The long queue of potential 'EU budget vetoes': Who will join next?

Update 21 November, 16:15

Portugal has stepped up its rhetoric by a notch, and has now joined the group of countries that have explicitly threatened to use their veto. Portuguese Prime Minister Pedro Passos Coelho told MPs, "The proposal that has been tabled [by European Council President Herman Van Rompuy] is completely unacceptable for Portugal. By saying this, I mean that I would block a decision [by EU heads of state and government] that had this proposal as its final result."

In practice, this means that one third of EU member states have so far explicitly said that they are ready to veto the next long-term EU budget.  

Update 21 November, 10:40

Another day, another EU budget veto threat - this time from Latvia. Prime Minister Valdis Dombrovskis has said that his country is prepared to veto the 2014-2020 EU budget unless it gets a better deal on agricultural subsidies and cohesion policy.

Update 20 November, 17:00

Italy has today officially moved to the group of countries that have explicitly threatened to veto the 2014-2020 EU budget. Italian Europe Minister Enzo Moavero Milanesi said Italy will be "ready to use its veto" if it considers that the next long-term EU budget is "harmful for the country and burdensome for the Italian taxpayer."

Also, Portugal added its voice to the group of member states that consider Van Rompuy's proposal "unacceptable", but stopped short of threatening a veto. 
 
And here's our original blog post,

You will have read a slew of stories about how the UK is threatening to veto the EU leaders' budget talks later this week and the various terrible consequences that will follow should it do so. The FT has a story today that EU diplomats are working to "circumvent" the UK's veto by moving to annual Qualified Majority Voting, which actually only means that they're working on a scenario for a roll-over, should a deal fail to be struck (we've already looked at that scenario in detail here) so don't get too excited.    
As some European sources have put it, a "miracle" would be needed to strike a deal on the 2014-2020 EU budget when EU leaders meet in Brussels on Thursday and Friday. And the UK is certainly not alone when it comes to putting its veto on the table. In fact, veto threats are flying around all over the place - we count seven veto threats in total. Here is a list of EU member states who have either explicitly threatened to veto the next long-term EU budget or said they are unhappy with the compromise currently on the table - which means they could wield their veto unless something changes.

UK: Has threatened to veto any proposal which does not involve, at worst, a freeze based on 2011 payments.

Denmark: Has warned it will use its veto unless it gets a rebate worth 1 billion DKK (slightly over £100 million) from the 2014-2020 EU budget.

France: Has said the compromise proposal put forward by European Council President Herman Van Rompuy "is not a basis for negotiations". Paris wants EU farm subsidies to be kept at least at 2013 levels, and said it will threaten to veto the talks should CAP spending be radically changed.

Sweden: Has hinted at using the veto in the past and believes Van Rompuy's proposal still does not go far enough. According to Swedish Europe Minister Birgitta Ohlsson, what is missing is "a clear model for reducing agriculture subsidies".

Austria: Has threatened to veto the long-term EU budget unless two conditions are satisfied. Firstly, Austria wants to continue receiving its 'rebate on the UK rebate' over the next seven-year EU budget period. Secondly, the Austrian government is opposed to cutting the rural development component of the CAP.

The Netherlands: Does not want to see the annual or long-term EU budget increase above inflation, and explicitly said it will use its veto if necessary.

Romania: Has warned it could use its veto, calling Van Rompuy's proposed cuts to farm subsidies and regional funds "unacceptable".

Italy: Has not threatened to veto the talks but dismissed Van Rompuy's compromise, saying it is "not a positive contribution" to the negotiations. Italy wants to see its net contribution to the EU budget cut, the reason being that its GDP per capita has now slipped slightly below the EU-27 average. Rome also opposes cuts to farm subsidies and cohesion policy.

Spain: Has rejected Van Rompuy's proposal as "unacceptable". Reports have suggested that, under the proposal, Spain risks losing up to €20 billion in total over seven years in both farm subsidies and cohesion funds. However, Madrid is still to drop the "V" word.

Poland: Has not explicitly threatened to wield its veto, but is clearly not happy with Van Rompuy's proposed cuts to EU regional spending. Poland is trying to muster support from other net recipients from the EU budget, such as Portugal - the so-called 'Friends of cohesion group'.

So, it looks like circumventing a veto on the 2014-2020 EU budget would mean much more than circumventing the UK.

The 'Monti paradox' couldn't last forever

Earlier this year, we looked at what we described as the 'Mario Monti paradox' - that is, how surprisingly popular the Yale-educated Italian Prime Minister was, despite being the unelected head of an unelected government of technocrats. We also warned, though, that Monti's lack of a clear mandate from Italian voters would come back and haunt him once the (badly needed) reforms adopted by his cabinet started to bite.

Well, that moment now seems to have come. According to a new SWG poll, 62% of Italians are against a second mandate for Monti. Even more significantly, trust in the Italian Prime Minister is at 36% - down from 71% when he entered office in November 2011.

With the Italian general elections only a few months away (the latest reports suggest that they could be brought forward to 10 March) these findings complicate things further. None of Italy's political parties looks set to gather enough support to govern alone. The centre-left Democratic Party is currently ahead in opinion polls, but is likely to win no more than 25-26% of votes.

Furthermore, Italian comedian Beppe Grillo's Five-Star Movement continues to poll at around 20% and has already ruled itself out of any alliance with 'establishment parties'. Sure enough, the Grillini will be tough in their opposition to the next government - whatever its political colour. Add that Silvio Berlusconi's PdL party has also said that it "wouldn't bet one cent" on a second mandate for Monti, and it really seems that, as the electoral campaign draws closer, no-one wants Il Professore to stay on - except for one or two smaller centre parties.

In other words, Italy is approaching the next general elections with no clear idea of what type of coalition would take over power - provided that Italian political parties are able to form one after the vote. Meanwhile, Italian voters are quite clearly saying that they would not be happy to end with an unelected Prime Minister again. Needless to say, all of this potentially opens for fresh political instability that Italy can ill-afford. 
    

Dieu save the baguette!

Many of you have probably already seen it, but this is the (quite clever) front cover the Economist has chosen to present its special report on France:

You decide what annoyed the French government the most:

a) 'Les Anglo-Saxons' making fun of France's economic grandeur with their unpleasant sense of humour;
b) The irreverent picture of a bunch of France's beloved baguettes about to explode;
c) The content of the report.

One thing is certain: the Economist has hardly made any new friends in Paris. Here are some reactions from the French government:

French Prime Minister Jean-Marc Ayrault (from Berlin yesterday)

"I can tell you that France is not at all impressed by the excess aimed at selling [more] copies."

French Industry Minister Arnaud Montebourg (on French radio Europe 1 this morning)

"Honestly, the Economist has never distinguished itself by its sense of self-restraint. It's the Charlie Hebdo [a well-known French satirical weekly] of the City."

Najat Vallaut-Belkacem (French Women's Rights Minister and government spokeswoman)

"[The Economist] should update its software...We borrow money at historically low rates, not to say negative. We have gained this credibility, and it is acknowledged by the markets."

We expect more reactions to come - and we may also elaborate a bit more on the future of the French economy in the eurozone at some point. For the moment, though, the idea that France should start to be looked at as a potential reason for concern does not sound completely far-fetched.

