Hope and trials in Myanmar

Myanmar has a long and difficult road ahead to achieve political stability, democracy and economic development. Hope rests on Aung San Suu Kyi to pull the nation together and lead the reforms after the 2015 election. Are Myanmar’s, and the world’s, expectations too high?

I went to Myanmar recently as part of the ‘young global leaders’ club organised by the World Economic Forum. I saw a country changing fast, full of anticipation but with an uncertain destiny. Yangon, the country’s old capital and commercial hub, illustrates Myanmar’s economic challenges, while Naypyidaw, the eerie new administrative capital, shows its political challenges.

Ramshackle Yangon (formerly Rangoon) almost comes as a shock, so used are we to ultra-modern and gleaming Asian cities. There are no multi-storey department stores, branded coffee shops or air-conditioned office towers. It feels weird to walk through crowded alleys where not a single person is on a mobile phone. Even though the price of a SIM card has come down from $1,000 a couple of years ago to around $60 today, mobile phone penetration in Myanmar is still only 4 per cent (in Thailand: 117 per cent). Internet penetration is even lower.

Myanmar is one of the world’s poorest countries. A quarter of the people live on less than $1.25 a day (though all statistics in Myanmar should be treated with great caution). The McKinsey Global Institute has calculated that even under a best-case scenario in which annual GDP growth doubles, GDP per head (on a PPP basis) would reach only $5,000 in 2030 – roughly where Morocco and Mongolia are today. While other ASEAN economies are thriving on the production of cars, electronics and consumer goods, almost half of Myanmar’s output comes from agriculture. The biggest export items are jade, logs and natural gas.

Training a skilled workforce will take decades: children stay in school for only four years on average, while the higher education system – 164 universities overseen by 13 ministries – is designed to prevent student revolts rather than produce good doctors and engineers. Frequent power-cuts make manufacturing difficult. Logistics are a struggle in the absence of modern road and rail networks. And only North Korea has a less developed banking sector.

But Myanmar offers plenty of opportunities, too. Labour is cheaper than in other Asian countries so Myanmar will attract the garment trade and other low value-added industries. McKinsey thinks that Myanmar could ‘leapfrog’ several stages of development by using digital technology to upgrade education, health-care and finance. Its strategic location between China, India and South East Asia could be attractive to investors. And the country has plenty of natural resources, including vast swathes of fertile land.

The West has lifted almost all economic sanctions. So far, however, potential foreign investors remain cautious: foreign direct investment was a paltry $1.4 billion in the year to April 2013 – though this was a fivefold increase on the previous year, when sanctions were still in force. If economic reforms reached a critical mass, that sum could quickly multiply.

That is a big ‘if’. A visit to Naypyidaw, in the centre of the country, suggests that the political system may not yet be able to sustain ambitious economic reforms. Naypyidaw is military dictatorship set in concrete: a vast expanse of emptiness (the city is seven times the size of Singapore), dotted with enormous official buildings (the parliament is bigger than the Pentagon) and connected by eight-lane highways (24 lanes in front of the presidential palace). These are completely empty – devoid of cars, mopeds or people. Although the government has forced civil servants to relocate and claims (implausibly) a population of 1 million, this place resembles a ghost town.

Other than official palaces and pastel-coloured condominiums for civil servants, Naypyidaw offers little else: a big new airport with few staff and even fewer passengers, a conference centre donated by China, a couple of American-style hypermarkets surrounded by deserted parking lots, a replica of Yangon’s golden Shwedagon pagoda and a zoo with penguins. The city also has a surprisingly large number of hotels, with lots more being built – presumably in preparation for the South East Asian games that Myanmar is hosting later this year and its forthcoming ASEAN chairmanship. But who will stay in them once these events are over?

Some say that the astrologer of Than Shwe, the former military dictator, told him to build the new capital in the middle of nowhere; others that the junta simply wanted an inland capital to avoid an American invasion or bombing (in Naypyidaw the ministerial buildings are several miles apart). Construction began in 2001, in secret. Five years later, the Burmese learnt about the new capital when it appeared on daily weather reports. Naypyidaw makes sure that Myanmar’s people are far removed from their rulers.

The big hope now is that the reform ambitions of President Thein Sein have more substance than the city in which he reigns. Over the last three years, the speed of Myanmar’s democratic opening has been breath-taking: Aung San Suu Kyi has been released from house arrest and her National League for Democracy (NLD) allowed to run in last year’s by-elections; most political prisoners have been set free; press censorship has been lifted; and the blacklist of foreigners and dissidents barred from entering the country has been cut drastically.

However, Myanmar still lacks many of the necessary ingredients for a successful reform programme: policy is made in a haphazard fashion and there is no medium-term roadmap; state administration is weak since civil servants have traditionally been appointed for their loyalty rather than their skills; and levels of corruption are on par with Afghanistan and Sudan.

Investors will stay wary as long as the outcome of the reform process remains uncertain. The army and its cronies, who used to benefit handsomely from Myanmar’s monopolistic and over-regulated economic system, appear resigned to the reforms, but may start pushing back. Perhaps the biggest risks stem from the country’s long-standing ethnic and religious conflicts. Around 60 per cent of the population are Buddhist Burman (or Bamar) people, while the rest are from various ethnic and religious minorities fighting for equality and economic opportunity. The government has now concluded ceasefires with all the armed groups, most recently in May with the Kachin Independence Army in the far north of the country. These conflicts were the cause of and justification for military rule over 60 years. Myanmar will not achieve liberal democracy unless it deals with them in a sustainable way.

The International Crisis Group warns that the ceasefires will fail without first, a political settlement in the shape of a constitution that gives significant autonomy and rights to the minorities; second, a workable plan for integrating the often war-ravaged minority areas (home to 70 per cent of the country’s natural resources) into Myanmar’s economy; and third, an effort to root out the cronyism and crime on which many of the country’s military have flourished.

Then there is the separate issue of the Rohingyas – an oppressed Muslim minority whose origins and right to be in Burma are disputed, unlike those of other ethnic groups. The growing tensions surrounding the Rohingyas have fostered some nasty Buddhist nationalism and violence against Muslims in Myanmar. 

Although some journalists and NGOs are speaking out about the need for a comprehensive settlement of the minorities problem, most people react with palpable unease when asked about it. Aung San Suu Kyi hesitated before condemning the violence against the Rohingyas, and when she did, she remained vague and cautious. Her reticence has upset some of her supporters in the West. One person who knows her well says that she is the only person who can unify her nation but that she needs to pick her fights carefully: if she pushes too hard on the minority issue now, her chances of becoming president in 2015 might diminish. Another of Aung San Suu Kyi’s contacts welcomes her transition from “icon to politician”, predicting that as president she would be more courageous on the ethnic minority conflicts than the present government.

At the World Economic Forum in Naypyidaw in early June, Aung San Suu Kyi declared that she would like to run for president in 2015. But this cannot happen unless the government changes the constitution, which prohibits people with foreign spouses and children from running for the office. Aung San Suu Kyi is the widow of the British academic Michael Aris, and her two children have British citizenship. If she is allowed to run and wins, she is almost bound to disappoint, given how enormous Myanmar’s challenges are. “There is perhaps too much hope”, she said in a briefing recently.

Given Aung San Suu Kyi’s iconic image and the sincerity with which Thein Sein seems to be pursuing reform, the West stands ready to help Myanmar with money, advice and trade. The EU has responded sensibly to Myanmar’s opening. It has lifted sanctions in a two-stage process, reinstating the so-called GSP preferences (free market access to goods from poor countries) and widening its aid effort beyond humanitarian programmes. The EU’s priorities – peace, democracy and development – seem right, and probably in that order too. The challenge now is to find ways of turning ambition into reality, including through co-ordination with the US on the one hand and China on the other.

Myanmar is so backward that even ‘capacity building’ – strengthening local administrations and the infrastructure needed to absorb aid programmes – will be difficult. At the same time, there is so much international goodwill that a surge of aid seems inevitable.  Among several things that can be done, the EU should help to channel aid towards capacity building. Despite all the difficulties and inevitable disappointments, this is a time and a place where anything is possible.

