by Charles Grant
As far as the rest of Europe was concerned, the worst thing about Poland’s Law and Justice government, led by Jaroslaw Kaczynski (and supported by his twin brother, President Lech Kaczynski), was its foreign policy. The twins’ attitude towards Russia, Germany and – sometimes – the EU was confrontational. The Civic Platform government that took over in October is shifting Poland’s foreign policy. Its ministers often speak to the Germans without reminding them of the war. More controversially, the government is trying to build bridges with Russia. Moscow has lifted its ban on meat exports from Poland, while Warsaw has consulted the Russians about the Bush administration’s plans to deploy missile defence systems in Poland. Prime Minister Donald Tusk is much less enthusiastic than the Kaczynskis about missile defence.
The Civic Platform government is even contemplating a radical shift in policy on gas pipelines. With help from German companies, Gazprom plans to build the Nordstream pipeline, under the Baltic Sea, to Germany. The economics of this project are rather a mystery. It will cost much more than a new land pipeline from Russia to Germany, passing through Poland. Many Poles therefore see Nordstream as a geopolitical threat: it would allow Russia to cut off gas to Poland without blocking supplies to Germany and the rest of Europe. Poles of all political stripes have therefore attacked the planned pipeline as a threat to their national security.
But Angela Merkel’s government, though keen to see warmer relations with Warsaw, continues to back Nordstream, and the odds are that it will be built. The Germans are now trying to persuade the Poles to join the project. The gas from Nordstream will run over German land near the Polish border. A short spur could take the gas into Poland. Some members of the Civic Platform government see the undoubted geopolitical benefits of joining the project: Russia could not squeeze gas supplies to the Poles if they could draw on Nordstream gas.
But two issues are making the government hesitate before abandoning its opposition to Nordstream. One is the economics of the project. If joining Nordstream meant that Poland had to take on a significant share of the huge costs of building the Baltic pipeline, it might not be worth it. However, some Poles believe that they can play on the Germans sense of guilt – they embarked on Nordstream without consulting the Poles – to get them to pay most of the bills. The second issue is Polish politics. If Tusk’s government ‘gives in’ to the Russians by supporting their pipeline, it will be hugely controversial. Jaroslaw Kaczynski would attack the government for failing to stop Nordstream and for pandering to Russia.
Although defeated in last October’s parliamentary election, Law and Justice remains powerful. The party increased its share of the vote from 27 to 32 percent, and only lost because support for its far-right allies, the League of Polish Families and Self-Defence, collapsed. The party’s hold on the presidency means that it can veto legislation promoted by the government.
Law and Justice is already attacking Civic Platform over missile defence. Both Kaczynskis want to get American missiles onto Polish soil as quickly as possible. They believe that participation in US missile defence systems will increase the security bond between Washington and Warsaw, and provide extra insurance against potential Russian aggression.
Tusk and his foreign minister, Radek Sikorski, take a different line. They argue – in my view rightly – that missile defence would enhance American security but worsen Polish security. Poland is not threatened by any putative Iranian missiles. If the US installed missiles on Polish soil, it would stoke up Russian hostility to Poland. The Polish government is therefore telling the US that, in return for taking the missiles, it wants: new air-defence systems, such as Patriot 3, to protect the missile site; agreements from the US to protect the missile base; and American investment in the Polish defence industry. Poland is therefore diverging from the Czech government, which is due to take the radars for the US system, and is much more enthusiastic about missile defence (although public opinion in both Poland and the Czech Republic would rather opt out).
Even if the US says yes to all the Polish demands, which is unlikely, I doubt that Tusk will sign up to anything so long as George W Bush is in office. There is considerable mistrust between some senior people in the Tusk and Bush governments. Poland will probably wait till the next president takes office, see what he or she wants to do, and then take a view. That kind of caution would probably in Poland’s best interests, even though the twins will attack the government for going soft on the Russians.
Charles Grant is director of the Centre for European Reform.
Thursday, January 17, 2008
Thursday, January 10, 2008
What, if anything, is Europe to do about Pakistan?
by Melissa Ball and Tomas Valasek
As if to prove that “when it rains, it pours”, Pakistan took yet another step towards chaos with the assassination on December 27th of Benazir Bhutto, the country’s former prime minister. This comes on the heels of months of protests by the country’s lawyers and judges, a mounting Islamist challenge to Pakistan’s secular nature, and the increasing isolation of Pervez Musharraf’s regime. With Bhutto’s untimely death, the country’s best hope for stability – a power-sharing agreement between Bhutto and Musharraf – is no longer possible. And while Pakistan remains relatively calm for now (it could be worse), a violent regime change or even a civil war no longer seem implausible.
Pakistan matters enormously. It borders the rising powers of India and China as well as two of the world’s worst trouble spots, Afghanistan and Iran. A failed Pakistan is certain to destabilize Afghanistan, and may well derail India’s peaceful development (if the violence in the contested region of Kashmir worsens). Equally importantly for Europe, Pakistan’s northwestern region serves as training and recruiting ground for al-Qaeda terrorists. Pakistan-trained terrorists have already struck in the UK but Germans, too, were found to be training in Pakistan’s terrorist camps, and the Taliban also claims to have French and other nationalities in its ranks. Add to this a sizeable stash of nuclear weapons, and the prospect of Pakistan disintegrating into its ethnic constituencies becomes scary indeed.
Pakistan may be thousands of miles away from Europe but its collapse would certainly reverberate here as well. Europe must think hard about what can be done to help. The Europeans’ biggest stake in Pakistan is via their involvement in Afghanistan. Troops from 21 European countries there are having a terrible time fighting the Taliban, who draw support from the tribes in Pakistan’s lawless northwestern region. It is becoming clear that Afghanistan cannot be secured unless Pakistan’s tribal areas are brought under some semblance of central control. If Pakistan collapses, that task will become impossible, and the chance for a successful Afghan state may slip away.
NATO commands the Afghanistan operation, and until recently, it ran a busy military-to-military dialogue with Pakistan. That conversation has largely stopped for now, NATO officials say, until Pakistan’s internal situation becomes more stable. But when and if it resumes, European countries involved in NATO’s Afghanistan mission should use the forum to press Pakistan for more co-operation on the fight against the Taliban. They should also explore whether the scope of the debates can be expanded to include Pakistan’s domestic situation.
But beyond this forum Europe’s leverage over Pakistan is limited. The reality is that events in Pakistan have a bigger impact on Europe than the European Union (EU) exerts on Pakistan. Asian countries by and large view the EU as a collection of nation-states rather than a whole. While on trade issues they speak to the EU, on foreign policy national capitals matter far more than the union. London almost certainly has a bigger say in Pakistan than Brussels.
That would be fine in principle except that member-states find it difficult to have a meaningful influence alone. In Pakistan, even the United States tried and failed to broker a Musharraf-Bhutto alliance. Islamabad has become introverted and closed.
The question then becomes how to use the EU’s limited influence, and, whether it is possible to expand it. On the first count, Europe’s main goal should be to ensure that the Pakistani elections next month are fair, free and timely. Europe has offered to send an election monitoring mission to assist with the forthcoming elections on February 18th (moved from January 8th). This includes 11 election experts and fifty long-term observers. Europe should make it clear to Musharraf that he must not delay the elections any longer for his own political gain, as Bhutto’s Pakistan People’s Party (which stands to benefit the most from the sympathy factor) fears. Musharraf’s decreasing credibility in conjunction with rigged elections would snuff out any hope of return to normality in the near to medium term.
Europe should also use its leverage over the US to lean on Washington to insist on fully democratic elections. For too long, Musharraf, who has been a willing aide in Washington’s fight against terrorism, enjoyed America’s nearly total support, despite having previously overthrown a civilian government. That attitude has begun to change lately – the US was behind the push for a Bhutto-Musharraf alliance, and US diplomats have been quietly talking to some of the Islamists opposition parties, too. Europe should encourage Washington to fully end their dependency on Musharraf, and to press for democratic elections.
Beyond these measures there seem precious few options for the EU to act, certainly in the short run. Since the September 11th attacks the EU has consciously tried to strengthen its role in the country. It gave Pakistani goods preferential access to European markets. In 2005 the EU provided tens of millions of euros to help Pakistan deal with the aftermath of a massive earthquake. Yet none of this seems to have raised Europe’s profile much. Javier Solana, the EU’s foreign policy representative is said to be speaking to Musharraf often but to little effect. But for now, Europe’s best hope is to use its limited leverage to press for democracy, and to hope for Musharraf to become more open to outside influence. A visit to Brussels would be a strong signal of interest.
In the long run, the EU could and should use its know-how in institution-building to help Pakistan overcome its ethnic divisions. As things stand, Pakistan’s political parties represent regional and ethnic interests rather than ideas. And while Bhutto, who hailed from the southern Sindh province, has gained nation-wide appeal and always viewed herself as Pakistani first, the fear is that her successors will put Sindhi interests before Pakistan. In that case, even if the elections are free and fair, the late Bhutto’s party victory may exacerbate ethnic tensions and fail to produce a stable government (not unlike in Iraq, where elections manifestly failed to heal the ethnic divide between the Sunnis, Shiites and Kurds).
The EU member-states have considerable know-how in building modern political parties. Those skills have already helped transform the politics of Central and Eastern Europe. The EU member-states should brainstorm about whether a similar formula could be applied to Pakistan. The strife-ridden country badly needs to transcend the politics of ethnicity. If the EU can help, it would make a major contribution to the stability of Pakistan – and perhaps win for itself a greater role in Pakistan’s domestic politics.
Melissa Ball is an associate at SEI and Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
As if to prove that “when it rains, it pours”, Pakistan took yet another step towards chaos with the assassination on December 27th of Benazir Bhutto, the country’s former prime minister. This comes on the heels of months of protests by the country’s lawyers and judges, a mounting Islamist challenge to Pakistan’s secular nature, and the increasing isolation of Pervez Musharraf’s regime. With Bhutto’s untimely death, the country’s best hope for stability – a power-sharing agreement between Bhutto and Musharraf – is no longer possible. And while Pakistan remains relatively calm for now (it could be worse), a violent regime change or even a civil war no longer seem implausible.
