Friday, March 30, 2012

The Toughest Budget Of The Post-Franco Era

The Spanish government has today unveiled the toughest austerity package of the post-Franco era. Pretty extraordinarily, given the country's situation, Spanish Prime Minister Mariano Rajoy didn't take part in the press conference following today's cabinet meeting.

It was therefore left to his deputy, Soraya Sáenz de Santamaría, to announce the bad news, accompanied by Energy Minister José Manuel Soria (on the right in the picture) and Treasury Minister Cristóbal Montoro (on the left). In reality, only some general figures were provided, while a clearer breakdown of spending cuts and tax hikes will be provided on Tuesday, after the package is submitted to the Spanish parliament.

We will provide a more comprehensive analysis then (a research piece on Spain is also in the pipeline, so watch this space).

For the moment, these are the most important measures announced today:
  • The total adjustment (i.e. cuts plus tax hikes) is of €27.3 billion. In reality, this needs to be added to the €15 billion package which was adopted as part of last year’s budget in December, but will be implemented this year. This gives us a total of over €42 billion
What has been done
  • Spanish ministries will have to cut their budgets, on average, by 16.9%. Foreign Affairs (-54.4%), Justice (-34.6%) and Defence (-31.9%) will face the toughest cuts. Agriculture (-7.4%), Health (-4.3%) and Economy (-3.8%) will be the least touched;

  • Electricity bills will increase by 7%, and gas bills by 5%;

  • A 'tax amnesty' will be launched. Tax evaders will be allowed to repatriate capital from abroad and will only have to pay 10% tax on the money (not a bad discount, as the highest tax rate in Spain is 43%). The Spanish government estimates that it can make around €2.5 billion out of this repatriation;

  • Certain corporate tax exemptions will be scrapped, so Spanish businesses will have to pay more taxes from now on;

  • Public investment will also be cut – notably, €1.5 billion will be cut from so-called “Active Employment Policies” (i.e. measures to favour labour market access)
What has NOT been done
  • There will be no VAT increase;

  • The salaries of civil servants will be frozen, but not cut;

  • Pensions will remain linked to inflation;

  • Unemployment benefits will remain untouched.
Will the toughest austerity package of the post-Franco era be enough for Spain to meet the deficit target of 5.3% of GDP agreed with the European Commission? Perhaps too early to tell, but this is where the hard work begins: after the announcements, these measures now need to be implemented...

Poland and EU defence: Having your Pączek and eating it

Speaking to the Polish Parliament yesterday, Foreign Minister Radoslaw Sikorski pointed the finger at the UK for not pulling its weight in the domain of European defence, claiming that he was "disappointed" that the UK did not want to build up joint EU defence capabilities, and that those member states that wanted to ought to use the ‘enhanced co-operation’ clause in the Lisbon Treaty to go ahead without it.

Sikorski set out a slightly distopian vision of the future in which:
"Tired by parsimony on defence budgets and Europe's general inefficiency, the US leaves Nato. The post-Western vacuum is filled by Russia in the east and by China in Asia. Transformational crises continue in the Arab world [but] Europe no longer sets a good example. And where is Poland in this black vision? Left to its own devices, on the periphery of a Europe mired in lethargy. Struggling with unfinished modernisation and deprived of a solid basis for national security."
However, actions speak larger than words, and it worth pointing out that Poland’s record on defence spending falls short of Sikorski’s rhetoric; 1.9% of GDP - below the 2% recommended minimum set by NATO. Moreover, when offered an opportunity to cooperate with other European and NATO countries in last years’ Libyan operation it decided to not to get involved, despite being pressed to do so by NATO leaders (although the government did volunteer logistical support).

Sikorski is however right about one thing – Europe’s unwillingness to shoulder the burden of its own defence. The Libyan operation exposed this on a grand scale; although on paper it was an impressive show of European (and non European) cooperation, with states such as France, the UK, Norway, Belgium, Denmark, the Netherlands and Sweden all sending planes to enforce to no-fly zone. Bulgaria, Romania, Italy, Spain and Turkey also helped to some extent and Estonia and Croatian said they would also help if need be, but Poland and Germany did not help and Cyprus was actively opposed.

Furthermore, the operation exposed Europe’s continued reliance on the US. France and the UK were for instance unable to operate independently, having to rely on US command and control, logistics and assets, with the strains on their forces quickly exposed.

So why has Sikorski decided to attack the UK for preventing the EU having a larger role in defence? Most likely it is a form of political displacement activity: Sikorski knows EU defence budgets are under pressure and there is no real prospect of EU states increasing their capabilities. He knows this structural problem would not be alleviated by more EU structures or headquarters duplicating those that already exist in NATO, but by blaming Europe’s defence failings on the UK he is at least fuelling a debate over the future of Europe’s defensive structures.

In our view, if Poland and other European states want to be serious on defence (if they don't that's a national democratic choice which others have to accept) then they should actually stick to the 2% of GDP NATO minimum guideline. Ironically the only EU member states to comfortably exceed it at the moment (apart from the UK at 2.7%) is Greece (2.9%) – the one country that should cut its defence budget. The USA by contrast to the EU average of 1.7% spends a staggering 5.4% of its GDP on defence. EU countries should also reform their defence capabilities by investing in deployable modern forces. In the modern world cooperation will, as seen in Libya, be via variable alliances and groupings, in that the breath of NATO is indispensable. It is not only Poland that fears a defenceless Europe beholden to Russia, but if it is going to lead on this issue it will have to pulls its own weight first.

Who's afraid of the big bad bailout fund?

Update - 12:10: Eurozone finance ministers have already reached an agreement and put out a statement. It's pretty much exactly as we expected, with all assigned funds being rolled into the headline lending volume to give the €800bn.

The fact remains though that, even combined, the funds will not be able to introduce more than €500bn in fresh lending. This was the aim all along. In fact, all eurozone finance ministers have done is correct a previous mistake which would have limited the combined lending capacity to €300bn (as originally the treaty essentially specified that only €500bn in loans could be outstanding at any one time). There should be no illusions that this changes almost nothing (we expect not even the markets which have been reacting to every piece of news will be moved much by this). One thing is for certain though this is a clear win for Germany.

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Eurozone finance ministers are meeting today, in what looks to be the most chilled get-together of this group in recent time. They’re set to sign off on an agreement that will see the combination of the eurozone’s temporary and permanent bailout funds, the EFSF and ESM. On paper, the funds have the potential to produce a combined firewall of €940bn. Still far too little if Italy and Spain went, but an impressive sum nonetheless. That is, on paper. In reality they won’t even come close to this.

In an interview with Bild this morning, German Finance Minister Wolfgang Schauble said he didn’t want to “unnerve markets with numbers”, but in a speech in Copenhagen he did just that, saying,
"We have 500 billion euros in fresh money available, together with the programs already agreed for Ireland, Portugal and the new program for Greece. It is about 800 billion (euros). I think it's enough."
Apparently, Schauble reached this number by adding €500bn from the ESM, €200bn from the EFSF, €56bn in bilateral loans to Greece and €60 billion from the third bailout fund, the European Financial Stability Mechanism (EFSM) – which is underwritten by all 27 member states via the EU budget. But much of this cash has already been spent, i.e. the EFSM only has €11bn left, and some of the other money can’t actually be lent out. In addition, the remaining €240bn in unused EFSF capacity will be held back for ‘exceptional circumstances’ until mid-2013.

