Monday, April 07, 2014

How to reduce dependence on Russian gas

At the European Summit on March 20th and 21st, government leaders were supposed to agree climate and energy targets for 2030. Instead, they discussed Crimea, Ukraine and Russia. Leaders were right to postpone discussion of the targets, but wrong to postpone action on reducing Europe’s dependence on Russian gas.

Russia supplies around a third of the EU’s gas. So the Union is to an extent dependent on Moscow – as it discovered when the Russians turned off the gas flow though Ukraine in 2009. But the Kremlin is, to a greater extent, dependent on revenue from oil, gas and coal exports – above all to the EU. Indeed, over half of the Russian government’s revenue comes from the sale of fossil fuels: 19 per cent each from gas and oil and 14 per cent from coal. The EU summit conclusions did refer to the need to diversify sources of gas, and asked the European Commission to prepare a report on this. That approach lacks the urgency which the situation in Ukraine demands. If EU leaders want to impose sanctions on Russia which may change its behaviour, rather than simply slapping Putin’s wrist, they should reduce purchases of Russian energy as far and fast as possible. To do that, they must develop alternative energy sources. That would cost money, but deliver major energy security, foreign policy and climate benefits.

The Swedish and Danish foreign ministers, Carl Bildt and Martin Lidegaard, have emphasised the importance of energy in responding to Russia’s invasion of Crimea. In March they wrote in European Voice that the EU must improve its energy efficiency, develop infrastructure to import fossil fuels from countries other than Russia, and increase alternative energy sources such as renewables. Swedish and Danish ministers are well placed to make these points: Sweden gets more of its energy from renewables than any other member-state, while Denmark is the only country to have set out plans to become 100 per cent reliant on renewables (by 2050). Poland buys nearly 90 per cent of its imported gas from Russia. So Polish Foreign Minister Radek Sikorski has shown courage in leading the calls for reducing energy dependence on Moscow (though Poland uses coal for most of its energy needs).

Europe’s post-Crimea energy strategy should focus on five strands:
* energy efficiency;
* alternative sources of gas;
* renewable energy;
* coal and gas with carbon capture and storage (CCS);
* nuclear power.


Greater energy efficiency is the goal that could be achieved most quickly. A rapid and ambitious programme of retrofitting double glazing and insulation to existing buildings, Europe-wide, could reduce energy demand for heating. It would also create thousands of new jobs. Less rapid but equally effective would be a major programme to upgrade and expand district heating: networks which transport heat from power stations or other combustion plants to homes and commercial buildings. District heating is widespread in Central and Eastern Europe, but most of it is old and inefficient, losing up to half of the heat during transport. (District heating networks in Scandinavia, by contrast, lose less than 10 per cent of the heat.) On alternative sources of gas, the quickest measure would be to expand the EU’s capacity to import liquefied natural gas (LNG). The Commission should stress, in all its contacts with the US government, the strategic advantages of the US exporting LNG. But increased imports of LNG are not dependent solely on successful trade negotiations with the USA; such gas is available from other non-Russian sources, notably Qatar. Greater use of LNG will require new infrastructure and any state that has a coast can develop LNG facilities. The Commission should give priority to less wealthy member-states that are highly dependent on Russian gas: the Baltic states, Bulgaria and Poland. This would not improve Europe’s overall energy security, but would help those countries highly dependent on Russian gas: the five countries mentioned above plus the Czech Republic, Finland, Hungary and Slovakia.

To improve EU energy security overall, EU institutions should do all they can to ensure that new pipelines are constructed to transport non-Russian gas from the Caspian Sea to Europe. Contracts have been signed for a Trans-Anatolian pipeline from Azerbaijan to the Mediterranean coast of Turkey, and a Trans-Adriatic pipeline from there to Italy. But construction has yet to begin. This pipeline would reduce EU dependence on Moscow, unlike Gazprom’s South Stream, which would simply be an alternative way of transporting Russian gas to the EU (while avoiding Ukraine).

Indigenous shale gas is another source of non-Russian gas. Governments which have banned fracking, either formally (France and Bulgaria) or informally (Germany) should now reverse this position. Renewable gas, which can be created from food and farm waste, manure and sewage, should also be expanded as much and as fast as possible. This is already widely used in Germany and Austria. Using these wastes to produce renewable gas would improve water quality, because the residue can be used as fertiliser rather than being discharged into rivers or seas. Greater use of renewable gas would help achieve climate policy objectives, as well as greater energy security. Renewable electricity must also be expanded. This would reduce the need to use gas for electricity generation, and also for heating (since heat can be provided in domestic and commercial buildings by electricity rather than by gas). The Commission could co-ordinate national subsidy schemes for renewables more closely, as this would cut administration costs for developers and reduce regulatory risk, so cutting the cost of capital. And all European institutions must work together to expand and improve the electricity grid, with a focus on the Baltic, Mediterranean and North Seas, and around the Pyrenees.

What role should coal play in future energy policy? Here the need for energy security conflicts with the need for climate protection. A quarter of the coal which the EU imports comes from Russia. The EU could survive easily without Russian coal, by mining more within its own borders and by importing more from other countries. However, coal is extremely polluting. Burning coal can cause high levels of toxic air pollution, damaging human health and harming the environment. EU rules have been effective in reducing toxic pollution from coal combustion. Coal generation also emits high levels of greenhouse gases – about twice as much pollution per unit of electricity as gas combustion does. Yet technology exists to cut greenhouse gases from coal combustion. CCS has been demonstrated at small scale, but not yet at large scale. The EU is falling behind Australia, Canada, China and USA in its attempt to roll it out.

CCS is not popular with the German public. But it is less unpopular than nuclear power. Before the 2011 Fukushima accident in Japan, Chancellor Angela Merkel said that low-carbon bridge technologies were necessary, to protect the climate while the world moves from fossil fuels to renewables. She was right. The transition to renewables will take at least half a century – probably longer. Gas is less bad for the climate than coal is, but not low-carbon enough to prevent dangerous climate change unless combined with CCS. Merkel’s post-Fukushima energy policy sets out an end point – total reliance on renewables – but pays no attention to what happens during the transition. The result – as statistics from Germany demonstrate – is increased greenhouse gas emissions.

Even the German desire for energy security and reduced dependence on Russian gas seems unlikely to persuade most Germans to reconsider nuclear power. There is more chance that they will reconsider CCS. But the most likely outcome is that Germany will become even more willing to burn coal without CCS. This would seriously compromise EU climate action. To avoid this outcome, EU institutions should set an emissions performance standard to regulate the maximum amount of greenhouse gas that can be emitted per unit of electricity generated. This would ban coal without CCS. However, demonstration and deployment of CCS will require subsidy. Renewables and nuclear power will also require some form of financial support. All these technologies are needed for climate protection. They could also help make Europe’s response to Russia’s annexation of Crimea more credible.

Reduced reliance on Russian energy sources, and increase in resilience in the event of a supply cut off, should be central elements in a long-term re-orientation of EU energy policy. European institutions and member-states should implement the five-strand strategy outlined above: use energy much more efficiently; develop all alternative gas sources; maximise renewable energy; demonstrate and deploy CCS; and build new nuclear power stations. This strategy will not be cheap. But the economic, security and climate action advantages will justify the cost. IMF managing director Christine Lagarde is right to say that climate change is “by far the greatest economic threat of the 21st century”.

Stephen Tindale is an associate fellow at the Centre for European Reform.

Thursday, April 03, 2014

Can the EU help Belarus to guard its independence?

Belarus is the forgotten member of the EU’s Eastern Partnership. The EU has negotiated ‘action plans’ with the other five members – Armenia, Azerbaijan, Georgia, Moldova and Ukraine. These involve the EU promising benefits in return for commitments to reform. And of those five, all but Armenia and Azerbaijan have signed or will sign association agreements with the EU. Belarus has been excluded because of its human rights record. However, following Russia’s annexation of Crimea, both Minsk and Brussels are thinking seriously about a closer relationship.

Events in Ukraine have worried the regime of Alexander Lukashenko, Belarus’s president since 1994. His government, of course, dislikes popular revolutions of the sort that overthrew Viktor Yanukovych in Kyiv. But it also opposes the dismembering of a country like Ukraine. On a recent visit to Belarus, I noticed that officials became visibly nervous when asked about the new ‘Putin doctrine’ – the assertion of Russia’s right to intervene in neighbouring states to protect the interests of Russians or Russian-speakers (ethnic Russians make up 8 per cent of the population of Belarus; everyone speaks Russian but 15-20 per cent also speak Belarusian regularly).


Belarus’s response to the Ukraine crisis has therefore been ambiguous. It has condemned the disorder of the Maidan protests, blaming the fall of Yanukovych on Ukraine’s economic mismanagement and corruption (Belarus is indeed richer and less corrupt than Ukraine). But in the early phases of the crisis, Lukashenko and his ministers spoke out in favour of Ukraine’s territorial integrity and against its ‘Yugoslavisation’. But then – presumably because of growing pressure from Moscow – Minsk stopped repeating this implied criticism of Russia. Lukashenko’s most recent public comment was to say that Crimea was now part of Russia and that, if forced to choose “Belarus will always be with Russia”. But he added that the annexation “sets a bad precedent”.


