The £1.7bn question (Part II) - What are other EU finance ministers saying?

Here's a round-up of comments from other EU finance ministers about the UK's £1.7bn EU budget surcharge and the deal struck at today's meeting. This being EU budget negotiations, everyone is claiming either 'nothing to see here' or victory. Apart from the Dutch, who are getting a pretty raw deal.

We've given our take on the deal in this blog post: when all is said and done, the UK will pay £850 million. The question is whether the rebate the UK gets from the EU budget always applied to the £1.7 billion, and whether, therefore, George Osborne is basically engaging in accounting manoeuvres.

Remember, due to the way the UK's rebate from the EU budget is structured, everyone is basically paying for it, so it's not in anyone else's interest to ever talk it up.

Irish Finance Minister Michael Noonan said,

“My understanding is that the UK will pay the whole amount but there will be no penalties attached or interest rate on that.”

Spain's Luis de Guindos argued,

“No-one has put into question the [European] Commission’s figures…as perfectly valid. Basically, what we agreed on is the possibility of a delay in payments.” 

Dutch Finance Minister Jeroen Dijsselbloem stressed,

“The UK has...a rebate, which they have had for a very long time and of course this mechanism of rebate will also apply on the new contribution. So it's not as if the British have been given a discount today. The old mechanism of the rebate will also apply on the UK contribution, which will increase.”  

According to Austria's Hans-Jörg Schelling,

“Whether the money is to be paid in instalments or as a lump sum is a discussion we can have. But the amount cannot be put in question.” 

Sweden's Magdalena Andersson stroke a more positive note,

“Compared to a situation where the Commission was not going to table a new proposal, of course this is a victory for the UK…Given the amounts, I can understand that one wants to discuss both transparency and the calculations.”  

As regards German Finance Minister Wolfgang Schäuble, he avoided taking a clear stance despite several attempts from journalists at his post-ECOFIN presser. All he said was,

“We have discussed instalments…but we haven't discussed the British rebate...which doesn't mean that the Brits do not raise these questions…I don’t have opinion on that.”

So all clear then...

The most depressing part of this episode is that an enormous amount of energy has been spent, and the UK has been pitted against natural allies, not least the Dutch. Secondly, absolutely nothing on the substance of the EU's wasteful budget has changed.

#EU reform: The status quo is not an option

Our ground-breaking EU reform conference is now imminent and, as widely trailed in today's media, UK Chancellor George Osborne will be giving the opening keynote speech.

You can join the conversation throughout the day on twitter, using the #EUreform hash tag, or follow @openeurope. Uniquely for this type of a conference, all sessions will be on the record. We call it "Open Europe rules" (as opposed to the more secretive Chatham House rules).

In a letter to today's Guardian, six leading MPs from across Europe, all attending the conference, argue:

Too often, the debate about "Europe" is based on emotional and ideological arguments, with all sides – from those who want more EU integration and those who want less – trading in hyperbole rather than engaging with substantive issues of policy. Of course we need to co-operate across borders in Europe. The question, as ever, is how. How do we square the need for cross-border action with democratic accountability? How do we live up to the promise to make decisions as close as possible to citizens? How do we make Europe really work for growth and jobs at a time when global competition is stiffening?  

Today, we are joining hundreds of parliamentarians and opinion-formers from across Europe at a unique conference in London organised by the thinktank Open Europe and the Fresh Start Project, dedicated to one question: how can we achieve EU reform? While our proposed solutions may differ, we agree on one thing: the status quo in Europe is not an option. If the EU is to thrive, it needs to embrace a series of bold reforms. Some of these will involve EU action, but where democratic and economic factors so dictate, this may also mean "less Europe". We want to replace the emotional point-scoring with a policy-based discussion about how to achieve a Europe that works better for both democracy and growth.

Gustav Blix Swedish MP (Moderate party); ranking member, committee on European Union affairs (Sweden)
Klaus Peter Willsch German MP (CDU); member, committee for economy and energy,
Germany; Deputy head of the committee on education, research and technology (Germany)
Angieszka Pomaska Polish MP (Civic Platform); Chair of the EU affairs committee in the Polish parliament (Poland)
Eva Kjer Hansen Chair of the European affairs committee (Liberal party), Danish parliament (Denmark) Andrea Leadsom MP for South Northamptonshire (Con); co-founder, Fresh Start Project; member of No 10 policy board (UK)
Dr Reinhold Lopatka Spokesperson for foreign and European affairs, Austrian People's party (OeVP); former secretary of state for European and international affairs (Austria)

Osborne says UK is £3.5bn better off after Cameron's EU budget deal. Is he right?

Coverage of the budget today will understandably focus predominantly on the wider debate about sticking to 'Plan A', and of course the inadvertent 'leaking' of the budget on the front page of the Evening Standard.

However, being the EU obsessives that we are, it is always interesting to look at the latest estimates for the UK's contributions to the EU budget, particulalry in the wake of last month's deal on the long-term budget.

During his statement in the Commons, George Osborne said that as a result of the deal struck by David Cameron in February, the UK would be better off to the tune of £3.5bn by 2017-18. This is repeated in the main budget document (page 23).

So is he right? Well, yes and no.

