Wednesday, October 31, 2018

An overview of Angela Merkel's policy failures

Published on CapX

In office since 2005, Angela Merkel is Germany’s second longest serving Chancellor since the Second World War. On Monday, she announced that she would be stepping down as CDU party leader but continuing as Chancellor until 2021. This is a u-turn on her earlier stance that the Chancellor should be the leader of the governing party and, to many, will look like a desperate attempt to cling on to power.

However long she lasts – and it may not be as long as she hopes – now is a good to consider what Angela Merkel achieved. Unfortunately, a close look at her time in charge is not flattering. That might explain why her party is at an all-time-low in the polls.  

Here, then, is an overview of what Merkel got wrong, and why that matters.
Merkel’s migration policies will cast a long shadow over her legacy. In 2010, Merkel stated that attempts to build a multicultural society in Germany have “utterly failed”. In August 2015, her government was using television adverts to warn people in Albania not to come to Germany as their chances of getting asylum were close to zero.

And then, that same month, her government decided to suspend the so-called Dublin rules. This meant that it would stop returning Syrian asylum seekers to their first port of entry in the EU. Suddenly, the “hard line” vanished.

Merkel made the assertion “Wir schaffen das“, meaning “we can manage this”, going against many in her own party. Maybe it had something to do with the fact that a few months earlier Merkel had been sharply criticised for her insensitive response to a sobbing Palestinian refugee girl who begged to be allowed to stay in Germany. Perhaps her approach after that of taking selfies with refugees to humanise them deserved praise, but the overall effect of her policy was not positive.

The suspension of the Dublin rules wasn’t the key factor leading to the great influx, which really began in March 2015. More important was Europe’s failure to close the Balkan route. This only happened in March 2016, which stopped the flow from people from Turkey to Greece and led to a large drop in drownings-at-sea. Many people, both genuine refugees and others, no longer tried to cross from Turkey, which had given shelter to more than 3.5 million refugees.

Still, the suspension of Dublin was the ultimate concession that the German government, along with the other countries along the Balkan route, had lost control over their borders. Following the chaos, a consensus has emerged that whatever the solution to helping refugees is, this chaos isn’t among it.
The large inflow of immigrants led to increased violent crime and allowed terror groups to take advantage of the situation. It was accompanied with high unemployment among newcomers and a low rate of return for those denied asylum.
It all made already complex integration challenges even harder. Merkel has long since u-turned again and abandoned her open-door approach. But it was too late to avoid a political fall-out.
Franz Josef Strauss, the longtime leader of the Bavarian CSU had always made sure that no party would manage to emerge to the right of the CSU, keen to make sure disgruntled voters continued to support mainstream parties. However, as yet another effect of Merkel’s migration policies, the rightwing populist AfD has had great electoral success and now sits in every State Parliament as well as the Bundestag. Of course, migration policy is very complex and Merkel cannot be blamed for the Syrian war and its effects, but her abdication of responsibility in the midst of the crisis made it all worse.
You might think that Germany’s excellent economic data means that Merkel deserves credit for her economic policy. Germany has the lowest unemployment numbers since 1990.
But this is in large part thanks to the fact that the German economy had been restructured by her predecessor, Gerhard Schroeder, in 2003. It was his Agenda 2010 which truly reinvigorated Germany’s labour market with restrictions in unemployment benefits but also income tax cuts. Unit labour cost competitiveness had really been restored by the end of 2005, when Merkel entered into office, and has since remained stable. This was not only due to Schroeder but also due to responsible wage restraint agreed between employers and employees.

Ever more expansive monetary policies conducted by the ECB from around 2007 have further suppressed the euro’s exchange rate, thereby helping Germany’s export industry. This was, for Germany, an unintended side effect of the ECB efforts to save the single currency. What began with relaxing collateral requirements for ECB loans to shaky banks culminated, through all kinds of measures, into quantitative easing and the ECB now being responsible for pretty much all lending to the Italian government.

