual, drawn out process. Greece would not be pushed out following a decision by the European Council or European Central Bank, they think. Instead, the government would run out of money and have to issue IOUs as a parallel currency, while imposing capital controls and intervening heavily in the banks to prop them up. This would not be a stable situation; the economy would not grow under such a scenario. As a result, the government would probably think it best in the long run to take the plunge and devalue by formally leaving the euro – then at least the economy would regain monetary autonomy, making it easier to boost demand.

German officials are sanguine about the consequences of Grexit. “It would not be problematic for our budget, financial sector or economic growth,” said one. “And one positive result could be that other countries would do their homework and become more disciplined” – an argument that the German council of economic experts has recently made, too. Tax payers are liable for around €240 billon of Greek debt, of which Germans could lose €70 billion. The officials think that would be manageable.

Most officials think the risk of contagion is minimal. “Spain, Portugal and Ireland would be alright because they have done their homework,” said one. Although Italy and France have not done much homework, he thought their fates – and whether they reformed – would be unrelated to what happened in Greece. In any case, Greece was a special case, he said – there was no longer much bank exposure to it.

He acknowledged that if the financial markets asked for a premium before lending to other eurozone countries as a result of Grexit, Germany would have to consider further eurozone integration, such as tighter fiscal discipline or the introduction of ‘economic reform contracts’. “In that case we would need to move fast, so hopefully we would be able to avoid changing the EU treaties.” He may be too nonchalant: if the markets were panicking about the euro’s viability it is highly unlikely that modest steps towards policy-integration or risk-sharing would reassure them.

Is there a difference between the approaches of Finance Minister Wolfgang Schäuble and Angela Merkel? Officials say that on the fundamentals, there is not, even though Merkel’s rhetoric is softer. They both want to keep Greece in the euro, but not under any circumstances, and not if the Greek government cannot get its act together. Some of their officials take a harder line. “As an economist, I am not sure if Greece should stay in the euro; it is structurally uncompetitive and could become a second Mezzogiorno,” said one. He noted that Latvia, Lithuania, Spain and Ireland had known they needed to change, and therefore taken painful decisions, but he thought that sometimes pressure to reform did not work. He worried that keeping Greece in at all costs would undermine European cohesion.

Inevitably, Merkel thinks more about the geopolitical context than Schäuble. She is under discreet pressure from the Obama administration, which worries about the risk of a Greek-Russian rapprochement. The IMF, the European Commission, France and Italy also want to find a way of keeping Greece in. A lot of European governments would be reluctant to make a visible write-down of their loans to Greece. The SPD – Merkel’s coalition partner in Berlin – says in private, though not in public, that Germany has overdone the austerity during the eurozone crisis, and it is against Grexit. Another reason for keeping Greece in the euro is that if it grew strongly outside the currency, anti-euro voices elsewhere would grow bolder.

The ECB, too, remains opposed to Grexit. For now it is taking a hard line on Greece, limiting the ability of Greek banks to fund the Greek government. Yet it was the (still untested) promise of Mario Draghi to do “whatever it takes to preserve the euro” that ensured the single currency’s survival in the summer of 2012. The ECB and others worry that in a future political crisis in another member-state, financial markets might start doubting the commitment of the core countries and the ECB to preserve the integrity of the euro. At that point, the eurozone would be thrown back into the self-fulfilling crisis mode that policy-makers have scrambled to leave behind during the past few years. The ECB would not risk the unravelling of that promise over Greece, unless put under considerable political pressure.

Within Greece, too, it should not be forgotten that a recent poll found 84 per cent of Greeks in favour of keeping the euro. Syriza does not have a mandate to negotiate an exit, and its high approval ratings could soon tumble if the country took steps to prepare for leaving the euro, such as capital controls and bank closures. It may well be that a Greek government which embarked on a path towards Grexit would fall before the event.

One key point for Merkel, apparently, is that Germany should not be blamed for Grexit. One visitor reports her line as being: “If Grexit happens, people will see the cause was that Greece failed to do its homework, not that we withheld solidarity.” In this blame game, Merkel is currently succeeding. It is astonishing how those who agree with Greece that the eurozone has overdone the austerity – like France and Italy, and to some degree the European Commission and the IMF – have been alienated by Syriza’s chaotic and confrontational style of governing, its extreme rhetoric and its inept diplomacy. As a result, Paris, Rome and Brussels are not speaking out on Greece’s behalf. And there are some eurozone governments, notably Finland, the Netherlands, Slovakia and Estonia, which are encouraging Germany to take a hard line. Even the Spanish and the Portuguese, having ‘done their homework’, are in this camp.

But this blame game could easily shift if Germany facilitated or actively pushed for a Greek exit. Not only the US, the IMF and the international press but also probably France and Italy would ultimately criticise Germany for its handling of the euro crisis – during which Greece has suffered from a depression of similar magnitude to that of Germany in the 1930s, the eurozone economy has failed to recover to its pre-crisis size, and the political extremes in Europe have gained much ground. The US has long understood that in its role of the transatlantic alliance’s hegemon, it must accept some costs for the greater good of the alliance’s stability. It expects as much from the EU’s hegemon, Germany, and in the event of a Grexit would hold Berlin largely responsible.

The threats from the Greeks to default on eurozone rescue loans, and from the Germans and their allies to push the Greeks out, are part of a game of brinkmanship: both sides need to be seen as fighting for their voters. A smooth and early agreement would raise suspicion among both sides’ electorates that their politicians could have achieved more from the negotiations. This does not mean, however, that neither Greece nor Germany will step over the brink.

