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8586 CER bulletin aug-sept 2012 26/07/2012 12:06 Page 1

Forthcoming events 24 September

30 September

9 October

CER/BNE/Open Europe fringe event at the Liberal Democrats conference ‘Europe, from crisis to growth’ Speakers include: The Rt Hon David Laws MP and Vicky Pryce 18.15-19.45, Hilton Metropole Hotel, Brighton CER/BNE/Open Europe fringe event at the Labour Party conference ‘Europe, from crisis to growth’ Speakers include: The Rt Hon Douglas Alexander MP and Chris Leslie MP 17.45-18.45, Exchange 2-3, Manchester Central CER/BNE/Open Europe fringe event at the Conservative Party conference ‘Europe, from crisis to growth’ Speakers include: Jo Johnson MP and The Rt Hon David Lidington MP (tbc) 19.30-21.00, ICC, Birmingham

Forthcoming publications Modernising Europe’s energy infrastructure Stephen Tindale

Can the EU hold together? Hugo Brady, Simon Tilford, Philip Whyte & Tomas Valasek Britain and EU police and justice policy: Will Cameron pull out in 2014? Hugo Brady Europe’s legitimacy problem Charles Grant

Recent publications Britain, Europe and the City of London: Can the triangle be managed? Philip Whyte Europe’s External Action Service: Ten steps towards a credible EU foreign policy Edward Burke Saving emissions trading from irrelevance Stephen Tindale Britain must defend the single market Jo Johnson The continent or the open sea: Does Britain have a European future? David Rennie five

★ A banking union – it is necessary, but is it likely?

by Tomas Valasek

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N 2010, FRANCE AND BRITAIN agreed to strengthen defence collaboration, mainly to save money through common research and acquisition of military equipment. The economic crisis forced their hand: they needed greater economies of scale to preserve certain capabilities in the face of smaller defence budgets (which Britain cut two years ago and France is poised to do soon). However, London and Paris no longer agree on the nature of their relationship. Britain’s coalition government would like it to be exclusive, as did former President Nicolas Sarkozy. But President François Hollande wants bilateral co-operation with the UK to form the core of a broader European effort. Hollande’s Socialist party believes that as many EU countries as possible should integrate their armed forces. On the campaign trail, Hollande and his now defence minister, Jean-Yves Le Drian, mildly praised collaboration with the UK, and committed themselves to respecting the 50year treaty that France’s previous government signed with Britain. But many French Socialists see the partnership, with its whiff of exclusivity, as counter to the idea of pan-European forces. Hollande’s solution has been to invite other countries to join the Franco-British partnership. In June, he signed an agreement with Berlin on broad defence co-operation, including on a new generation of ‘drones’ (which France had previously agreed to develop with Britain). The British government has responded by restating its preference for keeping cooperation with France exclusive. Meanwhile, the Defence Secretary Philip Hammond has described military ties with Paris as in “drift”. The French also worry that the UK may not remain in the EU for much longer, and that it is not taking co-operation with France seriously enough. In May 2012, Britain abandoned plans to fit its aircraft carriers with catapults and traps, which would have allowed French planes to land on them. The UK found the upgrades too expensive, and defence officials say that they were never central to co-operation with France. But the volte-face gave ammunition to critics of Franco-British cooperation in Paris. In July, Britain also launched an ‘audit’ of EU competences, with an eye to opting out of several areas of EU co-operation sometime after 2014. A pressure group close to the Conservatives, ‘Fresh Start’, has questioned whether Britain should remain in the EU’s common security and defence policy (CSDP). This

