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26 July 2022

Summer heat: unprepared or ignorant?

Europe was not prepared for the heat this summer. Some factors are structural: houses in the north are not build for the heat, economies are counting on cooler waters, and societies have yet to change their habits.

But the change in temperatures or volatility is nothing new and is there to last, according to climate change experts. Heat has been the biggest natural disaster in Europe over the past decades, but the level of preparedness did not match the urgency for action, writes Politico. Wildfires have been raging through Southern Europe, and there were heat fatalities throughout Europe which would have been preventable if we had been better-prepared.

This summer, we also found out that the heat adaptation is not only about health and wildfires. Transport, energy and tech infrastructure struggle in temperatures of 40 degrees or more. Nuclear reactors in France and Belgium had to be powered down as the river water used to cool them was too hot. The same applies for data warehouses. Google and Oracle faced failures of their cooling units up north due to what Oracle called unreasonably high temperatures. The heat, combined with the lack of water, means less cooling for data and reactors, something the industries are not yet prepared for. Transport has similarly struggled. The runway in Luton airport was melting under the heat, and British railways shut down in some areas. Bridges in Amsterdam had to be sprayed with water to allow proper functionality, and motorways in Italy and Germany had to be shut down due to forest or field fires.

In summers like these, emergency responses from fire fighters and hospitals will need to be on lengthy high alert periods. Field and wildfires were not only recorded in the south of Europe, but also more north, in Germany and Slovenia. Some of their emergency responses take simply too long. It takes at least two hours in Germany for firefighters to organise a helicopter through a bureaucratic process that goes through state ministries. This compares to about 26 minutes in Greece, where wild fires and heatwaves are a regular feature of the summer.

In the EU all member states have a climate adaptation position in their budget, but it is either underfunded or lacking a proper plan. Only half of the 27 EU countries have a heat emergency health plan in place. France is one exception, with its municipal plan to protect and alert its citizens, implemented after the devastating heat wave in 2003. In Germany, local authorities seem unprepared. Die Zeit found that 80% of the 300 district communities have no local heat plan in place. Yet heat-related deaths seem relatively high in Germany, and the federal environment ministry called upon them five years ago to do so.

Then societies need to adapt to this new era of heat and volatile weather patterns too. Questions like whether to hold a sports event in the heat, how to look after the vulnerable, and how to get more climate-smart in their use of energy will be for every society to figure out. Let’s hope they are better prepared next time.

25 July 2022

The German professors are back

Tomorrow and Wednesday, the German constitutional court will conduct hearings over the recovery fund. When the plaintiffs brought the case in 2020, the court initially refused to grant an injunction against it, but this itself is no indication on what the ruling will be. We see no way that the actual decision, or the German implementation of the decision, will be overturned. The significance of the case is about what the German government can do in the future. Our expectation is that the court will broadly agree with the government that this was a justified, one-off emergency measure. But it will lay down in black and white that this exercise must not be repeated.

This is also our reading of consecutive rulings of German constitutional court cases. Parliament is entitled to do what it does in an emergency, but it cannot bind future parliaments. An auto-renewal of the fund, or even the creation of a fictitious emergency to justify an extension, runs counter to German constitutional law. 

What we cannot ascertain is whether the views of the court itself might have changed. Legal opinion, too, changes over time, and some of the court's most conservative voices have retired, or are about to retire. But the profession of German constitutional lawyers is a close-knit community. You don't get to the top of the greasy pole of the German legal establishment with wildly unorthodox opinions. 

One important technical issue the court will debate is whether the recovery fund went beyond its narrow remit by channelling investments into digitalisation and the environment.

What the series of rulings will do in the long-run is to restrict the freedom of German government. As we keep saying, a fiscal union needs treaty change, and constitutional change in Germany and several other countries. There are no backdoors to a fiscal union.

22 July 2022

Shipping News, coal edition

One of the more shocking statistics about German electricity production is that coal constituted some 32% in the third quarter of 2021. Coal is not only the largest single source of power generation in Germany. Its share has been rising, up from 26.4% from a year earlier. The reason is the increase in gas prices. The withdrawal of three nuclear power stations at the beginning of this year, and the remaining three at the beginning of next year, will lead to a further increase in the proportion of coal in energy production. Robert Habeck wants coal to become the fallback in case Russia cuts off the gas. So there could a massive short-term increase in coal production.

