Tuesday, December 18, 2007

Don't be fooled: Bali was no breakthrough

by Simon Tilford

The United Nations Climate Change Conference in Bali produced as much as it was ever likely to do. There was no breakthrough, contrary to the claims of some that attended the conference. Nobody should read too much into reports that the US administration fears its negotiators gave too much away. This is just news management, an attempt to create the impression that the US moved further than it did. The US gave nothing away. The aim of the US negotiating team in Bali was to prevent any international agreement that might demand the US cut its emissions, despite the fact the country could do this at relatively moderate cost according to its own Environmental Protection Agency (EPA). This opposition stems partly from the personal intransigence of President Bush, but also reflects a deep-seated reluctance to allow the country’s freedom of action to be constrained by international agreements. It is another big blow to US soft power in the world.

Of course, on current trends the proposed target of a 25-40 percent cut in developed country emissions by 2020 is nonsense. There is no chance whatsoever of such targets being met unless EU governments get very serious, very quickly about curbing emissions. The construction of new coal-fired power stations would not be compatible with meeting such a target for example, so governments in Germany and the UK would have to scrap plans for a new generation of such plants. Germany would also have to overcome its squeamishness about nuclear power. Energy efficiency standards, for everything from cars to buildings would have to be ratcheted-up very aggressively. Crucially, the EU emissions trading scheme (ETS) would need very tight emissions caps. Only then will businesses be confident that the price of carbon will rise steadily, providing sufficiently strong incentives to invest in low-carbon technologies.

However, notwithstanding question marks over the realism of the 25-40 per cent target, the US position – that targets are meaningless without policies can be put in place at the outset to met those targets – is hugely cynical. It is impossible to agree policies to reduce emissions until governments know which targets their economies have to meet. Similarly, the US knows as well as everyone else that the commitments to curb emissions it wants to see from developing countries will only happen if the developed countries take the lead. It is simply not plausible for the US to turn to China and India and demand they commit to mandatory cuts before it does. Per capita US emissions are at least 4 times Chinese levels and more than 10 times Indian ones. Research from the EPA calculates that the US could cut emissions of greenhouse gases by 60 per cent by 2050 at a cost of just 3.2 per cent of GDP. To put that in perspective, US GDP will rise by nearly 200 per cent over this period (assuming annual real GDP growth of 2.5 per cent.) For the world’s only superpower to rule out such action almost looks like a calculated snub to the rest of the world and will prove a big blow to its moral authority.

However, it is still early days – the timetable for agreeing a replacement for Kyoto stretches into 2009, and hence beyond President Bush’s time in office. Whoever replaces him will have to be more open-minded about international action to challenge climate change, even if only for questions of political expediency. With only 18 months left in office Bush can afford to dismiss the damage being done to the US’s international standing and influence. The next president will not have such a luxury and, regardless of how seriously he/she takes the threat of climate change, will calculate that the costs of refusing to join the EU in its attempt to orchestrate international action to address climate change will outweigh the perceived costs of signing-up.

The EU can do much to ensure that the costs of US inaction are steep. The best way to put pressure on the next administration is for the EU to persevere and impose big unilateral cuts in its own emissions. This will not impair the competitiveness of the EU or cost it export markets. Indeed, the opposite is much more likely. The US is unwilling to take action, but neither does it want to see the EU building on its lead in energy efficient technologies. In an age of mounting energy scarcity, geo-political tension and ever more environmentally conscious consumers and businesses, aggressive emissions targets by the EU will be positive for Europe’s authority in the world and for its long-term economic prospects. The Chinese and Indians might not be ready to sign up to mandatory caps on their emissions, but they are only too aware of the need to make their development more environmentally sustainable. The EU is well placed to supply the technology. The more successful it is at doing this, the quicker the US will come to its senses.

Simon Tilford is chief economist at the Centre for European Reform.

Friday, December 07, 2007

Should Europol and Eurojust merge?

by Hugo Brady

Governments increasingly use Europol, the EU’s police office, and Eurojust - its prosecution unit - to investigate criminals operating across borders and bring them to justice. At Europol, national police and crime analysts gather intelligence on crimes ranging from drug trafficking to counterfeiting and terrorism. Eurojust mostly helps prosecute cases across national borders within the EU. All 27 member-states send police and prosecutors to the offices of Europol and Eurojust, each located separately in The Hague.

In 2008, new EU legislation is planned to give Europol wider investigative powers, cut bureaucracy, and give the body more freedom to gather intelligence and information like DNA data. It will also report yearly to the European Parliament and brief national parliaments, making it somewhat more accountable. But the new-look Europol will not be able to arrest people or start investigations independently of the member-states.

Plans are afoot to make Eurojust work better, too. Governments are pondering how best to guarantee the national prosecutors seconded to it have proper powers from their home authorities to be able to work effectively at international level. All Eurojust prosecutors should be invested with a basic level of powers, including powers to issue formal requests for evidence and authorise surveillance, phone taps and undercover operations. This is not currently the case and hampers Eurojust’s considerable potential: the unit’s caseload inceases by an average of 40 per cent yearly.

Such reforms are useful. But they fail to address a basic problem of cross-border crime fighting. Prosecutors and police across the EU have differing roles and powers and this is often an obstacle to effective co-operation between counterparts. In some countries police investigate but also have quasi-judicial powers; in others, prosecutors do police work as well as bring cases to trial. Take surveillance. Police at Europol can be unable to track a drug delivery properly from the Balkans to the Nordics because in some countries only the prosecutor can organise a cross-border surveillance operation. As a result, police can begin to doubt that cross-border co-operation is worth the hassle and uncertainty.

A radical way to address such problems would be to merge Europol and Eurojust into a single European law enforcement co-ordination body. A single body could ensure more coherent co-operation across the EU, whatever the division of labour between national police and prosecutors. It would also mean simpler procedures for dealing with intelligence, less duplication of efforts against the same criminals and better follow-through from investigation to prosecution in cross-border cases. Most member-states would be dead against such a move, however. Britain and Ireland do not want prosecutors to oversee the work of their police, even if only at European level. Others – like Spain and France – fear a merger that could mean the reverse: police investigating cases without the say-so of prosecutors.

But these difficult political issues could be circumvented and better co-ordination ensured by a more modest move. Europol and Eurojust should be re-located to the same building and some of their resources and facilities amalgamated. Each member-state would have a single national office made up of both police and prosecutors without any change to national hierarchies. Eurojust and Europol could simplfy data protection requirements by drawing up a single data protection regime for sharing information across borders to replace the current separate procedures. And intelligence-sharing could be made more secure and cost-effective with a common IT system.

How well Europol and Eurojust co-operate matters. In November 2007, a joint Europol-Eurojust operation (Operation Koala) destroyed a child pornography network that had disguised itself as a respectable international child modeling agency. Based on high quality information, Europol helped national police to identify customers buying illegal and abusive videos of children filmed in Belgium and the Netherlands. Eurojust helped co-ordinate judges and police from 28 countries that had with some connection with the network. As a result, multiple arrests were made – carried out simultaneously in several countries – and thousands of computers, videos and photographs seized as evidence.

However cases like Koala, where the two bodies achieve a high-level of co-operation, are the exception rather than the rule. According to one prosecutor, police and prosecutors working together on cross-border investigations “is the kind of thing that should be our bread and butter but unfortunately we’re not there yet.” Co-location might seem too basic a solution to boost co-operation. But police attest that Europol’s main value is the simple reality of having colleagues from 27 European countries working together on the same corridor in The Hague, an unparalleled resource in day-to-day police co-operation. The addition of prosecutors to this mix would produce a powerful synergy in law enforcement co-operation.

Hugo Brady is a research fellow at the Centre for European Reform.

Thursday, November 29, 2007

China is losing its EU friends

by Katinka Barysch

The EU is getting tough on China. That, at least, is the impression one gets from high-ranking EU officials that arrived for the annual EU-China summit in Beijing this week. Economics is the main reason for Europe’s changing mood. The EU’s trade deficit with China is set to reach €170 billion this year, and European business is losing an estimated €55 million a day because of Chinese red tape, trademark violations and unfair subsidies. The EU’s economic troika – Joaquin Almunia, Jean-Claude Juncker and Jean-Claude Trichet – called on China to let its currency rise against the euro. Commission President Barroso and his trade commissioner, Peter Mandelson, warned that they would no longer be able to withstand rising protectionist pressure in Europe, unless the Chinese made it easier for European companies to sell in their markets.

Will the Chinese be frightened? Maybe they should be. Those industries in the EU that compete directly with Chinese mass manufacturers – think Italian textiles, German light bulbs or Czech consumer electronics – have occasionally lobbied for protection. But European retailers and those industries that rely on cheap Chinese inputs, for example steel, have lobbied against. At the political level, the Chinese could usually rely on Germany, the UK and the Commission to make the case for open markets. However, this may no longer be the case.

The Commission’s patience seems to be wearing thin. Mandelson in October wrote a letter to Barroso that suggested that the EU’s dialogue-based approach to solving economic disputes with China may have run its course.
The British may be instinctive free traders. But British business is unlikely to lobby on China’s behalf. UK companies still sell roughly as much to Denmark and Dubai as they sell to China. On the other hand, China is now Britain’s 5th most important source of imports, with the result that the bilateral trade deficit reached €24 billion in 2006, a third of the UK’s total trade deficit with non-EU countries. Services, where UK companies are world leaders, account for only a tiny fraction of Chinese imports because domestic markets remain heavily protected. A recent survey showed that while globally almost half of company bosses see China as the biggest business opportunity, in the UK the share is only 37 per cent.
Perhaps most worrying for the Chinese is the shifting mood in Berlin, however. Germany alone accounts for around 40 per cent of all EU exports to China, not least because Germany specialises in exactly the kind of machine tools that China needs to build up its industrial sector. Since 2000, Germany’s exports to China have risen threefold. Since the German economy is much more dependent on exports than those of other big EU countries, it has had a strong interest in keeping economic relations with China smooth.

