by Philip Whyte
The world economy is going through its greatest financial crisis since the 1930s Great Depression. Who – or what – is to blame for the credit crunch? And what are the lessons to be learned? The arguments are still filling newspaper column inches, but a consensus has yet to emerge.
Some observers have blamed central banks – particularly the US Federal Reserve under Alan Greenspan’s stewardship. The main charge against the Greenspan Fed is that it pursued an excessively loose monetary policy following the bursting of the ‘dotcom’ bubble in 2000. Persistently low US interest rates, it is argued, were the proximate cause of the housing market bubble whose bursting has resulted in the current credit crunch. Low real interest rates do seem to have been a contributory factor, but they cannot be the only explanation. Some countries with lower real interest rates than the US did not experience house price bubbles (eg Germany and Japan). And some countries with higher real interest rates than the US experienced even greater house price bubbles than the US (eg the UK).
A second explanation might be financial innovation – particularly securitisation, the practice of packaging loans as securities that can then be sold on and traded in the open market. Until recently, securitisation was often praised for spreading risk. The trouble is that it also seems to have ratcheted up the overall amount of risk in the system. Since the originators of loans did not bear the ultimate risk, securitisation gave them every incentive to generate fees without considering whether borrowers had any chance of repaying their loans. This process might have been mitigated if credit rating agencies had done their jobs. But whether because of negligence or conflicts of interest – they are paid by sellers, not buyers – credit rating agencies dished out investment grade ratings to poor quality securities.
Banks are never popular even at the best times. So it comes as no surprise that they have also been in the line of fire. The case against them is that they allowed their greed to get the better of their judgement – resulting in irresponsible behaviour. Some observers believe that banks’ recklessness was encouraged by compensation structures that reward short-term performance. Banks have already owned up to some mistakes. An interim report by the Institute of International Finance (IIF), an association of bankers, admitted that banks were guilty of a ‘decline in underwriting standards’; had been too reliant on inadequate ratings; and had had trouble identifying where exposures resided. Intriguingly, the IIF report also concluded that banks should reconsider incentives and compensation structures.
Perhaps the most satisfying explanation involves some combination of all these factors. The credit crunch did not result from any of these factors in isolation, but from the way in which they interacted. Credit growth, for example, would not have been so buoyant had real interest rates been higher. A backdrop of unprecedentedly cheap money almost certainly encouraged banks to under-price risk. Banks’ reckless behaviour may also have been encouraged by the actions of central banks, such as the Fed’s decision back in 1998 to rescue Long Term Capital Management (LTCM), a hedge fund. By signalling that irresponsible institutions and managers could count on being bailed out by public money, critics claim, the US Fed created ‘moral hazard’ – laying the foundations for subsequent excesses.
Recent events have not cast the financial sector in a good light. The IIF believes that a regulatory clampdown is unnecessary, and that banks can learn from their mistakes. This is wishful thinking. A regulatory clampdown now looks inevitable – on both sides of the Atlantic. At this point in the game, the key must be to ensure that changes in financial sector regulations are sensible, well-designed and proportionate to their objectives. But there may also be lessons for the monetary authorities. For much of the past decade, the conventional wisdom, particularly in the Anglo-Saxon world, was that central banks could (or should) not target asset prices. The time may have come to revisit the subject. Alan Greenspan remains to be convinced. But do not be surprised if you come across more column inches arguing in favour of the need for central banks to ‘lean against the wind’.
Philip Whyte is a senior research fellow at the Centre for European Reform.
Wednesday, April 23, 2008
Thursday, April 10, 2008
Turkey’s turmoil, the EU’s reaction
by Katinka Barysch
Political turmoil is nothing new in Turkey. After six years of unusual stability, tensions have mounted since early 2007. The army threatened to topple the AKP government in case it made Abdullah Gul president. Gul did become president, and the AKP emerged strengthened from an early election. Now the chief prosecutor has pushed a case in front of the constitutional court that threatens to ban the AKP because of its alleged anti-secular activities, most notably ending the ban on women wearing headscarves in universities.
So far, the EU has tried to stay out of Turkey’s battle between the mildly Islamist AKP and the increasingly desperate secular establishment. But last week Olli Rehn said that the court case was a mistake. Both he and Javier Solana have indicated that if the constitutional court banned the AKP, the accession negotiations would be off – or at least that is how the Turkish press have interpreted their statements.
A number of the people I spoke to during a Turkey visit last week were unhappy about the EU apparently taking sides. They say that Turkey’s West European friends underestimate the threat of creeping Islamisation. They worry about what Commission President Barroso will say when he arrives for his first official visit to Turkey this week.
The AKP and its supporters have a point when they say that this case is political and therefore merits a political response. They say that the 160-page indictment is based more on past statements by AKP politicians than on their actions. Yet not one of the 11 constitutional judges voted against accepting the case. To many, this indicates that the outcome is a foregone conclusion.
The AKP would not be the first party to be banned for allegedly violating the constitution: 24 have been shut down since the 1960s, including the AKP’s predecessors. But the circumstances have changed. The AKP has built up an impressive track record of reforms and modernisation during its seven years in office. It is popular enough to rule without a coalition partner. If it were closed down, it would reappear in a different guise and probably win another election. However, its top leadership, including Prime Minister Erdogan and President Gul, would most likely be banned from politics for years. For an organisation as hierarchical as the AKP this is hardly an acceptable outcome.
Instead, the government is thinking about pushing through a constitutional amendment that would make it harder to ban political parties. AKP leaders refer to the Council of Europe, which has said that only parties that support violence should be outlawed. The AKP does not have quite enough votes in parliament to change the constitution. It would need some support from the opposition, which would come at a hefty price. Alternatively, the AKP could put any amendment to a referendum, which it would presumably win.
Such a strategy may work, in the sense that it would prevent a ‘judicial coup’ against the government. But it would hardly assuage the concerns of those who suspect the AKP of using democracy as a means to pursue a hidden agenda of Islamisation.
That is why the European Stability Initiative – in a scary report about Turkey’s ‘deep state’ released last week – is calling on the government not to amend the old constitution but adopt an entirely new, more modern one. The ESI is right that a move to make it harder to ban parties would be more acceptable if it was part of a wider reform package.
It is also true that Turkey needs a new constitution: the current one dates back to the last military coup in 1982. However, the draft that legal experts wrote for the AKP last year has disappeared from view. Promises of a nation-wide debate have so far remained unfulfilled. Instead, the AKP has started doing constitutional change ‘a la carte’, especially by ending the headscarf ban. That was a mistake. But a constitution that was hastily adopted in an attempt to ensure the AKP’s political survival would lack legitimacy. Turkey first needs a wider debate about individual rights and a suitable systems of checks and balances. Constitutional change is simply too important for the future stability of Turkey to be rushed (see also
More than just a debate about the headscarf, article by Katinka Barysch, Financial Times, 7 November 2007).
There are other steps the AKP can take to bolster its reformist credentials; and it is taking some already. Erdogan now talks more about the government’s commitment to EU accession than he has done in a long time. After years of delay, a group of MPs has finally submitted amendments to the controversial article 301, under which the likes of Orhan Pamuk have been prosecuted. There is much more that the AKP could do, from liberalising rules for other religions to promoting women’s rights and making it easier for smaller parties get funding and parliamentary representation.
Barroso and other EU politicians should explain to Turkey that, unfortunately, the EU cannot offer an easy way out of the current dilemma. But that whatever the AKP decides to do would be more acceptable if the AKP restarted the modernisation and EU accession efforts that it has been neglecting over the last two years.
Katinka Barysch is deputy director of the Centre for European Reform.
Political turmoil is nothing new in Turkey. After six years of unusual stability, tensions have mounted since early 2007. The army threatened to topple the AKP government in case it made Abdullah Gul president. Gul did become president, and the AKP emerged strengthened from an early election. Now the chief prosecutor has pushed a case in front of the constitutional court that threatens to ban the AKP because of its alleged anti-secular activities, most notably ending the ban on women wearing headscarves in universities.
So far, the EU has tried to stay out of Turkey’s battle between the mildly Islamist AKP and the increasingly desperate secular establishment. But last week Olli Rehn said that the court case was a mistake. Both he and Javier Solana have indicated that if the constitutional court banned the AKP, the accession negotiations would be off – or at least that is how the Turkish press have interpreted their statements.
A number of the people I spoke to during a Turkey visit last week were unhappy about the EU apparently taking sides. They say that Turkey’s West European friends underestimate the threat of creeping Islamisation. They worry about what Commission President Barroso will say when he arrives for his first official visit to Turkey this week.