set off warning bells in Paris: how, the French ask, can Franco-British cooperation become the core of European defence if Britain leaves CSDP – and perhaps the EU – altogether? THE ANSWER IS STRAIGHTFORWARD. If Paris and London need to deploy forces together – which they probably will, since they are Europe’s leading military powers and the US is shifting its attention to Asia – NATO can lead (as it did in Libya). Alternatively, if the EU is in command, it has the option of involving non-members (there are US police under EU command in Kosovo). A Britain outside the EU could take part in such operations provided it is given a role in the command chain: loose military alliances are de rigeur these days. The French Socialists are also wrong to worry that Franco-British collaboration may not be compatible with strong European defence. Most EU countries, including federalist-minded ones like Belgium, are building small regional defence groupings rather than a panEuropean force. They have found that differences between national strategic cultures, equipment needs and replacement timelines make it nearly impossible to agree common procurement among 27 countries. Smaller ‘islands of co-operation’, such as the Benelux or Visegrad, can still achieve economies of scale while minimising the risk that different expectations will delay delivery and increase costs. The UK and France should be seen as one such island of co-operation. If, as intended, it helps Europe's top two militaries save capabilities despite budget cuts, EU defence will have benefitted. Instead of arguing about whether to keep their co-operation exclusive, Paris and London should encourage others, especially the laggards in Europe’s south and east, to form more regional defence groupings. The UK and France should start sharing tips with them on which approaches work and which do not. Where other countries make a credible case, Paris and London should help cover the start-up costs of collaborative projects. France and the UK have a strong interest in not allowing other EU states to hollow out their forces (even if the task can sometimes seem hopeless). If other militaries do not shape up, the next time Europe needs to use force, Paris and London may find that they lead, but no one follows.

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Tomas Valasek is director of foreign policy and defence at the CER.

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Philip Whyte

★ Is the Franco-British defence treaty in trouble? 6

Tomas Valasek

Europe needs a Rooseveltian break with fear by Hugo Brady

T Issue 85 ★ August / September 2012

Priorities for the single market John Springford

In this issue

Is the Franco-British defence treaty in trouble?

CER 14 Great College Street London, SW1P 3RX www.cer.org.uk info@cer.org.uk T +44 20 7233 1199 F +44 20 7233 1117

HE EU HAS FOUR FREEDOMS – for the movement of goods, services, capital and people. Today, it needs a fifth: the freedom from fear. The euro has become a political doomsday machine, a time-bomb that threatens to destroy the great achievements of European integration: peace, political stability and the creation of the world’s largest single market. The global economy is also a hostage to the uncertain fate of the single currency. So too is Europe’s credibility as a responsible power. The euro is a Frankenstein which could destroy its creator, the EU. The currency’s dissolution would reap economic chaos, political division and social schism throughout Europe. Eurozone countries share a monetary union but not a treasury, lender of last resort or federal institutions to raise tax and transfer receipts between members. Critics say this unnatural arrangement cannot go on unless euro countries establish an economic – and therefore, political – union that incorporates some or all of these missing elements. But they have yet to explain to Germany’s chancellor, Angela Merkel, or other leaders how to sell this to their electorates. They know full well that voters will find the idea unacceptable and dangerous. The markets will therefore continue to attack the euro – with occasional respites – until either a politically viable solution is found or the single currency collapses under the weight of its own contradictions. How to break this cycle without giving in to the tyranny of extremes? Eurozone leaders should create a fifteen-year political union, set to expire in 2029. This would incorporate current ideas to stabilise the

single currency, such as a banking union, but also include the creation of some common eurozone debt. Concurrently, the European Commission would gain powers to push through ‘Merkel I’ reforms, otherwise known as the EU’s 2020 agenda, to boost long-term economic growth and employment, especially across the south of the eurozone. Painful adjustments would be cushioned by long-term ‘war’ loans from more prosperous euro countries and funds from the EU’s budget. AT PRESENT, EUROZONE VOTERS neither want a collapse of the euro (which would be a calamity) nor a federal super-state. But they might be persuaded of the merits of a third option – a temporary loss of economic sovereignty for three electoral cycles, which could secure their living standards for a generation. This would buy the kind of time from the markets that governments really need to fix Europe’s broken banking system, re-design the common currency and realise the slowburning benefits of wide-ranging economic reform. It would boost the confidence of businesses, banks and consumers in Europe that are currently too scared to invest, lend and spend as normal. And it would help free the global economy from introspection, in turn creating new export demand to brighten Europe’s growth outlook and make its debt burden more manageable. A New Deal for the euro would need to be a new beginning for the EU and a ‘European street’ that has grown increasingly disenchanted with the Union. Voters are unsentimental about the conviction of their parents’ generation that integration, however imperfect, is the only alternative to conflict in Europe.

