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.

The £1.7bn question - who's right: Osborne, Farage or the European Commission?

Below we give a blow by blow breakdown of what George Osborne did or did not secure at today’s EU finance ministers meeting. This basically comes down to the UK’s rebate and how it’s applied - and whether it was always going to apply to the £1.7bn.  Osborne claimed that:

As PM said EU bill unacceptable. Now we've halved the bill, delayed the bill & pay no interest on the bill. Result for Britain
— George Osborne (@George_Osborne) November 7, 2014

Whilst Ukip leader Nigel Farage has claimed that:

Osborne trying to spin his way out of disaster. UK still paying full £1.7bn, his credibility is about to nose dive.
— Nigel Farage (@Nigel_Farage) November 7, 2014

This is what EU Budget Commissioner Georgieva said at a press conference just now:

“As we all know the UK receives a rebate on their contribution, but in years when the UK has to pay additional because of GNI corrections, normally this payment would be on 31 December and it would be in the full amount. With the proposal [under discussion]…in exceptional years this period of time would be stretched into the next year, and when this happens, and it would be in these exceptional circumstances, then the payment and the rebate on the payment could converge. In a normal year, they would not. In a normal year, you have a payment on 31 December and then next year, in the spring, we have the calculation of the rebate on this payment.” 

So who’s right?

Well, Osborne is right that the UK will pay half of the initial £1.7bn demand, since the UK’s rebate will now knock off the difference. So in that sense, Farage is wrong. Britain “will not pay the full £1.7bn”. However, the Government’s position isn’t’ entirely what it seems either, since it’s possible (though still not clear) that the rebate was always going to apply to the £1.7bn.
 
Confused? Don’t worry. Few people know how the rebate actually works. Below is our attempt to clarify the issue.

What has actually been agreed?

• The UK secured a delay on its payments and will now have until September 2015 to pay. It will probably pay in July and September 2015.
• It was also agreed that the UK’s £1.7bn bill will have the UK’s rebate applied to it (in the same way all annual contributions do). The Government claims that it wasn’t ever clear whether the rebate would apply, however, Commissioner Georgieva’s suggest that it always would. Usually  the rebate operates on a one year time lag, but now it will be netted off at the same time when the payment is made. The UK government also claims that the rebate applied to the specific amount is above and beyond that which applies normally, due to the way different facets of the rebate are applied and the time period over which it was calculated (we're still looking into this one). 
• This accounts for the reduced the bill from £1.7bn to £850m.

So, Osborne has effectively achieved an ‘interest free’ payment plan for the surcharge, which will see it coincide with the rebate on said surcharge.

Would this always have happened?

• It has been unclear for some time how the rebate would factor in here. Either people were purposefully trying to obscure the question or it was genuinely unclear.
• However, now that it has been settled that the rebate would be applied, it can be said that this reduction would always have happened. The main change is that the rebate has been moved forwarded allowing the initial payment to be reduced.
• On net the UK will pay £850m, but this should always have been the case thanks to the rebate.

Does this impact other countries?

• Since other countries essentially pay for the UK rebate, they will on net be hit.
• Our understanding is that the countries will still get the full amount expected from the GNI calculations – i.e. France should still get €1bn.
• That said, since the rebate is being paid and also a year early, it is likely that their annual EU budget contributions will increase in 2015. On net then, the gains for certain countries (such as France) could actually be less than expected.

So are we looking at a cash flow problem for the EU budget?

• One outstanding question is how this will all work in practical terms. Judging from the European Council conclusions, countries who are getting a pay-out from the GNI calculations can still claim the money on 1 December.
• However, countries who are paying in large amounts can delay their payments until September 2015. It is not clear whether there is enough spare cash in the budget to smooth over this gap.
• Furthermore, the UK is using its rebate to offset its payment. This will not be covered until all countries have paid in their (higher) annual EU budget contributions next year. This further worsens the cash flow problem.

A political conspiracy or genuine uncertainty?

• Questions will now swirl around when all this was known. Surely, if the rebate applies, that was always known to be the case? Logically, since all UK contributions are subject to the rebate, it always was going to be. The only thing that wasn’t entirely clear was when and how it would be factored in. While this is tricky to work out, it’s not clear why the HM Treasury and the European Commission let the dispute run for two weeks. If this was a “set up” by the UK government to claim success, then the Commission was in on it.
• Maybe the handover in Commission has helped breed uncertainty.

