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28 September 2023

Betting against the central banks

In our main story this morning, we write about why hedge funds are betting against the bond markets, and why we think this bet might succeed; we also have stories on Emmanuel Macron's erratic fiscal interventions; on French exceptionalism in energy policy; on a possible power shift in Spain's PP; and, below, on the last thing the EU needs right now.

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Today's free story

How likely is Fico's return?

Robert Fico has a chance to come back to power for a third time in Slovakia's upcoming elections this weekend. The poll of the polls suggest a narrow lead of Fico’s Smer party over the liberal Progressive Slovakia, though two polls showed a last-minute leap for the latter.

The snap elections come after the collapse of the centre-right alliance, which took over from Smer in 2020. Fico was forced to resign in 2018 amid a public revolt over the murder of the investigative journalist Jan Kuciak, who looked into evidence of corruption involving Fico’s party and associates at the time of his murder.

The fear in Brussels is that Fico could come back to power driven by vengeance. His ousting in 2018 and Russia’s war in Ukraine changed his thinking. This time he openly supports Russia and has vowed to end arms delivery to Ukraine. This resonates with older voters, who were socialised during the Soviet era. Massive social media campaigns from accounts linked to Russia meant that a majority of Slovaks believe that the west is responsible for Russia’s war in Ukraine, according to a think tank study from Globesec. Support for Nato dropped to 58%, which is far lower than the high eighties or nineties reached in other central and Eastern European countries, with Bulgaria the other noticeable exception. Brussels is extremely concerned about those disinformation campaigns, and threatened huge fines on social media platforms if they do not more to combat the problem.

But even if Fico were to emerge as the leading figure in the elections, it won’t give him a majority like Victor Orbán has in Hungary. He may get something above 20% but not more. It would force him to seek a coalition partner. He would have to look either to the far-right, or to his former ally Peter Pellegrini, who took over as prime minister from Fico in 2018, only to split off and form a new party. Pellegrini's party is the third largest party in the polls and thus likely to be the kingmaker of any coalition. No indication has yet been given of where Pellegrini could end up and under what conditions.

Economically, Fico promised a turnaround and more social spending. But to do this without the financial help from Brussels would be difficult in economically difficult times like these. When it comes to defence, even if Slovakia were not to led any arms to Ukraine, this may be a nuisance but not the end of the world. So is this much ado about nothing, as Politico puts it? Fico has a track record of avoiding conflicts over Nato or the EU. He may feel braver with Orbán at his side, but as a junior partner, not as a driver.

Fico may not win after all. The poll of the polls shows some momentum for the liberal Progressive Slovakia, founded by Michal Simecka, vice chairman of the European Parliament. But the surge behind Fico highlights the fact that the eastern front against Russia is no longer as united.

27 September 2023

On getting older

Handelsblatt reported on an interesting study that looked in some detail into why European companies are increasingly falling behind the US and China. One reason is that we have been relying for our growth on increasingly old companies. The five largest companies in the US have in common that they have been founded in the last 50 years. Germany's forty largest companies are on average 146 years old. One of them, Merck, dates back to 1668. There is only one newcomer in the Dax 30: Zalando, an online e-commerce company founded in 2008. The second youngest one is SAP, the software maker, which is already 52 years old.

There is nothing wrong with old companies. They are great for developing existing technologies. Sometimes, they manage to reinvent themselves. But it is company upstarts that give you radically new technologies, the kind which arose out of the discovery of quantum mechanics in the early part of the century. It was discovered in Europe, of course, but exploited in the US after the second world war. An entire digital economy arose from this discovery, starting with the invention of the transistor in 1947.

The dominant players in the digital world were not the typewriter-makers of yesterday, but those who thought about the new market in a different way. The reason why Europe's car industry is behind Tesla and the Chinese is that they failed to see it coming, and when it came, they realised that the Chinese and the Americans had already secured the most important nodes of the next-generation supply chains. 

According to an analysis by Freshfields Bruckhaus Deringer, a law firm, the UK and Germany have the oldest companies among the largest 40 companies. In the UK the average age is 151. In the US it is only 70 years. 

