Brookings: Topics - European Union

Challenges and Opportunities: Aviation Emissions and the European Cap and Trade System

Joshua Meltzer — Tue, 21 May 2013 11:42:00 -0400

Editor's Note: This article was originally published in the Winter/Spring 2013 edition of the Georgetown Journal of International Affairs: The Future of Energy.

On January 1, 2012, the European Union extended its cap and trade system, the Emissions Trading Scheme (ETS), to include CO2 emissions from all airlines arriving in and departing from EU airspace. The EU has claimed that this unilateral action was in response to the slow progress towards reaching a global deal. However, the EU remains committed to reaching a global solution to the problem of aviation emissions and hopes that including international aviation in the ETS will spur action.

These additions to the ETS led the EU to take positions on a number of important policy issues that remain unresolved in the international climate change negotiations. These include issues such as how to attribute CO2 emissions from aviation to countries and how to operationalize the environmental principle of common but differentiated responsibilities (CBDR) – the notion that developed countries will do more to reduce their CO2 emissions than developing countries. Moreover, as many of these issues are also applicable to the broader UN climate change negotiations, the success or failure of the ETS approach to international aviation could affect progress in the wider climate change negotiations.

This article outlines how the EU has designed its system to address these challenges. It also provides an overview of the challenges to reaching a global deal on regulating CO2 emissions from international aviation. The final part of the paper considers the current state of international negotiations over avia- tion emissions and suggests pathways forward.

Read the full article »

Authors

Joshua Meltzer

Publication: Georgetown Journal of International Affairs

Image Source: © Darren Staples / Reuters

CO2 Emission Permit Prices Plunge In Europe: What's Up?

Adele Morris — Fri, 17 May 2013 13:47:00 -0400

Recent headlines proclaim "deep trouble" in the European cap-and-trade system for greenhouse gases, evidenced by the decline in allowance spot prices from over $25 per metric ton of carbon dioxide in June 2008 to about $3 this month. Although many press articles have referred to an "oversupply" of emissions permits, suggesting some kind of intrinsic imbalance, the markets are clearing just fine. It's just that the price is lower than forecast.

Whether this represents trouble or not depends on what you think the goal of the program should be. If the goal is to ensure that emissions in the covered industrial sectors are no higher than the emissions caps, then the program has worked just fine. It just didn't have to work very hard since much of the decline in emissions relative to projections was driven by the multi-year economic crisis. A sputtering EU economy lowered industrial activity and consumer energy demand, and this drove down allowance demand and prices. This makes compliance easier for the remaining emitters just at the time business and consumers are suffering most. This counter-cyclical property might be seen by some as a feature, not a bug.

On the other hand, if you think the goal of climate policy should be to provide stable cost effective long-run incentives to lower emissions relative to what would otherwise occur, then the ETS price plunge is a cautionary tale. First, it illustrates the importance of the design details of the carbon market. The ETS law included no provision to restrict automatically the number of allowances when prices get low. Efforts to withhold allowances failed when, not surprisingly, coal-dependent states balked at the proposed stringency in an economic downturn.

Second, the price volatility shows that the ETS hasn't really fixed the market failure in which fossil energy prices don't reflect their full social costs, including environmental damages. Economists widely advocate a price signal on carbon that would include those external costs, as best we can estimate them, in fuel prices through a carbon tax or a cap-and-trade system. The ETS illustrates one key drawback of a poorly designed cap-and-trade system: fluctuating allowance prices and abatement incentives. Price volatility makes no sense if you're trying to internalize an external cost because there's no reason to think the social cost of carbon fluctuates over the short run, much less drops by 90 percent over five years.

Third, the ETS illustrates the potential for laxity in one carbon market to erode abatement incentives abroad. For example, the Australians plan to convert their carbon tax to an ETS-linked permit program in July 2015. The prospect of linkage to the ETS lowers the expected Australian carbon price well below the current tax of about $25 per ton of CO2. To be sure, low prices in the ETS just amplify the investment-depressing effect of the broader uncertainty around a policy so incompetent one wonders if they'll go through with it.

Finally, the ETS experience reveals the limitations of framing the environmental success of a climate policy solely in terms of emissions levels. Many environmentalists are more comfortable with an emissions cap than a carbon tax because the cap provides more environmental certainty. However, the lower-than-predicted ETS allowance price has made it unexpectedly easy for utilities to fire up coal-powered plants and delay investments in cleaner natural gas and renewables, and this could set back climate efforts in the EU for years.

The fits and starts of the EU carbon market suggest the potential advantage of an enduring and credible incentive to reduce emissions through a carbon tax. Even if the EU had set a tax at the lesser of the estimated damages from emissions and the public's willingness to pay, it would surely have been greater than the current ETS price, suggesting that the policy with the greater environmental certainty has foregone the opportunity for greater environmental benefits.

Policymakers should expect the unexpected and do what they can to establish a climate policy that is robust to changing economic conditions at home and abroad. Compared to the EU's current approach, a modest predictable tax would be more robust to shocks, solidify the payoffs of investments in new technologies and emissions reductions, cost less (especially if the revenue is used wisely), and ultimately do more to protect the planet.

Authors

Adele Morris

Publication: Real Clear Markets

Image Source: © Alessandro Garofalo / Reuters

Balancing Technocrats with Democratic Politics

Kemal Derviş — Fri, 10 May 2013 10:16:00 -0400

A simplistic (actually, naive) view of markets is that they exist almost in a “state of nature,” and that the best of all worlds is one where they are free to operate without government interference. An equally simplistic view of democracy is that it is a political system in which periodic competitive elections give the winner the right to govern without constraint.

The reality is far more complex, of course. Markets can function only within an institutional and legal framework that includes property rights, enforcement of contracts, quality and information controls, and many other rules to govern transactions.

Similarly, while competitive elections are essential to any democratic system, a “winner-take-all” attitude to electoral outcomes, with the victor concentrating power, is incompatible with democracy in the long term. Well-functioning democracies are embedded in complex constitutional and other laws that separate executive, legislative, and judicial power, and that protect freedom of speech, assembly, and peaceful dissent by those who lose elections.

Regulatory institutions – such as bank supervisory agencies and bodies that oversee the telecommunications, food, and energy industries – play a vital role by maintaining the always-delicate balance between “free” markets and the actions of elected governments and legislatures. The central bank is perhaps the most important of these institutions, for it conducts monetary policy (and sometimes serves as the financial-sector regulator).

