by Katinka Barysch
The EU and Russia are planning to launch a ‘partnership for modernisation’ at their next summit in Rostov on May 31st. The initiative – launched by Commission President Barroso at the last summit six months ago – is meant to breathe new life into a relationship that has become stale and tense. It is unlikely to succeed.
At first glance, an EU-Russia modernisation partnership looks like an excellent idea. It could entail joint science programmes, pilot projects in high-tech industries or student exchanges. Such projects should in theory be free of the ideological clashes that have held back EU-Russia relations in the past. They could help to restore mutual trust. They could allow the EU to acquaint Russia with European norms and values, not through lecturing but through day-to-day co-operation. In the medium term, successful modernisation could help to transform the apathetic Russian middle class into an entrepreneurial class that demands property rights and civil liberties. Last but not least, a successful modernisation partnership would generate new business opportunities for companies from the EU, which would, for example, be able to sell energy savings technologies to Russia.
Politically, the modernisation partnership looks promising. Modernisation is what Russia talks about today. President Medvedev has warned repeatedly that unless Russia radically reforms its economy, the country will face terminal decline. Russia must diversify away from exporting energy, and create jobs for the 95 per cent or so of the workforce that does not work in oil and gas. Surveys have shown that Russian policy-makers overwhelmingly believe that Russia needs outside help with modernisation. The recently leaked memo from the Russian foreign minister also called for Russia to forge ‘modernisation alliances’ with European countries. The EU has found that lecturing Russia on the need to reform does not work. So why not speak in Russia’s own interest by offering help with what has become a national priority?
Moreover, some EU policy-makers hope that since it is mainly President Medvedev who is pushing for modernisation, a re-focusing of EU-Russia relations on this topic may strengthen his hands vis-à-vis the more statist and authoritarian Putin clan.
Finally, political disagreements and tensions will remain inevitable in EU-Russia relations, whether over gas sales or the fate of Ukraine. The modernisation partnership could encourage co-operation that is independent of politics and focuses on technical, environmental or social issues. Such co-operation could help to stabilise bilateral relations and mitigate the dangerous intellectual isolation in which many Russian bureaucrats and scientists seem to operate today.
However, there are also several reasons why the partnership for modernisation may be a bad idea.
First, and most importantly, what most people in the EU mean by modernisation is very different from the notion held by the Russian leadership. Russia’s concept of modernisation is state-led and project-focused: a state-financed nanotechnology institute, state-owned banks lending to selected sectors, a brand-new ‘innovation city’ outside Moscow set up by government fiat – these are the building blocks of Medvedev’s innovation economy.
This approach cannot work. In today’s dynamic global economy, picking winners is not something that governments can do. An innovative economy needs open markets, venture capital, free-thinking entrepreneurs, fast bankruptcy courts and solid protection of intellectual property. Russia’s business environment is characterised by wide-spread monopolies, ubiquitous corruption, stifling state-interferences, weak and contradictory laws, and so on. The whole idea that Russia can shift from an economy that relies on oil, gas and heavy industry to a cutting-edge, high-tech one is spurious. Russia should first try to move existing industrial sectors up the value chain by using imported technology and know-how. Large-scale indigenous innovation may come later.
A state-led approach to economic change is particularly problematic in today’s Russia because its public institutions function so badly. Sergei Guriev, a Moscow-based economist, has compared the quality of Russia’s state administration and legal system of today with that of South Korea 12 years ago, before it embarked on its impressive growth spurt. He concluded that South Korea’s institutions were quite simply in a different league and that Russia’s chances of catching up with the world’s most developed countries were slim.
The Russian leadership hardly trusts its own bureaucracy to implement a road building programme. How is it supposed to build a replica of Silicon Valley? Even if such isolated programmes were successful, their impact on the wider economy would be limited so long as competition is restricted and successful companies must fear kleptocratic officials. The risk is that the money that the Russian government is about to pump into selected sectors and high-profile projects will not only be wasted. It will create a constant, future demand on public resources that may well be better spent elsewhere.
In short, Russian modernisation does not need vertical state intervention but a horizontal improvement of the business environment. It is doubtful whether the Russian leadership has the political will to clamp down on corruption, improve competition, reform the education and science sectors and strengthen the rule of law.
The question the EU needs to ask itself is whether it should accept and support Russia’s flawed concept of modernisation, or whether it should make support conditional on Russia implementing at least some of the reforms needed to strengthen the rule of law and improve the economy. In the past, EU attempts to cajole or persuade Russia to implement reforms have had limited or no impact. The modernisation partnership is unlikely to be very different.
Katinka Barysch is deputy director at the Centre for European Reform
Friday, May 28, 2010
Friday, May 21, 2010
Financial regulation: Will British euroscepticism collide with European populism?
by Philip Whyte
When EU finance ministers met in Brussels on 18 May, many observers expected sparks to fly. The reason? This was the first EU meeting that Britain’s newly-elected government would attend. And a leading item on the agenda was the Commission’s proposed directive to regulate managers of ‘alternative investment funds’. France and Germany have pressed hard for the directive. Britain has deep reservations about it. The fear across the EU was that a hard-line British eurosceptic government ideologically resistant to regulating financial markets would come to Brussels seeking confrontation over the directive. In the event, the bust-up never happened. What lessons should one draw about the new, Conservative-led government’s attitude to the EU and to financial regulation?
The Conservative Party is more eurosceptic than it has ever been. Many of its members would like to withdraw from the EU altogether. The party’s leader, David Cameron, is no euro-enthusiast himself. But he is above all a pragmatist, not a rigid ideologue bent on confrontation. Recall that he enraged sections of his party when he decided not to hold a referendum on the Lisbon treaty once it had been ratified by all 27 member-states; and that he has formed a coalition with the UK’s most pro-European party, the Liberal Democrats. Besides, the government that he leads has more important things to do than pick needless fights in the EU. The focus of its attention over the next five years will be on consolidating the public finances and managing the inevitable social conflicts that will result.
What of financial regulation? A common view across Europe is that the financial crisis was the result of ‘unregulated Anglo-Saxon capitalism’; that the EU’s task is to cajole the reluctant British into clamping down on the City of London; and that the Conservatives may be particularly resistant to cooperating, given their ideological commitment to free markets and historical links to the City. Much of this account is inaccurate. Many of the regulatory failings exposed by the crisis were as much in evidence outside the Anglo-Saxon world as within it. The UK has pushed through many regulatory reforms before the EU. And the Conservative Party has distanced itself from the City and is considering measures – like breaking up large banks – that go far beyond what most EU countries are contemplating.
Does this mean that Britain and the EU will work harmoniously on the reform of financial regulation? The answer is: probably not. One problem is the populist undercurrent that is driving some reforms in the EU. The sad truth is that the alternative investment fund managers’ directive has been a poor advert for EU legislation. The Commission proposed it, under pressure from France and Germany, without carrying out the detailed impact assessment that its ‘better regulation’ agenda requires. The directive targets a rag-bag of disparate entities, mostly in the UK, that had nothing to do with the crisis and that will be saddled with inappropriate rules. And it is being imposed over the objections of the country that will be most affected by it by countries that will barely be affected by it at all.
Britain’s historical attitude to the EU – its enthusiasm for the single market, allied to its hostility to institutional integration – is another problem. Why? Because it is no longer clear that this Janus-faced position is tenable. As the UK’s Turner Review acknowledged, the financial crisis exposed fault-lines in the EU’s single market for banking that can only be solved in one of two ways. The first (the ‘less Europe’ option) is to return powers to host country authorities – a move that would mark a retreat from the single market. The second (the ‘more Europe’ option) is to beef up existing EU bodies so that a common rulebook can be developed and co-ordination between national supervisory authorities can be tightened. (This option does not currently envisage the creation of a pan-European supervisory authority.)
A key task facing the EU following the financial crisis is to rescue the single market in banking. If the EU is to succeed, Britain’s Conservative-led government and its EU partners must work together constructively. Britain’s EU partners need the Cameron government’s pragmatism to trump its euroscepticism. But European politicians would help if they showed cooler heads and more measured rhetoric than they are doing at present. Tirades against hedge funds, ‘speculators’ and Anglo-Saxons may play well in some EU countries. But in Britain, they increase the suspicion that European politicians are happier looking for scapegoats than learning the real lessons of the crisis. If it goes unchecked, European populism could become an obstacle to the Cameron government’s pragmatism.
Philip Whyte is senior research fellow at the Centre for European Reform
When EU finance ministers met in Brussels on 18 May, many observers expected sparks to fly. The reason? This was the first EU meeting that Britain’s newly-elected government would attend. And a leading item on the agenda was the Commission’s proposed directive to regulate managers of ‘alternative investment funds’. France and Germany have pressed hard for the directive. Britain has deep reservations about it. The fear across the EU was that a hard-line British eurosceptic government ideologically resistant to regulating financial markets would come to Brussels seeking confrontation over the directive. In the event, the bust-up never happened. What lessons should one draw about the new, Conservative-led government’s attitude to the EU and to financial regulation?
The Conservative Party is more eurosceptic than it has ever been. Many of its members would like to withdraw from the EU altogether. The party’s leader, David Cameron, is no euro-enthusiast himself. But he is above all a pragmatist, not a rigid ideologue bent on confrontation. Recall that he enraged sections of his party when he decided not to hold a referendum on the Lisbon treaty once it had been ratified by all 27 member-states; and that he has formed a coalition with the UK’s most pro-European party, the Liberal Democrats. Besides, the government that he leads has more important things to do than pick needless fights in the EU. The focus of its attention over the next five years will be on consolidating the public finances and managing the inevitable social conflicts that will result.
What of financial regulation? A common view across Europe is that the financial crisis was the result of ‘unregulated Anglo-Saxon capitalism’; that the EU’s task is to cajole the reluctant British into clamping down on the City of London; and that the Conservatives may be particularly resistant to cooperating, given their ideological commitment to free markets and historical links to the City. Much of this account is inaccurate. Many of the regulatory failings exposed by the crisis were as much in evidence outside the Anglo-Saxon world as within it. The UK has pushed through many regulatory reforms before the EU. And the Conservative Party has distanced itself from the City and is considering measures – like breaking up large banks – that go far beyond what most EU countries are contemplating.
Does this mean that Britain and the EU will work harmoniously on the reform of financial regulation? The answer is: probably not. One problem is the populist undercurrent that is driving some reforms in the EU. The sad truth is that the alternative investment fund managers’ directive has been a poor advert for EU legislation. The Commission proposed it, under pressure from France and Germany, without carrying out the detailed impact assessment that its ‘better regulation’ agenda requires. The directive targets a rag-bag of disparate entities, mostly in the UK, that had nothing to do with the crisis and that will be saddled with inappropriate rules. And it is being imposed over the objections of the country that will be most affected by it by countries that will barely be affected by it at all.