One thing that some government officials and opposition leaders agree on is that in the long term, there is a danger of the country losing its independence. Belarusians both for and against the government muse openly on whether, post-Lukashenko, there will be anyone strong enough to stand up to Russia. The self-styled ‘father of the nation’ has long played a clever game with Russia, extracting economic benefits to allow Belarusians to maintain a reasonable standard of living, in return for making promises that he often wriggles out of (per capita GDP is about 50 per cent higher than in Ukraine, and almost as high as in Russia). Around 10-15 per cent of the country’s GDP derives from Russian subsidies, mainly in the form of cheap oil and gas. Recent Russian credits were tied to the privatisation of state-owned industries, so that Russian industrial groups would be able to buy them, but the privatisations never happened.


Though Lukashenko’s slippery behaviour has infuriated Russia’s leaders, they have tolerated it since they see him – as Franklin Roosevelt supposedly said of Nicaragua’s President Somoza – as ‘our son-of-a-bitch’. Russia and Belarus share a common travel area and an air-defence system; recently Russia sent a squadron of fighter jets to a Belarusian airbase.


But although almost all Belarusians want their country to be independent, they are divided on where its future lies. Opinion pollsters and political analysts say that support for the EU has grown in recent years. Some of them reckon that about a third of the people want Belarus to be democratic and closer to the EU, a third want to stay close to Russia and a third do not care. But these analysts reckon that the crisis in Ukraine has boosted support for Lukashenko: he is seen as a bulwark against the instability and chaos of their southern neighbour. The state media, of course, reinforce this message.


The main reason to worry about Belarus losing its independence is the dire state of its economy. Unemployment is negligible, thanks in part to at least 70 per cent of the workforce being employed by the state. But economic growth has almost come to a halt and the factories are full of unsold goods. Apart from a respectable IT sector, Belarus has little modern industry. It sells refined oil products to the EU, and tractors, lorries and heavy vehicles to Russia. Sales to Russia have slumped, not only because of Russia’s own economic slow-down, but also because of Moscow’s entry into the WTO; Belarus’s goods now face stiff competition from emerging economies in the Russian market. They are not competitive because productivity growth in Belarus’s state-owned industries has been minimal. Another problem is that earnings from the staple export of potash have slumped: last year a Russian potash firm pulled out of its cartel with a Belarusian partner, leading to a sharp fall in the global price.


All these problems led to Belarus’s current account deficit ballooning from 3 per cent of GDP in 2012 to 10 per cent last year – that is $7.3 billion. Although the Belarusian rouble has depreciated by 15 per cent since 2011, when there was a sudden devaluation of 36 per cent, this deficit is likely to worsen in 2014. The central bank only has $6 billion of reserves, which means that the country is going to have to borrow a lot of money. It is hard to see Western governments or institutions lending substantial sums. Which leaves only Russia, and the regional bodies it controls. But Moscow will set tough conditions on any loans, and given the weakness of the Belarusian economy, Lukashenko may be less able to resist the conditionality than in the past.


Russia’s first demand is for supportive statements on Crimea, which Belarus has more-or-less complied with (in 2008, after Russia invaded Georgia, Belarus was less compliant: it refused to recognise the independence of Abkhazia and South Ossetia). The second demand is for the privatisation of state-owned industrial assets. The third demand is that Belarus agree to the Customs Union between Russia, Belarus and Kazakhstan being transformed into a stronger ‘Eurasian Economic Community’ (EEC).


That last demand is already the subject of tense negotiations between Moscow, Minsk and Astana. The Eurasian Economic Community is a pet project of President Vladimir Putin, who says that its rationale is economic but seems to see it as a geopolitical counterweight to the EU.


The Customs Union, up and running since 2010, has many holes in it. About a third of all goods and two-thirds of all services are excluded from its rules, so that the three members can protect cherished industries. Belarus and Kazakhstan have to accept the high external tariffs that Russia has insisted on, to protect sectors such as car manufacturing. Independent economists in Belarus say that it does not benefit much, since it had free trade with Russia before the Customs Union started – with one important proviso. Russia bought Belarus’s support for the Customs Union by offering it cheaper energy prices than those available to other export customers. Officials in Minsk are more positive about the economic benefits of the Customs Union, but still worry that its institutions – notably the Commission (in theory, modelled on the European Commission) that is based in Moscow – are dominated by Russians.


The plan is for Presidents Putin, Lukashenko and Nursultan Nazarbayev of Kazakhstan to sign an agreement on the Eurasian Economic Community in May. Armenia (which last September decided not to sign the EU association agreement that it had negotiated) and Kyrgyzstan have expressed an interest in joining but are several years away from doing so. The EEC is supposed to cover the ‘four freedoms’, meaning free movement of goods, services, capital and labour. However, the rules are still being haggled over. Belarusian officials say proudly that they and the Kazakhs have blocked Russian plans for the EEC to become a political organisation; they insist that they will thwart Russia’s desire to re-establish parts of the USSR via the Eurasian Economic Community. They are also reluctant to accept free movement of capital, since that would enable Russian oligarchs to start buying up Belarus.


Many Belarusian economists think that the Eurasian Economic Community would not bring much in the way of economic benefits. However, as with the Customs Union, there is an important qualification. Every year Belarus has to transfer about $4 billion to Russia, from the export duties paid on refined products made with Russian oil. Belarus is desperate to hold on to that money, and Russia may agree – in return for the EEC treaty being signed.


Lukashenko and his ministers are keen not to become too dependent on Russia, and have therefore renewed their on-off flirtation with the EU. Foreign Minister Vladimir Makei attended the EU’s Eastern Partnership summit in Vilnius last November, since Belarus is allowed to take part in the partnership’s multilateral discussions. That visit led to the EU and Belarus starting talks on ‘visa facilitation’ (a softer visa regime) and a readmission agreement (whereby Minsk would agree to take back those who enter the EU illegally from Belarus). They are also talking about talks on what the EU might do to help the Belarusian economy.


However, EU sanctions on Belarus, imposed because of its human rights record, remain in place. There are visa bans and asset freezes on 232 individuals associated with the regime. A number of companies close to the government are also sanctioned. Belarusian ministers argue that the EU’s stigmatisation of Belarus is unfair, given that Azerbaijan is a full member of the Eastern Partnership, despite having a human rights record no better than that of Belarus.


But despite a certain degree of bitterness towards the EU, some senior figures in the Belarusian government hope for a rapprochement. Opinion in the EU is divided. Those who oppose re-engaging Belarus point out that the last attempt to do so ended in tears. After the 2008 war in Georgia, Javier Solana, the then High Representative, visited Minsk and brokered a deal with Lukashenko. In 2009 his government released all political prisoners and in return the EU suspended sanctions and encouraged the IMF to lend. But at the time of the December 2010 presidential election, the security forces clamped down hard on demonstrators, presidential candidates were locked up and then in February 2012 the EU withdrew its ambassadors. Belarusian opponents of rapprochement, such as Andrei Sannikov – a former presidential candidate who was in prison and is now in exile – argue that the regime will never change as long as Lukashenko is in power, and that engagement is futile.


But advocates of engagement, who include senior figures in Lithuania, Poland and Sweden, draw a different lesson from Solana’s efforts: that in the right circumstances the regime is capable of softening, for example by releasing prisoners. There is talk of appointing an independent mediator to broker a deal between Brussels and Belarus. One name mentioned is Solana himself, now in retirement; another is Alexander Kwasniewski, the former Polish president, who last autumn tried and failed to bridge the gap between Yanukovych and the EU. The geopolitical fall-out from the Crimean crisis seems likely to ensure that the advocates of engagement win the argument. It is not in the EU’s interests for Belarus to become a complete satellite of Russia.


In May the Ice Hockey World Championship will take place in Minsk, which may give Lukashenko an excuse to release political prisoners (the EU counts six of them) and soften aspects of his regime. Nevertheless there are clear limits to how far any rapprochement can go. The IMF is unlikely to lend billions of dollars to a country with a state-run economy that is undemocratic. That means that Belarus needs Russia’s good will and money in order to sustain its economy. If Minsk moved too close to Brussels, Moscow would have plenty of levers to pull, in order to yank it back.


Charles Grant is director of the Centre for European Reform.

Tuesday, April 01, 2014

Europe and Russia: Continental divide?

In annexing Crimea, President Vladimir Putin violated a powerful post-1945 taboo against incorporating other countries’ territory into your own. So far, not only does he seem to be getting away with his land grab, but he has moved on to demanding that Ukraine becomes a looser federation and gives Russia a veto over its international relations. The EU and the US should be united in rejecting this attempt to reduce Ukraine to a satellite of Russia; and they should ensure that any larger ambitions Putin may have are contained.