In recent years, however, the rising euro has made German goods expensive outside the eurozone. And German, like other western companies, have suffered from China’s very cavalier attitude towards patents and trade marks. In 2006, German machinery exports to China actually fell. Germany’s trade deficit with China has more than doubled since 2000, to €16 billion in 2006, and it keeps growing. Perhaps unsurprisingly, the share of Germans who see China as an economic threat has jumped by 17 percentage points in just two years, to 55 per cent in 2007 – the biggest public opinion turnaround in any big OECD country.

German awareness of China as a competitor, not only a promising market, will rise further as Chinese industry moves up the value chain. Chinese car output, for example, is growing by 40 per cent a year. Although Chinese cars have a long way to go before they can compete with Volkswagen or BMW, the fact that China now produces more of them than Germany has fuelled some disquiet. As has the fact that China has dethroned Germany as the world’s biggest exporter.

At the same time as economic ties are souring, Germany and China have fallen out politically. The Chinese were very upset when Angela Merkel received the Dalai Lama in her Chancellor’s office in September 2007. Merkel initially said she’d expect Beijing to calm down quickly. It did not. Finance Minister Peer Steinbrueck had to cancel a planned trip to Beijing because his counterpart was no longer available. Chinese state-owned companies pulled out of a China-German trade fare. Scheduled dialogues on human rights, the rule of law and foreign policy co-operation were called off.

At the EU summit, Premier Wen Jiabao said that Germany could still be a partner and a friend – provided that Merkel acknowledged publicly that she had made a mistake by seeing the Dalai Lama. The Chancellor is also under growing pressure from German business groups and her SPD partners in the grand coalition. But she is unlikely to budge. In a speech to parliamentarians at home, she insisted that “human rights and the defence of economic interests are two sides of the same coin”.

While they have put relations with Germany on ice, the Chinese have reached out to France. Nicolas Sarkozy grasped the opportunity at a bilateral summit in Beijing on November 25th. As is customary, he came with a group of French business leaders, who signed deals worth around €20 billion (although such ‘summit deals’ have a habit of falling apart afterwards). However, Sarkozy is unlikely to be as friendly to the Chinese as his famously Sinophile predecessor, Jacques Chirac. While he promised strong ties, Sarkozy also admonished Beijing for its currency policy and warned that Europe may slap ‘carbon tariffs’ on Chinese goods unless the Beijing contributed to a post-Kyoto agreement.

Europe will not make a full turn towards protectionism. But there clearly is growing potential for economic friction with China. Beijing’s usual conciliatory language – promising gradual change and open dialogue – may no longer be enough. It may have to offer concrete action on currency policy and economic opening if it wants to win its European friends back.

Katinka Barysch is deputy director of the Centre for European Reform.

Friday, November 23, 2007

Bringing Syria into the Middle East peace process

by Clara Marina O'Donnell

The nearer the Annapolis conference comes, the less it looks likely to deliver peace between Israelis and Palestinians. The weakness of the key actors and the current conditions on the ground in the Palestinian territories offer little reason for optimism. But there is one thing that could allow Annapolis to make a big difference – bringing Syria into the peace process. And the EU has a special role to play in encouraging this move.

The key actors are too weak to enforce the costly compromises that peace will demand. The end-of-term Bush administration is widely discredited at home and bogged down by other issues in the region – notably Iraq, Afghanistan, and Iran. Israeli prime minister Ehud Olmert is breaking records for low approval ratings at the head of his fragile coalition, and faces allegations of corruption. The most critical shortcomings are on the Palestinian side. Fatah is so divided that the Palestinian Authority's President Mahmoud Abbas can barely claim to speak for the West Bank, still less for the Palestinian territories as a whole. And violent intra-Palestinian feuding worsens every day, as demonstrated most recently by the deadly shooting at the Arafat anniversary rally in sanction-ridden Gaza.

Without an improvement in the political situation on the Palestinian side, there is no chance of progress towards a final peaceful settlement. Israel will never agree to any concessions that could compromise its security if the other side is manifestly incapable of holding up its part of any deal – or worse, is on the brink of civil war.

Unless Gaza and the West Bank can be brought back together under a single and stable government, it is hard to see how sustainable peace is possible. But that objective looks increasingly unattainable. Hamas’ current violence towards other Palestinians is preventing the possibility of any rapprochement with Fatah. Abbas has started openly calling for the Hamas government in Gaza to be toppled, while the Israeli Defence Force is urging wide-scale military intervention in Gaza. But force may not be able to topple Hamas; Israel’s incursion into Lebanon last year showed just how difficult it is to dislodge a group of fighters who can easily blend into the local population. Worse, force could provoke Hamas to destabilise the West Bank, where the movement also has a strong footing.

Outsiders may need to try a tangential approach. Like pieces in a jigsaw, the region’s conflicts are interconnected, and the next step in solving the Israeli-Palestinian conflict may in fact lie in Syria.

Damascus has close ties with Hamas and hosts its leader-in-exile, Khaled Mashaal. At the same time, Syria is wearying of its international diplomatic isolation, and shows signs of wanting to improve relations with Arab nations, the West, and even Israel. It has hinted that it will be willing to attend Annapolis if the agenda includes the Golan Heights. In what looks like a gesture of good will, Damascus has refused to host a ‘spoilers conference’ that Hamas proposed as a foil to the Annapolis conference.

If Syria's relations with the West and Israel improved, Damascus might pressure Hamas to rein in its use of force, and even oblige it to compromise with Fatah. Such a shift in regional balance could also encourage moderate elements within Hamas: fearful of losing a key foreign supporter, they might ease their opposition to Israel, or distance themselves from the more radical elements in Hamas.

Many in the West will find the prospect of working with Syria uncomfortable. There is the suspicion that Syrian agents are linked to the murder of several anti-Syrian Lebanese politicians, and there is concern about a possible nuclear programme. But the idea of using Syria to influence third parties in the Middle East is not new. France cut ties with Damascus after the Hariri murder, but this week controversially sent two top aides of President Nicolas Sarkozy to Damascus. Their task is to woo the sponsors of Hezbollah towards co-operation in the forthcoming Lebanese presidential election.

Going one step further – winning Syrian support for resolving the Israeli-Palestinian conflict – could prove to be Annapolis’ success. Syria's presence at Annapolis and its engagement in the peace process would clip the wings of the radical elements in Palestinian politics. At present, Syria's attendance is still uncertain. The US and Israel are focusing only on the Palestinian issue, and are unwilling to address the Golan Heights. There is a role here for the EU, which has so far been conspicuous by its absence in the preparations for the conference. The EU should encourage the US and Israel to widen the focus of the current peace effort and include Syria. An invitation could be accompanied by a conditional offer to Syria: its claims to the Golan Heights could be put on the agenda at Annapolis, in exchange for constructive engagement with Hamas in the Palestinian territories, and with Hezbollah in Lebanon.

Clara Marina O'Donnell is research fellow at the Centre for European Reform.

Thursday, November 15, 2007

The euro as the world’s reserve currency?

by Simon Tilford

Back in the 1970s President Nixon’s treasury secretary, John Connally, famously quipped that “the dollar may be our currency, but it’s your problem”. One of the arguments in favour of establishing the euro was that it would quickly come to rival the dollar’s status as the world’s principle reserve currency and make it hard for the US to abuse its “exorbitant privilege” – devaluing the dollar imposes few costs on the US because its foreign debt is denominated in dollars. Is the wish of those Europeans that want to see the dollar dethroned about to come true? If so, would this be a win-win scenario for the eurozone?

There is no doubt that the threat to the dollar’s status is bigger than at any time since the end of the Second World War. The most likely outcome is that a rapid narrowing of the US current-account deficit and renewed fiscal discipline will combine to restore confidence in the dollar, and that it will retain its status as the world’s leading reserve currency. Confidence in the long-term prospects of the US economy remains strong, and the country’s huge and liquid financial markets make the dollar highly attractive as a reserve currency. However, a rout is a possibility, and could be triggered by a number of events, such as a debt crisis in the US or a steep rise in inflation, which would undercut the willingness of foreigners, crucially East Asian central banks, to hold so many of their reserves in the American currency. Let’s assume for a moment that the damage to the credibility of dollar is such that its role as the world’s favourite currency is lost.

The euro would be the only plausible replacement. It is the world’s second most important reserve currency, though a distant second to the US. The eurozone economy is huge (though not quite as big as the US), its economy is open, its financial markets increasingly deep and liquid, and the ECB now enjoys considerable credibility in the financial markets. But what would it mean for the eurozone, aside from schadenfreude? It would be easier for European companies to operate internationally as there would be less exchange rate risk. With import and export prices denominated in euros the economy, and the inflation rate, would be less vulnerable to shifts in exchange rates. Much more important than this, however, would be the gains from seignorage. As is the case at present in the US, the eurozone would benefit from what are effectively very low interest loans in the form of large central bank holdings of euros. Also, the growth of international trade would boost demand for euros, with the result that the euro-zone could very cheaply finance an external deficit, much as the US has been doing for decades.

But there are downsides to these potential advantages. As the issuer of a major international reserve currency, the eurozone would have to cope with different external risks, such as structural imbalances in the global economy, that are to a large extent responsible for the weakness of the dollar. The huge US current account deficit is the flipside of mercantilist economic policies being pursued by East Asian governments. Internationalisation of the euro could also make it harder to control the stock of euros in circulation and hence growth in the money supply and potentially inflation. An increase in the demand for euros would either cause the currency to appreciate, making exports less competitive, or require that the eurozone run a substantial external deficit in order to satisfy the external demand for euros. For this to happen, the ECB would need to run a looser monetary policy.

The potential for conflict within the eurozone is obvious. A stronger euro would be anathema to many eurozone countries, not least France and Italy, which are already very worried about euro strength. But a looser monetary policy would be anathema to countries such as Germany and the Netherlands that worry about the inflation implications of cheaper money. Indeed, it is far from obvious how the eurozone could run a sizeable current account deficit without exacerbating existing tensions between members of the single currency area with large current-account surpluses, such as Germany and Netherlands, and those with large or rising external deficits – most notably Spain, but also France and Italy. It would be possible for Germany and the Netherlands to continue to run big surpluses at the same time as the eurozone as a whole ran a bigger deficit, but only if other eurozone countries ran even bigger deficits. This is politically implausible.

Becoming the world’s principle reserve currency might not be worth the bragging rights.

Simon Tilford is chief economist at the Centre for European Reform.

