The EU: from French to German dominance

April 5, 2007 at 9:21 am | Posted in Political Economy | Leave a comment

Another interesting viewpoint from Stratfor:

EU: A Golden Anniversary — and a Hard Reality for France
By Peter Zeihan

The European Union celebrated the 50th anniversary of the signing of the Treaty of Rome on March 25. To mark the event, 27 heads of government gathered in Berlin, ostensibly to sign a declaration reaffirming the union’s values and outlining future goals. Disputes over the document’s text, however, proved so divisive that in order to avoid embarrassing refusals the leaders were not even asked to sign it. Meanwhile, the ceremonies were so dull that many officials wandered off into the streets of Berlin well before they concluded.

Europhobes point to such apathy as a perfect example of how Europe has failed. The union, they say, has no future if European presidents and prime ministers cannot even stay in a room long enough to commemorate the union’s golden anniversary — much less sign what in essence was a birthday card. Europhiles look at the same picture and turn it on its head. They argue that the union is so successful and its core features — peace in Europe and a rich common market — so entrenched that high-level attention is hardly needed.

Both are right, both are wrong — and both are missing the point. The European Union has succeeded and failed, not by the standards of the pundits but by the criteria of its founder.

France created the European Union both to protect and assert itself in the geography of the Cold War — and in that it was wildly successful. But that geography no longer exists, and the union now not only has grown beyond Paris’ grasp, but also has fallen under the influence of a power that until recently France controlled.

A French Creation

Located as it is near the west end of the Eurasian landmass, France has always faced the same geopolitical dilemma: It is just large and strong enough to project influence, but not quite large and strong enough to secure its well-being alone. This reality forces France to be proactive in achieving its goals. During the Napoleonic Age, this meant acting aggressively to assert its order on a chaotic Europe and farther abroad. In the first half of the 20th century, it meant being equally aggressive in seeking allies against a region that was developing an order France could not control.

Throughout both periods, however, the French met with defeat after defeat. Napoleonic France was not strong enough to take on the rest of Europe and Russia, while France’s Third Republic lacked the strength to defend itself against the other European powers without extensive outside help. Before World War II, France faced a melange of potentially hostile states — the United Kingdom, Spain, Germany, Italy and Russia being only the five most significant.

But in the early post-Cold War years, the very geography of Europe changed. As the dust from World War II settled, France saw a silver lining in the brewing clouds created by the U.S.-Soviet policy of Mutually Assured Destruction. Germany, Italy and Austria were occupied. Spain languished in isolation under Franco’s dictatorship. The United Kingdom largely disengaged itself from continental affairs. And most important, the Soviet Union’s Iron Curtain was explicitly designed to limit contact between East and West.

After a series of stinging national catastrophes beginning with Napoleon’s disastrous retreat from Moscow and culminating with the march by German troops under the Arc de Triomphe, Paris in the late 1940s finally found itself with no rivals.

In such an environment, Paris set out to create an entity that would be large enough to allow France to project power globally, but small enough for it to control. In 1948, France spearheaded the formation of the European Coal and Steel Community. This created the framework for the founding of the European Economic Community in 1957 (the Treaty of Rome), which in turn evolved into the European Union.

French domination of this entire process proved considerably durable, with the first true cracks not appearing until the final days of the Cold War. This should come as no surprise. The European Community/Union was designed explicitly to take advantage of the political geography of the Cold War, so when the Cold War ended, the continent’s geography changed. The pond in which France swam enlarged, and the Soviet Union’s imperial debris has since proven to be more than Paris can manage.

Nowadays, there is no shortage of challenges to French dominance in Europe. The United Kingdom is a full EU member, the belt of former Warsaw Pact states does not recognize Paris’ leading role and expansion into the Balkans has exposed the union to a raft of issues that are challenging to say the least. The greatest challenge to the French project, however, lies in the twin pillars of its foundation.