First, it's definitely the case that the UK government has secured a decent deal compared to previous long-term EU budget periods (at least in terms of absolute cash, not so much on content), for which it should be given credit. The EU budget is always complicated because the UK contribution is presented in several different ways. But the underlying data from the OBR (pages 138-9) does indeed show that due to the reduction in the long-term budget agreed last month, the UK is due to save £3.5bn by 2017-18 compared to the estimates made in the OBR's December forecast - this is the row labelled "New Multi-annual Fiscal Framework deal" in the table below.

However, the OBR figures also show that the UK will lose out due to two other factors: the change in the projected exchange rate, which will see the UK contribute roughly £1.2bn more up to 2017/18, and assumed increases of £0.7bn to the UK's contributions to the 2012 and 2013 annual budgets. It isn't clear what the row "other" refers to, but apparently it will reduce the UK contribution by £0.4bn up to 2017/18. 

We would also speculate that the OBR may have to revise its figure for the 2013 annual budget upwards again because the European Parliament has made its agreement to the long-term budget deal conditional on any funding shortfalls for 2012 and 2013 being financed with new funds rather than from future budgets - there are rumours the Commission is set to table another so-called "amending budget" to top up the 2012 budget, which would mean greater UK contributions.

But notwithstanding all of these intricacies, the OBR's figures illustrate that Cameron's deal on the budget will serve to limit the UK's gross contributions to the EU. But, as we've said before, this may not be the case for the UK's net contributions for several reasons, including changes to the UK rebate.

NB. It is important to note that the UK's actual contributions to the EU are higher than the figures presented above. This OBR table only deals with the UK's so-called gross GNI contribution, which is the largest share, but doesn't include the extra cash from VAT and customs duties that the UK also hands to the EU. It also doesn't reflect changes to payments the UK receives from the EU budget.

What next on the EU bank bonus cap?

Today has been billed as the final chance for UK Chancellor George Osborne to secure a change in the proposal to limit bank bonuses across the EU.

It is true that any change to the broad political agreement (including the level of the ratio limiting bonuses) would probably need to be secured today – a move which looks unlikely. However, as we note in today's press summary, the technical discussions over the specifics will continue for some months, presenting the opportunity to water down the proposal behind the scenes. Numerous issues remain unresolved such as: whether the cap will apply to all staff or just the highest paid, whether it will apply to all banks or only larger ones and, most importantly, whether the EU will stick with the plans to apply it to subsidiaries (both EU ones located elsewhere and foreign ones located in the EU).

So there could yet be room for some improvements to the proposal. There are also two other issues which have cropped up in this discussion: the possibility of the UK invoking the Luxembourg compromise and potential legal challenges against the proposal.

What is the Luxembourg compromise?

See below for a box from p.31 of our ‘Continental Shift’ report (really a worth a read by the way to understand the context of this and related debates) which explains the premise (click to enlarge):

It has been muted that Osborne could trigger this at today’s meeting. This is a last resort and seems unlikely – besides it is not clear how effective it would be in this case, as it is only a gentleman's agreement.

Is the proposal open to legal challenges?

According to the FT, banks have been receiving legal advice and believe they may have a case based on Article 153.5 of the Lisbon Treaty, which says:

“The provisions of this Article shall not apply to pay, the right of association, the right to strike or the right to impose lock-outs.”

Article 153 is in the social policy chapter of the treaties. Currently, the legal base for the rule is as part of CRD IV, i.e. under financial regulation and looking to address financial risk taking. 

The Commission and MEPs have also dismissed claims of illegality, on the grounds that the rules do not limit total pay, but simply set a ratio on variable pay in an attempt to reduce risk taking, and it is not therefore social policy.

It looks likely that there will be some legal challenges, although from the private sector rather than the UK Government.

Osborne's "reform or bust" remarks only get a page 10 hit in Die Welt

A month or so ago, David Cameron suggested, for the first time, that UK exit from the EU was "imaginable". Today, in an interview with Die Welt, and as we reported in our press summary, his Chancellor, George Osborne, has been far more explicit. Here's the relevant bit:

"I very much hope that Britain remains a member of the EU. But in order that we can remain in the European Union, the EU must change."

He added:

“I want to be an active part of a reformed EU. Europe and the UK need each other and our economies are very closely intertwined…More than half of British exports go to the EU, we sell more to Nordrhein-Westfalen than to India”.

“There are areas where we want the EU to do more. We want the internal markets for services, for digital services and for energy to be advanced and finally completed…We have plenty of ideas for Europe, but often it is frustrating that these ideas are not implemented. And we would wish that Germany would support us more strongly to push forward these ideas.”

Osborne's remarks are intellectually honest and reflect where the vast majority of his party and the British public stand, but it is also the first time that the Government has been so explicit in stating that the UK might face no alternative to exit if the EU proves unwilling to reform and meet the concerns of a country that has refused to embark on the euro project.

It is also a good thing for other EU politicians to understand where the UK, and particularly David Cameron, is coming from. But there is a balancing act here. As we've seen from the widely reported comments by Gunther Krichbaum, Chairman of the German Bundestag’s European Affairs Committee, Germany is very sensitive to the perception that it's being "blackmailed" into granting the UK specific concessions. As we mentioned in our previous blog posts, this is why pitching Cameron's EU speech as good for Europe, not solely the UK, is vitally important.

