Opinion & analysis

Boris Johnson’s no deal Brexit ‘zugzwang’ | Europp – LSE Blog

Featured image credit: Andrew Parsons / No 10 Downing Street (CC BY-NC-ND 2.0)

There are now only two weeks remaining for the UK and the EU to secure a post-Brexit trade agreement before the current transition arrangements expire. John Ryan writes that whichever way Boris Johnson and his government decide to move next, it seems inevitable the process will do irreparable harm to the UK’s interests.

Zugzwang is a situation in chess in which a player is under the obligation to make a move and in which any move available makes their position worse. Because chess players are forced to move alternately, a player in zugzwang has no option but to cause their own position harm. Guided by its red lines and hard Brexit stance, Boris Johnson’s government has manoeuvred itself into a zugzwang situation.

The main expected economic consequences of a looming no deal Brexit are that WTO tariff levels will be applied to UK exports to the EU, mostly around 5%, but 10% for automobiles, which will render UK production in this sector uncompetitive, and lead to plant closures. Looming also are devastating 40-90% tariffs on exports to the EU from sheep and cattle farmers.

Consequently, EU and international enterprises that include parts from the UK in their supply chains will switch away from the UK. The UK as a location of choice in Europe for foreign direct investment in the manufacturing industry will start to be eroded by other more attractive locations in the European Union. Big international manufacturers wanting to avoid disruption to their supply chains may move elsewhere in the EU.

There are already labour shortages in the UK, for example in the NHS, agriculture, and construction. This problem will be exacerbated with skilled labour choosing other locations in the EU. There will be a further, already ongoing depreciation of the pound, reducing UK living standards, and a probable credit rating downgrade. That will push up inflation, making the country poorer. While lower rates should boost consumer and business borrowing and spending, it will probably also mean a further weakening of the pound, making imports more expensive and pushing up the cost of living even more.

A smaller economy means fewer tax receipts, which means less money in government coffers. Prime minister Boris Johnson has suggested he will spend tens of billions of pounds that the government does not have on everything from extra expenditure on defence to building a bridge from Great Britain to Northern Ireland. Markets will probably take fright – pummelling the pound yet more and making it even harder for people to make ends meet.

The UK has benefitted from respect worldwide as a place of common sense, governmental competence, a sound legal order and trustworthiness. This will be shattered, in favour of an alternative image that has long been lurking in the background, that of an unreliable partner.

The Johnson government’s reckless hard Brexit stance is also putting the union of the United Kingdom at risk. The warnings are already there. Support for a second Scottish independence referendum will grow with a no deal. Support for the reunification of Ireland will also grow as a no deal Brexit leads to renewed border controls. The EU is amazed at how Johnson’s government can be so cavalier in its attitude towards Scotland and Northern Ireland.

A no deal Brexit would mean a hard border across the island of Ireland. This would now be a border between the UK and EU – and the bloc could not guarantee that goods would not be smuggled into its market if the border were open. Now, the economies of Northern Ireland and the Republic are intertwined. People and goods – particularly agricultural ones – cross the invisible frontier frequently, often many times during their production process. If border controls are imposed, both economies will be severely damaged.

While there are many factors, the UK government is ultimately fully responsible. It wanted Brexit. It created the chaos. It created the delay. It has not done the preparation. But most of all, Johnson’s government is vastly incompetent and has limited understanding of the country’s relations with the EU or experience of trade negotiations. Very few if any of the current Cabinet ministers would have made it into Margaret Thatcher’s or Tony Blair’s cabinets. The idea that in the real world it takes time, expertise and competence to make things work has clearly not occurred to them. And that is why they are to blame and no one else is.

The failure of the UK over the past four years is to realise why the whole Brexit process has been so painful – it is the balance of power of the UK population at nearly 67 million against that of the EU at 447 million. Even without the UK, the EU has a single market comparable in size to that of the US or China. Britain has made a series of painful concessions – most notably by agreeing to a separate status for Northern Ireland, which will see customs checks on goods crossing the Irish Sea, effectively dividing the United Kingdom.

The rhetoric from the UK government under Boris Johnson has been uncompromising, ready to put the fragile peace in Northern Ireland at risk, but this approach also reveals its ignorance to the wider implications of this stance. The uncomfortable truth is that the repercussions of this reckless approach would be much wider than UK-Ireland and UK-EU relations. It would put the ‘Global Britain’ vision and with it its centre piece of a US-UK free trade agreement at risk before it has even come to life. The only certainty is that whichever way Johnson and his government decide to move next, it will cause irreparable harm.

Relaunch or disintegration? What Covid-19 means for the future of Europe | Europp LSE Blog

Credit: European Council

How might the crisis brought on by Covid-19 affect the future of European integration? Sir Michael Leigh identifies two distinct interpretations of the pandemic so far: a scenario in which Covid-19 becomes the starting point for a relaunch of the EU, and an alternative path in which the crisis precipitates the EU’s disintegration.

The Covid-19 epidemic has been a testing time for the European Union, and for much of the world. Some see it as a pivotal experience for the EU, accelerating European integration in unexpected ways. Others see the epidemic as draining power from Brussels to national capitals, as states, and even regions and cities are the prime actors in efforts to bolster public health.

