EPP heads of govt retreat to Belgian castle to discuss European Council

It’s a busy weekend in Brussels. Yesterday’s Economic and Financial Affairs Council cleared the path for today’s European Council/Eurozone Summit, while the General Affairs yesterday discussed (PDF) economic policy and finalized the EU positions for the G20 summit in Cannes in November and the COP17 climate conference in Durban in December.

Angela Merkel's badge is waiting for her
Source Flickr CC BY-NC-SA mounteulympus

Somewhere in between, 13 heads of state and government belonging to the European People’s Party (EPP), reinforced by José Manuel Barroso, Herman van Rompuy and Jerzy Buzek, took a retreat to a beautiful castle outside of Brussels to save the Euro over a decent dinner.

Journalists were waiting in front of the castle nervously as the first shaded limousines pulled into the driveway. One by one, heads of state and government got out of their cars and walked past the journalists to the castle entrance. Angela Merkel, Finland’s Prime Minister Jyrki Katainen and Austria’s Foreign Minister Michael Spindelegger stopped to explain their expectancy of the summit, while Silvio Berlusconi put on a grin and ignored the journalists as his bodyguards walked him to the door. MEP Elmar Brok opened his passenger door alone and walked up to the castle by himself. By the time of his arrival, the journalists’ interest had waned and they were comparing their notes of the Merkel interview.

Your blogger had access to the advisors’ chamber, so over dinner I plugged into some interesting conversations. The advisors themselves were not fully aware of what was going on behind the closed doors of the meeting room, either. “Sometimes, very important progress is made in between the negotiations, in bilateral conversations in the hallway,” said German government spokesman Steffen Seibert. And after heads of government have negotiated a compromise among themselves, each of them returns home to win the approval of their Parliaments. “For those governments with a narrow majority, that can be quite a struggle,” Seibert said. Indeed, one reason for the postponement of the European Council to Wednesday is that Angela Merkel has not secured the approval of the German budget committee yet.

Throughout the dinner, buzz was high about the tête-à-tête between Sarkozy and Merkel after the EPP summit. Sarkozy did not participate in the summit but was due to arrive in Brussels later in the evening. According to media reports, however, the meeting only achieved little progress.

It seems that a lot of work remains as heads of government meet for the European Council today. And if the leaked conclusions prove to be true, there will not be an agreement on the recapitalization of the banks today.

Finally - a debate about the future of the European Union in Germany

For one and a half years, debates on the European Union in Germany could be largely summed up as "we always pay, we never get anything back". Not only is this wrong, the pure limitation to financial aspects also obstructed the view upon a more important question: In a world where the European Union "will account for only 18% of world GDP in 2020, signifying a decline of 28%" compared with 2000 levels, are citizens prepared to give the EU strong multilateral institutions? This question has long been left unanswered in Germany. The Lisbon treaty was nodded off without debate.

Thanks to finance minister Schäuble, the debate now seems to take a new turn. Schäuble has always been one of the most fervent supporters of more European integration. After his initiatives for a European Monetary Fund (more or less granted), a European rating agency (still negotiated) and an economic government for the Eurozone (granted), the German finance minister yesterday pursued that the answer to the European debt crisis can only be more Europe. For once, I've got the feeling that the debate is not directed against fellow European countries but towards the degree of competence to be given to Brussels.

Chancellor Angela Merkel gave a one-hour televised live interview last week in which she explained the reasons behind the EFSF. This doesn't happen very often, and it may have given many people a new view upon the EU and Germany's role in. People begin to understand that the country profits a lot from European integration and stronger institutions do not necessarily mean less democracy.

The time is right to pursue this debate and to wonder what Europe will look like in the future. Bavaria's CSU, in dire need of voter support, warns against a "European superstate", but it was apparent from the EFSF vote last week that there is room for more Europe in large parts of CDU, Social Democrats and Greens.

Unnoticed by many, chief German constitutional lawyer Andreas Voßkuhle recently gave an interview in which he predicted (14min30) that Germany may pave the way for stronger European institutions (within the next 10-20 years, roundabout), and give itself a new constitution to accommodate these changes. The time hasn't come for such a quantum leap, but I've got the feeling politicians start laying out the cobble stones to get there.

I hope that there will be an honest debate about the future of the EU, not only in the Parliament but also in the public sphere. After Schäuble started the debate, the next few days will show if other parties are prepared to exchange some serious arguments on this.

What does the financial crisis have to do with Three Mile Island?

A lot, if one believes the Financial Times columnist and book author Tim Harford. For his book Adapt, he researched the parallels between security in engineering and security in financial markets. Harford singles out three main issues which put the stability of the financial markets in danger: complex structures of financial institutions, interconnectedness of financial institutions and a lack of control through regulators.

The more complex a financial institution, the more likely it is that risks will not be recognized until it is to late. Harford compares the meltdown of Lehman Brothers with the failing reactor at Three Mile Island in the United States. The reactor, he says, started overheating at 4 a.m. when knowledgeable personnel was absent, the control room was difficult to understand due to its impractical design and security systems reinforced the catastrophe rather than attenuating it.