Germany and Gaullism

Cold War France needed two things to make the European project function: an ideology that bound Paris firmly to the leadership of Europe, and a platform on which it could stand to wield that leadership. France found its answers in war hero Charles de Gaulle and — ironically — in its World War II foe.

While de Gaulle did not become France’s president until 1959 — two years after the signing of the Treaty of Rome — his role as commander of the Free French Forces granted him the gravitas to shape debate within French society in both the Fourth Republic, which he challenged and displaced, and the Fifth Republic, which he forged and led. It was de Gaulle who imprinted on the French mind the idea that France could and should take up a leadership position in Cold War Europe as a counterbalance to both the United States and the Soviet Union. This, in de Gaulle’s mind, would provide the kernel from which a European alternative to either superpower could grow.

And he realized he could not do it alone.

Much has been made of the “Franco-German motor of European integration,” and rightly so. Even in defeat, Germany remained the industrial powerhouse of Europe while nearly one-quarter of the French population remained in agriculture. Without harnessing Germany’s economic muscle (and larger population), France could never have used Europe as a reliable platform.

De Gaulle’s strategy, therefore, was simple: Take advantage of Germany’s post-war guilt to sublimate German national ambitions completely within France’s European project. Use German markets to fuel French industrial expansion. Use German finances to feed French agriculture. And integrate the two states with the other community members to serve French interests.

Despite a number of changes in membership and circumstance, French diplomacy consistently succeeded in convincing the Germans that what was good for Europe (and, by extension, good for France) was good for Germany. France provided the direction and Germany provided the industrial and financial backing; as a result, Europe deepened and broadened.

But after German reunification formally began in 1990, France began to lose its pre-eminent position in European affairs. Yes, Germany remained critical in French thinking regarding Europe; but unlike the heady days of the 1960s and 1970s, when Paris largely determined the German position, reunified Germany began to inject its own preferences — very quietly — into European processes. By the time German reunification was completed in 1999, the press began to refer regularly to the Franco-German partnership rather than the Franco-German motor. It was a subtle but critical difference.

No longer divided and occupied by the Cold War superpowers, Germany was again whole and deciding its own policies in its new/old capital of Berlin. The very geography of not only Cold War Europe but also Cold War Germany had changed — and with that, French hopes for controlling the European agenda began to wane.

During this time, Franco-German relations remained cordial, but the European project began to take a new (German) direction:

Germany flexed its newly reunified muscles in the early 1990s and began meddling in what ultimately blossomed into the Yugoslav wars — which a more circumspect France did not appreciate.

German diplomats took the lead in crafting the euro — a currency governed by the same conservative policies used in German, not French, monetary management.

Germany stood to benefit the most, both economically and politically, from expanding the European Union eastward. France was justifiably nervous about such efforts, which limited its financial benefits from the union. It also diluted France’s political control of the organization — the original rationale for creating the union (in the French mind) in the first place.

Germany, not France, is the largest trading partner and political influence on all the states that have joined the union since 1990. Germany, not France, is the global economic powerhouse. And Germany, not France, is able to hold — indeed, demand — a robust discussion with any major power of the world on any topic. And all this became the state of affairs before the relatively pro-American Angela Merkel became German chancellor.

French unease with the ongoing evolution of the European Union is not difficult to unearth. President Jacques Chirac, himself a proud and committed Gaullist, has often used the European Union as a scapegoat for France’s (or his own) problems. Such an attitude toward an organization that he used to firmly control certainly contributed to France’s 2004 defeat of the European constitution (a document written, appropriately, by a Frenchman) in a popular referendum.

What has occurred since 1990 is a subconscious realization in France that the European Union no longer is its exclusive playground — that the European Union is quite capable of going down paths that France once could have blocked. In fact, with the qualified majority voting structure, France can even be forced down those paths against its will. The organization that France formed to secure its interests is now, at times, perceived to be threatening them. And the country responsible is not one of Chirac’s traditional bugaboos, the United Kingdom or the United States, but instead the power that the French leadership held firmly in hand for a half century: Germany.