Britain’s historical attitude to the EU – its enthusiasm for the single market, allied to its hostility to institutional integration – is another problem. Why? Because it is no longer clear that this Janus-faced position is tenable. As the UK’s Turner Review acknowledged, the financial crisis exposed fault-lines in the EU’s single market for banking that can only be solved in one of two ways. The first (the ‘less Europe’ option) is to return powers to host country authorities – a move that would mark a retreat from the single market. The second (the ‘more Europe’ option) is to beef up existing EU bodies so that a common rulebook can be developed and co-ordination between national supervisory authorities can be tightened. (This option does not currently envisage the creation of a pan-European supervisory authority.)
A key task facing the EU following the financial crisis is to rescue the single market in banking. If the EU is to succeed, Britain’s Conservative-led government and its EU partners must work together constructively. Britain’s EU partners need the Cameron government’s pragmatism to trump its euroscepticism. But European politicians would help if they showed cooler heads and more measured rhetoric than they are doing at present. Tirades against hedge funds, ‘speculators’ and Anglo-Saxons may play well in some EU countries. But in Britain, they increase the suspicion that European politicians are happier looking for scapegoats than learning the real lessons of the crisis. If it goes unchecked, European populism could become an obstacle to the Cameron government’s pragmatism.
Philip Whyte is senior research fellow at the Centre for European Reform
Thursday, May 13, 2010
Business leaders risk discrediting markets
by Simon Tilford
Despite their battered reputation, markets remain the best way of generating economic growth. But the market economy faces a crisis of legitimacy brought about by rising inequality and a breakdown of the relationship between risk and reward. The promise of capitalism is that wages rise in line with productivity growth. But over the last 15 years a hugely disproportionate share of the rewards from economic growth has accrued to those at the top, led by boardroom executives and senior bankers. By contrast, median incomes have stagnated. As a result, governments will struggle to convince electorates of the case for markets and free enterprise, and will have a tough time slimming down bloated public sectors.
One reason for the rise in inequality is falling demand for unskilled labour. Technological change and growing trade with emerging economies means that there is little demand for poorly-skilled workers. It is no surprise that the widening of wage differentials has been most pronounced in those European countries with large numbers of poorly-skilled workers. However, the rise in inequality also reflects a surge in what economists call ‘rent-seeking’: the ability of certain groups within society to extract disproportionate rewards (or ‘rents’) for their work.
Boardroom pay has ballooned across Europe, inflating wage differentials. According to Income Data Services, the executives of the UK’s 100 biggest companies earned 84 times the average pay of a full-time worker in 2009, up from 47 times in 2000. This trend is not confined to countries that are considered to be ‘economically-liberal’ such as the UK. It is happening across Europe. The dramatic rise in boardroom pay does not reflect share performance. Nor does it result from the fact that companies are competing for global talent: the overwhelming proportion of senior executives in all European countries are recruited nationally.
Another group to have attracted outsized rewards is employed in the financial services industry. Pay in the financial sector has risen far more rapidly than across the economy as a whole. But as Andrew Haldane of the Bank of England has convincingly demonstrated, the huge rise in the sector’s profitability and the subsequent growth in remuneration was the product of leverage – increased borrowing – and not an improved return on assets. The latter requires skill, the former does not. To make matter worse, the losses incurred by the banks when their excessive leverage provoked the financial crisis were covered by the taxpayer. In short, the banks were able to privatise the rewards while socialising the losses. Their subsequent return to profitability owes much to intervention of governments.
The exaggerated remuneration of top bankers and senior executives is essentially a form of rent-seeking. In essence, it is little different from public sector unions securing pay increases in excess of productivity growth or organised special interest groups defending social rights – unfunded pension liabilities, for example – that can only be exercised at the expense of others. The popular perception of business as a vehicle for ‘rent extraction’ rather than a source of employment, wealth and tax revenue is poisonous for the political economy of reform.
Rising inequality did not matter so much when economies were growing and public finances were manageable. But it does now. European governments face mighty challenges. They have to persuade sceptical electorates of the need for more flexible labour markets; the curtailment of social rights; a greater role for the private sector in areas currently dominated by the state; and even cuts in public services. But how can governments succeed in doing this if such reforms are blamed for rising inequality and for allowing unwarranted personal enrichment? Put another way, how can governments address rent-seeking by other powerful groups in society, such as the public sector unions, in the face of rent-seeking by those in the financial sector and on company boards?
The rise in income inequality needs to be reversed and the relationship between risk and reward restored if governments are to be able to sell market-led reforms to increasingly (and understandably) cynical electorates. Governments have to be able to demonstrate how people benefit from markets. They have to be able to show that markets prevent groups within society from extracting undue rewards, not abet them in their drive to do so. For their part, the leaders of finance and business need to recognise that their remuneration is an obstacle to the kinds of market-led reforms they themselves advocate and which are needed to boost economic performance.
Simon Tilford is chief economist at the Centre for European Reform
Despite their battered reputation, markets remain the best way of generating economic growth. But the market economy faces a crisis of legitimacy brought about by rising inequality and a breakdown of the relationship between risk and reward. The promise of capitalism is that wages rise in line with productivity growth. But over the last 15 years a hugely disproportionate share of the rewards from economic growth has accrued to those at the top, led by boardroom executives and senior bankers. By contrast, median incomes have stagnated. As a result, governments will struggle to convince electorates of the case for markets and free enterprise, and will have a tough time slimming down bloated public sectors.
One reason for the rise in inequality is falling demand for unskilled labour. Technological change and growing trade with emerging economies means that there is little demand for poorly-skilled workers. It is no surprise that the widening of wage differentials has been most pronounced in those European countries with large numbers of poorly-skilled workers. However, the rise in inequality also reflects a surge in what economists call ‘rent-seeking’: the ability of certain groups within society to extract disproportionate rewards (or ‘rents’) for their work.
Boardroom pay has ballooned across Europe, inflating wage differentials. According to Income Data Services, the executives of the UK’s 100 biggest companies earned 84 times the average pay of a full-time worker in 2009, up from 47 times in 2000. This trend is not confined to countries that are considered to be ‘economically-liberal’ such as the UK. It is happening across Europe. The dramatic rise in boardroom pay does not reflect share performance. Nor does it result from the fact that companies are competing for global talent: the overwhelming proportion of senior executives in all European countries are recruited nationally.
Another group to have attracted outsized rewards is employed in the financial services industry. Pay in the financial sector has risen far more rapidly than across the economy as a whole. But as Andrew Haldane of the Bank of England has convincingly demonstrated, the huge rise in the sector’s profitability and the subsequent growth in remuneration was the product of leverage – increased borrowing – and not an improved return on assets. The latter requires skill, the former does not. To make matter worse, the losses incurred by the banks when their excessive leverage provoked the financial crisis were covered by the taxpayer. In short, the banks were able to privatise the rewards while socialising the losses. Their subsequent return to profitability owes much to intervention of governments.
The exaggerated remuneration of top bankers and senior executives is essentially a form of rent-seeking. In essence, it is little different from public sector unions securing pay increases in excess of productivity growth or organised special interest groups defending social rights – unfunded pension liabilities, for example – that can only be exercised at the expense of others. The popular perception of business as a vehicle for ‘rent extraction’ rather than a source of employment, wealth and tax revenue is poisonous for the political economy of reform.
Rising inequality did not matter so much when economies were growing and public finances were manageable. But it does now. European governments face mighty challenges. They have to persuade sceptical electorates of the need for more flexible labour markets; the curtailment of social rights; a greater role for the private sector in areas currently dominated by the state; and even cuts in public services. But how can governments succeed in doing this if such reforms are blamed for rising inequality and for allowing unwarranted personal enrichment? Put another way, how can governments address rent-seeking by other powerful groups in society, such as the public sector unions, in the face of rent-seeking by those in the financial sector and on company boards?
The rise in income inequality needs to be reversed and the relationship between risk and reward restored if governments are to be able to sell market-led reforms to increasingly (and understandably) cynical electorates. Governments have to be able to demonstrate how people benefit from markets. They have to be able to show that markets prevent groups within society from extracting undue rewards, not abet them in their drive to do so. For their part, the leaders of finance and business need to recognise that their remuneration is an obstacle to the kinds of market-led reforms they themselves advocate and which are needed to boost economic performance.
Simon Tilford is chief economist at the Centre for European Reform
Monday, May 10, 2010
Closing the gap between rhetoric and reality is key to the euro's survival
by Simon Tilford
Europe faces a critical choice between greater integration and disintegration. The gap between the rhetoric of a united and integrated Europe and the reality of national interests and politics has always dogged Europe. For much of the EU’s history this gap simply held Europe back and undermined the seriousness of the EU in the eyes of the outside world. However, the gap between rhetoric and reality is lethal when it comes to the euro. Unless the reality is brought into line with the rhetoric, the eurozone will unravel.
The package of financial measures announced over the weekend of May 8th-9th to stabilise the eurozone crisis provides some big headline numbers. There will be an additional €60 billion for countries experiencing balance of payment problems. The EU will establish a ‘Special Purpose Vehicle’ with funds of up €440 billion to provide loans to struggling member-states and the IMF will guarantee half as much again. In a major U-turn, the ECB has suggested it may even step in to buy government bonds directly. But the EU’s response is still a case of ‘shooting the messenger’. There is too much talk of ‘speculative attacks on the euro’, of giving a ‘clear signal to the markets’ that the euro will be defended, even talk of keeping the ‘wolves’ from the gate. The subtext is that the markets are overacting and that investors are essentially conjuring up a crisis so they can profit from it. The assumption is that the adjustment needed in Greece, Portugal and other member-states is possible if only the markets will let them make it. As such, the EU is still working on a false premise.
Even assuming the package is approved and the money found (these are big assumptions given the strength of opposition in many member-states to bail-outs) it will not satisfy the markets for long. It does not address the underlying issue: the terrible economic growth prospects of the southern eurozone economies and Ireland. Unless these economies can avoid deflation and get their economies growing, they have no future in the eurozone. In order to qualify for loans from the new Special Purpose Vehicle member-states will have to meet strict deficit reduction terms, with the decision over whether money should be made available to be decided by majority. But what if these conditions are impossible to meet? The EU has bought itself some time – struggling eurozone economies will be able to refinance their debts for the time being – but it has not solved the crisis.