As we’ve been reminded of time and again, the only thing that matters is effective lending capacity. The real amount of cash that is still available to back stop struggling states, should it come to that, is only around €500bn. Here’s the lending capacity math (courtesy of some excellent analysis by the WSJ):
  • Mid-2012 – The ESM will be limited to €210bn (as it will only have €32bn in paid-in capital). Along with the €240bn in ‘exceptional’ funds, this gives a total potential lending of €450bn. (The money which is already out the door should be ignored)
  • Mid-2013 – Following a second instalment of capital the ESM will be able to lend €420bn. The ‘exceptional’ funds will be wound down around this point.
  • Mid-2014 – All ESM capital paid-in, reaches total lending capacity of €500bn.
(There is one caveat to these figures, in that the eurozone could decide to speed up the paying in of ESM capital if the funds were needed. However, this would likely face significant opposition from the likes of Germany and Finland, and is therefore most certainly a last resort).

So despite Schauble’s comment, euro finance ministers continue to throw various different numbers around, which bear few resemblances to reality. We also note that the French Finance Minister, François Baroin, yesterday floated an unfortunate analogy. He said,
"The bailout fund is a bit like the nuclear weapon in the military domain…It is not intended to be used but to act as a deterrent."
The problem here is that if it’s too big and terrible to ever be used, it’s likely that it won’t ever be used. Even jittery markets will be able to figure out that a large fund which would damage French and German credit ratings if ever extended will never be fully tapped. So clearly some circular logic at play. And let's not forget that it’s still far too small to save Italy and Spain should if worse come to worse.

But at least eurozone ministers can look forward to a quieter Friday than usual...

The Monti paradox

Over on EUobserver, we take a look at what can be described as the "Monti paradox":
One of the main reasons why the euro crisis has calmed down is Mario Monti – the Italian Prime Minister who replaced Silvio Berlusconi last year, and who now heads a ‘technocratic’ government of professors, economists and former government officials.

But while Monti is pushing through some vital changes in Italy, his lack of a clear mandate from voters could backfire – and spell big problems for the eurozone. There’s clearly a paradox here: Monti took over from Berlusconi (who really was a disaster) following pressure from Berlin and Paris, and runs a government with no directly elected politicians as members.Understandably, this left many worrying about the state of national democracy in Europe. But, at the same time, Monti has so far proven surprisingly popular.

In the polls, his approval ratings have been around 50-60% and he still enjoys strong (but not unconditional) backing in the Italian parliament. That he draws such levels of support should help, as Monti – an economic liberal educated in the US – is intent on driving through some serious structural reform in Italy, finally pushed by markets to do so.

Heaven knows Italy needs it, particularly in the labour market. At the moment, it’s easier to cross the Alps with elephants than to fire someone in Italy, meaning that it’s also extremely costly and cumbersome to hire people. Under the current system, almost anything can count as ‘unfair’ dismissal and judges have huge power to order employers to hire back workers, even for the most trivial reasons. The Italian system goes far beyond other countries with rigorous dismissal procedures, such as France.

For example, one famous case saw an Italian worker, who had called in sick, being filmed while he was taking part in a protest against a trade union leader in Turin (double irony here). Naturally, his boss decided to fire him as, under any reasonable definition, the worker was taking his boss for a ride. However, the worker appealed the case in Court, claiming ‘unfair’ dismissal. The judge sided with the worker and ordered the employer to hire the guy back. His lawyers maintained that the illness he was suffering from prevented him from doing his job but not from engaging in various other activities, including, apparently, protesting in a rally.

Monti is seeking to deal with such abuses by doing what common sense would suggest – radically changing the way ‘unfair dismissals’ are dealt with under Italian law. According to his plan, workers will have to be re-hired only if they have been victim of genuine discrimination (but, in all other cases of ‘unfair dismissal’, workers will still have the right to claim generous compensation).

Monti is also trying to push through a series of other key changes to Italy’s labour market, including making it easier for young workers to be put on permanent contracts and opening up professions such as chemists and notaries.

As is always the case when trying to change entitlement cultures, the road ahead for Monti looks rocky, with Italy’s biggest trade union planning a series of counter-attacks and the centre-left parties pledging to water down the measures in Parliament. And herein lays the risk: Monti has no popular or electoral mandate to fall back on when the going gets tough.

The governments in Spain and the UK are facing strikes and discontent as well, over tough reform measures. But, save coalition complications in Britain, both governments can always point to the mandate that they got from voters in a general election, even when the opinion polls turn against them.

Monti does not have that luxury and already there are signs that support for him is dwindling, as his reforms become better understood. A recent opinion poll showed support down from around 60% to 44% in less than one month, casting doubts as to whether he’ll stay until 2013, the end of his scheduled term.

This begs the question, what happens to his support once the reforms really start to bite, and his lack of a popular mandate really becomes apparent? The risk is that he ends up not only an unelected but also a deeply unpopular Prime Minister that is forced out before the reforms – which must be pushed through with patience and persistence over a number of years – have been completed.

The best scenario would perhaps be for Monti himself to run in the elections in 2013 (or even earlier), to get that clear mandate and get on with business.

Because who would take over from Monti? Support for single political parties in Italy is shrinking, and none of them look able to secure an absolute majority on their own, so we’re looking at another complicated coalition.

A centre-right one is more likely to continue Monti’s work though that is by no means a guarantee, while a centre-left alliance, which might feature smaller left-wing parties, could even reverse Monti’s reforms. If that is the course of democracy, so be it. But there should be no doubt that without the reforms currently being planned, Italy – and its €1.9 trillion debt mountain – will remain a huge liability for the eurozone.

Technocracy may be working in Italy for now, but at the end of the day, there is no replacing the power and conviction that only democratic legitimacy can provide.

Thursday, March 29, 2012

Two Big Days For Spain

A 24-hour general strike is under way in Spain, in protest against the centre-right government's labour market reforms. Reports in the Spanish media suggest that participation rates have been higher in the manufacturing sector than in services. 58 people have so far been arrested and nine injured following isolated clashes between protesters and the police.

For the moment, the Spanish government seems to be sticking to its guns. Economy Minister Luis de Guindos said yesterday that "not a comma" of the labour market reform would be changed after today's strike.

And tomorrow's going to be another big day for the future of Spain, with the government due to announce its budget for 2012 and a new round of austerity measures designed to bring the deficit down to the 5.3% of GDP agreed with the European Commission. At the moment, Spanish Prime Minister Mariano Rajoy and his ministers have been tight-lipped about the details of the new austerity package.

We know from Rajoy's recent remarks that Spanish ministries will be required to cut their budgets by 14-15%, while de Guindos hinted at "limited" tax hikes - but the bulk of the measures remain largely unknown. Doubts have also been cast over how much the Spanish government will actually have to cut in order to meet its deficit target for this year. €15bn in cuts were already scheduled at the end of last year, but a new report from the Spanish Savings Banks Foundation (FUNCAS) has put the total required figure at €55bn, while Spanish economist Luis Garicano has suggested between €53bn and €64bn. Both numbers are much higher than the 'mainstream' €34-35bn estimate being touted up to now.