Putin’s March 18th speech to Russia’s Federal Assembly should have triggered a comprehensive reappraisal of the West’s relationship with Russia. Through it ran a worrying thread of ethno-nationalism. Putin claimed that in creating Soviet Ukraine after the Russian Revolution, the Bolsheviks incorporated in it territory from the “historical south of Russia”, inhabited by ethnic Russians. He expressed his resentment that Russians had become the world’s largest “divided population” after the fall of the Soviet Union. And he spoke of “the striving of the Russian world, of historical Russia, to re-establish its unity”.

The West has consistently underestimated the extent to which Putin means what he says: he told George W Bush in 2008 that Ukraine was “not even a state”, and he is now acting accordingly. In 2006 he said that Russian ‘peacekeeping’ forces would stay in the Georgian separatist regions of Abkhazia and South Ossetia despite Georgian “provocations”; in 2008, using the excuse of such provocations, Russia took military action against Georgia, effectively annexed the two enclaves and strengthened its forces there. In 2005 Putin denied that Estonia had been occupied by the Soviet Union after the Second World War, and suggested that it had only existed as an independent state between 1918 and 1939 because of a deal between the Soviet Union and Germany (when in fact it fought a war of independence to escape from Russian control).

Despite Estonia’s NATO and EU membership, the West should not wholly discount the possibility that Putin still thinks of the independence of the Baltic States as a mistake that could be reversed. Indeed, Andrei Illarionov, a former senior economic adviser to Putin, believes that Putin’s ultimate aim is to re-establish Russia’s rule over the lands it held before the 1917 revolution – which would include Finland, the Baltic States and part of Poland as well as the former Soviet Union.

Given the state of Russia’s economy, such a goal would be pure fantasy; but Eastern and Central Europe, as well as Russia itself, would suffer enormous damage from any attempt to make it a reality. Both the EU and NATO need therefore to take measures to deter further intervention by Russia, whether in Ukraine or elsewhere; to reinforce the freedom of action of allies and partners in Europe; and to encourage change in Russia itself.

The immediate need is for deterrence. The Western response has to change Putin’s calculus. The US and Europe need to make clear that if Russia moves into more Ukrainian territory, they will deny Russian financial institutions access to dollar- and euro-denominated financial markets in a way that will cause serious damage to the Russian economy and specifically to the elite around Putin. Russia’s economy barely grew last year, and the World Bank has forecast a contraction of 1.8 per cent and record capital flight of $150 billion this year (capital flight in the first quarter of 2014 was $70 billion). As a result of the Ukraine crisis, Russia’s cost of borrowing is rising, and downward pressure on the ruble will lead to increased inflation. But these effects may not last if the West returns quickly to business as usual.

It will be hard to get agreement on more comprehensive economic sanctions against Russia, particularly in the EU, where countries like Italy (heavily dependent on Russian gas and industrial contracts) and Cyprus (still tied to Russia through its off-shore financial services sector) will resist. Germany is Russia’s largest trading partner in Europe, and German businesses would clearly prefer to avoid further action against Russia; a number, including Siemens, ThyssenKrupp, Adidas and Deutsche Post have publicly criticised the EU’s approach. The German government is sending mixed signals, with Vice Chancellor and Economy Minister Sigmar Gabriel telling ARD TV that Germany did not want sanctions but had to show that it did not accept Putin’s “imperial policy”.

The risk is that the limited measures taken so far and the obvious divisions in the EU may lead Putin to think that the West will in the long term tolerate action in Eastern and Southern Ukraine as well as Crimea. One element in achieving agreement on tougher sanctions may be a ‘solidarity package’ to support states which would suffer disproportionately from their imposition, at the expense of others who are less affected. Lithuania is already feeling the economic impact of Russia blocking some imports via the port of Klaipeda; and the Latvian Prime Minister has indicated that in the worst case scenario a total shut off of trade with Russia could reduce Latvia’s GDP by 10 per cent.

Deterrence should not be limited to financial steps. Though the immediate threat is to Ukraine, Russia has also made threatening moves in the Baltic, with surprise military exercises including amphibious landings in its Kaliningrad exclave. In an interview with German ARD TV on March 23rd, German Defence Minister Ursula von der Leyen urged increased NATO support for the Baltic states. She was right. NATO has already increased the size of its air policing mission, based in Lithuania (the UK will send four aircraft to join the mission in April), and the US has moved 12 F-16 aircraft to Poland. But so far NATO has not deployed any ground forces in the region. It should place small multinational contingents near the eastern borders of the Baltic States and Poland, as a visible statement of intent to live up to NATO’s Article 5 commitment to assist any ally subject to armed attack.

President Barack Obama and other Western leaders have made a serious mistake in categorically ruling out military involvement in Ukraine on the grounds that NATO’s security guarantee does not cover non-members. In doing this, they have reassured Putin that the West’s reaction will be diplomatic and economic; knowing that so far the EU has been split on imposing tough sanctions, he may feel that the price of further intervention is worth paying. Obama might instead have reminded Putin that Kuwait was not a NATO member, but the US-led coalition nonetheless intervened to restore its independence when Iraq sought to annex it in 1990. Western leaders should follow the Royal Navy motto: “Si vis pacem, para bellum” (“If you want peace, prepare war”). They should state publicly that if Ukraine were attacked and called for assistance in exercising its right to self-defence, they would be ready to deploy NATO forces. And to underline that this is more than empty rhetoric, they should open discussions with the Ukrainian government on concrete arrangements for such a deployment.

If such deterrent measures succeed in preventing any rash Russian action in the immediate future, they will still leave a changed security picture in Europe. A quarter century of (relatively) low levels of tension between the major powers in Europe is over. As long as Putin or others with similar views are in power in Russia, there will be a military and political threat to Russia’s neighbours.

In the 1997 NATO-Russia Founding Act, NATO stated that “in the current and foreseeable security environment”, it would carry out its missions without “additional permanent stationing of substantial combat forces”. Both sides agreed to respect the “sovereignty, independence and territorial integrity of all states and their inherent right to choose the means to ensure their own security”. NATO should announce that it is revisiting its policy in view of the changed situation. It would be imprudent for the alliance to abide by an agreement that Russia has abandoned.

NATO should review its relations with Georgia and Ukraine. Obama was clearly trying to reassure Putin when he said after the EU-US Summit in Brussels on March 26th that Georgia and Ukraine were “not currently on a path to NATO membership”; but he was ignoring the fact that successive NATO summits since 2008 have said that the two countries “will” become NATO members. NATO could withdraw that commitment, but that would merely reinforce Putin’s sense that former Soviet states are his to deal with as he wishes.

Georgia has consistently backed NATO membership and has been a major contributor to ISAF in Afghanistan; it should be rewarded at the NATO Summit in September with a Membership Action Plan (MAP) and a clear and short pathway to full NATO membership. There has never been a popular majority in Ukraine for joining the alliance, but after the Presidential election in Ukraine, once a new government is in place, NATO should discuss with Kyiv how the NATO/Ukraine relationship should develop. At least one recent opinion poll in Ukraine shows a sharp increase in support for NATO membership since the Russian intervention in Crimea, but at this stage membership remains a divisive issue and an unnecessary distraction from solving pressing economic and political problems.

The threats to Europe’s neighbourhood are not only or even primarily military. The prospects of all the EU’s Eastern Partners (Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine) have been blighted by corruption, poor governance and economic mismanagement. Ukraine would not have been so vulnerable either to internal instability or Russian meddling if it had been better governed and economically stronger. Moldova, though less corrupt than Ukraine, is still in 102nd position in Transparency International’s annual ‘Corruption Perceptions Index’. Georgia has done considerably better, but the rule of law is still weak there. And all three countries, lacking Russia’s mineral wealth, remain relatively poor.

Ukraine will need massive international assistance simply to meet its obligations this year; but financial aid should come with strict conditions, and with hands-on technical help. The priorities are to make state finances transparent and limit the opportunities for corruption; to establish courts that decide cases on the basis of laws, not in favour of the highest bidder; and to sort out Ukraine’s energy sector.

Ukraine’s gas industry has been a notoriously corrupt sector in a notoriously corrupt country. Energy inefficiency reduces competitiveness and increases dependence on Russia. Before the overthrow of President Viktor Yanukovych, the Ukrainian government had signed contracts with a number of Western oil majors to explore for both conventional and shale gas. Over time, these will enable Ukraine to buy less Russian gas; but reducing wasteful consumption will bring benefits more quickly and at lower cost. EU member-states like Denmark and Sweden have already identified energy efficiency as a priority area for investment.

