19 August 2011

Graham Bishop: Merkel/Sarkozy letter - historic steps for the eurozone… but could they spell the death knell of Britain in the EU?

The proposals include: rapid completion of existing economic governance measures; a legally-entrenched balanced budget rule; economic governance by the eurozone Heads of Government, concluding the negotiations for a common tax base for companies; “enhanced co-operation” in tax coordination; sanctioning States by withholding structural funds; Franco-German corporate tax harmonisation; and a proposal for a financial transaction tax.

These proposals ensure much fierce debate about the nature of “Europe” in the next few months. At the end of the debate, the short-sellers of eurozone government bonds will have to decide if such leaders really do have the political courage, and thus capability, of implementing their ideas. If the leaders do, then a steady movement in budget deficits along the projected track from 7 per cent of GDP in 2009 to less than 4 per cent next year should underpin bond markets as a whole. The existing SGP commitments are for a 1.5 per cent of GDP deficit in 2014. An agreement early in 2012 to install a balanced budget regime thereafter should preclude another crisis of this type in the future. If the markets become confident that will happen in practice, then there should be a strong recovery in many European bond markets.

Do the two leaders really mean what they are saying? There is a simple acid test ahead - for France in particular. The two governments call for the “rapid completion” of the six-pack of legislation on macro-economic surveillance. This includes the provision of a reverse QMV for the Member States to stop a Commission recommendation for action (and sanctions) against a State that is not dealing with identified imbalances. Given the steps already agreed, this would be the moment of collective control of an errant State – the final step towards a de facto political union. [1]

Yet France has consistently blocked an agreement with the European Parliament on this issue. If France continues with this blocking, then its genuine commitment to the other proposals in the letter must be in doubt. Alternatively, there may be a deeper game unfolding: economic governance of the eurozone may be about to turn into economic “government”. Instead of a French concept with German content such as the SGP, this proposal seems to have additional French content, such as tax harmonisation, and to be far more inter-governmental. That would be a fundamental change in German attitudes as, traditionally, Germany has been the defender of the “Community method”, where the European Commission is the defender of a Treaty deliberately biased to protect the influence of the smaller States

Progress in the euro-area States that are being supported is also encouraging: the ECB/IMF/EC troika’s judgement is that Portugal is on track with its ambitious and comprehensive programme even at this early stage; Ireland  remains on track and  Greece is “making significant progress”. Many commentators focus only on the fiscal adjustments but a key element of these programmes is measures to restore competitiveness, and that is a central component of the entire approach by the eurozone to resolve its difficulties sustainably.

The letter opened with a re-statement of the Franco-German historic mission to protect and strengthen the economic and monetary union. It is interesting that France and Germany have sought so strongly in recent months to re-assert their joint leadership role. But who else would be able to? Berlusconi in Italy is widely seen as a spent force, Zapatero in Spain will not be contesting the imminent election, and Cameron in Britain has chosen, decisively, not to be involved – and even enacted a “referendum lock” so that any further transfer of significant powers to the EU may have to be submitted to a referendum. Few would expect that to be won, so the UK will not now play any significant role in re-shaping the European Union to deal with this crisis.

The upshot is that France has had the opportunity to propose many of the economic governance ideas that it has long championed and Germany has not felt able to resist the ideas – except for the immediate issue of “eurobonds”. The implications of a split between France and Germany at this stage scarcely bear thinking about.

It is hardly a year since Chancellor Merkel would not countenance the Heads of Government of the eurozone meeting separately from the European Union Heads. Now she has agreed to a complete institutional framework for the euro area that is separate from that of the European Union: Heads of Government meeting twice a year (or more when needed); a President for two-and-a-half year terms (but they have asked van Rompuy to take this role – otherwise the split from the European Union would be an obvious chasm); this body would discipline errant members in breach of the European Union’s SGP; it would evaluate the development of competitiveness and act to prevent emergent problems (no mention of the role of the European Commission); the Eurogroup of finance ministers would be strengthened. Finally, the new ESM would have “new analysis capabilities”, but what could they be?

The proposals for action mainly ramp up the existing commitments under the “six-pack” though they are now spelt out in more detail. However, the thorny issue of tax is now to be tackled – at the corporate level. Tax has remained the last taboo for majority voting but the pressure is to be put on to complete the “common consolidated corporate tax base” proposal by end-2012. This author has always argued that would be the natural consequence of the decisions a decade ago to adopt International Accounting Standards for the entire EU – once companies account for their profits in a common format, it is obviously efficient for the tax authorities to use the same calculation.

But the plan goes further and calls for preventing “harmful tax practices”- probably code for Ireland and some others! However, the Franco-German economic union is to take the next step itself and harmonise both their corporate tax base and rate – from 2013. The gauntlet is powerfully thrown down to challenge the others! 

All of this is to be implemented in a way that “might” be beneficial to the cohesion of the entire European Union. But the point is made explicitly about using Art 136 for the eurozone members to take their own decisions and “enhanced cooperation” – presumably for the members of the Euro Plus Pact (covering all EU members except Britain, Sweden, Hungary and the Czech Republic).

However, France and Germany have decided to push a financial transaction tax very hard. This has been moving up the agenda for some time and at the end of June the European Commission made it into a revenue-raising plank of its proposal for the 5th Multi-Annual Financial Framework – for 2014-2020. In principle, this should be agreed by unanimity of the Member States in 2012, in good time for the start of the programme. Many financial market participants doubt if significant revenue would ever be collected from such a scheme – but the effort will certainly maximise anti-European feeling in the City of London (and its media friends), as global financial businesses located in the City will be expected to pay significant revenues direct to the EU.

This could trigger the moment of truth for Britain. If the 23 are forced to resort to “enhanced co-operation” continuously to avoid a British veto by Conservative Party pressure or a referendum decision, then that will become such a norm that Britain could effectively be out of the EU. How long would it be before “murky protectionism” began to take its toll on British exports to the EU, capital investment slithered away from Britain into the mainland to avoid that protectionism, and the British media whipped up an anti-European hysteria that obliged an “in or out” referendum? The writing is now writ large upon the wall.

© Graham Bishop