But the most interesting part of the Osborne / Krichbaum remarks, is the contrast in the media reactions in both countries to the interventions. This speaks volumes for the esteem in which each country views itself relative to the reality. Krichbaum, an important but largely domestic political figure, got a front page hit in the Times:

Osborne, the UK Chancellor, was buried on page 10 in Die Welt (in the economic section), despite issuing what could be seen as an ultimatum.

It shows that the UK at large needs a dose of self-confidence. The British audience should not be surprised if German politicians say they won't be blackmailed. This is both a long-standing German diplomatic stance (they won't be blackmailed by France, Spain, Italy, etc either) and pre-negotiation posturing. 

It also shows that it's time for everyone to breathe and calm down.

The OBR's new forecast and the EU budget: What's in there?

On the same day as George Osborne's Autumn Statement, the Office for Budget Responsibility (OBR) published its new Economic and Fiscal Outlook. As usual, the first section we looked at was the one about how much the UK pays into the EU budget. Here is a reader-friendly table we put together, comparing the UK's net contributions to the EU budget in the latest outlook published yesterday with those in the March 2012 outlook (click to enlarge).  

So, the numbers tell us that the UK's net contribution for 2011-12 turned out to be £1.3 billion lower than expected, but the net contribution for 2012-13 is going to be £2.1 billion higher than the previous forecasts indicated. Why?

The OBR is not exactly forthcoming with a clear explanation, but the report (on page 148) notes:  

The largest change [in expenditure transfers to the EU institutions] is in 2012-13, where we have increased our forecast by £1.5 billion [N.B.: Expenditure transfers to EU institutions are something slightly different from EU budget contributions as a whole]. This mainly reflects revised estimates of GNI and VAT bases for all EU countries in 2012 and 2013. Partly because of exchange rate changes these revisions increased the UK’s relative share in both the GNI and VAT bases, particularly for 2012, and thus increased our GNI contribution. 

This increases our expenditure contributions in all future years, but the effects are partially offset by increases in the abatement [the UK rebate] after 2012-13. The expenditure transfers [to the EU institutions] have also been increased in 2012-13 because of lower than expected surpluses carried forward in the EU budget from the outturn for 2011, and to reflect increases in amending budgets in 2012.

Therefore, essentially the OBR suggests that because the UK economy has done relatively well compared to other EU countries, its share of contributions in terms of Gross National Income (GNI) and VAT base have increased. This is natural given the way the budget is calculated, although it once again highlights the fallibility of economic forecasts at the national and international level - clearly the OBR's early forecast of how the UK economy would develop relative to the rest of the EU was some way off.

The OBR also notes the impact of exchange rate changes which have also increased the UK's contributions in sterling terms. Again this is hard to avoid, although the assumption that this will hold in the longer term is far from certain - and paves the way for future forecast revisions. All this is offset to some extent by the automatic adjustments in the UK rebate (designed to account for these sorts of changes), although as we have noted recently the UK rebate could decrease in the next budget period, hampering this offsetting process.

Finally, though, as the OBR warns, much of this is rather academic given the ongoing EU budget negotiations:

The forecast is subject to risks depending on the outcome of the negotiations for the EU budget for 2013, where we have assumed an increase of 2.8%, and for the new EU budget envelope for 2014 to 2020, where we have assumed a small real terms increase.

The first assumption sounds about right - given that MEPs now seem more willing to accept a 2.9% increase in payments in next year's EU budget, as opposed to the inflation-busting 6.8% increase proposed (twice!) by the European Commission. The second assumption is perhaps a bit pessimistic, given that David Cameron has said that he will veto anything different from, at worst, a 'real terms freeze' in the next seven-year EU budget - and Germany, Sweden and the Netherlands are also pushing for a similar freeze.

This is all clearly but another round in the series of forecasts of UK contributions to the EU budget, and far from the last since the negotiations on the next long term budget are under way. But if you are still confused by all these numbers and wondering how it could all end up, we would recommend reviewing our analysis of what could come out of the negotiations on the next long-term EU budget, and how much the UK would have to pay under each scenario.

A eurozone banking union will fundamentally change the rules of the game for Britain in Europe: Is Cameron ready to pull another veto?

Over on the Telegraph blog, we argue:

Talk of a banking union for the eurozone has become fashionable. Many, including the British government, see the idea as a way to provide some sort of backstop for the eurozone, where shaky banks remain a huge threat not only to the single currency, but also to the British economy.

Banking union, as a concept, has merits – it tries to deal with the ever elusive question: what happens when cross-border banks fail? But, viewed from London, a banking union is also political dynamite. It cuts to the heart of both a key national industry and Britain's future place in the EU as the eurozone integrates further.

There are only embryonic proposals on the table at the moment, and a lot is unclear. A banking union could involve a wind-down mechanism, resolution fund and deposit guarantee scheme – all on a cross-border basis. It could also take various different institutional shapes, putting the Commission, the ECB or national capitals respectively at the centre (expect turf battles). All of these vital decisions will take a lot of negotiation and time to sort out and may involve EU treaty changes – while there’s huge resistance in some member states, not least Germany. It may not be politically possible to achieve.

Regardless, the UK cannot take part in the banking union itself: politically, it would involve a massive transfer of powers to the EU, which no British government will go anywhere near. Economically it would be virtually impossible too, given the disproportional risk accounted for by the City of London, which neither side would be willing to accept. Instead, in a scenario reminiscent of David Cameron’s December veto, the question is whether London will simply nod through the changes (whether a Treaty change or not, the UK will have veto over at least some elements) or whether it will name a price for its approval.