The policy and regulatory mistakes that contributed to the subprime mortgage crisis – and thus to the US financial system’s near-meltdown and the eurozone’s travails – have brought the issue of optimal economic regulation and its relation to democracy to the fore once again. In the US, a significant share of the Republican Party favor abolishing not only the Department of Energy and the Environmental Protection Agency, but also the Federal Reserve! In their view, markets and private initiative require no significant regulation. The role of politics is to elect majorities that can abolish regulations and regulatory bodies.

Others around the world similarly oppose regulatory institutions, but for very different reasons. They argue that politicians can regulate and supervise without intermediate bodies that have some degree of autonomy. In their minds, these bodies merely impede and constrain realization of the people’s will.

If an elected government wants a bank to offer cheap credit to a group of enterprises so that they can hire more people, why should a supervisor be able to obstruct this democratic will? If these enterprises are told to hire the governing party’s supporters as an implicit condition of obtaining subsidized credit, that, too, is the expression of electorally legitimized popular will.

Management of the economy should be entrusted to competent and independent experts, a group of "Platonic Guardians" empowered to act in the state's higher interests, regardless of electoral outcomes or public opinion.

At the other end of the spectrum are technocratic super-defenders of regulatory bodies who believe that politicians and electorates are hopelessly confused, uneducated, and often corrupt. Management of the economy should be entrusted to competent and independent experts, a group of “Platonic Guardians” empowered to act in the state’s higher interests, regardless of electoral outcomes or public opinion.

The International Monetary Fund, the European Commission, and the European Central Bank are often viewed as such technocratic institutions – and as supporting the technocratic element within states and societies around the world. At the height of the eurozone crisis, the IMF, the EC, and the ECB (not to mention financial markets) warmly welcomed the economists Mario Monti and Lucas Papademos as highly respected “technocratic” prime ministers for Italy and Greece, respectively.

Experience in recent decades has shown that a balanced and “moderate” approach is needed on these matters. Electoral cycles (and the accompanying political pressures) are such that monetary policy, banking, and many other areas of policy and economic activity must be overseen by those with professional competence and a much longer time horizon than that of politicians.

Day-to-day politics cannot dominate the regulation that markets need. The single most important institutional reform underlying price stability throughout the world has been the stronger independence of central banks.

But, if independent technocrats are allowed to determine long-term policy and set objectives that cannot be influenced by democratic majorities, democracy itself is in serious jeopardy. I find it undemocratic, for example, that the ECB can set the eurozone-wide inflation target unilaterally. How much inflation a society finds desirable or tolerable (taking into account other important variables, such as employment, GDP growth, or poverty) is an inherently political question that should be debated in parliament. The central bank should be consulted, but its role should be to implement the objective without political interference: independence in terms of policy tools, not goals.

Globalization and the increasing complexity of financial and other markets make it imperative that the domains of private activity, political decision-making, and regulation be clarified. The challenge is even greater because some regulatory agencies must be multilateral, or at least intergovernmental, given the global nature of much economic activity. The difference and the distance between markets and politics must be clear – and, for the sake of both effectiveness and legitimacy, it must be based on rules that are well understood and on popular consent.

Authors

Kemal Derviş

Publication: Project Syndicate

Image Source: © Lisi Niesner / Reuters

Geopolitics in the Eastern Mediterranean: A Cypriot Perspective

Thu, 09 May 2013 14:30:00 -0400

Event Information

May 9, 2013
2:30 PM - 4:00 PM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

In recent months, the Republic of Cyprus has been at the center of a number of critical geopolitical developments—holding a largely successful presidency of the European Union (EU), announcing the discovery of large offshore natural gas deposits, and undergoing an economic crisis that led to a bank bailout and raised new uncertainties about the future of the eurozone. The Cypriot government has also announced recently that talks with Turkey could be re-launched in the fall in a new attempt to resolve the political standoff that has divided the country for a generation.

On May 9, the Center on the United States and Europe at Brookings (CUSE) and the Energy Security Initiative (ESI) hosted the Minister of Foreign Affairs of Cyprus Ioannis Kasoulides for a public address. In his remarks, the foreign minister offered his perspectives on a range of issues that are shaping Cyprus’s role in Europe and across the rapidly evolving Eastern Mediterranean region.

Minister Kasoulides previously served as the Cypriot government spokesman from 1993 to 1997. He was first appointed minister of foreign affairs in 1997 and served in that capacity until 2003. During his initial term as foreign minister he led the diplomatic effort that marked the initiation and completion of Cypriot accession negotiations to the EU. From 2004 to 2013 Kasoulides was a member of the European Parliament, where he served as the vice president of the EPP group and head of its foreign affairs working group. He was appointed to a second term as foreign minister in 2013.

Vice President Martin Indyk, director of Foreign Policy at Brookings, offered introductory remarks.

Video

The Social Impact of the Eurozone Crisis in Southern Europe: The EU Response and the Challenges Ahead

Fri, 03 May 2013 10:30:00 -0400

Event Information

May 3, 2013
10:30 AM - 12:00 PM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

As the ongoing eurozone crisis continues to threaten the European single market and endanger the global economy, it has unleashed uncertainties about Europe’s political and institutional durability. The economic crisis has also become increasingly a social crisis, especially in the heavily-indebted states of Southern Europe, where austerity measures and high unemployment have led to questions about the sustainability of the current situation.

On May 3, the Center on the United States and Europe at Brookings (CUSE) and the European Parliament’s Liaison Office, hosted a discussion with European Parliament Vice-President Gianni Pittella. In his remarks, Mr. Pittella discussed the social impact of the crisis and how the European Parliament has responded to address these challenges.

Gianni Pittella has been the first vice-president of the European Parliament since July 2009 when he was re-elected for the third time with the Democratic Party from the Southern Italy electoral district. He was first elected as a member of the European Parliament in 1999. Mr. Pittella is the author of numerous books, including most recently, Federalismo Avvelenato (Fondazione Zefiro, 2011) and A Brief History of the Future of the United States of Europe (Fazi, 2013), which he coauthored with Elido Fazi.

Brookings Nonresident Fellow Clara Marina O’Donnell provided introductory remarks and moderated the discussion.

Audio

The Social Impact of the Eurozone Crisis in Southern Europe: The EU Response and the Challenges Ahead

Transcript

Uncorrected Transcript (.pdf)

Event Materials

20130503_pitella_eurozone_transcript

Era of Big Oil Secrecy is Over

Daniel Kaufmann — Wed, 24 Apr 2013 15:49:00 -0400

Earlier this month, the European Union (EU) took a decisive step towards transparency: It agreed to mandate publicly-listed European companies as well as large private firms to disclose their payments to governments for oil, gas and mining projects. This transparency is crucial in the fight for better governance of resource-rich countries. It will empower citizens with information about the amount of money their governments receive, helping them to monitor how this money is ultimately used and to deter corruption.