The analysis of why that is so is in our view superficial. The study claims more venture capital, more unicorns, more stock exchange listings. It is the capital markets perspective. We agree with this, of course, but there is more to this story. Government intervention, and especially military purchases, has played a huge role in the development of digital technologies. This is unfortunately not a consolation to Europeans. We are using our high taxes to fund social transfers, not public sector investments. Innovators are therefore confronted with the worst of all worlds: a capital market not fit for purpose, high taxes and low public sector investments. 

We are not sure that the EU can simply emulate the US method one-by-one even if it gave itself a capital markets union. This requires a single safe asset and a fiscal union to function as intended. For a capital-markets driven system of innovation, you require a complete reboot of your entire socio-economic system. You would need to replace your pay-as-you go pension systems with pension funds. You would have to stop subsidising old industries, and let them fall over the cliff. 

You would need lower rates of corporate taxes, which you can only have through cuts in social transfers. You would also need to raise public investment spending. 

While libertarians never tire of advocating those policies, it is safe to predict that this will not happen, not even during a long-lasting period of economic decline. We know the politics of decline. 

The way the EU responds to industrial decline is through regulation. As we keep pointing out, your ability to regulate is a lagging function of your ability to innovate. The EU's regulatory predominance dates back to the glory days of European industry in the late 20th century.

The most likely political response to decline is to double down on social transfers, to increase protectionism, which is now starting to happen, or to be deflected by other agendas. Structural decline begets structural decline. 

So here is our central prediction: in ten years time, the average age of the top forty companies will be ten years higher.

26 September 2023

Value-based trade policies

One way in which values-based foreign policy manifests itself is through trade regulations. The latest example is the new corporate sustainability due diligence directive (CSDDD), which is currently the subject of discussions between the European Commission and the member states. The new law seeks to ensure that large EU companies and businesses operating in the EU identify, prevent, and mitigate their adverse impacts on human rights and the environment throughout their value chain.

It makes large EU companies directly accountable for its implementation. It is our understanding that the ultimate aim of this law is to allow EU citizens to consume products free of guilt. But is this even possible? This is not only about environmental and human rights standards and how the EU defines it. What about small producers that drop out of the chain because they cannot comply? How much responsibility is Europe taking for their livelihoods?

If the law were to be implemented, it would impose heavy compliance burdens on small and medium-sized firms. The companies that cannot afford it would be forced to exit the value chain of their European trading partners.

We are a small company ourselves and have seen the volume of paperwork we have to fill out rise over the years due to Brexit, Covid, due diligence regulations, and sanctions schemes. In certain periods, compliance work can get overwhelming.

If you are a producer in the global south, operating right at the margin of profitability, compliance with the new regulations would require new, costly processes beyond your abilities. Those small companies may simply drop out and no longer bother delivering to the EU. Or those firms may find markets elsewhere. They could even reach smaller companies in the EU that are not required to comply with the due diligence laws. So this new law is not totally sealing the EU market off from producers that do not comply with the regulation.

But even for those companies that will try to comply, for them the law would create legal uncertainty for quite some time, writes Euractiv. Those in Brussels suggest this can be solved by capacity building on the ground. If only those producers are supported in their compliance, they will find it easier. This is a logic that is similar to the one in foreign aid. Who then ensures capacity building? Companies or countries? Will small producers then end up with different compliance schemes, one for the EU, the other for the US? Who will help smaller firms rejig their production processes to become compliant? Local financial markets do not always exist for small or medium-sized firms.

Europeans need to look at the unintended consequences of their values-based trade policies. A guilt-free European consumer market may be a dream that will never fully be realised. Swapping one guilt-free trip for another responsibility that the EU is then not capable of assuming would conflict with other values. Economically too, heavy compliance procedures means prices will rise in the EU. Are EU consumers ready to foot the bill or simply switch to cheaper Chinese products? It is our experience that once a rule is put in place, it also creates ways to undermine them. This law seems to be no exception.