So what’s the verdict? Who’s right, Farage, Osborne and Georgieva? Well, Farage is wrong, Osborne right on the amount but may be exaggerated the extent of the concession. The most right is probably Georgieva - though, we still don't have evidence that the rebate was always going to apply.

And of course, the UK will still pay an additional £850 million.

We will update this as events unfold, but what a mess.

Germany's Bundestag votes in favour of stricter benefits rules for EU migrants

The German Bundestag today approved changes to the country’s Immigration Act which are meant to prevent the abuse of EU free movement. This is not yet a done deal as the Bundesrat - the German upper house - needs to approve the changes, and the grand coalition doesn't have an automatic majority there.

Re-capping our previous blogs on this, here are the key proposals - none of them will involve changes to EU law, according to the German government:

Six month maximum stay for EU job-seekers: Jobless EU migrants seeking work in Germany, who don't have sufficient means of supporting themselves (including health insurance) and have limited job opportunities, will be forced to prove after six months that they have a "reasonable chance" of being employed. Otherwise, they will be forced to leave. Exactly how this will work in practice is unclear. This is very similar to what the UK Government already is doing.

Five year re-entry bans: EU migrants abusing EU free movement (by forging documents or being in a fake marriage, for example) will face a re-entry ban of five years. 

Linking child benefit payments to national tax ID numbers: to avoid duplication of payments to EU migrants - which will only apply to EU migrants, not German citizens (which raises a number of questions and which may well be challenged at the ECJ, depending on the outcome of some pending ECJ rulings). 

€225m (€200m of this was already agreed) in financial assistance to help local authorities to deal with migration (€140m would come out of the European Social Fund). 

Interestingly the report that served as basis for the draft law also has a section on “possible further measures on the European level” which notes that:

“Also in other [EU] member states…the issue is debated, in parts very controversially. In this respect the question arises….if and in how far considerations for further steps on the European level or together with European regulations are necessary and reasonable. The Committee will deliver an opinion on this in its final report.”

There are two separate cases referred from German social courts to the ECJ to keep an eye on. The first ruling - relating to the access to benefits for “economically inactive” EU migrants - will be delivered on 11 November and Angela Merkel stressed already that she "spoke with David Cameron and we are both anxious to receive the verdict and we will interpret it together."

On EU Crime and Policing the UK lost an opportunity to negotiate a new deal

Open Europe's Christopher Howarth wrote the following article for the Telegraph. For more information as to the UK's crime and policing opt out please also see Open Europe's An Unavoidable Choice

Why is the European Arrest Warrant so controversial?

MPs are being faced with two equally unpalatable choices

To those unaware of the tortuous nature of EU treaty negotiations, it may seem odd that MPs are being asked to vote to opt into the European Arrest Warrant – and not just because it may cause ructions within the Conservative Party ahead of the Rochester and Strood by election. Weren't we in it already?

Actually, the EAW is only one of a package of 35 EU police and crime laws that the Government wants to opt into by December 1. And here's why it matters so much, both to the Government, and to its opponents:

Where did it all start?
It all goes back to the Lisbon Treaty. Prior to that, all EU crime and policing laws were dealt with "inter-governmentally". However, the architects of the Treaty were keen to place these measures under the remit of the European Court of Justice (ECJ) and the enforcement powers of the European Commission.

Realising that signing up to the ECJ’s jurisdiction would complicate its desire to avoid a referendum on the Treaty, Britain's Labour government brokered a deal. The ECJ would get jurisdiction in 2014, but in return the UK would get a "block opt out" on around 130 crime and policing measures.

This opt-out could have provided the basis for Britain to negotiate a new deal, perhaps using a bilateral UK-EU treaty, thus solving some of the underlying concerns. But this opportunity was lost - possibly as a result of internal Coalition politics.

But why does the vote have to be now?
Last summer the Prime Minister finally exercised the opt-out – which takes effect on December 1. But, having done so, the UK has until then to decide whether to opt back in to some of these laws on the new terms.

Having decided not to renegotiate a new deal, the Government is presenting Parliament with a choice of two bad options: stay out of the 35 measures the Government argues are essential to fight crime, or go in on terms that hand over ultimate authority over these laws to the ECJ and the European Commission for the first time.

