What to expect from the Commission's new economics team

Will France's Moscovici (left) be effectively shackled by
Finland's Katainen (centre) and Latvia's Dombrovskis (right)?

The new European Commission (EC) also sees the overhaul of its approach to the Eurozone. While Pierre Moscovici holds the Economic and Financial Affairs post (essentially Olli Rehn’s successor), he will be overseen by the Vice Presidents (VPs) for Jobs, Growth, Investment and Competitiveness and the Euro and Social Dialogue – Jyrki Katainen and Valdis Dombrovskis respectively.

An edge has been added to all this with quick German criticism of the decision to give former French Finance Minister Moscovici such a prominent economic post.

We have already pointed out in our full response to the new Commission that, contrary to popular belief (at least in some quarters in Germany), this does not necessarily change much – a lot of Eurozone rules are already set in stone. However, it is important to delve a bit more into who has what powers or controls which areas?

Katainen’s key responsibilities:

• Helping bring together an investment package to mobilise €300bn in additional public and private investment via the European Investment Bank within the next three months – expected to be discussed at tomorrow’s eurogroup meeting and unveiled soon.
• Coordinating the mid-term review of Europe 2020 strategy and long-term EU budget.
• Pushing economic policy coordination in line with view of “social market economy” while also pursuing a strong structural reform agenda.

Dombrovskis:

• Steering the ongoing reform of the Economic and Monetary Union and, importantly, in charge of pursuing the work of the four Presidents' report on creating a 'deep and genuine' EMU. This suggests he will play a significant role in the bid to create a sounder eurozone and finding a way to marry the existing currency union with greater political union. It's important to note that this will bring him into regular contact with Lord Hill who is responsible for banking union in the new Commission - exactly how the financial stability aspect and the eurozone prosperity aspect will fit together here will be interesting to watch.
• Formal oversight of the European semester – the mechanism through which budget rules are enforced in the eurozone. Also tasked with reviewing the mechanisms for achieving structural reform.

Moscovici:

• As might be expected there is significant overlap with those above. He has also been tasked with handling the European semester. It is expected he will handle the day to day evaluation and, in cooperation with others, will sign off on national budgets and reform plans.
• The language around the Stability and Growth Pact is also in line with previous thinking, tasking Moscovici with making “best possible use of the flexibility that is built into” the rules.
• The focus of this role seems to be on the macroeconomics and fiscal coordination of the eurozone. With that in mind, its expected Moscovici will attend eurogroup meetings on behalf of the Commission.

Overall then, while France may have got what it wished for, Moscovici looks firmly shackled to two fiscal conservatives. None of his tasks relating to the Eurozone are separated from these two VPs. More broadly, as the FT has pointed out, Moscovici (a French socialist) is also severely ideologically outnumbered not only within the broader Commission but specifically in the economic and financial posts.

Furthermore, the language used in the text of the letters remains quite Germanic and in line with the thinking of the current Commission:

“Combining growth-friendly fiscal consolidation, structural reforms and targeted support to investment will be key to a sustainable and strong recovery.”

“Sustainable growth cannot be built on ever-growing mountains of debt. We also know well that it is mainly companies that create jobs, not governments or EU institutions.”

There are also numerous mentions of “sound public finances” and the “social market economy” both core elements of the prevailing German economic thinking.

What to expect from the new Commission in terms of eurozone economic policy?

Finally, there are a couple of hints of what key proposals may be coming in the future. We have already mentioned the reference to a new investment package and the desire to push ahead with reviewing the current surveillance system. A further development seems to be for all those involved to try to engage a “broader range of actors at national level”, make the measures taken to improve the Eurozone more “socially legitimate” and find a more democratic alternative to the EU/IMF/ECB Troika. This suggests fostering national support for the likely continuation of significant structural reform and fiscal consolidation will be a key task for these Commissioners.

With that in mind, there is one final interesting line which is found in both Moscovici’s and Dombrovskis’ letter, they are tasked with forming:

“Proposals to encourage further structural reforms, possibly supported by financial incentives and a targeted fiscal capacity at Euro zone level”

This sounds eerily like a revival of the reform contracts, which Germany has been pushing for some time. The idea has been gaining ground once again after ECB President Mario Draghi suggested that structural reform should have similar oversight to that currently seen for national budgets. The latter part is also interesting, albeit very cryptic and vague. It could refer to the creation of a eurozone budget, possibly focused on tackling unemployment and related costs. Equally, it could refer to something along the lines of a wider assessment of the eurozone’s fiscal capacity and using it where there is scope to do so – meaning some kind of fiscal expansion in Germany (and other strong states) to offset fiscal contraction elsewhere.

Expect movement on these issues in coming months.

Eurozone reform contracts take shape - and they include "fiscal transfers"

As we have predicted numerous times - as recently as in our previous blog post - ‘reform contracts’ in the eurozone could well become the next thing. As a recap, these are agreements where one country commits to a series of structural reforms in exchange for low cost loans, or other form of help, to aid its economy. As we argued back in September - when it was unclear whether the idea would make a comeback - it's one of the  politically more feasible options for Germany as it involves more control and less cash.

@michaelsteen Tricky one. Merkel seems to float reform contracts in this recent interview: http://t.co/rToOm65l9a @SpiegelPeter
— Mats Persson (@matsJpersson) September 16, 2013

@michaelsteen @SpiegelPeter In theory more politically feasible for Berlin than other options, as it involves more control and less cash
— Mats Persson (@matsJpersson) September 16, 2013

Well, Reuters have now got their hands on the latest draft of the plans for these contracts and have published them in full here. The idea now seems to be firmly on the agenda, which is not the same to say it'll actually happen.

Below are the key points of the plans:

• The contracts are seen as a supplementary part of the ‘European Semester’ – the new system of economic governance. They will build on tools such as the macroeconomic surveillance and budgetary oversight, which we have already covered in detail. The contracts are targeted at those countries not making adjustments under the other procedures.

