We use cookies to help improve and maintain our site. More information.
close

30 September 2022

Schadenfreude? You must be kidding.

In our main story, we argue that the financial crisis is not going to be limited to the UK, and that we think the euro area is at much greater risk; we also have stories on Germany's €200bn energy price support scheme, and the many externalities; on Salvini's weakness and its implications for the next Italian government; on Liz Truss's weakness and the impact on Northern Ireland; and, below, on the Meloni effect in European politics.

If you would like to read more, please contact us for a free trial

Today's free story

Le Pen's plan to get into the Elysée

Marine Le Pen is not a fan of strategies, but she seems to have one to get her into the Elysée palace in 2027. The tortoise and the hare was a fable often used to compare her and Emmanuel Macron in the race. Will she overtake the centre this time?

First, her parliamentary strategy. Le Pen wants to demonstrate that her party, Rassemblement National (RN), has more to offer than strong words on immigration and insecurity. But how? She asked each of the 89 MPs to specialise in one area, be it on heritage, sustainable development, town planning, or higher education. Le Pen also developed a teflon strategy for how to respond to attacks from the government and Nupes, the party of the left, on their values: just respond by focussing on substance instead. This is how she hopes her MPs learn how to deflect attacks and gain respect from the public.

Broadening her remit will allow her to fix one of the most pertinent weaknesses of her past attempts to win the presidential elections: that she has no ally who she could govern with. Her current parliamentary group will be a breeding ground for future ministers. She already has some idea who could be future ministers of the economy, the budget, education, environment or family. Le Pen sowed the seeds over the past two presidential campaigns. Now that RN has managed to become the largest opposition party in the National Assembly, she is now hoping to reap the benefits.

Also, don't underestimate the Meloni effect: Giorgia Meloni, the leader of the Italian far-right, will become Italy's next prime minister, and is likely to still be in power at the time of the next French presidential elections in 2026. Macron’s government is being worn down by serial crises. He is immobilised, with only a relative majority in the assembly. The cost of living crisis is also manna from heaven for Le Pen, and it gives her I-told-you-so narrative credibility. She will reap the benefits from past campaigns. During the 2022 elections, she put down roots in many small communities and towns throughout the country. Those who left RN during the course of her campaign did so to join other far-right parties. It still meant that they voted for Le Pen in the second round. Having more far-right parties will benefit her in 2027, as it allows her to position herself as the new centre of gravity in a political landscape that is sliding to the right.

29 September 2022

Economic models don't grow on trees

There has been a lot of mental fog in the British debates on Brexit, and now also on the financial crisis triggered by Kwasi Kwarteng’s budget. No, the soaring bond yields have nothing to do with Brexit, and could have occurred within the EU. It is true that the fall of exports to the EU after Brexit raised the UK’s current account deficit. But a fall in the pound could have taken care of that. When you are not a member of the euro area, you are fully in charge of your own macroeconomic policies.

The same fog has descended on the debate on economic models. They don’t grow on trees. A hard version of Brexit would have required a change in economic model, not just the usual free market rhetoric. But neither the Johnson nor the Truss administrations have applied focus to this issue. Johnson’s hard version of Brexit would have required a strategic shift in business regulation. Truss seems more radical, and promised action in this area. But she will now be busy fixing the fiscal mess she and her chancellor created right at the beginning.

We saw an interesting argument put forward by Daniel Finkelstein in the Times, who argued that the UK will eventually return to the single market. He writes that Sir Keir Starmer is not disingenuous when he rules out a Brexit reversal of any kind, but that it might happen anyway. We agree with him on this specific point. This is not just the usual events intrude argument - the one that Finkelstein makes.

This is about the scarcity of feasible alternative economic models. It is possible for a country to change its economic model. The UK did this in the 1980s. But it was hard. The Germans will have to change their model, and are only just now realising the monumental implications. The UK has not even started to discuss this in earnest. The whole machinery of government - and the civil service - should have been reorganised in 2019 to deal with the consequences of a hard Brexit. It is an illusion to think that Brexit ever got done.

