EU’s neighbourhood policy has to include Russia

In 2003 the EU put in place a neighbourhood policy in preparation for its enlargement in 2004 to include ten additional members extending its new border eastwards. It was realised that by including those countries accepted as members into the EU, a new dividing line across the European continent could emerge between countries that as communist and then transition economies had previously had fairly close relations. The neighbourhood policy was designed to mitigate the new border by means of trade policies and a reasonably open visa regime and also to promote some of the political, legal and economic reforms which had been set as criteria for EU accession. It was not applied to Russia which would not have agreed to being monitored for progress towards standards set by the EU.

In theory pre-existing policies towards southern Mediterranean countries were incorporated into the neighbourhood policy but in practice they have remained different and this post is about the eastern neighbourhood and specifically Ukraine. Armenia, Azerbaijan and Georgia are important but do not border the EU. Belarus has been permanently under the grip of its dictator, Aleksander Lukashenko, who has not been interested in closer relations with the EU except on his own terms. Moldova is a small, albeit complicated, country.

With the Orange Revolution of 2004 which saw the election of Viktor Yevtushenko, who favoured liberalising reforms, as president defeating Viktor Yanukovych who resisted such changes. However President Yevtushenko was not a successful president and Yanukovych, after serving a period as prime minister,r was elected president six years later. Nevertheless Yanukovych did seem amenable to negotiating with the EU on its proposed Deep and Comprehensive Free Trade Agreement in 2013 and the outline of such an agreement was concluded in late 2013. Unfortunately this coincided with an attempt by President Putin to expand and deepen a Eurasian economic  and customs union between former Soviet countries, of which Ukraine was intended to be a key part. Both the EU and Russia considered that Ukraine had to choose rather than pursue a balanced policy of deepening economic relations with both its neighbours and Putin put pressure on Yanukovych to abandon the EU agreement in favour of the Eurasian economic customs union. Doing so angered much of civil society and led to the occupation of central Kiev by protestors and after violent confrontations in March 2014 Yanukovych fled to Russia. This was a deep humiliation to President Putin and Russia, which led to the reaction that has followed.

EU policy stumbled partly due to bad luck but also a flawed strategy

The ensuing conflict was to some extent bad luck as the unexpectedly strong support by much of the Ukrainian public for the EU agreement coincided with precisely opposite plans by President Putin. But there was also a flaw in the EU strategy. It had rightly looked at how to tackle the impact of EU enlargement on the EU’s new neighbours as a consequence of the enlargement but then failed to prepare for the impact of closer relations with the new neighbour Ukraine with that country’s own neighbour, Russia. It is possible that the democratic will of the majority of the Ukrainian people would have anyway brought it into conflict with Russi, and a minority of its population who feel themselves Russians, but the EU did not by any means do as much as it could have to make its agreement compatible with ongoing close economic relations between Ukraine, especially eastern Ukraine, with Russia. For example, the agreement provided for symmetrical opening of the Ukraine market to EU companies in relation to EU markets to Ukrainian companies, despite the much greater strength of the EU economy. This not only would be very tough for Ukrainian companies in trying to hold onto domestic markets but also make it more difficult for Russian companies to compete.

This is not to excuse the Russian response, which was effectively to annexe Crimea and then provoke a rebellion helped by Russian troops in the Donetsk and Lugansk regions of eastern Ukraine. However, the Russia led by Putin is the reality that the EU has to deal with and it now has to deal with a Ukraine whose territorial integrity has been violated and the best prospect in the medium term would seem to be that the Minsk agreement of February 2015 holds, and that the ongoing reduced level conflict since then reduces further rather than flares up again. For that to happen requires Ukraine to observe its side of the agreement as near perfectly as possible despite the fact that the other side is not doing so, so as not to provide any excuse for a major new conflict, and that it the government leans over backward to conciliate any sections of the population in the territory under its control that might be tempted to sympathise with the rebels. Rightly the EU is now including a Russian representative in ongoing discussions on the proposed trade agreement between Ukraine and the EU, whose implementation has been postponed.

At the same time, the EU should do much more through debt write-offs[1] and economic support to enable the government of Ukraine to put in place the reforms needed to create the kind of country that the electorate voted for in the 2014 elections, one where all, including powerful oligarchs, are equal before the law, there is a level playing field new businesses to grow and where trade with both the EU and wider world economy can expand.



[1] Writing in the Financial Times on May 18th, the former US Treasury secretary, Lawrence Summers, argued that the case for a debt reduction was as strong as any he had encountered in the last 25 years.

To tackle present challenges Greece and its euro zone partners need to overcome antagonism over past wrongs

In the epic of Greece’s adventures in the euro zone a small measure of encouragement  can be drawn from the agreement of the Syriza led government to pay its debt servicing instalment due to the IMF on April 9th and its ability to find the funds to do so. But the country is likely to stagger from one funding crisis to another every few weeks over the coming months so long as it is unable to negotiate a comprehensive new programme with the EU institutions and other euro zone countries. Such a programme mst inevitably bear some resemblance to the hated Memorandum between the previous New Democracy government and the hated Troika (IMF, ECB and EU Commission), which Syriza pledged to renounce. But there also can and should be differences, otherwise the democracy which the EU would claim as fundamental to its values has become a sham.