Pakistan matters enormously. It borders the rising powers of India and China as well as two of the world’s worst trouble spots, Afghanistan and Iran. A failed Pakistan is certain to destabilize Afghanistan, and may well derail India’s peaceful development (if the violence in the contested region of Kashmir worsens). Equally importantly for Europe, Pakistan’s northwestern region serves as training and recruiting ground for al-Qaeda terrorists. Pakistan-trained terrorists have already struck in the UK but Germans, too, were found to be training in Pakistan’s terrorist camps, and the Taliban also claims to have French and other nationalities in its ranks. Add to this a sizeable stash of nuclear weapons, and the prospect of Pakistan disintegrating into its ethnic constituencies becomes scary indeed.
Pakistan may be thousands of miles away from Europe but its collapse would certainly reverberate here as well. Europe must think hard about what can be done to help. The Europeans’ biggest stake in Pakistan is via their involvement in Afghanistan. Troops from 21 European countries there are having a terrible time fighting the Taliban, who draw support from the tribes in Pakistan’s lawless northwestern region. It is becoming clear that Afghanistan cannot be secured unless Pakistan’s tribal areas are brought under some semblance of central control. If Pakistan collapses, that task will become impossible, and the chance for a successful Afghan state may slip away.
NATO commands the Afghanistan operation, and until recently, it ran a busy military-to-military dialogue with Pakistan. That conversation has largely stopped for now, NATO officials say, until Pakistan’s internal situation becomes more stable. But when and if it resumes, European countries involved in NATO’s Afghanistan mission should use the forum to press Pakistan for more co-operation on the fight against the Taliban. They should also explore whether the scope of the debates can be expanded to include Pakistan’s domestic situation.
But beyond this forum Europe’s leverage over Pakistan is limited. The reality is that events in Pakistan have a bigger impact on Europe than the European Union (EU) exerts on Pakistan. Asian countries by and large view the EU as a collection of nation-states rather than a whole. While on trade issues they speak to the EU, on foreign policy national capitals matter far more than the union. London almost certainly has a bigger say in Pakistan than Brussels.
That would be fine in principle except that member-states find it difficult to have a meaningful influence alone. In Pakistan, even the United States tried and failed to broker a Musharraf-Bhutto alliance. Islamabad has become introverted and closed.
The question then becomes how to use the EU’s limited influence, and, whether it is possible to expand it. On the first count, Europe’s main goal should be to ensure that the Pakistani elections next month are fair, free and timely. Europe has offered to send an election monitoring mission to assist with the forthcoming elections on February 18th (moved from January 8th). This includes 11 election experts and fifty long-term observers. Europe should make it clear to Musharraf that he must not delay the elections any longer for his own political gain, as Bhutto’s Pakistan People’s Party (which stands to benefit the most from the sympathy factor) fears. Musharraf’s decreasing credibility in conjunction with rigged elections would snuff out any hope of return to normality in the near to medium term.
Europe should also use its leverage over the US to lean on Washington to insist on fully democratic elections. For too long, Musharraf, who has been a willing aide in Washington’s fight against terrorism, enjoyed America’s nearly total support, despite having previously overthrown a civilian government. That attitude has begun to change lately – the US was behind the push for a Bhutto-Musharraf alliance, and US diplomats have been quietly talking to some of the Islamists opposition parties, too. Europe should encourage Washington to fully end their dependency on Musharraf, and to press for democratic elections.
Beyond these measures there seem precious few options for the EU to act, certainly in the short run. Since the September 11th attacks the EU has consciously tried to strengthen its role in the country. It gave Pakistani goods preferential access to European markets. In 2005 the EU provided tens of millions of euros to help Pakistan deal with the aftermath of a massive earthquake. Yet none of this seems to have raised Europe’s profile much. Javier Solana, the EU’s foreign policy representative is said to be speaking to Musharraf often but to little effect. But for now, Europe’s best hope is to use its limited leverage to press for democracy, and to hope for Musharraf to become more open to outside influence. A visit to Brussels would be a strong signal of interest.
In the long run, the EU could and should use its know-how in institution-building to help Pakistan overcome its ethnic divisions. As things stand, Pakistan’s political parties represent regional and ethnic interests rather than ideas. And while Bhutto, who hailed from the southern Sindh province, has gained nation-wide appeal and always viewed herself as Pakistani first, the fear is that her successors will put Sindhi interests before Pakistan. In that case, even if the elections are free and fair, the late Bhutto’s party victory may exacerbate ethnic tensions and fail to produce a stable government (not unlike in Iraq, where elections manifestly failed to heal the ethnic divide between the Sunnis, Shiites and Kurds).
The EU member-states have considerable know-how in building modern political parties. Those skills have already helped transform the politics of Central and Eastern Europe. The EU member-states should brainstorm about whether a similar formula could be applied to Pakistan. The strife-ridden country badly needs to transcend the politics of ethnicity. If the EU can help, it would make a major contribution to the stability of Pakistan – and perhaps win for itself a greater role in Pakistan’s domestic politics.
Melissa Ball is an associate at SEI and Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.
Tuesday, December 18, 2007
Don't be fooled: Bali was no breakthrough
by Simon Tilford
The United Nations Climate Change Conference in Bali produced as much as it was ever likely to do. There was no breakthrough, contrary to the claims of some that attended the conference. Nobody should read too much into reports that the US administration fears its negotiators gave too much away. This is just news management, an attempt to create the impression that the US moved further than it did. The US gave nothing away. The aim of the US negotiating team in Bali was to prevent any international agreement that might demand the US cut its emissions, despite the fact the country could do this at relatively moderate cost according to its own Environmental Protection Agency (EPA). This opposition stems partly from the personal intransigence of President Bush, but also reflects a deep-seated reluctance to allow the country’s freedom of action to be constrained by international agreements. It is another big blow to US soft power in the world.
Of course, on current trends the proposed target of a 25-40 percent cut in developed country emissions by 2020 is nonsense. There is no chance whatsoever of such targets being met unless EU governments get very serious, very quickly about curbing emissions. The construction of new coal-fired power stations would not be compatible with meeting such a target for example, so governments in Germany and the UK would have to scrap plans for a new generation of such plants. Germany would also have to overcome its squeamishness about nuclear power. Energy efficiency standards, for everything from cars to buildings would have to be ratcheted-up very aggressively. Crucially, the EU emissions trading scheme (ETS) would need very tight emissions caps. Only then will businesses be confident that the price of carbon will rise steadily, providing sufficiently strong incentives to invest in low-carbon technologies.
However, notwithstanding question marks over the realism of the 25-40 per cent target, the US position – that targets are meaningless without policies can be put in place at the outset to met those targets – is hugely cynical. It is impossible to agree policies to reduce emissions until governments know which targets their economies have to meet. Similarly, the US knows as well as everyone else that the commitments to curb emissions it wants to see from developing countries will only happen if the developed countries take the lead. It is simply not plausible for the US to turn to China and India and demand they commit to mandatory cuts before it does. Per capita US emissions are at least 4 times Chinese levels and more than 10 times Indian ones. Research from the EPA calculates that the US could cut emissions of greenhouse gases by 60 per cent by 2050 at a cost of just 3.2 per cent of GDP. To put that in perspective, US GDP will rise by nearly 200 per cent over this period (assuming annual real GDP growth of 2.5 per cent.) For the world’s only superpower to rule out such action almost looks like a calculated snub to the rest of the world and will prove a big blow to its moral authority.
However, it is still early days – the timetable for agreeing a replacement for Kyoto stretches into 2009, and hence beyond President Bush’s time in office. Whoever replaces him will have to be more open-minded about international action to challenge climate change, even if only for questions of political expediency. With only 18 months left in office Bush can afford to dismiss the damage being done to the US’s international standing and influence. The next president will not have such a luxury and, regardless of how seriously he/she takes the threat of climate change, will calculate that the costs of refusing to join the EU in its attempt to orchestrate international action to address climate change will outweigh the perceived costs of signing-up.
The EU can do much to ensure that the costs of US inaction are steep. The best way to put pressure on the next administration is for the EU to persevere and impose big unilateral cuts in its own emissions. This will not impair the competitiveness of the EU or cost it export markets. Indeed, the opposite is much more likely. The US is unwilling to take action, but neither does it want to see the EU building on its lead in energy efficient technologies. In an age of mounting energy scarcity, geo-political tension and ever more environmentally conscious consumers and businesses, aggressive emissions targets by the EU will be positive for Europe’s authority in the world and for its long-term economic prospects. The Chinese and Indians might not be ready to sign up to mandatory caps on their emissions, but they are only too aware of the need to make their development more environmentally sustainable. The EU is well placed to supply the technology. The more successful it is at doing this, the quicker the US will come to its senses.
Simon Tilford is chief economist at the Centre for European Reform.
The United Nations Climate Change Conference in Bali produced as much as it was ever likely to do. There was no breakthrough, contrary to the claims of some that attended the conference. Nobody should read too much into reports that the US administration fears its negotiators gave too much away. This is just news management, an attempt to create the impression that the US moved further than it did. The US gave nothing away. The aim of the US negotiating team in Bali was to prevent any international agreement that might demand the US cut its emissions, despite the fact the country could do this at relatively moderate cost according to its own Environmental Protection Agency (EPA). This opposition stems partly from the personal intransigence of President Bush, but also reflects a deep-seated reluctance to allow the country’s freedom of action to be constrained by international agreements. It is another big blow to US soft power in the world.
Of course, on current trends the proposed target of a 25-40 percent cut in developed country emissions by 2020 is nonsense. There is no chance whatsoever of such targets being met unless EU governments get very serious, very quickly about curbing emissions. The construction of new coal-fired power stations would not be compatible with meeting such a target for example, so governments in Germany and the UK would have to scrap plans for a new generation of such plants. Germany would also have to overcome its squeamishness about nuclear power. Energy efficiency standards, for everything from cars to buildings would have to be ratcheted-up very aggressively. Crucially, the EU emissions trading scheme (ETS) would need very tight emissions caps. Only then will businesses be confident that the price of carbon will rise steadily, providing sufficiently strong incentives to invest in low-carbon technologies.