Unfortunately, the eurozone fulfils few, if any, of the criteria for a successful currency union. There are varying degrees of trade integration, but the participating economies can hardly be described as fully integrated. Nor are they flexible – labour markets in many economies remain highly regulated and many sectors are sheltered from competition. Labour mobility between the participating economies is virtually non-existent. There is nothing to prevent huge trade imbalances between the members rising and nothing to address them when they do. This would all perhaps be manageable if it was offset by a large degree of political integration and a fiscal union of some form – but neither exists. Moreover, as the last three months have graphically exposed, there are no eurozone crisis management mechanisms in place. Indeed, the EU’s strategy since the beginning of the year has been tailor-made to provoke precisely the contagion it has been so anxious to avoid.
To suggest that the markets are partly to blame for the crisis or for prolonging it only serves to reinforce perception of European other-worldliness. The markets have simply called the EU’s bluff. Indeed, they should have done so earlier – that way the crisis might have been avoided. Until relatively recently, the markets treated the debt of the various eurozone member-states as largely indivisible. The Greek authorities could borrow at similar interest rates to their German counterparts. This made no sense, but it reflected investors’ belief that it was impossible for a member of the eurozone to default. The financial markets were guilty of buying into the myth of an integrated eurozone.
The markets are right to doubt the sustainability of the current membership of the eurozone. It is hard to see how the struggling member-states are going to generate economic growth. They need a big external stimulus to offset budget cuts and falls in real wages. In short, their exports need to grow much more rapidly than imports, for a lengthy period. This is highly unlikely. Their import demand will be weak, of course, reflecting the collapse in domestic demand. But they need much stronger exports. In the absence of devaluation, they are dependent on a revival of demand elsewhere in the eurozone and the ability of their companies to become more price competitive and hence build their market share within the eurozone. The former is highly unlikely to happen – if anything, the export dependence of the likes of Germany and the Netherlands is being reinforced. There is nothing to force adjustment on these surplus economies within the eurozone and scant recognition that they need to rebalance in order to give others a chance of doing so.
What of the latter? The best way of improving price competitiveness is through higher productivity. But that is a long term challenge; they do not have that amount of time. They have no choice but to try and cut costs relative to the rest of the eurozone. Can they do so? The markets are rightly sceptical. It is true that Germany and the Netherlands have successfully pursued eye-watering wage restraint within the currency bloc. The problem of course is that it’s impossible for every economy to do this simultaneously. It is one thing for a member-state to cut costs relative to the rest of the eurozone when most member-states’ costs are rising pretty rapidly. It is a whole different ball game to do so when costs elsewhere in the eurozone – especially Germany – are falling, reflecting further wage restraint. This is a zero-sum game, whose result will be slump and deflation.
If the imbalances persist, a fiscal union will be essential for the eurozone to survive – the crisis-hit states will not be able to grow unless they can close their external deficits. But the obstacles to such fiscal supranationalism are insurmountable. The crisis has exposed the lack of solidarity between the member-states. A Parisian may grumble about seeing a chunk of his tax revenues flowing to the Pas de Calais or Marseille. Similarly, a resident of Bavaria may resent transfers to Bremen or Berlin. But there is sufficient solidarity between the regions of these countries to underpin such transfers on an ongoing basis. This solidarity does not exist within the eurozone.
The eurozone is on an unsustainable path, notwithstanding the latest package of measures. That is no fault of the markets. It is the result of the gap between European rhetoric and reality. There needs to be an acknowledgement that if the euro is to work it will require greater integration. The problem is that when countries signed-up to the single currency, they were not made aware that it would require such integration. Political elites need to start explaining why it does.
Simon Tilford is chief economist at the Centre for European Reform
Europe faces a critical choice between greater integration and disintegration. The gap between the rhetoric of a united and integrated Europe and the reality of national interests and politics has always dogged Europe. For much of the EU’s history this gap simply held Europe back and undermined the seriousness of the EU in the eyes of the outside world. However, the gap between rhetoric and reality is lethal when it comes to the euro. Unless the reality is brought into line with the rhetoric, the eurozone will unravel.
The package of financial measures announced over the weekend of May 8th-9th to stabilise the eurozone crisis provides some big headline numbers. There will be an additional €60 billion for countries experiencing balance of payment problems. The EU will establish a ‘Special Purpose Vehicle’ with funds of up €440 billion to provide loans to struggling member-states and the IMF will guarantee half as much again. In a major U-turn, the ECB has suggested it may even step in to buy government bonds directly. But the EU’s response is still a case of ‘shooting the messenger’. There is too much talk of ‘speculative attacks on the euro’, of giving a ‘clear signal to the markets’ that the euro will be defended, even talk of keeping the ‘wolves’ from the gate. The subtext is that the markets are overacting and that investors are essentially conjuring up a crisis so they can profit from it. The assumption is that the adjustment needed in Greece, Portugal and other member-states is possible if only the markets will let them make it. As such, the EU is still working on a false premise.
Even assuming the package is approved and the money found (these are big assumptions given the strength of opposition in many member-states to bail-outs) it will not satisfy the markets for long. It does not address the underlying issue: the terrible economic growth prospects of the southern eurozone economies and Ireland. Unless these economies can avoid deflation and get their economies growing, they have no future in the eurozone. In order to qualify for loans from the new Special Purpose Vehicle member-states will have to meet strict deficit reduction terms, with the decision over whether money should be made available to be decided by majority. But what if these conditions are impossible to meet? The EU has bought itself some time – struggling eurozone economies will be able to refinance their debts for the time being – but it has not solved the crisis.
Unfortunately, the eurozone fulfils few, if any, of the criteria for a successful currency union. There are varying degrees of trade integration, but the participating economies can hardly be described as fully integrated. Nor are they flexible – labour markets in many economies remain highly regulated and many sectors are sheltered from competition. Labour mobility between the participating economies is virtually non-existent. There is nothing to prevent huge trade imbalances between the members rising and nothing to address them when they do. This would all perhaps be manageable if it was offset by a large degree of political integration and a fiscal union of some form – but neither exists. Moreover, as the last three months have graphically exposed, there are no eurozone crisis management mechanisms in place. Indeed, the EU’s strategy since the beginning of the year has been tailor-made to provoke precisely the contagion it has been so anxious to avoid.
To suggest that the markets are partly to blame for the crisis or for prolonging it only serves to reinforce perception of European other-worldliness. The markets have simply called the EU’s bluff. Indeed, they should have done so earlier – that way the crisis might have been avoided. Until relatively recently, the markets treated the debt of the various eurozone member-states as largely indivisible. The Greek authorities could borrow at similar interest rates to their German counterparts. This made no sense, but it reflected investors’ belief that it was impossible for a member of the eurozone to default. The financial markets were guilty of buying into the myth of an integrated eurozone.
The markets are right to doubt the sustainability of the current membership of the eurozone. It is hard to see how the struggling member-states are going to generate economic growth. They need a big external stimulus to offset budget cuts and falls in real wages. In short, their exports need to grow much more rapidly than imports, for a lengthy period. This is highly unlikely. Their import demand will be weak, of course, reflecting the collapse in domestic demand. But they need much stronger exports. In the absence of devaluation, they are dependent on a revival of demand elsewhere in the eurozone and the ability of their companies to become more price competitive and hence build their market share within the eurozone. The former is highly unlikely to happen – if anything, the export dependence of the likes of Germany and the Netherlands is being reinforced. There is nothing to force adjustment on these surplus economies within the eurozone and scant recognition that they need to rebalance in order to give others a chance of doing so.
What of the latter? The best way of improving price competitiveness is through higher productivity. But that is a long term challenge; they do not have that amount of time. They have no choice but to try and cut costs relative to the rest of the eurozone. Can they do so? The markets are rightly sceptical. It is true that Germany and the Netherlands have successfully pursued eye-watering wage restraint within the currency bloc. The problem of course is that it’s impossible for every economy to do this simultaneously. It is one thing for a member-state to cut costs relative to the rest of the eurozone when most member-states’ costs are rising pretty rapidly. It is a whole different ball game to do so when costs elsewhere in the eurozone – especially Germany – are falling, reflecting further wage restraint. This is a zero-sum game, whose result will be slump and deflation.
If the imbalances persist, a fiscal union will be essential for the eurozone to survive – the crisis-hit states will not be able to grow unless they can close their external deficits. But the obstacles to such fiscal supranationalism are insurmountable. The crisis has exposed the lack of solidarity between the member-states. A Parisian may grumble about seeing a chunk of his tax revenues flowing to the Pas de Calais or Marseille. Similarly, a resident of Bavaria may resent transfers to Bremen or Berlin. But there is sufficient solidarity between the regions of these countries to underpin such transfers on an ongoing basis. This solidarity does not exist within the eurozone.
The eurozone is on an unsustainable path, notwithstanding the latest package of measures. That is no fault of the markets. It is the result of the gap between European rhetoric and reality. There needs to be an acknowledgement that if the euro is to work it will require greater integration. The problem is that when countries signed-up to the single currency, they were not made aware that it would require such integration. Political elites need to start explaining why it does.
Simon Tilford is chief economist at the Centre for European Reform
Friday, May 07, 2010
The dangers of a disgruntled Germany
By Katinka Barysch
Germany has finally agreed to help bail out Greece. The negotiations were acrimonious and took months. Angela Merkel’s hesitation and prevarication have increased the cost of the bail-out and unsettled financial markets. Politicians and commentators across the EU have accused Germany of being selfish and lacking solidarity with its EU partners. Germany feels isolated and misunderstood. The rift – if badly handled – could make Germany’s stance towards the EU more hard-nosed and inward-looking. Such a shift would change the way the EU works more than the Lisbon treaty ever could.
Berlin today is bristling with defiance. Germans are convinced that Angela Merkel’s strict conditions for the Greek bail-out will not only save German taxpayers’ money but are needed to prevent the eurozone from imploding. What is more, although Berlin’s PR policy has been wanting, German policy-makers and pundits are aggrieved that no-one in the other EU countries has made an effort to understand the domestic political realities that have shaped Merkel’s decisions.
The German press coverage about the bail-out has ranged from the doubtful to the visceral. Day after day, Bild Zeitung, the biggest tabloid, ran stories about Greeks retiring at 50 and dodging their taxes. The money that Germany will make available (€8.7 billion in the first year and up to €23 billion by 2012) is portrayed as a transfer not a loan. It will force the government to shelve promised tax cuts and curb social benefits, according to the media. A big majority of Germans are against any EU money for Greece, even if the country goes bust. The fact that there has been so little political leadership on the Greek crisis has allowed the media to dominate the public debate. Neither politicians nor the media have made much of an effort to remind Germans how much their country has benefited from the EU and the euro.
The public backlash against the bail-out came at a time when Germany was preparing for a pivotal election in the state of North Rhine-Westphalia on May 9th. If Merkel’s CDU and the FDP lose their majority there, their already strained coalition at the national level risks becoming dysfunctional. What’s more, the CDU / FDP coalition would lose their majority in the Bundesrat, the second chamber of parliament, which would force it to seek compromises with the opposition on all important pieces of legislation going forward. Hence Merkel’s desperate attempt to delay any decisions about Greece until after the election.