The ECB has bought up twice as many assets as the US Fed as a share of GDP. There are strong rumours that ECB President Mario Draghi has been granted tacit consent by Angela Merkel to do all of this. In any case, it has hurt German savers and driven some to invest in risky investments such as stocks and real estate, with some claiming Germany is in the middle of a real estate bubble. But German government revenues skyrocketed, largely driven by central banks’ easy money policies both in Europe and globally but also by Germany’s status as a safe haven, established long before Merkel was on the scene.

While Merkel’s government was lecturing other Eurozone countries to embark on competitiveness reforms, her own governments didn’t do much.
In her second term, with the liberal FDP, she blocked attempts to lower taxes and after that she conceded to the social democratic demand of a federal minimum wage, which may well create unemployment in the future if it continues to be raised. Previously, salary requirements had been the business of sectoral agreements. In short, Merkel unwound some of Schroeder’s labour market flexibility which had boosted the economy, ultimately helping the most vulnerable.

On energy, Merkel, who is a trained physicist, performed a u-turn largely inspired by public opinion or at least by a number of loud voices – not that it tars her with the populist label. Here, the decision to phase out nuclear power with the goal of almost completely shifting from fossil fuels to renewable energy by mid-century, may ultimately cost €1.1 trillion by 2050. The move was made right after the Fukushima nuclear disaster in March of 2011 – even if some more independent thinking greens consider this to be the ultimate stress-test for nuclear.

An average four-person household had to pay more than double for power in 2017 compared to 2000. German industry has also suffered. Even the goal to reduce CO2 emissions isn’t being achieved, as these have been stagnating in Germany for three years now, while the country is about to miss pretty much all its national and EU emission reduction and clean energy targets for 2020. Moreover, coal is becoming more important. In the absence of nuclear, it provides the backup power needed when the wind doesn’t blow and the sun doesn’t shine.

Only recently, Merkel has once more abandoned environmentalist orthodoxy, promising to stop legislation to ward off diesel driving bans. This is a complex debate, with the consensus alternating for and against diesel, but the fact that her latest stance emerged just before state elections in Hesse isn’t exactly proof of a solid ideological backbone.

Picking a fight with Central and Eastern Europe
Merkel’s EU policies are leaving behind a trail of failure. In the autumn of 2015, in the midst of the migration chaos, she chose to act as a politician in a corner tends to act: pick an external adversary. Despite warnings from the French Interior Minister, Merkel’s government opted to push ahead with outvoting Eastern European countries and impose “mandatory refugee quotas” at the EU level.

Her message during the migration chaos and after has always been that the problem wasn’t so much the entry of irregular migrants but the fact that other countries didn’t follow her policy. The mandatory relocation decision really led to increased Euroscepticism in central and eastern Europe, as the already strained relationship with Germany soured. In practice, it also appeared impossible to spread people within a passport-free zone, as a child could have predicted. The few people who were relocated to poorer EU member states, such as Portugal, have mostly already left those countries.

For Merkel, it did help to divert attention from her own policy failures, at the expense of the good relationship with former Communist countries in which the West had been investing for decades. Moreover, politicians like Hungarian Prime Minister Viktor Orbán, who is being accused of reducing rule of law standards, subjected EU migrant quotas to a referendum, which helped to consolidate his position. Germany lost a lot of political capital it could have used to warn about some of the nasty measures taken by the Hungarian government, as for example the crackdownon NGOs.

Eurozone tension
Merkel has played a very questionable role in the Eurocrisis, breaking the sacred “no bailout rule”. This was a ban on Eurozone transfers that had been inserted in the EU Treaty in return for Germany giving up the deutschemark. As with the mandatory migration quota, other, smaller countries, were forced to comply, except that here there was a real effect: billions and billions of taxpayers funds were used to bail out the governments of Greece, Ireland, Portugal, Cyprus and Spain, even if in the latter case the money went straight to the banking system.

None of that includes the extraordinary actions of the ECB, which used all kinds of methods to prop up banks and their closely interlinked sovereigns, in the process hitting savers hard. To be fair to Merkel, here the dynamics of the pyramid scheme were so strong that any German politician would likely have been forced to go along with the bailout logic brought along by the fateful debt machine that is the euro. But this did a lot of damage to the support for the EU, as those who had to pay for the transfers weren’t happy, as well as those having to receive the conditions linked to it, as tolerating a “troika” of foreign bureaucrats micromanaging domestic policy.