 

Troika arrangement is flawed

For a start the Troika itself should be re-appraised.  Although it is not sure that it will be able to continue to do so, Greece has rightly felt an obligation to meet its IMF obligations (IMF debt being about 10% of the total) given that the IMF pools the funds of countries from all over the world, many much poorer than Greece. But for that reason the IMF should not be a lead player on what is a euro zone problem and one which the euro zone which taken as a whole commands enormous financial resources. Its role should become purely advisory. The ECB’s role should also be changed. In financial terms it is the motor of the euro zone and so has to be fully involved in the discussions but it is not a political institution and as such should not be taking decision except ones which strictly entail the sound functioning of the euro system. The Commission should continue to play a central role since the 28 commissioners are almost all formerly elected national politicians put forward by their national governments and are accountable to the European Parliament.  Clearly however the other national governments of the euro zone are a key part of the picture. The chair of the euro group of finance ministers, Jeroen Dijsselbloem, the Dutch finance minister, has a key co-ordinating role, and it is appropriate that he is from a country which has been close to Germany in its economic thinking but is not Germany.

 

Time for a programme of economic recovery

Secondly, after six years in which Greece has suffered more economic pain than any country in the EU since the 1940s, the programme must be focused on economic recovery. This must include further pursing measures to facilitate business growth and expansion some of which such as labour market reform the new government wanted to reverse. It should also encompass a much more active investment programme from the EU budget and European Investment Bank. Jean-Claude Juncker’s €315bn EU-wide investment programme a centrepiece of his programme before and after being elected by the European Parliament as the new Commission president seems to have gone off the radar. It would make good sense for Greece, as the most troubled economy in the EU to take a pioneering role as a showcase for what can be done if the funds are used imaginatively and appropriately in tackling the existing situation and future prospects of Greece rather than being hidebound by the thinking of a generation ago when the EU’s spending was expanded under Jacques Delors.

 

Stakes are very high

The future of Greece is a key political issue for the EU. Apart from the anomaly of Greenland (an autonomous part of Denmark) no country has so far left the EU or euro zone.  If Greece were to leave or be forced out of the euro zone it could still be part of the EU, but it would be an embittered country whose continued membership would be tenuous. It would be a potentially disastrous precedent for other countries.

The high political stakes have been highlighted by the trip of Alexis Tsipiras, the Greek prime minister, to the Kremlin and apparent attempt to curry favour with President Putin, at a time when the latter is provoking the EU by fomenting civil war in Ukraine in punishment for Ukraine having wanted an association agreement with the EU. Insofar as he is looking to Russia in order to emphasise the geo-political implications of what happens in Greece, that is a reasonable way to remind EU politicians that there is more at stake than whether EU countries get back the money they have lent. However, in seeming to condone Russia’s de facto invasion of Ukraine he risks losing sympathy for Greece. Bad as Greece’s situation is, unlike Ukraine (a poorer country than Greece and one that also has a debt problem), its territorial integrity is not seriously threatened despite its age-old concerns with regard to Turkey. If Greece is not willing to show any solidarity with Ukraine it will struggle to argue that its fellow euro zone member states should show solidarity to Greece.

 

Greece’sEU partners need to take long term view

If Greece needs to take a more enlightened view of its self-interest, so do its euro zone partners. The position of Germany and the tensions between Greece and Germany are of huge importance but it also must be remembered that other countries in the euro zone have also lent to Greece  and that many of them take a harder line even than Germany.

Given that the future of Greece is of historic importance in the story of the EU, German politicians should realise that history cannot be ignored. With most of Germany’s western  EU partners, a process of reconciliation took place in the late 1940s and 1950s, in connection with the formation of NATO the Council of Europe. the European Coal and Steel Community and the European Economic Community; and a similar process took place with central and eastern Europe in the 1970s as part of the Ostpolitik initiated by Willy Brandt and then in connection with the unification of Germany in 1990 when Germany accepted its loss of territory to Poland in 1945 and the expulsion without compensation of millions of Germans from Poland and former Czechoslovakia. This process of reconciliation does mean that relations between Germany and these countries is about the present and future, and to bring up the Second World War in relation to today’s politics is regarded as against unwritten rules.

No such process ever took place with Greece one of the countries to suffer in terms of loss of life and economic damage from German occupation.

Moreover an aspect of the Greek crisis is whether the new Greek government has to be regarded as responsible for the behaviour of previous Greek governments and whether over the coming decades Greece should be able to look to future not overburdened by the consequences of the past mistakes.

It should be added that Germany is not the only country with historical issues in relation to Greece. After the Second World War, the British supported the Greek right in two civil wars against the Greek Communist-led left which had led the resistance to Germany.

 

Historical wrongs do not take away responsibility to address the challenges of today

Once all that has been said, the Syriza led government of Greece needs to realise that its main challenge is not to settle historic grievances or to negotiate with its creditors but to prove that it can make a success of its decision to try to remain in the euro zone. That does require the understanding and help of rest of the euro zone but the main responsibility rests with the Greek government itself: to manage the public finances on both the revenue and expenditure side much better than in the past and create the conditions for economic recovery. The Syriza government may be suspicious about the merits of foreign business investment, but that is all the more reason that it must encourage Greek businesses to invest through measures such as attacking corruption, reducing unnecessary regulation and improving the legal system.  It would not be in the interest of Greece for its partners to take a nonchalant attitude to these matters as they unfortunately did in the period after Greece joined the euro zone. But Greece’s partners should also not provide an excuse for the Greek government to avoid its main task by making demands which understandably make the Greek electorate resentful.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Euro zone must help Greece find a way to economic recovery

