Fear and Loathing in Europe
Oct 04, 2005
Serhan Cevik (London)
Europe’s failure to open accession talks with Turkey reflects populist fears. Even though Turkey has already fulfilled the Copenhagen political criteria and the European Council made a unanimous decision to open accession negotiations with Turkey “without delay”, Europe’s leaders remain divided over the negotiating framework and thus over the start of accession talks. If the EU rejects the prospect of Turkish membership, financial markets would no doubt face a challenging outlook. However, in our view, by violating the basic principle of pacta sunt servanda, the EU would suffer even a greater loss in terms of political credibility and institutional legitimacy. Moreover, the refusal to accept the integration of a ‘Muslim’ country into a ‘Christian’ institutional sphere not only lacks legal justification but is also inconsistent with the foundations of today’s Europe. Turkey stands to gain a lot from the predictable path of accession talks, but closer ties with Turkey would also support the continent’s long-term strategic interests and give a competitive edge over other global players (see The Great Deception, May 26, 2005). Although we still think that the EU will eventually agree on opening accession talks with Turkey, we want to reiterate our view on the worst-case scenario.
In our view, political stability is behind Turkey’s macroeconomic stability. Political fragility was the most important reason for Turkey’s past failure to democratise and undertake a long list of structural reforms. However, political consolidation in the 2002 elections set the stage for a dramatic transformation in terms of institutional convergence and macroeconomic policy-making. This is why we believe that the Turkish economy is not as vulnerable to ‘exogenous shocks’ as it used to be in the past. In our opinion, Turkey is already a regional power and, if truth be told, does not need an ‘external anchor’ to complete its structural transformation. Of course, the prospect of EU membership played a key role in accelerating institutional reforms so far and likewise the accession process would drastically reduce the cost of transition. However, this is not sine qua non for Turkey’s institutional evolution towards liberal democracy and sustainable economic development. In other words, regardless of the forthcoming EU decision, Turkey should — and, in our view, will — stay on the existing ‘road map’ of democratisation and macroeconomic management (see What Plan B?, May 27, 2005). The Turkish economy is strong enough to withstand financial oscillations. Structural reforms and predictable macroeconomic policies have helped, stabilising the Turkish economy and accelerating its growth momentum. Along with declining inflation rates, real GDP increased by 26.7%, on a cumulative basis, in the last three and a half years. Would the EU’s rejection to start accession talks derail the economy off its welfare-enhancing path? As long as the Turkish authorities remain committed to prudent policies and structural adjustment, our answer is no. Of course, the country is not completely free from negative consequences of exogenous developments and still suffers from a variety of structural ailments. Nevertheless, we believe that the ruling government is aware of risks and would become even more dedicated to fiscal austerity and institutional reforms in order to curtail the consequences of financial oscillations. Even the worst-case scenario would not lead to a catastrophe in the economy. The existing policy framework — based on a flexible exchange rate regime, fiscal consolidation and structural reforms — would limit the pass-through into the real economy. Since Turkey has already made significant progress in macroeconomic normalisation and reducing risks to debt dynamics, a financial shock may lead to below-trend growth (for a short period of time) but not to an economic recession, in our view. For example, the overall budget deficit narrowed from 12.3% of GDP in 2002 to 3.9% last year and, on our estimates, will decline to about 2.8% of GDP this year. Given that the Treasury has increased its borrowing maturity from 9 months in 2003 to around 26 months so far this year, the roll-over risk is no longer the most important risk factor. Therefore, even the worst-case scenario would lead to a temporary weakening of the lira and bond prices but not to an economic catastrophe, in our view. The EU anchor is important for dealing with historical baggage. There are numerous benefits stemming from the accession process, but providing a favourable setting to address historical baggage and entrenched positions is probably the most important one. Turkey’s encouraging move on the Cyprus dilemma is a case in point. Therefore, the main risk of not having the EU anchor is, in our view, not economic fallout but a stalemate on political reforms and openings. This is why we have always argued that Europe needs Turkey as much as Turkey needs Europe.