Merkel specifically deserves to be blamed when she conflated the euro – a very shaky project – with the EU – which for all its downsides has still been very successful in terms of opening up trade in Europe.
The cross-border business and the wealth it brought not only helped to preserved peace after the Second World War but the prospect of membership also helped to stabilise Central and Eastern European countries after they escaped from the totalitarian Communist yoke.
Merkel didn’t, however, have any qualms using the credit earned by the European Union to save the common currency project, when she, together with French President Nicolas Sarkozy, utteredin 2011 the fateful words: “If the euro falls, Europe falls”. With friends like this, the EU doesn’t need enemies.

In 2015, Merkel made another seismic decision when she overruled her Finance Minister and decided against a Greek exit from the euro. This despite the fact that the bankrupt Greek banking system was more or less shut anyway. Greece could have been enabled to default and then allowed to keep using the euro, like Montenegro, with its banks however no longer enjoying access to the cheap ECB cash that had caused the epic built-up of debt.
A default would have meant shareholders of Greek banks – which were in large part the bankrupt Greek state – taking a big hit but transitional eurozone support could have served to help savers recovering their savings. The Greek banking system was recapitalized anyway, as Greece received 86 billion euro as part of its third bailout, but with Greek banks keeping access to cheap ECB cash.

Perhaps Merkel was right to fear that a Greek default could have “infected” other Eurozone countries, but how sustainable is a continuous merry-go-round of bailouts and political tension?
Doubtless at the forefront of her mind was the fact that a Greek default on Eurozone creditors would have been an embarrassment for Merkel, as she had allowed banks in 2011 to dump a large part of their exposure on Eurozone taxpayers. In any case, even despite the constraints, during the eurocrisis Merkel took the easy option, and in doing so clashing with her own Finance Minister, Wolfgang Schäuble, and other, more responsible policy makers, who at least tried to think about the future, instead of kicking the can down the road.

Undermining public support for the EU
Even disregarding the euro and migration crises, Merkel deserves much of the blame for the increased hostility to the EU project, which is visible in the success of anti-establishment populists across the continent and led to the Brexit vote in 2016.
When Merkel came to power in 2005, the “European Constitution”, yet another Treaty providing the EU with more powers and bureaucracy, such as the EU’s “Foreign Minister” and Council Presidency, had just been firmly rejected by the French and the Dutch.
One would think that such a clear message coming from two founding member states would have been enough to shelve the unnecessary changes, but together with other leaders, Merkel decided to repackage the “constitution” in the form of the Lisbon Treaty. In fact, she was the leading force behind continuing with the whole thing. It was rejected again in 2008, this time by Irish voters, who were simply asked to vote again one year later, when they fell into line, as the country had been badly hit by a financial crisis that was also partly the result of the cheap money enabled by euro membership.

How could EU leaders think all of this would simply pass without some political response from the public?
The writing was already on the wall when British PM Gordon Brown made up an excuse to miss the signing ceremony in December 2007. The next ten years, the financial crisis, the eurocrisis and the chaos of the migration crisis would further embolden Eurosceptic sentiment, not only in the UK, but across Europe, with referendums going against the EU’s preferred outcome in Denmark, Greece, the Netherlands and Hungary.

Contributing to Brexit

In 2014, Angela Merkel promised British Prime Minister David Cameron that she’d block the appointment of Jean-Claude Juncker, a classic Brussels-style EU federalist and proponent of things like an EU army, as European Commission President.
She once again capitulated to loud media voices in Germany as well as pressure from her SPD coalition partner to respect the outcome of the so-called “Spitzenkandidaten” process, whereby the nominee of the biggest political group in the European Parliament would automatically become EU Commission President. Juncker, an EU insider, had skillfully manoeuvred himself into that position and Merkel went along with it.
Today, most EU leaders are keen to avoid appointing whoever comes out as the leading “Spitzenkandidat” from EP elections. This is an implicit endorsement of the idea that the European Parliament isn’t legitimate simply because it has been directly elected. The institution, which also acquired more powers thanks to Merkel’s Lisbon Treaty has failed in many respects to be an effective check on the EU machine.