Two broad scenarios for the EU’s future encapsulate these different interpretations. These are not scientific scenarios, but rather narratives about how the EU may evolve. I call the first narrative “relaunch” – it lays out a path towards greater integration, based on trends visible today. The second narrative is called “disintegration,” which points to risks that could eventually lead to the EU’s collapse.

These two stories may seem like extreme cases. But they are not artificial constructs plucked from the air for the sake of argument. The most eloquent advocate of “relaunching” the EU is French President Emmanuel Macron, with the backing of German Chancellor Angela Merkel, and with the heads of EU institutions in supporting roles. Macron’s speeches, starting at the Sorbonne in 2017, as well as the “state of the Union” addresses of the two most recent Commission presidents are packed with concrete proposals for relaunching the EU.

Predictions or warnings of collapse do not come mainly from the usual suspects – Eurosceptics and extreme nationalists – but from mainstream pro-EU leaders and indeed academics and think-tankers. Chancellor Merkel in 2010, in the midst of the financial crisis, warned that the European Union itself could fail if the euro collapsed. This year Macron and Italian Prime Minister Giuseppe Conte both predicted the EU’s collapse unless it agreed to a generous Recovery Fund. The Polish Prime Minister spoke in December of the EU’s collapse if it persists with tough rule-of-law conditionality for the budget.

To be sure, such warnings are usually tactical, and in some cases cynical, intended to push others towards accepting the speaker’s preferred outcome to a contentious issue. Still, they resonate in the media and convey the message that collapse is thinkable. The academic literature, too, is filled with “obituaries” for Europe, “Euro-Tragedies”, studies of disintegration and dystrophies of what our continent will look like “after Europe.” An ECFR opinion poll last year showed that more than half the respondents in 14 countries believed that the EU is likely to collapse within a generation, even though a majority said that they themselves supported the European project.

These contrasting scenarios or narratives about the future of Europe should be tested rigorously using evidence on public opinion, trade, investment, capital flows, data exchange, transport, and other forms of political and economic inter-penetration. But for the present, we will make a brief qualitative review of whether the EU’s response to Covid-19 tends to sustain the “relaunch” or the “disintegration” hypothesis.

Relaunch

The philosophical foundation for the relaunch scenario is a version of the Monnet method, functionalism, and the theory of spill-over. Monnet has been quoted and misquoted lately about Europe being forged in adversity. This suggests that crises – like Covid-19 – can lead to steps forward that would otherwise have been unimaginable. These steps often occur as a result of the EU’s response to the unexpected consequences of earlier decisions.

Does the EU’s response to the epidemic comfort the relaunch scenario? According to this narrative, the EU’s reaction to Covid-19 responded to new demands and took the EU into new territory. The EU’s response improved its image and strengthened public trust – despite the worrying public health and economic situation that persists today and resistance to restrictive measures in several countries.

This positive narrative recalls that the Commission reacted to the initial shortage of personal protective equipment and masks by asking member countries to desist from export bans within the single market and that they promptly complied. The Commission then launched an entirely new activity, joint European procurement of personal protective equipment, ending Chinese and Russian “mask diplomacy” and, even more importantly, it introduced EU procurement of vaccines. The EU’s role in supplying vaccines, even if poorly understood, has improved the EU’s image in most member countries.

The Commission also put forward an innovative scheme to mitigate unemployment risks in the emergency (SURE). This involves loans at rates somewhat lower than otherwise available to national authorities. Headline figures in the billions of euros convey to the media and public opinion the message of European solidarity in a time of need.

The Commission has proposed a “health union” with a new agency (European Health Emergency Response Authority) in charge of stockpiling medical supplies and the existing European Centre for Disease Prevention and Control given more resources. These changes take the EU beyond its previous limited involvement in public health, which is mainly a national responsibility, even if administrative changes themselves do not enthrall public opinion and need time to show concrete effects.

The European Recovery Fund, dubbed “Next Generation EU”, broke the taboo on euro-bonds, whether or not it marks a truly “Hamiltonian” moment. It almost doubled the EU’s proposed budget for the next seven years. These funds will be partly devoted to ambitious new environmental and digital projects, addressing current and future needs. Time will tell whether this was a one-off crisis reaction or the start of a process. Chancellor Merkel understood that fiscal solidarity was needed to hold the EU together and managed to mobilise support for this inside Germany and even from the “frugal five”, Austria, Denmark, Finland, the Netherlands, and Sweden.”

In turn, the Recovery Fund created the need for new “own resources” to service and eventually repay the debt, assumed by the Commission on behalf of the EU. If, as seems likely, these new resources take the form of an EU tax, whether on carbon emissions, digital companies, or plastics, this would take the EU into wholly new territory, an almost classic example of spill-over. The European Central Bank, too, broke new ground with its Pandemic Emergency Purchase Programme, amounting to over 7% of GDP, despite the doubts of the German Constitutional Court.

