2017 will be risky year for EU (less the UK) but there are also reasons for hope

 

The year 2017 will be an eventful and important year for the EU. The expectation that the UK will set in motion in March a process to leave the EU in two years is a blow – the first time that a full country has decided to leave the EU (Greenland an autonomous region with a link to Denmark had previously left) and one that might suggest the possibility of further countries leaving. The immediate aftermath of the UK according polls conducted by the German Bertelsmann Institute was a strengthening of pro-EU feeling in all other countries and there does not appear to be any country with a majority in favour of leaving the EU. Nevertheless there are strong movements in many remaining member states which are either in favour of outright departure or want to weaken the EU; there is also increased opposition to euro membership in Italy.

With the governments of all other major countries either weak or unstable and with many of their economies still struggling, Germany has in recent years played a leading role, and this will be even more the case in 2017 with the UK having decided to leave. The coming election there in September is likely to see the Christian Democrats re-elected as the largest party and therefore the leading party in a coalition, which could be again with the Social Democrats (SPD) or other parties. Whatever the criticisms made of her, Angela Merkel as the unchallenged leader of the CDU will very probably be re-appointed as chancellor.

 

Italy with caretaker prime minister faces election by March 2018

Within the euro zone Italy had since Matteo Renzi became prime minister in 2014 had a stronger and for Italy relatively long-lasting government. For a time Renzi seemed the most effective leader after Merkel, but he resigned in December as a result of a badly misjudged referendum on constitutional reform. If the overall aim of the reform – to change Italy’s costly and unwieldy bicameral system – was a good one, details were flawed and it became associated with a separate electoral reform, which could have given excessive power to the largest party even if it had well below majority support. In addition, having promised to resign as prime minister if he lost, Renzi had to do so. As a result Italy faces a new period of political instability with elections likely in 2017 and necessary by March 2018. There is a possibility that the Five Star Movement (M5S) might come to power. It can be described as populist but is not as anti-immigrant as other populist movements. It has said that it would have a referendum on euro membership. The leader, Beppe Grillo, is hyper-critical of the other main parties, particular the Democratic Party (PD), which is still led by Renzi, but M5S’s own performance in city governments has been mixed and particularly poor so far in Rome.

 

Spain with new minority government stages economic recovery

Spain, following a year with only a caretaker government, now has one led by the previously incumbent right-of-centre Popular Party (PP), which has been given conditional support by the opposition Socialists (PSOE) and opposed by the newer and more left wing Podemos, as well as being challenged by Catalan nationalism. In the last year the economy has finally, seven years after its collapse in 2008-09, staged an impressive recovery with over half a million extra jobs created in 2016. This seems likely to continue meaning that despite political difficulties Spain is no longer a weak link in the euro zone.

 

First 2017 elections to take place in Netherlands

Elections will take place in the Netherlands in March when the performance of the virulently anti-Muslim party the PVV led by Geert Wilders will be watched. Netherlands’ governments have always been coalitions but the other main parties have said they will not form a coalition with the PVV. Such a strategy may seem right in principle but has the disadvantage that the PVV has been becoming the main opposition.

 

French elections in May should lead to stronger president

The next major EU elections in 2017 will probably be those for the French president and parliament in May. At present there are three leading candidates each with about a quarter of likely votes according to opinion polls: Marine Le Pen leader of the Front National, Francois Fillon, the choice of the right of centre, and Emmanuel Macron, a centrist who was minister in the Socialist government before resigning to declare his independent candidacy. President Hollande is not standing. The Socialist Party is holding a primary to choose its official candidate but none of the potential official Socialist candidates looks likely to rival Macron. Macron has been making speeches emphasizing his difference with Le Pen by giving full-hearted support to the EU and declaring that France should be open and multi-cultural. Fillon on the other hand may try to win over potential Le Pen voters by being more sceptical of the EU (though not in favour of a referendum on it) and appealing to identity politics. He has also called for drastic cuts in the size of the public sector, one of the largest in Europe relative to the economy, by reducing state employment by half a million. As a declared admirer of Mrs Thatcher, he may also pursue policies which increase inequality. Even if these succeed in helping the development of private sector enterprise,they could increase the number of people who feel left out and so could be vulnerable to Le Pen.

At the moment opinion polls suggest that in the second round of presidential elections between the two leading candidates in the first round, assuming Le Pen comes first or second, that either Fillon or Macron would win by between 60 and 65% of the vote against 35-40% for Le Pen. Given the surprise Leave vote in the EU and the Trump victory in the US, there is no room for complacency that this apparently comfortable lead will be reflected in the final vote.

If Fillon or Macron can win by a reasonably strong majority his government will at least for a time have the potential to be a near-equal partner with Germany led by Merkel, a role that President Hollande has not been able to fulfill. Unlike Hollande, both Macron and Fillon argue that difficult and painful reforms are needed to revive the French economy and to strengthen the fiscal position. They are not therefore setting themselves up for a dramatic decline in support when it becomes apparent that they cannot meet promises made during the campaign as happened with Hollande.

 

Merkel likely to remain chancellor after September election

Germany’s election takes place, as is traditional there, in September. The far-right party, the Alternative fur Deutschland, at present polling at 13%, is less of a threat there to the mainstream parties than similar parties are in the many other EU countries, despite the bold decision of Angela Merkel to welcome over a million refugees in 2015. Still, the far-right will for the first time in post-Second World War Germany have seats in the federal parliament, and its presence there is likely to be quite significant.

If she can hold the far-right opposition to its present level of support, Merkel is likely to achieve another convincing electoral victory. Her ability to remain an authoritative but not authoritarian chancellor after 13 years in the post is remarkable but at present she faces no major challenge from any competitor for the post. Germany led by Merkel has been a lynchpin of stability and liberal multi-culturalism in the EU as a whole.

 

Criticism of Germany’s fiscal policy are valid but should not be exaggerated

On the other hand Germany’s finance minister, Wolfgang Schauble, has been accused of dictating harshly restrictive monetary and fiscal policies which have served its interests more than its euro area partners. Schauble is the second most powerful figure in German politics. His popularity means that Merkel would find it very hard to overrule him and risk provoking his resignation.

