Eurasia Group's weekly selection of essential reading for the political risk junkie -- presented in no particular order. As always, feel free to give us your feedback or selections @EurasiaGroup or @IanBremmer.
David Horowitz, The Times of Israel
Israel's quantity of natural water per capita is the lowest in its entire region. But it seems Israel's water crisis may be a thing of the past. Why? More than 80 percent of Israel's purified sewage is reused for agriculture. The next best in the OECD? Spain, at 18 percent.
Stephen Brown and Holger Hansen, Reuters
Yes, Spain's unemployment rate is over 26 percent. But elsewhere in the Eurozone, it's a different story. Germany's unemployment rate is at its lowest since reunification in 1990 -- and Berlin is actively recruiting certain skilled labor.
In Italian elections this week, voters set a post-war record ... for lowest turnout.
Simon Shuster, TIME
In a recent study, a group of academics analyzed a random sampling of 25 dissertations from the history department of Moscow Pedagogical State University. They found that all but one had been "at least 50 percent plagiarized." So how high up the ranks does plagiarism go? Perhaps more to the point, how high up the ranks will Medvedev's campaign to weed out plagiarism be permitted to go?
Kenneth G. Lieberthal, Brookings
This piece takes a realistic approach to highlighting potential common ground on cybersecurity between the United States and China.
Katherine Maher, Foreign Policy
Have you ever thought of the internet as unclaimed territory, awaiting a basic framework for division of sovereignty? You're not the only one -- a lot of nations have, too.
MENAHEM KAHANA/AFP/Getty Images
Note: Today is the sixth in a series of posts that detail Eurasia Group's Top Risks for 2013
While the immediate crisis has subsided, risk still emanates from Europe in 2013. First, the process of institution-building to address the flaws of the eurozone structure will continue to be halting, especially in light of major elections in Italy and Germany. And second, many eurozone countries face recession or stagnation, which could test the eurozone structure in new ways.
To be clear, as in 2012, the risk of a eurozone break up is minimal, primarily because the European Central Bank has made clear it will do whatever it takes to preserve the euro. But the muddle-through approach presents risks in 2013, just as it did in 2012.
Germany heads to the polls in September. While Chancellor Angela Merkel has gained the strong backing of the German public for her handling of the eurozone crisis, the current government will be loath to contemplate any major new institutional or funding moves that might upset the careful balance she has struck. The most pressing concerns are policies allowing the direct recapitalization of eurozone banks and the building of an ambitious fiscal and banking union.
Italy holds elections on February 24-25 in which anti-austerity and populist parties could win more seats. Such a government would likely struggle to provide political stability, the reform drive could suffer, and financing costs could again rise.
Beyond the political calendar, a number of factors could test the temporary eurozone equilibrium. If France fails to hit budget deficit targets, President Francois Hollande's government will probably have to enact additional spending cuts and some tax hikes. Spanish Prime Minister Mariano Rajoy is unlikely to ask for financial assistance from the eurozone's new permanent bailout fund absent market pressure. But should that pressure arise, Spain would ostensibly have to agree to reform commitments stipulated by the ECB's agreement to purchase the country's bonds in the secondary market. Those commitments are likely to be met with resistance in hard-hit Spain, putting the ECB in a quandary: If Spain refuses to meet the conditions, does the ECB loosen its requirements, potentially encouraging moral hazard in other member states, or does it insist on reforms and potentially withhold assistance that could cause a new conflagration in the eurozone?
Later this week, we'll profile Risk #7: East Asian geopolitics.
Sean Gallup/Getty Images
By Carsten Nickel
It's a trick not every political leader can pull off: put some 420 billion euro on the European table to protect Europe's weakest economies from default and remain your country's most popular politician. That's what Angela Merkel has managed. Despite having made unpopular concessions to Greece only a few days earlier, delegates of her Christian Democratic Union (CDU) re-elected her as party leader with close to 98 percent support last week. Her public approval ratings remain north of 60 percent, and the trust that German voters have in Merkel's management of the eurozone crisis puts the Chancellor and her party in a strong position ahead of general elections next September.
The reason behind these impressive figures is that Merkel's mix of strong commitment to Europe on the one hand and the push for structural reform in southern Europe on the other exactly reflects the policy preferences of the average German voter. Divert too far from this path to the right, as Merkel's junior coalition partner, the Liberals, attempted in some regional election campaigns last year, and German voters will punish you for your lack of European solidarity. Step too far to the left, like opposition Social Democrats (SPD) have tried with calls for Eurobonds and a debt redemption fund, and voters lose trust in your ability to defend the German taxpayers' interests. In the middle stands Merkel. Her calm, approachable persona and her centrist incrementalism have persuaded German voters that two conflicting goals can be achieved: Save Europe and limit the financial burden on Berlin.