There is no doubt that many powerful voices, within Europe and further afield, will try to prevent Grexit. But Berlin plays a decisive role in eurozone crisis management, and in Berlin key decision-makers believe that Greek membership of the euro is becoming unsustainable. Germany’s friends should help it to see the bigger picture.

Charles Grant is the director and Christian Odendahl is the chief economist at the Centre for European Reform.

Wednesday, April 15, 2015

Not in front of the MPs: Why can’t Parliament have a frank discussion about the EU?

Britain’s Parliament does a poor job of examining EU business. Some simple reforms would improve the way that it scrutinises European legislation.

The British prime minister, David Cameron, wants to make the EU more democratic. National parliamentarians, in his view, understand citizens’ concerns better than MEPs who deliberate in far-away Brussels and Strasbourg; national parliaments should therefore play a greater role in EU decision-making. However, Cameron’s argument would carry more weight if UK parliamentary scrutiny were improved.

The European scrutiny committee of the House of Commons recently questioned whether Cameron means what he says about involving Parliament more in EU law-making. This committee examines EU documents and the British position on them. So if it says the government is not serious about giving Parliament a bigger role in EU affairs, its views deserve attention.

The rule in Britain is that, with a few exceptions (set out in a parliamentary resolution), the government does not agree to any EU proposal until Parliament has expressed a view through the scrutiny process. Each year the European scrutiny committee sifts around 1000-1100 EU documents, including both European Commission legislative proposals and non-legislative texts (such as Commission consultation papers). The committee can either clear them from scrutiny or ask ministers for further explanations.

Whenever the scrutiny committee considers the documents “politically or legally important” it can request a debate on them on the floor of the house, or in one of the Commons’ three EU committees. Each of these committees is responsible for a range of topics; for example, ‘EU Committee A’ deals among other things with energy, climate and environment, food and rural affairs. The three committees do not have a permanent membership. The committee of selection nominates MPs to serve on these committees whenever debates are requested.

In the March 2015 follow-up report to its own 2013 inquiry into the system of scrutinising EU affairs in Parliament, the European scrutiny committee criticised the coalition government for failing to pursue a fruitful dialogue with MPs over European policy. The committee complained that its requests for debates with ministerial participation had fallen on deaf ears in Downing Street.

Six of the plenary debates the committee requested in the current Parliament – just dissolved, pending May’s general election – have not been held. One of the unfulfilled requests was for a debate on the freedom of movement of EU citizens – a central issue in British politics and the general election.

The government’s response to the committee’s criticism has been to argue that few MPs are interested in the EU. William Hague, the Leader of the House (the minister responsible for arranging the government’s business in Parliament), told the committee in February 2015 that the only parliamentarians to request EU debates were members of the scrutiny committee. In other evidence to the committee’s inquiry, the government pointed out that on one occasion, an EU committee meeting on EU law-enforcement co-operation lasted only 13 minutes, because it attracted so little interest among MPs. Only one of the 13 MPs who attended the meeting put a question to the minister present.

Hague has a point. However many debates are scheduled, Parliament can only hold the executive to account if MPs understand the issues. But most MPs have neither the time nor the inclination to learn how the EU works. The EU is seen as too technical and complicated, and many MPs doubt whether voters would reward them for understanding its mechanics. In the 2014-2015 parliamentary session, the scrutiny committee’s overall attendance rate was 48.7 per cent. Julie Elliott, a Labour MP who was shadow energy minister in the last parliament, Linda Riordan MP (Labour) and Stephen Gilbert MP (Liberal Democrat) did not turn up for a single meeting.

Even if all the members of the scrutiny committee had a 100 per cent attendance record, they would need help from other committees to do their job effectively. This is not always forthcoming. To support the scrutiny process, the committee can request an opinion from a departmental select committee, but the latter is not obliged to provide one. Some select committees, like the home affairs and justice committees help, but others are less inclined to do so.

The overall level of knowledge about the EU could improve if the House of Commons spread EU business more equally among MPs. The lower house of the Dutch parliament, for instance, has a decentralised system in which sectoral committees are responsible for scrutiny of documents in their areas of responsibility. But asking Commons’ committees, which already have a full agenda, to take on extra responsibilities for EU scrutiny would not necessarily improve the current situation: committees could well prioritise domestic issues over EU business. The House of Commons should rather take a step-by-step approach which would give MPs time to learn on the job. The European scrutiny committee sensibly suggested that each of the departmental select committees appoint a European rapporteur. The justice committee and the business, innovation and skills committee, which have already nominated such rapporteurs, could serve as an example to others. European rapporteurs could serve as contact points for the chair of the scrutiny committee. They would also ensure that whenever the European scrutiny committee requested an opinion from a select committee on an EU document, it would get an answer. In the next parliament, all departmental select committees should appoint at least one European rapporteur.

MPs should talk to their colleagues in the House of Lords more often. There is a wide gap between MPs and members of the House of Lords in terms of their interest and expertise in European affairs. Peers who sit on the EU select committee and its six sub-committees (jointly referred to as the House of Lords EU committee) often have a better understanding of the EU than their Commons counterparts. Some, like Lord Kerr of Kinlochard (the chair of the CER’s board), worked for the British government and participated in formulating its European policy; other peers worked in the European Commission or served as MEPs. Without the constituency responsibilities of MPs, peers have more time to conduct in-depth inquiries into the EU and British policy on it.

