Could eurozone integration damage the single market?

Could eurozone integration damage the single market?

Could eurozone integration damage the single market?

Written by Charles Grant, 27 July 2015

Can Britain be at ease in a European Union that is increasingly focused on the euro and its troubles? Britain’s eurosceptics think not. The eurozone’s many problems require it to integrate more closely, and that will be bad for Britain, they say, since the euro countries will start to act as a bloc and manipulate EU institutions for their own benefit. Therefore Britain should quit this euro-centric club and negotiate a new and looser bilateral relationship with the EU.

David Cameron’s government has begun technical talks with its partners on reforms to the EU, prior to an in-or-out referendum. His officials say that though arguments over EU migrants’ access to benefits will generate more political heat, the relationship between the eurozone and the wider EU is the most important substantive problem. Both George Osborne, the chancellor, and many business leaders see this issue as a priority.

Their worry is that the 19 euro countries could caucus and impose their wishes on the 28-country single market. The euro countries can do so since new voting rules – introduced by the Lisbon treaty – came into force last year: their votes combined make a ‘qualified majority’ in the Council of Ministers. British ministers are particularly concerned about the City of London: other EU countries that know little about finance – or which seek to favour their own financial centres – could vote for rules that harm its competitiveness.

The recent furore over the European Financial Stability Mechanism (EFSM) has reinforced British worries. The eurozone wanted this fund, to which Britain has contributed, to make an urgent loan to Greece, to prevent it defaulting on payments due to the IMF and the ECB. Britain tried to stop the loan, reminding its partners of an earlier European Council decision that the EFSM should not be used for the eurozone bail-outs. But eurozone governments had a qualified majority in favour and pushed ahead. Since Britain could not block the loan, it decided to vote in favour, in return for guarantees against potential losses. To British officials, this is a clear example of eurozone putting the currency’s needs ahead of legal niceties or the interests of the euro-outs.

Therefore one of David Cameron’s key demands in the renegotiation is ‘safeguards’ for the single market. Unfortunately for Britain, however, few EU governments show much understanding for British concerns. Even a country such as Poland, which is many years away from joining the euro, is untroubled about the possibility of the eurozone acting in ways that harm the market. And in Berlin, the capital which matters most, few figures sympathise with the British position.

When the British ask for safeguards, German officials respond that eurozone countries do not caucus; how can they, when their disagreements on economic policy are so great? The British sometimes cite the ECB’s declared policy of making clearing houses for euro securities locate within the eurozone as an example of the problem they face: EU institutions want to privilege the eurozone in ways that may damage the City. But this policy did not result from caucusing in the Council of Ministers, and when the British complained about it to the European Court of Justice, they won their case, last March.

When the EU drew up rules on banking supervision in 2012, it found a way of alleviating British concerns: in the European Banking Authority, decisions require a majority of both euro and non-euro countries. But the Germans insist that such ‘double-majority’ voting should not apply to financial regulation more broadly, because as more countries joined the euro, the system would evolve towards a British veto. And for one country to enjoy such a privileged position, they say, would be contrary to the fundamental principles of the EU.

Many Germans suspect that the safeguard Cameron really wants is a veto for the City on financial rules. In fact he will not ask for that. But German paranoia about British intentions is fuelled by memories of the debacle of the European Council of December 2011: Cameron said he would not sign the ‘fiscal compact’ that Germany wanted without an agreement to change certain voting rules affecting the City. The Germans blocked the changes, he did not sign and the fiscal compact became a non-EU treaty. German officials are still bitter about this episode.

Might the EFSF affair be a harbinger of eurozone caucusing in other areas? At one point it looked as though the euro countries might unite behind a ‘financial transactions tax’ (FTT), which if applied to financial centres in the EU but not elsewhere in the world, could damage the City. But many member-states opposed the tax, including euro members such as the Netherlands and Ireland. So in 2012 a smaller group of 11 euro countries announced plans to proceed with an FTT of their own, which still had the potential to harm the City. However, the 11 failed to agree on the FTT’s design and it is now effectively dead.

