DIRECTOR'S PERSPECTIVE

by Saruhan Hatipoglu

sshatipoglu@beri.com

COGNITIVE DISSONANCE IN EUROPE:

An Ever Closer Union Has Intimacy Problems

Not All Engines Are Running.  Euro zone economic growth is following a stronger path this year, but it is not likely that Europe’s economy will experience steady expansion. The average growth rate in 2004 is expected to be lower than 2.0% for the entire region. The German economy is showing signs of accelerating growth with business confidence on the rise, but domestic demand is still fragile. The retail sales index contracted to 95.4 in May from 97.6 at the end of 2003, and weak income growth is not sending signals for sustained recovery in the coming months. France is enjoying one of the largest increases in business confidence as well but also suffers from sluggish consumer demand. With the exception of Spain, growth in key euro zone countries will be limited this year. Even the new EU president, the Netherlands, is expected to have only 1.5% of economic expansion in 2004. However, lack of sustained economic activity might just be the least of problems for Europe. 

Some Are More Equal Than Others.  Applicability of regulations is not uniform in the EU, and that is a cause for concern among the smaller member countries, including the current term president. When Germany and France escaped penalties for failing to abide by the 3.0% deficit/GDP ratio set by the EU Budget and Stability Act, the Netherlands was quick to protest. France’s GDP/capita was €23,340 last year (Germany’s was very similar), and the Netherlands was slightly higher at €25,150. Despite the similarity in wealth, France and Germany were allowed to breach the deficit target considerably (4.2% and 3.9%, respectively), while the Netherlands’ ratio was 3.2% last year. The forecast for the Dutch budget shortfall is 3.0% in 2004, while France and Germany will have another year of excessive deficits. It is also important to note that an average Dutch citizen is contributing six times more to the EU budget than their French counterparts, yet the big countries are being favored when it comes to enforcement of the rules. The British EU budget rebate is also under scrutiny, particularly by the smaller accession countries. Under a skillfully conducted negotiation in the1980s, then Prime Minister Margaret Thatcher had obtained £2 billion annual rebate from the EU. Currently the second wealthiest country in the EU (GDP/capita basis), the U.K. is at the center of criticism for receiving budget support. The European Commission recently decided to eliminate the rebate but faced a stern reaction from Prime Minister Blair, stating that the UK will not give up its refund. Then, there are the infamous French farmers qualified for large subsidies from the government, again raising questions about fairness in the EU. Taking all this into consideration, it is not surprising that there is ill-feeling and lack of harmony in Europe, particularly toward the favored founding brothers by the smaller old and new ones. But the little siblings are no longer silent about it, and they are preparing their weapons.

Whose Constitution is It?  The draft of the new EU Constitution has been approved. However, eleven countries* will have a referendum next year. A single objection in this series of confidence votes may signal the end of the constitution, and there are good reasons to expect a negative outcome in some countries. For example, the United Kingdom is clearly discontent. First, the intention of the European Commission to eliminate the British EU budget rebate angered many of its citizens, yet again raising the issue of sovereignty in the country. Second, the decision by Prime Minister Tony Blair to appoint his personal friend to be an EU Commissioner is likely to strike a bad chord with the British public. A negative protest vote is therefore a possibility. The Netherlands, likewise, is frustrated with both favoritism and emphasis on integration over job creation in the euro zone. France is open to surprises as well. The government is unpopular in the country, another reason President Chirac did not push for a referendum and would prefer not to hold one were it not for the Prime Minister and the rising star, Finance Minister Nicolas Sarkozy. An anti-Chirac vote is possible, particularly at a time when the opposing Socialists are also equally divided on the new constitution. And then who can guarantee a positive outcome in Poland, where the government recently criticized the European Commission proposal to introduce a limit on members’ net contributions to the EU budget? A no vote in any one of the eleven member states holding a referendum will make it challenging to ratify EU’s new constitution.

Foreign Policy Conundrum.  Europe is more divided than before on foreign policy. The debate on the Iraqi war revealed deep differences among member countries. Despite vociferous criticism of the U.S. by EU leaders, France and Germany, today there are over 16,000 troops in Iraq from the European Union led by 8,530 from the United Kingdom. The real surprise is that the Netherlands committed 1,263 troops to Iraq. Not too long ago, it would be difficult to imagine the Dutch disagreeing with France and Germany over crucial decisions concerning Europe. Gone are those days. With an increased membership, uncertainty in foreign policy will linger over issues ranging from Turkey’s admission to the union to peacekeeping; from trade negotiations to humanitarian assistance. These differences will challenge the harmony that the European Union is desperately seeking to establish.

Demography Is Destiny.  One of the biggest problems facing the EU is aging. All developed countries in the world are experiencing a demographic burden in varying degrees. However, the situation in Europe is alarming. “By 2050, there will be 124 million fewer Europeans, the biggest population decline in the Continent since the Black Plague,” says Paul A. Laudicina, Vice President and Managing Director of Global Business Policy Council of AT Kearney, a global management consulting firm. France, Italy and Spain are already labeled as high vulnerability countries with rapidly aging populations, according to a recent study by Watson Wyatt and the Center for Strategic and International Studies (CSIS). In 2040, for every 100 working-age adults there will be 100 retirees in Spain and Italy. In Spain, the number of elderly as part of the total population will rise from 22.0% to 45.5% in the next forty years and from 24.4% to 46.2% in Italy. The fiscal obligations of such a scenario are daunting. Some countries are already adopting strict reform measures to confront the problem. Germany, for example, recently passed one of the sharpest welfare reductions in the country’s history. Last month, German politicians also decided on a controversial immigration bill allowing skilled foreign workers to move to the country in an effort to close the widening demographic deficit. Likewise, Italy and other key EU countries are undertaking pension reform. However, such measures are facing stiff resistance from the opposition and public. The immigration issue is a particularly sensitive one that will continue to divide the EU and threaten a healthy response to the growing demographic problems. It is safe to say that, given current conditions, the EU is facing a clear and present danger to its fiscal stability.

Conclusion  There are distinct signs of division within the EU, as one would expect from a conglomerate of ethnic groups. These differences will become more severe when economic conditions fail to satisfy respective members. As the Union expands, the question of equality among members, immigration, further integration and accession issues, and foreign policy will gain more prominence. Now a family of 25 members, the EU has managed to overcome serious obstacles to becoming the United States of Europe. However, E Pluribus Unum is not a stone’s throw away.

*Belgium, Czech Republic, Denmark, France, Ireland, Luxembourg, the Netherlands, Poland, Portugal, Spain and United Kingdom

DIRECTOR'S PERSPECTIVE Last Updated 4 August 2004