George Osborne and No 10 have said they will seek safeguards to ensure that “British interests are secured and the single market is protected… anything affecting the single market should be agreed by all 27.” But is Cameron really willing to veto the same union that he is calling for?

Because if, according to UK wishes, a fully-fledged banking union indeed materialises, it’s very difficult to see how it would not cut right across the single market. The most obvious risk is over ‘location policy’ – whether in future a certain firm or financial activity must be supervised by eurozone authorities in order to do business there. This would essentially serve as a massive barrier to UK firms doing business in Europe – in an extreme case, the City of London would effectively become ‘offshore’ for the purposes of trade with euro countries.

But more probably, for a banking union based on cross-border liabilities to really work, it would need to be backed by perfectly harmonised regulations, to avoid a bank in one country essentially free-riding off the back of guarantees by taxpayers in another country. This is precisely why the Germans are so sceptical – without a single set of rules the banking union would spill over to fiscal union but without the corresponding central controls. Not only because backstopping banks is a big part of state liabilities, but also because banks flush with new eurozone-wide guarantees could lend to their domestic sovereigns at incredibly low rates, essentially providing artificial subsidies to states and removing market pressure for reform (sound familiar?). That would give rise to moral hazard of ridiculous proportions.

Instead, the eurozone will need a ‘single rulebook’ for banks, which may or may not be compatible with the current rules governing the single market in financial services. For example, to counter free-riding risks, individual countries could have no discretion whatsoever on capital requirements for banks. It would be a single target for all euro countries, with zero flexibility. This may not be a disaster for the UK – it could even be a benefit. But it could also go the other way, ending with an in-built eurozone majority voting to apply the single eurozone capital target for the EU as a whole, which could be substantially different to the needs of the UK. A eurozone banking union would also alter the basic relationship between the home and host countries of cross-border banks (i.e. subsidiaries), shifting the previous fragmentation from national borders, to the euro/non-euro divide.

Again, this may or may not be a problem for the UK, but the point is that inherent in the creation of a full-scale banking union is the fragmentation of the EU single market – which means that, if you’re sat in London, you should tread extremely carefully around the issue. A compromise may be possible (though it won’t be pretty) which would allow for the gap between the eurozone and the single market to remain narrow (we’ve suggested some potential compromises here). But the political dilemma for the UK government is clear: is it prepared to use another veto to block a banking union absent UK-specific safeguards – risking being perceived as hampering efforts to save the euro? Or will it simply nod through potentially game-changing proposals, risking the wrath of its backbenchers?

Referendum confusion: Is Cameron protecting Britain from British plans for a eurozone superstate?

The eurozone crisis alone is complicated enough. Add in UK domestic politics and calls for a referendum on EU membership, and this stuff becomes maddening.

Today's Europe coverage in the UK press was a wonderful cocktail of a euro Armageddon, EU-UK relations and a huge dose of British domestic politics.

The Telegraph reported that:

"The Prime Minister dismissed as 'nonsense' a suggestion from Angela Merkel, the German chancellor, that the European Union should eventually have a single national identity and described as 'nonsense' the idea of loyalty to a common European flag."

It also noted that Merkel said yesterday, “We need more Europe, a budget union, and we need a political union first and foremost”, which led the paper to proclaim that "David Cameron promises to 'protect' Britain from German plans for a eurozone superstate with common banking and political systems".

But is that really what's going on here? It's true that both Cameron and Osborne have floated the idea of "safeguards" if the eurozone presses ahead with a banking union and further integration. But here's the thing: Germany's default position remains strongly anti-fiscal burden sharing, meaning that Merkel's 'budget union' is still based on exporting German fiscal discipline to the eurozone-level by introducing stronger budget oversight and enforcement mechanisms - only then could some form of debt mutualisation be considered. A German-led superstate still seems years off - if it ever will be agreed (no matter how much other parts of the eurozone or markets might like to see it right now).

In contrast, David Cameron last month called for a bigger bailout fund, shared eurozone bonds and a more active monetary policy from the ECB - in other words, the eurozone quickly moving to "joint and several liabilities" with stronger states indefinitely underwriting weaker ones. That would really be a German-led super state.

So, who's plans are Cameron and Osborne really trying to 'safeguard' themselves against? Of course, Cameron is right to stay well clear and seek safeguards in return for nodding through treaty changes designed to achieve a fiscal or a banking union, for example for UK financial services. But this discussion leaves the impression that Cameron is actually seeking safeguards against his own plans for eurozone integration. Not necessarily a contradiction, but not a good starting point for future negotiations over EU treaty changes either.

There's also a second confusion: an EU referendum.

In response to questions about the impact on Britain of more eurozone integration, Osborne yesterday told the BBC Today Programme that:

“I think what the public are concerned about, the British people would be concerned about, would be if there was any transfer of power...A reshaped relationship with Europe would imply, would involve, a transfer of sovereignty or powers from the UK to Brussels.” 

In reality, Osborne merely re-stated what's in the 'referendum lock', i.e. a substantial transfer of powers to the EU will, by law, trigger a public vote. But the context is confusing. In all likelihood any eurozone focused treaty change would not legally and constitutionally impact the UK enough to trigger a referendum. Furthermore, the government's talk of safeguards suggests that, if none are present, the UK would veto any treaty change before it actually gets to a referendum. So a referendum still looks unlikely, at least on the back of the eurozone crisis.