Thursday, November 08, 2007

Sarkonomics – a user’s guide

by Philip Whyte

President Sarkozy is frequently portrayed in France and elsewhere as an “economic liberal”. This is a mistake. He is undoubtedly an economic reformer prepared to take on the privileges of labour market “insiders”; but he retains a French dirigiste’s belief in an active role for the state in economic development. This manifests itself in several areas, including his support for “national champions”, his mercantilist vision of international trade, and his belief that governments should have greater influence over the European Central Bank (ECB).

In a French context at least, Mr Sarkozy’s greatest claim to originality probably rests on his policy towards the labour market. From the mid-1970s until comparatively recently, successive French governments sought to stem the rise in recorded unemployment by strengthening employment protection legislation and pursuing a policy of labour market withdrawals—notably by shortening the working week, discouraging young people from joining the labour force too early, and coaxing older workers out of it by lowering the age of retirement.

In other words, for almost three decades French labour market policy was guided by the lump of labour fallacy—the idea that there is only a fixed amount of work to go around. These ill-conceived supply-side policies gave France one of the lowest employment rates in the EU. Mr Sarkozy’s economic priority is to raise France’s rate of employment by reversing, or at least mitigating, the flawed policies of the past. An early measure has been to relax the 35-hour working hour week by exempting overtime work from income tax (“making work pay”).

Inevitably, Mr Sarkozy’s reforms are facing opposition from “insiders” whose privileges they threaten. Public-sector workers such as train-drivers, who enjoy special pension rights which allow them to retire aged 50, have already been on strike to protest at the government’s proposals to raise the retirement age. In the past, such action could often count on the support of the wider population because reforms were often seen as the “thin end of the wedge”—the first salvo in a broader assault on “acquired social rights” (acquis sociaux).

Successive French governments have had a tendency to back down in the face of popular support for industrial action. This time should be different, for at least two reasons. First, Mr Sarkozy has staked his political reputation on pushing such reforms through: should he back down, his authority would be destroyed and the rest of his presidency shorn of purpose. Second, opinion polls indicate that strikes by privileged public-sector workers no longer enjoy the support of the wider population which realises that it bears the burden of supporting them.

Mr Sarkozy’s labour-market reforms are generally wining plaudits abroad, but other aspects of his economic programme are sparking conflict with France’s neighbours. Mr Sarkozy believes that macroeconomic policy needs to be relaxed while his structural reforms are pushed through. This explains why he has criticised the ECB for neglecting the strength of the euro’s exchange rate and for subordinating economic growth to low inflation. The French president’s broadsides against the ECB have been poorly received elsewhere in the EU—notably in Germany, where they have been seen as attacks on the ECB’s independence.

A similar conflict has emerged in the area of fiscal policy. France has not run a balanced budget since the 1970s and its budget deficit has consistently exceeded the Maastricht limit of 3% of GDP since 2002. Earlier in 2007, the French government (of which Mr Sarkozy was a member) committed itself to balancing its budget by 2010. But the budget for 2008 makes no effort to meet this target because it provides for tax cuts that are not offset by reduction in public expenditure. Commitments to the EU are being subordinated to domestic objectives.

As for Mr Sarkozy’s views on competition and international trade, they are anything but liberal. They spring from a mercantilist mind-set which sees a coincidence of interest between domestic firms and the French state and which believes that a country’s aim in international trade is to export more than it imports. This explains Mr Sarkozy’s support for “national champions”, his opposition to foreign takeovers of leading French firms, and his propensity for intervening to “shape” corporate mergers—witness his role in the tie-ups between Sanofi and Aventis (when he was finance minister) and between GDF and Suez (as president).

Philip Whyte is a senior research fellow at the Centre for European Reform.

Thursday, November 01, 2007

EU-Russia: no more ambitions

by Katinka Barysch

The CER organised a conference on EU-Russia relations in Brussels on October 30th, together with ‘Russia Profile’ magazine. I have been to dozens of these EU-Russia meetings in the last couple of years. More often than not, they turn nasty, with the Russians making angry accusations and the Europeans going into a sulk. At our seminar, the atmosphere was strangely subdued.

No doubt, this was partly due to the professionalism of the panellists. People like Vladimir Chizhov, Konstantin Kosachev, Helga Schmid and Christian Cleutinx make a living addressing big problems without sounding alarming (details of the event can be found here http://www.cer.org.uk/russia_new/events_russia_new.html).

But diplomatic protocol was not the only reason for the lull. A sense of resignation has descended over EU-Russia relations. We have quietly discarded our lofty ambition to build a “strategic partnership based on common values”. Today we just want to get along, somehow.

The same lack of expectations turned last week’s EU-Russia summit in Mafra into a success of sorts. The Portuguese presidency of the EU did not even try to unblock talks on a new EU-Russia treaty. The change of government in Poland has increased the chances that the dispute over meat exports will be resolved and that Warsaw will lift its veto. But neither Russia nor the EU has much enthusiasm for a new treaty. What for? Instead of a shared vision, there is uncertainty: in Russia over its future leadership and direction, and in the EU over whether it can forge a common position among 27 member-states.

Both sides are groping for a path through this period of uncertainty. “Realism” is the term most widely used to describe today’s bilateral relationship. One participant at our seminar called for a “partnership of patience”, another referred to a “carefully crafted holding pattern”.

This total collapse of ambition was probably inevitable. Once Russia started to turn away from pluralist democracy, the EU’s constant talk about ‘common values’ simply antagonised Moscow. The EU ended up frustrated and disappointed. Bitterness grew on both sides. The political rhetoric became so shrill that it started to endanger practical co-operation in energy, investment or security.

Now both sides are trying to reassure each other that things are not that bad after all. Look, trade is growing by 30 per cent a year. EU companies are doing good business in Russia. Russians are coming to the EU in record numbers. The Union is allowed to observe mediation attempts in Transdniestria. Micro-successes are still possible: we now have an ‘early warning mechanism’ in case of disruptions to energy supplies, and a new cultural dialogue. Process matters.

But can the EU and Russia really afford to put their relationship on ice and wait for better days? World politics intrudes in the current lull. Russia has blocked EU-backed plans for Kosovo independence. It is against tougher sanctions aimed at preventing Iran from building a nuclear bomb. Russia behaves as if it didn’t need friends. But when it looks around the world – at a rising China, a disillusioned US, an unstable Middle East – it must conclude that the European countries are still its easiest and most reliable partners.

Vis-à-vis Russia, the EU looks divided, confused and often weaker than it is. That is partly because Russia forces the EU to clarify its own objectives. Can the EU become a more powerful international player while at the same time upholding its founding principles of democracy and human rights? Since different member countries have different answers, the EU tries to avoid the question.

Russia also puts the EU’s energy plans to the test. While paying lip service to a common energy policy, EU member-states are rushing to strike bilateral deals with Gazprom. Energy was supposed to be an area where the EU and Russia have clear common interests. But now the Russians complain about a ‘Gazprom clause’ in the Commission’s latest liberalisation package: state-owned foreign companies would not be allowed to buy gas pipelines in the EU, unless their governments agreed to also give European companies better access to their home markets.

Russia is not well placed to lecture the Europeans on energy market liberalisation. But Moscow has a point when asking the EU what it means by reciprocity. If the concept degenerates from a means for mutual openness to a new protectionist tool, it will do nothing to alleviate EU concerns about Russian underinvestment in its gas fields.

The energy debate shows that the shift from ‘values’ to ‘interests’ in EU-Russia relations can only go so far. Values – or more plainly, the way we see things – determine everything we do. When people and politicians in the EU and Russia talk about energy security, they mean different things. The same holds true for democracy, and other terms that allegedly describe the core objectives of our relationship.

I was an early advocate of the EU focusing less on ‘common values’ and more on mutual interests, on areas where practical co-operation is feasible and desirable (see http://www.cer.org.uk/pdf/p564_russia_strat_squabb.pdf).
But I am also the first one to admit that we have come full circle. Ultimately, the EU and Russia need to agree what they want to get out of their interaction.

Katinka Barysch is deputy director of the Centre for European Reform.

Monday, October 29, 2007

Can the EU learn to live with Chinese mercantilism?

by Philip Whyte

Not long after its launch, the euro was famously dismissed by a disgruntled currency trader as a “toilet currency”. How things have changed. Since 2003, the euro’s external value has soared despite comparatively sluggish rates of economic growth in many of Europe’s largest economies. The strength of the euro has been a boon to European consumers who have been able to buy DVD players from China for less than the price of a meal at a run-of-the-mill restaurant. But not everyone has been celebrating—least of all France’s hyperactive president, Nicolas Sarkozy, who has been fretting about the economic downsides of a strong euro. Mr Sarkozy believes that the euro is now over-valued and that French companies’ trade competitiveness is being damaged as a result. Ever since he entered office in May, therefore, he has thrashed around looking for a culprit.

At first, he blamed the European Central Bank (ECB) for neglecting the euro’s external value and for pursuing its inflation target at the expense of economic growth. This struck many observers as odd, for at least two reasons. First, a central bank cannot target the inflation rate and the exchange rate simultaneously: was Mr Sarkozy suggesting that the ECB jettison its inflation target? Second, it seemed perverse to accuse the ECB of pursuing an excessively restrictive monetary policy. Real interest rates remain low by historical standards, and were even negative for much of the period between 2003 and 2004. More recent indicators—notably buoyant rates of broad money growth and lending to the private sector—hardly point to a central bank that has sacrificed economic growth on the altar of low inflation. Mr Sarkozy’s broadsides were in any case widely seen as an attack on the ECB’s institutional independence—so no-one was surprised when they were given short shrift.

Mr Sarkozy then shifted his attention across the Atlantic. Authorities in the US, he argued, needed to act to stem the US dollar’s decline against the euro. Again, however, it was not clear what Mr Sarkozy was proposing the US authorities should do. Raise short-term interest rates? You must be joking! The US Federal Reserve is trying to contain the fall-out from the crisis in sub-prime lending which is threatening to push the world’s largest economy into recession. This is why it cut short-term interest rates in September. In any case, it is hard to see what the US Federal Reserve could possibly do to support the US dollar. The dollar is weakening because the US is struggling to attract the capital inflows needed to fund its current-account deficit. As the world’s largest debtor, the US has to attract three-quarters of the world’s capital flows to service its external deficit. This is unsustainable—and not just because US assets have offered investors absolutely terrible returns in recent years. A weak US dollar is imperative if the US’s external deficit is to narrow.