However, notwithstanding question marks over the realism of the 25-40 per cent target, the US position – that targets are meaningless without policies can be put in place at the outset to met those targets – is hugely cynical. It is impossible to agree policies to reduce emissions until governments know which targets their economies have to meet. Similarly, the US knows as well as everyone else that the commitments to curb emissions it wants to see from developing countries will only happen if the developed countries take the lead. It is simply not plausible for the US to turn to China and India and demand they commit to mandatory cuts before it does. Per capita US emissions are at least 4 times Chinese levels and more than 10 times Indian ones. Research from the EPA calculates that the US could cut emissions of greenhouse gases by 60 per cent by 2050 at a cost of just 3.2 per cent of GDP. To put that in perspective, US GDP will rise by nearly 200 per cent over this period (assuming annual real GDP growth of 2.5 per cent.) For the world’s only superpower to rule out such action almost looks like a calculated snub to the rest of the world and will prove a big blow to its moral authority.
However, it is still early days – the timetable for agreeing a replacement for Kyoto stretches into 2009, and hence beyond President Bush’s time in office. Whoever replaces him will have to be more open-minded about international action to challenge climate change, even if only for questions of political expediency. With only 18 months left in office Bush can afford to dismiss the damage being done to the US’s international standing and influence. The next president will not have such a luxury and, regardless of how seriously he/she takes the threat of climate change, will calculate that the costs of refusing to join the EU in its attempt to orchestrate international action to address climate change will outweigh the perceived costs of signing-up.
The EU can do much to ensure that the costs of US inaction are steep. The best way to put pressure on the next administration is for the EU to persevere and impose big unilateral cuts in its own emissions. This will not impair the competitiveness of the EU or cost it export markets. Indeed, the opposite is much more likely. The US is unwilling to take action, but neither does it want to see the EU building on its lead in energy efficient technologies. In an age of mounting energy scarcity, geo-political tension and ever more environmentally conscious consumers and businesses, aggressive emissions targets by the EU will be positive for Europe’s authority in the world and for its long-term economic prospects. The Chinese and Indians might not be ready to sign up to mandatory caps on their emissions, but they are only too aware of the need to make their development more environmentally sustainable. The EU is well placed to supply the technology. The more successful it is at doing this, the quicker the US will come to its senses.
Simon Tilford is chief economist at the Centre for European Reform.
Friday, December 07, 2007
Should Europol and Eurojust merge?
by Hugo Brady
Governments increasingly use Europol, the EU’s police office, and Eurojust - its prosecution unit - to investigate criminals operating across borders and bring them to justice. At Europol, national police and crime analysts gather intelligence on crimes ranging from drug trafficking to counterfeiting and terrorism. Eurojust mostly helps prosecute cases across national borders within the EU. All 27 member-states send police and prosecutors to the offices of Europol and Eurojust, each located separately in The Hague.
In 2008, new EU legislation is planned to give Europol wider investigative powers, cut bureaucracy, and give the body more freedom to gather intelligence and information like DNA data. It will also report yearly to the European Parliament and brief national parliaments, making it somewhat more accountable. But the new-look Europol will not be able to arrest people or start investigations independently of the member-states.
Plans are afoot to make Eurojust work better, too. Governments are pondering how best to guarantee the national prosecutors seconded to it have proper powers from their home authorities to be able to work effectively at international level. All Eurojust prosecutors should be invested with a basic level of powers, including powers to issue formal requests for evidence and authorise surveillance, phone taps and undercover operations. This is not currently the case and hampers Eurojust’s considerable potential: the unit’s caseload inceases by an average of 40 per cent yearly.
Such reforms are useful. But they fail to address a basic problem of cross-border crime fighting. Prosecutors and police across the EU have differing roles and powers and this is often an obstacle to effective co-operation between counterparts. In some countries police investigate but also have quasi-judicial powers; in others, prosecutors do police work as well as bring cases to trial. Take surveillance. Police at Europol can be unable to track a drug delivery properly from the Balkans to the Nordics because in some countries only the prosecutor can organise a cross-border surveillance operation. As a result, police can begin to doubt that cross-border co-operation is worth the hassle and uncertainty.
A radical way to address such problems would be to merge Europol and Eurojust into a single European law enforcement co-ordination body. A single body could ensure more coherent co-operation across the EU, whatever the division of labour between national police and prosecutors. It would also mean simpler procedures for dealing with intelligence, less duplication of efforts against the same criminals and better follow-through from investigation to prosecution in cross-border cases. Most member-states would be dead against such a move, however. Britain and Ireland do not want prosecutors to oversee the work of their police, even if only at European level. Others – like Spain and France – fear a merger that could mean the reverse: police investigating cases without the say-so of prosecutors.
But these difficult political issues could be circumvented and better co-ordination ensured by a more modest move. Europol and Eurojust should be re-located to the same building and some of their resources and facilities amalgamated. Each member-state would have a single national office made up of both police and prosecutors without any change to national hierarchies. Eurojust and Europol could simplfy data protection requirements by drawing up a single data protection regime for sharing information across borders to replace the current separate procedures. And intelligence-sharing could be made more secure and cost-effective with a common IT system.
How well Europol and Eurojust co-operate matters. In November 2007, a joint Europol-Eurojust operation (Operation Koala) destroyed a child pornography network that had disguised itself as a respectable international child modeling agency. Based on high quality information, Europol helped national police to identify customers buying illegal and abusive videos of children filmed in Belgium and the Netherlands. Eurojust helped co-ordinate judges and police from 28 countries that had with some connection with the network. As a result, multiple arrests were made – carried out simultaneously in several countries – and thousands of computers, videos and photographs seized as evidence.
However cases like Koala, where the two bodies achieve a high-level of co-operation, are the exception rather than the rule. According to one prosecutor, police and prosecutors working together on cross-border investigations “is the kind of thing that should be our bread and butter but unfortunately we’re not there yet.” Co-location might seem too basic a solution to boost co-operation. But police attest that Europol’s main value is the simple reality of having colleagues from 27 European countries working together on the same corridor in The Hague, an unparalleled resource in day-to-day police co-operation. The addition of prosecutors to this mix would produce a powerful synergy in law enforcement co-operation.
Hugo Brady is a research fellow at the Centre for European Reform.
Governments increasingly use Europol, the EU’s police office, and Eurojust - its prosecution unit - to investigate criminals operating across borders and bring them to justice. At Europol, national police and crime analysts gather intelligence on crimes ranging from drug trafficking to counterfeiting and terrorism. Eurojust mostly helps prosecute cases across national borders within the EU. All 27 member-states send police and prosecutors to the offices of Europol and Eurojust, each located separately in The Hague.
In 2008, new EU legislation is planned to give Europol wider investigative powers, cut bureaucracy, and give the body more freedom to gather intelligence and information like DNA data. It will also report yearly to the European Parliament and brief national parliaments, making it somewhat more accountable. But the new-look Europol will not be able to arrest people or start investigations independently of the member-states.
Plans are afoot to make Eurojust work better, too. Governments are pondering how best to guarantee the national prosecutors seconded to it have proper powers from their home authorities to be able to work effectively at international level. All Eurojust prosecutors should be invested with a basic level of powers, including powers to issue formal requests for evidence and authorise surveillance, phone taps and undercover operations. This is not currently the case and hampers Eurojust’s considerable potential: the unit’s caseload inceases by an average of 40 per cent yearly.
Such reforms are useful. But they fail to address a basic problem of cross-border crime fighting. Prosecutors and police across the EU have differing roles and powers and this is often an obstacle to effective co-operation between counterparts. In some countries police investigate but also have quasi-judicial powers; in others, prosecutors do police work as well as bring cases to trial. Take surveillance. Police at Europol can be unable to track a drug delivery properly from the Balkans to the Nordics because in some countries only the prosecutor can organise a cross-border surveillance operation. As a result, police can begin to doubt that cross-border co-operation is worth the hassle and uncertainty.
A radical way to address such problems would be to merge Europol and Eurojust into a single European law enforcement co-ordination body. A single body could ensure more coherent co-operation across the EU, whatever the division of labour between national police and prosecutors. It would also mean simpler procedures for dealing with intelligence, less duplication of efforts against the same criminals and better follow-through from investigation to prosecution in cross-border cases. Most member-states would be dead against such a move, however. Britain and Ireland do not want prosecutors to oversee the work of their police, even if only at European level. Others – like Spain and France – fear a merger that could mean the reverse: police investigating cases without the say-so of prosecutors.
But these difficult political issues could be circumvented and better co-ordination ensured by a more modest move. Europol and Eurojust should be re-located to the same building and some of their resources and facilities amalgamated. Each member-state would have a single national office made up of both police and prosecutors without any change to national hierarchies. Eurojust and Europol could simplfy data protection requirements by drawing up a single data protection regime for sharing information across borders to replace the current separate procedures. And intelligence-sharing could be made more secure and cost-effective with a common IT system.
How well Europol and Eurojust co-operate matters. In November 2007, a joint Europol-Eurojust operation (Operation Koala) destroyed a child pornography network that had disguised itself as a respectable international child modeling agency. Based on high quality information, Europol helped national police to identify customers buying illegal and abusive videos of children filmed in Belgium and the Netherlands. Eurojust helped co-ordinate judges and police from 28 countries that had with some connection with the network. As a result, multiple arrests were made – carried out simultaneously in several countries – and thousands of computers, videos and photographs seized as evidence.
However cases like Koala, where the two bodies achieve a high-level of co-operation, are the exception rather than the rule. According to one prosecutor, police and prosecutors working together on cross-border investigations “is the kind of thing that should be our bread and butter but unfortunately we’re not there yet.” Co-location might seem too basic a solution to boost co-operation. But police attest that Europol’s main value is the simple reality of having colleagues from 27 European countries working together on the same corridor in The Hague, an unparalleled resource in day-to-day police co-operation. The addition of prosecutors to this mix would produce a powerful synergy in law enforcement co-operation.
Hugo Brady is a research fellow at the Centre for European Reform.
Thursday, November 29, 2007
China is losing its EU friends
by Katinka Barysch
The EU is getting tough on China. That, at least, is the impression one gets from high-ranking EU officials that arrived for the annual EU-China summit in Beijing this week. Economics is the main reason for Europe’s changing mood. The EU’s trade deficit with China is set to reach €170 billion this year, and European business is losing an estimated €55 million a day because of Chinese red tape, trademark violations and unfair subsidies. The EU’s economic troika – Joaquin Almunia, Jean-Claude Juncker and Jean-Claude Trichet – called on China to let its currency rise against the euro. Commission President Barroso and his trade commissioner, Peter Mandelson, warned that they would no longer be able to withstand rising protectionist pressure in Europe, unless the Chinese made it easier for European companies to sell in their markets.