Opacity has long ties with corruption, and both are detrimental to growth. Our research shows that countries that control corruption and improve governance can triple their incomes per capita in the long term - a 300% dividend. As seen in the figure, this good governance dividend also applies to countries rich in natural resources.

The benefits of transparency dwarf the cost of disclosure. Today about 40 percent of the 1.7 billion people in resource-rich countries live in poverty, making less than $2 a day. Such poverty in the midst of immense resource wealth is due to low standards of governance and transparency, a critical issue for which oil and mining companies are also responsible.

The EU rules are part of the international community’s response to the opacity challenge, and are modeled after U.S. rules the Securities and Exchange Commission (SEC) released last August to implement the Cardin-Lugar amendment of the 2010 Dodd-Frank Act.

This move towards mandatory disclosure in two of the world’s largest capital markets signals what European Commissioner Michel Barnier has called a “new era of transparency.”

BIG OIL BATTLES NEW RULES

The emergence of this new global standard, however, does not mean the campaign for revenue transparency is over. While the transparency train has clearly left the station, not everyone is on board. Major multinational oil companies have been trying to water down these requirements on both sides of the Atlantic. These companies have put their reputations in jeopardy by backing the American Petroleum Institute (API) in its lawsuit against the SEC to stop implementation of the U.S. rules. Now that the EU has joined the drive for disclosure, Big Oil faces a major problem in its assault on transparency.

The new EU disclosure deal undercuts a number of API’s arguments. API’s inflated estimates of compliance costs are now increasingly irrelevant, as major cross-listed companies, like Shell and BP, will have to comply with EU rules regardless of the lawsuit’s outcome. API’s claims that the SEC acted arbitrarily by adopting the U.S. rules - already questionable given that Congress mandated the rules and the SEC conducted an exhaustive public comment process during its rulemaking - are also undermined by the EU’s agreement to adopt very similar measures. The EU legislation will, in fact, encompass more than the U.S. rules as it covers large, privately held companies (and the timber sector), in addition to publicly listed companies.

And API’s argument that the rules cause competitive harm is even less compelling since the EU will apply analogous rules to companies under its jurisdiction, helping to level the playing field. Together, the U.S. and EU regulations will cover capital-markets listed companies, accounting for nearly 70 percent of the market capitalisation of extractive industry firms on the world’s most significant stock exchanges.

SECRECY DAMAGING REPUTATIONS

By continuing to support API’s lawsuit, companies are incurring significant costs defending opacity, not only pecuniary, but reputational as well. The public is becoming increasingly aware of their fight against transparency. While a few companies are taking some steps away from secrecy - Norway’s Statoil disavowed support for the API lawsuit - they are still the exception.

Shell, for instance, faced setbacks when Alan Detheridge, one of its former executives, openly criticized the company’s efforts to block U.S. and EU transparency, and the Dutch government pledged its support for strong EU rules consistent with U.S. law. The company has now started to change its tune, claiming it has supported mandatory reporting requirements all along - an assertion The Economist wryly noted contradicts Shell’s membership in API and refusal to disavow support for the U.S. lawsuit.

Oil companies should draw lessons from Shell’s mishaps, seizing the moment to actually “walk the talk” on transparency. Instead of litigating against transparency, companies should focus on complying with the U.S. and EU rules and enlist their lawyers to prepare for new reporting. Companies covered by the U.S. and EU rules should also join the global transparency movement to ensure these disclosure standards apply to all relevant companies. Obtaining a G8 commitment to mandatory disclosure at this year’s Summit would bring key countries like Canada into the fold. An effort to enact similar legislation in additional markets, including Australia and emerging Asian and South American economies, should follow.

The U.S.-EU legislative consensus on a global standard of transparency is a watershed moment for improving the governance of natural resources worldwide. Big Oil should not stand in the way. To restore their credibility and support good governance and development around the world, oil companies should publicly state their intent to comply with the new disclosure standards and urge API to drop its lawsuit.

Authors

Daniel Kaufmann

Publication: Reuters/TrustLaw

Image Source: © Beawiharta Beawiharta / Reuters

Ukraine at a Crossroads with Europe?

Steven Pifer — Mon, 22 Apr 2013 11:43:00 -0400

The Kyiv Security Forum, held in the Ukrainian capital on April 18-19, brought together Ukrainians, Europeans and Americans to discuss the current challenges facing Ukraine. Much of the discussion centered on Ukraine’s relationship with the European Union, in particular on whether Kyiv will make sufficient progress in meeting EU conditions to permit signature in November of an EU-Ukraine association agreement.

Several speakers asserted that Ukraine is at a crossroads with Europe. “Ukraine is at a crossroads” has been written or said so many times over the past 20 years that it has become something of a cliché. This time, however, it may be for real. The choices that Kyiv makes in the next weeks and months will determine whether Ukraine moves closer to Europe or whether the EU-Ukraine relationship gets stuck on hold.

EU and Ukrainian negotiators concluded the association agreement at the end of 2011. It would significantly deepen Ukraine’s links with the European Union. Among other things, it includes a deep and comprehensive free trade agreement that would open up large segments of the EU’s economy to Ukrainian exports. It is a big deal.

Although the association agreement was initialed in early 2012, it has since sat in limbo. The European Union has declined to sign given growing concerns over the past two years about negative developments regarding democracy within Ukraine.

EU officials have asked Kyiv to make progress on three conditions—implementation of its general reform agenda, reform of its electoral law, and an end to selective prosecution—in order to permit signature of the agreement at the EU Eastern Partnership summit in November. These conditions were reaffirmed at an EU-Ukraine summit in February, which called for “concrete progress” by May.

Many regard the third condition as the most critical. More than a dozen senior members of the opposition have been sent to jail since President Victor Yanukovych took office in 2010. Most attention focuses on the case of former prime minister Yuliya Tymoshenko. She was convicted in 2011 for signing a gas contract with Russia in a trial that received broad criticism in the West. The near unanimous view in European capitals and Washington holds that Tymoshenko is a victim of selective prosecution. On the day her conviction was announced, even Moscow joined in the barrage of condemnation of the verdict.

In the seven weeks since the EU-Ukraine summit, there has been good news and bad news. The good news: Yanukovych pardoned Yuriy Lutsenko, a leading opposition leader, along with one other opposition member.

The bad news: Serhiy Vlasenko, Tymoshenko’s lawyer, was stripped of his membership in the Rada (Ukraine’s parliament) on grounds that he could not hold his Rada seat and continue his legal work. Critics cite this as another selective application of the rules, as many Rada members, including in the pro-government Regions Party, hold outside jobs that would appear to contravene the rule. And more bad news: the Prosecutor General is pursing another case against Tymoshenko, alleging her involvement in the 1996 murder of businessman Yevhen Shcherban. Given the many questions about how the 2011 trial was conducted, few analysts have confidence that this legal process will be objective.

