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5 February 2021

The politics of Sputnik V

Sputnik 1 was the first artificial satellite, launched in 1957 as a demonstration of Soviet technological superiority. Sputnik V is a vaccine with exactly the same claim. 

We find it interesting that Germany in particular is treating Sputnik V as a potential political saviour. We notice that Angela Merkel is getting nervous. At a phone-in with citizens, she came under attack from people who accused her of putting their lives at risk. The EU's vaccine disaster has the potential to turn into a first-order political crisis for the government in an election year. Merkel is particularly worried about the now-observable spread of the new UK and South Africa strains. The vaccination programme may not end up arresting the spread of those mutants in time. 

Sputnik V is technically similar to the Oxford/AstraZeneca vaccine. Yet while German officials cast doubt on the UK product, they are embracing the Russian one with a far less critical mind. They did so even before the latest Russian test results were published in the Lancet. We take no view on the effectiveness of vaccines and on published statistics. What does not escape our attention, however, is the politics of Sputnik V.

Germany can hardly rely on a Russian vaccine to escape from a self-inflicted political crisis, and then boycott the Nord Stream 2 gas pipeline. Sputnik V will end up vaccinating Germany against the advocacy of sanctions. We already hear lots of voices - including from Martin Schulz - that Germany should separate its support for Nord Stream 2 and its stance on the imprisonment of Alexei Navalny. This is telling us that German politicians care less about Navalny than they pretend. Germany made itself dependent on Russian gas because it messed up energy policy with the sudden withdrawal from nuclear power. Now they are making themselves dependent on Russian vaccines after they messed up vaccine procurement. Germany wants to do business with Russia. 

4 February 2021

Sánchez's marriage of convenience

Pedro Sánchez plays a dangerous game. El País reports that the Spanish prime minister was under fire yesterday after his comments that Santiago Abascal, leader of Spain’s far-right Vox party, was a leader with flashes of a sense of state and responsibility. In the same session of the Congress of Deputies, Vox members went on to rail against an invasion of immigrants to Spain, prompting outcry across the board and accusations of fascism.

Yesterday’s drama demonstrates the pitfalls of accepting far-right support. Vox surprised observers last Thursday when it abstained from a vote that will allow the government to spend €140bn of EU recovery fund spending between 2021 and 2026. Politico reports that his coalition government had been on track to be defeated after the opposition People’s Party and Catalan Republican Left party, ERC, announced their intentions to vote against the bill. While Vox criticised the government for opaque mechanisms put in place to spend the money, its 52 MPs did not vote against it. Vox insisted that there had been no negotiations with the government in exchange for its support, choosing instead to blast the PP for being destructive. The socialists refused to comment.

It was a different situation just a few months ago, when Vox brought forward a vote of no confidence against Sánchez over his handling of the pandemic.  He and his coalition survived thanks to the support of the PP, and Sánchez offered similar praise to its leader, Pablo Casado, for having a sense of state. The tables have certainly turned since then, and Cascado was fiercely critical of Sánchez yesterday, calling the new alliance a Frankenstein government and comparing Abascal to far-right protestors who stormed the US Capitol last month.

Beyond the drama, it is worth examining why PP was not planning to support last week’s spending bill. Like Vox, the PP has accused the government of opacity in spending plans. It has also argued that the funds could be spent without an accompanying decree reforming the machinery of the government. ERC leader Gabriel Rufián, meanwhile, said that business leaders have too much control over how recovery funds will be spent, while insufficient decision-making power has been granted to regional authorities. He argued that the money will be handed over to Spain’s biggest listed companies.

These concerns are growing, and yesterday the PP complained that the government is hiding a report from the Council of State on who exactly will be managing recovery fund money, and how. The socialists once again refused to comment, telling the press later that the government has no legal obligation to send the report to parliament. We have seen a similar narrative play out in Italy, and it did not end well for Giuseppe Conte. Furthermore, the Dutch CDA party paid a heavy price for accepting support from the far-right to govern in 2010-2012. Sánchez may have survived the latest round of political drama, but we expect that his new alliance will not end well.

