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October 24, 2018

Can the eurozone be governed without a parliament?

We have argued that eurozone reform is one of the most likely casualties from the budget standoff between Italy and the European Commission even if politicians have not dared pronounce the reform process dead yet. But economists are already getting impatient about the lack of progress. We note two separate comments, by Paul de Grauwe on his personal blog and by Anne-Laure Delatte on VoxEU, questioning the EU's political governance structures. Both argue for the need to give an elected European assembly a greater say over fiscal policy.

De Grauwe's comment is framed explicitly in terms of the Italian budget conflict. He argues that the European Commission is not accountable to voters for the consequences of tax and spending decisions - national governments are.  The Commission is authorised by the treaties to exert top-down control over national budgets, but lacks the political legitimacy to do so. De Grauwe predicts recurrent episodes where democratically elected national governments defy the EU fiscal rules. He points to the precedent of Germany and France breaching the deficit rules in 2003. In the absence of greater political unification, De Grauwe says the Commission should avoid reigniting the eurozone debt crisis by being flexible on the Italian budget and accepting the democratic mandate given by the Italian electorate. 

Delatte observes that intergovernmental compromises have been effective for advancing European integration several times in the past, but do not seem to be effective for eurozone reform. The reason may be that past compromises were ultimately seen as win-win whereas the risk-reduction vs. risk-sharing compromise currently under discussion for the eurozone appears to be more about limiting the size of losses in a lose-lose situation. The risk reduction proposals, aimed at breaking the doom loop between banks and their governments, puts debtor governments at risk of a market liquidity crisis. The risk sharing proposals, aimed at giving the banking union common backstops such as deposit insurance, put creditor countries at risk of permanent transfers. Both sides end up preferring the imperfect status quo to what they see a a lose-lose compromise.

De Grauwe is right in substance but the immediate consequences of the Commission relenting as he suggests would be a loss of credibility for the fiscal compact, without necessarily any progress on political unification. Currently, the main issue dividing the European governments is one of mutual trust, not one of interest. And that may be the source of the European governments' inability to see the eurozone reform as a win-win compromise as Delatte frames the issue.

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October 24, 2018

EU to grant UK-wide backstop

The Brexit process remains full of uncertainty, but what we do know is the broad scope of the withdrawal agreement. As Tony Connelly, Europe editor of the Irish broadcaster RTE News, reports the EU is now ready to offer a UK-wide backstop. This would be in a protocol to the treaty, to be negotiated separately. Protocols have legal power, so this would be more than just a statement of intent. The Irish backstop would still be in the main treaty. Such a solution has been rumoured for some time, but Connelly says he has seen a draft where this is now officially included.

This proposal does not solve the outstanding issues automatically, but it focuses the discussions. The UK would still try to firm up the process so as to meet Theresa May’s reinforced red lines. The new draft agreement no longer talks about Northern Ireland as integral part of the EU’s customs territory, but uses watered-down language less offensive to the unionists. 

The EU’s position is that a customs agreement with the UK cannot be done under Article 50, and is too complex in any case to be negotiated in a few weeks. The estimated time frame is one to two years. We assume that the UK would be seeking a backstop in case there is no agreement. May is seeking something that allows her to claim that there will only be a time-limited interim period, and that no situation arises that ever imposes a border in the Irish channel. We are moving forward, but we are not there yet.

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October 24, 2018

Merkel flip-flops on diesel legislation

This is a small story, way below the threshold we would normally set for inclusion in our briefing, but it is indicative of the panic in the German government right now before the state elections in Hesse on Sunday. Frankfurt is the main metropolitan area in that state. We already reported on Angela Merkel’s idea of legislating to make it harder for cities to impose diesel bans. But new emissions tests in Frankfurt point to such a significant deterioration that the new legislation would make no difference. The ban would still come. Merkel has decided to flip-flop at the last minute, and to go on air in a local radio station announcing the inclusion of Frankfurt in the list of cities that would benefit from the recently agreed programme to induce diesel owners to buy new cars. Unfortunately, the car industry has not yet given any details, and calculations we have seen do not suggest that this recent agreement between the government and the car industry will have much of an effect. Stopping the ban might have been popular in Frankfurt’s commuter belts, but an uncertain bribe less so.

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