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Aug 7, 2017 | 09:30 GMT

14 mins read

The EU Prepares to Pursue Reforms Under Brighter Skies

The European Union comprises 28 member states possessing a wide rainbow of flags.
(IAN WALDIE/Getty Images)
Forecast Highlights
  • After the German general elections in September, EU members will start a long dialogue to reform the bloc.
  • The negotiations will again expose the different, and often conflicting, interests between the European Union's northern and southern members.
  • A key player to watch in the coming years is Italy, as the future role of the country will be an important topic during Franco-German negotiations on EU reform.
By the end of the year, the political situation in Europe will look much clearer than it did at the start of 2017. In March, the British government formally announced its plans to leave the European Union, triggering a two-year negotiation process. In June, French voters elected a president who, barring an unexpected crisis, will remain in office for the next five years. In September, Germany will hold general elections that will probably keep pro-EU forces in power. Afterward, with the political environment likely more conducive to reform than it has been over the past decade, EU member states will start working on the future of Continental integration. But as in the past, their different interests and priorities will shape the negotiations and their outcome.

The Future of the Banking Union

The goal of the EU banking union — one of the main topics on the reform agenda — is to make the eurozone's financial sector stronger and more resilient to crisis. In 2012, eurozone countries agreed on a three-step plan to deepen the integration of the currency area's banking sectors with this union. The first step was the introduction of a single mechanism to enhance the European Central Bank's role in supervising Europe's largest banks. The second step was the creation of a mechanism to ensure the orderly resolution of troubled banks without using public funds. Finally, the plan called for the creation of a common deposit insurance for eurozone banks.

The first two steps have been completed, albeit not without controversy. Early this year, Spain stuck to the new rules when it let shareholders, rather than taxpayers, deal with a failing bank's losses. But things were different in Italy, where the government used a loophole in EU regulations to inject public funds into a group of ailing banks. Member states including Germany and the Netherlands criticized the move, saying that the banking rules should be revised and the loopholes closed.

The third step remains by far the most controversial. The European Commission's original plan envisions that by 2024, deposits up to 100,000 euros (about $117,741) in any bank in the eurozone will be protected with money taken from national insurance schemes across the bloc. But Northern European countries like Germany, Finland and the Netherlands see the plan as unfair because they are forced to share risk with those in the south. So these nations have made their own proposals to limit the amount of money that would be involved in the joint-risk fund. Because of Europe's busy electoral calendar this year, the discussion over the future of the banking union has been temporarily put on hold, but it will be one of the hottest issues in the eurozone starting in 2018. The debate could even include non-eurozone countries, as Sweden and Denmark recently said they would assess whether or not to join the banking union.

Somewhat connected to the debate is the future of the ECB. Since the institution was created in the late 1990s, it has had a Dutch, a French and an Italian president. The term of the current president, Mario Draghi, expires in late 2019 and he cannot be reappointed. As the largest economy in the eurozone, Germany may decide that the time has come for a German to serve as the bank's chief. While the ECB is independent, from an ideological perspective a German president would probably have a vision of the eurozone that is similar to Berlin's, something southern eurozone members may oppose. The position has to be decided unanimously, which means that a heated debate and significant horse-trading will take place as Draghi's term ends.

Key Dates in Europe - 2017/2024

The Introduction of EU-Wide Spending Schemes

One of the main goals of the European Union is to ensure similar standards of living for all its members. To some extent the bloc is already a transfer union, since it has programs in place such as the Common Agricultural Policy and the cohesion funds that, in broad terms, collect money in the union's wealthiest areas and spend it in poorer regions. But since the start of the 2008 financial crisis, Southern European countries have asked the European Union to introduce bigger spending and investment programs at the Continental level.

In 2015, the European Commission introduced a program — the so-called Juncker Plan — to use EU funds to guarantee private investment. Its results have been mixed. While hundreds of projects have been approved, only a handful of them have been signed. More important, most of the investment took place in wealthy countries such as Germany and the United Kingdom, instead of in poorer countries such as Portugal or Romania.

In recent months, France and Spain have said that the eurozone should have a common finance minister in charge of managing a common budget to finance projects across the bloc. The Spanish proposal went further, suggesting the issuing of debt backed jointly by eurozone members and the creation of a common unemployment insurance. Northern European countries are skeptical of these proposals, especially if they are not accompanied by measures to make sure EU rules on debt and deficit are more strictly enforced.