EU awarded its second Nobel Prize of the year

Yesterday, a delegation headed by Bernadette Ségol, Secretary General of the European Trade Union Confederation (ETUC), delivered a 'Nobel Prize for Austerity' to the EU - a boomerang with 'Austerity will come back in your face' written on it, according to Italian news agency ANSA.

Unsurprisingly, Barroso, Van Rompuy and Schulz weren't exactly elbowing their way to the front of the queue to pick up the award, which was ultimately handed to EU Social Affairs Commissioner László Andor.

This was the only (relatively) light-hearted moment of a day which saw anti-austerity protests degenerate into violent clashes between demonstrators and the police in Italy, Spain and Portugal - while marches were also staged in several other European countries. Some Spaniards even rallied in Smith Square, London, in front of the European Commission and European Parliament's offices (see the picture, which was posted on Twitter yesterday evening).

We have stressed on several occasions that these protests are the inevitable consequence of the clash between eurozone membership and national democracy.

While structural reforms and fiscal consolidation are needed for struggling eurozone countries to try to regain competitiveness within the single currency, what the European Commission should be most concerned about is the fact that citizens in the weaker eurozone countries increasingly see the EU (and certain creditor member states) as the cause of their pain.

As we noted in a recent briefing, the average level of trust in the EU in Greece, Spain, Portugal, Ireland and Italy has reached an all-time low. Again, it is impossible to know where the tipping point lies exactly - but the recent episodes seem to confirm that the number of those who see the EU as a positive force is rapidly decreasing.        

Ave Angela, morituri te salutant

The spotlight is back on Greece today with the release of the much anticipated Troika report (read our daily press summary or follow us on Twitter for the latest updates), meaning that German Chancellor Angela Merkel's visit to Portugal has been pushed to the background.

However, clearly not everyone in Portugal is enthusiastic about Merkel's arrival. After the open letter signed by over 100 academics and intellectuals, arguing that the German Chancellor "has to be considered persona non grata in Portuguese territory", this is the front page of today's edition of Portuguese newspaper I Informação,

Another Latin expression, this one translates as, "Hail Angela, those who are going to die salute you" - a paraphrase of the famous salute made by gladiators to the Roman Emperor before the fights in the arena started. And another example that tensions can run high in Portugal too - even if the country does not usually receive the same degree of foreign media coverage as Greece or Spain.  
 

Economic realities push Europe closer to a Greek decision

We have a piece in City AM today, which look's  at the impact of this week's crucial votes in Greece, see below for the piece in full:

One down, one to go. The Greek government has got through one crucial vote this week and looks likely to ride out the budget vote on Sunday. Although markets and eurozone leaders will breathe a sigh of relief as Greece makes it through another crucial week in its economic crisis, the government has not been left unscathed.

Pushing through the latest, and supposedly last, package of stringent economic reforms and budget cuts has exposed deep cracks within the governing coalition, as the Democratic Left and Pasok parties put up a fight to slow the process of public sector cuts led by Prime Minister Antonis Samaras’ New Democracy party. It took two days to push the package through parliament, while a reported 100,000 Greeks took to the streets in Athens to protest against austerity, once more leading to violent clashes with police.

However, a bigger problem for the government is the flurry of economic figures which have again exposed deeper flaws in the Greek economy, propelling talk of a Greek exit from the eurozone back into the headlines. The new budget projects Greek debt peaking at 192% of GDP, rather than the 167% estimated previously, but even this revision seems to be built on optimistic assumptions. Unemployment, investment and exports are all projected to stabilise, despite most indicators predicting the opposite. In fact it is now abundantly clear that Greece will need an extension to its current bailout.

The questions to ask then are: how much would such an extension cost and how could it be funded? We estimate that slowing the Greek fiscal consolidation programme by two years could cost an extra €28.5bn (rising to €39bn if Greece fails to borrow from the markets – something which looks increasingly likely). The main options being proposed include: reducing the interest rates which Greece pays on its current bailout loans (which could raise around €3bn over two years) or putting a hold on interest payments for a few years (which could raise €10bn+, but would be much trickier legally). These options would likely be combined with some further austerity and increased short term debt issuance by Greece – both of which could actually increase Greek debt levels, not exactly what is needed. The kicker is that even this is unlikely to be enough.

The question of an extension then, drives home that a larger decision on Greece’s position in the eurozone is closing in on EU leaders. Even talk of using bailout loans to buy back Greek debt at a discount and then retire it, to provide extra funding, would require a big political decision on further loans to Greece. However the funding is found, it will likely involve breaking a taboo – either by the ECB (in terms of helping to fund states) or more likely by eurozone countries in allowing permanent transfers to a country whose future funding is far from assured.

The Greek government and the eurozone will make it through this week but this short-term success is likely to belie the massive decisions ahead.

Beyond posturing, Germany knows that the UK is needed in the EU

Our Director Mats Persson has a piece in today's Telegraph, where he argues,

Last week, even as British MPs were voting down the Government’s position on the EU budget, I was attending a European discussion of a very different kind. In a conference room in Berlin – at an event marking the launch of Open Europe’s new German partner organisation – hundreds of academics, journalists and policymakers sat listening to a brilliant speech by Otmar Issing, the former chief economist of the European Central Bank, about the intricacies of the eurozone bail-outs and where the single currency must go next – all blissfully unaware of the fraught debate in the House of Commons.

When you spend time in both Britain and Germany, it is impossible not to notice how distant their stances on Europe have become. When Angela Merkel meets David Cameron at Downing Street today, to discuss the EU budget, they ought to have plenty of common ground. Berlin actually stands to lose more than London: under the current plans, its contribution would rise by about 30 billion euros over the seven years, whereas the UK’s would go up by 17 billion. Nor does Merkel need to be told that the budget is a nonsense: even her Europhile foreign minister, Guido Westerwelle, says that the current set-up “leads to aberrations such as EU subsidies going to day-spas or romantic hotels”. 

So why are the talks expected to be frosty? The problem for the UK is, first, that the EU budget just isn’t that important to Germany at the moment. For the past two years, Berlin has been preoccupied by the eurozone bail-outs, and endless bickering over the lending capacity of the relevant funds (among other fascinating topics). 

Second, Germany still perceives its contribution as a necessary sign of its commitment to the greater good. Indeed, the bailouts – despite their unpopularity – have actually made Berlin more reluctant to kick up a fuss over the EU budget: a few billion more, in return for a bit of goodwill in the austerity-fatigued Mediterranean, is seen as a sound investment given the trillions at stake over the euro. Such subsidies are also a convenient way to hide part of the Länderfinanzausgleich – the unpopular transfer payments to the East. 

Allowing Cameron to take the flak over the budget therefore suits Merkel down to the ground. But what is really driving a wedge between them is the eurozone crisis. A host of recent stories have suggested that Merkel is “losing patience” with Britain’s reluctance to accept more integration, and with hints that the UK is prepared to leave the EU altogether (her best line likened Britain to the old men heckling from the sidelines in The Muppet Show). 