• They are designed to promote “ownership” of reform and “home grown” policies (which lines up with Merkel's comments from yesterday). There is, of course, a tension here, given that by definition they are part of a system of increasing economic oversight and some would say a loss of control of economic policy. As Eurogroup Chief Jeroen Dijsselbloem suggested yesterday, if these countries aren’t pushing these reforms, slightly cheaper loans are unlikely to be the deciding factors in pushing them to do so.

• Further to the above point, the text does stress that the policies will be drawn up by the domestic authorities and will be renegotiable (unlike the bailouts or other parts of the governance system which are more set in stone).That said, they will come with significant “monitoring” – which, to us, evokes the feeling of the EU/IMF/ECB Troika trips to bailout countries.

• The loans will involve “limited fiscal transfers across countries”, the large majority of which would come through the lower interest rate on loans compared to the borrowing countries usual market rate. The open admittance of fiscal transfers has slipped into the draft, this sort of open admission is rare in the eurozone crisis, but given that the contracts are an explicit trade off, it is not entirely surprising (again, as we've argued).

• “The specific amount of financing would not be linked to the direct cost of reforms”. Instead it will be used more generally as an incentive to reform and aid any parts of the economy that need it or to help relieve funding pressure generally. This makes some sense since simply ‘paying’ for reforms seems rather circular and dictatorial. However, making sure the level of reform demanded matches up to the loan size will be very tricky.

So this is something that could fly with the Germans, politically, but how much difference will that make in practice? There are already numerous platforms for reform – bailout programmes, precautionary credit lines, macroeconomic surveillance and budgetary oversight (as well as good old political pressure).

In the end it all comes down to the money. How much will be available and at what price? These questions are yet to be answered, but as with much in the crisis, the likelihood of a muddy compromise looms large.

Reviewing Germany's surplus

As expected, the European Commission today announced a review into Germany’s current account surplus under its Macroeconomic Imbalance Procedure (MIP).

This has been a topic of hot debate recently and has the potential to become a very important debate in the future of the euro and Germany's role in it. We laid out our thoughts on the issue in a detailed post last week. We recommend re-reading it, but the thrust is that, while rebalancing is needed, boosting imports in Germany or cutting exports would do little to help the peripheral economies because they simply do not produce goods and services which Germany want and do not produce the same exports to replace Germany’s if it lost competitiveness.

That said, by the letter of the law the Commission was right to launch the procedure given that Germany has broken its threshold on the current account surplus (over 6% of GDP since 2007, see graph below). The key point is for the Commission to judge it on its merits not as a political process – to be fair the Commission itself stressed this point but there have been hints that it takes a bit of a dim view of the large surplus.

What happens now? It’s early days yet. The Commission will begin its review and complete it by spring next year. The recommendations will then be included in next year’s European Semester and country specific economic recommendations. The key will be how hard the Commission goes on the arguments and how Germany responds. If it fails to implement the reforms the Commission does have the option of imposing a fine or even sanctions on Germany.

Signs on this front so far show the potential for conflict. German reactions have already been quite hostile with CSU General Secretary Alexander Dobrindt warning that, “You don't strengthen Europe by weakening Germany” and CDU General Secretary Hermann Gröhe adding, “Our export strength is the corner stone of our prosperity”. Bundesbank President Jens Weidmann added that expanding Germany fiscal policy is also not the answer, saying, “The positive knock-on effects would be limited”.

There are also a few points in the Commission’s report which are worth picking up on:

Emphasis on euro strength: Numerous times the report argues that Germany’s long standing surplus is helping push up the euro exchange rate, making the periphery’s adjustment harder. This seems a strange point to focus on given that it’s not Germany’s job to manage the exchange rate. There are also plenty of other factors which influence the euro, including but not limited to: actions of other central banks (notably the Fed weakening the dollar) and the repatriation of funds to Europe as banks and business refocus on core European operations. The report also says that Germany’s real effective exchange rate (REER) has come down due to a weaker euro, which seems a tad contradictory.

Causality between deficits and surpluses: The Commission highlights that defining a clear link between one country’s deficit and another’s surplus is not as simple as first seems. This is a point we made in our previous blog. While Germany may have previously been the flip side of other countries deficits, these deficits have now closed and Germany has maintained a surplus by trading with non-euro countries. The Commission also notes that countries such as Germany can play a key role in the supply chain – this means its exports create demand of imports of inputs from other countries, it also highlights that Germany is not always the source of the final demand for imports. The German government itself flagged this up, saying that “40%” of its exports rely on intermediate goods imported from EU partners.

Germany did play a role in previous peripheral deficits: As mentioned above Germany did play a role in sustaining the large deficits in the peripheral countries which helped cause the crisis. However, as touched upon in the report, this is more a failure of supervision (both financial and macroeconomic) and a failure on the part of the periphery to invest the money into factors which would promote long term economic growth. After all these investments were helping to drive significant growth at the time and these countries did reap some benefits, but failed to make them lasting. This dynamic was also almost inevitable as a result of pushing such different economies into a single interest and exchange rate policy.

Germany has troubling demographics: Countries such as Germany, with an ageing population, are always going to be inclined to save more. Judging what level of saving is warranted or needed given such constraints is tough, but it’s clear that German businesses and people have already made up their mind to save more.

Germany does need to unblock obstacles to domestic demand: The report is correct to highlight that Germany can do more to promote demand, notably by liberalising its services sector and reducing the level of taxation.

Germany above the threshold for public debt: the Commission will review this imbalance as well, highlighting constraints to any demands for further public spending.

All in all, the Commission does try to cover both sides of the argument but the tone still seems to lean towards asking Germany to do more to boost demand. If this is through liberalising measures it will be welcome (at least by us), however, if it calls further jumps in spending and wages it could find a very hostile reception in Germany.

In any case, the scene is set for what could become a crucial debate over the structure of the euro. The crux of the argument comes down to – what is Germany expected to do to save/aid the euro and what is it willing and able to do (politically, legally and economically)?

