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.

 

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.

Budget negotiations are key to future image of EU

On February 5th Herman Van Rompuy put out a video message (http://tvnewsroom.consilium.europa.eu/event/video-messages-of-herman-van-rompuy/eu-budget-negotiations-the-bigger-picture-must-not-get-lost) which made an admirably concise plea for a budget to focus on jobs and particularly jobs for young people and also insisted on moderation, which he surprisingly defined as a real terms cut. This would imply that the demands of the UK, Sweden and the Netherlands in terms of expenditure discipline would be met or even exceeded.

Budget is small in relative terms,but high in absolute terms

As a percentage of national budgets (about 2%) the EU budget is much smaller than implied by the claims of over-centralisation of power. It has remained at around 1% of gross national income (considered a fairer measure than gross domestic product) over the last 20 years well below its allowed maximum of 1.24% of GNI. To have done this during a period when the EU has expanded to include 12 new countries almost all well below the 75% of average income threshold which entitles them to substantial funding to help catch up, and when a monetary union has been created for 17 member states, an embryonic diplomatic service has been set up and effective measures for criminal justice have been put in place is a significant achievement.

The gains in terms of both political stability and prosperity from the single market are not possible to measure but surely hugely outweigh the costs of the EU. Nevertheless when expressed in absolute terms, the amounts are large enough to become politically contentious, at a time when all countries are having to make cuts which are causing large scale public redundancies, closures of hospitals, and other public services like libraries. The UK, France and Italy are currently spending about €16bn (£13bn) in gross terms and €6bn (£5bn) in net terms in contributions to the EU budget.

Some but not all is all is well spent

Some of this money is very well spent. There is huge over-demand for the 11% of the total EU budget spent on boosting collaboration between EU countries (and sometimes also other countries) on scientific research and the development of new technologies. This is money well spent on boosting the EU’s economic potential and ability to thrive in the face of competition from rapidly growing economies like China and India. A strong plea for this spending to be maintained was made on February 5th in a letter to the Financial Times by leading British scientists. Another area of money well spend is co-operation on justice mainly criminal justice, which takes up just 2% of the budget. According to the British Association of Chief Police Officers (ACPO) if, as is being considered, the UK were to opt out of the European Arrest Warrant (EAW) just one of about 20 important EU measures in the field of criminal justice, the result would be “fewer extraditions, longer delays, higher costs, more offenders evading justice and increased risks to public safety”.

Slightly lower in terms of money well spent is the category of administration which absorbs 6%. At 0.06% of national income this is good value for underpinning the benefits of a rules-based single market with a level playing field evened by the enforcement of rules on competition. Yet at a time of austerity the pay and privileges of the upper tiers of the Commission which exceed those of leaders of national governments look excessive.

The largest items of spending are agriculture and regional policy. Agricultural spending, narrowly defined to standard income support for farmers amounts to 27% of spending. If the EU were starting from scratch this might see excessive, but there has been a continuing decline from about 70% when the UK joined the EU in 1973 and most of the spending no longer supports (ie increases) prices as it used to. There is however an additional item called rural development environment and fisheries which absorbs 10% of the total. This is almost as much as is spent on research and innovation and yet its purpose. It includes the very different objectives of environmental conservation or improvement and diversification to non-farming economic activities. It is a category which at least merits careful scrutiny.

Focus of regional spending should be on job creation

But the category which needs most attention is the 37% spent on helping the poorer or most economically troubled regions. This spending has in the past been heavily focused on infrastructure, which does not necessarily bring fundamental economic development. What is most needed is to foster the development and expansion of new micro, small and medium businesses which having already  been responsible for the great majority of job creation across the EU in recent years have the best potential to provide employment opportunities in southern European regions where rates of youth unemployment often exceed 50%.