Whatever the size of the cuts announced tomorrow, the sense is that today's will not be the last general strike the Spanish government will have to deal with.

Tuesday, March 27, 2012

Who were the naughtiest Europeans of 2011?

No, this is not another one of those taxpayer funded EU awards. This is about what takes place beyond the rhetoric, political horse-trading and posturing amongst ministers and diplomats in Brussels. This about the tiny matter of actually implementing the measures that you've agreed and signed up to. Surely, that must constitute a key qualification for being a good European?

The European Court of Justice (ECJ) has just released its annual report of activities for 2011, and a specific graph caught our attention:

The graph illustrates the number of "Judgements concerning failure of a member state to fulfil its obligations" - in plain English, the number of times a country either broke or refused to implement EU law. We note that ten member states, including countries as diverse as the UK, Bulgaria, Denmark, Latvia and Slovakia, ended 2011 with a clean sheet. Gold stars to them.

In contrast, Belgium was the naughtiest EU member state of last year, with the ECJ ruling against the country for failing to implement EU law no less than nine times. Various southern European countries were pretty naughty too: Italy and Portugal were slapped with eight rulings each, and Spain seven. France and Germany were both pretty naughty Europeans as well, losing six and five cases respectively, while Greece lost four.

Taking the longer view, the picture looks worryingly similar. Between 2007 and 2011, the UK lost 14 court cases for failing to implement EU law, while Germany lost 25, France 36, Spain 56 and Italy 66. It is also noteworthy that the newest member states are much better at implementing EU law than the EU's founding members.

We cannot help but to flag up the irony at play here. Countries that have traditionally put themselves forward as champions of European integration have a pretty appalling record in abiding by EU law. While this is nothing new, it should nonetheless challenge lazy assumptions and labels such as being "good" and "bad" Europeans.

A bit like the "good citizen" being defined as someone who is excellent at dreaming up new laws but with a terrible habit of then breaking them.

Isn't a good European someone who wants the EU to regulate far less but far better and with far better and pointed implementation of the laws that are agreed? Someone who wants a slimmed-down EU based on substance rather than one based on rhetoric?

We know the answer, do you?

Monday, March 26, 2012

Is this party over?

Yesterday's elections in the German region of Saarland saw a somewhat unexpected surge for Angela Merkel's CDU party, which won 35.2% of the votes, ahead of the Social Democrats (SPD) on 30.6% and the far-left Die Linke on 16.1%.

As Torsten Krauel comments in Die Welt, despite expectations of an SPD victory, “The CDU held its own. Angela Merkel will appreciate this when it comes to the formulation of further conceivable eurozone rescue packages”.

But perhaps equally significantly, Merkel’s junior coalition partner at the national level, the FDP, won only 1.2% of votes - a massive drop of 8% compared with the previous elections. In fact, the FDP only just beat the neo-Nazi NPD party by 267 votes.

This also means that in all the regional elections that have taken place over the last two years, the FDP has only managed to get re-elected its heartland of Baden-Württemberg, and even then they just about scraped in with 5.3% of the vote. Despite its history as a party of government (it has often played the role of kingmaker for either the SPD or CDU/CSU), it is literally being wiped off the map, having completely failed to re-invent itself.

As the party stares into the abyss, former party leader and one-time golden boy of German politics Guido Westerwelle (in our view increasingly marginalised as Foreign Minister) organises conferences looking at the prospects for fundamentally re-shaping the EU's constitutional architecture after the crisis, which although undeniably important in the longer term, can hardly be deemed to be a priority for voters concerned about the 'here-and-now' of the eurozone crisis and Germany's role in the bailouts.

Meanwhile, Germany’s young and swinging Pirate Party, which has been critical of the bailouts, came fourth with 7.4%, meaning it has secured seats in Saarland’s regional parliament for the first time. It also won seats in last year's regional election in Berlin and looks competitive in polls ahead of the impending elections in Nordrhein-Westfalen, Germany's most populous state. The Pirates are also contributing to a wider cultural change in German politics, for example pushing mainstream politicians to become more social media-savy, e.g. by joining Twitter, which the Pirates have utilised to great effect.

So as the FDP's star wanes (or more accurately comes crashing down to earth), the Pirates are definitely the ones to keep an eye on...

Is the future of the euro inevitably linked to gold?

Here's a rather interesting - although perhaps not a new - perspective on the euro. Slightly more optimistic than the doom and gloom that are commonplace these days (yes, we're guilty too).

James Rickards, an American lawyer, economist and investment banker (and a notorious Fed money printing critic), and author of bestselling "Currency Wars", published in 2011, has, somewhat counter-intuitively, rushed to defence of the euro.

In an interview with Goldmoney, Rickards sets out the two main reasons why he's "bullish" on the euro:

1) There's sufficient political will amongst EU leaders to introduce fiscal transfers from north to south, thereby paying the price to keep the euro intact

2) The eurozone sits on a formidable backstop, as its member states hold more gold than the U.S. (8.133 tons vs. more than 10.000 tons), noting that the size of the UK debt mountain could be of more concern than that of the eurozone (despite, we would add, total debt levels in eurozone being higher than those in the U.S).

Rickard is actually convinced that the euro will in some way be pegged to gold eventually, as that is the only credible backstop that the euro has at its disposal.

We're not entirely convinced - but an interesting perspective. You can watch the interview below.


Friday, March 23, 2012

Have the Germans been good Europeans this week?

Earlier this week, German Foreign Minister Guido Westerwelle held a meeting with a number of his European counterparts dedicated to 'conceptualising' the political composition of Europe after the crisis has passed and provide some though leadership.

Ahead of the meeting, the German Foreign Ministry released a Communication entitled “Explaining Europe, Discussing Europe”, which put Germany’s EU policy into ideological context, including statements like:
“Our country is prospering in the united Europe. The fact that we have closer ties with our European neighbours today than ever before is a tremendous enrichment for us... Europe is the definitive answer to 'the German question'. That is why we bear a particular responsibility for ensuring that European integration is carried forward with our neighbours in France, Poland and the other member states."
To what extent Westerwelle's initiative enjoyed support from across the German Coalition government, including the Chancellery, as well as the Bundestag and the German public as a whole, is an open question.

However, as we have pointed out on numerous occasions, the above rhetoric is a reflection of Germany’s ideological commitment to European co-operation in the post-war era. However, modern Germany also has a number of other important ideological foundations such as a commitment to low inflation and restrained monetary policy, a strong system of political checks and balances via the Basic Law, and a strong tradition of individual rights and liberties. The realities of EU integration often clash with these other key principles, as a number of stories from Germany this week have served to illustrate. We will briefly cover these in turn:

1. The size of the Eurozone bailouts

While opposition to the bailouts is hardly a new development in Germany, we learnt this week that the German government looks to have finally dropped its opposition to running the eurozone’s two bailout funds, the temporary EFSF and the permanent replacement ESM in parallel, or possibly even combining them. The government decided its position had led to Germany being isolated within Europe, however as Handelsblatt reports, many MPs within the Coalition are unhappy and could rebel on the issue.