"You don't have to dictate": Hollande doesn't like to be bossed around by Europe

Well, we know that French economic and budgetary souveraineté runs incredibly deep. So that French President François Hollande didn't react with enthusiam to the European Commission's new economic policy recommendations to France shouldn't come as a surprise. This is what Hollande had to say (courtesy of AFP),

The [European] Commission doesn't have to dictate to France what it has to do. It simply has to say that France must restore its public accounts.

Two quick points:

1. It may seem that, through statements like these, Hollande contradicts his own call for a "real economic government" for the eurozone. But remember, when France talks about le gouvernement économique, what it has in mind is an intergovernmental structure where member states have the last word - not a supranational one where the European Commission has the power to veto national budgets. Incidentally, the latter is what Germany wants.
    
2. In turn, the remarks clearly show how difficult it will be to achieve a eurozone fiscal union. Will France ever accept being bossed around on economic issues - and the type of strict supervisory powers Germany demands for underwriting the eurozone?

As we've said before, this is a pretty brutal Catch-22 situation. We keep our eyes open for further reactions. 

Hollande goes on the offensive - two years to achieve political union in Europe

The French media called it François Hollande's "grand oral exam". The French President has just held a big press conference at the Elysée palace marking his first year in office. And he said a couple of very interesting things about his vision for the eurozone and Europe.

Hollande pledged to launch an "offensive" to "drag Europe out of its lethargy".

He called for an "economic government" for the eurozone,

"which would meet every month, with a real president appointed for a long term and who would be assigned this as his only task."

According to Hollande,

"This economic government would discuss the main economic policy decisions to be taken by the member states, would harmonise taxation, would start convergence in the social [policy] domain...and would launch a plan to fight tax fraud."

As if these remarks weren't controversial enough, Hollande re-stated his belief that the eurozone should have its own "budgetary capacity" and "the possibility to, gradually, borrow money". In the Q&A session he also suggested the ECB could be doing more on liquidity.

The French President concluded the EU-related part of his keynote speech by saying,

"Germany has said several times that it is ready to move to a political union, to a new stage of [European] integration. France is willing to provide the content to this political union."

With a real coup de théâtre, Hollande gave himself "two years to achieve" this political union. 

It will be extremely interesting to see what the response from Berlin will be. For the moment, Hollande's press conference is another reminder of how distant France and Germany are in the debate over the way ahead for the eurozone - with Paris sticking to its 'solidarity/integration first and supervision/discipline later' line, and Berlin insisting that things should evolve the other way around. 

Tackling the slow, painful decline: A bad day of economic data for the eurozone

Some have said the worst of the eurozone crisis is over – this morning’s economic data did not provide much support to their argument.

 

Top of the list are the growth figures for the eurozone in Q4 2012 – as a whole the bloc contracted by a massive 0.6%. Maybe not a huge surprise but still worse than most expected. Furthermore, there were few glimmers of hope. 

As the graph above shows, Germany posted a contraction of 0.6%, Italy 0.9% and Portugal a massive 1.8% (more on this in a minute). France’s 0.3% contraction looked relatively mild, although it confirmed that the French economy saw zero growth in 2012 – it also put pay to any hopes of the French government achieving its growth projections for 2013 or its deficit target (see here for more on this). For all of these countries, this was the worst quarterly growth performance in almost four years (2009Q1).

The Italian statistics agency confirmed that growth for 2012 was -2.2%, a timely reminder of Italy’s real problem – an endemic and chronic lack of economic growth. The absence of any credible policy for correcting this in the current electoral campaign should be of grave concern to all of Europe.

Portugal was undoubtedly the stand out performer, but not in a good way. The 1.8% contraction in the final quarter brought the annual real terms contraction in 2012 to 3.2%. This result, along with the German contraction (which was put down to a collapse in European demand for German exports), highlights the substantial risk of expecting export lead recoveries to materialise when the entire eurozone is in a recession. The stumbling growth in the US and China at the end of 2012 likely created a further drag.

In fact, the only countries to provide any strongly positive data were the smaller central and eastern European economies – particularly Estonia, Latvia and Lithuania. Some would highlight that these are the countries that have already completed a significant round of structural reforms and internal devaluation. In any case, they are far from large enough to help pull the rest of the eurozone out of its current slump.

Meanwhile, the Greek statistics agency Elstat also released its figures for Greek unemployment in November 2012. Overall unemployment reached 27%. As we have noted many times before, this far outstrips the EU/IMF/ECB troika estimate for the end of 2012 which was 24.4% (this is even after it was revised upwards significantly in the IMF’s January report on Greece).

More worryingly though, youth unemployment has reached a whopping 61.7%. Think about that figure - it's absolutely extraordinary, especially when compared to the fact that it was only 28% three years ago. We can’t help but wonder how long such high levels of unemployment can be sustained before the political and economic impact becomes too heavy for the state to carry alone (i.e. before Greece demands further eurozone funding and concessions on its reform programme). Again, the risk is that the very fabric of Greek society could start disintegrating under such sustained pressure.

There has been plenty of optimism around the eurozone recently, some of it warranted and we should relish this. But this data should be a timely reminder of, arguably, the biggest challenge of them all for the eurozone: how to reverse the trend of slow, grinding decline.

If EU leaders thought for one minute that there were room for complacency, they can think again.

Right said fred

This is some very sensible stuff, from the usually very sensible Swedish Prime Minister Frederik Reinfeldt, reacting to yesterday's meeting between Merkel and Sarkozy.

On economic governance

“The best thing would be clear formulas for advancing decontamination of public finances.”

On financial transaction tax

“I do not believe in this idea, if it is not adapted globally, for everyone at the same time. What was expressed yesterday was the idea to only impose it in the Eurozone.”

“Sweden is interesting because we are the only country with any real experience on this type of transaction tax. If it is only imposed on one part of a market, our experience is that it brings small amounts of income, but transactions move away. If this is imposed on the Eurozone, it is easy to see how a large part of international transactions move to London, or why not Stockholm?”

On Eurobonds

“In reality this means that well managed countries accept higher interest rates, in order to push rates down in less well managed countries."

