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26 July 2023

The heat is on

We all have seen the images of wild fires in Greece, Italy, Algeria or Tunisia. Then there is Turkey, Croatia and and Portugal The list of countries affected by wildfires gets longer every day.

Looking at the large burned-down area on the island of Rhodes, where 19,000 people, including tourists, had to be evacuated, one wonders what will happen to its climate if temperatures continue to rise.

Greece has not seen such devastation in the past 150 years. And according to forecasts it is not going to get any better. Average temperatures are expected to rise by an additional 2.5°C up to 5°C, by the end of the century, according to the most recent estimates of climate models as reflected in a report of the Committee for the Resilience of Greek Forest Ecosystems to Climate Change (EADO) of the Academy of Athens.

The length of hot periods in the country's lowlands is estimated to increase by 10-15 more days by the mid of the century and 30-50 days, that is if no measures are taken to mitigate greenhouse emissions. At the same time, precipitation will be lower by up to 20%, increasing evaporation and the likelihood of droughts, which by itself causes temperatures to increase even further. Italy and Spain are no better off. At this rate, it will turn the northern shores of the Mediterranean and parts of Greece into a sub-Saharan climate, according to Christos Zerefos, supervisor of the Atmospheric Physics and Climatology Research Centre of the Academy of Athens.

It is increasingly clear that this is no longer a one-off tragedy, but a permanent and recurring feature of the local climate. This has wide ranging consequences. It will change not only the landscape, but the local economy and the societies that can live in such a climate too. People will have to find ways to adapt or move. New health and safety risks will need to be incorporated into building permissions, work conditions, insurances and travel plans. Temperatures around 45°C are unlikely to attract the number of tourists local economies were used to. Agriculture in semi-arid climate conditions will require adaptation, with new crops and better water management.

It is no longer the question of whether climate change is happening, but to what degree. And in EU politics it will play one local pressure point against the other: a burning Southern Europe against a green Northern Europe. Responsibilities under the common climate change agenda will not sit neatly next to each other. The Netherlands and the EPP may be eager to protect its farmers, delaying in adaptation and emissions reduction. In Southern Europe, it is now about farmers’ survival, and emissions cuts that should have happened decades ago.

25 July 2023

Meloni's European dilemma

There are a few different political figures elsewhere in Europe who will feel the impact of this week’s Spanish elections, but perhaps none more so than Giorgia Meloni. She and Fratelli d’Italia are keen allies of Vox, and a PP-Vox coalition would have set up the kind of alliance she wants to see at the EU level, as FdI seek a closer relationship with the European centre-right. This is another hitch in a plan that will be more difficult to pull off than it looks.  

Meloni is now firmly in charge of her own coalition in Italy, and there are no major domestic political problems to deal with, at least for now. That, along with European elections coming up next year, will mean more attention to how she fits into the EU-wide picture. This is especially the case since the Italian media and politicians pay a lot of attention to European elections. They typically follow Italian general elections by a year or two, so they are an important early indicator of where governing parties stand after some time in office.

At the EU level, Meloni’s basic issue is that the Eurosceptic faction she is part of, the ECR, is both out-of-step with her damascene conversion to pragmatic pro-Europeanism, and not very influential. There are issues, like migration and fiscal policy, where Meloni will want and need a European-level solution. Crossing your arms and saying no all the time, which is her eastern European allies’ default position on most issues, won’t work.

The distance between the ECR and the pro-European factions also complicates any attempts Meloni might make at getting involved in post-election horse-trading over senior roles in Brussels. Like David Cameron found out after moving the Conservatives over to the ECR, being outside of the big centrist factions dents your influence.

There are two potential solutions to this. One is for Meloni to try and engineer an alliance between the ECR and EPP. There are a couple of reasons why this might work. Firstly, thanks to FdI’s own electoral strength in Italy, the ECR will probably gain a lot of ground in next year’s elections. Secondly, the parties have moved closer to each other on issues like migration and the environment.

But there are problems with this. The Spain result now makes this process a bit more difficult: Italy is the only big country where ECR and EPP members govern together. Without a PP-Vox alliance in power, the case for a tie-up is, practically speaking, thinner. Cooperation between the two would bring the EPP further from the other centrists, complicating things in 2024. Perhaps most importantly, in Poland Civic Platform, who are part of the EPP, are ECR member Law and Justice’s bitter rivals. Since there is an election in Poland later this year, that makes the relationship between the two especially sensitive.

