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12 February 2024

How big is Russia?

The first casualty in war is the truth - it happens on our side too. We do it with words and with data. One of the biggest repeated data delusions in the west is that the Russian economy is the size of Spain. This kind of comparison is not only statistically illiterate. It has important political consequences. If we pretend that Russia is small, it is easier to convince people that the battle is winnable, or that the sanctions are very effective.

We noted a tweet by Mikhail Khodorkovsky, one of the old oligarchs, who has now refashioned himself as a supporter of democracy. He falsely claimed in a tweet that Russia ranks 32nd in the league table of world economies. This statistic refers to GDP measured in the US dollar exchange rate. It is ludicrous to use dollar GDP for a country we have cut off from the dollar markets. You have to use purchasing power parity to arrive at a more meaningful comparison, especially in a geopolitical context. We don't care the dollar price of a Russian bullet or tank. We care about how many tanks and bullets the Russians can afford to produce and pay for in roubles. On PPP, Russia ranks on place 5 in the world, directly ahead of Germany. And China ranks above the US. A large part of the west's geopolitical delusion rest on statistical delusions. We live in a place where fake news meets fake data.

9 February 2024

Tusk - meddling again

Donald Tusk has an unfortunate habit of meddling in other countries' democratic processes. Cheered on by the second referendum supporters in the UK during the Brexit years, he became an active participant in the European election campaign in the UK, where he campaigned against Nigel Farage's Brexit Party, and the Conservatives, both of which supported Brexit. Tusk was not just any European politician. He was the president of the European Council at the time.  

We called it a massive political misjudgement at the time - very typical of the delusions that Brussels was under during the entire Brexit process. The UK ended up with the hardest version of Brexit short of a no-deal break-up, precisely because EU policymakers mistakenly thought they could wring this.

Tusk, now  prime minister of Poland, appears not to have drawn any lessons from his disastrous attempt to meddle in the democratic processes of other countries. This is what he wrote yesterday:

"Dear Republican Senators of America. Ronald Reagan, who helped millions of us to win back our freedom and independence, must be turning in his grave today. Shame on you."

One can only hope that US Senators have more important things to do than to listen to Tusk. Because if they did, the might jump the over way. If support for Ukraine becomes a morality play, an exercise in virtue signalling, then don't be surprised that some people will disagree. We believe that a case for military aid can be made, but it has to be made on the basis of strategic interests. His argument strengthens the other side, just as his intervention in 2019 strengthened the Brexiters. 

A failure by Congress to approve the package would constitute a serious setback. The White House still has the ability to act - this is not a binary issue. But it would send a strong political signal - that the support of the west is coming to an end. 

After the defeat of the border deal package in the Senate, to which Tusk's tweet referred, the path towards a military aid package is uncertain. After the defeat of the package, the Senate took a procedural vote not to kill the idea of a Ukraine aid bill outright. What especially the European news media do not tell is that the main obstacle lies in the House of Representatives, where the Republicans have a majority. The Senate may approve a version of a military aid bill, possibly with amendments. It will then be up to the Republican Speaker of the House to table, or not to table this bill for discussion. Congress is also about to shift back towards domestic fiscal policies, so that the foreign aid might simply fall down the list of priorities in the legislative agenda. 

One further important consideration is the impact of Donald Trump. Despite all the media excitement about the possibility that he might get barred from running, yesterday's hearing in the Supreme Court gave us a very strong indication that this is yet another case of wishful thinking. If Trump maintains his lead in the South Carolina primaries on 24 February, the Republican race will be essentially over. At that point, he will be the party's presumptive candidate. He has also widened his lead over Joe Biden in the polls. 

The future of the Ukraine bill is therefore highly uncertain, and it won't help for Europeans like Tusk to hyperventilate about this. Maybe Tusk should encourage his European colleagues to get serious about political integration instead.  Was he not once in a position where he could have done something about it?

8 February 2024

How will France revise its budget?

Emmanuel Macron and Gabriel Attal are big believers in the idea that, for a government, the best way to look after its public deficit is to look after growth. It is a classic assumption in French budget policy. But how do you mitigate risks? Some governments presented budgets that were on the cautious side, counting on better-than-expected figures at the end of the exercise. This government is not one of them. They are in for worse-than-expected economic growth and a budget revision this year, when the EU is just about to reactivate its stability pact.