25 September 2023

Values-oriented foreign policy's limits

When making foreign policy decisions, modern states face a trade-off between at least three different, competing priorities. One is trade and economic considerations, another is hard security concerns, and the third is fundamental values. A consequence of Russia’s invasion of Ukraine was supposedly that the pendulum would tilt back towards valued-oriented policymaking. The most common justification for supporting Ukraine that western politicians have given to domestic audiences is that it helps uphold the rules-based order.

But the west has, recently, found upholding this values-oriented policy stance more difficult in practice. This has meant decisions about where to stand firm on one’s values, and where to let them slip a bit, undermining the premise of taking these kinds of stances in the first place.

One recent example of this has been the changing US relationship with Iran, where a kind of quiet rapprochement has taken place. The Wall Street Journal has recently reported that the more visible release of five American prisoners by Iran has been accompanied by a more subtle relaxation of US sanctions enforcement on Iran’s oil exports. As a result, those exports have increased to about 2m barrels per day, the highest levels since the US pulled out of the Iran nuclear deal in 2018.

Another has been the EU’s limp-wristed response to Azerbaijan’s recent invasion of Nagorno-Karabakh. Azerbaijan had been blockading the mostly ethnically Armenian enclave, which is de jure Azerbaijani but has been controlled de facto by an Armenian breakaway republic since the 1990s, for around nine months. Last week, Azerbaijan’s military launched an attack on the enclave, which quickly overwhelmed its defenders. The EU has condemned both the blockade and the ceasefire violation, but there hasn’t been a more severe response, such as the use of economic sanctions.

In both instances, Russia’s invasion of Ukraine, and the west’s own response to it, have complicated the US and EU’s room for manoeuvre. Sanctions against Russia’s oil industry mean that the scope for applying measures against, say, Iran’s become more limited: you cannot simply embargo so many of the world’s biggest oil producers. Azerbaijan, which is a big gas exporter, has become a more important partner to the EU after supplies from Russia decreased. From 2021 to 2022, Azerbaijani gas flows to the EU increased from 8.1bn cubic metres to 11.4.

Another consideration is that taking a harder line against both Iran and Azerbaijan risks driving those countries closer to Russia, China, or both. Iran has already provided military support to Russia, and is in a quasi-dependent relationship with China, the single largest buyer of Iranian oil. Russia is also the broker in the conflict between Azerbaijan and Armenia over Nagorno-Karabakh.

The point we are making here is not to mark out western policymakers as being especially hypocritical. All countries make these kinds of choices. It is rather that trying to justify your foreign policy decisions to voters based on high-minded principles can be difficult when you don’t have the will, or ability, to apply those principles consistently. Politicians everywhere struggle with getting voters to trust the decisions they make. Resorting to moral arguments, but not applying your framework consistently, risks eroding that trust further.

22 September 2023

German centre does not hold

It was not a corrupt conspiracy and a dysfunctional constitution that swept the Nazis to power in 1933. It was centrist coalitions that pursued austerity in the years before. German political parties today have drawn the wrong conclusions from the breakdown of the Weimar Republic. By refusing to enter coalitions with the AfD, they are repeating exactly the same mistake their predecessors did in the early 1930s. They are only looking at 1933, when it was already too late. The political error occurred in the years before.

Here is some high-quality evidence that the political centre in Germany is opening up to the far-right. Its latest comes from the Friedrich Ebert Foundation, a political foundation funded by the SPD. The Mitte-Studie, literally the study of the centre, is conducted every two years with a statistical detail that far exceeds any polls. It shows a dramatic lurch to the right amongst voters that used to support centrist parties.  

The population in this study is limited to a group defined as the political centre, not in terms of voting behaviour, but income and social position: society's middle ground. Its lack of representativeness is a strength. The headline result of this study is that the number of people within the political centre that hold extreme right-wing views has gone up from 2-3% two years ago to 8% now. In addition to this, there is 20% of the population that falls into a grey area, people who are not oriented towards democracy, but who are not fully paid-up members of a particular right-wing ideology. What matters is not the headline number, but the relative shifts. This 28% is the group from which the AfD recruits, plus its own core supporters, many of whom would naturally fall outside the classification of the political centre. We have put the AfD's potential support at around one third of the entire electorate. These data suggest that the total potential might be even higher. If you wanted to relate these data to polling numbers, we would read this as follows: of those who used to support the political centre, 28% are open to supporting extremist parties on the right. Not all of them support the AfD, but many do. 

