Make Europe Grow Again and other calls for political courage
What caught my eye this week including the challenges facing the incoming EU Commission, is Barnier continuity Macron, America's Ukraine timidity and why isn't Labour braver?
I ran into a number of Wealth of Nations readers in Brussels this week who said I was spoiling you with so much content in a single newsletter at the weekends. They suggested I broke it up into a couple of newsletters each week. I may do that. Let me know what you think. In the meantime, apologies if this one is bit long again…
1. Make Europe Grow Again
I spent much of last week in Brussels, catching up with old friends and contacts and attending the annual meetings of Bruegel, the leading European economics think-tank. It was an interesting time to be there, as the European institutions prepare for the start of a new Commission “mandate”. On Wednesday, Ursula von der Leyen will announce her new college of Commissioners, who will run the executive arm of the EU for the next five years. Ahead of this, Bruegel had helpfully prepared this book of “memos” to the incoming Commissioners setting out its recommendations on how they should address the challenges they will face in each of their portfolios.
I have to say that I came away feeling distinctly gloomy about the outlook for the continent. That is unusual for me since I have always been pretty upbeat about Europe’s ability to overcome its various challenges, in line with Jean Monnet’s dictum that “Europe will be forged in crisis”. Over the past decade or so, Europe has come through a series of shocks with more success than most commentators expected or would acknowledge. They include the global financial crisis and eurozone debt crisis, Brexit, the pandemic and the energy crisis caused by Russia’s invasion of Ukraine.
The challenges today are less immediate but just as pressing: they include the need to bolster the continent’s defence in the face of Russian revanchism and potential American isolationism and the need to revive an economy that is falling ever further behind America on almost all measures. Europe’s GDP per capita, for example, has risen 25 per cent since 1999, compared to 38 per cent in America. Indeed, as I have previously argued, the two are linked, since without a strong economy there can be no strong defence. Foreign policy, after all, begins at home.
The problem is that many of the solutions that the Bruegel scholars are proposing, while eminently sensible, will either require member states to stump up more money for the EU budget at a time when every government is grappling with its own debt pressures or or to hand Brussels new powers. Neither are easy. Jeromin Zettlemeyer, the director of Bruegel, admitted that he didn’t see how the EU could fulfil its ambitions for both clean energy and defence without a new issuance of common EU bonds, similar to the unprecedented - and supposedly one-off - €700 billion next generation EU programme designed to fund the pandemic recovery. Yet a senior Dutch finance ministry official was clear that her new government was likely to oppose more EU borrowing. What the EU could tax to fund increased spending, given the reluctance of member states to provide bigger grants, was an open question. Most participants seemed to consider Bruegel’s suggestion that member states should co-fund the Common Agricultural Policy’s farming subsidies to be a non-starter.
Meanwhile many of the reforms identified as priorities to deepen the single market and improve competitiveness impinge on the most sensitive areas of national sovereignty, including energy, capital markets and defence. These raise issues that are so intractable that they have defeated EU reformers for years. A panel on creating a capital markets union to provide European businesses with alternative sources of funding rehearsed exactly the same arguments I used to hear a decade ago. During that time, the need for action on this front has become even more acute as over-zealous post-crisis banking reform has effectively killed the banking sector as a provider of risk capital. The only difference now is that Bruegel has been reluctantly forced to accept that vital reforms of insolvency rules, taxation and pension systems needed to create a pan-European bond and venture capital market, is out of reach. Instead it recommends that Brussels establishes a new pan-EU regulator.
That makes it hard to be optimistic about the long-term outlook for the European economy. The truth is that Europe has fallen dramatically behind in almost all the key technologies of the future. It has lost the lead in clean energy technology, despite having invented much of it; it is losing the battle over electric vehicles; it is nowhere in AI and quantum computing. There are many reason for this, of course, and I plan to examine them in a future post. But there is no doubt that the lack of an appropriate financial ecosystem is one of them. As one despairing panelist put it, the EU generates a huge current account surplus equivalent to 3 per cent of GDP, yet these savings get invested in American funds, which are then invested in European innovations that typically end up being commercialised in America.
I have similar concerns about Europe’s ability to get its act together on defence, even though everyone recognises this is an absolute strategic priority. The reality is that Europe’s deeply fragmented defence industry is not producing anything like enough weaponry to compete with Russia, which has placed its entire economy on a war footing. Addressing this would require eliminating national vetoes on the defence industry to allow for the creation of a genuine single market. It would also require the use of EU funds to manage joint procurement programmes which in turn are essential if the current inflated costs of European armaments are to come down.
This new single market should, as Bruegel recommends, be extended to the UK, which has an important defence industry well-integrated into the EU market. But how realistic is any of this? Which smaller countries will be willing to see their own domestic defence industries disappear in cross-border consolidation, or see the EU budget used to fund investments in the defence industries of much larger economies? And will any EU government be willing to see EU defence industry jobs, technologies and subsidies ending up benefitting above all others the renegade UK?