Today, MPs and peers rarely exchange views on the EU. Nor do they co-ordinate their positions on Commission proposals. Since 2006, national parliaments have been able to provide the Commission with direct feedback on its new proposals and consultation papers. After pro-Europeans lost referendums in the Netherlands and France on ratifying the EU constitutional treaty in 2005, the European Commission realised that it needed a dialogue with national parliaments on EU business; it hoped that this would narrow the gap between national and European politics. The House of Lords has grasped the opportunity but the House of Commons has been reluctant to engage in such a dialogue with the Commission. Since December 2009, after the Lisbon treaty entered into force, parliaments have also been able to object to the Commission’s legislative proposals when they think that member-states can better tackle the subject matter themselves (the so-called subsidiarity principle). The House of Commons makes use of this procedure more enthusiastically than the House of Lords: in the years 2012 and 2013 the House of Commons questioned eight of the Commission’s proposals on subsidiarity grounds; in the same period the House of Lords raised objections to only four of them. This lack of co-ordination between the houses weakens Westminster’s ability to get the Commission to take on board British concerns.

MPs and peers should establish a joint committee on the future of the UK’s relationship with the EU, to provide parliamentary oversight in the event of a future government trying to renegotiate the terms of the UK’s EU membership. There are precedents, in the joint committees on human rights and on national security strategy. Such a committee should not replace the existing European scrutiny committee in the Commons or the EU committee in the Lords but rather complement their work. Normal EU business would carry on, despite the government’s efforts to renegotiate the terms of British membership. A joint committee could help to ensure that parliamentarians in both houses were equally well-informed and could contribute fully to a discussion of the UK’s relationship with Europe.

British parliamentarians should make better use of the experience of their colleagues in the European Parliament. The UK national parliament office in Brussels organises joint meetings for MPs, peers and British MEPs twice a year. This is not often enough to support effective co-operation on European affairs. In the German Bundestag and the Polish Sejm (the lower chamber of the Polish parliament), MEPs can participate in meetings of the EU affairs committees. But in the House of Commons only MPs can take part and speak in the scrutiny committee or on the floor of the house; MEPs can only contribute if the scrutiny committee invites them to give evidence as part of an inquiry. It would therefore be difficult to copy German or Polish practice in the UK. Individual MPs, however, should make more use of their party channels to make contact with British MEPs. MEPs could help them to understand the legislative process in Brussels, and in particular in the policy areas that the British care the most about.

Parliamentarians can do a lot to help themselves, but there also are things the British government should do to facilitate Parliament’s knowledge of and interest in EU affairs. The scrutiny committee sensibly proposed that the incoming prime minister allocate sufficient time for debates in the Commons on EU matters, within a month of a request from the committee. MPs also complained that the government refused to circulate to Parliament classified or sensitive EU documents which were relevant to the scrutiny process. The new government could organise informal briefings for MPs from the scrutiny committee and peers from the EU committee on sensitive topics. The government has held such briefings on EU proposals for international sanctions, but only for peers. Briefings should take place on so-called Privy Council terms, whereby parliamentarians promise not to reveal what they learn during the meetings.

The new government should also reinstate regular Commons debates on European Council meetings, before they take place. These were abandoned in 2010 after the Conservative-led government took office. David Cameron has usually reported back to the Commons after EU summits. If the British government wishes to renegotiate the terms of UK membership, it will be up to the European Council to decide whether to consider its proposals for reform, or not. MPs should be able to discuss this process and provide their own input before each summit.

Rather than blaming each other for Parliament’s ineffective contribution to EU policy, MPs and ministers should accept that improving parliamentary scrutiny of EU affairs requires a joint effort. MPs need to be better prepared for discussions on the UK’s approach to the EU. Any British proposal for national parliaments to have a stronger voice in the EU will be more credible if the prime minister of the day is prepared to discuss EU business more openly in Westminster.

Agata Gostyńska is a research fellow at the Centre for European reform. This insight is part of on-going research supported by a grant from the Open Society Foundations.

Friday, April 10, 2015

The slow dance between Minsk and Brussels

The crisis in Ukraine is making Belarus more dependent on Russia. But it has also made the Belarusian leadership keener to balance its close ties to Moscow with a warmer relationship with Brussels.

Most Europeans think little about Belarus, a country of ten million people that nestles between Russia, Ukraine, Poland, Lithuania and Latvia. It has been politically stable for a long time: Alexander Lukashenko was first elected to the presidency in 1994, and is virtually certain to win the next presidential election, in November. But even though the authoritarian political system seems immutable, the economy and the foreign policy may be less so. The EU needs to wake up to the geopolitical opportunities that could arise in Belarus.

Lukashenko has skilfully managed the Belarus-Russia relationship, accepting Moscow’s lead on many but not all issues, and flirting with the EU when Russia’s embrace threatened to become suffocating. With some reluctance, Belarus has joined the Moscow-led Eurasian Economic Union (EEU), on the understanding that Russia will continue to provide cheap energy. But Belarus has still not recognised the independence of Abkhazia and South Ossetia, as Russia requested after its war with Georgia in 2008. And Lukashenko’s line on Crimea is that Belarus recognises Russia’s annexation de facto – but not de jure.

The war in Ukraine and Russia’s economic crisis have created new strains in a Belarusian economy that was already fragile. Belarus has traditionally relied on export industries like lorries and tractors, but these have been slowly losing competitiveness, as wages – largely set by the state – have risen much faster than productivity.

In recent years, excess consumption has contributed to a large current account deficit, which reached $5 billion, or 6.7 per cent of Belarus’s GDP, in 2014. The problems in the Russian economy – the market for around half of Belarus’s exports – have worsened the current account. The collapse of the Russian rouble meant that Belarusian exports to Russia became uncompetitive. Russia’s accession to the World Trade Organisation (WTO) in 2012 had already hit Belarus by allowing goods from other parts of the world to compete against Belarusian products in the Russian market. The shrinkage of the Ukrainian economy – another important export market – has been an additional blow to Belarus.