Merkel also did not step up to the plate during David Cameron’s attempted renegotiation of the UK’s relationship with the EU, ruling out Treaty change early on, which made big reforms impossible. She also largely left the initiative to Juncker’s European Commission. In the light of the importance of UK-German relations, she should consider herself lucky to have escaped any blame for Brexit, even if Cameron outsourced much of the negotiation to diplomats and should probably have been more aggressive in pushing his case.

Not so liberal
If Merkel can be blamed for mismanaging migration policy, energy policy, enabling eurozone transfers, not embarking on competitiveness reform, pushing public opinion against the EU by pursuing all kinds of aggressive power transfers to the EU level and underestimating the risk of Brexit, surely she should be given credit for being a rock-solid supporter of the international “liberal order”, in the face of emerging authoritarianism, as is often claimed?

But even on this point her track record is no better than mixed. Apart from the migration chaos that emboldens authoritarian tendencies in society, her government enacted the controversial lawrequiring social media companies to remove hate speech and other illegal content, or risk fines of up to 50 million euros. The law was criticized by the likes of “Reporters Without Borders” and a UN Special Rapporteur, while two liberal MPs are challenging it at Germany’s Constitutional Court.

It’s not the first time that Merkel and her government have been on the wrong side of the debate on freedom of speech. Most infamously, Merkel apologised to Turkish authoritarian President Erdoğan after satirist Jan Böhmermann had made fun of him on German TV.

Moreover, there is the issue of Merkel working to allow the so-called “Nord Stream 2” pipeline between Russia and Germany, which bypasses existing pipelines running across Poland and Ukraine. Together with the Baltic countries, they see this as a strategic Kremlin threat to the security of their energy supply. Scandinavian countries, the UK and the US are also hostile. Merkel’s party colleague Günther Oettinger, who used to be EU Energy Commissioner, has openly accused her of increasing Europe’s and Germany’s dependency on Gazprom. A lot of pragmatism may well be needed when doing business with companies coming from authoritarian-led countries like Russia and China but in this case Angela Merkel is at odds with the liberal West. Clinging on to power is not an achievement that deserves much praise. Merkel should be judged on what she did with that power. And in a wide range of policy areas, the Chancellor’s track record is not something to be proud of.

Thursday, October 18, 2018

BBC World News Interview on Brexit

My interview with BBC World News, discussing the latest on Brexit, during the EU Summit:

Friday, October 05, 2018

Why the EU should soften its stance on the “Irish backstop”

Published on CapX

After the Conservative Party conference, the Brexit negotiations have picked up pace. EU diplomats are reported to be more optimistic a deal can be reached, with some of them even thinking they are “very close”.

This optimism is thanks to ever stronger indications of a possible fudge for the Northern Irish border, which I described in my previous CapX piece and which was first brought to light by The Telegraph’s Peter Foster, in the middle of the Summer. The UK government is, however, still working out the details of its backstop proposal. 

Apart from the precise role of the EU’s top court, the so-called “Irish backstop” is the main reason why there still isn’t a deal on the divorce part of Brexit, which will be agreed in the “withdrawal agreement”. This is a fallback arrangement that aims to avoid a hard border in Ireland in case there is no deal on the future relationship between the UK and the EU on January 1, 2021, at the end of the so-called “transition stage” during which Britain would keep full access to the EU’s market in return for becoming a full rule-taker.

The British government agreed last December on the principle of having a backstop, but the content of it still needs to be agreed. In February, the EU proposed creating both a customs border and a regulatory border between Northern Ireland and the rest of the UK. Again, this is a fallback option. It’s not meant to be used, but in case there is no FTA between the EU and the UK, it will regulate trade between the UK and the EU from 2021 on, together with WTO provisions.

Britain has been open to discussing regulatory checks within its territory. After all, there are already regulatory differences between Northern Ireland and mainland UK, due to devolution. The UK government has however been very clear that it was opposed to carving up the UK’s customs territory. Trade policy and tariffs will be a central UK government competence after Brexit.