At the Kyiv Security Forum, several speakers made clear the key importance that Europe attaches to what happens to Tymoshenko. Jacek Saryusz-Wolski, Vice President of the European People’s Party—the European Parliamentary party with which Tymoshenko’s party is affiliated—took a stark position: Tymoshenko had to be released, or there would be no signature in November, and Ukraine would miss its window of opportunity with the European Union. EU Ambassador to Ukraine Jan Tombinski cautioned that Kyiv had to understand that the European Union only accepted democratic states that abided by the rule of law. European Parliament member Pawel Robert-Kowal warned that, even if the association agreement were signed, Ukraine had to demonstrate real progress, as the agreement would face the challenge of ratification by 27 individual EU member states.

During and on the margins of the conference, some Ukrainians expressed optimism that the Ukrainian government would take a positive step regarding Tymoshenko. Others doubted that Yanukovych would take any action on his archrival. Some expected the Ukrainian government to try to do the minimum necessary in order to argue that it had met the EU conditions and assert that freeing Lutsenko, but not Tymoshenko, should prove sufficient progress on the condition of selective prosecution.

Right now, EU member states appear to be split. Some, primarily in Central Europe and the Baltic region, do not want to delay signature of the association agreement over Tymoshenko. They fear that Ukraine might otherwise drift into Russia’s orbit.

Other EU member states, apparently now in the majority, believe Kyiv must do more to show its commitment to European democratic values. France and Germany lead this group. The fate of Tymoshenko has become a domestic issue in Germany, and Chancellor Angela Merkel said on April 17 that, “if the Yuliya Tymoshenko case is not settled, the association agreement cannot be signed.” Ukrainian diplomats understand that Berlin presents the toughest case to win over.

Although the European Union and Ukraine have agreed that concrete progress should be made by May, that might not prove a hard deadline for an EU decision on whether or not to sign the association agreement in November. Some in Kyiv believe a final EU decision could wait until later in the year, perhaps as late as October.

The question remains, regardless of when the European Union decides: will Ukraine do enough to secure signature? That may turn on Tymoshenko’s fate—and how badly Yanukovych wants the association agreement.

Neither Brussels nor Kyiv appear to have a Plan B in case the association agreement is not signed. In late March, Tombinski warned that, if the agreement were not signed in November, the press of other EU business in 2014 and the Ukrainian presidential election in 2015 would put Ukraine and the association agreement on the back-burner until late 2015. Another European diplomat recently suggested the delay would last until 2016.

Ukrainians do not want to think about what happens if the association agreement is not signed. But they expect a failure to sign to be warmly welcomed in Moscow, to be followed by a greater Russian push to draw Ukraine into the Customs Union that currently includes Russia, Belarus and Kazakhstan. Yanukovych thus far has resisted joining the Customs Union. Doing so would be incompatible with a free trade agreement with the European Union and would essentially kill the association agreement—which is almost certainly Moscow’s objective.

So, Ukraine may indeed be facing a critical crossroads. It is one where the key choices are as much about Yanukovych’s domestic policy—how democracy will develop and how the opposition is treated—as they are about foreign policy. If Yanukovych makes the right choices, he will take an important step in integrating Ukraine into Europe. If he makes the wrong choices, he risks miring the country in a gray zone between Europe and Russia and having to face Moscow’s pressure with a severely weakened hand.

Editor's note: Steven Pifer, a senior fellow in the Center on the United States and Europe and a former ambassador to Ukraine, was in Ukraine April 18-20 to attend the Kyiv Security Forum.

Authors

Steven Pifer

Image Source: © POOL New / Reuters

The Way Forward for the Eurozone and Europe: A Conversation with European Policymakers

Thu, 18 Apr 2013 16:15:00 -0400

Event Information

April 18, 2013
4:15 PM - 6:00 PM EDT

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

Register for the Event
On April 18, Global Economy and Development at Brookings and the Center for the United States and Europe hosted a discussion on the European economy and the ongoing crisis in the eurozone with a distinguished panel of European policymakers. Panelists included: Olli Rehn, European Commission vice president for economic and monetary affairs and the euro; Jeroen Dijsselbloem, Dutch finance minister and president of the Eurogroup; Klaus Regling, managing director of the European Stability Mechanism; Werner Hoyer, president of the European Investment Bank; and Jorg Asmussen, executive board member of the European Central Bank. Brookings President Strobe Talbott provided introductory remarks. Vice President Kemal Derviş, director of Global Economy and Development, moderated the discussion.

Video

Full Event - The Way Forward for the Eurozone and Europe: A Conversation with European Policymakers

Audio

The Way Forward for the Eurozone and Europe: A Conversation with European Policymakers

Transcript

Uncorrected Transcript (.pdf)

Event Materials

20130418_eurozone_europe_transcript

How Effective Are Regional Organizations in Disaster Risk Reduction and Management?

Elizabeth Ferris — Thu, 18 Apr 2013 12:00:00 -0400

Regional organizations are playing an increasingly important role in disaster risk reduction and management, but how effective are they? Leading up to our event on April 22 (Earth Day), I'll continue to share with you some additional interesting findings from my annual disasters review with Daniel Petz and Chareen Stark.

Join the conversation on Twitter using #Disasters2012.

While regional organizations are playing an increasingly important role in disasters, there has been remarkably little research on their role in disaster risk management. In an effort to address this gap, Daniel Petz and I examined thirteen regional organizations, to see how they stack up against one another according to 17 indicators of effectiveness.

Here are our results (a glossary of acronyms appears at the end of this blog post):

As you can see above, the landscape of regional organizations is complex and diverse.

In most regions, governments and other actors see value in working together to prevent disasters and—to a lesser extent—to respond to disasters occurring in their respective regions. At the same time, regional organizations have worked out different mechanisms for encouraging collaboration, including frameworks for disaster risk reduction, regional military protocols, joint training exercises and regional insurance schemes. Also, technical cooperation mechanisms—such as early warning systems—have been established, but few regional bodies provide ways of channeling financial assistance after a disaster.