The study identifies a rise in antisemitism, white supremacy, extreme nationalism, and other features one could identify with the far-right. An important shift that took place over the last two years is that people are no longer embarrassed to reveal their far-right attitudes if they hold them. Here is another snapshot: 6% want the Führer back, 16% hate foreigners, and 34% believe that immigrants come to Germany to exploit the welfare system. Another 38% believe in conspiracy theories. 

We are not surprised to see this. If you keep on governing with grand coalitions, don't be surprised that people that used to support you shift to the extremes. That is especially so if you elevate the principle of kicking the can down the road as the principle by which you govern. The more you double down with grand coalitions, the worse it gets. The AfD is now polling at 21-22%. This level makes it progressively harder for the centrist parties to form coalitions.

21 September 2023

Delusions of the lingua franca

The great British delusion about Europe is that they set the big narrative, because they own the language. Brexit was a reality check about the power of British European narratives. But the delusions persist. The most glaring example for us is the insatiable appetite for European editions of newspapers. The latest is the Guardian. Unfortunately, UK media ventures have a long history of being commercial and editorial failures. Older readers may recall Robert Maxwell's The European, a tabloid that should have been the Anti-European. Serious newspapers and news magazines also have their European editions, more favourable to the EU but not any less patronising.

But as someone who has been closely involved in one of these ventures many years ago, we came to the conclusion that this form of media colonialism is doomed to failure. European editions of UK newspapers were never truly European. Nor was the Remain campaign in the Brexit campaign. Neither defended the case for European integration as such, but espoused a special version of European integration limited to Utilitarian transactional relationships. 

The big mistake British intellectuals with a general pro-European disposition keep on making is the idea of English as the lingua franca, and the idea of English liberalism as the guiding ideology. Both betray a colonial mindset. People who live in Finland and Spain speak languages that could not be more different. They don't need English media to make sense of their Europe. Especially not in this digital age. 

It is also trivially true that simultaneous translation of the EU's 24 official languages goes through a single connector language, which is English. This is no longer necessary in the age of machine translation, which has now reached a quality level beyond that of human translators. People still use a version of English when they meet informally. It is still the language spoken around coffee machines in offices. But don't misinterpret this fact as proof of English as the lingua franca. As a former UK minister said to us in a private conversation once: English is a great language for buying, but not for selling. 

People from Finland and Spain, when they get up in the morning, read Finnish and Spanish newspapers. That is true even if they are fluent English speakers. So they should. They have newspapers that do a much better job at explaining the EU to them than a UK paper. Have you noticed, for example, that the British media almost invariably refers to the EU as a bloc, as in Eastern Bloc. They all do this, but it is a shorthand that non-English European news media do not use. That choice of language betrays an underlying attitude. Europeans do not all agree with each other on the future of European integration. But even Viktor Orbán is not your classic British eurosceptic. 

We know ourselves from first-hand experience with a UK-based European media venture that they fail because the owners have fundamental misperceptions of the European media market. There was a small market for prestigious international newspapers, but they always ended up as coffee table decoration, unread of course. The lower end of the market discovered that there wasn't a market for British tabloid-style journalism. 

One of the many consequences of Brexit is that UK views no longer count as much in the EU as they used to. We keep on saying that denial is the first stage of grief. Denial is the predominant feature of the British euro debates. It will take some time. 

20 September 2023

Tunisia's double game

Tunisia has well understood how to play the Europeans on migrant flows. The EU acts like a besieged citadel and tends to be defensive. Once in this position, it can be blackmailed, something Tunis has realised. This is the playbook that has been successfully applied before by Morocco and Turkey. And it appears that what we see in Lampedusa is the direct result of similar efforts from Tunisia’s government, to encourage migration towards Europe in order to get the Europeans to pay for it.