Perhaps I am being too pessimistic. In what is sure to be another big moment in Brussels next week, coming perhaps as soon as Monday, Mario Draghi will unveil his recommendations on how to improve the EU’s competitiveness following a review commissioned by von der Leyen. The former Italian prime minister and European Central Bank president is a formidable operator and knows how to get things done in the European system. It seems that his recommendations are likely to find their way into the mission statements of the new Commissioners, so perhaps there will be sufficient political impetus to drive some of these reforms forward.
The question is whether the EU can defy its own history and generate the political momentum to deliver such reforms in the absence of any immediate crisis to focus minds. What’s more, can it do this at a time of political polarisation and fragmentation both within and between countries which makes forging compromises even harder than usual? The alternative is a drift into ever greater weakness, vulnerability, polarisation and fragmentation, until crisis becomes unavoidable.
2. Continuity Macron?
Is Michel Barnier’s appointment as prime minister of France signal the continuation or the end of Macronism? asks this op-ed in Le Monde. Macron clearly believes it is a continuation, having seen off the left-wing alliance which threatened to dismantle his achievements, particularly his pension reforms. Barnier himself is known within his Les Republicains party as a “disappointed Macronist” and Macron considered him for the prime ministership before in 2020. On the other hand, many in LR see Barnier’s appointment as evidence that “the great replacement of Macron is underway” and spy an opportunity for the party to “reclaim power from within” despite being only the fifth largest party in the National Assembly with just 47 seats.
Of course, we won’t know the answer to the question until the former Brexit negotiator forms his cabinet and sets out his policies. Barnier’s first challenge will be simply to form a government that can win the confidence of the National Assembly. That won’t be easy given that it will be dependent for its survival on the parliamentary backing of Marine Le Pen’s far right Rasssamblement National, the very party that Macron’s political project was designed to keep from power. Barnier knows that he will need to show a degree of independence from the unpopular president who is opposed by two thirds of the National Assembly, as he has already signalled:
During the handover from former prime minister Gabriel Attal on Thursday, Barnier made it clear from the outset that he had no intention of being reduced to the role of executor or assistant and that he would bring his "added value," setting a new tone. By not thanking the president in his first speech, the prime minister signaled that he wouldn't be subordinate to the man who appointed him. In a subtle critique of Macron's track record, he announced that he intended to "act," rather than "talk," to "listen" to intermediary bodies, to "respect the 'people below'" and not to impose everything from up high.
But Barnier does not only have to worry about the votes in the National Assembly. He will also face the judgment of the markets when his government presents a budget for 2025 which, under the constitution, it is supposed to do by October 1. That will prove an equally formidable early test of his famous negotiating skills, as was clear when the outgoing budget minister updated the National Assembly on the state of the public finances last week. Thomas Cazenave provided new data showing that the public deficit could reach 5.6% of GDP this year. That is 1.2 points higher than the government's target was in January, and 0.5 points higher than it was in the spring, when the government was forced to admit that tax revenues would be lower than it had forecast. As a result, the current budget plans designed to bring the deficit back to 3 per cent by 2027, as required under eurozone rules, are already obsolete.
As an editorial in Le Monde notes: “The urgency of the situation seems completely at odds with the political spectacle we've been witnessing in recent weeks. By allowing the summer to pass before starting consultations to find a prime minister, the president is forcing the nation's representatives to sort out the budget bill in a very short space of time, and amid a highly charged atmosphere.” What’s more, most of the parties went into those elections with fantasy budget plans, based on a rosy economic future with no acknowledgement that the coffers are empty. Can Barnier find a way through this fiscal mess that satisfies not only the National Assembly, but the financial markets and France’s eurozone partners? It won’t be easy.
3. America’s Ukraine Timidity
Volodmyr Zelensky was in Germany this week meeting western allies in Ramstein where he pleaded once again for faster delivery of more military equipment to enable Ukraine to defend itself against Russian attacks. But it is not just in the military sphere where western support has been slow to arrive. Earlier this year, after months of wrangling, the G7 agreed at its summit in Puglia to provide Ukraine with a $50 billion loan, to be funded by the profits on Russian assets frozen in Europe. But as this excellent column by Martin Sandbu in the Financial Times noted, this complex piece of financial engineering has run into predictable trouble. The problem:
The EU only renews its sanctions for six months at a time, so that profit stream could cease as soon as a single member state vetoes renewal. That brings risk not just for non-EU members in the scheme but also Kyiv: a contingent fiscal liability could complicate the IMF’s debt sustainability judgments.