The Commission’s plans for a capital markets union (CMU) – led by Jonathan Hill, the British commissioner – will generate a series of new financial regulations. But most euro countries agree with the British that CMU is an excellent idea, so eurozone caucusing is unlikely to be a problem.
One other issue, however, could perhaps prove problematic. The Single Supervisory Mechanism, which supervises eurozone banks, worries about the ‘doom loop’ through which banks lend to governments that are in turn responsible for back-stopping them; the deterioration of a sovereign’s credit risk may weaken that country’s financial system. In the eurozone there is a case for tackling this problem through the imposition of limits on how much a bank can lend to its own government. In Britain and other member-states with their own central banks, where the case is weaker, there may be resistance to proposals for EU-wide rules.

In truth, there is unlikely to be much eurozone caucusing in the foreseeable future. The British government’s point, however, is that the eurozone will integrate further, increasing the risk of caucusing. What safeguards could it ask for that might be acceptable to other governments? There could be a promise of a future treaty article stating that nothing done by the eurozone may damage the single market. Non-euro countries could gain the right to observe meetings of eurozone ministers. They could also be allowed to press an ‘emergency brake’: if one of them thought a eurozone decision would damage the market, the decision would be postponed for, say, a year, while the European Council reviewed it.

The British government has not convinced many of its partners that its concerns about the relationship between the euro and the single market are justified. The Treasury, in particular, needs to do a better job of getting its message across, if it is to win credible safeguards. But the other EU governments, too, need to make an effort to help the British on this issue. Cameron needs to be able to argue that the deal he has won will protect the single market and the City from the risks of eurozone integration. Otherwise British voters may conclude that the EU is driven by the interests of the eurozone, and the referendum may be lost.

Charles Grant is director of the Centre for European Reform.

How to keep Greece in

How to keep Greece in

How to keep Greece in

Written by Christian Odendahl, 27 July 2015

A paralysed banking system and a lingering threat of exit from the eurozone would hurt any economy. Greece needs swift action to restore its financial sector, an end to all threats of Grexit, a bigger EU investment programme than currently planned, debt relief and a Greek-led cross-party plan on institutional reforms.

Greece’s economy is in dire straits after months of political mismanagement and brinkmanship, which culminated in the closure of the country’s banks, the imposition of capital controls and the threat of expulsion from the eurozone. Such limbo would be toxic for any economy, but especially for a highly indebted one caught in an economic depression and in urgent need of reform. What Greece needs, however, might not be politically feasible, on the part of the Greeks or the rest of the eurozone – in which case it is worth considering whether it is in Greece’s interest to leave the eurozone.

The first essential condition for continued Greek membership of the eurozone is a functioning banking system. The banks, deemed solvent by the new single European supervisor in its balance sheet screening exercise in October, are dependent on emergency liquidity assistance (ELA) from the ECB. The reason is that Greek banks cannot sell illiquid assets such as corporate loans as fast as Greek customers currently want to withdraw money from their accounts. The ELA is intended to stop such bank runs, by providing liquidity against banks’ illiquid collateral – something that is at the heart of any central bank’s mandate. The problem is that Greek banks’ collateral depends in part on the solvency of the Greek government: some assets are tax credits, others state-guaranteed.

The ECB took the political decision before the Greek referendum to stop increasing the ELA, which forced the banking system to shut down. This has undermined confidence in the banking system, damaged consumption and investment, and made another recapitalisation of up to €25 billion necessary. Capping ELA was a very costly political threat that failed to impress: Greeks voted ‘Oxi’ to the creditors’ offer in any case. The longer the recapitalisation is drawn out because of lack of an agreement, the greater the damage to the Greek economy. What is more, it is still unclear what bank liabilities will be bailed in, apart from equity and unsecured bond-holders. If unsecured deposits are converted into bank capital, the Greek economy will take another blow. Unsecured deposits in banks are largely non-financial companies’ working capital. The recapitalisation must be done swiftly, and needs to spare deposits of any kind, to preserve what little confidence remains in the Greek banking system.