All of which of course is true, though a rules-based system for public spending - where Sweden clearly takes a similar line to to Germany - is fine in theory, but difficult in practice (read: national democratic politics).

Incidentally, when will Reinfeldt come out against Sweden joining the euro? The Swedish centre-right parties' support (their leaderships, not members) for the euro - a manifestly flawed project which has nothing to do with liberal economics - remains one of the greatest political anomalies in Europe today.

Grabbing a six-pack

Amid the ongoing Greek and eurozone debt crisis, MEPs and member states are trying to agree on a set of proposals for enhanced 'economic governance' in the eurozone. The aim: never again.

MEPs will vote on the proposals tomorrow, but it looks like they're not 100% satisfied with member states' offer and may therefore adopt only part of the compromise texts agreed with the Hungarian Presidency. According to UK Lib Dem MEP Sharon Bowles - who chairs the European Parliament's Economic and Monetary Affairs Committee - MEPs will "keep the door open to a final vote in July, so the Council can come back with an improved offer."

The whole discussion has been somewhat lost in the Greek saga, but here's our take. The proposal involves the so-called "six pack", which includes:

- New rules on how member states can plan and calculate their budget (including statistics and forecasts for budget planning, known as “budgetary frameworks”. This involves all EU member states, but the UK has an opt-out from “numerical fiscal rules”.

- Stronger surveillance of EU budgets, including sanctions on member states that manipulate statistics

- Stronger sanctions for member states that break the EU's budget rules (within the existing "Excessive Deficit Procedure"). All EU member states will be subject to the Commission's recommendations and warnings on their respective budgets, but the proposed sanctions are for eurozone countries only

- A “European Semester”, which involves member states making their budgets subject to “peer review” from the Commission and other member states. This involves all EU member states, but the UK’s different budget cycle is taken into account (meaning that Britain's pre-budget report is what will be peer reviewed which is public anyway)

- Rules to prevent and correct "macroeconomic imbalances "– this refers to the build up of massive current account deficits or surpluses and involves all EU member states, but stops short of detailing actual sanctions (there’s a specific proposal for that)

- A mechanism for imposing sanctions on countries running excessive macroeconomic imbalances. This applies to eurozone only

Let's look at two of the more contentious issues: will the UK be affected by the proposals and will these measures actually make a difference for the future of the eurozone?

First, Britain's involvement. The lastest proposal from the EP seems pretty harmless for the UK:

- Sanctions for breaches of EU budget rules and for excessive macroeconomic imbalances are for eurozone countries only;

- The European Parliament’s proposal to “leave the door open” for non-eurozone countries willing to sign up to the sanctions mechanisms has been scrapped in the latest compromise text;

- The UK’s different budgetary year is taken into account for the submission of budget guidelines, stability and convergence plans, etc.;

- Only the UK among non-eurozone countries benefits from a special opt-out on the country-specific “numerical fiscal rules” which member states must follow when they try to bring deficit below the SGP thresholds.

So what about the package as a whole? Well, it's not going to change the world. The two major proposals are:

Budget deficit rules and accompanied sanctions: The rationale here is to beef up the sanctions imposed on member states for ignoring the eurozone's fiscal rules. It's hard to argue against this on practical grounds. As we all know, the original Stability & Growth pact (SGP) was blatantly ignored (by Germany and France first) and Europe needs fiscal discipline. Will this new arrangement be any different? Much of the new arrangement is a mere copy of the SGP. However, under the new package sanctions could be imposed on eurozone countries at an earlier stage, if they ignore recommendations from the Council.

Macro-economic imbalances and accompanied sanctions: This is a tricky one. The principal is correct - fiscal discipline alone is not a sufficient solution to the eurozone crisis. The imbalances in the eurozone ultimately stem from huge competitiveness gaps between countries. But how in the world do you actually measure such imbalances - and more importantly, how do you make macroeconomic imbalances subject to pre-emptive or corrective sanctions.?For example, how do you penalise a country whose productivity falls for various reasons or whose economy suffers from a lack of diversity, which in turn stores up imbalances?

Of course, there's also the question of democratic legitimacy. Will electorates and national parliaments accept having some potentially important decisions on spending and tax being subject to supranational rules, rather than votes in elected popular chambers?

But another key question is, will these proposals actually do that much to stamp out the huge tensions and weaknesses we today see in the eurozone?

The answer is probably no.

Taking their own advice?

Finance Ministers meet today in Brussels to discuss proposals for strengthening the EU’s “economic governance”, spearheaded by European Council President Herman Van Rompuy and his “task force” on the subject (which so far has failed to convince member states). In parallel with whatever Van Rompuy and the Finance Ministers come up with, the Commission will on Wednesday table its proposals for various measures intended to pre-empt another sovereign debt crisis. These will include sanctions for countries which run unhealthy budget deficits .

According to German daily Die Welt, the Commission is also contemplating the introduction of a “warning system” to monitor wages in member states' public sectors. This is potentially hugely controversial stuff, depending on what the proposal looks like in the end. Marco Buti from the European Commission for Economic and Financial Affairs explains the rationale: "the wage development in the public sector does of course have a great influence on the economy".

Fair enough. However, although it's not entirely clear to us which EU institution will be in charge of deciding when public sector wages are posing a risk to the sustainability of the overall economy under the forthcoming proposal, if Mr. Buti sees the Commission in this role, he might be up against some resistance. Says Buti, "when wages in the public sector damage competitiveness and price stability then the country will be requested [by the Commission] to change this policy."

Problem is, the Commission isn’t exactly in the strongest moral position to give lectures to member states on public sector pay. EU officials’ salaries are already far higher than the majority of public servants in member states, and the Commission now wants to award its officials three pay rises by 2011, adding up to a pay hike of 5% – at a time when most member states are busy imposing pay freezes and deep cuts. The same reasoning can be applied to the Commission’s drive to make Europe’s various pensions systems more sustainable (including retiring later). Meanwhile, EU officials can retire at 63 with up to 70% final salary pensions, and many take early retirement.