It is not that the Germany of today holds nefarious intent toward France, simply that it now holds German interests pre-eminent in its policymaking. With Germany undoubtedly the most powerful entity in the union, having Europe’s drum reverberating with a deep German bass is a serious problem for Paris.

And it certainly is reflected in French domestic politics. The ideology of Gaullism — like the organization of the European Union — was crafted for a different geopolitical reality. With the Cold War dead and the Iron Curtain gone, the idea of French domination of Europe is simply a geographic impossibility. As such, it should come to no surprise that not one of the leading contenders for the French presidency is a Gaullist. The candidate closest to that stance is Nicolas Sarkozy, who while technically Chirac’s successor is about as pro-American as a Frenchman can be.

So, with the French-German relationship as changed as the geography of Europe, what becomes of the union? The answer could be clearer than it seems.

French rationale for creating the European Union can ultimately be distilled down to three words: Guarantee French security. While the French effort has obviously made use of economic tools, the goal was political and military in nature. However, there is not a policymaker alive in Berlin who thinks a German bid for political and military dominance of Europe would be met with anything other than terror and rage. Until such anxieties cease to concern German decision-makers, Berlin’s goals for the European Union will largely be limited to the economic sphere — just as they have been since 1990. If Germany can make the union all about economic issues, then its position as Europe’s largest economy will do the rest.

There is a reason why Merkel’s first summit in her current role as EU president focused on energy security. There is a reason why Germany is the only major eurozone economy that has not called for more political oversight of the European Central Bank (ECB). There is a reason why it was a German who negotiated and wrote the Maastricht Treaty on monetary union. There is a reason why ECB policymakers look first and foremost at German economic data. And there is a reason why the ECB is located in Frankfurt.

So, when thinking of evolutions in the European Union, consider the implications of having the word “euro” replaced with “deutsche mark.” For all practical purposes, that is what the euro is.

The Robotic Senate

August 9, 2006 at 8:08 am | Posted in Political Economy | 2 Comments

Via Ben Hyde: Slicing and Dicing the Senate. Reduce each senator to two parameters, and you can draw a line dividing any vote with 95% accuracy. A vertical line means an issue was decided according to economic position, and a horizontal line means it was decided according to social position.

It’s interesting that diagonal lines seem to work with as much accuracy. So for example on a given vote, economically liberal senators will be in favor, but only if they are not too socially conservative. It’s pretty amazing that such a simplistic model works so well.

Unusual China analysis

January 27, 2006 at 9:49 am | Posted in Political Economy | Leave a comment

George Friedman’s Stratfor is a great source of independent analysis that often stands in contrast to the conventional wisdom. Here’s an interesting report on China’s political and economic situation.

Dissecting the ‘Chinese Miracle’
By Peter Zeihan

The “Chinese miracle” has been a leading economic story for several years now. The headlines are familiar: “China’s GDP Growth Fastest in Asia.” “China Overtakes United Kingdom as Fourth-Largest Economy.” “China Becomes World’s Second-Largest Energy Consumer.” “China Revises GDP Growth Rates Upward — Again.” Everywhere, one can find news articles about China, rising like a phoenix from the economic debris of its Maoist system to change and challenge the world in every way imaginable.

But just like the phoenix, the idea of an inevitable Chinese juggernaut is a myth.

Moreover, Western markets have been at least subconsciously aware of this for a decade. More than half of the $1.1 trillion in foreign direct investment that has flowed into China since 1995 has not been foreign at all, but money recirculated through tax havens by various local businessmen and governing officials looking to avoid taxation. Of the remainder, Western investment into China has remained startlingly constant at about $7 billion annually. Only Asian investors whose systems are often plagued (like Japan’s) by similar problems of profitability or (like Indonesia’s) outright collapse have been increasing their exposure in China.

Once the numbers are broken down, it’s clear that the reality of China does not live up to the hype. While it is true that growth rates have been extremely strong, growth does not necessarily equal health. China’s core problem, the inability to allocate capital efficiently, is embedded in its development model. The goals of that model — rapid urbanization, mass employment and maximization of capital flow — have been met, but to the detriment of profitability and return on capital. In time, China is likely to find itself undone not only by its failures, but also by its successes.