*Here are the acronyms for key terms we used above:

DRM = disaster risk management
DRR = disaster risk reduction
DM = disaster management

CCA = climate change adaptation
IDRL = international disaster response laws, rules and principles

and for the regional organizations we studied:

ASEAN = Association of Southeast Asian Nations
AU = African Union
CAN = Andean Community of Nations
CARICOM = Caribbean Community
CoE = Council of Europe
ECOWAS = Economic Community of West African States
EU = European Union
LAS = League of Arab States
OAS = Organization of American States
SAARC = South Asian Association for Regional Cooperation
SADC = Southern African Development Community
SICA = Central American Integration System
SPC = Secretariat of the Pacific Community

Authors

Elizabeth Ferris

Europe on a Slippery Slope

Thomas Wright — Wed, 17 Apr 2013 00:00:00 -0400

Editor's note: This article originally appeared in the International Herald Tribune.

Throughout the euro crisis, observers have been asking if the euro zone will disintegrate — as if it is a decision that will be made by its leaders at some point in the future. This holds out the prospect of a great historic choice: Europeans can choose to properly unite and overcome their crisis or they can choose dissolution. We wait with bated breath for the next summit or the latest “most crucial month in the euro’s history,” which now seems to come several times a year.

But, this may be the wrong way of looking at the euro crisis. Integration and disintegration are not just the products of deliberate decisions. They are both processes, set in motion by actions regardless of the stated intentions of leaders. Once underway, each process takes several election cycles — probably a decade or so — to reach completion. Only one will prevail in the end, but it is possible that in the early stages these two processes can coexist even as each vies for supremacy.

Looked at this way, the euro zone is in serious trouble. The events of the past six months are consistent with a process of disintegration, while the process of integration has steadily weakened. The question is no longer, “Will Europe unravel?” We should be asking, “Can European disintegration be reversed?”

The trigger that brought integration to a halt and set disintegration in motion is surprising. In July 2012, the European Central Bank chief, Mario Draghi, declared that he would do whatever it takes to save the euro, and in August he kept his promise by introducing a program of Outright Monetary Transactions to finance troubled member states, thus bringing down the price of sovereign debt. The temporary lull led José Manuel Barroso, president of the European Commission, to confidently declare that “the existential threat against the euro has essentially been overcome.”

But Barroso could not have been more mistaken. The E.C.B.’s actions, while welcome, had a major unintended consequence. European governments became complacent and stopped pushing the policies needed to save the euro. The German government now believes that a quantum leap toward deeper fiscal and political integration through treaty change (the only way it could be done) is no longer necessary. At the December summit meeting, it was taken off the table. Instead, the Germans will push for incremental steps to increase coordination. Banking union has been watered down to the point where it is grossly insufficient. The euro zone is proposing a common supervisory mechanism, but banking debt will remain primarily a national concern.

The optimists say that the small steps the euro zone has taken are the first in a long journey, but this assumes that it will be easier to accomplish extraordinarily difficult goals later. Unfortunately, European politics are becoming polarized in a way that makes further progress unlikely. The core member states have run out of patience with the periphery and do not want to take on new commitments, such as a real banking union. Voters in the periphery are turning toward politicians who will say no to German austerity, as Italians recently demonstrated.

As integration stalled, the euro zone experienced its first major act of disintegration. The spectacularly botched rescue of Cyprus formally created a two-tier euro zone. Deposits are safer in Germany than in the periphery and this has enormous implications. We should expect large-scale capital flight if markets fear that other states will need a bailout. With capital controls in place, Cyprus itself is half in and half out of the single currency.

The next decisive moment may be when a member state on the periphery elects a government with a cast iron mandate to say no to a German government that has a cast iron mandate not to buckle. This almost happened in Greece in June of 2012, and it may yet happen in Italy in a couple of months. This could cause a withdrawal of E.C.B. support and an escalation that will lead to new acts of disintegration.

Winston Churchill once said: “It is not enough that we do our best; sometimes we have to do what’s required.” All European leaders should have this advice engraved onto a plaque and then affix it to their desks. Throughout the euro crisis, they have sought credit for good intentions and effort. They continually point out that the euro zone has moved far further and faster than anyone could have imagined before the crisis.

They are right, but it is completely irrelevant.

There are other forces at work and at the moment they are prevailing. Europe’s leaders need to be honest about the steps necessary to reverse a long spiral of disintegration. If they can’t do that, they need to ask how they can manage the process in the least damaging way possible.

Authors

Thomas Wright

Publication: International Herald Tribune

Image Source: © Kai Pfaffenbach / Reuters

Don't Forget Free Trade with Turkey

Kemal Kirişci — Mon, 15 Apr 2013 00:00:00 -0400

Last month, both the U.S. and the European Union (EU) took important internal steps to prepare the ground work for negotiations to establish the Transatlantic Trade and Investment Partnership. TTIP would create the largest integrated market in the world, bringing together half of the world’s GDP and 30 percent of world trade. If it went beyond eliminating already low-level tariffs and succeeded in aligning regulatory standards on both sides of the Atlantic, it also could generate more than 3 percent GDP growth. Beyond bilateral effects, TTIP could also spill over to global-trading trends and serve as a tool for strengthening the Western economic order. But in its current form TTIP would leave Turkey, currently the sixteenth-largest economy in the world, and a long-standing transatlantic ally, out in the cold.

Turkey has been deeply integrated within the EU’s internal market since the establishment of a customs union in 1996. Turkey is in membership negotiations with the EU and has therefore already adopted a number of the EU’s internal regulations.

But under current rules, Turkey must negotiate its own agreement with countries the EU signs preferential trade agreements with. This puts Turkey at a significant disadvantage, as the EU-Turkey Customs Union is structured to allow these countries to access Turkish markets without having to reciprocate by opening their own markets. As long as these agreements were signed with countries that had smaller economies, the cost to Turkey was negligible. But the EU has recently begun negotiating and signing trade agreements with countries that have relatively large economies and high volumes of foreign trade, including Canada, Japan, India, Korea and Mexico. Most of these countries have exports that compete with Turkish ones. Thus, it’s a “lose-lose” situation: Turkey faces greater competition in the EU as well as in its own domestic market without enjoying preferential access to these other markets.

Along with other grievances, this asymmetry helps to explain Turkish prime minister Recep Tayyip Erdogan’s announcement in February that Turkey should consider joining the Sino-Russian Shanghai Cooperation Organization (SCO) in favor of the EU. Even though he subsequently retracted this position, his economy minister, Zafer Caglayan, argued in early April that the EU Customs Union had become “an agreement of servitude” and that Turkey either had to renegotiate new terms or get out of the deal. Caglayan’s remarks may well be a bluff intended only for domestic consumption.

Nevertheless, the exclusion of Turkey from TTIP would only aggravate current grievances about the Customs Union, ranging from ground transportation quotas (which deny Turkey the possibility of exporting greater volumes of goods) to requiring Turkish businesspeople to obtain visas for travel to the EU while the goods they sell travel freely. To many in Turkey, such practices seem to be barriers that deny Turkey its full export potential to the EU market.