In recent months, the government has slowed the growth of demand, hoping that this will help the current account to rebalance. It devalued the currency by 40 per cent at the end of last year, in an attempt to maintain exports to Russia, but the result has been inflation that is now approaching 20 per cent. The Belarusian economy may shrink this year. Officially, unemployment is negligible, but it is becoming a problem and many factories are working only a few days a week.

Belarus is habitually short of the foreign currency reserves that may be needed to plug the current account deficit, repay foreign loans or manage the exchange rate. They currently stand at only $4.6 billion. Every year Minsk asks Russia for loans, and sometimes receives them, but in March, when it asked for $2 billion, Moscow offered only $110 million. The IMF recently sent a mission to Minsk but is unlikely to provide major credits because the government will not commit to privatisation or other structural reforms – such as liberalising prices or cutting subsidies for utility bills.

Belarusian ministers say they know they need to embrace the kinds of structural reform that the IMF demands – and in particular to curb the role of the state, which controls more than 70 per cent of output. But they are reluctant to move quickly, lest reform trigger social instability in the run-up to the presidential election. They are particularly wary of privatisation, pointing to the not entirely happy experiences of Russia and Ukraine: the sale of state assets could allow Russian oligarchs to become established in Belarus. Nor is the government enthusiastic about allowing Western firms to take control of key companies.

Belarus’s economic weakness increases its vulnerability to Russian pressure – and the latest proposal from Moscow, which has not gone down well in Minsk, is for the EEU to become a currency union. Russian subsidies to the economy, in the form of cheap oil and gas, have been worth at least 10 per cent of GDP in recent years (Belarus’s main export to the EU is refined oil products, made with cheap Russian oil). Although the drop in the oil price has diminished the value of the subsidy, Belarusians know they cannot stray too far from Russia’s gravitational field.

Nevertheless, within official circles there are divisions on how far Belarus should lean westwards. First deputy foreign minister Alexander Mikhnevich told a recent international round-table in Minsk that Belarus had made a conscious choice to integrate with both the Eurasian Economic Union and the EU, in search of economic relations with the widest possible range of countries. There are various views on how much the economy should liberalise – with the liberalisers, it seems, not winning the argument at the moment. The officials who want to be a bit less dependent on Russia tend to be the same ones who favour some economic opening.

Some senior figures in Minsk acknowledge that the EEU – whose other members are Armenia, Kazakhstan and Russia, with Kyrgyzstan due to join soon – is not really working. There is free movement of labour among its members. But more than 600 products are currently exempt from the EEU’s free trade provisions. There are countless non-tariff barriers and many parts of EEU treaty will not apply till 2025. Recently, without consulting the Eurasian Economic Commission, which manages the EEU, Moscow blocked imports of many Belarusian products – such as meat, fruit and vegetables. This was to punish Minsk for taking advantage of Russia’s ban on certain EU goods by sending large quantities of them into Russia, labelled ‘Belarusian’. In their more candid moments, officials complain that the Russians only follow the EEU’s rules when they suit Russia. Nevertheless everyone understands the implicit bargain with Russia: Belarus accepts the EEU in return for cheap oil and gas.

Events in Crimea and the Donbass have perturbed Belarus’s rulers. They worry about the ‘Putin doctrine’ – that Russia reserves the right to intervene outside its borders to protect ethnic Russian and Russian-speakers. So Belarus’s leaders have given a new priority to improving ties with the EU, to balance Russia’s influence. The EU moves slowly but is now – with the encouragement of the Obama administration – starting to respond.

The EU’s institutions and key governments are in broad agreement that they should seek closer links to Belarus, with a view to lessening its dependence on Russia. This geostrategic approach means the EU will focus somewhat less on human rights. Officials from Minsk and Brussels now meet each other regularly. Belarus’s main demand is that EU sanctions be eased – more than 200 individuals (including Lukashenko) and about 20 companies are blacklisted by the EU on account of human right violations. Brussels’s main demand is that the remaining political prisoners be released (depending on who is counting, there are between three and six of them).

The Belarusians have a particular grievance with the EU. They need to refinance a $1 billion international bond issue that matures in August, and also wish to issue new bonds. But they are barred from the market by Euroclear, the Brussels-based clearing house for international bonds, which interprets EU sanctions to mean that Belarusian issues are prohibited. EU officials say the sanctions should not prevent bond issues and believe that they can fix the problem.

Some opposition activists in Minsk fear that the West will ‘Azerbaijanise’ its relations with Belarus – meaning that it will ignore human rights for the geostrategic gain of strengthening Belarusian independence. But much of civil society would welcome a rapprochement between Minsk and Brussels, in the hope that this could lead to a softer regime, and allow Belarusian NGOs greater access to Western funding and advice.

EU officials are quite optimistic about the possibility of modest change in Belarus, particularly after the presidential election in November. They say that the ministries are comparatively well-organised, efficient and uncorrupt – and sometimes easier to deal with than the government in Ukraine. But this positive mood would soon end if – as has happened in the past – the authorities cracked down on the opposition before or after the presidential election.

If Lukashenko maintains a relatively soft touch, the EU will do a certain amount to help Belarus – even without the release of political prisoners. The two sides have begun a dialogue on the economic modernisation of the country. They have agreed to restart a dialogue on human rights that met on only one previous occasion, in 2009. The EU could assist Belarus’s entry into the World Trade Organisation by forging a bilateral deal with it on WTO issues. It could expand the modest role of the European Bank for Reconstruction and Development in Belarus, and allow the European Investment Bank to operate there.