To be sure, there are legal and political wrangles concerning several of these initiatives. Hungary and Poland fiercely opposed rule-of-law-conditionality. But compromise solutions have been reached, through a typical bargaining process, with a package deal emerging in which member states feel their diverse interests are preserved.

Continuing with this optimistic narrative, Covid-19 has revived Franco-German cooperation, which had been languishing, and which used to be seen as the “locomotive” of European integration since the days of the late French President Valery Giscard d’Estaing and German Chancellor Helmut Schmidt. The Commission came forward with detailed proposals for the recovery fund and budget only after Paris and Berlin had agreed on the broad approach and amounts.

The relaunch scenario also takes sustenance from the view that Eurosceptic populists have had a bad epidemic. Migration, their core issue, has lost its edge, for now, as arrivals have fallen because of the epidemic. The Eurozone and Schengen rules, to which populists object, have been suspended. Anti-EU populists have tried to re-invent themselves as opponents of Covid-19 restrictions, with little success so far.

Public opinion across Europe approves of the EU taking new powers to deal with public health challenges and is more critical of the response at the national level. To be sure, expectations of national governments are higher than expectations of the EU, and so are more easily disappointed. In a European Parliament survey published in early December, two thirds of respondents agreed that the EU should have more competences to deal with crises like the Coronavirus epidemic, while 77% think the EU should have greater financial means.

Disintegration

The second scenario, disintegration, gives a more discouraging reading of the EU’s response to Covid-19. The narrative goes like this. EU members responded to the epidemic in disarray, each determining its own strategy, without a thought for fellow-Europeans. Initial bans on exports of masks and other PPE were quickly reversed but left a bad after-taste.

Most countries, with little or no coordination, chose their own suppression strategies – using lockdowns – but Sweden, the Netherlands, and the UK (then still part of the single market) vacillated, under the influence of herd immunity notions. Countries and regions adopted their own lockdown rules, their own border closures, their own easing of restrictions over the summer, their own second wave restrictions, and their own rules for the 2020/2021 winter holidays, with little effective coordination or exchange of best practice.

This second, more pessimistic narrative argues that three of the EU’s pillars have been shaken by Covid-19: Schengen (border closures), state aid rules, meant to ensure fair competition, and the Stability and Growth Pact, which remains the core set of macroeconomic rules for eurozone members

The suspension of the usual rules in these three areas is supposed to be temporary and in line with escape clauses, but many in Europe recall the French adage that “only the temporary is permanent.” Few tears will be shed about the shelving of the stability pact (that Romano Prodi once called “stupid”). But, in this more pessimistic narrative, Germany’s massive use of state aid, drawing on its large surpluses, distorts competition and widens divergences in the single market.

A strong recovery fund is needed to restore a level playing field. But the disintegration narrative sees shortcomings in the financial underpinning of the EU’s response to Covid-19. The Recovery Fund is considerably diluted compared with the original Franco-German proposal. The grant element is now little more than 300 billion euros out of the total figure of 750 billion euros, including loans.

In any event, the attraction of the loan element is limited, given historically low interest rates. The headline figure of 1.8 trillion euros for the Recovery Fund and 7-year budget was reached only by cutting innovative, future oriented spending (such as science, research, education, transport, and development assistance).

The fight over Poland and Hungary’s rejection of rule-of-law conditions for the recovery fund and budget as well as the eventual compromise, intended to hold the Union together, tarnishes the EU’s image. In this narrative, Eurosceptic populism has been, at best, dormant during the epidemic. Democratic shortcomings in several member states call into question the EU’s legitimacy and reduce its credibility as a normative power.

Implications

Overall, and despite the continuing public health and economic crisis, the positive account of the EU’s response to Covid-19 is more convincing. At first it seemed that the epidemic would marginalise the EU, because of predominantly national responsibility for public health. But many governments now see the EU’s role as indispensable as they struggle with their own governance problems between regional and central authorities, and face unemployment, increasing income inequality and rising national debt.

The EU closes the year committed to a degree of fiscal solidarity that would have been unimaginable before the epidemic. This also translates into a higher level of public trust, though divisions in attitudes towards the EU persist. In its budget discussions, the EU at last faced up to the problem of democratic backsliding, albeit with a compromise formula on rule-of-law conditionality that must prove its effectiveness.

This brief informal review of the EU’s response to Covid-19 also makes clear that the integration versus disintegration debate is based on a false dichotomy. The dichotomy arises from the now somewhat dated view that any development should be judged by whether it is a step towards or away from an “ever-closer union.” The dichotomy is expressed in the classic but now outmoded metaphor of the man on the bicycle who must keep peddling faster or fall off. As my colleague Erik Jones has put it:

The mistake is to believe that European integration − or any integration, for that matter − is either yes or no, forward or backward, progress or regress. Integration and disintegration can take place at the same time.

Our two scenarios both contain elements of truth and confirm that integration and disintegration may occur simultaneously. It is hard to predict which will predominate in the medium-term. Any complacency about the EU’s performance would be out of place, with many Europeans still suffering, economic prospects muted, unresolved issues remaining, and Eurosceptics casting around for their best line of attack. But the evidence suggests that Covid-19 may turn out to be a salutary shock for the EU, obliging it to set aside certain doubtful and divisive procedures and to focus on those policy areas that address the urgent needs of the population as well as critical global challenges.