It has been pointed out many times before – by Dan Hannan in the European Parliament last week for example – but it can never be repeated enough times: the mismatch between what the EU institutions preach on public finances and what they practice is mind-boggling.

If member states had the same pay and pension policies as the EU institutions, we fear that they would go bust in no time.

Economic governance: a tale of two polls

A new poll published yesterday by the German Marshall Fund of the United States makes for interesting reading.

With a few exceptions, majorities in the eurozone countries said the euro has been a bad thing for their economy, including France (60%) and Germany (53%), but also Spain (53%) and Portugal (52%). Italians were divided on the benefits of the euro with 47% saying the euro has been good and 48% saying it has been bad for their economy. Only the Dutch (52%) and Slovaks (64%) had majorities saying the euro has been a good thing.

Unsurprisingly, a full 83% in the UK thought that using the euro would be a bad thing for the economy.

But perhaps just as interestingly, the poll found that a plurality of EU respondents (46%) believe that in dealing with the current economic crisis, each country’s national government should have primary responsibility. Roughly two-in-five EU respondents (39%) said that the EU should have primary responsibility for handling the current economic crisis.

Only in Germany did the majority (54%) agree that the EU should have the leading role in economic decision-making. The French were divided on the issue, with 47% saying the national government and 43% saying the EU should have the primary responsibility.

This certainly makes an interesting comparison with the Commission's recent claims that "75% of EU citizens want more European economic governance", based on a rather creative interpretation of its Eurobarometer survey, which we have debunked before. EUobserver notes that the results "sharply contradict" the European Commission's interpretation.

Respondents were only asked whether or not “a stronger coordination of economic and financial policies among all EU member states” would be effective to combat the ongoing crisis (see p. 38 here). The question didn’t even mention the role of the EU or the term “European economic governance”. The Commission got its 75 percent figure by adding up the respondents who thought that stronger coordination would be “very effective” (26 percent) and those who only thought it would be “fairly effective” (49 percent).

Herman Van Rompuy's taskforce clearly has a very difficult job on its hands if it's to convince people on the need for greater economic governance.

So that €750bn bailout was just a misunderstanding?

In an interview with the FT published today, Jean-Claude Trichet makes a pretty extraordinary comment. He seems to deny that the eurozone was ever really in crisis:

"I don’t think that the euro area was close to disaster at all – seen from the inside."

So €750bn eurzone bailout packages, €110bn 'loans' to Greece and the ECB compromising its independence by buying government debt, are just business as usual? Trichet blames the misconception that the euro is in trouble on a lack of understanding:

"Seen from the outside, I would say that it’s always difficult for external observers to judge and analyse correctly the capacity of Europe to face up to exceptional difficulties."

If only Trichet were right. Unfortunately it seems that EU leaders are still unwilling to admit to the fundamental failures of the EMU project - such as huge divergences within the eurozone and monetary union without fiscal union. Tightening budget rules is all very well, for example, but what about a country like Spain that wasn't in breach of them running up to the crisis?

Until the eurozone elite faces up to this fairly simple and fundamental reality, the truth is that it is they that 'don't get it', not us mere 'outsiders'.

A classic example of EU spin

Here's an example of some good old EU spin for you:

The European Commission today announced the results from the latest Eurobarometer poll - carried out in May during the height of the crisis - with a press release carrying the headline,"EU citizens favour stronger European economic governance". 75 percent of Europeans, we are told by the press release, are in favour of giving the EU a stronger role in the coordination of member states' economic and budgetary policies.

EU Justice Commissioner Viviane Reding - who also is in charge of Communication - comments:

"The clear majority for enhanced European economic governance shows that people see the EU as a decisive part of the solution to the crisis".

Clearly, something fishy is going in here, not least since only 26 percent of people then go on to say that they consider the EU best placed to deal with the financial and economic crisis.

And sure enough, the Commission is trying to take us for a ride. Respondents to the Eurobarometer survey were only asked whether or not "a stronger coordination of economic and financial policies among all EU member states" would be effective to combat the ongoing crisis (see p. 38 here). The question doesn't even mention the role of the EU or the term "European economic governance". Creatively, the Commission then adds up the respondents who think that stronger coordination would be "very effective" (26 percent) and those who only find it "fairly effective" (49 percent) to reach the 75 percent figure.

Seriously, how stupid do they think we are? By no stretch of the imagination is this the same as 75 percent of Europeans being in favour of giving the EU more powers to monitor national economies, which the Commission is trying to make us believe in its press release.

The Eurobarometer could have asked this question instead: “Do you think that the EU should be given more powers to monitor your country’s economy, including decisions on public spending and taxation?” We suspect the result would have been completely different.

What the Commission really should be focussing on is the troubling fact that only 49 percent of respondents think that EU membership is "a good thing" down from 53 percent last year. Or that the percentage of people who think that EU membership is "a bad thing" has reached its highest level in a decade - now at 18 percent (see p. 12).

What's more, the percentage of people who think that EU membership is a good thing has decreased by 5 percent in France and the Netherlands, for example, and by a striking 10 percent in Germany (down to 50 percent) in only one year. Incidentally, these countries are all net contributors to the EU budget.

Is the Commission getting the hints? We hope so, but somehow doubt it.

Ps. If we were to use the same method as the Commission to support our claims, we could add up respondents who said that EU membership is "a bad thing" with those who said it is "neither good nor bad" (29 percent) to obtain a remarkable 47 percent of "EU non-enthusiasts".

Hungary declares "economic freedom fight" with EU and IMF

The new Hungarian government, and its Prime Minister Viktor Orbán, has decided it's had enough of being dictated to by the EU and the IMF, which both recently halted bailout-loan talks, saying Hungary wasn't doing enough to make durable cuts in state spending.

Orbán's government has said it will adhere to the 2010 budget-deficit target - 3.8% of GDP - set under the terms of its current loan agreement with the IMF and EU. But it insists how it goes about it shouldn't be the IMF or the EU's concern.

"It's an economic freedom fight," said a senior official in Mr. Orbán's administration. "We are getting back the financial independence of the country."