Much more would happen if the political prisoners were freed. The EU would then lift sanctions. It would make Belarus a full member of its Eastern Partnership (alongside Armenia, Azerbaijan, Georgia, Moldova and Ukraine), thereby giving it access to several sorts of EU funding. Brussels would probably negotiate something similar to the ‘enhanced partnership and co-operation agreement’ that it initialled with the Kazakh government in January.

This slow dance between Minsk and Brussels has begun despite the Ukraine crisis having damaged the EU’s brand in Belarus. The fighting in the Donbass made Belarusians fear that progress towards Europe could lead to chaos. One recent opinion poll showed that 55 per cent of Belarusians view Russia favourably, against 30 per cent for the EU (according to some estimates, two thirds of Belarusians watch Russian TV, which is very biased to Russia’s point of view, and about a third watch Belarusian TV, which is rather less biased in Russia’s favour). But this has not deterred Lukashenko and his ministers from seeking to use the EU as a lever to curb their economic and cultural dependency on Russia.

Since the annexation of Crimea, Lukashenko has tried to encourage a greater sense of national identity, for example by promoting more use of the Belarusian language. He has emphasised his role as a ‘peacemaker’ – hosting the summits which led to the two Minsk agreements on the Donbass – who is neither in Russia’s camp nor the West’s. He has even spoken of the army’s capacity to transfer troops from the west of the country to Vitebsk (in north-east Belarus), which implies a potential threat to the east. Opinion polls suggest that nearly half of Belarusians resent the Russian military bases in their country. And a recent argument over the Belarusian Orthodox church, which comes under that of Russia, annoyed some Belarusians. The Russian church replaced a respected head of the church in Minsk with a Russian who has little feel for the country.

The country’s sense of identity is certainly weak, even compared to Ukraine. Much of it is negative: Belarusians think they are not Russian, not Polish (Poland dominated the country for more centuries than Russia has done) and not Western. A lot of people probably care more about their economic prospects than national feelings. But the Ukraine crisis has given a fillip to some Belarusians’s sense of national identity, in the sense that they do not want to be subsumed into Russia.

The EU should seek to engage not only civil society but also President Lukashenko’s regime. This could help to strengthen the country’s independence, encourage the government to treat NGOs and the opposition more kindly, reduce Belarus’s isolation and make it a little more European. Such outcomes, though far from certain, would be a worthwhile achievement.

Charles Grant is director of the Centre for European Reform. He recently took part in a study trip to Belarus, organised by the European Council on Foreign Relations.

Wednesday, April 08, 2015

Security in the age of austerity: You get what you pay for

Europe’s neighbourhood is too dangerous for decisions on defence budgets to be left to austerity-minded finance ministers. The UK should set a good example.

The EU is in a dangerous neighbourhood, but shrinking European defence budgets suggest that finance ministries either have not noticed or do not care. According to the Stockholm International Peace Research Institute (SIPRI), from 2004 to 2013 defence spending in Europe fell by 6.5 per cent (in constant dollar terms); in some countries, including the UK and Italy, it fell by more than 10 per cent. Over the same period, Russia's defence expenditure more than doubled, and China's rose by 170 per cent. Saudi Arabia is now spending more on defence than the UK.

At the NATO Wales Summit in September 2014, the alliance's member-states agreed that they would "aim to move towards the existing NATO guideline of spending 2 per cent of GDP on defence within a decade". Since then, countries like Belgium and Italy have announced further cuts. Across Europe, defence spending in 2013 (according to NATO figures) averaged around 1.6 per cent of GDP. Only Estonia, Greece and the UK spent 2 per cent or more.

Some European politicians have begun to discuss the threats that Europe faces and the need to invest in countering them. The EU high representative for foreign and security policy, Federica Mogherini, has started work on updating the EU's 2003 security strategy (see Rem Korteweg’s insight of January 19th). Britain's foreign secretary, Philip Hammond, spoke at the Royal United Services Institute on March 10th of the threats to the UK from terrorism and Russia. President Bronisław Komorowski of Poland told the German Marshall Fund's Brussels Forum on March 22nd that the post-Cold War peace dividend had run its course. But what will Europe do to respond?

Prime Minister David Cameron vocally supported the NATO 2 per cent target at the time of the NATO summit. But the UK is likely to undershoot it by 2017, if not sooner. To disguise this, government ministers have been trying to include other spending (especially on the intelligence services) under the heading of 'defence'. The Chancellor the Exchequer, George Osborne, repeatedly avoided endorsing the 2 per cent figure during an interview on March 19th, saying only that the Conservative Party was "committed to keeping our country safe". In election campaigns, the Conservatives have often portrayed themselves as supporters of strong defence; but this time they are trying not to talk about it at all. The Labour Party is poorly placed to exploit this: Shadow Chancellor Ed Balls has suggested that a Labour government would also cut defence spending, though by less than the Conservatives.

The UK's position is bad news for several reasons. First, Britain has traditionally been the strongest link between the US and Europe in the defence and security fields. Now Britain seems to be adopting bad European habits. From President Barack Obama downwards, publicly and privately, the Americans have been critical of the trend of declining defence spending in the UK. Senior Americans like the former defence secretary Robert Gates have long warned that Europe cannot continue to benefit from US defence spending while doing little for itself. If the US cannot even rely on the UK, the risk that America will reduce its commitment to European security will grow.

Second, cuts in the UK's defence capabilities hit the Franco-British relationship, which is central to any serious European defence co-operation. The UK and France provided both the political impetus and military muscle for operations against Colonel Qadhafi in Libya in 2011. But the UK's role in French operations in Mali and the Central African Republic since then has essentially been limited to providing air transport. Paris knows that it cannot lead European defence efforts by itself. French officials have privately expressed strong concerns about the effect of likely budget decisions on the UK's force structures and therefore on its ability to co-operate with France. They are also worried that defence budget cuts, like the 2013 parliamentary vote against intervening in Syria, are signs of a growing British isolationism.