3 February 2021

EU's blunder in NI

One of the lasting damages from the European Commission's vaccine debacle is the political fallout in Northern Ireland. Triggering and then quickly revoking Art. 16 of the NI protocol to prevent the shipment of vaccines to the UK through the Irish border united and mobilised unionists and loyalists. This move comes on top of an unexpected EU ban on soil and pets that enraged communities in Northern Ireland. Could this swing public opinion against unification and back towards Great Britain? Clearly there is a sense of betrayal, or at least a feeling that the Good Friday institutions are not taken seriously in Brussels.

Arlene Foster and her DUP launched yesterday a campaign to get the protocol scrapped altogether from the Brexit agreement. Her party has lost ground in a recent online poll to the more hardline TUV. Both parties oppose the protocol because it places a customs and regulatory line in the Irish Sea between Northern Ireland and Great Britain. It was the Brexit compromise to avoid a hard border with the Republic of Ireland, and Foster went along with it. It meant that the North remains part of the EU's single market for goods, and must therefore apply EU customs rules at its ports and airports. A three-month grace period was granted which is coming to an end in April. Yet there are already shortages and higher prices affecting peoples' lives. Soil and plants are banned and can no longer be sent from Great Britain, ostensibly due to health concerns. Why UK garden centres seem suddenly to pose a threat is a hard one to explain to people. Some firms have stopped delivering to Northern Ireland altogether, and pets arriving via the Irish sea are now checked for diseases. Are pets now a risk to the EU or are they part of fraud and smuggling into the Republic of Ireland? Call it teething problems, as Michael Gove puts it, but the symbolism will not be wasted on the Northern Irish. The EU already had to withdraw officials conducting post-Brexit trade checks after they were threatened. 

Where to go from here? Gove called on the EU to double down on the effort to make the NI protocol work. The Guardian writes that original Brexit plan was to draw up a list of goods at risk of going over the border, but this did not happen because of rows between negotiators and time constraints.

Precious time and goodwill have been lost, perhaps irreversibly so for the DUP. As Brexit is felt in everyday life, the Northern Irish are reminded of where they want to belong. And the EU just lit the way for them by flexing its muscles over pets, plants and vaccines.

2 February 2021

When is debt too high?

How much more debt can France afford in 2021? With a third lockdown on the horizon, France is now actively discussing this question. By the end of the year, pubic debt is expected to reach 120% of GDP. François Villeroy de Galhau, governor of the Banque de France, told the senate's finance committee that there is no room for more spending and that public debt would continue to grow with a deficit beyond 3% of GDP, despite low interest rates. The OFCE research institute, on the other hand, sees the historic low interest rates as an opportunity to spend another 5% of GDP, or €100bn, on economic stimulus on the condition that this money is spend on growth-enhancing investments and that they do not turn into recurring budget items.

Whether or not public debt is sustainable depends on the state's capacity to generate tax revenues. It also depends on the long-term growth trajectory. Higher growth will lower the debt-to-GDP ratio over time. It also depends on the interest rate countries pay on the debt, and the value it loses due to inflation. In today's world, growth rates are higher than interest rates and likely to stay that way for quite some time.  Public debt can thus be high and yet sustainable. The country simply grows out of its debt without much need for heavy-handed austerity, as debt service costs remain low, revenues keep coming in and the debt to GDP ratio falls over time. 

This is why public debt accumulated to fight the Covid-19 crisis is not a concern as such. This is the position of the IMF and the OECD. Among the French, Olivier Blanchard is a leading advocate of that thesis. Politics, however, may intrude. 

France has a habit of keeping expenditures growing rather than stabilising them, a problem acknowledged implicitly by the OFCE. It will depend on whether they can indeed go back after the crisis and stabilise expenditures, as Bruno Le Maire promised, or whether some of that increasing expenditure turns into structural features of the budget. This would make public debt vulnerable to an eventual change in interest rate in the long run. In the end, it comes down to politics and will coincide with the presidential election campaign.