Will the Chinese be frightened? Maybe they should be. Those industries in the EU that compete directly with Chinese mass manufacturers – think Italian textiles, German light bulbs or Czech consumer electronics – have occasionally lobbied for protection. But European retailers and those industries that rely on cheap Chinese inputs, for example steel, have lobbied against. At the political level, the Chinese could usually rely on Germany, the UK and the Commission to make the case for open markets. However, this may no longer be the case.
The Commission’s patience seems to be wearing thin. Mandelson in October wrote a letter to Barroso that suggested that the EU’s dialogue-based approach to solving economic disputes with China may have run its course.
The British may be instinctive free traders. But British business is unlikely to lobby on China’s behalf. UK companies still sell roughly as much to Denmark and Dubai as they sell to China. On the other hand, China is now Britain’s 5th most important source of imports, with the result that the bilateral trade deficit reached €24 billion in 2006, a third of the UK’s total trade deficit with non-EU countries. Services, where UK companies are world leaders, account for only a tiny fraction of Chinese imports because domestic markets remain heavily protected. A recent survey showed that while globally almost half of company bosses see China as the biggest business opportunity, in the UK the share is only 37 per cent.
Perhaps most worrying for the Chinese is the shifting mood in Berlin, however. Germany alone accounts for around 40 per cent of all EU exports to China, not least because Germany specialises in exactly the kind of machine tools that China needs to build up its industrial sector. Since 2000, Germany’s exports to China have risen threefold. Since the German economy is much more dependent on exports than those of other big EU countries, it has had a strong interest in keeping economic relations with China smooth.
In recent years, however, the rising euro has made German goods expensive outside the eurozone. And German, like other western companies, have suffered from China’s very cavalier attitude towards patents and trade marks. In 2006, German machinery exports to China actually fell. Germany’s trade deficit with China has more than doubled since 2000, to €16 billion in 2006, and it keeps growing. Perhaps unsurprisingly, the share of Germans who see China as an economic threat has jumped by 17 percentage points in just two years, to 55 per cent in 2007 – the biggest public opinion turnaround in any big OECD country.
German awareness of China as a competitor, not only a promising market, will rise further as Chinese industry moves up the value chain. Chinese car output, for example, is growing by 40 per cent a year. Although Chinese cars have a long way to go before they can compete with Volkswagen or BMW, the fact that China now produces more of them than Germany has fuelled some disquiet. As has the fact that China has dethroned Germany as the world’s biggest exporter.
At the same time as economic ties are souring, Germany and China have fallen out politically. The Chinese were very upset when Angela Merkel received the Dalai Lama in her Chancellor’s office in September 2007. Merkel initially said she’d expect Beijing to calm down quickly. It did not. Finance Minister Peer Steinbrueck had to cancel a planned trip to Beijing because his counterpart was no longer available. Chinese state-owned companies pulled out of a China-German trade fare. Scheduled dialogues on human rights, the rule of law and foreign policy co-operation were called off.
At the EU summit, Premier Wen Jiabao said that Germany could still be a partner and a friend – provided that Merkel acknowledged publicly that she had made a mistake by seeing the Dalai Lama. The Chancellor is also under growing pressure from German business groups and her SPD partners in the grand coalition. But she is unlikely to budge. In a speech to parliamentarians at home, she insisted that “human rights and the defence of economic interests are two sides of the same coin”.
While they have put relations with Germany on ice, the Chinese have reached out to France. Nicolas Sarkozy grasped the opportunity at a bilateral summit in Beijing on November 25th. As is customary, he came with a group of French business leaders, who signed deals worth around €20 billion (although such ‘summit deals’ have a habit of falling apart afterwards). However, Sarkozy is unlikely to be as friendly to the Chinese as his famously Sinophile predecessor, Jacques Chirac. While he promised strong ties, Sarkozy also admonished Beijing for its currency policy and warned that Europe may slap ‘carbon tariffs’ on Chinese goods unless the Beijing contributed to a post-Kyoto agreement.
Europe will not make a full turn towards protectionism. But there clearly is growing potential for economic friction with China. Beijing’s usual conciliatory language – promising gradual change and open dialogue – may no longer be enough. It may have to offer concrete action on currency policy and economic opening if it wants to win its European friends back.
Katinka Barysch is deputy director of the Centre for European Reform.
The EU is getting tough on China. That, at least, is the impression one gets from high-ranking EU officials that arrived for the annual EU-China summit in Beijing this week. Economics is the main reason for Europe’s changing mood. The EU’s trade deficit with China is set to reach €170 billion this year, and European business is losing an estimated €55 million a day because of Chinese red tape, trademark violations and unfair subsidies. The EU’s economic troika – Joaquin Almunia, Jean-Claude Juncker and Jean-Claude Trichet – called on China to let its currency rise against the euro. Commission President Barroso and his trade commissioner, Peter Mandelson, warned that they would no longer be able to withstand rising protectionist pressure in Europe, unless the Chinese made it easier for European companies to sell in their markets.
Will the Chinese be frightened? Maybe they should be. Those industries in the EU that compete directly with Chinese mass manufacturers – think Italian textiles, German light bulbs or Czech consumer electronics – have occasionally lobbied for protection. But European retailers and those industries that rely on cheap Chinese inputs, for example steel, have lobbied against. At the political level, the Chinese could usually rely on Germany, the UK and the Commission to make the case for open markets. However, this may no longer be the case.
The Commission’s patience seems to be wearing thin. Mandelson in October wrote a letter to Barroso that suggested that the EU’s dialogue-based approach to solving economic disputes with China may have run its course.
The British may be instinctive free traders. But British business is unlikely to lobby on China’s behalf. UK companies still sell roughly as much to Denmark and Dubai as they sell to China. On the other hand, China is now Britain’s 5th most important source of imports, with the result that the bilateral trade deficit reached €24 billion in 2006, a third of the UK’s total trade deficit with non-EU countries. Services, where UK companies are world leaders, account for only a tiny fraction of Chinese imports because domestic markets remain heavily protected. A recent survey showed that while globally almost half of company bosses see China as the biggest business opportunity, in the UK the share is only 37 per cent.
Perhaps most worrying for the Chinese is the shifting mood in Berlin, however. Germany alone accounts for around 40 per cent of all EU exports to China, not least because Germany specialises in exactly the kind of machine tools that China needs to build up its industrial sector. Since 2000, Germany’s exports to China have risen threefold. Since the German economy is much more dependent on exports than those of other big EU countries, it has had a strong interest in keeping economic relations with China smooth.
In recent years, however, the rising euro has made German goods expensive outside the eurozone. And German, like other western companies, have suffered from China’s very cavalier attitude towards patents and trade marks. In 2006, German machinery exports to China actually fell. Germany’s trade deficit with China has more than doubled since 2000, to €16 billion in 2006, and it keeps growing. Perhaps unsurprisingly, the share of Germans who see China as an economic threat has jumped by 17 percentage points in just two years, to 55 per cent in 2007 – the biggest public opinion turnaround in any big OECD country.
German awareness of China as a competitor, not only a promising market, will rise further as Chinese industry moves up the value chain. Chinese car output, for example, is growing by 40 per cent a year. Although Chinese cars have a long way to go before they can compete with Volkswagen or BMW, the fact that China now produces more of them than Germany has fuelled some disquiet. As has the fact that China has dethroned Germany as the world’s biggest exporter.
At the same time as economic ties are souring, Germany and China have fallen out politically. The Chinese were very upset when Angela Merkel received the Dalai Lama in her Chancellor’s office in September 2007. Merkel initially said she’d expect Beijing to calm down quickly. It did not. Finance Minister Peer Steinbrueck had to cancel a planned trip to Beijing because his counterpart was no longer available. Chinese state-owned companies pulled out of a China-German trade fare. Scheduled dialogues on human rights, the rule of law and foreign policy co-operation were called off.
At the EU summit, Premier Wen Jiabao said that Germany could still be a partner and a friend – provided that Merkel acknowledged publicly that she had made a mistake by seeing the Dalai Lama. The Chancellor is also under growing pressure from German business groups and her SPD partners in the grand coalition. But she is unlikely to budge. In a speech to parliamentarians at home, she insisted that “human rights and the defence of economic interests are two sides of the same coin”.
While they have put relations with Germany on ice, the Chinese have reached out to France. Nicolas Sarkozy grasped the opportunity at a bilateral summit in Beijing on November 25th. As is customary, he came with a group of French business leaders, who signed deals worth around €20 billion (although such ‘summit deals’ have a habit of falling apart afterwards). However, Sarkozy is unlikely to be as friendly to the Chinese as his famously Sinophile predecessor, Jacques Chirac. While he promised strong ties, Sarkozy also admonished Beijing for its currency policy and warned that Europe may slap ‘carbon tariffs’ on Chinese goods unless the Beijing contributed to a post-Kyoto agreement.
Europe will not make a full turn towards protectionism. But there clearly is growing potential for economic friction with China. Beijing’s usual conciliatory language – promising gradual change and open dialogue – may no longer be enough. It may have to offer concrete action on currency policy and economic opening if it wants to win its European friends back.
Katinka Barysch is deputy director of the Centre for European Reform.
Friday, November 23, 2007
Bringing Syria into the Middle East peace process
by Clara Marina O'Donnell
The nearer the Annapolis conference comes, the less it looks likely to deliver peace between Israelis and Palestinians. The weakness of the key actors and the current conditions on the ground in the Palestinian territories offer little reason for optimism. But there is one thing that could allow Annapolis to make a big difference – bringing Syria into the peace process. And the EU has a special role to play in encouraging this move.
The key actors are too weak to enforce the costly compromises that peace will demand. The end-of-term Bush administration is widely discredited at home and bogged down by other issues in the region – notably Iraq, Afghanistan, and Iran. Israeli prime minister Ehud Olmert is breaking records for low approval ratings at the head of his fragile coalition, and faces allegations of corruption. The most critical shortcomings are on the Palestinian side. Fatah is so divided that the Palestinian Authority's President Mahmoud Abbas can barely claim to speak for the West Bank, still less for the Palestinian territories as a whole. And violent intra-Palestinian feuding worsens every day, as demonstrated most recently by the deadly shooting at the Arafat anniversary rally in sanction-ridden Gaza.