Part of the problem is that Germany and Britain keep on talking past each other. This is not just down to diverging views of the role of the market, or the merits of European project. It’s also down to bad diplomacy. Cameron and George Osborne have made a habit of lecturing the Germans on the “inexorable logic” of the eurozone becoming a debt union – for which German taxpayers would foot the bill. This is a spectacular own goal, since it obscures a key area of agreement: namely, that Europe’s economic malaise should be dealt with by structural, free-market reforms rather than doling out cheap cash. 

Recent reports suggest that Merkel’s frustrations have reached the point where she’s prepared to wave goodbye to Britain altogether. In the past, so the analysis goes, Berlin needed London to balance the Mediterranean bloc. Now, Germany’s chequebook does all the talking. Certain people in Merkel’s office have taken to slipping this into chats with journalists, in case those in Westminster have missed it. 

Beyond this posturing, however, Berlin knows that an EU without the UK would be a much less pleasant place. The single market would shrink by 15 per cent, with 75 billion euros in annual German exports facing extra costs. Germany’s contribution to the EU budget would increase by an additional 10 or 15 billion euros. Nor would Britain’s global clout be easy to replace. If it really came to a situation where the UK was on the verge of leaving the EU, Germany would almost certainly crunch the numbers and conclude that, as Ludwig Erhard said, “without Britain, Europe would only be a torso”. But taking the long view, I am optimistic that a new Anglo-German deal is still there to be struck – one that would not just keep Britain in Europe, but create a Europe that Britain could live with. 

How could this happen? First, both Cameron and Merkel need fundamental change within the EU in order to keep their domestic audiences on side. Almost two thirds of Germans, for example, oppose the idea of giving more cash to Europe.

Second, many in Germany now accept that a flexible Europe, allowing for different modes of membership, is inevitable. Such diversity could be a very good thing. It is also exactly what Britain wants. 

Third, Germany is desperate to ensure that integration does not destroy the single market, which remains an asset. This should include making sure that any eurozone banking union doesn’t push the City of London “offshore”, which would cut off a facilitator of investment and a gateway to global markets for Germany. 

Both London and Berlin support the prudent use of public money, and oppose the papering over of economic cracks through fast and loose money. Both want to boost cross-border trade, in Europe and across the world. If the British Government stops its misguided lecturing, and advocates that kind of change, it may find it has more friends than it realised. 

Deja vu anyone? EU auditors refuse to sign off EU spending for 18th year running

This morning, the EU’s Court of Auditors published its report on the EU’s 2011 accounts. Although the auditors concluded that the Commission’s accounts are reliable, they also found that the actual spending was “affected by material error”, and for the 18th year in a row they refused to sign off on it.

Here are the key points:

Total spending in 2011 was €127.2bn, of which 3.9% - or €4.96bn - was “affected by material error”. In 2010, the corresponding figures were 3.7% and €5.38bn, meaning an increase of €580m in the amount of erroneous spending.

Breaking down the budget into policy headings, we see that only the areas of External relations, aid and enlargement and administrative spending were deemed to be “free from material error”, i.e. an error rate of below 2%. For the other policy areas:

Agriculture: market and direct support
Total Spending = €43.8bn
Estimated error rate = 2.9%
Erroneous Spending = €1.27bn

Rural development, environment, fisheries and health
Total Spending = €13.3bn
Estimated error rate = 7.7%
Erroneous Spending = €1.02bn

Regional policy, energy and transport
Total Spending = €33.4bn
Estimated error rate = 6%
Erroneous Spending = €2bn

Employment and social affairs
Total Spending = €10.2bn
Estimated error rate = 2.2%
Erroneous Spending = €0.22bn

Research and other internal policies
Total Spending = €10.6bn
Estimated error rate = 3%
Erroneous Spending = €0.32bn

The Court also found that controls over 86% of the EU budget were only "partially effective".

The Court also highlighted a few practical examples of how such errors were made. Here are a few examples from the report:

• A farmer was granted a special premium for 150 sheep. The Court found that the beneficiary did not have any sheep. The corresponding payment was therefore irregular.
• In two Member States Italy (Lombardia) and Spain (Galicia), the Court found cases where ‘permanent pasture’ reference parcels were recorded as being 100% eligible despite the fact that they are fully or partially covered with dense forest or other ineligible features.
• European Social Fund - one of the so-called structural funds - gave money to a commercial association, as support for its activities, which included advising small and medium-sized enterprises (SMEs). The costs of several staff members of the association were charged to the ESF project, although evidence supporting the charging of their time to the project could not be provided. The Court considers that the project staff costs have been overcharged by 60%.
• A beneficiary from the EU's research funding pot declared overheads amounting to €366,891 and included the indirect costs of all its departments while only considering the research personnel as an allocation key when charging these costs to research projects. This resulted in non-related costs being charged, leading to an over-claim of €180,670.

Vitor Caldeira, the ECA's chairman, is quoted in the Telegraph as saying that auditors had "found too many cases of EU money not hitting the target or being used sub-optimally", an argument we have also made repeatedly, not least in recent reports on the EU’s largest spending areas – Regional and Agricultural policy. Caldeira concluded that: 

“With Europe's public finances under severe pressure, there remains scope to spend EU money more efficiently and in a better targeted manner. Member states must agree on better rules for how EU money is spent, and member states and the commission must enforce them properly. In this way, the EU budget could be used more efficiently and effectively to deliver greater added value for citizens." 

We couldn't have put it better ourselves. Brussels needs to get its own house in order (albeit many of the faults lie with national managing authorities) rather than demanding ever more money from European taxpayers.

Some more (draft) bad news for the Spanish government

The European Commission is due to unveil its autumn economic forecasts on Friday, but El País has already seen a draft of what the Spanish government is going to be told - and, unsurprisingly, there seems to be no good news coming from Brussels.

First off, the Commission is going to confirm that the growth forecasts used by the Spanish government to table its budget for next year were overly optimistic. According to the Commission, the Spanish economy will contract by 1.5% of GDP next year - three times higher than the 0.5% the Spanish government was betting on (or maybe we should say 'hoping for'?). Incidentally, we also flagged up this weakness in the Spanish budget for 2013 when it was presented at the end of September (see here).

Unfortunately for Mariano Rajoy and his cabinet, though, the bad news does not end there. The draft seen by El País also shows that Spain is set to miss all the deficit targets agreed with Brussels until 2014 - and not exactly by a whisker. Worryingly, the Commission believes Spain's deficit at the end of 2014 will be 5.8% of GDP - with the target set at 2.8%. In other words, Spain looks set to fail to bring its deficit below the threshold of 3% of GDP enshrined in the EU Treaties, even after being granted an extra year to do so.

If confirmed, the Commission's forecasts will deal another blow to the credibility of the Spanish government - not least because Madrid decided to stick to outdated growth predictions to table its budget for next year, despite the IMF and others clearly warning that the recession was going to be much worse.

The official figures will be out on Friday - and we will post a more comprehensive analysis then.

Given all this then, it is a slightly ironic day for Spanish Finance Minister Luis de Guindos to publish an op-ed in the WSJ under the headline, "Spain's future is bright. Nobody in the international arena doubts the bold determination of the Spanish government." These figures suggest differently, and we expect Spain could find an increasingly impatient audience at meetings with other eurozone countries, especially after its decision to block the appointment of Luxembourg's Yves Mersch to the ECB's Executive Board.