We note that the French discussion about debt stands in stark contrast to last week's German debate on the future of the debt brake. It triggered by Helge Braun, Angela Merkel's chancellery minister, who proposed a more flexible post-pandemic exit strategy than what would otherwise be required under the constitution. The CDU rank and file react with outrage against suggestions of a constitutional reform, as did Armin Laschet, the new CDU leader. This tells us that even if France were to move towards acceptance of higher debt, Germany is unlikely to follow. As with every crisis, expect eurozone fiscal imbalances to grow. 

1 February 2021

When in a hole…

… stop digging. The EU has manoeuvred itself into a political hole with its ill-judged vaccine policies, to which we have been drawing attention since December. What we are seeing now is an attempt to cover up the bad decisions with even more bad decisions, like Ursula von der Leyen's astonishingly ill-judged - and mercifully withdrawn - attempt on Friday to trigger Art. 16 of the Brexit withdrawal agreement and impose a hard border in Ireland. 

Vaccination is not as big a story in the European media compared to, for example, the UK or the US. But don't mis-read that. The impact of the policy error has yet to be felt. Even in the UK, which is vaccinating some 600,000 people a day, the lockdown is unlikely to be lifted for some time. The EU might be lucky in that the Kent-variant of the virus may not spread as fast as it did in the UK during December. But if it does, the vaccination policy will not be remembered as a mere policy error, like austerity, but as a cause of death.

The ensuing cover-up took several forms over the weekend. The strangest one must have been Martin Selmayr's tweet yesterday, later retracted, that Europe was doing really well on vaccinations, beating Africa in the race. More worryingly Emmanuel Macron called the AstraZeneca vaccine completely ineffective for older people. So he is trying to cover up the mistake of not buying enough vaccines by questioning the effectiveness of the vaccine. The craziest comment we have read came from Jens Spahn, the German health minister, who said he was open to the Russian vaccine. So Germany is banning AstraZeneca on the grounds that sufficient test data are not available for the group of over-65 years olds, but is open to a Russian vaccine for which no testing is available that would meet EU standards. 

This is telling us that Berlin, Paris and Brussels are engaged in a form of synchronised panicking - which they are addressing with usual misinformation. The media are starting to smell a rat. Spiegel did a hatchet job on Ursula von der Leyen, reminding its readers of her record at the defence ministry, her last job before she came to Brussels. Bild is focusing on the mistakes of the German government. We are less interested in personal attacks, but in the wider political consequences. We see the EU's vaccine crisis having three successive inter-related effects: a prolonged lockdown, a longer second leg of our double-dip recession, and an anti-incumbent mood. These have yet to play out. With elections in the Netherlands in March, in Germany in September and in France in April 2022, there is potential for upheaval.

29 January 2021

Hungary goes its own way, again

Hungary’s drift from the EU continues, this week with a decision by Frontex, the EU border agency, to withdraw from the country over its handling of asylum seekers.

EUobserver broke the story on Wednesday, reporting that the agency confirmed it would suspend its activities in Hungary because it is continuing to push asylum seekers back into Serbia, in violation of a European Court of Justice ruling from December last year.

Frontex’s decision comes after Budapest-based NGO, the Hungarian Helsinki Committee, documented thousands of cases of pushbacks, including 4400 since the ECJ ruling alone. The New York Times reports that since the practice first started in 2016, more than 50,000 asylum seekers have been expelled.

This marks the first time Frontex has ever left an EU member state. Under EU regulations, Frontex alone holds responsibility for making the decision, and can leave a country if it has strong reason to believe illegal actions are taking place.

The move is unlikely to make a huge impact on either Frontex or Hungary – as of September 2017, there were only 20 Frontex officers deployed on the Hungarian-Serbian border. Furthermore, Frontex itself is currently under investigation for employing similar pushback practices in Greece. 

