As almost all European governments are cutting spending, it is hardly a surprise that the EU’s budget is under fire. The European Commission has rather optimistically proposed a real terms increase of five per cent in total spending over the next budget period, which runs from 2014 to 2020. This amounts to 1.05 per cent of projected EU GDP over that period. Most of the countries that pay more into the budget than they get back reject this proposal. Germany and Ireland want the budget limited to one per cent of EU GDP (which means that as Europe’s economies grow, the budget can grow too, but at a slower rate than the Commission wants). However, British Prime Minister David Cameron wants to go further: he has promised to veto anything but a freeze in real terms. It may be difficult to back down from this position in budget negotiations: the opposition Labour party combined with backbench Conservative rebels to win a parliamentary vote last week that called for a cut to the budget, defeating the government. Cameron would be unlikely to get a larger EU budget through the UK’s parliament if he compromises at the summit, on November 22nd.

Britain is not the only budget hawk: Sweden and the Netherlands have also demanded big cuts to the Commission’s proposal. But neither has demanded a freeze. The UK is likely to be further isolated in Europe, after its veto of the fiscal compact in December last year, if Cameron refuses to compromise. Amid the politicking over the size of the total budget, Westminster has paid little attention to the potential costs to the Exchequer of the proposals on the negotiating table, and how much extra the UK could pay. This note offers some answers, and in doing so allows us to judge whether UK obduracy is likely to achieve very much.

How much does the UK currently pay, and how much does it receive?
As a comparatively rich country with a small agricultural sector, the UK has in recent years been a net contributor to the EU budget. The UK passes tax revenue to Brussels, and receives less expenditure in the form of Common Agricultural Policy (CAP) payments, regional development funds, and other transfers in return. But it has a rebate from Brussels – a reduction in its contributions negotiated by Margaret Thatcher in 1984, which many other EU countries consider to be unfair now that Britain is one of the richer members of the club.

Britain’s net contribution is how much it pays in, less how much it receives back, in EU spending and the rebate. In most budget negotiations, British governments try to reduce wasteful and iniquitous farm spending and the size of the budget, and protect the rebate. Tony Blair’s 2005 agreement to cut the rebate to help pay for the costs of EU enlargement is the exception that proves the rule: even Blair, a pro-European prime minister at the height of his power, did so reluctantly, and fought hard for CAP reform.

Given that any country can veto the EU budget, member-states must build alliances to succeed. The UK is isolated after its veto of the fiscal treaty, and so would do well to be cautious if it wants to reduce spending. Britain wants the budget frozen at its 2011 level. But if the talks collapse, which is a distinct possibility, the 2013 budget will simply be rolled over to 2014, but with inflation added. The budget would end up far larger than 2011.

If the UK really wanted to cut wasteful spending and promote growth, it could accept the German proposal for a budget capped at one per cent of EU GDP, in exchange for cuts to the CAP and a transfer of that money into infrastructure and regional development spending. France has threatened to veto any budget that does so, but they could be isolated if Britain were prepared to make concessions, which President Hollande may wish to avoid, given the difficult negotiations over the euro.

But such a deal may be difficult for Cameron, who has chosen to make budget cuts his priority. The UK’s net contribution grew by three-quarters between 2006 and 2012, from £3.9 billion to £7.4 billion (€4.8 to €9.2 billion). The UK’s transfers to Brussels were low in 2008 and 2009 because it suffered a larger recession than other member-states, and in 2010 and 2011 payments were larger because its economy made a (small) recovery. On the expenditure side of the ledger, European Social Fund and Regional Development Fund spending in the UK is falling over time. These funds provide support for struggling regions with an income less than three-quarters of the EU average. Over the course of the last budget, Brussels has phased in the poorer newer members in Central and Eastern Europe, so that a greater proportion of structural funds go to these countries. These two factors explain most of the rise in the UK’s net contribution.

As regional funding has declined, agricultural payments have become the large majority of EU spending in Britain. This change in the composition of spending explains why Cameron is in a difficult negotiating position. Switching money from the CAP to regional spending would mean that the UK’s net contribution would rise, as fewer regional funds are disbursed in Britain, thanks to enlargement. If Cameron were to try to offer up more of the rebate to convince France to reform the CAP, the UK’s net contribution would rise even further. Thus, Cameron can either try to limit the UK’s contribution to the EU or try to improve what it is spent on. The best policy would be the latter, but the best politics – at least in domestic terms – is the former.