A study by the German IFO Institute lists Turkey among countries that are likely to experience a net loss of welfare from TTIP. Such an outcome would aggravate existing grievances and create additional pressures on Turkey to break away from the EU and the broader Western liberal order— an outcome detrimental to the interests of both the EU and the United States.

Turkey was a participant in the formation of the global economic order at the end of the Second World War and has remained a part of it in spite of occasional ups and downs. The EU’s engagement with Turkey, first through a Customs Union and then through the pre-accession process, has bolstered revolutionary political and economic reforms. This contributed to massive economic growth in Turkey, and it became a source of stability in a region that has long suffered from entrenched conflicts. Now a model for economic and political transformation in its neighborhood, Turkey has become a major player in integrating the Balkans, the southern Caucasus and the Middle East into the world economy.

Yet in the last few years, as accession negotiations with the EU stalled, Turkey has looked for other economic opportunities in its immediate neighborhood and beyond. This period has also seen the quality of Turkish democracy decline alongside setbacks in earlier political reforms, particularly freedom of expression. TTIPing Turkey would reengage it with the West.

The instability in the Middle East, as well as growing recognition in Turkey of the economic and security advantages that come with the West, have been gently pushing Turkey back toward Europe. The EU is reciprocating with efforts to revive the accession process. In addition, the recent apology by Israel to Turkey will help deepen cooperation with the United States. And the truce announced by the leader of the separatist PKK is opening the prospects of finding a political solution to the Kurdish problem in Turkey, which in turn should help improve the quality of democracy in the country.

While U.S.-EU negotiations on TTIP are going to be challenging, this should not be an excuse for excluding Turkey from the partnership. The EU must rise to the challenge of recognizing Turkey’s concerns. This year marks the fiftieth anniversary of relations between the EU and Turkey. But the EU has not shown any concern for the interests of its long-standing partner. The TTIP impact report prepared by the European Commission makes no reference to Turkey or how TTIP would impact on the customs union. At least a member of the European Parliament has asked the European Trade Commissioner to consider this question, which may be a step in the right direction.

The United States also should avoid to the temptation to reap the benefits of access to Turkish markets without opening its own market to Turkey. The benefits of involving Turkey in TTIP far outweigh the costs resulting from the additional burdens of the negotiation process. TTIP would create more jobs for Americans and Europeans, not just Turks.

Close economic integration between Turkey and its neighborhood means that a Turkey in TTIP would also benefit countries ranging from Armenia to Ukraine—and even countries like Iraq and Syria, once they achieve some stability. Turkey under TTIP would motivate other countries to join the Western economic order and support the values associated with it. Such an outcome would be win-win for the EU, the United States, Turkey, and a Western economic order under challenge from other parts of the world.

Editor's note: This article was originally published by The National Journal.

Authors

Kemal Kirişci

Publication: The National Interest

Image Source: © Murad Sezer / Reuters

Economic Policy’s Narrative Imperative

Kemal Derviş — Mon, 15 Apr 2013 10:40:00 -0400

The best advice I received when taking up policymaking responsibilities in Turkey more than a decade ago was to take “a lot of time and care to develop and communicate the ‘narrative’ to support the policy program that you want to succeed.” The more that economic policy is subject to public debate – that is, the more democracy there is – the more important such policy narratives are.

The crisis faced by the European Union and the eurozone is a telling example of the need for a narrative that explains public policy and generates political support for it. A successful narrative can be neither too complicated nor simplistic. It must capture the imagination, address the public’s anxieties, and generate realistic hope. Voters often sense cheap populism.

European Central Bank President Mario Draghi provided such a narrative to the financial markets last July. He said that the ECB would do everything necessary to prevent the disintegration of the euro, adding simply: “Believe me, it will be enough.”

With that sentence, Draghi eliminated the perceived re-denomination tail risk that was highest in the case of Greece, but that was driving up borrowing costs in Spain, Italy, and Portugal as well. It was not a populist message, because the ECB does indeed have the firepower to buy enough sovereign bonds on the secondary market to put a ceiling on interest rates, at least for many months.

Central bankers, more generally, are typically able to provide short- or medium-term narratives to financial markets.

Central bankers, more generally, are typically able to provide short- or medium-term narratives to financial markets. US Federal Reserve Board Chairman Ben Bernanke provided his own by pledging that US short-term interest rates would remain very low, and the Bank of Japan’s new chairman, Haruhiko Kuroda, has just provided another by saying that he will double the money supply so that inflation reaches 2%.

While central bankers can provide such narratives to financial markets, it is political leaders who must provide the overall socioeconomic messages that encourage long-term real investment, electoral support for reform, and hope for the future. Central bank alchemy, to borrow a term from the US journalist Neil Irwin’s new book, has its limits.

Europe, in particular, needs a narrative of long-term hope that will trigger a real recovery. France is coming closer to the danger zone, and even Germany’s annual GDP growth is falling well below 1% per year. In the meantime, the easing of sovereign interest-rate spreads provides little comfort to the growing army of unemployed in southern Europe, where youth unemployment has reached dramatic heights – close to 60% in Greece and Spain, and almost 40% in Italy.

The narrative should address three essential questions. How can the European model of strong social solidarity and security be reformed, but endure? How can economic growth be revived and sustained throughout the EU? And how can Europe’s institutions function with enhanced legitimacy to accommodate countries that share the euro and others that retain their national currencies?

For starters, a revolution is required in the organization of work, learning, and leisure. Social solidarity, essential to European identity, can and must include longer work lives, but also more work-sharing, adult learning, and shorter average work weeks (particularly close to retirement).

Such flexibility requires the consent of all: employees must adjust to changing requirements; employers must re-organize their enterprises to allow more work-sharing, work from home, and learning intervals; and governments must overhaul taxes, income support, and regulation to promote a “flex-solidarity revolution” that encourages personal choice and responsibility, while remaining committed to social cohesion. This can lead to a better future for all, with citizens gaining better access to adult education, having more free time to pursue personal interests, and remaining productive and occupationally engaged far longer into their healthy lives.

Europe does not need Asia’s rates of economic growth. It can secure decent jobs and prosperity, with a sustained annual growth rate of around 2%.

Europe does not need Asia’s rates of economic growth. It can secure decent jobs and prosperity, with a sustained annual growth rate of around 2%. To achieve that, German voters should be told not that their country’s resources will forever flow to Spain, but that their wages can rise at twice the rate of the recent past without risking inflation or a current-account deficit, because Germany has the world’s largest external surplus.