This will certainly prove to be an interesting backdrop to the ongoing EU discussions regarding 'economic government'.

Germany's worst nightmare?

The Commission has today presented plans to tighten up budgetary supervision and oversight in an attempt to avoid a repeat of the current eurozone crisis in the future (i.e. making up for the obvious and fundamental flaw of the eurozone, which is that monetary union cannot exist without economic and political union). “We want governments to send their budget outlines to Brussels for review before they are approved by their national parliaments," EU Economic and Monetary Affairs Commissioner Olli Rehn said today. "We can then see early whether a country is adhering to the Stability and Growth Pact. If not, we would intervene."

However, the Commission has also said that it wants to "expand economic surveillance beyond the budgetary dimension to address other macroeconomic imbalances, including competitiveness developments and underlying structural challenges." This jargon-laden sentence represents a victory for the belief, long-held by the French in particular, that the eurozone should coordinate not just monetary and fiscal policy but also create a genuine economic union/government. The Commission says:

Looking at the euro area as a whole and on a country-by-country basis, the Commission would assess the risk of all possible forms of macroeconomic imbalances that jeopardise the proper functioning of the euro area...The Council, with only euro-area Members voting, would invite the Member State(s) concerned to take the necessary action to remedy the situation. Should the Member State(s), within a stipulated time frame fail to take the appropriate measures to correct the excessive imbalance, the Council, with a view to ensure the proper functioning of EMU, could step up the surveillance for the Member State concerned and decide, on a proposal by the Commission, to issue precise economic policy recommendations. Where necessary, the Commission would use its possibility to issue early warnings directly to a euro-area Member State.

This, in effect, means using the EU's institutions to encourage/force eurozone states to adopt economic policies that fit not just economic but also political aims - an anathema to the doctrine of low inflation, price stability and frugality engrained in the German public's psyche.

As many people have pointed out, improving competitiveness and employment in the periphery eurozone states such as Greece, Portugal and Spain is not just a one-way street of lowering wages in these countries but also increasing domestic demand in Germany for these countries' goods and services. French Finance Minister Christine Lagarde infuriated Chancellor Merkel earlier this year when she said,

"Clearly Germany has done an awfully good job in the last 10 years or so improving competitiveness. When you look at unit labour costs, they have done a tremendous job in that respect. I’m not sure it is a sustainable model for the long term and for the whole of the group. Clearly we need better convergence. While we need to make an effort, it takes two to tango."

Merkel's response was to immediately rebuff any idea that Germany should do more to boost domestic demand:

"The problem has to be solved from the Greek side, and everything has to be oriented in that direction rather than thinking of hasty help that does not achieve anything in the long run and merely weakens the euro even more."

However, IMF chief Dominique Strauss-Kahn has been stirring German sensitivities again today by suggesting that the eurozone introduce short-term fiscal transfers between member states.

To add insult to injury, the proposals tabled by the Commission will be decided by majority voting, meaning that Germany could be outvoted and be asked to revise its budget. We can't see that there's anyway Germany will accept this. The German public has already been asked to stump up a €123bn bailout package and swallow a growing politicisation of the European Central Bank, with its decision to start buying government bonds. But it seems the Commission, backed by the French political elite, has kept pushing.

There surely comes a point when Germany has to push back.

They said it wouldn't happen

What was inconceivable only a couple of months ago has now happened: EU leaders have agreed a massive €500 billion bailout package for eurozone countries facing sovereign debt problems – on top of the €110 billion already committed in a separate rescue package for Greece. An additional €250 billion could also come from the IMF should things get really sticky.

You have to go back pretty far in history to find a time when Europe’s leaders have been so desperate. And you can see why. Markets remained unconvinced of the adequacy of the original rescue package for Greece, and you could sense some serious anxiety over the risk of an escalating sovereign debt crisis, involving Spain, Portugal, Ireland and Italy (The UK is not exactly immune either, although its situation is different). In the last week, the EU elite realised in horror that their flagship project might actually be on the verge of collapsing under the weight of its own contradictions.

Of course, these kinds of tensions are exactly what the sceptics always warned against, and those who blindly argued in favour the Single Currency have some serious soul-searching to do. But it’s still in everyone’s interest that the eurozone sorts out its mess, and the massive bailout package agreed over the weekend seems to have calmed the markets - for now.

As an event in the EU’s history, what happened over the weekend is absolutely extraordinary on so many different levels:

1) Until very recently, Eurozone bailouts were considered a no-go, since both the letter and the spirit of the EU Treaties simply don’t allow for them. Just consider that as late as March this year, Angela Merkel said, "We have a Treaty under which there is no possibility of paying to bailout States in difficulty”.

But as we noted many times before, EU law has a tendency to become irrelevant in times of crisis and the once heralded no bailout principle has now been watered down to the point of becoming meaningless. Having said that, the ‘big’ bailout fund still has some ways to go before it is approved by national parliaments and has passed all legal hurdles, as Edmund Conway points out on his Telegraph blog.

2) The scale of the bailout is mind-boggling. Again, consider that only a few weeks ago, the amount discussed was closer to €30 billion in a one-off bailout for Greece (and before that €20-25 billion). Then, on May 3^rd, that amount had almost quadrupled. As Italian Foreign Minister Franco Frattini put it, “It was necessary to intervene right away to help Greece. To avoid damage we initially talked about 50 billion euros, but decided on 110 billion only 10 days later.” And roughly a week later the deal had been rolled out to all eurozone countries, now involving hundreds of billions of euros.

You can forgive people for wondering where this will end. Particularly given that throwing good money after bad in this kind of way isn’t really solving the fundamental problems of the weak solvency, competiveness and productivity that weaker eurozone countries are currently facing. So this deal could easily spiral out of control and see UK and European taxpayers becoming exposed to ever growing debt burdens of governments over which they have no democratic control whatsoever. This simply isn’t sustainable.

3) EU leaders are basing parts of the bailout on Article 122 of the EU Treaties. This is profoundly dishonest and involves a huge legal stretch. Article 122 states that,

"Where a member state is in difficulties or is seriously threatened with difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the member state."