How much could the UK contribute to the next budget?
Britain’s net contribution to the next budget will not be decided before the negotiations at the summit in late November – and quite possibly not even then. But we can make some assumptions about how much more the British taxpayer might end up paying. The UK’s fiscal watchdog, the Office of Budget Responsibility, assumes that the UK net contribution is going to stay at around the 2012 level as a percentage of the total EU budget – five per cent. This seems right, for the following reasons. The UK is unlikely to give up or reduce its rebate. British economic growth is projected to be around the EU average: if it grew faster than other countries, the budget arithmetic would mean it would become a bigger net contributor. Finally, regional development funding is not coming back to the UK: Central and Eastern Europe will remain poorer than Western Europe between now and 2020. Given that the UK contribution should stay at around the same level, as a proportion of the total budget, we can then project forward how much it is likely to contribute, given the three main proposals on the table.

* A budget freeze (UK proposal: the British Parliament’s vote for a cut is only advisory, and this remains the UK government’s position)
* A budget capped at one per cent of EU GDP (the German position)
* A five per cent increase in the budget, as a proportion of EU GDP, to 1.05 per cent (the Commission proposal)

Last month over a million Catalonians marched for independence in Barcelona. Opinion polls say that support in the province for separation from Spain has doubled since the economic crisis started – and some polls put it at over 50 per cent. The Economist sees a clear link with the economic crisis, noting recently: "Whereas one-third of Catalans are convinced separatists, many others are simply enraged by their tax money propping up poorer regions." Meanwhile in Belgium, Bart de Wever's nationalist New Flemish Alliance did well in Flanders' local elections, and de Wever has become mayor of Antwerp. Like Catalan separatists, the Flemish dislike subsidising their poorer neighbours in Wallonia.  The two events seem to suggest a trend. But while bailouts and the austerity that stems from the euro crisis are making central governments unpopular throughout Europe, Spain's and Belgium's woes may be a poor predictor of developments elsewhere.

The growing support for independence in Catalonia is only partly driven by the crisis. Jordi Vaquer of the Barcelona Centre for International Affairs notes that the Partido Popular's (PP) return to power in Madrid in 2012 bears some responsibility for the surge of pro-independence sentiment in Catalonia. The conservative PP blames Spain's budgetary woes on the provinces' profligacy (they represent 40 per cent of total public spending in Spain). The Madrid government has set out to tighten control over the regions' finances. Many in Catalonia think the PP is using the crisis as an excuse to pursue their longstanding agenda of curbing regional autonomy. They note that Spain's economic woes are mainly the result of excessive private sector borrowing, over which the provinces have had no control.

Pro-independence sentiment in Spain and other parts of Europe has also grown stronger because some separatist parties have grown more adept at selling their message. The New Flemish Alliance (NVA) is a much smoother party than the hard-right Flemish Interest, who NVA replaced as the standard-bearer for independence. In Edinburgh, Alex Salmond of the Scottish National Party (SNP) has proven to be a capable leader, who has governed competently during his five-and-a-half years in power (Scotland has enjoyed considerable autonomy since the 1998 devolution of some powers from London to Edinburgh). In an effort to showcase his party's new moderation, he recently persuaded it to ditch its longstanding policy of withdrawal from NATO. Both de Wever and Salmond say they would keep a common army with their southern neighbours. The success of these moderate, articulate nationalists in some parts of Europe has boosted the appeal of pro-independence movements elsewhere. "Previously, voters in Catalonia saw separatism as something that dictators in the former Soviet Union and Yugoslavia did. Now it has become difficult to brush aside nationalists as crazies," Vaquer observes. 

But while the Flemish and Scottish pro-independence parties have learned not to scare voters, the appeal of nationalism in other parts of the EU has waned. The Slovaks elected a parliament in 2012 that for the first time in the country's 20-year history does not include the Hungary-bashing Slovak National Party (voters have grown wary of infighting in its top ranks, and of its leader's penchant for yachts and jets). A mildly-separatist party of ethnic Hungarians in Slovakia has also lost its place in the parliament in the same election; another mostly Hungarian party that openly favours good relations with the central government in Bratislava has taken its place. Politics in Europe remains deeply local – and while nationalist leaders in Spain or Flanders have being doing well, others have fallen victim to their own hubris or incompetence.