Creating a common safe asset without eurobonds, by A. Thomadakis and W. Boonstra | European Capital Markets Institute (ECMI)

On 7 December, the European Capital Markets Institute (ECMI) published a policy brief by Apostolos Thomadakis and Wim Boonstra, named Creating a common safe asset without eurobonds, which acknowledged that Europe needs a capital market that is sustainably integrated and as single as possible.

The authors highlight that this will not be achieved without a broad and solid foundation. The international position of the euro is stagnating close to historical lows, while the lack of a European-wide common safe asset highlights the fragmented nature of national government bond markets. Although collective issuance of government debt by member states through eurobonds seems to be unattainable for political reasons, there are other ways to arrive at a common safe asset. Debt issuance by the European Central Bank (ECB) and the European Union could play a constructive role here. By financing the European budget through bond issues and at the same time allowing the ECB to issue short-term money-market paper, Europe could tackle multiple challenges in one fell swoop.

Download the full publication here

About the authors:

Wim Boonstra is Senior Economist at Rabobank, and Professor in Economic and Monetary Policy at VU University Amsterdam

Apostolos Thomadakis, Ph.D. is a Researcher at ECMI

The Biden presidency is a last call for Europe, by K. Lanoo | CEPS

Image credits: European Parliament

Official visit US Vice President in 2015 Credits: European Parliament

The presidency of Joe Biden heralds an opportunity for Europe, and more particularly the EU, to revive its relationship with the US. But it may also be its last chance. The EU will have to demonstrate tangible progress in the areas of defence, trade and global policy stances generally to ensure the good will of the new American administration.

After very strained EU-US relations over the past four years, the election of Biden and his early statements have produced a huge sigh of relief among many policymakers in the EU, and Europeans at large. The stances of President Trump and his closest advisers were unprecedented in the history of transatlantic relations:  from the open attacks on the EU and some of its leaders, to support for extreme-right Eurosceptic parties and governments, and threats and attacks on the security and trade front.

To some degree, the Trump administration was only pointing to issues others had already raised tacitly before: the asymmetries on many levels in the transatlantic relationship had to end. Europe has sheltered for too long under the security umbrella of the US, and not taken enough responsibilities of its own. Despite warnings that date back to the end of the G.W. Bush administration, defence budgets have hardly increased (see the Dutch Advisory Council on International Affairs (AIV) report). On the goods trade side, where the EU has a huge surplus of more than €150 bn (2019), the US often applies lower tariffs on EU imports than vice versa. The obvious example is the most important EU export product, cars, where the US places a 2.5% tariff on EU vehicles, while the EU applies a 10% on US ones. This has insulated the EU market from competition, which is why it is behind others on electric cars, for example.

The US security umbrella has already folded in Europe’s south-eastern neighbourhood, and will not reopen, nor has it been replaced by European security. Notwithstanding the calls for a geopolitical Commission, Europe has been absent while Russia, and in the second instance Turkey, is becoming the hegemon in the region. As Russia brokered deals in Armenia, Syria (Idlib) and Libya, and extended its influence, Europe was nowhere to be seen. The void left by the retreat of the US has been filled by a former Cold War enemy.

Europe’s precarious security situation became apparent under Trump; without NATO it has no real  actionable security or crisis intervention structure, and is thus very vulnerable without the US. Most recently, EU plans for a more advanced security cooperation (PESCO), started under the previous legislature, have been overshadowed by uncertain proposals to include the UK’s defence capacity in a structure above the EU, in a European security Council. In the meantime, taken collectively, European member states that are allies of NATO do not meet the 2% defense spending as a percentage of GDP objective set by NATO, but stick on average to around 1.6%. This means that Europe lacks core operational capacities, such as the air transport capacity to move troops to crisis-hit regions, for example. EU countries should agree urgently on a division of competences and local specialisation, as part of a European defence agenda, as the Dutch Council for International Affairs argued in its recent report. The EU will only be taken seriously by the US – and also by President Biden – if it takes on more tasks itself.

On the trade front, it will take a long time to re-establish EU-US cooperation to the level where Obama left it. Biden has not yet mentioned TTIP as one of the engagements he would restore, although he will allow the WTO to function again. In the meantime, the EU has advanced with important bilateral trade deals, most importantly with Japan, but also with Canada and Mercosur, while specific trade agreements with China are progressing, such as an investment agreement. The current US Trade Representative, Robert Lighthizer, saw this web of bilateral trade deals as the resurrection of “the system of colonial preferences that prevailed in the pre-GATT era”. These deals do not advance liberalisation, he argued, but force countries to adopt protectionist measures such as ‘geographic indications’. WTO member states should therefore recommit to market reform and most-favoured-nation status, he advised in a piece in the WSJ in September. This is what Biden has already announced, to remove Trump’s tariffs and bring the WTO back to the centre, which the EU should be fully aware of.