The AKP and its supporters have a point when they say that this case is political and therefore merits a political response. They say that the 160-page indictment is based more on past statements by AKP politicians than on their actions. Yet not one of the 11 constitutional judges voted against accepting the case. To many, this indicates that the outcome is a foregone conclusion.
The AKP would not be the first party to be banned for allegedly violating the constitution: 24 have been shut down since the 1960s, including the AKP’s predecessors. But the circumstances have changed. The AKP has built up an impressive track record of reforms and modernisation during its seven years in office. It is popular enough to rule without a coalition partner. If it were closed down, it would reappear in a different guise and probably win another election. However, its top leadership, including Prime Minister Erdogan and President Gul, would most likely be banned from politics for years. For an organisation as hierarchical as the AKP this is hardly an acceptable outcome.
Instead, the government is thinking about pushing through a constitutional amendment that would make it harder to ban political parties. AKP leaders refer to the Council of Europe, which has said that only parties that support violence should be outlawed. The AKP does not have quite enough votes in parliament to change the constitution. It would need some support from the opposition, which would come at a hefty price. Alternatively, the AKP could put any amendment to a referendum, which it would presumably win.
Such a strategy may work, in the sense that it would prevent a ‘judicial coup’ against the government. But it would hardly assuage the concerns of those who suspect the AKP of using democracy as a means to pursue a hidden agenda of Islamisation.
That is why the European Stability Initiative – in a scary report about Turkey’s ‘deep state’ released last week – is calling on the government not to amend the old constitution but adopt an entirely new, more modern one. The ESI is right that a move to make it harder to ban parties would be more acceptable if it was part of a wider reform package.
It is also true that Turkey needs a new constitution: the current one dates back to the last military coup in 1982. However, the draft that legal experts wrote for the AKP last year has disappeared from view. Promises of a nation-wide debate have so far remained unfulfilled. Instead, the AKP has started doing constitutional change ‘a la carte’, especially by ending the headscarf ban. That was a mistake. But a constitution that was hastily adopted in an attempt to ensure the AKP’s political survival would lack legitimacy. Turkey first needs a wider debate about individual rights and a suitable systems of checks and balances. Constitutional change is simply too important for the future stability of Turkey to be rushed (see also
More than just a debate about the headscarf, article by Katinka Barysch, Financial Times, 7 November 2007).
There are other steps the AKP can take to bolster its reformist credentials; and it is taking some already. Erdogan now talks more about the government’s commitment to EU accession than he has done in a long time. After years of delay, a group of MPs has finally submitted amendments to the controversial article 301, under which the likes of Orhan Pamuk have been prosecuted. There is much more that the AKP could do, from liberalising rules for other religions to promoting women’s rights and making it easier for smaller parties get funding and parliamentary representation.
Barroso and other EU politicians should explain to Turkey that, unfortunately, the EU cannot offer an easy way out of the current dilemma. But that whatever the AKP decides to do would be more acceptable if the AKP restarted the modernisation and EU accession efforts that it has been neglecting over the last two years.
Katinka Barysch is deputy director of the Centre for European Reform.
Thursday, April 03, 2008
Eurozone economic outlook: Too much complacency
by Simon Tilford
A year ago the prospect of the dollar falling to 1.60 against the euro would have brought on cold sweats across Europe. Yet, here we are and there is no sense of crisis. Indeed, business confidence remains strong across much of the eurozone, credit is expanding rapidly, and exports are holding up well. On the face of it, the eurozone really does seem to be shaking off the recession in the US and the steep rise in the value of the euro. A closer look, however, reveals a less rosy picture.
It is true that credit growth remains robust, but this is a backward looking indicator. A lot of these loans will already have been in the pipeline. Higher money market rates and the delayed impact of last year’s interest rate increases by the European Central Bank (ECB) will slow credit growth over the coming months. Moreover, domestic consumption is weakening across the eurozone. Crucially, German consumers remain as cautious as ever, despite employment having boomed in the country over the last two years. German retail sales were lower in February than a year earlier, with people particularly keen to avoid large purchases. The German car industry may be flourishing, but this is despite, rather than because of, what is happening in Germany: car sales were down 14 per cent year on year in March. This was an even bigger decline than in the US.
The ECB will not ride to the rescue. Despite the strength of the euro (which lowers the price of imported goods), eurozone inflation hit a record 3.5 per cent in March, over one and a half percentage points above the ECB’s inflation target of “close to but less than” 2 per cent. The strength of inflation is largely down to rising energy and food prices, but it also reflects a pick-up in “core” inflation pressures. With the ECB worried about rising wage settlements in Germany and elsewhere in the eurozone, it is very likely that there will no easing of monetary policy in the eurozone this year.
Nor can eurozone firms look to exports for support, especially if, as appears likely, the euro is set for a period of prolonged strength. The high-flying currency is already hitting exports from the Mediterranean countries hard, and will soon have a similar impact further north. There is little empirical basis for the widespread belief in Germany that demand for that country’s exports is largely unrelated to price. The strength of the global economy is important of course, but there is a close correlation between demand for German exports and the exchange rate.
Of course, there are some exporters for whom the strength of the euro is not a pressing issue. Demand for certain very specialised equipment, such as printing presses or mining machinery, probably varies little by price, because there are few makers of such equipment. Buyers expect the machine to last a long time and are hence more concerned about servicing and reliability than price. But the majority of exporters do not operate in such markets. For example, makers of white goods such as dishwashers and washing machines as well as office equipment and cars – all big German exports – operate in very price-sensitive markets.
The eurozone as a whole is certainly better placed than the US, but Europeans are too complacent about the ability of their economies to ride out the current storm. First, the sensitivity of exporters to the strength of the euro is greater than many believe. Even the eurozone economies most confident about their export prospects – Germany, the Netherlands and Finland – will experience a sharp slowdown in external demand. Second, rising inflation all but rules out cuts in eurozone interest rates in 2008.
Simon Tilford is chief economist at the Centre for European Reform.
A year ago the prospect of the dollar falling to 1.60 against the euro would have brought on cold sweats across Europe. Yet, here we are and there is no sense of crisis. Indeed, business confidence remains strong across much of the eurozone, credit is expanding rapidly, and exports are holding up well. On the face of it, the eurozone really does seem to be shaking off the recession in the US and the steep rise in the value of the euro. A closer look, however, reveals a less rosy picture.
It is true that credit growth remains robust, but this is a backward looking indicator. A lot of these loans will already have been in the pipeline. Higher money market rates and the delayed impact of last year’s interest rate increases by the European Central Bank (ECB) will slow credit growth over the coming months. Moreover, domestic consumption is weakening across the eurozone. Crucially, German consumers remain as cautious as ever, despite employment having boomed in the country over the last two years. German retail sales were lower in February than a year earlier, with people particularly keen to avoid large purchases. The German car industry may be flourishing, but this is despite, rather than because of, what is happening in Germany: car sales were down 14 per cent year on year in March. This was an even bigger decline than in the US.
The ECB will not ride to the rescue. Despite the strength of the euro (which lowers the price of imported goods), eurozone inflation hit a record 3.5 per cent in March, over one and a half percentage points above the ECB’s inflation target of “close to but less than” 2 per cent. The strength of inflation is largely down to rising energy and food prices, but it also reflects a pick-up in “core” inflation pressures. With the ECB worried about rising wage settlements in Germany and elsewhere in the eurozone, it is very likely that there will no easing of monetary policy in the eurozone this year.
Nor can eurozone firms look to exports for support, especially if, as appears likely, the euro is set for a period of prolonged strength. The high-flying currency is already hitting exports from the Mediterranean countries hard, and will soon have a similar impact further north. There is little empirical basis for the widespread belief in Germany that demand for that country’s exports is largely unrelated to price. The strength of the global economy is important of course, but there is a close correlation between demand for German exports and the exchange rate.
Of course, there are some exporters for whom the strength of the euro is not a pressing issue. Demand for certain very specialised equipment, such as printing presses or mining machinery, probably varies little by price, because there are few makers of such equipment. Buyers expect the machine to last a long time and are hence more concerned about servicing and reliability than price. But the majority of exporters do not operate in such markets. For example, makers of white goods such as dishwashers and washing machines as well as office equipment and cars – all big German exports – operate in very price-sensitive markets.
The eurozone as a whole is certainly better placed than the US, but Europeans are too complacent about the ability of their economies to ride out the current storm. First, the sensitivity of exporters to the strength of the euro is greater than many believe. Even the eurozone economies most confident about their export prospects – Germany, the Netherlands and Finland – will experience a sharp slowdown in external demand. Second, rising inflation all but rules out cuts in eurozone interest rates in 2008.
Simon Tilford is chief economist at the Centre for European Reform.
