by Charles Grant
When I visited China a year ago, I was struck by the strong feeling among many foreign firms there that the business environment was getting tougher. Western businessmen complained, in particular, about discrimination against foreigners. On a recent trip to China, I found a more nuanced situation. In some sectors, notably those where intellectual property (IP) is important, there are growing complaints of unfair treatment. But in other sectors foreign companies are making good money, without grumbling much.
Western business leaders are certainly complaining more loudly than they used to. In July, the Financial Times reported Jeffrey Immelt, the chairman of General Electric, as saying that he was “really worried about China. I am not sure that in the end they want any of us to win, or any of us to be successful.” A few days later Jürgen Hambrecht, the CEO of BASF, told Wen Jiabao, the Chinese prime minister, that foreign firms were being forced to transfer know-how to Chinese companies, in return for market access. Hambrecht told him that this did “not exactly correspond to our views of a partnership”. At the same meeting Peter Löscher, the CEO of Siemens, urged Wen to ensure that foreign firms could compete fairly for government procurement contracts. (Like a lot of western business leaders, Löscher had previously taken the Chinese government’s side, as when he criticised German Chancellor Angela Merkel for meeting the Dalai Lama.)
One government measure that has provoked foreign business leaders is the regulation on ‘indigenous innovation’ that was published last November. This would, if enforced, exclude foreign firms from public procurement contracts unless they agreed to hand over IP. The regulation seems to have been driven by the Chinese Communist Party’s belief that market forces alone will not provide a high-tech economy, and that the state therefore needs to get hold of and control advanced technologies. The EU, the US and many other governments lobbied strongly against the measure.
Whether this regulation will bite remains unclear. The government announced a delay in implementation and Chen Deming, the minister of commerce, said the regulation would not affect firms that could prove they added value in China. Some western business lobbies fear that, despite recent reassurances, the regulation will in the long run take effect. If it is enforced, firms like IBM and Microsoft are likely to cut back on R&D in China. On Capitol Hill, Microsoft is now taking a hard line on IP issues in China; until recently, it tended to sympathise with the Chinese point of view. China can no longer assume that US business leaders will, as a bloc, support its interests in Washington.
A similar shift is evident among some European companies. According to the head of one large German firm in China: “They assume their market is so big, that foreigners will stay, and put up with losing IP. That’s a miscalculation. Most foreign investors think IP is very important and that they have a duty not to hand it over.” He thinks that enforcement of the indigenous innovation regulation would dampen FDI in China. Big western manufacturers would not pull out but would source more components to countries such as Vietnam, Taiwan, Malaysia, Indonesia and Singapore. China’s free trade agreements with these countries now make it easier to supply Chinese factories from them.
Within the past two years, some high-tech foreign firms have had to pay higher rates of tax, while new restrictions on representative offices – each is allowed only three non-Chinese staff – are proving irksome. Foreign firms involved in making wind turbines, such as GE, Siemens and Vestas, are particularly annoyed that, as they see it, procurement rules have been skewed to exclude them from the Chinese market (the largest in the world), to the benefit of local firms.
Two-fifths of European businesses in China surveyed by the EU Chamber of Commerce in June 2010 expected the regulatory environment to worsen in the next two years. The same proportion described the discriminatory application of laws and regulations as a ‘significant’ obstacle. The EU Chamber concluded: “Optimism in the overall economic climate has been dampened dramatically by concerns about regulatory interference and unpredictability in the market.”
Some of the shifting balance of power between foreign investors and the Chinese authorities is the inevitable result of the country’s development. A lot of Chinese companies are now stronger and better-equipped to compete with European or American rivals. Twenty years ago the Chinese needed western capital, skills and technology. Now they need the technology, but they have less need of the skills, and plenty of their own capital.
Another issue for foreign investors is that costs are rising, in part due to labour unrest that has been prevalent in the Pearl River Delta area. The emergence of free trade unions is an important and positive step for the country’s future development, signalling the emergence of a civil society that is not controlled by government or party. But many foreign businesses see the new trade unions merely as a source of growing costs.
Mining companies, energy firms, banks and insurers, among others, still face restrictions on their activities in China. Many of them nevertheless make money. That is the case for Shell and BP, which are significant investors, often through joint ventures, but would like to engage in a wider range of activities than they currently do. In many other sectors, such as retailing, advertising, hotels, pharmaceuticals and cars, companies report they are doing well without too much government interference. For example Tesco finds it easier to open stores than two years ago, as central government permission is no longer required; but Tesco says that Chinese retailers face less hassle from red tape than do foreign ones. WPP is allowed to own 100 per cent of local advertising agencies and says that as a foreign firm it faces no discrimination – except that it pays more tax than local competitors. Car companies are doing particularly well: BMW has doubled sales in China over the past year, and Daimler is forming a joint venture to develop electric vehicles.
Since the spring, the government has made an effort to appear friendly to foreign firms: Premier Wen met foreign business leaders to listen to their complaints; several ministries opened their doors to foreign investors in China and asked how they could help; and in July the government appeared to accept a compromise in its dispute with Google, with the result that Chinese citizens can search uncensored via Hong Kong. Chinese analysts point out that many local authorities still compete for FDI and therefore offer special deals (for example, on tax and utilities) to foreign firms.
When China joined the World Trade Organisation in 2002, it failed to sign the agreement on public procurement that prevents discrimination against foreign firms. In July China made new proposals for acceding to this agreement – but western governments think them inadequate (for example, China is not offering to open up local government procurement). Also in July, Chen Deming wrote in the Financial Times that China is “ever more open to business”. He is right that most of the formal rules applying to foreign investors are less restrictive than they were ten years ago. According to his figures, global FDI fell by nearly 40 per cent in 2009, but only by 2.6 per cent in China.
My conclusion is that China still welcomes FDI, but that it is becoming more insistent on setting the terms. For example, it wants to choose the location for big foreign industrial investments – often in the underdeveloped west of the country, where a lot of foreign firms would rather not go. The Chinese government is probably right to calculate that, for all their grumbling, most foreign firms will stay; China is just too big a market to ignore. In any case, despite the difficulties, many foreign investors in China claim that they are managing to hang on to their IP.
China’s strategy is to exploit foreigners’ desire for access to its markets as a means of gaining their technology. From China’s point of view that is a reasonable policy. If a lot of foreign investors clubbed together to speak with one voice and make credible threats to China, they might persuade its leadership to re-examine that strategy. But neither the big foreign companies in China, nor the European and American governments, are likely to get significantly tougher with China. So do not expect much change in China’s policies towards foreign investors.
Charles Grant is director of the Centre for European Reform
Friday, July 30, 2010
Monday, July 19, 2010
Who is winning Eastern Europe's great game?
By Katinka Barysch
The US is withdrawing from the former Soviet space; the European Union struggles to be taken seriously there. Does that leave Russia free to strengthen its influence in the countries around its borders? Not necessarily, for the situation in the region is complex.
Hillary Clinton toured the Caucasus recently to reassure Georgia, Armenia and Azerbaijan that Washington had not abandoned them in its quest to ‘reset’ relations with Russia. Nevertheless, the predominant feeling in those countries is that the US is a lot less interested and engaged than it had been during the presidencies of George W Bush and Bill Clinton. Similarly, many Central Asians feel that the Obama administration pays little attention to them, unless they can serve as launch pads for planes destined for Afghanistan. NATO membership for Ukraine and Georgia is no longer on the cards.
While much of America’s attention has moved elsewhere, the European Union hardly has a foothold in the region. The EU’s neighbourhood policy has proved rather ineffective, and the 2009 ‘Eastern partnership’ has not yet had time to make much of a difference. Ukraine, still smarting that the EU has never offered the prospect of membership, appears to be turning towards Russia. Moldova looks keener than ever to get closer to the EU – with few people in Brussels and other capitals taking notice. The EU’s Central Asia strategy has lacked political backing and consistency. In the Caucasus and Central Asia, the EU is a rather new player and its traditional approach of exporting norms and values as the basis for bilateral relations has not been received well. The fact that the EU’s foreign policy machinery is currently in bureaucratic paralysis does not help.
In theory, US neglect and European weakness could leave Russia free to consolidate what President Medvedev likes to refer to as a ‘sphere of privileged interests’. Russia is certainly trying. But success has been patchy at best.
Although by far the most populous and prosperous country in the region, Russia does not necessarily have the means to project power into the neighbourhood. Its tools looked more formidable before they were actually used. Now some of them have turned out to be blunt.
Russia’s use of military force in Georgia last year backfired when even Moscow’s staunchest allies scrambled to become less reliant on their dangerous-looking big neighbour: Belarus turned to the EU, Armenia started talking to Turkey and not a single one of the former Soviet countries has followed Moscow in recognising the independence of Abkhazia and South Ossetia.
Russia has repeatedly used trade embargoes and other economic means to put pressure on its neighbours, in particular smaller ones where Russia’s own business interests are limited, such as Georgia or Latvia. But there is arguably not a single instance where the use of economic sanctions has got Russia what it wanted. Businesses in the countries affected have reinforced their efforts to find alternative markets and sources of investments, making them less dependent on Russia in the long term. Russia’s strategy of gaining influence through directly controlling local businesses has proven more successful: in Armenia for example, various sectors from banking to transport are dominated by Russian-owned companies. How this will translate into political leverage remains to be seen.
This leaves energy as the most promising tool of Russia’s neighbourhood policy. Russia has used pipeline plans, nuclear projects, gas prices and oil deliveries to get what it wants from its neighbours. But even here, Russia’s success rate is mixed. In Belarus and Ukraine, Russia is making headway towards its aim of gaining control over transit pipelines. The recent standoff between Belarus and Russia over gas prices and transit fees only highlighted Minsk’s lack of options: Lukashenko’s announcement that he would buy gas from Venezuela was little more than symbolic. In Ukraine, Russia managed to use the offer of cheaper gas to get the lease for its Black Sea fleet in Sevastopol extended. It has also successfully pressured Kyiv into at least considering merging parts of the two countries’ gas monopolies, Gazprom and Naftogaz, which would give Moscow effective control over Ukraine’s transit pipelines.