A big week for Greece - but still few answers

As we noted in our press summary today, this week is lining up to be another big one for Greece.

The Greek government faces two crucial votes in parliament – first on Wednesday to push through the latest package of structural reforms (as demanded by the EU/IMF/ECB) troika and second on Sunday to approve the latest and, according to Greek PM Antonis Samaras, the last austerity budget for next year.

Since the governing coalition was formed after the second summer elections, such votes have usually passed without much fanfare. However, this time around the Democratic Left (which holds 16 seats in parliament) has said it will not vote with the its coalition partners. Pasok (which holds 31 seats) is also facing a period of internal strife with one MP already leaving and up to five others threatening to at least vote against the government. New Democracy (127 seats) should have an easier job pulling its MPs together.

The votes should pass but the margin for error is tiny, possibly only two or three votes, notably provoking unrest amongst financial markets and other eurozone leaders. In the end, given that the end of the government would very possibly signal the end of Greece as eurozone member, the (perceived) fear factor is likely to be enough to once again push the vote through.

This clears the way for the release of the next €31.5bn tranche of bailout funds and a potential two year extension to the Greek bailout. Today’s FT notes that the extra funding for the extension is likely to come from an increase in short term debt issuance by Greece and possibly a reduction in interest rates on eurozone loans to Greece – exactly as Open Europe predicted in its recent flash analysis on the issue.

The FT article also includes a potential plan for the ECB to return profits from its purchases of Greek bonds to Greece via eurozone governments to avoid the thorny issue of the central bank directly financing a state. This sounds plausible on the surface since the returning of profits to national governments should happen naturally anyway under the ECB rules. The only issue being that this can only happen overtime as the profits accrue as the bonds are paid off, so its unlikely to be paid out in a single chunk at one time (as is needed here).

One final point on the cost of the extension. We put it at around €28.5bn, although estimates range from €15bn to €40bn. We didn’t include a delay in Greece’s return to borrowing from the markets, which is looking increasingly likely. If Greece doesn’t return to borrowing until after 2016 it could add a further €10.6bn to the cost of an extension.

So although this is a big week for Greece, even a clear government win in both votes will do little to answer questions over Greece’s future in the eurozone.

Another disastrous budget for Greece

This week saw the release of the Greek budget plan for 2013-2016 and it did not make for happy reading. The English version is yet to be released but below we reproduce some of the key facts and figures from the Greek report. The table below essentially sums up the report and the crushing blow it delivers to hopes of a Greek recovery:

Debt peaking at a 192% of GDP in 2014! Astonishing given that less than six months ago the EU/IMF/ECB Troika seemed supremely confident that Greek GDP could stabilise at 120% of GDP by 2020 and would peak in 2013 at only 167% of GDP. (It’s also worth checking out this FT Alphaville post which highlights just how wrong some of the previous estimates were).

It’s easy to say that Greece failed to fully implement reforms and adhere to the bailout conditions (which it did) but at some point the failure of policies themselves and the fudging of the numbers must be admitted.

To many of us all of this was already abundantly clear but the release of the official figures confirming it at least ensures that the political debate will need to be moved on – expect ‘Grexit’ discussions to return to the headlines with a vengeance.

There are also a few interesting nuggets in the budget which suggest to us that further revisions may be likely:

• Firstly, unemployment is expected to go from 22.4% this year to 22.8% next year and then decline to 17.1% in 2016. It’s hard to see how this can happen with both government and private spending expected to fall over this period, while there will also be plenty of labour market reforms which tend to increase unemployment, at least in the short term. 
• Despite dropping by 15% this year, investments are expected to fall by only 3.7% next year and then return to growth. Again this seems massively optimistic without a permanent fiscal transfer supporting Greece and remove the cloud of a Grexit which continues to deter investors. 
• Exports are expected to grow at an increasing rate over the next five years, despite the eurozone and the global economy potentially posting low levels of growth. 
• Private consumption is expected to fall by 7% next year (after 7.7% this year), and yet this is expected to be consistent with a 4.5% contraction in GDP rather than a 6.5% one seen this year. Combined with falling government spending and structural reform this is again hard to imagine. 
• Table 2.5 highlights what could happen if Greece does not implement its medium term fiscal strategy (aka. its austerity packages and structural reforms), putting debt at 220% of GDP in 2016. This highlights how easily the levels could once again veer off track if many of these unrealistic targets are not met. 

As we mentioned in our recent note, a two year extension will be far from enough for Greece and this budget further reinforces that fact. With it now out in the open, discussions over the next few weeks should focus on more than just Greece’s next two years, but the fundamental decision of whether Greece belongs in the euro.

Open Europe Berlin: one to watch!

This is exciting stuff. As we've argued repeatedly, the future of Europe will largely be decided in Germany, as that country goes through a very dynamic, internal debate.

Which is why Wednesday's  launch of Open Europe Berlin gGmbH, Open Europe’s new independent partner organisation, was so incredibly timely. 220+ journalists, policy-makers, business leaders, academics, diplomats and others crowded at a packed Hotel de Rome in Berlin, to listen to OEB Director Prof. Dr. Michael Wohlgemuth and the keynote speaker Otmar Issing, former chief economist at the ECB.

The message from the podium no doubt struck a chord: the future of Europe isn't alternativlos – without alternatives to ever more centralisation. In his welcome address, OE Berlin Director, Prof. Dr. Michael Wohlgemuth argued that:

“We stand for a Europe governed by the rule of law and a Europe of citizens, not of bureaucrats… We are Europe-friendly but we place emphasis on measures that made Europe free & prosperous, not central planning… the current crisis measures will lead to institutional sclerosis & harmonised lack of responsibility, a clear case of ‘moral hazard’… Instead we stand for a liberal & competitive Europe; a democratically controllable decentralised arrangement within a clear rules based system.” 

OE Berlin Director Prof. Dr. Wohlgemuth delivering his opening remarks

In a keynote address entitled “More Europe – what kind of Europe?”, the former ECB Chief Economist Otmar Issing noted that “A think tank contributing fresh thinking on Europe is sorely needed and deserves support.”

Otmar Issing and event moderator Karen Horn

In his speech, Issing argued that:

“Placing too much value on a currency, whether it is the D-Mark or the Euro is not a good idea. It cannot be maintained at any cost...I welcome solidarity when it is about helping the weak get back on their feet. However, the fiscal union is a false interpretation of solidarity…The fiscal union is a clear case of wrong incentives. I do not believe that ‘more Europe’, a political union, is an alternative to the present state of affairs.” 

Instead, he said that failures within the euro were structural and were not caused by ‘financial speculation’, and that member states had to deal with their own problems rather than trying to move them to the European level. Issing also criticised the EU Commission’s “deeply absurd” rush towards establishing a banking union. He added that the proposed ‘Chinese wall’ between supervision and monetary policy at the ECB was “illusionary”.

The full video of the launch event is available here (auf Deutsch).

The crowd mingles at the Hotel de Rome

For German media coverage of the launch, see here.