Friday, March 28, 2008
The new politics of EU internal security
by Hugo Brady
EU interior ministers are racing to finish a raft of new legislation on terrorism, crime and illegal immigration by the end of the year. One reason for their sudden sense of urgency is politics. Interior officials are anxious to make the most of the last few months of an old regime. If ratified as expected, the EU’s new rulebook, the Lisbon treaty, will give the European Parliament powers for the first time to amend future EU laws in these areas from 2009 onwards.
This is area of international co-operation that has long been the exclusive domain of national governments. For over 20 years, interior ministries – meeting in the EU, UN and Council of Europe – have quietly agreed and implemented inter-governmental agreements on internal security and judicial co-operation between themselves. There was little need to accommodate outside views and concerns. Now officials look nervously to 2009 when euro-parliamentarians should begin to use their new authority.
The ministries are right to be anxious. The European Parliament’s civil liberties and justice and home affairs (JHA) body – known as the LIBE committee – has made no secret of its intention to exercise the new powers to the full. The committee wants to reverse a trend in EU decision-making on terrorism, crime and immigration that many parliamentarians feel is wrongly skewed towards state security at the expense of civil liberties. For example, MEPs have been wary of the member-states’ eagerness to create databases and new information-sharing arrangements for terrorism and other cross-border crimes. They complain that the member-states are conspicuously less interested in reaching an agreement on data protection legislation needed to ensure such data is not mis-used.
The parliament has already demonstrated that it is not afraid to cause the member-states real headaches in internal security co-operation, in order to advance its views. In 2006, MEPs successfully applied to the European Court of Justice to quash an EU-US agreement on the sharing of airline passenger data. (The agreement was rapidly re-negotiated.) The member-states fear similar upsets that could hamper other types of co-operation against terrorism, crime and illegal immigration, if the LIBE committee pursues an agenda defined in outright opposition to the governments’. Some form of rapprochement between the parliament and the governments is needed to avoid a gridlock.
The chief divergence between the two on security matters is really more a problem of style than substance. The language the member-states use to present JHA initiatives to the public is couched almost exclusively in terms of the need to protect citizens from cross-border threats. The language used by the LIBE committee on internal security issues emphasises the need to protect the citizen from the state. Hence their future working relationship must involve a new modus vivendi, one where MEPs learn the language of state security and where the member-states show greater respect for the language of liberty.
The MEPs should bear in mind that their electorates mostly expect JHA co-operation to make them safer. Arguably, they look more to their national parliaments and judiciaries to safeguard their civil liberties. The parliament stands a better chance of achieving its goal of a more balanced justice and security agenda if it can show the EU governments that it is serious about working with them to pass laws that enhance the individual’s security as well as liberty. One idea, symbolic but also highly resonant, would be for the parliament to change the name of the LIBE committee simply to the ‘committee for justice, liberty and security’. Another useful step would be to significantly boost the resources the parliament gives to the analysis of JHA issues. Most proposals in this area are so highly technical in nature that they can only be credibly influenced by those with a full mastery of the issues at hand.
The parliament already enjoys some power over EU policies on border controls, immigration and visas. It has shown itself a perfectly credible partner on security issues linked to these and other areas so long as its role is respected. For example, in 2005 the LIBE committee was successfully wooed by the EU presidency to allow single market rules to be tweaked to allow for the retention of telecoms data for use in terrorism investigations.
EU governments have been dismissive of the parliament’s civil liberties concerns in the past. This is partly because interior ministries believe that it is their responsibility to ensure cross-border security co-operation does not infringe the civil liberties of their own nationals. They should now recognise that MEPs too have a legitimate part to play in this process. A good start would be for officials to involve the LIBE committee fully in the security-related legislation they are currently rushing through. This would be less cynical than waiting until legally obliged to do so under the new treaty. It would also be good politics, setting the tone for a more constructive working relationship in future.
Hugo Brady is a research fellow at the Centre for European Reform.
EU interior ministers are racing to finish a raft of new legislation on terrorism, crime and illegal immigration by the end of the year. One reason for their sudden sense of urgency is politics. Interior officials are anxious to make the most of the last few months of an old regime. If ratified as expected, the EU’s new rulebook, the Lisbon treaty, will give the European Parliament powers for the first time to amend future EU laws in these areas from 2009 onwards.
This is area of international co-operation that has long been the exclusive domain of national governments. For over 20 years, interior ministries – meeting in the EU, UN and Council of Europe – have quietly agreed and implemented inter-governmental agreements on internal security and judicial co-operation between themselves. There was little need to accommodate outside views and concerns. Now officials look nervously to 2009 when euro-parliamentarians should begin to use their new authority.
The ministries are right to be anxious. The European Parliament’s civil liberties and justice and home affairs (JHA) body – known as the LIBE committee – has made no secret of its intention to exercise the new powers to the full. The committee wants to reverse a trend in EU decision-making on terrorism, crime and immigration that many parliamentarians feel is wrongly skewed towards state security at the expense of civil liberties. For example, MEPs have been wary of the member-states’ eagerness to create databases and new information-sharing arrangements for terrorism and other cross-border crimes. They complain that the member-states are conspicuously less interested in reaching an agreement on data protection legislation needed to ensure such data is not mis-used.
The parliament has already demonstrated that it is not afraid to cause the member-states real headaches in internal security co-operation, in order to advance its views. In 2006, MEPs successfully applied to the European Court of Justice to quash an EU-US agreement on the sharing of airline passenger data. (The agreement was rapidly re-negotiated.) The member-states fear similar upsets that could hamper other types of co-operation against terrorism, crime and illegal immigration, if the LIBE committee pursues an agenda defined in outright opposition to the governments’. Some form of rapprochement between the parliament and the governments is needed to avoid a gridlock.
The chief divergence between the two on security matters is really more a problem of style than substance. The language the member-states use to present JHA initiatives to the public is couched almost exclusively in terms of the need to protect citizens from cross-border threats. The language used by the LIBE committee on internal security issues emphasises the need to protect the citizen from the state. Hence their future working relationship must involve a new modus vivendi, one where MEPs learn the language of state security and where the member-states show greater respect for the language of liberty.
The MEPs should bear in mind that their electorates mostly expect JHA co-operation to make them safer. Arguably, they look more to their national parliaments and judiciaries to safeguard their civil liberties. The parliament stands a better chance of achieving its goal of a more balanced justice and security agenda if it can show the EU governments that it is serious about working with them to pass laws that enhance the individual’s security as well as liberty. One idea, symbolic but also highly resonant, would be for the parliament to change the name of the LIBE committee simply to the ‘committee for justice, liberty and security’. Another useful step would be to significantly boost the resources the parliament gives to the analysis of JHA issues. Most proposals in this area are so highly technical in nature that they can only be credibly influenced by those with a full mastery of the issues at hand.
The parliament already enjoys some power over EU policies on border controls, immigration and visas. It has shown itself a perfectly credible partner on security issues linked to these and other areas so long as its role is respected. For example, in 2005 the LIBE committee was successfully wooed by the EU presidency to allow single market rules to be tweaked to allow for the retention of telecoms data for use in terrorism investigations.
EU governments have been dismissive of the parliament’s civil liberties concerns in the past. This is partly because interior ministries believe that it is their responsibility to ensure cross-border security co-operation does not infringe the civil liberties of their own nationals. They should now recognise that MEPs too have a legitimate part to play in this process. A good start would be for officials to involve the LIBE committee fully in the security-related legislation they are currently rushing through. This would be less cynical than waiting until legally obliged to do so under the new treaty. It would also be good politics, setting the tone for a more constructive working relationship in future.
Hugo Brady is a research fellow at the Centre for European Reform.
Wednesday, March 19, 2008
A joint response to the credit crunch
by Katinka Barysch
Ailing banks are being rescued, markets remain frozen, economic numbers are becoming gloomier. Of course, central banks and governments are focusing on fire-fighting, on cutting interest rates, on providing cash to liquidity-starved banks and to consumers. But slowly they are turning their thoughts to what comes next. How do we make sure that similar crises do not happen again?
EU leaders, at their Brussels summit last week, agreed that the responsibility to clean up the financial mess rested primarily with the banks and mortgage lenders that caused it. But they also promised that European governments were prepared to “take regulatory and supervisory actions where necessary”. Their to-do list is very similar to that of the US government, as laid out by US Treasury Secretary Hank Paulsen on March 14th: regulation that catches up with financial innovation; better ways to identify risky assets and higher capital requirements in case these go sour; and tighter rules for the credit rating agencies that are accused of over-rating packaged debt securities.
Neither the EU nor the US is planning big legislative packages for now. But if another bank or three fails over the next couple of months, the pressure to ‘do something’ would grow. “We are aware of the risk of over-regulation in response to the credit crisis”, said a top US regulator during the Brussels Forum last weekend. “But a response there will be. And we should not be timid.”