Looking at it from an economic standpoint, the incoming administration may take a pragmatic approach: it will restore good old relations with Europe, but will turn to where the gravity is shifting: Asia. In the share of the global GDP weighting, the EU continues to lose ground, the US remains in the lead, while China is advancing. These trends are accelerated by the Covid-19 crisis, which has highlighted our dependence on US big tech. This puts Europe in a dire position with its digital tax, where the only solution is a global one for effective taxation in the realm of the OECD.

The EU will thus need to watch out in the coming weeks and months that it fulfils its side of the bargain in relations with the US, and make genuine commitments on the security and defence side, also by advocating a truly open trade agenda in line with the WTO commitments, to boost its competitiveness.

The EU will need a permanent structure for regular interaction with the US, as is the case for its other most important trading partners. Many attempts were made in the past, such as the Transatlantic Economic Council (TEC), but with limited success. Given Europe’s declining importance as an economic power, this is its last chance, also because more US-centred administrations will come back in the US. Yet another reason for the EU to overcome its perennial divisions, get its act together and assume its rightful role in the world order.

About the author

Karel Lannoo has been Chief Executive of CEPS since 2000, Europe’s leading independent European think tank, ranked among the top ten think tanks in the world. He manages a staff of 70 people. Karel Lanoo was an Independent Director of BME (Bolsas y Mercados Españolas), the listed company that manages the Spanish securities markets (2006-18) and is a member of foundation boards and advisory councils. He has published several books on capital markets, MiFID, and the financial crisis, the most recent of which is The Great Financial Plumbing, From Northern Rock to Banking Union, 2015. He is also the author of many op-eds and articles published by CEPS or in international newspapers and reviews. Karel is a regular speaker in hearings for national and international institutions (the European Commission, European Parliament, etc.) and at international conferences and executive learning courses.

Germany’s silent rebalancing has been undone by Covid-19 | Europp – LSE Blog

Low German wages are often cited as a key contributing factor to imbalances in the Eurozone. Donato Di Carlo and Martin Höpner demonstrate that while nominal unit labour cost growth in Germany consistently undershot that of other Eurozone countries in the first decade of the euro, the country has undergone a ‘silent rebalancing’ following the financial crisis. Unfortunately, this incomplete process is likely to be reversed by the shock from Covid-19.

The history of the euro has been punctuated by external shocks. Just as the financial crisis signalled the end of the first decade of the single currency, the outbreak of Covid-19 has now ended the second phase of Europe’s Economic and Monetary Union (EMU). Given the major implications the pandemic is likely to have, it is worth taking stock of where EMU stands and the future development of its member states.

Prior to the financial crisis, EMU was marked by internal real exchange rate distortions, brought about by excessive wage growth in the South and restraint in the North, particularly in Germany. In a monetary union with a one-size-fits-all monetary policy and no exchange rate adjustments, this is precisely what should be avoided. But how much of this divergence during the first phase has been reversed since the financial crisis? And have wages in Germany grown sufficiently to provide a correction to the previous decade’s undervaluation?

Germany’s silent rebalancing

Figure 1 below shows cumulated nominal unit labour cost (NULC) increases for the period 1999-2019 (1998=100) in comparison to the ECB’s inflation target. We display developments in Germany, France, the Eurozone and Southern Europe (Greece, Italy, Portugal and Spain – labelled as GIPS in the chart). On average, NULC increases were close to the inflation target for the euro area. But the average hides large differences. Germany can be assigned blame for undershooting, which reached a peak in 2007, while Southern Europe can equally be assigned blame for overshooting.

Figure 1: Euro Area cumulated nominal unit labour cost increases, total economy

Note: Indexes, 1998=100. Cumulated nominal unit labour costs reflect a ratio of compensation per employee to real GDP per person employed in the total economy. GIPS is an unweighted average of Greece, Italy, Portugal and Spain. Source: AMECO Database, European Commission (updated 5 November 2020).

In 2009, the discrepancy between Germany and Southern Europe had reached 30 percentage points, pointing at substantial intra-EMU real exchange rate distortions. Remarkably, France features stable NULC growth in line with the ECB’s inflation target throughout the whole period. This is not a coincidence. Although French unions are organisationally weak, the French state has maintained more wage steering capacity than most others. Public sector wages are set centrally under the shadow of state unilateralism. In the private sector, contrary to Germany, statutory extensions of collective agreements’ coverage are encompassing.

Since 2011, however, there has been a partial re-convergence in the EMU characterised by (painful) internal devaluation in the South and gradual wage reflation in Germany which has accelerated since 2017. Southern European countries have restored the competitiveness of their (relatively small) export sectors while harming their (relatively large) sheltered sectors. For lack of import demand from EMU peers, Germany diverted its exports to extra-EMU consumers of capital goods.

But Germany’s ‘silent’ rebalancing before Covid-19 is worth emphasising. To be sure, Germany’s wage growth was not out of this world. But the post-crisis partial re-convergence was nevertheless double-sided and brought about not only by restraint in the South, but also expansion in Germany. Germany’s NULC increases were large enough to correct much of its previous undervaluation, relative to the Eurozone average. But within Germany there has been a two-tier sectoral dualisation between the industrial and service sectors and within the service sector.