Service-sector industries throughout the EU must be opened up. The countries with stronger fiscal positions should take the lead in a major pan-European skill-upgrading program. The number of pan-European scholarships should be doubled. School programs everywhere should aim to educate trilingual citizens.

Moreover, a full European banking union with shared resources for resolution should be created without further delay. The European Investment Bank, which received a significant capital increase in 2012, should add a large investment-support program for medium-size enterprises to its current operations, with a subsidy financed from the European budget to encourage first-time job takers for a limited period. Jobs and training for young people must be the centerpiece for the new growth pact, and projects must move ahead in “crisis mode,” rather than according to business as usual.

Finally, while monetary union obviously requires greater sharing of sovereignty, there should also be a “greater Europe” that includes the United Kingdom and others. This implies two-tier institutions that can accommodate both types of countries: the “euro-ins” and those that prefer to preserve their monetary sovereignty in a larger Europe built around a vibrant single market and common democratic values.

These interconnected visions can and must be realized if Europe is to thrive again. Together, they form a compelling narrative that European leaders must begin to articulate.

Authors

Kemal Derviş

Publication: Project Syndicate

Scotland as a Good Global Citizen: A Discussion with First Minister Alex Salmond

Tue, 09 Apr 2013 10:30:00 -0400

Event Information

April 9, 2013
10:30 AM - 12:00 PM EDT

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

In an historic referendum set for autumn 2014, the people of Scotland will vote to determine if Scotland should be an independent country. The decision on Scottish independence will carry with it far-reaching economic, legal, political and security consequences for all of the United Kingdom (UK). The debate about Scottish independence will also be watched closely across the continent of Europe. An independent Scotland would have to review its relationships with the rest of the world, including its priorities in foreign and diplomatic affairs and its memberships of international organizations such as the European Union.

On April 9, the Center on the United States and Europe at Brookings (CUSE) hosted First Minister Alex Salmond, MSP, leader of the Scottish Government, for an address on Scotland’s future as an independent nation. In his remarks, First Minister Salmond discussed the Scottish values and principles that would shape a modern, independent Scotland and the choices and opportunities that would characterize Scotland’s contributions to the world. The Right Honorable Alex Salmond has served as first minister of Scotland since 2007. He first became a member of the Scottish Parliament in 1999 and has served as the leader of the Scottish National Party (SNP) since 2004. Salmond was first elected as a member of the UK Parliament in 1987 and served until 2010.

Vice President Martin Indyk, director of Foreign Policy at Brookings, provided introductory remarks, and Fiona Hill, director of CUSE, moderated the discussion.

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Scotland as a Good Global Citizen: A Discussion with First Minister Alex Salmond

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20130409_scotland_salmond_transcript

A World in Turmoil: An Exploration of Issues Affecting Today's Global Order

Martin S. Indyk and Javier Solana — Fri, 05 Apr 2013 00:00:00 -0400

With a range of critical issues confronting the U.S. and the international community today, Distinguished Fellow Javier Solana and Vice President for Foreign Policy Martin Indyk discuss some of the most pressing challenges, from the war in Syria to the Euro crisis to Iran’s nuclear program.

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A World in Turmoil: An Exploration of Issues Affecting Today's Global Order

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A World in Turmoil: My Conversation with Javier Solana

Fri, 05 Apr 2013 00:00:00 -0400

There are many tensions and problems facing the world today. Distinguished Fellow Javier Solana and I discussed some of the most challenging issues in the current geopolitical landscape, including the Euro crisis, the war in Syria, and Iran's brinksmanship.

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A World in Turmoil: An Exploration of Issues Affecting Today's Global Order

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A World in Turmoil: An Exploration of Issues Affecting Today's Global Order

UK's Euroscepticism Could Cost Britain Power

Thomas Wright — Wed, 27 Mar 2013 00:00:00 -0400

The idea that Britain should use its influence to remake the European Union is not an unreasonable one. There is a strong argument that the EU is on an unsustainable path — the eurocrisis is creating a dangerous divide between the periphery and core, the eurozone is encroaching upon the EU, there is a yawning gap between the people and their leaders, and Europe has much to do if it is to be competitive in a world dominated by the US and China. Britain is a country with the diplomatic skill and heft to move the EU in the right direction.

Unfortunately, this idea is not on the table. What prime minister David Cameron has offered is a referendum that strikes many international observers as diplomatically irrational.

Regardless of the pros and cons of membership, the four-year wait till a vote is held creates immense uncertainty about the British economy and Britain's role in the world. Investment decisions, diplomatic engagements and countless other initiatives will be placed on hold as long as it is unclear whether Britain will be in or out.

However, there is an even greater risk with the prime minister's approach. It is much more likely to lead to an exit than his publicly stated position suggests. Cameron has promised a vote if he renegotiates the terms of Britain's membership with the European Union. This way, he can have it both ways — rail against the status quo, but claim he is in favour of membership.

By implication, he has not promised a vote if he is unable to renegotiate the terms of membership. This is a rather gaping loophole. From the perspective of the rest of the EU, the easiest path is to refuse to renegotiate — hence, no referendum and no risk of Britain leaving. And it appears as if this is exactly what is happening.

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Authors

Thomas Wright

Publication: Politics.co.uk

The EU and North Africa: Defining the Criteria for Effective Partnership

Ruth H. Santini — Tue, 26 Mar 2013 15:09:00 -0400

With a persistent economic downturn spreading across North Africa, ensuing social disruptions and rising political instability especially in Egypt and Tunisia, one might wonder what role Western actors are trying to play in the region. As the new US Secretary of State traveled to Egypt and pushed for an end of divisive political bickering on the road to new parliamentary elections, forcefully insisting on economic reforms to finalize a $4.8 billion IMF loan, Europe was nowhere to be seen.

However, on March 20th, following its own bureaucratic schedule, the European Commission came out with an assessment of the European Neighbourhood Policy (ENP) and the annual reports on the progress status of a number of ENP countries, among which Egypt.

The EU openly recognizes it must work with other partners in order to support political and economic transitions. Many external actors are engaged and contribute to shape the pace and direction of political change, first and foremost the US and Gulf countries. With the creation in 2012 of EU bilateral “task forces” with Egypt, Tunisia and Jordan, we have seen greater coordination among international donors in terms of economic support. What has not (yet) materialized is greater multilateral political coordination in terms of which joint messages to get across to these countries’ political establishments when democratic backsliding occurs. The EU acknowledges that economic and political developments are intertwined and tries to influence the latter by focusing on the former. Brussels has so far committed 3.5 billion euros to the southern neighborhood for the 2011-2013 period and more recently 300 million euros in smaller grants. Compared to that, the US on March 10thagreed to allot a package of $190 million in aid to Egypt from a commitment of $450 million aimed at industrial support.