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8586 CER bulletin aug-sept 2012 26/07/2012 12:06 Page 2

Any grand bargain must therefore be accompanied by true reform of the EU’s institutions. Governments have justified the transfer of ever more sovereignty to Brussels with parallel increases in the powers of the directly-elected European Parliament. However, the body cannot propose or repeal legislation and turnout has fallen at every European poll over the past 30 years. If the average turnout in the parliament’s 2014 election falls below 40 per cent, the parliament should be wound down and replaced by a People’s Congress of Europe. This would primarily be made up of national politicians specially mandated to ensure the legitimacy of the political union during its lifetime.

Hugo Brady is a senior research fellow at the CER.

A banking union – it is necessary, but is it likely? by Philip Whyte

C

OULD THE EU’S SUMMIT OF June 29th come to be regarded as a watershed? Following umpteen crisis summits that have failed to tackle the root causes of the eurozone crisis, EU leaders finally got to the heart of the matter: the need to break the vicious interaction between weak banks and fiscally weakened states. They committed themselves, “as a matter of urgency”, to consider Commission proposals for the establishment of a ‘banking union’. They were right to do so. Such a union is key to the eurozone’s survival. But the obstacles to its adoption are still huge. To understand why a banking union is essential to the eurozone’s survival,

consider how the US and the eurozone responded to the 2008 crisis. Both sides faced the same problem: over-leveraged banks that had insufficient capital to absorb losses on bad loans, particularly to the housing and construction sectors. The policy challenge was to wind down (where possible) or recapitalise (where necessary) insolvent banks, and reassure depositors that their money was safe. Where the US and the eurozone differed was the level at which the problem was tackled. In the US, the crucial action took place at federal level. The Federal Deposit Insurance Corporation (FDIC) wound up insolvent banks when it could (450 have

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been liquidated since 2008, including large-ish entities like Washington Mutual). Institutions considered too systemic to fail were recapitalised by a federal instrument, the Troubled Asset And (TARP). Programme Relief depositors were backed by a US-wide protection scheme administered by the FDIC. The use of US-wide instruments was and is a symbol and guarantee of states’ commitment to the union. In the eurozone, by contrast, almost all the action took place at national level. followed. consequences Several Governments were slower to recognise (and spent a lot of time trying to conceal) the weakness of ‘their’ national banks. Fewer of these were wound up (a reflection of their crucial importance in local politics). When banks were recapitalised, individual states (like Ireland) were pushed into a sovereign debt crisis. And national deposit protection schemes could not prevent depositor flight from countries with weak sovereigns such as Greece. The point is not that the US’s response to the financial crisis was perfect (it was not). It is that the eurozone’s structure gave rise to problems that did not arise in the US – because banks and states interact very differently when certain key functions are performed at state rather than federal level. Unlike Ireland, the US state of Delaware was not plunged into a sovereign debt crisis when the insurance giant AIG was bailed out. Unlike in Greece, fears of a default by the US state of California have not provoked runs (or ‘jogs’) on banks incorporated in that state. EUROPEAN POLICY-MAKERS HAVE been reluctant to accept that the eurozone’s decentralised nature makes it an inherently unstable currency union that forces its constituent states and ‘their’ banks into a pernicious and deadly embrace. On the face of it, all that changed at the June 29th summit, when member-states agreed to consider establishing a banking union. Among the features of such a union would be: a shared supervisory authority; a collective deposit protection scheme for the currency union; and a common resolution framework for dealing with weak banks. What, then, are the prospects of European leaders agreeing to establish a banking union along these lines? The idea of a banking union is sometimes spoken of as an easier route to ‘mutualisation’ (or federalisation) than issuing common debt – partly, the reasoning goes, because citizens do not understand what a banking union entails. But this is only true as far as it goes. Member-states have