Katinka Barysch was until recently deputy director of the Centre for European Reform

Don't let England's poujadists kill London's golden goose

One of the UK’s key economic advantages is its success at attracting skilled immigrants. In particular, the ability of London to generate the wealth that Britain depends on to finance its public services is inextricably linked to the city’s openness to ideas, capital and immigrants. But Britain’s immigration debate is now all about how to make it harder for newcomers rather than making the country more attractive to them. To a large extent, this is being driven by the concerns and fears of suburban and rural voters, especially older ones. The readiness of politicians from across the political spectrum to pander to these fears is damaging the economy, feeding euroscepticism and with it the possibility of the UK quitting the EU.

The government wants to reduce net immigration to less than 100,000 a year. To this end it has tightened up the regime for student visas and for skilled immigration into the UK from outside the EU (non-EU countries account for two-thirds of the net immigration: the EU the remainder). There is little the government can do about EU immigrants, which explains the increasingly hysterical campaign to reduce their access to benefits. The government argues that the scale of immigration is prejudicing the employment prospects of lower-skilled British workers (over the last year more than half of new jobs went to immigrants, and youth unemployment is at a record high, ergo they are taking British jobs); placing a further burden on an already overwhelmed National Health Service (NHS) and school system; and leading to abuse of the country’s welfare system.

These claims are either wrong or misleading. Net immigration into the UK is not particularly high. It certainly rose following the opening up of the UK labour market to the new eastern European members of the EU in 2004. Over the 8 years to 2011 net immigration averaged 214,000 a year, before falling to 165,000 in 2012. In the context of a country as populous as the UK, this is a relatively modest inflow – adding about 0.3 per cent to population each year. And it is not especially high in a European context: over the last ten years, net immigration in Britain has been higher than France and Germany, but lower than in Italy or Spain. Talk of ‘mass immigration’ is well wide of the mark.

The UK is also very good at attracting skilled immigrants: almost 40 per cent of first generation immigrants have a university degree; the comparable figures for France and Germany are half that, and even lower for Spain and Italy. Indeed, the south-east of England is home to the biggest concentration of foreign professionals anywhere on earth. The reasons for this success range from the English language to the greater readiness of UK employers to recognise foreign qualifications. Many other first generation immigrants have vocational qualifications in skills like construction, which are in short supply in the UK. Even those in unskilled work are probably not displacing many local workers: these jobs tend to pay at or near the minimum wage – if employers hire immigrants, whose English is sometimes patchy and who often move on quickly, it must be partly because the locals are unwilling to take these jobs.

First generation immigrants tend to live in the most economically dynamic parts of the UK. This is inevitable – immigrants are drawn to where the work and opportunities are. But these areas are also wealthy and dynamic because of their openness. Contrary to popular myth, the areas of greatest immigration are not the ones with the greatest hostility to migration. London, for example, is easily the most tolerant region of the UK. The areas where there is most hostility to immigrants tend to be those where there are fewest immigrants, or where cultural and religious differences are pronounced, as in some northern English towns.

Openness largely explains London’s long renaissance and emergence as the only world city in Europe. It is perhaps the UK’s most precious economic asset. Huge amounts of tax revenue are redistributed from London to the rest of the country. According to the Centre for Economics and Business Research, one in every five pounds earned in London goes to subsidise other regions of the UK. Without this redistribution (and a smaller but still very large one from the rest of south-east England), the bleak economic prospects of swaths of Britain would be even bleaker. Of course London should be supporting the rest of the UK; it is easily the wealthiest region of the country. But the British government needs to resist popular pressures for controls which would erode London’s ability to generate that wealth.

British politicians need to think about what policies are needed to help London and its environs exploit its unique position. First, they should reverse the cap on student visas. This ill-thought out step has already damaged British universities – one of the country’s most successful export-industries – by making it harder for people to study in the UK. The number of foreign students in Britain is a much envied source of soft power (many either stay or retain long-term links with the country) and export earnings. While other European countries urgently try and attract more foreign students, Britain fashions ways of deterring them.

Second, the government should lift or scrap the caps placed on non-EU skilled immigrants. Given the increasingly fierce global competition for such workers, it is self-defeating to limit the number allowed into the country.

Third, the government should stop stigmatising EU immigrants. There is no evidence of benefit tourism or health tourism. If anything, the reverse is the case; EU immigrants in the UK are on average much younger that UK ones living elsewhere in the EU, and more likely to be in work than the native population. If there is a country in the EU with legitimate cause to resent health tourism, it is Spain, which must cope with large numbers of elderly Britons.

Fourth, it needs to open the way for more construction. The crippling cost of property is now a serious threat to the prosperity of London and the south of England generally; unless action is taken firms will find it increasingly hard to entice people to work there. It will, in turn, be impossible to build these houses unless contractors can rely on imported labour. Britain has an acute shortage of skilled construction workers and there is little indication that the unemployed elsewhere in the country have any desire to do this kind of work in London. There is a reason why London’s building sites are full of Poles rather than Liverpudlians.

How should the government address the rising anti-immigrant feeling that threatens the UK’s economic vibrancy and even its membership of the EU? It can do little about ignorance, other than to stop legitimising it by playing up to it. Instead of scape-goating the migrants that Britain needs, the government should concentrate on addressing the underlying cause of the popular frustration: an acute shortage of affordable housing, even in many economically depressed parts of the country; a lack of vocational training for those that do not go to university, and over-burdened public services. If there is a shortage of primary school places in London, the answer is to build more primary schools. Most countries in Europe would do anything for this problem: with the populations ageing rapidly, European countries (including Britain) need all the young people they can get. If the NHS lacks capacity in London, expand that capacity. After all, immigrants pay tax. Indeed, the OECD calculates that in the UK they pay more into the pot than they take out.

Britons, especially those living outside London, will all be much the poorer if politicians fail to challenge the widespread belief that immigration is a burden rather than a boon.

Simon Tilford is deputy director of the Centre for European Reform.

What is wrong with the European Commission?

The European Commission, a crucial EU institution, is beset with difficulties. It is popular with neither governments nor voters. Twenty years ago, many people looked to the Commission to set the EU’s agenda and take the lead in managing crises. But few people expect the Commission to play that role today.

Ever since the time when Jacques Delors ran the Commission (1985 to 1995), its authority vis-à-vis EU governments has been waning. The member-states – and especially the big ones – have sought to constrain an institution that they consider over-mighty.

The Lisbon treaty, in force since 2009, created two important institutional innovations: the permanent president of the European Council, a post now occupied by Herman Van Rompuy; and the European External Action Service (EEAS), a body now led by Catherine Ashton. Both of these carry out some tasks that the Commission used to do and have contributed to its sense of insecurity.

Paradoxically, the euro crisis has led to the Commission gaining unprecedented formal powers – on the surveillance of national economic policies – but further eroded its standing and credibility. National governments have provided the money for helping countries in trouble, so they set the terms for bail-outs. The Commission has had to leave the high politics to the European Council, and often to a few key governments, while focusing on its subordinate though important technical role.

The eurozone’s travails have accelerated a longstanding shift in the nature of EU governance. The EU used to take few executive decisions that were politically salient. The Commission proposed laws and regulated, while the Council of Ministers and European Parliament passed laws. Both the Commission and the Council acted, from time to time, as an executive – for example the former blocked corporate mergers and the latter imposed sanctions on countries in other parts of the world.

But the euro crisis has drawn the EU into taking increasingly political executive decisions. The EU has forced heavily-indebted counties to cut budget deficits, pass painful reforms and wind up banks. The Commission may propose such measures, but only eurozone prime ministers or finance ministers have the authority to take these decisions.

These are long-term trends, but personalities also matter. The current ‘college’ of commissioners contains few heavyweight politicians. Within the Commission, Barroso is a strong leader who dominates his colleagues; given the number of commissioners – one for each of the 28 member-states – he may have no choice but to rule with a firm hand. But outside the Commission, some governments complain about what they perceive as weak leadership. During Barroso’s second term as president, which started in 2009, Berlin, Paris and London have become more critical of the Commission. Even some of the smaller member-states, traditionally allies of the Commission, complain about it more than they used to.

A number of governments accuse the Commission of failing to prioritise; of implementing new initiatives too slowly; or of focusing insufficiently on fixing the eurozone. Some of this is unfair: the politicians who criticise the Commission for not coming up with relevant solutions to the eurozone’s problems are sometimes the same ones who get annoyed when it does propose a big idea, such as eurobonds. And while the Germans have sometimes whinged about the Commission being too soft on countries under surveillance, many others believe that it has been too Germanic in its enthusiasm for budgetary discipline. Evidently, the Commission cannot please everyone.