The situation is very different in the Caucasus and Central Asia, where energy producing countries are gaining room for manoeuvre through building stronger links with China, Iran and Turkey. Turkmenistan opened a large gas pipeline to China at the beginning of the year and signed another gas delivery contract with Iran in June. It has invited international oil majors to help build an internal pipeline that could one day deliver Turkmen gas from the massive Yolotan field to the Caspian shores and from there to Europe. It had previously promised to let Russia build the pipeline and buy much of the gas. Azerbaijan has spurned a Russian offer to buy up all the gas from its new Shah Deniz 2 field, instead committing it to Turkey and to European buyers. Russia’s attempts to lock up Caspian gas supplies by foiling pipeline projects such as Nabucco are looking increasingly desperate.
The perceived withdrawal of the US and the ineffectiveness of EU policy in the region has not so far played into Russia’s hands. Russia (like the EU and other players in the region) has had to learn that the former Soviet Union does not constitute a homogenous neighbourhood. There are cocky and cash-rich energy suppliers such as Azerbaijan and Kazakhstan, and there are poor and divided countries such as Moldova and Armenia. Russia can cajole and coerce in one place but it has to plead and please in another. All countries in the region will benefit from being less dependent on Russia, in trade and energy terms as well as in politics. While the US might pay less attention to the region, the EU should redouble its efforts, while also taking more account of the the specific situations of individual countries.
Katinka Barysch is deputy director of the CER
The US is withdrawing from the former Soviet space; the European Union struggles to be taken seriously there. Does that leave Russia free to strengthen its influence in the countries around its borders? Not necessarily, for the situation in the region is complex.
Hillary Clinton toured the Caucasus recently to reassure Georgia, Armenia and Azerbaijan that Washington had not abandoned them in its quest to ‘reset’ relations with Russia. Nevertheless, the predominant feeling in those countries is that the US is a lot less interested and engaged than it had been during the presidencies of George W Bush and Bill Clinton. Similarly, many Central Asians feel that the Obama administration pays little attention to them, unless they can serve as launch pads for planes destined for Afghanistan. NATO membership for Ukraine and Georgia is no longer on the cards.
While much of America’s attention has moved elsewhere, the European Union hardly has a foothold in the region. The EU’s neighbourhood policy has proved rather ineffective, and the 2009 ‘Eastern partnership’ has not yet had time to make much of a difference. Ukraine, still smarting that the EU has never offered the prospect of membership, appears to be turning towards Russia. Moldova looks keener than ever to get closer to the EU – with few people in Brussels and other capitals taking notice. The EU’s Central Asia strategy has lacked political backing and consistency. In the Caucasus and Central Asia, the EU is a rather new player and its traditional approach of exporting norms and values as the basis for bilateral relations has not been received well. The fact that the EU’s foreign policy machinery is currently in bureaucratic paralysis does not help.
In theory, US neglect and European weakness could leave Russia free to consolidate what President Medvedev likes to refer to as a ‘sphere of privileged interests’. Russia is certainly trying. But success has been patchy at best.
Although by far the most populous and prosperous country in the region, Russia does not necessarily have the means to project power into the neighbourhood. Its tools looked more formidable before they were actually used. Now some of them have turned out to be blunt.
Russia’s use of military force in Georgia last year backfired when even Moscow’s staunchest allies scrambled to become less reliant on their dangerous-looking big neighbour: Belarus turned to the EU, Armenia started talking to Turkey and not a single one of the former Soviet countries has followed Moscow in recognising the independence of Abkhazia and South Ossetia.
Russia has repeatedly used trade embargoes and other economic means to put pressure on its neighbours, in particular smaller ones where Russia’s own business interests are limited, such as Georgia or Latvia. But there is arguably not a single instance where the use of economic sanctions has got Russia what it wanted. Businesses in the countries affected have reinforced their efforts to find alternative markets and sources of investments, making them less dependent on Russia in the long term. Russia’s strategy of gaining influence through directly controlling local businesses has proven more successful: in Armenia for example, various sectors from banking to transport are dominated by Russian-owned companies. How this will translate into political leverage remains to be seen.
This leaves energy as the most promising tool of Russia’s neighbourhood policy. Russia has used pipeline plans, nuclear projects, gas prices and oil deliveries to get what it wants from its neighbours. But even here, Russia’s success rate is mixed. In Belarus and Ukraine, Russia is making headway towards its aim of gaining control over transit pipelines. The recent standoff between Belarus and Russia over gas prices and transit fees only highlighted Minsk’s lack of options: Lukashenko’s announcement that he would buy gas from Venezuela was little more than symbolic. In Ukraine, Russia managed to use the offer of cheaper gas to get the lease for its Black Sea fleet in Sevastopol extended. It has also successfully pressured Kyiv into at least considering merging parts of the two countries’ gas monopolies, Gazprom and Naftogaz, which would give Moscow effective control over Ukraine’s transit pipelines.
The situation is very different in the Caucasus and Central Asia, where energy producing countries are gaining room for manoeuvre through building stronger links with China, Iran and Turkey. Turkmenistan opened a large gas pipeline to China at the beginning of the year and signed another gas delivery contract with Iran in June. It has invited international oil majors to help build an internal pipeline that could one day deliver Turkmen gas from the massive Yolotan field to the Caspian shores and from there to Europe. It had previously promised to let Russia build the pipeline and buy much of the gas. Azerbaijan has spurned a Russian offer to buy up all the gas from its new Shah Deniz 2 field, instead committing it to Turkey and to European buyers. Russia’s attempts to lock up Caspian gas supplies by foiling pipeline projects such as Nabucco are looking increasingly desperate.
The perceived withdrawal of the US and the ineffectiveness of EU policy in the region has not so far played into Russia’s hands. Russia (like the EU and other players in the region) has had to learn that the former Soviet Union does not constitute a homogenous neighbourhood. There are cocky and cash-rich energy suppliers such as Azerbaijan and Kazakhstan, and there are poor and divided countries such as Moldova and Armenia. Russia can cajole and coerce in one place but it has to plead and please in another. All countries in the region will benefit from being less dependent on Russia, in trade and energy terms as well as in politics. While the US might pay less attention to the region, the EU should redouble its efforts, while also taking more account of the the specific situations of individual countries.
Katinka Barysch is deputy director of the CER
Thursday, July 08, 2010
Membership for Russia a step too far for NATO?
by Tomas Valasek
There are growing signs that Russia’s relations with NATO are on the mend. Senior Russian thinkers, some close to the government, have been cautiously talking up the possibility of Russia joining the alliance, as have several western officials and think-tanks (including the CER.) While some powerful forces in Russia continue to view NATO as a hostile force, the latest signs from Moscow are encouraging. But even assuming that the more pro-western forces within Russia prevail, membership of NATO will remain at best a long-term goal. In the short and medium term, Russia and NATO need to put considerable effort into reducing mistrust.
A group of prominent Russian thinkers recently invited their western counterparts to talk about the possibility of Russia joining NATO. What prompted this initiative is not obvious, but the atmospherics have clearly changed. Russia is being nicer to its neighbours, while a number of European countries – including those in Central and Eastern Europe – are being nicer to Moscow. NATO has effectively put enlargement on hold. Barack Obama’s ‘reset’ seems to be changing attitudes on all sides. The challenge before Russia and NATO is to try to turn this opportunity into a lasting improvement in relations.
The allies are not of one mind on the subject of Russian membership of the alliance. But conversations with NATO officials and diplomats suggest that NATO could be ready by its November summit to offer Moscow the possibility of joining, if and when the latter meets accession criteria. With additional persuasion – though this is more questionable – NATO may even create a special accession track for Russia, different from the one NATO used for previous candidates, so that Moscow feels that it is being treated like a great power. But the allies’ bottom line is that, one way or another, Moscow will need to adopt many of NATO’s norms, including those on democracy and transparency, before it can become a member.
Those Russians who want to explore the possibility of accession seem to have a different approach in mind. They are looking for a bargain of sorts with NATO. The alliance would promise not to enlarge eastward or arm regimes deemed unfriendly by Russia. Moscow would gain a veto over alliance decisions on matters which may affect Russia. In exchange, NATO would get better co-operation from Russia on things like missile defence or Afghanistan. NATO’s rules or norms do not seem to be a part of the bargain. Tellingly, few Russians use the term ‘membership’ with regard to NATO. They talk either of ‘integration’ or ‘organisational unity’. The former implies that both sides adopt some of the other side’s rules; the latter implies that neither side compromises internally. Either model is distant from what NATO has in mind.
But if membership is not the right thing for NATO and Russia to focus on in the near term, are there other viable ways to improve co-operation in the next few months and years? One Russian speaker at the meeting in Moscow put forth a possible solution. Instead of exploring membership, NATO and Russia should ‘demilitarise’ their relationship. Moscow would stop holding exercises that simulate a war with NATO, like the ‘Zapad’ exercise last year, in which 12,500 Russian and Belorusian troops repelled a fictitious attack from NATO. Russia would also change its strategic documents to make clear that NATO is not a ‘threat’ or ‘danger’. NATO would respond in kind, with no exercises and no new bases near Russia’s borders. If demilitarisation is successful, the theory goes, NATO and Russia would gradually come to view each other as partners. And that could open doors to even closer forms of co-operation in the future.
This is a sensible idea but not without difficulties. For a start, is Russia ready? The government is sending out mixed signals. Besides being nicer to its neighbours lately, Moscow has also launched sweeping defence reforms. These will change the Russian military from a grand force built to fight NATO into a smaller but more agile army better suited for regional conflicts like the one in Chechnya. That is good news for NATO. But only last year the Russian government also agreed a new military doctrine, which calls NATO’s activities the greatest danger to Russian security. So there is presumably a large segment of the Russian establishment that would oppose closer ties with the alliance.
In order to take up demilitarisation, NATO would have to be convinced that Russia is equally serious. Just as important, this initiative would need to win the support of the new allies in Central and Eastern Europe. Some of them feel that NATO has been neglecting the possibility of a conflict in Europe, and they want the alliance to adopt new ‘reassurance’ measures. These would involve, among other things, the creation of a new centre at NATO tasked with keeping an eye on future crises, including those involving Russia.