The current French budget is built on a growth rate of 1.4%, already considered ambitious and above market consensus when announced. With the first signs of a slowdown and a low forecast from Insee for the rest of the year, this now looks untenable. Whether politicians blame it on the international economy or not, the results for the budget are the same. Growth and revenues are going to be less than predicted.

The deficit target, already missed last year, is therefore in danger of being missed again this year. The finance ministry is looking into how the 4.4% target could still be achieved. This may require an extra €10bn in budget savings. This would be a tall order, and certainly not the message Attal’s government wants to send out shortly before the European elections.

The government is thus internally divided over how to proceed. There are two options. The first is to rule by decree, freeze all credits, and adjust at the end. The second is to present an amended budget by March at the latest and push it through parliament using Art 49.3 if necessary. No prices for guessing who prefers what. Macron and Attal are in favour of the first and Le Maire the second.

Ruling by decree would allow the government to tiptoe around the European elections. Renaissance MPs fear that announcing additional savings or even an amended budget ahead of the elections could cost them votes and boost the chances of Jordan Bardella, who is the lead-candidate for Rassemblement National. But this option also risks a not-so-sympathetic verdict from Standard & Poor in their rating shortly before the European elections. A downgrade would increases interest rate charges, and thus make the budget situation even worse.

An amended budget would put things into order. It would signal credibility and responsibility, and may assure other finance ministers in the EU. But given that the government has no majority in the National Assembly, they would be in for a political spectacle with the right. Les Républicains already talk about triggering a censure motion, though that could be an own goal for a party keen to preserve the image of a budget-conscientious party. The government will discuss the options in the next days.

Either way, it means that Attal will have less budget room for projects to buy out protesters or votes in the assembly. Let’s hope the farmers were the last to protest until next year’s budget.

7 February 2024

Labour's trilemma resurfaces

This week in British politics is reminiscent of Napoleon’s quip about preferring lucky generals. Labour has been fortunate to have the latest round of Tory infighting overshadow its own internal disputes. But the rift that has opened up in Labour, over green spending, is quite a serious one. It speaks to wider philosophical differences within the party, which could come out into the open.

The issue is what to do with one of the few concrete headline policies that Labour has announced: its £28bn a year spending pledge for green industry. Labour’s problem has been that this is very difficult to keep consistent with a tight fiscal policy, and promises not to raise substantial new taxes. It has already backed out of introducing the plan from the first year of a new government onwards. Now, the question is whether to get rid of it entirely.

Our interpretation is that there are three camps in the debate. One is shadow energy minister Ed Miliband. He is an enthusiastic supporter of the pledge, and an active green industrial policy more generally. On the other side, you have Rachel Reeves, the shadow chancellor. She makes a virtue of fiscal prudence. Sir Keir Starmer seems to be somewhere in the middle. He appears to be convinced on the merits by the Miliband side. But he is also scared of giving the Tories the opportunity to attack Labour as profligate or tax-raising. Hence a recent assertion that he was still behind the pledge, but with the caveat that it had to fit within Labour’s fiscal rules.

What you have then is a trilemma. There is a desire to boost public investment, and a recognition that austerity is one of the reasons for the UK’s moribund economic performance in recent years. At the same time, the party also wants to keep deficits down, but avoid electorally damaging tax hikes or spending cuts. Something is going to have to give.

The political arithmetic gets even more complicated when you think about the few things Labour could do to boost economic growth without spending more money. Top of that list would be simplifying the UK’s planning system, which makes building housing and infrastructure very difficult. But there’s a reason why successive governments have promised planning reform and failed to deliver it. When angry letters from constituents reach MPs, these ideas tend to slow to a halt.

Sir Keir is, on current form, very likely to be the prime minister by this time next year. But if he wants to make a success of Labour’s time in government, he has to get off the fence and figure out what his party’s priorities are. Otherwise, we risk seeing more of the same drift that has been a feature of recent British policymaking.