With memories of Sarbanes-Oxley still fresh in their minds, Europeans shudder at the thought of the US rushing into new financial markets regulations. Conversely, Americans are worried that cases such as Societe Generale in France, IKB in Germany or Northern Rock in the UK could trigger an over-reaction in some European countries. The risk of unilateral action is probably lower now because the US and the EU have reinforced their communication and co-operation on financial issues in recent years.
This could pay off now in terms of better co-ordination. The challenges of preventing future financial crises are effectively the same in Europe and America. We can look for solutions together. Or we can do so separately and then spend years trying to reconcile them so as not to impede transatlantic capital flows.
Our track record on this is mixed: the EU and the US have long worked together in existing forums, such as the Basel committee on banking supervision. For issues that are not covered there, they set up a financial regulatory dialogue in 2004. But it needed the big political push that came from the establishment of the Transatlantic Economic Council in 2007 for the two sides to make progress on even the most long-standing and vexing issue (namely the reconciliation of accounting standards).
Moreover, transatlantic co-operation can only work if the EU itself has a coherent stance. That does not yet seem to be the case.
In December Italy’s finance minister, Tommaso Padoa-Schioppa, argued that the turmoil showed the need for a European rule-book for banking and more powers at the EU level to supervise pan-European banks. He also pointed out the lack of an EU mechanism for handling crises: “Even with signs of a clear risk of contagion”, he wrote in the FT “no common analysis of the situation, no sharing of confidential information, no co-ordinated communication and no emergency meetings appear to have taken place among EU supervisors”. His EU colleagues in Ecofin were not convinced of the need for stronger EU powers, preferring a more evolutionary approach that leaves responsibility firmly with the member-states.
Is that enough? More than 40 banks in Europe now operate across borders. Imagine if Northern Rock had also sold mortgages in say, Belgium, Poland and Spain. Who would have taken the lead in finding a pan-European solution? Could a plethora of EU supervisors persuade the ECB (and the Bank of England) to help with liquidity?
The next Ecofin meeting in April is supposed to come up with new plans for regulatory convergence, stronger supervision and an EU-wide early warning mechanism. That will be difficult enough, given that some Europeans fear that the Commission may use the current market turmoil for a ‘power grab’ in finance. But the Europeans also need to talk to their counterparts in the US to make sure that whatever they decide fits with the response that is emerging on the other side of the Atlantic.
Katinka Barysch is deputy director of the Centre for European Reform.
Ailing banks are being rescued, markets remain frozen, economic numbers are becoming gloomier. Of course, central banks and governments are focusing on fire-fighting, on cutting interest rates, on providing cash to liquidity-starved banks and to consumers. But slowly they are turning their thoughts to what comes next. How do we make sure that similar crises do not happen again?
EU leaders, at their Brussels summit last week, agreed that the responsibility to clean up the financial mess rested primarily with the banks and mortgage lenders that caused it. But they also promised that European governments were prepared to “take regulatory and supervisory actions where necessary”. Their to-do list is very similar to that of the US government, as laid out by US Treasury Secretary Hank Paulsen on March 14th: regulation that catches up with financial innovation; better ways to identify risky assets and higher capital requirements in case these go sour; and tighter rules for the credit rating agencies that are accused of over-rating packaged debt securities.
Neither the EU nor the US is planning big legislative packages for now. But if another bank or three fails over the next couple of months, the pressure to ‘do something’ would grow. “We are aware of the risk of over-regulation in response to the credit crisis”, said a top US regulator during the Brussels Forum last weekend. “But a response there will be. And we should not be timid.”
With memories of Sarbanes-Oxley still fresh in their minds, Europeans shudder at the thought of the US rushing into new financial markets regulations. Conversely, Americans are worried that cases such as Societe Generale in France, IKB in Germany or Northern Rock in the UK could trigger an over-reaction in some European countries. The risk of unilateral action is probably lower now because the US and the EU have reinforced their communication and co-operation on financial issues in recent years.
This could pay off now in terms of better co-ordination. The challenges of preventing future financial crises are effectively the same in Europe and America. We can look for solutions together. Or we can do so separately and then spend years trying to reconcile them so as not to impede transatlantic capital flows.
Our track record on this is mixed: the EU and the US have long worked together in existing forums, such as the Basel committee on banking supervision. For issues that are not covered there, they set up a financial regulatory dialogue in 2004. But it needed the big political push that came from the establishment of the Transatlantic Economic Council in 2007 for the two sides to make progress on even the most long-standing and vexing issue (namely the reconciliation of accounting standards).
Moreover, transatlantic co-operation can only work if the EU itself has a coherent stance. That does not yet seem to be the case.
In December Italy’s finance minister, Tommaso Padoa-Schioppa, argued that the turmoil showed the need for a European rule-book for banking and more powers at the EU level to supervise pan-European banks. He also pointed out the lack of an EU mechanism for handling crises: “Even with signs of a clear risk of contagion”, he wrote in the FT “no common analysis of the situation, no sharing of confidential information, no co-ordinated communication and no emergency meetings appear to have taken place among EU supervisors”. His EU colleagues in Ecofin were not convinced of the need for stronger EU powers, preferring a more evolutionary approach that leaves responsibility firmly with the member-states.
Is that enough? More than 40 banks in Europe now operate across borders. Imagine if Northern Rock had also sold mortgages in say, Belgium, Poland and Spain. Who would have taken the lead in finding a pan-European solution? Could a plethora of EU supervisors persuade the ECB (and the Bank of England) to help with liquidity?
The next Ecofin meeting in April is supposed to come up with new plans for regulatory convergence, stronger supervision and an EU-wide early warning mechanism. That will be difficult enough, given that some Europeans fear that the Commission may use the current market turmoil for a ‘power grab’ in finance. But the Europeans also need to talk to their counterparts in the US to make sure that whatever they decide fits with the response that is emerging on the other side of the Atlantic.
Katinka Barysch is deputy director of the Centre for European Reform.
Thursday, March 13, 2008
Dmitry Medvedev – Putin clone or the new man?
by Bobo Lo
As Dmitry Medvedev walked across Red Square to join the concert celebrating his crushing victory in the Russian presidential elections, he could have been forgiven for wondering whether he had reached the pinnacle of achievement or been handed a poisoned chalice. For someone who had just garnered more than 70 per cent of the popular vote, he looked remarkably ill at ease.
Perhaps it was the knowledge that the electorate had not voted for him so much as for the man walking beside him. Vladimir Putin has not only dominated Russian politics over the past eight years, but is arguably the strongest leader his country has seen since the death of Stalin more than 50 years ago.
Mr Medvedev can seek comfort in precedent. In August 1999, Boris Yeltsin picked out a virtual unknown to be his heir-apparent in the Kremlin. His choice, Vladimir Putin, was almost universally disrespected as a puppet with little ability or even personality. Russia’s chattering classes were liberal in their scorn and predicted that the oligarchs who dominated in the 1990s would continue to manipulate the political process.
The key question today is whether Dmitry Medvedev can replicate Putin’s feat. Will he become his own man, a ‘new man’ for a new era, or will he forever be in thrall to the siloviki (security figures) who have dominated Russian politics under Putin?
The new president starts out with some important advantages. He has a decent record of public service and has managed to avoid scandal and charges of incompetence. He is a ‘Mr Cleanskin’, which counts for something in a country where corruption is endemic and the public cynical. He has few serious enemies, and plays well to a foreign and particularly Western audience. Most importantly, he is Putin’s personal choice, so the chances of lasting out his presidential term are good.
On the other hand, the circumstances of his election – or rather selection – suggest that he faces a real battle in establishing himself as a credible political figure. It is hard to escape the feeling that Putin chose him because he was the least threatening, rather than most capable, of the possible candidates. As a ‘made man’ who models himself consciously on his patron, Medvedev represents the best bet for preserving Putin’s policies and legacy.
Just to make sure, however, Putin is moving into the White House as Prime Minister. The presidential succession has shown that he is far from ready to ride into the sunset (or lie on a Sardinian beach). Although Kremlin insiders had speculated that he might become Russia’s Deng Xiaoping – a ‘father of the nation’ above the trappings of high office – Putin has opted for the safety of institutional legitimacy.
It is unclear how all this will work. There is no tradition of dual power (dvoevlastie) in Russia. On the rare occasions it has been tried, it has failed, with unfortunate and sometimes disastrous consequences. If nature abhors a vacuum, then Russians have a similar aversion to power-sharing.