In 2014 the Scots may dampen separatist spirits in Europe. Earlier this month, the SNP agreed with the London government to hold a referendum on Scottish independence in the autumn of that year. However, a recent Ipsos MORI poll shows that only 35 per cent of those who plan to vote will opt for separation from Britain. If the Scottish referendum on independence fails, nationalist movements like those in Catalonia or the Basque country may find their case weakened (though the Scottish nationalists may make progress with their demands for greater autonomy from the central government).

In Scotland, ironically, the euro crisis has proved very damaging to the cause of independence. In the past the SNP said that an independent Scotland would join the euro. In current circumstances that policy would not be a vote winner. So the SNP’s new line is to favour independence but keep the pound. But if there is one thing that the euro crisis has taught people, it is that currency unions do not work without some sort of fiscal union. A separate Scotland that used the pound would have to accept the constraints of a 'fiscal compact' with the remainder of the United Kingdom. So it would not be as free from London’s dictat as many Scots would wish.

There is little doubt that austerity measures have generated anger against political classes everywhere in Europe. In Spain, this protest takes the form of demonstrations against the 'Madrid elites', from which pro-independence movements benefit. In the future, similar conditions may exist in other parts of Europe, such as Italy or France, so events in Catalonia or Flanders bear watching. But it would be too simple to extrapolate from them that other countries will go the way of Spain or Belgium. The grievances that drive pro-independence movements differ from country to country. And so does the quality of local political elites, both on the pro-independence side and among the central governments, which have the job of addressing the grievances that fuel separatism.

Tomas Valasek is former director of foreign policy and defence at the CER.

"When I use a word," Humpty Dumpty said, "it means just what I choose it to mean – neither more nor less." 
"The question is," said Alice, "whether you can make words mean so many different things." 
"The question is," said Humpty Dumpty, "which is to be master – that’s all." 
(Lewis Carroll, Through the Looking Glass, Chapter 6)

The underlying purpose of the ‘European project’ has always been clearer than its ultimate destination. Its purpose – to escape a traumatic past disfigured by dictatorship and war – has never been particularly contentious (what sane European would want a return to that?). But the same cannot be said of the EU’s final destination. For much of its history, the EU has hidden behind the foggy ambiguity of its aspiration to build an “ever closer union among the peoples of Europe”. The trouble is that this worthy aspiration has always meant very different things to different people. Those of a minimalist disposition, often to be found among the British, have usually understood it to mean little more than the removal of cross-border barriers to the free movement of goods, services, capital and people. Those of a more ambitious bent, more often to be found in continental Europe, have seen the ultimate goal of the project to be some sort of ‘political union’ (however understood).

The eurozone crisis has once again exposed the gulf between British and continental visions of the EU. But it has done a lot more. It has also forced European leaders to speak a little less airily about ‘political union’ than they have become accustomed to in the past. All agree that the single currency must be embedded in a real ‘political union’ if it is to survive. But they are being forced to define their terms. Roughly speaking, two schools of thought have emerged. One (mostly northern European) school thinks that the crisis resulted from errant behaviour. For it, political union means tighter rules, more strictly enforced. The second school believes that the architecture of the eurozone is flawed. For it, political union means transferring a number of critical responsibilities from national to European level. If the first school frets about moral hazard, the second worries about a dearth of solidarity. The first school emphasises collective discipline, the second mutual burden-sharing.

Which of the two schools has the better story to tell? Although Greece is a convincing poster child for the first school, the balance of evidence weighs heavily in favour of the second. To start with, compliance with rules before 2008 turned out to be a poor predictor of countries’ subsequent plight. Like Mark Twain’s stories, the eurozone had its good little boys to whom bad things happened and its naughty boys who prospered. (Ireland never broke the fiscal rules before 2008 but is now in a slump, while Germany did and is not.) Second, despite having lower levels of debt in aggregate, it is the eurozone, not the US, which has been in the eye of the storm – strong evidence that it is the eurozone’s architecture, rather than the behaviour of its constituents, which is to blame. Third, the more the principle of collective responsibility has been asserted, the worse the eurozone’s plight has become: efforts to instill discipline have signally failed to restore confidence in the eurozone.