At least the Eurozone governments and the newly Greek government after two weeks of tense negotiations (which some described as a “game of chicken”) come to an agreement on policy parameters to tide them over a period of up to four months in which to discuss how Greece should approach its economic future on which its political future as part of the EU and NATO also depend. Germany’s finance minister, Wolfgang Schauble, who played a key part in the negotiations along with Jeroen Dijsselbloem, the Dutch finance minister, and chair of the group of euro zone finance ministers, said that gratuitous insults to today’s Germany comparing it to Nazi Germany did not help the Greek side. In itself this may be a reasonable point, but Germany’s most widely read tabloid Bild Zeitung has for the last six years been building up a picture in the German public of Greeks as feckless work-shirkers which has influenced the political debate and is indirectly reflected in the somewhat patronizing remarks about Greece by German (and also Dutch, Finnish and other) politicians who have never had to deal with in their generation anything like the Greek economic depression of the last six years, which is more comparable to the economic hardships of Europe between the wars than anything endured by any EU country since 1950.

The issue that should be discussed in the next four months is quite simple: how to enable the Greek economy to be start to provide employment and hope for its people, especially young people. That is how it is seen in Greece. Tragically it is not how it is seen in much of the rest of the euro zone although the political cohesion of the euro zone and the EU itself actually depends on a positive answer to the question.  Some of those who rebelled against agreeing with the Eurozone-Greek agreement in the Bundestag actually said that the agreement encouraged “moral hazard”, in other words implying that the Greek people had not yet suffered sufficiently from the policy mistakes made by their governments in the decade before the crisis to have been warned against making the same mistakes again. They imply that there should be no moral hazard for those who voluntarily made the foolish decision to lend money to Greece in the early 2000s, loans which created a bubble which was actually harmful to the Greek economy.

It is not fair to compare Germany’s present government with the Nazis as some Greeks have occasionally done, but it is fair to point out that six years after the end of the Second World War the countries which had formerly been Germany’s enemies were willing to provide the economic conditions for Germany to make a new start, consolidated by the 1953 London agreement which halved Germany’s debt. Surely if Germany deserved another chance in the early 1950s despite its earlier policies and their impact on its fellow Europeans, Greece deserves another chance now. However, although Germany  is seen as the main protagonist vis-à-vis Greece, it has to be said that there are many other countries whose agreement to a longer term deal with Greece cannot be taken for granted.

Whether Greece can recover depends on part on its fellow euro zone members but it does also depend on the new Greek government. First,  although right to resist ever-increasing primary surplus demands it will have to manage the public finances to maintain a primary surplus, and this is not compatible with fulfilling many of its promises. Secondly, although it understandably resists an unthinking continuation of the whole policy prescription imposed on it by the hated troika (IMF, ECB and European Commission), there are parts of the policy which are essential to providing the conditions for the private sector to generate new jobs, including reducing the costs to employers if they have to dismiss employees for economic reasons and opening up trades and professions to new entrants. Such changes are also encouraged by the OECD, an organization which the government refers to more than once in the policy outline it has given to euro zone governments. There are other parts of the prescription that the Syriza government is committed to, such as measures against corruption and tax evasion.  There are also some it can legitimately question. It has agreed to continue with privatisations in progress but should be entitled to question the benefits of further privatizations. The sale of assets can only make a modest contribution to reducing debt and takes away potential sources of future government revenue. Sometimes it can go badly wrong as for example in the case of Croatia’s privatization of Pliva to a foreign investor, which proceeded to close the company, which had a good track record of research and development of pharmaceuticals.

Germany risks losing EU moral leadership over handling of Greece

Germany, led by Angela Merkel, is at present the leading country in the EU and deservedly so. The standing of President Hollande though bolstered by his sure handling of the crisis caused by the shooting of Charlie Hebdo staff and Jewish hostages, is weakened by his having come to power on the basis of policies that could not work and have had to be reversed; the UK’s policy towards the EU changes day by day largely driven by the nationalist UK Independence Party and the rightwing of the governing Conservative Party; and, though Italy has a stronger than usual government under the youthful Matteo Renzi, that follows 20 years dominated by a politician in constant trouble with the judiciary for tax evasion and other illegal business practices, and Renzi acknowledges that the standing of Italy depends on the success or otherwise of a 1,000 day reform programme.

Germany has achieved not only political stability and economic strength, but also moral leadership resulting from a number of factors;

First, it has achieved what can rightly be called a social market economy. Its competitiveness is combined by company structures which give employees a large say through works councils and supervisory boards and a large proportion of companies are located in their communities and feel a social obligation to those communities particularly in providing younger ones with high quality training schemes. Trade unions though they come sometimes cause disruption through industrial action still have a respected role in large parts of the economy.

Second, Germany has a consistent foreign policy based on support for the EU, and for NATO as a defensive alliance, while taking a very cautious approach to military interventions elsewhere in the world. With regard to the EU’s largest neighbour, Russia, Germany has made strenuous efforts to achieve good and stable relations but has recongised that Russia’s incursions into Ukraine are unacceptable and have to be resisted by economic sanctions.

