British prime minister David Cameron is in a tight spot on EU reform. He must balance calls by eurosceptics in his Conservative Party to repatriate powers from Brussels, and the political reality in Europe that favours less far-reaching change. Cameron hopes to start renegotiating the terms of British EU membership after the 2015 election and believes Germany and the Netherlands will support him in this endeavour. But their plans and timetables do not match his.
Across the Union the debate about reform is gathering momentum. It has reached EU foreign ministers at General Affairs Council meetings in November 2013 and March of this year. Cameron has said that he wants to reform the EU, and renegotiate the UK’s relationship with it, before an in/out referendum in 2017. But instead of leading the debate, Cameron has been holding his cards close to his chest. It is an unwise strategy that threatens to leave him empty-handed.
His wish list for reform is unclear and Europe’s leaders are left to guess which changes Cameron wants. In an op-ed published in The Telegraph on March 15th 2014, Cameron said he does not want to “lay all Britain’s cards on the table”. This reflects the difficult position he is in. No proposal for EU reform acceptable to his European colleagues will be enough to appease the eurosceptics in his own party. Besides, his government cannot reach a common position because his coalition partners, the Liberal Democrats, disagree strongly with his ‘renegotiation and referendum’ strategy. Instead, he wants to wait until after the 2015 general election before discussing reform in earnest. But his caution is making potential European allies impatient.
Cameron has mentioned few practical steps to improve the Union; in general he thinks powers should flow back and forth between the national and European levels and he wants to remove the words “ever-closer union” from the EU treaties. But beyond this, there have mostly been vague promises of repatriation and reforms (for instance, about restricting benefits to migrants and cutting red tape) in the event of treaty change. The latter is particularly problematic for other member-states. Some European governments, like the Netherlands or France, may favour changes to the EU treaties in theory, but they dread the mechanics it involves; a potentially long-winded intergovernmental conference which would require referendums that increasingly eurosceptic populations might not support. Or, like Germany, they see treaty change as a long-term endeavour, not a short-term issue.
Cameron however, needs allies if he hopes to get the change in Brussels he wants. In his op-ed, Cameron pointed to the leaders of the Netherlands and Germany as his fellow travellers for EU reform. Downing Street has been flirting with The Hague and Berlin for some time. In February, Cameron rolled out the ‘reddest of red carpets’ for German Chancellor Angela Merkel, inviting her to address the Houses of Parliament. That same month, Dutch prime minister Mark Rutte sat down for an ‘informal dinner’ at Chequers to talk about EU reform.
But instead of opening up the treaties and repatriating powers, The Hague and Berlin are thinking differently. Their focus has shifted to reform initiatives that do not require cumbersome treaty change. And their views are gaining traction across Europe.
Central to their thinking is strengthening subsidiarity. This concept – enshrined in the Treaty on European Union – holds that the Union should act only when doing so achieves better outcomes than member-states acting separately at the national level. Subsidiarity is not an instrument for repatriation, since it accepts the division of competences, but where the treaties are ambiguous it does allow greater flexibility in deciding where powers lie, and it is a check on an overly ambitious Commission.
Subsidiarity will not be a panacea for the Union’s problems, but lifting the concept out of its technical and legalistic environment, and onto the highest political platform, would be helpful. For too long subsidiarity – an important but ill-defined concept – has been allowed to shelter in the dark recesses of the EU treaties. Putting subsidiarity into practice means paying more political attention to it.
In an op-ed in Handelsblatt on March 18th 2014, Germany’s foreign minister Frank-Walter Steinmeier and Dutch foreign minister Frans Timmermans called for an EU that is more selective in the issues it tackles, saying it “should be big on big issues and small on small issues.” Stronger enforcement of subsidiarity, they say, would cull unnecessary initiatives from the Commission and reduce the EU’s democratic deficit since national parliaments would become more involved: better use of ‘yellow card’ procedures would allow European parliaments to co-operate and block Commission initiatives they deem unnecessary or inappropriate. The two ministers continue that if Commissioners were to work in clusters, rather than pursuing 28 separate dossiers, the EU would be more focused and effective, and increase its legitimacy with the European public. (The CER made similar suggestions in ‘How to build a modern European Union’, October 2013.)
Among the few things Cameron has spelt out that he wants are a stronger role for national parliaments and better enforcement of subsidiarity. So he is giving intellectual support to the Dutch-German idea. It also resonates with Finland, Sweden and France. (Some of these countries, like France, may prefer treaty change in the long run – for instance to strengthen eurozone governance – but realise this is currently not politically feasible.) An added benefit of the Dutch-German plan is that it can be done within the existing treaties; it would require a political deal.
In her speech at Westminster, Angela Merkel referred to such a deal when she said “more attention needs to be paid to the subsidiarity principle in Europe. [European governments] should set priorities for the future Commission’s work.” Indeed, a political agreement between the European governments, the European Parliament and the Commission could set the agenda for a more focused Commission – outlining the areas where the Commission would, and would not legislate – underline the centrality of subsidiarity and support stronger involvement of national parliaments.
When could such a deal be reached, since the European Council, the European Parliament and the Commission must all be involved? Germany and the Netherlands foresee a window of opportunity between the election of the new European Parliament on May 22nd, and when the new Commission takes office in the second half of 2014. Only then, they believe, will the new European institutions be receptive to a political ‘gentlemen’s agreement’. There is no point in making a deal with the current lame-duck Commission or the outgoing Parliament, and it makes little sense to strike a deal after the next Commission has already started proposing EU policies.
This suggested timing will cause problems for Cameron, who hopes to keep his powder dry until after the UK general election in May 2015. He would have to support a political agreement that reined in the Commission and strengthened subsidiarity – because he agrees with the need to do both – particularly if the initiative came from his allies in Berlin and The Hague. But if a deal is done in late 2014, and then in May 2015 Cameron wins a majority without the Liberal Democrats and embarks on his renegotiation strategy, momentum for reform among his European colleagues will have dissipated. This would cause a major headache for Cameron who has been betting that he does not have to seriously discuss renegotiation or reform until next year.
Instead, Cameron should make his objectives on EU reform clear; embrace the prospect of reform by political agreement – rather than treaty change; and start contributing to the European debate with a British subsidiarity agenda, for which the government’s balance of competences review could provide the basis. If the moment passes him by, other prospects for reform may become increasingly unlikely.
Rem Korteweg is a senior research fellow at the Centre for European Reform.
Wednesday, March 26, 2014
Monday, March 10, 2014
The eurozone’s ruinous embrace of ‘competitive devaluation'
The euro was supposed to put an end to competitive currency
devaluations, and with it ‘unfair competition’. But this has not been the case.
Germany was often portrayed (wrongly) as the victim of other countries’
competitive devaluations before the introduction of the euro. But contrary to
received wisdom, Germany’s real exchange rate – which takes into account
differing inflation trends in Germany and its trading partners – did not rise
in the run-up to the introduction of the single currency. And it has fallen steeply
during the 15 years of the euro’s existence. This has handed German firms a
competitive advantage of the kind the euro was supposed to eradicate. What is
more, Germany is not under pressure to do anything about it. In fact, other eurozone
countries are being encouraged to follow suit.
The European Commission compiles so-called ‘harmonised competitiveness indices’ for eurozone economies (see chart one). These are the member-states’ real exchange rates in anything but name. They show that Germany’s fell by almost 20 per cent between the beginning of 1999 and the end of 2011, before edging up a bit in 2012-13. The main reason for the decline in the country’s real exchange rate was very low wage increases and hence weak inflation. Spain’s (and to a lesser extent) Italy’s real exchange rates rose rapidly over the early part of the 2000s but have fallen sharply since 2008: Italy’s is now barely higher than in 1999, whereas Spain’s is up around 9 per cent. France’s real exchange rate is actually lower now than in 1999 (or in terms of the Commission’s analysis), its ‘competitiveness’ has improved. In short, the eurozone’s imbalances have less to do with its Latin members allowing costs to get out of hand than they do with Germany engineering a beggar-thy-neighbour cut in costs.
Chart one: Harmonised ‘competitiveness’ indices
(real exchange rates, quarter 1 1999 = 100)
Source: European Central Bank
To the extent that the steep fall in Germany’s real exchange rate within the eurozone is acknowledged in Brussels and Berlin, it is typically attributed to the need to reverse the rise in the country’s real exchange rate in the run-up to the introduction of the euro. German firms, so the argument goes, needed to rebuild their competitiveness after the shock of reunification, so set about reducing costs, which led to a fall in the real exchange rate. The problem with this analysis is that it is not corroborated by the data. Chart two below shows the real exchange rates of Germany, France, Spain and Italy between 1980 and 1998. Germany’s was actually lower in 1998 than it had been in 1980. There were devaluations in France in 1983-84, and in Italy and Spain following their ejections from the Exchange Rate Mechanism (ERM) in 1992, but in each case these devaluations were largely corrective (in response to bouts of currency overvaluation) and by 1998 their real exchange rates were back to where they were in 1980. Over the period as a whole, it was Germany that had the more ‘competitively valued’ real exchange rates.
Chart two: Real effective exchange rates
(quarter 1 1980 = 100)
Source: UNCTAD, Global Development Indicators
The result is that Germany now has a hugely undervalued real exchange rate (something that neither Italy nor Spain managed before the introduction of the single currency). Why is Germany not accused of engaging in a competitive devaluation, when Spain and Italy were? After all, Germany’s real exchange has fallen sharply relative to its long-term trend, whereas the 1990s devaluations just took the lira and peseta back down to their long-term trends.
One reason is the widespread belief that eurozone countries do not have real exchange rates because they all share the euro. By virtue of sharing the euro, devaluations are seen as impossible. A devaluation is only considered a devaluation if it involves a movement in a country’s nominal exchange rates, such as when the lira and the peseta were ejected from the ERM. But when devaluation comes about as a result of low inflation (which in turn is usually the product of weak domestic demand), it is seen as a ‘competitiveness’ gain. However, the impact on other countries is the same: they face a loss of price competitiveness relative to firms based in the devaluing country and sell less to it.
Far from being considered a problem and condemned as a ‘beggar-thy-neighbour’ strategy (as was the case with Italy and Spain), Germany is lauded for its success in reducing its real exchange rate, and other countries are called upon to emulate it in order to improve their ‘competitiveness’. So, in a curious reversal the country that underwent a large competitive devaluation is not only under little pressure to reverse it but is widely regarded as a benchmark for others.
This conflation of real exchange rates with competitiveness has been damaging. A real or ‘internal devaluation’ of the kind engineered by Germany in the eurozone has harmful macroeconomic effects because it involves suppressing domestic demand and with it inflation over a long period of time. By contrast, Spain and Italy quickly returned to growth in the 1990s following their devaluations, with the result that German exports to these countries did not suffer. If Italy and Spain persevere with attempts to devalue their real exchange rates rather than Germany revaluing its real exchange rate, the result will be persistently weak demand across the eurozone, a worsening of the currency union’s already broad-based deflationary pressures and further increases in debt ratios.
While the Commission has criticised Germany’s excessive and persistent current account surplus, it has been at pains to stress that it would make no sense for the Germans to cede ‘competitiveness’. Yet it is impossible for all members of the eurozone to enjoy the unfair advantage of an undervalued exchange rate. The Commission’s implicit assumption seems to be that all eurozone economies can engineer real (or internal) devaluations, boosting their exports to non-eurozone markets and driving an economic recovery across the eurozone. But there has already been a big swing in the eurozone’s current account position, from a deficit of around €85 billion (1 per cent) in 2008 to a surplus of almost 2.5 per cent in 2013, as Germany’s surplus remained very large while the deficits of the southern members-states narrowed. It is a moot point whether the eurozone's external surplus can continue rising: it already comprises a big drag on a fragile global economy, which the eurozone in turn is increasingly dependent on. Moreover, an economy with a big trade surplus tends to experience currency appreciation because demand for its currency outstrips the supply of it, something which is now happening to the euro. A strong euro will hit demand for eurozone exports, especially the more price sensitive ones of the currency union’s southern economies.
The eurozone needs Germany’s real exchange rate to rise (that is, for the unfair advantage that Germany has carved out within the eurozone to reverse), but this will not be easy. Germany’s export-led economy – underpinned by its social partners’ ability to deliver wage restraint – combined with rapid population ageing mean that it will generate little inflation. The German economy is growing more quickly than the eurozone as a whole, but Germany’s rate of inflation is barely above the eurozone average, not least because real wages fell in 2013. More expansionary macroeconomic policies could help. First, a combination of income tax cuts and increased public investment would boost domestic demand (and hence inflation) without posing a threat to fiscal stability: the country ran a budget surplus in 2013, with the result that its debt ratio fell. Second, Germany could withdraw its opposition to the ECB embarking on aggressive monetary stimulus, which would in turn boost economic activity (and inflation) in Germany. The problem is that a fiscal stimulus of this kind would contravene Germany's constitutional requirement to balance the budget. And there is little sign that Germany will accept aggressive moves by the ECB to reflate the eurozone economy.
For its part, the Commission needs to stop defining competitiveness in terms of the real exchange rate. Competitiveness defined in this way is a zero-sum game: one country’s ‘gain’ is another’s loss. If competitiveness means anything useful it is labour productivity or total factor productivity, not the real exchange rate which can fall simply because of wage restraint depressing demand and leading to deflationary pressures. European member-states cannot rely on the ECB coming to the rescue and countering the deflationary impact of the current race for competitiveness. They should demand that Germany do the unthinkable: lose competitiveness!
Simon Tilford is deputy director of the Centre for European Reform.
The European Commission compiles so-called ‘harmonised competitiveness indices’ for eurozone economies (see chart one). These are the member-states’ real exchange rates in anything but name. They show that Germany’s fell by almost 20 per cent between the beginning of 1999 and the end of 2011, before edging up a bit in 2012-13. The main reason for the decline in the country’s real exchange rate was very low wage increases and hence weak inflation. Spain’s (and to a lesser extent) Italy’s real exchange rates rose rapidly over the early part of the 2000s but have fallen sharply since 2008: Italy’s is now barely higher than in 1999, whereas Spain’s is up around 9 per cent. France’s real exchange rate is actually lower now than in 1999 (or in terms of the Commission’s analysis), its ‘competitiveness’ has improved. In short, the eurozone’s imbalances have less to do with its Latin members allowing costs to get out of hand than they do with Germany engineering a beggar-thy-neighbour cut in costs.
Chart one: Harmonised ‘competitiveness’ indices
(real exchange rates, quarter 1 1999 = 100)
Source: European Central Bank
To the extent that the steep fall in Germany’s real exchange rate within the eurozone is acknowledged in Brussels and Berlin, it is typically attributed to the need to reverse the rise in the country’s real exchange rate in the run-up to the introduction of the euro. German firms, so the argument goes, needed to rebuild their competitiveness after the shock of reunification, so set about reducing costs, which led to a fall in the real exchange rate. The problem with this analysis is that it is not corroborated by the data. Chart two below shows the real exchange rates of Germany, France, Spain and Italy between 1980 and 1998. Germany’s was actually lower in 1998 than it had been in 1980. There were devaluations in France in 1983-84, and in Italy and Spain following their ejections from the Exchange Rate Mechanism (ERM) in 1992, but in each case these devaluations were largely corrective (in response to bouts of currency overvaluation) and by 1998 their real exchange rates were back to where they were in 1980. Over the period as a whole, it was Germany that had the more ‘competitively valued’ real exchange rates.