With strategic clarity, Merkel has also drawn the right conclusions from the decline of her former coalition partner, the SPD. Social Democrats still suffer from the disappointment caused by the supply-side reforms introduced under former Chancellor Gerhard Schroeder during the early 2000s. The party's vote share has halved over the last 15 years. In response, Merkel maintains a centrist political position, enabling her to form coalitions with the Liberals, the SPD, or potentially even the Greens. And by offering little opportunity to attack her along the clear-cut lines of left-right politics, Merkel makes sure that traditional SPD voters do not return to the polls anytime soon, denying the party an easy way out of its misery.
Ahead of the 2013 elections, Merkel is therefore unlikely to come under pressure to depart from her current policies. The negative result is that silver-bullet solutions for the eurozone crisis remain unlikely and structural problems such as intra-eurozone imbalances will not be addressed. On the upside, investors in Germany will find it reassuring that the country's high-productivity export model is unlikely to be challenged by calls for demand-side policies. German companies will therefore remain in a strong position to compete for market share in emerging economies across the globe. In Berlin, meanwhile, only one politician wins: Angela Merkel.Carsten Nickel is an analyst in Eurasia Group's Europe practice.
Sean Gallup/Getty Images
Eurasia Group's weekly selection of essential reading for the political risk junkie-presented in no particular order. As always, feel free to give us your feedback or selections @EurasiaGroup or @IanBremmer.
1. "Al Qaeda 3.0:
Terrorism's Emergent New Power Bases"
Bruce Riedel, The Daily Beast
In a world where international governance is breaking down, leaders are focused more on domestic than on foreign policy challenges. This trend extends to al Qaeda, an organization transitioning from global to local goals.
2. "India's African ‘Safari'"
Sudha Ramachandran, The Diplomat
We hear a lot about the US and China's conflicting investment approaches in Africa, but there's precious little written on Africa's fourth largest trading partner: India. With trade increasing by a factor of 17 over the last decade, India-Africa relations are becoming much more interesting.
3. "How Crash Cover-Up
Altered China's Succession"
Jonathan Ansfield, New York Times
How will Beijing's leadership manage the challenges that come with an era of more open information? What will the rest of us learn about the Chinese leadership's taste in cars, clothes and once-hidden power politics?
4. "Merkel's mastery of
Michael Fry, The Scotsman
Is Angela Merkel the most talented politician in the world? Her domestic political tactics shed light on her policies with regard to the Eurozone and beyond.
5. "A free-trade agreement
David Ignatius, The Washington Post
Though still on the drawing board, the Trans-Pacific Partnership has far-reaching security and economic implications for North America and the Asia Pacific region. Progress on an Atlantic equivalent seems beyond the horizon. But is an ‘economic NATO' already in the planning stages?
6. "The mother of all
worst-case assumptions about Iran"
Stephen M. Walt, Foreign Policy
Would a nuclear Iran carry "shattering geopolitical significance?" This piece overstates its case at times, but it's a question that demands consideration.
The Weekly Bonus:
"Floating Housing (And
Golf Courses) For Post-Climate-Change Island Paradises"
Co.EXIST blog, Fast Company
In a G-Zero world, don't expect political leaders to tackle climate change. An ineffectual climate summit meeting in Doha this week makes that all the more obvious. If climate change continues unabated, the Maldives will end up underwater. The government knows it, hosting a cabinet meeting on the ocean floor in full scuba gear in 2009, and inquiring about land purchases abroad. But even the most daunting risks come with opportunities, however whimsical they may seem.
By Michal Meidan and Carsten Nickel
There are many reasons why China's economy has begun to cool, but the dramatic slowdown within the European Union, China's largest trade partner, is among the most important. Fears for Europe's growth and stability weigh heavily in Beijing, and China's risk-averse leaders are willing to invest in Europe's recovery.
But Beijing won't risk throwing good money after bad with substantial bailouts for risky peripherals like Spain, Italy or Greece. That would play badly inside China, where public perception that government is bailing out wealthy Europeans during a slowdown at home wouldn't play well. Greek haircuts earlier this year left Chinese investors with huge losses, and to invest in the European Financial Stability Facility (Europe's current bailout fund) is to form closer ties with meddlesome bureaucrats in Brussels.