If two consecutive Tory administrations failed to come up with a post-Brexit model, Sir Keir is not going to do this either. Labour never wanted this. You can’t blame them for not having a model. Labour is focused on things like levelling up, redistribution, the nationalisation of energy and the railways. Whether you think this is good or bad, it has nothing to do with Brexit. Whatever Labour or the Tories have prioritised, they could have done all of this inside the EU. The areas where they could have deviated from the EU, to the benefit of business, is on matters like data protection, competition policy, or a system of business regulation that reflects the old industrial world of the 20th century, from which the EU is finding it hard to escape.

The only thing they did was to draw up a new immigration regime, which is far too restrictive, and now constitutes an additional source of inflation. It has created a structural shortage of labour. As a member of the EU’s single market, the UK would have had to comply with free movement, but it could have regulated free movement in a much more intelligent way than it did before, just as other continental countries have there. There are shades of grey between unfettered free movement and no free movement.

We have concluded some time ago that the UK is not ready for the type of Brexit it chose. The Truss government is the last chance to get Brexit really done, we are not holding our breath. And then, events will intrude.

28 September 2022

Erdogan now talks like Putin did

Recep Tayyip Erdogan is doubling down in rhetoric against Greece, which has eerie parallels to Vladimir Putin’s ahead of the invasion in Urkaine, noted by @GreekAnalyst. This is what Erdogan had to say yesterday:

“The weapons piled up in Western Thrace and the islands make no sense to us because our power is far beyond them, but we remind you that this means a covert occupation… Greece is not our equal in any way. Greek leaders will pay for this.”

Covert occupation? Did we miss something? Is Erdogan still anchored in today’s territorial reality or does he come from the dream of a blue homeland that stretches far beyond its current borders? How does this sit with Turkey siding with Ukraine on territorial integrity? Is this past trauma speaking or a calculated precursor for a more aggressive and assertive foreign policy? Will we see a series of copycats from Putin's diplomacy book of maximum pressure?

An aggressor who turns into a victim is most troubling for diplomacy. Focussing on what the other side does wrong keeps attention away from scrutiny of one's own behaviour. Over the weekend Ankara summoned the Greek ambassador to protest what it is calling the deployment of 23 US-made armoured vehicles to the Greek Aegean islands of Samos and Lesbos, which Ankara maintains should remain demilitarised in line with international treaties. Turkey’s National Security Council will also meet today to decide on how to respond to an eventual negative US response to the F-16 fighter programme or, if positive, an offer with strings attached.

The Aegean islands were part of the history of wars between the two countries. Turkey repeatedly argued that the militarisation of the islands challenges their sovereignty, as they sit so close to the Turkish coastline. Now claiming that this is occupation is one step further up the ladder of escalation.

What is the response from Greece and the West? Kyriakos Mitsoutakis warned that Turkey was up against not just Greece but all of Europe and Greece's allies in Nato. The Greek prime minister said Greece will remain calm and confident, backed by international law. The EU and the US sent messages of support, urging Turkey to de-escalate. The US says a conflict between two Nato countries in times like these is not helpful. The question for Erdogan is how far is he willing to go to jeopardise his relations with the west. And how far the EU and the US will go to reprimand Turkey. These are unchartered waters of a cold conflict that has the potential for hot incidents, with wider ramifications for the EU and Nato.

27 September 2022

New tensions between Greece and Turkey

There is no end to the escalation of tensions between Turkey and Greece. The latest episode started with Turkey complaining that Greece is violating the non-military status of the Aegean islands, presenting aerial images purportedly showing ships loaded with US armoured vehicles docking at two Greek islands, Lesbos and Samos. Greece has reportedly sent 23 tactical wheeled armoured vehicles to the two islands.

Ankara summoned the Greek ambassador and filed a diplomatic complaint with the US. Athens branded the move as "completely unfounded and incompatible with international law", and accused Ankara of aggressive behaviour, according to Al-Monitor.

Turkey has been calling for a demilitarisation of the Aegean islands in line with the 1923 Treaty of Lausanne for a long time. From the Turkish perspective, these islands are very close to its mainland and there is a traumatic history of losses in past wars with Greece. All this nurtures a sense of vulnerability, meaning that a Greek military presence on those islands is quickly seen as a threat. Turkey argues that militarisation challenges their sovereignty, while Greece insists on its right to defend themselves. These tensions are likely to continue.