Secondly, the threat of exit from the eurozone must end. In order to resume investment, firms, consumers and investors need to be sure that Greece will remain a member of the eurozone. A lingering threat of eurozone exit will kill any recovery, and could make the threat of exit self-fulfilling. But the very public suggestion by German finance minister Wolfgang Schäuble that Greece should leave the euro will not be forgotten – especially since he repeated it after creditors had reached a deal with Greece early on July 13th, apparently oblivious to the fact that he was seriously undermining it.

To kill the exit threat, the creditors need to double the size of the EU’s proposed investment plan for Greece. The EU aims to frontload and accelerate the disbursement of already agreed structural funds. While a good idea in principle, it will not amount to a stimulus, because structural fund investment was above average in both 2013 and 2014. Furthermore, there was no Greek austerity in 2014. The combination of above-average EU funds and the pause in austerity largely explains why the Greek economy stopped shrinking in 2014. The best outcome from frontloading EU funds would be a similar amount of investment as last year, which would not amount to additional stimulus, and would certainly not be enough to compensate for the fiscal tightening that the forthcoming memorandum of understanding (MoU) is likely to entail. To offset this renewed austerity, the eurozone needs to increase the funds for investment from €35 to €70 billion over 7 years.

Chart 1: Greek EU fund absorption (in million euros) was comparatively high in 2014

Source: European Commission

Politically, EU leaders need to pledge more strongly that the eurozone is irreversible unless a member-state asks to withdraw. Angela Merkel would surely be criticised for such a pledge, since many in Germany see the threat of exit as a means to enforce discipline. But that argument risks take moral hazard too far, potentially making the threat self-fulfilling in a severe crisis.

Another condition for Greece staying in the euro is political ownership by Greece of the reforms that are needed to unleash the growth potential of the country. The eurozone, knowing that the Greek political class is hostile to reform, is trying to micromanage the process and insisting that measures be taken before bail-out funds are disbursed (‘prior actions’). The problem, of course, is that Greeks cannot be forced to take ownership of reform. Moreover, the sort of institutional reforms that Greece needs will take a long time, and will not be sustainable unless they change the way the political system works.

What is needed to reform the country is a Greek-led, cross-party plan on the key areas of reform – the justice system, land rights and registry, the public bureaucracy, tax collection, privatisation and deregulation of product markets. This plan would need the backing of a large proportion of civil society and ideally monitored by Greek experts, not the troika. Tsipras needs to be the leader of this broad reform consensus, and finally start delivering on the reforms he has promised. Such a Greek plan could then be supported by the rest of Europe through both financial and technical help. Relying on a Greek-led and Greek-monitored reform plan would of course ultimately be a leap of faith for the creditors, but after years of largely unsuccessful reform efforts in these key areas, such a leap is one worth taking.

Debt relief is the final item on the list of Greek needs. Although Greek debt is mostly to official lenders and can be serviced on the current concessional terms, debt restructuring is still necessary. Greece cannot refinance its debt burden on the markets, so unless it is reduced to a level that investors believe is sustainable, the country will remain dependent on concessional funding by the creditors and the threat of Grexit will remain. Greece needs a clear, realistic and conditional debt restructuring plan so that its people have an incentive to implement the tough institutional reforms needed, and investors can be confident that Greece’s future lies in the eurozone. If growth stayed low despite Greek reform efforts, the plan would need to include provisions that automatically increased the debt relief.