A number of EU countries, particularly in Central and Northern Europe, are even more dependent than Ukraine on Russian gas. Reducing this dependence will take time, but is vital if the potential for Russia to use gas as a geopolitical tool is to be reduced. In a forthcoming CER insight Stephen Tindale will set out the options in detail. Europe needs more LNG terminals, and freer access to LNG, including from the US (which, thanks to shale gas, now has a surplus of gas). It needs more interconnectors, both for gas and electricity, particularly between the countries of Central Europe. These countries rely on pipelines from Russia but are largely isolated from each other and from other sources of gas and electricity. Interconnectors would support diversification, increasing both security of supply and competition. Europe needs more pipelines from the Caspian Sea and Iraqi Kurdistan. And it needs to overcome its fear of fracking and of nuclear power.

Europe is also losing the propaganda battle with Russia, not only in Ukraine but in some EU member-states. Russia has a number of means to get its messages across. Many Western articles on events in Ukraine are influenced by Russian reporting on the supposedly deep linguistic and ethnic divide between Eastern and Western Ukraine – a divide which Ukrainian census data shows is very blurred. Because Russian leaders constantly repeat that the Crimean ‘referendum’ reflected the will of the people, most Western media are now uncritically reporting this line without commenting on the shortcomings in the process. Outlets like RT, the Kremlin-controlled English language TV channel, though ridiculed by experts for their misinformation, still get quoted in social media; their views are given the same value as more objective journalism. And Western populists and anti-Europeans, including Nigel Farage of the UK Independence Party and Lord Tebbit of the Conservative Party, are promoting the Russian narrative that EU ‘expansionism’ has created the problems in Ukraine.

Western media should not stoop to propaganda, but Western governments should be more active in ensuring that objective information is available – including through direct engagement on social media. The US embassy in Kyiv has done a better job than most of trying to counter propaganda directed at Ukraine; the EU Delegation there could do a lot more. If Russia’s version of the story is allowed to dominate, it will foment division not only in Ukraine but also in Latvia and Estonia, where Russian TV is widely watched; and Western publics will be less likely to back strong action if Russia continues to expand into its ‘historical’ territories.

A return to some form of implicit containment and East-West competition may be the most likely short- to medium-term scenario, albeit this would (and should) fall far short of a comprehensive ‘Cold War’. But much better in the long term, both for the West and Russia, would be a constructive, win-win relationship. This seems out of reach as long as Putin is in power, or the oligarchic concentration of political and economic power around the Kremlin and the securocrats continues. Putin has been paranoid about attempts by the West to engineer a revolution against him. Perhaps it is time the EU gave up trying to reassure him, and instead worked on a long-term programme to support democratic change in Russia. Elements of this might include:

* Strong enforcement of the international ‘rules of the game’, including in the WTO. EU member-states should also make full use of existing anti-corruption and anti-money laundering legislation, and publicise examples of those in Putin’s circle who have grown rich in suspicious circumstances (the explanation by the US Treasury of the links between Putin and some of those sanctioned by the Americans in relation to the annexation of Crimea provides an excellent model).

* Investment in the next generation of Russians through scholarship schemes and increased links between universities. The more that ordinary Russians are exposed to the realities of life in the West – and particularly in former Communist countries which have benefited from economic and political reform – the harder it will be to mislead them with propaganda, and the more they will understand how free societies work.

* Support for small and medium enterprises (SMEs) in Russia. SMEs suffer from weak rule of law in the current system; entrepreneurs have a strong interest in change. There is funding available for help to SMEs in the framework of the EU-Russia ‘Partnership for Modernisation’, but there should be more.

* Support to civil society organisations – not necessarily political ones, but those working in areas such as protecting the environment, aiding vulnerable groups or identifying and combating corruption. This would be deeply unpopular with the Russian government, which has tried to brand NGOs that work with international donors as ‘foreign agents’, but it should be left to the NGOs themselves to decide whether to run the risk of taking Western funding or advice.

* Long-term political and economic engagement with Russia’s neighbours. If the EU can help the countries of the Eastern Partnership move from basket-cases to success stories, that will show that post-Soviet countries, including Russia, have alternatives to the way they have done things for the last 20 years, and undermine Putin’s argument for the system he has created.

* Consistent messaging to Russian society that it was not democracy and the free market that left Russia chaotic and impoverished in the 1990s, but the legacy of autocracy and communism, the worst elements of which Putin is now perpetuating with his imperial adventures.

Ian Bond is director of foreign policy at the Centre for European Reform.

Wednesday, March 26, 2014

Why Cameron's timing on EU reform is off

British prime minister David Cameron is in a tight spot on EU reform. He must balance calls by eurosceptics in his Conservative Party to repatriate powers from Brussels, and the political reality in Europe that favours less far-reaching change. Cameron hopes to start renegotiating the terms of British EU membership after the 2015 election and believes Germany and the Netherlands will support him in this endeavour. But their plans and timetables do not match his.

Across the Union the debate about reform is gathering momentum. It has reached EU foreign ministers at General Affairs Council meetings in November 2013 and March of this year. Cameron has said that he wants to reform the EU, and renegotiate the UK’s relationship with it, before an in/out referendum in 2017. But instead of leading the debate, Cameron has been holding his cards close to his chest. It is an unwise strategy that threatens to leave him empty-handed.

His wish list for reform is unclear and Europe’s leaders are left to guess which changes Cameron wants. In an op-ed published in The Telegraph on March 15th 2014, Cameron said he does not want to “lay all Britain’s cards on the table”. This reflects the difficult position he is in. No proposal for EU reform acceptable to his European colleagues will be enough to appease the eurosceptics in his own party. Besides, his government cannot reach a common position because his coalition partners, the Liberal Democrats, disagree strongly with his ‘renegotiation and referendum’ strategy. Instead, he wants to wait until after the 2015 general election before discussing reform in earnest. But his caution is making potential European allies impatient.

Cameron has mentioned few practical steps to improve the Union; in general he thinks powers should flow back and forth between the national and European levels and he wants to remove the words “ever-closer union” from the EU treaties. But beyond this, there have mostly been vague promises of repatriation and reforms (for instance, about restricting benefits to migrants and cutting red tape) in the event of treaty change. The latter is particularly problematic for other member-states. Some European governments, like the Netherlands or France, may favour changes to the EU treaties in theory, but they dread the mechanics it involves; a potentially long-winded intergovernmental conference which would require referendums that increasingly eurosceptic populations might not support. Or, like Germany, they see treaty change as a long-term endeavour, not a short-term issue.

Cameron however, needs allies if he hopes to get the change in Brussels he wants. In his op-ed, Cameron pointed to the leaders of the Netherlands and Germany as his fellow travellers for EU reform. Downing Street has been flirting with The Hague and Berlin for some time. In February, Cameron rolled out the ‘reddest of red carpets’ for German Chancellor Angela Merkel, inviting her to address the Houses of Parliament. That same month, Dutch prime minister Mark Rutte sat down for an ‘informal dinner’ at Chequers to talk about EU reform.

But instead of opening up the treaties and repatriating powers, The Hague and Berlin are thinking differently. Their focus has shifted to reform initiatives that do not require cumbersome treaty change. And their views are gaining traction across Europe.

Central to their thinking is strengthening subsidiarity. This concept – enshrined in the Treaty on European Union – holds that the Union should act only when doing so achieves better outcomes than member-states acting separately at the national level. Subsidiarity is not an instrument for repatriation, since it accepts the division of competences, but where the treaties are ambiguous it does allow greater flexibility in deciding where powers lie, and it is a check on an overly ambitious Commission.

Subsidiarity will not be a panacea for the Union’s problems, but lifting the concept out of its technical and legalistic environment, and onto the highest political platform, would be helpful. For too long subsidiarity – an important but ill-defined concept – has been allowed to shelter in the dark recesses of the EU treaties. Putting subsidiarity into practice means paying more political attention to it.

In an op-ed in Handelsblatt on March 18th 2014, Germany’s foreign minister Frank-Walter Steinmeier and Dutch foreign minister Frans Timmermans called for an EU that is more selective in the issues it tackles, saying it “should be big on big issues and small on small issues.” Stronger enforcement of subsidiarity, they say, would cull unnecessary initiatives from the Commission and reduce the EU’s democratic deficit since national parliaments would become more involved: better use of ‘yellow card’ procedures would allow European parliaments to co-operate and block Commission initiatives they deem unnecessary or inappropriate. The two ministers continue that if Commissioners were to work in clusters, rather than pursuing 28 separate dossiers, the EU would be more focused and effective, and increase its legitimacy with the European public. (The CER made similar suggestions in ‘How to build a modern European Union’, October 2013.)

Among the few things Cameron has spelt out that he wants are a stronger role for national parliaments and better enforcement of subsidiarity. So he is giving intellectual support to the Dutch-German idea. It also resonates with Finland, Sweden and France. (Some of these countries, like France, may prefer treaty change in the long run – for instance to strengthen eurozone governance – but realise this is currently not politically feasible.) An added benefit of the Dutch-German plan is that it can be done within the existing treaties; it would require a political deal.

In her speech at Westminster, Angela Merkel referred to such a deal when she said “more attention needs to be paid to the subsidiarity principle in Europe. [European governments] should set priorities for the future Commission’s work.” Indeed, a political agreement between the European governments, the European Parliament and the Commission could set the agenda for a more focused Commission – outlining the areas where the Commission would, and would not legislate – underline the centrality of subsidiarity and support stronger involvement of national parliaments.