23 September 2022

Understanding the Italian election

Italy’s election is almost upon us. This will be our last briefing before polls close on Sunday night. Although there’s been a polling blackout for a couple of weeks, it would be a real surprise if the right-wing coalition of Fratelli d’Italia, Lega, and Forza Italia didn’t win. FdI are likely to come out much stronger than any other party in the coalition, and Giorgia Meloni is the best bet as Italy’s new prime minister.

The right-wingers are in a strong position thanks to their ability to make the most of Italy’s complicated electoral system. There are a few quirks of how the Italian legislature, and the country’s elections, work that make it unique within Europe. The first is a parliamentary model that political scientists refer to as perfect bicameralism. This means that both houses of parliament, the Chamber of Deputies and the Senate, have an equal amount of power constitutionally.

In order to form a government, a party, or coalition of parties, must be able to command a majority in both the Chamber of Deputies and Senate. Because proportionally elected seats are allocated nationwide in the Chamber of Deputies but regionally in the Senate, the composition of the two houses is usually slightly different. This makes coalition-building even more necessary than it is in other European countries.

But the most significant quirk for this election is Italy’s electoral system. Because the Italian constitution does not set out a specific voting method for conducting elections, this has changed frequently in recent history. The latest system, which has been in place since 2017, is known in Italian as the rosatellum, after the lawmaker who came up with it. Under it, a third of all seats in both the Chamber of Deputies and Senate are elected via first-past-the-post constituencies, like they would be in the US House of Representatives or British parliament.

What this means in practice is that alliances between parties that can jointly decide to avoid fielding candidates in the same constituencies have a considerable advantage. That’s the secret to the right-wing coalition’s success. They are facing a centre-left that is divided into three camps: an alliance between the PD and some smaller left-wing parties, Five Star, and a tie-up between two prominent centrist politicians. Facing off with an opposition that will be running against each other, success is all-but-guaranteed.

If there are any spoilers, they are likely to come in the Senate elections. A constitutional amendment in 2020 significantly cut the number of parliamentary seats to 400 in the Chamber of Deputies and just 200 in the Senate. This makes the difference between victory and defeat much slimmer. The Senate’s regional basis also helps the centre-left parties, since their support bases are more strongly concentrated in specific parts of the country. The PD are still strongest in the left’s traditional heartlands of Tuscany and Emilio-Romagna. Five Star are the most popular party in southern Italy.

While we still expect a right-wing victory overall, observers should watch out for Five Star. One of the big stories of the campaign has been their comeback in the south, off the back of a cost-of-living focused campaign. They could over-perform, at the expense of Lega.

22 September 2022

I shall be austere tomorrow

No one expects an austerity package from EU member states in times like these, the least from France. The whatever-it-takes during the pandemic may be over, as Bruno Le Maire keeps on insisting, but faced with the energy crisis, the pendulum won’t swing to the other side either. Also, since Emmanuel Macron lost his outright majority in parliament, there are concessions to be made to the opposition in parliament to ensure the passage of the 2023 budget. This is likely to come with a price tag.

We already see the cursor moving in this direction. The latest copy of the 2023 budget increased public expenditure by €7.5bn compared to the draft in August. The biggest chunk of this, €4.7bn, is dedicated to the environment ministry, mainly to compensate for the rise in prices for gas and electricity. The government is clearly preparing for more payouts. The total cost of the support measures from petrol to energy cheques is estimated at €47bn, according to Les Echos. The other big chunk of this increase, €2bn, goes towards health. 

This may not be the last budget draft to register an increase in expenditure. Elisabeth Borne is currently making the rounds, talking to the main opposition parties to sound out their positions. Apart from the budget there is the pension reform on the table where the opposition has each their own take. Austerity can wait for another year or two. Politics reigns supreme.

21 September 2022

RIP QMV

Remember Olaf Scholz's speech in Prague, hailed as his answer to Emmanuel Macron Sorbonne speech? Scholz proposed an end to majority voting on foreign policy, a reiteration of a long-standing German demand. In the German world view, the big problem with EU is not that Germany has dirty deals going with Russia and China, but the fact that small countries can veto EU foreign policy decisions.