Germany supports the idea of creating a eurozone finance minister, but with a different goal in mind. From Berlin's perspective, such a minister should have the power to enforce budgetary discipline in the currency area. Moreover, Germany remains strictly opposed to debt mutualization in the eurozone. While Berlin's position on these issues can change somewhat depending on whether a center-right or a center-left government is formed after the September elections (the center-left tends to be more supportive of public spending in the country and abroad), Germany's core strategy of protecting its taxpayers' money will not significantly change.

Military Cooperation

In June, the leaders of all member states endorsed the creation of a European defense fund to coordinate and supplement national investments in military research and in the acquisition of equipment and technology. They also agreed on the need to strengthen their cooperation on military matters. The goal is to pool resources, reduce duplication, promote standardization and enhance the ability of European armed forces to work together. According to the current timeline, which is subject to change as countries negotiate the details, both the defense fund and a permanent cooperation structure should be operational in 2019.

These decisions are connected to the United Kingdom's exit from the European Union, as the remaining member states needed a way to show unity after the shock of last year's Brexit referendum. With eurozone reforms proving controversial, defense is one of the few topics where some degree of consensus can be found. In addition, the British government had resisted these kinds of moves in the past, opting to keep the European Union as closely aligned with the North Atlantic Treaty Organization and the United States as possible.

But these plans could still face obstacles. The different defense priorities of each EU country could make it more difficult to prioritize areas of joint investment. For example, some countries may want jets while others may want artillery. EU members will also have to deal with the inevitable disputes about which industries will be given which projects and where the new equipment will be built. Countries with large military industrial sectors, such as France and Italy, will probably aim to be given sizable portions of the projects, a move that could irritate other countries.

The Schengen Area and Migration

The constant arrival of asylum seekers and economic migrants by sea has put the entire EU immigration system under stress. The Dublin system, which requires asylum requests to be processed in the country of a migrant's first entry, puts too much pressure on Italy and Greece. At the same time, a decision by several countries in Northern Europe to introduce border controls in order to discourage immigration is raising questions about the future of the passport-free Schengen area.

Migration is one case where Southern European countries do not share a common position. Countries like France and Spain have refused to accept some of the migrants who arrive in Italy. Moreover, France will probably side with Austria and other northern countries when it comes to authorizing prolonged border controls to sever migration routes. The European Union is likely to continue focusing its migration strategy on offering financial, logistical and intelligence assistance to the countries of origin and transit of migrants, as well as providing financial and technical assistance to Italy and Greece. A substantial redesign of the bloc's migration policies will remain elusive, and the migration issue will continue to create friction within the European Union and fuel anti-immigration and anti-EU sentiments in the bloc.

The Post-Brexit EU Budget

The European Union approves its general budget, known as the multiannual financial framework, every seven years. Member states discuss not only how much money should be available, but also how it should be spent. Countries such as France are interested in big agricultural subsidies, while countries like Poland want to keep the structural funds in place. Germany and the United Kingdom, in turn, have recently pushed for smaller EU budgets and more efficient spending.

The current multiannual financial framework ends in 2020, which means negotiations for the next seven-year period will start at some point between 2018 and 2019. While all budget negotiations tend to be tense, the next one will be particularly important because member states will have to decide how to react to the Brexit. The United Kingdom is a net contributor to the EU budget, with an annual contribution of roughly 10 billion euros. In a post-Britain European Union, the bloc will essentially have three options. The first is to approve a smaller budget, which would not require countries to increase their national contributions but would demand spending cuts at the bloc level. The second option is for the European Union to boost its own sources of revenue. This would be a controversial move, since the union would have to impose its own taxes, a decision that some member states could oppose. The final option is for EU members to raise their national contributions to make up for the loss of the United Kingdom's contribution. But countries such as Germany, Sweden and Denmark already have spoken against this option.

Connected to the budget debate is the possibility that the European Union may link disbursements to EU values. The European Commission and Germany, with Poland's controversial judicial reforms in mind, recently said that countries adopting policies that violate EU values could see their EU funds temporarily frozen. When negotiations for the next multiannual financial framework start, some member states will suggest linking funds and values. But such a move is unlikely to be approved, given how many countries may worry about being next in line for the freezing of funds. Overall, linking the disbursement of money to vaguely defined political criteria could exacerbate divisions within the bloc.