Instead, China is increasing its direct investment in Germany, still Europe's economic engine, and, by extension, in Berlin's ability to manage crises and restore the continent's growth. That's good news for German Chancellor Angela Merkel, who sees the strategic importance of improving relations with the world's other leading manufacturing-dependent surplus economy. China has become Germany's third-largest export market behind France and the United States, and with demand among Germany's neighbors unlikely to increase anytime soon, German manufacturers will grow increasingly dependent on China and its markets.
Economic ties between China and Germany began to tighten following the onset of the financial crisis in 2008 as demand generated by the Chinese stimulus plan became an important source of Germany's recovery. Closer ties with German automakers and producers of renewable energy help Chinese firms develop new technologies and climb the value chain.
is a downside for Germany. Expanded commercial ties will force Merkel's
government to contend with domestic concerns that China's labor practices fall
far short of acceptable standards and that German companies doing new business
in China will have their intellectual property stolen. But Chinese purchases of
German Bunds will help Merkel ease domestic fears that German support for
Eurozone weaklings will sap the country's strength. That's why Merkel's once
vocal criticism of China's human rights record has all but disappeared -- and why Berlin,
unlike European institutions in Brussels, has yet to demand equal access to Chinese
That's crucial for China. Beijing will continue to pay lip service to its ties with EU institutions, but growing ties between Beijing and Berlin will complicate Brussels' efforts to develop a common foreign and trade policy toward China, increasing Beijing's bargaining power with individual European partners.
Today, when China's leaders look toward Europe's core, they see a weakened France, a marginalized Britain, and a rising Germany. By betting on Berlin, China is hoping that Germany will use its increasingly decisive role in EU decision-making to provide China with market economy status, and the commercial advantages that come with it, and even to help lift Europe's arms embargo on Beijing. For its part, Germany is hoping ties with China can boost growth at a moment when it's badly needed.
For the moment, it's an increasingly profitable partnership.
Michal Meidan is an analyst in Eurasia Group's Asia practice. Carsten Nickel is an analyst in the firm's Europe practice.
Sean Gallup/Getty Images
By Carsten Nickel
"It's not for Germany to decide for the whole of Europe," Francois Hollande, the socialist candidate favored to win the presidential run-off, reminded Chancellor Angela Merkel on French TV last week. Gone seem the days of the "Merkozy" era when Merkel decided that austerity was the way forward out of the euro crisis -- and President Nicolas Sarkozy followed suit. With much of Europe caught in recession and political opposition from Paris on the rise, the question is: Is the austerity doctrine coming under pressure in Germany? The answer is: Probably not.
A growth-versus-austerity debate has already kicked off in Germany and is set to further intensify over the next few weeks. The second round of the French elections, Greek parliamentary elections, and elections in the German federal state of Schleswig-Holstein -- all held on May 6 -- will amplify the pressure on Merkel. After Hollande's strong display in the first round of the French presidential elections, the German Social Democratic Party (SPD) congratulated its French counterpart and told Merkel that it would delay the ratification of her prestige project, the European fiscal compact, because it was lacking the growth component demanded by Hollande. The chancellor, notoriously inclined to political U-turns, quickly began proclaiming growth-enhancing policies as the "second pillar" of her eurozone strategy. German commentators saw her encircled by advocates of fiscal expansion.
But the current noise should not be overestimated. Germany's overall preference for fiscal prudence is likely to prevail because of two factors. The first is the political weakness of the opposition, providing Merkel with a strategically comfortable position at the center of German politics. The second is the country's coordinated market economy, which prioritizes supply-side adjustments to limit wage restraint; expansionary policies would abet inflation and wage growth.
Social Democrats might perform well in the upcoming state elections, but the party's program regarding the euro crisis remains shallow, while public support for expansionary policies stays weak. Moreover, voters have not forgotten that it was former chancellor Gerhard Schroeder's SPD government that introduced the supply-side reforms to Germany, which Merkel now wants to prescribe to the rest of Europe. Meanwhile, the rise of the internet activists' Pirate Party diminishes the chances for a coalition of SPD and Greens after the 2013 Bundestag elections. And the chronic weaknesses of Merkel's coalition partner, as well as her own high personal approval ratings, provide her with much political leverage.
Merkel will pragmatically co-opt growth rhetoric over the next few weeks, and the opposition might delay ratification of the fiscal compact, both of which the SPD will sell as a success. But the party will not demand substantial growth-enhancing policies in return for their support of the compact in the Bundestag, and Merkel has already spelled out what her agenda for growth looks like: Enact labor market reforms, increase the pension eligibility age, and liberalize your economies, she told European partners. Not quite the expansionary policies many German commentators saw forthcoming.