There is some speculation that an underestimated Medvedev could ‘do a Putin’, in other words, take power incrementally and surreptitiously. However, this would require not just his predecessor’s backing but also departure from the political stage. The constitution gives the president enormous powers at the expense of the government and legislature, but in Russia influence has always rested with strong personalities over weak institutions. As long as Putin remains politically active, Medvedev will have little opportunity (or inclination) to make his mark.
We should moderate our expectations accordingly. Under Medvedev, Russia will remain much as it is – a semi-authoritarian capitalist system, dominated by vested interests. There will be some softening around the edges, but these will be of a cosmetic rather than substantive character. In foreign policy, Putin’s presence will ensure that Russia maintains a tough stance with the West and a proprietorial interest towards its neighbourhood. The Kremlin will stay committed to the vision of Russia as a great global power, and will pursue this aggressively. Dmitry Medvedev may eventually become more than a Putin clone, but the advent of Post-Putin Man remains a distant prospect.
Bobo Lo is director of the Russia and China Programmes at the Centre for European Reform.
As Dmitry Medvedev walked across Red Square to join the concert celebrating his crushing victory in the Russian presidential elections, he could have been forgiven for wondering whether he had reached the pinnacle of achievement or been handed a poisoned chalice. For someone who had just garnered more than 70 per cent of the popular vote, he looked remarkably ill at ease.
Perhaps it was the knowledge that the electorate had not voted for him so much as for the man walking beside him. Vladimir Putin has not only dominated Russian politics over the past eight years, but is arguably the strongest leader his country has seen since the death of Stalin more than 50 years ago.
Mr Medvedev can seek comfort in precedent. In August 1999, Boris Yeltsin picked out a virtual unknown to be his heir-apparent in the Kremlin. His choice, Vladimir Putin, was almost universally disrespected as a puppet with little ability or even personality. Russia’s chattering classes were liberal in their scorn and predicted that the oligarchs who dominated in the 1990s would continue to manipulate the political process.
The key question today is whether Dmitry Medvedev can replicate Putin’s feat. Will he become his own man, a ‘new man’ for a new era, or will he forever be in thrall to the siloviki (security figures) who have dominated Russian politics under Putin?
The new president starts out with some important advantages. He has a decent record of public service and has managed to avoid scandal and charges of incompetence. He is a ‘Mr Cleanskin’, which counts for something in a country where corruption is endemic and the public cynical. He has few serious enemies, and plays well to a foreign and particularly Western audience. Most importantly, he is Putin’s personal choice, so the chances of lasting out his presidential term are good.
On the other hand, the circumstances of his election – or rather selection – suggest that he faces a real battle in establishing himself as a credible political figure. It is hard to escape the feeling that Putin chose him because he was the least threatening, rather than most capable, of the possible candidates. As a ‘made man’ who models himself consciously on his patron, Medvedev represents the best bet for preserving Putin’s policies and legacy.
Just to make sure, however, Putin is moving into the White House as Prime Minister. The presidential succession has shown that he is far from ready to ride into the sunset (or lie on a Sardinian beach). Although Kremlin insiders had speculated that he might become Russia’s Deng Xiaoping – a ‘father of the nation’ above the trappings of high office – Putin has opted for the safety of institutional legitimacy.
It is unclear how all this will work. There is no tradition of dual power (dvoevlastie) in Russia. On the rare occasions it has been tried, it has failed, with unfortunate and sometimes disastrous consequences. If nature abhors a vacuum, then Russians have a similar aversion to power-sharing.
There is some speculation that an underestimated Medvedev could ‘do a Putin’, in other words, take power incrementally and surreptitiously. However, this would require not just his predecessor’s backing but also departure from the political stage. The constitution gives the president enormous powers at the expense of the government and legislature, but in Russia influence has always rested with strong personalities over weak institutions. As long as Putin remains politically active, Medvedev will have little opportunity (or inclination) to make his mark.
We should moderate our expectations accordingly. Under Medvedev, Russia will remain much as it is – a semi-authoritarian capitalist system, dominated by vested interests. There will be some softening around the edges, but these will be of a cosmetic rather than substantive character. In foreign policy, Putin’s presence will ensure that Russia maintains a tough stance with the West and a proprietorial interest towards its neighbourhood. The Kremlin will stay committed to the vision of Russia as a great global power, and will pursue this aggressively. Dmitry Medvedev may eventually become more than a Putin clone, but the advent of Post-Putin Man remains a distant prospect.
Bobo Lo is director of the Russia and China Programmes at the Centre for European Reform.
Monday, March 10, 2008
The Czechs in the EU: In the middle of the class
by Charles Grant
On a recent visit to Prague, people kept asking me how the Czech Republic was doing as EU member-state, and whether it was a successful member. With the Czechs preparing to take over the rotating presidency of the EU next January, a lot of people outside the Czech Republic will start to ask that question, too.
In my view, the Czechs are neither at the top nor the bottom of the ‘class of 2004’, that is the group of countries that joined the EU almost four years ago. They have not been curmudgeonly and difficult, as have, say, the Poles, threatening to veto the Lisbon treaty because of its voting rules, or the Greek Cypriots, who have prevented the EU ending the isolation of Northern Cyprus because of their conflict with Turkey. But the Czech Republic has not become an easy-going, middle-of-the-road member like Slovenia.
The Czechs have not been afraid to take strong positions on a number of issues. On the positive side (as far as the CER is concerned), the Czechs are ardent free-traders, always voting against anti-dumping duties as a matter of principle. The government believes that EU foreign policy should take account of human rights, and vigorously seeks to promote them in countries like Belarus, Burma, Cuba and Iran. The economy has performed quite well (certainly compared with Hungary), growing by about 6 per cent a year. It meets most of the ‘Maastricht criteria’ that aspiring euro members should comply with.
But the Czechs have put aside their plans to join the euro. This is because President Vaclav Klaus, a Thatcherite eurosceptic, is deeply hostile to monetary union. Although an over-valued crown is hurting Czech exporters such as Skoda, and two thirds of the country’s trade is with the eurozone, the Czechs are unlikely to join the euro so long as Klaus is in office (he has just begun a second five-year term).
On other issues, too, Klaus often takes idiosyncratic positions that put Prague at odds with other EU capitals. He is the only EU leader to argue that climate change is not a problem, and his interventions have ensured that Prime Minister Topolanek’s government is hesitating over supporting some of the European Commission’s recent proposals on climate change.
Part of Klaus’s strange political genius is that he manages to be pro-US, and particularly pro-Bush, while enjoying a warm relationship with Vladimir Putin. His Atlanticism spurs him to welcome American radars onto Czech soil, as part of the US’s controversial (and unpopular among Czechs) missile defence system. Yet Klaus also defends Putin from his western critics, praises his achievements in Russia, and speaks proudly of the medal that the Russian president recently bestowed upon him. Perhaps it is not so strange for the leader of a small and rather weak country – that was invaded only 40 years ago – to be so respectful of the powerful, whether or not they are democrats.
When I was last in Prague, just before the country joined the EU, everybody complained about corruption. On my recent visit I was told that the problem was no better. At all levels of government, apparently, bribery may play a role. The courts, too, suffer from this malaise. The fact that corruption afflicts many other countries that have recently joined the EU – as well as some of the older members – is no excuse. During the 1990s the Czech Republic seemed in many ways the most advanced of the countries applying for membership. When it comes to governance, the Czechs are no longer ahead of the pack, and have fallen behind the Baltic states.
The Czechs are natural allies of the British. If one listens to people in the Czech government talking of the need to slash spending on the common agricultural policy, they sound like officials in the British Treasury. The Czechs support close transatlantic ties and are wary of European federalism.
Yet despite their natural sympathy for the UK, many Czechs complain of being ignored by the British. Ministers in London seldom find time to visit Prague – though French ministers are often in town, cultivating partnerships with the Czechs. Last autumn, when Czech ministers spoke out in favour of the British stance on Zimbabwe, and said they would boycott the EU-Africa summit if Robert Mugabe turned up, nobody in London bothered to call Prague to say thank you. The British are generally not the most popular people in Europe. They should therefore do more to nurture close ties with those who share their world view, such as the Czechs.
Charles Grant is director of the Centre for European Reform.
On a recent visit to Prague, people kept asking me how the Czech Republic was doing as EU member-state, and whether it was a successful member. With the Czechs preparing to take over the rotating presidency of the EU next January, a lot of people outside the Czech Republic will start to ask that question, too.
In my view, the Czechs are neither at the top nor the bottom of the ‘class of 2004’, that is the group of countries that joined the EU almost four years ago. They have not been curmudgeonly and difficult, as have, say, the Poles, threatening to veto the Lisbon treaty because of its voting rules, or the Greek Cypriots, who have prevented the EU ending the isolation of Northern Cyprus because of their conflict with Turkey. But the Czech Republic has not become an easy-going, middle-of-the-road member like Slovenia.