But why is the European Arrest Warrant so important?
Of these 35 laws, the EAW is the most controversial for several reasons. On the one hand, there are obvious concerns about handing over British citizens to another EU state without giving that person the right to ask if there is a case against them. On the other hand, the police argues it is vital to protect the public from crime.

If the UK opts in, it will forfeit to the ECJ the ultimate ability to say no to the extradition of its citizens – a step that even states within the US are able to take. Stay out, and we will fall back on previous arrangements that were slower, less reliable and therefore may allow some criminals to escape justice. And yes, the UK Government has made some welcome domestic reforms to how the EAW operates, but time will tell whether these will withstand future ECJ interpretation.

What does this all mean?
It means that, unfortunately, MPs have been presented with an unenviable choice. However they vote in the coming weeks, many Conservative MPs will certainly want to revisit this issue in any EU renegotiation.

'Benefit tourism' is a red herring but welfare and low-income migration are inextricably linked

Today’s UCL report on the fiscal impact of migration to the UK has understandably provoked a lot of interest.

The top line findings are that:

• Between 1995 and 2011, migrants from EEA countries made a positive fiscal contribution over that period of more than £4bn, while those from non-EEA countries made a negative contribution of £118bn, compared to an overall negative native fiscal contribution of £591bn.
• The positive net fiscal contribution of recent immigrant cohorts (those arriving since 2000) from the A10 (the ten Central and East European EU member states that joined since 2004) amounted to almost £5bn, while the net fiscal contributions of recent European immigrants from the rest of the EU totalled £15bn. Recent non-European immigrants’ net contribution was likewise positive, at about £5bn. Over the same period, the net fiscal contribution of native UK born was negative, amounting to almost £617bn.

The obvious conclusion to draw from such studies is that the economic case for EU migration is clear and that ‘benefit tourism’ is simply a myth in the immigration debate (as others point out, there are social and economic arguments for and against migration). Open Europe has consistently sided with those who argue that on net, EU migration is positive for the UK, also from a purely transactional point of view.

Why then the focus on EU migrants’ access to welfare?

We and others have suggested that the Government should prioritise this as an issue for negotiations on the reform of EU free movement - rather than seeking to impose caps on the number of EU migrants or end free movement. Not because we think the majority of EU migrants are ‘benefit tourists’ but because that, unlike many other EU states, the UK offers effective income support to low-paid migrants. This creates some unintended consequences.

Again, at the aggregate level, free movement brings economic benefits. But the aggregate net benefit masks net losers (similarly, there is no such thing as a typical EU migrant – they perform different jobs, earn different wages and, if they are entitled to claim welfare, may not do so). Nevertheless, it is the duty of governments to come up with policies that mitigate the effect on those who might lose out from migration.

The labour market is the obvious area where the impact of migration is felt differently. The evidence overwhelmingly supports the view that low-skilled and low-wage workers can be adversely affected in the form of greater competition for jobs and a depressing effect on wages, even if the magnitude of this tends to be overstated. Higher-paid workers tend to gain.

This is where welfare does come into it – particularly for a country such as the UK which supports low incomes with fairly generous levels of income support in various forms. ‘Benefit tourism’ is indeed a red herring, in the sense that the vast majority of migrants move to work, not to ‘sponge off the state’. However, as our recent pamphlet argued, it is hard to justify to domestic electorates in economic and social terms why low-paid migrant workers should be immediately entitled to income support paid for by their new host country. These relaxed rules on access to state top-ups not only act as an extra incentive to migrate into low-income jobs, they prevent national governments from targeting these policies at their own citizens.

Many have suggested that reform to EU access to welfare rules is simply about tackling ‘abuse’ and ‘welfare tourism’. This not only stigmatises migrants, the vast majority of whom do not ‘abuse’ the system but simply abide by the current rules, it devalues the fundamental point – which is that it is probably not politically sustainable for national governments, in some instances from the get-go, to subsidise low-income migration via their welfare systems.

Two additional points. First, such a system need not mean that EU migrants are left to fend entirely for themselves, only that like in most other EU countries, benefits are tied to contributions through employment. For example, non-EU migrants who have a right to live in the UK but 'without recourse to public funds' are entitled to basic safety net benefits tied to their National Insurance contributions, but not income support. There are also discussions to be had about raising the floor for working conditions in general, including revisions to the minimum wage.

However, secondly, the UK should also be aware of the trade-offs involved. Fewer EU migrants and higher wages - if that is the objective - could well make the UK a less competitive place.