Another option is for FdI to leave the ECR and join the EPP. This is, in theory, a neater strategy. But there are also stumbling blocks if Meloni decides to pursue this further. It would complicate things within her coalition, since Forza Italia are part of the EPP, and the idea that they are the pro-European moderates in government is something they make a big deal of. Bringing in another big EPP member would upset the balance of power within the group, and potentially alienate more liberal members of the faction.

24 July 2023

Draghi's fiscal union

Mario Draghi has made an elegant, and slightly unfashionable case for European fiscal and political integration. It is worth going through the logic of his arguments, rather than just falling into reflexive pro- or anti-type positions. 

Draghi is one of the pro-Europeans who understands the limits of what he calls technocratic functionalist integration. This is a reference to the EU's debt-funded recovery fund. Draghi's message is that this won't get us to a fiscal union. On this point, we agree. We also agree with the main point he makes in the speech: that a fiscal union is needed, or else the EU is doomed. The quack solutions of the last decade will not be permanently available: The EU, he says, used to be reliant on the US for security, on China for exports and on Russia for gas, and, we might add, on the ECB for a bailout. The only common instrument are fiscal rules that try to accomplish too many objectives at the same time.

Here is his key conclusion:

"... if we look further ahead we need to acknowledge that truly credible fiscal rules cannot work without an equivalent re-thinking of where fiscal powers should reside. As automatic rules represent a devolution of powers to the centre, they can only work if they are matched by a greater degree of spending from the centre."

Quite right. We recall that during the sovereign debt crisis, the main instrument to stabilise the bond markets were the ECB's asset purchases. They were a lucky coincidence, justified only by low inflation rates. It took a pandemic to recreate a time-limited joint fiscal facility that on our calculations is some 0.1-0.2% of EU GDP per year for five years: less if stretched out for longer.

We are ultimately more pessimistic than Draghi because we see a generalised loss of the pro-Europeans narrative. This is the case in Germany, for instance, where a supposedly pro-EU government is treating the EU as an obstacle to be surmounted in the pursuit of national objectives.

With the right combination of leaders, and the right type of symmetric shock, a political union project is indeed possible. But so is the other possibility: that with each crisis, we become a little bit more national. Banks are more national today than they were before the financial crisis. The rules of European competition policy have been largely suspended in response to the pandemic and the US inflation reduction act. The EU will not disintegrate in a loud bang. But it might become quietly less effective.

Perhaps he should have given that speech when he was prime minister. And in Europe. Our sense is that advocacy of real political integration in Europe has turned into a retirement project.

21 July 2023

Quantum austerity

The trouble with austerity is that it always, without exception, hits public investment and ultimately economic growth. Investment is the part of national or federal spending that can be cut the easiest. It is happening again, in Germany, where the consequences of the 2024 austerity budget are slowly emerging. 

Euractiv reports that one of the many savings Christian Lindner identified to meet his 0.35% deficit goal for next year was the budget for quantum computing research. Having missed out on the digital revolution in the late 20th century, on digital business models and digital industry in the 21st century, Germany has now identified the next big industrial trend to sacrifice at the altar of austerity. Previously, during the pandemic, the government scoped out quantum computing as an area worthy of support to compete with the US, China and Japan. But that was then.

The total budget earmarked for quantum research was €2bn. This has now been cut by 10%. This does not sound like a lot of money, but it will hit start-up projects that require federal co-funding for research. At the start of the pandemic the German government allocated a total €130bn in investments, most of which was spent on a VAT rate cut, and family support. The quantum research programme was part of that package.

Smaller companies in particular have found that is very difficult to get hold off public money because of excessive bureaucratic application processes. This is also the reason why the US inflation reduction act constitutes such a potent threat to the EU. It is real money. In Europe, we exaggerate the size of our investment programmes for the gullible media, but the money that actually gets delivered is a small fraction of headline numbers. It is happening to the recovery fund as well.

The reason we are reporting the cut in the relatively small quantum research budget is what it reveals: Germany and the EU are once again on course to de-prioritise investments. 

The biggest problem with fiscal rules that target deficits, rather than spending, is exactly this. When non-discretionary spending items dominate your budget, and when defence spending can no longer be cut for political reasons, high-tech investments are next in line. Technology research is the low-hanging fruit for the Austerians.

20 July 2023

Raiffeisen troubles

After Russia took over Danone and Carlsberg, what fate is awaiting Austria’s Raiffeisen bank? The US and EU’s banking authorities pressure the bank for some time now to exit Russia, but progress is slow and risks are getting higher. After some failed attempts to swap assets with Russian banks in Europe, Raiffeisen is stuck between the rock and a hard place. They still serve western clients present in Russia and face the dilemma of either being hit by sanctions from the US and the EU if they stay or a hostile takeover from the Kremlin if they were to seek an exit.