In April, three economists and a law professor announced that they would challenge any bail-out in the constitutional court. They claim that giving money to Greece violates both the no bail-out clause in the EU treaty and the 1993 verdict of the court that makes Germany’s participation in the euro conditional on stability being maintained in the eurozone. They want an injunction to stop the loan being disbursed while the court deliberates on its legality. The outcome of such a case is uncertain. But Germans have consistently rated their constitutional court the most highly respected institution in the land. No government could dare to do something that is in open contravention of a previous court ruling. That is why the government has worked so hard to make the bail-out watertight.
Merkel felt that her hands were tied by very real and immediate constraints. But her cautious and delayed reaction is also in line with a deeper shift in Germany’s European policies. In a European Union of 27, Germans no longer automatically assume that their national interest coincides with that of the Union. Since saving the Lisbon treaty in 2007, Merkel has shown no vision in her EU policies. For the generation of Helmut Kohl, the EU was a matter of war and peace, for Merkel it is one of costs and benefits. Her European policies are all about pragmatism and problem solving. But the absence of obvious allies makes finding European solutions harder: Merkel is disappointed by Commission President Jose Manuel Barroso and distrustful of French President Nicolas Sarkozy. There is also a clash in political style that accentuates disagreements between Germany and its partners. At home, Merkel’s tactic of tip-toeing towards feasible solutions has made her consistently popular. At the EU level, it clashes with Sarkozy and British Premier Gordon Brown, both prone to over-promise and under-deliver.
Many argue that Germany is becoming a ‘normal’ country in the EU and that is just fine. But it was exactly because Germany did not always behave like the UK and France that European integration moved forward and European solutions were possible. The country’s political elite is still wedded to the European project even though Germany is no longer willing to pay over the odds to make European compromises possible. The risk is that the Greek crisis brings a latent sense of frustration and disillusionment with the EU to the boil. It is hard to see how the EU could make progress on anything – whether it is services market liberalisation or a common energy policy – with a reluctant, grumpy and inward-looking Germany at its heart.
It is time for some damage limitation. Germany’s partners are right to point out the costs of Germany’s tardy response. But they need to show at least some understanding of Merkel’s domestic conundrum and acknowledge her efforts that have now made the bail-out possible. There were several EU countries that wanted tough conditions for Greece just as badly. They need to stop hiding behind Berlin. Others need to acknowledge that European solidarity also requires responsibility on the part of all EU member-states.
Berlin, in turn, needs to finally show some leadership now by pushing for sustainable solutions to the eurozone malaise. These do not only include tougher surveillance of, and sanctions against, eurozone countries that spend too much. The eurozone also needs a mechanism to deal with similar fiscal crises in the future. And it needs an open debate about the imbalances that threaten to undermine the euro and why Germany does not buy as much from its European partners as it sells to them.
Katinka Barysch is deputy director at the CER
Germany has finally agreed to help bail out Greece. The negotiations were acrimonious and took months. Angela Merkel’s hesitation and prevarication have increased the cost of the bail-out and unsettled financial markets. Politicians and commentators across the EU have accused Germany of being selfish and lacking solidarity with its EU partners. Germany feels isolated and misunderstood. The rift – if badly handled – could make Germany’s stance towards the EU more hard-nosed and inward-looking. Such a shift would change the way the EU works more than the Lisbon treaty ever could.
Berlin today is bristling with defiance. Germans are convinced that Angela Merkel’s strict conditions for the Greek bail-out will not only save German taxpayers’ money but are needed to prevent the eurozone from imploding. What is more, although Berlin’s PR policy has been wanting, German policy-makers and pundits are aggrieved that no-one in the other EU countries has made an effort to understand the domestic political realities that have shaped Merkel’s decisions.
The German press coverage about the bail-out has ranged from the doubtful to the visceral. Day after day, Bild Zeitung, the biggest tabloid, ran stories about Greeks retiring at 50 and dodging their taxes. The money that Germany will make available (€8.7 billion in the first year and up to €23 billion by 2012) is portrayed as a transfer not a loan. It will force the government to shelve promised tax cuts and curb social benefits, according to the media. A big majority of Germans are against any EU money for Greece, even if the country goes bust. The fact that there has been so little political leadership on the Greek crisis has allowed the media to dominate the public debate. Neither politicians nor the media have made much of an effort to remind Germans how much their country has benefited from the EU and the euro.
The public backlash against the bail-out came at a time when Germany was preparing for a pivotal election in the state of North Rhine-Westphalia on May 9th. If Merkel’s CDU and the FDP lose their majority there, their already strained coalition at the national level risks becoming dysfunctional. What’s more, the CDU / FDP coalition would lose their majority in the Bundesrat, the second chamber of parliament, which would force it to seek compromises with the opposition on all important pieces of legislation going forward. Hence Merkel’s desperate attempt to delay any decisions about Greece until after the election.
In April, three economists and a law professor announced that they would challenge any bail-out in the constitutional court. They claim that giving money to Greece violates both the no bail-out clause in the EU treaty and the 1993 verdict of the court that makes Germany’s participation in the euro conditional on stability being maintained in the eurozone. They want an injunction to stop the loan being disbursed while the court deliberates on its legality. The outcome of such a case is uncertain. But Germans have consistently rated their constitutional court the most highly respected institution in the land. No government could dare to do something that is in open contravention of a previous court ruling. That is why the government has worked so hard to make the bail-out watertight.
Merkel felt that her hands were tied by very real and immediate constraints. But her cautious and delayed reaction is also in line with a deeper shift in Germany’s European policies. In a European Union of 27, Germans no longer automatically assume that their national interest coincides with that of the Union. Since saving the Lisbon treaty in 2007, Merkel has shown no vision in her EU policies. For the generation of Helmut Kohl, the EU was a matter of war and peace, for Merkel it is one of costs and benefits. Her European policies are all about pragmatism and problem solving. But the absence of obvious allies makes finding European solutions harder: Merkel is disappointed by Commission President Jose Manuel Barroso and distrustful of French President Nicolas Sarkozy. There is also a clash in political style that accentuates disagreements between Germany and its partners. At home, Merkel’s tactic of tip-toeing towards feasible solutions has made her consistently popular. At the EU level, it clashes with Sarkozy and British Premier Gordon Brown, both prone to over-promise and under-deliver.
Many argue that Germany is becoming a ‘normal’ country in the EU and that is just fine. But it was exactly because Germany did not always behave like the UK and France that European integration moved forward and European solutions were possible. The country’s political elite is still wedded to the European project even though Germany is no longer willing to pay over the odds to make European compromises possible. The risk is that the Greek crisis brings a latent sense of frustration and disillusionment with the EU to the boil. It is hard to see how the EU could make progress on anything – whether it is services market liberalisation or a common energy policy – with a reluctant, grumpy and inward-looking Germany at its heart.
It is time for some damage limitation. Germany’s partners are right to point out the costs of Germany’s tardy response. But they need to show at least some understanding of Merkel’s domestic conundrum and acknowledge her efforts that have now made the bail-out possible. There were several EU countries that wanted tough conditions for Greece just as badly. They need to stop hiding behind Berlin. Others need to acknowledge that European solidarity also requires responsibility on the part of all EU member-states.
Berlin, in turn, needs to finally show some leadership now by pushing for sustainable solutions to the eurozone malaise. These do not only include tougher surveillance of, and sanctions against, eurozone countries that spend too much. The eurozone also needs a mechanism to deal with similar fiscal crises in the future. And it needs an open debate about the imbalances that threaten to undermine the euro and why Germany does not buy as much from its European partners as it sells to them.
Katinka Barysch is deputy director at the CER
Human rights cannot be a luxury in Afghanistan
by Joanna Buckley
The Afghans with whom I worked in Bamyan province, Afghanistan, often asked me why foreigners were so concerned about the destruction of historical monuments yet seemingly so indifferent to the human suffering that occurred. They were referring to the international outcry which followed the demolition of the ancient statues of Buddha, carved into the side of the Bamyan valley and destroyed by the Taliban in March 2001. To this day, foreigners in Afghanistan travel to Bamyan to visit the gaping holes that once housed the giant sandstone statues. To most Hazaras, the ethnic minority that lives in Bamyan, these empty niches represent more than the wanton destruction of their cultural heritage: they are also a reminder of killings that took place around the same time. In the most notorious incident, in January 2001, Taliban forces were accused of the massacre of hundreds of civilians in Yakawlang district, north of the province’s capital. This is just one example of the many atrocities that occurred during almost three decades of conflict in Afghanistan. But in the rush to end the war and leave Afghanistan there is the risk that the international community will fail to address violations of human rights and past war crimes.
That would be a mistake. The western strategy for Afghanistan is based on convincing the Afghan population that the government of President Hamid Karzai is worth supporting - and eventually leaving the country in his hands. But the Kabul administration lacks credibility, particularly following the elections of August 2009 which were marred by widespread fraud; and because it has left violations of human rights unpunished, fostering a culture of impunity. In December 2009 the government published the 'national reconciliation, general amnesty and national stability law', which effectively granted a blanket amnesty to all those involved in the many years of conflict in Afghanistan.
Western governments seem intent on ignoring this situation. In a January 2010 talk in London the former British ambassador and newly appointed ‘senior civilian representative’ for NATO, Mark Sedwill, said that peace will require dealing with “some pretty unsavoury characters”. Diplomats attending a major international conference on Afghanistan in London in early 2010 confirmed that, despite official government rhetoric to the contrary, Sedwill echoes the prevailing sentiment - that there is no room at the moment for taking human rights into consideration. Human rights have become a luxury - a potential added bonus. Instead, politicians and diplomats working in Kabul are focusing on ways to end the conflict through a political settlement. This would involve measures to provide alternative opportunities for insurgents involved in the current fighting (reintegration), most probably coupled with some kind of high-level political deal with the Taliban (reconciliation).
The governments involved in Afghanistan’s reconstruction are right to look for ways to persuade insurgents to lay down arms. And Ambassador Sedwill correctly argued that it would be hypocritical to impose stringent moral standards on insurgents while many members of the government are implicated in serious crimes. Others suggest that attempts to marginalise Afghan warlords now by holding them to account for past abuses will result in further insecurity, possibly leading to civil war. But this does not need to be an either or situation: there are ways of building human rights considerations into a future political settlement and in fact utilising these to strengthen any deal reached, providing a mechanism of leverage.