Slowly, it dawned on Mr Sarkozy that the problem might lie to the east rather than the west. In the run-up to the G7 meeting in late October, the French government spoke rather less about the US dollar and rather more about the Chinese yuan. It had taken its time, but at last it had stumbled on the heart of the problem: namely, that parts of the world—mainly China, Japan and oil exporters in the Middle East and elsewhere—are saving vastly more than they are investing. This excess of savings over investment has resulted in colossal outflows of capital which have supported the spending habits of governments and households in the US and, to a lesser extent, Europe. That’s right, you read correctly. Developing economies such as China are now large net creditors to the developed world. This is totally at odds with what one might normally expect. Capital usually flows in the other direction, from the developed to the developing world. So what happened?

The short answer is that China and a number of other Asian economies have spent the best part of the last decade pursuing unashamedly mercantilist policies. There are two reasons for this. One is the abiding attraction of an egregious fallacy: that a country’s primary objective in trade is to export more than it imports. The other is the experience of the Asian crisis in the late 1990s, when countries with large external deficits were unable to defend their currencies in the face of huge capital outflows. Stung by this experience, many Asian countries did not choose to abandon fixed exchange rates. Instead, they decided that they should continue to maintain a peg of sorts against the US dollar—but by actively intervening to keep their currencies artificially weak. Since that date, many Asian countries have turned trade deficits into vast surpluses by accumulating foreign exchange reserves. And the world has been stuck with an asymmetric monetary system in which the euro and the US dollar have floated freely against each other, but not against Asian currencies.

The apparently insatiable appetite of China and other Asian countries for piles of depreciating US dollars has had undoubted benefits for the EU. The most important is the boost to domestic demand that the resulting strength of the euro has provided. This has worked in at least two ways. First, by bearing down on import prices, the strength of the euro has contained inflation—allowing the ECB to keep official interest rates lower than they would otherwise have been. Second, it has boosted consumers’ purchasing power. The Chinese government, in other words, has indirectly given European consumers and mortgage holders something looking like a free ride. The downside is that the yuan’s exchange rate is generating protectionist demands from beleaguered European firms labouring under the weight of a currency that has borne the brunt of global adjustments since 2002. The EU trade commissioner, Peter Mandelson, has been muttering darkly about the speed at which the EU’s trade deficit with China is growing; and hinted that the EU cannot maintain an open market for Chinese goods if the Chinese government does not change policy direction.

In the mid-nineteenth century, the UK famously used gunboats to open Chinese markets to opium. Times have changed and few would now advocate similar methods to persuade the Chinese government to let the yuan appreciate. In fact, there is not much the EU can do, other than to raise the rhetorical volume and wait for the domestic tensions generated by China’s policy to play themselves out. No-one knows how long this process will last. The Chinese people’s capacity for pain is legendary. But the point will surely come when the Chinese government succumbs to internal pressure and refocuses economic policy on raising the living standards of the wretched Chinese people rather than relentlessly acquiring assets in a depreciating foreign currency. When this happens, Mr Sarkozy should pay particularly close attention. For the mercantilism that China has practised looks suspiciously like that which he would be tempted to pursue if ever he were let loose on the ECB!

Philip Whyte is a senior research fellow at the Centre for European Reform.

Friday, October 19, 2007

A grand bargain with Russia?

by Charles Grant

Relations between the Russia and the West have not been so prickly since the break-up of the Soviet Union. Viewed from the US and the EU, Russia is being obstructive across a whole swathe of issues, such as its blockade of trade with Georgia, its refusal to accept independence for Kosovo, and its opposition to further UN sanctions on Iran.

But although Russian foreign policy seems increasingly driven by a strident nationalism, there may be a method behind it. In Washington and Brussels, influential figures (including Henry Kissinger) think Russia may be seeking a ‘grand bargain’. President Vladimir Putin dropped hints that he might be open to such a bargain when he met think-tankers (myself included) at Sochi in September. “If our partners want something from Russia, they must be specific, and not ask for everything at once,” he said. “If you want to talk about Kosovo, OK, if you want to talk about the Iran nuclear problem, OK, but then don’t talk about Russian democracy at the same time.” He has a point: the US has tended to make wide-ranging demands of Russia without prioritising them.

The EU has a central role to play in any set of bargains between the West and Russia, given its extensive trade and investment links. The EU should seek to work with the Russians on three areas where they have mutual interests, and where a bit of horse-trading could be beneficial.

• Russia and the EU share many long-term interests in energy. Europeans want assurances that Russia will develop new gas fields, since a gap between demand and what Russia can supply is likely to emerge within a few years. The Russians worry that the EU’s moves to liberalise the European energy market may prevent Gazprom from buying pipelines there. Russia will have to abide by the EU’s rules on energy markets, just as the EU will have to accept that Russia does not allow foreign firms to buy key energy assets. Mutual dependency should encourage both sides to compromise.

• Both would benefit from Russia’s full integration into the global financial system. Thanks to the high oil price, Russia’s government and leading companies are sitting on funds worth several hundreds of billions of dollars. They want to put some of the cash into foreign firms. But the EU is becoming concerned about ‘sovereign wealth funds’. It should allow these funds to invest in European firms, so long as they are transparent and operate independently of politicians. And the EU should welcome Russian acquisitions of its companies, so long its rules are respected and European firms gain reciprocal rights.

• Both the EU and Russia have an interest in the countries of their common neighbourhood becoming stable, prosperous and well-governed. The EU should offer to work with Russia to promote peaceful change in Belarus, stability and unity in Ukraine, and a resolution of the ‘frozen conflicts’ in Transdnestria, South Ossetia, Abkhazia and Nagorno-Karabakh. The Russians may baulk at this: they fear encirclement by an expanding NATO and more ‘colour revolutions’, like those that loosened their control over Georgia and Ukraine. EU governments should allay Russian concerns by saying they will not support NATO membership for Ukraine or Georgia in the medium term. But the EU should offer such countries closer ties – and make clear to Moscow that they must be free to determine their own destiny.

The EU has a huge stake in the future of Kosovo; it cannot integrate the Western Balkans until that territory’s status is resolved. It will provide most of the money, soldiers, policeman and administrators to make any peace plan work. Russia has almost no interest in Kosovo, other than as a card to play against the West. The EU and the US believe that the least bad option for Kosovo is supervised independence, which Russia rejects.

But what if Russia was offered something in return? The US decision to deploy missile defence systems in Europe, against an Iranian threat that does not yet exist, was unwise. Russia’s anger over the deployment is genuine. Some former US officials claim that the deployment would break the spirit of promises made to Russia in the 1990s: the US said it would have no significant military presence in the Central European countries that joined NATO.

Russia’s heavy-handed over-reaction to US plans for missile defence – threatening to target missiles on Central Europe – makes it hard for Europeans to oppose those plans. Nevertheless, the Europeans should urge Washington to postpone the deployment indefinitely – so long as Russia accepts independence for Kosovo in return. Russia may shun this sort of bargain. But if its rulers are serious about maximising Russian power, they should negotiate with western leaders over their differences, rather than turn their back on them. (A longer version of this article appears in the November edition of www.prospect-magazine.co.uk).

Charles Grant is director of the Centre for European Reform.

Friday, October 05, 2007

What now, Ukraine?

by Tomas Valasek

Ukrainians voters have spoken, sort of. On September 30th, they elected a new parliament. They made some heartening choices, backing forces of reform and sidelining smaller, less relevant parties. Less happily, they also produced a deadlock by giving virtually the same proportion of votes to the main two competing blocs. As a result, we are no wiser four days after the elections about who will lead Ukraine for the next four years.

The biggest winner is electoral democracy itself. Although Kyiv was abuzz with rumours of vote-rigging before the election, Western observers say that the actual poll appears to have been relatively untainted. Turnout – at 65 per cent – was low by Ukrainian standards but this is partly due to fatigue (this was the third national election in as many years). Importantly, the share of votes cast for smaller parties which fail to make the threshold required for entry into the parliament has nearly halved since last elections, from 20 per cent to 12. Far fewer votes are wasted. Four years on since the blatantly rigged 2004 presidential election which triggered the Orange Revolution, Ukraine has conducted three fair national polls. The country’s voters remain committed and take their rights ever more seriously.

Their choices this time around seem encouraging, too. The party of former Prime Minister Yulia Tymoshenko has doubled its share of votes since the 2006 elections, and fell just short of becoming the dominant force in the country. Tymoshenko is an unusual figure – she is suspected, not without reason, of building a cult of personality. Her populist rhetoric can often border on the irresponsible. But she has built a genuine base of support by attacking the cosy business-government relationships that corrode Ukrainian politics. Independently wealthy, she promises to defend the interests of her voters rather than corporate sponsors. And that would be an improvement on the way the two other main parties, President Viktor Yushchenko’s Our Ukraine and Prime Minister Viktor Yanukovich’s Party of Regions, go about their business.

But the poll was not all good news. It has failed to accomplish its main intended goal: to break the standoff between Yanukovich and Yushchenko and to produce a clear leader for Ukraine. The prime minister and the president have been in conflict since spring when Yushchenko accused Yanukovich of bribing parliamentarians to switch sides. The early vote was called to break the impasse.

This has not happened. The ‘blue camp’, the Party of regions and the Communists, and the ‘orange camp’, Yushchenko’s and Tymoshenko’s parties, scored virtually identical per centage results. A smallish independent party, the Lytvyn bloc, which barely made it into the parliament, can in theory break the deadlock.

The trouble is that the key political figures in Ukraine have little faith in the veracity of the results, no matter what Western observers say. None of the leaders seems ready concede an election decided by just a per centage point or two. Voters will suspect the Lytvyn bloc, irrespective of who it sides with, of having sold its votes. To complicate matters further, another small party, the Socialists, are insisting they gained over 3 per cent and are demanding a recount and a share of seats in the parliament. Yanukovich may yet decide to support their claim in the hope of forming a government without Yushchenko or Tymoshenko.