The Czechs have not been afraid to take strong positions on a number of issues. On the positive side (as far as the CER is concerned), the Czechs are ardent free-traders, always voting against anti-dumping duties as a matter of principle. The government believes that EU foreign policy should take account of human rights, and vigorously seeks to promote them in countries like Belarus, Burma, Cuba and Iran. The economy has performed quite well (certainly compared with Hungary), growing by about 6 per cent a year. It meets most of the ‘Maastricht criteria’ that aspiring euro members should comply with.
But the Czechs have put aside their plans to join the euro. This is because President Vaclav Klaus, a Thatcherite eurosceptic, is deeply hostile to monetary union. Although an over-valued crown is hurting Czech exporters such as Skoda, and two thirds of the country’s trade is with the eurozone, the Czechs are unlikely to join the euro so long as Klaus is in office (he has just begun a second five-year term).
On other issues, too, Klaus often takes idiosyncratic positions that put Prague at odds with other EU capitals. He is the only EU leader to argue that climate change is not a problem, and his interventions have ensured that Prime Minister Topolanek’s government is hesitating over supporting some of the European Commission’s recent proposals on climate change.
Part of Klaus’s strange political genius is that he manages to be pro-US, and particularly pro-Bush, while enjoying a warm relationship with Vladimir Putin. His Atlanticism spurs him to welcome American radars onto Czech soil, as part of the US’s controversial (and unpopular among Czechs) missile defence system. Yet Klaus also defends Putin from his western critics, praises his achievements in Russia, and speaks proudly of the medal that the Russian president recently bestowed upon him. Perhaps it is not so strange for the leader of a small and rather weak country – that was invaded only 40 years ago – to be so respectful of the powerful, whether or not they are democrats.
When I was last in Prague, just before the country joined the EU, everybody complained about corruption. On my recent visit I was told that the problem was no better. At all levels of government, apparently, bribery may play a role. The courts, too, suffer from this malaise. The fact that corruption afflicts many other countries that have recently joined the EU – as well as some of the older members – is no excuse. During the 1990s the Czech Republic seemed in many ways the most advanced of the countries applying for membership. When it comes to governance, the Czechs are no longer ahead of the pack, and have fallen behind the Baltic states.
The Czechs are natural allies of the British. If one listens to people in the Czech government talking of the need to slash spending on the common agricultural policy, they sound like officials in the British Treasury. The Czechs support close transatlantic ties and are wary of European federalism.
Yet despite their natural sympathy for the UK, many Czechs complain of being ignored by the British. Ministers in London seldom find time to visit Prague – though French ministers are often in town, cultivating partnerships with the Czechs. Last autumn, when Czech ministers spoke out in favour of the British stance on Zimbabwe, and said they would boycott the EU-Africa summit if Robert Mugabe turned up, nobody in London bothered to call Prague to say thank you. The British are generally not the most popular people in Europe. They should therefore do more to nurture close ties with those who share their world view, such as the Czechs.
Charles Grant is director of the Centre for European Reform.
Friday, February 29, 2008
Kosovo – the economic dilemma
by Katinka Barysch
Now that Kosovo’s independence party is over, the hard work begins. Despite the efforts of the UN and the EU, the institutions of government remain fragile, corruption is rife, and organised crime is a problem. Although growth has picked up, the economy remains in a woeful state. Kosovars like to blame poverty and joblessness on politics. Many hope that, now that the status question has finally been settled, money will start flowing in, creating growth and jobs.
This may be true as far as official assistance is concerned: as an independent country, Kosovo hopes to be able to borrow from the IMF, the World Bank and other financial institutions. More aid will also be forthcoming, since the international community cannot afford to see Kosovo fail. The European Commission and the World Bank are planning to convene a donors conference over the next couple of months. The Commission expects the Europeans to drum up €2 billion, and the Americans say they will contribute $400 million.
However, the Europeans are also aware of the risk of turning Kosovo into an aid-dependent protectorate. Since 1999, the EU and its member-states have already given €2.6 billion to Kosovo. A lot of that went into rebuilding houses and roads after the 1998-99 conflict. But it has failed to build a viable economy. Even today, perhaps 20 per cent of Kosovo’s GDP directly depend on foreign aid.
Kosovo’s economic problems are not only the result of the sanctions of the 1990s and the 1998-99 conflict: when it was still part of Yugoslavia, Kosovo already relied on big transfers from Belgrade, and unemployment was much higher than in other parts of the federation. But in the 1990s the economy basically collapsed. And despite signs of recovery in recent years, the challenges remain huge.
Official unemployment stands at around 40 per cent. And even if black market activities and subsistence agriculture are taken into account, there are more Kosovars on the dole than in a job. Unemployment is particularly high among those under 25, who make up half of Kosovo’s 2 million people. Around half a million Kosovars have left to work in the EU, many of them illegally.
Of those who stayed at home, more than a third live below the poverty line, and social services only reach a tiny share of them. There are no industries to speak off, and little to export apart from scrap metal. The current-account deficit amounts to 50 per cent of GDP (although that is inflated by the big international presence). Although the EU claims that it has invested €400 million into the power sector alone, regular electricity blackouts remain the biggest problem for local businesses.
The news is not all bad: GDP growth has picked up despite a gradual reduction in international aid; household incomes have been rising; tax revenue has started to recover, and privatisation has provided the budget with an independent source of cash; and almost all children now go to school, at least some of the time.
Some foreign companies have started to look at the mining and power sectors: Kosovo sits on Europe’s second largest deposits of brown coal, and it also has sizeable resources of lead, zinc and nickel. Building up these sectors for exports would reduce the external deficit and bring in foreign exchange. But since energy and mining are capital rather than labour intensive industries, they will not create many jobs. The resolution of status alone will not be enough to attract foreign investment into other manufacturing sectors and services. Kosovo will need a more open and transparent business environment, an efficient state administration and skilled workers. Despite the EU’s help and promise of eventual accession, such reforms will take years.
The World Bank says that even with 6 per cent annual growth (twice what Kosovo manages at the moment), it would take ten years to cut unemployment by half, from 40 to 20 per cent. Persistent unemployment, in particular among the young, will fuel frustration, which would be bad for political peace.
There are two things that the EU could do to help Kosovo’s economy now, apart from giving money and advice. Both will be controversial. First, it should help the farm sector, which is where most Kosovars work. It is hugely inefficient but has potential for quick improvements. With EU farm aid and better market access, Kosovo could start selling fruit, vegetables and meat abroad. Second, the EU should keep its labour markets open: one in five Kosovo households relies on remittances from abroad, and they probably contribute more to Kosovo’s economy than all foreign aid put together.
Katinka Barysch is deputy director of the Centre for European Reform.
Now that Kosovo’s independence party is over, the hard work begins. Despite the efforts of the UN and the EU, the institutions of government remain fragile, corruption is rife, and organised crime is a problem. Although growth has picked up, the economy remains in a woeful state. Kosovars like to blame poverty and joblessness on politics. Many hope that, now that the status question has finally been settled, money will start flowing in, creating growth and jobs.
This may be true as far as official assistance is concerned: as an independent country, Kosovo hopes to be able to borrow from the IMF, the World Bank and other financial institutions. More aid will also be forthcoming, since the international community cannot afford to see Kosovo fail. The European Commission and the World Bank are planning to convene a donors conference over the next couple of months. The Commission expects the Europeans to drum up €2 billion, and the Americans say they will contribute $400 million.
However, the Europeans are also aware of the risk of turning Kosovo into an aid-dependent protectorate. Since 1999, the EU and its member-states have already given €2.6 billion to Kosovo. A lot of that went into rebuilding houses and roads after the 1998-99 conflict. But it has failed to build a viable economy. Even today, perhaps 20 per cent of Kosovo’s GDP directly depend on foreign aid.
Kosovo’s economic problems are not only the result of the sanctions of the 1990s and the 1998-99 conflict: when it was still part of Yugoslavia, Kosovo already relied on big transfers from Belgrade, and unemployment was much higher than in other parts of the federation. But in the 1990s the economy basically collapsed. And despite signs of recovery in recent years, the challenges remain huge.
Official unemployment stands at around 40 per cent. And even if black market activities and subsistence agriculture are taken into account, there are more Kosovars on the dole than in a job. Unemployment is particularly high among those under 25, who make up half of Kosovo’s 2 million people. Around half a million Kosovars have left to work in the EU, many of them illegally.