Insurgents and members of the Afghan government implicated in human rights abuses should agree to draw a line under the past. But those involved in future violations should be held to account. In these cases evidence of past crimes would be considered. If required, violators of human rights should be referred to the International Criminal Court (ICC) - Afghanistan has ratified the Rome Statute that created the ICC and is bound by its provisions. The United Nations, which has a more neutral reputation in Afghanistan than NATO or the US and UK governments, should monitor compliance with the human rights provisions of a peace agreement. Other international organisations should offer the UN full political and financial support in its role - in particular the European Union, which has been a vocal defender of human rights and the rule of law in Afghanistan. They should also support a more holistic process for transitional justice, including initiatives to recognise, investigate and document past crimes.
The foreign governments, which promised that their military intervention would result in justice for all Afghans, have a responsibility and an opportunity to help implement such an agreement. The US and UK governments have rightly stressed that any future reconciliation process has to be Afghan-led. But common sense dictates that talks between the Kabul government and those insurgents open to negotiations will at some point require the services of a foreign neutral broker. The experience of the civil war in Afghanistan in the 1990s illustrates that maintaining a peace deal once it has been reached is a treacherous affair. The presence of an outside guarantor and the inclusion of human rights conditions would make any deal reached more enduring.Implementation will require the international community to show a concerted political will and a co-ordinated approach. This is not an easy thing to achieve; the various institutions and governments involved assign differing priorities to protecting human rights. But most would like to leave Afghanistan soon. They need to understand that foreign troops will not be able to leave until the Kabul government asserts its authority over the country, and the Afghan government will never be able to gain the trust of its people unless it can guarantee their rights.
Joanna Buckley is a former political adviser, Office of the Special Representative of the EU for Afghanistan, and former information analyst, United Nations Assistance Mission in Afghanistan. She is also the author of “Can the EU be more effective in Afghanistan?”, a new report published by the Centre for European Reform.
The Afghans with whom I worked in Bamyan province, Afghanistan, often asked me why foreigners were so concerned about the destruction of historical monuments yet seemingly so indifferent to the human suffering that occurred. They were referring to the international outcry which followed the demolition of the ancient statues of Buddha, carved into the side of the Bamyan valley and destroyed by the Taliban in March 2001. To this day, foreigners in Afghanistan travel to Bamyan to visit the gaping holes that once housed the giant sandstone statues. To most Hazaras, the ethnic minority that lives in Bamyan, these empty niches represent more than the wanton destruction of their cultural heritage: they are also a reminder of killings that took place around the same time. In the most notorious incident, in January 2001, Taliban forces were accused of the massacre of hundreds of civilians in Yakawlang district, north of the province’s capital. This is just one example of the many atrocities that occurred during almost three decades of conflict in Afghanistan. But in the rush to end the war and leave Afghanistan there is the risk that the international community will fail to address violations of human rights and past war crimes.
That would be a mistake. The western strategy for Afghanistan is based on convincing the Afghan population that the government of President Hamid Karzai is worth supporting - and eventually leaving the country in his hands. But the Kabul administration lacks credibility, particularly following the elections of August 2009 which were marred by widespread fraud; and because it has left violations of human rights unpunished, fostering a culture of impunity. In December 2009 the government published the 'national reconciliation, general amnesty and national stability law', which effectively granted a blanket amnesty to all those involved in the many years of conflict in Afghanistan.
Western governments seem intent on ignoring this situation. In a January 2010 talk in London the former British ambassador and newly appointed ‘senior civilian representative’ for NATO, Mark Sedwill, said that peace will require dealing with “some pretty unsavoury characters”. Diplomats attending a major international conference on Afghanistan in London in early 2010 confirmed that, despite official government rhetoric to the contrary, Sedwill echoes the prevailing sentiment - that there is no room at the moment for taking human rights into consideration. Human rights have become a luxury - a potential added bonus. Instead, politicians and diplomats working in Kabul are focusing on ways to end the conflict through a political settlement. This would involve measures to provide alternative opportunities for insurgents involved in the current fighting (reintegration), most probably coupled with some kind of high-level political deal with the Taliban (reconciliation).
The governments involved in Afghanistan’s reconstruction are right to look for ways to persuade insurgents to lay down arms. And Ambassador Sedwill correctly argued that it would be hypocritical to impose stringent moral standards on insurgents while many members of the government are implicated in serious crimes. Others suggest that attempts to marginalise Afghan warlords now by holding them to account for past abuses will result in further insecurity, possibly leading to civil war. But this does not need to be an either or situation: there are ways of building human rights considerations into a future political settlement and in fact utilising these to strengthen any deal reached, providing a mechanism of leverage.
Insurgents and members of the Afghan government implicated in human rights abuses should agree to draw a line under the past. But those involved in future violations should be held to account. In these cases evidence of past crimes would be considered. If required, violators of human rights should be referred to the International Criminal Court (ICC) - Afghanistan has ratified the Rome Statute that created the ICC and is bound by its provisions. The United Nations, which has a more neutral reputation in Afghanistan than NATO or the US and UK governments, should monitor compliance with the human rights provisions of a peace agreement. Other international organisations should offer the UN full political and financial support in its role - in particular the European Union, which has been a vocal defender of human rights and the rule of law in Afghanistan. They should also support a more holistic process for transitional justice, including initiatives to recognise, investigate and document past crimes.
The foreign governments, which promised that their military intervention would result in justice for all Afghans, have a responsibility and an opportunity to help implement such an agreement. The US and UK governments have rightly stressed that any future reconciliation process has to be Afghan-led. But common sense dictates that talks between the Kabul government and those insurgents open to negotiations will at some point require the services of a foreign neutral broker. The experience of the civil war in Afghanistan in the 1990s illustrates that maintaining a peace deal once it has been reached is a treacherous affair. The presence of an outside guarantor and the inclusion of human rights conditions would make any deal reached more enduring.Implementation will require the international community to show a concerted political will and a co-ordinated approach. This is not an easy thing to achieve; the various institutions and governments involved assign differing priorities to protecting human rights. But most would like to leave Afghanistan soon. They need to understand that foreign troops will not be able to leave until the Kabul government asserts its authority over the country, and the Afghan government will never be able to gain the trust of its people unless it can guarantee their rights.
Joanna Buckley is a former political adviser, Office of the Special Representative of the EU for Afghanistan, and former information analyst, United Nations Assistance Mission in Afghanistan. She is also the author of “Can the EU be more effective in Afghanistan?”, a new report published by the Centre for European Reform.
Friday, April 30, 2010
Turning Japanese?
by Simon Tilford
Japan has long had the highest level of public debt of any developed economy. The country’s public debt to GDP ratio is around 200 per cent of GDP, far in excess of even the EU’s worst performers. The collapse of real estate and equity prices in the early 1990s and the resulting banking crisis combined with a fast ageing population have condemned Japan to huge deficits, economic stagnation, and deflation, and an enormous rise in overall indebtedness. The country has been able to finance these deficits domestically, and very cheaply, because of Japan’s high domestic savings, and the readiness of Japanese savers to accept a very low rate of return. Deflation (and the strength of the Yen) has meant the Japanese have been willing to invest in Japanese governments bonds despite the low rate of nominal interest rather than invest abroad.
European governments have tended to be very dismissive of any suggestion that Europe is at risk of heading in a Japanese direction. Typically, they argue that the Japanese made egregious policy mistakes, which Europe would not repeat, such as failing to recapitalise the country’s banks quickly enough or tightening fiscal policy before the economic recovery had gained sufficient momentum. These criticisms of the Japanese authorities are probably fair. However, there are structural reasons for Japan’s plight, which many European economies share. And, despite protestations to the contrary, Europe is busy making the same policy mistakes as the Japanese authorities. Much of Europe is now on a Japanese course. Indeed, for some European countries the outlook looks much worse.
One group of EU economies should escape this predicament, largely as a result of favourable demographics. These include the Nordic economies, the Netherlands, and notwithstanding their current fiscal travails, France and the UK. Debt ratios will rise very strongly in all these economies, especially France and the UK, but these should be sustainable because their economies will continue to grow and they should avoid prolonged deflation. Although their populations are ageing, they will largely escape the demographic tsunami which is set to overwhelm much of Europe. For example, fertility rates in France and UK are over 1.9, and hence close to the replacement rate of 2.1 – the level needed to ensure stable populations. It is a similar story in the Nordics, while the picture is bit less favourable in the Netherlands, where the fertility rate is around 1.7.
A second group – basically comprising Germany (and probably Austria) – looks on course to emulate Japan’s experience. Germany has not experienced an asset price collapse equivalent to Japan, or the associated explosion in private sector indebtedness. But there are plenty of similarities between the two countries. Germany is experiencing a similarly drastic population ageing. The country’s fertility rate has been hovering around 1.3 for a generation, guaranteeing – in the absence of mass immigration – very rapid population decline. Like Japan, the country’s economic growth potential is now very low, domestic demand stagnant and deflationary pressures building. Germany also has badly undercapitalised banks. Like Japan, Germany can rely on large trade surpluses to partially offset the weakness of the domestic economy. High levels of domestic savings probably mean that Germany will be able to finance the borrowing domestically and be able to run up a similar debt burden to Japan without running into serious financing difficulties.
However, like Japan, this accumulation of debt will not be sustainable indefinitely. Japan’s household savings rate has fallen steeply in recent years as its ageing population starts to draw down on savings. The only reason the Japanese have been able to continue financing the fiscal deficit domestically is that corporate sector savings have ballooned, reflecting a collapse in investment. Once Japanese firms start to invest or their profitability declines, Japan will have to attract capital from abroad and foreign investors will demand a higher rate of interest than domestic investors are currently prepared to accept. Higher borrowing costs will spell serious trouble for a country as indebted as Japan.
A third group of EU economies – Italy, Portugal and Spain and of course Greece – looks set to fare worse than Japan. These economies combine the worst of all worlds. They have very weak public finances, fast ageing populations, very poor economic growth prospects and current account deficits – in the case of Greece, Portugal and Spain, very large ones. They cannot inflate their way out of their predicament, because they are members of the eurozone. Unlike Germany and Austria, they do not have surplus savings, and rely – to a greater or lesser extent – on foreigners to finance their deficits. Investors have already concluded that the debt dynamics of the weakest of the four – Greece – are unsustainable. Given their very poor growth prospects and dependence on foreign borrowing, Portugal and Spain will struggle to convince investors that they will be able to service steadily rising levels of debt. Italy looks somewhat less vulnerable than the other countries in this group in that it has a higher savings rate. However, it is hard to imagine Italian or foreign investors remaining sanguine about an unchecked build-up of Italian debt.
Simon Tilford is the chief economist at the Centre for European Reform.