6 February 2024

Farmers' protests - a cultural view

Farmers' protests are still spreading across Europe. At this moment Austria, Denmark, Finland and Sweden are the only four EU member states where farmers have not taken to the streets, according to Euractiv. We are no experts when it comes to farming, but we are wondering why is it that in some countries farmers protest while in those few ones they do not. Not all farmers that are on the streets have income problems or are against the new green transition norms or are concerned about Mercosur or Ukrainian imports. Some protests are organised out of solidarity with other farmers with the upcoming European elections in mind. 

Living in the UK, we looked into why there are no farmers protests here. Lliam Stokes asked the same question in his article for UnHerd. It is not that UK farmers feel less of an existential threat. A poll showed that 49% of fruit and vegetable growers and 32% of dairy farmers fear their business won’t survive until the end of 2025. But UK farmers seem to feel less of an urgency to take to the streets, also weary that populist parties may exploit their protests and that the public won’t support them. Another factor is that UK farmers differ from the European peers in the sense that two thirds have farms with more than 50 hectares of land, while two third of the EU farmer businesses are a tenth of that size and UK farmers have not to cope with the imports from Ukraine as much as their EU peers have to do.

There may also be cultural differences at play including the roots for healthy eating. In countries like Germany or France, the first organic shops in cities emerged from a movement on the left of the political spectrum. We remember the first products were not enjoyable to eat but people bought them for the good cause. In the UK, farm shops or markets with their emphasis on conservation and tradition have always been part of healthy food shopping. Wealthier city people would drive to farms on a Saturday or Sunday for their veggies and fruits. Small producers and artisans offer their products on markets in the city, while sourdough bakeries shot up over the past years in cities where there had been mostly toast bread from the supermarket before. The green movement seem to come more from farmers and innovative artisans here, not from regulators.  


5 February 2024

Changing tack in the Middle East

These are critical times in the Middle East. The US has launched airstrikes on Iraq and Syria targeting Iranian-backed militias in retaliation for an attack on an American base in Jordan, and destroyed Houthi missiles that were ready to attack ships passing through the Red Sea. As long as the war in Gaza continues, the risk of escalation into the region remains significant.

Europe is not a key player in the mediation towards the end of the conflict. The EU Middle East peace plan proposal, circulated two weeks ago, backed a two-state solution. Member states agree on these principles, but are disunited on how to achieve them amid Israel’s blunt rejection.

But there are things that can be done. UK foreign minister David Cameron backed the idea of recognising a Palestinian state before any Israeli-Palestinian talks on a two-state solution come to a conclusion. Recognising Palestine will not be at the beginning but also does not have to be the end of the process, according to Cameron.

There is also movement on sanctions. Joe Biden signed off sanctions on four young settlers for escalating violence against Palestinians and Israeli activists. It is a small step towards enforcing red lines on extremists. Not that those four settlers would ever want to enter the US or have assets there that they no longer could access to. Nor will those sanctions stop them on their messianic mission. But there are knock-on effects. Other countries like Canada have followed up with sanctions against settlers too. One Israeli bank already froze the accounts of one of them. Banks that deal in the US financial system will have to decide whether to comply with US sanctions or risk secondary effects. The settlers did not act alone, but in a political context that allowed settlers to expand in the West Bank illegally over decades. There is thus an implicit threat that sanctions could eventually reach politicians too.

The EU has been discussing sanctions since December without being able to agree on them. Last week one or two countries are still rejecting sanctions against extremist settlers, according to the Irish Times, naming Hungary and the Czech Republic. Those in favour of sanctions argue that displacement and violence of Palestinians make the two-state solution less likely. But all EU countries need to agree on this. The latest spat amongst member states is over the EU’s aid to Unrwa, the United Nations relief agency that supports two-thirds of Gaza’s population. Within the EU, Germany, Italy, the Netherlands, Finland, Estonia, Austria and Romania followed the US and suspended funding for Unrwa, after Israel accused 12 employees of being involved in Hamas’s October 7th attacks. The EU promised an audit, but did not suspend funding.

Other ideas have come forth which do not stand much chance of being adopted. Leo Varadkar suggested in Brussels last week that the EU, as Israel’s biggest trading partner, should look into the EU-Israel Association Agreement on the grounds of a breach of its human rights clause, which would put free trade arrangements into question.