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Going for a Grand Coalition
Oct 04, 2005
Elga Bartsch (London)
This weekend’s by-election in Dresden, where a belated ballot of 220,000 voters completed the results of the September 18 general election, has removed another hurdle for the formation of a government in Germany. The results caused the Christian Democrats’ (CDU/CSU) lead over the Social Democrats (SPD) in the lower house of parliament to widen by one seat to a total of four seats. At this stage, a grand coalition between Chancellor Schroeder’s SPD and the opposition CDU/CSU led by Angela Merkel seems increasingly likely. The informal talks between both parties held thus far seem to have gotten off to a promising start and further talks are taking place this Wednesday. The main stumbling block to entering official negotiations on a coalition agreement remains that both contenders still claim their right to the Chancellory. Interestingly, Chancellor Schroeder’s insistence on keeping his job seems to have -- at least temporarily -- cemented Mrs. Merkel’s position within the CDU/CSU. If it weren’t for outside attacks, a detailed dissection of the reasons for a much worse-than-expected election outcome for the CDU/CSU might have already undermined her position as the party leader. In addition, the present political position, where the two large parties have roughly the same number of seats (226 versus 222) in the new Bundestag, is a tricky one. Hence, her rivals within the CDU/CSU might prefer to sit on the sidelines. A potential exit from the present stalemate could also be that Schroeder and Merkel have to leave. In such an event, their joint departure could make way for Roland Koch (CDU) and Peer Steinbrueck (SPD), who already have cooperated in the past when putting together a list of cut-backs in subsidies and tax breaks. But so have Edmund Stoiber (CSU), who seems to be eyeing a move to Berlin, and Franz Muentefering (SPD) on reforming the federal relations. The question of who is going to be Germany’s next Chancellor no longer seems to be a make or break question for the grand coalition, as the SPD party chairman, Mr Muentefering, has said that securing the top job for Gerhard Schroeder was an SPD objective for the upcoming negotiations. Previously, it had sounded more of a precondition. Leaving political personae aside for a moment, a grand coalition clearly would have its work cut out. We have argued in the past that, based on their election platforms, both parties seem to have little agreement on many key policy areas (see A Clear “Neither Nor”, September 19, 2005). The only exception is the consensus achieved at this Spring’s job summit to lower corporate taxes a bit further while rolling back some tax breaks (see Not a Grand Plan, But Maybe a Grand Coalition, March 17, 2005). While the CDU/CSU favour further reduction in income taxes, the SPD firmly opposes those. Both parties could dust off the so-called Koch-Steinbrueck list of cut-backs to subsidies and tax breaks, which essentially proposed to cut almost all of them by the same proportional amount of 4% per year. This would mean that the allowance for first-home buyers and for commuters would be scaled back while surcharges for night-time and weekend work would remain tax free. The biggest challenge for fiscal experts on the both sides, however, will be to plug a structural budget hole of at least €25bn p.a. in the next federal budget alone. Hence, the newly founded cooperation might already be put to a serious test as early as November’s budget debates in parliament. Press reports suggest that an agreement might have been reached between the parties to consolidate public finances more ambitiously than the election platforms had suggested. According to these reports, an informal consensus has been reached to bring the general government budget deficit below 3% of GDP again by 2007. Previously, the CDU/CSU had only aimed for 2009. The key battleground in terms of shaping the performance of the German economy and the political reform agenda will be the parties’ labour market policies. Here the CDU/CSU proposes to marginally lift employment protection rules for new hires at small companies of up to 20 employees and to extend the possibilities for individual companies to deviate from the industry-wide wage contract further. The SPD strictly opposes all further efforts to hollow out the industry-wide wage bargaining system in Germany. In fact, the SPD would like to launch a formal minimum wage legislation, which thus far does not exist for most sectors, except construction. But looking at the announced lay-offs over the last few months compiled by the European Restructuring Monitor, which now shows a total of 70,000 layoffs year-to-date compared to 32,000 up to and including July, many German companies don’t intend to wait for a bit of extra labour market flexibility granted by the government. At the same time, we see a noticeable pick-up in new jobs to be created in Germany. In July, only a tiny 6,000 new jobs had been announced thus far this year, now we are looking at 28,000 new hires to be made. A similar message that the labour market outlook is gradually becoming better came from the latest labour market report, which showed a monthly rise in job openings of 25,000 to a total of 468,000 in September. Last but not least, a grand coalition would provide a unique chance to prune back Germany’s proliferating political system. With 70% of votes, a grand coalition can easily muster the two-thirds majority needed for constitutional changes. Two potential constitutional changes would be key, in my view: First, the rising fragmentation of the political spectrum in Germany could warrant deliberating a move from the present proportional voting system to a majority voting system. Second, the complex system of federal relations in Germany -- political, legal and fiscal -- desperately needs some serious streamlining. The firstgrand coalition, made some fundamental changes to Germany’s economic and fiscal policy-making in the late 1960s. On the one hand, in response to the first post-war recession in 1967 the grand coalition introduced Keynesian demand-management to the German economic policy toolkit. The failure to fine-tune the business cycle through fiscal policy measures, amongst other instruments, is at the heart of today’s elevated deficit and debt levels. Second, the CDU/SPD government introduced a complex system of transfers between the regional states and the federal government. This system is not only threatening to undermine Germany’s stellar credit rating but also proving to be a major hurdle to the implementation of reforms because the co-financing of many spending programmes and the sharing of tax revenues across different layers of government implies that the upper house of parliament, the Bundesrat, has to approve the majority of legislative changes. So, after nearly 40 years the time might be right for another grand coalition…
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