Germany's coordinated market economy is behind its recent economic success and its resistance to spend. In key sectors such as the automotive industry, organized workers and employers bargain without political interference. Firms offer generous welfare schemes and job security, receiving highly skilled manual workers and-crucially-wage restraint in return. Germany's answer to rising competition from Asia has been to increase productivity in a coordinated effort. With Germans unwilling to see their export surpluses as a key factor behind the eurozone's woes, their preference for austerity is here to stay.
Carsten Nickel is an analyst with Eurasia Group's Europe practice.
Jesco Denzel/Bundesregierung-Pool via Getty Images
By Antonio Barroso
With the survival of "Merkozy" at stake, German Chancellor Angela Merkel has inserted herself into the French presidential election on behalf of her eurozone partner, President Nicolas Sarkozy. It's not just because a Francois Hollande victory would make finding a new pithy nickname for the German-French duopoly difficult (though it would be a challenge -- "Hollmerk?" "Merkande?") Or because it has become trendy for like-minded political figures to support each other in races across national boundaries within the EU.
Merkel views the preservation of her partnership with Sarkozy as an important element in the timely resolution of the eurozone crisis, despite their rocky start, numerous disagreements, and natural rivalry. The devil that Merkel now knows well, and has spent considerable capital cultivating, is preferable to the devil she doesn't know, and can only speculate about -- a socialist who, while pro-European, has bashed the financial sector, disparaged austerity, and promised to maintain social spending. There are too many uncertainties in a Hollande presidency for Merkel to sit idly by in Berlin as Sarkozy continues to trail significantly in the polls ahead of the April 22 first-round vote.
That's why Merkel has actively stumped for Sarkozy, tying German conservatism to its French counterpart. The alliance between the German and French leaders is not just a personal bond, forged through the crucible of the eurozone crisis. Merkel believes she now has a partner in Sarkozy who shares her beliefs about the currency bloc -- and will push those interests (which also happen to be Germany's interests) in Brussels. After all of the painstaking negotiations and one-on-one meetings, she's not about to start all over again.
Hollande's political party, his campaign statements, and the fragility of the eurozone have many observers worried that a Hollande presidency would put France -- and the eurozone -- into greater danger. Some view Merkel's visible and vocal support of Sarkozy as validation of this viewpoint. But there are a few reasons why a Merkel-Hollande partnership would not be the market-rattling, eurozone-damaging outcome that many predict.
As wary as Hollande might be about austerity, or about the German model, his ability to take the EU in his ideal policy direction is limited. Why? Because the markets are on Merkel's side. Hollande only has so much room to maneuver before the markets punish France with higher borrowing costs, which would in turn threaten the integrity of the eurozone's bailout fund and its continuing efforts to prevent contagion. The pro-European Hollande does not want to preside over a new ugly chapter in the eurozone crisis.
It's also important to distinguish between what is campaign fodder and how Hollande would govern. Yes, Hollande has criticized the fiscal pact that Sarkozy, along with 24 other European leaders, agreed to in order to harmonize budgetary policies in member nations. But when Sarkozy is making his ability to lead France during an economic crisis a central campaign issue, Hollande has to find a way to distinguish himself. Hollande also can't proclaim the virtues of austerity -- and what is inherently a conservative fiscal policy -- as the leader of France's socialist party. Under the pressure of governing one of the eurozone's two major players, Hollande's policies are unlikely to differ drastically from Sarkozy's.
So is Merkel expending too much energy to stump for her favored candidate? Not necessarily. Hollande's socialist leanings, his reluctance to alienate his core voters, and his lack of a personal relationship with Merkel all suggest that decision-making between the two powers, and the eurozone as a whole, would be slower with Hollande as president. These ingredients are also the makings of a difficult personal relationship between the two leaders. And if there is one thing that markets have taught the eurozone, it is that dawdling in decision-making can be nearly as painful as making the wrong decision. The importance of Merkel's ability to pick up the phone, call Paris, and hear a familiar voice on the other end of the line should not be discounted. She doesn't have the luxury of time to cultivate another ally in the Elysee Palace.
Antonio Barroso is an analyst in Eurasia Group's Europe practice.