German wage dynamics

The second figure displays cumulated NULC changes for the 1998-2018 period (1998=100; data for 2019 are not available yet) for five sectors: industry, construction, low-end services, financial and insurance activities, and the public sector. The findings are remarkable. During EMU’s first phase, restraint in Germany was not driven primarily by the manufacturing sector, but by services and construction.

Marked wage restraint featured in low-end private services, the public sector and construction. High-end services like financial and insurance activities, in contrast, enjoyed sustained wage growth. Increasing dualisation indicates that Germany is not a case of inter-sectoral pattern bargaining, a term used by political economy and industrial relations scholars to describe wage regimes in which the exposed sectors set a competitiveness-safeguarding target which they afterwards transmit to the sheltered sectors. Were that to be the case, we would not observe such inter-sectoral divergence.

Figure 2: Cumulated nominal unit labour cost increases in five economic sectors within Germany

Note: Indexes, 1998=100. Cumulated nominal unit labour costs are a ratio of sectoral hourly compensation to hourly GDP in the total economy. Low-end services are defined as categories G-I in the Stan Industry list. Source: authors’ calculations; data from OECD STAN Database (2020 edition).

Considering that wage-setting is beyond the central government’s reach in Germany (even in the public sector), it is hard to attribute these outcomes to a conscious mercantilist grand plan. Instead, wage developments in these sectors must be understood in light of the respective sector-specific dynamics.

Wage moderation in low-end services (e.g. hospitality and retail) comes as no surprise. This reflects the erosion of unionisation and collective agreements, high unemployment, and labour market liberalisation. It is the extreme restraint in the public sector which is surprising. Public sector employees are highly skilled and relatively well unionised. The public sector’s collective bargaining coverage is the highest across sectors. Yet, public sector wage growth fell even behind the low-end services.

These puzzling public sector developments can be explained only by taking the fiscal policy context into account. Chancellor Schröder’s tax reform in 2000 dealt a blow to the public finances of the Länder. In the quest for fiscal consolidation, the finance ministers of the Länder exited the centralised framework for public sector wage bargaining and fiercely imposed wage restraint and cutbacks throughout the mid-2000s. Germany was unique with regard to its public sector wage developments in the first euro decade. No other euro member came even close.

Wage dynamics in construction resembled those of the public and low-end services sectors. The German construction sector had been shrinking since the Bundesbank’s hard monetary policy stance after the reunification boom. Before the financial crisis, a one-size-fits-none monetary policy resulted in a relatively high real interest rate in low-inflation Germany – which slowed down real estate activity. Based on data from the OECD and the Federal Statistical Office of Germany, the percentage of workers who were employed in construction shifted from 9% in the 1990s to 6% in the mid-2000s, while the number of finished dwellings halved. Beyond the widespread fear of losing jobs, wage policies in the construction sector were shaken up by the European free movement of workers, non-enforcement of the posted workers directive, and illicit work. In no other euro member state did construction wage restraint go as far as in Germany until the financial crisis.

Germany’s great disinflationary push was, in sum, driven by the sheltered sector. Industrial wages were undershooting too, but this was less pronounced than in the case of services, with the exception of financial services. In German industry, trade unions remained and are still powerful. The logic of the industrial wage regime, however, changed due to decentralisation, a process that started in the 1990s and accelerated in the 2000s.

Many firms from then on directly negotiated with trade unions. Where firms remained covered by central collective agreements, opening clauses paved the way to the expansion of firm-level agreements. Firm-level competitive corporatism is only one part of the explanation for the cost competitiveness of the German industrial sector, however. The other part is that the industrial sector consumes construction and other services, delivered by sectors in which wage moderation went much further than in industry.

The Covid-19 effect

In the euro’s second decade, the trajectory of wage growth has changed course and nominal unit labour costs have risen in line with industrial sector dynamics. This rise occurred in the context of an increasingly tight labour market. From above 11% in the mid-2000s, unemployment went down to around 3% (according to the OECD’s adjusted unemployment figures; the national figures are higher). Labour scarcity is a positive contextual factor for wage increases. Wage growth in construction has benefitted from the sector’s steady expansion and rising house prices. The introduction of a minimum wage in 2015 and the reregulation of temporary agency work has strengthened the positions of workers in low-end services.

Germany’s gradual rebalancing was significant, but incomplete. Although the economic and fiscal conditions for rising wages became increasingly better during the second half of the 2010s, Germany has not fully corrected the undervaluation which began following the introduction of the euro. Perhaps, without the pandemic, it would only have taken a few more years for full correction. But the Covid-19 crisis has put an end to such hopes. In the past, Germany reacted to crises by enforcing competitive undervaluation in the private sector and fiscal cutbacks in public sector wage setting. We have no indication that this time will be different.