If these measures prove politically impossible, for either side, Greece may be better off outside the euro. After all, immediately before the bail-out agreement was struck, Germany seemed to offer relatively generous terms, including debt relief, technical assistance and humanitarian aid, if Greece agreed to leave. While such generosity reflects poorly on the motives of German negotiators, a managed and supported exit might be less painful for Greece than yet another unworkable programme, operating under the shadow of the risk of exit. For the eurozone, Grexit would be a political failure of epic proportions, and a large economic risk to take. It would surely be better to keep Greece in, with no ifs or buts.

Christian Odendahl is chief economist at the Centre for European Reform.

Britain's renegotiation: Advice to Mr Cameron

Britain's renegotiation: Advice to Mr Cameron

Britain's renegotiation: Advice to Mr Cameron

Written by John Kerr, 24 July 2015

To succeed in his renegotiation, David Cameron needs to build an alliance for reforms that benefit the EU as a whole.

Shortly after midnight on June 26th, a new chapter in the chequered history of Britain in Europe opened in Brussels. The European Council conclusions note, in two lines on page eight, that David Cameron, re-elected as prime minister, "set out his plans for an (In/Out) referendum in the UK" and that "the European Council agreed to revert to the matter in December". What will happen then will depend on how Cameron handles his intended negotiation about reform of the EU and Britain's relationship with it: he has yet to tell the European Council what he wants. But his plans will certainly work in London: the promise of a referendum was set out in the Conservative Party's election manifesto, and, despite misgivings in the House of Lords, a century-old convention that the unelected upper chamber does not obstruct a government's manifesto measures means that the necessary enabling legislation will not be blocked. So in 2017, or, more likely 2016, the British will vote on Brexit.

Cameron has not always wanted this. His 2010 position, enshrined in law in the last parliament, was that a referendum would only be needed if further transfers of sovereignty to the EU from its member-states were approved by government and parliament. He dismissed the idea of a free-standing In/Out plebiscite as unwise because of the uncertainty it would create, affecting markets, confidence and hence the economy. But as pressures from the anti-EU wing of the Conservative party built up, and the threat from the UK Independence Party (UKIP) grew, he changed his stance. In early 2013 he announced the strategy of ‘renegotiation and referendum’ which he must now implement.

Some saw it less as strategy and more as short-term political choreography designed to take the wind from UKIP's sails. Others saw the promised negotiation as a particularly dangerous gamble: the response of Herman Van Rompuy, the then president of the European Council, was to ask, in a speech at London's Guildhall, “How do you convince a room full of people, when you keep your hand on the door handle? How to encourage a friend to change, if your eyes are searching for your coat?” David Cameron is about to find out.

Much will depend on what he asks for. His descriptions of his negotiating aims have so far been unspecific. Clues in his speeches point to efforts to improve European competitiveness and deepen the single market, combined somewhat paradoxically with calls for constraints on the immigration flows which hold down Britain’s labour costs. Immigrants‘ access to welfare is also to be re-examined. Safeguards for the City of London as the eurozone expands and deepens seem certain to feature. And there may be some tilting at windmills.

Since a negotiating success or failure could affect the referendum result, the exercise matters. Given that Cameron‘s track record in EU diplomacy is somewhat mixed, how should one advise him to maximise his chances of success? Seven points come to mind.

1. Solidarity matters
Dealing with the expected British demands is not top of most Europeans’ agenda, so what the British say and do about others’ worries may affect their willingness to address British concerns. Take Ukraine: the general perception that Britain has been largely absent from the effort to deter and contain Putin’s aggression weakens the UK negotiating hand, particularly among those living on Russia‘s border. Then take refugees: London’s opposition to new arrangements for Mediterranean rescues lest they create an undesirable ‘pull factor’, and its insistence that the care of those who make it across the sea is not a UK concern, have won few friends. And then take Greece: self-congratulation at escaping any bail-out obligations, and brusque calls for an early resolution that must be cost-free for the UK, have been counter-productive in the wider EU context. The British government needs to show it cares and will try to help. The British need to cool their criticisms of those struggling with real, not self-generated, crises. A friend in need is a friend indeed, and rather more obvious sympathy and solidarity could be a good investment.