Without an improvement in the political situation on the Palestinian side, there is no chance of progress towards a final peaceful settlement. Israel will never agree to any concessions that could compromise its security if the other side is manifestly incapable of holding up its part of any deal – or worse, is on the brink of civil war.
Unless Gaza and the West Bank can be brought back together under a single and stable government, it is hard to see how sustainable peace is possible. But that objective looks increasingly unattainable. Hamas’ current violence towards other Palestinians is preventing the possibility of any rapprochement with Fatah. Abbas has started openly calling for the Hamas government in Gaza to be toppled, while the Israeli Defence Force is urging wide-scale military intervention in Gaza. But force may not be able to topple Hamas; Israel’s incursion into Lebanon last year showed just how difficult it is to dislodge a group of fighters who can easily blend into the local population. Worse, force could provoke Hamas to destabilise the West Bank, where the movement also has a strong footing.
Outsiders may need to try a tangential approach. Like pieces in a jigsaw, the region’s conflicts are interconnected, and the next step in solving the Israeli-Palestinian conflict may in fact lie in Syria.
Damascus has close ties with Hamas and hosts its leader-in-exile, Khaled Mashaal. At the same time, Syria is wearying of its international diplomatic isolation, and shows signs of wanting to improve relations with Arab nations, the West, and even Israel. It has hinted that it will be willing to attend Annapolis if the agenda includes the Golan Heights. In what looks like a gesture of good will, Damascus has refused to host a ‘spoilers conference’ that Hamas proposed as a foil to the Annapolis conference.
If Syria's relations with the West and Israel improved, Damascus might pressure Hamas to rein in its use of force, and even oblige it to compromise with Fatah. Such a shift in regional balance could also encourage moderate elements within Hamas: fearful of losing a key foreign supporter, they might ease their opposition to Israel, or distance themselves from the more radical elements in Hamas.
Many in the West will find the prospect of working with Syria uncomfortable. There is the suspicion that Syrian agents are linked to the murder of several anti-Syrian Lebanese politicians, and there is concern about a possible nuclear programme. But the idea of using Syria to influence third parties in the Middle East is not new. France cut ties with Damascus after the Hariri murder, but this week controversially sent two top aides of President Nicolas Sarkozy to Damascus. Their task is to woo the sponsors of Hezbollah towards co-operation in the forthcoming Lebanese presidential election.
Going one step further – winning Syrian support for resolving the Israeli-Palestinian conflict – could prove to be Annapolis’ success. Syria's presence at Annapolis and its engagement in the peace process would clip the wings of the radical elements in Palestinian politics. At present, Syria's attendance is still uncertain. The US and Israel are focusing only on the Palestinian issue, and are unwilling to address the Golan Heights. There is a role here for the EU, which has so far been conspicuous by its absence in the preparations for the conference. The EU should encourage the US and Israel to widen the focus of the current peace effort and include Syria. An invitation could be accompanied by a conditional offer to Syria: its claims to the Golan Heights could be put on the agenda at Annapolis, in exchange for constructive engagement with Hamas in the Palestinian territories, and with Hezbollah in Lebanon.
Clara Marina O'Donnell is research fellow at the Centre for European Reform.
The nearer the Annapolis conference comes, the less it looks likely to deliver peace between Israelis and Palestinians. The weakness of the key actors and the current conditions on the ground in the Palestinian territories offer little reason for optimism. But there is one thing that could allow Annapolis to make a big difference – bringing Syria into the peace process. And the EU has a special role to play in encouraging this move.
The key actors are too weak to enforce the costly compromises that peace will demand. The end-of-term Bush administration is widely discredited at home and bogged down by other issues in the region – notably Iraq, Afghanistan, and Iran. Israeli prime minister Ehud Olmert is breaking records for low approval ratings at the head of his fragile coalition, and faces allegations of corruption. The most critical shortcomings are on the Palestinian side. Fatah is so divided that the Palestinian Authority's President Mahmoud Abbas can barely claim to speak for the West Bank, still less for the Palestinian territories as a whole. And violent intra-Palestinian feuding worsens every day, as demonstrated most recently by the deadly shooting at the Arafat anniversary rally in sanction-ridden Gaza.
Without an improvement in the political situation on the Palestinian side, there is no chance of progress towards a final peaceful settlement. Israel will never agree to any concessions that could compromise its security if the other side is manifestly incapable of holding up its part of any deal – or worse, is on the brink of civil war.
Unless Gaza and the West Bank can be brought back together under a single and stable government, it is hard to see how sustainable peace is possible. But that objective looks increasingly unattainable. Hamas’ current violence towards other Palestinians is preventing the possibility of any rapprochement with Fatah. Abbas has started openly calling for the Hamas government in Gaza to be toppled, while the Israeli Defence Force is urging wide-scale military intervention in Gaza. But force may not be able to topple Hamas; Israel’s incursion into Lebanon last year showed just how difficult it is to dislodge a group of fighters who can easily blend into the local population. Worse, force could provoke Hamas to destabilise the West Bank, where the movement also has a strong footing.
Outsiders may need to try a tangential approach. Like pieces in a jigsaw, the region’s conflicts are interconnected, and the next step in solving the Israeli-Palestinian conflict may in fact lie in Syria.
Damascus has close ties with Hamas and hosts its leader-in-exile, Khaled Mashaal. At the same time, Syria is wearying of its international diplomatic isolation, and shows signs of wanting to improve relations with Arab nations, the West, and even Israel. It has hinted that it will be willing to attend Annapolis if the agenda includes the Golan Heights. In what looks like a gesture of good will, Damascus has refused to host a ‘spoilers conference’ that Hamas proposed as a foil to the Annapolis conference.
If Syria's relations with the West and Israel improved, Damascus might pressure Hamas to rein in its use of force, and even oblige it to compromise with Fatah. Such a shift in regional balance could also encourage moderate elements within Hamas: fearful of losing a key foreign supporter, they might ease their opposition to Israel, or distance themselves from the more radical elements in Hamas.
Many in the West will find the prospect of working with Syria uncomfortable. There is the suspicion that Syrian agents are linked to the murder of several anti-Syrian Lebanese politicians, and there is concern about a possible nuclear programme. But the idea of using Syria to influence third parties in the Middle East is not new. France cut ties with Damascus after the Hariri murder, but this week controversially sent two top aides of President Nicolas Sarkozy to Damascus. Their task is to woo the sponsors of Hezbollah towards co-operation in the forthcoming Lebanese presidential election.
Going one step further – winning Syrian support for resolving the Israeli-Palestinian conflict – could prove to be Annapolis’ success. Syria's presence at Annapolis and its engagement in the peace process would clip the wings of the radical elements in Palestinian politics. At present, Syria's attendance is still uncertain. The US and Israel are focusing only on the Palestinian issue, and are unwilling to address the Golan Heights. There is a role here for the EU, which has so far been conspicuous by its absence in the preparations for the conference. The EU should encourage the US and Israel to widen the focus of the current peace effort and include Syria. An invitation could be accompanied by a conditional offer to Syria: its claims to the Golan Heights could be put on the agenda at Annapolis, in exchange for constructive engagement with Hamas in the Palestinian territories, and with Hezbollah in Lebanon.
Clara Marina O'Donnell is research fellow at the Centre for European Reform.
Thursday, November 15, 2007
The euro as the world’s reserve currency?
by Simon Tilford
Back in the 1970s President Nixon’s treasury secretary, John Connally, famously quipped that “the dollar may be our currency, but it’s your problem”. One of the arguments in favour of establishing the euro was that it would quickly come to rival the dollar’s status as the world’s principle reserve currency and make it hard for the US to abuse its “exorbitant privilege” – devaluing the dollar imposes few costs on the US because its foreign debt is denominated in dollars. Is the wish of those Europeans that want to see the dollar dethroned about to come true? If so, would this be a win-win scenario for the eurozone?
There is no doubt that the threat to the dollar’s status is bigger than at any time since the end of the Second World War. The most likely outcome is that a rapid narrowing of the US current-account deficit and renewed fiscal discipline will combine to restore confidence in the dollar, and that it will retain its status as the world’s leading reserve currency. Confidence in the long-term prospects of the US economy remains strong, and the country’s huge and liquid financial markets make the dollar highly attractive as a reserve currency. However, a rout is a possibility, and could be triggered by a number of events, such as a debt crisis in the US or a steep rise in inflation, which would undercut the willingness of foreigners, crucially East Asian central banks, to hold so many of their reserves in the American currency. Let’s assume for a moment that the damage to the credibility of dollar is such that its role as the world’s favourite currency is lost.
The euro would be the only plausible replacement. It is the world’s second most important reserve currency, though a distant second to the US. The eurozone economy is huge (though not quite as big as the US), its economy is open, its financial markets increasingly deep and liquid, and the ECB now enjoys considerable credibility in the financial markets. But what would it mean for the eurozone, aside from schadenfreude? It would be easier for European companies to operate internationally as there would be less exchange rate risk. With import and export prices denominated in euros the economy, and the inflation rate, would be less vulnerable to shifts in exchange rates. Much more important than this, however, would be the gains from seignorage. As is the case at present in the US, the eurozone would benefit from what are effectively very low interest loans in the form of large central bank holdings of euros. Also, the growth of international trade would boost demand for euros, with the result that the euro-zone could very cheaply finance an external deficit, much as the US has been doing for decades.
But there are downsides to these potential advantages. As the issuer of a major international reserve currency, the eurozone would have to cope with different external risks, such as structural imbalances in the global economy, that are to a large extent responsible for the weakness of the dollar. The huge US current account deficit is the flipside of mercantilist economic policies being pursued by East Asian governments. Internationalisation of the euro could also make it harder to control the stock of euros in circulation and hence growth in the money supply and potentially inflation. An increase in the demand for euros would either cause the currency to appreciate, making exports less competitive, or require that the eurozone run a substantial external deficit in order to satisfy the external demand for euros. For this to happen, the ECB would need to run a looser monetary policy.
The potential for conflict within the eurozone is obvious. A stronger euro would be anathema to many eurozone countries, not least France and Italy, which are already very worried about euro strength. But a looser monetary policy would be anathema to countries such as Germany and the Netherlands that worry about the inflation implications of cheaper money. Indeed, it is far from obvious how the eurozone could run a sizeable current account deficit without exacerbating existing tensions between members of the single currency area with large current-account surpluses, such as Germany and Netherlands, and those with large or rising external deficits – most notably Spain, but also France and Italy. It would be possible for Germany and the Netherlands to continue to run big surpluses at the same time as the eurozone as a whole ran a bigger deficit, but only if other eurozone countries ran even bigger deficits. This is politically implausible.