Two reasons, in particular, explain the member-states’ diminishing confidence in the Commission. First, they argue that the Commission proposes too many detailed rules, particularly in areas such as the environment, food safety and social policy. In May 2013, for example, Polish ministers complained about Commission attempts to regulate the shale gas industry and to ban menthol cigarettes – both of which are popular in Poland. In the same month the Commission proposed banning olive oil in re-usable bottles, but then climbed down after a storm of protest. Earlier in the year, German politicians sharply criticised a Commission proposal to set quotas for women on company boards.

Some senior Commission officials acknowledge that the institution can be over-active. But they blame the increasing sway of the Parliament over the Commission. And that is the second reason why some national capitals have turned against the Commission.

The Parliament has exerted more influence over the second Barroso Commission than the first, and not only because the Lisbon treaty gave it more power. Lobbyists and NGOs find it quite easy to get MEPs to support their projects for new EU rules. The Parliament then puts pressure on commissioners to come up with new directives. They are loath to annoy the Parliament since it can make trouble. Another reason why commissioners like to propose new rules is to justify their existence. The Commission’s secretariat-general works hard to cull what it regards as superfluous legislative proposals, but does not always win arguments against commissioners.

None of this is to say that that the Commission should ignore the Parliament. That body is better placed than any other to vet the work of commissioners and, working with the Court of Auditors, to criticise their mistakes. Before the appointment of the last two Commissions, the Parliament played an admirable role in questioning sub-standard commissioners-designate and forcing them to withdraw. Given the Parliament’s powers of co-decision over new laws, the Commission cannot and should not ignore it.

The problem is that over the past four years the Commission has become much closer to the Parliament than to the Council on many issues. The Commission should be accountable to both – it is appointed by governments and approved by the Parliament. But it should also be independent of both.

The politicisation of the Commission is a problem. There has always been some ambiguity over its contradictory roles:  it is a political body that initiates legislation and brokers compromises among the member-states, but also a technical body that polices markets and rules, and negotiates on behalf of the member-states. During the euro crisis the Commission’s technical role has grown, which makes the ambiguity more problematic. When it pronounces, say, that France may be given two further years in which to meet the 3 per cent budget rule, is that the result of objective economic analysis or a reflection of the shifting political climate in national capitals? This ambiguity gives governments and others an excuse to criticise the Commission.

Politicisation can mean favouring political parties. Some socialist politicians claim that the Commission has been over-indulgent of Viktor Orban, the prime minister accused of curtailing political pluralism in Hungary, because his European People’s Party is the leading force in the Commission and the Parliament. There is not much evidence for that particular allegation, but if the Commission becomes too party-political, its ability to carry out technical functions effectively – or in this case, to act as a guardian of liberal democracy – may be compromised.

Next year’s European elections could accelerate the Commission’s politicisation. Most of the pan-European political parties say they will each designate a candidate for Commission president. After the elections they want the European Council to propose the candidate of the party with the most MEPs as president – and then the Parliament to invest him or her. Were the European Council to propose any other name, MEPs would reject it.

If this scheme works, there might be a bit more interest in the European elections. But it is far from certain that the political parties and the European Council will, in the end, play this game. If they do allow the Parliament to appoint Barroso’s successor, the Commission is likely to become more beholden to the Parliament – and the leading party within it – than is currently the case.

Such an outcome would be alarming, because the EU needs a strong and independent Commission – to consider the wider European interest, draw governments’ attention to long-term trends, propose solutions to pressing problems (whether in the wider EU or the eurozone), work doggedly to deepen the single market, and perform its monitoring role in eurozone governance. As the eurozone integrates, one key task will be to ensure a smooth relationship between the countries inside the euro and those outside it. Decisions made by the eurozone should not damage or fragment the single market.

So what can be done to strengthen this flagging institution? The most important step requires not a treaty amendment or an institutional reform, but simply an agreement among heads of government. They should decide to reinforce the Commission’s independence by appointing strong figures as commissioners, and above all by ensuring that a heavyweight politician takes on the presidency.

The member-states should mandate the new president and his team to maintain their independence from the European Parliament, and support them in their efforts to do so. After the last European elections the Commission and the Parliament reached an ‘inter-institutional agreement’, covering future legislation and procedures, which gave the Parliament several things that it wanted. The Council of Ministers spurned the opportunity to make this a tripartite arrangement; if it had done, it could have balanced the legislative activism of the Parliament and pulled the Commission closer to it. After the next European elections the three main EU institutions should seek a tripartite accord on the EU’s work programme.

As for reform of the Commission itself, the problem of too many commissioners needs to be tackled. There are not enough important jobs for 28 of them, and with so many people around the table, substantive discussions are almost impossible. The one-commissioner-per-country rule encourages both governments and those they appoint to the Commission to assume – in breach of the treaties – that the job of commissioners is to represent their homeland.

So the next president should divide his or her commissioners into seniors – who could become vice presidents – and juniors. There should be an informal understanding that, though all commissioners are of equal legal status, the senior ones will co-ordinate the work of the juniors in their particular areas of responsibility. The seniors should meet regularly. In the longer run, when the treaties are re-opened, the EU should adopt a system whereby big countries would always have a commissioner (though not necessarily one of the top jobs) and smaller countries would take it in turns.

Another useful treaty change would be to give the European Council the right to sack the Commission. The Parliament has that power and by threatening to use it forced the resignation of the Santer Commission in 1999. If the treaties said that either body could sack the Commission, its equidistance between governments and MEPs would be reinforced. And that would help to give the EU the strong and independent Commission that it needs.

Charles Grant is director of the Centre for European Reform

Turkey’s Twitter generation is its European future

The protests that started in Istanbul’s Gezi Park two weeks ago have spread across Turkey and show little sign of dying down. They signify a clash between a modernising Turkish society and a still rigid and old-fashioned political system. The protests have resulted in the tragic loss of several lives and are endangering Turkey’s hard-won economic stability as investors take fright. But they also have a silver lining. They might force the government to reconsider its rejection of pluralism. And they might even help to revive Turkey's moribund accession process to the EU.

Turkey's government has spent millions of euros over the last decade on European advertising campaigns to update its image and lessen public opposition to its EU membership bid. The Gezi Park protestors have had a more profound impact on Turkey’s international image in just a few weeks. European news bulletins and social media have been showing a new generation of Turks who, in articulate English, explain how much they value democracy, personal freedoms and tolerance between people with different lifestyles. The colourful banners of Taksim Square have replaced the stock images of mosques, Anatolian peasants or monumental Bosphorus bridges. The huge change that has taken place in Turkish society over the past two decades is suddenly evident to European voters, many of whom previously equated Turkey with Islamism, Kurdish terrorists and mass migration. The images from Gezi Park resonate particularly with younger Europeans who see it as Turkey’s version of the Occupy movements, the Spanish ‘Indignados’ and German ‘Wutbürger’. It is these younger Europeans who will vote on Turkish EU accession if and when the accession negotiations are finished.

The Twitter effect is a new element in the Turkey-EU relationship. The laughable failure of Turkey’s mainstream press to cover the protests accurately has driven people to rely on Twitter and Facebook as their main source of news. Twitter could not have asked for a better marketing campaign than Erdogan’s ranting against “lies on social media”. Turkey is also a trending topic in social media conversations within the EU: here, comments are at the same time becoming more in favour of Turkish accession (because of its people) and more sceptical of it (because of its government).

The EU’s dilemma is how to encourage Turkish society without rewarding the government. The conditionality of the accession talks is a blunt weapon. Germany or another member-state might be tempted to block the opening of the next chapter in the negotiations (on regional policy) to express disdain about government’s brutal reaction to the protests. But such sanctions would only feed the paranoia that Erdogan’s party is spreading about alleged international plots against Turkey. They would reduce the EU’s leverage still further.

Instead, the EU should hug Turkey closer at this great moment in Turkey’s democratic journey. The EU is right to criticise police violence and repression of the media in unequivocal terms – and it should also engage in an intense dialogue with the Turkish government about how to increase pluralism and personal freedoms. There are chapters in the negotiations that could help to guide Turkey through this major transition – such as Chapters 23 and 24 on fundamental rights, justice and home affairs – which Cyprus and other EU countries should unblock.