When could such a deal be reached, since the European Council, the European Parliament and the Commission must all be involved? Germany and the Netherlands foresee a window of opportunity between the election of the new European Parliament on May 22nd, and when the new Commission takes office in the second half of 2014. Only then, they believe, will the new European institutions be receptive to a political ‘gentlemen’s agreement’. There is no point in making a deal with the current lame-duck Commission or the outgoing Parliament, and it makes little sense to strike a deal after the next Commission has already started proposing EU policies.

This suggested timing will cause problems for Cameron, who hopes to keep his powder dry until after the UK general election in May 2015. He would have to support a political agreement that reined in the Commission and strengthened subsidiarity – because he agrees with the need to do both – particularly if the initiative came from his allies in Berlin and The Hague. But if a deal is done in late 2014, and then in May 2015 Cameron wins a majority without the Liberal Democrats and embarks on his renegotiation strategy, momentum for reform among his European colleagues will have dissipated. This would cause a major headache for Cameron who has been betting that he does not have to seriously discuss renegotiation or reform until next year.

Instead, Cameron should make his objectives on EU reform clear; embrace the prospect of reform by political agreement – rather than treaty change; and start contributing to the European debate with a British subsidiarity agenda, for which the government’s balance of competences review could provide the basis. If the moment passes him by, other prospects for reform may become increasingly unlikely.

Rem Korteweg is a senior research fellow at the Centre for European Reform.

 

Monday, March 10, 2014

The eurozone’s ruinous embrace of ‘competitive devaluation'

The euro was supposed to put an end to competitive currency devaluations, and with it ‘unfair competition’. But this has not been the case. Germany was often portrayed (wrongly) as the victim of other countries’ competitive devaluations before the introduction of the euro. But contrary to received wisdom, Germany’s real exchange rate – which takes into account differing inflation trends in Germany and its trading partners – did not rise in the run-up to the introduction of the single currency. And it has fallen steeply during the 15 years of the euro’s existence. This has handed German firms a competitive advantage of the kind the euro was supposed to eradicate. What is more, Germany is not under pressure to do anything about it. In fact, other eurozone countries are being encouraged to follow suit.

The European Commission compiles so-called ‘harmonised competitiveness indices’ for eurozone economies (see chart one). These are the member-states’ real exchange rates in anything but name. They show that Germany’s fell by almost 20 per cent between the beginning of 1999 and the end of 2011, before edging up a bit in 2012-13. The main reason for the decline in the country’s real exchange rate was very low wage increases and hence weak inflation. Spain’s (and to a lesser extent) Italy’s real exchange rates rose rapidly over the early part of the 2000s but have fallen sharply since 2008: Italy’s is now barely higher than in 1999, whereas Spain’s is up around 9 per cent. France’s real exchange rate is actually lower now than in 1999 (or in terms of the Commission’s analysis), its ‘competitiveness’ has improved. In short, the eurozone’s imbalances have less to do with its Latin members allowing costs to get out of hand than they do with Germany engineering a beggar-thy-neighbour cut in costs.

Chart one: Harmonised ‘competitiveness’ indices
(real exchange rates, quarter 1 1999 = 100)


















Source: European Central Bank

To the extent that the steep fall in Germany’s real exchange rate within the eurozone is acknowledged in Brussels and Berlin, it is typically attributed to the need to reverse the rise in the country’s real exchange rate in the run-up to the introduction of the euro. German firms, so the argument goes, needed to rebuild their competitiveness after the shock of reunification, so set about reducing costs, which led to a fall in the real exchange rate. The problem with this analysis is that it is not corroborated by the data. Chart two below shows the real exchange rates of Germany, France, Spain and Italy between 1980 and 1998. Germany’s was actually lower in 1998 than it had been in 1980. There were devaluations in France in 1983-84, and in Italy and Spain following their ejections from the Exchange Rate Mechanism (ERM) in 1992, but in each case these devaluations were largely corrective (in response to bouts of currency overvaluation) and by 1998 their real exchange rates were back to where they were in 1980. Over the period as a whole, it was Germany that had the more ‘competitively valued’ real exchange rates.

Chart two: Real effective exchange rates
(quarter 1 1980 = 100)



Source: UNCTAD, Global Development Indicators

The result is that Germany now has a hugely undervalued real exchange rate (something that neither Italy nor Spain managed before the introduction of the single currency). Why is Germany not accused of engaging in a competitive devaluation, when Spain and Italy were? After all, Germany’s real exchange has fallen sharply relative to its long-term trend, whereas the 1990s devaluations just took the lira and peseta back down to their long-term trends.

One reason is the widespread belief that eurozone countries do not have real exchange rates because they all share the euro. By virtue of sharing the euro, devaluations are seen as impossible. A devaluation is only considered a devaluation if it involves a movement in a country’s nominal exchange rates, such as when the lira and the peseta were ejected from the ERM. But when devaluation comes about as a result of low inflation (which in turn is usually the product of weak domestic demand), it is seen as a ‘competitiveness’ gain. However, the impact on other countries is the same: they face a loss of price competitiveness relative to firms based in the devaluing country and sell less to it.

Far from being considered a problem and condemned as a ‘beggar-thy-neighbour’ strategy (as was the case with Italy and Spain), Germany is lauded for its success in reducing its real exchange rate, and other countries are called upon to emulate it in order to improve their ‘competitiveness’. So, in a curious reversal the country that underwent a large competitive devaluation is not only under little pressure to reverse it but is widely regarded as a benchmark for others.

This conflation of real exchange rates with competitiveness has been damaging. A real or ‘internal devaluation’ of the kind engineered by Germany in the eurozone has harmful macroeconomic effects because it involves suppressing domestic demand and with it inflation over a long period of time. By contrast, Spain and Italy quickly returned to growth in the 1990s following their devaluations, with the result that German exports to these countries did not suffer. If Italy and Spain persevere with attempts to devalue their real exchange rates rather than Germany revaluing its real exchange rate, the result will be persistently weak demand across the eurozone, a worsening of the currency union’s already broad-based deflationary pressures and further increases in debt ratios.

While the Commission has criticised Germany’s excessive and persistent current account surplus, it has been at pains to stress that it would make no sense for the Germans to cede ‘competitiveness’. Yet it is impossible for all members of the eurozone to enjoy the unfair advantage of an undervalued exchange rate. The Commission’s implicit assumption seems to be that all eurozone economies can engineer real (or internal) devaluations, boosting their exports to non-eurozone markets and driving an economic recovery across the eurozone. But there has already been a big swing in the eurozone’s current account position, from a deficit of around €85 billion (1 per cent) in 2008 to a surplus of almost 2.5 per cent in 2013, as Germany’s surplus remained very large while the deficits of the southern members-states narrowed. It is a moot point whether the eurozone's external surplus can continue rising: it already comprises a big drag on a fragile global economy, which the eurozone in turn is increasingly dependent on. Moreover, an economy with a big trade surplus tends to experience currency appreciation because demand for its currency outstrips the supply of it, something which is now happening to the euro. A strong euro will hit demand for eurozone exports, especially the more price sensitive ones of the currency union’s southern economies.

The eurozone needs Germany’s real exchange rate to rise (that is, for the unfair advantage that Germany has carved out within the eurozone to reverse), but this will not be easy. Germany’s export-led economy – underpinned by its social partners’ ability to deliver wage restraint – combined with rapid population ageing mean that it will generate little inflation. The German economy is growing more quickly than the eurozone as a whole, but Germany’s rate of inflation is barely above the eurozone average, not least because real wages fell in 2013. More expansionary macroeconomic policies could help. First, a combination of income tax cuts and increased public investment would boost domestic demand (and hence inflation) without posing a threat to fiscal stability: the country ran a budget surplus in 2013, with the result that its debt ratio fell. Second, Germany could withdraw its opposition to the ECB embarking on aggressive monetary stimulus, which would in turn boost economic activity (and inflation) in Germany. The problem is that a fiscal stimulus of this kind would contravene Germany's constitutional requirement to balance the budget. And there is little sign that Germany will accept aggressive moves by the ECB to reflate the eurozone economy.

For its part, the Commission needs to stop defining competitiveness in terms of the real exchange rate. Competitiveness defined in this way is a zero-sum game: one country’s ‘gain’ is another’s loss. If competitiveness means anything useful it is labour productivity or total factor productivity, not the real exchange rate which can fall simply because of wage restraint depressing demand and leading to deflationary pressures. European member-states cannot rely on the ECB coming to the rescue and countering the deflationary impact of the current race for competitiveness. They should demand that Germany do the unthinkable: lose competitiveness!

Simon Tilford is deputy director of the Centre for European Reform.