Amongst western banks, Raiffeisen is the most important bank still operating in Russia, ahead of Italy's Unicredit, the Dutch ING and the Hungarian OTP.

Half of the western companies still present in Russia have turned towards Raiffeisen since the outbreak of the war, according to Les Echos. Not yet subject to sanctions and still connected to the Swift interbank messaging system, Raiffeisen has been a valuable interconnection between the two worlds.

The result was an increase in its assets by 36% since then. Despite losing 500,000 customers, it still has a total of 3.2m, and deposits have risen by 28% to €20.8bn for their Russian subsidiary. The number of employees rose to 9,890. Its profits for the first three months of this year were up 214% on the first quarter of last year.

Could the Kremlin do to Raiffeisen what it has done to Danone? Taking over a systemically relevant bank has more repercussions than taking over a dairy producer. The moment Russia seizes Raiffeisen’s assets, their link to Swift would be cut off. It also would cause a domino effect to all those other western companies that still rely on Raiffeisen to protect their assets. Either it is done overnight or not at all. It depends on how valuable the link to the Swift system and the presence of those remaining western companies still is to the Kremlin. The move on Danone certainly was a shock and a reminder of how precarious the situation of companies still operating in Russia is.

19 July 2023

Germany's toxic economic discourse

Each country has its own economic discourse. The German one is more distinct than any other we know. Yesterday, we came across a tweet by Jens Spahn, the former CDU health secretary. His tweet encapsulates a whole number of typical German misunderstandings about economic policy. It is worth dissecting this point for point, to see just how derailed the entire policy discussion has become. Our translation.

"Europe is crashing economically. We are threatened with deindustrialisation. The traffic light coalition must now finally wake up and pursue an industrial location policy that strengthens the German and EU economies. Energy prices must come down, bureaucracy must be reduced, working hours must be made more flexible. We need more trade agreements instead of small-scale regulations and ever new burdens for our economy."

Everything in this tweet is wrong. Europe is not crashing economically. Deindustrialisation is happening, but we think of it as an opportunity, not a threat. The notion of an industrial location policy is a very big deal in Germany: Standort-Politik is an expression that has no equivalent in English, French or Italian. When that happens, it is usually a red flag. What it means is a reduction of all economic policy to industrial competitiveness through real wage suppression, subsidies, and sweetheart funding arrangements with banks that act like an extension of politics. Standort-Politik is another way of saying Neo-Mercantilism.

As for energy prices, we too would like them lower, but we don't have magic powers. The reduction of bureaucracy is a meaningless claim coming from a lawmaker. Give us simpler laws and there will be less bureaucracy. Working hours are fairly flexible in Germany already.

As for more trade agreements, no, this is not going to happen. The great age of the trade agreements is over. The best that could happen is for agreements already in the pipeline to be concluded, like the Mercosur deal about, which we wrote yesterday. One can accuse Olaf Scholz and his government of many things, and we do, but he is not the reason why this particular agreement is stalled. The problem lies in incompatible demands from the Netherlands, Austria, and France on our side and Brazil on the other side.

The reason we are highlighting this is not to single out Spahn. What he said is very typical of the economic discourse in Germany. Almost everybody freaks out about de-industrialisation, but hardly anybody speaks about economic diversification into other sectors. Would this not be the obvious response to a sectoral shifts? Or about making Germany more attractive for entrepreneurs. Or about abolishing the constitutional debt brake, which has led to chronic public sector underinvestment. The way it is constructed does not allow debt to be incurred for investments: sustainable investment rules, as this practice is known elsewhere.

Or what about making it easier for foreign students to study at German universities? We recently had the occasion to look into this matter at some depth, and failed to understand the rules ourselves. There are quite a few things one could do to strengthen the German economy to confront its existential crisis.

But doubling down on the old Standort-Politik is silly at a time when the external economic conditions no longer make it viable. Interestingly, we see only a tiny number of people in the German policy discourse who are ready to challenge a consensus that equates industry and the economy.

This has lead us to conclude that a country that cannot even diagnose its problems correctly will surely not solve them. They will hang to their industrial past for as long as possible because they never contemplated another world.

18 July 2023

Squeezed by left and right

There has been a shocking poll in Thuringia, the only German state run by a prime minister of the Left Party, and also a stronghold of the AfD. The poll is about the impact of a potential new party led by Sahra Wagenknecht, the most flamboyant of all Left Party MPs, who has fallen out with her colleagues over Ukraine and immigration. She is pro-Russia and anti-immigrant, positions that put her much closer to the AfD than the Left Party.