In a way, the Gezi Park protests are a victory of the accession process so far. Erdogan rose to power by reassuring Turkey’s more liberal, secular classes that he was serious about EU accession and the democratic and economic opening this entailed. Especially during his early years in power, Erdogan significantly strengthened the freedoms of assembly, association and expression. Today’s protests are the result of this enormous opening of the Turkish political space.

Walking around Taksim Square before it was cleared by the police, I saw the vast variety of political opinions and causes represented there: pictures of imprisoned Kurdish leader Abdullah Öcalan were held up next to a banner for the Muslim Anti-Capitalist League; environmentalists sat in their tents alongside self-declared Communists; youngsters played music while headscarved mothers pushed prams round the park. The atmosphere was festive and friendly, a remarkable display of tolerance and mutual respect. Most of the protesters eschewed violence even in the face of police brutality. The dozens of causes gathered there have conflicting ideologies and visions for Turkey. What unites them is a desire for more pluralism and space for dissent. The fact that these small, diverse organisations immediately sprouted when a breath of oxygen came into the public space is testament to the vibrancy of Turkish civil society.

The problem is that Erdogan’s old-fashioned leadership is more and more at odds with this more pluralist and modern society. The battles between police and protestors are part of a much bigger battle between ‘leader knows best’ politics and modern social participation. Many, if not most, Turks still favour strong leadership and the education system promotes a reverence for Mustafa Kemal Atatürk as the father of the nation.

But Erdogan’s reaction to the protests has made the paternalistic style look like Victorian parenting techniques in a modern family. Erdogan initially refused to enter a dialogue with the rebellious children until they stopped disobeying him. Turkey’s citizens, however, are no longer content to be infantilised. They do not want the prime minister to tell them to drink yoghurt, bear three children and stop drinking alcohol after 10 pm. Erdogan’s ministers, who blamed banks, speculators, a global conspiracy – anyone but themselves – for the protests only showed how out of touch they are with important parts of their own society. Erdogan would have done better to copy Spain’s Mariano Rajoy in his dialogue with the Indignados than Vladimir Putin lambasting Pussy Riot.

Erdogan’s AKP is not alone in having missed or misinterpreted Turkey’s social opening. The other big parties that have dominated Turkish politics for decades fared no better. The secularist centre-left CHP party – which Erdogan has accused of organising the protests – was nowhere to be seen in Gezi Park. Therefore, Gezi Park is also an expression of frustration about the AKP’s (or more precisely Erdogan’s) dominance of Turkish politics, not only over the last 15 years but also for the foreseeable future. It is an outcry of the many social groups who feel disenfranchised by the AKP’s ‘tyranny of the majority’.

The underlying problem is that the AKP fears pluralism. It equates criticism of the government with treachery to the Turkish state that needs to be punished. There is a chance that these protests will help Turkey to start accepting its diversity. If the protests keep spreading, Erdogan and his party will be forced to accept that the expression of opinions and beliefs that they dislike is part of any modern democracy. Europeans should help this process along, not reject Turkey at this critical moment.

Heather Grabbe is director of the Open Society European Policy Institute in Brussels. She was senior advisor to Olli Rehn when he was Commissioner for enlargement. She previously wrote on EU-Turkey relations while deputy director of the Centre for European Reform.

Can national parliaments make the EU more legitimate?

The EU has long had a problem of legitimacy, but the euro crisis has made it worse. According to Eurobarometer, 72 per cent of Spaniards do not trust the EU. The Pew Research Centre finds that 75 per cent of Italians think European economic integration has been bad for their country, as do 77 per cent of the French and 78 per cent of the Greeks.

For more than 60 years, the EU has been built and managed by technocrats, hidden from the public gaze – or so it has seemed. In fact national governments have taken most of the key decisions, but public scrutiny has been insufficient. This model cannot endure, because the EU has started to intrude – particularly in the euro countries – into politically sensitive areas of policy-making.

Political institutions can gain legitimacy from either ‘outputs’ or ‘inputs’. The outputs are the benefits that institutions are seen to deliver. The inputs are the elections through which those exercising power are held to account. The euro crisis has weakened both sorts of legitimacy.

The outputs are hardly impressive. Economies are shrinking in many member-states, credit is in short supply in southern Europe, unemployment in the eurozone is over 12 per cent, and youth unemployment in Greece, Italy, Portugal and Spain is between 40 and 65 per cent. Neither the EU nor the euro appears to be delivering much in the way of benefits – whether to Greeks who blame Germans for austerity, or to Germans who resent contributing to Greek bail-outs.

Input legitimacy has also suffered. Given the complexity of decision-making, with power shared among many institutions, lines of accountability in the EU have never been easy to follow. But the perception that power is unaccountable is growing, especially in the heavily-indebted eurozone countries.

Power over economic policy has flowed away from national parliaments and governments to financial markets and to unelected institutions. Having mismanaged their economies, Greece, Portugal, Ireland and Cyprus have had to negotiate programmes of deficit reduction and structural reform with the ‘troika’ of the European Commission, European Central Bank and International Monetary Fund. Other countries, such as Italy, Spain and Slovenia, have avoided full bail-out programmes but had to follow the Commission’s budgetary prescriptions in order to avoid reprimands and possible disciplinary proceedings. Decisions on bail-outs and the conditionality that applies to them have been taken by eurozone finance ministers and heads of government. It is not at all clear where and how such decisions can be held to account, as became evident during the messy rescue of Cyprus in March.

There is no silver bullet that can suddenly make the EU respected, admired or even popular among many Europeans. Its institutions are geographically distant, hard to understand and often deal with obscure technicalities. However, unless the EU becomes more legitimate and credible in the eyes of voters, parts of it could start to unravel. For example, at some point eurozone governments may seek to strengthen their currency by taking major steps towards a more integrated system of economic policy-making. But then a general election, a referendum or a parliamentary vote could block those steps and so threaten the euro’s future.

The best way to improve the EU’s standing would be to improve its ‘outputs’. If European leaders moved quickly to establish a banking union, to strengthen the EU’s financial system; if Germany did more to stimulate demand, thereby helping southern European economies to grow; if structural reform started to restore the competiveness of those economies; and if unemployment started to fall – then EU leaders would look competent, and support for eurosceptics and populists would wane. For the most part such outcomes require not new institutions, but better policies.

Nevertheless EU governance is in bad need of an overhaul. For many federalists, the answer to perceptions of a democratic deficit is simple: when decisions take place at EU level, the European Parliament should exercise democratic control (alongside the Council of Ministers). And if more decisions are being taken at EU level, the powers of the Parliament over them should grow.

However, these arguments face both practical and theoretical difficulties. The practical problem is that the Parliament has serious shortcomings as an institution. Since its first direct elections in 1979, four major treaties have boosted its powers. MEPs now have considerable sway over the EU’s laws, budget and international agreements. Yet in every European election, the turn-out has declined – from 63 per cent in 1979 to just 43 per cent in 2009.

MEPs do a good job in some areas. In recent years they have, for example, improved the directive on hedge funds and private equity, and helped to reform the Common Fisheries Policy. But few voters are aware of the Parliament’s good work and many of them are sceptical that MEPs represent their interests; a lot of MEPs have little connection to national political systems.

Much of the time, the Parliament’s priority appears to be more power for itself. Since the 2009 European elections, MEPs have increased their hold over the Commission, and not only because of the extra powers the Lisbon treaty gave them. One of their techniques is to block what the Commission wants in one area, in order to extract a concession in another. The Parliament always wants ‘more Europe’ – a bigger budget and a larger role for the EU – but there is little evidence that most voters think the same way.

There are also theoretical objections to the Parliament becoming the main body for democratic oversight of the eurozone. In the EU’s usual law-making procedures – known as the ‘community method’ – the Parliament plays an important role. Thus in the last few years it has amended and approved new laws on eurozone budgetary discipline. And it is probably the best-placed body to question the Commission on its monitoring of member-state economies.

However, the money that rescues heavily-indebted member-states has to be voted by national parliaments. The EU budget is not involved to a significant degree, so the European Parliament plays only a minimal role in bail-outs. Decisions on bail-outs and the conditionality that applies to them are taken at EU level by eurozone finance ministers and heads of government. But these decisions have to be implemented by national parliaments: the German Bundestag had to vote money for Cyprus’s bail-out, while the Cypriot parliament had to approve the winding up of Cypriot banks.