Chart two: Real effective exchange rates
(quarter 1 1980 = 100)
The result is that Germany now has a hugely undervalued real exchange rate (something that neither Italy nor Spain managed before the introduction of the single currency). Why is Germany not accused of engaging in a competitive devaluation, when Spain and Italy were? After all, Germany’s real exchange has fallen sharply relative to its long-term trend, whereas the 1990s devaluations just took the lira and peseta back down to their long-term trends.
One reason is the widespread belief that eurozone countries do not have real exchange rates because they all share the euro. By virtue of sharing the euro, devaluations are seen as impossible. A devaluation is only considered a devaluation if it involves a movement in a country’s nominal exchange rates, such as when the lira and the peseta were ejected from the ERM. But when devaluation comes about as a result of low inflation (which in turn is usually the product of weak domestic demand), it is seen as a ‘competitiveness’ gain. However, the impact on other countries is the same: they face a loss of price competitiveness relative to firms based in the devaluing country and sell less to it.
Far from being considered a problem and condemned as a ‘beggar-thy-neighbour’ strategy (as was the case with Italy and Spain), Germany is lauded for its success in reducing its real exchange rate, and other countries are called upon to emulate it in order to improve their ‘competitiveness’. So, in a curious reversal the country that underwent a large competitive devaluation is not only under little pressure to reverse it but is widely regarded as a benchmark for others.
This conflation of real exchange rates with competitiveness has been damaging. A real or ‘internal devaluation’ of the kind engineered by Germany in the eurozone has harmful macroeconomic effects because it involves suppressing domestic demand and with it inflation over a long period of time. By contrast, Spain and Italy quickly returned to growth in the 1990s following their devaluations, with the result that German exports to these countries did not suffer. If Italy and Spain persevere with attempts to devalue their real exchange rates rather than Germany revaluing its real exchange rate, the result will be persistently weak demand across the eurozone, a worsening of the currency union’s already broad-based deflationary pressures and further increases in debt ratios.
While the Commission has criticised Germany’s excessive and persistent current account surplus, it has been at pains to stress that it would make no sense for the Germans to cede ‘competitiveness’. Yet it is impossible for all members of the eurozone to enjoy the unfair advantage of an undervalued exchange rate. The Commission’s implicit assumption seems to be that all eurozone economies can engineer real (or internal) devaluations, boosting their exports to non-eurozone markets and driving an economic recovery across the eurozone. But there has already been a big swing in the eurozone’s current account position, from a deficit of around €85 billion (1 per cent) in 2008 to a surplus of almost 2.5 per cent in 2013, as Germany’s surplus remained very large while the deficits of the southern members-states narrowed. It is a moot point whether the eurozone's external surplus can continue rising: it already comprises a big drag on a fragile global economy, which the eurozone in turn is increasingly dependent on. Moreover, an economy with a big trade surplus tends to experience currency appreciation because demand for its currency outstrips the supply of it, something which is now happening to the euro. A strong euro will hit demand for eurozone exports, especially the more price sensitive ones of the currency union’s southern economies.
The eurozone needs Germany’s real exchange rate to rise (that is, for the unfair advantage that Germany has carved out within the eurozone to reverse), but this will not be easy. Germany’s export-led economy – underpinned by its social partners’ ability to deliver wage restraint – combined with rapid population ageing mean that it will generate little inflation. The German economy is growing more quickly than the eurozone as a whole, but Germany’s rate of inflation is barely above the eurozone average, not least because real wages fell in 2013. More expansionary macroeconomic policies could help. First, a combination of income tax cuts and increased public investment would boost domestic demand (and hence inflation) without posing a threat to fiscal stability: the country ran a budget surplus in 2013, with the result that its debt ratio fell. Second, Germany could withdraw its opposition to the ECB embarking on aggressive monetary stimulus, which would in turn boost economic activity (and inflation) in Germany. The problem is that a fiscal stimulus of this kind would contravene Germany's constitutional requirement to balance the budget. And there is little sign that Germany will accept aggressive moves by the ECB to reflate the eurozone economy.
For its part, the Commission needs to stop defining competitiveness in terms of the real exchange rate. Competitiveness defined in this way is a zero-sum game: one country’s ‘gain’ is another’s loss. If competitiveness means anything useful it is labour productivity or total factor productivity, not the real exchange rate which can fall simply because of wage restraint depressing demand and leading to deflationary pressures. European member-states cannot rely on the ECB coming to the rescue and countering the deflationary impact of the current race for competitiveness. They should demand that Germany do the unthinkable: lose competitiveness!
Simon Tilford is deputy director of the Centre for European Reform.
Monday, March 03, 2014
French federalists propose a Euro Community
A dozen French EU experts have written a manifesto proposing the creation of a new ‘Community’ for the eurozone. The self-styled ‘Eiffel group’ makes an intelligent case for a federal, political union that would exist alongside the existing European Union. The chances of such a Community emerging are, in my view, rather small. But the manifesto deserves to be read, because the authors are serious people with first-hand knowledge of how the EU works. They include Yves Bertoncini, director of the Notre Europe - Jacques Delors Institute; Laurence Boone, an economist at Bank of America Merrill Lynch; Sylvie Goulard, a liberal MEP; Denis Simonneau, a member of the board of GDF Suez; and Shahin Vallée, economic adviser to President Herman Van Rompuy. If they get their way, the EU itself would become a second-class club with little appeal to members such as Denmark, Sweden or the UK.
The Eiffel group’s analysis of the euro crisis is similar to that of the Centre for European Reform. The authors argue, for instance, that fiscal policy has been too restrictive. And they are unhappy with the way Germany exerts leadership in the eurozone. “The current situation, where German federal bodies (Bundestag or the Karlsruhe court) hold the fate of the euro in their hands is not good for Germany, placed in a position of hegemony, nor for Germany’s partners, reduced to complying.”
But the institutional thinking of the Eiffel group makes the CER uncomfortable. Its chief proposal is for the euro countries and others committed to a “common destiny” to negotiate a treaty for a Euro Community. This Community would be about much more than the euro, covering education, training and innovation. It would invest in digital, transport and energy networks, as well as research. The group proposes new instruments to absorb economic shocks and support the most vulnerable people. It wants EU-level unemployment benefits and “partial harmonisation” of labour markets.
The authors call for “putting an end to the ill-defined concept of subsidiarity [the idea that decision-making should rest at the lowest practicable level], a pretext for the renationalisation of policies”. And they would aim for a common external representation (though the authors say very little about what kind of foreign policy the Community should have).
A eurozone parliament would elect an executive to run the Community. That parliament’s members would double-up as MEPs. A levy on companies or a carbon tax would pay for the Community’s budget. It would borrow collectively to finance future projects, though not to cover past debts.
The Eiffel group is hostile to a greater role for national parliaments in the EU or the new Community. Nor does it want joint meetings of national parliamentarians and MEPs, as envisaged in the 2012 ‘fiscal compact’ treaty. “The principle must be imposed that a European decision requires European control, and a national decision national control.”
The existing European Court of Justice would police the Community’s rules and enforce sanctions on those who breach them. However, nothing is said about how the European Commission – or, indeed, the entire EU – would relate to the new Community. The authors appear to think that the relationship between the euro-ins and -outs is not a problem, because they expect most of the member-states outside the euro to join it within a few years.
The manifesto’s discussion of the single market is cursory. It suggests that the single market take in countries that cannot easily join the EU, such as Albania, Moldova, Turkey and Ukraine. It assumes that Britain would be much happier if left in an outer tier consisting of not much more than the market, alongside such countries. Though they never state it openly, the authors imply that a big advantage of the new Community would be to ensure that the British cannot block further European integration.
This French manifesto was inspired by a similar German enterprise: last year the ‘Glienicker group’ of German experts drew up its own federal manifesto. The Eiffel group believes that France and Germany together have a special responsibility to manage European integration (Italy, Spain and Poland are scarcely mentioned in the French manifesto). Nevertheless many Germans will have problems with the Eiffel proposals.
Germans tend to like subsidiarity, and may baulk at the Eiffel group’s derogatory language on this principle. Similarly, they are big fans of the single market (even if they are reluctant to extend it further into services), so may wonder why these French authors seem so uninterested in it. The suggestion that the poorer Balkan countries, Turkey and Ukraine should join the single market implies that it is a slap-dash creation, rather than a construction that needs to be policed vigorously with strong rules and institutions.
The Eiffel group calls for the Community to build energy, transport and digital networks, but surely many of the most important infrastructure projects would achieve more if extended across the entire EU rather than merely the eurozone? For example, carbon capture and storage cannot take off seriously in the EU without a pan-European network of pipes to take CO2 from the places it is emitted to suitable underground burial sites (such as those which lie under the North Sea).
Some Germans will agree with the Eiffel Group that the eurozone needs to develop into a strong Community, but they will be concerned that the authors more-or-less ignore the relationship between the 28 and the 18. How could one ensure a smooth fit between the EU and the Community? What happens to the Commission? And what if the Community executive takes actions that harm the single market?
The manifesto implies that such difficulties will be resolved by nearly all the EU countries joining the euro. But that may be wishful thinking. Lithuania apart, none of the euro-outs has taken even the first steps towards joining the euro, such as entering the Exchange Rate Mechanism. In Poland both the constitution and public opinion seem likely to prevent the adoption of the euro until well into the next decade. Some non-euro countries – unlike the UK – may be willing to accept the disciplines of the euro, because they plan to join in the long run. But they will still want to ensure that the single market remains intact and that economically illiberal forces in the eurozone do not smother it.
French authors have a particular credibility problem in proposing the kinds of idea contained in this manifesto. This is because a number of senior people in France – though not the manifesto’s authors – lament the enlargement of the EU into Central and Eastern Europe, regret the waning of French influence in the wider EU, and hope to build a new, smaller club around the euro, in which France can exert significant influence. Not long ago, I heard a senior French official say that the EU was no longer useful for France, because there were too many Central Europeans in it, and because the French could no longer steer the Union.
Those outside France may imagine, however unfairly, that the Eiffel group is serving a protectionist agenda: they know that economic liberalism is, in relative terms, weaker in the eurozone than the wider EU (where the presence of Denmark, Poland, Sweden and the UK, among others, reinforces market economics). The manifesto’s reference to harmonising labour market rules and unemployment benefits in the eurozone will reinforce such fears.
As for questions of democracy and accountability, it is not only the British who argue that the European Parliament has a legitimacy problem and that national parliaments should play a bigger role in the EU. Since the CER published proposals in favour of enhancing the role of national parliaments, last October, we have had more-or-less sympathetic reactions from several governments, including Denmark, Germany, the Netherlands, Poland and Spain.
The Eiffel group has come up with an interesting and thoughtful contribution to the debate on Europe’s future. On paper, many of the authors’ ideas for a more federal eurozone make sense. They seem to imagine that the UK and others outside the euro will try to block the integration that the authors regard as necessary. But the real obstacle to these proposals lies not in London but elsewhere. The euro countries cannot hand over powers to a new Community unless their leaders can convince electorates – during election or referendum campaigns – that a federal government is desirable. So far, there is no sign that leaders in France or elsewhere are capable of that task.
In private, one of the authors has explained to me that the manifesto’s key point is that the current set-up does not work and is economically and politically unsustainable; he believes that both elites and citizens can be convinced of that point, and that they will therefore see the need for a tighter euro union. He may be right that the eurozone cannot flourish without significant reform. But politicians will find it very hard to persuade voters that a lot of powers now held by member-states should be transferred to new or existing Brussels institutions.
Charles Grant is director of the Centre for European Reform.
The Eiffel group’s analysis of the euro crisis is similar to that of the Centre for European Reform. The authors argue, for instance, that fiscal policy has been too restrictive. And they are unhappy with the way Germany exerts leadership in the eurozone. “The current situation, where German federal bodies (Bundestag or the Karlsruhe court) hold the fate of the euro in their hands is not good for Germany, placed in a position of hegemony, nor for Germany’s partners, reduced to complying.”
But the institutional thinking of the Eiffel group makes the CER uncomfortable. Its chief proposal is for the euro countries and others committed to a “common destiny” to negotiate a treaty for a Euro Community. This Community would be about much more than the euro, covering education, training and innovation. It would invest in digital, transport and energy networks, as well as research. The group proposes new instruments to absorb economic shocks and support the most vulnerable people. It wants EU-level unemployment benefits and “partial harmonisation” of labour markets.
The authors call for “putting an end to the ill-defined concept of subsidiarity [the idea that decision-making should rest at the lowest practicable level], a pretext for the renationalisation of policies”. And they would aim for a common external representation (though the authors say very little about what kind of foreign policy the Community should have).
A eurozone parliament would elect an executive to run the Community. That parliament’s members would double-up as MEPs. A levy on companies or a carbon tax would pay for the Community’s budget. It would borrow collectively to finance future projects, though not to cover past debts.
The Eiffel group is hostile to a greater role for national parliaments in the EU or the new Community. Nor does it want joint meetings of national parliamentarians and MEPs, as envisaged in the 2012 ‘fiscal compact’ treaty. “The principle must be imposed that a European decision requires European control, and a national decision national control.”
The existing European Court of Justice would police the Community’s rules and enforce sanctions on those who breach them. However, nothing is said about how the European Commission – or, indeed, the entire EU – would relate to the new Community. The authors appear to think that the relationship between the euro-ins and -outs is not a problem, because they expect most of the member-states outside the euro to join it within a few years.
The manifesto’s discussion of the single market is cursory. It suggests that the single market take in countries that cannot easily join the EU, such as Albania, Moldova, Turkey and Ukraine. It assumes that Britain would be much happier if left in an outer tier consisting of not much more than the market, alongside such countries. Though they never state it openly, the authors imply that a big advantage of the new Community would be to ensure that the British cannot block further European integration.
This French manifesto was inspired by a similar German enterprise: last year the ‘Glienicker group’ of German experts drew up its own federal manifesto. The Eiffel group believes that France and Germany together have a special responsibility to manage European integration (Italy, Spain and Poland are scarcely mentioned in the French manifesto). Nevertheless many Germans will have problems with the Eiffel proposals.
Germans tend to like subsidiarity, and may baulk at the Eiffel group’s derogatory language on this principle. Similarly, they are big fans of the single market (even if they are reluctant to extend it further into services), so may wonder why these French authors seem so uninterested in it. The suggestion that the poorer Balkan countries, Turkey and Ukraine should join the single market implies that it is a slap-dash creation, rather than a construction that needs to be policed vigorously with strong rules and institutions.
The Eiffel group calls for the Community to build energy, transport and digital networks, but surely many of the most important infrastructure projects would achieve more if extended across the entire EU rather than merely the eurozone? For example, carbon capture and storage cannot take off seriously in the EU without a pan-European network of pipes to take CO2 from the places it is emitted to suitable underground burial sites (such as those which lie under the North Sea).
Some Germans will agree with the Eiffel Group that the eurozone needs to develop into a strong Community, but they will be concerned that the authors more-or-less ignore the relationship between the 28 and the 18. How could one ensure a smooth fit between the EU and the Community? What happens to the Commission? And what if the Community executive takes actions that harm the single market?
The manifesto implies that such difficulties will be resolved by nearly all the EU countries joining the euro. But that may be wishful thinking. Lithuania apart, none of the euro-outs has taken even the first steps towards joining the euro, such as entering the Exchange Rate Mechanism. In Poland both the constitution and public opinion seem likely to prevent the adoption of the euro until well into the next decade. Some non-euro countries – unlike the UK – may be willing to accept the disciplines of the euro, because they plan to join in the long run. But they will still want to ensure that the single market remains intact and that economically illiberal forces in the eurozone do not smother it.