Some in NATO will argue that ‘reassurance’ would kill the hopes of a rapprochement with Russia, by provoking Moscow. But in fact the opposite is the case: without reassurance NATO will not reach the consensus it needs to offer Russia a new relationship – whether it means demilitarisation or, in the long run, integration. The right approach for NATO is to rebuild trust among the allies through reassurance while striving to reform its relationship with Russia. ‘Demilitarisation’ sounds like a useful idea to explore. The new allies should be supportive: after all, they stand to gain the most should Russia stop rehearsing attacks on Central and Eastern Europe. ‘Demilitarisation’ would be the ultimate reassurance measure.
Tomas Valasek is Director of foreign policy and defence at the Centre for European Reform.
There are growing signs that Russia’s relations with NATO are on the mend. Senior Russian thinkers, some close to the government, have been cautiously talking up the possibility of Russia joining the alliance, as have several western officials and think-tanks (including the CER.) While some powerful forces in Russia continue to view NATO as a hostile force, the latest signs from Moscow are encouraging. But even assuming that the more pro-western forces within Russia prevail, membership of NATO will remain at best a long-term goal. In the short and medium term, Russia and NATO need to put considerable effort into reducing mistrust.
A group of prominent Russian thinkers recently invited their western counterparts to talk about the possibility of Russia joining NATO. What prompted this initiative is not obvious, but the atmospherics have clearly changed. Russia is being nicer to its neighbours, while a number of European countries – including those in Central and Eastern Europe – are being nicer to Moscow. NATO has effectively put enlargement on hold. Barack Obama’s ‘reset’ seems to be changing attitudes on all sides. The challenge before Russia and NATO is to try to turn this opportunity into a lasting improvement in relations.
The allies are not of one mind on the subject of Russian membership of the alliance. But conversations with NATO officials and diplomats suggest that NATO could be ready by its November summit to offer Moscow the possibility of joining, if and when the latter meets accession criteria. With additional persuasion – though this is more questionable – NATO may even create a special accession track for Russia, different from the one NATO used for previous candidates, so that Moscow feels that it is being treated like a great power. But the allies’ bottom line is that, one way or another, Moscow will need to adopt many of NATO’s norms, including those on democracy and transparency, before it can become a member.
Those Russians who want to explore the possibility of accession seem to have a different approach in mind. They are looking for a bargain of sorts with NATO. The alliance would promise not to enlarge eastward or arm regimes deemed unfriendly by Russia. Moscow would gain a veto over alliance decisions on matters which may affect Russia. In exchange, NATO would get better co-operation from Russia on things like missile defence or Afghanistan. NATO’s rules or norms do not seem to be a part of the bargain. Tellingly, few Russians use the term ‘membership’ with regard to NATO. They talk either of ‘integration’ or ‘organisational unity’. The former implies that both sides adopt some of the other side’s rules; the latter implies that neither side compromises internally. Either model is distant from what NATO has in mind.
But if membership is not the right thing for NATO and Russia to focus on in the near term, are there other viable ways to improve co-operation in the next few months and years? One Russian speaker at the meeting in Moscow put forth a possible solution. Instead of exploring membership, NATO and Russia should ‘demilitarise’ their relationship. Moscow would stop holding exercises that simulate a war with NATO, like the ‘Zapad’ exercise last year, in which 12,500 Russian and Belorusian troops repelled a fictitious attack from NATO. Russia would also change its strategic documents to make clear that NATO is not a ‘threat’ or ‘danger’. NATO would respond in kind, with no exercises and no new bases near Russia’s borders. If demilitarisation is successful, the theory goes, NATO and Russia would gradually come to view each other as partners. And that could open doors to even closer forms of co-operation in the future.
This is a sensible idea but not without difficulties. For a start, is Russia ready? The government is sending out mixed signals. Besides being nicer to its neighbours lately, Moscow has also launched sweeping defence reforms. These will change the Russian military from a grand force built to fight NATO into a smaller but more agile army better suited for regional conflicts like the one in Chechnya. That is good news for NATO. But only last year the Russian government also agreed a new military doctrine, which calls NATO’s activities the greatest danger to Russian security. So there is presumably a large segment of the Russian establishment that would oppose closer ties with the alliance.
In order to take up demilitarisation, NATO would have to be convinced that Russia is equally serious. Just as important, this initiative would need to win the support of the new allies in Central and Eastern Europe. Some of them feel that NATO has been neglecting the possibility of a conflict in Europe, and they want the alliance to adopt new ‘reassurance’ measures. These would involve, among other things, the creation of a new centre at NATO tasked with keeping an eye on future crises, including those involving Russia.
Some in NATO will argue that ‘reassurance’ would kill the hopes of a rapprochement with Russia, by provoking Moscow. But in fact the opposite is the case: without reassurance NATO will not reach the consensus it needs to offer Russia a new relationship – whether it means demilitarisation or, in the long run, integration. The right approach for NATO is to rebuild trust among the allies through reassurance while striving to reform its relationship with Russia. ‘Demilitarisation’ sounds like a useful idea to explore. The new allies should be supportive: after all, they stand to gain the most should Russia stop rehearsing attacks on Central and Eastern Europe. ‘Demilitarisation’ would be the ultimate reassurance measure.
Tomas Valasek is Director of foreign policy and defence at the Centre for European Reform.
Thursday, June 24, 2010
EU JHA co-operation: After Lisbon, reality bites
By Hugo Brady
EU policies on policing, justice and immigration were widely expected to take a big leap forward after the ratification of the Lisbon treaty. But interested outsiders should not assume that new powers for the EU’s institutions will translate automatically into more coherent European action in security and migration matters. In fact, the EU’s governments and its institutions face serious challenges in justice and home affairs (JHA) co-operation in the years ahead.
First, JHA policy-making is becoming more fractious and politically divided under the new treaty. Sensitive issues like terrorism or organised crime are now subject to the same rules as the EU's single market, meaning that the European Parliament can amend or block such decisions for the first time. This may not sound very radical. But for the EU's conservative interior and justice ministries – as well as key partners like the US – it is a brave new world.
Take terrorism. Last February, the European Parliament shocked both EU governments and the Obama administration alike by rapidly using its new powers to vote down the so-called Swift agreement. (This arrangement allowed US intelligence services to comb European financial transactions en masse for counter-terror purposes.) The parliament has since signalled that it will also vote down a modified version of the agreement which officials had hoped might soothe concerns over data privacy. Furthermore, EU officials worry that MEPs may reject any new security-related law on principle. There is an urgent need for EU governments and the parliament to find a new modus vivendi that allows them to work together constructively on such matters.
Second, EU countries complain that it is now harder under Lisbon to project a single voice in international fora when law and order and immigration issues are discussed. Officials are currently at a loss to know who takes the lead on terrorism or corruption issues in, say, the UN or OSCE. Is it the EU's six-month rotating presidency, the European Commission or the embryonic external action service? Although the Commission would bitterly oppose such a move, it should be up to the High Representative for foreign policy to decide in future who is best placed to lead the EU's external representation in these areas.
Third, the Commission's justice and security directorate, which has drafted most JHA legislation since 1999, is set to be divided in two. The split – into separate home affairs and justice departments – is largely at the behest of Viviane Reding, the EU's firebrand justice commissioner. Reding wants to use her new directorate to re-balance the JHA policy area which she believes has been hitherto too pro-American and too security-focused.
The decision to split up the Commission's JHA directorate is probably a mistake. Part of its added value in security and migration matters was the ability to bring all the relevant policy elements – policing, justice, immigration – together under one roof. There is also a danger that the split could result in more in-fighting and a loss of shared purpose. Better checks and balances were needed in EU internal security co-operation. But these have now been provided in the guise of a more powerful parliament and the extension of the jurisdiction of the EU's Court of Justice over all JHA legislation.
Lastly, despite new powers under the treaty, there is a dearth of really strong ideas from either the governments or the institutions about how the EU's JHA agenda should develop over the next five years. EU governments have recently agreed both an 82-page list of proposals for improving JHA co-operation (known as the Stockholm programme) and a wide-ranging ‘internal security strategy’. But the fact that these largely lack substance hints that the future of European co-operation on security and migration issues will centre on consolidating existing achievements rather than launching bold new initiatives.
One priority is to safeguard the EU’s Schengen area of passport-free travel. Schengen ranks alongside the euro as one of the EU's most tangible achievements. Like the euro, each Schengen country relies largely on assurances of good faith from others in the club, in this case that the common border is being maintained properly. But not all Schengen members are trusted equally. French police are increasing their spot-checks on cars crossing the border from Spain, for example, while Finnish border guards routinely check passports of non-EU travellers en route from Greece. To make the passport-free zone work properly, EU countries must agree a more transparent system for verifying border standards. They must also ensure that Romania and Bulgaria – both chomping at the bit to join – are not allowed in prematurely until they have carried out thoroughgoing reform of their police and judiciaries.
The gap between rhetoric and reality in the Schengen area should serve as a warning against future hubris. The EU’s new powers in policing, justice and immigration will only be a success if they result in the member-states adopting policies that seriously address current security and migration challenges. We will soon know whether a vague new treaty, a divided Brussels bureaucracy and a truculent European Parliament will help or hinder that ambition.
Hugo Brady is a senior research fellow at the Centre for European Reform.
EU policies on policing, justice and immigration were widely expected to take a big leap forward after the ratification of the Lisbon treaty. But interested outsiders should not assume that new powers for the EU’s institutions will translate automatically into more coherent European action in security and migration matters. In fact, the EU’s governments and its institutions face serious challenges in justice and home affairs (JHA) co-operation in the years ahead.
First, JHA policy-making is becoming more fractious and politically divided under the new treaty. Sensitive issues like terrorism or organised crime are now subject to the same rules as the EU's single market, meaning that the European Parliament can amend or block such decisions for the first time. This may not sound very radical. But for the EU's conservative interior and justice ministries – as well as key partners like the US – it is a brave new world.