The Chinese Model

Until very recently, China’s economic system operated in this way:

State-owned banks held a monopoly on deposits in the country, allowing them to take advantage of Asians’ legendary savings rate and thus ensuring a massive pool of capital. The state banks then lent to state-owned enterprises (SOEs). This served two purposes. First, it kept the money in the family and assisted Beijing in maintaining control of the broader economic and political system. Second, because loans were disbursed frequently and at subsidized rates — and banks did not insist upon strict repayment — the state was able to guarantee ongoing employment to the Chinese masses.

This last point was — and remains — of critical importance to the Chinese Politburo: they know what can happen when the proletariat rises in anger. That is, after all, how they became the Politburo in the first place.

The cost of keeping the money circulating in this way, of course, is that China’s state firms are now so indebted as to make their balance sheets a joke, and the banks are swimming in bad debts — independent estimates peg the amount at around 35-50 percent of the country’s GDP. Yet so long as the economic system remains closed, the process can be kept up ad infinitum: After all, what does it matter if the banks are broke if they are state-backed and shielded from competition and enjoy exclusive access to all of the country’s depositors?

This system, initiated under Deng Xiaoping in 1979, served China well for years. It yielded unrestricted growth and rapid urbanization, and helped China emerge as a major economic power. And so long as China kept its financial system under wraps, it would remain invulnerable.

But the dawning problem is that China is not in its own little world: It is now a World Trade Organization member, and nearly half of its GDP is locked up in international trade. Its WTO commitments dictate that by December, Beijing must allow any interested foreign companies to compete in the Chinese banking market without restriction. But without some fairly severe adjustments, this shift would swiftly suck the capital out of the Chinese banking system. After all, if you are a Chinese depositor, who would you put your money with — a foreign bank offering 2 percent interest and a passbook that means something, or a local state bank that can (probably) be counted on to give your money back (without interest)?

The Chinese are well aware of their problems, and perhaps their greatest asset at this point is that — unlike the Soviets before them — they are hiding neither the nature nor the size of the problem. Chinese state media have been reporting on the bad loan issue for the better part of two years, and state officials regularly consult each other as well as academics and businesspeople on what precisely they should do to avert a catastrophe.

The result has been a series of stopgap measures to buy time. Among these, the most far-reaching initiative has been a partial reform of the financial sector. The government has founded a series of asset-management companies to take over the bad loans from the state banks, thus scrubbing them free of most of the nonperforming loans. The scrubbed banks are then opened up so that interested foreign investors can purchase shares.

So far as it goes, this is a win-win scenario: Foreign banks get access to assets in-country before the December jump-in date, and the state banks avoid meltdown. In addition, a measure of foreign management expertise is injected into the system that hopefully will teach the state banks how to lend appropriately and — if all goes well — lead to the formation of a healthy financial sector. At the same time, the deep-pocketed foreign companies come away with a vested interest in keeping their new partners — and by extension, the Chinese government — fully afloat.

The only downside is that central government, through its asset-management firms, assumes responsibility for financially supporting all of China’s loss-making state-owned enterprises.

But this rather ingenious banking shell game addresses only the immediate problem of a looming financial catastrophe. Left completely untouched is the existence of a few hundred billion dollars in dud loans — linked to tens of thousands of dud firms for which the central government is now directly responsible.

Which still leaves for China the unsettled question: “Now what do we do?”

Two Opposing “Solutions”

As can be expected from a country that just underwent a leadership change, there are two competing solutions.

The first solution belongs to the generation of leadership personified by Deng Xiaoping and Jiang Zemin, and could be summed up as a philosophy of “Grow faster and it will all work out.” It could be said that during Jiang’s presidency, while the leadership certainly perceived China’s debt problem, they — like their counterparts in Japan — felt that attacking the problem at its source — the banking system — would lead to an economic collapse (not to mention infuriate political supporters who benefited greatly from the system of cheap credit).