French authors have a particular credibility problem in proposing the kinds of idea contained in this manifesto. This is because a number of senior people in France – though not the manifesto’s authors – lament the enlargement of the EU into Central and Eastern Europe, regret the waning of French influence in the wider EU, and hope to build a new, smaller club around the euro, in which France can exert significant influence. Not long ago, I heard a senior French official say that the EU was no longer useful for France, because there were too many Central Europeans in it, and because the French could no longer steer the Union.
Those outside France may imagine, however unfairly, that the Eiffel group is serving a protectionist agenda: they know that economic liberalism is, in relative terms, weaker in the eurozone than the wider EU (where the presence of Denmark, Poland, Sweden and the UK, among others, reinforces market economics). The manifesto’s reference to harmonising labour market rules and unemployment benefits in the eurozone will reinforce such fears.
As for questions of democracy and accountability, it is not only the British who argue that the European Parliament has a legitimacy problem and that national parliaments should play a bigger role in the EU. Since the CER published proposals in favour of enhancing the role of national parliaments, last October, we have had more-or-less sympathetic reactions from several governments, including Denmark, Germany, the Netherlands, Poland and Spain.
The Eiffel group has come up with an interesting and thoughtful contribution to the debate on Europe’s future. On paper, many of the authors’ ideas for a more federal eurozone make sense. They seem to imagine that the UK and others outside the euro will try to block the integration that the authors regard as necessary. But the real obstacle to these proposals lies not in London but elsewhere. The euro countries cannot hand over powers to a new Community unless their leaders can convince electorates – during election or referendum campaigns – that a federal government is desirable. So far, there is no sign that leaders in France or elsewhere are capable of that task.
In private, one of the authors has explained to me that the manifesto’s key point is that the current set-up does not work and is economically and politically unsustainable; he believes that both elites and citizens can be convinced of that point, and that they will therefore see the need for a tighter euro union. He may be right that the eurozone cannot flourish without significant reform. But politicians will find it very hard to persuade voters that a lot of powers now held by member-states should be transferred to new or existing Brussels institutions.
Charles Grant is director of the Centre for European Reform.
Friday, February 28, 2014
Ukraine after Yanukovych: Dropping the pirate?
President Viktor Yanukovych of Ukraine clearly had no sense of irony when he placed a mock pirate ship in the lake at the mansion he built on (stolen) state land outside Kyiv. With all his vices, however, as long as he remained in power Russia, the West and Ukrainian politicians had no reason to reconsider their own inadequate policies on Ukraine. Now he has gone, all three must raise their game. This insight looks at each in turn, but focuses on what the EU can do for Ukraine, and what Ukraine needs to do for itself.
For Russia, Yanukovych was an acceptable leader of Ukraine, despite his faults. With his power base near the Russian border and his ties to oligarchs dependent on Russian markets, he was not the man to stand up to Moscow’s pressure to walk away from an association agreement with the EU in autumn 2013. His reward for doing Moscow’s bidding was a one-third cut in the price of Russian gas (to be reviewed quarterly, in case he thought of changing his mind) and a $15 billion loan (about €10 billion), of which $3 billion (€2 billion) was disbursed before his fall.
The Russians clearly did not expect that Yanukovych’s failure to sign a one-thousand page document that few if any of his opponents had read would lead to a revolution. Yet three months after Yanukovych cast his lot in with Russia, he is out of office and – as Russian Prime Minister Dmitri Medvedev said on February 24th – “We do not understand what is going on there”.
The smart thing for the Russians to do would be to join Yanukovych’s Ukrainian ex-supporters in denouncing his crimes, and then to rebuild their influence. Russia will continue to supply much of Ukraine’s gas. It already has a free-trade agreement with Kyiv, and mutually profitable trade should continue, particularly in areas like defence equipment where Soviet-era supply chains still exist. Many Ukrainians have family ties in Russia or work there. These people have no reason to feel enmity towards Moscow. A prosperous, EU-aligned neighbour should pose no threat to Russia’s interests. It could even be a better customer for Russia; it might pay its bills, for one thing.
So far the signs are that Russia is not doing the smart thing. Russian foreign minister Sergei Lavrov has claimed that the political opposition are following the lead of “pogromists”; Medvedev has claimed that what has happened threatens the lives of Russian citizens. In Crimea, the only region of Ukraine where there is an ethnic Russian majority, visiting members of the Russian Duma announced an initiative to make it easier for Crimean residents to get Russian passports. These are provocative moves. The presence of large numbers of similar ‘Russian citizens’ in Georgia’s separatist enclaves of Abkhazia and South Ossetia provided a pretext for Russia to step in to ‘protect’ them in 2008. The occupation of the Crimean parliament and major airports by armed men, and large-scale Russian military exercises near the Ukrainian border, all add to the tension.
For the West also, the fall of Yanukovych demands fresh thinking. The UK and the US were co-signatories with Russia of the ‘Budapest Memorandum’ of 1994, in which (in return for Ukraine sending Soviet nuclear weapons back to Russia) the other three countries undertook to respect Ukraine’s independence, sovereignty and borders; not to use or threaten force; and not to use economic coercion. The memorandum said that the three would consult “in the event a situation arises which raises a question concerning these commitments”. It is time the UK and US used this agreement to deliver firm messages to Moscow about the impact of its actions on future relations.
The thuggish and corrupt Yanukovych had few friends in Europe. Now the EU will have to deal with a government in whose creation it has had a hand, and an interim president who has already said that a return to the path of European integration is his priority. Brussels and the member-states should not wait passively to see what happens, as they did after the 2004 Orange Revolution. They should drive change with a judicious mixture of generosity and tough love.
Ukraine will need assistance to avoid default almost immediately. It needs to pay its various creditors over €10 billion by the end of this year; it has gas debts to Russia of over €1 billion. The IMF suspended lending to Ukraine in 2011 because of its failure to carry out agreed reforms. IMF managing director Christine Lagarde made clear after the G20 finance ministers meeting on February 23rd that Ukraine would have to start reforms before international lenders would return. If Kyiv takes her advice, Western countries should be ready to step up technical assistance and political engagement to ensure that key reforms in areas such as energy pricing are implemented quickly and effectively. They could help with funds and advice to reduce the impact of cuts in fuel subsidies on poor customers. A sharp reduction in energy subsidies in Bulgaria in early 2013 led to protests and the fall of the government.
A lot of the short-term pain of reform will fall on un-modernised heavy industries in the east and south of the country, which have relied on unsustainably low gas prices to remain viable. The deep and comprehensive free trade agreement (DCFTA) offered by the EU should offer a significant long-term boost in growth (estimated at about 0.5 per cent per annum), but the gains will be diffused widely, while the losses will be concentrated. Russia has put a considerable propaganda effort into heightening the fears of the likely losers. Moscow will probably now put up the price of gas and perhaps restrict the flow in order to punish the new Ukrainian government, further hitting Ukrainian competitiveness. The EU is close to offering Ukraine financial assistance (likely to be more than the $1 billion (about €700 million) announced by the US). Regions of western and central Europe which have successfully undergone economic restructuring should share their expertise with Ukraine. The EU should also press forward with plans to enable Ukraine to get gas from Slovakia, assistance with energy efficiency and other steps to mitigate Ukraine’s dependence on Russian gas.
The EU has concluded that although the interim government might like to sign the association agreement as soon as possible, it would be better not to do so before presidential elections in Ukraine on May 25th. One reason for this is to avoid questions about the legitimacy of the transitional authorities; another is to allow more time for an increased public information campaign to explain what the association agreement means for Ukraine. The British government commissioned research in Ukraine in early 2013 which showed low levels of knowledge about the EU and high levels of suspicion, particularly in the east. The British Embassy in Kyiv has done much since then to ensure that information about the agreement is available, including translating a summary into Russian as well as Ukrainian. Meanwhile the EU delegation’s staff have taken the lead in ensuring that the Ukrainian authorities are technically prepared for the time when the agreement is in force. But it is time that the information effort was stepped up and properly resourced, ideally with the EU delegation and as many member-states as possible spreading the word. Central European countries have a particularly important contribution to make because of their own experiences of transition, association agreements and ultimately EU membership; senior visitors from these countries could help to reassure eastern Ukraine of the benefits of association with the EU.
As a result of events in Kyiv, member-state resistance to offering Ukraine an EU membership perspective seems to be fading, gradually. The last statement by EU foreign ministers ended enigmatically: “the Council expresses its conviction that [the association] agreement does not constitute the final goal in EU-Ukraine co-operation”. Several senior European officials have gone further, including President of the European Council Herman Van Rompuy, who said that the future of Ukraine belonged with the EU. Successive Ukrainian governments have defined their country as ‘European’; it is time that the EU started to set out the conditions Ukraine would have to meet in order to become a member of the Union.
There is a Russian saying that it is better to see once than hear a hundred times. The EU should press forward as quickly as possible with visa liberalisation for Ukrainians, to make it easier for people to see what two decades of transition have achieved in countries like Poland and the Baltic states. The Union should also increase funding for student exchange programmes and study visits to EU countries by officials, particularly from eastern Ukraine.
One reason Ukraine’s economy is in such a mess is the immense scale of corruption. The Swedish economist Anders Aslund estimates the Yanukovych family fortune at $12 billion (almost €9 billion), but the president and his relatives were not the only ones profiting at the expense of the Ukrainian state. A number of EU member-states, including Austria and the UK, have been happy to put out the welcome mat for members of Yanukovych’s circle. Former prime minister Mykola Azarov and his wife have property in Austria; companies which are alleged to be fronts for Yanukovych and his family are based in London.
These and other European countries should now help the Ukrainians to recover some of the loot. They should also look closely at their own implementation of anti-money laundering legislation. In 2011 the UK’s Financial Services Authority found that three quarters of the banks it investigated had not done enough to establish that customers who were senior politicians or their families had acquired their wealth legitimately. Putting this right would help Ukraine (and other countries) recover funds from corrupt politicians, and also set the tone for the future. Western countries should not preach good governance and the rule of law in Kyiv while allowing Ukrainian leaders to launder their money in European capitals.
Ukraine’s economic future will not be secured, however, by asset recovery (however politically valuable it would be). It needs trade and investment to drive growth. Even before the DCFTA comes into force, the EU should be generous with market access. The Union set an important precedent by increasing Moldova’s wine export quota in January 2014 to compensate for Russia restricting its imports of Moldovan wine; if Russia takes similar steps against Ukrainian agricultural and industrial products (as seems likely), the EU should respond by opening its markets again.
Finally, the Ukrainians themselves need fresh thinking. It has been easy to blame Yanukovych for all that ails their country. But his departure does not mean the end of their problems; and he was not responsible for all of the mess. From independence onwards, Ukrainian presidents and governments have ducked hard choices and allowed corruption to flourish.
In 2004 the protesters in the Orange Revolution were (to some extent at least) led by the politicians. In 2014, the protesters on the Maidan were consistently ahead of the politicians and wary of the opposition as well as the government. When Vitali Klitschko, leader of one of the main opposition parties, announced to the crowd the terms of the (still-born) deal brokered between Yanukovych and the opposition by the French, German and Polish foreign ministers, he was booed off the stage. The engagement of civil society in political life is in some ways encouraging: much better than apathy. But it also contains threats: the risk of vigilante justice, and the temptation for politicians to resort to populist measures, rather than attempting hard but necessary reforms.
The new authorities need to prioritise. Whether Ukraine defaults or not, its economy is a mess. The interim government needs to be frank with the population about how tough it will be to turn Ukraine round after two decades of decline, and it needs to start the process quickly, without waiting for the presidential elections in May. That way, all parties in the unity government will share responsibility for the reforms required to put Ukraine on track for sustainable economic growth. The interim prime minister, Arseniy Yatsenyuk, a highly intelligent technocrat, has started to explain how bad things are; he needs support from other politicians. Leaders should not be distracted by peripheral issues: reducing the status of the Russian language will no doubt please some western Ukrainians, but it should not have been one of the first pieces of legislation passed by parliament after the fall of Yanukovych. It will do nothing for the economy, and will exacerbate worries in the south and east on which separatists can then play.
Ukraine needs a constitution that works. The 2004 constitution left too many uncertainties about the division of powers between the president, the prime minister and parliament; the 2010 constitution put too much power in the hands of the president. With the help of the Council of Europe’s Venice Commission on democracy through law, the new authorities should start work on a new constitution, to be put to a referendum as soon as possible. The president to be elected in May 2014 should serve a shortened term pending adoption of the new constitution.
Ukraine also needs honest politicians. The Office for Democratic Institutions and Human Rights (ODIHR), part of the Organisation for Security and Cooperation in Europe (OSCE), judged the 2012 parliamentary elections to have been a step backwards for Ukraine, characterised by abuse of administrative resources, murky campaign finances and biased media coverage. The resulting parliament is now in charge of the country. Various oligarchs ‘own’ blocks of seats in the Rada; it was their decision to drop Yanukovych which led to the vote to replace him. The interim government should ask ODIHR to help draw up new electoral legislation, including on campaign finance, establish a new electoral commission and hold parliamentary elections as soon as a new constitution is in place. It should also work with international anti-corruption bodies to draft and implement far-reaching legislation to force politicians and officials to declare their assets and any possible conflicts of interest.
Ukraine itself does not have the resources to pay for a major economic change programme itself; it will need foreign investments, as the countries of Central Europe did. To attract foreign investment it will need to change the ingrained culture of corruption. By leaving behind a treasure trove of documents showing the extent of graft, Yanukovych has strengthened the hands of transparency campaigners (some of whom are now poring over the evidence). Ukraine should work with organisations like the Open Government Partnership and Transparency International to build openness into government contracting processes and the tax system. It should also ask for help from the OSCE and the Council of Europe to rebuild the judiciary and law-enforcement bodies so that they serve the people and the state, not the elites who corruptly buy their services.
Ukraine has rich agricultural land, an industrial heritage and an educated population. It should be doing much better than it is. After two false starts, perhaps it will be third time lucky. The pirate king has gone; now Ukraine should be helped to chart a new course.
Ian Bond is director of foreign policy at the Centre for European Reform.
For Russia, Yanukovych was an acceptable leader of Ukraine, despite his faults. With his power base near the Russian border and his ties to oligarchs dependent on Russian markets, he was not the man to stand up to Moscow’s pressure to walk away from an association agreement with the EU in autumn 2013. His reward for doing Moscow’s bidding was a one-third cut in the price of Russian gas (to be reviewed quarterly, in case he thought of changing his mind) and a $15 billion loan (about €10 billion), of which $3 billion (€2 billion) was disbursed before his fall.
The Russians clearly did not expect that Yanukovych’s failure to sign a one-thousand page document that few if any of his opponents had read would lead to a revolution. Yet three months after Yanukovych cast his lot in with Russia, he is out of office and – as Russian Prime Minister Dmitri Medvedev said on February 24th – “We do not understand what is going on there”.
The smart thing for the Russians to do would be to join Yanukovych’s Ukrainian ex-supporters in denouncing his crimes, and then to rebuild their influence. Russia will continue to supply much of Ukraine’s gas. It already has a free-trade agreement with Kyiv, and mutually profitable trade should continue, particularly in areas like defence equipment where Soviet-era supply chains still exist. Many Ukrainians have family ties in Russia or work there. These people have no reason to feel enmity towards Moscow. A prosperous, EU-aligned neighbour should pose no threat to Russia’s interests. It could even be a better customer for Russia; it might pay its bills, for one thing.
So far the signs are that Russia is not doing the smart thing. Russian foreign minister Sergei Lavrov has claimed that the political opposition are following the lead of “pogromists”; Medvedev has claimed that what has happened threatens the lives of Russian citizens. In Crimea, the only region of Ukraine where there is an ethnic Russian majority, visiting members of the Russian Duma announced an initiative to make it easier for Crimean residents to get Russian passports. These are provocative moves. The presence of large numbers of similar ‘Russian citizens’ in Georgia’s separatist enclaves of Abkhazia and South Ossetia provided a pretext for Russia to step in to ‘protect’ them in 2008. The occupation of the Crimean parliament and major airports by armed men, and large-scale Russian military exercises near the Ukrainian border, all add to the tension.