Franck Prevel/Getty Images
By Scott Rosenstein
Saving lives is an easy policy to defend. And advocating saving lives is an easy way to roll out policies that might otherwise be considered opportunistic. The ongoing E. coli outbreak in northern Germany is no exception. To be sure, the situation is grave. To date, 24 people have died and more than 2,400 have gotten sick. The outbreak has also destroyed livelihoods: Spanish cucumber farmers, wrongly identified as the source of the outbreak, have estimated losses of $280 million per week, while vegetable sales throughout Europe have plunged. The source of the outbreak has yet to be identified, spawning further anxiety and economic dislocation. But official responses to the crisis may be more self-serving than well-guided.
On 2 June, Russia announced that it was banning imports of fresh vegetables from the entire EU region. The Russian ambassador to the EU defended the move, saying: "I can certainly understand the grievances of EU farmers and I sympathize, but you can certainly understand no material loss is comparable to the loss of human life." His plea is hard to bicker with, but from an epidemiological standpoint the ban is provocative. All the E. coli cases recorded in the past month can be traced to northern Germany, suggesting that the contaminated food (regardless of where it originated) has been confined to that region.
So why is Russia taking such an aggressive stance? While health
concerns may be part of the story, the primary drivers are likely economic
Russia's ban may or may not work itself. The country's vegetable trade imbalance with the EU is partly attributable to the generous agricultural subsidies that EU farmers enjoy and that stifle competition from abroad. The ban will do little to convince EU policymakers to rethink those subsidies, and in fact, may reinforce support for them. The EU just announced a $210 million aid package for farmers affected by the E. coli outbreak, and more money may get passed around if farmers continue to suffer. Moreover, if the outbreak is past its peak, as some German officials are cautiously suggesting, and if Russia's ban threatens to distract from the upcoming Russia-EU summit, starts to jeopardize Russia's hopes of joining the WTO, or bumps up the price of vegetables at home, Moscow will likely backtrack.
Nevertheless, the world's convoluted food supply chain will continue to create complicated, costly, and sometimes deadly food safety scandals. And while some responses will be grounded in caution and scientific rigor, officials will also continue to take the opportunity to curry favor with domestic constituencies. In the coming weeks, particularly if the outbreak continues spreading, both tactics will likely be on display. Keep an eye on:
Scott Rosenstein is an analyst in Eurasia Group's global health practice.
Jorge Guerrero/AFP/Getty Images
By Ian Bremmer and David Gordon
2010 was a difficult year for Europe, and things won't get easier in 2011. The eurozone will remain intact, but there's a serious risk that the debt crisis will become increasingly unmanageable this year. As peripheral countries struggle to implement structural reforms, the politics of austerity will put additional public pressure on supporters of the EU project in core countries like Germany and France.
In recent weeks, the EU has done little to allay investors' fears about the solvency of both sovereigns and banking systems in a number of peripheral eurozone countries. Key questions on the nature and timing of future financial bailouts remain unanswered, and important potential remedies, like increasing the European Financial Stability Facility (EFSF) and introducing new eurozone bonds, have been taken off the table, at least for now.
At the moment, the core countries, led by Germany, are committed to the euro and the European integration project, even as they avoid efforts to find systemic solutions to the crisis. In Spain and Portugal, governments are moving to fast-track fiscal consolidation and structural reform in an effort to preempt market pressures. While markets remain skeptical, the hope in Brussels, Berlin, and Paris is that this is just the beginning of a sustained rebalancing that will help stabilize the eurozone. In this view, the European economic crisis is the catalyst needed to restore policy convergence within the eurozone and to enforce peripheral Europe's compliance with the "Lisbon agenda" of labor and product market reform. Yet the idea that the EU, the ECB, and national governments can rapidly remake fiscal patterns of peripheral Europe -- let alone their labor markets and regulatory regimes -- strains credulity. That's especially true given the weak economic forecast for these countries and their inability to undertake currency devaluations.
Ireland, Greece, Portugal, and Spain have all taken impressive first steps on the fiscal side, but policy sustainability remains an open question. Politicians in each of these governments will have a hard time enforcing cuts to wages and entitlements that erode their nations' standards of living. Structural reforms like privatization and trade union regulation will threaten well-organized groups, which will mobilize in opposition. The result will not be explicit rejection of these programs, let alone an exodus from the eurozone. Peripheral Europe is more likely to take a page from developing countries in how they manage relations with the International Monetary Fund and World Bank -- with a lot of fudging and passive opting out of important parts of their plans.