Jiang’s recommendation was that everyone should build everything imaginable in hopes that the resulting massive growth and development would help catapult China to “developed country” status — or, at the very least, raise overall wealth levels sufficiently that the population would not turn rebellious. In the minds of Jiang and his generation of leaders, the belief was that only rapid economic growth — defined as that in excess of 8 percent annually — could contain growing unemployment and urbanization pressures and thus hold social instability at bay.

The second solution comes from the current generation of leadership, represented by President Hu Jintao. This solution calls for rationalizing both development goals and credit allocation. The leadership wants to eliminate the “growth for its own sake” philosophy, consolidate inefficient producers and upgrade everything with a liberal dose of technology. Key to this strategy is a centrally planned effort to focus economic development on the inland areas that need it most — and this entails tighter control over credit. Hu wants loans to go only to enterprises that will use money efficiently or to projects that serve specific national development goals — narrowing the rich-poor, urban-rural and coastal-interior gaps in particular.

There are massive drawbacks to either solution.

Regional and local governors enthusiastically seized upon Jiang’s program to massively expand their own personal fiefdoms. And as corporate empires of these local leaders grew, so too did Chinese demand for every conceivable industrial commodity. One result was the massive increases in commodity prices of 2003 and 2004, but the results for the Chinese economy were negligible. China consumes 12 percent of global energy, 25 percent of aluminum, 28 percent of steel and 42 percent of cement — but is responsible for only 4.3 percent of total global economic output. Ultimately, while “solution” espoused by Jiang’s generation did forestall a civil breakdown, it also saddled China with thousands of new non-competitive projects, even more bad debt, and a culture of corruption so deep that cases of applied capital punishment for graft and embezzlement have soared into the thousands.

Yet the potential drawbacks of the solution offered by Hu’s generation are even worse. In attempting to consolidate, modernize and rationalize Jiang’s legacy, Hu’s government is butting heads with nearly all of the country’s local and regional leaderships. These people did quite well for themselves under Jiang and are not letting go of their wealth easily. Such resistance has forced the Hu government to reform by a thousand pinpricks, needling specific local leaders on specific projects while using control of the asset management firms as a financial hammer. After all, since the central government relieved the state banks of their bad loan burden, it now has the perfect tool to strip power from those local leaders who prove less-than-enthusiastic about the changes in government policy.

Or at least that is how it is supposed to work. Local government officials have become so entrenched in their economic and political fiefdoms that they are, at best, simply ignoring the central government or, at worst, actively impeding central government edicts.

Hu’s team is indeed making progress, but with the problem mammoth and the resistance both entrenched and stubborn, they can move only so fast for fear of risking a broader collapse or rebellion. And this does not take into consideration Beijing’s efforts to strengthen the Chinese interior — where the poorest Chinese actually live. Complicating matters even more, Hu’s strategy relies upon the central government’s ability to wring money out of the wealthy coastal regions to pay for the reconstruction of the interior.

That has made the coastal leaders even more disgruntled. However, they have come upon a fresh source of funding, replacing the traditional sources of capital that now are drying up as a result of the personnel changes in Beijing: the underground lending system, which was spurred by the official government monopoly over banks in years past. The central government now estimates that the underground banking sector is worth 800 billion yuan, or some 28 percent of the value of all loans granted in country.

Dealing with Failure — And Success

The question in our mind is which strategy will fail — or even succeed — first. If Jiang’s system prevails, then growth will continue, along with the attendant rise in commodity prices — but at the cost of growing income disparity and environmental degradation. The likely outcome of such “success” would be a broad rebellion by the country’s interior regions as money becomes increasingly concentrated in the coastal regions long favored by Jiang. And that is assuming the financial system does not collapse first under its own weight.

Local rebellions in China’s rural regions have already become common, but two of are particular note.