In fact the monetary policy of the European Central Bank, in promising if required unlimited intervention to keep key countries in the euro area and keeping interest rates close to zero has been highly criticized both by Schauble and by the Bundesbank. In fiscal policy Schauble has largely got his own way which has is in some respects been excessively harsh, especially in still refusing to write off un-repayable Greek and Portuguese debt and being unwilling to take into account the pressures on Italy’s public finances by the need to tackle the bulk of the cross-Mediterranean migrant flow in the last 12 months and suffering severe earthquakes. On the other hand, German policy has been consistent with holding the euro area together, and, whatever happened the post-2008-09 crash period would have been a difficult one inside the euro area as it has been outside the euro area. While some criticisms of German policy are justifiable it is not helpful to suggest that the difficulties of other countries should be solved more in Germany than domestically. Ireland has for several years shown that a euro zone crisis country could recover and in 2016 Spain recovered with the addition of over half a million extra jobs.

 

Role of EU institutions is important but likely to remain low profile

Given the upsets in the UK and the US in 2016 and the substantial support for right wing populist parties in many EU countries there are clearly risks that the cohesion of the EU apart from the UK. However, there are also grounds for hope that it can hold together despite both internal strains and unpredictable policies of the US and Russia, as well as the possibility of large new flows of refugees via Turkey or Libya. The ability to do so depends primarily on what happens in member states. The performance and decisions of the EU institutions, the Commission, Parliament and Court of Justice are important in the longer term but it is unlikely that they will do anything in the coming 12 months which has a decisive impact on the EU’s prospects. Following the departure of the Socialist Martin Schulz to return to German politics, the new president of the European Parliament, Antonio Tajani a member of the centre-right European Peoples’ Party is likely to have a lower profile. The European Commission, headed by Jean-Claude Juncker, has kept a generally low profile and is likely to do so.

One delicate issue is how far to go in criticizing authoritarian governments in Poland and Hungary for actions that seem to come into conflict with commitments made at the time of EU entry on principles like the independence of the judiciary. Overall, the EU institutions are unlikely to and should not push for more power since this could provoke a backlash in countries other than the UK  but they will still have important roles to play in keeping the EU functioning in very difficult circumstances.

What Future for the EU of 27?

Echoes of UK anti-EU opinion are found in the 27

The UK was never a lynchpin of the EU and the immediate effect of its vote to leave has been to strengthen pro-remain opinion in other countries. However, there are strong anti-EU sentiments in many member states and there is a notable lack of solidarity amongst the 27 in facing current issues, so there is no room for complacency. The British desire to blame the problems of modern life on “Brussels bureaucrats” has echoes in many other countries and there are strong parties which like UKIP play on nationalism “we against them” in France, Netherlands, Germany and many other countries. But at present emotions in the 27 are stirred almost entirely against would-be immigrants or asylum-seekers from outside the EU, particularly Muslims, partly because except in Germany there is less movement of intra-EU labour into any of the 27 than into the UK. Moreover no other country has any equivalent of the UK’s anti-EU press (Sun, Daily Mail, Daily Express and Daily Telegraph).

 

A divide remains between east and west

There are two fault lines through the EU-27, that of the former divide between communist eastern Europe and western Europe and that between north and south. The one between east and west reflects the fact that there is much less ethnic diversity in the east and consequently a fear of the consequences of any immigration from outside Europe and the ability of their societies to cope. This explains why there has been such strong resistance to any refugee quotas despite the fact that the numbers being asked of them are tiny compared with the million refugees taken in by Germany in 2015.  Two eastern European countries, Hungary and Poland, have also witnessed a worrying retreat from principles such as independent judiciary and a free and diverse press, which were part of the criteria for their entry to the EU, although the Polish Law and Justice Party is having to contend with a loss in popularity.

 

Another is between north and south

The second divide is across the euro zone where southern countries are struggling with high debt and stagnant economies, while Germany and some smaller countries are doing much better economically and have their public finances under tighter control. (France is only partly a southern country but does have some of the same problems.) It may well be the case that some of their difficulties would have been mitigated had southern countries not joined the euro zone at the start as this led to rising public and private borrowing from 2000 to 2008 encouraged by low interest rates and excessive confidence. But that does not mean that anything would be gained by breaking up the euro zone now. Croatia which is not in the euro zone has similar problems to countries that are in the zone. Short term growth might be achieved by currency depreciation and monetary accommodation of the consequent inflation but at some inflation would have to be brought under control. The labour market problems notably in Spain and Portugal existed before joining the euro. In Spain there was a big rise in employment after 2000 but much of the increase was due to the excessive boom particularly in construction backed by private sector borrowing. The recession in Spain brought about a big rise in public borrowing to a country whose public finances had been exemplary. In contrast Italy, Portugal and Greece were all crippled by high public debt already before the introduction of the euro.

 

Germany has taken role of disciplinarian

Germany has acted as a strict disciplinarian, not because it is trying to exercise power but because it believes that is the right policy for all countries and essential for the stability of the euro zone. It acknowledges a mea culpa in breaking the fiscal rules which Germany itself had insisted on as a foundation of the currency union in 2002-03 which undermined efforts to promote fiscal discipline in other countries during years of relatively strong demand. It has reacted by trying very hard to impose very tight fiscal discipline on itself, perhaps excessively especially in prioritising such discipline over infrastructure repair and improvement. It has a point in not excluding investment from fiscal targets since this can result in unnecessary investment, which will not lead to increased revenue in the future. It should, however, engage in debate on prioritising investment that is either going to become essential soon in the future or which can bring in revenue through fares, road tolls or other charges.