This mess would normally be considered worrying but not dangerous. Elections elsewhere have been decided by lesser margins; in 2000 George W Bush came to the presidency of the United States, a country of 300 million, thanks to 500-odd votes in Florida.

But unlike most democracies, Ukraine lacks a credible and independent judiciary. And in mature democracies the courts have the last say. The US election was eventually settled through a Supreme court ruling. The way the court reached its decision – by a 5-4 vote along ideological lines – was controversial and arguably dented the court’s credibility. But once made, the ruling stood without question. Few believe Ukraine’s own Constitutional court could act with such finality. During the crisis leading up to the elections its rulings have repeatedly been ignored by both the president and the prime minister.

Absent a credible judiciary, it is unlikely that either the ‘blue’ or ‘orange’ bloc will gain all-out power. Their margins are too small, neither side will want to concede such close elections, and no independent body can authoritatively rule in favour of one camp or the other. The odds are that Yushchenko and Yanukovich will settle the elections through an agreement to rule jointly, with or without smaller coalition parties. Their alliance is the only available combination of forces with a majority strong enough to overcome any challenge to election results.

If so, Ukraine would be right back where it started six or so months ago. Yanukovich and Yushchenko, two leaders who utterly failed to co-operate the first time they shared power, would be expected to do so again.

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.

Friday, September 21, 2007

Middle ground missing in Middle East?

by Clara Marina O'Donnell

Over the last few weeks,Tony Blair, Javier Solana and Bernard Kouchner have been there; this week Condoleezza Rice has done so – as, for that matter, has Madonna. If you like motorcades, Israel is the place to go. Ever since the US said it would sponsor a peace conference in November, the Middle East has been a hive of activity.

But is all the high-level diplomacy having any impact on the ground? Certainly the comings and goings of the great and the good keep the up-market hotels in business. But the reality at grass-roots level, as judged by this writer’s recent visit, seems far removed from the glitzy political meetings.

Settlements in the West Bank continue to grow (and new ones are created) at a rapid rate - so much so that the growth rate of the Israeli population in the West Bank is higher than in the rest of Israel. Construction work continues on the ‘wall’, eating into territory beyond the Green Line, the internationally recognised border, sometimes going far into the West Bank and separating Arab farmers from their lands. Roadblocks remain firmly in place, despite a promise by Ehud Olmert, the Israeli Prime Minister, to Mahmoud Abbas, the Palestinian president, to reduce them. The official explanation for the delay is implementation difficulties. Yet an Israeli government plan has existed for a year on how to safely reduce internal checkpoints, so far to no effect.

Gaza remains completely isolated. The private sector has collapsed, the public sector is barely ticking over, and unemployment is soaring, as this week's UK government report (The Economic Aspects of peace in the Middle East) confirms. Hamas is still firmly in control and Quassam rockets are being fired into Israel virtually every day. The plight of Gaza’s 1.4 million inhabitants is widely ignored – including by the Palestinian Authority in Ramallah. During this author’s stay, the only real attention paid to Gaza was an Israeli cabinet debate on stopping Israeli supplies of water and electricity to Gaza as collective punishment for the firing of Quassam rockets. The likelihood of such a move has increased since then, with Israel having declared Gaza an “enemy entity”.

The measured, almost friendly banter between Israeli and Ramallah-based Palestinian leaders (Olmert and Abbas were shown smoking cigarettes together during one of their latest rounds of talks) says nothing about the mood in the streets. In private, there are people on both sides who take a blunt and uncompromising view of the conflict, shrouded in religious, ethnic and existential terms. The memory of the terror of the second intifada is still vivid in many Israelis’ minds. Palestinian schoolbooks incite hatred towards Israel. And some Israelis step over the line between legitimate security concerns and xenophobia: during a conference in Tel Aviv the Israeli ambassador to the UN argued that all of Islam had its hands covered in blood.

The complexity of the Middle East can never be over-estimated. But the all-too-evident disconnects between political rhetoric and practical action, between public discourse and private sentiment, and between leaders and led, suggests that some of the challenges may currently be under-estimated. And it might explain why nearly no one this writer spoke to had any hopes in the November conference.

Clara Marina O'Donnell is a research fellow at the Centre for European Reform.

Thursday, September 13, 2007

The Microsoft appeal: The Commission was right

by Simon Tilford

On September 17th the European Union’s Court of First Appeal will rule on Microsoft’s long-awaited appeal against the record fine imposed on the company by the Commission in 2004 for abusing its dominant position in computer operating systems. The decision to fine Microsoft has prompted unprecedented criticism of EU competition policy and even accusations of anti-US bias. If the court upholds the Commission’s decision, demands for it to be stripped of its competence over competition law will no doubt intensify. The criticism of the Commission is without merit.

Indeed, the Microsoft case is a poor choice for critics of the Commission to champion. Attempts to portray its ruling as anti-competitive and as a threat to innovation do not really stack up. This case is not, as Microsoft and its supporters contend, about punishing a company for being successful by compromising its intellectual property. The market for IT is not so different from other markets that the suspension of antitrust law is justified. Rather, the case is about making it possible to compete with Microsoft in its core areas of business.

Supporters of Microsoft tend to conflate various issues. First, they accuse the Commission of undermining competition and hence innovation by placing constraints on dominant firms in the IT sector. According to this argument, dominant companies will only make big investments if they are confident they will face no significant competitors. Second, they argue that the Commission should focus on the impact on the consumer and not on the level of market dominance; that is, it doesn’t matter how much of a market a company (in this sense, Microsoft) controls, if its dominance benefits the consumer.

There are obvious weaknesses to these arguments. If it were the case that companies only innovate when they are confident that they will be allowed a monopoly, no company operating in a competitive market would invest in product development. But of course they do. They have to do so in order to ensure that their product or service is better than that of the competition. Only then can they hope to win a profitable share of the market. It is this need to be better than the opposition that drives innovation and productivity growth.

Similarly, it is not clear how Microsoft’s dominance benefits consumers. Is it because the company’s size (and hence ability to leverage huge economies of scale) allow it to offer products at low prices? If so, this would be an argument for abolishing competition policy. Or is it because consumers benefit from the ubiquity of Microsoft products? This ubiquity almost certainly does provide short-term benefits to consumers. But it is hard to see how allowing such dominance could serve consumers in the long-term if it precludes innovative companies challenging Microsoft.

Just because Microsoft won the race does not mean it should be permitted to dominate huge markets indefinitely. This would not be tolerated in any other market, including other high-tech markets. The IT market is a fast-moving one, but this is hardly a unique characteristic.

EU competition policy is already under attack from member-states that would like to provide their companies with more support and who want to promote national champions to positions of market dominance. A ruling by the Court of First Appeal in favour of Microsoft could not come at a worse time. It would play into the hands of those like France’s President Sarkozy that want to dilute EU competition policy, and who question what competition has done for the EU.

Simon Tilford is chief economist at the Centre for European Reform.

Wednesday, August 29, 2007

Sarkozy on America and the world

by Tomas Valasek

In his first 100 days in the office, Nicolas Sarkozy turned France’s domestic political scene on its head. He trounced and marginalised the far-right National Front in the May presidential elections. In parliamentary elections a few weeks later, he wiped out Francois Bayrou’s bid to form a centrist party. And once firmly installed in the Elysée palace, he emasculated the leading opposition party, the Socialists, by poaching their best minds.

What in the world, one might wonder, will he do to France’s foreign policy when he puts his mind to it?

Well, on Monday we got our first hint. Sarkozy gave a speech to an assembly of French ambassadors from around the world. The presentation was typical Sarkozy. It oozed confidence. The speech showed him prepared. And, in a number of important ways, it showed him willing to depart from policies of Jacques Chirac.

The most interesting part of this speech was about Iran. Before even mentioning the country by name, he notes that France has an obligation to help the rise of emerging states by giving them access to nuclear technology for peaceful use. In saying so, he seems to be pre-emptively addressing Tehran’s accusations of double-standards. But then, when Sarkozy starts talking directly about Iran, he hammers. To France, a nuclear-armed Iran is simply unacceptable. France will support a new round of UN Security Council sanctions (when only last month it was said to be lobbying in New York against it because French companies may be among the most affected). And finally, the coup de grâce: unless Iran respects its obligations it will not escape “the catastrophic alternative: a nuclear-armed Iran or the bombing of Iran”. Sarkozy is effectively laying the blame for possible US intervention at Tehran’s feet. He is making Iran the issue, not the US. He does not condone bombing but suggests that he may not be entirely opposed either. And if it happens, it will be Iran’s fault. This is a significant change from Jacques Chirac’s days.

Washington’s joy at the speech will not be unqualified. Sarkozy is not warm to America. When addressing it directly, he calls for “pragmatic” relations. Sarkozy’s agenda for the French presidency of the EU in 2008 is not particularly US friendly. The emphasis on immigration, energy and environment offers little hope of rapprochement. With the exception of energy these are issues that are either intra-European (immigration) or on which the EU and France do not see eye-to-eye (environment). On NATO, Sarkozy says he wants the alliance to co-operate smoothly on military matters with the EU. But he makes no hint of how to resolve the impasse that effectively keeps the EU and NATO from talking to each other. Worse (from the US perspective) he wants to strengthen the EU’s operational planning capacity, which has been a thorn in the side of both London and Washington.

On the other hand, where Sarkozy talks of issues that matter to the US – China, Iran, the Middle East – he strikes a line similar to Washington’s. That is true not only for Iran but also for the Middle East, Russia and China. Sarkozy comes down stronger on the side of Israel than any other French leader in recent history. He proudly calls himself a friend of Israel. He says peace with Palestine is very important but it will not happen if the Palestinians cannot form a government. Sarkozy called the Hamas takeover of Gaza “the first step toward establishing Islamic radical foothold on Palestine territories” and said that the Palestinian Authority must be rebuilt under its president Mahmoud Abbas.

On Russia and China Sarkozy strikes a realist tone. He ignores their domestic affairs altogether. Their foreign policies come for criticism. Sarkozy chided China for using monetary policy as a power tool, and Russia for using energy as a “brutal” weapon. (Interestingly, nowhere does he raise issues that made his foreign minister, Bernard Kouchner famous: the slide toward authoritarian regime in Russia, or violations of freedom of speech in China. In foreign policy, as in everything else, Sarkozy seems determined to run things directly from the Elysée.)