The poll puts her in the lead in the state at 25%, followed by the AfD at 22% and the Left Party at 18%. German journalists have focused on the extent to which she could cannibalise the AfD's vote. What they did not point out is the far more worrying statistics that two thirds of the people polled in Thuringia are supporting extremist parties. Even if the centrist parties all join up, it will not be possible for them to form a government.

Of course, this is just a poll. Experience has shown that traditional party allegiances return as polling day approaches. But as the previous federal elections have shown, there has been a huge volatility between the parties. This is why we are not as confident as Olaf Scholz, who recently promised to halve the AfD's support by the next elections.

A Wagenknecht party could be nightmare for the Left Party, but it would also clear the air, and allow the Left Party to refocus on its agenda. The party has landed a coup when it got Carola Rackete to stand for the European election. Rackete is known as the captain of the Sea Watch 3, who picked up 53 migrants in the Mediterranean Sea, off the Libyan costs in 2019, heading towards Lampedusa. Italy had closed the port to migrant ships, but Rackete decided to dock in defiance of orders by Matteo Salvini, prompting her arrest by Italian authorities.

As Die Welt pointed out, the nomination of Rackete could be a problem for the Greens, who have come under increasing criticism from left-wing action groups. Die Welt writes that the strategy of the Left Party is no longer to portray itself as the left-wing alternative of the SPD, but as a left-wing alternative to the Greens. There are a lot of frustrated environmentalists in Germany.

The only constant in German politics right now is the disappointment with the government, and the weakness of Friedrich Merz.

17 July 2023

Ukraine has six months

Die Welt is quoting Petr Pavel, the Czech president and a retired army general, that Ukraine has about six months to finish the job. This is not because of the winter weather, but intruding political events: elections in the US, and in both Russia and Ukraine. The territorial gains Ukraine will have made by then will form the basis of a negotiated armistice with Russia afterwards. Die Welt noted that this was one of the few unscripted comments from the Nato summit at Vilnius. 

We also noted a dispatch from the historian Timothy Garton-Ash from Kiev, who wrote about the frustration of his Ukrainian friends after the strong rebuff Ukraine had received from Nato. The following passage got our attention.

"Listening closely to Biden and senior officials from his administration, I'm increasingly persuaded that the underlying US strategy is to use the prospect of Israel-style security commitments, and eventual NATO membership, to incentivise Ukraine to make a peace agreement (with concomitant loss of territory). If that's what happens, the sense of anger and betrayal inside Ukraine will be strong."

We think that this assessment, both in terms of what the US and Germany want to happen, and in terms of the reaction in Ukraine and eastern Europe, makes sense.

It is consistent with what we have been hearing from Germany. Olaf Scholz is studiously avoiding any reference to Ukraine recapturing all of the occupied territories. He only speaks of territories, meaning some but not necessarily all. The US and Germany want to wait and see how far Ukraine gets with its counter-offensive, and then put pressure on them to cut a deal.

The acute gap between rhetoric and action is reflected in the Ukraine support tracker by the Kiel Institute for the World Economy. It noted that 

"the difference between pledged and actually delivered arms can be very high. Among the major suppliers, the USA and Germany in particular have pledged significantly more than they have delivered."

Die Welt noted that Ukraine's counter-offensive has stalled because the Ukrainians urgently need fighter aircraft and cruise missiles to make inroads into Russian held territory. 

Joe Biden already declared that Vladimir Putin had lost the war. Comments such as these are telling us that the US president has already shifted focus from the military situation on the ground to selling a dirty deal. We have to be careful that this is not turning into another Vietnam or Afghanistan-style disaster.

14 July 2023

Ireland's overheating recession

The Irish economy is technically in a recession, but economists are warning of an overheating. How can this be? If measured in GDP terms, there has been a drop mainly through a fall in exports from multinational companies. But GDP has always been a terrible measure for the Irish economy due to the presence of many multinational export-driven companies in Ireland. Domestic factors suggest overheating instead. Consumption continues to hold up, there is full employment, inflation remains high, and housing costs continue to rise, albeit less so since interest rates have been going up.