2. Try alliances
Fifteen years ago, the then Conservative prime minister, John Major, understood that the German aspiration for political union, and the French aspiration for monetary union, both intended to bind a peaceful united Germany into a greater Europe. Wisely choosing not to be obstructive, he won for London the association with monetary union that has made the City the major market for financial transactions in the euro, while securing a UK opt-out from adopting the single currency. Major was good at alliances: Helmut Kohl and François Mitterrand, along with the Netherlands’ Ruud Lubbers, were his allies at Maastricht. It feels different now: British influence in Brussels has waned, and allies may well be hard to find. Rather than presenting a purely UK shopping list of reforms, it might be better also to speak out in favour of good ideas born elsewhere, such as the Juncker-Timmermans effort in the European Commission to rein back EU legislative over-kill. Denigrating the European Parliament is not particularly constructive – perhaps London should press hard for progress with the proposals from the Dutch and others, including the House of Lords, for an enhanced complementary role for national parliaments. Though isolation may seem splendid, it is alliances that win results. But this renegotiation is not Waterloo, and Cameron should not expect Mrs Merkel to play Marshal von Blücher, delivering victory. The Germans will help, but not at any price; and everyone has to agree.

3. Remember "the vision thing"
Most European governments do not see intra-EU relations as a purely transactional and zero-sum game. For countries whose soil twice ran with blood in the last 100 years, the EU is greater than the sum of its parts. That is equally true for those that suffered under a dictatorship or watched from behind the Iron Curtain as Western Europe’s democratic nations came together, uniting in common respect for human rights, the four freedoms and the rule of law. Margaret Thatcher‘s famous reminder at Bruges in 1988 that the great cities of eastern Europe were also part of the European story, and must be brought back into it, is still remembered there. Gratitude for past UK championship of EU enlargement underlies present puzzlement at Britain’s apparent retreat into insularity. To call for the suppression of the Rome treaty’s aspiration to “ever closer union among the peoples of Europe” seems not only insensitive but quixotic, since in its present position in the treaty it has no normative effect.

4. Don't over-bid
All the EU’s governments see the need to permit the deepening of the 19-member eurozone while preserving the unity of the 28-strong single market. The problem is genuinely challenging, but the willingness to find viable solutions is real. What the UK should most definitely not do is what it tried and failed to do in December 2011: dictating terms did not work, particularly as they were over-ambitious and under-explained (Cameron refused to sign the ‘fiscal compact’ treaty because Germany and other partners rejected his request to change voting rules on some issues affecting the City of London). The British cannot reinvent national vetoes, particularly in financial services – the very area where Mrs Thatcher fought hardest to introduce majority voting to over-ride national protectionism, a task which the Commission’s current Capital Markets Union initiative is seeking to advance further. Defending the City is best done not by Maginot-style red lines and by bringing cases before the European Court of Justice (ECJ), but by underlining the pan-European interest. As Europe‘s champion among the big three global financial centres, London is a major EU asset. The message for Cameron, therefore, is where possible go with the grain and propose solutions which help all parties, and do not over-bid.

5. Don't attempt the impossible
Freedom of movement, equality and non-discrimination are fundamental EU principles. Rules on access to welfare for citizens arriving from other member-states can be changed by majority vote, and some changes are indeed conceivable. But discrimination among those already in work, paying UK taxes and social security charges, is different; proposals which would introduce discrimination, and so fall foul of the ECJ, would get nowhere.