For the West also, the fall of Yanukovych demands fresh thinking. The UK and the US were co-signatories with Russia of the ‘Budapest Memorandum’ of 1994, in which (in return for Ukraine sending Soviet nuclear weapons back to Russia) the other three countries undertook to respect Ukraine’s independence, sovereignty and borders; not to use or threaten force; and not to use economic coercion. The memorandum said that the three would consult “in the event a situation arises which raises a question concerning these commitments”. It is time the UK and US used this agreement to deliver firm messages to Moscow about the impact of its actions on future relations.
The thuggish and corrupt Yanukovych had few friends in Europe. Now the EU will have to deal with a government in whose creation it has had a hand, and an interim president who has already said that a return to the path of European integration is his priority. Brussels and the member-states should not wait passively to see what happens, as they did after the 2004 Orange Revolution. They should drive change with a judicious mixture of generosity and tough love.
Ukraine will need assistance to avoid default almost immediately. It needs to pay its various creditors over €10 billion by the end of this year; it has gas debts to Russia of over €1 billion. The IMF suspended lending to Ukraine in 2011 because of its failure to carry out agreed reforms. IMF managing director Christine Lagarde made clear after the G20 finance ministers meeting on February 23rd that Ukraine would have to start reforms before international lenders would return. If Kyiv takes her advice, Western countries should be ready to step up technical assistance and political engagement to ensure that key reforms in areas such as energy pricing are implemented quickly and effectively. They could help with funds and advice to reduce the impact of cuts in fuel subsidies on poor customers. A sharp reduction in energy subsidies in Bulgaria in early 2013 led to protests and the fall of the government.
A lot of the short-term pain of reform will fall on un-modernised heavy industries in the east and south of the country, which have relied on unsustainably low gas prices to remain viable. The deep and comprehensive free trade agreement (DCFTA) offered by the EU should offer a significant long-term boost in growth (estimated at about 0.5 per cent per annum), but the gains will be diffused widely, while the losses will be concentrated. Russia has put a considerable propaganda effort into heightening the fears of the likely losers. Moscow will probably now put up the price of gas and perhaps restrict the flow in order to punish the new Ukrainian government, further hitting Ukrainian competitiveness. The EU is close to offering Ukraine financial assistance (likely to be more than the $1 billion (about €700 million) announced by the US). Regions of western and central Europe which have successfully undergone economic restructuring should share their expertise with Ukraine. The EU should also press forward with plans to enable Ukraine to get gas from Slovakia, assistance with energy efficiency and other steps to mitigate Ukraine’s dependence on Russian gas.
The EU has concluded that although the interim government might like to sign the association agreement as soon as possible, it would be better not to do so before presidential elections in Ukraine on May 25th. One reason for this is to avoid questions about the legitimacy of the transitional authorities; another is to allow more time for an increased public information campaign to explain what the association agreement means for Ukraine. The British government commissioned research in Ukraine in early 2013 which showed low levels of knowledge about the EU and high levels of suspicion, particularly in the east. The British Embassy in Kyiv has done much since then to ensure that information about the agreement is available, including translating a summary into Russian as well as Ukrainian. Meanwhile the EU delegation’s staff have taken the lead in ensuring that the Ukrainian authorities are technically prepared for the time when the agreement is in force. But it is time that the information effort was stepped up and properly resourced, ideally with the EU delegation and as many member-states as possible spreading the word. Central European countries have a particularly important contribution to make because of their own experiences of transition, association agreements and ultimately EU membership; senior visitors from these countries could help to reassure eastern Ukraine of the benefits of association with the EU.
As a result of events in Kyiv, member-state resistance to offering Ukraine an EU membership perspective seems to be fading, gradually. The last statement by EU foreign ministers ended enigmatically: “the Council expresses its conviction that [the association] agreement does not constitute the final goal in EU-Ukraine co-operation”. Several senior European officials have gone further, including President of the European Council Herman Van Rompuy, who said that the future of Ukraine belonged with the EU. Successive Ukrainian governments have defined their country as ‘European’; it is time that the EU started to set out the conditions Ukraine would have to meet in order to become a member of the Union.
There is a Russian saying that it is better to see once than hear a hundred times. The EU should press forward as quickly as possible with visa liberalisation for Ukrainians, to make it easier for people to see what two decades of transition have achieved in countries like Poland and the Baltic states. The Union should also increase funding for student exchange programmes and study visits to EU countries by officials, particularly from eastern Ukraine.
One reason Ukraine’s economy is in such a mess is the immense scale of corruption. The Swedish economist Anders Aslund estimates the Yanukovych family fortune at $12 billion (almost €9 billion), but the president and his relatives were not the only ones profiting at the expense of the Ukrainian state. A number of EU member-states, including Austria and the UK, have been happy to put out the welcome mat for members of Yanukovych’s circle. Former prime minister Mykola Azarov and his wife have property in Austria; companies which are alleged to be fronts for Yanukovych and his family are based in London.
These and other European countries should now help the Ukrainians to recover some of the loot. They should also look closely at their own implementation of anti-money laundering legislation. In 2011 the UK’s Financial Services Authority found that three quarters of the banks it investigated had not done enough to establish that customers who were senior politicians or their families had acquired their wealth legitimately. Putting this right would help Ukraine (and other countries) recover funds from corrupt politicians, and also set the tone for the future. Western countries should not preach good governance and the rule of law in Kyiv while allowing Ukrainian leaders to launder their money in European capitals.
Ukraine’s economic future will not be secured, however, by asset recovery (however politically valuable it would be). It needs trade and investment to drive growth. Even before the DCFTA comes into force, the EU should be generous with market access. The Union set an important precedent by increasing Moldova’s wine export quota in January 2014 to compensate for Russia restricting its imports of Moldovan wine; if Russia takes similar steps against Ukrainian agricultural and industrial products (as seems likely), the EU should respond by opening its markets again.
Finally, the Ukrainians themselves need fresh thinking. It has been easy to blame Yanukovych for all that ails their country. But his departure does not mean the end of their problems; and he was not responsible for all of the mess. From independence onwards, Ukrainian presidents and governments have ducked hard choices and allowed corruption to flourish.
In 2004 the protesters in the Orange Revolution were (to some extent at least) led by the politicians. In 2014, the protesters on the Maidan were consistently ahead of the politicians and wary of the opposition as well as the government. When Vitali Klitschko, leader of one of the main opposition parties, announced to the crowd the terms of the (still-born) deal brokered between Yanukovych and the opposition by the French, German and Polish foreign ministers, he was booed off the stage. The engagement of civil society in political life is in some ways encouraging: much better than apathy. But it also contains threats: the risk of vigilante justice, and the temptation for politicians to resort to populist measures, rather than attempting hard but necessary reforms.
The new authorities need to prioritise. Whether Ukraine defaults or not, its economy is a mess. The interim government needs to be frank with the population about how tough it will be to turn Ukraine round after two decades of decline, and it needs to start the process quickly, without waiting for the presidential elections in May. That way, all parties in the unity government will share responsibility for the reforms required to put Ukraine on track for sustainable economic growth. The interim prime minister, Arseniy Yatsenyuk, a highly intelligent technocrat, has started to explain how bad things are; he needs support from other politicians. Leaders should not be distracted by peripheral issues: reducing the status of the Russian language will no doubt please some western Ukrainians, but it should not have been one of the first pieces of legislation passed by parliament after the fall of Yanukovych. It will do nothing for the economy, and will exacerbate worries in the south and east on which separatists can then play.
Ukraine needs a constitution that works. The 2004 constitution left too many uncertainties about the division of powers between the president, the prime minister and parliament; the 2010 constitution put too much power in the hands of the president. With the help of the Council of Europe’s Venice Commission on democracy through law, the new authorities should start work on a new constitution, to be put to a referendum as soon as possible. The president to be elected in May 2014 should serve a shortened term pending adoption of the new constitution.
Ukraine also needs honest politicians. The Office for Democratic Institutions and Human Rights (ODIHR), part of the Organisation for Security and Cooperation in Europe (OSCE), judged the 2012 parliamentary elections to have been a step backwards for Ukraine, characterised by abuse of administrative resources, murky campaign finances and biased media coverage. The resulting parliament is now in charge of the country. Various oligarchs ‘own’ blocks of seats in the Rada; it was their decision to drop Yanukovych which led to the vote to replace him. The interim government should ask ODIHR to help draw up new electoral legislation, including on campaign finance, establish a new electoral commission and hold parliamentary elections as soon as a new constitution is in place. It should also work with international anti-corruption bodies to draft and implement far-reaching legislation to force politicians and officials to declare their assets and any possible conflicts of interest.
Ukraine itself does not have the resources to pay for a major economic change programme itself; it will need foreign investments, as the countries of Central Europe did. To attract foreign investment it will need to change the ingrained culture of corruption. By leaving behind a treasure trove of documents showing the extent of graft, Yanukovych has strengthened the hands of transparency campaigners (some of whom are now poring over the evidence). Ukraine should work with organisations like the Open Government Partnership and Transparency International to build openness into government contracting processes and the tax system. It should also ask for help from the OSCE and the Council of Europe to rebuild the judiciary and law-enforcement bodies so that they serve the people and the state, not the elites who corruptly buy their services.
Ukraine has rich agricultural land, an industrial heritage and an educated population. It should be doing much better than it is. After two false starts, perhaps it will be third time lucky. The pirate king has gone; now Ukraine should be helped to chart a new course.
Ian Bond is director of foreign policy at the Centre for European Reform.
Wednesday, February 19, 2014
Sherlock and the European catastrophe
Benedict Cumberbatch sat across from the prime minister in best thin white duke mode, a look of disbelief frozen on his face. “David, you do realise that I’m an actor? 'Sherlock' was just a TV detective show adapted for today's Britain. We've made too many seasons of it already. I’ve moved on.”
David Cameron fixed him with his fleshy, good-natured gaze. “Oh, I'm well aware. But you in particular seemed, well…just so natural as Sherlock. My predecessor-but-one was a thespian too, Benedict. And there's literally no-one else I can turn to: I’m in serious trouble on my Europe file.”
It was 2017 and a sunny May morning in Downing Street. PJ Harvey's anguished tones drifted down a corridor from a radio in one of No 10's over-stuffed offices. “Goddamn’ Europeans! Take me back to beautiful England...” The TV detective’s mouth turned up a corner. “What appears to be the problem, prime minister?”
“Well, as I say, it's my European policy.” He glumly nodded towards the desk. “Anyone who sits in that chair has Europe waiting for them like a great ugly toad from the first day they get in the door. I don’t see why I should be the one the whole thing finally caves in on...This EU referendum we promised: the vote is on Saturday.”
Cumberbatch’s fingertips pyramided to his lips. “Yes, it’s all over the news, special debates on Newsnight for a month and all that. The newspapers are full of it. Everyone says it’ll probably be a narrow Yes to stay in.”
Cameron looked pained. “No. The Yes side is going to lose, Benedict.”
The actor stared. “But the polls look 50-50. Whatever about all the bluster, people hardly expect us to leave Europe, do they?”
Cameron went on, unhearing. “I suppose that I sort of, hoped – you know – that something would just turn up, as Mr Micawber says. I did everything I could to keep the Conservative party happy. I pulled my MEPs out of their cozy, chummy group in the European Parliament and made them hang around with a bunch of political wild-men instead, even before we got into office at all. Not that anyone here ever gave me credit for it. They noticed on the continent though. But the really serious trouble started when the eurozone crisis broke out and I vetoed their fiscal compact. That sent my thrill-seeking backbenchers into ecstatics. My God, it got the other leaders’ backs up something terrible. Before then, our usual policy was to be in the room for those kinds of discussions. I took a big risk walking away from that.”
“But how did that help the UK?” asks Cumberbatch, crossing his legs pensively.
“Well, it looked like the lights were going out all over Europe...my economic advisers told me the eurozone was doomed. I mean I'm no expert but anyone can see the thing is hardly an economic miracle. We thought they'd be re-making the entire EU by now, that we’d have the chance to extract some concessions before having to hold the blessed referendum. You know, on social policy and so forth. So I wanted to show them I was prepared to block things early on. Can someone please turn that radio off – we’re trying to have a meeting in here!”
“And…what happened then?”
“Nothing”, lamented Cameron. “The whole euro crisis just went into a sort of political deep freeze after they cooked up some legal mumbo jumbo. I got a few helpful noises on immigration from the other governments after the European elections alright. Then I floated this ‘Regulation Treaty’ idea the year we got re-elected, but I just couldn’t sell it. The only thing I could point to in the end was pulling out of European policing. Gordon Brown already got that during the Lisbon talks though, before I got in.”
“David, you’re a PR man. Surely, you know not to take political risks on crime. Look how successful Sherlock and the other crime dramas are for goodness sakes.”
“Yes, but no-one ever asks the French police for help in them, do they Benedict? And we were getting ready for the 800th Magna Carta celebrations in 2015. I was hardly going to adopt the Code Napoleon the same year, was I? Even the main villains in Sherlock were only Swedish and Irish.”
Cumberbatch snorted. “Ha; well, our producers thought that was as foreign as the British viewer likes to go on a Tuesday night. Hang on, that's interesting. How have Sweden and Ireland done in Europe over the last few years?”
“Well, Ireland got bailed out by the other Europeans and us. After that, they got bossed around by the ECB for a bit. But then they started raising money on the markets at a better rate than the Treasury. The continentals even made Kenny, the Irish prime minister – or whatever it is they call it – European Council president. They called it: “a gesture to the Anglo-Saxons”. The Irish just loved that. We only got the pesky development commissioner.”
“Ok. Well, how did Sweden do then? We agree with them on most things too, don't we?”
“Fredrik? Obviously, he thinks the whole euro thing is bonkers as well. He told me Halley’s Comet will be here again before the Swedes sign up. But he just sort of sat on the fence at the Council meetings, pledged a few kronor to the bail-outs, even signed up to the fiscal compact. Says if the Danes can wear it, so can he.”
“Let me put it another way, David. If Sweden or Ireland needed a leg up from Brussels or the other Europeans for some reason, would they be more or less likely to get it than us?”
“Theoretically: more likely. But you don’t understand: the whole treaty change thing is a damned dangerous business. No-one wants it because it means referendums everywhere. Can you imagine that around Europe with the economy the way it is now? Angela made sure I got my ‘Declaration That Britain Has A Point, Whatever It Is’, at the December summit even though everyone’s already mad at her for taking the French to court over their national debt. But that won’t be near enough to get us out of trouble here. Can you believe the way this campaign has become such a godsend for Boris? He has all the fun running the No side while I just get abuse up and down the country. His tweets are sickening.”
Cumberbatch looked at the prime minister, wondering. “But David, it’s a bit premature to rehearse your resignation speech, no? Everyone says that the debate has turned out to be surprisingly cathartic; that the No side is split and on the defensive; that the country has quietly Europeanised since the last poll forty years ago. You know: we’re drinking drinkable wine, calling our kids Radek, letting Deutsche Bahn run the railways – all that. If anything, people seem bored with the whole EU thing at the moment.”
Cameron winced: “Exactly, Benedict: Turnout, turnout! I couldn’t get the idea of a minimum quorum into the referendum bill. The pity is we didn’t go back into government with the Lib Dems; they would have insisted on it, even after their demolition in the elections. I know the debate is lively: what with the fabrications from the No side and the counter-fabrications from the Yes side. The young people tell pollsters that they'd prefer to be in, so long as we don’t join the euro. But who’s going to get up out of bed on a Saturday morning to vote for Brussels?