 

Renzi would like more flexibility

At present, the government of Matteo Renzi in Italy can claim to be the main spokesperson for southern Europe, given that his government has by Italian standards lasted a long time (just over two and a half years) and the next largest country, Spain, has been without a parliamentary-backed government for the whole of this year. But he is holding a referendum on December 4th on major constitutional reforms designed to produce a less costly and more effective parliament. He had earlier said he would resign if the reforms are defeated although he has recently been reticent about this. The reforms can be criticized in detail but are part of a wider reform programme that is trying to bring about changes that have long been recommended by organisations like the OECD, IMF, the European Commission, and indeed Germany, to reduce the cost of public sector administration while safeguarding key services like health and education, reduce regulatory and tax disincentives to establishing new businesses or increasing their size by hiring more employees. Renzi is straining at the leash of the fiscal rules to, on the one hand, try to help companies take on more employees by reducing labour taxes and the other to boost public investment; one need is to rebuild after the earthquake around Amatrice in August with buildings able to withstand future earthquakes.

 

On refugees Germany is closer to Italy and Greece than to many other countries

Despite tensions on fiscal policy, Germany is actually closer to Italy and to Greece in that both southern countries are like Germany struggling to take a degree of moral responsibility for the migrants risking their lives in crossing the sea. In the case of those coming to Italy a substantial number are from sub-Saharan Africa. In some cases they are fleeing from war or terrorism instigated by Boko Haram or other insurgents but where only a limited part of a country is so affected they should in theory be able to be returned to another part of the country. However, the process is costly and difficult and should perhaps be accompanied by financial aid. In Greece most migrants are from countries to which return is impossible. Germany is provided some financial aid to Greece to help it make living conditions bearable its many asylum seekers who are no longer able to continue to another country.

 

In the end EU will survive only if it can act as a community

Although aspects of the EU involve a legal framework of rules and enforcement, an equally important aspect is that it is a community of nations trying to act together and share political and ethical objectives. In a way it is a pity that the word Community was replaced by Union in the organisation’s title by the 1992 Maastricht Treaty. In any case, the EU’s leaders should not forget that acting as a community remains essential to its effectiveness and possibly its survival and that not everything can be done through rules or joint institutions, for which there is little appetite amongst public opinion in most member states.

 

Refugees replace Greece in the headlines

Angela Merkel changes image of Germany

How much has changed in a month! The headlines are no longer about the struggle of the Greek government and people to find a way forward for their becalmed economy but the more traumatic sufferings of the Syrian people fleeing their civil war. The latter is not new: the war has lasted four years and the numbers coming to Europe have been steadily increasing over the last twelve months. Germany was already committed to accepting large numbers of the refugees and local authorities an voluntary organisations were busy preparing to facilitate their arrival. But the numbers have increased, particularly coming through Turkey and the Balkans overland or via Greek islands. Most important Angela Merkel decided that the issue could no longer be treated as a subsidiary problem but had become the greatest challenge facing the European Union this year and perhaps for years to come. Not only the courage and humanity of her decision to prepare to accept up to 800,000 refugees this year and 500,000 a year subsequently, but the extent to which it is endorsed by large numbers of ordinary German people who have openly even enthusiastically welcomed the arrival of refugees, for example at Munich’s main railway station, have been remarkable. Opposition has so far been muted and mainly concentrated in former eastern Germany.

The image of Germany as rigid and hard-hearted particularly in Greece and other southern European countries but also more widely across the EU by its insistence on harsh fiscal austerity and its refusal to countenance debt forgiveness has been overturned. The Greek drama has not come to an end. A second general election this year is to take place on September 20th. However, for better or worse, the wings of the radicals are likely to be clipped. The main contest is between the traditional centre-right party New Democracy and a Syriza separated from its most leftwing component, and committed to implementing a programme of pragmatic reforms agreed with its creditors, not least the hardline German finance minister, Wolfgang Schauble. It has become clear that a dramatically different economic policy would only be possible if Greece were to leave the euro, a choice supported by a significant but minority section of the Greek population. The dramatic decline in living standards since 2009 and the 50% level of young people’s unemployment in Greece have had devastating consequences that are more comparable to the conditions of the 30s than anything in western Europe since the 1950. Nevertheless it is evident to Greece, which has received many desperate refugees on its easternmost islands, as well as the rest of Europe, that the plight of the Syrian people and other refugees is far worse.

 

Differences between east and west Europe

The refugee crisis has thus done a little to ease divisions between northern Europe and southern Europe, but has opened divisions between west Europe and countries in central and eastern Europe which feel that the refugee problem is not theirs. There are some differences between these former communist countries. The Hungarian government has made it clear that it feels little but hostility to the refugees coming through, even though it knows that they are all heading onwards, mostly to Germany. At least the Polish government has agreed in principle to take 2,000 refugees while putting forward the argument , up to a point valid, that Poland’s demography and economy make it much less suitable to taking large numbers of refugees than Germany. Donald Tusk, the former Polish prime minister, now president of the European Council, has shown the statesmanship to take a wider view of the issue than he probably would have if still prime minster of Poland.

The new president of Poland, Andrzej Duda, has pointed out that the situation in its neighbour Ukraine remains of concern to Poland, much more so than to countries further away from Ukraine. There are substantial numbers of Ukrainians in Poland. Although only a minority of those there at present come from eastern Ukraine and so are refugees rather than migrants in search of employment the numbers of both could rise if the situation deteriorated. In recent months Ukraine has not been very much in the news and to an extent no news is good news even if the low level war in the east continues to cause loss of life. The government is trying to put a bill through parliament to give very substantial powers to the provinces of Donetsk and Luhansk including control over the police forces and courts while allowing Ukraine to regain control of its eastern border, as agreed with Russia at Minsk. Such an eventuality looks theoretical at present but the bill shows that the government is rightly willing to make sacrifices in  the search for peace and stability. In doing so it provoked a violent response from the far-right Svoboda group which killed a policeman outside parliament and the loss of support in parliament from the nationalist Radical Party.

 

Quotas may not work but sharing is essential

The refugee crisis is seen differently across the 28-member EU, as is the case with other issues like the troubles of southern members of the euro zone. No one is suggesting that other countries should open the doors to the extent that Germany is doing. The 160,000 for the rest of the Schengen area proposed by the European Commission is several times lower than the number Germany is prepared to take. In the end rigid quotas probably will not work since it is hard to say how Syrian or other Muslim refugees could be settled in a country as hostile to them as Hungary even if its government agreed. Nevertheless a degree of sharing is required if the EU is to hold together.