Court of Auditors highlights errors in EU spending again

Each year the EU's Court of Auditors issues its opinion on the EU's spending and each year it is the same - "material errors" amounting to billions of euros probably misspent.

First of all, let's get the usual caveats out of the way - the auditors have signed off the accounts, which means that they are a reliable picture of EU revenue and spending. However, there remain significant errors in how the money was spent.

This is from the ECA press release:

The ECA’s estimate of the error rate is not a measure of fraud, inefficiency or waste. It is an estimate of the money that should not have been paid from the EU budget because it was not used in accordance with EU rules.

The other defence that the European Commission will make is that much of this spending is a shared responsibility between national governments and the EU institutions. But that does not excuse the fact that the errors keep rolling in year after year with little improvement and that much of this results from the complexity and Byzantine nature of EU spending programmes.

So how bad was it this year? 

Well here are some of the main findings for 2013:

•  93% of the EU Budget is affected by "material errors"
•  The error rate was 4.7%, amounting to c.€7bn euros "that should not have been paid out from EU budget"

Illustrative examples of waste highlighted by the EU's Auditors:

• Claims under the CAP for grassland that was actually forest.
• Claims for four Spanish border control helicopters that spent little time controlling borders.
• The salary of a private school director in Portugal charged to an EU project.
• €150 million of pre-accession exenditure validated by the Commission on the basis of estimates rather than for incurred, paid and accepted costs.

Is control of spending getting better?

Rate at which EU funding is misspent

One of the more depressing aspects of the EU budget is that the rate at which money is misspent remains consistently high. As we can see over time, it has gone down and then back up leading to the conclusion that the problem is persistent. This year it was 4.7%, which is lower than some previous years but still higher than others pointing to the fact there has been no "solution" to poor financial control.

Same old suspects?

Although there are a number of examples of misspending in Southern Europe, examples are also catalogued across the EU including in regional funding within richer states such as Germany. This begs the question as to why the EU is funding poorly controlled programmes in states that are net contributors and able to pay for their own, probably better quality programmes.

A solution - reform the budget?

Cutting regional funding in rich EU states would cut the EU error total, the EU budget and give states more autonomy all in one go as Open Europe has consistently argued.. Likewise Open Europe has also proposed radical CAP reform moving spending back to national governments. This would allow for more scrutiny of spending as well as well as remove some of the incentives to national governments to spend the money as fast as possible whatever the quality of projects.

Other Court of Auditor suggestions:

The Auditor's make a number of sensible recommendations and observations, including the following which are particularly interesting: 

• A better harmonisation of how GNI is calculated: The Court of Auditors has found that there are inconsistencies as to how different states calculate their "unofficial" economies. Given that the EU budget contributions are based on relative sizes of member states GNI and that recent statistical revisions have led to the UK receiving a large £1.7 surcharge any inconsistencies will no doubt be looked at very closely in HM Treasury.
 

• EU value added often difficult to discern: The EU's globalisation fund was picked out as an example of funding that has a low rate of EU "value added." That begs a question as to why it exists.

Verdict: Good report but, unfortunately, we will no doubt be returning to the subject of misspending when next year's report comes out... 

The Podemos Express: What lies behind the extraordinary rise of Spain's new protest party?

The extraordinary rise of Podemos, Spain's eight-month-old protest party, continues. A new Metroscopia poll for El País, released on Sunday, showed that the party would win a Spanish general election, if held today, with 27.7% of votes. The Socialist Party would finish second on 26.2%, followed by Spanish Prime Minister Mariano Rajoy's Partido Popular on 20.2% – less than half the 44.6% the party won in the November 2011 general election.

This is unbelievable stuff, but what lies behind the instant success of Podemos? 

As with all protest parties, there are a number of inter-related, mutually re-reinforcing causes: 

New media: Can establish and multiply protest movements in a heart beat. Italy's Five Star Movement is a well-know example. Podemos, too, has fed off this.

Corruption scandals: There have been a series of pretty big ones in Spain over the past two years (see this blog post we wrote last year, for instance). That said, though, Spanish politics have struggled with flaky politicians for some time, so this in itself doesn't answer the 'Why now?' question. 

Loss of trust in mainstream parties: This is the same story as virtually everywhere in Europe. In the Metroscopia poll we mentioned above, 42% of respondents said they were inclined to vote for Podemos because of "a feeling of disappointment and disillusionment with the other parties". 