But this is another example of Hungary going its own way. As we noted last week, Hungary was reported to be in negotiations with China for vaccine supplies. Katalin Halmai, a journalist with Népszava, tweeted yesterday that the government is now planning to purchase the vaccine without authorisation from the relevant Hungarian authority, announcing that it will import any vaccine that has been tested on more than one million people anywhere in the world.

And unlike other countries where the incumbent effect of 2020 has been wearing off, Viktor Orbán has been gaining in the polls. Europe elects reported this week that 52% of Hungarian voters support Orbán’s Fidesz party, up one percentage point from previous polls. Support for a recently-created united opposition party has also been rising, but it is still only polling at 45%.

28 January 2021

Vaccine nationalism as collective action problem

The over-riding theme of Eurointelligence since we started 15 years ago was Europe’s collective action problem. It was our presumption at the time that it can only be overcome during emergencies. We were wrong. What the eurozone crisis and the pandemic have taught us is that the collective action problem persists even during crises. Right now it manifests itself in the form of vaccine nationalism.

The idea of threatened export bans is downright potty. We don’t need to take them seriously in substance, except in terms of what these threats tell us about the prevailing mindset. There is a sense of panic in Brussels and Berlin right now, as exemplified by Angela Merkel’s words that this thing has gotten out of control.

The mismanagement occurred at various levels. But procurement bottlenecks is the big one. The reason why Spain has halted first-time vaccinations, for example, is the lack of supplies.

In La Repubblica this morning we were surprised to see a stinging criticism of the EU by Francesco Guerrera, who is otherwise as pro-European as you can get in Italian journalism. Instead of acting, he writes, the EU wasted 24 hours in a useless public relations war with the head of AstraZeneca. He accused the EU of going beyond pure vaccine nationalism by trying to take a step towards vaccine protectionism. He cites a study by the International Chamber of Commerce that such selfishness could cost the world economy $9.2tn.

“Like economic protectionism, vaccine protectionism needs an enemy that can be attacked by politicians desperate for popular consent. In this case, but not surprisingly, AstraZeneca.”

We see the EU’s response as typical for someone who made a mistake and then resorts to a blame game. What Europe needs to do right now is to get working on plugging the vaccines gap. Only 2% of EU citizens have been vaccinated, compared to 11% in the UK. That gap is still widening. The constructive way forward is for the EU and its large pharma industry to new build vaccine production capacity - on the lines of Sanofi’s plans to manufacture the BioNTech vaccine.

We also agree with Jean Pisani-Ferry, who made a similar point on a global level. The outbreak of a new Covid-19 variant, 501Y.V3, which has wreaked unbelievable havoc in Manaus, Brazil, warrants a global response. The advanced nations should fund a comprehensive vaccine programme for the poorer nations. The alternative is close your borders, which is economically insane. His diagnosis is similar to our criticism of an endemic collection action problem: he says countries are trying to free-ride. Everybody wants the others to pay for a common good. Donald Trump’s withdrawal from the WHO was an obvious example. We would add to this that the EU is now trying to do exactly the same.

27 January 2021

Towards vaccine nationalism

Are we heading towards vaccine nationalism? This is the warning from UK's vaccine minister after the European Commission and Germany called for a fair distribution of AstraZeneca vaccines. Failure to produce enough vaccines in the Belgian production plant was cited by AstraZeneca to explain the shortage of EU vaccines. They were, though, still honouring the order to the UK while cutting down the order from the EU by 60%. A fair burden sharing, as advocated by Angela Merkel and her health minister - what would this entail? Sending vaccines back from the UK to the continent? Stopping further exports to the UK? 

AstraZeneca's chief executive said that the UK signed the contract three months before the EU, and that this first-come-first serve principle is the fair way forward. He said the UK distribution system is up and running, unlike the EU's, and they had time to iron out supply chain glitches. The EU had approached the company with a request to redirect parts of the vaccine at least until March, when more vaccines become available. The Commission argues that the EU spent millions for its research and production facilities, and thus expect the contract to be honoured.