Third, Germany has in recent decades, become a country open to large scale immigration. Although immigration under the free movement principle from other EU countries is higher than to the UK it has not led to controversy and it has taken more refugees from Syria than most other EU countries (albeit little in relation to those in Lebanon, Turkey and Jordan). The anti-Islamic Pegida movement is a cause for concern but its support is still much less than for the UK Independence Party or France’s Front National, and it has been categorically condemned by Mrs Merkel.

However, although German policy under Angela Merkel and the finance minister, Wolfgang Schauble, has contributed to keeping the euro zone together since it was hit by crisis six years ago (first in Greece, but then spreading), the soundness of its policy has been open to question as has whether it is a genuine European policy or one designed to protect narrower German interests. In the early years of the euro, Germany, despite having strongly insisted that members of the euro zone must be underpinned by strong economic fundamentals as set out in the so called Maastricht criteria in the 1992 Maastricht treaty, failed to enforce these criteria. Countries were allowed to join the euro zone which only on a very generous interpretation of the rules met the Maastricht criteria, and most egregiously Greece joined two years after the others on figures which it was known had been manipulated by advisers from Goldman Sachs. While Germany was itself breaking the Maastricht rules in the early 2000s, investors poured money into Greek and other south European government bonds and banks with no effective warning of the dangers from the European Central Bank then still largely dominated by German thinking (its then chief economist, Otmar Issing is German).

Germany acknowledges that it made mistakes during this early period in the history of the euro, but the only lessons its policy makers draw is that fiscal discipline must now be imposed ruthlessly in very different times. They do not want to allow Greece,  after six years of economic and social turmoil, Greece should be allowed a new start and that even a small part of the adverse consequences of past mistakes should be borne by the richer countries. Unattributed comments from German government sources have suggested that Germany would be relaxed about Greece leaving the euro, if a new government  questions the policies being imposed on it and whether it can ever reasonably be expected to pay back its foreign public debt. If, after suffering more than any other EU economy has ever suffered since the beginning of the euro, in order with the aim of remaining in the euro, Greece were to be effectively expelled because of disagreements with a newly elected government, the economic contagion might be containable (as it would not have been in earlier years), but the political contagion resulting from a breakdown of EU solidarity would be unpredictable and irreversible.

It is understandable that Germany does not want to sign blank cheques for transfers to poorer EU members similar to those West Germany has provided and still is providing to other Germans in eastern Germany. The EU, Germans reasonably insist, is not a “transfer union”. But, with Greece now running a primary surplus (excluding interest payments) on its government accounts, demands that it should fully service and eventually pay back its 177% of GDP debt are in effect demands for transfers from Greece to richer countries in exchange for the poisoned chalice of inflows in the 2000s whose impact on the Greek economy was almost entirely harmful.

That said, it has to be admitted that a negotiated writedown of Greek debt will not in practice be easy or quick. The more aggressive stance of the victorious Syriza towards the demands of the Troika (IMF, European Commission and European Central Bank) can not be seen to be immediately rewarded in preference to New Democracy’s more cooperative approach.

Secondly, although Germany does to a considerable extent pull the strings of the Troika, it is not all-powerful. First the IMF cannot consider any forgiveness of its debt. It is not an EU institution and represents many other countries, mainly much poorer than the EU. The IMF can continue to offer advice from its wide experience on policy reforms but it cannot be part of the debate on fiscal obligations within the euro zone. The European Commission and the ECB with regard to its role in the Troika–,which is completely separate from its main function of setting monetary policy on which it is independent–are effectively constrained by euro zone member states, of which Germany is the most powerful, but not of course the only one. Through the European Stability Mechanism all other euro zone countries, both strong and weak, have stakes in Greek debt and would correspondingly share in any debt write-down. Logically opposition to such a write-down should come most from the weaker countries though that does not seem to be the case. The most hardline stance is that taken by the prime minister of Finland, Alexander Stubb. Finland presents a unique problem. It is an anomaly in the euro zone in that it is the only Nordic member and its original decision to join was taken by the government of the time against a much degree of opposition than in other member states at the time of joining. The government there is under pressure from the nationalist True Finns (as though other parties were not truly Finnish) which makes a big issue of providing “help” to allegedly profligate southern Europeans. Finland might have to be treated as an anomaly and excluded from any deal. Of more concern should be adding to the debt of weaker member states but given the relatively small size of the Greek economy, and that lending to it is shared between all the other euro zone states, a substantial write-down of the €320bn debt is not going to have a dramatic impact on any of the others.

A final concern is to what extent a write-down of Greek debt would lead to other indebted euro zone countries to demand their own write-downs. But the only other country which may need such a write-down is Portugal and this would be to a lesser extent than for Greece. Italy’s public debt to GDP ratio is 130% but the country has lived with a similar ratio for 20 years, since before it joined the euro, and a high proportion of its debt is held domestically. Ireland also has a high debt to GDP ratio, but is now coming out of its prolonged recession and has always despite cuts in living standards, been one of the richest countries in the euro zone. Spain’s public sector debt is lower  and similar to that of Germany’s.

Moves to tackle Greece’s unmanageable debt will take time and the new Greek government will have to ensure that its accounts remain in primary surplus, but after six years of painful measures, it would  be wrong to prevent it from taking measures to ease the hardship of the most vulnerable people or to push it into even deeper cuts in expenditure to meet the demands of creditors and even more wrong to remove Greece from the euro zone as an answer to an impasse in the negotiations.