“…only the hardcore anti-EU people, that’s who. We’ll end up leaving the Union in a fit of absence of mind. And Boris and his wild-eyed friends have fooled enough people into believing that only a No vote can get us “the real deal” from the bureaucrats. Well, if he wants my job so much, let him stay up all night arguing in that abattoir in Brussels. Nothing makes the continentals gang up together more than a good Brit-bash. They don’t have a bloody thing in common otherwise. But can’t all that be avoided somehow, even now?”
Cumberbatch’s grey blue eyes widened. He stood up and flicked on his high-collared Milford coat. “Prime Minister, this really isn’t my area, you know. But Sherlock would deduce that you’d missed something obvious and hidden in plain sight somewhere along the way. Anyway, my flight to Los Angeles leaves in a few hours.”
“Don’t remind me about the Americans; I’ve had HRC on the phone every week for the past two months asking me what my ‘strategic vision’ is for after the referendum. Look, couldn't you ask your brother in MI6, Mycroft Holmes? He was a great help to us during the Olympics.”
“You're scaring me now David...”
Hugo Brady is a senior research fellow and the CER's Brussels representative.
NB: Lyrics reproduced from PJ Harvey’s ‘The Last Living Rose’.
David Cameron fixed him with his fleshy, good-natured gaze. “Oh, I'm well aware. But you in particular seemed, well…just so natural as Sherlock. My predecessor-but-one was a thespian too, Benedict. And there's literally no-one else I can turn to: I’m in serious trouble on my Europe file.”
It was 2017 and a sunny May morning in Downing Street. PJ Harvey's anguished tones drifted down a corridor from a radio in one of No 10's over-stuffed offices. “Goddamn’ Europeans! Take me back to beautiful England...” The TV detective’s mouth turned up a corner. “What appears to be the problem, prime minister?”
“Well, as I say, it's my European policy.” He glumly nodded towards the desk. “Anyone who sits in that chair has Europe waiting for them like a great ugly toad from the first day they get in the door. I don’t see why I should be the one the whole thing finally caves in on...This EU referendum we promised: the vote is on Saturday.”
...
Fog rolling down behind the mountains,
On the graveyards, and dead sea-captains
…
Fog rolling down behind the mountains,
On the graveyards, and dead sea-captains
…
Cumberbatch’s fingertips pyramided to his lips. “Yes, it’s all over the news, special debates on Newsnight for a month and all that. The newspapers are full of it. Everyone says it’ll probably be a narrow Yes to stay in.”
Cameron looked pained. “No. The Yes side is going to lose, Benedict.”
The actor stared. “But the polls look 50-50. Whatever about all the bluster, people hardly expect us to leave Europe, do they?”
Cameron went on, unhearing. “I suppose that I sort of, hoped – you know – that something would just turn up, as Mr Micawber says. I did everything I could to keep the Conservative party happy. I pulled my MEPs out of their cozy, chummy group in the European Parliament and made them hang around with a bunch of political wild-men instead, even before we got into office at all. Not that anyone here ever gave me credit for it. They noticed on the continent though. But the really serious trouble started when the eurozone crisis broke out and I vetoed their fiscal compact. That sent my thrill-seeking backbenchers into ecstatics. My God, it got the other leaders’ backs up something terrible. Before then, our usual policy was to be in the room for those kinds of discussions. I took a big risk walking away from that.”
“But how did that help the UK?” asks Cumberbatch, crossing his legs pensively.
“Well, it looked like the lights were going out all over Europe...my economic advisers told me the eurozone was doomed. I mean I'm no expert but anyone can see the thing is hardly an economic miracle. We thought they'd be re-making the entire EU by now, that we’d have the chance to extract some concessions before having to hold the blessed referendum. You know, on social policy and so forth. So I wanted to show them I was prepared to block things early on. Can someone please turn that radio off – we’re trying to have a meeting in here!”
…
And the grey damp filthiness of ages,
And battered books
…
And the grey damp filthiness of ages,
And battered books
…
“And…what happened then?”
“Nothing”, lamented Cameron. “The whole euro crisis just went into a sort of political deep freeze after they cooked up some legal mumbo jumbo. I got a few helpful noises on immigration from the other governments after the European elections alright. Then I floated this ‘Regulation Treaty’ idea the year we got re-elected, but I just couldn’t sell it. The only thing I could point to in the end was pulling out of European policing. Gordon Brown already got that during the Lisbon talks though, before I got in.”
“David, you’re a PR man. Surely, you know not to take political risks on crime. Look how successful Sherlock and the other crime dramas are for goodness sakes.”
“Yes, but no-one ever asks the French police for help in them, do they Benedict? And we were getting ready for the 800th Magna Carta celebrations in 2015. I was hardly going to adopt the Code Napoleon the same year, was I? Even the main villains in Sherlock were only Swedish and Irish.”
Cumberbatch snorted. “Ha; well, our producers thought that was as foreign as the British viewer likes to go on a Tuesday night. Hang on, that's interesting. How have Sweden and Ireland done in Europe over the last few years?”
“Well, Ireland got bailed out by the other Europeans and us. After that, they got bossed around by the ECB for a bit. But then they started raising money on the markets at a better rate than the Treasury. The continentals even made Kenny, the Irish prime minister – or whatever it is they call it – European Council president. They called it: “a gesture to the Anglo-Saxons”. The Irish just loved that. We only got the pesky development commissioner.”
“Ok. Well, how did Sweden do then? We agree with them on most things too, don't we?”
“Fredrik? Obviously, he thinks the whole euro thing is bonkers as well. He told me Halley’s Comet will be here again before the Swedes sign up. But he just sort of sat on the fence at the Council meetings, pledged a few kronor to the bail-outs, even signed up to the fiscal compact. Says if the Danes can wear it, so can he.”
...
The sky move, the ocean shimmer,
The hedge shake,
And the last living rose quiver
...
The sky move, the ocean shimmer,
The hedge shake,
And the last living rose quiver
...
“Let me put it another way, David. If Sweden or Ireland needed a leg up from Brussels or the other Europeans for some reason, would they be more or less likely to get it than us?”
“Theoretically: more likely. But you don’t understand: the whole treaty change thing is a damned dangerous business. No-one wants it because it means referendums everywhere. Can you imagine that around Europe with the economy the way it is now? Angela made sure I got my ‘Declaration That Britain Has A Point, Whatever It Is’, at the December summit even though everyone’s already mad at her for taking the French to court over their national debt. But that won’t be near enough to get us out of trouble here. Can you believe the way this campaign has become such a godsend for Boris? He has all the fun running the No side while I just get abuse up and down the country. His tweets are sickening.”
Cumberbatch looked at the prime minister, wondering. “But David, it’s a bit premature to rehearse your resignation speech, no? Everyone says that the debate has turned out to be surprisingly cathartic; that the No side is split and on the defensive; that the country has quietly Europeanised since the last poll forty years ago. You know: we’re drinking drinkable wine, calling our kids Radek, letting Deutsche Bahn run the railways – all that. If anything, people seem bored with the whole EU thing at the moment.”
Cameron winced: “Exactly, Benedict: Turnout, turnout! I couldn’t get the idea of a minimum quorum into the referendum bill. The pity is we didn’t go back into government with the Lib Dems; they would have insisted on it, even after their demolition in the elections. I know the debate is lively: what with the fabrications from the No side and the counter-fabrications from the Yes side. The young people tell pollsters that they'd prefer to be in, so long as we don’t join the euro. But who’s going to get up out of bed on a Saturday morning to vote for Brussels?
...
Past the Thames River, glistening like gold
Hastily sold
For nothing
Past the Thames River, glistening like gold
Hastily sold
For nothing
...
“…only the hardcore anti-EU people, that’s who. We’ll end up leaving the Union in a fit of absence of mind. And Boris and his wild-eyed friends have fooled enough people into believing that only a No vote can get us “the real deal” from the bureaucrats. Well, if he wants my job so much, let him stay up all night arguing in that abattoir in Brussels. Nothing makes the continentals gang up together more than a good Brit-bash. They don’t have a bloody thing in common otherwise. But can’t all that be avoided somehow, even now?”
Cumberbatch’s grey blue eyes widened. He stood up and flicked on his high-collared Milford coat. “Prime Minister, this really isn’t my area, you know. But Sherlock would deduce that you’d missed something obvious and hidden in plain sight somewhere along the way. Anyway, my flight to Los Angeles leaves in a few hours.”
“Don’t remind me about the Americans; I’ve had HRC on the phone every week for the past two months asking me what my ‘strategic vision’ is for after the referendum. Look, couldn't you ask your brother in MI6, Mycroft Holmes? He was a great help to us during the Olympics.”
“You're scaring me now David...”
Hugo Brady is a senior research fellow and the CER's Brussels representative.
NB: Lyrics reproduced from PJ Harvey’s ‘The Last Living Rose’.
Wednesday, February 05, 2014
What explains Europe’s rejection of macroeconomic orthodoxy?
The 1930s depression led to the birth of Keynesian economics, because the prevailing economics orthodoxy had no answers to the crisis. Keynes demonstrated that the government could, and should, intervene to correct a shortfall of demand in the economy. The rise of monetarism in the 1970s saw the challenging of the Keynesian reading of the 1930s. Monetarists argued that the 1930s depression was caused by governments failing to prevent the collapse of the money supply (the amount of money in circulation), which led to a collapse of demand rather than a collapse of demand leading to a collapse of money, as per the Keynesian analysis. Despite their differences, both camps agree that there is an indispensable role for macroeconomic policy in combating a slump.
By contrast, the depression that started in 2008, and which Europe is still struggling to emerge from, has led to the explicit rejection of Keynesian economics across Europe, and the implicit rejection of monetarism. How has a crisis borne largely of poorly run and regulated financial institutions, combined with the creation of a currency union modelled on the gold standard been used to turn the clock back on both economic theory and history? And what does it mean for Europe?
Keynesian critics of the direction of macroeconomic policy-making in Europe have long become accustomed to having their views caricatured. Their criticism of the pace of austerity is presented as a call to ‘artificially pump up demand’. This assertion rests on two assumptions: Keynesians ignore the supply side of the economy, and that Europe’s crisis is a result of government failure to push through supply-side reforms. This chorus of criticism has picked up further with signs of economic improvement in the eurozone and UK, despite fiscal austerity for the last three years.
What have Keynesians actually said, as opposed to what has been attributed to them? They argue that fiscal policy is an indispensable tool to stabilise economies suffering from a drop in domestic demand. This is especially so when interest rates had fallen to close to zero (neutering the effectiveness of monetary policy). When businesses and consumers do not want to borrow and invest even when nominal interest rates are close to zero, monetary policy is unable to stimulate demand. Keynesians also argue that fiscal policy is especially important in a currency union (where interest rates are set for the currency union as a whole rather than for the needs of individual economies). Few Keynesians dismiss the importance of supply-side policies; rather they argued that supply-side reforms will not help address a crisis of demand (and that the wrong macroeconomic policies can outweigh the potentially positive impact of supply-side policies). Finally, mainstream Keynesian economists have not said that austerity would prevent economic recovery at some point. Instead, they have said that recovery would take place at a lower level of activity, with an unnecessary accumulation of debt and the risk of deflation.
Keynesian advice was followed (up to a point) in the early stages of the crisis, and by late 2009, the European economy was recovering (see chart). However a dramatic tightening of fiscal policy in 2010 helped push the eurozone and UK economies back into a recession, which in the case of the eurozone only came to an end with an easing of fiscal austerity over the second half of 2013. Since then, European governments and the European Commission have argued that any attempt to boost demand would be at best useless and at worst damaging.
The rejection of monetarism has been less strident, but no less striking. Monetarists are sceptical that governments can affect the amount of demand in the economy through fiscal policy, but are unequivocal that central banks should prevent a collapse in the money supply. Following the launch of the euro, the ECB initially focused on two pillars when setting interest rates – an inflation target of 2 per cent and a ‘reference value’ of 4.5 per cent annual growth in money supply (M3) – but has quietly dropped the second pillar. Annual growth in M3 slid to just 1 per cent in December 2013.
The ECB is not entirely to blame for this, of course – fiscal austerity at a time of weak domestic demand was always going to hit demand hard (and so reduce inflation). But the ECB (though not the Bank of England) was slow to cut interest rates and reluctant to embrace unorthodox policies such as quantitative easing. This is all the more puzzling as the ECB is modelled to a large extent on the German Bundesbank, which was instrumental in making sure that the ECB targeted the money supply as well as inflation.
Where has this rejection of orthodox thinking led Europe? The chart below shows the relative performance of the US, eurozone and UK economies since the beginning of 2008. The US authorities have followed a pretty much standard textbook approach to the crisis, providing some fiscal stimulus to offset the weakness of demand and injecting as much monetary stimulus as possible. The US recovery has been disappointing (by US standards) but still compares highly favourably with what has happened in Europe.
What about growth prospects? Advocates of Europe’s current approach argue that the reforms being pushed have improved Europe’s growth potential. However, even the European Commission and the IMF – the architects of the European approach – expect a very modest recovery, averaging 1.3 per cent a year for the next three years (compared with over 3 per cent in the US). Many other forecasters are even more pessimistic about Europe’s prospects.
The reason for this pessimism is obvious – the damage done to the supply-side of European economies by low rates of investment (both public and private) and high unemployment (the longer someone is out of work, the less likely that person is to find a job). Far from boosting the supply side of the European economy, austerity has made structural changes less, not more likely: fiscal stimulus in the US allowed the private sector to reduce debt levels, hastening the point at which investment recovered. By contrast, the process of reducing private sector debt levels has much further to go in Europe.
Real GDP (Q1 2008 = 100)
Source: European Central Bank
What has happened to public debt? The argument for fiscal austerity was that it was necessary in order to arrest the rise in debt ratios, even if the result was a hit to economic growth. The eurozone’s ratio of debt to GDP has risen by a bit less than the US’s since the beginning of 2008 (see chart), but the US ratio is now falling quite quickly as economic recovery boosts tax revenues. The eurozone’s debt ratio did drop slightly in the third quarter of 2013, but this reflected an exceptional fall in Germany rather than the start of a trend. Moreover, in a fiscally decentralised monetary union, the aggregate debt figure is pretty meaningless. What matters in the eurozone are the debt ratios of countries such as Italy and Spain. The UK has experienced a huge rise in debt partly because it suffered a very deep recession and slow recovery and partly because of the costs of clearing up its banking sector (around 10 percentage points of GDP).
Public debt (per cent, GDP)
The reason why the ratio of eurozone debt to GDP is likely to keep rising is a combination of weak growth prospects and weak inflation across much of the eurozone. The ECB would never wait until inflation hit 4 per cent before it raised interest rates, yet it has allowed inflation to fall below 1 per cent, arguing that it needs time to gauge the scale of deflationary pressure. This is a risky strategy. Inflation does not need to turn negative to do a lot of damage. The lower the inflation rate, the bigger the primary budget surplus a government needs to run in order to prevent the stock of public debt to GDP rising , hastening the point at which debt becomes unsustainable. Low inflation also pushes up real interest rates, further depressing demand.
How low is inflation across the eurozone going to go? Much will depend on the international environment. A prolonged emerging market crisis would push up the value of the euro, compounding deflationary pressures in the eurozone. The other crucial variable is Germany. If German domestic demand were to pick up strongly (lifting the country’s inflation rate), this could help offset deflationary pressure elsewhere in the currency union. Higher German inflation would help struggling members of the eurozone to regain export competitiveness relative to Germany, as well as reduce the value of the euro, boosting their exports to countries outside the currency union.