Such high voltage politics may last only until more vaccines become available in February, but this episode could leave a bitter aftertaste and poison trade relations between the EU and the UK.

Another complication is that AstraZeneca vaccine is not even approved in the EU yet, while the UK regulator gave its green light in December. The European Medicines Agency, Ema, said yesterday that the AstraZeneca vaccine might not be approved for the elderly. News reports based on government sources in Germany questioned the efficiency of the vaccine for 65+ year olds, an accusation the company denied. The German health ministry, too, dismissed these news reports yesterday, saying they had confused the efficacy rate with the number of people over 65 in the trials. But the German government also voiced concerns about the breadth of AstraZeneca's trial participation. AstraZeneca has said 10% of participants were over the age of 65. This may be considered too low for Ema to grant permission. The US drug regulator, for example, has not approved AstraZeneca vaccine either. They prefer to wait for the outcome of a large American trial with 30,000 people.

If it is only about the production site problems, that can be dealt with by securing more production sites. It is not clear to us why the whole EU vaccine supply should depend on a single plant in Belgium. Even if it is part of a vertical production, meaning that the Belgian plant is responsible for one particular aspect of the production, it would make sense to diversify risks. 

The good news is that Sanofi, the last big French pharma company, agreed to produce the Pfizer/BioNtech vaccine. Their Covid-19 vaccine programme flopped after a lab mistake. They still continue with the research, but in the meantime offer their production facilities in Germany to provide 1m doses of the Pfizer/BioNtech vaccine in the autumn.

In France, meanwhile, another form of national nostalgia is brewing. The two vaccine R&D efforts by the Pasteur institute and Sanofi suffered setbacks. Combined with the fact that two successful pharma companies, AstraZeneca and Moderna, are led by a French chief executives, this is seen as an unbearable humiliation in the land of vaccine pioneer Louis Pasteur. François Bayrou, leader of Modem and close ally of Emmanuel Macron, said yesterday that it's a sign of decline that is unacceptable. France's relative decline in power and influence often captures people's imagination, and could benefit Marine Le Pen with her nostalgia for the past.

26 January 2021

With each crisis, eurozone falls behind

Adam Tooze has a terrific comment of the kind very few European economic commentators would dare to publish for fear of causing offence: Europe’s economy is falling behind the US and other industrial countries. We have a ratchet effect with each crisis. It is a consequence of lack of resilience. The recovery fund may have been a political success, but it is economically insufficient.

Tooze points out that its total size is smaller than the investment short-fall that already happened. And then consider that disbursements won’t start until the middle of this year.

Tooze looked at the recent assessments from the OECD, the IMF and the EIB to conclude that Europe not only had a much worse recession in 2020, but that it will take much longer to return to 2019 levels of GDP - this won’t happen until 2022. US growth fell by 3.5% last year, whereas the euro area was down by 7.6%. Perhaps the most interesting statistic he quotes is the gap in disposable household income. Despite the huge rise in US unemployment, disposable income went up in the US last year, while it fell in the EU.

"While Brussels was feting Next Generation EU, gross fixed-capital formation in the euro area fell by more than 10 per cent, compared with ‘only’ 1.7 per cent in the US. To put that in round figures, the European Commission and the EIB estimate that the shortfall in private investment will come to €831 billion in 2020 and 2021—greater than the offsetting recovery package. It should be particularly concerning that investment slumped most severely in southern Europe, which has been suffering chronically low investment since 2010."

We agree with his observation that the current strength of the euro is the exact opposite of what its seems: speculative investors are piling into euros because they expect US inflation to return back to target quickly. But we do not agree with his conclusion that the ECB has not done enough, whereas we arrive at a harsher judgement about the recovery fund. Our view is that the EU should have agreed a discretionary €1-2tn fiscal stimulus rather than opt for a small, complex, multi-annual inter-governmental investment programme. What has not changed is that the EU always seeks a structural solution to a cyclical slump.