Can the euro zone’s economic and argumentative gridlock be broken?

The euro zone economy is no longer in meltdown, but nor is it providing job opportunities for half a generation of young people across the southern half of its territory. Its economic gridlock is matched by gridlock in the debate between economic commentators and public opinion in Germany and some other northern countries who feel that they are resisting future generations being crippled by public debt, and those in the other countries as well as commentators in the Anglo-Saxon world — though not part of the euro zone they have an interest in its performance– who argue that stagnant economies sustaining massive unemployment and entering a possibly prolonged period of deflation will not only fail a generation, but be stuck in a deflationary debt trap which further austerity will only make worse. The European Central Bank’s attempts at an expansionary monetary policy will remain insufficient. The arguments apply not just to the public finances of the southern countries but also to Germany itself, which outsiders see as having plenty of space for fiscal stimulus but the Germans feel has to unwind the debt accumulated after unification and avoid a repeat of the bad example it gave in the early 2000s to other countries by breaking the provisions of the fiscal pact which Germany itself had insisted on as a precondition of the creation of the euro.

There is no simple answer to resolve the differences between the two sides. But there could be a more constructive dialogue on ways to stimulate the economy which do not harm long term fiscal sustainability.  Some Keynesians argue that almost any for of fiscal stimulus will pay for itself by the tax revenues or saved benefit payouts which stronger economic growth would provide, but to fiscal conservatives this sounds complacent and reckless.  However, some measures could stimulate economic recovery while not risking undermining long-term public finances.

The most indisputably beneficial measure but one which has by no means been fully applied would be for governments to borrow on the markets to pay all their bills to private businesses as soon as they are incurred. Nominally this  would increase public deficits but would not add to effective debt, and would put substantial financial resources into the hands of the businesses concerned and thereby into economies.

A second measure which should also carry the argument convincingly is to bring fully up to date all maintenance and repairs of essential infrastructure. This would clearly reduce the need for future expenditure. There is such a backlog in Germany and other countries. The impact on long term public finances could be further improved, for example by for example deciding that in Germany, where passenger vehicles now use autobahns for free, they would have to pay tolls as already freight vehicles do, and passenger vehicles in France and Italy.

A third somewhat more contentious but nevertheless strongly arguable class of measure would be to put in place public investments which will directly generate future income. There are admittedly few such projects which could be confidently predicted to bring about enough return to fully repay capital and interest. However, given that there are clearly offsetting receipts to public finances from the income tax paid by individuals and companies working on the projects as well as by further multiplier effects, a public investment project could be shown to be likely to have net beneficial effects on long term public finances if it can be predicted with reasonable confidence to generate substantial income streams, even if these are not sufficient to make the project profitable from a narrow accounting viewpoint. An example would be rail or urban transport projects where projected fares would pay for running costs but where the cost of capital would be partly subsidised.

There is furthermore the huge and urgent field of energy, or energy-saving, investments necessary for long term climate sustainability but also for nearer term economic and political sustainability in weaning Europe off dependence on Russian and Middle Eastern oil and gas and ensuring that there will be sufficient generating capacity. Much of that may be provided through private investment if there market conditions are provided but there could also be a significant role for up-front public sector investment, for example in an integrated electricity grid throughout the EU.

Jean-Claude Juncker has said that a €300bn investment programme to stimulate the economy will be a priority once his new college of commissioners takes over on November 1st. As with government promises of such funding, there will be justified scepticism as to whether any such programme really represents new money rather than a repackaging of existing funds. Certainly, there can be no increase in allocation from the EU budget which is fixed until 2020. More could be done to leverage EU funds with private sector finance but that also is already part of the policy Mr Juncker inherits. The most obvious and uncontroversial alternative source is the European Investment Bank which has a good record and is able to borrow at very low interest rates. But in order to maintain its triple A credit rating it would have to continue to fund relatively unrisky projects. Its scope can be expanded but not probably to the extent of the planned €300bn. Something else is likely to be needed to meet the target. The objective should be to persuade Germany whose support is essential to other plans which would be more risky and controversial but which could nevertheless be justified by using the above arguments as beneficial or at least neutral regarding the euro zone’s long term fiscal sustainability. Trying to win these limited arguments would be difficult but would be more likely to achieve success that trying to argue that public debt and deficits can simply be ignored.

The Junckernaut is no federalist juggernaut

The move to choose the former Luxembourgeois prime minister, Jean-Claude Juncker, as the next president of the European Commission has received an enormous boost from David Cameron’s cack-handed diplomacy but fears that he represents a federalist drive in the EU are entirely misplaced. For most people in the core EU countries, and especially Belgium and Luxembourg, homage to pro-integration rhetoric is almost like that of Christians to the creed or of British Conservatives to resisting the alleged onslaught of legislative red tape emanating from Brussels (even for those who would be hard-pressed to think of a single example which actually affects their lives). That it should be such an article of faith is unsurprising from citizens of countries that have been overrun by invading armies twice in the last century. In practice, however, Mr Juncker is highly pragmatic.

What is federalism?

The word federalism needs to be defined. In a technical sense, it means that there are different powers for different layers of authority. In that sense the EU and its forerunners have been federalist since the setting of the European Coal and Steel Community in 1951, for which the pooling of sovereignty was the fundamental basis of the French initiative to set up the ECSC and was the reason why the UK stayed out, why it attempted the alternative European Free Trade Area and why when the UK did accede to the European Economic Community and ECSC in 1973, it was so controversial as to provoke a referendum in 1975.

In practice, the term federalism has been used both by its proponents and its opponents to mean a much more integrated political body, comparable in some degree to existing federations such as the US and the Federal Republic of Germany. It is hard to imagine a serious move in this direction without a major impact on taxation or expenditure. At present EU expenditure is limited to 1% of GDP which is less than a fortieth of average public expenditure in member states, compared to more like half in the US or Germany. From the point of view of taxation, the only important unifying factors originally were external customs duties and the fact that all member states are required to impose value added tax, though at rates and coverage which they could choose. Some harmonisation of VAT rates was agreed as part of the 1992 Single Market Programme, but with the sole purpose of eliminating the need for varying rates to result in member states keeping border controls on the movement of goods and services. The single market programme did also in other ways result in some more authority moving up to the EU level. Such powers were drawn up by the British internal market commissioner at the time, Lord Cockfield, who had been appointed by Mrs Thatcher, who fully supported the changes.