2. The EU’s Data Retention Directive

This has always been the subject of a long-running dispute between the EU and Germany after Germany’s Constitutional Court (often an inconvenient truth for EU laws) ruled that the Directive was incompatible with the Basic Law. Consequently, the government repealed the legislation but has not to date put forward a replacement, meaning it is in breach of EU Law. Germany has failed to heed the Commission’s reprimand back in October, and this week EU Home Affairs Commissioner Cecilia Malmstrom (whose native Sweden has so far also failed to transpose the Directive into national law) insisted that Germany issues a commitment to doing so within the next four weeks. The Directive is very unpopular in Germany, as yesterday’s Süddeutsche comment cartoon shows:



3. The ‘VW’ law

Another long-standing dispute between the EU and Germany concerns the so-called VW law, under which the state government of Lower Saxony controls a blocking minority of 20% of Volkswagen shares. The EU has long contested that the law illegally restricts the flow of capital in Europe, but despite being amended in 2008 following an ECJ ruling, the Commission announced this week that it would again seek to challenge it prompting German Economy Minister Philipp Rösler to say that the government stands by the law and intends to “aggressively defend” it.

4. Revision of the Posted Workers’ Directive

Another story in the German press this week argued that the Commission’s revision of the Posted Workers’ Directive could make it far harder for member states to crack down on black market labour, clearly a big issue in Germany’s large construction sector. An editorial in Die Welt argued:
“Brussels should not regulate every aspect of life to the smallest detail…member states constantly get the feeling that the democratically barely legitimised EU commission interferes in things which are none of its business, and, what is worse, their interventions only make things worse.”
As the four examples illustrate, when rhetoric clashes with realities of EU integration, Germans are often very keen to defend their own way of doing things - just like all other member states...

Taxing unicorns

The European Commission continues to spend a huge amount of taxpayers’ time and money pushing around its proposal for an EU financial transaction tax (FTT), despite it by all accounts looking like a complete non-starter – something which even the German government, one of the instigators, has now implicitly admitted.

Following a barrage of criticism for its initial proposal, tabled in the autumn, the Commission is now desperately trying to brush up on its figures and presentation, to counter what it claims to be a series of “distortions” about the nature and impact of the tax. The aim is clearly to make the proposal more attractive in places like the UK and Sweden (good luck!). In this vein, EU Budget Commissioner Janusz Lewandoski gave a lengthy presentation in the European Parliament yesterday highlighting the potential ‘savings’ which EU countries could make on their contributions to the EU budget if an FTT was introduced and then used to fund part of the EU budget.

This would have been a nice try had it not been for one small issue: the Commission’s polished figures and arguments are completely contradictory and illusory. In fact, Lewandowski’s presentation might as well have been about a proposal for a new tax on unicorns (we can already see the tabloid headlines).

The Commission’s “improved” case for the FTT, rests on one policy proposal and one assumption (p.10 in the presentation):
- Policy: All countries will contribute 2/3 of the nationally-collected revenue from an FTT to the EU budget, which will reduce the contribution for some member states

- Assumption: “Taxable transaction volume develops in proportion to nominal GNI” – this means that the potential revenue from the FTT (essentially the size of a countries’ financial service sector) is directly proportional to its nominal GNI
The Commission has even produced a graph showing how contributions from member states would change were an FTT used to fund the EU budget. Under this scenario, says the Commission, the FTT would be a ‘win-win’ for the UK because the Government would suddenly have a new stream of revenue – a third of which the Commission would kindly allow the UK could keep for itself, while the rest would fund the EU budget, replacing the current contribution.

It’s very difficult to take this seriously. Everyone knows that the assumption that countries’ financial services sectors are proportional to their GNI is fundamentally untrue. The UK financial services sector is huge and proportionately much bigger than the financial services sector in other EU countries. This also means that the actual policy proposal makes no sense whatsoever.

In the real world, the UK accounts for around 72% of all EU financial transactions. Any budget contributions from an EU wide FTT would need a complex burden sharing arrangement to even out the contributions across the EU – something which is just assumed away under this proposal but still remains a very real obstacle. If the assumption doesn’t hold then contributing 2/3 of the UK FTT revenues to the EU budget would probably radically increase the UK's EU budget contributions (hence the need for some form of burden sharing).

So fundamentally the figures and the graphical representation, although pretty, are totally incorrect.

These assumptions are also incompatible with the figures which were originally drawn from the Commission’s impact assessment on the proposed EU FTT. These figures were based on volumes of financial activity accurately measured around Europe, and therefore accepted that the UK is home to Europe’s largest financial centre.

The original European Commission proposal also accepted that 90% of derivatives transactions, along with many other financial services, could be displaced outside the EU as a result of a European FTT. Given the UK’s share of this market it would hit the economy and tax intake incredibly hard. The reality is that the cost of an EU-wide FTT to the UK economy as a whole would be huge, (see here, here and here for a full discussion of the FTT drawbacks for the UK and Europe).

There are plenty of other steps which need to be taken to improve regulation and oversight of financial services in the EU, not least on-going issues with bank capital levels. The Commission would be far better spending its time and taxpayers’ cash on these productive measures rather than defending Kafkaesque proposals with little chance of working in practice or being accepted.

At some point, you just have to admit defeat.

Thursday, March 22, 2012

Can A Fictional Character Break EU Law?

Apparently yes. Here's a peculiar story which is all over Italian media: according to Italian papers, the EU Fisheries Commissioner Maria Damanaki has written a letter to the 86-year-old, famous Italian writer Andrea Camilleri complaining - somewhat tongue-in-cheek, we hope - that the writer's best-known fictional character is regularly and blatantly breaking EU law.

A bit of cultural background: Camilleri is the author of a series of best-selling crime novels, which have also been turned into successful TV episodes for Italy's public broadcaster RAI. The main character of the novels is Sicilian police detective Salvo Montalbano - played by actor Luca Zingaretti in the TV version (see picture) - whose favourite dish happens to be small squids.

The problem is that the sale of so-called 'baby fish' for human consumption is forbidden under EU law. Thus, Commissioner Damanaki worries that every time Montalbano enjoys a portion of small squids at home or in his favourite restaurant, he sends the wrong message to millions of readers and viewers. She has therefore kindly asked Camilleri to change the eating habits of his fictional creation.

Damanaki writes on her blog,
I am a big fan of Andrea Camilleri, the well-known Italian writer who created Montalbano, and I intend to write him a letter to pay tribute to his work, but also to ask him to stop having the protagonist of his novels eating small squids: that is unethical!
The outspoken 86-year-old writer has said that he has not yet received any letter from Damanaki, but added,
Well, perhaps a bit more seriousness is needed. Montalbano likes cliff mullets, which are not forbidden, and sometimes also eats bianchetti [white baits]...
Our question: If Camilleri refuses to comply, will Ms. Damanaki launch a fictional infringement procedure?

Wednesday, March 21, 2012

The budget which austerity can't touch?