Kais Saied, Tunesia’s president, is a believer in the great replacement theory, and is keen to preserve the Arab-Muslim nature of his society. His xenophobic views and actions prompted African leaders to organise repatriation operations for migrants who felt in danger. In Europe, few leaders even noticed what was going on, too focussed on finding solutions to their own migration problem.

The deal that Ursula von der Leyen and Giorgia Meloni agreed with Saied in July was heralded as a new blueprint for Europe’s efforts to keep migrants out. But the opposite seems to be happening now.

Key of the agreement with Tunisia was the EU’s promise to fund the fight against illegal immigration, paying some €105m directly and promising another €150m in fiscal support. Two months later, the Tunisian government complained that no money has arrived yet. Europeans now accuse Saied of moving migrants from the city of Sfax to coastal areas in order to facilitate their departure towards the Italian island of Lampedusa, which is less than 150 kilometres away. Opening the passage towards Europe takes pressure away domestically, which could score the president some points with his supporters.

Saied can also use the situation to pressure the EU into giving him the money without any conditions attached. He does not want to reform the government, nor abolish subsidies on certain products as the IMF has requested. We always warned that deals like the ones the EU struck with Turkey, and now with Tunisia, are a pact with the devil. They invite devious behaviour on both sides without solving anything. As long as Europe’s governments feel trapped between losing out to the far-right in their home countries and making deals with autocrats that make it look like they are doing something to deter migrants from coming towards Europe, this will remain Europe’s Achilles heel.

19 September 2023

Is Goldman infiltrating Syriza?

A surprise winner emerged from the first round of Syriza’s leadership contest. Stefanos Kasselakis, a 35-year-old owner of a shipping company and former Goldman Sachs banker who lives in Miami, came out of nowhere and declared his candidacy in the last minute. Through a well-organised social media campaign, he became the talk of the town in just one weekend. 

Kasselakis came first with 45% of the votes followed by Efi Achtsioglou with 36.2% and Euclid Tsakalotos with 8.78%. So the run-off is between Kasselakis, with an appeal for renewal similar to Alexis Tsipras when he was first elected leader, and Achtsioglou, the former labour minister, who had been the favourite to win this elections until Kasselakis entered the picture. Polls had predicted that she would beat Kasselakis to win this race. This still can happen in the run up next Sunday, but it is no longer a foregone conclusion.

Kasselakis is not known in Greek politics: his political credentials boil down to volunteering as a student for Joe Biden in the 2008 primaries. Kasselakis's more liberal economic views may not square well with the leftists in the party, but he is considered the better candidate to beat Kyriakos Mitsotakis. If he were to be elected the new leader, he could broaden the appeal for Syriza in a political space where New Democracy is claiming the liberals mostly for itself. But it would be an extraordinary turnaround.

18 September 2023

Starmer's European cake

The big delusion of the UK policy consensus before Brexit was that a relationship based on multiple opt-outs was sustainable. As a semi-detached member, the UK never took ownership of European integration. The Remain campaign never knew how to sell.  

Sir Keir Starmer's attempt to re-write the relationship is based on a delusion of a similar kind, that it is possible to stay outside the single market and the customs union, and get a better deal. This is a political lie. It will almost certainly be exposed as such, and not only by us. Based on the polls, Labour has to be regarded as the odds-one favourite to win the next election. Rishi Sunak was a predictably appalling choice for the job of prime minister. We think, however, that the polling gap will narrow as we approach election day as voters will focus on policies for housing and transport, which should favour the Tories in suburban and rural areas. We should remember that the elections are still more than a year off. The Tories will have an opportunity to unpick Labour's agenda as election day approaches.

Probably the biggest delusion yet to be unpicked is Sir Keir's repeated assertion that there is a better deal with the EU out there. This is simply not true. There was a lot of vindictive commentary from the EU during the entire Brexit process, but the deal that was eventually agreed was a reasonable third-country trade deal. The two big remaining issues at the time have since been resolved: Northern Ireland and Britain's associate membership of the EU Horizon's science programme. If your bottom line is that you do not wish to rejoin the single market and the customs union, there really is not a lot more out there.

The existing agreement is up for renewal in two years. There will be a new European Commission by then. Germany, France, Italy and the Netherlands are all struggling with their economies, and experiencing political uncertainty. When Sir Keir calls Johnson's trade deal too thin, he misjudges what a trade deal with the EU can do. 