Take terrorism. Last February, the European Parliament shocked both EU governments and the Obama administration alike by rapidly using its new powers to vote down the so-called Swift agreement. (This arrangement allowed US intelligence services to comb European financial transactions en masse for counter-terror purposes.) The parliament has since signalled that it will also vote down a modified version of the agreement which officials had hoped might soothe concerns over data privacy. Furthermore, EU officials worry that MEPs may reject any new security-related law on principle. There is an urgent need for EU governments and the parliament to find a new modus vivendi that allows them to work together constructively on such matters.
Second, EU countries complain that it is now harder under Lisbon to project a single voice in international fora when law and order and immigration issues are discussed. Officials are currently at a loss to know who takes the lead on terrorism or corruption issues in, say, the UN or OSCE. Is it the EU's six-month rotating presidency, the European Commission or the embryonic external action service? Although the Commission would bitterly oppose such a move, it should be up to the High Representative for foreign policy to decide in future who is best placed to lead the EU's external representation in these areas.
Third, the Commission's justice and security directorate, which has drafted most JHA legislation since 1999, is set to be divided in two. The split – into separate home affairs and justice departments – is largely at the behest of Viviane Reding, the EU's firebrand justice commissioner. Reding wants to use her new directorate to re-balance the JHA policy area which she believes has been hitherto too pro-American and too security-focused.
The decision to split up the Commission's JHA directorate is probably a mistake. Part of its added value in security and migration matters was the ability to bring all the relevant policy elements – policing, justice, immigration – together under one roof. There is also a danger that the split could result in more in-fighting and a loss of shared purpose. Better checks and balances were needed in EU internal security co-operation. But these have now been provided in the guise of a more powerful parliament and the extension of the jurisdiction of the EU's Court of Justice over all JHA legislation.
Lastly, despite new powers under the treaty, there is a dearth of really strong ideas from either the governments or the institutions about how the EU's JHA agenda should develop over the next five years. EU governments have recently agreed both an 82-page list of proposals for improving JHA co-operation (known as the Stockholm programme) and a wide-ranging ‘internal security strategy’. But the fact that these largely lack substance hints that the future of European co-operation on security and migration issues will centre on consolidating existing achievements rather than launching bold new initiatives.
One priority is to safeguard the EU’s Schengen area of passport-free travel. Schengen ranks alongside the euro as one of the EU's most tangible achievements. Like the euro, each Schengen country relies largely on assurances of good faith from others in the club, in this case that the common border is being maintained properly. But not all Schengen members are trusted equally. French police are increasing their spot-checks on cars crossing the border from Spain, for example, while Finnish border guards routinely check passports of non-EU travellers en route from Greece. To make the passport-free zone work properly, EU countries must agree a more transparent system for verifying border standards. They must also ensure that Romania and Bulgaria – both chomping at the bit to join – are not allowed in prematurely until they have carried out thoroughgoing reform of their police and judiciaries.
The gap between rhetoric and reality in the Schengen area should serve as a warning against future hubris. The EU’s new powers in policing, justice and immigration will only be a success if they result in the member-states adopting policies that seriously address current security and migration challenges. We will soon know whether a vague new treaty, a divided Brussels bureaucracy and a truculent European Parliament will help or hinder that ambition.
Hugo Brady is a senior research fellow at the Centre for European Reform.
Tuesday, June 15, 2010
The eurozone retreats into a beggar-thy-neighbour cul-de-sac
by Simon Tilford
Almost every member of the eurozone is rushing to slash public spending. While there is no doubting the scale of the fiscal challenge, the eurozone economy is not strong enough to cope with the contractionary effects of a generalised budgetary tightening. And if the eurozone falls back into recession, there will be no chance of putting public finances on a sustainable footing. Furthermore, excessive austerity in Europe will make it even harder to bring about the necessary rebalancing of the global economy, risking a protectionist backlash in the US. Unfortunately, these risks will receive scant attention when European leaders come together for this week's summit in Brussels.
Eurozone policy-makers appear to believe that fiscal policy has no impact on levels of economic activity, even when private demand is as weak as it is in Europe. Of course, some eurozone economies – Greece, Portugal and Spain, for example – have little option but to cut now. However, those member-states running big trade surpluses with the rest of the currency bloc need to hold off tightening fiscal policy until their domestic economies are growing sustainably. The German government believes it is leading by example in embarking on a severe round of budget cuts. But this is the last thing the eurozone needs at this point and demonstrates an alarming parochialism. The fiscal crisis cannot be solved without economic growth. And the eurozone will only return to decent economic growth if the bloc's surplus economies, in particular Germany, start to consume more.
The German economy is very unbalanced. The weakness of domestic demand (a reflection of an extremely high savings rate and years of eye-watering wage restraint) means the country is running a massive current account surplus with the rest of the eurozone. This surplus is a drag on the eurozone economy. Germany's austerity programme all but guarantees very weak domestic demand in the country and effectively ends any chance of narrowing its trade surplus with the rest of the currency union. But unless this surplus narrows substantially, it will be very hard to get the eurozone economy growing, and all but impossible to address the eurozone's fiscal crisis.
Germany's Chancellor Merkel argues that her government's cuts will make Germany more competitive (and hence boost its export sector). In short, Germany's economic growth strategy is predicated on a further increase in its exports relative to its imports. For a country with a huge external surplus and a relatively sound fiscal position to be cutting public spending at this point is highly irresponsible. Germany is defining its economic policy purely in national terms without consideration for the impact on the sustainability of the common currency or the outlook for the broader international economy.
After years of relying on demand generated elsewhere in Europe, Germany now needs to become a source of it. The country is sending a damaging signal to the financial markets – it does not care about economic growth. No-one should be surprised that bond spreads (the difference in government borrowing costs) within the eurozone have widened sharply since Germany announced its budget plan. Instead of some masochistic rush to see who can cut by most, the eurozone needs a co-ordinated response. Germany, whose borrowing costs have fallen to just 2.5 per cent, should be doing all it can to boost its domestic demand, not depress it further.
The Netherlands' external surplus – relative to the size of its economy – is as large as Germany's, and the Dutch rely even more than the Germans on trade with other eurozone economies. But assuming that the conservative People's Party for Freedom and Democracy (VVD) succeeds in forming a coalition government with Geert Wilders' Freedom Party (PVV) and the centre-right Christian Democratic Appeal (CDA), Holland will adopt the same beggar-thy-neighbour strategy as Germany. It is possible that fiscal austerity and further wage restraint will work for Germany and the Netherlands, on the assumption that their firms can take further market share within the eurozone. But this is a zero-sum game: it is not as if every economy can allow domestic demand to stagnate and rely on exports. One country's surplus is another's deficit. They are banking on being able to export the consequences of their austerity to others.
Nor are the Europeans giving any thought to how their austerity (and neglect of economic growth) will impact on the rest of the world. An uncoordinated and premature fiscal contraction against the backdrop of a stagnant eurozone economy will prove contractionary for the world as a whole. The weakness of economic growth will prevent a rise in eurozone interest rates, which will keep the euro weak and boost the exports of those member-states, such as Germany, that trade a lot internationally. As a result, it will throw a further obstacle in the way of the urgently needed rebalancing of the global economy away from its excessive reliance on the US consumer. This reliance can only be reduced if surplus economies in Europe and Asia consume more, not less.
With China resolutely refusing to reduce its export dependence and Europe retreating into a destructive beggar-thy-neighbour cul-de-sac, it will not be long before protectionist sentiment in the US rises. And this will be understandable, despite the inevitable condemnations by European governments.
Simon Tilford is chief economist at the Centre for European Reform.
Almost every member of the eurozone is rushing to slash public spending. While there is no doubting the scale of the fiscal challenge, the eurozone economy is not strong enough to cope with the contractionary effects of a generalised budgetary tightening. And if the eurozone falls back into recession, there will be no chance of putting public finances on a sustainable footing. Furthermore, excessive austerity in Europe will make it even harder to bring about the necessary rebalancing of the global economy, risking a protectionist backlash in the US. Unfortunately, these risks will receive scant attention when European leaders come together for this week's summit in Brussels.
Eurozone policy-makers appear to believe that fiscal policy has no impact on levels of economic activity, even when private demand is as weak as it is in Europe. Of course, some eurozone economies – Greece, Portugal and Spain, for example – have little option but to cut now. However, those member-states running big trade surpluses with the rest of the currency bloc need to hold off tightening fiscal policy until their domestic economies are growing sustainably. The German government believes it is leading by example in embarking on a severe round of budget cuts. But this is the last thing the eurozone needs at this point and demonstrates an alarming parochialism. The fiscal crisis cannot be solved without economic growth. And the eurozone will only return to decent economic growth if the bloc's surplus economies, in particular Germany, start to consume more.
The German economy is very unbalanced. The weakness of domestic demand (a reflection of an extremely high savings rate and years of eye-watering wage restraint) means the country is running a massive current account surplus with the rest of the eurozone. This surplus is a drag on the eurozone economy. Germany's austerity programme all but guarantees very weak domestic demand in the country and effectively ends any chance of narrowing its trade surplus with the rest of the currency union. But unless this surplus narrows substantially, it will be very hard to get the eurozone economy growing, and all but impossible to address the eurozone's fiscal crisis.
Germany's Chancellor Merkel argues that her government's cuts will make Germany more competitive (and hence boost its export sector). In short, Germany's economic growth strategy is predicated on a further increase in its exports relative to its imports. For a country with a huge external surplus and a relatively sound fiscal position to be cutting public spending at this point is highly irresponsible. Germany is defining its economic policy purely in national terms without consideration for the impact on the sustainability of the common currency or the outlook for the broader international economy.
After years of relying on demand generated elsewhere in Europe, Germany now needs to become a source of it. The country is sending a damaging signal to the financial markets – it does not care about economic growth. No-one should be surprised that bond spreads (the difference in government borrowing costs) within the eurozone have widened sharply since Germany announced its budget plan. Instead of some masochistic rush to see who can cut by most, the eurozone needs a co-ordinated response. Germany, whose borrowing costs have fallen to just 2.5 per cent, should be doing all it can to boost its domestic demand, not depress it further.