Juncker resisted tax harmonisation

Apart from VAT, any moves to harmonise taxation across the EU require unanimity. This has remained the case as a result of the opposition to harmonising tax from a number of countries, including Luxembourg. Under the leadership of Juncker, Luxembourg  strenuously resisted moves which would limit its ability to attract investment and otherwise benefit from low corporate and other tax rates. Indeed it was only very reluctantly and after many years of resistance that Luxembourg agreed to comply with measures to limit its provisions for bank secrecy which were obviously designed to enable depositors to evade taxation in the EU countries to which they belonged.

On the EU expenditure side, there is no possibility that it could rise even slightly above 1% of GDP during the term of the next Commission because it is so limited by the Framework Budget for 2014-20 which has been enacted by the Council and Parliament.

UK arguments cut no ice

The main reason why Juncker was being pushed by the European Parliament is as an answer to the EU’s alleged democratic deficit, since he had the backing of the largest party emerging from the May 22-25 EP elections, the European Peoples’ Party. As a way to increase democracy in the EU, the move is deeply flawed (not least because at the time of the Parliament elections at the end of May less than 10% of the electorate had actually heard of Juncker). The case against the justification of Juncker by the argument that it would make the EU more dramatic has been made by almost all UK commentators including highly pro-EU ones, in the British press. The fact remains that, however cogent these arguments may seem to the British, opinion in other EU countries especially Germany is very different. There are a number of reasons for the different German view, but they have been given a decisive push by Cameron’s attempt to veto Juncker. When asked whether they would agree with Cameron that the European Parliament should not impose its own choice as Commission president, 60% of Germans disagree (ie 60% support Juncker). This answer clearly relates to how the question was put, but as a result of Cameron’s public attempt to veto Juncker, the question is now seen in Germany in large part as one of the right of the rest of the EU not to be subjected to a British diktat. In the UK much of public opinion sees the EU debate in terms of whether the UK should be dictated to by “Brussels”. In some EU countries, the UK question is increasingly seen as whether the UK should dictate to the rest of the EU. Most opinion in these countries would like the UK to remain in the EU–but not at the cost of being told what to do by the UK.

A UK right of opt-out from any substantive further powers being given to the EU is acceptable to its partners. But the UK may have to accept a Juncker Commission, particularly following Cameron’s faux-pas. Juncker is probably not the best candidate for the job but whether or not he is chosen will not have much impact on whether other member states want to move further down the path of integration and will have no impact whatever on the UK’s right to opt out of any such moves. In regard to whether a Juncker Commission might be unsympathetic to the UK, the British government has dug itself into a whole. It had better stop digging.

 

 

European Parliament election results, outside of France and UK, are positive for EU and euro

The European Parliament election results were much better in most countries than expected from the point of view of those who favour the survival of the EU, and also the survival of the euro. The only two, admittedly important, exceptions were the UK and France where anti-EU, anti-immigration parties won the most MEPs, as had seemed likely. In two euro area countries, the Netherlands and Finland, there were significant setbacks for similar parties. In Austria the Freedom Party which has stirred controversy for decades remained stable with 20% and in Hungary right wing nationalist parties did well but not more so than in previous elections. Elsewhere in central and eastern Europe the great majority of seats continued to be won by strongly pro-EU parties, although this was also in line with expectations.

Encouraging results were recorded in most of the countries at the centre of the euro zone crisis of the last five years. Germany voted overwhelmingly for parties that support its membership of both the euro, highly controversial both at the beginning and, more recently, over supporting measures to bail-out weaker members and particularly the European Central Bank’s preparedness if necessary to save the euro to make unlimited purchases of their government debt. The anti-euro (but not extreme and not anti-EU) party Alternative fur Deutschland won a very modes 6.7% of the vote, while the extreme NPD won %.

In Greece, Italy, Spain and Portugal, all of which have suffered severe losses of living standards and high unemployment during the last five years, there were overwhelming majorities in favour of parties committed to remaining in the euro and the EU. The highest anti-euro vote was in Italy, for Beppe Grillo’s Five Star Movement which has called for a referendum in euro membership and is anti the whole of the rest of Italy’s political establishment received 20% of the vote, but while a year ago it came close to the vote of the largest established party the left-of-centre Partito Democratico,this time the PD, led by the young new prime minister, Matteo Renzi won double the vote of Grillo’s party with just over 40%, well above that achieved by any left-of-centre party in the history of the Italian Republic. In Greece, the leading party in the EP election was the more left wing Syriza, led by Alexis Tsipiras, which calls for an end to austerity but not for leaving the euro area or EU. The governing New Democracy still held on as the second largest party despite direct responsibility for draconian economic measures needed to cut the public sector deficit. The extreme and sometimes violent right wing New Dawn won 9.6% of the vote which is disturbing but not an increase on previous elections. In Spain there was virtually no votes for parties against membership of the euro or EU despite one of the deepest economic depressions after Greece and unemployment of young people over 50% according to official figures. The two parties which have governed Spain since its entry into the EU in 1992 and into the euro in 1999, and were responsible therefore together and in roughly equal measure both for the austerity policies of the last five years and the mistakes in earlier years that contributed to the crisis, the Popular Party (PP) and the Socialist Party (PSOE) together won 49% of the vote which in the circumstances was a reasonable performance, although it led the leader of the PSOE which came behind the PP to resign. The rest of the vote was widely divided. Not at all surprisingly the established party to the left of the PSOE the United Left (IU) increased their vote somewhat to 10%. More interestingly a new party, Podemos, formed out of the Indignados movement of peaceful city centre protests by young people won 7%. Podemos like the Greek Syriza wants an end to austerity policies but does not call for exit from the euro. Another new party is the centrist Union for Progress and Democracy which won 4.7%. There were increased votes for regional parties, which in Catalonia and the Basque Country are calling for full independence within the euro and the EU. These do represent something of a problem since a fragmentation of the already large number of member states would make EU governance more difficult and there would be controversy over admitting new countries formed out of member states as EU member states. In Portugal there was also an increase in opposition to austerity policies but not towards the euro and EU.