‘Core’ consumer price inflation (annual, per cent)
Source: European Central Bank
Greece aside, the European crisis was not a product of fiscal largesse. Mismanagement of public finances in the run-up to the crisis meant that some countries had less scope to impart fiscal stimulus than they should have done (the UK and Italy, for example). But the crisis was caused by the private sector (the failure of the financial system to allocate resources efficiently and to price risk appropriately) and policy-makers’ failure to acknowledge the implications of launching a single currency. So what explains Europe’s rejection of economic orthodoxy, be it Keynesian or monetarist?
Ideological leanings have played a part in some countries – they explain the restrictiveness of fiscal policy in the UK and Germany, for example. The British government has used the fiscal crisis to push through radical reforms of social welfare in an effort to shrink the size of the state. For its part, the German government has dismissed as ‘Keynesian folly’ calls for it to impart a fiscal stimulus to boost Germany’s lacklustre domestic demand, despite running a budget surplus in 2013.
However, the lack of integration within the eurozone is easily the most important reason for the dramatic decline in the quality of macroeconomic policy in Europe. Eurozone governments’ inability to agree a form of fiscal burden-sharing led to highly pro-cyclical fiscal policy in some countries and has prevented rapid action to address the region’s banking sector problems. The banking systems of some economies are both fragile and too large for their governments to comfortably backstop. This pushes up the cost of capital for banks in these countries, leading to big differences in borrowing costs across the currency union and cementing differences in economic performance. Finally, the ECB has been reluctant to ease monetary policy further for fear of the political reaction in Germany (where officials and policy-makers are worried about the economy overheating and low interest rates are angering savers). Savers cannot reasonably expect a return on their savings when there is a glut of capital across the eurozone as a whole, and businesses are loath to invest, but they are an important electoral constituency, especially in fast-ageing Germany.
In conclusion, it is hard to be optimistic about Europe’s economy while conventional economic thinking and history are being ignored. ECB representatives from the countries facing the most acute deflation threat are becoming more assertive, but the central bank will remain politically constrained. Moreover, the fiscal stance across the eurozone will remain restrictive, not least because of the impact of weak inflation on deficits and debt levels and hence on the scope for governments to ease up on the pace of austerity. Modest steps by the ECB, a gradual clean-up of the banks and a very modest cyclical economic recovery are unlikely to be enough to head off the threat of deflation.
Simon Tilford is deputy director of the Centre for European Reform.
Thursday, January 16, 2014
Climate policies are more important than targets
The European Commission is due to publish its proposals for a 2030 climate and energy framework on 22 January. The European Council will discuss the Commission’s proposals in March. European institutions should be commended for focussing on climate policy at a time when the Eurozone crisis is not over, MEPs face elections and the commissioners are in their last year. However, there is too much focus on targets – whether there should be one or three, how ambitious the they should be, and whether they should be legally binding. Well-constructed targets can play a useful role in guiding subsequent policy making. But effective policies are more important, and could be crafted even without targets.
The 2030 framework will replace the 20-20-20 targets: that there must be a 20 per cent reduction in greenhouse gas emissions, 20 per cent of total energy must be from renewables and there should be a 20 per cent improvement in energy efficiency, all by 2020. For 2030, the Commission favours three targets, again on greenhouse gases, renewables and energy efficiency. The European Parliament also supports three. The Czech Republic, Poland and the UK argue for one, on greenhouse gas reductions. Commission officials say that it is the pro-nuclear member-states which oppose a renewables target. But Paris has joined seven other governments in calling for a 2030 renewables target, proving that it is quite possible to be pro-nuclear and pro-renewables.
London and Prague say, rightly, that greenhouse gas reduction is the most important climate issue. So, they argue, there should be just one, technology-neutral target. Poland, which gets most of its energy from coal, would prefer no climate targets at all, but does not take this line in public. Some other Central and East European member-states would privately prefer no further renewables target, because they and their publics dislike Brussels ‘interference’ in their energy mix. A greenhouse gas reduction target alone would not be a disaster for climate policy, as long as it was sufficiently ambitious, for example, to cut greenhouse gas emissions in half by 2030. But the Parliament voted for a 40 per cent reduction target, and energy commissioner Günther Oettinger is arguing for only 35 per cent. Neither of these would be strong enough to propel the European economy towards reliance on clean energy. 35 or 40 per cent greenhouse gas reduction by 2030 could essentially be delivered through business as usual. If there is to be only a greenhouse gas reduction target, it must be 50 per cent.
However a 50 per cent greenhouse gas reduction target would work better if combined with a renewable energy target. The flaw in the British/Czech argument for a single target is that climate change is not the only issue that matters when deciding energy policy. Affordability and energy security matter, too. So do other types of pollution, and the problems of nuclear waste and proliferation. Taking all these issues into account, technologies are not neutral, so a technology-neutral target is insufficient. The ‘best’ form of energy is energy which is not used, so efficiency should be top of the energy policy agenda, rather than forgotten or near the bottom, as it too often is in member-states.
Renewables are the best form of energy supply. They will never run out, produce very little pollution and are widely spread across Europe – wind in the north, wind and sun in the south. Most renewables are expensive at present, but the cost is falling fast. Europe could eventually get all of its energy from renewables: electricity, renewable gas (for heating) and biofuels (for aviation and heavy goods vehicles). Energy policy should therefore promote renewable energy above other energy sources.
But the move from the current level of renewable energy in the EU – around 13 per cent – to close to 100 per cent will take many decades. Widespread installation cannot be done overnight. Advances in technology for electricity storage and aviation biofuels are needed. Denmark has set itself a target to get all of its energy from renewable sources by 2050. There is no guarantee that this will be met, and other member-states will take longer. The EU should set a target to obtain 40 per cent of energy from renewables by 2030, 60 per cent by 2040, 80 per cent by 2050 and 100 per cent by 2060. This clear timetable would provide greater certainty to the renewable industry and investors. It would also underline to the public that the move to a renewable energy economy cannot be achieved overnight. This would help people understand that low-carbon energy sources are needed as “bridge technologies” – the phrase used by German Chancellor Angela Merkel before her post-Fukushima nuclear u-turn. The two options are nuclear power and carbon capture and storage (CCS). In parts of Europe, notably Germany, the public opposes both nuclear and CCS. German greens argue that gas is a low-carbon bridge technology. Gas is lower carbon than coal, but without CCS is much more climate-damaging than renewables or nuclear are.
To help expand renewable energy, the Commission must give priority to the improvement and extension of electricity grids, including North Sea and Mediterranean grids. To help reduce greenhouse gas emissions, the Commission should also propose to strengthen the 2010 ‘industrial emissions directive’ by including an emissions performance standard for power stations. This would limit the amount of greenhouse gas that a power station can emit per unit of electricity generated. California introduced such a standard in 2007, and the Obama administration is now introducing one across the US. Canada has also introduced an emissions performance standard. In Europe, the UK is the only member-state to have introduced one, though this only applies to new power stations. Obama’s policy will also apply to existing power stations. The EU should follow his lead.
Should there be a 2030 energy efficiency target alongside the greenhouse gas and renewables targets? The case for this is less clear, not because energy efficiency is less important (as argued above, energy efficiency is the best form of energy), but because the value of a target as opposed to stronger policies is less obvious for energy efficiency. The 2020 energy efficiency target is not legally binding. “Legally-binding” has become a mantra for campaigners in the UN global negotiations (even though the UN has no means of enforcing anything that is agreed) and in the EU. The Commission has tools to enforce legal targets, but they are not strong enough to ensure compliance. To take one example: the UK will not meet its 2020 legally-binding renewable energy target. Nobody will go to prison. Whoever is in power will blame previous governments for the failure.
When pressed to make the 2020 energy efficiency target legally-binding, Commission officials argued, rightly, that legally-binding measures were more important than targets. The Commission proposed one such measure for the ‘energy efficiency directive’ – that new power stations should have combined heat and power (CHP) technology. Unfortunately this proposal was not accepted by the Council. The Commission should propose this again, as an amendment to the 2012 ‘energy efficiency directive’. It should also propose a strengthening of the 2002 ‘energy performance of buildings directive’. This currently requires that buildings should meet high energy efficiency standards when they are substantially renovated. It should be strengthened to require buildings to be energy efficient when they are sold or rented out, as is already the case in Sweden.
So the Commission should propose a combination of targets and policies in its 2030 climate and energy framework. It should propose a 50 per cent greenhouse gas reduction target and a 40 per cent renewable energy target. To help deliver these targets, the Commission should propose that CCS becomes mandatory on new coal-fired power stations, that CHP becomes mandatory on all new power stations that involve combustion, and that buildings are required to be made more energy efficient whenever they are sold or rented out. And the Council should accept these proposals in March. Otherwise climate and energy policy will be on hold for the rest of 2014. The need for investor certainty beyond 2020, and the need for rapid emissions reduction, mean that such a gap would be extremely costly.
Stephen Tindale is an associate fellow at the Centre for European Reform.
The 2030 framework will replace the 20-20-20 targets: that there must be a 20 per cent reduction in greenhouse gas emissions, 20 per cent of total energy must be from renewables and there should be a 20 per cent improvement in energy efficiency, all by 2020. For 2030, the Commission favours three targets, again on greenhouse gases, renewables and energy efficiency. The European Parliament also supports three. The Czech Republic, Poland and the UK argue for one, on greenhouse gas reductions. Commission officials say that it is the pro-nuclear member-states which oppose a renewables target. But Paris has joined seven other governments in calling for a 2030 renewables target, proving that it is quite possible to be pro-nuclear and pro-renewables.
London and Prague say, rightly, that greenhouse gas reduction is the most important climate issue. So, they argue, there should be just one, technology-neutral target. Poland, which gets most of its energy from coal, would prefer no climate targets at all, but does not take this line in public. Some other Central and East European member-states would privately prefer no further renewables target, because they and their publics dislike Brussels ‘interference’ in their energy mix. A greenhouse gas reduction target alone would not be a disaster for climate policy, as long as it was sufficiently ambitious, for example, to cut greenhouse gas emissions in half by 2030. But the Parliament voted for a 40 per cent reduction target, and energy commissioner Günther Oettinger is arguing for only 35 per cent. Neither of these would be strong enough to propel the European economy towards reliance on clean energy. 35 or 40 per cent greenhouse gas reduction by 2030 could essentially be delivered through business as usual. If there is to be only a greenhouse gas reduction target, it must be 50 per cent.
However a 50 per cent greenhouse gas reduction target would work better if combined with a renewable energy target. The flaw in the British/Czech argument for a single target is that climate change is not the only issue that matters when deciding energy policy. Affordability and energy security matter, too. So do other types of pollution, and the problems of nuclear waste and proliferation. Taking all these issues into account, technologies are not neutral, so a technology-neutral target is insufficient. The ‘best’ form of energy is energy which is not used, so efficiency should be top of the energy policy agenda, rather than forgotten or near the bottom, as it too often is in member-states.
Renewables are the best form of energy supply. They will never run out, produce very little pollution and are widely spread across Europe – wind in the north, wind and sun in the south. Most renewables are expensive at present, but the cost is falling fast. Europe could eventually get all of its energy from renewables: electricity, renewable gas (for heating) and biofuels (for aviation and heavy goods vehicles). Energy policy should therefore promote renewable energy above other energy sources.
But the move from the current level of renewable energy in the EU – around 13 per cent – to close to 100 per cent will take many decades. Widespread installation cannot be done overnight. Advances in technology for electricity storage and aviation biofuels are needed. Denmark has set itself a target to get all of its energy from renewable sources by 2050. There is no guarantee that this will be met, and other member-states will take longer. The EU should set a target to obtain 40 per cent of energy from renewables by 2030, 60 per cent by 2040, 80 per cent by 2050 and 100 per cent by 2060. This clear timetable would provide greater certainty to the renewable industry and investors. It would also underline to the public that the move to a renewable energy economy cannot be achieved overnight. This would help people understand that low-carbon energy sources are needed as “bridge technologies” – the phrase used by German Chancellor Angela Merkel before her post-Fukushima nuclear u-turn. The two options are nuclear power and carbon capture and storage (CCS). In parts of Europe, notably Germany, the public opposes both nuclear and CCS. German greens argue that gas is a low-carbon bridge technology. Gas is lower carbon than coal, but without CCS is much more climate-damaging than renewables or nuclear are.
To help expand renewable energy, the Commission must give priority to the improvement and extension of electricity grids, including North Sea and Mediterranean grids. To help reduce greenhouse gas emissions, the Commission should also propose to strengthen the 2010 ‘industrial emissions directive’ by including an emissions performance standard for power stations. This would limit the amount of greenhouse gas that a power station can emit per unit of electricity generated. California introduced such a standard in 2007, and the Obama administration is now introducing one across the US. Canada has also introduced an emissions performance standard. In Europe, the UK is the only member-state to have introduced one, though this only applies to new power stations. Obama’s policy will also apply to existing power stations. The EU should follow his lead.
Should there be a 2030 energy efficiency target alongside the greenhouse gas and renewables targets? The case for this is less clear, not because energy efficiency is less important (as argued above, energy efficiency is the best form of energy), but because the value of a target as opposed to stronger policies is less obvious for energy efficiency. The 2020 energy efficiency target is not legally binding. “Legally-binding” has become a mantra for campaigners in the UN global negotiations (even though the UN has no means of enforcing anything that is agreed) and in the EU. The Commission has tools to enforce legal targets, but they are not strong enough to ensure compliance. To take one example: the UK will not meet its 2020 legally-binding renewable energy target. Nobody will go to prison. Whoever is in power will blame previous governments for the failure.
When pressed to make the 2020 energy efficiency target legally-binding, Commission officials argued, rightly, that legally-binding measures were more important than targets. The Commission proposed one such measure for the ‘energy efficiency directive’ – that new power stations should have combined heat and power (CHP) technology. Unfortunately this proposal was not accepted by the Council. The Commission should propose this again, as an amendment to the 2012 ‘energy efficiency directive’. It should also propose a strengthening of the 2002 ‘energy performance of buildings directive’. This currently requires that buildings should meet high energy efficiency standards when they are substantially renovated. It should be strengthened to require buildings to be energy efficient when they are sold or rented out, as is already the case in Sweden.
So the Commission should propose a combination of targets and policies in its 2030 climate and energy framework. It should propose a 50 per cent greenhouse gas reduction target and a 40 per cent renewable energy target. To help deliver these targets, the Commission should propose that CCS becomes mandatory on new coal-fired power stations, that CHP becomes mandatory on all new power stations that involve combustion, and that buildings are required to be made more energy efficient whenever they are sold or rented out. And the Council should accept these proposals in March. Otherwise climate and energy policy will be on hold for the rest of 2014. The need for investor certainty beyond 2020, and the need for rapid emissions reduction, mean that such a gap would be extremely costly.
Stephen Tindale is an associate fellow at the Centre for European Reform.
Monday, January 13, 2014
Gas on troubled waters?
The discovery of natural gas resources beneath Cypriot waters is complicating the region’s politics. If poorly managed, the development of Cypriot gas could harden political divisions on the island and increase tensions with Turkey. But, if well-managed, it presents a rare opportunity to improve relations on the island, advance the region’s diplomatic and economic outlook and produce a foreign policy victory for Europe. The central question is how Cyprus should bring its natural gas to market. The EU has mainly focused on the contribution that eastern Mediterranean hydrocarbons can make towards meeting its energy objectives, but it should push for a Cypriot export option that favours regional stability and promotes reconciliation on the island. A tricky diplomatic chess-game waits.