The bottom line is that we should not be anticipating further wage expansion in Germany. It will not occur in the low-end services sector where Germany has turned into a ‘liberal market economy’. Nor will it come about in the exposed industrial sector, in which powerful works councils are prepared to trade wage increases against job security. As for the public sector, the government has already expressed its intention to return to fiscal consolidation as of 2022. This is an important message for Germany’s neighbours and trading partners. Due to the need to confront the immediate health hazard, some generous wage increases and one-off payments will occur in the public sector and perhaps also in construction, depending on further developments in the real estate market. But we doubt that this will be enough to break the foreseeable overall dynamic of wage moderation.


Note: This article gives the views of the authors, not the position of EUROPP – European Politics and Policy or the London School of Economics. Featured image credit: Alex Osaki (CC BY-NC-SA 2.0)


Policy Insight | New Asia-Pacific trade deal. Implications for East Asia and the EU | CEPS

The conclusion of a new overarching Regional Comprehensive Economic Partnership (RCEP) Free Trade Agreement (FTA) between 15 Asia-Pacific countries has been celebrated across the globe. Its signatories are the 10 members of the Association of Southeast Asian Nations (ASEAN) countries and Japan, Korea, China, Australia and New Zealand; India withdrew from the agreement at the last moment.

The signing of the RCEP is certainly good news for world trade and investment. It brings together a group of countries representing 30% of the global population and generating 29% of its GDP. It aims to facilitate and solidify global value chains; accept opening-up in terms of tariffs (while aiming to discipline non-tariff barriers); build a legal framework for services, trade, and investment; and address e-commerce issues such as the commitment not to impose data localisation. Much like the EU-Canada Comprehensive Economic and Trade Agreement (CETA), the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) (an FTA between 11 APEC countries, without the US), and the EU/Japan Economic Partnership Agreement (EPA), the RCEP demonstrates once again that the US under the Trump administration was effectively alone in its attempts to disrupt further globalisation. Nevertheless, the RCEP is not a deep FTA and stipulates slow liberalisation over long periods of time, among its other peculiarities. It may also impact East Asian regionalism in the long term.

This paper explains the Association of Southeast Asian Nations (ASEAN)-led origin of the RCEP in the context of APEC, summarises the substance of the agreement, and gives an inevitably crude first estimate of its impact on trade and overall income, as well as its structural implications. It concludes with reflections on the possible long-term implications of the RCEP for East Asian regionalism, for world trade and investment, and for the European Union.

Follow this link to download the full publication

Europe’s Capital Markets puzzle, by K. Lannoo and A. Thomadakis | European Capital Markets Institute (ECMI)

On 18 November, the European Capital Markets Institute (ECMI) published a policy brief by Karel Lannoo and Apostolos Thomadakis named Europe’s Capital Markets puzzle, which acknowledged that creating an attractive framework for more market financing in Europe is proving to be an increasingly complex puzzle.

The EU and other European states are battling on several fronts, but without the unity and vision that is needed to move forward. Brexit is one of the difficult pieces of the puzzle, but also problematic is the dominance of universal banks, even more in mainland Europe, and limited acquaintance with more market finance. Market financing is however paramount for Europe’s competitiveness. 

The EU Commission’s latest action plan – the New CMU Action Plan – lacks workable solutions and gets lost in small items that will not allow for significant change or bring Europe’s markets up to speed. A positive development on the horizon is the emergence of a euro safe asset, a crucial building block for European capital markets, but the issues it raises are not reflected in the action plan either. Six years after the launch, we are no closer to the benchmark set by the United States.

The real actionable items of the new plan are limited; several elements are intentions, proposals for studies or elements to strengthen existing frameworks. Of course, there is no need for an extensive new legislative agenda. But rather a clear vision and strategy on what the EU wants to achieve, by when and how, on which there seems to be no agreement. The incremental approach followed over in recent years is now harming the EU’s long-term interests.

Download the full publication here

About the authors:

Karel Lannoo is General Manager of ECMI and CEO of CEPS.

Apostolos Thomadakis, Ph.D. is a Researcher at ECMI.

 

Global Outlook on Financing for Sustainable Development 2021: A New Way to Invest for People and Planet | OECD

The Global Outlook on Financing for Sustainable Development 2021 calls for collective action to address both the short-term collapse in resources of developing countries as well as long-term strategies to build back better following the outbreak of the COVID-19 pandemic.
The financing gap to achieve the Sustainable Development Goals (SDGs) in developing countries was estimated at several trillions of dollars annually before the pandemic. The report demonstrates that progress to leave no one behind has since reversed, and the international community faces unprecedented challenges to implement the holistic financing strategy set out in the Addis Ababa Action Agenda (AAAA). The report finds that trillions of dollars in financial assets held by asset managers, banks and institutional investors are contributing to inequalities and unsustainable practices. It highlights the need to enhance the quality of financing through better incentives, accountability and transparency mechanisms, integrating the long-term risks of climate change, global health, and other non-financial factors into investment decisions. The report concludes with a plan of action for all actors to work jointly to reduce market failures in the global financial system and to seize opportunities to align financing in support of the 2030 Agenda for sustainable development.