The overall impression Sarkozy leaves is that he is neither anti-American nor pro-American. He does not take cheap shots: although he notes that France was right on Iraq, he does not gloat. He states in the preamble that “the leaders of the past twenty years failed to construct a workable post-Cold war order”. But he is both right and diplomatic in saying so, so America should not take offence. The speech effectively removes America as the defining issue of French foreign policy. France will not view foreign policy as an opportunity to score points at America’s expense; it will judge the world’s problems on their own merits. Where Sarkozy does so, he finds that he has a lot in common with the US. But he will not go out of his way to restore America’s good standing in Europe; the Americans will need to do that work themselves.

Overall this is a very strong presentation. He clearly thought about foreign policy a lot. We have come to associate Sarkozy’s France with exuberant confidence but it bears remembering that only three years ago, the world looked very different through French eyes. The then-Foreign Minister Michel Barnier, also speaking in 2004 to assembled French ambassadors, lamented the decline of France in Europe (because of enlargement of the EU to include pro-US countries). Sarkozy could not have struck a more different note.

Tomas Valasek is director of foreign policy & defence at the Centre for European Reform.

Friday, August 24, 2007

Poland’s poll and the EU treaty

by Katinka Barysch

Poland’s early election may coincide with the last days of talks on the new EU Reform Treaty. Although the Kaczynskis are unlikely to reopen a deal agreed in June on the treaty's content, last minute political posturing for a home audience could delay the text being signed off.

Many Europeans were relieved when Prime Minister Jaroslaw Kaczyinski sacked his junior coalition partners in August. Kaczynski’s somewhat prickly and paranoid Law and Justice party (PiS) has been difficult enough to deal with. The inclusion of the arch-nationalist League of Polish Families (LPR) and Andrzej Lepper’s populist Self-Defence made it worse. This government has (perhaps understandably) blocked EU talks with Russia, (outrageously) used World War guilt to get more EU votes and (unwisely) threatened to veto the whole Reform Treaty. The spectre of Poland holding an election exactly when the inter-governmental conference (IGC) is supposed to wrap up the treaty talks will haunt many in foreign ministries across the EU.

The Polish parliament has postponed the final decision of whether and when to hold an early election to September 7th. The PiS minority government has little reason to hang on while the opposition Civic Platform (PO) would love to capitalise on its current poll lead. The earliest possible date –and the one most widely mooted – is October 21st. That is three days after EU leaders are supposed to sign the Reform Treaty.

The Kaczynskis (Jaroslaw and his twin brother Lech, who is president) would gain little from making the treaty an election issue. After all, they had claimed victory after the June summit. Although the other Europeans had refused to re-open talks on the EU voting system – Poland had insisted on sticking with the Nice formula, then pushed for a rule based on the square root of populations – they did agree to delay the introduction of the ‘double majority’ system until 2017. Polish officials afterwards grumbled that an agreement on blocking minorities was not sufficiently spelled out. But this is not a big enough issue to re-open the entire treaty package.

The PO does not like the June deal: it was PO leaders who had come up with the memorable “Nice or death” slogan and first pushed for the square roots system. But on the whole, the PO’s attitude towards the EU is similar to that of the PiS, although less anti-German (which is why Jaroslaw has recently been portraying the PO as Berlin’s puppet). To gain votes, the PO will want to stress what makes it different from the PiS, such as administrative competence, pro-business policies and more liberal attitudes towards social issues.

Neither the LPR nor Self-Defence can be sure to overcome the 5 per cent threshold for parliamentary representation. So they will run together, and do their utmost to steal nationalist and conservative votes from the more mainstream PiS and PO. Their eurosceptic rants and calls for a referendum on the treaty could put the PiS and the PO on the defensive. Despite the Poles’ generally pro-EU attitudes, many Polish party leaders appear to have convinced themselves that elections are won on the right.

The lone pro-European voice in the forthcoming election will be Aleksander Kwasniewski, the popular former president, and the Left and Democrats, a movement put together from bits of the former Communist party. Although the left almost faced political oblivion in the 2005 election, it is now rising steadily in the polls.

For most Poles, Europe is not a major concern at the moment. Life is good: the economy is growing at a brisk 7 per cent, unemployment is at a post-Communist low and EU money has started to flow in. In the latest Eurobarometer survey, almost 80 per cent of Poles said their country has benefited from being in the EU.

Nevertheless, Europe could become an issue in the election campaign, not least because the Commission is asking for radical restructuring of the iconic shipyard in Gdansk. To prevent the radical parties from benefiting from anti-EU sentiment, the Kaczynskis could seek to postpone final agreement on the treaty. This would be no disaster: signing it at the December summit would still leave EU members enough time to ratify it before the 2009 deadline. But the Portuguese presidency would be peeved (it wants to focus on Africa in December), as would be Gordon Brown who wants to get the treaty ratification out of the way as quickly as possible. Poland would once again be singled out as the EU’s troublemaker.

Those who are hoping for a fundamental shift in Poland’s EU stance after the election may be disappointed. The PO’s Europe policy would be more polished and constructive, but no less assertive when it comes to Poland’s national interest. Moreover, the PO is unlikely to gain an outright majority. Although the PO and the PiS agree on much, personal animosities would make ruling together fiendishly difficult. The PO and the Left, on the other hand, share a dislike of the Kaczynski twins. But it is doubtful whether this would be enough to overcome the PO’s suspicion of the former Communists, as well as programmatic differences. As long as Poland is ruled by unstable and often short-sighted coalitions, the EU will remain a tempting platform for politicians to showcase their nationalist credentials.

Katinka Barysch is chief economist at the Centre for European Reform.

Thursday, August 02, 2007

Europe in the US-UK special relationship

by Tomas Valasek

Gordon Brown scarcely mentioned Europe during his visit to the United States, certainly much less than Tony Blair used to. That is understandable. The current prime minister is blessed with the fortune of sharing his time in office with Angela Merkel and Nicolas Sarkozy, two pragmatic, Atlanticist leaders. Unlike Tony Blair, Gordon Brown does not need to worry about keeping the US and EU strands of UK foreign policy from coming apart. This gives him a freer hand in reviewing US-UK co-operation on key foreign policy issues.

Tony Blair sided with Washington over Iraq in part to keep the European Union’s common foreign policy from slipping into an openly anti-American stance. While he believed that removing Saddam Hussein was important in its own right, he also calculated that allying the UK with the US would keep Europe from trying to collectively weaken the US position on Iraq, and possibly elsewhere. (The exact intentions of messieurs Chirac and Schröder will always be subject to different interpretations. But their words and actions during the Iraq crisis strongly suggest that, in addition to heartfelt opposition to the US-led war, they also viewed the crisis as an opportunity to build the EU into a tool for balancing US power worldwide.)

The EU is now shaping the US-UK special relationship in subtle yet sometimes decisive ways. In the case of Iraq Tony Blair would likely have supported Washington irrespective of French or German views. But he clearly also felt that their opposition gave him little option; and that by breaking with Washington the UK would fuel anti-American tendencies around Europe, and possibly precipitate a permanent transatlantic split. The previous prime minister was dealt a terrible deck of cards: siding with Washington, Blair knew very well, meant plunging the EU into a foreign policy crisis – which it did, in 2003.

If only Blair had Gordon Brown’s current options. Four years later, both Chirac and Schröder are gone. Angela Merkel and Nicolas Sarkozy are far more pragmatic and Atlanticist than their predecessors. They are far less tempted than Chirac and Schröder to construct a European foreign policy identity on the basis of opposition to the US. And President Bush, too, has been chastised by the Iraq experience. His second administration is distinctly more multilateralist, less guns and more butter.

The role of Europe in the US-UK relationship has changed correspondingly. Unlike Tony Blair, Prime Minister Brown can afford to not worry about Europe as he reassesses the relationship with Washington. His European counterparts, by and large, have good working relations of their own with the US. Brown is far freer than his predecessor to refashion the priorities of US-UK foreign policy co-operation, knowing that a possible occasional strain in the relationship is not going to have wider repercussions in Europe.

Arguably, Britain has lost some of its usefulness to the US, too. Many find the idea of the UK acting as a bridge between the US and Europe fanciful. But, without UK leadership, the other Atlanticist EU countries, mostly new member-states in Central Europe, would have come under tremendous pressure from Germany and France to form a united EU front against the US. Tony Blair’s words and deeds demonstrably helped shore up support for the US in Europe. Gordon Brown is not likely to be called upon to play the same role. EU members are making far more pragmatic and less ideologically-driven decisions on their relations with the US than they were in 2003. As US-European ties become less confrontational, there is less need for the UK to play its balancing role within Europe.

Now that Gordon Brown is free to judge the US foreign policy on its own merit, without worrying about the EU context, what use did he make of this manoeuvring room at his meeting with George Bush over the weekend of July 25th- 26th?

Arguably, not much. Most of the change that stemmed from the summit was cosmetic. Gordon Brown clearly went to the US resolved to shake off the poodle image without undermining the special relationship. He succeeded in this. His cool, reserved demeanor with the US president restored dignity to London’s standing in the US and in Europe.

As far as substance is concerned, Brown sounded surprisingly hawkish on Iran (although more in his pre-trip press conferences than at the summit itself), while gently creating a little distance from Washington on the issue of a timetable for withdrawing troops from Iraq – Britain wants to be out sooner. But he may have missed an opportunity to clearly state his differences on the Middle East peace process. Britain is gingerly moving towards engaging Hamas and working with it to make it a legitimate and responsible actor. The White House has struck out in the opposite direction. President Bush last week announced a raft of initiatives meant to isolate Hamas and bolster its main rival, President Abbas. Gordon Brown remained largely silent on this point during his press conference with George Bush. This could mean that he agrees or – more likely – that he wanted to avoid a dispute in the open. And that is a pity. Because of the change of leadership in Europe, the prime minister is less constrained in his dealings with Washington than his predecessor. If he believes US policy on the Middle East to be wrong, this was the time to say it.

Tomas Valasek is director of foreign policy & defence at the Centre for European Reform.

Tuesday, July 24, 2007

Where next for Turkey?