The political challenges facing reform in the periphery will make it more difficult for defenders of financial bailouts within core countries, and we're likely to see new political fissures on this issue, especially in Germany. This problem will heighten the sense of broader political conflict on the continent, increase policy coordination risk (especially between Berlin and Paris), and undermine market confidence in the EU's ability to sort out the crisis.
All of this leads to the real danger: that the eurozone countries big enough to matter in global finance -- namely, Spain and Italy -- will find it increasingly difficult to borrow at rates that are financially sustainable. If that happens, the chances of a systemic crisis will grow dramatically.
On Wednesday, we'll look at no. 3 on our list of Top Risks for 2011: the geopolitics of cybersecurity.
Ian Bremmer is president of Eurasia Group. David Gordon is the firm's head of research.
LUKE SHARRETT/AFP/Getty Images
By Eurasia Group's Europe practice
It hasn't been an easy year for Europe, and 2011 doesn't look much better. Hopes that a rescue package for Ireland would halt the debt crisis contagion have been dashed -- Portugal, Spain, Italy, and Belgium already face market pressure, and if the situation deteriorates, the European Union and IMF are likely to push for some form of structured assistance to Portugal. It may not end there. Italy and Belgium could be the next to face bond market problems, and non-eurozone countries like Hungary and Romania could face growing scrutiny about their finances. Eurozone watchers are already questioning the ability and willingness of core eurozone countries (particularly Germany) to spend additional bailout money beyond the current European Financial Stability Facility (EFSF) commitments that would be required. Such concerns raise both existential and tactical questions about the longer-term viability of the euro.
If countries abandon the euro, everybody loses. That scenario isn't a significant risk at this point, but some countries face the real prospect of restructuring and/or default, and they'll be much poorer following internal devaluation and/or a bout of domestic deflation. The next few years will be particularly tough for Greece, Ireland, Portugal, Spain, and Italy. In broader terms, there's a clear North-South divide emerging. Southern countries, in both Western and Eastern Europe, face a variety of challenges ranging from fiscal policy to macroeconomic rebalancing and competitiveness that will be extremely difficult to overcome in the short term. We've already seen social unrest in several countries as a result, and we'll see more in 2011.
In the broadest sense, the process of EU convergence has been thrown into reverse. For capital markets, this means that yields on bonds issued by non-core members are no longer converging to the lower rates that markets give core members. The widening spreads are obvious not only in peripheral eurozone countries like Greece, Ireland, Portugal, and Spain, but are also showing up among non-eurozone EU member states like Hungary, Romania, and Bulgaria. This divergence comes from two sources: a decline in the belief that the European Union will provide universal bailouts within the eurozone, and doubts among market players about the strength of political enthusiasm in Eastern Europe (where bond spreads have stabilized for now) for adopting the euro.
In 2011, the idea of an ever-closer union will provoke deeper skepticism than we've seen in years, but the European Union has an opportunity to use this crisis to build support for the sorts of reform that only crisis can make possible. Policymakers are working along three tracks. First, they want to establish a permanent crisis resolution mechanism -- an extension of the EFSF that includes some form of burden sharing with private investors. The second element would consist of fiscal reforms that actually enforce growth and stability pact targets that have been ignored in several capitals for many years. The third part would involve macroeconomic rebalancing, with a focus on labor market and judicial reforms to improve economic competitiveness. But during the European Council summit in mid-December, leaders made only limited commitments to take these issues head on, and more talks will be necessary in coming months. They did agree, however, on a permanent mechanism to help eurozone nations crippled by debts. Market players need a lot more detail on how the crisis mechanism will work, but it's a step in the right direction. Monitoring and enforcing fiscal targets will be more straightforward, with some enhanced penalties and European Commission oversight rules.
Then there's the need to make several European economies much more competitive. Belief in the ability of the European Union to force true macroeconomic rebalancing requires faith in the political will of both Brussels and core eurozone countries to push through systemic changes that will generate lots of pain. Selling those changes, and persuading crisis-weary publics to accept that the pain will last well beyond 2011, will prove the biggest challenge of all.
This post was written by analysts in Eurasia Group's Europe practice.
ARIS MESSINIS/AFP/Getty Images
There are several fascinating elections due this year. Next month, we can look forward to Britain's most unpredictable outcome in 100 years. In Poland, former Prime Minister Jaroslaw Kaczynski has become a presidential candidate in hopes of succeeding his twin brother Lech, killed in a plane crash earlier this month. Japan's ruling DPJ faces a referendum on its first turbulent months in power with upper house elections this summer. In November, recession-weary Americans will go to the polls to elect a new congress.