Unemployment is at 3.8%, and employment growth may have eased off a bit, but it is still higher than last year’s figures. Recruitment of skilled workers is reportedly difficult. So the labour market is already running hot, pushing wages up 4.3% with labour shortages in some sectors. Inflation has eased since energy costs came down, but is still at 6.1%. Those price increases reflect rising costs, but also higher demand. The economy is already seeing second-round effects from inflation where companies pass on their cost increases to customers, be it for concert tickets or restaurant visits. House prices, too, came off their peak since interest rates started to rise. But renting prices continued to rise strongly, and a shortage of houses to sell or rent, as well as of social infrastructure such as childcare, hospital beds or a big enough energy grid show all signs of overheating. The labour market may further exacerbate this trend, as companies seek to recruit from abroad. This risks pushing up housing and rental prices further, making that situation worse.

The Esri research institute, the central bank, and the fiscal advisory council of the finance ministry all have the same message for the government, which is currently preparing its 2024 budget: the economy is running hot.

But the government, instead of taking out the heat, is likely to add to it with a spending plan above the imposed 5% limit. By supporting households through the cost-of-living crisis, the government adds to the problem by increasing demand pressures. The state also wants to make some investments in housing and infrastructure, all of which will take heat out of the economy eventually, but in the short term it adds more to more.

Politicians do want to be proactive and do something, especially if they have the money to do so. Not many governments have large tax revenues to spend like Ireland, thanks to the presence of multinational companies. This was only interrupted by the financial crisis in 2008. Since then extra tax revenues have been going towards rainy day funds, or have been used for extra spending, either discretionary or structural.  Investing to ease the pressures will be unavoidable even if it creates short term inflation, argues the Irish Times. The central bank suggested that the government could compensate this hike by taxing more, though this is not a measure politicians would like to be linked to.

In a way, the various indicators are representative for the Irish conundrum where international and national factors have immediate impact on the country's economic fate.

13 July 2023

Nature Restoration law: A yes, but...

The Nature Restoration Law was finally adopted by the European Parliament. Manfred Weber failed to stop the law, as his right-wing alliance did not get a majority organised to stop it in the plenary. The Renew party tabled an amendment that made the law more palatable to the conservatives, and the EPP's members from Ireland and Czech Republic openly defied the party line and voted in favour. A high drama came to an end, and environmentalists cried victory, but some hard work still remains ahead.

It was a tight race until the end. Two votes happened in short sequence: In a first vote, the original text from the European Commission was not rejected, which gave the EP a chance to work out an amended version that was adopted by the plenary shortly after. The final vote on the entire amended proposal passed with 336 in favour and 300 votes against. In total, 21 EPP lawmakers defied Manfred Weber’s party line. The amended text will now go back to the committees before being discussed with the European Council. So this may not be the end of the trouble, but a failure at this point seems unlikely.

Compared with the European Commission’s proposal, the current draft is a watered down version, as it is allowing more flexibility in the application of the binding targets. The Renew group, in its attempt to break the deadlock, submitted an amendment that mimicked almost word-for-word the proposal that the EU Council adopted a month ago which allows for more flexibility in applying the targets, according to Euronews. Despite the EPP’s defeat in the final vote, Weber welcomed the new version, saying that it is more palatable to his group due to flexibility provisions such as the emergency break in case food prices shoot up. So with more loopholes to defy mandatory obligations, this sounds to us more like a Yes, but adoption, whose success depends on the concrete measures member states are willing to take.

The law is part of the EU’s green deal. It sets mandatory targets to rehabilitate habitats and species under various themes such as farmlands, pollinators, free-flowing rivers, and marine ecosystems. The overall target in the original text was to restore 20% of the EU’s total land and sea areas by 2030. This was later increased to 30% in line with the deal from Cop15 in Montréal last December. But the text voted through in the EP yesterday keeps the target at 20%. This is another concession to the conservatives and their lobbying efforts for farmers.

The final text also scrapped obligations to restore peatland. Peatland, which is a type of wetland, forms over thousands of years from the remains of dead plants, storing more carbon than any other ecosystem. But when peatland is drained for agricultural purposes, it turns from being a CO2 sink into a greenhouse gas producer. Across Europe, 7% of the continent's greenhouse gas emissions are the result of drained peatlands and wetlands. Peatland farming is practised in the Netherlands, Poland and Germany,  where large swathes of farmland are on drained peatland. For example, about 7% of German farmland is on peatland, producing 37% of farming CO2 emissions.

The EU’s proposal foresaw a paradigm shift in agriculture, shifting from draining to rewetting peat land. Farmers warned that this leads to a fall in productivity and food insecurity. As long as it is for them financially still more attractive to drain peatland and plant cash crops, they will have the upper hand in the food security argument.

In addition, there will be a delay in the implementation of the law until an impact assessment on Europe's food security has been carried out. This was one of the main arguments used by the EPP and the far-right in their attempt to stop the law. What remains in practice of this law remains thus to be seen.