Controlled explosion of a bank/CC BY-NC
total_incompletion

In the financial meltdown of Lehman Brothers, Harford sees the same process. Pricewaterhouse & Coopers was asked to organize Lehman Brothers Europe's orderly insolvency but when its consultants arrived, they had no idea how to understand the complexity of the institution with its numbers of divisions, assets and real estate. They ended up following Lehman Brother employees around to understand what there job actually was.

Likewise, politicians were not given adequate information permitting them to handle the financial crisis responsibly. Harford cites an example of Tim Geither, the head of New York FED at the time of the Lehman Brother collapse, who received the information about AIG's imminent breakdown at 4 a.m. after a transatlantic flight on a handwritten DIN A4 paper with a lot of numbers.

Finally, security systems reinforced the financial meltdown. According to Harford, even small banks that didn't engage in risky speculation often took out an insurance with a re-insurer like AIG. The goal: if for whatever reason customers should withdraw more money than the bank had in cash, the remainder would be covered by the re-insurer. Given that most re-insurers were rated AAA, this also gave the small bank an AAA rating (as it was now absolutely certain that the bank could service its debt). However, in practice re-insurer A also had a re-insurance contract with re-insurer B, who had a contract with re-insurer C, who had a contract with re-insurer - A! At the moment where A's panicking clients withdrew money, it not only pulled B and C into the abyss, but also the small commercial bank. Its portfolio was suddenly no longer insured and became rated C; it did not obtain any more loans from other financial actors except for skyrocketing interest rates.

The example shows two things. Not only was there a latent error lurking in the equation: The security system would fail exactly at the moment when everybody sold stocks and rushed to the banks to withdraw their money. But the security system also put players in danger that it was supposed to protect. Besides, it gave an incentive to insured banks to take a greater risk, certain that they would be covered if their speculation backfired.

Harford draws four conclusions from his findings: it is crucial to

• understand the structure of a financial institution to reduce risks and latent errors, 
• not only understand but reduce complexity of this institution, 
• decouple regular bank activities from risky activities so that they cannot be endangered by the collapse of the speculative sector and 
• encourage whistleblowers within the institution to uncover risks and to communicate them. 

I encourage you to listen to the entire talk Tim Harford recently gave at the LSE. You can find it here. 

Poland awaits a tough Council Presidency

Another month and Poland will replace Hungary at the helm of the EU Council of Ministers. The new Presidency is yet to clarify its priorities, but the general lines are clear. Poland wants to focus on “European integration as the source of growth”, a “Secure Europe” and a “Europe benefiting from openness”.

It will be a tough time. As Euroskeptics are gaining ground in Finland, Denmark, France and the UK, the European Parliament insists on an increase of the EU's funds for the period of 2014-2020. Further European integration will be difficult to bring about. In an analysis for the Polish foreign ministry, the authors expect financial negotiations "on all fronts", given that the reform packages of Common Agricultural Policy (between 44% and 40% of total budget in 2007-13), Cohesion Policy and other policies will be on the table by the second half of 2011.

With regard to the European internal market, Poland has set high stakes for itself. It wants to "introduce a new model of economic growth, one that would allow the Union to secure appropriate level of economic development for the coming decades and guarantee the well-being of EU citizens". Focusing on the electronic services market and on the establishment of a European patent are two aspects that the Presidency wants to pursue in this regard.

It will be particularly interesting to see the Polish contribution in energy policy. While most European countries are looking to expand renewable energy, Poland still derives around 54% of its energy from coal and wants to start a nuclear energy program. And yet, the government wants to make renewable energy and the development of a European energy infrastructure an important part of its Presidency.

During the second half of 2011, many eyes in Europe will turn to Poland. Can it use the Presidency to be an honest broker and at the same time become one of the five big players in the EU?

The government is somewhat condemned to success: a failure of European solidarity right now could be taken as a go-ahead for other countries to let European integration unravel. To top it, the Council Presidency is expected to be overshadowed by legislative elections in Poland which are set to take place in October 2011.

Not an easy Presidency. But if it is successful, Poland will take a more central place in EU policy-making in future.

Christine Lagarde is right

It is surprising how harsh the reactions were from the German side when French finance minister Christine Lagarde told policy-makers in Berlin to step up domestic consumption. German enterpreneurs suggested other Member States "do their homework" and step up their own competitiveness so that they wouldn't need additional German investment. The government and Commissioner Günter Oettinger agreed that German products should remain cheap as not to compromise its export revenues.

But in my view, Christine Lagarde is absolutely right. As I have expressed here, Germany's so-called "competitiveness" is essentially a public bailout of the enterprises on the shoulders of the working population. Of course it is true that Germany has the strongest economy in Europe and contributes much to growth in other Member States. But that can be increased by shifting resources back from the businesses to the consumer: A legally imposed minimum wage as practiced almost everywhere in the EU would raise aggregate consumption - and note that people have proven on various occasions throughout the crisis that they did not save the money they had at their disposal - which then means

• more consumption of domestic goods and services
  
• more consumption of foreign (inter alia European) goods and services
• more possibility to invest in enterprises at home and abroad, and thereby a greater involvement of the citizens into economic decision-making and a greater democracy in some enterprises
  

Yes, it also means that enterprises have less financial room for manoeuvre and investment. It means that some enterprises will relocate, to European states with a lower labor cost (beneficial for inter-EU trade) or to extra-European states (bad for the EU). But as the high-skilled services sector is taking ever-increasing importance and businesses have already come back from Asia in fear of technology theft, a large part of enterprises will not compromise the conditions that they find in the education level, social climate and infrastructure of central Europe.