Monday, March 03, 2014

French federalists propose a Euro Community

A dozen French EU experts have written a manifesto proposing the creation of a new ‘Community’ for the eurozone. The self-styled ‘Eiffel group’ makes an intelligent case for a federal, political union that would exist alongside the existing European Union. The chances of such a Community emerging are, in my view, rather small. But the manifesto deserves to be read, because the authors are serious people with first-hand knowledge of how the EU works. They include Yves Bertoncini, director of the Notre Europe - Jacques Delors Institute; Laurence Boone, an economist at Bank of America Merrill Lynch; Sylvie Goulard, a liberal MEP; Denis Simonneau, a member of the board of GDF Suez; and Shahin VallĂ©e, economic adviser to President Herman Van Rompuy. If they get their way, the EU itself would become a second-class club with little appeal to members such as Denmark, Sweden or the UK.

The Eiffel group’s analysis of the euro crisis is similar to that of the Centre for European Reform. The authors argue, for instance, that fiscal policy has been too restrictive. And they are unhappy with the way Germany exerts leadership in the eurozone. “The current situation, where German federal bodies (Bundestag or the Karlsruhe court) hold the fate of the euro in their hands is not good for Germany, placed in a position of hegemony, nor for Germany’s partners, reduced to complying.”

But the institutional thinking of the Eiffel group makes the CER uncomfortable. Its chief proposal is for the euro countries and others committed to a “common destiny” to negotiate a treaty for a Euro Community. This Community would be about much more than the euro, covering education, training and innovation. It would invest in digital, transport and energy networks, as well as research. The group proposes new instruments to absorb economic shocks and support the most vulnerable people. It wants EU-level unemployment benefits and “partial harmonisation” of labour markets. 

The authors call for “putting an end to the ill-defined concept of subsidiarity [the idea that decision-making should rest at the lowest practicable level], a pretext for the renationalisation of policies”. And they would aim for a common external representation (though the authors say very little about what kind of foreign policy the Community should have).

A eurozone parliament would elect an executive to run the Community. That parliament’s members would double-up as MEPs. A levy on companies or a carbon tax would pay for the Community’s budget. It would borrow collectively to finance future projects, though not to cover past debts.

The Eiffel group is hostile to a greater role for national parliaments in the EU or the new Community. Nor does it want joint meetings of national parliamentarians and MEPs, as envisaged in the 2012 ‘fiscal compact’ treaty.  “The principle must be imposed that a European decision requires European control, and a national decision national control.”

The existing European Court of Justice would police the Community’s rules and enforce sanctions on those who breach them. However, nothing is said about how the European Commission – or, indeed, the entire EU – would relate to the new Community. The authors appear to think that the relationship between the euro-ins and -outs is not a problem, because they expect most of the member-states outside the euro to join it within a few years.

The manifesto’s discussion of the single market is cursory. It suggests that the single market take in countries that cannot easily join the EU, such as Albania, Moldova, Turkey and Ukraine. It assumes that Britain would be much happier if left in an outer tier consisting of not much more than the market, alongside such countries. Though they never state it openly, the authors imply that a big advantage of the new Community would be to ensure that the British cannot block further European integration.

This French manifesto was inspired by a similar German enterprise: last year the ‘Glienicker group’ of German experts drew up its own federal manifesto. The Eiffel group believes that France and Germany together have a special responsibility to manage European integration (Italy, Spain and Poland are scarcely mentioned in the French manifesto). Nevertheless many Germans will have problems with the Eiffel proposals.

Germans tend to like subsidiarity, and may baulk at the Eiffel group’s derogatory language on this principle. Similarly, they are big fans of the single market (even if they are reluctant to extend it further into services), so may wonder why these French authors seem so uninterested in it. The suggestion that the poorer Balkan countries, Turkey and Ukraine should join the single market implies that it is a slap-dash creation, rather than a construction that needs to be policed vigorously with strong rules and institutions.

The Eiffel group calls for the Community to build energy, transport and digital networks, but surely many of the most important infrastructure projects would achieve more if extended across the entire EU rather than merely the eurozone? For example, carbon capture and storage cannot take off seriously in the EU without a pan-European network of pipes to take CO2 from the places it is emitted to suitable underground burial sites (such as those which lie under the North Sea).

Some Germans will agree with the Eiffel Group that the eurozone needs to develop into a strong Community, but they will be concerned that the authors more-or-less ignore the relationship between the 28 and the 18. How could one ensure a smooth fit between the EU and the Community? What happens to the Commission? And what if the Community executive takes actions that harm the single market?

The manifesto implies that such difficulties will be resolved by nearly all the EU countries joining the euro. But that may be wishful thinking. Lithuania apart, none of the euro-outs has taken even the first steps towards joining the euro, such as entering the Exchange Rate Mechanism. In Poland both the constitution and public opinion seem likely to prevent the adoption of the euro until well into the next decade. Some non-euro countries – unlike the UK – may be willing to accept the disciplines of the euro, because they plan to join in the long run. But they will still want to ensure that the single market remains intact and that economically illiberal forces in the eurozone do not smother it.

French authors have a particular credibility problem in proposing the kinds of idea contained in this manifesto. This is because a number of senior people in France – though not the manifesto’s authors – lament the enlargement of the EU into Central and Eastern Europe, regret the waning of French influence in the wider EU, and hope to build a new, smaller club around the euro, in which France can exert significant influence. Not long ago, I heard a senior French official say that the EU was no longer useful for France, because there were too many Central Europeans in it, and because the French could no longer steer the Union.

Those outside France may imagine, however unfairly, that the Eiffel group is serving a protectionist agenda: they know that economic liberalism is, in relative terms, weaker in the eurozone than the wider EU (where the presence of Denmark, Poland, Sweden and the UK, among others, reinforces market economics). The manifesto’s reference to harmonising labour market rules and unemployment benefits in the eurozone will reinforce such fears.

As for questions of democracy and accountability, it is not only the British who argue that the European Parliament has a legitimacy problem and that national parliaments should play a bigger role in the EU. Since the CER published proposals in favour of enhancing the role of national parliaments, last October, we have had more-or-less sympathetic reactions from several governments, including Denmark, Germany, the Netherlands, Poland and Spain.

The Eiffel group has come up with an interesting and thoughtful contribution to the debate on Europe’s future. On paper, many of the authors’ ideas for a more federal eurozone make sense. They seem to imagine that the UK and others outside the euro will try to block the integration that the authors regard as necessary. But the real obstacle to these proposals lies not in London but elsewhere. The euro countries cannot hand over powers to a new Community unless their leaders can convince electorates – during election or referendum campaigns – that a federal government is desirable. So far, there is no sign that leaders in France or elsewhere are capable of that task.

In private, one of the authors has explained to me that the manifesto’s key point is that the current set-up does not work and is economically and politically unsustainable; he believes that both elites and citizens can be convinced of that point, and that they will therefore see the need for a tighter euro union. He may be right that the eurozone cannot flourish without significant reform. But politicians will find it very hard to persuade voters that a lot of powers now held by member-states should be transferred to new or existing Brussels institutions.

Charles Grant is director of the Centre for European Reform.

Friday, February 28, 2014

Ukraine after Yanukovych: Dropping the pirate?

President Viktor Yanukovych of Ukraine clearly had no sense of irony when he placed a mock pirate ship in the lake at the mansion he built on (stolen) state land outside Kyiv. With all his vices, however, as long as he remained in power Russia, the West and Ukrainian politicians had no reason to reconsider their own inadequate policies on Ukraine. Now he has gone, all three must raise their game. This insight looks at each in turn, but focuses on what the EU can do for Ukraine, and what Ukraine needs to do for itself.

For Russia, Yanukovych was an acceptable leader of Ukraine, despite his faults. With his power base near the Russian border and his ties to oligarchs dependent on Russian markets, he was not the man to stand up to Moscow’s pressure to walk away from an association agreement with the EU in autumn 2013. His reward for doing Moscow’s bidding was a one-third cut in the price of Russian gas (to be reviewed quarterly, in case he thought of changing his mind) and a $15 billion loan (about €10 billion), of which $3 billion (€2 billion) was disbursed before his fall.

The Russians clearly did not expect that Yanukovych’s failure to sign a one-thousand page document that few if any of his opponents had read would lead to a revolution. Yet three months after Yanukovych cast his lot in with Russia, he is out of office and – as Russian Prime Minister Dmitri Medvedev said on February 24th “We do not understand what is going on there”.

The smart thing for the Russians to do would be to join Yanukovych’s Ukrainian ex-supporters in denouncing his crimes, and then to rebuild their influence. Russia will continue to supply much of Ukraine’s gas. It already has a free-trade agreement with Kyiv, and mutually profitable trade should continue, particularly in areas like defence equipment where Soviet-era supply chains still exist. Many Ukrainians have family ties in Russia or work there. These people have no reason to feel enmity towards Moscow. A prosperous, EU-aligned neighbour should pose no threat to Russia’s interests. It could even be a better customer for Russia; it might pay its bills, for one thing.