Open Europe London Director Mats Persson outside OE Berlin office on Oranienburger Strasse in Berlin's Mitte district

Nick Clegg’s opposition to renegotiation could risk the UK’s EU membership

Following Nick Clegg's Europe speech at Chatham House yesterday, we argued on the Spectator's Coffee House blog,

Nick Clegg this morning fell into the usual ‘all or nothing’ fallacy on Europe. He said: ‘As soon as we start talking about repatriation, we descend into the in-versus-out debate.’ But the Deputy Prime Minister is wrong: the in/out debate is already underway, and rather than seek to defend the unpopular status quo, Nick Clegg should back renegotiation as the best option for those who wish to put the UK’s membership on a stable democratic footing.

But instead of attempting to address the causes for the EU’s unpopularity, the inflated budget, democracy deficit and bureaucracy etc. Nick Clegg sought to channel the debate into his own in/out debate where the problems of ‘out’ justify doing nothing about the problems of ‘in’.

Clegg said that UK can either be a full member of the EU or outside, like Norway and Switzerland. He is right that Norway as a member of the EEA does indeed implement a large proportion of EU law over which it has little influence and that Switzerland does not have full access for its services industries. He also pointed out that with no EU deal ‘firms who currently pay no import tariffs on the goods they send to the continent would be faced with taxes of up to 22 per cent’.  It is actually more like 10 per cent but the point is the same. However, protesting that no one is suggesting joining the EEA or not having a free trade deal with the EU is missing the point. Nick Clegg is presenting a false choice.

There is not one standard EU membership. The UK is not in the Schengen travel area, others are. The UK has a different deal on EU crime and police law than Denmark, which is fully opted out. There are neutral states and those involved in EU defence, there is the euro, the list goes on. But for Clegg there are only two types.

‘There’s the core: where the Eurozone countries are now pulling together more closely… Then there is the ring around that… And the outer circle… The UK is in the inner circle – but the terrain is shifting. The core is tightening – to what degree we don’t yet know.’

Clegg believes we should remain ‘a strong UK, influential in Europe’, but does not define what he wants to influence or convincingly explain why we should be in anything beyond the single market and some absolutely vital cross-border measures. Clegg’s reasoning:

‘What kind of club gives you a full pass, with all the perks, but doesn’t expect you to pay the full membership fee or abide by all the rules?’

This is an odd justification for the EU’s Common Agricultural Policy, Common Fisheries Policy, social and employment regulation, wasteful regional policy and unnecessary loss of democratic control. Are these accepted as some bizarre self-imposed flagellation for daring to desire free trade? If so, why not just accept a rise in the EU budget and get on with it? It’s the ‘subscription’ fee after all.

So what should the UK aim for? In a recent paper we set out that for now the UK benefits from being in the EU’s customs union and single market for good and services but that all other areas should be decided on a case by case basis. Is this pick -and-mix EU possible? Yes. The EU, as Clegg acknowledges, is changing. The eurozone is renegotiating its membership terms, and the treaties will need to be revisited sooner or later. This will present the UK with the opportunity to reform its membership terms and put it on a stable democratic foundation in line with public opinion.

Why David Cameron can threaten to veto the EU budget

Over on the Spectator's Coffee House blog, we argue,

When in 1996 the US Congress threw out Bill Clinton’s Federal budget they precipitated a partial shutdown of the US Government. However, anyone looking at the growing prospect of a UK EU budget veto and cheerfully imagining Eurocrats being shut out of their offices on 31 December 2013 will be disappointed. Because when it comes to EU budgets, a veto is not quite a veto – the EU will continue one way or another to claim its dues.

Nethertheless, a UK veto is not meaningless. Not least because, as we have set out here, the scenarios that could play out after a UK veto may not be that much worse for the UK than those already on the table (including, ironically, the UK’s own suggested ‘freeze’). It is important to realise that a ‘freeze’ in the overall EU budget could actually mean a rise in the UK’s net contribution. This is because the UK’s rebate only applies to spending in the ‘old’ member states and so shifting funds to the newer states would leave the UK out of pocket. We estimate that even under a ‘freeze’ the UK’s net contribution could rise by between €1 billion and €2.4 billion over seven years.

After a veto there are broadly two possibilities. The first is that the EU carries over its 2013 budget ceilings, adjusted for inflation. Member states would then have to negotiate an ad hoc deal, based on a Qualified Majority Vote rather than unanimity, which could see the overall EU budget increase above and beyond anything Cameron wants to see. However, this could actually mean a limited rise in the UK’s net contribution as the rebate reduction would not kick in.

Secondly, and less likely, the European Parliament could tear up the current budget altogether. Should they do so, the Commission could then table a completely new proposal for the annual budgets without any spending ceilings. These would be subject to QMV and could also lead to a large increase in the UK contribution.  This would also be a major act of hubris as MEPs aren’t exactly popular as it is.

However, a clear majority of member states desperately want a new deal. The new member states would lose out from the previous year’s budget. In addition, all other budget corrections – including the Swedish and Dutch rebates on the UK’s rebate – will expire in 2013, while the UK rebate would stay, meaning many net contributors would also stand to lose if there’s no new deal.

This all gives the UK veto potency which should be used all the way up to 2014 to push for radical reform of the largest spending items such as the Common Agricultural Policy and to repatriate EU regional policy.

Cameron’s EU budget veto is a powerful tool for change

Over on the Telegraph blog, we argue:

Labour has joined the battle over the EU’s next long-term budget. The budget, to run between 2014 and 2020, will be discussed at an EU summit on 22 and 23 November. David Cameron wants a “real terms freeze” (based on the cash that was paid out from the 2011 EU budget), Labour says he should go for a “real terms cut”, though it is not clear how that is defined. A motion will be debated on Wednesday in Parliament calling for a cut in the EU budget. It’s not binding, but if Labour MPs side with Tory backbenchers it could be embarrassing for the Government. The discussion is generally confused. 

Cameron is running short of allies in Europe for his real terms freeze – the Swedes and the Dutch are still with him. Cameron looks unlikely to back down, however, and it may come to him vetoing it. So what happens if Cameron vetoes the EU budget? The spin from some is that the talks move to QMV, and Cameron is toast anyway.

It’s a bit more complicated than this, however. If there’s no agreement by the end of 2013, there are two, broad possible outcomes:

Carry over the current EU budget:  If EU leaders fail to reach a deal before the end of next year, the 2013 budget structure is carried over, adjusted to inflation (the standard GDP deflator of 2pc). How the cash is allocated is decided by Qualified Majority Vote (QMV) rather than unanimity, circumventing the UK’s veto.

The point is that the UK uses 2011 payments as its baseline figure and this is likely to be considerably lower than the budget allocations or the overall ceiling for subsequent years. The combination of QMV and switching baseline scenario could therefore substantially increase the size of the EU budget, compared to both Cameron’s proposal and the various compromise deals floating around.

Tear up the budget completely and create a new proposal: The European Parliament could go rogue, tearing up the so-called “inter-institutional agreement” between itself and EU ministers, meaning that each year the Commission has to table a completely new proposal for the annual budgets although without any spending ceilings. These, also, will be subject to QMV.

So is Cameron’s veto pointless? Not at all. For a range of reasons, many EU countries would will desperately want to avoid this minefield:

• Under a “no deal” scenario, EU leaders will need to decide some 55 separate EU spending areas, through individual QMV decisions, all subject to a cobweb of disagreements. This would be hugely time-consuming.