6. Don't make a fetish of treaty change
Back in 1974, Prime Minister Harold Wilson worked to improve the terms on which the UK had joined without amending the accession treaty. This made it easier for other European leaders to help him. No new treaty ratification procedures were needed anywhere, and the only referendum was the one in the UK that he won in 1975. As then, so now. Whatever changes the British seek will be far harder to secure if they have to be enshrined in new treaty provisions. Treaty amendment procedures are onerous and take time. More importantly, referendums would be required in several member-states. Since no government can bind its successor, let alone its electorate, promises of specific changes at some future date offer no magic solution. It is wiser to do as the eurozone countries currently do and work within the treaty. Fortunately, the Conservatives' manifesto was silent on treaty change. The UK negotiators should follow that example.

7. Credibility counts: convince them you care
Governments that agree to make concessions to the British could run into trouble at home. Before agreeing, they will therefore assess the possible cost to themselves and set that against reducing the risk of a disruptive UK secession from the EU. The worst outcome would be to make concessions which did not in the end avert Britain’s secession, earning them both immediate criticism and eventual disruption. This makes Herman Van Rompuy‘s question highly pertinent: if a ‘renegotiation’ deal were to be struck, would David Cameron and his government fight for it, and oppose Brexit in the ensuing referendum campaign? The other members of the European Council will be watching him closely. Press reports already tell them that certain members of his cabinet would shed no tears if the negotiations failed, and whatever their outcome intend to campaign in favour of Brexit.

Where does Cameron stand himself? His election speeches, when they touched on Europe, tended to be critical; he regularly described the EU as “too big, too bossy, too bureaucratic”. His fellow European leaders may charitably attribute this stance to his problems in the party, but they may also ask how long it will continue, and whether it does not help those arguing for Brexit. If, once they see his specific proposals, they then think a deal possible, they will be far more likely to strike one if he has convinced them that he would fight for it as wholeheartedly, skilfully and successfully as he fought the recent election.

David Cameron says that the British people are not happy with the status quo. If so, that may be because they have been told they should not be, and because a defining characteristic of the British is an infinite capacity to grumble. But they are also averse to change. Lord Salisbury, a late 19th century prime minister, famously asked “Change? Why should we change? Things are bad enough as they are”. When Edward Heath took the UK into the EEC, polls showed that the nation disapproved; yet only a couple of years later Harold Wilson’s ‘renegotiation’ won the day in an In/Out referendum and Britain stayed in. In both cases, the change option was unpopular. That is probably the reason why, despite carping from politicians and press, a number of recent opinion polls show a clear majority against Brexit. That could change if Cameron‘s negotiations go badly wrong. It is very important that everyone – not only in the UK but also in the wider EU – who wants to avoid a British secession should say so, swallow their doubts about the Cameron strategy and try to ensure that a deal is struck. We are where we are – enough posturing, it is time to be serious.

Lord Kerr is a former ambassador to the EU, permanent under-secretary of the Foreign and Commonwealth Office and secretary-general of the Convention on the Future of Europe. He is also chairman of the CER. An earlier version of this article was published by Friends of Europe.


Added on 27 Jul 2015 at 15:17 by john bruton

Very good advice!

Added on 25 Jul 2015 at 11:51 by Brendan Donnelly

This is certanly excellent advice to Mr. Cameron in his negotiations with other governments of the European Union. Unfortunately, Mr. Cameron must at the same time negotiate with his Party, which has a completely different set of priorities and attitudes. The only chance that Mr. Cameron has of persuading any significant proportion of his Party to support the results of his "renegotiation" is to convince them that he has wrenched bcak from the teeth of reluctant and recalcitrant foreigners those dmagaing concessions that never should have been made in the first place by fifth columnists like Edward Heath and Tony Blair. Calm, rational and consensual discussion with other heads of government is precisely not what Mr. Cameron needs to satisfy those elements of his Party that he hopes to win over for his strategy of "renegotiation." They will want to be persuaded that he has stood up to foreign bullies, faced them down and made them realize that they need Britain more than Britain needs them. I rather doubt personally whether this circle can be squared, but it is always worth recalling that the Prime Minister will be trying to play in the coming months to two very disparate audiences, one abroad and one in his own Party.

Brendan Donnelly

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