The UK government’s insistence on the integrity of a UK customs territory , something which is shared by the Labour party, surprised the EU this Summer and EU leaders were also surprised to hear Theresa May repeating in Salzburg that the UK could not agree a customs border within the UK.
At an Open Europe event at the Conservative Party Conference, Brexit secretary Dominic Raab specified that if there would be regulatory checks in the Irish Sea and that there could not be new regulatory barriers. He thereby echoes the Democratic Unionist Party, which he wants to grant an effective veto by giving the Northern Ireland Assembly, where the DUP has a blocking minority along with the other Unionist parties, a say on the matter.

Can a regulatory barrier in the Irish Sea be fudged? Perhaps. One could think of a scenario whereby some Labour MPs would  abstain, making up for the no-votes of Eurosceptic Tories and perhaps the DUP. But this is unlikely.

Theresa May is reportedly thinking about pushing the legislation through Parliament at the beginning of December. That vote will be shaky almost regardless of what the final deal looks like, but a customs barrier in the Irish Sea would make the Parliamentary arithmetic even more challenging.
The UK’s proposal, outlined in the Chequers agreement in June, is for the whole of the UK to remain under the EU’s customs regime after the transition stage, but only for a limited period. This would create a new deadline by which a deal with the EU needs to be reached to avoid customs checks on the Irish border.

In the meantime, and during the transition stage itself, Trade Secretary Liam Fox would be able to negotiate trade deals with third countries, even if those deals could then only enter into force at the end of what could be called the second transition stage for customs only. It’s a compromise. But one that recognizes the time needed to adapt customs systems and negotiate trade deals, including securing the continued trade access Britain enjoys thanks to trade deals concluded by the EU.
The EU isn’t biting yet, however. The good news is that the Irish government and some in the EU are open to the whole of the UK remaining under the EU’s customs regime. That isn’t that surprising given that will be the case during the first, agreed on, transition phase.

The bad news is that Ireland and EU negotiator Michel Barnier refuse to put a time limit on this arrangement. And they don’t want any “second transition stage” written in the withdrawal agreement. They would rather it were included in a non-binding declaration on the future relationship.  For now.
However, we should be optimistic about the prospect of a deal, simply because EU member states will follow Ireland's lead on the "Irish backstop", which is the biggest missing piece. Ireland would pay a high price for a no-deal outcome.

However welcome the signs of flexibility on the Irish and EU side, it’s important to consider why the current EU stance on the “Irish backstop” is not reasonable and should be softened:

Carving out a part of the UK’s customs territory only makes Brexit even more complicated

The key problem is that the EU genuinely seemed to think that offering to carve up the UK’s customs territory was reasonable. Why did the Irish government not warn its EU partners not to do this?
Sure, the Canary islands aren’t a part of the EU’s customs territory, and parts of Austria were part of the EU’s customs territory before the country joined the EU, but these examples don’t feature the same sot of political sensitivities as Northern Ireland, where a part of the population fears one day ending up in a united Irish republic as a small minority.

Some on the EU side seem to realise that their offer was less than reasonable. But an insistence that the EU is not asking to carve up the UK’s customs territory will be unpersuasive as long as it flies in the face of the facts.

For example, the chairman of the Brexit committee in the Irish Senate has stated "we don’t want to see any border in the United Kingdom" and Polish MEP Danuta Hübner, a member of the European Parliament's "Brexit Steering Group", wrote that EU proposals for the backstop “have nothing to do with potential emergence of a new border in the Irish Sea.”

A customs border in the Irish Sea border may well violate the Good Friday Agreement
Irrespective of Brexit, to isolate Northern Ireland from the UK’s customs regime could be a breach of the peace accord reached in the 1990s. Theresa May is among those that have made this point. So the UK government and Parliament should not impose a customs border in the Irish Sea even if they want to, given that the consent of a majority in Northern Ireland is required.

A customs border in the Irish Sea is undemocratic

Fundamentally, there is also the issue of democracy: Northern Ireland’s population would fall under the EU’s trade regime, including possibly higher tariffs than the ones negotiated by the UK, without enjoying a democratic say in EU trade policy. That would be taxation without representation. 