These are reasons to increase the involvement of national parliamentarians in eurozone governance – and in the EU more broadly. Critics of their involvement argue that most of them focus on national issues and have little understanding of the wider European interest. Those are valid points. Any attempt to enhance the role of members of parliament (MPs) therefore needs to encourage them to ‘think European’. The European Council has helped heads of government to do so. The prime ministers who attend wear two hats – as national political leaders and members of the EU’s supreme authority. As Luuk van Middelaar, an adviser to Herman Van Rompuy, demonstrates in his excellent new book ‘The passage to Europe’, when national leaders attend the European Council, they start to consider the European interest – sometimes to their own surprise.

So how can MPs play a bigger role in scrutinising the EU? There are increasing numbers of ‘inter-parliamentary’ bodies that bring together MPs and MEPs. These range from the general Conference of European Scrutiny Committees (COSAC) to more specialised groups for foreign policy and Europol. And the recent fiscal stability treaty set up a ‘conference’ that will gather MPs and MEPs to scrutinise the operation of the treaty and discuss wider economic issues. However, these bodies – though useful – are merely consultative and are often treated disdainfully by MEPs. They do not give MPs a sufficient stake in the EU.

Accountability should start at home. Some parliaments, such as that of Denmark, have good systems for holding ministers to account, before and after they attend the Council of Ministers. Others, including that of Britain, scrutinise draft EU laws but do not follow Council meetings closely. National parliaments could improve their systems by emulating best practice across the Union.

The links between national parliaments should be strengthened. The Lisbon treaty created the ‘yellow-card’ procedure, whereby if a third or more of national parliaments believe that a Commission proposal breaches subsidiarity – the principle that decisions should be taken at the lowest level compatible with efficiency – they may ask that it be withdrawn. The Commission must then do so or justify why it intends to proceed. So far this procedure has been used just once, when the Commission withdrew a measure that would have enhanced trade union rights. A small treaty change could turn the yellow-card procedure into a red-card procedure, so that, say, half the national parliaments could force the Commission to withdraw a proposal. A similar system could enable national parliaments to club together to make the Commission propose the withdrawal of a redundant or unnecessary EU law.

A more fundamental reform would be to implement the long-discussed idea of establishing a forum for national parliamentarians in Brussels. The forum’s workload should be modest, so that the best and brightest MPs would want to participate. It should not duplicate the legislative work of the European Parliament. Rather, the forum should ask questions about, and write reports on, those aspects of EU and eurozone governance that involve unanimous decision-making and in which the Parliament plays no significant role.

This forum could become a check on the European Council. It could challenge EU actions and decisions that concern foreign and defence policy, or co-operation on policing and counter-terrorism. On eurozone matters the new body could – meeting in reduced format, without MPs from non-euro countries – question the euro group president or give opinions on bail-out packages. The forum could start work as an informal body and, if it proved useful, be given formal powers – such as the election of the euro group president – through a new treaty.

Hopefully, the forum would encourage MPs to think European. Sceptics and cynics will rightly argue that a new institution cannot on its own make the EU accountable. But in the long run, MPs will have to become more involved in the workings of the EU. Because MPs are usually closer to their constituents than MEPs, and because they are elected on a higher turnout, they stand a better chance of improving the EU’s legitimacy.

Charles Grant is director of the Centre for European Reform.

The CER commission on the UK and the single market

The case for British membership of the EU has always rested primarily on the country’s participation in the single market. The CER’s commission on the UK and the single market held its first meeting this week. It will examine whether participation in the EU helps or hinders Britain’s economy. If the referendum on EU membership takes place, the commission’s report will provide balanced evidence to help the UK make its decision.

Membership of the EU cannot be weighed solely in pounds and pence. But in a period of economic stagnation, any decision about membership will be shaped by the pecuniary costs and benefits. Unfortunately, the British debate has lacked objective analysis of these, with both eurosceptics and europhiles using evidence selectively to make their case. As the UK is not a member of the eurozone, and is unlikely to join, an appraisal of EU membership should centre on the single market.

Martin Wolf of the Financial Times, and Brian Bender, former permanent secretary at the UK business department, introduced the discussion at the inaugural meeting of the commission. There was broad agreement that Britain only has two choices: leave the EU and withdraw from formal participation in the single market, or stay in. Commissioners ruled out a third option: that of joining the European Economic Area. Theoretically, Britain could be in the single market, but not in the EU. The EEA provides Norway, Iceland and Liechtenstein with free access to the single market, but they have to sign up to its rules, and have no say over what the rules are. As one reason for dissatisfaction with EU membership is the loss of sovereignty over rule-making, it was felt that this would be worse than either staying in or leaving.

Few commissioners thought that leaving would be an economic disaster for Britain. There would be little significant impact on jobs, because the level of employment was largely determined by how well the British labour market matched the demand for and supply of workers, rather than the amount of trade that the UK conducts with Europe.

The impact of exit on national income was more contentious. Many estimates put the economic gains from membership of the single market at around 2 per cent of GDP. But some commissioners argued that the immediate impact of leaving would be closer to zero. Others argued that there would be a small negative impact on UK national income in the short term, but there would be a steady erosion of Britain’s attractiveness as a location for foreign investment.

Commissioners questioned whether leaving the EU would allow Britain to extricate itself completely from EU rules in any case. The EU would remain the UK’s largest trading partner, and companies exporting to the rest of Europe would have to conform to EU product standards.

The second option was stay in the EU on current or renegotiated terms. Some commissioners thought that cherry-picking the single market – repatriating social and employment rules, for example – was not really on the table because it would be unacceptable to the other member-states.

One British interest was deepening the single market. A second was making the EU regulate less. Some participants questioned whether these two interests were compatible. The UK liked the single market, but did not like the transfer of rule-making power to Brussels that further integration would entail. So it faced an uncomfortable choice: it may have to cede more sovereignty in order to get more out of its economic relationship with the rest of Europe. And if it decides to promote integration, it may in any case be difficult to get other member-states to sign up to a deeper single market. Countries like France were cooler on the single market than Britain, and their priority was addressing the eurozone’s problems, rather than furthering trade integration. But a focus of the CER’s commission should be the policies needed to open markets in industries in which the UK has a  comparative advantage.

Commissioners were divided on whether Britain should seek to reform the EU to make it a less active regulator. Participants from the business world said that the European Commission and Parliament had become hyper-active and too keen to regulate, which was costly for Britain. Others disagreed, and said that EU regulation hardly tied up Britain’s economy in red tape: by OECD measures, Britain had among the least regulated labour and product markets in the developed world. The EU’s institutions had failings, they said, but also benefits for the UK: the EU acted as a counterweight to national protectionism; and a common external trade negotiator had more bargaining power than Britain would wield on its own.

The commission meetings that follow will take evidence from experts in particular areas of the single market: the free movement of labour, of goods and services, and of capital, to assess whether the single market works for Britain in these areas. The report, which will be published in the spring of 2014, will provide a cool-headed appraisal of the UK’s two options.  If commissioners find that staying in would be best for Britain, the report will propose reforms to deepen Britain’s trade integration with Europe.

John Springford is secretary to the commission and a CER research fellow. More details about the commission can be found here.

Tilting at European windmills

Britain’s European debate is moving from process (referendum when? how?) to substance – the question of whether the costs of EU membership outweigh the benefits. This debate is healthy. What baffles me is that some of the most frequently made arguments in this debate are baseless yet enduring.

I have done a number of public debates with UKIP leader Nigel Farage and other zealous eurosceptics. Such debates are not part of my job: the Centre for European Reform is an independent think-tank, not a campaigning organisation. Yet as an analyst, I believe that the debate about Europe should be well informed.

Hard-core eurosceptics often base their arguments around claims that are simply not correct. Their pro-European counterparts are then left to protest lamely that the eurosceptics are economical with the truth. The eurosceptics have the initiative; the pro-Europeans have the moral high ground. As long as eurosceptics get away with telling the public that EU windmills are dangerous giants, the debate about Europe will be skewed.

One of the most frequently repeated arguments in the British EU debate is that “the Commission in Brussels dictates 75 per cent of our laws” (this is a quote from UKIP’s website but I have heard the number repeated in public debates and in the national media).  The European Commission does not dictate laws; it is allowed to propose laws. But it is the ministers from the (elected) EU governments that negotiate and agree them, together with the (elected) European Parliament.