The Future of Continental Integration

The European Union is not homogeneous when it comes to level of integration. For example, some countries use the euro as their currency while others don't, and some countries are members of the passport-free Schengen area while others aren't. But the official goal of the European Union has always been that, at some point, all member states should converge. As political fragmentation has prompted national governments and EU institutions to toy with the idea of a "multi-speed Europe," this objective may change. The new aim could be for some members to deepen their integration while others would be allowed to opt out.

But countries have different interpretations of what a multi-speed Europe would mean, should it become the European Union's new goal. For some, it would mean that the members of the eurozone would continue their journey toward a federal superstate, while non-euro countries would be little more than trade partners. This is a terrifying prospect for Central and Eastern Europe, where most of the non-eurozone countries are located, because they rely on EU membership for their economic prosperity and, to some degree, for their national security. As a result, the endorsement of a multi-speed Europe could mean the formalization of the bloc's east-west divide. But it would also risk exacerbating the bloc's north-south divisions, mostly because of the mistrust and conflicting interests between the two regions.

While a multi-speed Europe seems the sensible thing to do in times of fragmentation, it also carries the risk of freezing the bloc's current rifts instead of healing them, especially if it formally splits the European Union into "core" and "peripheral" countries — a division that already exists but has never been institutionalized. A core group of EU members would be smaller and probably less influential than the current European Union is in world affairs. Even the definition of what the "core" is could be problematic, since France and Germany see each other as core EU members but so does Italy. A formal division between first- and second-class members could make decision-making even more complex, as it would probably require new structures and institutions to govern the new version of the European Union.

The Germany-France-Italy Triangle

The upcoming negotiations to reform the European Union will test the stability of the Franco-German alliance. Paris and Berlin are interested in preserving their ties, but they have different views on many of the topics on the table. The situation in Italy will be an important factor during Franco-German negotiations, too, because Germany is worried about Italy's economic fragility and will use it as an excuse to resist many of the reforms in the eurozone that the southern bloc wants. France, for its part, will be trapped between the interests it shares with Italy and its need to preserve an alliance with Germany. And Italy, in turn, fears that its fragile political and economic situation could limit its influence in negotiations over eurozone reform. Rome is also concerned that France will cut deals with Germany privileging Franco-German relations over Italy's interests. A victory by Italian Euroskeptic forces in the country's coming general elections could make things even more complicated.

Other players will also challenge the Germany-France-Italy triangle and demand a seat at the negotiating table. Spain is the eurozone's fourth-largest economy, but a decade of crisis has weakened its role in making big EU decisions. Because the Spanish economy is now facing robust growth, it's only natural that Madrid demands a greater say in EU affairs, including the appointment of Spanish officials in key EU positions. The risk that the balance of power in Europe could move to the south will probably make northern countries like the Netherlands, Austria and Finland step up and defend their national interests. On issues outside of the eurozone, Central and Eastern Europeans will also demand a say, though their own regional frictions will limit their ability to speak with a single voice.  

It's been a decade since the Treaty of Lisbon last overhauled the European Union. Amid member states' conflicting interests and the growing influence of populism and nationalism in most countries, nobody in the European Union in recent years wanted to open Pandora's box and discuss a new treaty. Even now, when most European economies are growing again, an attempt at treaty reform could result in members calling for powers be transferred back to them, rather than delegated to Brussels. As a result, EU members are likely to try to deal with the Continent's political fragmentation by reaching intergovernmental agreements, allowing member states to opt out of some areas and making as many reforms as possible without reforming the treaty itself.

But intergovernmental agreements can do only so much. Issues such as permitting debt mutualization, creating a separate budget, appointing a finance minister for the eurozone or transforming the bloc into a transfer union probably require treaty reform. Such reforms would require unanimous approval by all members, and even referendums to ratify them in some countries. Economic and political conditions may be better in most European countries than they were five years ago, but Euroskepticism remains strong. And even if compromises on treaty change are found, the ratification process could still lead to unpleasant surprises for the European Union.

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