not committed themselves to establishing a banking union – merely to consider doing so. And the national obstacles to forming such a union remain formidable. Some countries may balk at the prospect of the ECB supervising certain types of bank (which are often vehicles for patronage and politically-directed credit). They may resist giving a supranational body the power to liquidate national banks. A common deposit protection scheme may raise similar objections as those to a eurobond. And the European Stability Mechanism will not necessarily evolve into a European TARP, because politicians may struggle to accept that the national taxpayers to whom they are responsible should stand behind banks in other countries. Moreover, even if governments could agree to a full banking union, this would still not be enough to fully stabilise the relationship between states and banks in the eurozone. One of the peculiarities of the eurozone is that sound banks within it can still be vulnerable to runs. The reason is that Greece is not California. Since the weakness of its public finance raises doubts about its continued membership of the currency, depositors face incentives to take money out of Greece to protect their savings from being redenominated into a currency that loses its value against the euro. IT IS NO MYSTERY WHY THE eurozone is arranged as it is, nor why there is such resistance to reorganising it. Its configuration simply matches political realities at national level. If the existence of federal institutions and functions reflects the commitment of individual states to the union in the US, their absence reflects the limits of individual states’ commitment to the eurozone. Because Germany does not stand in relation to Spain the way Texas does to Florida (and is disinclined to do so), the eurozone is prone to strains that do not arise in the US and that threaten its survival. The question now is whether the currency union’s member-states can finally accept the logic of what they have created. It has become increasingly hard to see how they can will the survival of the eurozone and simultaneously oppose the very features that are critical to making it work. One such feature is a proper banking union. In June, European leaders gave themselves until the end of 2012 to consider setting up such a union. They may not have that time, and they cannot afford to fail.

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Philip Whyte is a senior research fellow at the CER.

CER in the press NEW STATESMAN 19th July 2012 For further reading on UK relations with the EU, by far the best thing published recently is this excellent CER report ‘The continent or the open sea: Does Britain have a European future?’ by David Rennie of The Economist.

LE MONDE 12th July 2012 “There is a 50 per cent chance that Cameron will have to hold a referendum on EU membership during the next parliament”, says Charles Grant, the very Europhile and competent director of the CER.

THE NEW YORK TIMES

Issue 85 ★ August / September 2012

EUROPE’S TEMPORARY POLITICAL union would need other elements, too. There would need to be enforceable rules to ensure basic standards of national administration and to protect the rule of law in member countries. The single market would have to be re-launched so that it becomes a working reality, especially in terms of trade in services. European Commissioners would need to shrink in number but grow in terms of political pedigree to help bolster their authority. And the EU would need to show itself capable of abolishing unproductive quangos like its Economic and Social Committee and Committee of the Regions. The key to this process would be political consent at the outset and its freedom to fail in the end. A sunset clause would ensure that any national

sovereignty lost under the deal would automatically revert back to euro countries in 2029. If, after a decade of operation, the Congress of Europe decided that the dissolution of the common currency was the wisest option, pre-arranged plans for a gradual, managed break-up would ensue. Voters would have to ratify the temporary political union (or not) in general elections; some leaders would have to seek a fresh mandate for the move by going to the country; and some countries would have to change their constitutions, including, perhaps, Germany. Governments should begin engaging public opinion with a collective admission that their efforts to save the euro will not work without a mandate for radical action from their electorates. The creation of the euro looks to have been a profound error. But its collapse would have devastating consequences for Europe’s societies and the global economy. An audacious mistake can only be rectified by greater audacity. The US survived the Great Depression of the 1930s because Franklin D Roosevelt and his government were willing to experiment – politically, legally, socially – in hitherto unimagined ways. Europeans do not need nor want the shotgun marriage of a permanent, federal union. However, they must move in together for a while to get through a particularly sticky passage in their history. If not, they may have much more to fear than fear itself.