Third, British ministers will no longer have any credibility when they press other European leaders to spend more on defence, if the UK itself is heading in the opposite direction. All governments in Europe are under pressure to reduce expenditure; for most, with honourable exceptions like Poland, it is politically easier to cut defence budgets than health and welfare. Britain may encourage a downward spiral in defence spending in Europe.

Some EU leaders will be happy if the UK stops nagging them to do more on defence. But Commission President Jean-Claude Juncker was wrong to tell Welt am Sonntag on March 8th that “military answers are always the wrong answers”. Sometimes only effective military action can create the space to settle conflicts politically. By repeating the mantra that “there is no military solution” in Ukraine, the West has handed the initiative to Putin, who is ready to impose one. Andrew Wilson of University College London said memorably at the beginning of the Ukraine crisis that the EU “took a baguette to a knife fight”. A frank debate about European defence and security needs to acknowledge that the EU does not just need soft power tools like trade, aid and the rule of law if it is to ensure stability and progress in the neighbourhood. Europe may keep a baguette in one hand; it needs a sharp knife in the other.

Juncker was also wrong to suggest that Europe needed its own army – not just because the idea energises British eurosceptics in a sensitive pre-election period; but because institutions and processes cannot substitute for defence capabilities and political will. Having a European operational headquarters is of no use if there are too few forces to command and no consensus on what to do with those forces that exist. The EU can do more, however – if allowed by the UK and others – to help rationalise European defence markets, ensuring that the money that is available is spent efficiently; and to encourage its member-states to work together better on defence. There are good examples of countries agreeing to share capabilities, rather than duplicating them, among the Benelux and Nordic countries. But Europe needs to get beyond delivering the same output for smaller input, and increase both. That should be the focus of the European Council’s discussions on European defence in June, and of NATO’s spring ministerial meetings.

The next British government also needs to recognise the European dimension of defence and security policy. Britain faces larger and more diverse threats than in 2010 when it published its last national security strategy. But whatever Britain spends on countering them, the impact will be greater if the rest of Europe takes defence more seriously. A good starting point for the government that wins May’s election would be to reinforce Franco-British co-operation, to reassure France that the UK will remain a reliable defence partner. Then these two countries should persuade European finance ministers to stop budgeting on the basis that the world is at peace and defence spending is a luxury.

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

The low-hanging fruit of European capital markets

The planned capital markets union in Europe faces many obstacles. Commissioner Hill was right to start with the lower-hanging fruit but it will not help the eurozone in the short term.

Europe’s economy is too dependent on bank finance. A greater reliance on capital markets would help to boost the region's economic growth and resilience in future financial crises. To this end, the European Commission is aiming to create a capital markets union (CMU) in an effort to lower Europe’s dependence on bank finance and encourage the integration and deepening of its capital markets. But there are plenty of obstacles. Jonathan Hill, the EU’s finance commissioner, is sensibly focusing on the lower hanging fruit. But even these ‘early action’ measures will take time to implement, and as such will not improve Europe’s short-term economic prospects.

Contrary to the US, banks provide the bulk of financing to businesses in Europe. To some extent, this reflects the fact that US firms are on average larger: almost 60 per cent of American employees work for firms with a staff of more than 250; the corresponding figure in Europe is just a third. Participants in capital markets are less willing to invest in smaller firms, because it is relatively more costly to acquire the information needed to determine the risks of lending to them. Banks, with their closer relationship to customers, usually possess that information. Europe's bank dependence also reflects underdeveloped capital markets in Europe.

One problem with bank lending is that it tends to be pro-cyclical, growing strongly during booms and contracting during busts, thus amplifying the business cycle. There are two reasons for this. First, a financial crisis leads to losses and reduces a bank’s capital. Since banks have to finance a share of their loan book with their own capital rather than with deposits or bonds, they need to rebuild their ‘capital ratio’, which often leads them to curtail lending. Second, regulation tends to tighten after crises: often regulators demand that banks finance a larger share of their loan books with their own capital, or change the amount of assets that banks need to hold to remain liquid. Such changes in regulation often lead to further cuts in lending.

To some extent, pro-cyclical regulation is inevitable, but it is more painful in a bank-based economy. Since the crisis, European firms have struggled to access funding because the region’s banks have reined in lending and capital markets were underdeveloped. Regulation was also tightened unduly, for example regarding securitisation. And monetary and fiscal policy failed to offset the negative impact of pro-cyclical bank lending on the economy. Some of these mistakes are being corrected: macroeconomic policies have become less contractionary; and regulation has been relaxed in areas where the post-crisis response went over the top, though arguably not enough.

A fully-fledged CMU would broaden the funding base for firms and infrastructure projects, making the European economy less bank-dependent and more robust. Larger and deeper capital markets would also help the European Central Bank (ECB) to conduct monetary policy: when a central bank lowers interest rates, there are two ways through which they can be transmitted to firms, via bank interest rates and via the cost of funding on capital markets. Moreover, the ECB would have a wider choice of assets (beyond government bonds) to buy in future ‘quantitative easing’ programmes.

However, a fully-fledged CMU requires politically and legally difficult measures like the harmonisation of insolvency, corporate and tax laws – which will take years to implement, if they are ever agreed at all. What is more, the reform momentum is currently strong and should not be spread too thinly over too many projects. The Commission is therefore right to set out three priorities for early action.