Common currency, common identity? How the euro has fostered a European identity | Europp – LSE Blog

Featured image credit: Paolo Margari (CC BY-NC-ND 2.0)

Does European institution building in key areas of national sovereignty go hand in hand with the emergence of a common identity among European citizens? Drawing on a new study, Fedra Negri, Francesco Nicoli and Theresa Kuhn show that the introduction of the euro has fostered a European identity, leading to a small but significant decrease in the share of people who identify only with their nation and not with the EU.

Over the past few decades, the European Union has acquired important powers in policy areas that are intrinsically linked to national sovereignty. Indeed, the supranational Court of Justice of the European Union (1952), the EU Customs Union (1968) and the Schengen Area (1985) can be seen as the first building blocks of a set of European core state powers. More recently, the euro (launched in 1999; currency changeover in 2002) has pushed European integration even further.

From its onset, the euro was intended to be more than a mere instrument for economic exchange. It aimed to provide a symbol of collective identity that could be tangibly experienced, not only by national and European political elites, but also by a wider audience of European citizens as they engage in cross-border exchanges, purchases, and interactions. As Thomas Risse put it in 2003, ‘[w]e miss the significance of the advent of the Euro for European political, economic, and social order if we ignore its identity dimension’ (p. 487). A common currency is one of the most visible ‘identity markers’ that shapes the EU as a taken-for-granted social fact and helps in building an imagined community.

Almost two decades after the currency changeover, can we say that the euro has helped make the European society real in people’s minds? To start with, have a look at the figure below that displays the share of Eurobarometer respondents who identify only with their nation and not with the EU by country group over time.

Figure 1: Share of Eurobarometer respondents who identify only with their nation and not with the EU

Note: Mannheim Trend File (1996-2002) and Eurobarometer waves (2003-2017). Unweighted by population.

Overall, their share ranges between 13% (Luxembourg in 2016 and 2017) and 72% (UK in 2010). Compared to the full sample average (44%, horizontal grey solid line) and to the countries that introduced the euro in 2002 (41%, dashed line), the share of respondents who identify only with their nation is systematically higher in the member states that entered the EU in 2004 and 2007 and adopted the euro between 2007 and 2015 (46%, dash-dotted line) and in those that did not adopt the single currency (49%, dotted line). It is worth noting that the share of respondents who exclusively identify with their nation increased in all countries between 2005 and 2010, years characterised by both the rejection of the Treaty Establishing a Constitution for Europe in France (May 2005) and the Netherlands (June 2005) and the euro-crisis. However, from 2010 to 2014 – the years of the debt crisis – the share of respondents who identified exclusively with their nation decreased.

Given these trends, we formulate two hypotheses. Our baseline hypothesis maintains that the introduction of the euro is associated with a lower share of people who report an exclusive national identity. Second, we expect that, if the integration of a core competence of sovereignty, such as monetary policy, influences collective identities, then this does not simply happen from one day to the next, but is constructed over time. Thus, our second hypothesis maintains that the negative effect of the euro’s introduction on exclusive national identity increases over time.

The empirical analysis combines Eurobarometer survey data with macro-economic indicators from Eurostat. Our units of analysis are 26 EU member states, observed in the post-Maastricht period from 1996 to 2017 (the UK is included as it was a member state in the sample period; Cyprus and Croatia are excluded due to missing data).

Supporting our baseline hypothesis, our results show that, immediately after its introduction, the euro became a symbol affecting Europeans’ feelings of belonging towards Europe: in detail, the adoption of the euro is associated with a modest in magnitude, but statistically significant and robust across model specifications, reduction (-3%) of the share of people with exclusive national identity. This evidence builds a bridge to the first study on the relationship between the introduction of the Euro and European identity, published by Thomas Risse shortly after the euro changeover, in 2003. He demonstrated that the single currency, being ‘a visible link from Brussels to the daily lives of the citizens’ (p. 501), affected respondents’ identification with Europe already in the short run.

It could be questioned whether an effect of -3% is large enough to claim that the euro has had a positive effect on European identity. A look at descriptive statistics provides a partial answer: the standard deviation of the share of respondents reporting an exclusive national identity within the countries in our sample is equal to 5.7%. Moreover, across countries and years, its mean value is 44%. Considering these descriptive statistics, a change of 3% triggered by the adoption of the euro is not as negligible as it may seem. Moreover, it is worth noting that the euro is not the only supranational institution affecting European citizens’ ordinary lives. Thus, there are reasons to believe that, together, European institutions are capable of building and fostering collective identities.

Instead, contrary to our expectations, our results do not support our second hypothesis: the currency changeover exhausts its effects on European identity in the short run. The euro triggers a momentum-like, short-run, negative effect on the share of people with exclusive national identity, but such a negative effect does not increase over time.

All in all, our study suggests that common identities may stem from the construction of state powers, insofar as these contribute to creating the conditions that allow meaningful social interactions. While the lack of common identity is often used as a rhetorical artefact to constrain the construction of supranational institutions, our study suggests that integration processes could benefit from effective institutional designs as the latter may be essential factors in the emergence and fostering of a common identity.

For more information, see the authors’ accompanying paper in European Union Politics