• The powerful block of new member states would lose out massively from the previous year’s deal being carried over, since under the new budget period they are expected to receive proportionately more money. They will badly want a new deal.

• In addition, the UK isn’t the only country with a “rebate”. But unlike the UK’s rebate, all other budget corrections – including the Swedish and Dutch rebate on the UK’s rebate (yes, there’s such a thing) – will expire in 2013, while the UK rebate remains constant (courtesy of Margaret Thatcher). Many net contributors are therefore keen on a new deal.

• For its part, it would take a lot of nerve for the European Parliament – which is already struggling with democratic legitimacy – to tear up the inter-institutional agreement altogether (I dare them).

There’s another twist involving the UK’s rebate which may not make an ad hoc deal appear that bad for the UK either. Even under  Cameron’s “freeze”, the UK’s net contribution could go up by between €1bn (2.2pc) and €2.4bn (5.4pc) over seven years, as more cash would go to new member states not covered by the UK rebate. Under a “no deal” this effect may be mitigated to a significant extent, meaning the UK’s net contribution wouldn’t be greatly affected (for the detail, see here).

Cameron could have done some other things – including repatriating structural funds for richer member states – but at least he’s trying to achieve some change and do the right thing.  Ultimately, this episode shows just how politically and economically unsustainable the EU budget is. It needs to be one of the first items up for re-negotiation as the UK seeks new EU membership terms.

About that Spanish bad bank...

The Bank of Spain has just made an announcement regarding the country’s bad bank plan which fleshes out more details of the proposals following the recent consultation period. The press release and presentation are here and here, respectively.

Key points:

• The bad bank (known as Sareb) will be a for profit company (expecting a 'conservative' return on equity of 15%), majority owned by private investors (read other Spanish financial institutions) with a minority government stake. It will have 8% capital. 
• Its duration will be up to 15 years. 
• A transfer of up to €90bn of assets will take place in two stages. Stage 1 will see around €45bn in assets transferred from the most troubled (already nationalised) banks. Other banks will transfer assets in a secondary stage. (See picture below for the timetable). 

•  The valuation of assets will work from the baseline scenario of the Oliver Wyman stress tests (which we analysed here). It will be adjusted for the ‘costs’ of transferring the assets to Sareb. (See below for a breakdown of rough valuations). 

More details are still to come but here are some of our initial thoughts:

- One phrase that caught our eye was this: “The transfer price is not a reference for the valuation of non-transferred bank assets.” According to whom? Surely just asserting that this is not reference for the valuation of assets means nothing unless the market agrees? As we saw with NAMA, the market will still price broader assets of the prices used in the transfer, hence long standing market distortions in Ireland.

- The delayed/staggered nature of the transfer of assets could create a two tier market for similar assets, since the ones valued in the bad bank will be valued much lower than those kept on by the viable banks. This could hamper the viable banks attempts to sell off assets at reasonable values.

- The write downs, although substantial, still seem lacking in areas (not least due to the flaws in the OW baseline stress test scenario). For example, assuming foreclosed land will be worth 20% of previous value may seem substantial, but when there is an real estate oversupply which could take a decade to unwind the prospect of this land being worth anything soon seems unlikely.

- The timeline looks positive with significant progress expected in the near future, however, the full transfer of all assets to Sareb could run well into middle 2013. This delay could drag out the issue and further distort the price discovery in the Spanish real estate market. Also as Zerohedge points out, this timeline may be fine in a vacuum but with everything else going on in Greece, problems could escalate quicker than expected.

- As we’ve noted before, although the private investment is positive, it looks likely to come from mostly other Spanish institutions. This furthers the ‘nationalisation’ of banking sectors and intertwines the problem banks with the healthy banks. 

- The plan seems to be, since the institution is not a majority owned by the government, that it will not appear in general government liabilities. It's not clear whether this will pass muster with Eurostat, or how any losses/transfers from the public sector will impact government finances.

Overall then, a bit of a mixed bag. Some positive plans and it’s good that the plan is progressing (if a bit later than desired) but still plenty of potential pitfalls.

Revising the Greek bailout: Two more years of extend and pretend?

Open Europe published a new flash analysis on Friday, which looks at the prospects of a revision to the Greek bailout. It now looks almost certain that Greece will receive a two year extension to its fiscal consolidation and reform programme. However, questions remain over how much it will cost and how it will be funded. Open Europe estimates that the extension would cost a minimum of €28.5bn, if Greece meets all its targets. Meanwhile, none of the options for providing the funding looks politically or economically palatable.

The €28.5bn comes from: an extra €14bn due to slower deficit reduction, an extra €12bn from reducded privatisation receipts and an further €2.5bn from increased government arrears (unpaid bills).

We examine six key options for filling this gap:

1. A reduction in interest rates - which looks very likely but could only deliver €2bn - €3bn.

2. Increased short term debt issuance and more austerity - this looks possible and could deliver anywhere between €15bn - €20bn.

3. Extending length of loans to Greece - unlikely, it could raise €9.1bn in the short term, but on net it would give zero reduction.

4. ECB forgoing interest and/or profit on its Greek bonds - looks very unlikely, but could yield €1.15bn - €2.3bn (interest rate cut) and/or €14.25bn (forgoing profit).

5. Bond buybacks - again very unlikely, but it would mark a much larger step than simply covering the funding gap, as it could deliver €45.65bn overall and €17.15bn after the two year extension is paid for.

6. Write-down original eurozone bilateral loans -  this would be a huge step and could provide €26bn to €52bn but looks very unlikely to be approved, especially as it would support in national parliaments. 

Overall then, its hard to see how the gap will be filled without some larger decision being taken over the future of Greece in the eurozone. To read the full note, click here.

Never mind the Tories – What will Labour do about Europe?

Over on the Guardian's Comment is Free section, we argue:

When talking to diplomats, policymakers and journalists from around the EU, by far the most common question I get is: "What do you think the Tories will do on Europe?"

That question may soon have to be revised. It may not be the Tories, but the Labour party that will decide Britain's place in Europe – possibly even pushing it out altogether.

Much can happen before 2015, but there is a possibility that the Tories could suffer defeat at the polls at the next elections. Then Brussels' biggest fear – a sweeping Tory-led renegotiation of the UK's EU membership terms – will not materialise, at least not any time soon. Instead, either as part of a Lib-Lab pact or majority government, the ball will be in Labour's court. So what will Labour do?

In its 2015 election manifesto, the Conservative party could well promise renegotiation followed by a referendum on the result. It's far from set in stone, but increasingly likely. Tory scepticism on Europe as an issue may not allow David Cameron to get away with less. Labour effectively has two choices in how to respond:

Option one: Gamble on Europe not being an electoral issue.

The thinking is that the EU always ranks low on the list of voters' concerns. National elections are never fought over Brussels. This is only partially true. Europe is a low priority if presented as a single issue – but the fact is, it's not. To varying degrees, it permeates other issues such as the economy, general trust in politicians and, most importantly, immigration (which consistently ranks high) – something that is likely to be established by the current government's "balance of competences" review. Labour could try ducking the question in a campaign, but if the Tory party manages to successfully tap into the public's growing hostility towards the EU status quo – and with the eurozone's demands for greater integration unlikely to go away – it could really hurt Labour.