First, it wants to make it easier for firms based in one member-state to find investors in others. This requires that information about companies be easily accessible and in a form that analysts all around Europe understand. The prospectuses, the key documents that contain information about an asset such as a corporate bond, are costly to produce and need to be harmonised and simplified. Credit scores should also be made easily available and comparable across the EU.  The Commission is calling for a consultation on the existing prospectus directive and credit scores framework to start the reform process. It also wants to support the growth of the so-called private placement markets in which medium-sized companies can market bonds in volumes that would be too small for public offerings.

Second, the Commission aims to rebuild the European market for securitisation. Securitisation allows banks and financial markets to work together: banks have superior knowledge of local small and medium-sized enterprises (SMEs) and households, and can provide loans to financially sound borrowers; financial markets are eager financiers of such loans but only if they come in the right shapes and sizes. Securitisation allows banks to bundle loans together, and sell tranches to investors. Banks therefore have an incentive to extend more loans if they can sell bundles of them; participants in financial markets, including pension and insurance funds, can invest in SMEs and other assets that are too small to invest in individually; and the ECB has a large asset class that it can buy in its monetary policy operations.

Securitisation has an image problem as it is seen by many in Europe as a cause of the financial crisis. But just as Greek public finances were not the reason for the euro crisis, securitisation was not the reason for the 2008-9 crash: highly leveraged banks, overly complex securitisation, faulty risk models and a run on the refinancing markets of banks and shadow banks all worked together to create a perfect storm. Simple securitisation, on the other hand, was largely blameless. This is especially true in the EU, where the default rate of all ‘structured finance products’ was only 1.6 per cent between mid-2007 and mid-2014, compared to almost 20 per cent in the US. The key is to make the process of securitisation transparent and comparable across the EU. This is what the Commission aims to help achieve, and has started a consultation process on the issue.

The last ‘early action’ aims to boost long-term investments, especially the use of European long-term investment funds (ELTIFs). In essence, ELTIFs are a new regulatory class of funds which allow issuers to ‘lock up’ investors’ money for a long time, and market them across Europe. The aim is to make it easier for capital to flow across borders into long-term projects such as infrastructure. Here again, the Commission is consulting on how to support the use of these instruments.

These three measures are realistic first steps: they focus on relevant issues (access to funding, securitisation and long-term investment); and they cover areas where there is a role for the Commission to drive the process forward. Moreover, the Commission has a powerful ally in the ECB, especially on securitisation, and the support of the German and British governments. But even plucking the lower hanging fruit of the CMU will take time. For example, a new regulatory framework for securitisation could take two years until it is fully operational. The construction of the CMU is a long-term goal, not a solution to Europe’s immediate economic problems.

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

Thursday, April 02, 2015

It’s the geopolitics, stupid: Why TTIP matters

A transatlantic free-trade agreement offers geopolitical benefits for the EU and the West. Supporters of a deal should make this point to claim back ground from the anti-TTIP camp.

Proponents of the transatlantic trade and investment partnership between the US and the EU, better known as TTIP, face an uphill struggle. Since negotiations started in 2013, the momentum has been with TTIP’s opponents. In Europe, they have mobilised support on social media, in parliaments and on the streets. Anti-TTIP protests shut down parts of Brussels in December. Nobody is demonstrating in favour of a deal.

TTIP’s advocates focus on the economic benefits: removing the remaining tariffs, aligning rules and standards, and reducing the paperwork required for doing transatlantic business should all lead to economic growth. But the full economic gains of TTIP are unlikely to be visible for several years after its implementation. In contrast, TTIP’s European opponents are exploiting protectionist, anti-American and eurosceptic sentiment. Critics such as trade unions and left-of-centre parties in Germany, France and Austria warn that TTIP is a secretive agreement that would force Europe to adopt inferior, American standards and would subordinate European democracies to US corporate interests. In response, the European Commission has decided to make many of its negotiating documents public. But that will not satisfy many opponents to a deal. Policy-makers and politicians must therefore focus their message on the undecided and those whose interests are not purely economic. While the economic benefits of TTIP are difficult to quantify, the geostrategic impact warrants closer attention in Europe.

A successful TTIP would bring Europe a number of strategic benefits. TTIP would allow the West to set global trade standards, strengthen Western diplomacy, improve European energy security and reaffirm transatlantic ties.

States use economic competition in pursuit of geopolitical objectives. After years of crises, low growth and political tension in the West, some countries in Asia, Latin America and Africa have become attracted to state-led economic models such as that of Beijing. China and other undemocratic emerging economies are therefore using their economic success as a springboard to political influence. Russia – though certainly not an economic success – has created the Eurasian Economic Union to look like a quasi-EU while promoting Russian political and economic interests in its neighbourhood. China is trying to set up alternatives to Western-dominated international financial institutions. The UK, France and Germany provoked American irritation when they announced that they would join the Asian Infrastructure Investment Bank as founding members. The US is concerned that the Chinese-led institution could be a means to circumvent the World Bank. The creation of a transatlantic trade bloc, however, would strengthen the Western economic model against the growing influence of undemocratic states.

Size matters, particularly in the geopolitics of trade. A new, seamless market based on a transatlantic tariff-free zone with a large degree of regulatory convergence would be a major attraction for others. If two economic giants agreed to align consumer safety, environmental, investment protection and other standards, their combined pull would bring others to copy these standards to gain market access. This would expand Western influence.