A permanent backstop would hand the EU a veto over UK regaining trade policy

If indeed the whole of Britain would stay under the common customs regime in case there is no deal by 2021, but then permanently, unless an EU-UK trade deal is concluded, it would mean that the UK would only be able to let trade deals concluded with the US, China, Indonesia India or anyone else enter into force under the condition that there is first a trade deal with the EU.

The EU – or basically Ireland -- could hold up this EU-UK FTA by claiming that it wasn’t good enough to avoid a hard border in Ireland. Surely, Ireland must realise that requesting a veto over the UK regaining trade sovereignty is an excessive demand. And yet, it is the key issue now holding up a deal.

Reuters reports today that there is a "plan in the making" where by "the EU would get assurances that the emergency Irish border fix would be indefinite" but it isn't clear to what extent the British government is engaging with this, let alone how it could get through Parliament.

A permanent backstop might violate the EU’s own treaty rules

Under Article 50, the EU is only allowed to agree a treaty with a member state that is leaving the club to sort out the aspects of the divorce. A future trade arrangement needs to negotiated on another legal basis.

As part of designing a transition, sorting out some trade aspects is possible, but it needs to be temporary, as otherwise it could no longer be seen as being part of the divorce aspect but of the future relationship. It is far from clear that Barnier and his colleagues could justify an interminable Irish backstop under the terms of Article 50 if it creates permanent arrangement for trade flows between Northern Ireland and the EU.

To take the British proposal off the table makes customs checks more likely

The British government has suggested a solution, dubbed the “facilitated customs arrangement” or “FCA”. This would avoid customs checks, therefore solving the Northern Ireland problem but would also avoid a heavy burden on big manufacturers like Airbus, Honda or BMW that continuously ship parts and supplies back and forth from the UK to Europe’s mainland.

The solution involves the UK government collecting EU-level tariffs on any good entering the UK. It would then send the receipts through to the EU. British companies could then claim back some of the tariff paid if they could prove that the product they imported has not gone to the European Union and if the UK tariff is lower. Given that we’re only talking about tariffs and not about regulatory checks – where the UK would also be happy to align – there is no risk that if this system doesn’t work in an optimal way that there would be unsafe products entering the EU.

The only risk would be that the EU would lose some money, something the UK government could simply insure the EU against, for example by promising it would financially compensate for any losses as compared to the current income. Either way, we are not talking about huge amounts.
Unfortunately, the EU dismissed this proposal almost without consideration. Brussels claims that it can’t outsource its customs to third countries, even if in 2009 it agreed to trust a non-member’s (Switzerland’s) customs checks as equivalent . Again, Ireland hasn’t  been very helpful here.
Another argument is that the EU doesn’t want to change its own rules, for example the “Union Customs Code”, which can take a while, simply because a member is leaving. That argument overlooks that Brexit is more than a member leaving the club.

It resembles more something like a break-up of the EU club, as the UK economy is equal to the 19 smallest economies of the European Union. Just like in a divorce, it may not be very fair for an abandoned partner to have to make changes to his or her life, but it’s an inevitability. (In this case, both parties are to blame for the breakup.

If “FCA” is no longer an option to avoid customs checks between the EU and the UK, the only alternative is “maximum facilitation” or “max fac”. That basically entails employing technology to minimize disruption. It’s something that surely can go a long way, but it won’t be perfect.

In Switzerland, big companies seem to be able to deal with customs bureaucracy, but smaller firms find it more difficult. Perhaps the Irish government should look again at FCA. All of this is, of course, still separate from the possible need to align regulations in selected areas for the UK to keep market access and avoid regulatory, non-custom related border checks with the EU.


It is important that a hard border in Ireland is avoided, but how responsible is it for the EU to make all kinds of unreasonable demands that unnecessarily complicate an already challenging Brexit negotiation?

It is high time for the EU side to accept that the backstop to avoid a hard border in Northern Ireland cannot be a backdoor to keeping the UK under the EU’s customs regime. Lack of flexibility is only making no deal more likely, and the first victims here would be along the Irish border.

Britain has made some imperfect suggestions to avoid customs checks. These entail that the EU will need to make some internal changes as a result of Brexit. If the EU doesn’t like that, it should regret not having listened to longstanding British complaints about the EU’s direction, which are only  becoming more mainstream on mainland Europe.