Japan has long had the highest level of public debt of any developed economy. The country’s public debt to GDP ratio is around 200 per cent of GDP, far in excess of even the EU’s worst performers. The collapse of real estate and equity prices in the early 1990s and the resulting banking crisis combined with a fast ageing population have condemned Japan to huge deficits, economic stagnation, and deflation, and an enormous rise in overall indebtedness. The country has been able to finance these deficits domestically, and very cheaply, because of Japan’s high domestic savings, and the readiness of Japanese savers to accept a very low rate of return. Deflation (and the strength of the Yen) has meant the Japanese have been willing to invest in Japanese governments bonds despite the low rate of nominal interest rather than invest abroad.
European governments have tended to be very dismissive of any suggestion that Europe is at risk of heading in a Japanese direction. Typically, they argue that the Japanese made egregious policy mistakes, which Europe would not repeat, such as failing to recapitalise the country’s banks quickly enough or tightening fiscal policy before the economic recovery had gained sufficient momentum. These criticisms of the Japanese authorities are probably fair. However, there are structural reasons for Japan’s plight, which many European economies share. And, despite protestations to the contrary, Europe is busy making the same policy mistakes as the Japanese authorities. Much of Europe is now on a Japanese course. Indeed, for some European countries the outlook looks much worse.
One group of EU economies should escape this predicament, largely as a result of favourable demographics. These include the Nordic economies, the Netherlands, and notwithstanding their current fiscal travails, France and the UK. Debt ratios will rise very strongly in all these economies, especially France and the UK, but these should be sustainable because their economies will continue to grow and they should avoid prolonged deflation. Although their populations are ageing, they will largely escape the demographic tsunami which is set to overwhelm much of Europe. For example, fertility rates in France and UK are over 1.9, and hence close to the replacement rate of 2.1 – the level needed to ensure stable populations. It is a similar story in the Nordics, while the picture is bit less favourable in the Netherlands, where the fertility rate is around 1.7.
A second group – basically comprising Germany (and probably Austria) – looks on course to emulate Japan’s experience. Germany has not experienced an asset price collapse equivalent to Japan, or the associated explosion in private sector indebtedness. But there are plenty of similarities between the two countries. Germany is experiencing a similarly drastic population ageing. The country’s fertility rate has been hovering around 1.3 for a generation, guaranteeing – in the absence of mass immigration – very rapid population decline. Like Japan, the country’s economic growth potential is now very low, domestic demand stagnant and deflationary pressures building. Germany also has badly undercapitalised banks. Like Japan, Germany can rely on large trade surpluses to partially offset the weakness of the domestic economy. High levels of domestic savings probably mean that Germany will be able to finance the borrowing domestically and be able to run up a similar debt burden to Japan without running into serious financing difficulties.
However, like Japan, this accumulation of debt will not be sustainable indefinitely. Japan’s household savings rate has fallen steeply in recent years as its ageing population starts to draw down on savings. The only reason the Japanese have been able to continue financing the fiscal deficit domestically is that corporate sector savings have ballooned, reflecting a collapse in investment. Once Japanese firms start to invest or their profitability declines, Japan will have to attract capital from abroad and foreign investors will demand a higher rate of interest than domestic investors are currently prepared to accept. Higher borrowing costs will spell serious trouble for a country as indebted as Japan.
A third group of EU economies – Italy, Portugal and Spain and of course Greece – looks set to fare worse than Japan. These economies combine the worst of all worlds. They have very weak public finances, fast ageing populations, very poor economic growth prospects and current account deficits – in the case of Greece, Portugal and Spain, very large ones. They cannot inflate their way out of their predicament, because they are members of the eurozone. Unlike Germany and Austria, they do not have surplus savings, and rely – to a greater or lesser extent – on foreigners to finance their deficits. Investors have already concluded that the debt dynamics of the weakest of the four – Greece – are unsustainable. Given their very poor growth prospects and dependence on foreign borrowing, Portugal and Spain will struggle to convince investors that they will be able to service steadily rising levels of debt. Italy looks somewhat less vulnerable than the other countries in this group in that it has a higher savings rate. However, it is hard to imagine Italian or foreign investors remaining sanguine about an unchecked build-up of Italian debt.
Simon Tilford is the chief economist at the Centre for European Reform.
Wednesday, April 21, 2010
Clameronism
From 'A Thousand Years of History: Britain in Europe 1066-2066', Oxford University Press, 2070.
Britain's 'national government' of 2010 was not unprecedented. Britons had accepted patriotic coalitions before during the First Great Recession and Second World War. Still, David Cameron's Conservatives fought hard in the aftermath of that year’s general election to preserve a minority government propped up by an unlikely assortment of regional parties and independents. But industrial unrest and a stuttering economic recovery ate away at investor confidence in Britain’s public finances. With pressure on sterling mounting, Cameron was finally forced to invite Liberal leader, Nick Clegg, into a national coalition.
Buoyed by a huge increase in the Liberal vote, Clegg at first opted for opposition. He bet that a swift second election was likely and that the Liberal Democrats would again double their seats. But the threat of a new financial crisis later that year spelt an end to normal politics. And Cameron's offer to give Vince Cable – the Liberals' ever popular shadow chancellor – the role of deputy at the treasury to help fight Britain's "economic blitz" could not be refused.
Clegg himself took on the post of foreign secretary, setting the scene for the coalition's first crisis: Britain's European policy. Despite howls of protest from the Conservative grass roots, Cameron agreed to "put on hold" Tory demands for a membership renegotiation that would have withdrawn Britain from EU policies on social policy, human rights and justice and policing. Instead, Britain pursued its interests in Europe based on a joint strategy called 'Leading critically: A new pro-Europeanism', swiftly dubbed "Clameronism" by The Economist.
For a time, the odd fusion of Cameron's detached euroscepticism and Clegg's pro-European stance worked well. Though he had to cope with a handful of defections from his own party, Cameron no longer had to fret about how he might extract himself from his pre-election promises on the EU when they proved undeliverable. Nor did he have to endure the ignominy of blocking Croatia's EU accession with demands for special concessions for the UK. And Clegg's ability to woo the European Parliament – where the Alliance of European Liberals held the balance of power – proved critical in protecting Britain from overly onerous financial regulation and restrictive laws on working hours. The Conservatives, meanwhile, could afford occasional gestures to stubbornly high eurosceptic sentiment at home.
In 2012, a British-French initiative set up St-Malo II, an EU defence avant-garde needed to cope with plummeting defence budgets. Later, President Strauss-Kahn supported the European Commission's drive to complete a functioning EU services market by 2017 in return for basic rules on corporate taxation. Ever closer Anglo-French partnership contrasted sharply with what became known as Germany's 'strategic lethargy', where Berlin glumly viewed continued European integration as a negative but lacked the will to take alternative initiatives.
It was ironic, then, that events in Germany were to trigger the unravelling of the Tory-Liberal consensus and the end of what many considered to be their unholy alliance. In the so-called 'Four Professors' crisis of 2013, a brittle hodgepodge of bailout guarantees needed to keep Greece and other countries in the euro were struck down as unconstitutional by the Bundesverfassungsgericht on a third attempt by a group of German academic economists. A mushrooming series of financial and political crises finally forced EU leaders to confront the question of European Economic Union (EEU) at a hastily convened Inter-Governmental Conference in early 2014.
The so-called Treaty of Prague – which established a centrally managed eurozone treasury fund equal to 3 per cent of EU GDP – irrevocably split the coalition. A major change to the EU's treaties with implications for its budget, the treaty still required ratification in Britain. Cameron was unable to contain a backbench revolt in his own party over what were perceived as overly weak safeguards secured on Britain’s ‘red lines’ by the foreign secretary. For his part, Clegg insisted on a protocol which would leave open the option that Britain might one day join the euro.
Both parties had previously committed to holding a referendum on Britain's future in Europe and now that too became unavoidable. The Liberals, campaigning with Gladstonian fervour, insisted that a vote on the Prague treaty was vital for EU stability and must be considered the same as a vote on Britain's continued membership. The Tories countered that a rejection would merely halt the establishment of a European super-state on the brink of becoming financially independent of the member-states. The bitterly fought referendum, held alongside a general election in May 2014, marked a decisive shift in Britain's relationship with ‘Europe’, especially given the scale of the resulting landslide…
Hugo Brady is a senior research fellow at the Centre for European Reform.
Britain's 'national government' of 2010 was not unprecedented. Britons had accepted patriotic coalitions before during the First Great Recession and Second World War. Still, David Cameron's Conservatives fought hard in the aftermath of that year’s general election to preserve a minority government propped up by an unlikely assortment of regional parties and independents. But industrial unrest and a stuttering economic recovery ate away at investor confidence in Britain’s public finances. With pressure on sterling mounting, Cameron was finally forced to invite Liberal leader, Nick Clegg, into a national coalition.
Buoyed by a huge increase in the Liberal vote, Clegg at first opted for opposition. He bet that a swift second election was likely and that the Liberal Democrats would again double their seats. But the threat of a new financial crisis later that year spelt an end to normal politics. And Cameron's offer to give Vince Cable – the Liberals' ever popular shadow chancellor – the role of deputy at the treasury to help fight Britain's "economic blitz" could not be refused.
Clegg himself took on the post of foreign secretary, setting the scene for the coalition's first crisis: Britain's European policy. Despite howls of protest from the Conservative grass roots, Cameron agreed to "put on hold" Tory demands for a membership renegotiation that would have withdrawn Britain from EU policies on social policy, human rights and justice and policing. Instead, Britain pursued its interests in Europe based on a joint strategy called 'Leading critically: A new pro-Europeanism', swiftly dubbed "Clameronism" by The Economist.
For a time, the odd fusion of Cameron's detached euroscepticism and Clegg's pro-European stance worked well. Though he had to cope with a handful of defections from his own party, Cameron no longer had to fret about how he might extract himself from his pre-election promises on the EU when they proved undeliverable. Nor did he have to endure the ignominy of blocking Croatia's EU accession with demands for special concessions for the UK. And Clegg's ability to woo the European Parliament – where the Alliance of European Liberals held the balance of power – proved critical in protecting Britain from overly onerous financial regulation and restrictive laws on working hours. The Conservatives, meanwhile, could afford occasional gestures to stubbornly high eurosceptic sentiment at home.
In 2012, a British-French initiative set up St-Malo II, an EU defence avant-garde needed to cope with plummeting defence budgets. Later, President Strauss-Kahn supported the European Commission's drive to complete a functioning EU services market by 2017 in return for basic rules on corporate taxation. Ever closer Anglo-French partnership contrasted sharply with what became known as Germany's 'strategic lethargy', where Berlin glumly viewed continued European integration as a negative but lacked the will to take alternative initiatives.