The delusion of an end to majority voting over foreign policy ended in the European Council yesterday after the Czech council presidency made some discrete enquires, and was told by several countries that they are not willing to give up their veto. They need it to protect themselves against Germany. Hungary’s no was predictable. But Ireland also said no, on the grounds that this is silly deflection of the more urgent tasks that are needed right now. Austria is not keen on it either. Most countries were circumspect. Only five countries fully supported Scholz's foray: France, Italy, the Netherlands, Denmark and Sweden.

We are not surprised to hear this. The fundamental problem with Europe’s foreign policy is that in the past it has been driven mostly by German commercial policy. What Scholz should have done instead of making demands on others, is to start by announcing a shift in German foreign policy itself, away from the Neo-Mercantilist model. And then seek allies for the new approach. It is not about what the EU can do for Germany, but what Germany can do for the EU.

This did not happen because of the way Germans are framing the debate. In that debate, the problem with the Nord Stream 2 is not the pipeline itself, or the dependency it created. It’s all Vladimir Putin’s fault. Who could have predicted that he would invade another country?

Another debate that never happened in Germany is the foreign policy impact of a large and persistent current account surplus. You can’t be a Neo-Mercantlist and a human rights advocate at the same time. The persistence of such surpluses requires dirty deals with dictators in foreign lands. The discussion Germany, and the EU, need beyond the urgent issue of the current crises is what constitutes a European foreign policy interest. Is our guiding principle respect for democracy and human rights? Is it to prevent geopolitical imbalances? Or do we continue to equate our interests with those of BASF and VW? There is no consensus in Europe on this matter. Don’t start with QMV.

20 September 2022

Cyprus - the US gun against Turkey

By lifting the three decade long arms embargo on Cyprus the US is recalibrating the power dynamics in the Eastern Mediterranean: it is offering Cyprus a way out of Russian military purchases and is sending a warning to Turkey to know its place when it comes to its land and sea claims against Cyprus’s territory. There's no doubt that American arms could shift the power balance in the region. It is a warning to Turkey not to escalate further, and an opening bid for Nato negotiations with Turkey.

It is not a complete lift of the embargo though. The US will remove blocks for one year on the sale or transfer of non-lethal defence articles and defence services. The US imposed the arms embargo in 1987, in the hope that it could encourage the reunification of the island, about one third of which has been controlled by Turkey since an invasion in 1974. But the move was counterproductive, pushing the Cypriot government to create alliances with other countries without leading to progress on reunification.

The timing for lifting the arms embargo announcement was no accident. Photos of Recep Tayyip Erdogan circulated showing him arm in arm with Vladimir Putin, as part of a trio with China’s president. The US will use Cyprus like a gun at the negotiation table, a reminder that the US can make life difficult for Erdogan in so many different ways as the world is shaping itself into spheres of influence according to the logic of whoever is not with us is against us, writes the editorial of the Greek newspaper To Vima.

The lifting of the arms embargo is a tactical move as part of a new Cold War that is about to emerge as the new world order. We can see the short term rationale, but what are the long term consequences for the region? Is their calculation that Erdogan can be reasoned with once he receives a reminder of who is in charge? What will they put on the table to convince him to return to his Nato allies? Erdogan is a cunning negotiator, as the EU has previously found out. These negotiations will drag on for a while. In the meantime, Cyprus will become a new market for the US arms industry. It is also perhaps worth pointing out that Cyprus is one of the few remaining EU members that is not in Nato. This is another way of welcoming Cyprus into the alliance.

19 September 2022

Who is investing in China?

Trade is no longer what it used to be. European companies pulled out of Russia in protest against the invasion of Ukraine. EU institutions are looking into new ways of monitoring human rights adherence and the application of environmental values in supply chains. Suddenly there is a lot more to consider when investing in new ventures abroad.

This also applies to China. A new report by Rhodium, a private China research institute, suggests that there is already a structural shift visible in European foreign direct investment into China that cannot only be explained by China’s zero-Covid policy.