Becoming the world’s principle reserve currency might not be worth the bragging rights.
Simon Tilford is chief economist at the Centre for European Reform.
Back in the 1970s President Nixon’s treasury secretary, John Connally, famously quipped that “the dollar may be our currency, but it’s your problem”. One of the arguments in favour of establishing the euro was that it would quickly come to rival the dollar’s status as the world’s principle reserve currency and make it hard for the US to abuse its “exorbitant privilege” – devaluing the dollar imposes few costs on the US because its foreign debt is denominated in dollars. Is the wish of those Europeans that want to see the dollar dethroned about to come true? If so, would this be a win-win scenario for the eurozone?
There is no doubt that the threat to the dollar’s status is bigger than at any time since the end of the Second World War. The most likely outcome is that a rapid narrowing of the US current-account deficit and renewed fiscal discipline will combine to restore confidence in the dollar, and that it will retain its status as the world’s leading reserve currency. Confidence in the long-term prospects of the US economy remains strong, and the country’s huge and liquid financial markets make the dollar highly attractive as a reserve currency. However, a rout is a possibility, and could be triggered by a number of events, such as a debt crisis in the US or a steep rise in inflation, which would undercut the willingness of foreigners, crucially East Asian central banks, to hold so many of their reserves in the American currency. Let’s assume for a moment that the damage to the credibility of dollar is such that its role as the world’s favourite currency is lost.
The euro would be the only plausible replacement. It is the world’s second most important reserve currency, though a distant second to the US. The eurozone economy is huge (though not quite as big as the US), its economy is open, its financial markets increasingly deep and liquid, and the ECB now enjoys considerable credibility in the financial markets. But what would it mean for the eurozone, aside from schadenfreude? It would be easier for European companies to operate internationally as there would be less exchange rate risk. With import and export prices denominated in euros the economy, and the inflation rate, would be less vulnerable to shifts in exchange rates. Much more important than this, however, would be the gains from seignorage. As is the case at present in the US, the eurozone would benefit from what are effectively very low interest loans in the form of large central bank holdings of euros. Also, the growth of international trade would boost demand for euros, with the result that the euro-zone could very cheaply finance an external deficit, much as the US has been doing for decades.
But there are downsides to these potential advantages. As the issuer of a major international reserve currency, the eurozone would have to cope with different external risks, such as structural imbalances in the global economy, that are to a large extent responsible for the weakness of the dollar. The huge US current account deficit is the flipside of mercantilist economic policies being pursued by East Asian governments. Internationalisation of the euro could also make it harder to control the stock of euros in circulation and hence growth in the money supply and potentially inflation. An increase in the demand for euros would either cause the currency to appreciate, making exports less competitive, or require that the eurozone run a substantial external deficit in order to satisfy the external demand for euros. For this to happen, the ECB would need to run a looser monetary policy.
The potential for conflict within the eurozone is obvious. A stronger euro would be anathema to many eurozone countries, not least France and Italy, which are already very worried about euro strength. But a looser monetary policy would be anathema to countries such as Germany and the Netherlands that worry about the inflation implications of cheaper money. Indeed, it is far from obvious how the eurozone could run a sizeable current account deficit without exacerbating existing tensions between members of the single currency area with large current-account surpluses, such as Germany and Netherlands, and those with large or rising external deficits – most notably Spain, but also France and Italy. It would be possible for Germany and the Netherlands to continue to run big surpluses at the same time as the eurozone as a whole ran a bigger deficit, but only if other eurozone countries ran even bigger deficits. This is politically implausible.
Becoming the world’s principle reserve currency might not be worth the bragging rights.
Simon Tilford is chief economist at the Centre for European Reform.
Thursday, November 08, 2007
Sarkonomics – a user’s guide
by Philip Whyte
President Sarkozy is frequently portrayed in France and elsewhere as an “economic liberal”. This is a mistake. He is undoubtedly an economic reformer prepared to take on the privileges of labour market “insiders”; but he retains a French dirigiste’s belief in an active role for the state in economic development. This manifests itself in several areas, including his support for “national champions”, his mercantilist vision of international trade, and his belief that governments should have greater influence over the European Central Bank (ECB).
In a French context at least, Mr Sarkozy’s greatest claim to originality probably rests on his policy towards the labour market. From the mid-1970s until comparatively recently, successive French governments sought to stem the rise in recorded unemployment by strengthening employment protection legislation and pursuing a policy of labour market withdrawals—notably by shortening the working week, discouraging young people from joining the labour force too early, and coaxing older workers out of it by lowering the age of retirement.
In other words, for almost three decades French labour market policy was guided by the lump of labour fallacy—the idea that there is only a fixed amount of work to go around. These ill-conceived supply-side policies gave France one of the lowest employment rates in the EU. Mr Sarkozy’s economic priority is to raise France’s rate of employment by reversing, or at least mitigating, the flawed policies of the past. An early measure has been to relax the 35-hour working hour week by exempting overtime work from income tax (“making work pay”).
Inevitably, Mr Sarkozy’s reforms are facing opposition from “insiders” whose privileges they threaten. Public-sector workers such as train-drivers, who enjoy special pension rights which allow them to retire aged 50, have already been on strike to protest at the government’s proposals to raise the retirement age. In the past, such action could often count on the support of the wider population because reforms were often seen as the “thin end of the wedge”—the first salvo in a broader assault on “acquired social rights” (acquis sociaux).
Successive French governments have had a tendency to back down in the face of popular support for industrial action. This time should be different, for at least two reasons. First, Mr Sarkozy has staked his political reputation on pushing such reforms through: should he back down, his authority would be destroyed and the rest of his presidency shorn of purpose. Second, opinion polls indicate that strikes by privileged public-sector workers no longer enjoy the support of the wider population which realises that it bears the burden of supporting them.
Mr Sarkozy’s labour-market reforms are generally wining plaudits abroad, but other aspects of his economic programme are sparking conflict with France’s neighbours. Mr Sarkozy believes that macroeconomic policy needs to be relaxed while his structural reforms are pushed through. This explains why he has criticised the ECB for neglecting the strength of the euro’s exchange rate and for subordinating economic growth to low inflation. The French president’s broadsides against the ECB have been poorly received elsewhere in the EU—notably in Germany, where they have been seen as attacks on the ECB’s independence.
A similar conflict has emerged in the area of fiscal policy. France has not run a balanced budget since the 1970s and its budget deficit has consistently exceeded the Maastricht limit of 3% of GDP since 2002. Earlier in 2007, the French government (of which Mr Sarkozy was a member) committed itself to balancing its budget by 2010. But the budget for 2008 makes no effort to meet this target because it provides for tax cuts that are not offset by reduction in public expenditure. Commitments to the EU are being subordinated to domestic objectives.
As for Mr Sarkozy’s views on competition and international trade, they are anything but liberal. They spring from a mercantilist mind-set which sees a coincidence of interest between domestic firms and the French state and which believes that a country’s aim in international trade is to export more than it imports. This explains Mr Sarkozy’s support for “national champions”, his opposition to foreign takeovers of leading French firms, and his propensity for intervening to “shape” corporate mergers—witness his role in the tie-ups between Sanofi and Aventis (when he was finance minister) and between GDF and Suez (as president).
Philip Whyte is a senior research fellow at the Centre for European Reform.
President Sarkozy is frequently portrayed in France and elsewhere as an “economic liberal”. This is a mistake. He is undoubtedly an economic reformer prepared to take on the privileges of labour market “insiders”; but he retains a French dirigiste’s belief in an active role for the state in economic development. This manifests itself in several areas, including his support for “national champions”, his mercantilist vision of international trade, and his belief that governments should have greater influence over the European Central Bank (ECB).
In a French context at least, Mr Sarkozy’s greatest claim to originality probably rests on his policy towards the labour market. From the mid-1970s until comparatively recently, successive French governments sought to stem the rise in recorded unemployment by strengthening employment protection legislation and pursuing a policy of labour market withdrawals—notably by shortening the working week, discouraging young people from joining the labour force too early, and coaxing older workers out of it by lowering the age of retirement.
In other words, for almost three decades French labour market policy was guided by the lump of labour fallacy—the idea that there is only a fixed amount of work to go around. These ill-conceived supply-side policies gave France one of the lowest employment rates in the EU. Mr Sarkozy’s economic priority is to raise France’s rate of employment by reversing, or at least mitigating, the flawed policies of the past. An early measure has been to relax the 35-hour working hour week by exempting overtime work from income tax (“making work pay”).
Inevitably, Mr Sarkozy’s reforms are facing opposition from “insiders” whose privileges they threaten. Public-sector workers such as train-drivers, who enjoy special pension rights which allow them to retire aged 50, have already been on strike to protest at the government’s proposals to raise the retirement age. In the past, such action could often count on the support of the wider population because reforms were often seen as the “thin end of the wedge”—the first salvo in a broader assault on “acquired social rights” (acquis sociaux).
Successive French governments have had a tendency to back down in the face of popular support for industrial action. This time should be different, for at least two reasons. First, Mr Sarkozy has staked his political reputation on pushing such reforms through: should he back down, his authority would be destroyed and the rest of his presidency shorn of purpose. Second, opinion polls indicate that strikes by privileged public-sector workers no longer enjoy the support of the wider population which realises that it bears the burden of supporting them.
Mr Sarkozy’s labour-market reforms are generally wining plaudits abroad, but other aspects of his economic programme are sparking conflict with France’s neighbours. Mr Sarkozy believes that macroeconomic policy needs to be relaxed while his structural reforms are pushed through. This explains why he has criticised the ECB for neglecting the strength of the euro’s exchange rate and for subordinating economic growth to low inflation. The French president’s broadsides against the ECB have been poorly received elsewhere in the EU—notably in Germany, where they have been seen as attacks on the ECB’s independence.