The Netherlands' external surplus – relative to the size of its economy – is as large as Germany's, and the Dutch rely even more than the Germans on trade with other eurozone economies. But assuming that the conservative People's Party for Freedom and Democracy (VVD) succeeds in forming a coalition government with Geert Wilders' Freedom Party (PVV) and the centre-right Christian Democratic Appeal (CDA), Holland will adopt the same beggar-thy-neighbour strategy as Germany. It is possible that fiscal austerity and further wage restraint will work for Germany and the Netherlands, on the assumption that their firms can take further market share within the eurozone. But this is a zero-sum game: it is not as if every economy can allow domestic demand to stagnate and rely on exports. One country's surplus is another's deficit. They are banking on being able to export the consequences of their austerity to others.
Nor are the Europeans giving any thought to how their austerity (and neglect of economic growth) will impact on the rest of the world. An uncoordinated and premature fiscal contraction against the backdrop of a stagnant eurozone economy will prove contractionary for the world as a whole. The weakness of economic growth will prevent a rise in eurozone interest rates, which will keep the euro weak and boost the exports of those member-states, such as Germany, that trade a lot internationally. As a result, it will throw a further obstacle in the way of the urgently needed rebalancing of the global economy away from its excessive reliance on the US consumer. This reliance can only be reduced if surplus economies in Europe and Asia consume more, not less.
With China resolutely refusing to reduce its export dependence and Europe retreating into a destructive beggar-thy-neighbour cul-de-sac, it will not be long before protectionist sentiment in the US rises. And this will be understandable, despite the inevitable condemnations by European governments.
Simon Tilford is chief economist at the Centre for European Reform.
Friday, June 11, 2010
Shale gas and EU energy security
by Katinka Barysch
Will unconventional gas solve Europe’s energy security problem? Many EU member-states rely a lot on Russian gas; in the case of some Central and East European countries the dependence is total. What if these countries suddenly discovered that they themselves sit on huge gas reserves? They should not hold their breath. Unconventional gas will make a big difference to the EU’s energy security – but perhaps not in the way that shale gas enthusiasts expect.
Unconventional gas (UG) is gas trapped in rock formations. The technology now exists to get this gas out. It involves drilling into the rocks and then blasting in water mixed with chemicals to extract the gas. In the US, the new technology has been a ‘game changer’. US production of shale gas (one form of UG) tripled in 2004-08, allowing America to overtake Russia as the world’s biggest gas producer. The US is now self-sufficient – which has enabled it to mothball its terminals for importing liquefied natural gas (LNG, gas that is frozen to liquid form and transported by tankers).
Is something similar about to happen in Europe? Some energy experts estimate that Europe’s UG reserves could be several times bigger than its conventional gas reserves. The likes of Exxon, Chevron, Shell and ConocoPhilips have already snapped up land plots in places that look promising for UG exploration, most notably in Poland, Sweden and Germany.
Should the EU scrap expensive and complicated diversification plans, such as the proposed Nabucco pipeline to import Caspian gas, and simply wait for the UG boom to happen in Europe? At a recent energy security conference in Vienna, gas experts, geologists and industry representatives urged caution.
* Estimates of European UG reserves are based on geological surveys that were not carried out with UG in mind. Only drilling holes in the ground will show whether the geology is indeed suitable for producing and commercially exploiting UG. So far, there has been very little drilling in Europe. A couple of wells in Hungary have been abandoned as unpromising. In southern Sweden, environmental concerns may make gas extraction impossible irrespective of whether the geology proves suitable. In Poland, the country considered most promising, not a single well has been drilled so far.
* In the US, it was small, technology-savvy energy companies that made the shale gas boom possible. The giant international oil companies have only recently joined the fray by buying up smaller companies with the right technology and know-how. Europe’s energy markets are still dominated by national champions. There are few nimble, innovative players. Expertise and infrastructure for UG development is scarce. Engineers are being flown in from Texas or Pennsylvania. In the whole of Europe, there are only 67 land rigs (the structures used in drilling for UG), compared with thousands in the US.
* US legislation tends to be rather kind to oil and gas companies. For example, the law that regulates the safety of drinking water has an intentional loophole that excludes ‘fracking’, the technology used to blast water and chemicals into rocks. Only now, with the shale gas boom in full swing, are environmental concerns mounting in the US. In Europe, by contrast, exploration starts with these concerns already being widely discussed. UG production needs huge amounts of water and, more importantly, uses chemicals that seep into the ground (usually at a depth of several thousand metres but that could store up problems in later years). Some UG drillings have made the earth shake near-by.
* Big UG sites require lots of space (they consist of scores of rigs close together), as well as new roads, reservoirs and pipelines. Planning restrictions in Europe are often tight, partly because the continent is more densely populated: typically 250-400 people live on each square kilometre in EU countries compared with 80 in the US.
* In the US, whoever owns a plot of land owns the resources beneath it. In EU countries, the resources below surface usually belong to the state. There will be no ‘poor farmers to shale gas millionaires’ stories in Europe. If only big energy companies gain, UG production could be less socially acceptable. Moreover, those companies looking for UG in Europe complain that local regulators and environment ministries have no experience with awarding the necessary licenses. Progress can be frustratingly slow.
* The US shale gas boom happened at a time when gas prices were rising and most analysts predicted steadily growing gas demand for years ahead. The situation is very different now. The European market is over-supplied at the moment, prices on the 'spot' market for short-term gas contracts have fallen significantly, and the medium-term outlook is highly uncertain. “High prices allowed us to make lots of mistakes when building up the US shale gas industry,” says one gas expert. “With depressed prices and demand in Europe, we have to be profitable straight away.” Because of the smaller scale of production and the dearth of infrastructure and expertise, it will probably cost two to three times as much to produce UG in Europe than in the US. So it is not clear whether European UG will be able to compete with LNG and pipeline gas.
Whether and when Europe’s first UG projects will become profitable is still anyone’s guess. One manager who runs a UG project in Poland says that in a best case scenario his company would need around three years to drill exploratory wells, another three to determine whether resources are commercially viable and yet more time to figure out how to get supplies to customers. One person involved in the Swedish exploration says he would expect commercialisation in around ten years.
“In Europe, unconventional gas is not a game changer,” concludes one executive of a big EU gas company. UG will most likely develop in Europe, but a repeat of the US shale gas boom is doubtful. The good news is that regardless of UG developments in Europe, the shale gas boom in the US is changing the global, and European, gas market.
Scores of new LNG terminals are being constructed in the Gulf, Africa and elsewhere. But the US LNG market has disappeared almost overnight. Other than Asia, that only leaves Europe as a destination for rapidly growing amounts of LNG. Already, market prices for LNG have collapsed in Europe, which, in turn, has forced pipeline gas suppliers such as Norway’s Statoil and Russia’s Gazprom to re-negotiate contracts with their biggest European customers. LNG imports mean more competition in a market hitherto dominated by 30-year contracts with fixed volumes and prices linked to the international oil price. That system is crumbling. Gazprom and other suppliers will have to make a bigger effort to be cheap and reliable – and that before even a single molecule of unconventional gas has been produced on the European continent.
Katinka Barysch is deputy director of the Centre for European Reform
Will unconventional gas solve Europe’s energy security problem? Many EU member-states rely a lot on Russian gas; in the case of some Central and East European countries the dependence is total. What if these countries suddenly discovered that they themselves sit on huge gas reserves? They should not hold their breath. Unconventional gas will make a big difference to the EU’s energy security – but perhaps not in the way that shale gas enthusiasts expect.
Unconventional gas (UG) is gas trapped in rock formations. The technology now exists to get this gas out. It involves drilling into the rocks and then blasting in water mixed with chemicals to extract the gas. In the US, the new technology has been a ‘game changer’. US production of shale gas (one form of UG) tripled in 2004-08, allowing America to overtake Russia as the world’s biggest gas producer. The US is now self-sufficient – which has enabled it to mothball its terminals for importing liquefied natural gas (LNG, gas that is frozen to liquid form and transported by tankers).
Is something similar about to happen in Europe? Some energy experts estimate that Europe’s UG reserves could be several times bigger than its conventional gas reserves. The likes of Exxon, Chevron, Shell and ConocoPhilips have already snapped up land plots in places that look promising for UG exploration, most notably in Poland, Sweden and Germany.
Should the EU scrap expensive and complicated diversification plans, such as the proposed Nabucco pipeline to import Caspian gas, and simply wait for the UG boom to happen in Europe? At a recent energy security conference in Vienna, gas experts, geologists and industry representatives urged caution.
* Estimates of European UG reserves are based on geological surveys that were not carried out with UG in mind. Only drilling holes in the ground will show whether the geology is indeed suitable for producing and commercially exploiting UG. So far, there has been very little drilling in Europe. A couple of wells in Hungary have been abandoned as unpromising. In southern Sweden, environmental concerns may make gas extraction impossible irrespective of whether the geology proves suitable. In Poland, the country considered most promising, not a single well has been drilled so far.
* In the US, it was small, technology-savvy energy companies that made the shale gas boom possible. The giant international oil companies have only recently joined the fray by buying up smaller companies with the right technology and know-how. Europe’s energy markets are still dominated by national champions. There are few nimble, innovative players. Expertise and infrastructure for UG development is scarce. Engineers are being flown in from Texas or Pennsylvania. In the whole of Europe, there are only 67 land rigs (the structures used in drilling for UG), compared with thousands in the US.
* US legislation tends to be rather kind to oil and gas companies. For example, the law that regulates the safety of drinking water has an intentional loophole that excludes ‘fracking’, the technology used to blast water and chemicals into rocks. Only now, with the shale gas boom in full swing, are environmental concerns mounting in the US. In Europe, by contrast, exploration starts with these concerns already being widely discussed. UG production needs huge amounts of water and, more importantly, uses chemicals that seep into the ground (usually at a depth of several thousand metres but that could store up problems in later years). Some UG drillings have made the earth shake near-by.
* Big UG sites require lots of space (they consist of scores of rigs close together), as well as new roads, reservoirs and pipelines. Planning restrictions in Europe are often tight, partly because the continent is more densely populated: typically 250-400 people live on each square kilometre in EU countries compared with 80 in the US.