EU partners must keep out of Greek election

The calling of a general election in Greece at the end of January poses a challenge to democracy in the euro zone.  The main challenger to New Democracy, the leading governing party, is Syriza, a left wing party which is challenging the economic policy which the government has adopted over the last three years. That policy has been largely in response to demands from the troika (European Commission, European Central Bank and IMF) in return for a loan programme which was needed to prevent a banking collapse which would have forced Greece out of the euro zone. New Democracy itself had in opposition challenged the policy imposed on the previous PASOK government by the troika but did a u-turn on winning the election which it to an extent has got away with in the eyes of a sufficient percentage of its voters to remain one of the leading parties. Syriza could not possibly implement its whole anti-austerity programme while staying in the euro zone as it says it wants to but it would have to implement some changes if it won to retain any credibility at all with those who had put it in office.

Spokespeople of the EU institutions and leading EU governments have a huge dilemma. On the one hand they may feel a need to state the realities of what it considers any Greek government has to do to stay in the euro zone. On the other doing so is likely to be seen in Greece as interfering in the election on the side of the government. Already Pierre Moscovici the new economy commissioner and the German finance minister, Wolfgang Schauble, have intervened in favour of continuing with the existing programme being implemented by the government as being the only one to return to growth while Mr Schauble has said that a change of policy would make it much more difficult to “help” Greece., though many in Greece would question whether the country is actually being helped. Immediate reactions to the announcement of the election are perhaps understandable but such people will have to restrain themselves during the campaign if the election is to look at all like a free choice for the Greek people between alternatives.

Three years ago a significant policy shift would have almost certainly led to Greece leaving the euro zone. However the situation is now different, at least to some extent. The euro zone has stabilized though not recovered from its economic doldrums and crucially the Greek public sector has a primary surplus. The latter means that the Greek taxpayer is fully funding Greek public expenditure with a bit to spare except for the servicing of debt. Syriza has a point when it argues that the Greek taxpayer cannot afford to pay this debt which was incurred by previous government with the participation of lenders who foolishly believed the Greek economy can absorb and eventually repay such loans and with the tacit approval of the European Central Bank including its then German chief economist Otmar Issing. No-one suggests that debt should be easily renounced but when it proves to have been a disastrous mistake the pain of tackling the situation should be shared between creditors and lenders and it is evident that the Greek public has suffered far more over the last six years than the financial creditors or the other governments of the euro zone who now indirectly hold much of the debt.

Syriza may not win the election given that it leads New Democracy by only a few percentage points in the opinion polls a lead which could be reversed and even it emerges as the largest party it will still be well short of an overall majority and may not be in a position to lead a coalition government.

If Syriza does lead the next government and its leader Alexis Tsipiras is the next prime minister, he will not be able to fulfill his promise to end austerity since the financial resources are not available to do so and would not be even if the debt could be wiped out. The primary surplus is a small one and it would not be possible to move into deficit. He will in this and other ways be faced with a reality which cannot be changed by the rhetoric that he has used to attack present policies. But that is for the Greek electorate to judge. The rest of the EU needs to stay out of the campaign and let the Greek people make up their minds. After that if Syriza were to form a government they will need to work out how to deal with it.

Immigration risks British exit

John Major speaking to the Konrad Adenauer Stiftung in Berlin said on November 13 that he considered there was a near 50% chance of the UK leaving the EU, the main reason being the allegedly excessive level of immigration. If the chances of the Conservative Party doing well enough in the May 2015 UK election to form a new government and carry out its promise to hold a 2017 referendum on EU membership are 50% then the implication is that if the referendum is held there is a near 100% of it leading to exit. This would be surprising given that an Ipsos-Mori poll on showed a large majority in favour of staying in. However, John Major’s assessment could prove right. In late November David Cameron came close to making demands that were self-contradictory. On the one hand he seemed about to demands a reform of the priniciple of free movement of labour to the extent of applying and the other hand he rightly called in his speech to the CBI on November 10th for the “safeguarding the internal market” amongst all 28 members at a time when the majority euro zone countries are developing closer integration amongst themselves.

The internal market which was designed in 1985 and 1986 by the commissioner appointed by the then British prime minister, Margaret Thatcher, Lord Cockfield, has four pillars, the free movement of goods, services, capital and labour. If quotas can be introduced on the free movement of labour one of the four pillars is fundamentally weakened and the precedent set for a member state (or the whole euro zone towards countries outside the euro zone) to introduce quotas on the movement of capital, services or goods.

On November 28th Cameron stepped back for calling for immigration quotas calling instead for more reasonable limits to in-work benefits but he could yet be persuaded into making such a demand.

The issue is linked to other government policies

How has immigration, particularly from other European countries, become such a concern in the UK? Germany has had similarly large numbers of immigrants from other EU countries in recent years and as a relatively strong economy is also likely to remain a magnet for immigrants. But immigration in Germany is not now a major political issue, although the leading governing party, the Christian Democratic Union used to insist that Germany was not an “immigration country”.

There are a number of reasons that those concerned about immigration put forward as reasons for their concern, of which the most substantial are that it puts a strain on health and social services, it reduces job opportunities for existing British citizens especially young people and reduces wages, and that adds to the problems caused by the shortage of housing in parts of the country, especially the south-east. The first concern, though possibly true in particular localities, does not stand up to evidence overall. As a recent study by University College, London, has shown EU immigrants put more into tax to fund social services than they take from them and from welfare benefits. Moreover many of those working in the health and care sectors are immigrants, both from in and outside of the EU. With regard to schools, it has been noted that schools with large immigrant intakes as in London or other inner cities are performing better than those in rural areas with low immigrant intakes.