It was ironic, then, that events in Germany were to trigger the unravelling of the Tory-Liberal consensus and the end of what many considered to be their unholy alliance. In the so-called 'Four Professors' crisis of 2013, a brittle hodgepodge of bailout guarantees needed to keep Greece and other countries in the euro were struck down as unconstitutional by the Bundesverfassungsgericht on a third attempt by a group of German academic economists. A mushrooming series of financial and political crises finally forced EU leaders to confront the question of European Economic Union (EEU) at a hastily convened Inter-Governmental Conference in early 2014.
The so-called Treaty of Prague – which established a centrally managed eurozone treasury fund equal to 3 per cent of EU GDP – irrevocably split the coalition. A major change to the EU's treaties with implications for its budget, the treaty still required ratification in Britain. Cameron was unable to contain a backbench revolt in his own party over what were perceived as overly weak safeguards secured on Britain’s ‘red lines’ by the foreign secretary. For his part, Clegg insisted on a protocol which would leave open the option that Britain might one day join the euro.
Both parties had previously committed to holding a referendum on Britain's future in Europe and now that too became unavoidable. The Liberals, campaigning with Gladstonian fervour, insisted that a vote on the Prague treaty was vital for EU stability and must be considered the same as a vote on Britain's continued membership. The Tories countered that a rejection would merely halt the establishment of a European super-state on the brink of becoming financially independent of the member-states. The bitterly fought referendum, held alongside a general election in May 2014, marked a decisive shift in Britain's relationship with ‘Europe’, especially given the scale of the resulting landslide…
Hugo Brady is a senior research fellow at the Centre for European Reform.
Wednesday, April 14, 2010
Whatever happened to the G20?
By Katinka Barysch
George W Bush convened the first G20 summit in Washington in November 2008, at the height of the global financial and economic crisis. At two further summits in 2009, G20 leaders pledged to co-ordinate their economic stimulus packages (as well as exit strategies), avoid protectionism, address global imbalances, triple the resources of the IMF, and work out stricter rules for banks, hedge funds and other financial players.
The G20 was hailed as the body that would prevent the global economy from hurtling into another great depression. It would also allow the world's top economies, including for the first time the big emerging markets, to co-ordinate their policies in such a way as to make future crises less likely.
"Whatever happens, the G20 is already a winner", wrote Martin Wolf in the Financial Times at the time of the G20 Pittsburgh summit in September 2009. "The fact that it has become central to global policymaking may prove a more important legacy of this crisis than any specific agreements it reaches."
Less than 18 months after the initial Washington summit, however, the G20 has almost disappeared from public view. As growth has returned in most countries, the sense of urgency to 'fix' the world economy has started to fade. The new body's legitimacy is already being questioned. That is unfortunate because the G20 still has a daunting to-do list. The risk now is that the debate about what the G20 should do is superseded by one about what it should look like.
Critics are right that the G20 is unwieldy. Once the representatives from international organisations such as the IMF and the WTO, as well as regional groupings such as ASEAN, are added, the total number of leaders and top officials at G20 summits is closer to 30. The easiest way to cut the G20 down to size would be to reduce Europe's over-representation: France, Germany, Italy and the UK are members. Spain, which holds the rotating EU presidency, will once again attend the next G20 summit. So will the presidents of the European Commission, the European Council and the European Central Bank (and now Jean-Claude Juncker, who heads the eurogroup, wants to come, too). The fact that one third of G20 participants hail from Europe and only two from Africa reduces the legitimacy of this body in the eyes of many poorer countries.
The Europeans will one day have to streamline their representation. (Meanwhile, Pascal Lamy suggests how the Europeans can make less of a nuisance of themselves, see 'Too many Europeans in G20: If you must hog the seats, could you at least talk less?'.) Perhaps other emerging economies will be added instead. But this is not the time to open the Pandora's box of who should be allowed to attend G20 summits. If the group is to regain momentum and authority, it needs to first and foremost deliver on its promises.
On trade, G20 governments have not fully lived up to their pledge to refrain from protectionism. In the 12 months following the Washington summit, the countries represented there adopted 179 policies that harmed foreign trade, investment or workers, according to Global Trade Alert. The overall damage, however, has been limited and the pace with which G20 countries have imposed new tariffs and anti-dumping actions has slowed in the last six months. World leaders had also instructed their trade negotiators to finish the WTO's Doha round by the end of 2009. But multilateral trade talks remain stuck.
The G20's report card is similarly mixed when it comes to re-regulating financial markets. Despite the promise to work out new rules together, several G20 members have announced measures without consulting their partners, for example the US administration's Volcker rule or the EU’s alternative investment directive. Nevertheless, the newly established Financial Stability Board (consisting of G20 finance ministers, central bankers and regulators) has helped to forge a broad consensus on what needs to be done in terms of capital and liquidity ratios, bankers' pay and so on. At the next G20 summit in June in Toronto, governments are likely to back plans for a new levy on banks.
Least progress has been achieved on global imbalances. The G20 has been sidelined, while the real discussions about exchange rate policies and trade balances have taken place between Washington and Beijing. Whether the Americans manage to put global imbalances on the Toronto agenda despite Chinese opposition is a serious test for the new forum.
To achieve results, the G20 leaders need to do two things. First, they need to concentrate on unfinished business and resist the temptation, or the pressure, to take on new tasks. The G20 has rightly rejected suggestions that it should discuss geo-political issues, such as Iran's nuclear programme. It should avoid being saddled with global climate change discussions. South Korea's idea of adding development and poverty reduction to the agenda of the G20 summit in Seoul in November is harder to dismiss. Such a broadening of the agenda would keep emerging economies interested and show that the G20 agenda does not merely reflect rich countries' interests.
Second, for the G20 to make a difference, leaders need to focus on the urgent but unexciting task of integrating the G20 into the existing systems of global governance. The G20, like the G7/8 before it, is a process, not an organisation. It cannot take legally binding decisions. It does not have a permanent secretariat. But it does have a signalling function that can galvanise governments and other international organisations to act. It did so, for example, by adopting a strong stance on tax havens at the London summit in April 2009. In March 2010, Angel Gurria, secretary-general of the OECD, said (at the GMF Brussels Forum) that on taxation and transparency, there has been "more progress in the last 12 months than in the previous 12 years, because of a clear mandate from the G20". But not all institutional links function that smoothly. Officials in the UN and other venerable bodies resent that the G20 is hogging the limelight. Yet it is these bodies that will have to implement G20 decisions.
Katinka Barysch is deputy director of the Centre for European Reform.
George W Bush convened the first G20 summit in Washington in November 2008, at the height of the global financial and economic crisis. At two further summits in 2009, G20 leaders pledged to co-ordinate their economic stimulus packages (as well as exit strategies), avoid protectionism, address global imbalances, triple the resources of the IMF, and work out stricter rules for banks, hedge funds and other financial players.
The G20 was hailed as the body that would prevent the global economy from hurtling into another great depression. It would also allow the world's top economies, including for the first time the big emerging markets, to co-ordinate their policies in such a way as to make future crises less likely.
"Whatever happens, the G20 is already a winner", wrote Martin Wolf in the Financial Times at the time of the G20 Pittsburgh summit in September 2009. "The fact that it has become central to global policymaking may prove a more important legacy of this crisis than any specific agreements it reaches."
Less than 18 months after the initial Washington summit, however, the G20 has almost disappeared from public view. As growth has returned in most countries, the sense of urgency to 'fix' the world economy has started to fade. The new body's legitimacy is already being questioned. That is unfortunate because the G20 still has a daunting to-do list. The risk now is that the debate about what the G20 should do is superseded by one about what it should look like.
Critics are right that the G20 is unwieldy. Once the representatives from international organisations such as the IMF and the WTO, as well as regional groupings such as ASEAN, are added, the total number of leaders and top officials at G20 summits is closer to 30. The easiest way to cut the G20 down to size would be to reduce Europe's over-representation: France, Germany, Italy and the UK are members. Spain, which holds the rotating EU presidency, will once again attend the next G20 summit. So will the presidents of the European Commission, the European Council and the European Central Bank (and now Jean-Claude Juncker, who heads the eurogroup, wants to come, too). The fact that one third of G20 participants hail from Europe and only two from Africa reduces the legitimacy of this body in the eyes of many poorer countries.
The Europeans will one day have to streamline their representation. (Meanwhile, Pascal Lamy suggests how the Europeans can make less of a nuisance of themselves, see 'Too many Europeans in G20: If you must hog the seats, could you at least talk less?'.) Perhaps other emerging economies will be added instead. But this is not the time to open the Pandora's box of who should be allowed to attend G20 summits. If the group is to regain momentum and authority, it needs to first and foremost deliver on its promises.
On trade, G20 governments have not fully lived up to their pledge to refrain from protectionism. In the 12 months following the Washington summit, the countries represented there adopted 179 policies that harmed foreign trade, investment or workers, according to Global Trade Alert. The overall damage, however, has been limited and the pace with which G20 countries have imposed new tariffs and anti-dumping actions has slowed in the last six months. World leaders had also instructed their trade negotiators to finish the WTO's Doha round by the end of 2009. But multilateral trade talks remain stuck.
The G20's report card is similarly mixed when it comes to re-regulating financial markets. Despite the promise to work out new rules together, several G20 members have announced measures without consulting their partners, for example the US administration's Volcker rule or the EU’s alternative investment directive. Nevertheless, the newly established Financial Stability Board (consisting of G20 finance ministers, central bankers and regulators) has helped to forge a broad consensus on what needs to be done in terms of capital and liquidity ratios, bankers' pay and so on. At the next G20 summit in June in Toronto, governments are likely to back plans for a new levy on banks.
Least progress has been achieved on global imbalances. The G20 has been sidelined, while the real discussions about exchange rate policies and trade balances have taken place between Washington and Beijing. Whether the Americans manage to put global imbalances on the Toronto agenda despite Chinese opposition is a serious test for the new forum.
To achieve results, the G20 leaders need to do two things. First, they need to concentrate on unfinished business and resist the temptation, or the pressure, to take on new tasks. The G20 has rightly rejected suggestions that it should discuss geo-political issues, such as Iran's nuclear programme. It should avoid being saddled with global climate change discussions. South Korea's idea of adding development and poverty reduction to the agenda of the G20 summit in Seoul in November is harder to dismiss. Such a broadening of the agenda would keep emerging economies interested and show that the G20 agenda does not merely reflect rich countries' interests.
Second, for the G20 to make a difference, leaders need to focus on the urgent but unexciting task of integrating the G20 into the existing systems of global governance. The G20, like the G7/8 before it, is a process, not an organisation. It cannot take legally binding decisions. It does not have a permanent secretariat. But it does have a signalling function that can galvanise governments and other international organisations to act. It did so, for example, by adopting a strong stance on tax havens at the London summit in April 2009. In March 2010, Angel Gurria, secretary-general of the OECD, said (at the GMF Brussels Forum) that on taxation and transparency, there has been "more progress in the last 12 months than in the previous 12 years, because of a clear mandate from the G20". But not all institutional links function that smoothly. Officials in the UN and other venerable bodies resent that the G20 is hogging the limelight. Yet it is these bodies that will have to implement G20 decisions.