Amongst all the hustle and bustle of the budget, there's always the interesting side-story of how much, exactly, UK taxpayers contributed to the EU.

Combing through the latest figures released by the OBR today (yes, we're talking the very fine print, which only people with some sort of obsession look at), we noticed a massive discrepancy for the UK’s net contribution to the EU, compared to the figures produced in the pre-budget report back in November.

In fact, the estimate for 2010-11 increased by £1.1bn (13.6%) compared to what the UK government budgeted for in November, while the estimate for 2011-12 increased by £1.8bn (26%). Some of this is expected to be recouped over the following two years with lower contributions but overall the forecasts for the UK net contribution up to 2014 have increased by £1.8bn.

The table below sets out the new estimated net contributions to the EU budget (see here and here to compare the original tables):





Not a sum to be sniffed at given the savings which the government is looking to make and the overall amounts involved here.

So why were the forecasts from only four months ago so far off?

The OBR and Treasury reports from today provide little insight on this front. The main change comes from a fall in the public sector funds which the UK receives from the EU (e.g. farm subsidies and regional spending). Since this falls and the gross contributions stays roughly the same, on net the UK is contributing more.

Why have these funds fallen so suddenly?

Again, it’s difficult to say, but it seems strange given that all the EU spending has been negotiated and laid out well in advance. One reason could be that the UK government decided to shelve some projects which involved ‘co-financing’, where the government has to fund part of the project (between 25% - 50%) to release the EU funding for the rest of it. The government may have reduced such projects to reduce its spending, which would have resulted in it accessing a lower amount of EU funds. It also seems strange to us that the UK rebate did not adjust for this (or has not been forecast to) since part of its calculation relies on how much the UK actually gets back from the EU budget.

This also goes to show the perverse incentives inherent in the EU budget, where national governments have to spend money to unlock the funding (under co-financing) - or see the funds cancelled. Though there's an opportunity to recoup some of the cash further down the road, it puts any government that is trying to cut its deficit in a very difficult position. One way or another, it'll lose out.

In any case, it is more than a little concerning that the forecasts were so substantially wrong only a few months ago (particularly since the 2010-11 budget year had already finished by that point).

The EU budget contribution is clearly not the biggest or most important item on today's agenda - but it's definitely not becoming any better value for taxpayers' money.

Coalition rope pulling - the European Arrest Warrant

Yesterday's news that a British man has been served with a European Arrest Warrant (EAW) in a high profile case he was cleared of by a Portuguese court in 1995 has again raised the issue of the malfunctioning European Arrest Warrant (EAW).

The problems with the EAW are well documented and mostly flow from the flawed assumption that all European justice systems are broadly of the same quality and tradition - the reality is that they differ - as well as an absence of civil liberties checks and a proportionality principle, some hand down better justice than others.

That being the case, there is a need for stronger safeguards before the UK hands over its own citizens to other countries. Reform has been spoken of for years (the need for it even admitted by the European Commission) so why the muted British response? As with much of the Government's programme it comes down to internal Coalition horse-trading. Here is how the parties stack up:

Conservatives:
  • As a backbench MP, David Cameron described the EAW "highly objectionable":
"I find the European arrest warrant highly objectionable because of the problem of dual criminality... let us be clear about what it means. One of our constituents goes to Spain on holiday, commits an alleged offence, and returns home. All that is necessary for him or her to return is that the warrant is correctly filled out… and that a district judge in the UK sees the warrant and judges that the offence falls into one of the 32 categories. At no time is it asked whether the offence is a crime in this country."
  • 102 Conservative MPs backed the conclusions of Open Europe's recent report which argued for the block repatriation of EU powers on crime and policing, with the option of opting back in to selected measures.
  • Conservative MPs and MEPs have long campaigned for reform of the EAW. Conservative MPs, including David Cameron, voted against the EAW in the House of Commons and made EAW-reform a part of their last European Parliament Election Campaign saying “Conservative MEPs will uphold civil rights, and will work to avoid a repeat of the lack of safeguards in the European Arrest Warrant.”
Liberal Democrats:

The issue of the EAW cuts across two Liberal Democrat core beliefs; a commitment to European co-operation and Civil Liberties.
  • Nick Clegg recently defended the EAW as "indispensable" though also admitting that it needed reform.
  • Liberal Democrat MEPs helped to shape the EAW in the European Parliament; Sir Graham Watson MEP was the Parliament's rapporteur (Nich Clegg and Chris Huhne were both MEPs at the time)
  • Ed Davey, now a Business Minister (then Lid Dem Europe's spokesman) was keen on the EAW at the time of the Lisbon Treaty debates, arguing the Conservatives wished to create a “Costa del Crime”.
  • Curiously Nick Clegg has also championed reform of other extradition arrangements, such as the US/UK extradition treaty calling it "lopsided and unfair".
  • In fairness, Lib Dems have also called for reform of the EAW, with MEP Baroness Ludford highlightingd the EAW's problems (she is also a patron of Fair Trials International).

So what will happen when a decision is forced on the Coalition in 2014?

As we have highlighted in a recent report, under the Lisbon Treaty, the UK will have to decide by 2014 whether to accept the jurisdiction of the European Court of Justice (ECJ) over the EAW and 130 other EU Crime and Policing measures. At this point (or preferably before) the Coalition will have to decide whether it wants the ECJ to have permanent jurisdiction over an unreformed EAW or leave the EAW altogether.

The Conservatives and Liberal Democrats have long held opposing views on the EAW that will be difficult to climb down from and make the collective decision very tough. In the end it is likely the loudest voice will prevail - and this could well turn into a loud and noise debate.


But perhaps there is another way forwards. There is a growing consensus that the EAW and extradition laws generally need to be reformed, something the Liberal Democrats recognise with regards to the UK/US extradition treaty when the wider issue of Europe is not at stake. It should therefore be possible to find a middle ground. This would be for the Coalition to opt out of ECJ jurisdiction over the unreformed EAW and argue for reform in order to make it possible to rejoin it later. For this to happen it would be best to make the decision now in order that the substantive negotiation is completed in time for 2014.

Internal coalition disagreements aside, surely this is an area where all sides stand to gain from EU reform?

Tuesday, March 20, 2012

Ashton In Hot Water

Update 15:02 - Two additional twists to this story. The Telegraph's Bruno Waterfield has just noted on Twitter that an 'amended' version of Ashton's speech has now been published (see here). The controversial paragraph now reads, "When we see what is happening in Gaza and Sderot [an Israeli town less than one mile from Gaza] and in different parts of the world" - i.e. it explicitly mentions victims on the Israeli side of the Gaza strip. Amending a transcript would seem like a weird exercise had it not been for the fact that Ashton actually does make the reference to the two sides in the speech she delivered yesterday (available here, the reference is 12:30 in).

In other words, a full-scale diplomatic row has been triggered by what looks like a most unfortunate typo in a transcript.
..

EU foreign policy chief Baroness Catherine Ashton - or 'High Representative for Foreign Affairs and Security Policy and Vice President of the European Commission', as her official title reads - has a difficult job. In fact, its up there with managing the English national football team in terms of 'can't win' positions.