CER 14 Great College Street London, SW1P 3RX www.cer.org.uk info@cer.org.uk T +44 20 7233 1199 F +44 20 7233 1117

10th July 2012 “The fundamental problem with the eurozone is that what happens at the federal level in the United States still happens at the national level in the eurozone,” said Philip Whyte of the CER.

THE CHRISTIAN SCIENCE MONITOR 10th July 2012 “Cameron wants relations with France to work,” says Philip Whyte of the CER. But “Britain’s continued membership in the EU is unclear. Momentum for a referendum in three to four years is becoming nearly unstoppable”.

THE NEW YORK TIMES 6th July 2012 “There’s a greater and greater political trend toward an emphasis only on the eurozone [in today’s EU],” said Hugo Brady of the CER, referring to the 17 countries that use the currency.

THE NEW YORK TIMES 1st July 2012 The result for Simon Tilford of the CER, looks like this: “Germany is much more vulnerable than German

policy-makers appear to believe. Germany’s strength is exaggerated and its weaknesses downplayed.”

INTERNATIONAL HERALD TRIBUNE 29th June 2012 “The current disconnect between Paris and Berlin is destabilising the euro,” Charles Grant director of the CER, wrote this week. “In the long run the euro is not sustainable without a grand bargain between France and Germany.”

THE GUARDIAN 28th June 2012 Edward Burke of the CER said “Moscow knows the writing is on the wall for the Assad regime and that its slow demise will likely precipitate an increasingly deadly civil war that will damage Russian interests.”

REUTERS 25th June 2012 “Ankara itself has been averse to consider military action against Syria so far. So it is likely that the invocation of [NATO’s] Article 4 is designed to put more diplomatic pressure on Assad,” said Clara Marina O’Donnell of the CER.

THE WALL STREET JOURNAL 15th June 2012 “Domestically, [Merkel] hasn’t paid the price for the deepening of the financial crisis,” says Simon Tilford of the CER. “But certainly, she’s looking increasingly isolated within the eurozone. ...There was a window of opportunity five to six months ago to forge a consensual relationship with Mario Monti. But Merkel didn’t play that so well.”

THE NEW YORK TIMES 15th June 2012 “The last thing the EU wants or needs is a failed state on

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its borders in a region as combustible as this,” said Simon Tilford of the CER. “Greece would not be left to its fate because they cannot afford to let a country descend into chaos.”

THE VOICE OF AMERICA 12th June 2012 Stephen Tindale of the CER said, “Almost half of the Russian government’s revenue comes from various taxes on oil and gas exports.”

THE WASHINGTON POST 31st May 2012 “The atmosphere in Europe has changed fundamentally. Yes, we were in an economic crisis in 2011, when Libya happened, but there was still a sense it was a manageable crisis. Europe had confidence that it doesn’t have today,” said Tomas Valasek of the CER.

THE ECONOMIST 26th May 2012 The Lisbon treaty gives national parliaments only a limited role. Charles Grant of the CER, suggests enlarging this. He would give more prominence to COSAC, the group that brings together national parliaments' European affairs committees, perhaps putting a delegation of national MPs in Brussels to work more closely with the European Parliament.

THE FINANCIAL TIMES 24th May 2012 “Intellectually, I think Cameron is right with his analysis [on the failure of eurozone leaders to manage the euro crisis],” says Charles Grant of the CER. “But the way he has said it has increased concern in the markets and that has damaged Britain’s soft power.”


Issue 85 - 2012