Arguments that immigration depresses wages for the lower paid and that it puts pressure on housing cannot be so easily refuted. In both cases, however, the problems are also linked to longstanding aspects of UK government policy.

Although the UK has done well, compared with many EU counterparts, in increasing the number of jobs and so in limiting unemployment, it is being increasingly noted that the wages and conditions of these jobs is often low and may be deteriorating. The UK has prided itself on a very flexible labour market and there is little doubt that this leads to lower unemployment, especially of young people, than countries in southern Europe. Certainly the UK does not want to copy the labour market conditions of southern Europe which have resulted in low employment rates and high youth unemployment.

However, the extent to which the scales are weighed in favour of employers in relation to employees, and the behaviour of employers in boosting profits, and pay for higher management, at the expense of wages and conditions for most employees, especially those at the bottom, has gone too far. This means not only that wages are often very low, and subsidized by tax and welfare benefits provided by the UK taxpayer, but also that other conditions, such as the reliability of income as a result of the prevalence of zero hours or very short term contracts, and the provision of training, are now very poor and despite government efforts to squeeze welfare benefits for unemployed, are very unattractive to British citizens. They are more attractive to people from eastern Europe because they send money back to their own countries where living costs are much lower and when they see themselves as only temporarily based in the UK are willing to live in crowded or low standard accommodation.

One example is given by the road haulage sector. With EU rules on working hours coming into force after a period of exemption for the UK, representatives of the sector complain they do not have sufficient numbers of trained drivers. But this is because they have failed to invest in their staff by providing adequate conditions and training to attract British citizens, relying instead on the use of agencies providing temporary work often to foreigners. It is not just a matter of wages, but the lack of a reasonable degree of job security (it is accepted that jobs for life are a thing of the past, but employees should be able to look forward in normal circumstances to staying in the same place for at least 12 months unless the company they work for is in acute difficulty); training; and other conditions such as pressure to work excessive overtime at the expense of long-term health and family life.

This is not a call for massive new regulations. Legal changes such as the imposition of a minimum wage can be successful in achieving modest improvements in conditions without reducing employment opportunities, but they need to be carefully thought and can only achieve limited improvements. They cannot change the labour market culture to one like Germany where employers feel that providing good training, working under a meister (mentor) and time off to study, are a part of being respected in the locality to which they belong, where works councils are considered a normal part of governance which helps to overcome difficulties and seize opportunities and where unions are seen as part of a “social partnership”. The latter certainly looks far-fetched in the UK but improvements are possible. The government does have a role for example in the message it sends by the way it treats its own employees. The practice of outsourcing public services which do the same as previous government agencies but save money purely by reducing the wages and conditions of employees carries a lot of responsibility for sending the message that poor employment conditions is good business practice.

Another element of government policy which links with the concerns of those who claim that immigration is too high is housing. Since the 1980s social housing has been sold without the proceeds of sales being used to replace the stock so that social housing provision is inadequate. Instead a large part of public money spent on housing goes on subsidizing the rents of those on low to moderate incomes. Whereas no-one would expect immigrants to jump the queue for social housing they have been entitled to the rent subsidies. Given that these subsidies are part of government policy to provide housing to those already resident but inadequately housed the government ought to be able to justify requiring a substantial delay before providing such subsidies to new immigrants, but it should also do more to boost the availability of social housing in areas of need.

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.

Tomorrow October 7th could be key date for UK’s future in the EU

Tomorrow, October 7th, will be an important day for Britain’s future prospects of remaining in the EU, if the Conservatives again lead a government the next election. Jonathan Hill, the former leader of the House of Lords, who has been put forward by Jean-Claude Juncker as commissioner for financial services in the next Commission, is being recalled to Parliament to face further questions, the only commissioner to have been recalled so far  although there are question marks over a few others). The reasons for his recall include the fact that he will have to learn quickly since he is not an expert in financial services, although he answered all the questions competently. Apparently controversially he said he had no view on eurobonds or taxation, but these are both matters with which he will be primarily responsible and which are highly political so any non-anodyne remark would have been likely to have been criticized. While some of Mr Juncker’s selection of commissioners are highly expert such as the transport and health commissioners, Maros Sefcovic (Slovakia) and Vytenis Andriukaitis (Lithuania), there are others without significant experience such as the environment commissioner, Karmenu Vella (Malta)  or who have little experience and the energy commissioner, Miguel Arias Canate, has had experience mainly with the oil sector on which he will be supposed to reduce dependence.

There is actually a good case, given the failure of practitioners with high levels of expertise to have spotted the weaknesses in banks and other financial companies, for someone coming from the outside with a fresh, common sense approach.

Mr Hill, coming from a country outside the euro zone would not be best suited to have a major role in running the euro zone banking union. But supervision of banks will be the responsibility of the European Central Bank and with regard to legislation, Parliament has already agreed to a flawed compromise on winding up unviable banks. Any future legislation will be determined primarily by what is acceptable to member governments rather than anything the Commission does.