* In the US, whoever owns a plot of land owns the resources beneath it. In EU countries, the resources below surface usually belong to the state. There will be no ‘poor farmers to shale gas millionaires’ stories in Europe. If only big energy companies gain, UG production could be less socially acceptable. Moreover, those companies looking for UG in Europe complain that local regulators and environment ministries have no experience with awarding the necessary licenses. Progress can be frustratingly slow.
* The US shale gas boom happened at a time when gas prices were rising and most analysts predicted steadily growing gas demand for years ahead. The situation is very different now. The European market is over-supplied at the moment, prices on the 'spot' market for short-term gas contracts have fallen significantly, and the medium-term outlook is highly uncertain. “High prices allowed us to make lots of mistakes when building up the US shale gas industry,” says one gas expert. “With depressed prices and demand in Europe, we have to be profitable straight away.” Because of the smaller scale of production and the dearth of infrastructure and expertise, it will probably cost two to three times as much to produce UG in Europe than in the US. So it is not clear whether European UG will be able to compete with LNG and pipeline gas.
Whether and when Europe’s first UG projects will become profitable is still anyone’s guess. One manager who runs a UG project in Poland says that in a best case scenario his company would need around three years to drill exploratory wells, another three to determine whether resources are commercially viable and yet more time to figure out how to get supplies to customers. One person involved in the Swedish exploration says he would expect commercialisation in around ten years.
“In Europe, unconventional gas is not a game changer,” concludes one executive of a big EU gas company. UG will most likely develop in Europe, but a repeat of the US shale gas boom is doubtful. The good news is that regardless of UG developments in Europe, the shale gas boom in the US is changing the global, and European, gas market.
Scores of new LNG terminals are being constructed in the Gulf, Africa and elsewhere. But the US LNG market has disappeared almost overnight. Other than Asia, that only leaves Europe as a destination for rapidly growing amounts of LNG. Already, market prices for LNG have collapsed in Europe, which, in turn, has forced pipeline gas suppliers such as Norway’s Statoil and Russia’s Gazprom to re-negotiate contracts with their biggest European customers. LNG imports mean more competition in a market hitherto dominated by 30-year contracts with fixed volumes and prices linked to the international oil price. That system is crumbling. Gazprom and other suppliers will have to make a bigger effort to be cheap and reliable – and that before even a single molecule of unconventional gas has been produced on the European continent.
Katinka Barysch is deputy director of the Centre for European Reform
Friday, June 04, 2010
Eurozone governance: Why the Commission is right
By Philip Whyte
The collapse of market confidence sparked by the parlous state of Greece’s public finances is forcing the EU to review how the eurozone is run. This is entirely welcome. The crisis has cruelly exposed fault-lines in the system of governance – and confidence is unlikely to be restored unless these flaws are rectified. There are profound disagreements, however, about what these flaws are. Broadly speaking, there is a narrow view and a broader one. If the eurozone is to extricate itself from its current mess, it is essential that the broader prevail.
The narrow view – advanced by Germany – holds that the eurozone’s difficulties are the result of government irresponsibility. The way to restore market confidence, then, is to force wayward governments, starting with Greece’s, to mend their ways by repairing their public finances. Errant behaviour, moreover, must be discouraged by strengthening fiscal rules and imposing tougher penalties on miscreants – for example, by withholding EU structural funds, suspending countries’ voting rights, or, in extremis, expelling rogue states from the eurozone.
Germany’s view is not totally wrong. Greece’s behaviour has been egregious and the incontinence of its government has played a key part in the country’s difficulties. The eurozone’s budgetary rules have been repeatedly flouted by member-states (including Germany). Public finances are weak and need to be strengthened over the medium term. Eurozone governments have to reassure markets that they are not profligates. In short, crafting a more credible framework for fiscal policy in the eurozone must form part of the task of reconstruction.
The problem with Germany’s position, however, is that it is one-eyed. The eurozone’s problems are not reducible to budgetary indiscipline alone. In the years leading up to the global financial crisis, Spain was running a budget surplus, not a deficit. The weakening of the country’s public finances since 2008 is not, therefore, connected to government irresponsibility before the crisis. Nor will budgetary austerity solve Spain’s underlying economic problems, which are high levels of private-sector debt and a dramatic a loss of trade competitiveness.
The Commission is therefore right to argue for a much broader reform of the way the eurozone is run. The proposals that it published on May 12th do not neglect the need for strengthening the weakened Stability and Growth Pact, or for deepening fiscal policy co-ordination. But the Commission also wants to beef up the Eurogroup’s surveillance of macroeconomic imbalances. This surely makes sense. Imbalances between members cannot simply be ignored – particularly in the absence of a fiscal union to transfer funds to depressed areas.
Nevertheless, some countries – Germany among them – are reluctant to allow the question of imbalances to get more airtime in the Eurogroup. Not coincidentally, enthusiasm for discussing imbalances is weakest among the countries that run large trade and current-account surpluses. This reticence is as easy to understand as it is impossible to justify. The countries believe their surpluses are badges of their ‘competitiveness’. As they see it, it is for deficit countries to become fitter, not for surplus countries to become flabbier.
The position of the surplus countries, however, is misguided. To start with, trade surpluses tell us nothing about economic dynamism. German politicians often liken their country to a toned athlete who is trouncing the international competition. They should think again. Yes, Germany has world class companies producing first-rate products. But productivity growth in recent years has been so weak that output per head is now below the eurozone average. The only reason German unit labour costs have fallen is that real wages have too.
The surplus countries are also incoherent. They condemn irresponsibility in the deficit countries, yet remain wedded to their own surpluses. This makes no sense. Deficits and surpluses are umbilically linked: one entails the other. Only in an Alice in Wonderland world would it be possible for the trade gap in ‘Deficit-land’ to decline without an offsetting adjustment in ‘Surplus-land’. Why do surplus countries struggle to accept this? The answer must be that they have grown reliant on the foreign irresponsibility that they like to decry.
If European policy-makers are to restore the financial markets’ flagging faith in the eurozone, they must persuade investors that the region is not heading for a prolonged economic slump. The Commission’s proposals on eurozone governance rightly identify many of the key elements that would provide such reassurance: a rebalancing of demand within the eurozone from the deficit to the surplus countries; supply-side reforms to raise the region’s long-term growth potential; and credible plans for fiscal consolidation over the medium term.
The danger, however, is that the minimalist German view will prevail, with reforms to eurozone governance focusing primarily on fiscal policy, the Commission’s proposals on macroeconomic surveillance being emasculated, and supply-side reforms being taken as seriously as they were under the Lisbon agenda (that is, not very). Should this scenario transpire, the eurozone could find itself condemned to permanent crisis, with chronically weak growth across the region as a whole, and politically destabilising debt-deflation in the south.
Friday, May 28, 2010
Can the EU help Russia modernise?
by Katinka Barysch
The EU and Russia are planning to launch a ‘partnership for modernisation’ at their next summit in Rostov on May 31st. The initiative – launched by Commission President Barroso at the last summit six months ago – is meant to breathe new life into a relationship that has become stale and tense. It is unlikely to succeed.
At first glance, an EU-Russia modernisation partnership looks like an excellent idea. It could entail joint science programmes, pilot projects in high-tech industries or student exchanges. Such projects should in theory be free of the ideological clashes that have held back EU-Russia relations in the past. They could help to restore mutual trust. They could allow the EU to acquaint Russia with European norms and values, not through lecturing but through day-to-day co-operation. In the medium term, successful modernisation could help to transform the apathetic Russian middle class into an entrepreneurial class that demands property rights and civil liberties. Last but not least, a successful modernisation partnership would generate new business opportunities for companies from the EU, which would, for example, be able to sell energy savings technologies to Russia.
Politically, the modernisation partnership looks promising. Modernisation is what Russia talks about today. President Medvedev has warned repeatedly that unless Russia radically reforms its economy, the country will face terminal decline. Russia must diversify away from exporting energy, and create jobs for the 95 per cent or so of the workforce that does not work in oil and gas. Surveys have shown that Russian policy-makers overwhelmingly believe that Russia needs outside help with modernisation. The recently leaked memo from the Russian foreign minister also called for Russia to forge ‘modernisation alliances’ with European countries. The EU has found that lecturing Russia on the need to reform does not work. So why not speak in Russia’s own interest by offering help with what has become a national priority?
Moreover, some EU policy-makers hope that since it is mainly President Medvedev who is pushing for modernisation, a re-focusing of EU-Russia relations on this topic may strengthen his hands vis-à-vis the more statist and authoritarian Putin clan.
Finally, political disagreements and tensions will remain inevitable in EU-Russia relations, whether over gas sales or the fate of Ukraine. The modernisation partnership could encourage co-operation that is independent of politics and focuses on technical, environmental or social issues. Such co-operation could help to stabilise bilateral relations and mitigate the dangerous intellectual isolation in which many Russian bureaucrats and scientists seem to operate today.
However, there are also several reasons why the partnership for modernisation may be a bad idea.
First, and most importantly, what most people in the EU mean by modernisation is very different from the notion held by the Russian leadership. Russia’s concept of modernisation is state-led and project-focused: a state-financed nanotechnology institute, state-owned banks lending to selected sectors, a brand-new ‘innovation city’ outside Moscow set up by government fiat – these are the building blocks of Medvedev’s innovation economy.
This approach cannot work. In today’s dynamic global economy, picking winners is not something that governments can do. An innovative economy needs open markets, venture capital, free-thinking entrepreneurs, fast bankruptcy courts and solid protection of intellectual property. Russia’s business environment is characterised by wide-spread monopolies, ubiquitous corruption, stifling state-interferences, weak and contradictory laws, and so on. The whole idea that Russia can shift from an economy that relies on oil, gas and heavy industry to a cutting-edge, high-tech one is spurious. Russia should first try to move existing industrial sectors up the value chain by using imported technology and know-how. Large-scale indigenous innovation may come later.
A state-led approach to economic change is particularly problematic in today’s Russia because its public institutions function so badly. Sergei Guriev, a Moscow-based economist, has compared the quality of Russia’s state administration and legal system of today with that of South Korea 12 years ago, before it embarked on its impressive growth spurt. He concluded that South Korea’s institutions were quite simply in a different league and that Russia’s chances of catching up with the world’s most developed countries were slim.