Neither Hamas nor Benjamin Netanyahu’s government have an interest in a truce if they cannot survive politically. Pressure and solutions thus have to come from the outside for Israel to put the two-state solution on the table. As Bernie Sanders pointed out, it is our reputation that is at stake too. The promise of normalisation between Israel and Arab states once there is a fair solution for Palestine could help take the air out of the extremist movement. Recognising Palestinian rights to the land would be a first step to ensuring Israel’s right to exist.

2 February 2024

Sunak's successful NI fudge

Rishi Sunak delivered on what Boris Johnson had promised the DUP in Northern Ireland, a compromise that is acceptable to everyone - the EU, Brexiteers and the DUP. It allows the Northern Ireland Assembly in Stormont to reconvene for the first time in two years. It is no small achievement, but it is a fudge, comments Sam Coates from Sky News.

Northern Ireland still has a special status in the UK as the only one of the four nations with borderless access to the single market. It also means that most EU regulation is still expected to be implemented only in Northern Ireland and not the three other nations of the UK. But assurances were enough for the DUP leadership to accept that this is as good as it gets.

The latest deal builds on the Windsor Agreement, in force since October last year, which divides exports from Great Britain into a green lane for those destined to stay in Northern Ireland, and a red line for transit to the EU or elsewhere. Two new pieces of legislation are now expected to be agreed by the UK-EU Joint Committee, which will ensure that there are no checks for goods destined for Northern Ireland under any circumstances, and confirm Northern Ireland’s place in the UK. It also promises an East-West Council, a new trade body to facilitate trade inside the UK, and one UK cabinet meeting in Northern Ireland annually. Northern Ireland will also receive with this deal £3bn to spend on public services.

The real test will come in the future. The commitment may discourage the UK from diverging too much from EU regulation if they have to do an impact assessment for every piece of legislation. There is also still potential for trouble in the future. The Windsor Framework introduced a mechanism called the Stormont brake, which would let the assembly object to new EU rules that could affect Northern Ireland's trade arrangements. This has not been tested yet, since the assembly has not convened for the past year. But if the EU were to take a different regulatory course from the UK, expect objections to come forth from the assembly.

It also will be interesting to watch how the executive will function with Michelle O’Neill and Sinn Fein as the largest party and the DUP in second. This order has not been tried ever before. It is likely to make some unionists uncomfortable with a first minister of a party that supports leaving the UK and unifying with the Republic of Ireland. That would, of course, end any ambiguity about Northern Ireland's status in the single market.

Flexibility, pragmatism and trust were some of the words used in the accord. This will eventually be tested. But Northern Ireland has a regional government again. Let’s hope they use this time to improve daily life for people there in health, education and the various other area in their competence. This would give less prominence to the identity battle between unionists and republicans that has dominated the political discourse since Brexit.

1 February 2024

How will they repay the debt?

We had a laugh this morning when we read a news headline in Handelsblatt: How can Italy and France ever dispose of their debt?

This is a question that nobody else in the world would ever ask in this naive way, including most fiscal conservatives. The reason why Germans are prone to ask this questions is that their language uses the same word for debt and for guilt. Language affects how we think. The Germans don't like Schulden, and assume, wrongly, that no one else does either.

The more important questions to ask about French and Italian debt are under what conditions the combined level of private and public sector debt in these countries is sustainable, and what would happen in the event of a sovereign debt crisis. Even though Italy has a higher level of public sector debt than France, we are more concerned about France, because of very high level of private-sector debt, the current fiscal dynamics, and French politics. It may just take a downgrading by a ratings agency to unleash a truly toxic dynamic.

The EU would be without an instrument for a sovereign debt crisis in a large country. The ECB's Transmission Protection Instrument is relatively flexible, but it cannot credibly be used for a country like France that has exceeded the 3% deficit rule for more than a decade. 

The ECB would be confronted with an existential question. If they agree a bailout against all prudential principles, the euro area would become the profligate debasement zone that German economics professors of times past always warned us about. And if they don't, the euro area would collapse in an instant. To say that there are no good options would be an understatement. This is the kind of risk you run in a monetary union that is not a fiscal union. EU countries cannot bail each other out. 