The 75 per cent figure comes from a statement that Hans-Gerhard Pöttering, then president of the European Parliament, made in 2009:  "Today approximately 75 per cent of the European Union legislation is decided by the European Parliament together with the Council of Ministers and has a direct impact in our daily lives.” Note: Pöttering was talking about the share of EU legislation that is influenced by the European Parliament. He did not refer to national legislation.

So what is the true share of UK legislation linked to EU directives? There is no easy answer. First, EU laws and national laws cannot be compared like for like. EU regulations apply directly in the member-states. EU directives are implemented through national laws and regulations. Sometimes one national law implements four EU directives, sometimes four national laws implement one EU directive.

A lot of British business regulation is likely to be related in some way or another to the single market and hence to the EU. But the EU does not get much involved in setting British rules governing tax (other than VAT and excise duties), social security, pensions, education, policing (except cross-border operations), spatial planning or the health service. The House of Commons Library has tried to calculate the percentage of secondary legislation in the UK that results from EU requirements and concluded that "[t]his figure has fluctuated between 8 and 10 per cent in the last decade". OpenEurope, a eurosceptic think-tank, has spent a couple of years looking at the question of how much British law can be traced back to the EU. The researchers concluded that it was not possible to determine the share with any kind of accuracy.

Nor is it a straightforward question how much EU regulation costs the UK. The anti-EU Bruges Group claims that EU regulation costs the UK £28 billion a year, but it is not clear where this figure comes from. Some eurosceptics have also claimed that EU regulation cost the UK over £100 billion over the last decade. This figure is probably based on research that OpenEurope did in 2010. It should be used with great caution.

OpenEurope looked at the impact assessments attached to 2,000 UK business regulations since 1998. (Many national governments, as well as the EU, try to estimate the potential positive and negative impacts of planned pieces of legislation before they enact them.) OpenEurope’s researchers then added up the estimated costs of the proposed regulations as well as the estimated benefits. They found that the 2,000 pieces of regulation could have cost the economy a total of £176 billion since 1998, and that £124 billion of this could have come from regulation that was in some way related to EU policies. I say “could have” because the £176 billion and £124 billion figures are made up of ministerial estimates of potential costs, not actual costs.

The researchers also added up the estimated benefits of the regulations and found that they are significantly bigger (by 60 per cent) than the estimated costs. In other words, although regulations can be burdensome, their net effect on the economy is thought to be positive because they usually help business to trade with one another as well as making workers more productive and products safer. OpenEurope says that the positive net effect is smaller for EU-related regulations than for national regulations. But it admits that it is particularly hard to quantify the benefits of EU regulation since impact assessments do not usually take into account wider benefits, such as access to the single market or the price decreases resulting from stronger international competition.

The costs of EU regulation also depend on how it is implemented in the individual EU countries. Some governments go beyond what is required by the EU. A 2006 review found no evidence that the UK was doing more ‘gold plating’ than other EU countries. But any meaningful estimate of the burden of EU regulation would have to consider the share of costs added at the national level.

These costs would then have to be set against the benefits of being a member of the single market and the world’s largest trading bloc. These benefits are every bit as hard to calculate as the costs of EU membership. Therefore, when pro-Europeans use figures such as the 3.3 million jobs that directly depend on exports to the EU or the £3,300 that every British household gains from being inside the EU each year, they should also be taken with more than a pinch of salt.

Eurosceptics claim that access to the European market is no longer worth much since Britain now “mostly” trades with non-EU countries. It is true that the share of British exports that go to the other EU countries has fallen to just below 50 per cent and that sales to emerging markets are growing faster  –  that is exactly what you would expect, given that the eurozone is in recession while many emerging markets are still growing briskly.

But British exports to emerging economies are starting from a surprisingly low base: in 2007, 3.3 per cent of UK exports went to the BRIC countries; by 2012, that share had risen to 5.6 per cent. Britain still sells more to Germany than to Brazil, Russia, India, China and South Africa, Australia, New Zealand and Canada – combined. Another key export market for Britain is the US – with which the EU is currently negotiating a free trade and investment agreement.

Eurosceptics often imply that if Britain severed its ties with the EU, it would trade more with emerging markets. In a purely arithmetical sense this might well be true: if British business found it more difficult to access markets in France, Spain and Poland they might try harder to sell things in India and Indonesia. But the idea that the EU is holding Britain back is spurious. Germany sells six times as many goods and services to China as the UK does. If it is the EU holding Britain back, why is it not holding back Germany?

Another figure that the eurosceptics like to use is £50 million: that is supposed to be the daily British contribution to the EU budget. This number has some validity, although it is outdated. In 2011 the gross UK contribution to the EU budget was £13.83 billion, or £37 million a day. Is this a lot or a little? It depends how you look at it. As a share of GDP, the UK’s gross contribution is the lowest of any EU country, lower than those of poorer countries such as Poland or Bulgaria. And of course, Britain also gets money back from the EU for its farmers, universities and poorer regions. Once these revenues are factored in, Britain’s net contribution amounts to roughly 1 per cent of total government spending.

Even 1 per cent is a lot if, as many eurosceptics claim, the money is wasted. UKIP calls the European Union a “bureaucratic monster” and sometimes implies that most EU spending goes to meddlesome bureaucrats. In reality, around 5 per cent of the EU budget is spent on administration, and half of that on the European Commission. The European Commission has 23,000 employees, less than Birmingham City Council. It is true that EU officials are “unelected”, as are the 32,000 officials in the British Home Office and those of any other state administration around the world. No doubt, the EU’s bureaucracy could be streamlined and made more effective but the real potential for savings – as many British politicians have pointed out for years – is in the common agricultural policy and funds for poorer regions.

The latest figure that has crept into the European debate is £150 billion – that is supposed to be the sum that the UK could lose through the euro crisis, according to the Bruges Group. Among the heroic assumptions underlying this calculation is that all other 26 EU countries would go bankrupt simultaneously so that Britain would be lumbered with the entire £60 billion costs of a lending facility called the European Financial Stabilisation Mechanism; that the European Investment Bank (an AAA-rated infrastructure lender) would fold; and that Britain would be called upon to bail out the European Central Bank if the euro broke up.

The fundamental truth is that the European Union is an extremely complex undertaking that cannot easily be reduced to simple numbers – either on the positive or on the negative side. But perhaps by feeding random numbers, half-truth and fiction into the debate, the hard-core eurosceptics will force other politicians and journalists to do a better job of explaining what is really at stake in Britain’s EU membership.

Katinka Barysch is deputy director of the Centre for European Reform.

A dose of inflation would help the eurozone medicine go down

Everyone accepts that persistently high inflation can damage economic growth and arbitrarily punish some groups in society while benefiting others. But in Europe at least, the risks of excessively low inflation are often ignored. In the face of chronically weak demand, the eurozone now faces the prospect of deflation. This promises to depress economic growth further and make it yet harder to pay down debt. Indeed, the role of higher inflation in helping to address the eurozone crisis is poorly understood. If the single currency is to survive, it needs much higher inflation than at present, especially in Germany.

Policy-makers are right to warn of the risks of losing control over inflation. Persistently high and volatile inflation can make it hard for firms to calculate prices and future profits, deterring them from investing. It can create wage spirals and, crucially, redistribute income from savers to borrowers. But eurozone policy-makers are dangerously sanguine about the risks of low inflation. When inflation falls very low, consumers and firms tend to sit on cash rather than spend it, in the case of consumers because they expect prices to fall further or in the case of firms because they fear a further weakening of demand. This is what economists mean by a ‘liquidity trap’: households do not want to spend and firms do not want to invest, making a prolonged recession self-fulfilling. Meanwhile, very weak growth and low inflation make it much harder to pay down debt. The US and most of Europe spent much of the 1930s in such a liquidity trap, and after spending the last 20 years in one, Japan is now desperately trying to escape it. If the eurozone is not to get caught in such a vicious circle, it will need to rapidly stimulate its economy.