With all that going on, you probably haven't thought much about next month's local elections in North Rhine-Westphalia, Germany's largest state. Eager to institutionalize a post-bailout era of greater fiscal discipline, the German government is preparing to push for a major revision of eurozone rules in the form of a new European Union treaty. The aim is to build momentum behind a drive for fiscal consolidation and greater powers to enforce rules across the currency union.
But it's hard to imagine that Chancellor Angela Merkel's government will get what it wants. Irreconcilable differences remain among key European states, and Germany doesn't have the political power it held a generation ago in the run-up to introduction of the euro. Today's union is much larger, and the perceived benefits of convergence are worth less. The contentious debate over a new treaty will unfold just as the battle is heating up to replace Jean-Claude Trichet as president of Europe's Central Bank.
The immediate concern is that Standard & Poor's lowered Greece's debt rating to junk on Tuesday and Portugal by two steps. The big longer-term worry for Europe is that politicians locked into tough deflationary programs (in Greece and beyond) will take the once-taboo step of pushing for debt restructuring. We're not talking about the break-up of the eurozone, no matter how much apocalyptic rhetoric we hear in days to come or how many pundits write articles this fall with titles like "Who killed Europe?" But the less dramatic risks for European fiscal policy are plenty serious.
That's where Germany's local elections come in. The balloting in North Rhine-Westphalia, home to more than 20 percent of Germany's citizens, will provide a real test of Angela Merkel's center-right government. A bad result would jeopardize Germany's shot at tax reform. More to the point, it would weaken the entire eurozone by undermining support for fiscal discipline at the heart of Europe.
A return of the German left, even a modest one, will generate much more expansionary policy than we saw during the grand coalition period between 2005 and 2009. That will create stronger institutional support for German labor demands, driving a rebalancing within the eurozone as German labor costs begin to rise. That will undermine European competitiveness at a delicate moment in the union's recovery from recession. Over the longer term, it's hard to imagine Europe's fiscal woes improving in that environment. That's why I believe strongly in the eurozone, but not in a strong eurozone.
Ian Bremmer is president of Eurasia Group and author of The End of the Free Market: Who Wins the War Between States and Corporations? (Portfolio, May 2010)
AXEL SCHMIDT/AFP/Getty Images
By Eurasia Group analysts Irmak Bademli and Wolfango Piccoli
Turkey's ailing bid for EU membership will face greater difficulties following the win of the Christian Democratic Union (CDU) and the Free Democratic Party (FDP) in Germany's recent elections. The FDP's replacement of the pro-Turkey Social Democratic Party (SPD) will allow Chancellor Angela Merkel, who has long favored a "privileged partnership" rather than full membership for Turkey, to become more vocal in her opposition to Ankara's EU entry. Meanwhile, Cyprus remains a major obstacle in Turkey's path to EU membership.
The SPD's exit from power was a major loss for Ankara, which now faces skeptical governments in both Paris and Berlin. The party had been instrumental in tempering Chancellor Merkel's anti-Ankara views during her first term in office from 2005 to 2009. While the FDP's victory does not rule out Turkish membership, leading figures in the party recently said that they do not think Turkey is ready for EU membership due to "major deficits" in Ankara's efforts to meet the EU's criteria.
In the near term, however, the changeover in Germany will not bring a total breakdown in Turkey-EU talks. The ongoing negotiations over Cyprus are entering a delicate stage and Merkel, like other EU leaders, wants to see them succeed.
At the end of 2006, Turkey's refusal to extend its customs union agreement with the EU to Cyprus led the EU to freeze talks over 8 of the 35 policy chapters that each candidate country has to negotiate to become eligible for membership. This fall, the EU will review Turkey's progress in its accession negotiations, in particular focusing on the Cyprus issue. If Turkey has not complied with its customs union obligations by the time the EU carries out its review, some anti-Turkey member states could put pressure on the EU to take sterner action. The European Commission, for its part, is expected to bury its review of the freeze within its larger annual report on Turkey's progress, which will be issued on 14 October.
The EU's options to deal with noncompliance are not clearly spelled out, but they could range from a mild rebuke to further sanctions. A full-suspension of talks, however, is not on the table this year -- despite calls from the Greek Cypriots to punish Turkey if it continues to ignore its obligations. Little progress has been made in the Cyprus negotiations, which began in September 2008, and the failure to reach a settlement by early 2010 could bring a total breakdown in Turkey-EU talks.