Of those who stayed at home, more than a third live below the poverty line, and social services only reach a tiny share of them. There are no industries to speak off, and little to export apart from scrap metal. The current-account deficit amounts to 50 per cent of GDP (although that is inflated by the big international presence). Although the EU claims that it has invested €400 million into the power sector alone, regular electricity blackouts remain the biggest problem for local businesses.
The news is not all bad: GDP growth has picked up despite a gradual reduction in international aid; household incomes have been rising; tax revenue has started to recover, and privatisation has provided the budget with an independent source of cash; and almost all children now go to school, at least some of the time.
Some foreign companies have started to look at the mining and power sectors: Kosovo sits on Europe’s second largest deposits of brown coal, and it also has sizeable resources of lead, zinc and nickel. Building up these sectors for exports would reduce the external deficit and bring in foreign exchange. But since energy and mining are capital rather than labour intensive industries, they will not create many jobs. The resolution of status alone will not be enough to attract foreign investment into other manufacturing sectors and services. Kosovo will need a more open and transparent business environment, an efficient state administration and skilled workers. Despite the EU’s help and promise of eventual accession, such reforms will take years.
The World Bank says that even with 6 per cent annual growth (twice what Kosovo manages at the moment), it would take ten years to cut unemployment by half, from 40 to 20 per cent. Persistent unemployment, in particular among the young, will fuel frustration, which would be bad for political peace.
There are two things that the EU could do to help Kosovo’s economy now, apart from giving money and advice. Both will be controversial. First, it should help the farm sector, which is where most Kosovars work. It is hugely inefficient but has potential for quick improvements. With EU farm aid and better market access, Kosovo could start selling fruit, vegetables and meat abroad. Second, the EU should keep its labour markets open: one in five Kosovo households relies on remittances from abroad, and they probably contribute more to Kosovo’s economy than all foreign aid put together.
Katinka Barysch is deputy director of the Centre for European Reform.
Monday, February 25, 2008
The EU in Kosovo: Learning to let go
By Tomas Valasek
Here’s a secret about Kosovo’s independence – it is not real; not yet anyway. Without outside help, Kosovo would not function today. But at the same time, the new EU mission will have to justify its presence in the eyes of the Kosovo people. It must make every effort to transfer responsibility for running the new country to the Kosovars.
At its birth on February 17th, the country lacked most ministries, or, for that matter, a sustainable economy (the official unemployment rate is around 40 per cent). A veritable who’s who of international organisations takes care of everything from sanitation to security. Some 17,000 NATO peacekeepers make sure that violence does not erupt between the Albanian majority and the 130,000 Serbs still living in Kosovo. UNMIK (the United Nation’s interim administration mission in Kosovo) took charge of most government business after the 1999 mission. As part of UNMIK, a group of officials and experts from various EU countries has run much of Kosovo’s economic policy, from devising privatisation to collecting customs revenues. About 20 per cent of Kosovo’s GDP directly depend on foreign aid. UNMIK has also negotiated regional and bilateral agreements for Kosovo, for example on trade, energy and transport. In addition, an army of volunteers working for 300-odd different NGOs look after Kosovo’s 2 million inhabitants.
So for the foreseeable future, Kosovo will need heavy international assistance, both financial and in the form of experts on the ground. But here’s the rub: staying too long may be equally, if not more, counterproductive than leaving early. And this holds especially true for the new EU mission: the 2,000 EU judges, administrators, and police, who will soon replace the UN in Kosovo. The EU gave them an ambitious mandate: they are to not only advise the new Kosovo authorities but also to ‘independently [if necessary]… ensure the rule of law”. They’ll even have the authority to reverse or annul decisions by Kosovo authorities. Kosovo may not quite be a protectorate like the one the EU runs in Bosnia. But no independent country outside the EU gives Brussels the right to annul its domestic legislation.
The EU’s extensive powers in Kosovo will be tolerated by the country’s government. Because its legal case for separation from Serbia will always be disputed, the government’s best chance for respect and recognition is to make a success of its independence. That means using EU money intelligently to build up the economy, guaranteeing the human rights of the Serbian and other minorities, instilling the rule of law and clamping down on organised crime and corruption. Pristina will need the EU’s assistance to accomplish all this, so it will strive to be on good terms with Brussels.
The people of Kosovo – that’s another story. They strove to be independent, not to end up in a situation where the EU administrators have the last say. If the EU mission is too heavy-handed, it will cause resentment among ordinary Kosovars. Already, anti-EU graffiti has appeared in the streets in Pristina. To makes matters even more delicate, the UN, from which the EU takes over, has a terrible reputation in Kosovo. In eight years of running this tiny country, the size of a small Baltic republic, it has not managed to guarantee basic services like around-the-clock electricity, despite multi-million dollar investments into the power sector. Kai Eide, formerly a high-ranking UN official, suggested in 2005 that the UN mission itself had become an obstacle to building Kosovo’s economy and governance, and he advised the UN to leave.
So the EU is marching into a quandary. Kosovo needs its help and assistance – and the EU needs Kosovo to succeed. But by trying too hard, the EU could make a bad situation worse. The only thing worse than a Kosovo poor and badly governed is a Kosovo poor, badly governed, and hostile to the EU. For the EU to make its Kosovo mission a success, it needs to treat Kosovo with caution and respect. It needs be firm with Pristina if the government fails to respect minority rights and root out crime and corruption. But otherwise, it should try to reduce interference and concentrate on building up local administrative capacity. At every step, the EU needs to make clear to the Kosovars that it is there to help with the transition, not to permanently set the agenda.
Lastly, the EU needs to demonstrate its usefulness to the Kosovars, to show that its presence there makes a material difference to their lives. The EU should not assume that Kosovo’s dependence on foreign aid and expertise in itself justifies its mission in the eyes of the local population. A couple of tangible successes would help. None would probably be more important than finally fixing the electricity grid, thus giving Kosovo’s economy a much needed boost.
Tomas Valasek is director of foreign policy and defence at Centre for European Reform
Here’s a secret about Kosovo’s independence – it is not real; not yet anyway. Without outside help, Kosovo would not function today. But at the same time, the new EU mission will have to justify its presence in the eyes of the Kosovo people. It must make every effort to transfer responsibility for running the new country to the Kosovars.
At its birth on February 17th, the country lacked most ministries, or, for that matter, a sustainable economy (the official unemployment rate is around 40 per cent). A veritable who’s who of international organisations takes care of everything from sanitation to security. Some 17,000 NATO peacekeepers make sure that violence does not erupt between the Albanian majority and the 130,000 Serbs still living in Kosovo. UNMIK (the United Nation’s interim administration mission in Kosovo) took charge of most government business after the 1999 mission. As part of UNMIK, a group of officials and experts from various EU countries has run much of Kosovo’s economic policy, from devising privatisation to collecting customs revenues. About 20 per cent of Kosovo’s GDP directly depend on foreign aid. UNMIK has also negotiated regional and bilateral agreements for Kosovo, for example on trade, energy and transport. In addition, an army of volunteers working for 300-odd different NGOs look after Kosovo’s 2 million inhabitants.
So for the foreseeable future, Kosovo will need heavy international assistance, both financial and in the form of experts on the ground. But here’s the rub: staying too long may be equally, if not more, counterproductive than leaving early. And this holds especially true for the new EU mission: the 2,000 EU judges, administrators, and police, who will soon replace the UN in Kosovo. The EU gave them an ambitious mandate: they are to not only advise the new Kosovo authorities but also to ‘independently [if necessary]… ensure the rule of law”. They’ll even have the authority to reverse or annul decisions by Kosovo authorities. Kosovo may not quite be a protectorate like the one the EU runs in Bosnia. But no independent country outside the EU gives Brussels the right to annul its domestic legislation.
The EU’s extensive powers in Kosovo will be tolerated by the country’s government. Because its legal case for separation from Serbia will always be disputed, the government’s best chance for respect and recognition is to make a success of its independence. That means using EU money intelligently to build up the economy, guaranteeing the human rights of the Serbian and other minorities, instilling the rule of law and clamping down on organised crime and corruption. Pristina will need the EU’s assistance to accomplish all this, so it will strive to be on good terms with Brussels.
The people of Kosovo – that’s another story. They strove to be independent, not to end up in a situation where the EU administrators have the last say. If the EU mission is too heavy-handed, it will cause resentment among ordinary Kosovars. Already, anti-EU graffiti has appeared in the streets in Pristina. To makes matters even more delicate, the UN, from which the EU takes over, has a terrible reputation in Kosovo. In eight years of running this tiny country, the size of a small Baltic republic, it has not managed to guarantee basic services like around-the-clock electricity, despite multi-million dollar investments into the power sector. Kai Eide, formerly a high-ranking UN official, suggested in 2005 that the UN mission itself had become an obstacle to building Kosovo’s economy and governance, and he advised the UN to leave.