25 January 2021

Recovery fund not going as planned

There are two seemingly unconnected stories that caught our eye this morning. When read together, they tell us that the recovery fund is in deep trouble. One story is from Handelsblatt, which reports that the European Commission is withholding recovery fund money from Germany on the grounds that Berlin is refusing to undertake structural reforms. The other is based on a comment by Federico Fubini in Corriere della Sera, who writes that Italy is on the verge of making some poor decisions in respect of how the fund is managed.

The lack of structural reform in Germany does not surprise us. It was structural reform that prematurely ended the Schroder government in 2005. Reluctance to reform is how Angela Merkel survived 16 years in office. When the Commission asked Germany to draw up a reform list, what it got was a tax cut for electric cars, and some other measures the government and the federal states had already planned. The Commission was fobbed off.

The aspect that troubles us the most is a different one. The Commission is picking the wrong fight. Among the things it demands, according to the Handelsblatt article, is that Germany reforms its pension systems and removes the preferential treatment of married couples in the tax code. So we are asking ourselves: why on earth is the Commission not using this once-in-a-lifetime opportunity to address the far more important issue of Germany’s external imbalances? Or legal impediments to the use of digital technology. Remember that the CDU could not legally choose its chairman through an online voting procedure?

It is, of course, unrealistic to expect Ursula von der Leyen to pick an existential fight with Merkel over Germany’s economic model. So the Commission ended up nitpicking on small reforms that are ultimately irrelevant to economic growth and resilience. What this is telling us is that the recovery fund, like the fabled Juncker investment fund, could end up as smoke and mirrors.

We should recall that the grants component of the fund - €310bn - is big in absolute money terms, but only about 0.4% of GDP if you spread its spending over five years. While not a fiscal stimulus, it still constitutes a potentially useful structural reform facility - if the reforms are of the right kind. Investments into your own digital infrastructure - and in Germany’s case changing your constitution to allow people to use it - that’s reform. Reducing pensions or eliminating some quirks in the tax code should way be down on our list.

Fubini comes to a similarly disturbing conclusion in his commentary on Italy’s government crisis. He writes that the recovery fund is the who-shall-not-be-named in the current political critics. The politics is all about who governs with whom. For Italy, the money is almost macroeconomically relevant, especially if you include the loan component, which raises the headline total to some €200bn. But there is no discussion in Italy about what to do with the money, and how to run the spending.

We should recall that the recovery fund triggered the political crisis in Italy. Matteo Renzi questioned Giuseppe Conte’s power grab as set out in chapter three of Italy’s draft national plan. It suggested a small group of ministers around Conte would have the sole responsibility of running the fund without parliamentary oversight. The proposal that was finally submitted to parliament did not address this issue at all - as though the problem of governance no longer existed. Conte does not talk about it any more, which is telling us that there is no agreement about this issue in the coalition. So we have no idea how he will manage the fund, and more importantly what reforms will be associated with it. Here we see the parallel with Germany: both governments treat it as a windfall - some useful co-financing for existing fiscal plans.

We agree with Fubini that one of the priorities for Italy is a plausible public finance plan. This is not about austerity, but about a long-term strategy for debt sustainability. For Italy one of our priorities would be reforms to the overblown and over-powerful public sector and its inefficient judiciary. And a lot of digital infrastructure investment.

We understand that it is not possible to force countries to undertake structural reforms against political majorities. Lack of grassroots support is how the Lisbon Agenda failed during the first decade of this century. But the recovery fund would constitute a good moment for some hard thinking about the type of reforms needed in the 21st century.

We conclude from these two stories that this opportunity will be lost. It is our central expectation now that the recovery fund will end up like the Juncker fund: member states will categorise some of their existing investments under the recovery fund umbrella, and will use the freed-up resources for tax cuts and welfare checks. So it will be a simple stimulus.

And northern Europeans will draw the inevitable and logically correct conclusion that it was a waste of money.