Therefore, Christine Lagarde is absolutely right. For the last ten years, German entreprises, withholding pay rises of the employees despite inflation and higher product revenues, have benefitted from a society that does not take to the street except against nuclear power and right-extremists. They have benefitted from a disunited, individualized workforce that can be easily put under pressure. They have benefitted from state contributions if they employed a recipient of social security.

Let's not talk about repaying those ten years. But it is about time the employees/consumers obtained their rights for the benefit of the rest of Europe.


Update: Couldn't say it better than Robert von Heusinger in this article (translation: Google Languages/myself):

"Let's take the economic growth as the epitome of wealth and power of an economy. Here the matter is clear: France grew by an average of 1.5 percent in the last ten years, while Germany only grew by paltry 0.8 percent. Also in terms of employment as the epitome of participation and self-esteem of the people, the country across the Rhine performed better: while France's employment grew by 0.8 percent per year on average, in Germany it only climbed by 0.5 percent.

Where does this French success come from? From domestic demand, private consumption. It averaged 2.2 percent, four times as high as in Germany (0.5 percent). How did France achieve this - in spite of globalization? Through higher wages, that's the simple answer. The slightly more sophisticated one: it was achieved through an economic policy that recognizes interrelationships instead of blindly reducing national debt, shrinking the state sector, and relying merely on competitiveness."

Update 2: Christine Lagarde is completely wrong, on the other hand, if she suggests to finance consumer spending through tax cuts. That would take money away from state services like education and research and development that dearly need it. Consumer spending has to be financed through the real economy. The money has to be shifted from the enterprises to the citizens, not from the state to the citizens.

Germany, the poor man of Europe

Last week, Germany's finance minister Wolfgang Schäuble defended the 2010 state budget before the Bundestag. He plans an additional debt of 85,8 million to stimulate the economy, while he preferred to keep silence on plans for general tax relief (which will cost another millions of EUR in future).

As a member of the young generation in Germany, it's difficult to take CDU/FDP financial politics seriously any more. The government is selling off the future of the country in a feeble hope of rekindling domestic consumption. It is now doing something that has been neglected throughout the last decade: increasing domestic purchasing power.

Indeed, from 2000 to 2008, wage raises have been below inflation so that real income actually decreased by 0,8%. This trend continued until 2009. Proud of being export leader in the world, changing governments in Germany supported supply-side measures which would reduce wages and product prices and thereby create affordable products for foreign consumers. In other words, generally speaking, revenues for German enterprises have been generated on the back of the workforce for the last ten years. No wonder that domestic consumption broke down.

In a monetary union (MU), this kind of "beggar thy neighbor"-policy which gives one country an advantage over others due to fewer imports and more exports can only function for a few years. Afterwards, the lack in purchasing power (and thus, imports) has a tremendous impact upon fiscal stability in the rest of the MU and will start to drag the entire construction down.

Leading German economists have responded to this question over the last decade by stressing supply-side measures. If the wages remain low, the argument goes, enterprises have the room to invest and create new jobs which will increase aggregate purchasing power. However, the financial crisis has revealed that enterprises seldom used their discretion to create new jobs or invest in product development and R&D. Instead, they placed their export revenues into flawed financial products and ended up gambling away the fortune of the country.

Therefore, I think it's legitimate to say that enterprises have had their chance. They had their chance for the last ten years, throughout different government coalitions, and enterprises failed horribly in fulfilling their social responsibility. Supply-side measures were a failure, and the government finally understood it.

So it's all about boosting demand now. The best measure to increase domestic purchasing power would be a legally imposed minimum wage in Germany as it is the case in all EU countries except Cyprus. This would equalize purchasing power between Germany and the rest of the EU and prevent a race to the bottom in 2011 when the Schengen criteria are relaxed and more Eastern European workers gain access to the German job market.

However, the government is still too afraid to hold enterprises to their responsibility. Rather than financing purchasing power through the real economy, our current government prefers to reduce VAT for hotels while it finances domestic consumption through tax money. Borrowed money, mind, which future generations will have to repay.

Again, the government is bailing out enterprises like it bailed out the banks in 2009. As a young person, you cannot take this government seriously any more.


for supporting and contradicting viewpoints, see here

the political talk "Anne Will" (in German) had the same topic on Sunday evening, the audio file is here:


Update (10/02/2010): Herman van Rompuy, in a note seen by the German Handelsblatt, condemns the German beggar-thy-neighbor policy as uncooperative and calls for a model similar to the "economic government" proposed by France.