So the EU is marching into a quandary. Kosovo needs its help and assistance – and the EU needs Kosovo to succeed. But by trying too hard, the EU could make a bad situation worse. The only thing worse than a Kosovo poor and badly governed is a Kosovo poor, badly governed, and hostile to the EU. For the EU to make its Kosovo mission a success, it needs to treat Kosovo with caution and respect. It needs be firm with Pristina if the government fails to respect minority rights and root out crime and corruption. But otherwise, it should try to reduce interference and concentrate on building up local administrative capacity. At every step, the EU needs to make clear to the Kosovars that it is there to help with the transition, not to permanently set the agenda.
Lastly, the EU needs to demonstrate its usefulness to the Kosovars, to show that its presence there makes a material difference to their lives. The EU should not assume that Kosovo’s dependence on foreign aid and expertise in itself justifies its mission in the eyes of the local population. A couple of tangible successes would help. None would probably be more important than finally fixing the electricity grid, thus giving Kosovo’s economy a much needed boost.
Tomas Valasek is director of foreign policy and defence at Centre for European Reform
Wednesday, February 13, 2008
Time for the Export-Weltmeister to start consuming
by Simon Tilford
Too many Europeans are blaming the US for the economic slowdown in Europe, as if everything would have been fine if only the Americans were not so irresponsible. This is complacent. The European economy would have faced a tricky rebalancing irrespective of the credit crisis. It is not sustainable for one group of EU economies to provide a disproportionate share of EU domestic demand while others run ever bigger current account surpluses.
Europeans are right to highlight the fact that the EU economy is a comparable size to the US one. However, European policy-makers and central bankers are on somewhat shakier ground when they queue up to claim that the EU economy is fundamentally more balanced that its US counterpart. Europeans should ask themselves the following question: would a US economy growing at the same pace as the EU economy did in 2007 be as easily rattled by a financial crisis in Europe and fall in the value of the euro as the European economy has been by the credit crisis in the US and the fall in the dollar? The answer is clearly no.
The European economy as a whole has become more flexible in recent years. Labour markets are now more efficient, employment rates (those employed as a percentage of the working age population) are up and many product markets are now much more competitive. These developments have helped accelerate the diffusion of new technologies. However, a look at the structure of EU economic growth demonstrates why the current recovery is so fragile, and why Europeans are wrong to focus so strongly on external shocks for explanations.
The UK and Spain, but also France and the new member-states have accounted for a very large share of the growth in EU domestic demand this decade. Consumption in these economies has grown more rapidly than output. The result has been a steady increase in their current account deficits. Spain’s hit an estimated 9 per cent of GDP in 2007, the UK’s 4 per cent, whereas deficits in Italy and France were around 2.5 per cent 1.5 per cent respectively. External deficits across the new member-states are big, in some cases startlingly so.
Over this period, another group of member-states led by Germany, but also including the Netherlands and Sweden, have seen their output expand much more rapidly than domestic consumption, with the result that their surpluses have ballooned. Germany’s and Sweden’s stood at 6 per cent of GDP in 2007, and that of the Netherlands was 7 per cent. Much of the rise in their combined surplus since 2000 has been with other members of the EU. In effect, these economies have been a huge drag on the European economy, and have not been, as they are sometimes erroneously portrayed, drivers of economic growth.
Economies cannot rely indefinitely on exports for economic stimulus, as other economies cannot run huge deficits indefinitely. A number of the countries that have generated strong growth in domestic demand must now rebalance their economies. The construction boom in Spain that has done so much to drive investment and private consumption in that country has ended and will depress Spanish consumption, perhaps for many years. For its part, the build-up of debt that contributed considerably to the strong performance of the UK economy in recent years has now run its course. France and Italy are in no position to take up the slack, not least because of their weak fiscal positions but also because they need to hold down wage settlements in order to prevent any further loss of competitiveness to the Germans. Neither are the new member-states, whose imbalances are starting to attract the attentions of the financial markets.
The countries that have relied on exports to the rest of the EU for a big chunk of their overall growth are going to have to rebalance and contribute to EU growth rather than being a drag on it. The prospects are not good. For example, for years German economists and politicians have been saying that Germany needed to regain competitiveness by ruthlessly holding down costs. This, they argued, would boost exports and feed through into investment and jobs. There has been a pick-up in investment and expansion of employment, but both remain vulnerable to a downturn in external demand because there has been no recovery in consumption. German private consumption actually fell in 2007 and domestic demand grew at half the pace of GDP. German real wages are likely to rise this year for the first time since 2003, but consumer confidence remains exceptionally low.
The EU needs to recognise that one of its core economic challenges is the excessive dependence of Germany and a number of other economies on exports to drive growth. The growth strategies of these countries should not be held up as examples for others to emulate. A huge current account surplus does not necessarily indicate an economy is ‘competitive’. It can also point to the weakness of domestic demand.
Simon Tilford is chief economist at the Centre for European Reform.
Too many Europeans are blaming the US for the economic slowdown in Europe, as if everything would have been fine if only the Americans were not so irresponsible. This is complacent. The European economy would have faced a tricky rebalancing irrespective of the credit crisis. It is not sustainable for one group of EU economies to provide a disproportionate share of EU domestic demand while others run ever bigger current account surpluses.
Europeans are right to highlight the fact that the EU economy is a comparable size to the US one. However, European policy-makers and central bankers are on somewhat shakier ground when they queue up to claim that the EU economy is fundamentally more balanced that its US counterpart. Europeans should ask themselves the following question: would a US economy growing at the same pace as the EU economy did in 2007 be as easily rattled by a financial crisis in Europe and fall in the value of the euro as the European economy has been by the credit crisis in the US and the fall in the dollar? The answer is clearly no.
The European economy as a whole has become more flexible in recent years. Labour markets are now more efficient, employment rates (those employed as a percentage of the working age population) are up and many product markets are now much more competitive. These developments have helped accelerate the diffusion of new technologies. However, a look at the structure of EU economic growth demonstrates why the current recovery is so fragile, and why Europeans are wrong to focus so strongly on external shocks for explanations.
The UK and Spain, but also France and the new member-states have accounted for a very large share of the growth in EU domestic demand this decade. Consumption in these economies has grown more rapidly than output. The result has been a steady increase in their current account deficits. Spain’s hit an estimated 9 per cent of GDP in 2007, the UK’s 4 per cent, whereas deficits in Italy and France were around 2.5 per cent 1.5 per cent respectively. External deficits across the new member-states are big, in some cases startlingly so.
Over this period, another group of member-states led by Germany, but also including the Netherlands and Sweden, have seen their output expand much more rapidly than domestic consumption, with the result that their surpluses have ballooned. Germany’s and Sweden’s stood at 6 per cent of GDP in 2007, and that of the Netherlands was 7 per cent. Much of the rise in their combined surplus since 2000 has been with other members of the EU. In effect, these economies have been a huge drag on the European economy, and have not been, as they are sometimes erroneously portrayed, drivers of economic growth.
Economies cannot rely indefinitely on exports for economic stimulus, as other economies cannot run huge deficits indefinitely. A number of the countries that have generated strong growth in domestic demand must now rebalance their economies. The construction boom in Spain that has done so much to drive investment and private consumption in that country has ended and will depress Spanish consumption, perhaps for many years. For its part, the build-up of debt that contributed considerably to the strong performance of the UK economy in recent years has now run its course. France and Italy are in no position to take up the slack, not least because of their weak fiscal positions but also because they need to hold down wage settlements in order to prevent any further loss of competitiveness to the Germans. Neither are the new member-states, whose imbalances are starting to attract the attentions of the financial markets.
The countries that have relied on exports to the rest of the EU for a big chunk of their overall growth are going to have to rebalance and contribute to EU growth rather than being a drag on it. The prospects are not good. For example, for years German economists and politicians have been saying that Germany needed to regain competitiveness by ruthlessly holding down costs. This, they argued, would boost exports and feed through into investment and jobs. There has been a pick-up in investment and expansion of employment, but both remain vulnerable to a downturn in external demand because there has been no recovery in consumption. German private consumption actually fell in 2007 and domestic demand grew at half the pace of GDP. German real wages are likely to rise this year for the first time since 2003, but consumer confidence remains exceptionally low.
The EU needs to recognise that one of its core economic challenges is the excessive dependence of Germany and a number of other economies on exports to drive growth. The growth strategies of these countries should not be held up as examples for others to emulate. A huge current account surplus does not necessarily indicate an economy is ‘competitive’. It can also point to the weakness of domestic demand.
Simon Tilford is chief economist at the Centre for European Reform.
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