By Katinka Barysch and Charles Grant

Some of Turkey’s critics say that it has no place in the EU because it is not a European country. Others criticise the quality of its democracy. The first group tends to focus on the Islamist philosophy of the ruling AK party, while the second group complains about the role of the armed forces in public life. The dramatic series of events in Turkey over the past four months should go some way towards reassuring both camps.

In April, the armed forces threatened the AKP over its choice of Abdullah Gul as its presidential candidate. The constitutional court declared the first round of voting in the parliament invalid. Millions marched in the streets in defence of secularism. Prime Minister Recep Tayyip Erdogan called an early election to defuse the crisis. His AK party won enough votes to form another single-party government.

These events show that Turkey’s democracy is maturing fast. Having hinted that it might launch a coup, the army has respected the democratic process and stayed in its barracks. The AKP won voters’ confidence by promoting a moderate brand of Islamism, and by adding more secular candidates and women to its electoral list. Celebrating his re-election, a statesman-like Erdogan called for reconciliation, reform and universal respect for Turkey’s secular constitution.

Erdogan will need all his considerable political skills to get through the challenges of the next twelve months. The election outcome was good for the AKP but it showed a country split down the middle. With 47 per cent of the vote, the AKP did significantly better than in 2002. Then, much of its support was due to voters’ disillusionment with a bickering and self-serving political establishment. This time round, its victory was a reward for good economic management and – despite the occasional backtracking – political moderation.

Some 38 per cent of Turkish voters opted for nationalist parties, if one adds up the votes of the hard-line MHP, the nominally centre-left CHP and Cem Uzan’s radical GP. There is little that unites these parties, apart from their attempts to portray the AKP as radical on Islam and limp-wristed on security. But the scare tactics of the secular establishment and the army obviously failed to convince most Turks.

Three of the 14 parties that ran in the election overcame the 10 per cent vote threshold for parliamentary representation; in the previous parliament it was only the AKP and the CHP. Now they are being joined by 71 MHP members and 28 ‘independents’, most of whom are from the Kurdish party, the DTP. So although the AKP received a higher share of the vote than in 2002, it will have fewer seats in parliament. With 342 MPs, the AKP still has enough votes to pass laws, but not to change the constitution or, importantly, elect a new president.

Turkey will hold a referendum on an AKP proposal to move the presidential election from the parliament to the people, but not until the autumn. So the next president will once again be chosen by Turkey’s 550 MPs. Two-thirds (or 367) of them need to be present to make the first round of voting valid, following a constitutional court ruling in April. If the CHP and the MHP boycotted the presidential ballot to prevent an AKP candidate winning, there would probably be another early election. Erdogan might try to push through his candidate with the help of the ‘independents’. But then the army would decry an Islamist-Kurdish conspiracy and roll back onto the political scene. It will not be easy to find a candidate that looks acceptable to both the secular-nationalist opposition and the more conservative parts of the AKP. But Erdogan should be able to do it. He may placate his own AKP by hinting that he could himself stand in the first popular presidential poll. If, as seems likely, Erdogan finds a compromise presidential candidate, he would undermine the army’s claim that Turkey’s secular order is under threat.

The AKP also faces tricky decisions over Iraq. It was perhaps no coincidence that General Yasar Buyukanit, Turkey’s army chief, asked for a mandate to take action against outposts of Kurdish PKK guerrillas in Northern Iraq, just a few months before the election. The government had little choice but to say No. Such cross-border incursions would wreck what is already a tense relationship with Washington and create considerable strains with the EU. And then there is the risk of the military getting bogged down in a prolonged guerrilla war on foreign territory. Nevertheless, the army’s persistent hectoring made the government look weak on the security front, and probably helped to increase the MHP’s share of the vote. If the PKK is sufficiently provocative – for example letting off big bombs in tourist resorts – the government would have little choice but to endorse a military intervention.

Once the presidential election is out of the way, the new government will have to get down to work. The AKP gets a lot of its legitimacy from its impressive economic record. Markets jumped with joy over the AKP’s re-election. But the government now faces the tricky task of putting its reform successes on a more sustainable footing. This will include continued privatisation (not least to attract the money to finance a current-account deficit that hit a worrying 8 per cent of GDP last year); an overhaul of social security; further improvements in the budget; better infrastructure (two million people a year are moving from the rural areas into already overcrowded cities) and labour market reforms. In this young country, around a quarter of a million jobs need to be created every year, just to keep the unemployment rate constant at 10 per cent.

The AKP will have to navigate these tricky waters at a time when the EU anchor has become loser. Nicolas Sarkozy has vetoed the opening of the chapter on economic and monetary union in Turkey’s accession negotiations, because he says that only full members need to bother with single currency rules. And Turkey, he claims, will not achieve that status so long as he is president. He wants the EU have another big debate about the future boundaries of Europe in December. His views on that are clear.

Erdogan is to be congratulated for his measured response to Sarkozy’s tactics. In the past, Turkish politicians often warned that EU wavering would result in a nationalist backlash and political instability in Turkey. But now Erdogan’s government is promising to soldier on with its EU preparations. “We will be ready in 2014”, he says, “irrespective of what the EU does”.

Much of the AKP’s positive agenda since 2002 has been inspired by the objective of EU accession. The party’s pro-EU credentials helped it to mitigate the deep suspicions it encountered among the urban elites. What would happen to the AKP’s reform plans and its legitimacy if Sarkozy succeeded in ruling out Turkey’s full membership? The new government needs the EU anchor to consolidate its successes.

Katinka Barysch is chief economist and Charles Grant is the Director of Centre for European Reform

Wednesday, July 18, 2007

Of mice, men and the language of EU reform

by Hugo Brady

Beware the humourless, especially in politics. At a CER/Clifford Chance conference last week, Guiliano Amato, Italy’s interior minister, pronounced that the Reform Treaty was a return to familiar territory for the EU: an unreadable treaty. A few refused to get the joke, portraying Amato’s playful observation as an explosive revelation that the Reform Treaty is indeed the EU constitution encrypted. ("Loathsome smugness", seethes Open Europe’s blog).

How odd. The conference was clearly on the record and Amato's warmly ironic tone was anything but pompous. But Open Europe also missed the bigger point in Amato’s speech: his admission that we never had a real constitution to start with. Amato, a widely admired statesman and former prime minister, was vice-chair of the convention that first wrote the EU constitution in 2003. The convention, he said, had wrongly dressed up a set of fairly good ideas, designed to make the EU’s institutions, foreign and justice policies work better, as being something it was not: a grand constitution.

The governments stuck with the name ‘constitution’ in the hope, rather than the expectation, that it might grab the attention of citizens and make the EU more popular. But according to Amato, the document was always much more a ‘boy’ than a ‘girl’, referring to the French words ‘le traité’ (masculine) and ‘la constitution’ (feminine). This reflects the nature of the EU itself, which Amato christened a "hermaphrodite": not merely an inter-governmental organisation but far from being a state.

True, much of proposed Reform Treaty is to be taken from the wreck of the so-called constitution. But, aside from the name, other controversial aspects are being amended or dropped: there are about 20 significant changes in all. The new treaty will be completely stripped of any pretensions to be a US constitution-style founding charter. As the communications commissioner, Margot Wallström, who also addressed the conference, quipped: mice are genetically 90 per cent identical to human beings "but the remaining ten per cent makes all the difference".

Nonetheless language, legal and otherwise, matters in the European debate. Hence the outcry over Sarkozy’s deletion of a key reference to ‘undistorted competition’ from the new treaty or Commission president Barroso’s well-intentioned, but foolish, description of the EU as a new "non-imperial empire" (a misnomer in any case: a non-empire empire?). And now, when just about everyone else has finally accepted that the idea of a constitution for Europe is dead, British Eurosceptics cling to the term in a bid to pressure the government into holding a referendum.

Why? Sovereignty is hardly the issue. Sir Stephen Wall, another keynote speaker last Thursday, noted the British are blasé, in contrast with their European counterparts, on key issues of sovereignty like trade liberalisation and foreign ownership of industry. The thought of foreigners owning home-grown car industries makes continental politicians shiver; the British care little. Neither can it be a reaction to British politicians and diplomats having failed to defend national interests the negotiations on the treaty. Peter Altmaier, a minister in Angela Merkel's government, rather ruefully outlined to the conference how the UK had won the most from the three negotiations leading to this treaty: the convention, the 2004 inter-governmental conference on the constitution, and the recent June summit.

No, Eurosceptics here hope a referendum on Europe will be the beginning of the disengagement from the EU they long for. A referendum would be the perfect political arena to portray issues like the role of EU foreign policy or the primacy of EU law as an affront to British sovereignty and awake fears of what Hugh Gaitskill, a former Labour leader, famously called “the end of a thousand years of history”.

In the past, well meaning pro-Europeans and commentators have also called for a referendum in Britain on the EU, as a way of challenging the orthodoxies of the British European debate. This is wrong-headed. Yes, Gordon Brown should encourage passionate debate on Britain’s interests in Europe. But if he fails to stand firm against calls for a referendum, he risks opening a Pandora's box of obfuscation and media-fed nationalism, as well as handing a platform to fringe political forces from across the UK. (I exaggerate? Read Frederick Forsythe's "Pledge a referendum on Europe Mr Cameron", FT July 16th.) To paraphrase Gaitskill's wife, as she listened to the standing ovation elicited by his famous speech: a British referendum on Europe would make all the wrong people cheer.

Hugo Brady is a research fellow at the Centre for European Reform.

Wednesday, July 11, 2007

The EU should talk to Hamas

by Charles Grant and Clara O’Donnell

The conspicuous role of Hamas in the recent release of Alan Johnston was not only good news for the BBC correspondent. Hamas showed that it cares about how it is perceived abroad, that it wants to be considered a credible actor, and that it hopes to end its international isolation. This means that the EU and other outsiders have potential leverage over the organisation that rules Gaza. Several European governments believe that the Union should rethink its current policy of refusing to engage with Hamas. They argue, with much justice, that the attempt to weaken Hamas by isolating it has failed; and that this policy seems to have strengthened support for Hamas among Palestinians, while Fatah, its great rival, has suffered from being seen as the West’s favoured friend.