The fact that the UK is able to act as the financial services centre of the whole EU,including the euro zone despite not being party of the euro zone, is potentially controversial. Nevertheless, it is accepted that a fundamental principle of the EU is free competition throughout member states. Given that Mr Juncker has put forward Mr Hill as an olive branch to the British following David Cameron’s unjustified attacks on Mr Juncker’s own appointment, his rejection would be seen widely as a slap in the face for both Mr Juncker and the British government which would create very unfavourable conditions for the referendum on EU membership which any Conservative led government intends to hold in 2017. The recall of Mr Hill probably reflects political maneuvering within the European Parliament. From one point of view it might be argued that the UK government can hardly complain since its own EU policy is largely formulated as a result of political maneuvering to try to hold together the Conservative Party and head of the threat to the Conservatives from the UK Independence Party. However, Parliament will have to consider the huge potential consequences that a rejection of Mr Hill could have for the UK’s continuing membership of the EU.

Juncker’s proposed Commission includes two surprises

The two most surprising things about the proposed college of commissioners presented by Jean-Claude Juncker on September 10th and to take office–if endorsed by the European Parliament–0n November 1st, are: first, its structure, a structure which is likely to have consequences for not only the internal working of the Commission but how it appears to the outside world; and second, how far the appointments go to meeting British aims (of which the appointment of the British commissioner, Lord Hill, to be responsible for financial services, is only one aspect).

 

New structure aims to remove silo-mentalities

Mr Juncker has said that it is intended to remove “silo-mentalities” and at least for some aspects of the Commission’s work this is likely to be the case. Apart from the foreign policy representative much of whose work is outside that of the Commission, and Kristilina Georgieva, who is to become vice-president for budget and human resources, there will be five other vice-presidents who, unlike previous vice-presidents who usually had major portfolios, will not have specific departmental responsibilities but instead will be tasked with co-ordinating policy under different, but overlapping fields, namely:

Better Regulation—Frans Timmermans (outgoing Netherlands foreign minister);

The Digital Single Market—Andrus Ansip (resigned in March 2014 after nine years as prime minister of Estonia);

Energy Union—Alenka Bratusek (was  forced to resign in May 2014 as prime minister of Slovenia after 13 months in the post);

The Euro and Social Dialogue—Valdis Dombrovskis (resigned after five years as prime minister of Latvia in November 2013); and

Jobs, Growth, Investment and Competitiveness—Jyrki Katainen (resigned as prime minister of Finland in June 2014 after three years in office to join Commission).

Each of the above will be asked to coordinate the work of several of the other commissioners who do have specific departments (Directorates-General). Given that four of the five co-ordinating commissioners are former prime ministers, all who have chosen to leave active careers in domestic politics to make contributions at the EU level, it can be expected that they will want to wield power and in so doing are likely to cause tensions or even come into open conflict with the commissioners they are supervising. In particular, Mr Katainen who decided to step down as prime minister of Finland to go to the Commission, and Mr Dombrovskis will expect to have a major influence on economic policy matters in the euro zone. As they both have been associated with fiscal discipline in their own countries and, in the case of Mr Katainen with regard to other euro zone countries, they are likely to come into conflict with Pierre Moscovici, the former Socialist French finance minister, who judged by his past record will want to emphasise a “flexible” interpretation of the euro zone’s fiscal rules. Both Mr Katainen and Mr Dombrovskis will also have a strong interest in the employment portfolio which will be taken by Marianne Thyssen, A Belgian Christian Democrat.

Other policy domains where tensions are likely include: the controversial energy field between Ms Bratusek and Miguel Arias Canete, the Spanish commissioner who will be in charge of DG Climate Action and DG Energy; and the digital economy between Ansip and Gunther Oettinger, the German outgoing energy commissioner who will take charge of DG for Communications Networks, Content and Technology and DG Informatics.

 

Hopes for drive for better regulation enhanced by choice of Timmermans

Two key players operating hopefully with a reasonable degree of harmony will be Mr Timmermans in charge of co-ordinating policy related  Better Regulation,as well as the Rule of Law and Charter of Fundamental Rights, and Elzbieta Bienkowska in charge of the departments for the internal market, industry, entrepreneurship and SMEs. The EU is held together largely by its body of legislation, and the majority of that legislation is designed to facilitate the internal market. The legislation attracts much criticism for its allegedly onerous and intrusive impact on businesses.  If one were to judge by almost all the examples given in the UK’s tabloid press of such excess, the criticism would appear to be largely based on inaccurate reporting. However, given the fact that the legislative acquis over 60 years has reached 100,000 pages it would indeed seem likely that there is huge scope for streamlining and where appropriate eliminating legislation with the aim of reducing regulation to the minimum necessary to achieve the key objective of free movement while safeguarding the health and safety of workers and consumers maintaining environmental standards and saving energy.

In a speech as the Netherlands foreign minister in February 2014 Mr Timmermans said that “the European Union needs to be modest and understand that there is no Union without the member states…The EU exists by the grace of the member states and their democratic institutions. The EU would do well to secure greater involvement in Brussels decision-making by those democratic institutions, governments and parliaments.

We are making proposals to bolster the role of national parliaments, and favour a smaller European Commission focusing on core tasks.”