There clearly was a move against existing economic policies in southern Europe but that is part of a healthy democracy. The question is whether their voice will be heard. The southern member states have had little choice over the last five years because of the need to either keep the support of bond markets or, where these are lost, to meet the conditions for loans managed by the troika of the IMF, ECB and European Commission. With government accounts now moving into primary surplus (income less expenditure excluding debt servicing) which gives a little more room for manoevre at a domestic level but policies at the EU level remain important for them. Given his strong position domestically and the fact that Italy will take on the presidency of EU Council of Ministers’ meetings in the second half of 2014, Renzi is likely to try to push for more expansionist policies. However, fiscal policies of countries without difficulties in borrowing are decided at a domestic level, while monetary policy is conducted by the ECB, which is strictly independent of governments. Nevertheless the ECB is now considering the controversial idea of quantitative easing and doing so by encouraging banks to lend more at reasonable interest rates to small and medium enterprises, given the huge imbalance in lending conditions between the member states of the supposedly single monetary area, the euro zone. Renzi or others could risk a backlash if they try to push the ECB in this direction but they are entitled to argue against any efforts at the political level to support the Bundesbank which may resist monetary loosening but be outvoted on the ECB board. No-one should be complacent over the situation in euro zone states with high unemployment, but the euro zone does at present look to be a going concern, and to have political legitimacy in most of its member states.

British-German relations are good but impact on UK objectives should not be exaggerated

The Adam von Trott Memorial Appeal and Mansfield College held a day’s seminar on November 7th under the title “Britain and Germany in Europe: What Prospects?” Adam von Trott was invited to spend a term at Mansfield College following his participation in a  world Christian student meeting in Liverpool in 1929. He later took a full degree at Balliol College as a Rhodes scholar in the trademark Oxford combination of Philosophy, Politics and Economics. During the war he wrote proposals for a post war Europe and social reform and conspired against the Nazi regime. He took part in the July 20th 1944 plot to assassinate Hitler and was executed for this.

The seminar was about the present and future and addressed a range of political themes. It was a success first in that it was well attended by people of all ages both British and German (the latter particularly German students at Oxford).  Secondly, it was an interchange of ideas involving British and German speakers, including the minister and current charge d’affaires at the German embassy, Rudolf Adam, which while not avoiding mentioning the two world wars, was notably lacking in underlying tensions.

This reflects a certain stratum of society, but British–German relations are also good at a political level. The Conservatives under David Cameron caused considerable offence to the Christian Democrats in Germany by pulling out of the European Peoples Party in the European Parliament and by vetoing the incorporation of fiscal rules affecting only euro members in December 2011, but Angela Merkel has nevertheless devoted considerable effort to establishing good relations with the British prime minister and those members of his party who want Britain to stay in a reformed EU now see Germany as an ally in its efforts to reform the EU along British priorities—focusing on the single market and trade while holding spending down and rolling back EU rules where not needed for the purposes of the single market. Even those who want to leave the EU no longer, as some older Thatcherites did, see the EU as a cover for a new form of German domination.

The Labour Party also has good relations with German Social Democrats and many of its policy makers admire German patterns of industrial relations—where unions still have a role and where there are well established forms of employee consultation in company decision-making—and the German training system.

Despite all this, the seminar did, however, point towards a possible danger in over-expectations on the British side. In tackling the euro zone crisis over the last five years Germany as the strongest economy has played a dominant role. In the EU as a whole it is economically and politically the most important country, at a time when French political leadership is weak. However, that does not mean that if the UK and Germany are in agreement they can get their way on everything. That can only happen if they are supported by a majority of other countries in the EU’s voting system. Furthermore, if Germany were faced with a choice between furthering Anglo-German relations and the maintenance of Germany’s harmonious relations with its immediate neighbours, including France and Poland, the latter would unquestionably have to take priority.

The prospects for renegotiating the terms of EU membership are poor. In 1974-75, a Labour government renegotiated the terms of the 1973 UK accession but achieved negligible concessions from eight other member states. This time 27 other member states would have to agree to any treaty change. A referendum in 1975 to stay in the then European Community was easily won but that reflected the fact the EC was then seen as an economic success while the UK was in great economic difficulty. At present the UK economy is also in difficulty but less so than in 1974, while the EU’s performance is much weaker, with the exception of Germany and some small member states. If a failed renegotiation were seen as a humiliation to the UK it could therefore have much more effect on the outcome of a referendum than last time.

The prospects for persuading other member states in everybody’s interests to reform the EU are more favourable. Already, the 2014-20 budget has for the first time been cut in real terms compared to the previous seven year period and a process of eliminating superfluous legislation has already achieved significant results (albeit only a fraction of what could be done).  One sensitive policy area, fisheries, has been radically reformed and decentralized.  There is clearly much more that can be done[i] but the UK will not get its way on everything. The controversial working time directive is unlikely for example to be eliminated though as it is essentially voluntary this is of much less importance to British business than is often claimed.

 



[i]  See Cut EU Red Tape October 2013 by a UK Business Task Force. The proposals are clear and well argued. They will not all be accepted by those who think that s competitiveness and efficiency are objectives that should automatically over-rule other objectives. But there should be general agreement that there is far too much red tape at both EU and national levels, which is not proportional to achieving environmental, health, safety or other objectives. The report could do more to clarify where its proposals are primarily to eliminate paper work and where there will be some impact on other objectives, but where it is arguing that such benefits are disproportionate to the costs.  It may be pointed out that not means all the proposals are for “less EU”.  For example proposals to extend the market in services, simplify VAT payments where two or more countries are involved, improve licensing of medicines across the EU and eliminating barriers to e-commerce, all require positive action at the EU level, overriding the rules and practices of member states.