Except the industry is not ready for it. One big problem is transportation. We reported on the falling levels of the river Rhine, and its huge role for Germany’s supply chain. This is where all the heavy stuff is transported, like coal. Germany has no problems importing coal, but struggles to get the coal to power stations. Apart from low water levels, the capacity of Germany’s logistics industry is being used up to transport wheat and other cereals from Ukraine. The rail system is also overloaded. Transportation infrastructure is fixed in the short run. And since coal production is ultimately doomed, nobody has invested in long-term transportation infrastructure projects, and we presume nobody will.

The reason for the lack of investment is the government's plan to phase out coal production by 2030. What they did not see coming is the reversal of the downward trend in global production that started last year and that, we presume, will have continued this year. Habeck’s plan to expand coal production further in case of a Russian gas embargo came as a shock to the industry, as Bild reports. They were not prepared for this. It means the decommissioned coal-fired power stations would have to be dusted off and rekindled. They also haven't invested in staff.

So here is the next supply chain bottleneck.

21 July 2022

Nord Stream 1 is back

Nord Stream 1, which acts as the primary Russian gas supply route to Germany, is re-opening today. It is impossible to tell how the situation will develop in the coming days and weeks, and there will be some remaining turbine-related tension. But the signs point to it staying running, but well below capacity.

A preliminary indication that there may well be gas flowing through Nord Stream 1 today were day-ahead nominations for two other pipelines that the Russia-Germany link feeds into. The NEL and Opal pipelines both receive gas from the German endpoint of Nord Stream 1 in the town of Greifswald, and both have transit capacity booked for today. These indicated that the amount of gas Germany receives should be in line with what they were getting before 11 July or somewhat lower, 30-40% of the pipeline’s capacity. Data from Nord Stream 1 have now confirmed that gas is flowing at 40% capacity, or 65m cubic metres a day, a critical point for the German government.

From a logical standpoint, this would also make a lot of sense. Putin doesn’t need to completely cut off the gas to inhibit the EU’s ability to refill its storage facilities. This is something that the German government, the European Commission, and the International Energy Agency have all been at pains to point out.

Curtailing but not stopping flows has a triple effect. It reduces the EU’s resilience ahead of the winter by preventing them from meeting gas storage targets, and drives prices up, meaning more revenue for the Kremlin. Finally, it also reduces the pressure on the EU’s member states to act collectively in response to the threat. A robust response at the European level is less likely with gas still flowing, albeit at a low level, than if it is shut off completely.

That’s a problem for the EU, because this is when you really want to be dealing with the problem at the highest level possible. If Putin shuts off the gas over winter, they will be trying to sort out a plan amidst the wreckage. The Commission has brought forward a fairly robust package to reduce gas demand going forward, asking member states to cut demand by 15% between the beginning of August and winter. But action on this, much less on something like joint procurement, will need more political will.

Spain has already poured cold water on the idea. Illustrating the kind of political disagreements that are to come, Teresa Ribera, the country's energy minister, repurposed an old German turn of phrase from the Merkel years. The Spanish, according to her, had not lived beyond their means from an energy point of view. We doubt that Ribera and the Spanish government are the only ones who feel that way about this. 

On the storage front, Germany hasn’t been doing itself any favours either. Although Handelsblatt has reported that it is close to a deal with stricken gas buyer Uniper, nothing has been inked yet and negotiations have been a roundabout. Uniper has had to start drawing from its storage to fulfil its obligations. The longer this carries on for, the tougher a position Germany, and Europe as a whole, will be in over winter.

20 July 2022

European Parliament to dissolve Fidesz

Well, it won’t. But it should.

We had a good laugh when we heard that Fidesz voted to abolish the European Parliament in its current form. We are not sure that there are any other forms. The EP has a stronger foundation in the body of European law than any single member state. Under Art. 50 TEU, member states are free to leave whenever they choose, but the European Parliament cannot be dissolved. Nor can it dissolve itself.

We can and should have a serious discussion about how to reform the European Parliament, but Fidesz' stunt is not a contribution to that discussion. Fidesz is effectively saying that it does not agree with Hungary’s membership of the EU. So why not take them up on this?

Maybe as a start, the European Parliament might want to pass a resolution to dissolve Fidesz. Or challenge Fidesz to trigger Art. 50 if they are in disagreement with the treaties. The EU’s previous strategy to get Hungary into line through the rule of law mechanism has predictably failed. It was not only predictable, but also predicted, including by us. The reason is that the EU relies on member states to pass legislation and decisions that require unanimity. It was a reflection of the EU centrist-bureaucratic mindset to think that it would be a clever idea to withhold budget appropriations. This is the military equivalent of a blockade. We always advise countries to avoid blockades of any kind, including the economic kind, because western democracies don’t have the stomach for this. If you were really serious - which you are not - you would follow the advice of Mark Rutte: dissolve the EU, and reconstitute it in exactly the same way as it is now - minus Hungary. Clearly, this is not going to happen.