The Russian leadership hardly trusts its own bureaucracy to implement a road building programme. How is it supposed to build a replica of Silicon Valley? Even if such isolated programmes were successful, their impact on the wider economy would be limited so long as competition is restricted and successful companies must fear kleptocratic officials. The risk is that the money that the Russian government is about to pump into selected sectors and high-profile projects will not only be wasted. It will create a constant, future demand on public resources that may well be better spent elsewhere.
In short, Russian modernisation does not need vertical state intervention but a horizontal improvement of the business environment. It is doubtful whether the Russian leadership has the political will to clamp down on corruption, improve competition, reform the education and science sectors and strengthen the rule of law.
The question the EU needs to ask itself is whether it should accept and support Russia’s flawed concept of modernisation, or whether it should make support conditional on Russia implementing at least some of the reforms needed to strengthen the rule of law and improve the economy. In the past, EU attempts to cajole or persuade Russia to implement reforms have had limited or no impact. The modernisation partnership is unlikely to be very different.
Katinka Barysch is deputy director at the Centre for European Reform
The EU and Russia are planning to launch a ‘partnership for modernisation’ at their next summit in Rostov on May 31st. The initiative – launched by Commission President Barroso at the last summit six months ago – is meant to breathe new life into a relationship that has become stale and tense. It is unlikely to succeed.
At first glance, an EU-Russia modernisation partnership looks like an excellent idea. It could entail joint science programmes, pilot projects in high-tech industries or student exchanges. Such projects should in theory be free of the ideological clashes that have held back EU-Russia relations in the past. They could help to restore mutual trust. They could allow the EU to acquaint Russia with European norms and values, not through lecturing but through day-to-day co-operation. In the medium term, successful modernisation could help to transform the apathetic Russian middle class into an entrepreneurial class that demands property rights and civil liberties. Last but not least, a successful modernisation partnership would generate new business opportunities for companies from the EU, which would, for example, be able to sell energy savings technologies to Russia.
Politically, the modernisation partnership looks promising. Modernisation is what Russia talks about today. President Medvedev has warned repeatedly that unless Russia radically reforms its economy, the country will face terminal decline. Russia must diversify away from exporting energy, and create jobs for the 95 per cent or so of the workforce that does not work in oil and gas. Surveys have shown that Russian policy-makers overwhelmingly believe that Russia needs outside help with modernisation. The recently leaked memo from the Russian foreign minister also called for Russia to forge ‘modernisation alliances’ with European countries. The EU has found that lecturing Russia on the need to reform does not work. So why not speak in Russia’s own interest by offering help with what has become a national priority?
Moreover, some EU policy-makers hope that since it is mainly President Medvedev who is pushing for modernisation, a re-focusing of EU-Russia relations on this topic may strengthen his hands vis-à-vis the more statist and authoritarian Putin clan.
Finally, political disagreements and tensions will remain inevitable in EU-Russia relations, whether over gas sales or the fate of Ukraine. The modernisation partnership could encourage co-operation that is independent of politics and focuses on technical, environmental or social issues. Such co-operation could help to stabilise bilateral relations and mitigate the dangerous intellectual isolation in which many Russian bureaucrats and scientists seem to operate today.
However, there are also several reasons why the partnership for modernisation may be a bad idea.
First, and most importantly, what most people in the EU mean by modernisation is very different from the notion held by the Russian leadership. Russia’s concept of modernisation is state-led and project-focused: a state-financed nanotechnology institute, state-owned banks lending to selected sectors, a brand-new ‘innovation city’ outside Moscow set up by government fiat – these are the building blocks of Medvedev’s innovation economy.
This approach cannot work. In today’s dynamic global economy, picking winners is not something that governments can do. An innovative economy needs open markets, venture capital, free-thinking entrepreneurs, fast bankruptcy courts and solid protection of intellectual property. Russia’s business environment is characterised by wide-spread monopolies, ubiquitous corruption, stifling state-interferences, weak and contradictory laws, and so on. The whole idea that Russia can shift from an economy that relies on oil, gas and heavy industry to a cutting-edge, high-tech one is spurious. Russia should first try to move existing industrial sectors up the value chain by using imported technology and know-how. Large-scale indigenous innovation may come later.
A state-led approach to economic change is particularly problematic in today’s Russia because its public institutions function so badly. Sergei Guriev, a Moscow-based economist, has compared the quality of Russia’s state administration and legal system of today with that of South Korea 12 years ago, before it embarked on its impressive growth spurt. He concluded that South Korea’s institutions were quite simply in a different league and that Russia’s chances of catching up with the world’s most developed countries were slim.
The Russian leadership hardly trusts its own bureaucracy to implement a road building programme. How is it supposed to build a replica of Silicon Valley? Even if such isolated programmes were successful, their impact on the wider economy would be limited so long as competition is restricted and successful companies must fear kleptocratic officials. The risk is that the money that the Russian government is about to pump into selected sectors and high-profile projects will not only be wasted. It will create a constant, future demand on public resources that may well be better spent elsewhere.
In short, Russian modernisation does not need vertical state intervention but a horizontal improvement of the business environment. It is doubtful whether the Russian leadership has the political will to clamp down on corruption, improve competition, reform the education and science sectors and strengthen the rule of law.
The question the EU needs to ask itself is whether it should accept and support Russia’s flawed concept of modernisation, or whether it should make support conditional on Russia implementing at least some of the reforms needed to strengthen the rule of law and improve the economy. In the past, EU attempts to cajole or persuade Russia to implement reforms have had limited or no impact. The modernisation partnership is unlikely to be very different.
Katinka Barysch is deputy director at the Centre for European Reform
Friday, May 21, 2010
Financial regulation: Will British euroscepticism collide with European populism?
by Philip Whyte
When EU finance ministers met in Brussels on 18 May, many observers expected sparks to fly. The reason? This was the first EU meeting that Britain’s newly-elected government would attend. And a leading item on the agenda was the Commission’s proposed directive to regulate managers of ‘alternative investment funds’. France and Germany have pressed hard for the directive. Britain has deep reservations about it. The fear across the EU was that a hard-line British eurosceptic government ideologically resistant to regulating financial markets would come to Brussels seeking confrontation over the directive. In the event, the bust-up never happened. What lessons should one draw about the new, Conservative-led government’s attitude to the EU and to financial regulation?
The Conservative Party is more eurosceptic than it has ever been. Many of its members would like to withdraw from the EU altogether. The party’s leader, David Cameron, is no euro-enthusiast himself. But he is above all a pragmatist, not a rigid ideologue bent on confrontation. Recall that he enraged sections of his party when he decided not to hold a referendum on the Lisbon treaty once it had been ratified by all 27 member-states; and that he has formed a coalition with the UK’s most pro-European party, the Liberal Democrats. Besides, the government that he leads has more important things to do than pick needless fights in the EU. The focus of its attention over the next five years will be on consolidating the public finances and managing the inevitable social conflicts that will result.
What of financial regulation? A common view across Europe is that the financial crisis was the result of ‘unregulated Anglo-Saxon capitalism’; that the EU’s task is to cajole the reluctant British into clamping down on the City of London; and that the Conservatives may be particularly resistant to cooperating, given their ideological commitment to free markets and historical links to the City. Much of this account is inaccurate. Many of the regulatory failings exposed by the crisis were as much in evidence outside the Anglo-Saxon world as within it. The UK has pushed through many regulatory reforms before the EU. And the Conservative Party has distanced itself from the City and is considering measures – like breaking up large banks – that go far beyond what most EU countries are contemplating.
Does this mean that Britain and the EU will work harmoniously on the reform of financial regulation? The answer is: probably not. One problem is the populist undercurrent that is driving some reforms in the EU. The sad truth is that the alternative investment fund managers’ directive has been a poor advert for EU legislation. The Commission proposed it, under pressure from France and Germany, without carrying out the detailed impact assessment that its ‘better regulation’ agenda requires. The directive targets a rag-bag of disparate entities, mostly in the UK, that had nothing to do with the crisis and that will be saddled with inappropriate rules. And it is being imposed over the objections of the country that will be most affected by it by countries that will barely be affected by it at all.
Britain’s historical attitude to the EU – its enthusiasm for the single market, allied to its hostility to institutional integration – is another problem. Why? Because it is no longer clear that this Janus-faced position is tenable. As the UK’s Turner Review acknowledged, the financial crisis exposed fault-lines in the EU’s single market for banking that can only be solved in one of two ways. The first (the ‘less Europe’ option) is to return powers to host country authorities – a move that would mark a retreat from the single market. The second (the ‘more Europe’ option) is to beef up existing EU bodies so that a common rulebook can be developed and co-ordination between national supervisory authorities can be tightened. (This option does not currently envisage the creation of a pan-European supervisory authority.)
A key task facing the EU following the financial crisis is to rescue the single market in banking. If the EU is to succeed, Britain’s Conservative-led government and its EU partners must work together constructively. Britain’s EU partners need the Cameron government’s pragmatism to trump its euroscepticism. But European politicians would help if they showed cooler heads and more measured rhetoric than they are doing at present. Tirades against hedge funds, ‘speculators’ and Anglo-Saxons may play well in some EU countries. But in Britain, they increase the suspicion that European politicians are happier looking for scapegoats than learning the real lessons of the crisis. If it goes unchecked, European populism could become an obstacle to the Cameron government’s pragmatism.
Philip Whyte is senior research fellow at the Centre for European Reform
When EU finance ministers met in Brussels on 18 May, many observers expected sparks to fly. The reason? This was the first EU meeting that Britain’s newly-elected government would attend. And a leading item on the agenda was the Commission’s proposed directive to regulate managers of ‘alternative investment funds’. France and Germany have pressed hard for the directive. Britain has deep reservations about it. The fear across the EU was that a hard-line British eurosceptic government ideologically resistant to regulating financial markets would come to Brussels seeking confrontation over the directive. In the event, the bust-up never happened. What lessons should one draw about the new, Conservative-led government’s attitude to the EU and to financial regulation?