Merkel triumphs but faces tough negotiations

There are still constraints on chancellor’s power

After her triumph in the September 22nd election Angela Merkel stands astride Germany, and Germany, as economy and economic policy maker, stands astride Europe. Yet there are a number of qualifications to her triumph. First she is a consensus builder not someone like the late Margaret Thatcher who imposed her own ideology. Second, the claim that she is five seats short of an overall majority for her party is misleading since despite the fact that her Christian Democratic Union (CDU) and Horst Seehofer’s Christian Social Union (CSU) form a single faction in the Bundestag, the CSU is very different—more rightwing for example on taxes, more nationalist and sceptical in relation to the priority Merkel has given to holding the euro area together. Third, a small majority of seats in the Bundestag as well as the existing large majority of seats in the Bundesrat are held by left of centre parties. If it were not for the promise of Socialdemocratic Party (SPD) leaders that they would not ally with Die Linke, the left wing party that is particularly strong in the east and won 9% of votes overall, Merkel would have had to give way to an SPD-led government and go into opposition.

Finding a partner will not be easy

Merkel needs a new coalition partner since a minority government would despite her stature be seen as a weak one and she has lost her former partner, the Free Democratic Party (FDP) which just failed to make the 5% threshold needed for parliamentary representation. The other possible partners, the SPD and the Greens are also fearful of the effect on their own popular standing of being a junior partner to Merkel. Indeed the SPD experienced a severe loss of their vote between the 2005 election after which they formed a coalition with the CDU/CSU in the first Merkel government and the 2009 election. Thomas Kielinger, the London correspondent of Die Welt, has even compared her with the black widow spider, which has a habit of killing her mate. In fact any junior coalition partner has the problem posed by shared responsibility but limited influence as in the case of the UK’s Liberal-Democratic Party in coalition with the Conservatives.

A coalition with the SPD is much more likely than one with the Greens (the latter being possibly compatible with the CDU but would not be favoured by the CSU). But a CDU/CSU-SPD coalition can by no means be taken for granted. Negotiations will be long and arduous and the SPD can be expected to bargain hard to be in a position to have some rewards to show to the electorate in four years, both in terms of policy – they may press for an extension of sectoral minimum wages into a national one for example – and in the profile of their ministers. However, the foreign ministry previously held by Guido Westerwelle of the FDP makes little impact on domestic opinion and the CDU looks likely to try to keep Wolfgang Schauble as finance minister. In any case the finance minister will spend much of his or her time trying to manage wider euro area issues and the fact that the SPD’s Peer Steinbruck was finance minister in the last CDU/CSU-SPD coalition did not prevent a very poor election result at the end of the term.

But Merkel will keep control of euro area policy 

If a coalition is agreed with the SPD, the one key policy area most watched from outside Germany—policy towards euro area partners—is not likely to change as a result of the negotiations. Although SPD spokespeople called for a somewhat more flexible line to ease the pain being caused by deleveraging in southern member states and Ireland, it is not likely to push too hard since there are few if any German votes to be won by being easier on other countries. Moreover, the CSU which considers Merkel’s policy already to have over-committed German financial resources will pull in the opposite direction. And it is likely that Merkel herself will give priority to maintaining control in this area, since she knows that its success or failure will be key to how she will be remembered. If the SPD were to push hard for the removal of Schauble she would at least insist on someone whom she could trust and work with.

 

Much talk on youth unemployment and just a little action

Youth unemployment moves up the agenda

Recent weeks have seen increased traction to the perception that youth unemployment across the EU, especially the euro zone, has to be treated as a major—indeed the major crisis, if one is reassured that financial meltdown of the euro zone has been relegated. Of course the danger of the latter cannot be treated as though it had been eliminated but rising unemployment, especially of young people, could undermine the political support needed to sustain the kind of policies in southern Europe, and even in France, that are required to prevent financial meltdown, as so clearly indicated by the result of the Italian election of March 24-25th where huge swings in votes to the rightwing PdL and the internet based protest movement M5S, must be interpreted as protests against the well intentioned policies of the previous government led by the respected academic Mario Monti, to comply with the desiderata of the EU institutions.

 

Situation in southern Europe cannot be ignored in the north

This means not only that youth unemployment must become the top priority of governments in the peripheral countries most affected, and of the European institutions, but also of the countries like Germany the Netherlands and Finland that are doing much better in terms both of overall economic performance and specifically in providing opportunities for young job-seekers. If these countries are committed to the survival, let alone deepening, of the process of European political integration that goes back to 1951, as the great majority of political parties in all these countries claim to be (with the exceptions of Geert Wilders’ Netherlands Freedom Party and Timo Soini’s True Finns), then the employment crisis in fellow member states has to be taken as a serious challenge to their own credibility.

Recently some members of Germany’s government have shown signs that they are aware of this challenge. In mid-May the German employment minister, Ursula von der Leyen signed an agreement with her Spanish counterpart, Fatima Banez,  to facilitate the availability of apprenticeships in Germany for Spanish nationals and for German experts to provide advice to Spanish companies willing to learn on how aspects of the successful German apprenticeship system, whose roots go back centuries and which has been a major feature of the post-Second World War German economy, might be implemented in Spain. This would build on existing Spanish government efforts to promote apprenticeships. The  scheme has been supported by Wolfgang Schauble, the formidable German finance minister who has said “we must be faster and more definitive in fighting youth unemployment”. He also agreed on May 22nd with the Portuguese finance minister, Vitor Gaspar, that the German state development bank, KfW, should help set up a Portuguese institution to promote work or training for young people. On June 3rd the KfW signed a deal to lend €800m to its already existing Spanish counterpart, ICO  (with an extra €200m once agreed by parliament for “mezzanine” financing). On July 3rd, Angela Merkel is to host a meeting of EU employment ministers in Berlin.

 

But measures so far are mere drops in the ocean

However, the measures mentioned above are no more than drops in the ocean. While the subject of youth unemployment has risen dramatically in the field of international discussion across Europe, as seen in the OECD Forum at its headquarters in Paris on May 28-29th, there is as yet no policy measures which are likely to be make a significant impact. The €6bn of EU funds structural funds which are frequently mentioned are over the whole 2014-20 period so amounting to less than €1bn a year, which is 1% of the EU’s modest budget and 0.01% of EU GDP. It can be argued that larger sums if made available might be mis-spent given high levels of corruption in parts of southern Europe but that means that the rapid use and of EU funds to provide job and training opportunities, followed by rigorous assessments of their success with a view to applying any lessons to further funding, are urgently required.