A similar conflict has emerged in the area of fiscal policy. France has not run a balanced budget since the 1970s and its budget deficit has consistently exceeded the Maastricht limit of 3% of GDP since 2002. Earlier in 2007, the French government (of which Mr Sarkozy was a member) committed itself to balancing its budget by 2010. But the budget for 2008 makes no effort to meet this target because it provides for tax cuts that are not offset by reduction in public expenditure. Commitments to the EU are being subordinated to domestic objectives.
As for Mr Sarkozy’s views on competition and international trade, they are anything but liberal. They spring from a mercantilist mind-set which sees a coincidence of interest between domestic firms and the French state and which believes that a country’s aim in international trade is to export more than it imports. This explains Mr Sarkozy’s support for “national champions”, his opposition to foreign takeovers of leading French firms, and his propensity for intervening to “shape” corporate mergers—witness his role in the tie-ups between Sanofi and Aventis (when he was finance minister) and between GDF and Suez (as president).
Philip Whyte is a senior research fellow at the Centre for European Reform.
Thursday, November 01, 2007
EU-Russia: no more ambitions
by Katinka Barysch
The CER organised a conference on EU-Russia relations in Brussels on October 30th, together with ‘Russia Profile’ magazine. I have been to dozens of these EU-Russia meetings in the last couple of years. More often than not, they turn nasty, with the Russians making angry accusations and the Europeans going into a sulk. At our seminar, the atmosphere was strangely subdued.
No doubt, this was partly due to the professionalism of the panellists. People like Vladimir Chizhov, Konstantin Kosachev, Helga Schmid and Christian Cleutinx make a living addressing big problems without sounding alarming (details of the event can be found here http://www.cer.org.uk/russia_new/events_russia_new.html).
But diplomatic protocol was not the only reason for the lull. A sense of resignation has descended over EU-Russia relations. We have quietly discarded our lofty ambition to build a “strategic partnership based on common values”. Today we just want to get along, somehow.
The same lack of expectations turned last week’s EU-Russia summit in Mafra into a success of sorts. The Portuguese presidency of the EU did not even try to unblock talks on a new EU-Russia treaty. The change of government in Poland has increased the chances that the dispute over meat exports will be resolved and that Warsaw will lift its veto. But neither Russia nor the EU has much enthusiasm for a new treaty. What for? Instead of a shared vision, there is uncertainty: in Russia over its future leadership and direction, and in the EU over whether it can forge a common position among 27 member-states.
Both sides are groping for a path through this period of uncertainty. “Realism” is the term most widely used to describe today’s bilateral relationship. One participant at our seminar called for a “partnership of patience”, another referred to a “carefully crafted holding pattern”.
This total collapse of ambition was probably inevitable. Once Russia started to turn away from pluralist democracy, the EU’s constant talk about ‘common values’ simply antagonised Moscow. The EU ended up frustrated and disappointed. Bitterness grew on both sides. The political rhetoric became so shrill that it started to endanger practical co-operation in energy, investment or security.
Now both sides are trying to reassure each other that things are not that bad after all. Look, trade is growing by 30 per cent a year. EU companies are doing good business in Russia. Russians are coming to the EU in record numbers. The Union is allowed to observe mediation attempts in Transdniestria. Micro-successes are still possible: we now have an ‘early warning mechanism’ in case of disruptions to energy supplies, and a new cultural dialogue. Process matters.
But can the EU and Russia really afford to put their relationship on ice and wait for better days? World politics intrudes in the current lull. Russia has blocked EU-backed plans for Kosovo independence. It is against tougher sanctions aimed at preventing Iran from building a nuclear bomb. Russia behaves as if it didn’t need friends. But when it looks around the world – at a rising China, a disillusioned US, an unstable Middle East – it must conclude that the European countries are still its easiest and most reliable partners.
Vis-Ã -vis Russia, the EU looks divided, confused and often weaker than it is. That is partly because Russia forces the EU to clarify its own objectives. Can the EU become a more powerful international player while at the same time upholding its founding principles of democracy and human rights? Since different member countries have different answers, the EU tries to avoid the question.
Russia also puts the EU’s energy plans to the test. While paying lip service to a common energy policy, EU member-states are rushing to strike bilateral deals with Gazprom. Energy was supposed to be an area where the EU and Russia have clear common interests. But now the Russians complain about a ‘Gazprom clause’ in the Commission’s latest liberalisation package: state-owned foreign companies would not be allowed to buy gas pipelines in the EU, unless their governments agreed to also give European companies better access to their home markets.
Russia is not well placed to lecture the Europeans on energy market liberalisation. But Moscow has a point when asking the EU what it means by reciprocity. If the concept degenerates from a means for mutual openness to a new protectionist tool, it will do nothing to alleviate EU concerns about Russian underinvestment in its gas fields.
The energy debate shows that the shift from ‘values’ to ‘interests’ in EU-Russia relations can only go so far. Values – or more plainly, the way we see things – determine everything we do. When people and politicians in the EU and Russia talk about energy security, they mean different things. The same holds true for democracy, and other terms that allegedly describe the core objectives of our relationship.
I was an early advocate of the EU focusing less on ‘common values’ and more on mutual interests, on areas where practical co-operation is feasible and desirable (see http://www.cer.org.uk/pdf/p564_russia_strat_squabb.pdf).
But I am also the first one to admit that we have come full circle. Ultimately, the EU and Russia need to agree what they want to get out of their interaction.
Katinka Barysch is deputy director of the Centre for European Reform.
The CER organised a conference on EU-Russia relations in Brussels on October 30th, together with ‘Russia Profile’ magazine. I have been to dozens of these EU-Russia meetings in the last couple of years. More often than not, they turn nasty, with the Russians making angry accusations and the Europeans going into a sulk. At our seminar, the atmosphere was strangely subdued.
No doubt, this was partly due to the professionalism of the panellists. People like Vladimir Chizhov, Konstantin Kosachev, Helga Schmid and Christian Cleutinx make a living addressing big problems without sounding alarming (details of the event can be found here http://www.cer.org.uk/russia_new/events_russia_new.html).
But diplomatic protocol was not the only reason for the lull. A sense of resignation has descended over EU-Russia relations. We have quietly discarded our lofty ambition to build a “strategic partnership based on common values”. Today we just want to get along, somehow.
The same lack of expectations turned last week’s EU-Russia summit in Mafra into a success of sorts. The Portuguese presidency of the EU did not even try to unblock talks on a new EU-Russia treaty. The change of government in Poland has increased the chances that the dispute over meat exports will be resolved and that Warsaw will lift its veto. But neither Russia nor the EU has much enthusiasm for a new treaty. What for? Instead of a shared vision, there is uncertainty: in Russia over its future leadership and direction, and in the EU over whether it can forge a common position among 27 member-states.
Both sides are groping for a path through this period of uncertainty. “Realism” is the term most widely used to describe today’s bilateral relationship. One participant at our seminar called for a “partnership of patience”, another referred to a “carefully crafted holding pattern”.
This total collapse of ambition was probably inevitable. Once Russia started to turn away from pluralist democracy, the EU’s constant talk about ‘common values’ simply antagonised Moscow. The EU ended up frustrated and disappointed. Bitterness grew on both sides. The political rhetoric became so shrill that it started to endanger practical co-operation in energy, investment or security.
Now both sides are trying to reassure each other that things are not that bad after all. Look, trade is growing by 30 per cent a year. EU companies are doing good business in Russia. Russians are coming to the EU in record numbers. The Union is allowed to observe mediation attempts in Transdniestria. Micro-successes are still possible: we now have an ‘early warning mechanism’ in case of disruptions to energy supplies, and a new cultural dialogue. Process matters.
But can the EU and Russia really afford to put their relationship on ice and wait for better days? World politics intrudes in the current lull. Russia has blocked EU-backed plans for Kosovo independence. It is against tougher sanctions aimed at preventing Iran from building a nuclear bomb. Russia behaves as if it didn’t need friends. But when it looks around the world – at a rising China, a disillusioned US, an unstable Middle East – it must conclude that the European countries are still its easiest and most reliable partners.
Vis-Ã -vis Russia, the EU looks divided, confused and often weaker than it is. That is partly because Russia forces the EU to clarify its own objectives. Can the EU become a more powerful international player while at the same time upholding its founding principles of democracy and human rights? Since different member countries have different answers, the EU tries to avoid the question.
Russia also puts the EU’s energy plans to the test. While paying lip service to a common energy policy, EU member-states are rushing to strike bilateral deals with Gazprom. Energy was supposed to be an area where the EU and Russia have clear common interests. But now the Russians complain about a ‘Gazprom clause’ in the Commission’s latest liberalisation package: state-owned foreign companies would not be allowed to buy gas pipelines in the EU, unless their governments agreed to also give European companies better access to their home markets.
Russia is not well placed to lecture the Europeans on energy market liberalisation. But Moscow has a point when asking the EU what it means by reciprocity. If the concept degenerates from a means for mutual openness to a new protectionist tool, it will do nothing to alleviate EU concerns about Russian underinvestment in its gas fields.
The energy debate shows that the shift from ‘values’ to ‘interests’ in EU-Russia relations can only go so far. Values – or more plainly, the way we see things – determine everything we do. When people and politicians in the EU and Russia talk about energy security, they mean different things. The same holds true for democracy, and other terms that allegedly describe the core objectives of our relationship.
I was an early advocate of the EU focusing less on ‘common values’ and more on mutual interests, on areas where practical co-operation is feasible and desirable (see http://www.cer.org.uk/pdf/p564_russia_strat_squabb.pdf).
But I am also the first one to admit that we have come full circle. Ultimately, the EU and Russia need to agree what they want to get out of their interaction.
Katinka Barysch is deputy director of the Centre for European Reform.
Monday, October 29, 2007
Can the EU learn to live with Chinese mercantilism?
by Philip Whyte
Not long after its launch, the euro was famously dismissed by a disgruntled currency trader as a “toilet currency”. How things have changed. Since 2003, the euro’s external value has soared despite comparatively sluggish rates of economic growth in many of Europe’s largest economies. The strength of the euro has been a boon to European consumers who have been able to buy DVD players from China for less than the price of a meal at a run-of-the-mill restaurant. But not everyone has been celebrating—least of all France’s hyperactive president, Nicolas Sarkozy, who has been fretting about the economic downsides of a strong euro. Mr Sarkozy believes that the euro is now over-valued and that French companies’ trade competitiveness is being damaged as a result. Ever since he entered office in May, therefore, he has thrashed around looking for a culprit.