The partition of Cyprus is a stain on the idea of a Europe that is ‘whole and free’, and is a huge irritant in the EU’s relations with Turkey, an increasingly important partner on energy and foreign policy matters. A solution to the Cypriot stalemate could unblock EU-NATO relations: Turkey and Cyprus have been preventing the two organisations discussing strategic issues together or making full use of each other’s assets. The EU and NATO co-operate with one hand tied behind their backs, harming Europe’s security.
In 2011, US-based Noble Energy announced the discovery of a natural gas field, dubbed Aphrodite, in Cyprus’ south-eastern maritime zone. Initially its size was assessed at around 5 to 8 trillion cubic feet (tcf), but a second appraisal drilling in 2013 corrected this estimate downward to 4.1 tcf. (By way of comparison, Europe consumes nearly 18 tcf annually.) Nicosia wants to export much of its gas to attract foreign capital and alleviate the burden of the €10 billion IMF-EU bailout it received in March 2013 (and an earlier Russian loan of €2.5 billion). The Cypriots desperately need economic growth: the recession-hit economy is expected to contract by nearly 8 per cent in 2013 and unemployment stands at 20 per cent.
Cyprus must find a way of bringing its gas to market. Among the possible options, the cheapest, a short pipeline from Cyprus to Turkey, is unrealistic. Although a gas pipeline could theoretically be part of any political negotiation between Ankara and Nicosia, the two sides are not talking, trust is absent and Nicosia would be unlikely to cede any control over its crown jewels to Ankara.
Relations between the two sides are very poor. Turkey and the unrecognised Turkish Republic of Northern Cyprus have staked claims on parts of the waters surrounding the island, including areas suspected to be gas-rich (for a map of the overlapping claims, see page 7 of this publication from the Oxford Institute for Energy Studies). Exploration is proceeding, however, with France's Total and Italy's ENI among those involved. Without an agreement on maritime boundaries, this will increase tensions with Turkey. Ankara does not recognise the government in Nicosia and has threatened military force if Cyprus allows drilling in the disputed maritime zone. Until now, no discoveries have been made in contested waters. But ENI (in a consortium with South Korea’s KOGAS) expects to start drilling this year in areas which the Turkish Cypriots claim. The sale of several other areas has been delayed because Ankara claims parts of them. To underline its seriousness, in early 2013 Turkey suspended some of ENI’s Turkish operations in retaliation for its Cypriot move. Turkish grandstanding is unlikely to lead to a military conflict, but Cyprus has taken precautions and is strengthening its defence relationships, including with Israel and Italy, and is set to procure two French naval vessels. So for the time being a pipeline to Turkey is impossible.
Nicosia says that economic decisions should not be stalled by politics and is pushing ahead with the development of its resources. It has an interest in marketing the gas as soon as possible; energy analysts expect that global gas prices may start to fall in the next decade as new sources, such as US shale gas, become globally available. Cyprus’ energy minister Yiorgos Lakkotrypis has estimated profits for Cyprus from the Aphrodite field to be between €8.8 and €13.2 billion.
The second export option is a pipeline to Greece via Crete. In October 2013, the European Commission designated the proposed EastMed pipeline a ‘project of common interest’, potentially making it eligible for EU funding. The European Commission is championing an agenda to diversify its energy imports away from Russia and considers gas from the eastern Mediterranean, including Cyprus, a welcome alternative. The EastMed pipeline would bypass Turkey, denying Ankara further influence over Europe’s energy supply as a transit country. (If the EU chooses to import gas from the Caspian, or from Iraq or Iran, Turkey is the transit corridor.) However, because of the depth of the Mediterranean, the EastMed pipeline raises engineering challenges which could make costs prohibitively high. Also, the pipeline would do little to reduce Cypriot-Turkish tensions.
Nicosia’s favoured option is to construct an LNG terminal at Vassiliko, in southern Cyprus. An LNG terminal would give Cyprus maximum export independence, allowing it to sell its gas globally – including to the lucrative Asian market – rather than tie itself by pipeline to one customer. An LNG terminal could turn Cyprus into a regional energy hub in the eastern Mediterranean; Israel (or even Lebanon and Syria) could eventually export gas through a Cypriot terminal. Extending a pipeline connecting the Aphrodite field and the LNG terminal to Israel’s neighbouring offshore gas fields would be relatively straightforward.
Much will depend on the amount of gas available. At a recent conference in Nicosia, energy experts from across Europe questioned the viability of the LNG terminal. Cypriot gas discoveries may be insufficient for the development of even a small-scale LNG plant. Noble Energy has admitted that 6 or 7 tcf would be needed to warrant the required investment of €8-€10 billion. Cyprus either needs to find more gas, or attract gas from its neighbours to feed into the LNG terminal.
One of those neighbours, Israel, has made the largest discoveries so far in the eastern Mediterranean, including the 18.9 tcf Leviathan field and the 10 tcf Tamar field. The Israeli High Court has decided that 40 per cent of Israel’s natural gas resources will be made available for export.
For Israel, constructing a pipeline to Turkey is the cheapest option, but is geopolitically complex. Diplomatic relations between Ankara and Israel have slowly improved since Israel’s prime minister Benjamin Netanyahu apologised for the Gaza flotilla incident but Turkey still maintains that Israel must pay compensation to the victims. However, an Israeli-Turkish pipeline is in Ankara’s interest. Not only would Israel’s sizeable resources contribute to satisfying Turkey’s growing energy demands, but it would also strengthen Turkey’s role as a transit country.
A Israeli-Turkish deal would not preclude Israel from co-operating with Cyprus either, as the government of Israel has indicated that it favours a combination of export options. It is unlikely that Israel will opt to export all of its gas through a Cypriot LNG terminal, as this would make Israel’s exports vulnerable to Cypriot politics and security issues. But it may export some.
All this creates the possibility of a grand bargain between Turkey, Israel and Cyprus. Nicosia would receive a share of Israeli gas exports to process through its LNG terminal, making it economically viable, and in return Nicosia would acquiesce to an Israeli-Turkish pipeline crossing its exclusive economic zone. Turkey would secure more access to gas, and Israel would have diversified its export routes. This mutually beneficial deal could calm the waters between Ankara and Nicosia, and encourage reconciliation on the island. Although difficult, it is the option that would produce the best economic, political and strategic benefits for most parties concerned, including the EU.
Russia, however, might be a spoiler in such a triangular arrangement. The Russian government has a commercial and political interest in maximising the amount of Russian gas that reaches Europe and restricting the amount of non-Russian gas. Russian energy firms have been making inroads in the eastern Mediterranean, in particular by securing gas exploration rights in Syria and flirting with Lebanon. In early 2013 Gazprom signed a deal to export LNG from Israel’s Tamar field. So far no Russian energy company is active in Cyprus offshore, but Russia still has significant economic and political influence on the island. The EU should remain aware of Russian commercial and political efforts in the region.
Cyprus’ ability to export LNG greatly depends on Israeli choices. For if political obstacles continue to stand in the way of an Israeli-Turkish pipeline, Tel Aviv might simply develop an LNG terminal of its own (floating offshore or at an onshore location), making a Cypriot LNG plant obsolete. The EU should continue to engage with Israel, and energy companies like Noble Energy, throwing its weight behind regional co-operation around an LNG terminal in Cyprus. The EU’s foreign policy service should also work together with the United States to help improve political and economic relations between Israel and Turkey, in particular a possible pipeline.
The EU should think strategically about linking its energy and foreign policies. Brussels should use its leverage of being the most likely destination of natural gas from the region. When making its assessment of Cyprus’ gas export options, it must consider the impact on regional stability and the potential to achieve progress towards Cypriot reconciliation. If not, the story of Cypriot natural gas may become another tale of missed opportunities.
Rem Korteweg is a senior research fellow at the Centre for European Reform.
The partition of Cyprus is a stain on the idea of a Europe that is ‘whole and free’, and is a huge irritant in the EU’s relations with Turkey, an increasingly important partner on energy and foreign policy matters. A solution to the Cypriot stalemate could unblock EU-NATO relations: Turkey and Cyprus have been preventing the two organisations discussing strategic issues together or making full use of each other’s assets. The EU and NATO co-operate with one hand tied behind their backs, harming Europe’s security.
In 2011, US-based Noble Energy announced the discovery of a natural gas field, dubbed Aphrodite, in Cyprus’ south-eastern maritime zone. Initially its size was assessed at around 5 to 8 trillion cubic feet (tcf), but a second appraisal drilling in 2013 corrected this estimate downward to 4.1 tcf. (By way of comparison, Europe consumes nearly 18 tcf annually.) Nicosia wants to export much of its gas to attract foreign capital and alleviate the burden of the €10 billion IMF-EU bailout it received in March 2013 (and an earlier Russian loan of €2.5 billion). The Cypriots desperately need economic growth: the recession-hit economy is expected to contract by nearly 8 per cent in 2013 and unemployment stands at 20 per cent.
Cyprus must find a way of bringing its gas to market. Among the possible options, the cheapest, a short pipeline from Cyprus to Turkey, is unrealistic. Although a gas pipeline could theoretically be part of any political negotiation between Ankara and Nicosia, the two sides are not talking, trust is absent and Nicosia would be unlikely to cede any control over its crown jewels to Ankara.
Relations between the two sides are very poor. Turkey and the unrecognised Turkish Republic of Northern Cyprus have staked claims on parts of the waters surrounding the island, including areas suspected to be gas-rich (for a map of the overlapping claims, see page 7 of this publication from the Oxford Institute for Energy Studies). Exploration is proceeding, however, with France's Total and Italy's ENI among those involved. Without an agreement on maritime boundaries, this will increase tensions with Turkey. Ankara does not recognise the government in Nicosia and has threatened military force if Cyprus allows drilling in the disputed maritime zone. Until now, no discoveries have been made in contested waters. But ENI (in a consortium with South Korea’s KOGAS) expects to start drilling this year in areas which the Turkish Cypriots claim. The sale of several other areas has been delayed because Ankara claims parts of them. To underline its seriousness, in early 2013 Turkey suspended some of ENI’s Turkish operations in retaliation for its Cypriot move. Turkish grandstanding is unlikely to lead to a military conflict, but Cyprus has taken precautions and is strengthening its defence relationships, including with Israel and Italy, and is set to procure two French naval vessels. So for the time being a pipeline to Turkey is impossible.
Nicosia says that economic decisions should not be stalled by politics and is pushing ahead with the development of its resources. It has an interest in marketing the gas as soon as possible; energy analysts expect that global gas prices may start to fall in the next decade as new sources, such as US shale gas, become globally available. Cyprus’ energy minister Yiorgos Lakkotrypis has estimated profits for Cyprus from the Aphrodite field to be between €8.8 and €13.2 billion.
The second export option is a pipeline to Greece via Crete. In October 2013, the European Commission designated the proposed EastMed pipeline a ‘project of common interest’, potentially making it eligible for EU funding. The European Commission is championing an agenda to diversify its energy imports away from Russia and considers gas from the eastern Mediterranean, including Cyprus, a welcome alternative. The EastMed pipeline would bypass Turkey, denying Ankara further influence over Europe’s energy supply as a transit country. (If the EU chooses to import gas from the Caspian, or from Iraq or Iran, Turkey is the transit corridor.) However, because of the depth of the Mediterranean, the EastMed pipeline raises engineering challenges which could make costs prohibitively high. Also, the pipeline would do little to reduce Cypriot-Turkish tensions.
Nicosia’s favoured option is to construct an LNG terminal at Vassiliko, in southern Cyprus. An LNG terminal would give Cyprus maximum export independence, allowing it to sell its gas globally – including to the lucrative Asian market – rather than tie itself by pipeline to one customer. An LNG terminal could turn Cyprus into a regional energy hub in the eastern Mediterranean; Israel (or even Lebanon and Syria) could eventually export gas through a Cypriot terminal. Extending a pipeline connecting the Aphrodite field and the LNG terminal to Israel’s neighbouring offshore gas fields would be relatively straightforward.
Much will depend on the amount of gas available. At a recent conference in Nicosia, energy experts from across Europe questioned the viability of the LNG terminal. Cypriot gas discoveries may be insufficient for the development of even a small-scale LNG plant. Noble Energy has admitted that 6 or 7 tcf would be needed to warrant the required investment of €8-€10 billion. Cyprus either needs to find more gas, or attract gas from its neighbours to feed into the LNG terminal.
One of those neighbours, Israel, has made the largest discoveries so far in the eastern Mediterranean, including the 18.9 tcf Leviathan field and the 10 tcf Tamar field. The Israeli High Court has decided that 40 per cent of Israel’s natural gas resources will be made available for export.
For Israel, constructing a pipeline to Turkey is the cheapest option, but is geopolitically complex. Diplomatic relations between Ankara and Israel have slowly improved since Israel’s prime minister Benjamin Netanyahu apologised for the Gaza flotilla incident but Turkey still maintains that Israel must pay compensation to the victims. However, an Israeli-Turkish pipeline is in Ankara’s interest. Not only would Israel’s sizeable resources contribute to satisfying Turkey’s growing energy demands, but it would also strengthen Turkey’s role as a transit country.
A Israeli-Turkish deal would not preclude Israel from co-operating with Cyprus either, as the government of Israel has indicated that it favours a combination of export options. It is unlikely that Israel will opt to export all of its gas through a Cypriot LNG terminal, as this would make Israel’s exports vulnerable to Cypriot politics and security issues. But it may export some.
All this creates the possibility of a grand bargain between Turkey, Israel and Cyprus. Nicosia would receive a share of Israeli gas exports to process through its LNG terminal, making it economically viable, and in return Nicosia would acquiesce to an Israeli-Turkish pipeline crossing its exclusive economic zone. Turkey would secure more access to gas, and Israel would have diversified its export routes. This mutually beneficial deal could calm the waters between Ankara and Nicosia, and encourage reconciliation on the island. Although difficult, it is the option that would produce the best economic, political and strategic benefits for most parties concerned, including the EU.
Russia, however, might be a spoiler in such a triangular arrangement. The Russian government has a commercial and political interest in maximising the amount of Russian gas that reaches Europe and restricting the amount of non-Russian gas. Russian energy firms have been making inroads in the eastern Mediterranean, in particular by securing gas exploration rights in Syria and flirting with Lebanon. In early 2013 Gazprom signed a deal to export LNG from Israel’s Tamar field. So far no Russian energy company is active in Cyprus offshore, but Russia still has significant economic and political influence on the island. The EU should remain aware of Russian commercial and political efforts in the region.
Cyprus’ ability to export LNG greatly depends on Israeli choices. For if political obstacles continue to stand in the way of an Israeli-Turkish pipeline, Tel Aviv might simply develop an LNG terminal of its own (floating offshore or at an onshore location), making a Cypriot LNG plant obsolete. The EU should continue to engage with Israel, and energy companies like Noble Energy, throwing its weight behind regional co-operation around an LNG terminal in Cyprus. The EU’s foreign policy service should also work together with the United States to help improve political and economic relations between Israel and Turkey, in particular a possible pipeline.
The EU should think strategically about linking its energy and foreign policies. Brussels should use its leverage of being the most likely destination of natural gas from the region. When making its assessment of Cyprus’ gas export options, it must consider the impact on regional stability and the potential to achieve progress towards Cypriot reconciliation. If not, the story of Cypriot natural gas may become another tale of missed opportunities.
Rem Korteweg is a senior research fellow at the Centre for European Reform.