After having been on the receiving end of a barrage of criticism from left, right and centre, not least a letter signed by twelve member states in December - including Germany, France, Italy and Poland – in which they expressed concerns over the functioning of the EU's diplomatic service, the EEAS, Baroness Ashton has landed herself in some fresh controversy.

In a speech to a group of Palestinian youth in Brussels yesterday, she said,
"And the days when we remember young people who have been killed in all sorts of terrible circumstances - the Belgian children having lost their lives in a terrible tragedy and when we think of what happened in Toulouse today, when we remember what happened in Norway a year ago, when we know what is happening in Syria, when we see what is happening in Gaza and in different parts of the world - we remember young people and children who lose their lives."
This didn't go down well with the Israeli government, with a number of ministers coming out to criticise Ashton for what they see as an inappropriate comparison and reference. Defence Minister Ehud Barak said, "I hope that the EU's foreign minister will quickly realise the mistake she made and withdraw her comments." Opposition leader Tzipi Livni added,"There is no similarity between an act of hatred or a leader killing members of his nation and a country fighting terror, even if civilians are harmed."

Interior Minister Eli Yishai went even further and called for Ashton's resignation:
"The statement by Lady Ashton further harms the ability of the European Union to be an honest broker [between Israel and the Palestinians...[Ashton] can no longer serve in her position."

In a statement today, Ashton's spokesperson sought to clarify the remarks:

We want to make this clear, because her words yesterday...were grossly distorted by one of the news agencies. In her remarks, [Ashton] referred to tragedies taking the lives of children around the world and drew no parallel whatsoever between the circumstances of the Toulouse attack and the situation in Gaza.

Judge for yourselves - Asthon's full speech is available here, with the last paragraph being the key one for the discussion.

As we said, Ashton really does have a difficult job.

Spain v Commission: another round

The relationship between the European Commission and the Spanish government is clearly not all warm and fuzzy at the moment. After the discussion on deficit reduction targets, Spain has now also come under fire for its use of EU structural funds.

Spanish Agriculture Minister Miguel Arias Cañete (in the picture) recently told MPs that the plan for the construction of desalination plants across the country has turned out to be "a spectacular failure". He explained,
According to the plan, 51 plants were to be built. At the moment, 17 are in use and 15 are under construction. €1,664 million was invested, and we need an additional €762 million if we want all these 32 desalination plants to be operative.
Furthermore, Arias Cañete noted that the existing plants are only working at 16.45% of their maximum capacity. Although the project was launched by the previous Socialist government, it is now for the new centre-right cabinet led by Mariano Rajoy to sort out the situation and decide, among other things, if it is still worth starting work on the remaining 19 plants, as initially planned.

As you may expect, the bulk of funding for these plants came via the EU's structural funds, out of which Spain has done very well. And the European Commission is not happy. Here is what a spokeswoman for EU Environment Commissioner Janez Potočnik said in an e-mail quoted by El País,
A significant amount of European funds, around €1.5bn, has been invested in desalination plants across Spain over the past few years. We have taken note of the statement to the [Spanish] parliament that they are working at 16% of their capacity. This calls into question the effective use of European taxpayers' money.
The Commission also said that it now expects the Spanish government to "take the appropriate measures to achieve the best use of these infrastructures paid with EU funds", warning of "a big negative impact on the availability of European funds for Spain".

Incidentally, in our recent report on EU regional spending, we pointed out that while EU subsidies may have benefited individual regions during a limited period of time, they have been poorly targeted in Spain. When Spain needed to address its overheated economy and property bubble, EU structural and cohesion funds were channelled towards infrastructure projects, which were already subject to abundant private credit and over-investment at the time. Indeed, 28% of these funds are still set to go towards infrastructure projects in different forms during the current EU budget period (2007-2013).

Spain needs a lot of things, but more roads or non-operational desalination plants are not among them.

All of this goes to show that EU regional spending is in urgent need of a radical overhaul, which would far better serve Spanish and European economies. In case you missed it, we set out how such an overhaul should look in the report we published in January.

The expression "win-win" springs to mind.

Monday, March 19, 2012

Has Osborne taken a crash course in Portuguese accounting?

Has the Treasury been taking some accounting tips from Portugal? One would hope not given Lisbon's current predicament.

But an interesting story has surfaced ahead of the UK government’s budget announcement. Apparently, the UK government is taking over the Royal Mail pension funds, transferring its assets and liabilities onto the government balance sheet.

Now, we don't have a dog in this fight, but there's an interesting EU angle here, which we suspect few people have spotted. In fact, the episode instantly reminded us of the situation we have seen in Portugal over the past two years, where one off transfers from pension funds have allowed the government to meet its deficit targets (see here and here). Essentially, the assets move onto the government’s balance sheet and can be sold to raise money (or just held for accounting purposes). However, the liabilities which are ‘contingent’, since they fall well into the future, do not appear in the standard calculations of government debt. This means that, magically, public finances get a sudden boost (allowing the government to increase spending or cut the deficit further). Unfortunately, the downside for taxpayers is that they will now be liable for these future pension pay-outs. As ever, there's no such thing as a free lunch.

Not exactly good accounting, and, as others have pointed out, something which no EU government would let a private company get away with.

This isn't a huge deal, but it's interesting that the IMF and the EU team - and therefore indirectly the UK - which bailed out Portugal, didn’t seem all too happy with Portugal for taking such unusual one-off measures. The latest EU/IMF/ECB troika report notes that such measures do not constitute part of the “structural consolidation” and should be seen as exceptional.

To be fair to the government, it hasn't yet said how this money will be used. It will be interesting to see if it goes towards meeting deficit targets, funding a tax cut or any other budget adjustments. One thing to keep in mind though is that this is a one-off boost, if its used to cover a permanent cut in revenue or increase in expenditure there will be a new hole to fill in the budget next year.

In any case, since Portugal is likely to need a second bailout as some point soon, we hope that this isn't a bad omen for the UK economy...

Friday, March 16, 2012

Do Germans really want a "United States of Europe"















Over on the Telegraph blog, we argue:

If judged solely on the British public debate on the future of the EU, one could be forgiven for thinking that – driven by eurozone crisis – everyone else in "Europe" is now happily storming towards a European superstate, leaving the UK behind. It's sort of inevitable, the logic goes.

Such a narrative is deceptively simplistic.

A new, interesting YouGov-Cambridge poll out this week, looking at European attitudes amongst citizens in the UK, Germany, France, Italy and Scandinavia is a case in point. As expected, a full 40% of Brits want a “looser” relationship with Europe. Another 13% want no more integration while 20% want to withdraw altogether. These attitudes span the political divide.

Pointing to the results in the three eurozone countries surveyed, YouGov-Cambridge concludes: "The eurozone and Britain are heading in two starkly different directions, with Europe on course for more integration – and possibly all or some elements of a 'United States of Europe." But is this really what this poll, and similar ones on voter sentiments, are telling us?

In particular, does such a conclusion capture the complex debate currently taking place in Germany – a country which, in the wake of the euro crisis, to a large extent holds the key to the future of Europe? (See here, here and here for examples.)