So the EU will need to smarten up. The fight against Hungary has to be political. For starters, remember that dictators and their fan clubs are vulnerable to humiliation. Time to get out the kompromat

19 July 2022

Adapting to the heat

Today will be another heat peak in Western Europe with record temperatures. Portugal, Spain, Italy, France and the UK are particularly badly affected. Hundreds of people have died already, and wildfires are raging in some regions.  The UK called its first ever heat emergency, not used to the kinds of temperatures in which airport runways are melting. The Gironde region around Bordeaux has seen more than 100,000 hectares set ablaze.

The heat is not only affecting peoples’ health. It will also affect food growing on the land. Farmers are already concerned about the harvest this year, another worry on top of the war in Ukraine and its repercussions on world supply of grains, gas and fertiliser.

We are still in the first response, where all is about damage control. Keep people hydrated and warned about the risks, put emergency services on alert. But this kind of weather is unlikely to be an outlier. Climate change promises more volatile and extreme weather patterns. Are we ready for this new trend?

A change in climate should not mean that people and the land cannot thrive. But it needs some change to adapt to the new reality. And this transition can be bumpy or smooth, depending on the choices we make.

This transition affects all parts of a society and crafts. How can we keep people healthy, and crops resilient, in these new weather patterns? Architects will seek more efficient ways to keep houses cool, for instance. British houses are not build for this heat. There are no shutters in most buildings. Farming will have to open up to new methods from agricultural science, or practices already used in other similarly hot countries. At all stages of the process, there is an opportunity to revise practices and become more climate-resilient.

We seem to be still in the early stages of the learning curve. Africa may have some valuable lessons to teach us if we can translate them into our cultures. We are so used to exporting our know-how, including on farming methods, to Africa. But how to live and thrive in hot climates is something we are far less familiar with. Most of the news and media coverage only focusses on the disaster itself. But people also develop some astonishing forms of resilience that we can only learn from. It is not an orderly process, but a resilience built on their networks with all their creativity and capacity to adapt to an ever-changing environment.

18 July 2022

What Scholz wants from the EU

Ask what you can do for the EU, and not what the EU can do for you. That would be our response to Olaf Scholz. He demanded in a newspaper article this morning that the EU abolishes the national veto on foreign policy.

Smaller EU countries would be mad to give up the veto in foreign policy in our view unless Germany commits to a shift towards a more EU-compatible economic model. The two are toxically intertwined. There was not a word on this from Scholz, no grand bargain on offer. Right now Germany needs a strong EU to further its own interests. But that wasn't always so, and won't be always so in the future.

The fundamental problem we see is the complete lack of awareness inside Germany of how its own political choices affect other EU countries. The dominating narrative about the euro area's sovereign debt crisis remains one of profligate southern European government and of rule-abiding Germans, generous in their support for southern Europe. The Merkel government could not care less about objections from east European countries and the US to the Nord Stream 2 pipeline. There is also no hint in discussions that structurally high export surpluses are the mirror image of structural savings surpluses and financial imbalances within the euro area.

Writing in FAZ this morning, Scholz is framing Germany's problem as one of overdependence on Russia. But it goes deeper. The dependence on Russian gas is intertwined with a gas-guzzling economic model that requires large export surpluses simply to stay afloat. The times when Germany's current account is in balance, as it is now, are the times when the country is in economic crisis. Germany dependence on Russia and China was not an accident. It was part of a wider strategy.

If you harmonise EU foreign policy without addressing this imbalance, all you do is making foreign policy more potent, but without changing the actual policy itself. We are elevating national neo-Mercantilism to a European neo-Mercantilism.

Others should respond to Scholz' proposals not by rejecting them outright, but by making demands of their own. The most important would be, in our view, to complete the banking and capital markets union, which would leverage the EU's ability to impose economic sanctions on third countries. We would even go further and insist on a full fiscal union, if only to prevent a situation where a common EU foreign policy is subjected to sectarian German and French economic interests.

Whatever you do, do not follow the old adage to integrate first, and think about the consequences later. This is what brought the euro's perma-crises. This is the time to widen the debate to the goals of foreign policy itself, rather than focus just on voting rights.

