Europe in search of direction | Deloitte UK has been saved
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The Brexit vote has set the UK on a new path. The form Brexit takes will take time, possibly years, to emerge. But there is another, and for me, more fundamental question facing Europe.
2017 marks the sixtieth anniversary of the foundation of the European Union. Its founding principle was progress to “ever closer union”. Today, amid challenges created by low growth, migration, the growth of insurgent political parties and Brexit, this principle is in question as never before.
Concern about the direction of the EU has spread from the fringe to the mainstream. Angela Merkel, a politician not given to hyperbole, has said that Europe is in “a critical situation”. In his state of the Union address last September the President of the European Commission, Jean-Claude Juncker, talked of the “existential crisis” facing the EU.
Donald Tusk, the President of the European Council, analysed the crisis in stark terms, “the spectre of a break-up is haunting Europe….Obsessed with the idea of instant and total integration, we failed to notice that ordinary people, the citizens of Europe do not share our Euro-enthusiasm. Disillusioned with the great visions of the future, they demand that we cope with the present reality….Today, Euro-scepticism, or even Euro-pessimism have become an alternative to those illusions. And increasingly louder are those who question the very principle of a united Europe”.
This is a far cry from the rapid political and economic integration of the 1990s and early 2000s. For most of its existence the EU has responded to crises with further integration. The EU’s response to the underperformance of Europe’s economies in the 1980s was to double down on creating a free market in good, services, capital and labour. The launch of the Single Market in 1992 marked a new phase of speedy integration and was followed by the Schengen Agreement of 1997 which created free movement of people across most borders and, in 1999, the launch of the Single Currency.
The high water mark of EU integration came in 2004, with the biggest single expansion of the EU in its history, with ten new countries, mainly in central and eastern Europe, joining the Union. In 2007 Romania and Bulgaria became members.
Since then institutional enthusiasm and capacity for integration has receded. Deep recessions in some euro area countries and tensions in the operation of the Single Currency and have sharpened concerns about the ability of the EU to deliver growth. Borderless travel in Europe has been imperilled by the re-introduction of border controls to reduce migrants and refugee flows in several countries, including Sweden, Austria and Hungary. Dissatisfaction with the status quo has fuelled the rise of Eurosceptic political parties across the EU. Populist parties of the extreme left and right in France, Germany, the Netherlands, Denmark and Italy are calling for referenda on EU membership in their countries.
In the years of integration before 2008 financial markets focussed more on the performance of the euro area as a whole than the countries within it. The creation of the Single Currency, and the view that it, and economic integration, were forever, led to a convergence of borrowing costs for governments across the euro area. Countries with traditionally high borrowing costs, such as Italy or Greece, saw interest rates plummet to near-German levels. The Single Currency convinced investors that the risks attached to lending to the Italian or Greek government were not significantly different from the risks of lending to the German government, one of the world’s most creditworthy. Investors took the view that integration was irreversible. But that assumption has been under pressure since the financial crisis and bond yields have de-converged as investors try to protect themselves against the risk of countries leaving the euro. Today Germany’s annual cost of borrowing, at just 0.3%, is near an all-time low. Greece pays more than 20 times as much to borrow.
The challenges of recent years have revealed important differences of opinion within the EU. The views of central and eastern member states on migration have tended to diverge from those of the Commission and western countries. The euro crisis underscored the tension between Germany’s commitment to sound finances and low inflation and the needs of the indebted, recession-stricken economies of southern Europe. Today Germany opposes a Europe-wide system of deposit insurance to protect investors in banks. To its supporters in the Commission deposit insurance is vital in guarding against future financial crises. Germany worries that it could be left to foot the bill for reimbursing depositors in failed banks in other euro area nations.
In its response to Europe’s malaise the EU sought initially, as it has in the wake of previous crises, to double down on integration. The Five Presidents' Report, published in June 2015, provided a roadmap to achieve a fiscal and, ultimately, political, union. Rising Euroscepticism and divisions of opinion between member states have put a brake on such plans. As one commentator has noted, just 18 months on from its publication, “the Five President’s Report reads like a science fiction novel. Even Mario Draghi, the President of the European Central Bank, and Jean Claude Juncker, President of the European Commission, the main backers of deepening the economic and monetary union, have toned it down” (euroactiv.com, 11th October 2016).
For the first time the EU is likely to be in a phase of simultaneous contraction and expansion. The focus seems to be on getting institutions to work and deliver for voters. In some areas, as with Brexit or perhaps with borders, there may be a rolling back of the EU. It is conceivable that, in time, some members of the euro area leave. In other areas, particularly defence and security cooperation, the EU wants to push forward. But this sort of pragmatic reform may struggle to deliver the fundamental, and often politically difficult, changes which could strengthen the EU.
Another feature of the new order is a growing role for nation states in decision-making. Cooperation between governments, rather than proceeding as one, is the order of the day. This is not wholly new. The single currency marked a leap forward for integration but it excluded the UK, Sweden and Denmark at birth and now excludes most of the new members in central and eastern Europe. The UK and Ireland opted out of the Schengen passport free zone. The campaign to topple Libya’s Colonel Gaddafi was a NATO operation, though Germany and the central European nations did not contribute forces. More recently over migration and the euro crisis it has been heads of states, not the European Commission, who have been in the driving seat.
The difficulty of achieving agreement between 28 member states – 27 without the UK – points to more cooperation between like-minded nations to achieve shared aims.
Paradoxically, many supporters of greater integration think such an approach would keep alive the dream of political and economic union by enabling an inner group of countries to press ahead with integration. France’s former president, Valéry Giscard d'Estaing, recently described the six founding members of the EU, along with Spain, Portugal and Greece, as “real Europe” which, he said had the “European spirit”. Giscard did not see the UK and the Scandinavian, central and eastern European nations as having the same centrality or commitment to the European venture.
An EU in which all members states proceed in unison may well have passed. The one size fits all approach looks out of step with today’s reality. But if “ever closer union” has run out of steam what will replace it? My guess is that it will be flexible coalitions of willing states. The future direction of the EU, not Brexit, is for my money, the biggest question facing Europe today.
Ian Stewart is a Partner and Chief Economist at Deloitte where he advises Boards and companies on macroeconomics. Ian devised the Deloitte Survey of Chief Financial Officers and writes a popular weekly economics blog, the Monday Briefing. His previous roles include Chief Economist for Europe at Merrill Lynch, Head of Economics in the Conservative Research Department and Special Adviser to the Secretary of State for Work and Pensions. Ian was educated at the London School of Economics.