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Authors

Ruth H. Santini

Publication: Aspenia Online

Portugal and the Euro Area: A Conversation with Portuguese Minister of State and Finance Vítor Gaspar

Tue, 26 Mar 2013 10:00:00 -0400

Event Information

March 26, 2013
10:00 AM - 11:30 AM EDT

Saul Room/Zilkha Lounge
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

In 2011, Portugal suffered a sudden stop in international financing, triggering an abrupt adjustment process. As the crisis in the euro area continues, Portugal continues to feel its impact, with the recession entering a third consecutive year in 2013 and unemployment reaching record highs.

On March 26, Global Economy and Development at Brookings hosted a conversation with Portuguese Minister of State and Finance Vítor Gaspar on the challenges Portugal faces as the euro area looks to find a path toward recovery. Mr. Gaspar was appointed minister of State and Finance in June 2011. Gaspar is also a professor of economics, having taught at various Portuguese universities. He holds a Ph.D. in economics from Universidade Nova de Lisboa. . He was the head of the Bureau of European Policy Advisers at the European Commission from January 2007 to February 2010. From September 1998 to December 2004, he served as the director-general of research at the European Central Bank. Prior to that, he held various high ranking positions in government and at Banco de Portugal.

Brookings Managing Director William Antholis moderated the conversation.

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Portugal and the Euro Area: A Conversation with Portuguese Minister of State and Finance Vítor Gaspar

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A New Business Model for Cyprus

Javier Solana — Mon, 25 Mar 2013 00:00:00 -0400

Once again, Europe has peered into the abyss. But the tentative agreement between Cyprus and the troika (the European Commission, the International Monetary Fund, and the European Central Bank) probably means that the worst has been avoided. Big losses for large depositors in Cypriot banks will now be imposed, and the country’s second-largest bank will be shuttered. Looking ahead, however, Cyprus has the means not only to recover, but even to heal its longstanding division with the Turkish-backed statelet in the north of the island.

Cyprus, of course, is just the latest country to be hit by the economic crisis surging through the Mediterranean. For years, Cyprus had an immense banking bubble, with the sector’s assets estimated at roughly seven times the country’s GDP, as foreign money poured into a tax haven within the eurozone’s secure environment.

The design of the bailout has been shaped both by domestic pressures faced by eurozone leaders and by the exceptional nature of the Cypriot banking bubble: many European leaders suspect that the island had become a money-laundering center for Russian individuals and entities, which pumped an estimated one-third of the €68 billion into the country’s banks. Regardless of the details of the ultimate deal, the risk is that the ghost of Russia’s bailout of Cyprus in 2011 could provoke severe side effects across Southern Europe, both for governments’ borrowing costs and for small savers.

Nevertheless, it is imperative not to lose sight of some very valuable assets that Cyprus holds – assets that could mean the country’s economic salvation.

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Authors

Javier Solana

Publication: Project Syndicate

Cyprus II: Considerable Improvement, but Serious Risks Remain

Douglas J. Elliott — Mon, 25 Mar 2013 10:55:00 -0400

We can heave a sigh of relief about the revised Cyprus deal. Early this morning, Cyprus, the various European authorities, and the IMF found common ground on the outline of a deal that is much better than the very flawed agreement of the previous weekend. At the same time, the earlier botched proposal will carry some long-term costs and the actions taken now, while necessary, create real risks of their own.

The best news is simply that an agreement of any kind was reached, allowing European support to flow to Cyprus and preventing, for now anyway, the possibility of an exit from the eurozone. It is also very good news that insured bank depositors in Cyprus will be protected after all, eliminating a terrible precedent with repercussions across Europe. Further, there are real advantages to inflicting large losses on the uninsured depositors and the bondholders of the two largest Cypriot banks. This is by far the strongest message Europe has ever sent that people must pay attention to the strength of the banks with which they deal. It brings the hope that market discipline will finally be a significant aid to outright regulation in ensuring that European banks act prudently at all times.

The first risk is the flip side of passing losses on to those who put their money in banks. In practice, Europe has a long tradition of protecting all depositors, not just the insured ones, and, in most cases, the bondholders as well. For example, the much vaunted, and highly successful, Swedish bank rescues included guarantees for all liabilities. Over time, in reaction to this, there may be major flows of deposits from the weak banking systems in Europe to the stronger ones, further exacerbating credit crunches in the periphery. The ECB and national central banks can offset these flows, but only with further distortions that carry costs of their own. Weaker banks, and those in weaker countries, will find their borrowing costs rising on bonds as well, as investors take heed of the lessons of Cyprus. Even banks in strong countries are likely to see costs increase over time, as depositors and investors react to this major change in regulatory regime. These costs will generally be passed on to customers, potentially slowing economies down at least modestly further. (The ECB can partially counteract this effective tightening of credit conditions, but it is already close to “pushing on a string”, hitting conditions where it is difficult to ease further and have any effect.)

The second problem is that we cannot “unring the bell” of potential hits to insured depositors. The first Cyprus deal raised the real possibility that insured depositors across Europe could lose money if their banking systems and national governments became too weak. The strong reactions to this, and its complete elimination from the final deal, reduce this damage considerably, but it will remain in people’s minds. If there is another serious banking crisis in a weak eurozone nation, depositors may be more prone to move their funds to safer banks and safer countries, in a classic bank run.

The remaining risks are about Cyprus itself. The economy will be severely damaged by the deal and the turmoil around it. A severe recession will be exacerbated by the losses taken by businesses and others with large, and therefore uninsured, bank deposits, and by the restrictions on banking transactions that may remain for some time. Confidence, of course, has been badly shot. Further, nearly a fifth of the Cypriot economy consists of financial services, a sector that will shrink very sharply now. There will also be other conditions imposed on Cyprus as part of the larger agreement with the eurozone and the IMF that will likely hurt in the short run even if they may be for the best in the long term.

It is going to be extremely difficult for a fast-sinking Cypriot economy to produce the results necessary to hold the country’s debt down to a sustainable level. Thus, we are being set up for a future round of tense negotiations to either bring in more eurozone support or take drastic actions such as a bond default, similar to Greece’s. Such a default would carry at least some contagion risk for the rest of the eurozone, unless the larger crisis is essentially resolved by then.

In short, there is no cause for real celebration, but there is reason to feel relieved that disaster was avoided and some of the ill effects of last week’s debacle have been erased. The initial market reactions seem about right; they are up after the weekend’s news, but not soaring.

Authors

Douglas J. Elliott