"They're all the same": Related to the above, and especially during the post-crisis years, many Spanish voters don't see much difference between Partido Popular and the Socialist Party. Again, though, Spain has been a two-party, 'centripetal' system for quite some time, so why is it that voters turn against mainstream politicians now? 

EU-mandated austerity: This is a big part of the story, which reinforces the above point. Partido Popular and the Socialist Party are broadly seen by the Spanish electorate as implementing the same set of austerity policies. Remember, the first substantial austerity package during the Eurozone crisis in Spain was passed by the Socialist government of José Luis Rodríguez Zapatero in May 2010. 

Podemos: a 'shadow eurosceptic' party

Podemos certainly doesn't describe itself as 'eurosceptic', and it's not 'eurosceptic' in the northern European sense. Both the party and the Spanish public as a whole remain committed to the Euro. According to the European Commission's latest Eurobarometer survey, 56% of Spaniards think the Euro is "a good thing" for their country – up from 53% last year – compared to 34% who think it is "a bad thing".   

But just as with SYRIZA in Greece, a big part of the Podemos package is predicated on opposition to policies which are, in one way or another, driven by Spain's Eurozone membership – most importantly fiscal consolidation and internal devaluation.

In other words, Podemos could be described as a 'shadow eurosceptic' party.

Podemos leader Pablo Iglesias did say in a recent interview:

"The [Spanish] Socialists should acknowledge that they got it wrong with [the] Maastricht [Treaty]. They got it wrong by letting Spain be turned into a colony of northern European countries."  

Per implication, this means envisaging a Euro without the Maastricht criteria. Similarly, some of the main policy proposals of Podemos seem to be outright incompatible with Eurozone membership. For example, the party's flagship proposal is a "basic income for each and every citizen, for the mere fact of being citizens". According to the party's own estimates, the measure would cost the Spanish government €145 billion – roughly 14.5% of Spanish GDP. That would bust every EU budget rule on the books. 

Other proposals, such as more "democratic and parliamentary control" over the ECB, won't happen as long as Germany is around. 

Therefore, to a certain extent, Podemos offers voters a 'false choice': Euro membership with far-left spending policies. Interestingly, the firebrand anti-austerity talk of Podemos is already having a knock-on effect. Under the leadership of Pedro Sánchez, the Socialist Party has also stepped up its anti-austerity rhetoric. We will see if this will have an impact on upcoming opinion polls.

In our 2012 report looking at internal devaluation in the Eurozone periphery, we noted: 

"The history of the Baltic states – and to some extent Ireland – shows that large scale internal devaluation is fully possible in certain circumstances. But, against a backdrop of plummeting real GDP, internal devaluation also produces a politically explosive combination of falling wages and rising unemployment – all leading to a reversal in living standards. This is the Eurozone's great curse: do what's economically necessary but risk massive political and social fallout."

The rise of Podemos shows just how real that risk still is.

EU budget row: How much interest will the UK pay if it refuses to cough up?

300% interest - in the EU it is legal

As most of you will know by now, the European Commission has asked the UK to pay an extra £1.7bn surcharge into this year's EU budget - before December 1. David Cameron has said he won't pay anything "near that amount", which in turn has triggered an almighty stand-off with the Commission itself insisting that if the UK fails to pay, it'll be charged interest from day one.

There has been a lot of confusion as to how much interest the UK will be legally liable to pay if it follows through on David Cameron's threat to refuse to pay. The answer as always lies in an EU Regulation as we pointed out here.

So how much is it? The short answer is a lot. Let's say Cameron holds out for one month. He'll then owe the EU £3.5 million in addition to the original £1.7bn surcharge. If he holds out for six months, UK taxpayers are looking at an additional £39.1 million while one year will increase the bill to £89 million - the annual interest will then stand at 5.25% . If the debt is still outstanding after 10 years, the UK would owe an eye watering £5.5bn of interest on a £1.7bn debt - over 300% interest.

In other words, under EU rules, the penal rate is ever increasing.