Monday, December 16, 2013
What Germany's new coalition government means for the EU
Almost three months after the general election in September, Germany finally has a new government. In a grassroots referendum, members of Germany’s Social Democrats (SPD) voted to accept a coalition agreement that party leaders had drawn up with Angela Merkel’s Christian Democrats (CDU) and its smaller, more conservative sister party, the Christian Social Union (CSU). The new government is unlikely to change EU policy a great deal.
In German, the coalition agreement is called Koalitionsvertrag, or coalition treaty. Germans like treaties and other rules that bind. But Germans also know that coalition agreements do not necessarily bind the politicians that sign them. Few of the big decisions that have shaped German politics in recent years were included in coalition agreements; for example the decisions to send troops into foreign wars, abolish conscription or shut down all nuclear power stations were not. The last coalition agreement of 2009 said nothing about the euro crisis.
Therefore, the new coalition treaty should be taken for what it is: a declaration of intent and a snapshot of what the three parties involved are thinking at the moment. Even bearing this in mind, the European policy chapter of the new agreement will inspire few people. The three parties make a strong commitment to the EU (“European integration remains our most important task”) and to the euro (“Germany stands by the single currency”). But like the rest of the text, the Europe chapter often papers over conflicts by simply adding up positions: we want fiscal consolidation; and growth. We want a stronger Europe; and subsidiarity. We want more solidarity; as long as countries take responsibility for their own problems. And so on.
There are few concrete proposals for reforming the EU. Beyond a vague promise to “adjust the treaty provisions on economic and monetary union” (perhaps to allow for banking union, stronger fiscal oversight or reform contracts), there is no mention of a major treaty change, nor of a move towards fiscal or political union.
The agreement reconfirms the ‘community method’ as being central to EU decision-making (the community method involves the European Commission, Parliament and Council of Ministers in EU law-making) – despite the fact that Merkel has on several occasions expressed a preference for inter-governmental decision-making. Unless the euro crisis flares up again, European governance is likely to revert from crisis mode (late-night phone calls between big country leaders and dramatic Eurogroup summits) to the established interaction between Commission, Parliament and Council. However, other than stronger fiscal oversight, the Commission is unlikely to gain much additional authority as long as Merkel stays in power.
Guido Westerwelle, the FDP foreign minister, has been replaced by Frank-Walter Steinmeier, who held that job during the last grand coalition. Steinmeier is less of a true believer in European integration than Westerwelle. Nevertheless he will be one of the strong figures in the government and the weight of the foreign ministry – traditionally, sympathetic to the EU – in decision-making may grow.
The agreement advises Brussels to “focus on the big issues of the future” instead of meddling in policy areas that are better left to the member-states or their regions. It also calls for a measurable reduction of EU regulation in selected areas, specifically those that affect small and medium-sized businesses. The new German government also wants to see a “more streamlined and efficient college of commissioners, with clearer responsibilities for individual commissioners”. This implies that the German government is open to the idea of dividing the college into junior and senior Commissioners (as proposed in a recent CER report).
The coalition agreement seems to confirm a gradual disillusionment of the German political class with the European Parliament. Traditionally, Germany has been one of the strongest backers of the EU’s legislature. However, the coalition deal states that for the democratic legitimacy of the EU, the involvement of national parliaments in EU business is “equally important as” a strong European Parliament. This will please people in Britain, the Netherlands, Denmark and other countries that want to see a stronger role for national legislatures in the EU. But it will surprise and infuriate many MEPs.
Relations between Berlin and the Parliament may be rocky in the coming years, partly because Merkel does not like its idea that the party with the most seats after the European elections should see its designated candidate automatically become Commission president (see the recent CER essay by Heather Grabbe and Stefan Lehne). The coalition agreement does not deal with this topic, but instead calls for an EU-wide electoral system with a minimum threshold to keep fringe parties out of the European Parliament.
When it comes to handling the euro crisis, the coalition treaty reconfirms the traditional German line that the main responsibility for dealing with it lies with the euro countries that got into trouble. “The public debt ratios in the euro countries need to be reduced further”, states the agreement. And it calls for the EU to strengthen its oversight and control over national budgets.
But the coalition parties also acknowledge that fiscal overspending was not the only reason for the crisis. The debate in Germany has in any case moved on from stereotyping work-shy Southern Europeans. But it is noteworthy that the coalition text explicitly lists fundamental flaws in the construction of the euro, mentioning financial market distortions and macro-economic imbalances among the causes of the crisis. It is equally noteworthy that the agreement does not offer new solutions to these problems.
The agreement states that economic imbalances in the eurozone need to be addressed through the efforts of “all euro member-states”. But those who had hoped that the inclusion of the Social Democrats in the government would result in Germany spending much more, and thus helping to rebalance the eurozone economy, are likely to be disappointed. Sebastian Dullien from ECFR has calculated that the extra spending promised for infrastructure, education, municipalities and pensions amounts to 0.1 per cent of German GDP for each year that the new government can expect to be in power. Most of the additional spending will go on consumption. A new national minimum wage and the first strengthening of trade union rights in decades could push wages up, which might lower Germany’s large current-account surplus. What Germany particularly needs for sustained growth, however, is more investment. On growth-boosting structural reforms in Germany, the coalition agreement says little.
The agreement demands that the EU must finally break the “interdependence between private bank debt and public debt”. It does not promise faster or more wide-ranging steps towards a banking union than had hitherto been proposed by Angela Merkel and Wolfgang Schäuble, her finance minister (who will stay in post). The new government insists that shareholders and creditors must be first in line when a bank gets into trouble, and that a new eurozone resolution fund should be paid for by the banks themselves, not taxpayers. Until the new fund has collected enough money, the European Stability Mechanism, the eurozone’s bail-out fund, may be used for bank recapitalisations, but only as a last resort (if bail-ins and national bail-outs are exhausted) and only up to a limit of €60 billion. As expected, Germany does not want its local savings banks included in the banking union, and it still rejects joint European deposit insurance.
Looking beyond the crisis, the coalition agreement puts a lot of emphasis on the need for structural reforms in the eurozone, to increase economic growth rates in a sustainable way. The idea of “reform contracts” between individual euro countries and the “European level” is taken up again. However, there is no explicit commitment to a new eurozone budget to motivate countries that struggle with tough reforms. Instead, the coalition agreement calls for a better use of EU Structural Funds and the European Investment Bank to underpin structural change and modernisation.
The SPD’s influence is visible in a lengthy section about the need to strengthen the “social dimension” of the EU. However, the only tangible measures in this respect are German help for neighbouring countries that want to improve their apprenticeship systems (this started under the last Merkel government) and the drawing-up of an EU social “scoreboard”. This scoreboard (a Commission idea) would be an attempt to feed warning signs of high employment and social pain into the EU’s strengthened fiscal and economic surveillance.
It should not come as a surprise that the coalition agreement largely perpetuates Germany’s euro policies of the last four years. First, when it comes to euro crisis management, Germany has effectively had a grand coalition since 2010. In her last government (a coalition with the liberal FDP), Angela Merkel was faced with a small but persistent anti-bailout rebellion within her own ranks. Therefore, she had to rely on the SPD to pass almost all big euro-related measures in parliament. Therefore, Germany’s euro crisis management was already to some extent a compromise between the CDU/CSU and the SPD.
Second, existing and pending rulings by the powerful constitutional court put clear limits on what any German government can do. The court has ruled that no German government is allowed to create unlimited liabilities for the German taxpayer. The coalition agreement’s reiteration that the new government will not support eurozone debt mutualisation is therefore not surprising.
Third, German voters overwhelmingly support the cautious course that Merkel has charted in the crisis so far. For the SPD to demand a radical departure would have been politically risky – and hard to sell now that most Germans think the worst of the crisis is behind them.
Finally, the past four years have taught German politicians that it would be foolish to lay down either ambitious goals or rigid red lines at a time of crisis. As long as the eurozone looks shaky, German politicians will want to have a large degree of flexibility to react to developments. For some, the fact that the coalition programme is rather vague on EU policy will be disappointing. But this vagueness will allow the new German government to react flexibly if there is renewed instability in the eurozone.
Katinka Barysch is director of political relations at Allianz SE. The views expressed here are her own.
In German, the coalition agreement is called Koalitionsvertrag, or coalition treaty. Germans like treaties and other rules that bind. But Germans also know that coalition agreements do not necessarily bind the politicians that sign them. Few of the big decisions that have shaped German politics in recent years were included in coalition agreements; for example the decisions to send troops into foreign wars, abolish conscription or shut down all nuclear power stations were not. The last coalition agreement of 2009 said nothing about the euro crisis.
Therefore, the new coalition treaty should be taken for what it is: a declaration of intent and a snapshot of what the three parties involved are thinking at the moment. Even bearing this in mind, the European policy chapter of the new agreement will inspire few people. The three parties make a strong commitment to the EU (“European integration remains our most important task”) and to the euro (“Germany stands by the single currency”). But like the rest of the text, the Europe chapter often papers over conflicts by simply adding up positions: we want fiscal consolidation; and growth. We want a stronger Europe; and subsidiarity. We want more solidarity; as long as countries take responsibility for their own problems. And so on.
There are few concrete proposals for reforming the EU. Beyond a vague promise to “adjust the treaty provisions on economic and monetary union” (perhaps to allow for banking union, stronger fiscal oversight or reform contracts), there is no mention of a major treaty change, nor of a move towards fiscal or political union.
The agreement reconfirms the ‘community method’ as being central to EU decision-making (the community method involves the European Commission, Parliament and Council of Ministers in EU law-making) – despite the fact that Merkel has on several occasions expressed a preference for inter-governmental decision-making. Unless the euro crisis flares up again, European governance is likely to revert from crisis mode (late-night phone calls between big country leaders and dramatic Eurogroup summits) to the established interaction between Commission, Parliament and Council. However, other than stronger fiscal oversight, the Commission is unlikely to gain much additional authority as long as Merkel stays in power.
Guido Westerwelle, the FDP foreign minister, has been replaced by Frank-Walter Steinmeier, who held that job during the last grand coalition. Steinmeier is less of a true believer in European integration than Westerwelle. Nevertheless he will be one of the strong figures in the government and the weight of the foreign ministry – traditionally, sympathetic to the EU – in decision-making may grow.
The agreement advises Brussels to “focus on the big issues of the future” instead of meddling in policy areas that are better left to the member-states or their regions. It also calls for a measurable reduction of EU regulation in selected areas, specifically those that affect small and medium-sized businesses. The new German government also wants to see a “more streamlined and efficient college of commissioners, with clearer responsibilities for individual commissioners”. This implies that the German government is open to the idea of dividing the college into junior and senior Commissioners (as proposed in a recent CER report).
The coalition agreement seems to confirm a gradual disillusionment of the German political class with the European Parliament. Traditionally, Germany has been one of the strongest backers of the EU’s legislature. However, the coalition deal states that for the democratic legitimacy of the EU, the involvement of national parliaments in EU business is “equally important as” a strong European Parliament. This will please people in Britain, the Netherlands, Denmark and other countries that want to see a stronger role for national legislatures in the EU. But it will surprise and infuriate many MEPs.
Relations between Berlin and the Parliament may be rocky in the coming years, partly because Merkel does not like its idea that the party with the most seats after the European elections should see its designated candidate automatically become Commission president (see the recent CER essay by Heather Grabbe and Stefan Lehne). The coalition agreement does not deal with this topic, but instead calls for an EU-wide electoral system with a minimum threshold to keep fringe parties out of the European Parliament.
When it comes to handling the euro crisis, the coalition treaty reconfirms the traditional German line that the main responsibility for dealing with it lies with the euro countries that got into trouble. “The public debt ratios in the euro countries need to be reduced further”, states the agreement. And it calls for the EU to strengthen its oversight and control over national budgets.
But the coalition parties also acknowledge that fiscal overspending was not the only reason for the crisis. The debate in Germany has in any case moved on from stereotyping work-shy Southern Europeans. But it is noteworthy that the coalition text explicitly lists fundamental flaws in the construction of the euro, mentioning financial market distortions and macro-economic imbalances among the causes of the crisis. It is equally noteworthy that the agreement does not offer new solutions to these problems.
The agreement states that economic imbalances in the eurozone need to be addressed through the efforts of “all euro member-states”. But those who had hoped that the inclusion of the Social Democrats in the government would result in Germany spending much more, and thus helping to rebalance the eurozone economy, are likely to be disappointed. Sebastian Dullien from ECFR has calculated that the extra spending promised for infrastructure, education, municipalities and pensions amounts to 0.1 per cent of German GDP for each year that the new government can expect to be in power. Most of the additional spending will go on consumption. A new national minimum wage and the first strengthening of trade union rights in decades could push wages up, which might lower Germany’s large current-account surplus. What Germany particularly needs for sustained growth, however, is more investment. On growth-boosting structural reforms in Germany, the coalition agreement says little.
The agreement demands that the EU must finally break the “interdependence between private bank debt and public debt”. It does not promise faster or more wide-ranging steps towards a banking union than had hitherto been proposed by Angela Merkel and Wolfgang Schäuble, her finance minister (who will stay in post). The new government insists that shareholders and creditors must be first in line when a bank gets into trouble, and that a new eurozone resolution fund should be paid for by the banks themselves, not taxpayers. Until the new fund has collected enough money, the European Stability Mechanism, the eurozone’s bail-out fund, may be used for bank recapitalisations, but only as a last resort (if bail-ins and national bail-outs are exhausted) and only up to a limit of €60 billion. As expected, Germany does not want its local savings banks included in the banking union, and it still rejects joint European deposit insurance.
Looking beyond the crisis, the coalition agreement puts a lot of emphasis on the need for structural reforms in the eurozone, to increase economic growth rates in a sustainable way. The idea of “reform contracts” between individual euro countries and the “European level” is taken up again. However, there is no explicit commitment to a new eurozone budget to motivate countries that struggle with tough reforms. Instead, the coalition agreement calls for a better use of EU Structural Funds and the European Investment Bank to underpin structural change and modernisation.
The SPD’s influence is visible in a lengthy section about the need to strengthen the “social dimension” of the EU. However, the only tangible measures in this respect are German help for neighbouring countries that want to improve their apprenticeship systems (this started under the last Merkel government) and the drawing-up of an EU social “scoreboard”. This scoreboard (a Commission idea) would be an attempt to feed warning signs of high employment and social pain into the EU’s strengthened fiscal and economic surveillance.
It should not come as a surprise that the coalition agreement largely perpetuates Germany’s euro policies of the last four years. First, when it comes to euro crisis management, Germany has effectively had a grand coalition since 2010. In her last government (a coalition with the liberal FDP), Angela Merkel was faced with a small but persistent anti-bailout rebellion within her own ranks. Therefore, she had to rely on the SPD to pass almost all big euro-related measures in parliament. Therefore, Germany’s euro crisis management was already to some extent a compromise between the CDU/CSU and the SPD.
Second, existing and pending rulings by the powerful constitutional court put clear limits on what any German government can do. The court has ruled that no German government is allowed to create unlimited liabilities for the German taxpayer. The coalition agreement’s reiteration that the new government will not support eurozone debt mutualisation is therefore not surprising.
Third, German voters overwhelmingly support the cautious course that Merkel has charted in the crisis so far. For the SPD to demand a radical departure would have been politically risky – and hard to sell now that most Germans think the worst of the crisis is behind them.
Finally, the past four years have taught German politicians that it would be foolish to lay down either ambitious goals or rigid red lines at a time of crisis. As long as the eurozone looks shaky, German politicians will want to have a large degree of flexibility to react to developments. For some, the fact that the coalition programme is rather vague on EU policy will be disappointing. But this vagueness will allow the new German government to react flexibly if there is renewed instability in the eurozone.
Katinka Barysch is director of political relations at Allianz SE. The views expressed here are her own.
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