Headline eurozone inflation turned negative over the second half of 2009, before rebounding and averaging almost 3 per cent over the second half 2011, and hence well above the ECB’s target of ‘close to 2 per cent’. The apparent strength of inflation was used to rebut those who argued that the eurozone needed lower interest rates and more fiscal stimulus to counter the downturn. Such policies, it was argued, would lead to unacceptably high inflation. For example, the ECB persistently used above target inflation to justify its refusal to cut interest rates further or launch unorthodox forms of monetary stimulus such as quantitative easing (QE). This refers to the practice of central banks purchasing financial assets from commercial banks and other private institutions. But much of the inflation over this period reflected higher energy (and food prices) and crucially, increases in administered prices and value-added-tax (as governments have attempted to get on top of fiscal deficits). In reality, the headline rate of inflation says little about underlying inflation pressures. For example, at no point has inflation excluding energy and food exceeded 2 per cent. And stripping out the impact of tax rises and increases in administered prices, inflation has been below 2 per cent throughout.  

The argument for targeting headline (as opposed to core) inflation is that it is the headline rate which sets inflation expectations and wage settlements, and hence the future rate of inflation. But this has not been the case: the headline rate of eurozone inflation fell to 1.2 per cent in April 2013. Excluding energy and food, as well as rises in taxes and administered prices, it will have been just 0.4 per cent and hence perilously close to zero. In some countries this underlying measure of inflation is already well into negative territory. For example, in Spain prices are falling by between 0.5 per cent and 1 per cent. The headline rate of inflation will fall back rapidly, once the impact of tax rises and increases in administered prices fall out of the inflation indices. The reasons for the extreme weakness of underlying inflation are obvious. With economic activity so depressed, workers are having to accept whatever wage rises employers offer, while firms are having to cut prices because disposable income is falling.

Many eurozone policy-makers appear to welcome the fact that inflation is now so low in the struggling eurozone countries. After all, only by ensuring that their costs rise less slowly than Germany’s can they hope to rebuild their trade competitiveness.  But they also need some inflation in order to gradually erode the real value of their debts and ensure their debt burdens are sustainable. Were German inflation running at 3-4 per cent, the struggling eurozone economies might be able to reconcile these conflicting pressures. But German inflation stood at just 1.1 per cent in April, making the adjustment very difficult. 

The European Commission likes to laud the narrowing of current account deficits in the peripheral countries as evidence of the progress these countries are making in boosting their competitiveness.  But this is largely down to collapsing demand for imports, not wage restraint or structural reforms. For example, Spanish imports were 20 per cent lower in 2012 than in 2007, Italy’s fell 12 per cent over the same period. This, in turn reflects the weakness of domestic demand – down by 13 per cent and 9 per cent respectively over this period. Were domestic demand to recover in Spain and Italy, their current account deficits would quickly widen again. As the Commission’s own data illustrate, real exchange rates remain hugely out of kilter across the eurozone. The ‘German euro’ is strongly undervalued, whereas in Italy and Spain the reverse is the case. 

Normally, when faced with such pervasive economic weakness and mounting deflation pressures, central banks would be doing whatever it took to raise inflation expectations. Only in that way can they hope to bring about the negative real interest rates needed to persuade firms and business to invest: when real interest rates are negative, it is expensive to sit on cash. If interest rates were close to zero, this would mean unconventional measures aimed at loosening monetary policy, such as QE, and committing to run a very loose monetary stance for a prolonged period of time. 

The ECB reduced interest rates by 0.25 of a percentage point to 0.5 per cent at its May meeting, but there is little indication that it is planning an aggressive monetary relaxation. The ECB could also launch QE so long as it concentrated its asset purchases on the eurozone assets as a whole rather than on particular member-states. Crucially, it could attempt to boost inflation expectations by committing to keep interest rates at their current lows until 2015 (as the US Federal Reserve has done). At present, the impact of low eurozone interest rates on inflation expectations is limited by the fear that the ECB will tighten as soon as inflation starts to rise. If households and businesses are confident that policy will remain loose even once inflation has started to rise, it could make them readier to spend rather than sit on cash.

There are essentially two reasons why this is not happening. First, Europe’s policy-makers continue to deny that Europe is in a liquidity trap. They believe that eurozone economies are so weak because growth potential has fallen steeply, rather than because demand has fallen far short of supply. The solution therefore lies in structural reforms; monetary stimulus and a drive to raise inflation expectations would achieve little. There is no doubting that the rate of potential output growth across the eurozone has fallen as a result of structural problems. But there is also no doubt that output gaps (the difference between actual and potential output) remain huge, as acknowledged by the IMF, and are getting bigger as households are not spending and firms are not investing. 

Second, although the eurozone as a whole needs higher inflation, some countries are much more in need of it than others. The Bundesbank has acknowledged that higher German inflation could be necessary to facilitate adjustment, but concern that it could erode the real value of savings means that Germany continues to stand in the way of monetary stimulus. Although Jens Weidmann voted in favour of cutting interest rates at the ECB’s meeting earlier this month, he has warned that the eurozone must avoid negative interest rates. 

However, the choice for Germany is not between the status quo or higher inflation but between large debt defaults across the eurozone (and a possible dismantling of the eurozone) on the one hand or higher inflation on the other. The least painful of these would be higher inflation, even if it were unpopular with German savers. Default was manageable in Greece, but defaults by Italy and Spain would pose an incomparably sterner test for the eurozone. The collapse of the euro, even ignoring the political fall-out, would be very painful for Germany: the country’s real exchange rate would rise very strongly.

Faced with such unpalatable alternatives, the new German government (whatever its composition) will probably not stand in the way of the ECB loosening monetary policy further, perhaps by launching QE. But the Germans are almost certain to oppose any ECB commitment to maintain a loose stance until the recovery is underway and inflation is rising, as this would imply robust inflation in Germany. If so, the central bank could struggle to raise inflation expectations. And the eurozone will struggle to escape its liquidity trap.

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

Commission should move to structural reform of the ETS

The EU regularly describes the ETS as the centrepiece of its climate policy. This centrepiece is currently a failure. Climate change is already killing hundreds of thousands of people each year, and costing the global economy hundreds of billions of dollars. Yet European efforts to strengthen the ETS are moving at a snail’s pace.

Last month the European Parliament rejected Commission proposals to postpone the auction of carbon allowances under the Emissions Trading System (ETS). The Commission had proposed this in an attempt to stop the carbon price falling even further, but Parliament’s rejection of such ‘backloading’ means that the carbon price is now down to about €3 per tonne. This is far too low to encourage firms to invest in low-carbon technologies.

In June 2012 I argued in a CER policy brief 'Saving emissions trading from irrelevance' that withdrawing allowances from the market - which could be done either temporarily, as the Commission proposed, or permanently - was necessary to prevent the ETS becoming irrelevant. I assumed that allowance withdrawal was the approach that had the best chance of being agreed quickly. Nearly a year later, allowance withdrawal has still not been agreed.  A second vote in Parliament is scheduled for early July. MEPs ought to pass the Commission proposal.

However, allowance withdrawal will not be enough to rescue the ETS. It needs to be combined with structural reform. I argued last year that the EU should also set an ETS price floor, to provide price stability and make the carbon price high enough to attract investment to low-carbon options. I concluded that the Commission should make these proposals as soon as possible.

In November 2012 the Commission did suggest structural reform. In its report ‘The state of the European carbon market in 2012’ it wrote: “A carbon price floor would create more certainty about the minimum price, giving a better signal for investors.” But it went on to repeat long-standing objections to price intervention. Price-based mechanisms would “alter the very nature of the current EU ETS being a quantity-based market instrument. They require governance arrangements, including a process to decide on the level of the price floor”.

A price floor would indeed alter the nature of the ETS. It would turn the ETS from a quantity-based instrument into a price-based instrument. But it would also turn the ETS from an irrelevant instrument into an effective one. The Commission’s concerns about governance (with their implicit worries about political interference) are greatly overstated. Governance arrangements already exist to decide the quantity of allowances. Similar arrangements could be created to decide the price level.

On 7th May 2013 nine energy and environment ministers, from Germany, France, the Netherlands, Sweden, Denmark, Portugal, Finland, Slovenia and the UK, signed a statement urging the European Parliament to support the postponement of auctions and the Commission to “bring forward, by the end of the year at the latest, proposals to perform a proper structural reform of the EU ETS”.  This statement is welcome. But the Commission should not wait until the end of the year before making its structural reform proposals. The backloading proposal was only ever a small first step. The Commission should not be distracted by continuing exchanges  with Parliament on allowance withdrawal from the much more important task of proposing structural reforms.

