EU Summit preview: Flexible, more flexible, Cameron?

They will not bend it like Beckham but when European leaders meet in Brussels this week, they are likely to present varying forms of flexibility. Flexible and rigid. These have probably been the best two key words describing the main issues of this week’s European Summit: flexibility on the Eurozone’s fiscal rules and rigidity in the power game on the nomination of the next president of the European Commission. As regards to the Eurozone’s fiscal rules, the economic stagnation in France and Italy combined with the overall rather anaemic recovery of the Eurozone has revived the debate on growth versus austerity. Irony or not, it is mainly the countries, which up to now have not really been glowing with structural reforms, that are now pushing for more fiscal wiggle room. It is also the same countries which have not built in automatic correction mechanisms in their national debt brakes under the so-called fiscal compact. The basic idea behind a new initiative of mainly social democratic governments is to give countries more time for fiscal consolidation in return for structural reforms. Moreover, it should be possible to exclude certain investments and the costs of economic reforms from nominal fiscal deficits. Many social-democratic leaders suggested that the fiscal framework should be applied in a more flexible way. In our view, these attempts of publicly watering down the Eurozone’s fiscal framework are mainly hot air and much ado about nothing. The discussions on flexible interpretations of the rules are as old as the rules themselves. The calculation of the so-called cyclically-adjusted fiscal balances has already shown how complex and open for interpretations these methodologies can be. Moreover, the Eurozone’s fiscal rules already provide more time to adjust in a period of very low or negative GDP growth. Of course, as long as it is a tit-for-tat, including structural reforms into the fiscal equation can make sense. However, this can be better done by clear-cut and strict commitments and supervision than by new methodological tricks. Moreover, let’s not forget that earlier proposals by Germany to introduce binding reform contracts between countries had been rejected by many. The basic principle for economic rules to work is that they should be easy and simple. Further complexity by adding proxies for structural reforms could make sense economically but would make the fiscal framework even more complicated. Monitoring of fiscal policies would then definitely be an art, not a science. It is obvious that flexibility will be one of the buzz words at this week’s Summit. However, the interpretation of flexibility is likely to differ. While several countries led by France and Italy seem to advocate new rules with new flexibility, Germany will stick to the flexibility under the current rules. As long as there is no agreement on any binding framework for structural reforms, it is very hard to see Germany agreeing to any changes of the fiscal framework. The other big topic that will address at least some government leaders’ flexibility is the first stage of European musical chairs: the nomination of the next president of the European Commission. Remember that government leaders have to propose a candidate who will then have to be nominated by European Parliament. Despite earlier reservations, a consensus amongst government leaders to support Jean-Claude Juncker has emerged. Only British Prime Minister Cameron and his Hungarian colleague Orban are still publicly opposing Juncker. Cameron suggested earlier that failing to get his way may increase the chances of a UK exit from the EU. This threat, however, has turned out to be an own goal. Many other European politicians showed little understanding for what some called tactical exaggeration with Cameron’s aides now seemingly resigned to defeat on Juncker’s appointment. Cameron is in a difficult position having promised a referendum on EU membership should his Conservative Party win the 2015 General Election. He has said that he would campaign in favour of remaining in the EU so long as the UK’s relationship with the EU can be renegotiated with certain EU powers “brought back” under domestic control. With Juncker in charge the perception – rightly or wrongly – is that Cameron will be less likely to win any concessions. With the Labour Party currently leading in the UK polls it is possible that the proposed referendum never takes place. However, the Labour leadership is coming under pressure from its own backbenchers to offer it given that UKIP, the anti-EU party that “won” the recent European parliamentary elections, is starting to eat into its support. However, another interesting aspect of all this is the increased polarisation in the UK population’s thinking on its relationship with the EU. UKIP’s surge in the polls has been attracting headlines, but we also see that a greater proportion (and rising) of the UK's population are in favour of staying in the EU. However, it isn’t a majority being led by positive sentiment to Europe – it is more the fear factor of what might happen should the UK leave with people worried about jobs and growth. If there is a form of negotiation that brings some powers back to the UK then approval to stay in the EU rises to 57% according to a recent YouGov poll. However, if no EU concessions are won by the UK government, which would lead to a widespread press revolt and could quickly lead to a reversal in the polls, there is a high probability that the UK leaves the EU in 2016/17. If this occurs, the assumption is that the UK will quickly be allowed into the European Free Trade Association (with Norway, Switzerland, Iceland and Liechtenstein), which basically would give the UK population what it wants – access to the single market without the political ties. It would also allow Europe to press on with greater integration without having to continually make amendments to appease the British. That said, there may be some concern within Brussels about losing the UK given it is still a large, important (and rapidly growing) economy that positively contributes to the EU’s coffers. Some may also take the view that having the UK within the EU also helps boost the EU’s own global influence – US President Obama has recently explicitly stated he wants to see the UK remain part of the EU. Furthermore, demographics do not look good for the EU and losing the UK (whose demographics are dramatically different) may intensify worries over the outlook for the EU’s population, growth and wealth over coming decades. All in all, this week’s Summit almost looks like sports event with government leaders bending and stretching their flexibility. As in real sports, overstretched flexibility can sometimes lead to unexpected injuries. This piece is a co-production together with my ING colleague and UK expert James Knightley