Iberia and Italy send contradictory messages to EU policy-makers

 

Portugal cuts to the bone

The Portuguese government’s newly announced cuts of 30,000 government employees designed to replace the cuts in holiday pay and pensions that were disallowed in early April by the Constitutional Tribunal threaten to weaken key services like education, where Portugal is anyway weak, and healthcare, where a relatively well-performing service could be undermined. Portugal like other countries has already endured five years of declining incomes which in the last 12 months have been severely intensified. During this period its long-term external imbalance as measured by the current account deficit has finally been rectified which implies that exports of goods and services now exceed imports of goods and services by a margin sufficient to service the large external debt. But further government cuts threaten to wreak deeper and more permanent damage to the social fabric than has already occurred.

The same is true perhaps even more so with Spain where unemployment has reached a staggering 27% with well over 50% of young people unemployed. If some of these have precarious and low paid jobs in the grey economy such employment hardly provides a basis for their future.

 

Help out of debt-depression spiral is desperately needed

In both Portugal and Spain governments of the centre-right have been implementing harsh austerity policies prescribed by the European Commission and the creditor countries (Germany and the Netherlands being the largest of such countries) and also striving to put in place the kind of structural reforms to labour and product markets which they are being urged to take. Yet even the beginnings of economic recovery remain elusive. Portugal for example has seen a 20% increase in exports outside the EU but with the majority of exports being to an EU in recession this is insufficient to make a noticeable difference. They have a real need for some complementary action by the creditors and European institutions. This commentary does not believe there is any magic answer to the debt-depression spiral but Germany and others could ease fiscal policy a little and allow wages to rise slightly faster so boosting disposable incomes. They could move a little faster to a banking union which would gradually tackle the divided lending markets where businesses in southern Europe have to pay to banks double or more the interest rates charged by German or Dutch banks in their own countries. Germany and its allies in the ECB could take slightly more risks with the distant danger of excessive inflation.

Estimates of the EU budget required to oil monetary union before the actual plans where drawn up in the Maastricht treaty of 1992 were up to 5% of GDP, the actual budget has been held rigidly within a 1% limit. Loans through the European Stability Mechanism or otherwise are not transfers. They do entail the risk of default but such default could be more rather than less likely if southern economies continue their downward trajectory.

On the other hand the German fear, fed by the country’s own experience of massive transfers since unification to eastern Germany which failed to bring economic convergence, of pouring money into countries which use it to avoid rather than help necessary financial discipline and reform is also understandable. What is being done in Portugal and Spain (and even more so in Greece) should make Germany and its creditor allies see that such fears are now as justified as fearing that an anorexic could become obese by over-eatin.

 

But Italy sends another message

However the message coming to the creditors from Italy is very different from that from Spain, Portugal or Greece. Although Italy has a massive and chronic government debt its private sector has a low level of debt and huge financial assets so overall it is a wealthy country and not heavily indebted externally. It is less far off eliminating its government deficit than the other countries and its failure to do so is a result of politicians who in an effort to be re-elected have not taken feasible and necessary measures.

In November 2011, the financial markets and Italy’s partners (then President Sarkozy as much as Chancellor Merkel) lost confidence in the government of Silvio Berlusconi and the yields being demanded of Italian debt threatened to bring the country to financial collapse. As a result the head of state, President Napolitano who normally kept aloof from the country’s politics, intervened to appoint the academic economist, Mario Monti, as prime minister of a government of non-politicians to “save” Italy. Its first set of measures entitled “Salva-Italia”) included a tax on first homes (second homes were already taxed). Although similar property taxes are common in other countries, this was highly unpopular in Italy, and from late 2012 Mr Berlusconi staged a spectacular recovery from near political oblivion to almost winning the March election, a central theme of which was his promise to abolish this very property tax which had been necessary to convince external creditors including private bondholders that Italy was financially viable.

In view of such events in Italy, Germans would not be completely mistaken if they concluded that an easing of financial pressures on Italy would make it easier for politicians like Mr Berlusconi to return to power and use that power to entrench their privileges rather than make the reforms needed to allow Italy to perform adequately within the monetary union.

 

Italy’s problems are not just a result of the economic downturn

It is true that Italy is also suffering from prolonged recession and is offering its young people poor economic prospects but this predicament is more due to deep flaws in Italian politics and society than to the euro zone crisis. The success of Beppe Grillo’s Five Star Movement (M5S) which came from obscurity to 25% of the votes in the March 2013 election reflected a feeling amongst much of the population that Italy’s political class was self-serving. Unfortunately, though, this message was blurred by the simultaneous recovery of Italy’s most self-serving politician Silvio Berlusconi, helped by his control of much of the country’s television. Other flaws include the notorious organized crime clans which though being combatted seriously in Sicily remains rampant in two large southern regions, Calabria and Campania, where their impact on the wider economy is profound. The justice system includes many brave and dedicated public servants but remains appalling slow and is also over-politicised. Most professions remain encumbered by restrictive practices which makes entry even by well qualified young people difficult.

 

New prime minister Letta has to square the circle

Enrico Letta, deputy leader of the Democratic Party (PD) which just emerged as the largest party in the March election, but performed much less well than seemed likely at the start of the campaign, leads a new grand coalition between the PD and Berlusconi’s People of Liberty (PdL) having failed to persuade Grillo to enter constructive discussions. The government states that it wants to ease austerity but sis committed to maintaining the budget projections of the Monti government including a 2.9% of GDP deficit in 2013, but will have to remove the property tax if it is to retain the support of Berlusconi. It will somehow have to find expenditure cuts or other tax increases to meet this commitment. Neither are likely to be possible without taking on entrenched interest groups linked to one or other of the two parties in the coalition. Hard-nosed German and Dutch policy-makers will be watching.