So far the signs are that Russia is not doing the smart thing. Russian foreign minister Sergei Lavrov has claimed that the political opposition are following the lead of “pogromists”; Medvedev has claimed that what has happened threatens the lives of Russian citizens. In Crimea, the only region of Ukraine where there is an ethnic Russian majority, visiting members of the Russian Duma announced an initiative to make it easier for Crimean residents to get Russian passports. These are provocative moves. The presence of large numbers of similar ‘Russian citizens’ in Georgia’s separatist enclaves of Abkhazia and South Ossetia provided a pretext for Russia to step in to ‘protect’ them in 2008. The occupation of the Crimean parliament and major airports by armed men, and large-scale Russian military exercises near the Ukrainian border, all add to the tension.

For the West also, the fall of Yanukovych demands fresh thinking. The UK and the US were co-signatories with Russia of the ‘Budapest Memorandum’ of 1994, in which (in return for Ukraine sending Soviet nuclear weapons back to Russia) the other three countries undertook to respect Ukraine’s independence, sovereignty and borders; not to use or threaten force; and not to use economic coercion. The memorandum said that the three would consult “in the event a situation arises which raises a question concerning these commitments”. It is time the UK and US used this agreement to deliver firm messages to Moscow about the impact of its actions on future relations.

The thuggish and corrupt Yanukovych had few friends in Europe. Now the EU will have to deal with a government in whose creation it has had a hand, and an interim president who has already said that a return to the path of European integration is his priority. Brussels and the member-states should not wait passively to see what happens, as they did after the 2004 Orange Revolution. They should drive change with a judicious mixture of generosity and tough love.

Ukraine will need assistance to avoid default almost immediately. It needs to pay its various creditors over €10 billion by the end of this year; it has gas debts to Russia of over €1 billion. The IMF suspended lending to Ukraine in 2011 because of its failure to carry out agreed reforms. IMF managing director Christine Lagarde made clear after the G20 finance ministers meeting on February 23rd that Ukraine would have to start reforms before international lenders would return. If Kyiv takes her advice, Western countries should be ready to step up technical assistance and political engagement to ensure that key reforms in areas such as energy pricing are implemented quickly and effectively. They could help with funds and advice to reduce the impact of cuts in fuel subsidies on poor customers. A sharp reduction in energy subsidies in Bulgaria in early 2013 led to protests and the fall of the government.

A lot of the short-term pain of reform will fall on un-modernised heavy industries in the east and south of the country, which have relied on unsustainably low gas prices to remain viable. The deep and comprehensive free trade agreement (DCFTA) offered by the EU should offer a significant long-term boost in growth (estimated at about 0.5 per cent per annum), but the gains will be diffused widely, while the losses will be concentrated. Russia has put a considerable propaganda effort into heightening the fears of the likely losers. Moscow will probably now put up the price of gas and perhaps restrict the flow in order to punish the new Ukrainian government, further hitting Ukrainian competitiveness. The EU is close to offering Ukraine financial assistance (likely to be more than the $1 billion (about €700 million) announced by the US). Regions of western and central Europe which have successfully undergone economic restructuring should share their expertise with Ukraine. The EU should also press forward with plans to enable Ukraine to get gas from Slovakia, assistance with energy efficiency and other steps to mitigate Ukraine’s dependence on Russian gas.

The EU has concluded that although the interim government might like to sign the association agreement as soon as possible, it would be better not to do so before presidential elections in Ukraine on May 25th. One reason for this is to avoid questions about the legitimacy of the transitional authorities; another is to allow more time for an increased public information campaign to explain what the association agreement means for Ukraine. The British government commissioned research in Ukraine in early 2013 which showed low levels of knowledge about the EU and high levels of suspicion, particularly in the east. The British Embassy in Kyiv has done much since then to ensure that information about the agreement is available, including translating a summary into Russian as well as Ukrainian. Meanwhile the EU delegation’s staff have taken the lead in ensuring that the Ukrainian authorities are technically prepared for the time when the agreement is in force. But it is time that the information effort was stepped up and properly resourced, ideally with the EU delegation and as many member-states as possible spreading the word. Central European countries have a particularly important contribution to make because of their own experiences of transition, association agreements and ultimately EU membership; senior visitors from these countries could help to reassure eastern Ukraine of the benefits of association with the EU.

As a result of events in Kyiv, member-state resistance to offering Ukraine an EU membership perspective seems to be fading, gradually. The last statement by EU foreign ministers ended enigmatically: “the Council expresses its conviction that [the association] agreement does not constitute the final goal in EU-Ukraine co-operation”. Several senior European officials have gone further, including President of the European Council Herman Van Rompuy, who said that the future of Ukraine belonged with the EU. Successive Ukrainian governments have defined their country as ‘European’; it is time that the EU started to set out the conditions Ukraine would have to meet in order to become a member of the Union.

There is a Russian saying that it is better to see once than hear a hundred times. The EU should press forward as quickly as possible with visa liberalisation for Ukrainians, to make it easier for people to see what two decades of transition have achieved in countries like Poland and the Baltic states. The Union should also increase funding for student exchange programmes and study visits to EU countries by officials, particularly from eastern Ukraine.

One reason Ukraine’s economy is in such a mess is the immense scale of corruption. The Swedish economist Anders Aslund estimates the Yanukovych family fortune at $12 billion (almost €9 billion), but the president and his relatives were not the only ones profiting at the expense of the Ukrainian state. A number of EU member-states, including Austria and the UK, have been happy to put out the welcome mat for members of Yanukovych’s circle. Former prime minister Mykola Azarov and his wife have property in Austria; companies which are alleged to be fronts for Yanukovych and his family are based in London.

These and other European countries should now help the Ukrainians to recover some of the loot. They should also look closely at their own implementation of anti-money laundering legislation. In 2011 the UK’s Financial Services Authority found that three quarters of the banks it investigated had not done enough to establish that customers who were senior politicians or their families had acquired their wealth legitimately. Putting this right would help Ukraine (and other countries) recover funds from corrupt politicians, and also set the tone for the future. Western countries should not preach good governance and the rule of law in Kyiv while allowing Ukrainian leaders to launder their money in European capitals.

Ukraine’s economic future will not be secured, however, by asset recovery (however politically valuable it would be). It needs trade and investment to drive growth. Even before the DCFTA comes into force, the EU should be generous with market access. The Union set an important precedent by increasing Moldova’s wine export quota in January 2014 to compensate for Russia restricting its imports of Moldovan wine; if Russia takes similar steps against Ukrainian agricultural and industrial products (as seems likely), the EU should respond by opening its markets again.

Finally, the Ukrainians themselves need fresh thinking. It has been easy to blame Yanukovych for all that ails their country. But his departure does not mean the end of their problems; and he was not responsible for all of the mess. From independence onwards, Ukrainian presidents and governments have ducked hard choices and allowed corruption to flourish.

In 2004 the protesters in the Orange Revolution were (to some extent at least) led by the politicians. In 2014, the protesters on the Maidan were consistently ahead of the politicians and wary of the opposition as well as the government. When Vitali Klitschko, leader of one of the main opposition parties, announced to the crowd the terms of the (still-born) deal brokered between Yanukovych and the opposition by the French, German and Polish foreign ministers, he was booed off the stage. The engagement of civil society in political life is in some ways encouraging: much better than apathy. But it also contains threats: the risk of vigilante justice, and the temptation for politicians to resort to populist measures, rather than attempting hard but necessary reforms.

The new authorities need to prioritise. Whether Ukraine defaults or not, its economy is a mess. The interim government needs to be frank with the population about how tough it will be to turn Ukraine round after two decades of decline, and it needs to start the process quickly, without waiting for the presidential elections in May. That way, all parties in the unity government will share responsibility for the reforms required to put Ukraine on track for sustainable economic growth. The interim prime minister, Arseniy Yatsenyuk, a highly intelligent technocrat, has started to explain how bad things are; he needs support from other politicians. Leaders should not be distracted by peripheral issues: reducing the status of the Russian language will no doubt please some western Ukrainians, but it should not have been one of the first pieces of legislation passed by parliament after the fall of Yanukovych. It will do nothing for the economy, and will exacerbate worries in the south and east on which separatists can then play.

Ukraine needs a constitution that works. The 2004 constitution left too many uncertainties about the division of powers between the president, the prime minister and parliament; the 2010 constitution put too much power in the hands of the president. With the help of the Council of Europe’s Venice Commission on democracy through law, the new authorities should start work on a new constitution, to be put to a referendum as soon as possible. The president to be elected in May 2014 should serve a shortened term pending adoption of the new constitution.

Ukraine also needs honest politicians. The Office for Democratic Institutions and Human Rights (ODIHR), part of the Organisation for Security and Cooperation in Europe (OSCE), judged the 2012 parliamentary elections to have been a step backwards for Ukraine, characterised by abuse of administrative resources, murky campaign finances and biased media coverage. The resulting parliament is now in charge of the country. Various oligarchs ‘own’ blocks of seats in the Rada; it was their decision to drop Yanukovych which led to the vote to replace him. The interim government should ask ODIHR to help draw up new electoral legislation, including on campaign finance, establish a new electoral commission and hold parliamentary elections as soon as a new constitution is in place. It should also work with international anti-corruption bodies to draft and implement far-reaching legislation to force politicians and officials to declare their assets and any possible conflicts of interest.

