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Europe’s shifting politics: the challenge for smarter integration

Rome, 02/04/2014 - 03/04/2014, Aspen European Dialogue
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There is a broad consensus on the key issues that will determine the sustainability and efficiency of the eurozone (and the European Union as a whole). These include common mechanisms in Europe, domestic political consensus in the face of the considerable sacrifices imposed on citizens, the functioning of national institutions to introduce necessary reforms; and mutual trust between the member countries.

The degree of integration of economic policies has increased in response to the crisis, but a fundamental question has not been openly addressed: that of the choice between common rules (based on voluntary compliance) and a true economic government (with discretionary powers, and thus a clear political connotation). The overall climate is now even less favorable to transferring sovereignty, even as this process has become more urgent. In its current configuration, the eurozone has very few tools to stimulate growth. It is thus unable to tangibly reassure its citizens of the constructive role of the euro and the institutions responsible for its management. This has become a real dilemma.

There is broad consensus on the urgency of a true banking union, essential for supervision and possible action in the case of problems with lenders. The procedures must be clear and rigorous, but also as simple as possible. To date, however, the mechanisms have been complex and therefore less effective as a means of stabilization. The proposal to mutualize debt is still on the table. According to many observers, the main difficulty in creating Eurobonds lies in the conditions that Germany especially would lay down, i.e. centralization of the budgets of member states, to be transformed into a single budget - a step that other countries find unacceptable. The combination of solidarity and responsibility, however, is still Berlin's guiding principle for the euro.

In any event, we should remember the heterogeneous nature of the eurozone; structural reforms were supposed to overcome this, but none had been (sufficiently) implemented since the 2008 crisis. Nor were there common institutions capable of stimulating growth in the face of a series of shocks. The decisions that must be made today are inherently political, and the ECB is not the proper institution for this role, even if it had the mandate. The result is that today the eurozone (and the EU as a whole) is unable to pursue policies different from those that global markets require.

This has helped spread the impression that the euro has actually exacerbated the effects of the crisis on almost all member states. This is mainly due to the adoption of the Fiscal Compact. In the view of most experts, this interpretation is not correct, but it is also true that current rules do not seem sustainable (especially if growth rates remain low) and do not allow different intervention for different national situations. Here, it should be noted that the countries that have suffered the most during the crisis are those that received more easy money during the boom. This experience also teaches how crucial it is to have the ability to implement anti-cyclical policies.

On the plus side, today's markets believe that the euro is still far from a breaking point (as seen in the increased investment in the countries of southern Europe), while pessimism was prevalent just two years ago. Meanwhile, however, the tendency towards fragmentation, at the level of the business as well as political leadership and public opinion, has worsened. This is a difficult problem if a good degree of mutual trust is not re-established.

Against this background, the European elections in May will inevitably reveal the widespread popular dissent over to the classic cross-ideological orientations. Moreover, the new European Parliament will resemble many national parliaments, with a large representation of anti-system movements actively critical of current agreements and part of the same institutional framework. It will therefore be increasingly important to clearly present the costs and the risks of re-nationalization to the electorate.

Options for the Eurozone and the EU need to be set in a global context. In the international perspective, China's economy is in a phase of partial adjustment, although the authorities have decided to reduce control over means of production. For that reason, the pattern of growth has not yet changed profoundly. While the rate of growth has contracted, we should not forget that China's potential is still largely untapped and there are large margins increase the overall efficiency of the country system.

A significant factor in the coming months will be the development of the negotiations for the Trans-Pacific Partnership (TPP) and the role that China will play at the macro-regional level.

Meanwhile, the US is consolidating its growth trajectory, even though there are serious problems on the rate of long-term unemployment, income inequality, and social spending (health and social security). These factors will create significant constraints on Washington's freedom of action in various sectors, although the conquest of relative energy independence is having a significant effect on the competitiveness of the American economy. The crisis in Ukraine has raised the political profile of the Transatlantic Trade and Investment Partnership (TTIP) this is an opportunity to overcome many objections and reservations on both sides of the Atlantic.

As for relations with the Russian Federation and the balance of Eurasian security after the crisis of the Ukrainian Crimea, Moscow has chosen a very risky approach in the light of its own interests. This is particularly true given the internal challenges it faces in the coming years as well as those outside - especially along its eastern border and in Central Asia. The step taken by Putin in Crimea marks a turning point, but at the time, the strategies of Russia and the West were divergent. One serious mistake by the West was its inability to carefully analyze Putin's public statements in recent years: Russian revanchism is unsurprising in light of the stated policy of the Kremlin itself. For the future this means that events in the Ukraine are probably a step along a path not concluded – unless there are profound domestic changes in Russia, with a much more active middle class, less easily influenced by nationalist foreign policy. Internal politics now appear contradictory, given that the economy is heading towards a likely recession, while the President's popularity has increased sharply as a result of the crisis in the Ukraine.

To date, however, the essential feature of Russian policies seems to be its intention to ensure instability in some nearby territories, even using economic instruments to do so. That way, Russia can guarantee that no other actor exercises direct influence. The line of response to this challenge must be balanced and sophisticated.

Despite the gravity of the situation, a violation of fundamental principles of international order, we need a degree of pragmatic cooperation with Moscow in several areas. Indeed, direct contacts have continued even during the most acute crisis of direct. Up to now, a good degree of transatlantic solidarity has emerged, but some participants feel that differences of opinion and priorities are bound to occur if Moscow becomes more aggressive or if energy is used as a weapon to harm European interests.

As a supplier to Europe, Russia has traditionally been reliable, and in any case broad-spectrum penalties would have the effect of raising energy prices. That would put Central and Eastern European countries in serious trouble given their high degree of dependence. The major European contribution to a change in contractual relationships - with strategic implications - would be a common European Union energy policy. Some steps can also be taken in the coming months towards a Euro-American energy security strategy.

Meanwhile reflection is needed at European level on policies towards countries on the border with Russia. it must be recognized that the Ukraine has put a poorly functional country since independence, but also that Brussels' constructive influence on Kiev was very limited. This will have to be worked on with time and there are no quick and simple fixes.

The most encouraging aspect of the international reaction to events in the Ukraine was the strong cohesion in adopting a political condemnation, and identifying both immediate as well as future measures. The EU member states, in particular, need to move in solidarity. Not only do they need to deal with the challenges of security in view of its direct geopolitical interests (sectoral and regional), but in the overall framework of long-term common objectives as well. In this sense, it is difficult today to consider Russia as a full partner, but many ties (not just energy) with Europe are structural and should be cultivated, even in the possible scenario of the evolution of Russian society.

In the short term, in any case, international markets have launched strong and important signals on the cost that Moscow might have to endure in continuing its foreign policy along the path of revenge and unilateral initiatives.