The EU’s post-Brexit paralysis
It was billed as a show of post-Brexit unity of purpose. Without the fractious Brits to obstruct progress, leaders of the remaining 27 members of the European Union would come together to affirm their unshaken commitment to the goal of “ever-closer union”. Unsurprisingly, the reality of the weekend’s Bratislava gathering failed to live up to its billing. Without the presence of the habitually adversarial British to unite them in antagonism, the remaining leaders were left looking, if anything, more divided than ever. National electoral calendars will continue to dictate the positions of the major heads of government for at least the next 12 months, leaving their agendas visibly at odds. As a result, the chances of any moves towards the vision of greater economic and financial union outlined in last year’s Five Presidents’ Report are minimal. More to the point—with monetary policy apparently at the limits of its effectiveness— the EU’s differing national political imperatives leave little room for any relaxation of fiscal policy to support economic growth.
With progress towards a full banking union—complete with EU-wide deposit insurance—a capital markets union, and a fiscal union ruled out for the time being, the assembled leaders were left seeking common ground on which they could agree to advance. Their solution was to promote moves towards greater security and defense cooperation. Facing a common terrorist threat, and with conflicts continuing not far beyond the EU’s eastern and southern borders, Europe’s leaders see closer security integration as a “motherhood and apple pie” issue, on which everyone should be able to agree. Yet although the British will no longer be in the room to oppose the creation of a joint EU military force, which has long been a treasured objective of European federalists, a “Schengen of defense” remains a distant prospect, as none of the major players are prepared to transfer the required sovereignty to Brussels.
Of more immediate importance to investors is Europe’s electoral calendar. The erosion of the electoral share of both the CDU party of German chancellor Angela Merkel and of her SPD coalition partners in the weekend’s Berlin state election, and in particular the gains made by the right wing populist AfD party, only magnify the uncertainty ahead of Germany’s general election in September 2017. On top of that, France goes to the polls next April for a presidential election in which support appears to bleeding away from the center towards the extremes. Spain has been without an effective government for nine months, and may be facing its third general election in a year. And in November Italy votes in a referendum on constitutional reform in which a “No” vote could precipitate the resignation of prime minister Matteo Renzi, leaving Italy leaderless.
This timetable emphasizes the divergence on fiscal policy between Europe’s leaders as each attempts to court popular support among his or her domestic electorate and see off the challenge from populist parties.
Rome is calling for more fiscal transfers. Last week, the Italian Ministry of Finance pressed its calls further, publishing a paper proposing the introduction of unemployment insurance at a pan-European level.
Paris wants the EU to sign off on looser fiscal policy. After France has exceeded the EU’s 3% of GDP limit on fiscal deficits every year since 2007, contenders in next year’s presidential election are starting to call for the deficit limit to be relaxed from 2017.
Berlin continues to advocate a fiscal hard line, both domestically and for its EU partners. Contrary to the hopes of some observers, the recent announcement by finance minister Wolfgang Schauble of a EUR 2bn tax cut for next year and the prospect of a further 15bn in cuts to follow do not represent a fiscal U-turn. Instead, the proposed cuts are intended as relief measures for German workers who have found that recent wage increases have pushed them into higher tax brackets under Germany’s steeply progressive taxation system. In short, the cuts are intended to offset the inadvertent tightening that saw Berlin run a 18.5bn surplus in the first half of 2016, rather than as a loosening of policy.
All this leads to two conclusions. The first is that even without the recalcitrant British at the table, the EU will make no material progress on its declared agenda of economic and financial integration until after next year’s elections, and possibly not even then should populist Euroskeptic parties make substantial gains at the polls. The second conclusion is that no significant fiscal stimulus is likely in 2017. The flexibility allowed by the Stability And Growth Pact has been exhausted and the political timetable precludes any relaxation of the rules in the near term (the expanded Juncker plan announced last week is not a substitute; its structure limits its effectiveness. That leaves the European Central Bank alone in the growth driving seat, and as recent data has shown, the ECB’s policy traction appears increasingly limited.