Katinka Barysch is deputy director of the Centre for European Reform.
Thursday, April 01, 2010
Turkey's turmoil
by Katinka Barysch
Political convulsions are nothing new in Turkey. But recent events have made some observers gloomy about the fate of the country and its suitability as an EU member. Tensions are escalating between the ruling AK party, on the one hand, and the army and the secular opposition, on the other. Some observers warn that another military coup cannot be ruled out completely. Others think that the highest court could launch a new case to ban the AKP. Political disputes, however heated, do not disqualify Turkey from EU accession. The danger is that the government and its opponents damage state institutions and undermine the rule of law by using the police, courts and other public bodies in their battle for political survival. This is where the EU must focus its efforts.
Dozens of former generals and other military personnel have been jailed in recent months, accused of plotting coups against the government of Recep Tayyip Erdogan. This followed hundreds of arrests under the ‘Ergenekon’ case against an alleged terrorist network of arch-secular judges, professors, soldiers and officials. More than 100,000 Turks have had their phones tapped, say media reports. Many ordinary Turks fear being caught up in the continuing investigations.
The opposition accuses Erdogan’s AK party of transforming Turkey into an Islamist state and of using the police and the judiciary to get rid of its opponents. They feel vindicated by the government’s hasty moves to amend the constitution in a way that would give the AKP more influence over the composition of the constitutional court and the ‘supreme board of judges and prosecutors’.
AKP leaders say that the constitutional amendments are needed to get the country closer to the EU. They point out that the legal package contains some bits that are needed to allow for the opening of new ‘chapters’ in the accession talks (like allowing civil servants to strike) and others that are long-standing EU demands (such as making it harder for the courts to close down parties). They say that recent waves of arrests are part of a much-needed process of democratisation at the end of which elected politicians – not generals, judges and other unaccountable figures – will have the last say in Turkish politics.
A complex mix of social change, internal power struggles and clashing ideologies is behind the current commotion. A changing Turkey needs a new system of political checks and balances. For too long, Turkey’s secular establishment has relied on the army, the constitutional court and the (traditionally secular) president to keep elected politicians in check. In each decade since Turkey became democratic in 1950, the army has forced an elected government from power. The constitutional court has banned scores of political parties suspected of undermining the secular order or the unity of the state. Much of the media and the education system used to spread Kemalist ideology. These are not the ingredients of a modern democracy.
Change was inevitable. And in a country with many fault lines and a fair number of fanatics, it was never going to be smooth. Nevertheless, the new system that now seems to be emerging is flawed. The president now hails from the AKP and is accused of using his wide-ranging powers of appointment to fill public bodies with party supporters. The armed forces no longer appear unified or strong enough to depose of the government (they last tried, and failed, in 2007). But they are still fighting to forestall what they regard as the AKP’s growing dominance. The judiciary appears torn in the clash between secularists and pious conservatives. The media is deeply polarised.
Perhaps most importantly, Turkey’s political parties do not present a proper choice to the Turkish people. The main opposition parties – the Kemalist CHP and the nationalist MHP – proffer little more than identity politics. Both lack a vision for a modern, dynamic Turkey at peace with itself and its neighbours. Their tired slogans and obstructionism have limited appeal. The rigid hierarchy within these organisations (“Shrinking cults for outsized egos” FT columnist David Gardner recently called them) make internal renewal improbable.
The AKP promised to be a political force of a different kind: a grass-roots movement, transparent (ak means white or pure in Turkish), representative of a more diverse nation, focused on policies rather than ideologies. But eight years after winning its first election, the AKP has started to resemble its political opponents. Erdogan, it is said, takes all important decisions. Corruption allegations have become more frequent – as have the party leadership’s attempts to use state power to deflect them. Media outlets that criticise the government have come under pressure. The AKP used to accuse the CHP of using the courts and the security apparatus to intimidate its opponents. Now such allegations are heaped onto the AKP itself. Public bodies, such as the higher education board, have become more, not less politicised under AKP influence.
There are some stirrings in Turkey’s political system, with old parties trying to regroup and new ones springing up. But lack of money and a prohibitive 10 per cent threshold to enter parliament make life very tough for smaller parties and newcomers. Although Erdogan promised years ago to reduce the 10 per cent threshold, such a change is conspicuously absent from the constitutional reform package that the AKP has now sent to parliament.
The new enlargement commissioner, Stefan Fule, has said that “the proposed reforms [in the constitutional package] go in the right direction”. But while broadly satisfied with the substance, Fule and his colleagues are unhappy about the process. They are right. Even if the AKP manages to push through its package (it will probably have to resort to a referendum since it lacks the necessary super-majority in parliament), it is questionable whether the current antagonistic climate is a good time for a very incomplete constitutional reform. The move smacks of political manoeuvring and could discredit the very process of constitutional renewal. Given that Turkey’s democracy badly needs better rules, rights and institutions, this would be a tragedy. The AKP should wait until after the 2011 parliamentary election and then start the broad constitutional debate, including opposition parties and civil society, that it has promised ever since 2007. The EU is right not to take sides in Turkey’s current political battles. But it should not be afraid to say loud and clear that a more thorough reform of the constitution and the law on political parties is necessary if such battles are not to undermine Turkey’s accession chances in the medium term.
Katinka Barysch is the deputy director at the Centre for European Reform
Political convulsions are nothing new in Turkey. But recent events have made some observers gloomy about the fate of the country and its suitability as an EU member. Tensions are escalating between the ruling AK party, on the one hand, and the army and the secular opposition, on the other. Some observers warn that another military coup cannot be ruled out completely. Others think that the highest court could launch a new case to ban the AKP. Political disputes, however heated, do not disqualify Turkey from EU accession. The danger is that the government and its opponents damage state institutions and undermine the rule of law by using the police, courts and other public bodies in their battle for political survival. This is where the EU must focus its efforts.
Dozens of former generals and other military personnel have been jailed in recent months, accused of plotting coups against the government of Recep Tayyip Erdogan. This followed hundreds of arrests under the ‘Ergenekon’ case against an alleged terrorist network of arch-secular judges, professors, soldiers and officials. More than 100,000 Turks have had their phones tapped, say media reports. Many ordinary Turks fear being caught up in the continuing investigations.
The opposition accuses Erdogan’s AK party of transforming Turkey into an Islamist state and of using the police and the judiciary to get rid of its opponents. They feel vindicated by the government’s hasty moves to amend the constitution in a way that would give the AKP more influence over the composition of the constitutional court and the ‘supreme board of judges and prosecutors’.
AKP leaders say that the constitutional amendments are needed to get the country closer to the EU. They point out that the legal package contains some bits that are needed to allow for the opening of new ‘chapters’ in the accession talks (like allowing civil servants to strike) and others that are long-standing EU demands (such as making it harder for the courts to close down parties). They say that recent waves of arrests are part of a much-needed process of democratisation at the end of which elected politicians – not generals, judges and other unaccountable figures – will have the last say in Turkish politics.
A complex mix of social change, internal power struggles and clashing ideologies is behind the current commotion. A changing Turkey needs a new system of political checks and balances. For too long, Turkey’s secular establishment has relied on the army, the constitutional court and the (traditionally secular) president to keep elected politicians in check. In each decade since Turkey became democratic in 1950, the army has forced an elected government from power. The constitutional court has banned scores of political parties suspected of undermining the secular order or the unity of the state. Much of the media and the education system used to spread Kemalist ideology. These are not the ingredients of a modern democracy.
Change was inevitable. And in a country with many fault lines and a fair number of fanatics, it was never going to be smooth. Nevertheless, the new system that now seems to be emerging is flawed. The president now hails from the AKP and is accused of using his wide-ranging powers of appointment to fill public bodies with party supporters. The armed forces no longer appear unified or strong enough to depose of the government (they last tried, and failed, in 2007). But they are still fighting to forestall what they regard as the AKP’s growing dominance. The judiciary appears torn in the clash between secularists and pious conservatives. The media is deeply polarised.
Perhaps most importantly, Turkey’s political parties do not present a proper choice to the Turkish people. The main opposition parties – the Kemalist CHP and the nationalist MHP – proffer little more than identity politics. Both lack a vision for a modern, dynamic Turkey at peace with itself and its neighbours. Their tired slogans and obstructionism have limited appeal. The rigid hierarchy within these organisations (“Shrinking cults for outsized egos” FT columnist David Gardner recently called them) make internal renewal improbable.
The AKP promised to be a political force of a different kind: a grass-roots movement, transparent (ak means white or pure in Turkish), representative of a more diverse nation, focused on policies rather than ideologies. But eight years after winning its first election, the AKP has started to resemble its political opponents. Erdogan, it is said, takes all important decisions. Corruption allegations have become more frequent – as have the party leadership’s attempts to use state power to deflect them. Media outlets that criticise the government have come under pressure. The AKP used to accuse the CHP of using the courts and the security apparatus to intimidate its opponents. Now such allegations are heaped onto the AKP itself. Public bodies, such as the higher education board, have become more, not less politicised under AKP influence.
There are some stirrings in Turkey’s political system, with old parties trying to regroup and new ones springing up. But lack of money and a prohibitive 10 per cent threshold to enter parliament make life very tough for smaller parties and newcomers. Although Erdogan promised years ago to reduce the 10 per cent threshold, such a change is conspicuously absent from the constitutional reform package that the AKP has now sent to parliament.
The new enlargement commissioner, Stefan Fule, has said that “the proposed reforms [in the constitutional package] go in the right direction”. But while broadly satisfied with the substance, Fule and his colleagues are unhappy about the process. They are right. Even if the AKP manages to push through its package (it will probably have to resort to a referendum since it lacks the necessary super-majority in parliament), it is questionable whether the current antagonistic climate is a good time for a very incomplete constitutional reform. The move smacks of political manoeuvring and could discredit the very process of constitutional renewal. Given that Turkey’s democracy badly needs better rules, rights and institutions, this would be a tragedy. The AKP should wait until after the 2011 parliamentary election and then start the broad constitutional debate, including opposition parties and civil society, that it has promised ever since 2007. The EU is right not to take sides in Turkey’s current political battles. But it should not be afraid to say loud and clear that a more thorough reform of the constitution and the law on political parties is necessary if such battles are not to undermine Turkey’s accession chances in the medium term.
Katinka Barysch is the deputy director at the Centre for European Reform
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