At first, he blamed the European Central Bank (ECB) for neglecting the euro’s external value and for pursuing its inflation target at the expense of economic growth. This struck many observers as odd, for at least two reasons. First, a central bank cannot target the inflation rate and the exchange rate simultaneously: was Mr Sarkozy suggesting that the ECB jettison its inflation target? Second, it seemed perverse to accuse the ECB of pursuing an excessively restrictive monetary policy. Real interest rates remain low by historical standards, and were even negative for much of the period between 2003 and 2004. More recent indicators—notably buoyant rates of broad money growth and lending to the private sector—hardly point to a central bank that has sacrificed economic growth on the altar of low inflation. Mr Sarkozy’s broadsides were in any case widely seen as an attack on the ECB’s institutional independence—so no-one was surprised when they were given short shrift.
Mr Sarkozy then shifted his attention across the Atlantic. Authorities in the US, he argued, needed to act to stem the US dollar’s decline against the euro. Again, however, it was not clear what Mr Sarkozy was proposing the US authorities should do. Raise short-term interest rates? You must be joking! The US Federal Reserve is trying to contain the fall-out from the crisis in sub-prime lending which is threatening to push the world’s largest economy into recession. This is why it cut short-term interest rates in September. In any case, it is hard to see what the US Federal Reserve could possibly do to support the US dollar. The dollar is weakening because the US is struggling to attract the capital inflows needed to fund its current-account deficit. As the world’s largest debtor, the US has to attract three-quarters of the world’s capital flows to service its external deficit. This is unsustainable—and not just because US assets have offered investors absolutely terrible returns in recent years. A weak US dollar is imperative if the US’s external deficit is to narrow.
Slowly, it dawned on Mr Sarkozy that the problem might lie to the east rather than the west. In the run-up to the G7 meeting in late October, the French government spoke rather less about the US dollar and rather more about the Chinese yuan. It had taken its time, but at last it had stumbled on the heart of the problem: namely, that parts of the world—mainly China, Japan and oil exporters in the Middle East and elsewhere—are saving vastly more than they are investing. This excess of savings over investment has resulted in colossal outflows of capital which have supported the spending habits of governments and households in the US and, to a lesser extent, Europe. That’s right, you read correctly. Developing economies such as China are now large net creditors to the developed world. This is totally at odds with what one might normally expect. Capital usually flows in the other direction, from the developed to the developing world. So what happened?
The short answer is that China and a number of other Asian economies have spent the best part of the last decade pursuing unashamedly mercantilist policies. There are two reasons for this. One is the abiding attraction of an egregious fallacy: that a country’s primary objective in trade is to export more than it imports. The other is the experience of the Asian crisis in the late 1990s, when countries with large external deficits were unable to defend their currencies in the face of huge capital outflows. Stung by this experience, many Asian countries did not choose to abandon fixed exchange rates. Instead, they decided that they should continue to maintain a peg of sorts against the US dollar—but by actively intervening to keep their currencies artificially weak. Since that date, many Asian countries have turned trade deficits into vast surpluses by accumulating foreign exchange reserves. And the world has been stuck with an asymmetric monetary system in which the euro and the US dollar have floated freely against each other, but not against Asian currencies.
The apparently insatiable appetite of China and other Asian countries for piles of depreciating US dollars has had undoubted benefits for the EU. The most important is the boost to domestic demand that the resulting strength of the euro has provided. This has worked in at least two ways. First, by bearing down on import prices, the strength of the euro has contained inflation—allowing the ECB to keep official interest rates lower than they would otherwise have been. Second, it has boosted consumers’ purchasing power. The Chinese government, in other words, has indirectly given European consumers and mortgage holders something looking like a free ride. The downside is that the yuan’s exchange rate is generating protectionist demands from beleaguered European firms labouring under the weight of a currency that has borne the brunt of global adjustments since 2002. The EU trade commissioner, Peter Mandelson, has been muttering darkly about the speed at which the EU’s trade deficit with China is growing; and hinted that the EU cannot maintain an open market for Chinese goods if the Chinese government does not change policy direction.
In the mid-nineteenth century, the UK famously used gunboats to open Chinese markets to opium. Times have changed and few would now advocate similar methods to persuade the Chinese government to let the yuan appreciate. In fact, there is not much the EU can do, other than to raise the rhetorical volume and wait for the domestic tensions generated by China’s policy to play themselves out. No-one knows how long this process will last. The Chinese people’s capacity for pain is legendary. But the point will surely come when the Chinese government succumbs to internal pressure and refocuses economic policy on raising the living standards of the wretched Chinese people rather than relentlessly acquiring assets in a depreciating foreign currency. When this happens, Mr Sarkozy should pay particularly close attention. For the mercantilism that China has practised looks suspiciously like that which he would be tempted to pursue if ever he were let loose on the ECB!
Philip Whyte is a senior research fellow at the Centre for European Reform.
Not long after its launch, the euro was famously dismissed by a disgruntled currency trader as a “toilet currency”. How things have changed. Since 2003, the euro’s external value has soared despite comparatively sluggish rates of economic growth in many of Europe’s largest economies. The strength of the euro has been a boon to European consumers who have been able to buy DVD players from China for less than the price of a meal at a run-of-the-mill restaurant. But not everyone has been celebrating—least of all France’s hyperactive president, Nicolas Sarkozy, who has been fretting about the economic downsides of a strong euro. Mr Sarkozy believes that the euro is now over-valued and that French companies’ trade competitiveness is being damaged as a result. Ever since he entered office in May, therefore, he has thrashed around looking for a culprit.
At first, he blamed the European Central Bank (ECB) for neglecting the euro’s external value and for pursuing its inflation target at the expense of economic growth. This struck many observers as odd, for at least two reasons. First, a central bank cannot target the inflation rate and the exchange rate simultaneously: was Mr Sarkozy suggesting that the ECB jettison its inflation target? Second, it seemed perverse to accuse the ECB of pursuing an excessively restrictive monetary policy. Real interest rates remain low by historical standards, and were even negative for much of the period between 2003 and 2004. More recent indicators—notably buoyant rates of broad money growth and lending to the private sector—hardly point to a central bank that has sacrificed economic growth on the altar of low inflation. Mr Sarkozy’s broadsides were in any case widely seen as an attack on the ECB’s institutional independence—so no-one was surprised when they were given short shrift.
Mr Sarkozy then shifted his attention across the Atlantic. Authorities in the US, he argued, needed to act to stem the US dollar’s decline against the euro. Again, however, it was not clear what Mr Sarkozy was proposing the US authorities should do. Raise short-term interest rates? You must be joking! The US Federal Reserve is trying to contain the fall-out from the crisis in sub-prime lending which is threatening to push the world’s largest economy into recession. This is why it cut short-term interest rates in September. In any case, it is hard to see what the US Federal Reserve could possibly do to support the US dollar. The dollar is weakening because the US is struggling to attract the capital inflows needed to fund its current-account deficit. As the world’s largest debtor, the US has to attract three-quarters of the world’s capital flows to service its external deficit. This is unsustainable—and not just because US assets have offered investors absolutely terrible returns in recent years. A weak US dollar is imperative if the US’s external deficit is to narrow.
Slowly, it dawned on Mr Sarkozy that the problem might lie to the east rather than the west. In the run-up to the G7 meeting in late October, the French government spoke rather less about the US dollar and rather more about the Chinese yuan. It had taken its time, but at last it had stumbled on the heart of the problem: namely, that parts of the world—mainly China, Japan and oil exporters in the Middle East and elsewhere—are saving vastly more than they are investing. This excess of savings over investment has resulted in colossal outflows of capital which have supported the spending habits of governments and households in the US and, to a lesser extent, Europe. That’s right, you read correctly. Developing economies such as China are now large net creditors to the developed world. This is totally at odds with what one might normally expect. Capital usually flows in the other direction, from the developed to the developing world. So what happened?
The short answer is that China and a number of other Asian economies have spent the best part of the last decade pursuing unashamedly mercantilist policies. There are two reasons for this. One is the abiding attraction of an egregious fallacy: that a country’s primary objective in trade is to export more than it imports. The other is the experience of the Asian crisis in the late 1990s, when countries with large external deficits were unable to defend their currencies in the face of huge capital outflows. Stung by this experience, many Asian countries did not choose to abandon fixed exchange rates. Instead, they decided that they should continue to maintain a peg of sorts against the US dollar—but by actively intervening to keep their currencies artificially weak. Since that date, many Asian countries have turned trade deficits into vast surpluses by accumulating foreign exchange reserves. And the world has been stuck with an asymmetric monetary system in which the euro and the US dollar have floated freely against each other, but not against Asian currencies.
The apparently insatiable appetite of China and other Asian countries for piles of depreciating US dollars has had undoubted benefits for the EU. The most important is the boost to domestic demand that the resulting strength of the euro has provided. This has worked in at least two ways. First, by bearing down on import prices, the strength of the euro has contained inflation—allowing the ECB to keep official interest rates lower than they would otherwise have been. Second, it has boosted consumers’ purchasing power. The Chinese government, in other words, has indirectly given European consumers and mortgage holders something looking like a free ride. The downside is that the yuan’s exchange rate is generating protectionist demands from beleaguered European firms labouring under the weight of a currency that has borne the brunt of global adjustments since 2002. The EU trade commissioner, Peter Mandelson, has been muttering darkly about the speed at which the EU’s trade deficit with China is growing; and hinted that the EU cannot maintain an open market for Chinese goods if the Chinese government does not change policy direction.
In the mid-nineteenth century, the UK famously used gunboats to open Chinese markets to opium. Times have changed and few would now advocate similar methods to persuade the Chinese government to let the yuan appreciate. In fact, there is not much the EU can do, other than to raise the rhetorical volume and wait for the domestic tensions generated by China’s policy to play themselves out. No-one knows how long this process will last. The Chinese people’s capacity for pain is legendary. But the point will surely come when the Chinese government succumbs to internal pressure and refocuses economic policy on raising the living standards of the wretched Chinese people rather than relentlessly acquiring assets in a depreciating foreign currency. When this happens, Mr Sarkozy should pay particularly close attention. For the mercantilism that China has practised looks suspiciously like that which he would be tempted to pursue if ever he were let loose on the ECB!
Philip Whyte is a senior research fellow at the Centre for European Reform.
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