It is time for the EU to consider talking directly to Hamas. Currently, the position of the EU – alongside the other members of the quartet, the UN, the US and Russia – is that it will not talk unless three conditions are met: recognition of Israel, renunciation of violence, and acceptance of existing peace accords. And there remain many good arguments against the EU engaging with this Islamic group, such as its ambition for Islamic rule, its refusal to recognise Israel's right to exist, its links to violence and terror, and its numerous rocket attacks on Israelis. Although it won the last Palestinian elections, Hamas used force to seize power in Gaza in June 2007. That episode damaged its international credibility and its legitimacy as a winner of democratic elections, and it also limited the chances of getting Hamas and Fatah to work together constructively. Without a single government accepted as legitimate by most Palestinians, Israel has no partner to make peace with.

However, the EU should take note of some conciliatory moves from Hamas since it won the elections in January 2006. Hamas respected a unilateral ceasefire for six months. And when it became part of the government of national unity that was brokered by Saudi diplomacy at Mecca, Hamas tacitly accepted the Palestinian Authority’s existing international agreements. Furthermore, while Hamas has still not officially recognised Israel, its leader in Damascus, Khaled Meshaal, has said that the state of Israel is a "reality" and that “there will remain a state called Israel, this is a matter of fact”. At the moment Hamas is clearly not the kind of credible international actor that could be a serious partner for Israel; the argument is over the best way to turn it into such actor. And it is clear that the current policy is not working.

The EU should recognise that the policy of boycotting of Hamas but showering favours on Fatah in the West Bank has been at best ineffectual, and at worst it has contributed to radicalising Hamas and provoking Fatah’s overthrow in Gaza. The grim gap that now separates the two parts of Palestine is imposing unacceptable humanitarian costs – the Gaza economy is already in a dire state, largely because Israel closes most of the border crossings most of the time. So long as the EU continues to reject the outcome of legitimately-conducted elections, it exposes itself to accusations of double standards and reduces its credibility in the eyes of the many in the Arab world.

The EU should seek to entice the moderate elements in Hamas with the prospect of recognition and financial assistance, in exchange for good behaviour and a constructive attitude towards talks with Fatah. That could facilitate the return of a single government for all the Palestinian territories, which is a precondition for the revival of the peace process. The EU should not abandon the concept of conditionality, but of the three conditions the one it should worry about is the renunciation of violence. Were Hamas to return to suicide bombs or rocket attacks on Israel, the EU should have nothing to do with it.

Of course, there can be no peace in the region without the support of Israel and the US, both of which are strongly opposed to the recognition of Hamas. The EU must think very carefully about how it sells a new policy on Hamas to Israel and the United States. The ultimate goal in the Middle East is peace between Israel and the Palestinians, and if EU engagement with Hamas leads to a breakdown in the Union’s relations with Israel and the US, it will have achieved little. But the EU has a very strong argument to make. In the long term, it is in Israel’s interests that the moderate elements within Hamas – the strongest political entity in Palestine – be strengthened. Talks between the EU and Hamas could and should focus on that objective. The very process of talks with Hamas could have a transformational effect on the organisation, as was the case with the talks between the British government and the Irish Republican Army. Evidently, the talks might not produce that positive outcome. But neither the US nor Israel can claim that the status quo is doing much to enhance the security of Israelis.

The US, in its current pre-election phase, will be very reluctant to contemplate talking to Hamas. But in the Bush administration – which does not have to worry about winning votes in the next presidential election – moderates such as Condoleezza Rice now have the edge over hard-line Israel-firsters such as Dick Cheney. It is not inconceivable that the US could discreetly encourage the EU to take the lead in engaging with Hamas (as it earlier encouraged the EU to talk to Iran), while itself remaining aloof. The broader regional perspective may yet encourage the US – and possibly even Israel – to welcome the EU playing such a role. Given the growth of both Islamism and Iranian influence in the region stretching from Lebanon to Afghanistan, the US could reason that engaging Hamas would help to prevent an increase in the influence of either Iran or al-Qaeda in Gaza.

Charles Grant is the director and Clara O’Donnell is a research fellow at the Centre for European Reform.

Friday, June 29, 2007

Why Europeans don’t have babies

by Katinka Barysch

Europeans live longer, work less and have fewer babies. On current trends, the EU will not have enough workers to pay for its growing number of pensioners. Economists and policymakers have moved beyond scratching their (greying) heads in despair. They focus on what can be done to alleviate and possibly reverse the trend. That is also what they did at last week’s Munich Economic Summit that brought together some of the world’s best people on the subject (http://www.munich-economic-summit.com/mes_2007/participants.htm).

The EU’s average fertility rate is now 1.5, well below the 2.1 needed to maintain the size of a population. In Germany and Italy, the fertility rate is closer to 1, which means that each generation is 60 per cent smaller than the previous one. Even more worrying but less well-known is the fact that population decline – just like population growth – is exponential. In Germany, the birth rate started to fall in the 1960, well before Italy, Spain and other EU countries. By the 1990s, Germany was running short of 20 or 30-something potential mothers. A country that has had low birth rates for decades ends up in a ‘fertility’ trap.

Another fact that is rarely taken into account is how demographics interact with economic geography. Young people and those with skills are the most likely to leave declining areas, and women are apparently more prone to moving than men. Germany’s eastern Laender are a frightening illustration of this trend. The number of young people has dwindled, leaving the over-60s to themselves in some places. And among the 10 per cent of the population that has left the eastern Laender, there were many more women than men. In some towns, there are 160 young men for 100 young women. The fact that those men left behind tend to be unqualified and unemployed gives women little incentive to return. Similar developments can already be observed in some parts of Central and Eastern Europe, as well as in the continent’s northern and southern fringes. Europe will not age homogenously. It will be a patchwork of booming regions and those that are inhabited by octogenarians and angry young men.

No-one is yet talking about demographic micro-management. But all EU countries do need to address the inevitable raise (in many cases doubling) of the old-age dependency ratio (the number of workers to pensioners). The list of possible solutions is by now well known: work longer and harder, accept more immigrants and have more babies. But each remedy has its limits, so Vladimir Špidla, the EU’s social affairs commissioner, talks about ‘mainstreaming’ demographic concerns into all policy areas, not only pension reforms, but also education, tax, labour market and infrastructure policies.

Population decline is a European problem – globally the population is growing by 200,000 a day, adding the equivalent of Switzerland every six weeks. Some of the fastest growth happens in the EU’s vicinity, especially in North Africa and the Middle East. Children and teenagers make up over half of the populations of Iraq and Somalia. Many of them will want to move to where jobs are better and life is more stable.

But immigration can only help to alleviate Europe’s pension pressures, it cannot solve the problem. Hans-Werner Sinn, head of the Ifo Institute that runs the Economic Summit, says that even if immigrants stayed young forever, the EU-15 would need more than 190 million immigrants to keep its dependency ratio constant until 2035.

Similarly, the retirement age would have to go up to 77 if governments were to rely on this step alone to fix the pension problem. Instead, they usually adopt reform packages that include a gradual raise in retirement ages, cuts in state pension payouts and adding fully-funded ‘pillars’ to the pension systems. There are some interesting and encouraging examples of reform, for example the ‘notional contribution’ systems implemented by Sweden, Poland and Latvia. These are pay-as-you-go systems that mimic fully-funded pensions because each worker’s contributions are added up in a notional account’. Since the pension pay-out depends on how much a worker has paid in, people have an incentive to retire later.

In most other European countries reforms have been overly cautious, which may have something to do with the growing voting power of Europe’s elderly. Not only is the number of over-50s rising steadily, they also tend to be more politically active. In the last US presidential election, for example, 70 per cent of those over 65 voted, but only a third of the 18-24 year-olds. Pension reform would have to happen now, before the baby boom generation retires. But there is little sign of this.

Meanwhile, family-friendly policies are becoming increasingly popular, across the political spectrum. Munich’s assembled economists were unanimous that higher birth rates cannot solve Europe’s pension problem in the short run. Even an immediate doubling of the birth rates would only have an impact on dependency ratios in 30 years or so. But in the long run, Europe will need more babies to mitigate the economic consequences of an ageing and shrinking workforce. Can and should governments get involved?

Economists have calculated that bringing up a child costs €150,000 to €300,000 and that each child contributes a net €140,000 to a country’s pension system. The parents bear the costs but the benefits also go to those pensioners that have not raised children themselves. Therefore, some economists suggest that people with children should pay less tax and get bigger pensions. Others argue that state-funded childcare institutions are a better and more immediate way of redistributing money to those with children. The fact that France offers day care for all children over three may have helped with its impressive fertility rates. But childcare facilities alone do not make a difference: Germany’s eastern Laender have many more nurseries but fewer babies than the western part of the country.

A quick fix will not work. France has had pro-family policies since the 1870s. In Scandinavia, support for women and children runs through all aspects of life. David Willetts, the Conservative Party’s Secretary of State for Education and Skills approvingly speaks of ‘state feminism’. Nor do values or religion explain birth rates. Fertility rates are lowest in traditionalist countries with rigid family structures, such as Italy, Greece or Spain, but also Japan, South Korea and Iran. They are highest in those places that allow women to combine work with bringing up children. France’s 35-hour week gives parents plenty of free time to look after their offspring. Flexible labour markets in the UK and the US offers part-time job and makes it easier for women to go back to work after a maternity break.

Germany is almost an example of how not to do it. Education takes too long, often up to 20 years, which forces many women to delay having kids until their 30s. Women now tend to be better educated than men. But they struggle to find matching partners since many high-earning men prefer traditional stay-at-home wives. Over 40 per cent of German women expect that having a baby would be the end of their professional career. They have a point: schools close at mid-day and private child care is expensive. Part-time jobs are rare and often come without perks and social security. The expectations towards women that juggle work and kids are crushing, says Regine Stachelhaus, who admits that she only managed to bring up her son and run Hewlett Packard in Germany because her musician husband did not work regular hours.

Incidentally, Frau Stachelhaus was the only female speaker at this two-day conference. I counted fewer than ten women among the 150-odd participants. I would have though that women have a lot to contribute to debates about having babies, juggling work and families and caring for the elderly.

Katinka Barysch is chief economist at the Centre for European Reform.