Option two: Promise a referendum of their own and so neutralise the Tories' pledge.

The Labour party is unlikely to promise a public vote on a renegotiated EU deal – in large parts, they have already rubbished the idea – so it will have to be a straight in/out vote. The plan would be to call a referendum shortly after the elections, campaign for a yes, win the vote and move on to other business.

This would be a massive gamble. The experiences of François Hollande in France and Mariano Rajoy in Spain show that political honeymoons are rare in today's EU politics. And heaven knows what Europe and the British economy will look like in 2015/2016, with the Greek bailout package set to expire, for example. If the referendum coincides with, say, a major new drive for more EU integration, with fresh demands put on the UK; and with a large number of Tories campaigning to leave (more likely in opposition), the British public may be pushed over the edge. It would then be Labour that unintentionally pulls the UK out of Europe.

There may be some options in between, such as promising a referendum on forthcoming treaty changes – or pledges to pursue some milder reforms – but that will not sound overly convincing. And even leaving aside the referendum issue, Europe could hit Labour like a steam train: in a few years' time, the free-standing "fiscal treaty" is meant to be incorporated into the EU treaties. Will Labour nod that through, given that it effectively codifies the Bundesbank-style austerity, much criticised by Ed Balls and co? Will it veto Germany's plans for a fiscal discipline commissioner, if they materialise? How will it relate to the evolving eurozone banking union and potential accompanying treaty changes? Will it tear up the coalition's EU "referendum lock"? The more the eurozone agrees to do in common, the harder it will be for the UK to stand still. In fact, the eurozone crisis means that the status quo is no longer an option for Britain.

The problem is that, fundamentally – and much like the Tory leadership itself – it does not yet appear that Labour knows what it wants for the UK in the multi-tier Europe that is developing. The previous Labour administration's policy of simply sitting in the "euro waiting room" and hoping the public would come along for the ride is no longer credible. However, the wing of the party that said it always opposed euro membership has yet to articulate what its alternative plan is.

There are a lot of good and clever people on Labour's front benches. So far, it has suited Labour to treat Europe as a coalition piñata. Not for much longer. Labour now has the chance to develop a coherent and positive European vision and a plan of its own – designed around a flexible model for EU co-operation, in which Brussels does less in the UK, but does it better. Bank on the status quo or Tory splits, and both the party – and Europe – may be in for some unexpected surprises.

EU budget talks are heating up (and Brussels isn't doing itself any favours)

EU budget talks are heating up, with member states still unable to agree on the size of the next long-term budget, to run between 2014 and 2020.

EU leaders will try to settle differences at a summit on 22 and 22 November. As things currently stand, a deal looks unlikely, with David Cameron in a particularly tricky position (for just how tricky, see here). Today we got a taste of things to come: the Brussels institutions launched a three-pronged attack on economic common sense.

• The European Parliament voted for 6.8% increase to the EU’s 2013 budget (which is subject to Qualified Majority Voting and co-decision between national ministers and MEPs), thereby rejecting member states’ compromise 2.79% increase, instead going with the Commission.  

• In a report, the EP also backed a 5% increase to the EU’s long-term budget (and a lot bigger increase if off-balance sheet items are included), in line with the European Commission’s original proposal. This proposal has been rejected by all net contributing member states (which doesn’t mean that the net contributors agree amongst themselves).

• Finally, the Commission said today that it needs to amend the 2012 EU budget, since there's not enough cash left. If you’re a government on an EU-mandated austerity programme - or a a household - you’re forced to prioritise and find savings when there’s not enough money in the pot. If you’re an EU institution you ask for an additional €9bn (with roughly €3.1bn from fines imposed on member states, meaning that national governments will have to put up €5.9bn in total).  

Cheers for that.

So if the EP/Commisison 2012 and 2013 proposals stand, which they probably won’t (we’ll return to the long-term budget), UK taxpayers would be forced to cough up another £2bn or so (£1.3bn increase for 2013 + £700m extra funds for this year), depending a bit on exchange rate used and the UK's pre-rebate share of the EU budget (both vary).

And those people who want the UK to leave the EU just got some additional killer campaign material to play with.

Well done Brussels.

Hague's first Europe speech moves the Government in the right direction

William Hague’s first major (and long overdue) speech on Europe since coming to office struck a refreshing tone. In Berlin this morning, the Foreign Secretary set out a case for economic reform in the EU and a new vision for Britain’s place in Europe that was both robust and intellectually consistent. This was the thrust:

“The Eurozone countries must do what they must to resolve the crisis, but the way forward for the EU as a whole is not more centralisation and uniformity but of flexibility and variable geometry, that allows differing degrees of integration in different areas, done in ways that do not disadvantage those that do not wish to participate in everything, and preserves the things we all value.”  

It seems to signal a new tone, if not a new approach, by the Government. Gone was the needless and fruitless lecturing of the eurozone, the counterproductive demands for Germany to pick up the tab for the crisis and the intellectually inconsistent approach that has characterised the UK Government’s rhetoric to date. In short, it has been a complicated mix of demands for a federal eurozone, while threatening to veto the very same thing - 'eurosceptic fiscal federalism' as we've dubbed it. 

Instead, Hague offered a different, far more sensible approach,

“Clearly the Eurozone’s current structures are not working. We respect the democratic decision of the countries of the Eurozone to preserve it. That will require changes. We know the options. It is not for Britain to tell you what the exact remedy should be.”

In fact, Hague held up Germany as a positive economic role model:

“Others can learn lessons, Britons among them, from Germany’s policy choices: structural reforms, its sound public finances and its culture of excellence and enterprise have made Germany globally competitive. It is one of the great trading nations of the world.”

We would hasten to add, this model did not involve cheap central bank cash to paper over deep economic cracks - which seems to be what some members of the UK Government are suggesting the eurozone moves towards. However, the Foreign Secretary still avoided sounding soft. He reminded the German audience that the UK public’s scepticism of the EU is at an all-time high:

“I must also be frank: public disillusionment with the EU in Britain is the deepest it has ever been…People feel that the EU is a one way process, a great machine that sucks up decision-making from national parliaments to the European level until everything is decided by the EU. That needs to change. If we cannot show that decision-making can flow back to national parliaments then the system will become democratically unsustainable.”

He repeated the theme, first developed in David Cameron’s Conference speech, that Europe is losing the global economic race:

“If we do not succeed in making our economies globally competitive and generating sustainable growth then whatever else we do, whatever treaties we sign, whatever structures we build, whatever declarations we sign, will all ultimately be irrelevant. There will be no Social Europe, there will just be an Excluded Europe.”

He also repeated the obvious, yet important, British view that future eurozone integration would have to be compatible with the Single Market:

“While developing a governance of the Eurozone that really works we must equally ensure this leaves the Single Market coherent and intact. The debate on establishing a full banking union shows that this will be complex and sometimes difficult. There are obvious issues for countries not in the Eurozone, for whom it will never be acceptable to have a situation in which the Eurozone acts as a bloc in Single Market institutions in a way that determines the outcomes before the others have even met.”