Germany’s Peter Altmaier, environment minister, signed the statement. However, this does not mean that the German government is fully behind either backloading or ETS structural reform.  Different lines have been taken by the German economic and environmental  ministries. Chancellor Angela Merkel has spoken of the need for reform of the ETS, but is yet to take a clear position on what that reform should be. She probably will not do so before the federal elections in September.

The UK House of Lords European Union Committee issued a report on 2nd May calling for an ETS price floor. The Committee argues that this “would simultaneously increase investor confidence and help to stabilise possible financing for infrastructure, low carbon innovation and related applications.” The UK government has introduced its own ETS floor price, which may attract low-carbon investment to the UK but will not help the global climate, because fewer allowances bought in the UK will lead to more allowances being available elsewhere. And the UK government has said in the past that it opposes a Europe-wide price floor because it vehemently opposes EU involvement in revenue raising.

This is not a sensible position for any government to take. EU measures are not imposed by ‘Brussels bureaucrats’ – despite what parts of the British media like to claim – but negotiated by European institutions, including national governments in the Council.

 

National governments’ desire for extra revenue may actually help the ETS reform process. A €30 carbon price, rather than the current €3, would increase tenfold the amount of revenue that governments receive from the auctioning of emissions allowances. Many European governments badly need extra revenue. Even the German government needs more money in order to pay for its Energiewende.

So the Commission should be ambitious and press ahead with structural reform proposals, including a price floor. The ETS was a creditable experiment. But the experiment has not worked. The ETS must be transformed or abolished. Otherwise it is just a fig leaf, hiding Europe’s tardiness on climate change.

Stephen Tindale is an associate fellow at the Centre for European Reform.  

NATO and the costs of star wars

Over the last decade, the US has spent tens of billions of dollars constructing a shield to stop nuclear missiles from North Korea or Iran reaching its soil. So far, the shield does not work. Fortunately for the Americans, neither Pyongyang nor Tehran has nuclear missiles that could hit the US. Unfortunately, however, America's missile defence programme has upset China and Russia, two countries that do have nuclear arsenals that could reach its homeland. America's European partners in NATO should try to convince Washington to scale back its missile defence ambitions for the next few years. Not only would this allow the US government to spend its shrinking defence budget on more pressing military needs. It would also improve European security by reducing tensions between NATO and Russia.

Since the collapse of the Soviet Union, the US has been increasingly worried about nuclear attacks by 'rogue' states. In 1998, a study group chaired by Donald Rumsfeld predicted that North Korea and Iran could field intercontinental ballistic missiles within five years. Today, however, Iran has neither intercontinental missiles nor a nuclear bomb. In March of this year, a report from the Pentagon's intelligence agency (erroneously declassified) assessed "with moderate confidence" that Pyongyang could build a nuclear device that fits on a missile. But there is still no evidence that North Korean missiles are sophisticated enough to reach the US.

Although the American mainland is not currently under threat, every president since George H.W. Bush has sought to deploy nation-wide defences against a limited attack by ballistic missiles. Reviving some of President Ronald Reagan's 'star wars' ambitions, the US has had missile interceptors deployed in Alaska and California since 2004. Both the George W Bush and Obama administrations have also had various plans to deploy interceptors against intercontinental missiles at bases in Europe. (The Obama administration, working with NATO, has also been deploying interceptors in Europe to protect Europeans and US troops in the region against shorter-range missiles from Iran – a threat which does exist.) In March, Secretary of Defence Chuck Hagel announced that because of technical problems and budgetary constraints, the US is suspending its efforts to build Europe-based strategic interceptors. He also said that in response to the bellicose attitude of North Korea's new leader, the US will add 14 missile interceptors in on its West Coast, and perhaps deploy a few more on the East Coast, too.

The Obama administration has been wise to cancel the European leg of its strategic missile defence plans. Several recent studies had highlighted significant shortcomings in the programme. For example, a 2012 report by the National Academy of Sciences concluded that the interceptors planned for Europe would have been too slow to stop an incoming missile. But the US would be ill advised to increase the number of interceptors on the West – and possibly East – Coast. Studies have shown that the interceptors in Alaska and California do not work well either. According to Congress' Government Accountability Office, ten out of the 30 interceptors rely on technology which has never intercepted a missile during tests. The GAO estimates that it will take several years to repair this technology, costing the US taxpayer an additional $700 million. Hagel has promised to fix these glitches before the new interceptors are deployed. But the Pentagon does not yet have a solution to another big problem. None of its interceptors can distinguish between an incoming warhead and debris or decoys. (Ballistic missiles can easily carry decoys in addition to warheads.)

America's strategic missile defence efforts have made the US taxpayer fund a weapon that does not work to tackle a threat that does not exist. They have also antagonised China and Russia. Both countries worry that US technological breakthroughs could undermine their strategic deterrents. Moscow has been most displeased. The Kremlin has been asking for legal guarantees that the US would not direct its missile defences against Russia's strategic nuclear weapons. To reassure Russia, the Obama administration has encouraged Moscow to co-operate with NATO's defence programme against Iranian short and long-range missiles. (Moscow is less worried about NATO's defences against Iranian short-range missiles because the interceptors used would be too slow to stop a Russian strategic missile.) Washington has also been willing to provide Moscow political guarantees that its nuclear deterrent is not under threat.

But so far, the Obama administration has refused to give Russia legal guarantees. The US has made such commitments in the past. The Anti-Ballistic Missile Treaty established limits on what Moscow and Washington could do in this area from the 1970s until 2002. President George W Bush then withdrew from the agreement in order to pursue America’s missile defence ambitions unhindered. The Obama administration fears that Republican senators – who are keen on missile defence – would not ratify a treaty that would constrain the US. As a result, missile defence has become one of the most contentious issues in a troubled US-Russia relationship. Moscow has refused to negotiate further cuts in its nuclear arsenal until the issue is resolved. Last year, the chief of the General Staff of the Russian armed forces threatened to attack the European NATO countries hosting US missile defences. And according to press reports, Russian bombers have been simulating strikes against American missile defence installations.

Now that Hagel has cancelled the European leg of US strategic missile defences, there is a chance that NATO and Russia could end their dispute. Senior American and Russian officials have resumed talks about Russia co-operating with NATO's missile defence efforts. US policy-makers have also been encouraging Moscow to negotiate new bilateral nuclear reductions – a top priority for President Barack Obama. According to some Russian officials, President Vladimir Putin may be open to an agreement when he meets President Obama at the G8 in June or at their bilateral summit in September. But the Russians still want legal guarantees on strategic missile defences. 

Europeans welcome the possibility of improved NATO-Russia ties. Most of them have never been convinced of the need for, or feasibility of, strategic missile defences and many disliked Washington's decision to leave the ABM treaty. Germany and others have been keen for Russia to co-operate with NATO's missile defence programme as a way to alleviate tensions. To maximise the chances of a deal between Washington and Moscow, Europeans should now encourage their American allies to include legal guarantees on missile defence in a new nuclear arms reduction treaty with Russia. Steven Pifer and Michael O'Hanlon from the Brookings Institution point out in their book 'The opportunity' that treaty limits could still allow the US to deploy all its planned defences against North Korea and Iran: the US and Russia could for example agree to each having a maximum of 125 interceptors capable of engaging intercontinental missiles. (The ABM treaty initially allowed for 200.) The treaty could also be limited to ten years, so that both sides could reconsider its ceilings in light of how the threats from North Korea and Iran evolve.

The White House, and Europeans, would struggle to convince some Republican senators to ratify such a treaty. But without it, Russia is unlikely to reduce its numerous tactical nuclear weapons – an arsenal that worries both Democrats and Republicans.  Europeans should also discourage their US counterparts from deploying additional interceptors against strategic missiles until tests have shown them to be effective. The risk of wasting large sums of money at a time of savage defence cuts should help senators to reassess their views on missile defence.

As Greg Thielmann, a former senior US state department intelligence official, remarks, Europeans have "tamed ill-considered American instincts" in the past: in the 1980s, Europeans encouraged a reluctant Reagan administration to negotiate the Intermediate-Range Nuclear Forces Treaty. For the benefit of NATO-Russia relations and global arms control, the Europeans should encourage their ally to reassess its stance again.

Clara Marina O'Donnell is a senior research fellow at the Centre for European Reform and a non-resident fellow at the Brookings Institution.