As we’ve stated before, the European Council has previously said that any use of this article must be compatible with the no bailout rule in the EU Treaties. This interpretation is now being completely ignored.

Telegraph journalist Bruno Waterfield summarises the issue well on his EUobserver blog,

“'Exceptional occurrences beyond control’? This is a lie. A whopping, howling lie told to us by Europe’s political class. This crisis is a product of human agency, the choices and decisions taken by people facing circumstances that are man-made and, thus, susceptible to political intervention. To use a legal clause designed for earthquakes or potentially extreme unforeseen circumstances that threaten the existence of one member state to save the skins of the EU’s political class is profoundly deceitful – quite aside from being legally dodgy."

4) What we were told would never happen, has now occurred - British taxpayers have become directly liable for the debts of eurozone governments. Part of the rescue package involves extending a special fund, previously available only for non-eurozone members Latvia and Hungary. This so-called 'stability fund' will allow the EU Commission to borrow up to €60 billion on international markets, in addition to the €50 billion that was already in the pot, using the EU budget as collateral. If a receiving country fails to pay back the loan, all 27 EU member states would be forced to pay into the EU budget to cover the default, meaning that British taxpayers would be liable for about 13 percent of any losses (corresponding to the UK’s share of the EU budget). Alistair Darling maintains that the maximum loss to British taxpayers would “only” be €8 billion.

Mr Darling said yesterday that the UK will never “underwrite” the euro, but that is exactly what is happening (although the UK will be left out of the bulk of the rescue package, the €440 billion scheme of bilateral eurozone loans).

5) Eurozone leaders took a decision involving non-eurozone countries but without the latter being represented. Alistair Darling has said he supports the UK’s inclusion in the stability fund, but in reality he doesn’t have much of a choice. The decision was effectively taken at the eurozone summit on Friday and since the deal was decided using QMV (as it was based on Article 122), the UK didn’t have a veto when the deal was sealed in the Council of Ministers on Sunday. This is another thing that never was supposed to happen. The fact that the UK only has a caretaker government in place at the moment didn’t exactly help either.

6) Germany had to cave in to French demands on the scope and details of the bailout. According to FAZ, following the deal, Nicolas Sarkozy triumphantly said that "95 percent" of the agreed bailout package "reflect French proposals…at last we have decided to give the eurozone a real economic government." This whole arrangement has Sarkozy’s fingerprints all over it. Or as the Brussels correspondent for FAZ, Werner Mussler noted yesterday, "The facts are: Sarkozy has achieved what he always wanted: the fundamental decisions of the eurozone will be taken by the leaders of the euro states."

7) The line between fiscal and monetary policy has been blurred. Arguably the most significant move over the weekend was the ECB’s decision to buy eurozone government and private debt. In doing so the ECB clearly bowed to political pressure, compromising its independence while for the first time getting involved in fiscal policy – akin to ‘quantitative easing’ in the UK (The EU Treaties prevent the ECB from buying bonds directly from governments, so to circumvent the rules it will instead be buying debt second-hand from banks). This is huge. In combination with the other moves towards fiscal EU centralisation (including more EU budgetary controls), it’s now beyond doubt that we’re seeing the emergence of an economic government for the eurozone.

Will the Germans accept this brave new eurozone? That’s far from clear. Die Welt set out its position in a comment piece yesterday:

“This [the involvement of the ECB] will harm the stability of the euro in the longterm and bury the German belief in the stability of the euro. The costs of this error are not yet foreseeable...The German conceptions of stability principles, responsibility and a monetary policy independent of political influence are coming increasingly under pressure. The idea of an economic government with right of intervention in national economic policy, transfers of debt and a politically influenced central bank is on its way."

So EU leaders have given themselves some breathing space, but what have they actually solved? And at what cost, in the medium and long term, to the EU economy and to European democracy?

As the FT argued today:

“There can be no more pretence that monetary union respects the premise on which it was sold to European citizens, Germans in particular. There is a real chance that a euro member’s failure to pay its debts will land neighbours or the ECB with losses that can only amount to fiscal transfers or money-printing. Strict surveillance and ECB independence was meant to make it impossible to end up in this situation; both have been undermined...Pooling more sovereignty than it ever planned, the eurozone is now at the mercy of its most indebted members’ sovereign decisions.”

Threat or opportunity?

The German-led calls for an IMF-style bailout fund for the EU have caught most people on the hop, including the French, and the lack of detail suggests that the practicalities are only now being worked on inside the German Finance Ministry.

French officials have said that there are two fundamental issues still up for debate: whether the European Monetary Fund would cover only the eurozone or all of the EU's 27 member states, and whether the EU treaties should be amended to create the fund. Plainly, there is a long way to go before the EMF gets off the ground and the current debates are highly speculative.

But as far as the first question goes, if the proposed EMF were to include all 27 member states, rather than just the eurozone, this would obviously have significant implications for the UK as British taxpayers would be asked to underwrite other EU governments’ debts. It would also draw the UK into a system of EU 'economic government' that would potentially give the EU greater powers to interfere in monitor the Government's handling of the economy.

For both of these reasons, any UK government is likely to stay well clear of any participation in the EMF.

The second issue, over whether an EMF would require treaty change, is far from clear but there are a few hypothetical scenarios.

Paris appears cautious about any proposal for an EMF that would require treaty change. French Finance Minister Christine Lagarde reportedly said that "Other avenues should be explored" that are in line with the existing Lisbon Treaty. This suggests one of those creative legal EU solutions which confuses everyone (possibly involving the Lisbon Treaty's ratchet clause which allows for amendment of the Treaty without it being considered an actual treaty change).

However, Chancellor Angela Merkel yesterday made it clear that she thought that the creation of a bailout fund would certainly require changes to the EU treaties. "Without treaty changes we can't form such a fund," she said. And given that it would amount to a breach of the current 'no bailout' rules in the treaties, it is hard to argue with her.