This is how it is worked out. Firstly the regulation states an annual interest rate of 2% above base rates per year - making a current 2.5%. It's worth keeping in mind that this is much more than the UK pays itself to borrow (in maturities up to 12 years or so, see UK yield curve here). However there is a sting - a rising penal rate of 0.25% for each outstanding month, and the total interest is all paid at the higher rate. This quickly adds up as you can see below:

So if this drags on, it has the potential to really become messy. However, as with everything in the EU there is usually a political solution. The Netherlands and Italy are also upset at receiving demands while the calculations (particularly around the interaction with the UK rebate) and the EU amending budget that goes with it are still up for 'clarification' and/or amendment. As reports today also indicated, it seems likely the UK will be able to do a face saving deal to pay something more than zero and less than £1.7bn - but if not the implications are huge.

Commission forecasts paint a less than optimistic picture for eurozone outlook

The European Commission has this morning released its Autumn 2014 Economic forecasts. While these forecasts can often be quite mundane owing to the very managed message they are trying to send, this set look to be a bit different (see here for our take on Winter 2014 and Autumn 2013). Maybe unsurprisingly the tone to more sceptical, critical and possibly realistic. Below outline some interesting themes.

Another downward growth revision
Once again growth for the Eurozone has been revised down. The previous forecast saw 1.2% and 1.8% growth in 2014 and 2015 respectively. The new forecast predicts 0.8% and 1.1% respectively, quite a significant downward revision, especially since growth next year is now expected to be below the original forecast for this year. The initial blame (in the press release) for this revision seems to be laid at the feet of “increasing geopolitical risks and less favourable world economic prospects”. However, that raises the question of why it is seen as enduring up to 2016. In the report itself the assessment is thankfully more candid highlighting “incomplete internal and external adjustment” and “low productivity gains”.

More realism about the labour market
There is a wider acceptance in these forecasts that unemployment will remain elevated for some time and that differences in labour market performance will persist. That said, at the moment any real prospect on employment growth in the Eurozone seems optimistic.

Bad news in nearly all the large economies
France and Germany’s growth prospects for this year have been revised downwards to 0.3% and 1.3%, from 1% and 1.8% respectively. Italy is expected to contract by 0.4% this year and only grow 0.6% and 1.1% in 2015 and 2016 respectively. Given that these three countries account for nearly 60% of Eurozone GDP this suggests a very poor outlook for the Eurozone with growth risks tilted to the downside. In general, the core vs. periphery split is less clear in this report, at least in growth terms as many countries are now acting as a drag on the Eurozone economy for a number of reasons.

Significant and increasing reliance on domestic over external demand
Early on in the crisis there was a clear focus on facilitating export led recoveries, often in the German model. However, over the past 12 – 18 months this has shifted, possibly driven by global economic weakness, and these forecasts finalise the shift. The Commission itself says,  “Net exports are likely to contribute only marginally to GDP growth over the forecast horizon”. Spain is a prime example of this, see here for a longer discussion of the issue.

While finding a balance between the two is important (we cannot have 18 Germanys in the Eurozone) the shift may have been too stark. Let’s not forget that there is still a huge amount of public and private debt (both household and corporate) in the Eurozone, especially in problem countries. This will limit potential domestic demand growth. So while the flows are shifting in a way which should see an uptick in domestic demand, we should not forget that the huge stock of debt may provide a ceiling on this as a driver of growth.

Low inflation is here to stay
The Commission has also downgraded its inflation forecast with CPI expected to be 0.8% in 2015 compared to previous forecast of 1.2%, while it is only expected to be 1.5% in 2016. The forecast for 2015 is below the ECB’s of 1.1% but the 2016 is above the ECB’s which is 1.4%. Interestingly, the Commission continues to make the case that “low, or negative, inflation rates as part of [some countries] inevitable adjustment process”. This is an argument which has been absent all recent ECB press conferences. In terms of deflation, the Commission sides with the ECB, saying the risks of outright deflation remain low.

We’ll update the blog throughout the day as we pour over the 185 page report. But for now, we’ll leave you with a thought from Commissioner Jyrki Katainen in the press conference, when asked how much the forecasts can be trusted given a history of being incorrect he simply responded, “Nobody knows”. Quite.

EU migration - a deliverable proposal for reform

As we already noted here, today we published a new pamphlet by Professor Damian Chalmers of the LSE and our Research Director Stephen Booth.

The basic question the authors ask is, in the current political climate, how in the world can we ‘save’ EU free movement? As we’ve stated repeatedly, Open Europe thinks that the single market – including free movement of workers – remains a clear net benefit to the UK and EU. However, like everything else, it needs to be subject to up-to-date, clear and fair rules to make sure it stands.