The EU and the US are negotiating TTIP mainly for the benefit of European and American citizens, consumers and companies, but the negotiators are surely aware of the deal’s potential impact on other trading partners. TTIP can become a new centre of gravity for global trade. Once an agreement has been reached, countries which already have far-reaching agreements with either the US or the EU should be offered access to TTIP. For some it would be relatively straightforward to ‘dock’ to the deal: Canada recently signed an EU trade agreement seen by many as a precursor to TTIP, and Norway is a member of the European Economic Area, and will have to accept TTIP’s standards. But for a country like Turkey it will be different. Turkey’s customs union with the EU does not include areas that are covered by TTIP, such as agriculture and public procurement: in these areas, US firms would have an advantage over Turkish firms in Europe. TTIP would therefore give Ankara a strong interest in deepening the customs union. The EU should talk to Turkey about TTIP, but Western concern over President Tayyip Erdogan’s creeping authoritarianism and his controversial foreign policies suggest the talks may be icy. The EU should use the additional diplomatic leverage TTIP would generate.

In spite of the attention it gets in Europe, Brussels and Washington are not pursuing TTIP in isolation. In Asia, the EU has bilateral free-trade talks with Japan, India and five south-east Asian countries underway, and it has concluded deals with South Korea and Singapore. The United States is negotiating a ‘mega-regional’ trade agreement, called the Trans Pacific Partnership (TPP), with eleven Pacific countries including Japan, Malaysia, Australia and Mexico. In a way, TPP is TTIP’s Pacific counterpart: it would also set regional standards and reduce non-tariff barriers. These twin trade talks involve more than a billion people in 40 countries producing 60 per cent of global GDP (based on 2013 World Bank figures). The WTO’s Doha round has been stalled, perhaps indefinitely, and the TPP-TTIP tandem could become the basis of a new-style multilateral trade accord, centred around Western leadership.

Despite their complementarity, TPP figures more prominently in Washington’s policy debate than TTIP: TPP is likely to conclude sooner, President Barack Obama has made it a central element in his Asia strategy, and some of TPP’s Congressional champions say that Asia is the future, while dismissing the eurozone’s glacial growth prospects. European diplomats in Washington should not enter both deals into a beauty contest, rather they should impress their combined strategic value upon the Americans.

TTIP would also set an example for other trade talks. The European Union and China are discussing an investment agreement, though the negotiations are slow-moving. Investment protection is one of the EU’s principal demands: it wants to see a Chinese economy that is more transparent, where the rule of law protects foreign intellectual property and investment. Herein lies the strategic value of a robust investor-state dispute settlement mechanism in TTIP – even if it is one of the main issues fuelling opposition in Europe. An EU-US deal with a strong clause on investor protection would make it more difficult for Beijing to push for an EU-China investment treaty without one.

Then there is TTIP’s energy dimension. The US fracking revolution has put the country on the cusp of exporting liquid natural gas (LNG). The EU thinks American LNG will help to diversify European energy imports and reduce reliance on Russian gas. A free-trade deal would allow EU gas companies to avoid the hassle of securing licences for LNG imports from the US government. This should be a compelling reason in favour of TTIP for those countries concerned about their dependence on Russia. Although some European leaders will have to do a better job at explaining one irony: why they are happy to import US shale gas, but unwilling to drill for it at home.

American oil also features in transatlantic energy discussions. Innovations like those that have spurred shale gas production have turned the US into the world’s largest producer of oil and refined petroleum products. But the US has banned crude oil exports since the 1973 oil crisis. While the European Commission would like TTIP to cover oil, Congress is hesitant to loosen its grip on this national treasure. Trade in crude oil would be a major boon for Europe, and EU negotiators should demand it: it would help European refiners and the petrochemical industry, improve European energy security and increase market pressure on other major oil exporters, particularly Russia. In the United States, a growing chorus is pointing to the benefits for US foreign policy of lifting the oil export ban.

A deal on TTIP would help to keep the US committed to Europe. NATO remains the bedrock of the transatlantic security partnership, but America’s strategic gaze is increasingly drawn towards the Far East. Most European defence budgets continue to decline. This makes US politicians more and more reluctant to invest in the NATO alliance. TTIP could be a ‘second anchor’ for US commitment to Europe. A deal would not be a substitute for NATO, but TTIP could offer Americans a persuasive economic rationale for continuing to support a strong transatlantic bond. Mike Froman, the US Trade Representative who negotiates TTIP, said in 2013 that a deal “would complement one of the greatest alliances of all time with an equally compelling economic relationship.”

But trade negotiations are hard and could drag on, or even fail. German Chancellor Angela Merkel and European Commission President Jean-Claude Juncker said on March 4th that a deal should be reached in 2015. The US negotiator said a deal should be done on ‘one tank of gas’, meaning within President Obama’s term in office. This may not be realistic. A delay is one thing, but if the two sides fail to reach a meaningful agreement, there would be a number of negative consequences.

Besides the West’s unity, the EU’s credibility as a global actor is at stake. Brussels sees itself as an economic power, not a military power. If anything, the size and depth of the European single market is a magnet of attraction for other countries; that gives the EU global influence. Investing in TTIP’s success but then failing to deliver it would be a blow to the EU’s geopolitical standing.

Should the negotiations collapse, mutual recrimination would lead to a deeper transatlantic divide. If TTIP broke down and TPP succeeded, it would cement America’s pivot to Asia and raise further doubts about Europe’s importance to the US. Moscow would see a collapse of the talks as a new opportunity to exploit, energising its anti-Western rhetoric. Beijing would still have concerns about TPP, but it would be relieved that Brussels and Washington could not impose their trade standards in unison. And finally, a failed TTIP would do nothing for the EU’s reputation in the UK and other free-trading member states. For Britain, in particular, this would be dangerous if the failure coincided with a referendum campaign on EU membership. Pro-EU Tories rely on Europe’s ability to negotiate important free-trade agreements as an argument for staying in.

Rem Korteweg is a senior research fellow at the Centre for European Reform.