Commentators are already suggesting that new EU treaty negotiations would present both Labour and the Conservatives with big problems. Gordon Brown promised MPs that after Lisbon there would not be any institutional changes in the next Parliament:

I can confirm that, not just for this Parliament but also for the next, it is the position of the Government to oppose any further institutional change in the relationship between the EU and its member states. [Hansard, 22 October 2007]

Similarly, the Conservatives announced last year that they would give voters a referendum on future transfers of power to the EU.

However, depending on how this plays out, an EMF that didn't include the UK could actually present the UK with a sizeable bargaining chip, particularly a future Conservative government. Treaty change would require the Government's consent, whether the UK is involved in the EMF or not. In other words, this could be an opporunity for an incoming Conservative government.

The Conservatives have said they want to renegotiate areas of the UK's membership, notably opt-outs from costly EU employment regulation and intrusive justice and home affairs legislation. In addition, an incoming UK Government has a lot of work to do on the EU budget and the single market issues, including financial legislation.

There is possibly a deal to be done here – the Tories could say "if want to go ahead with the EMF and closer economic integration of the eurozone you need to give us something that we want in return." In Cameron's own words, it would be the ideal opportunity to argue and demonstrate "that European integration is not a one way street and that powers can be returned from the EU to its member countries".

The tricky issue is of course that the Conservatives' promised - or at least are now percieved to have promised - that any siginficant treaty change leading to further integration would trigger a referendum in the UK. And the establishment of an EMF would be a big change, as it would create a whole new EU institution and a lender of last resort at the EU-level. This, in turn, is a clear step towards fiscal federalism, regardless of whether the UK takes part.

At the same time, if not involving Britian at all, the argument can be made that it does not involve a transfer of powers from the UK to the EU per se. Indeed, if put in the right context, it could be presented as a method of regaining powers from the EU, by taking the creation of EMF 'hostage' in EU negotiations.

The critics were quick to say that Cameron's policy was unrealistic and undeliverable, but if the proposal for an EMF gains speed he may be presented with an early opportunity to prove them wrong.

If all the pieces fall into place, he should take it.

Merkel backs IMF-style fund for eurozone

More news on the eurozone front this weekend as we learned that France and Germany are preparing plans for an IMF-style European Monetary Fund (EMF). German Finance Minister Wolfgang Schäuble has said he will "present proposals soon" for a new eurozone institution that has "comparable powers of intervention" to the International Monetary Fund.

Schäuble has today received backing from his Chancellor, Angela Merkel, who said, the EU's current tools "are not sufficient." She added, "The European Union must be able to respond to the challenges of the moment" and if establishing an EMF required revising the EU treaties it would be a price worth paying becasue "we’re saying we want to solve our problems ourselves."

However, it seems that the German government may meet strong resistance from the German political and economic establishment. Juergen Stark, a German Executive Board Member at the European Central Bank, has chosen to write in tomorrow's edition of Handelsblatt that "Such a mechanism would not be compatible with the principles of the monetary union". He has also warned that "public acceptance of the euro and the European Union would be undermined."

Stark's column argues that establishing an EMF would risk over-politicisation and further increase the eurozone's susceptibility to 'moral hazard' or free-riding from certain member states. "Countries which have not abided by the rules, which profit unilaterally from the euro, without taking their duties seriously, should not be rewarded," he writes.

Given Merkel's obvious unwillingness to sign up to any Greek bailout, such public support for the EMF proposal is a little surprising. Given that Germany would be the biggest contributor to such a fund, surely it amounts to a very similar thing: a German guarantee for the eurozone.

Certainly one to watch...

'Economic government' and the democratic deficit

The comment pages of today and the weekend's papers were understandably filled with reflections on a potential Greek bailout and the wider implications for the euro and the EU as a whole. We argued in our recent briefing that a bailout would have far-reaching negative implications for the eurozone, establishing a precedent for rescuing profligate states that fails to address the inherent problems of a monetary union between the eurozone's differing economies without the harmonisation of fiscal policies, for which there is no public support.

The crisis is nonetheless being used to justify the establishment of EU 'economic government' - the next step towards the federalists' Holy Grail of fiscal or political union, with common taxes and redistribution across the eurozone. This marks a significant change to the rules of the game, with the EU now largely dictating the terms of Greece's economic policy to the Greek government. This is precisely what citizens were told wasn't going to happen when EMU was designed and agreed, even if certain politicians had other ideas.

In the Weekend FT Tony Barber noted that:

It looks very much as if Greece’s fiscal sovereignty will be, for most practical purposes, temporarily suspended. [The EU] can either clutch its worry beads and hope that Greece, acting under formidable outside pressure, will transform itself into a self-disciplined polity. Or it can exploit this crisis as an opportunity to shift European monetary union into a higher gear by taking irrevocable steps to closer fiscal integration.

Meanwhile, in the Guardian, Gary Younge argued that the eurozone crisis is emblematic of an EU democratic crisis:

The issue is not the failure to match economic and monetary ­union with political union. It is the naked disregard for democratic engagement in the entire system that in no small part ­explains why voter turnout in EU elections has plummeted by more than 30% in the last 30 years. Whenever people vote no to a phase of integration – as they did in Ireland two years ago – the EU simply orders them to vote again until they produce the right result. Once they vote yes there is no turning back.

The Weekend FT's leader writers concurred:

...even for advocates of closer integration in Europe, this is a mistake. The EU suffers from a lack of popular legitimacy. The manner in which the Lisbon treaty was passed was unedifying, giving the impression that the EU is a stitch-up by a small elite. If Europe, or just the Eurozone, is to become more deeply joined, it should be a deliberate and honest process, not an accidental and covert one.

However, there is a short term path of less resistance. As the Weekend FT article argues:

There is no need for the EU to expose itself to these difficulties. It has another option for saving Greece: the International Monetary Fund. It would be embarrassing for a member of the EU to receive help from the Washington-based Fund, so admitting the continent could not solve its own problems. But better that than sleepwalking into constitutional upheaval.

Going to the IMF is the best of a bad bunch of short term options but the EU's leaders have a nasty habit of staking pride and prestige ahead of the democratic process.