To address this, Brussels has presented EU governments with options that include longer renewal periods or tying the end of the asset block to Moscow compensating Kyiv. The former would require Hungary to relinquish its twice-yearly veto power. The latter would be tantamount to the confiscation so strongly feared by Paris, Berlin and the European Central Bank.
Neither option seems likely to gain unanimity.
There was something about this ruse that always seemed a bit too clever by half. As Sandbu says, “the problem is that western leaders have tried to get something for nothing: new funding for Kyiv, but with no new taxpayer commitments, no financial risk and no seizure of the assets even of a criminal state.” In particular, it was conjured up to get around the growing political resistance to providing more support for Ukraine in America. The complex structure is being dictated in large part by the need to ensure that the loan did not require the consent of Congress. Even now, I am told that there is a risk that if the EU cannot extend sanctions, the US may not participate, leaving the EU to pick up America’s $20 billion share of the loan.
Such an outcome would be in keeping with the Biden administration’s approach to the war, which has often been characterised as giving Ukraine just enough support not to lose to Russia, but not enough to win. As Sandbu says, the $50 billion loan is best seen as a sign of timidity not confidence. It was very much a third best alternative to taxpayer funding of Ukraine or transferring the seized assets outright. Blame for failure to do the latter is typically aimed at Europeans, who have warned of risks to financial stability and confidence in the euro. But it is striking that America has not seized the far smaller share of frozen assets in its financial system, a move that might have set a precedent that could have made it easier for Europeans to do the same.
Let’s hope that whoever wins the US election in November shows greater boldness to tip the scales more decisively in Kyiv’s favour, both militarily and financially.
4. Why isn’t Labour Braver?
I was delighted to see John Crompton’s recent guest post for Wealth of Nations cited by Patience Wheatcroft in an excellent column for the New European urging Rachel Reeves to embrace a more radical approach to accounting as she tries to grapple with her grim fiscal inheritance (Reeves needs to be a bit braver with her accounts). It is good to see that the case for incorporating a balance sheet approach based on net worth into Britain’s fiscal framework is gaining such distinguished support even if, despite what Reeves intimated before the election, there is little sign of it happening.
But Patience’s column does raise a worrying question: why is the new Labour government not braver? I raised this in my newsletter a couple of weeks ago in the context of Keir Starmer’s disappointing timidity over the European Union’s offer of a youth mobility deal. But one could say the same about other aspects of Labour’s agenda too. The much-ballyhooed National Wealth Fund, for example, has turned out to be a nothing-burger, just an extra £7 billion of funding for the existing National Infrastructure Bank that is struggling to invest its existing capital within the tight guidelines set by the Treasury, while it is still not clear what Great British Energy, the government’s other flagship investment vehicle, will actually do.
One plausible explanation, suggested to me by a senior official the other day, is that the election simply came too soon for Labour, which had not had time to flesh out its policy agenda. That may seem an odd excuse for a party that was in opposition for four and a half years. But the truth is that for much of that time, the party was far behind in the polls, mired in scandal and riven with internal divisions, short of money and widely considered to have no prospect of getting back into government for at least another electoral cycle. I wrote in May, in the context of Labour’s approach to Brexit, how it was clear that, with only a small team of shadow ministers and advisers and without access until very late in the day to the expertise of the civil service, Labour lacked the detailed understanding of EU issues needed to assess what is negotiable and the associated trade-offs. It seems that was true of other policy areas.
The conventional wisdom is that Rishi Sunak’s decision to call an early general election was a disaster for the Conservative party, which was denied the chance to reap the benefits of a reviving economy. Meanwhile the right-wing press assumed that Labour’s lack of a detailed manifesto must mean it had a secret agenda that it was hiding from the public. But it may be that the early election may ultimately prove to have been an even bigger problem for Labour, which found itself prematurely thrust into office without a clear plan after all and must now make it up as it goes along.
Europe undoubtedly has trouble getting its defence industries moving. But let's not get overly impressed by Russia and its war footing economy. Pre-war, a GDP the same as Italy's. Russia can't make much. Russia is industrially incompetent. No new Migs. Or tanks, they drag them out of storage. Many of them haven't moved for 40 years, and it's not the nice dry Arizona desert. 1200 casualties a day for a cumulative total near 700,000. 1, some say 2 million Russians have fled to avoid being drafted; their finest, best educated young men mostly. There's a labour shortage. High inflation - 16% is the official number, so for sure it's higher. Russian no longer publishes most economic numbers, so it's all a guess. A war economy may give impressive looking GDP growth numbers. But everything they make is blown up. Reality is, the Russian economy is shrinking. Oil? A low price set by the Chinese. They can't increase sales because the pipelines aren't built. Whatever Europe is not doing well enough, Russia does far, far worse.
He obviously misses those Brussels' days. At least he is clear about his opposition to Brexit. Those meals with cronies in Brussels....where did they go?