But, most interestingly, Hague started to articulate a vision of the EU that the UK might be at home in:

“Often important things will not be agreed or cannot be done through the EU. It would be neither right nor realistic to think that questions of war and peace could or should be decided by QMV. Indeed, just because some things work well in coordination with all of our European partners does not mean we should do everything at 27. A more effective EU does not have to mean a bigger, more expensive or more centralised EU.” 

“…The EU is already a diverse place and with further enlargement it will become more so: by the time all the Western Balkan nations join there will be more than thirty countries in it. Its peoples do and will want different things from the EU. Some will be in the Eurozone and some not. Some are comfortable with ideas of federalism, other are not. Some, like Britain, play an active part in foreign and security policy, others find its practice difficult. Some yearn to go further in opening up markets. Others find the idea threatening.

We should recognise and embrace that diversity – it would be a dangerous denial of reality to wish it away. We must respond to what our people and democratic institutions are saying – not just in Britain, but across Europe.”

This was not the finished article by any means but it did signify that the Government (or at least its Conservative part) might finally be coming around to the idea that it needs to explain to the rest of the EU - and UK voters - what it wants from any future renegotiation (Hague also outlined the UK’s review of EU powers), and where the referendum will fit in.

The question is whether Cameron’s much anticipated speech this autumn will deliver.

Spanish regional elections: Why the victory for Rajoy's party in Galicia should not be overplayed

Following the latest round of regional elections in Spain on Sunday, the foreign media clearly seem to have focused their attention on the victory of Spanish Prime Minister Mariano Rajoy's Partido Popular (PP) in Galicia (see, among others, this article from today's FT). Of course, the fact that outgoing Galician President and PP candidate Alberto Núñez Feijóo (pictured with Rajoy) has not only confirmed his absolute majority, but also managed to consolidate it by winning three more seats than he had during his previous term is remarkable, given the nationwide drop in the party's popularity.

However, the significance of the victory in Galicia should not be exaggerated, for a number of reasons. Firstly, Rajoy is Galician. Although, as noted by the Spanish press, he avoided appearing next to Feijóo during most of the electoral campaign, Rajoy did travel quite a lot across the region - and it would be naïve to think that his personal involvement did not win Feijóo a few extra votes.

Secondly, Galicia is a region with solid right-wing credentials. The region has been governed by centre-right forces for much of the time since Spain returned to democracy - including fifteen consecutive years between 1990 and 2005 under Manuel Fraga Iribarne, a former minister under Francisco Franco (a Galician native himself) and the founder of Alianza Popular in 1976, which became Partido Popular in 1989.

Therefore, we definitely think the results of the Basque elections were far more interesting - for one very simple reason. Unlike after the previous elections in 2009, Rajoy's Partido Popular and the opposition Socialist party together do not command a sufficient majority to stop the candidate of the Basque Nationalist Party (PNV) Íñigo Urkullu becoming the region's new President - although he will need the support of other parties to secure a majority in the Basque parliament.

It is not unusual for nationalist parties to be in government in the Basque Country, but the context looks quite different this time. During the electoral campaign, Urkullu has clearly said that he wants to make the Basque Country a "European nation". The expression must sound worryingly familiar to Rajoy and his cabinet, as it clearly echoes Catalan President Artur Mas's recent calls for Catalonia to become "a normal nation within Europe".

Incidentally, a new Feedback poll for Catalan TV channel RAC1 this morning credited Mas’s party with 67 seats in the 25 November regional elections – only one seat short of an absolute majority in the Catalan parliament. The same poll also found that over 70% of Catalans are in favour of pushing ahead with plans for a referendum on the relationship between Spain and Catalonia, even if the Spanish government prohibits it.

The Catalan elections are yet to take place, but there is clearly the potential for a major 'sovereigntist' headache here - and at a time when the Spanish government can least afford it.

Eurozone votes for eurozone laws: one way to solve the European Parliament’s “West Lothian question”

In the UK, Scottish MPs can vote on English matters (such as the English NHS and education etc.) where, because they are devolved to the Edinburgh parliament, English MPs have no say on specific Scottish matters. This has been labelled the “West Lothian Question”. Solving it is has been a perennial subject for debate, going way back to debates on Irish home rule in the 19th century right through to Scottish devolution. As yet it remains unanswered.

With a multi-tier Europe becoming more of a reality every day, in wake of further Eurozone integration, the EU is now facing its own West Lothian question. If some countries don’t take part in say, more fiscal integration or if some countries – such as the UK – wish to devolve some EU powers back to the national level, how would the EU’s voting system take that into account?

European Parliament President Martin Schulz said yesterday for instance in an interview with Die Welt, that:

"it can't be the case that individual member states pull out of the common [policy] areas, but believe that they can continue to co-decide on legislation. That's the case for negotiations in the Council, but also in the Commission and for us in the Parliament. The withdrawal of Great Britain raises the second big question apart from the euro question: how do we deal with this now from a legislative perspective? With Schengen, it was already the case that London doesn’t take part but was allowed to co-decide on legislation. We must make this systematic. When Cameron starts picking what he prefers from current Treaty law, we must consider which consequences this has for us as an institution. Whoever doesn't take part in certain policies, should no longer take part in the legislative process. When you withdraw, you need to withdraw completely.”

And he is also quoted by DPA as saying:

“The euro is the currency of the union. The parliament of the union is the European Parliament. Thus the parliament of the euro is the European Parliament. We have 27 EU member states and two, namely Denmark and the UK, said we won’t go along with the euro. All other states are required to introduce the euro sooner or later. Therefore we need a ‘27 minus’ approach on EP decisions on Eurozone-specific issues”.

Schultz has asked the West Lothian question
- but does he have the answer?

Schultz seems to be arguing for the eurozone votes for Eurozone laws. He makes a good point, but how would this work? Well, Britain has some experience of assessing the relative merits of limiting MPs to voting on different laws. In essence the problems that have been thrown up are these:


Problem in UK: How do you ascertain what is a ‘eurozone’ law is when something might effect both parts? 19th Century British PM William Gladstone, for instance, concluded that: "it passed the wit of man to frame any distinct, thorough-going, universal severance between the one class of subject and the other."

Not a problem in EU: In the UK these problems remain due to the imprecise nature of UK governance. However, in the EU all legislation is based on treaty articles and EU competences, so deciding who votes on what should be far easier, though if the line between the banking union and the single market, for example, gets blurred this could suddenly become problematic.

Problem in the UK: English votes for English laws in the UK raised the prospect of a UK government unable to govern England because, it may not in fact command a majority of English MPs (only an ‘overall’ majority) creating constitutional chaos (think posts such as the Home Secretary).

Not a problem in EU: In an EU context allowing differing governments to get on with their business would probably suit the UK just fine, as would limiting MEPs’ power over UK affairs (though we acknowledge the risk of eurozone caucusing etc).

In principle, there’s no reason why variable geometry in the EU voting system can not be made to work – in fact, it could be an important component of a reformed EU, in areas such as the CAP, JHA and social and employment laws, as per the model we’ve outlined below. When these are up for discussion a UK MEP would simply not vote.

Politically, it would need to be managed very carefully. Some euro-outs, such as Sweden, will probably oppose such a differentiated approach. But it would be fair democratically and, as Europe moves towards a multi-tier model, perhaps something the EU will eventually get used to.


Will eurozone votes for eurozone laws catch on in a multi tier EU?