Over-complex Europe keeps making same mistakes

PARIS Mon May 14, 2012 10:57am BST

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PARIS (Reuters) - Americans call it a Rube Goldberg machine, Britons a Heath Robinson contraption and the Danes a Storm P machine.

The European Union's policy-making system often resembles one of those cartoon designs of an implausibly convoluted system for achieving a simple task - held together by sticking plaster, string, frequent tinkering and plenty of wishful thinking.

What is striking when you compare Europe's policies on agriculture, monetary union and climate change is the similarity of the way the EU keeps bolting on patches and extra wiring to try to fix problems created by its own solutions.

Over the last five decades, the EU has set out to achieve a set of worthy goals by regulating markets - self-sufficiency in food, currency stability, fighting climate change.

Each of these policies created perverse incentives or what economists call "moral hazard", causing unintended consequences such as grain mountains and wine lakes, real estate bubbles and debt overhangs, and the collapse of the carbon price.

When things go off the rails, the EU reflex is never to question or scrap the policy, since political dogma, vested interests and institutional inertia rule out going back on what in Eurospeak is called the "acquis" - European achievements.

The default response is always "more Europe", although not necessarily the most straightforward solution, which is often fenced around with political vetoes.

"In political science, it's called 'past dependence'," says Helen Wallace of the London School of Economics, an authority on European governance. "You are so locked in by what you have done before that you end up doing a version of it again and again."

While similar behaviour exists in national governments and private businesses, the EU is special due to the number of veto holders who can obstruct change, but also because supporters of the European integration project are reluctant to be critical when policies go wrong, she said.

Furthermore, EU policies are enshrined in law and treaties, making them harder to amend, an adviser to European Commission President Jose Manuel Barroso noted.

Take the Common Agricultural Policy. Conceived in the 1950s and early 1960s to feed postwar Europe at stable prices for producers and consumers, the system subsidised farmers to over-produce cereals, wine, meat and dairy products. By the early 1980s, it was swallowing 70 percent of the community budget.

Surpluses grew so large they had to be taken off the market and stored for long periods in giant warehouses and tanks at taxpayers' expense. Some were sold off at subsidised prices to the former Soviet Union and developing countries.

Then farmers were paid to dig up their vines, reduce their herds and take land out of cultivation and leave it fallow. Eventually, the link between subsidies and production was cut, but farmers still receive EU payments for maintaining the countryside and producing high-quality food.

Today the Common Agricultural Policy still guzzles 40 percent of the EU budget. Don't count on that level of spending falling significantly before 2020 in negotiations on the next seven-year budget framework due to climax later this year.

The same pattern can be observed with the single European currency, launched in 1999 initially with 11 members, to provide currency stability for business and consumers and give Europe greater power on global foreign exchanges.

The euro zone's one-size-fits-all interest rate provided an irresistible temptation in countries such as Spain and Ireland to build and buy homes that people had never been able to afford before. Wages rose faster than productivity in poorer peripheral euro countries, fuelling a consumer boom but sapping their economic competitiveness.

Governments were lulled into excessive borrowing by the fact that for nearly a decade, bondholders accepted almost the same return when lending to Greece and Portugal as they did from economic powerhouse Germany.

When the Spanish and Irish real estate bubbles burst and Greece revealed in 2009 that its public debt and deficit were far higher than previously declared, there was panic on bond markets and the euro system threatened to melt down.

But there was no going back to first principles. The euro was the EU's highest achievement of economic integration and the only way out considered by policymakers was fast forward.

A political veto by Germany blocked the boldest solutions proposed by many economists, such as mutualising Europe's debts, issuing common euro zone bonds or creating a joint bank resolution and guarantee system.

With countries locked into the single currency and unable to devalue, the only option instead was for stronger member states to bail out weaklings while imposing eye-watering austerity conditions to make them cut public spending, wages and pensions.

The European Financial Stability Facility, the temporary bailout fund created by euro zone countries, is the ultimate Rube Goldberg machine. Each member state has a veto on all its actions, and loan guarantees are national, not joint.

So Finland could hold up the rescue of Greece to demand collateral on its share of the loans, while a junior party in Slovakia's governing coalition was able to obstruct an expansion of the fund's scope for weeks.

The dysfunctional decision-making system is a major reason why the euro zone has been behind the curve in responding to the sovereign debt crisis since it began in late 2009.

Another part of the crisis response has been gradually to give the European Commission greater power to tell member states how to manage national budgets within agreed EU rules, raising questions of democratic legitimacy since the EU executive is increasingly unpopular in many countries.

Now some of the same solutions are being proposed for the EU's Emissions Trading Scheme, introduced in 2005 to curb greenhouse gas emissions by capping the amount of carbon that industries are allowed to emit and making allowances tradeable.

It was always a second best alternative to imposing a carbon tax, which the treaty requirement for unanimous decision-making on taxation made impossible.

The ETS got off on the wrong foot by handing windfall profits to utilities which initially received free allowances. They now have to pay but the system has now been brought low by a glut of permits at a time when recession and energy saving measures have reduced the amount of carbon being produced.

As a result, the carbon price has slumped to below 7 euros a tonne, roughly a third of the level seen by experts as the minimum needed to make the system viable.

At that price, it is now cheaper to build and run a coal-fired power station than one using less polluting natural gas.

So the European Commission is now proposing to take carbon permits off the market and tweak the auction timetable to create scarcity, while some experts are calling for an independent European central bank for carbon to regulate the supply of allowances to keep the price within an agreed range.

A management consultant who worked previously in national government and the EU presidency said Europe defaults to "Rube Goldberg" solutions partly because decisions are always a trade-off between multiple, divergent national and sectoral interest.

"There are so many differences of ideology, financial interest and institutional interest. It is a fallacy to assume that there is a 'correct solution'," said the consultant, who declined to be identified because he is not authorised to speak for his company.

(Writing by Paul Taylor; Editing by Toby Chopra)

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