15 July 2022

Putin, a rational agent from the textbook

Microeconomic thinking can sometimes be very useful to cut through the fog of political discourse. Olivier Blanchard got the Russian gas policies spot on with his comment that Russia is a gas monopolist who faces inelastic European demand, meaning that Europe is dependent on it and has no alternative suppliers. Blanchard goes on to say we are in the rare situation where the monopolist has a reason to raise the price of his commodity to near infinity. The reason is that we announced to the world our intention to get out of Russian gas permanently once we have found alternative energy sources. The only thing that keeps a monopolist sweet is the expectation of further business in the future. We have taken that expectation away. The rational agent from the economics textbook would thus behave like the meanest monopolist. Raise the price until the pips squeak. 

A short while later, the Russia foreign ministry essentially followed up on Blanchard. It said that the further operation of the Nord Stream 1 pipeline will depend on economic sanctions. We expect the Germans to take Russia’s blackmail very seriously. Despite official denials, we believe that there is intense pressure within the government for a dirty deal with Putin: you, the Russians, keep the gas flowing. We, the Germans, commit to buying your gas at least 10 years. But we won't tell anyone now. Nobody will care anymore when this becomes clear in two years time. 

This is not what the Germans will ever admit. Not even privately. We may be wrong on this. We may underestimate Olaf Scholz' determination to make Germany, and his party, independent from Russia. The Germans won’t blame Scholz and his government for gas shortages. Everybody knows that the dependency on Russian gas was the work of Gerhard Schröder and Angela Merkel, not of Scholz, Robert Habeck or Christian Lindner.

It would be a triumph of hope over experience. Our experience has been that Germany goes to the most extreme length to preserve its gas-dependent business model. A dirty deal with Putin would go a long way also to defuse the biggest conflict inside the coalition. The FDP is currently putting pressure on Habeck to keep the three nuclear power stations running. Spiegel reports that this issue is now on the verge of turning into a first-order government crisis. The Greens are saying that the nuclear exit will happen, no matter what. If the gas flows, Lindner can stick to his fiscal deficit reduction plan, on which he staked his credibility. And the SPD is off the hook too. The fate of heavy industry and that of the SPD are closely intertwined. 

The Greens hold all the cards. The FDP can’t really afford to walk out of the coalition over this issue. It has no alternative political power options and the polls look dismal for them. If Putin keeps the gas flowing, this conflict won’t boil over. Also, we should not underestimate the pressure Scholz is under from German industry. They tell him every day that the German industrial model depends for its survival on the kindness of dictators. They are right. German industry has a very long tradition of coddling dictators, domestic and foreign. Like Berney Ecclestone, they, too, would take a bullet for Putin.

If the gas miraculously comes back at the end of next week, we know for sure that Putin received iron-clad assurances from his German friends. This will not be made official. Scholz seems comfortable with sending conflicting messages, like when he promised weapons deliveries to Ukraine, and then frustrated them administratively. He may play the same game on energy sanctions. Say one thing, and do another. This is how Germany has been playing its variance alliances in the past. It would constitute in policy if they changed this. 

We already saw that the Scholz administration was willing to break sanctions just for the sake of the gas. They put pressure on the Canadian government, presumably with some heavy pushing from the Biden administration, to send a turbine to Gazprom that was apparently needed for the maintenance work. The idea was, as Habeck said, not to give Putin an excuse to cut off the gas. It is rather naive, but very typical of the German discourse, to think that Putin needs excuses.

We look at Putin as that elusive rational agent from an mciroeconomics textbook. And he is confronted by customers who have never read economic textbooks. We are just adding one and one together.

14 July 2022

Too clever by half

Elimination competitions like the Conservative leadership elections have their own rules and their own dynamic. The best way to describe the dynamic of the preselection process is the old adage about French presidential elections. People vote for their preferred candidate in the beginning, and for the least objectionable one in the end. This is going to happen here too.

Forget all this idle talk about momentum, or tactical voting, and remember that journalists are paid to create stories even if there aren’t any. We also had a laugh when we heard that supporters of Rishi Sunak would vote tactically in favour of the two candidates he would be sure to beat in the final round. This was too clever by half, if only because the two candidates he was certain to defeat were both eliminated in round one.

Tactical voting at that level of sophistication is almost impossible because the vote is secret, and you have no way of knowing how the others are voting. It is a version of the prisoners' dilemma in game theory.

In an election like this one, the initial rounds broadly reflect first preferences across a wide range of candidates. Since the final vote is cast by a different group, Conservative party members, tactical voting is certain to become dominant. Instead of voting for your first best choice, you are voting against your least favourite one. In the final round of voting next week, where three candidates get whittled down to two, this is the moment to watch out for. If this will be a contest between Sunak, the fiscal responsibility and anti-Johnson candidate, Penny Mordaunt, who combines social reform with a hard line on defence, and Liz Truss, who ticks all the Thatcherite boxes, it is quite possible that Mordaunt prevails because she is less hated, and also less known, than the other two big beasts.