While it is hard to trace a sense of urgency on the Greek Cypriot side, the April 2010 presidential elections in the self-declared Turkish Republic of Northern Cyprus (TRNC) are generally regarded as a deadline for the reunification talks. Without a settlement, the present incumbent Mehmet Ali Talat may lose his seat in April 2010 and be replaced by a president less supportive of a settlement. This development will further complicate the already difficult negotiations.
By Eurasia Group analyst Courtney Rickert
Amid headlines that the global economic crisis has stabilized, an important question arises: Which countries' economies will recover most quickly, and which recoveries will be the most sustainable? The key to finding an answer lies in understanding how countries were exposed to the global downturn and assessing their policy responses. Countries that choose to adjust to the changed global economic environment will come out on top in the long term.
While all internationally integrated economies have suffered growth declines, some economies entered the recession in a better position than others. Part of this divergence is a result of the quality of government policies, such as balanced fiscal positions and low inflation. Other key factors in determining a country's exposure to the crisis are trade imbalances and overinvestment in select sectors, such as real estate, in the period leading up to the global financial crisis.
Countries that had persistent trade deficits -- such as the US-financed them by borrowing heavily from abroad. Frequently, international borrowing fed domestic consumption far more than investment. This excess consumption contributed to bubbles during the boom years -- notably in financial assets and real estate-that have since popped. These economies have been slower to stabilize, but the housing and retail markets are naturally adjusting as home prices fall, banks become more prudent, and consumers buy less. In these cases, there is little need for long-term adjustments to macroeconomic policies.
On the other hand, government policy choices will play an important role in countries that sustained trade surpluses, such as China, Germany, and Japan, because these surpluses were a result of government policies that promoted exports. Their economies have been hard hit by declining global demand-particularly in the US. Although government stimulus spending has propped up their economies in the short term, China, Germany, and Japan will face a fundamentally different global market in the long term -- one that is unlikely to revert to the pre-crisis status quo levels of global demand. Governments in these countries will have to choose whether to reorient their economies away from export dependence or try to muddle through and hope for a return of foreign demand.
Effective policy responses in all countries have required crisis stabilization, the cleanup of sectors that experienced overinvestment, and adjustment to the rapidly shifting global flow of funds and goods. Even the best-run governments will face difficulty managing these activities smoothly, but many are demonstrating the ability and willingness to do so. Below are snapshots of policy responses in the four largest economies: the United States., Japan, China, and Germany.
The United States had a large trade deficit during the expansionary period, allowing it to adjust relatively easily to declining global demand. However, as a result of international capital inflows, it also had significant overinvestment in financial assets and real estate. The Obama administration responded relatively aggressively to the crisis by taking action to clean up the financial sector and implementing a $787 billion fiscal stimulus plan, but spending has been slow to materialize. The US economy is forecast to contract by 2.6% in 2009 and show only minimal growth in 2010, as individuals and firms paying down their debts remain a drag on economic growth. But compared to the major trade surplus countries, the United States' relatively fluid economy will likely to adjust to the new global environment more smoothly and rapidly.
Japan's exposure to the current crisis has been exacerbated by its efforts to sustain trade surpluses, but its economy had already been adjusting before the crisis began, with production increasingly moving overseas. Moreover, when the global decline in demand hit, Japanese firms decreased production and rapidly leveled off at much lower output. In addition, the 30 August elections are expected to displace the long-ruling Liberal Democratic Party (LDP), bringing to power a government that is more interested in protecting the interests of consumers rather than producers. This situation is reducing Japan's dependence on exports, providing a more stable base for growth.
The global slowdown has hurt demand for Chinese goods and threatened the vitality of China's export-oriented economic growth. While exports are unlikely to return to their previous levels in the near to medium term, Beijing's massive stimulus spending, relaxed monetary policy, and export promotion will partially counter the collapse in demand. If China is to secure long-term growth, however, efforts to rebalance the economy toward greater domestic consumption -- by putting more income in workers' pockets-must be considered.
The export orientation of the German economy and tight integration with the wider European economy limits the government's ability to stimulate domestic demand. Moreover, liabilities in the banking sector are worrying. While the government has fiscal room to maneuver, focus on the upcoming election and fears about the cost of potential interventions in both the real and financial sector have constrained Berlin. Most importantly, the government is averse to policies that would lead to a structural change in the country's export orientation. While this could begin to erode after the 27 September elections, any shift in German policy will be limited by concerns about government debt levels.
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The Call, from Ian Bremmer, uses cutting-edge political science to predict the political future -- and how it will shape the global economy.