He lists the following areas where he thinks he could improve on the deal: business, veterinary compliance, professional services, security, innovation, and research. We can't rule out that they will cooperate on vaccines, for example, or some other limited areas, for which there was no time to reach agreement during the negotiations in 2020. The reason why trade deals with third countries are thin is because vested interests intervene. If the trade deal had been negotiated over a longer period, it would have not produced a materially different treaty. 

We have been arguing that the EU needs to rethink its third-country relations from the ground up. In particular, we think it is a good idea to create an outer layer of integration with countries that seek to be members of the single market, but without the monetary union and other joint policies, for example on immigration. But if the UK does not want to join the single market, there is not much the EU can do. 

Here is a scenario for how this can play out. The contradiction of Sir Keir's policy on Europe will either become an election theme. Or it will become apparent once they hit reality. If the EU plays hardball, as it surely will, pressure will grow from inside the Labour Party for another referendum. The only way to do this would be the way David Cameron did this: put it in a manifesto and see whether you get a majority. Cameron did this in 2015, very much to everybody's surprise, including his own. We would not bet on history repeating itself in the reverse direction. Getting back in is a harder job than getting out. At the very least, you would need somebody who knows what they are doing. 


15 September 2023

How close is too close?

If Brexit is comparable to a breakup or divorce, it is one where the party who ended the relationship talks about it all the time, whilst the other basically ignores it and moves on with their life. The UK’s political class insist that the post-Brexit status quo is not changing. But as Brexit has become increasingly unpopular, and neither party shows much sign of delivering a compelling way to make it work economically or politically, it feels inevitable that there will be some movement.

The EU has not discussed this much, which makes some sense as the UK is undecided about what it wants. That can only go on for so long, however. At some point, the EU should think more about what its own desired endpoint for relations with the UK look like, why, and what this will mean for the EU’s institutional framework as a whole.

We say this as Labour has now defined its approach to irregular migration, the so-called small boats issue. The domestic approach to this will be: softer on the people, harder on the people-smugglers. But the more interesting part is Labour's policy to try to negotiate a returns agreement with the EU. Its response to the question of whether there would be a quid pro quo, taking some refugees or asylum-seekers in exchange for allowing returns to the EU, was that it would be a matter for negotiation.

If this emerged, it might be a proof-of-concept for an even deeper relationship with the EU later on. The biggest red line for the UK has been freedom of movement. Unlike the Windsor framework over Northern Ireland or re-entering the Horizon programme, a returns agreement with quotas would mean budging on migration maximalism. If the political capital Labour gains from being able to solve the small boats problem exceeds the backlash over quotas, that suggests there may be more leeway over migration if it delivers tangible benefits.

But a pro-single market government would pose a problem that it doesn’t seem like the EU has thought much about. Right now, there are countries that are part of the single market, or which use the euro, that sit outside the EU’s decision-making framework. But these countries are much smaller than the UK, both economically and in terms of population. The UK’s sheer size relative to the average EU member state would give it a level of informal influence that Norway or Switzerland don’t have, even if it was outside of the EU’s decision-making process.

Here the internal UK debate is, once again, misleading. It is one about rule-takers and rule-makers, and about seats at the table. As almost anyone who has worked in the EU institutions will attest, it is difficult enough to force member states to implement legislation they have actually agreed to. The EU still has to resolve numerous disputes with Norway and Switzerland. Imagine what it would be like if a much larger country perennially stalled. As for seats at the table, even outside of the EU institutions there are opportunities for the UK government to try and persuade EU member states.

The EU has said numerous times that it is not a fan of à la carte arrangements, but the UK would carry too much weight for any current framework to be workable. Doing so would destabilise the EU, as legislators would have to constantly consider how laws would impact a country that would account for a large proportion of the single market’s GDP and population, despite it not being formally part of the process. It would also be different from Ukraine, since you couldn’t bundle it into the accession process. Ukraine comes up a lot in current discussions on treaty reform, but it’s time to talk about the UK too.