In March, the villagers of Huaxi in the Zhejiang region protested against a local official who had used his connections to build a chemical plant on the outskirts of town. When rumors of police brutality surfaced, some 20,000 villagers quite literally seized control of the town from 3,000 security personnel. Before all was said and done, the villagers invited regional press agencies in to chronicle events in the town that had told the Politburo to go to hell, and started burning police property and parading riot control equipment before anyone who would watch. They actually sold tickets to their rebellion. Huaxi marked the first time local officials actually lost control of a town.

Then, in December, protests erupted against a local official in Shanwei, who had similarly lined his pockets with the money that was supposed to have been made available to farmers displaced by his expanding wind-power farm. The local governor figured that since he was investing not just in an energy-generating project in energy-starved China, but a green energy project, that he would have carte blanche to run events as he saw fit. He was right. When the protests turned violent, government forces opened fire — the first authorized use of force by government troops against protesters since the Tiananmen Square incident in 1989.

Such events are, in part, evidence of a degree of success for the strategy espoused by Jiang’s generation. The grow-grow-grow policy results in massive demand for labor by tens of thousands of economically questionable — and typically state-owned — corporations. This, in turn, draws workers from the rural regions to the rapidly expanding urban centers by the tens of millions. The dominant sense among those who are left behind — or those who find their urban experiences less-than-savory — is that they have been exploited. This is particularly true in places like Shanwei, on the outskirts of urban regions, when urban governors begin confiscating agricultural land for their pet projects.

But for all the complications created by Jiang’s solution to China’s economic challenges, it is Hu’s counter-solution that could truly shatter the system. In addition to dealing with all the corrupt flotsam and high-priced jetsam of Jiang’s policies, Hu must rip down what Jiang set out to accomplish: thousands of fresh enterprises that are unencumbered by profit concerns. A steady culling of China’s non-competitive industry is perhaps a good idea from the central government’s point of view — and essential for the transformation of the Chinese economy into one that would actually be viable in the long term — but not if you happen to be one of the local officials who personally benefited from Jiang’s policies.

The approach of Hu’s generation is nothing less than an attempt to recast the country in a mold that is loosely based on Western economics and finance. Even in the best-case scenario, the central government not only needs to put thousands of mewling firms to the sword and deal with the massive unemployment that will result, it also needs to eliminate the businessmen and governing officials who did well under the previous system (which did not even begin to loosen its grip until 2003). And the only way Beijing can pay for its efforts to develop the interior is to tax the coast dry at the same time it is being gutted politically and economically.

The challenge is to keep this undeclared war at a tolerable level, even while ratcheting up pressure on the coastal lords in terms of both taxation and rationalization. But just as Jiang’s “solution” faces the doomsday possibility of a long rural march to rebellion, Hu’s strategy well might trigger a coastal revolution. As the central government gradually increases its pressure on the assets and power of China’s coastal lords, there is a danger that those in the coastal regions will do what anyone would in such a situation: reach out for whatever allies — economic and political — might become available. And if China’s history is any guide, they will not stop reaching simply because they reach the ocean.

The last time China’s coastal provinces rebelled, they achieved de facto independence — by helping foreign powers secure spheres of influence — during the Boxer Rebellion. This resulted, among things, in a near-total breakdown of central authority.

Jim Simons funds RHIC

January 16, 2006 at 4:56 pm | Posted in Math / Physics, Political Economy | Leave a comment

Via Peter Woit. Simons (of Chern-Simons fame) is an amazing story alone, mathematicians branching out successfully into commercial endeavors aren’t all that common; and his funds are more than successful, they look to be as wrapped up in the world economy as LTCM (more via Steve Hsu).

RHIC needing a billionaire to bail it out financially is pretty sad, though; such a small amount of money in such a huge budget…but even more, it makes clear that basic research and particularly physics has such a lack of mindshare with those with political clout. I think this might be at least one reason behind the unusually strong focus on string theory in the US: quite apart from any scientific issues, without a highly visible and unified effort that can capture the imaginations of voters or at least policymakers, institutional funding for theoretical physics seems to be shaky at best.

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