Osborne and Cameron are in an unenviable position - the eurozone crisis threatens to send Britain into a deeper recession, and remains a fundamental threat not only to the UK economy but also now to the Conservatives' 2015 election prospects. Tory backbenchers and UKIP are both breathing down the necks of the Conservative leadership over an EU referendum. All factors considered, Osborne and Cameron are doing a decent job balancing all these interests.

At the same time though, as we hint at in today's Telegraph, the UK government could end up in a rather strange position by sending all these political hares running at the same time. Is it going to veto the same Treaty changes (to establish a fiscal / banking union) that it is now effectively calling for? If it's deemed that these treaty changes de facto transfer powers away from the UK - i.e. by shifting the institutional balance of power towards the eurozone at the UK's expense - will it then also call a referendum on those treaty changes? What would the question be?

This may all work out both in the polls at home and in talks in Europe. But given the unrealistic expectations it raises - and how very difficult it will be to square all these various factors - it may well come back to haunt the Tory leadership, at home as well as abroad.

The UK should throw its weight behind a Europe based on sound money

In today's Telegraph, we argue:

Whatever the future of the single currency – and the entire European project – it will largely be decided in Berlin. The most important relationship for David Cameron is therefore with the German Chancellor, Angela Merkel. But there is a risk that the Prime Minister will miss a vital chance to cement a new Anglo-German deal on the future of the European Union.

For years, the UK’s European diplomacy has been defined by its relations with the Élysée, but the eurozone crisis has demonstrated that Germany now stands alone as Europe’s leader, however reluctantly. Despite there being a great deal of cultural and political overlap, however, the basic problem is that Britain does not really understand Germany, and vice versa. Britain perceives itself as a seafaring country of traders, Germany as a continental land of engineers.

Much like the UK, Germany is undertaking a highly charged internal debate about its place in Europe. For the first time, the twin pillars of Germany’s extraordinarily successful post-war settlement are in conflict: its commitment to Europe, and its belief in sound money and stable budgets. Whatever the outcome of this debate, it will have a defining impact on the future of the EU.

The UK, however, risks ending up on the wrong side of the debate. To the great annoyance of Berlin, Cameron and George Osborne have developed a fondness for calling on the eurozone to move towards fiscal union, including eurobonds, and for the ECB to effectively start the printing presses. Britain has a right to voice its opinion – a full-scale crisis would have implications well beyond the eurozone – but its advice is misguided.

Eurobonds and cheap money create huge incentives for more spending, which is exactly what the Coalition is arguing against at home, and feel awfully like solving a debt crisis with more debt. Cameron has also stressed that “Europe’s lack of competitiveness remains its Achilles’ heel”. But, as Merkel has rightly countered, eurobonds do nothing to address this. If anything, allowing countries to piggyback on Germany’s credit rating takes away pressure for the vital reforms that many of these countries need.

After having spent a decade in opposition calling for a more dynamic European economy and a slimmed-down, more democratic EU, the Conservative leadership’s cocktail of Eurosceptic fiscal federalism is not only intellectually inconsistent but, in the key debate about the future of the EU, needlessly aligns the UK with European federalists and socialists such as François Hollande.

At the same time, it locks Britain into a weak negotiation position over future EU treaty changes – which will be needed if the eurozone is going to move to fiscal union – as Britain can hardly block the same treaty change that it has effectively argued for.

Instead of prejudging the eurozone’s future, Britain should spend all its political capital on convincing Merkel that Europe as a whole needs to move in the direction of free trade and structural reform. This means that, instead of talking about “digital government” as Cameron and Merkel did yesterday, Cameron should have said the following: “I will support the Chancellor’s vision for a Europe based on responsible spending, sound money, liberal cross-border trade and respect for the rule of law. Like the Chancellor, I believe that Europe must learn how to live within its means and reform itself if it is going to remain a vibrant economic actor on the world stage. But just as Germany will need to seek the right conditions to be comfortable with its new position in Europe, so must Britain. Since we cannot join the euro, Britain will need a different – and more flexible – set of arrangements under EU law than euro members. This is the only way to reconcile continued EU membership with UK public opinion.”

In the end, this would benefit Germany, Britain and Europe as a whole.

UK government to Merkel: move to fiscal union or else...

Regular readers know what we think of the UK government's peculiar habit of lecturing the eurozone on the need to move to a full fiscal union (meaning eurozone governments completely running over their own electorates). Well, over the weekend, the Coalition moved from dropping hints to - it seems - issuing outright instructions.

Here's Nick Clegg in an interview with Der Spiegel (at least qualifying his remarks):

"You have to have something which creates a fiscal accompaniment to monetary union. Whilst I have a huge amount of sympathy with German taxpayers and German politicians who are reluctant, understandably because Germany is the paymaster of the European Union, to entertain these ideas, I fear that they are unavoidable. It is not sustainable to believe that the eurozone can thrive through fiscal discipline alone - it also has to, at some level, include an ability to either share debt or to deal with shocks in one part of the system or the other through fiscal transfers."

And here's George Osborne, writing in the Sunday Times,

"The eurozone needs to follow what I described a year ago as the 'remorseless logic' of monetary union towards greater fiscal integration and burden-sharing. I mentioned eurobonds as one possible mechanism, and there are others."