The symptoms of this failure are numerous. Financial markets within the union have fragmented as private-sector capital has drained out of countries in the ‘periphery’. Long-term borrowing costs inside the union have become unsustainably polarised, pushing systemically important countries such as Spain and Italy perilously close to insolvency. Target 2 balances within the European System of Central Banks have ballooned as public-sector capital flows have replaced private ones. Countries experiencing private-sector capital flight have been forced to pursue self-defeating policies of fiscal austerity. Sound banks domiciled in countries with stressed sovereigns have become vulnerable to depositor flight. And so on. The countries under strain partly have themselves to blame. But they are also victims of the eurozone’s structure: Spain’s borrowing costs are vastly higher than those of euro ‘outs’ such as the UK, even though Spain’s public finances are in no worse shape.

European policy-makers have been slow to accept that the eurozone’s institutional configuration makes it structurally unstable. But in June 2012, the so-called ‘Gang of Four’ – a group consisting of the presidents of the European Council (Herman Van Rompuy), the European Commission (Jose-Manuel Barroso), the European Central Bank (Mario Draghi) and the Eurogroup (Jean-Claude Juncker) – submitted an important plan to set the eurozone on a more stable long-term footing. It marked an important departure, because its focus shifted to correcting the eurozone’s architectural flaws rather than the behaviour of its members. The policy areas covered – banking supervision, resolution regimes, deposit protection – may have been dry and technical. But the plan was deeply political. It proposed that the stabilisation of the eurozone required key functions to be moved from national level to European level. It was, in other words, a plan to federalise the eurozone.

Why is the federalisation of certain functions necessary to restore confidence in the eurozone? The answer is not that the tasks concerned will necessarily be carried out more competently at European level (the reverse may even be the case). It is that the existence of federal powers and instruments is both a symbol and a guarantee of member-states’ commitment to the union. The reason the eurozone faces an existential crisis while the US does not is not the result of a financial market conspiracy orchestrated by Anglo-Saxons (as some Europeans darkly claim). It is that the eurozone’s decentralised configuration raises doubts about individual states’ commitment to the union. Unlike in the eurozone, bank failures in the US did not push any of the constituent states (such as Delaware) into insolvency, because the associated costs were mutualised. No one thinks that the parlous state of California’s public finances will result in its exit from the US (unlike, say, Greece from the eurozone).
  
A currency union embedded in a fiscally decentralised confederation, it turns out, has been a highly unstable arrangement (particularly in the aftermath of a financial crisis). The adoption of new rules that constrain national sovereignty have not really helped to restore confidence or stability. Indeed, as new rules have proliferated, the eurozone has come to look less like a single currency and more like a rigid fixed exchange rate system on life support. For much of the past two years, redenomination risk has stalked the eurozone. So the Gang of Four is right. The eurozone needs a degree of federalisation to persuade investors and depositors that its members are committed to the currency union’s integrity and survival. Far from being some obscure technocratic fix, a banking union is better understood as an essential pillar of the sort of political union that the eurozone needs if it is to endure and prosper. The question, then, is whether the member-states now accept this.

The answer is that they are still split. The recent report by EU foreign ministers on the future of Europe (the ‘Westerwelle report’) hinted at a number of unresolved arguments between confederal and federal visions of Europe. A striking feature of the report was the number of reservations placed by certain member-states on the proposals of the Gang of Four. On the subject of a banking union, for example, the report said that “some members of the group underlined the importance of a common deposit protection scheme and of a restructuring and resolution scheme”. By implication, other member-states still think that such steps are unnecessary. Indeed, the impression created by the Westerwelle report is that there is more agreement among member-states about the need to develop the foreign policy than the economic dimension of political union. If this is what EU leaders end up doing, they risk creating a Potemkin village rather than a political union that stabilises the eurozone.

Alice’s question to Humpty Dumpty was spot on. Words can be made to mean very different things. Since the onset of the eurozone crisis, two meanings of political union have done battle. The first has emphasised collective discipline, or the need for rules that bind member-states. This is the language of confederalism. The other has emphasised mutualisation, or the need for solidarity and common institutions. This is the language of federalism. For much of the past two years, the language of confederalism has dominated: reforms have focused on improving behaviour rather than on fixing the eurozone’s flawed structure. But a more federal language is starting to emerge. There is more acceptance now than there was two years ago that rules may be necessary to curb moral hazard, but that they are insufficient to eliminate redenomination risk (and so restore confidence in the eurozone’s stability). This view, however, is still far from being universally shared by the member-states

Philip Whyte is a senior research fellow at the Centre for European Reform