Regarding the particular question which commentators have focused on, respondents were asked whether they supported “'turning the EU into a fully integrated ‘United States of Europe’, with a central European treasury that strictly enforces common rules on national budgets and government spending for individual countries”. 35% of Germans answered in favour (as did 38% of French and 63% of Italians).

It's easy to get excited about this, but it is important to consider a number of factors. First, German voters are actually split right down the middle on the question, with 32% saying they opposed the idea. Secondly, the question will have had different connotations in Germany, where federalism means a structure with clearly defined powers across all levels of government, with a system of checks and balances. In Britain, it simply connotes more EU centralisation. Thirdly, and most importantly, the question itself is phrased in such a way that implies greater enforcement of budgetary discipline.

It’s hardly surprising that German voters would support this, given the widely held perception there that what "profligate" eurozone members need is more budget discipline (German taxpayers’ cash is on the line, remember).

Unsurprisingly, as soon as the focus switches from more budget oversight and discipline to more cash, Germans’ support for further integration plummets, which YouGov-Cambridge also concedes. For example:

- In a separate question, which made no reference to strict penalties” or “enforcement” 68% of Germans said they believed “tax rates and national budgets” should be controlled nationally

- 53% think that it’s “wrong” for Germany to spend money to save the euro

- 40% think Eurobonds would be a “bad thing” for Germany, and only 17% think they would be a “good thing”

- 51% want Greece to leave the euro, which per definition is integration in reverse

In other words, Germans – and voters in most other EU countries for that matter – tend to be supportive of EU integration where this conforms to their own image, but they otherwise oppose it. This also means that Germans still remain opposed to the form of eurozone integration that to many obersvers really counts at the moment – more cash going from north to south.

There clearly are areas where UK public opinion differs from core eurozone countries, for example on military cooperation and banking regulation. But following the money, all of a sudden, the ideological gap between German and British public opinion looks a lot narrower.

All of this to say that, ultimately, we have no idea how voters in the eurozone – and Germany in particular – will respond to proposals for a fully-fledged political and fiscal union, and therefore what the future of the euro will look like.

So what do Lib Dem voters really think about Europe?

Over on Lib Dem Voice's 'Independent View' we've published a guest post looking at the what the party's voters and members really think about the UK and Europe, and how we think the leadership ought to respond:

In the polarised and often exaggerated UK debate on the EU, the Lib Dems have often been caricaturised by much of the press and Tory MPs as being unreservedly in favour of greater EU integration or even an ‘EU super state’. The truth is of course far more nuanced.

That’s why a new YouGov/Cambridge cross-country poll out earlier this week is so interesting. It shows that a majority of UK voters (53%) support either no further EU integration or a looser arrangement. Only 14% said they wanted more integration. These attitudes span the political divide, with 50% of Lib Dem voters saying they wanted either a looser relationship with the EU or outright withdrawal. On the thorny question of whether primary responsibility for specific policy areas should lie with national capitals or Brussels, Lib Dem voters want more national control over areas such as police and crime, employment laws and trade almost as much as the average UK voter, and even more on agriculture.



















Source: YouGov-Cambride poll ‘Cross-country attitudes on Europe’, 13 March 2012

Similar trends can be seen in the Voice’s own polling (here and here) suggesting that both Lib Dem members and voters would reject working closer economic and political union in Europe. But while Lib Dem politicians have criticised individual aspects of EU policy, such as the Working Time Directive or the Common Fisheries Policy, on the whole the party leadership has so far not put forward an alternative vision for the EU-UK relationship.

This is worrying for two main reasons: first, as today’s poll show, the gap between what voters and the political party think on Europe is widening – a trend which is seen in party politics acrossEurope. This isn’t healthy in the long-run. Secondly, the eurozone crisis is changing the wayEuropeoperates, pulling those countries that share the single currency closer together, forcing those outside to decide what kind of relationship they want with the core. In short, the status quo is no longer an option. Britain needs a new vision for European cooperation, and so do the Lib Dems.

The principles of localism, which have been overwhelming endorsement by the coalition, and the Lib Dems in particular, could serve as the basis for a new, positive vision of Britain in Europe. In a recent report, entitled “The Case for European Localism”, Open Europe argued that the EU ought to focus more its core competencies of boosting trade and the Single Market, and less on political institution-building. National parliaments would be accorded a more prominent role in EU affairs, something that would increase democratic accountability and transparency. Far more decisions should be made nationally, regionally or locally.

European localism would act as an overarching strategy, within which the UK could chose individual areas where it wanted to maintain a bigger role for the EU, such as environmental policy, but devolve competencies over other areas, such as crime and policing, regional policy, agriculture or social and employment law.

With overwhelming backing from voters, the Lib Dems have a valuable opportunity to capture the centre ground on the EU debate and fashion a new, vibrant and more nuanced narrative that moves beyond the tired in/out debate.

How will the leadership respond?

Thursday, March 15, 2012

So will German taxpayers have to fork out for Messi and Ronaldo?

So the eurozone crisis has made it to the one place where it is guaranteed to hit home - the sports pages. The main page of the sports section in yesterday's Bild ran with the headline, "Will German taxpayers eventually have to fork out for Messi and Ronaldo?"

The fear, said Bild, is that the Spanish government is about to authorise a 'debt amnesty' for Spain's professional football clubs - including Barcelona and Real Madrid. A "crazy idea", said the paper, as forfeiting money owed to the Spanish government by various football clubs, could further increase the country's already pretty scary deficit. This should worry readers of the sports section, the paper continued, as should Spain hit the iceberg and be forced to seek a Greece-style rescue package, then German taxpayers would effectively, albeit indirectly, be bailing out Barça and Real.

Far-fetched? Most certainly, but the story caught our attention for four reasons:
  • Over at Open Europe, we have developed a slight obsession with Bild (the best barometer of German public opinion)
  • That Germany's largest-selling newspaper includes, in its sports section, a line on the recent discussions over Spain's deficit targets shows that the euro crisis is now as much of a household issue as they come

  • If Madrid was to cancel all or part of the money that Spanish football clubs owe it, that could actually leave a hole in Spain's public finances, given the size of the balance sheets of some of these clubs (which are notoriously over-leveraged).
  • Closer to home (which at OE includes Newcastle, Wisla Krakow and Napoli), the move could, shock horror, also give Spanish football clubs an additional advantage over European clubs
As expected, after a bit of fact-checking and cross-checking with the Spanish press, it turns out that Bild's story is largely a matter of 'lost in translation'. Here's what we've got:
  • Following a parliamentary question by Caridad García, an MP from the Izquierda Unida (United Left) party, the Spanish government has recently revealed that Spain's professional football clubs owe an impressive €759 million to the country's Tax Agency - of which almost €490 million is owed by clubs in the Primera División (the Spanish Premier League).

  • Asked how the Spanish government was planning to address the issue, Sports Minister Miguel Cardenal said that a plan is currently being put together to "make this debt disappear (hacer desaparecer esta deuda, in Spanish) within a reasonable time frame". Now, we suspect that this is where misunderstanding arose.