Meanwhile, David Cameron followed up last week's comments that the eurozone need to increase the bailout funds, move to"fiscal burden sharing" and the ECB starting to act as lender of last resort (quite a wish list), by saying that the forthcoming Greek elections have to become "a moment of clarity and decisiveness for the eurozone" noting that,

"We now have to send a very clear message to (the Greek) people - There is a choice, you can either vote to stay in the euro with all the commitments you have made, or, if you vote another way, you are effectively voting to leave."

To be fair, Shadow Chancellor Ed Balls was quick on the lecturing too. While telling the BBC Today Programme that:

"I don't think David Cameron's posturing helps at all, I think it just makes it worse"

He did some posturing of is own, telling Sky News' Murnaghan Show, however:

"In the end... somebody has got to persuade Germany that this is a catastrophe for Britain, Europe and the world and that Germany has got to change course...The problem is, the German people went into the eurozone 10 years ago on the clear promise that they weren't going to bail out Italy and the central bank wasn't going to play this role. Both things have got to change." 

So how did the German commentators and politicians respond to his unusual show of cross-party consensus in the UK (minus London Mayor Boris Johnson, calling the UK government's stance on eurozone fiscal union "unbelievable"), in favour of more European integration? Barely a whimper. There were a lot of talk of Hollande, and one mention of Clegg's interview, but apart from that, the German press was deadly silent on this issue, although hinting at a Cameron U-turn, Süddeutsche's Nikolous Piper has this to say:

"Two years ago, at the summit of the G-20 leaders in Toronto, Merkel was able to enforce the requirement that developed countries should cut their budget deficits by 2013. She was supported by the then newly elected British Prime Minister David Cameron. In the meantime, Cameron’s austerity policies led Britain into a recession, with a corresponding loss of credibility."

We get it. British euro lecturing is for domestic consumption, but is this really where Cameron wants to be in Europe (the perception isn't exactly helpful)?

Should the UK contribute to the IMF?

George Osborne is in Washington DC today for an IMF meeting. In another one of those ‘domestic politics meet financial crisis’, Osborne is under pressure from his MPs not to contribute any more cash to the IMF unless there are guarantees that the money won’t be used, as the popular phrase is in Westminster goes, to “bail out a currency” (and no, we’re not talking about the Yen). There are a whole range of confusions surrounding this entire debate, so here’s an effort to clear them up:

Where are we at?

The UK can provide £10bn without a vote in Parliament, as this cash goes back to a previous commitment. For anything more, it needs approval from its MPs, which could be sticky (see below). Osborne has so far refused to contribute the £10bn, let alone even more, until certain conditions have been met.

Is contributing to the IMF the same as giving to, say, the EFSF (the euro bailout fund)?

Certainly not. The IMF is (a) a serious organisation that has saved many countries including the UK (b) its loans rank senior to other debts and so are always repaid (c) nobody has ever lost a cent on the IMF and (d) this would actually be an opportunity to modernise a 1948 organisation by giving the BRICs a more proportionate say in return for fresh capital (if you want to keep the IMF relevant, this is inevitable).

Are Tory MPs really that opposed?

There’s been a lot of shouting to the press over this issue, but the feeling is that most Tory MPs realise that contributing to the IMF could be a sensible move provided that certain conditions are fulfilled.

So what conditions need to be fulfilled for the UK to contribute?

The UK government has set out two: the top-up needs to be global (all countries contributing not only EU ones) and the money can’t be used specifically to bail out the euro.

We would add that there also needs to be a change in tact. As we told BBC five live this morning, “The main problem is that the eurozone’s approach to the crisis hasn’t changed, despite widespread criticism including from the IMF, it still fails to address the underlying problems: the lack of growth, the lack of competitiveness in the peripheral countries and the massive risks still held by the under capitalised European banking sector. Any further contributions should be conditional on a change in tack and some acceptance that this bailout and austerity policy has failed.”

What is likely to happen?

At the moment it looks as if the IMF will reach its target of $400bn, possibly even without funds from the UK, US and Canada. The two latter countries look unlikely to contribute additional funds, so the prospect for additional contributions from the full membership looks dim.

The question is, what will the IMF need to give in return? A rebalancing of power towards emerging market members is inevitable and the BRICs are pushing for it to start in exchange for funds this time around. That means there are plenty of complex negotiations still to take place. A broad political agreement may be in place by the end of the weekend, but there will be plenty of legal and technical details to be fleshed out.

Will the increase change anything?

Not really. Ultimately dispersal of IMF funds in the eurozone crisis is reliant on similar provisions from the eurozone bailout funds. So far the format has been 2/3 eurozone and 1/3 IMF. As we have previously noted, despite EU claims, the lending capacity of the eurozone bailout funds remains €500bn. This means the maximum which will likely be able to be tapped from the IMF is €250bn (although it is incredibly doubtful the IMF would ever put up that much unless the eurozone were teetering on the brink). As is often the case, the issue of IMF funds is tinkering at the edges of the crisis, eurozone leaders still fail to address the underlying problems of the crisis or even put up a sizeable bailout fund of their own.

Should the UK contribute then?

Well, first the government should wait and see if the $400bn target can be met without a UK contribution. If that is the case all the better. If not, and if all the BRICs have contributed, the UK may need to put up its £10bn (which has already been approved by Parliament). Obviously, as we have noted the usual caveats and conditions should apply and the UK along with the IMF should continue to push for a reformed approach to the crisis.