Ukraine itself does not have the resources to pay for a major economic change programme itself; it will need foreign investments, as the countries of Central Europe did. To attract foreign investment it will need to change the ingrained culture of corruption. By leaving behind a treasure trove of documents showing the extent of graft, Yanukovych has strengthened the hands of transparency campaigners (some of whom are now poring over the evidence). Ukraine should work with organisations like the Open Government Partnership and Transparency International to build openness into government contracting processes and the tax system. It should also ask for help from the OSCE and the Council of Europe to rebuild the judiciary and law-enforcement bodies so that they serve the people and the state, not the elites who corruptly buy their services.

Ukraine has rich agricultural land, an industrial heritage and an educated population. It should be doing much better than it is. After two false starts, perhaps it will be third time lucky. The pirate king has gone; now Ukraine should be helped to chart a new course.

Ian Bond is director of foreign policy at the Centre for European Reform.

Wednesday, February 19, 2014

Sherlock and the European catastrophe

Benedict Cumberbatch sat across from the prime minister in best thin white duke mode, a look of disbelief frozen on his face. “David, you do realise that I’m an actor? 'Sherlock' was just a TV detective show adapted for today's Britain. We've made too many seasons of it already. I’ve moved on.”

David Cameron fixed him with his fleshy, good-natured gaze. “Oh, I'm well aware. But you in particular seemed, well…just so natural as Sherlock. My predecessor-but-one was a thespian too, Benedict. And there's literally no-one else I can turn to: I’m in serious trouble on my Europe file.”

It was 2017 and a sunny May morning in Downing Street. PJ Harvey's anguished tones drifted down a corridor from a radio in one of No 10's over-stuffed offices. “Goddamn’ Europeans! Take me back to beautiful England...” The TV detective’s mouth turned up a corner. “What appears to be the problem, prime minister?”

 
“Well, as I say, it's my European policy.” He glumly nodded towards the desk. “Anyone who sits in that chair has Europe waiting for them like a great ugly toad from the first day they get in the door. I don’t see why I should be the one the whole thing finally caves in on...This EU referendum we promised: the vote is on Saturday.”

...
Fog rolling down behind the mountains,
On the graveyards, and dead sea-captains


Cumberbatch’s fingertips pyramided to his lips. “Yes, it’s all over the news, special debates on Newsnight for a month and all that. The newspapers are full of it. Everyone says it’ll probably be a narrow Yes to stay in.”

Cameron looked pained. “No. The Yes side is going to lose, Benedict.”

The actor stared. “But the polls look 50-50. Whatever about all the bluster, people hardly expect us to leave Europe, do they?”

Cameron went on, unhearing. “I suppose that I sort of, hoped – you know – that something would just turn up, as Mr Micawber says. I did everything I could to keep the Conservative party happy. I pulled my MEPs out of their cozy, chummy group in the European Parliament and made them hang around with a bunch of political wild-men instead, even before we got into office at all. Not that anyone here ever gave me credit for it. They noticed on the continent though. But the really serious trouble started when the eurozone crisis broke out and I vetoed their fiscal compact. That sent my thrill-seeking backbenchers into ecstatics. My God, it got the other leaders’ backs up something terrible. Before then, our usual policy was to be in the room for those kinds of discussions. I took a big risk walking away from that.”

“But how did that help the UK?” asks Cumberbatch, crossing his legs pensively.

“Well, it looked like the lights were going out all over Europe...my economic advisers told me the eurozone was doomed. I mean I'm no expert but anyone can see the thing is hardly an economic miracle. We thought they'd be re-making the entire EU by now, that we’d have the chance to extract some concessions before having to hold the blessed referendum. You know, on social policy and so forth. So I wanted to show them I was prepared to block things early on. Can someone please turn that radio off – we’re trying to have a meeting in here!”


And the grey damp filthiness of ages,
And battered books


“And…what happened then?”

“Nothing”, lamented Cameron. “The whole euro crisis just went into a sort of political deep freeze after they cooked up some legal mumbo jumbo. I got a few helpful noises on immigration from the other governments after the European elections alright. Then I floated this ‘Regulation Treaty’ idea the year we got re-elected, but I just couldn’t sell it. The only thing I could point to in the end was pulling out of European policing. Gordon Brown already got that during the Lisbon talks though, before I got in.”

“David, you’re a PR man. Surely, you know not to take political risks on crime. Look how successful Sherlock and the other crime dramas are for goodness sakes.”

“Yes, but no-one ever asks the French police for help in them, do they Benedict? And we were getting ready for the 800th Magna Carta celebrations in 2015. I was hardly going to adopt the Code Napoleon the same year, was I? Even the main villains in Sherlock were only Swedish and Irish.”

Cumberbatch snorted. “Ha; well, our producers thought that was as foreign as the British viewer likes to go on a Tuesday night. Hang on, that's interesting. How have Sweden and Ireland done in Europe over the last few years?”

“Well, Ireland got bailed out by the other Europeans and us. After that, they got bossed around by the ECB for a bit. But then they started raising money on the markets at a better rate than the Treasury. The continentals even made Kenny, the Irish prime minister – or whatever it is they call it – European Council president. They called it: “a gesture to the Anglo-Saxons”. The Irish just loved that. We only got the pesky development commissioner.”

“Ok. Well, how did Sweden do then? We agree with them on most things too, don't we?”

“Fredrik? Obviously, he thinks the whole euro thing is bonkers as well. He told me Halley’s Comet will be here again before the Swedes sign up. But he just sort of sat on the fence at the Council meetings, pledged a few kronor to the bail-outs, even signed up to the fiscal compact. Says if the Danes can wear it, so can he.”

...
The sky move, the ocean shimmer,
The hedge shake,
And the last living rose quiver

...

“Let me put it another way, David. If Sweden or Ireland needed a leg up from Brussels or the other Europeans for some reason, would they be more or less likely to get it than us?” 

“Theoretically: more likely. But you don’t understand: the whole treaty change thing is a damned dangerous business. No-one wants it because it means referendums everywhere. Can you imagine that around Europe with the economy the way it is now? Angela made sure I got my ‘Declaration That Britain Has A Point, Whatever It Is’, at the December summit even though everyone’s already mad at her for taking the French to court over their national debt. But that won’t be near enough to get us out of trouble here. Can you believe the way this campaign has become such a godsend for Boris? He has all the fun running the No side while I just get abuse up and down the country. His tweets are sickening.”

Cumberbatch looked at the prime minister, wondering. “But David, it’s a bit premature to rehearse your resignation speech, no? Everyone says that the debate has turned out to be surprisingly cathartic; that the No side is split and on the defensive; that the country has quietly Europeanised since the last poll forty years ago. You know: we’re drinking drinkable wine, calling our kids Radek, letting Deutsche Bahn run the railways – all that. If anything, people seem bored with the whole EU thing at the moment.”

Cameron winced: “Exactly, Benedict: Turnout, turnout! I couldn’t get the idea of a minimum quorum into the referendum bill. The pity is we didn’t go back into government with the Lib Dems; they would have insisted on it, even after their demolition in the elections. I know the debate is lively: what with the fabrications from the No side and the counter-fabrications from the Yes side. The young people tell pollsters that they'd prefer to be in, so long as we don’t join the euro. But who’s going to get up out of bed on a Saturday morning to vote for Brussels?

...
Past the Thames River, glistening like gold
Hastily sold
For nothing
...

 “…only the hardcore anti-EU people, that’s who. We’ll end up leaving the Union in a fit of absence of mind. And Boris and his wild-eyed friends have fooled enough people into believing that only a No vote can get us “the real deal” from the bureaucrats. Well, if he wants my job so much, let him stay up all night arguing in that abattoir in Brussels. Nothing makes the continentals gang up together more than a good Brit-bash. They don’t have a bloody thing in common otherwise. But can’t all that be avoided somehow, even now?”

Cumberbatch’s grey blue eyes widened. He stood up and flicked on his high-collared Milford coat. “Prime Minister, this really isn’t my area, you know. But Sherlock would deduce that you’d missed something obvious and hidden in plain sight somewhere along the way. Anyway, my flight to Los Angeles leaves in a few hours.”

“Don’t remind me about the Americans; I’ve had HRC on the phone every week for the past two months asking me what my ‘strategic vision’ is for after the referendum. Look, couldn't you ask your brother in MI6, Mycroft Holmes? He was a great help to us during the Olympics.”

“You're scaring me now David...”

Hugo Brady is a senior research fellow and the CER's Brussels representative.

NB: Lyrics reproduced from PJ Harvey’s ‘The Last Living Rose’.