Voting is always about both what you like and what you hate. As with everything Tory, it is easier to know what they hate than what they want. So that in the final round of the preselection contest, it is quite possible that negative sentiments outweigh the positive ones. The most hated candidates are Sunak and Truss. It is not a pro-Brexit or anti-Brexit thing, at least not directly. It is true that nobody talks about Brexit. What they are talking about is even older: Thatcherite supply-side policies. Should you consolidate your finances first, and then cut taxes, or do it the other way round? And it is about defence spending. Sunak is least enthusiastic about defence spending if only because he knows that high defence spending kills your budget. Just ask Christian Lindner.

The most interesting of all the candidate is Kemi Badenoch, who came out with the astonishing proposal to break up the UK treasury. This is exactly what we would propose too. If you were to embark on a strategy to produce an alternative post-Brexit economic model, this is where you would have to start. With Sunak-vs-Truss, this is not going to happen. Or with Sunak-vs-Starmer. Badenoch is the first UK politician we have encountered who talks about post-Brexit regime shifts with clarity. We suppose she could be the leader one day.

Our baseline case is this. The Tories will go for Truss, Sunak or Mordaunt now. Then go on to lose the next elections. The leadership contest that is going to be really interesting is the one that happens then.

13 July 2022

So much for the rule of law

Whether over foreign policy, as was the case with the Russian oil sanctions, or tax, as we discussed yesterday, Viktor Orbán has a knack for frustrating the rest of the EU’s best-laid plans. While there’s always some nominal, usually economic performance-related excuse, it’s not hard to figure out that the real motivator behind Hungary’s moves is EU recovery money. The European Commission has yet to approve €7.2bn worth of grants for Hungary, and is exercising the recovery fund’s conditionality mechanism because it has concerns over potential misuse of public funds.

Orbán has more than enough incentive to kick over a fuss over the funds. His government’s fiscal solidity, and Hungary’s wider economy, is in serious trouble. Hungary’s budget deficit for the first half of the year is virtually the same as the value of its EU recovery grants, and is 92% of its full-year target. Lavish pre-election spending and inflation-shielding measures inflated the figure, which the government risks overshooting.

Hungary’s budgetary position has eased somewhat through May and June, but that’s thanks to an even bigger problem: inflation is not going away. Core inflation hit 13.8% year-on-year in June, the highest it’s been in 24 years, well before Hungarian EU membership began. Hungary’s central bank raised its base rate by 200bps yesterday, after a 185bps hike two weeks ago, to try and stave off a collapse in the forint. As of this morning, the forint is down 9.6% year-to-date against the euro.

This leaves Orbán with a tricky economic problem to solve, one that would be easier to deal with if he had access to EU funding. His carrot-and-stick approach to the dispute with the Commission was initially stick-heavy. First, there was the standoff over oil, which lasted almost a month. Then more recently, blocking corporate tax harmonisation in line with OECD guidelines. But there has, more recently been some carrot, and he has promised to make a few changes to how funds are disbursed by the government in an attempt to appease the Commission.

These changes are, however, cosmetic. As Kim Lane Scheppele argues, while they address the procedural side of the issue, they do not tackle the fundamental cause of the Commission’s concerns: institutional capture. Orbán’s Hungary suffers from a serious lack of administrative, prosecutorial, and judicial oversight. So long as government officials, businesses, functionaries, prosecutors and courts are caught up in the same nexus, an environment exists in which corruption can thrive.

But handling these issues could raise a consistency question for the Commission. They recently struck a deal with Poland over recovery funding after the PiS-led government agreed to rule-of-law concessions. These were, however, also cosmetic, and did not fully address the issue at the heart of that particular dispute: the government’s ability to unduly influence the judiciary.

For various reasons, the Commission has clearly made their peace with Poland, and is taking a different tack with Hungary. Poland’s rule-of-law problems are not explicitly related to the funds themselves, unlike Hungary’s. The Polish government is also much more popular within the EU after their strident response to Russia’s invasion of Ukraine. Hungary, by contrast, is isolated. Crucially, Poland’s backing for Hungary is more tenuous now.

The Commission could continue to take a hard line against Orbán, having already picked their battles. But Hungary can still wield its veto. The Commission’s battle with Budapest could also be complicated by the largest anti-corruption party in Bulgaria’s parliament failing to form a government last week. An election before the end of the year would potentially return Boyko Borissov’s scandal-wracked Gerb party to government, piling more on the Commission’s plate.