What kind of fiscal integration, Mr Osborne?

This just in from PA:

George Osborne today repeated his call for greater fiscal integration among eurozone countries battling the ongoing debt crisis.

The Chancellor urged governments in the single currency nations to follow the "remorseless logic" of further financial fusion.

He said: "The financial crisis in the eurozone is extremely serious.
Fortunately Britain is not in the euro; unfortunately however, we are not immune to the instability on our doorstep.

"The euro area must implement its policy commitments to address the crisis."

Mr Osborne added: "The euro area should follow the remorseless logic of monetary union with greater fiscal integration.

"We must ensure we are not part of that integration and our national interests are protected and promoted at all points."

Conservative David Nuttall (Bury North) called on ministers to press for eurozone countries to be allowed to ditch the currency without sacrificing membership of the European Union.

But the Chancellor stressed the euro was "here to stay" and said there was "no immediate prospect of major treaty renegotiation".

Speaking at Treasury questions in the Commons, he claimed Labour remained committed in principle to taking the UK into the single currency.

Of course, we see what's going on here. A British Chancellor worried about a highly fragile recovery at home, wants to avoid an immediate meltdown in the eurozone - something which would send the UK economy back to recession. Understandable in one way.

And yet, at the same time, not. Because if he supports fiscal integration on the basis that it'll fix the eurozone, and therefore aid the UK's recovery, surely it follows that he should specify what kind of fiscal integration he has in mind. There's fiscal union and there's fiscal union. Half-hearted fiscal integration that doesn't solve any of the underlying economic problems in the eurozone, but still leads to a pretty nasty political fallout (we all know the political cost of bailouts and collective borrowing by now), must signify the worst of all worlds for the UK.

For example, as we've argued before, it is far from clear that the watered down mix between eurobonds and national bonds that currently is being discussed will actually end the crisis. Such an arrangement would discourage fiscal discipline while possibly even increasing overall borrowing costs for indebted economies, as the national share of the bonds would face alarmingly high rates. There's also the massive question of implementation and how eurobonds could be applied without imploding the existing bond market.

Some clarity on this please...

Britain's growth: Europe remains the X factor

Conservative Home has launched a "growth manifesto" with contributions from a number of UK thank-tanks with the aim of providing ideas for how to return Britain to growth ("Here you go George; A Growth Manifesto from London's think tanks", is how the piece is aptly titled). 0.2% second quarter GDP growth is hardly impressive so ideas are certainly needed.

We've chimed in with our own thoughts, focusing on a long-term solution to the eurozone crisis in combination with pro-growth, liberalising measures in Europe (save on capital requirements for banks, where tougher regulation is needed). Like Mervyn King and others, we believe that the eurozone crisis remains the biggest threat to the UK's financial stability. But as we argued in the Sunday Telegraph last week, amid fears of another nasty economic downturn in Euroland - and the contracted demand for UK exports that comes with it - the crisis and the measures in its wake are also a direct threat to UK growth.

In fact, a large-scale meltdown in the eurozone could send the UK straight back into recession. The point being that fudging it - which EU leaders are currently doing - is a risky strategy. Here are our thoughts:

The Government needs to push for a long-term solution to the eurozone debt crisis – bailouts aren’t working, debt restructuring will be needed. The longer the crisis goes on, the worse the prospects for eurozone growth and stability look and, as our biggest trading partner, this will have an impact on the UK economy. In the medium-term the UK needs to seek allies in pushing for a better-functioning single market, including deregulation, removing cross-border barriers to services and digital industries, and protecting the interests of the City of London from the EU’s new financial supervisory architecture. This includes securing the flexibility to apply capital requirements for banks as the UK sees fit. In the longer term, the UK should look to diversify its trade away from the eurozone, tapping into the growth potential of emerging markets, which will be necessary in any case but also provides a Plan B if the eurozone fails to get its act together. The UK also needs to continue to push for a reduction in EU external trade barriers and encourage the expansion of free trade agreements with other economies/trading blocs.

Progress?

UK Chancellor George Osborne yesterday refused to sign off the EU budget for 2009 in a routine vote in Brussels. This was a purely symbolic - but still important - gesture to protest wasteful spending in the EU. A spokesperson for the Treasury said that

The Chancellor has put Europe on notice that we can't afford not to put Europe's house in order.

The UK government is talking up EU budget reform, which can come back and bite them if they fail to deliver (remember the budget freeze promised by Cameron, which sort of back-fired?), but is also showing political will to get something done. That's a good sign.

Osborne was joined by Sweden and the Netherlands in abstaining in the vote. The reason for the Dutch absention was, as the country's Finance Ministry bluntly put it, that "€2 billion has disappeared" from the EU budget, which strikes us as a pretty valid reason.

Last year only the Netherlands abstained from the budget vote, meaning that we're looking at progress this year.

With this rate, all member states will refuse to sign off the annual budget by 2022 or 2016 (depending on how optimistically you count).

We're not exactly holding our breath though.

Different perceptions

This is from UK Chancellor George Osborne in today's FT:

The goal of a stronger banking system is so important that we must not allow unnecessary distractions in other areas to get in the way of agreement...Nor should we allow badly thought through regulation needlessly to undermine European competitiveness in financial services. Talk of competition between London, Paris and Frankfurt misses the point. It is the relative competitiveness of Europe, with London as its major financial hub, against other centres in Asia and America that is the real issue. No one should doubt that Britain is determined to remain a global financial centre serving Europe and the world.