On the basis of this and other declarations, we can expect that Mr Timmermans will launch a drive to improve the quality of regulation and to steer it away from activity in areas, which are not the EU’s core tasks, such as the internal market and legislation to protect the environment. He should be able to work closely with Ms Bienkowska who, having been deputy prime in the present centre-right government in Poland, is likely to have similar ideas to Mr Timmermans and want to meet the legitimate calls of the British government, with which Poland has a good and close rapport, for reform. She will no doubt retain close relations with Donald Tusk, the outgoing prime minister of Poland under whom she has served, who is also on Noevember 1st, to become president of the European Council, representing heads of government. Mr Tusk has stated that the task of trying to prevent the UK leaving the EU is one of his three top priorities along with resolving the conflict between Ukraine and Russia and reviving the EU economy.

Mr Timmermans and Ms Bienkowska will not be able to deal with everything the UK wants to change. The 48-hour week (although it is not in practice applied) and other pieces of social legislation are disliked by the UK Conservatives but their abolition would be politically controversial in other countries, and will therefore have to be dealt with in the European Council not the Commission, as will UK requests for treaty changes. It may well, however, be possible to make substantial changes to reduce the impact of EU regulation without major political controversy.

 

Can next Commission revive the euro zone economy?

Reforms to EU regulation are highly important to the UK, the Netherlands and some other countries in northern Europe, but are of little interest in France or southern Europe, where all the concern is on what can be done to revive the euro zone economy. As discussed above, the allocation of posts should lead to a lively debate within the next Commission and it would not necessarily be a bad thing if such debate proves to be reported rather than interpreting collective responsibility to strictly.

However, whether the Commission can actually do very much on its own to stimulate the euro zone economy is open to doubt. There will be a lot of debate over what degree of flexibility can be allowed in relation to the constraints on budget deficits given the weak state of many euro zone countries’ economies, but realistically the scope for such flexibility without driving a coach and horses through both the letter and spirit of the Maastricht Treaty which would not be tolerated by Germany, the Netherlands of Finland, is little more than marginal. Something may be achieved by promoting an EU-wide public sector investment programme as proposed by Mr Juncker with extra funding achieved by expanding the European Investment Bank, but the size of such a programme will still be modest. The best hope would be to help support the European Central Bank’s moves to make more money available to banks that on-lend to businesses and to purchase Asset-Backed Securities consisting of investments in businesses, for example by directing EU regional funds towards grants and loans to small and medium enterprises and putting pressure on government to remove administrative obstacles to business start-ups and expansion which in some countries like Italy remain substantial. That could in turn link back with any Commission drive to improve EU regulation, which could be combined with pressure on member states’ administrations to implement EU directives (which leave large scope for national interpretation) in a simple and efficient way.

 

 

 

After five years depression Spanish employment rebounds

Employment jumps dramatically

After five years of depression, the Spanish economy is growing again. Employment rose by 402,000 in the second quarter. In the second quarter of 2013 employment rose by 98,000. The underlying economy was then still declining but not very steeply so no more than 150,000 of the extra jobs in the second quarter of 2014 are likely to have been for seasonal reasons, leaving 250,000 new jobs because of a recovering economy. This could imply a million jobs in a year if the recovery continues at the same rate.

 

Boom and bust still a danger

It is important that the recovery is not creating a new external debt burden as happened in the boom in the early to mid 2000s. Here the evidence is mixed. The development of the current account deficit from €3bn in the first quarter of 013 to €10.4bn in the first quarter of 2014 (there was a surplus of €8.0bn for the whole of 2013) looks alarming. But there was also a big, and rising, positive errors and omissions item of €8.0bn. The so-called capital account which consists mainly of EU grants for investment showed an inflow of €3.5bn. This left the financial account with a moderate outflow (implying reduced net liabilities) of €1.0bn. There was a net outflow of direct investment – the part of the financial account, which does not add to debt—of €3.8bn, but this reflected an unusually strong outflow from Spain  in the first quarter. In most recent quarters there has been a substantial net inflow of direct investment. Therefore, though there was an increase in net debt liabilities of the Spanish economy of €2.8bn in the first quarter, the trend still appears to suggest an ongoing reduction in net debt. However, the figures will require careful monitoring.

 

Export performance and reduced import dependence are key

In some ways recovery should generate further recovery as the incomes of the newly employment (although they are likely mainly to be relatively low incomes) enable the newly employed to spend more. They should also pay more in tax and receive less in benefits so helping government to reduce the still high government sector deficit. However, it will also tend to pull in more imports so recent moderate rises in exports of goods and services (3.4% in 2013) will need to continue and, if possible, expand, if new imbalances are to be avoided. Reducing import dependency also could help, not least by investing in increased energy efficiency, which would also help address the fact that 69% of Spaniards, a higher percentage than in  most other EU countries, are worried about the cost of utility bills.

 

Spain has demonstrated high degree of social resilience

Unemployment reached 26% and youth unemployment has been over 50% for several years. Although there is a significant amount of employment in the informal economy this is very unsatisfactory particularly for young people trying to enter the labour market. The fact that Spain has been through a five year depression without destabilizing social unrest or the rise of extremist parties is a tribute to the resilience of its social fabric. The rise of the new party, Podemos (We can) which won 7% of votes in the May European Parliament elections follows from the peaceful protests and encampments of Indignados is encouraging.

 

The one major concern is the demands of the Autonomous Community of Catalonia to hold a referendum in November calling for Catalan independence. Such a referendum would not be binding and it is claimed by the Spanish government that it would  be illegal under the Spanish constitution but strong calls for independence cannot just be ignored. This is one matter on which the government of Mariano Rajoy has shown little tact, seeking to browbeat rather than persuade the Catalans that there interest remains in staying in Spain.