In our lead story about today's EU summit we made the point that the impasse with Viktor Orbán was not only foreseeable, but also foreseen, including by us. This is the big foreseeable financial accident. 

So the answer to the Handelsblatt question is: They won't. But you will.

31 January 2024

Germany - stuck in the 20th century

A hilarious debate has broken out in Germany - about whether teachers are lazy. The debate was triggered by the OECD's Pisa study co-ordinator Andreas Schleicher, who told a German newspaper that German teachers had not arrived in the 21st century. This debate comes in response to Germany's poor results in the last Pisa comparison between schools. Schleicher said teachers were complaining too much about their workload. We think Schleicher missed a trick. You don't ever win arguments about work ethic, but the criticism that German education is stuck in the 20th century is right. It is part of a much broader issue. The car industry, too, is stuck in the 20th century.  

We can offer three observations. First, as we write in our lead story this morning, the way the German government implements austerity has led to an underfunding of critical public services. Teaching is the authority of the federal states, which had particular funding pressures. Germany spends 4.1% of GDP on education. France and the UK spend 5.5% each. Estonia, the leader of the Pisa studies in Europe, spends 6.6%. 

Second we note that Germany's aversion to all things digital is particularly strong in the education sector. If you want to criticise the teachers, this is where we would start. We recall that back in 2015, the head of the German teachers association said that there was no evidence that children in schools with computers performed better than children in schools without. He argued that the digital revolution should have no impact whatsoever on education. This comment reflects widespread attitudes in German society. One of the consequences had been that German schools were wholly unprepared when Covid struck. We are not talking about mobile phones, but the use of electronic whiteboards in class, the use of software for data visualisation for example, and homework discussion groups. 

And finally, we note that the majority of Germany's 800,000 teachers have tenure: they are civil servants. This does not imply they are lazy. But it is also not surprising that they are not to ones who are most open to change.

30 January 2024

Another German party

With the AfD and Bündnis Sahra Wagenknecht, Germany now has two populist parties that operate outside the mainstream of politics. A third one is in the process of forming: a national-conservative split-off from the CDU. It is to be led by Hans-Georg Maaßen, a former president of Germany's national security service - the office for the protection of the constitution.

After he left his job, Maaßen joined the CDU and became chairman of a conservative caucus inside the party, the union of values. It is a group that over the years distanced itself from mainstream CDU positions. The union, for example, rejects any form of immigration. It is also open to a coalition with the AfD, a taboo subject in the CDU. 

A poll, commissioned by a weekly conservative magazine suggested that the potential for such a party is 15%. The potential is a category that has become increasingly important in German opinion polling because it reflects overlapping party preferences, as opposed to the highly volatile pinpoint forecast. The potential for a Maaßen party is similar to that of a Wagenknecht party. Success will depend primarily on a party's ability to project itself with a clear profile. We think there is a political space between the CDU, which has moved increasingly to the centre, even with Friedrich Merz as leader, and an AfD that has moved to the right. But that space needs to be filled intelligently. We are not sure that Maaßen is of the same political calibre as Wagenknecht. 

In the past, it has always been difficult for such parties to form because the CDU accommodated conservatives in its leadership, and because any attempt to create a national-conservative alternative always ended with an infiltration of neo-Nazis. That is exactly what happened to the AfD, which started off as a party of economics professors opposed to the euro, and ended up where it is today. A similar fate befell Die Republikaner in the 1990s. 

We think that Maaßen has a chance to defy the same fate, if only because the AfD already exists. There is no point in neo-Nazis trying to infiltrate yet another party, given their high success rate with the AfD. The strong radical Christian overtones of the union-of-value may also set it apart. We think this party could have legs, not necessarily for this year's election, or even the federal election in 2025, but afterwards. If the CDU/CSU returns to power in 2025, it will form a coalition with either the SPD or the Greens - or both.  This will open up political space for a conservative party on the right. 

Maaßen's group is not yet an official party. He has now left the CDU, and this week he assembled a leadership group of people ahead of a process towards the formal formation of a new party.