And this is from a feature in FAZ (not online), looking at London as Europe's key financial centre:

the City of London has lost support from the British Government. Banks must fear overregulation from Brussels, particularly political decisions and a lack of skilled regulators in the EU’s new financial supervisors. That more than 1000 hedge fund managers have left the UK for Switzerland, is bearable, but that big institutions such as HSBC, Standard Chartered and Barclays are threatening to leave the City if future regulations harm them, is a big hit.

Not quite the same take on the issue...

Financial supervision: a gamble or a victory?

An article in yesterday’s Telegraph celebrated the ‘victory’ of George Osborne, who, it claimed, secured an agreement at yesterday’s ECOFIN meeting that one of the new pan-European financial regulators – the European Banking Authority (EBA) – will have its seat in London. The European Parliament has demanded that all three of the new supervisors be based in Frankfurt, and working under the auspices of a 'quasi-umbrella' organisation.

But is this really a victory? There was absolutely no way that member states were going to accept the EP's proposal to make Frankfurt the sole supervisory centre - it is politically impossible and MEPs know that. Remember, Germany already has the most important financial institution of them all, the ECB, and there's at least one francophone President who has no intention of allowing another key-institution be handed over to the Germans.

That is presumably why the French press also left aside the geography of the proposal, and focussed on the vital aspect: how much power that will be transferred from member states to these new authorities. Reuters France notes that,

the UK, under the pressure of its peers and of the European Parliament, has notably accepted the principle that the new European Supervisory Authorities for banks, markets and insurances will be able to address a financial institution directly – bypassing national supervisors – in emergency situations.

This is potentially huge as it will for the first time - via the EBA, ESMA and EIOPA (the three supervisors in question) - give the EU direct supervisory powers, with their decisions taking precedence over those of national supervisors. We knew that this would be the case for Credit Rating Agencies' EU operations (which kind of makes sense), but the UK now seems to have lost the plot on extending the scope beyond CRAs.

To be fair to Osborne, he's fighting the legacy of the previous UK government and his leverage is highly limited as this will all be decided by Qualified Majority.

As a 'concession' EU finance ministers agreed that the Council (rather than the Commission, as the Commission wants, or the new EU Systemic Risk Board, which the EP insists on) will determine when an “emergency situation” occurs. But this was always the Council's position. And as was made very clear at a debate Open Europe organised on the topic on Monday - there are few safeguards in place against this mechanism being misused or hijacked by political/ideological interests in the future. Crucially, the decision on whether to call an "emergency" will be taken by simple majority, meaning that the UK has exactly the same voting strength as everyone else (despite being home to the bulk of Europe's financial sector).

The potential pitfall ought to be obvious. Only a couple of months ago EU leaders used a clause in the Treaties (Article 122), designed for natural disasters and "exceptional occurrences beyond [member states']control" to make taxpayers in one country liable for the mistakes of a government in a different country, in a decision which involved majority vote (when it should have been unanimity), and which took the EU a huge step closer to a common bond (and fiscal federalism). Using Article 122 in this way was absolutely inconceivable when the Lisbon Treaty was discussed and ratified, particularly as the Treaties clearly and unequivocally prohibit bailouts (see here and here to get a feel for just how arbitrarily EU leaders used Article 122).

Give EU leaders "emergency powers" and they could well use them to justify the most dramatic and previously unthinkable measures. The recent ban on short-selling in Germany also ought to give an indication of how such measures stand the risk of being driven by politics rather than economic reality or long-term thinking.

There could be cases where strong and decisive action at the EU-level could be beneficial, but think about this: what exactly would the new EU supervisors have prevented in the financial crisis - given that the causes of the crisis were inherently global; a credit bubble in the US, global trade imbalances and so forth.

The new EU bodies will also be in charge of drawing up a 'single rule book' in the EU's financial services market and implementing uniform technical standards across Europe, overriding national authorities. This could actually benefit the City of London by ensuring the consistent implementation of directives and standards across the bloc, i.e. uniform application of UCITS IV so that fund managers can market their funds in all member states without additional barriers.

However, here there are also possible pitfalls. All of this assumes that the UK will actually write the single rulebook - which is a heroic assumption indeed (think the AIFM Directive). And as William Underhill, Chairman of the City of London Law Society's Company Law Committee, pointed out at Open Europe's debate:

What are the boundaries of the single EU rulebook that lies behind a lot of this new architecture?...The assumption is that the single rulebook in all circumstances justifies the change, whereas I think we still need to look at each specific proposal, each technical standard that comes forward needs to be justified against more subsidiarity principles.

In other words, the risk is that the EU, incrementally and over time, resorts to more interventions, in the name of a single rulebook.

So there are possible benefits, but it could also go in the completely opposite direction. A leader in today's Wall Street Journal describes the potential consequences:

One need not be conspiracy-minded or euroskeptic to see that more harmonization of regulation and supervision means less room for the U.K. to outcompete its rivals on the Continent. The transfer of power to the EU being negotiated this week in Brussels will, of necessity even if not by design, erode the U.K.'s competitive advantages in the financial sphere.

So this amounts to a pretty serious gamble. After all, the EU needs more safeguards against arbitrary government, not fewer.