Therefore, the pamphlet argues that instead of reaching for “quotas” or a “points-based system”, Cameron should focus on the “pull factors” – who can access what benefits and when – which if done right, will have a big impact but without ending the basic free movement principle (a red line to Merkel and others).

Chalmers and Booth – both writing in a personal capacity - argue that national governments should be able to limit EU migrants’ access to out-of-work and in-work benefits, social housing and publicly funded apprenticeships until after three years. EU citizens would have a right to access public healthcare within their host country, but, for the first three years, the costs would be borne by their state of nationality and, insofar as there was a shortfall, through private health insurance that they were required to purchase. Children of an EU citizen would have a right to access childcare and primary and secondary education. The changes wouldn't be retroactive but only apply to future EU workers.

This could be done through EU legislation and avoid a treaty change to the totemic EU principle of free movement. But it needs to be recognised that, while it often comes with overall net benefits, free movement does have an impact, particularly at the low-skilled / low-income end of the job market where the competition between school/university leavers, those moving from welfare into work and migrant labour can be fierce, with the consequent knock-effect this can have on wages.

The length of the qualification period can be discussed and needs careful thought to strike the right balance between incentive to work and ability to live.

The proposal could kill three birds with one stone:

First, it would remove the effective “subsidy” to EU workers who perform the lowest-paid jobs in the UK by removing the state top-up to low wages. For those thinking of coming to the UK, this could certainly change their cost/benefit calculation before they make the leap. It would create a fairer system, which could well have an impact on numbers and boost public confidence in free movement.

Secondly, and just as importantly, it would hand back an important public policy tool to national governments. If welfare (out of work and in work) is not open to EU migrants, national governments can better target their policies at their own citizens – helping the young with publicly-funded apprenticeship or those coming of welfare with income top-ups. The effect of these policies is blunted if they open to people across the entire EU.

Thirdly, unlike ideas for quotas or caps on EU migrants, it leaves the basic principle of free movement of workers intact, while not requiring a complicated EU treaty change.

Finally, because of that, this proposal could win support in other capitals, including, importantly, Berlin.

We will soon be publishing further research looking at the economic impact these and other potential proposals could have on EU migrants considering coming to the UK – and to what degree removing access to welfare for three years might act as a disincentive to those migrants who would be coming to working in the UK on the lowest incomes. We'll also look at other areas such as minimum wage. However, also, we’ll investigate the trade-off this involves in terms of the UK’s overall wealth and competitiveness, for which EU migrants no doubt play an important part.

Everyone take a deep breath: suggestions Merkel ready to accept Brexit following free movement row are wide of the mark

Der Spiegel reports that German Chancellor Angela Merkel warned David Cameron at last month’s EU summit that she would no longer try to keep the UK in the EU if Cameron sought to impose quotas or a cap on workers from other EU countries, as opposed to changing the rules around EU migrants’ access to benefits. The magazine also reported that the German Chancellery and Foreign Ministry fear that, for the first time, Cameron is pushing the UK towards a “point of no return” in terms of its EU membership and that a UK exit is “possible”. But there’s no reason to be get overly excited though.

• This was a report from one magazine which didn’t include any direct quotes from Merkel, but merely quoted unnamed sources. Moreover, as Sky News' Faisal Islam points out, the report isn't exactly front page either... its on page 36 of the print edition.
• The reported comments were specifically about reports in the UK media about Number 10 possibly considering putting outright caps on the number of EU migrants who can come to Britain to work, either via quotas or a points-based system. So one speculative media report leading to another.
• As we’ve argued repeatedly, there are two elements to free movement: volume – how many EU migrants come to the UK every year. And fairness: who can access what benefits and when. That Merkel doesn’t support an end to the basic right for EU migrants to come to the UK to work isn’t surprising at all. It’s been the German government position for ages. Stefan Seibert, Merkel’s spokesperson this morning re-stated Germany’s commitment to “the general principle of free movement”.

However, within that there’s a lot of scope for change and plenty of EU reforms that could fly in Berlin. Remember, the Bundestag will this week vote on a number of proposals aimed at tightening EU migrants’ access to benefits, including re-entry bans for those migrants that abuse of the German welfare system.