  • Though subject to dispute, Don Miguel may simply have meant that, in a way or another, football clubs will have to pay their debt quickly, or face sanctions, such as loss of points in the league table, forced relegation, and so forth. During the same interview, he made clear that "football clubs' debt will be paid by football clubs". Again this morning, he insisted that "no debt will be forgiven" for Spanish football clubs.
In other words, Bayern Munich and Borussia Dortmund's fans can sleep peacefully. They are not going to foot the bill for The Flea and CR7's multi-million wages...

Opening Pandora's Box?

Speaking to the press after the meeting of EU leaders earlier this month, Spanish Prime Minister Mariano Rajoy (see picture) surprised everyone by declaring that Spain had taken the "sovereign decision" to ignore the deficit reduction target of 4.4% of GDP agreed with the European Commission for this year.

As we pointed out here (and as Simon Nixon pointed out in the WSJ yesterday), the Commission had two options to cope with this situation: hardball or flexibility. And it has gone for the latter, although still asking Spain to bring its deficit down to 5.3% of GDP by the end of the year - that is, 0.5% lower than the 5.8% announced by Rajoy. This translates into an extra €5 billion of savings by the end of the year, something which Rajoy says Spain reasonably can achieve.

Leaving the bailouts aside for a second, Spain's behaviour may well be a hint at the true meaning of "economic governance" in the eurozone - constant bickering about who actually is in charge, the 'sovereign' member state or the European Commission (or some other vehicle of the Eurogroup).

In any case, the compromise 'deal' between the Spanish government and EU finance ministers gives rise to a number of questions:

Is this a victory for the Spanish government? Not at all. Despite Rajoy's efforts to sell it as such at home. Spain has only obtained a revision of its deficit target for 2012, but is still expected to cut its deficit to 3% of GDP by the end of 2013. In other words, the Spanish government is only kicking the can down the road and will have to make much tougher budget cuts next year in return for dodging them this year.

Is this a victory for the European Commission? Not really. At the end of the day, the Commission has allowed Spain to run a higher-than-agreed deficit for 2012. Needless to say, this did not go unnoticed. Explicit criticism has already come from Belgium and Austria, with the latter accusing the Commission of using "double standards" as Hungary - at the same meeting of finance ministers - saw almost half-a-billion euros of subsidies frozen for failing to comply with EU deficit rules.

Furthermore, Dutch Labour MPs have threatened to block the ratification of the new 'fiscal treaty' on budgetary discipline unless the Netherlands - like Spain - is allowed more time to put its own house in order. Dutch Prime Minister Mark Rutte’s coalition government needs the support of the opposition to pass the 'fiscal treaty' in parliament, as Geert Wilders’ far-right PVV party will vote against it.

The pact would still come into force if the Netherlands failed to ratify it - twelve eurozone ratifications would be sufficient. However, Triple-A countries are a rare breed in the euro area these days, and if one of them were to stay out, the 'fiscal treaty' would lose even more of its credibility. Uncertainty remains, but the Commission might really have opened a Pandora's box by revising Spain's deficit target for this year.

But are these targets even achievable? Almost certainly not. Spain's economy is expected to contract by 1% this year. Furthermore, the Spanish government has 'only' adopted a first package of around €15 billion in spending cuts and tax hikes, meaning that savings worth some €20 billion are necessary to meet the revised target for this year. Both of these facts are likely to increase the already sky-high unemployment rate. It's too early to tell whether the Spanish population is willing to stomach this. A new general strike against the Spanish government's labour market reform has been scheduled for 29 March - it won't be the last one.

The deficit target of 3% of GDP for 2013 looks even more out of reach - especially if this year's target is missed. As Rajoy told MPs yesterday, Spanish regions must be prepared to make "bigger" cuts, but some important Spanish regions (including Andalucía, where Rajoy's Partido Popular could win a majority after the 25 March elections, and wealthy Catalonia) do not seem particularly keen on taking more austerity. This is complicated by a feeling that the cuts are being 'imposed' by the central government. If the Spanish government fails to keep the regions on board, the chances of meeting the budget commitments look very slim indeed.

What's clear is that Spain will become a major testing ground for the effectiveness or otherwise of the eurozone's new economic governance structure.

Wednesday, March 14, 2012

Beijing beating Brussels at its own game?

Last week in Brussels, we organised a very interesting event looking at trade between the EU and Asia - the importance of which can hardly be over-stated given Europe's, shall we say, current economic predicament.

At the event, Conservative MEP Syed Kamall warned against the EU pursuing an “anti-business agenda” in trade talks, including excessive environmental standards, as “we end up with everything but trade.”

Today, we received another reminder of the dangers involved in the EU pursing green protectionism: other trading blocs may do the same.

From PA we learn that the EU, the US and Japan have launched a complaint at the World Trade Organisation, claiming that China is limiting its export of rare earths. This is a pretty bad situation, as these minerals are vital to the production of high-tech goods, such as hybrid cars, weapons, flat-screen TVs, mobile phones, mercury-vapour lights and camera lenses. And as China accounts for more than 90% of global production of 17 rare earth minerals that are used to make this stuff, Europe is pretty dependent on the trade.

But here's the intricate part, China says it's 'only protecting the environment'. The country's Commerce Ministry said in a statement:
"The Chinese policy objective is to achieve sustainable development in order to protect resources and the environment, and this is not a trade-distorting way of protecting domestic industries."
Tricky. Now, we're certainly not siding with China here, but merely making the humble observation that if Europe continues to flirt with Non Trade Barriers of various sorts, including 'green' ones, others may start to play it at its own game.

Perhaps something to keep in mind when certain EU leaders call for a "buy European act." Sooner or later, chickens could come home to roost.

Tuesday, March 13, 2012

Greece take II - it's official

Reuters has just released the latest EU/IMF/ECB troika report – the first to fully account for the bond swap and its impact on Greek debt. We’ll provide a fuller run down once we’ve had more time to trawl through the 195 page report (we have to give the troika some kudos for the turnaround on this one), but for now we’ll just flag up a few headline figures. We also couldn't resist comparing the new Troika estimates to our previous estimates of how Greece's debt will change following the bailout, which we published a couple of weeks ago. We would lie if we said we weren't pretty much spot on.

Greece's debt-to-GDP after PSI

Open Europe's estimates: 161%
New Troika report: 160%

Amount of money needed to recapitlise Greek banks

Open Europe estimates: €50bn
New Troika report: €48.8bn

Cost of private sector involvement (PSI)


Open Europe estimates: €86bn
New Troika report: €78bn

(The discrepancy between the OE and Troika estimates primarily seems to be a consequence of the Troika report not including the near €6bn to pay off accrued interest, which doesn’t get lumped into the ‘cost of PSI’ but may fall into other funding costs). In any case still doesn’t seem like great value for money.

Other interesting figures include:
  • Total EU/IMF assistance in 2012: €112bn (most yet for a single year)
  • Average revenue from privatisation: €4.4bn (despite the plan barely getting going)
  • Amount Greece needs to raise on the market in 2015: €7.6bn (despite new Greek bonds trading with the highest yields in the eurozone)
In addition, the graph below is pretty revealing. Given the optimistic privatisation targets and the optimistic growth projections the bold turquoise and dotted orange line give us some significant cause for concern to say the least.