The Conservative Party is more eurosceptic than it has ever been. Many of its members would like to withdraw from the EU altogether. The party’s leader, David Cameron, is no euro-enthusiast himself. But he is above all a pragmatist, not a rigid ideologue bent on confrontation. Recall that he enraged sections of his party when he decided not to hold a referendum on the Lisbon treaty once it had been ratified by all 27 member-states; and that he has formed a coalition with the UK’s most pro-European party, the Liberal Democrats. Besides, the government that he leads has more important things to do than pick needless fights in the EU. The focus of its attention over the next five years will be on consolidating the public finances and managing the inevitable social conflicts that will result.
What of financial regulation? A common view across Europe is that the financial crisis was the result of ‘unregulated Anglo-Saxon capitalism’; that the EU’s task is to cajole the reluctant British into clamping down on the City of London; and that the Conservatives may be particularly resistant to cooperating, given their ideological commitment to free markets and historical links to the City. Much of this account is inaccurate. Many of the regulatory failings exposed by the crisis were as much in evidence outside the Anglo-Saxon world as within it. The UK has pushed through many regulatory reforms before the EU. And the Conservative Party has distanced itself from the City and is considering measures – like breaking up large banks – that go far beyond what most EU countries are contemplating.
Does this mean that Britain and the EU will work harmoniously on the reform of financial regulation? The answer is: probably not. One problem is the populist undercurrent that is driving some reforms in the EU. The sad truth is that the alternative investment fund managers’ directive has been a poor advert for EU legislation. The Commission proposed it, under pressure from France and Germany, without carrying out the detailed impact assessment that its ‘better regulation’ agenda requires. The directive targets a rag-bag of disparate entities, mostly in the UK, that had nothing to do with the crisis and that will be saddled with inappropriate rules. And it is being imposed over the objections of the country that will be most affected by it by countries that will barely be affected by it at all.
Britain’s historical attitude to the EU – its enthusiasm for the single market, allied to its hostility to institutional integration – is another problem. Why? Because it is no longer clear that this Janus-faced position is tenable. As the UK’s Turner Review acknowledged, the financial crisis exposed fault-lines in the EU’s single market for banking that can only be solved in one of two ways. The first (the ‘less Europe’ option) is to return powers to host country authorities – a move that would mark a retreat from the single market. The second (the ‘more Europe’ option) is to beef up existing EU bodies so that a common rulebook can be developed and co-ordination between national supervisory authorities can be tightened. (This option does not currently envisage the creation of a pan-European supervisory authority.)
A key task facing the EU following the financial crisis is to rescue the single market in banking. If the EU is to succeed, Britain’s Conservative-led government and its EU partners must work together constructively. Britain’s EU partners need the Cameron government’s pragmatism to trump its euroscepticism. But European politicians would help if they showed cooler heads and more measured rhetoric than they are doing at present. Tirades against hedge funds, ‘speculators’ and Anglo-Saxons may play well in some EU countries. But in Britain, they increase the suspicion that European politicians are happier looking for scapegoats than learning the real lessons of the crisis. If it goes unchecked, European populism could become an obstacle to the Cameron government’s pragmatism.
Philip Whyte is senior research fellow at the Centre for European Reform
Thursday, May 13, 2010
Business leaders risk discrediting markets
by Simon Tilford
Despite their battered reputation, markets remain the best way of generating economic growth. But the market economy faces a crisis of legitimacy brought about by rising inequality and a breakdown of the relationship between risk and reward. The promise of capitalism is that wages rise in line with productivity growth. But over the last 15 years a hugely disproportionate share of the rewards from economic growth has accrued to those at the top, led by boardroom executives and senior bankers. By contrast, median incomes have stagnated. As a result, governments will struggle to convince electorates of the case for markets and free enterprise, and will have a tough time slimming down bloated public sectors.
One reason for the rise in inequality is falling demand for unskilled labour. Technological change and growing trade with emerging economies means that there is little demand for poorly-skilled workers. It is no surprise that the widening of wage differentials has been most pronounced in those European countries with large numbers of poorly-skilled workers. However, the rise in inequality also reflects a surge in what economists call ‘rent-seeking’: the ability of certain groups within society to extract disproportionate rewards (or ‘rents’) for their work.
Boardroom pay has ballooned across Europe, inflating wage differentials. According to Income Data Services, the executives of the UK’s 100 biggest companies earned 84 times the average pay of a full-time worker in 2009, up from 47 times in 2000. This trend is not confined to countries that are considered to be ‘economically-liberal’ such as the UK. It is happening across Europe. The dramatic rise in boardroom pay does not reflect share performance. Nor does it result from the fact that companies are competing for global talent: the overwhelming proportion of senior executives in all European countries are recruited nationally.
Another group to have attracted outsized rewards is employed in the financial services industry. Pay in the financial sector has risen far more rapidly than across the economy as a whole. But as Andrew Haldane of the Bank of England has convincingly demonstrated, the huge rise in the sector’s profitability and the subsequent growth in remuneration was the product of leverage – increased borrowing – and not an improved return on assets. The latter requires skill, the former does not. To make matter worse, the losses incurred by the banks when their excessive leverage provoked the financial crisis were covered by the taxpayer. In short, the banks were able to privatise the rewards while socialising the losses. Their subsequent return to profitability owes much to intervention of governments.
The exaggerated remuneration of top bankers and senior executives is essentially a form of rent-seeking. In essence, it is little different from public sector unions securing pay increases in excess of productivity growth or organised special interest groups defending social rights – unfunded pension liabilities, for example – that can only be exercised at the expense of others. The popular perception of business as a vehicle for ‘rent extraction’ rather than a source of employment, wealth and tax revenue is poisonous for the political economy of reform.
Rising inequality did not matter so much when economies were growing and public finances were manageable. But it does now. European governments face mighty challenges. They have to persuade sceptical electorates of the need for more flexible labour markets; the curtailment of social rights; a greater role for the private sector in areas currently dominated by the state; and even cuts in public services. But how can governments succeed in doing this if such reforms are blamed for rising inequality and for allowing unwarranted personal enrichment? Put another way, how can governments address rent-seeking by other powerful groups in society, such as the public sector unions, in the face of rent-seeking by those in the financial sector and on company boards?
The rise in income inequality needs to be reversed and the relationship between risk and reward restored if governments are to be able to sell market-led reforms to increasingly (and understandably) cynical electorates. Governments have to be able to demonstrate how people benefit from markets. They have to be able to show that markets prevent groups within society from extracting undue rewards, not abet them in their drive to do so. For their part, the leaders of finance and business need to recognise that their remuneration is an obstacle to the kinds of market-led reforms they themselves advocate and which are needed to boost economic performance.
Simon Tilford is chief economist at the Centre for European Reform
Despite their battered reputation, markets remain the best way of generating economic growth. But the market economy faces a crisis of legitimacy brought about by rising inequality and a breakdown of the relationship between risk and reward. The promise of capitalism is that wages rise in line with productivity growth. But over the last 15 years a hugely disproportionate share of the rewards from economic growth has accrued to those at the top, led by boardroom executives and senior bankers. By contrast, median incomes have stagnated. As a result, governments will struggle to convince electorates of the case for markets and free enterprise, and will have a tough time slimming down bloated public sectors.
One reason for the rise in inequality is falling demand for unskilled labour. Technological change and growing trade with emerging economies means that there is little demand for poorly-skilled workers. It is no surprise that the widening of wage differentials has been most pronounced in those European countries with large numbers of poorly-skilled workers. However, the rise in inequality also reflects a surge in what economists call ‘rent-seeking’: the ability of certain groups within society to extract disproportionate rewards (or ‘rents’) for their work.
Boardroom pay has ballooned across Europe, inflating wage differentials. According to Income Data Services, the executives of the UK’s 100 biggest companies earned 84 times the average pay of a full-time worker in 2009, up from 47 times in 2000. This trend is not confined to countries that are considered to be ‘economically-liberal’ such as the UK. It is happening across Europe. The dramatic rise in boardroom pay does not reflect share performance. Nor does it result from the fact that companies are competing for global talent: the overwhelming proportion of senior executives in all European countries are recruited nationally.
Another group to have attracted outsized rewards is employed in the financial services industry. Pay in the financial sector has risen far more rapidly than across the economy as a whole. But as Andrew Haldane of the Bank of England has convincingly demonstrated, the huge rise in the sector’s profitability and the subsequent growth in remuneration was the product of leverage – increased borrowing – and not an improved return on assets. The latter requires skill, the former does not. To make matter worse, the losses incurred by the banks when their excessive leverage provoked the financial crisis were covered by the taxpayer. In short, the banks were able to privatise the rewards while socialising the losses. Their subsequent return to profitability owes much to intervention of governments.
The exaggerated remuneration of top bankers and senior executives is essentially a form of rent-seeking. In essence, it is little different from public sector unions securing pay increases in excess of productivity growth or organised special interest groups defending social rights – unfunded pension liabilities, for example – that can only be exercised at the expense of others. The popular perception of business as a vehicle for ‘rent extraction’ rather than a source of employment, wealth and tax revenue is poisonous for the political economy of reform.
Rising inequality did not matter so much when economies were growing and public finances were manageable. But it does now. European governments face mighty challenges. They have to persuade sceptical electorates of the need for more flexible labour markets; the curtailment of social rights; a greater role for the private sector in areas currently dominated by the state; and even cuts in public services. But how can governments succeed in doing this if such reforms are blamed for rising inequality and for allowing unwarranted personal enrichment? Put another way, how can governments address rent-seeking by other powerful groups in society, such as the public sector unions, in the face of rent-seeking by those in the financial sector and on company boards?
The rise in income inequality needs to be reversed and the relationship between risk and reward restored if governments are to be able to sell market-led reforms to increasingly (and understandably) cynical electorates. Governments have to be able to demonstrate how people benefit from markets. They have to be able to show that markets prevent groups within society from extracting undue rewards, not abet them in their drive to do so. For their part, the leaders of finance and business need to recognise that their remuneration is an obstacle to the kinds of market-led reforms they themselves advocate and which are needed to boost economic performance.
Simon Tilford is chief economist at the Centre for European Reform
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