They registered the concentration of European FDI around a few players, and the absence of new investors. The top 10 European investors in China account for 80% of all investment over the past four years concentrating on five sectors, with the car industry standing out in particular. German companies lead the list, with VW, BMW, Daimler and BASF alone contributing 34% of FDI between 2018-2021. BASF just inaugurated a huge industrial site in Guangdang, that will in 2030 be one of BASF’s three major production sites in the world, investing €100bn into the development. They are there for the long haul, to make profits locally.

Another observation is that virtually no new investors have entered China over the past four years. This is partly due to China’s zero-Covid strategy, which has complicated flows and repelled investors. But according to Rhodium’s conversations with stakeholders, there are also long term risks that come into play. We expect Xi Jinping’s wish to take over Taiwan whilst still in power, and the possible US retaliations, to be perceived as a potential threat. Then there are human rights worries that feature more prominently in European debates, a sensitivity accelerated by Russia’s atrocities in Ukraine.

We see Germany also quietly retreating on its support for Chinese investments. Robert Habeck remarked recently that a fourth terminal of the Chinese shipping company Cosco in Hamburg may not be authorised. Olaf Scholz announced a diversification strategy from 2023. The government also started to revoke government guarantees for companies, currently at €11.3bn for China over a total of €19bn worldwide. The first guarantees pulled were for companies operating in Xinjiang over human rights concerns.

What is yet to come? Investors will continue to come to China. It is a huge market, after all. Past investments oblige future ones. A rollback of China’s zero-Covid restrictions is also likely to prompt investors to return. But amid the diversification strategy that governments and companies in Europe are currently undertaking, it may well be that investment in China will be mostly for the fully committed, writes Rhodium. This also may affect the internal logic of companies, decoupling their China operations from the rest. A strategy that suits China’s authorities well.

16 September 2022

Inside the Mercantilists' mind

We noted a lot of glee on Twitter about Vladimir Putin’s failure to secure any meaningful concessions from Presisent Xi Jinping of China. Michael McFaul, a former US ambassador to Russia, noted that Xi did not promise Putin any weapons, ammo and chips: only words of solidarity, and a willingness to buy discounted energy from Russia. We are not sure that this is exactly what happened yesterday.

Putin’s war is not in China’s interest. China is not openly supporting Russia. But beware of inverse logic.

China’s biggest geostrategic goal is to reduce its dependency on the west. China cannot risk a confrontation with the US - over Taiwan - for as long as its national wealth is invested in US treasuries. This transition will take time, and there are powerful interests inside China that work against it. What we do know about the interaction between geopolitics and economics is that you cannot be both a Mercantilist and a superpower. This is why the EU is what it is, and why the US is what it is. The US derives an increasingly important part of its power from its willingness to absorb the Mercantilists' savings surpluses.

China is not in a position to absorb Russia’s sanctioned surpluses. And it is dependent on exports to the US or to third countries where payment flows go through the US. China is therefore not able to flout sanctions openly, but it is supporting Putin in subtle ways, the most important of which is the export of dual-use goods. Chinese exports to Russia are a category to watch out for in the next few months.

We also keep wondering whether Olaf Scholz might be playing a similar game. He is rhetorically supporting Ukraine. But we also know that Scholz played a double-game in the past. He held a 90 minute phone call with Putin this week. The Germany media reported only that Scholz called on Putin to withdraw his troops - the ultimate dog-bites-man story. We suspect that the restatement of known positions was not the main part of a 90-minute long conversation. We are asking ourselves whether Scholz might have offered concessions to Putin on sanctions in exchange for a resumption of gas supplies. The most positive spin is that he might have offered Putin concessions for a peace settlement, but that’s not really in Scholz's power.

What we do know is that the Mercantalists think alike, new and old. We remember a story about Ludwig Erhard, a former German economics minister who later became chancellor: after East Germany built the wall, he pondered aloud how much he would have to pay Nikita Khrushchev to buy East Germany off him. He was surprised to learn that the country was not for sale. Putin is perhaps the biggest Mercantilist of all. The western sanctions are an example of why current account surpluses and waging war do not go together.

But the world is becoming less dependent on the west. Right now, we see the emergence of a new trading bloc, centred on China, with India, Russia, and parts of Africa. This is a formidable constellation. China will be the senior partner in that block. And Russia will need to find a new business model, with or without Putin. This is the big shift we are seeing - and from a western perspective there is nothing to be gleeful about.