It’s interesting that since the stories in the UK media about a points-based system or quotas for EU migrants, FAZ and the Sunday Times note that the UK government is now looking to make its EU free movement proposals “Germany-compatible”. Also, UK Chancellor George Osborne told the BBC this morning,

“It was never envisaged that you would have such large numbers of people coming, people coming who don’t have job offers, people who move on to our benefits system…We are going to do this in a calm and rational way, but the British people want this addressed.”

The “job offer” part is interesting – the right to move to another EU country without a specific job offer hasn’t always been there. However, note there’s nothing about a cap – what the Der Spiegel report was about.

Similarly, at Downing Street’s briefing to journalists today, Cameron’s spokeswoman said:

“When the founding fathers established the European Union and introduced the principle of free movement, it was about labour and how you integrate the countries of the single market. The mass migration that we have seen with new countries joining, the impact on countries like the UK, the free movement to claim benefit – these are areas that have evolved and need to be addressed.”

There’s the point about wider “impact” but, again, the main focal point is benefits.

Which may suggest that No 10 remains primarily committed to looking at “fairness” – not actually ending free movement per se.

So only tweaks then? Not at all. Open Europe has today published a new pamphlet by Professor Damian Chalmers and Open Europe Research Director Stephen Booth which argues that the basic right to go and work anywhere in the EU should stand – on the whole, free movement remains a clear benefit to the UK. However, national governments should be able to limit EU migrants’ access to out-of-work and in-work benefits, social housing and publicly funded apprenticeships until after three years.

Incidentally, Der Spiegel did not claim that Merkel was now ‘ready to accept’ the UK exiting the EU, as some UK media outlets have reported. Instead, she now considers Brexit “möglich”, which translates as “possible”, which is more along the lines that it is something she fears.

In other words, whilst certainly a strong indicator of the mood music in Germany and the UK, on specific substance, this is much less of a story than the headlines suggest.

Lisbon Treaty's new voting weights kick in - Eurozone gains a majority

It has been coming down the road for some time but what we once called the "Lisbon Treaty's ticking time bomb" has finally gone off. The eurozone will now have a 'Qualified Majority' in the EU Council, meaning that any UK attempts at forming last minute blocking minorities will now be that bit harder.

Eurozone gains a majority in the Council (old rules left, new rules right)

What are the new rules? 
There are two key differences (contained within Article 16 (4) here) whose effect can be seen on the diagram above:

• The first is the lowering of the winning vote threshold to 65% as seen by the red arrow. 
• The second major change is that the voting weights will now be recalculated each year according to a state's population, as calculated by Eurostat, giving greater weight to larger states (the majority of which are in the eurozone).
• There is one important caveat - as a concession to Poland, at any point until 31 March 2017 a state can request a specific vote is done by the old rules (on the left above) even though the new rules are now the norm.

How damaging could this voting change potentially be?
It goes without saying that the eurozone is not a cohesive block, and interests within the EU cut across the eurozone / non eurozone divide. However, that being said, given increased coordination within the eurozone due to the crisis there is a real danger that, where the eurozone has a collective interest, pre-meetings between eurozone states will become the final decision making body in the EU and could allow a eurozone 'caucus' to emerge. If that happened the UK would be placed in an invidious position.

The danger is real but not all is lost, on some issues the UK could still remain within a 'Qualified Majority'. For example, a block of economically liberal net contributors - dubbed the Northern Alliance - of Germany, The UK, The Netherlands, Sweden, Finland and Denmark would still (just) have a blocking minority of 36%. This alliance could use its influence on issues such as the EU Budget (as it has done before) and the US/EU free trade negotiations (and could well play an important role in helping to keep the TTIP alive).

There is also a positive sign that the non-Euro state's legitimate interests are being recognised. Open Europe has long proposed a system of "Double majority Voting" whereby EU laws have to gain a majority of 'Ins' as well as 'Outs', in order to prevent eurozone caucusing. Such a mechanism was recently adopted by the European Banking Authority. Furthermore, there is a wider acceptance of the need to offer those outside the eurozone, such as the UK, safeguards on certain issues - as demonstrated by the recent article by the British and German finance ministers in the FT.

The change in the voting weights and procedure is a subtle but important shift. It certainly opens the door for eurozone caucusing and makes it harder to get over the already high hurdle of forming a blocking minority on issues which do not sit well with certain member states. That said, awareness of the threat has grown along with acceptance that a new balance needs to be found between eurozone ins and outs. This should help mitigate the impact but it will still be important to watch how this develops.