By Lili Bayer
Prince Klemens von Metternich, the architect of the European continental system that emerged after Napoleon’s defeat, once remarked that any plan conceived in moderation must fail when the circumstances are set in extremes. The European Union developed and expanded during a time of relative prosperity. A new Russia, emerging from the ruins of the former Soviet Union, transformed as energy prices rose. But the favorable circumstances of the past decades no longer exist. Europe is now entering the new phase in a set of interrelated crises that the continent’s current system was never effectively designed to address.
Our 2016 forecast predicted that Europe will grapple with three interlocking challenges this year: the European Union’s economic problems, the refugee crisis and Russia’s relationship with Europe and the U.S. We noted that Germany is key to all three of Europe’s dilemmas and that 2016 will be a year of significant fragmentation in Europe. This week, Europe’s three crises are each progressing to another stage, augmenting the region’s challenges.
Europe’s economic challenges are not only a threat to the continent’s prosperity and stability, but also test the relationships among the European Union and its member states, especially those with Germany. The focal point of the European Union’s economic troubles is now Italy, where non-performing loans are posing a challenge to the stability of the county’s banking sector. On Jan. 26, Italian Finance Minister Pier Carlo Padoan will meet with EU Competition Commissioner Margrethe Vestager to negotiate the price of a potential state guarantee for lenders who want to sell their non-performing loans. The EU rejected an earlier Italian plan to create a so-called “bad bank,” and Rome is now attempting to craft a plan that would allow banks to offload bad debts with some government assistance while skirting EU rules on state aid. The future stability of Italy’s banking system depends in large part on the EU’s ability to allow for flexible and timely solutions to the problem of non-performing loans.
Meanwhile, in Greece, Prime Minister Alexis Tsipras is struggling, yet again, to implement reforms that are both acceptable to the country’s creditors and his constituents. Farmers are blocking highways and civil servants are planning demonstrations against upcoming changes to the pension system, as Tsipras attempts to use his narrow majority in parliament to continue to pass reforms.
There are signals that the EU is coming to see the Italian banking system’s troubles as what they are – a growing crisis with the potential to affect economies across Europe. When it comes to Greece, the dispute over pension reform is merely the latest element of ongoing negotiations over the implementation of Greece’s reforms. But in reality, Italy’s banking problems and Greece’s chronic reform difficulties are two sides of the same coin. The European Union is highly fragmented and struggles to address economic challenges effectively and in a timely manner, but it remains in Germany’s interest to safeguard the unity of the eurozone. Berlin wants to avoid contagion within the bloc and needs to maintain the eurozone as a strong export destination for German goods. The European Union is unable to offer cohesive, long-term solutions to economic problems, but Germany will likely push for ad-hoc, short-term solutions to ensure that both Italy and Greece remain members of the currency bloc.
Europe’s second crisis is the ongoing flow of refugees and migrants to the European Union’s borders. EU Justice and Home Affairs ministers met in Amsterdam on Jan. 25, ahead of a planned summit in February, to discuss (among other things) an extension of temporary border controls inside the Schengen zone for another 18 months. Several key EU members – including Germany and Austria – are seeking the extension as they work to better manage the flow of refugees. At the same time, some EU members are pushing to isolate Greece from the Schengen zone. The establishment of border controls across the Schengen zone has already eroded one of the basic principles of the EU, the free movement of people, and by extension also threatens to undermine another important element of European integration, the free movement of goods. In fact, European Commission President Jean-Claude Juncker warned last week that more border controls could cost 3 billion euros ($3.25 billion) a year in lost business. As with Europe’s economic challenges, responses to the refugee crisis have been ad hoc, with no comprehensive strategy for mitigating the crisis. Much of the future trajectory of the crisis depends on Germany’s decision-making and leadership within the bloc, but Berlin’s shifting stance on how to address the crisis has contributed to the bloc’s fragmented response.
Russia’s relationship with Europe is also evolving, as Europe increasingly fragments and Russia weakens. Russian Prime Minister Dmitry Medvedev on Jan. 25 ordered his Cabinet to submit a new anti-crisis plan within a week. Russian government sources told Reuters that due to the country’s worsening economic conditions, the Russian government is setting aside 135 billion rubles ($1.7 billion) to boost Russia’s economy and may also spend 340 billion rubles in an effort to reduce potential social unrest. The 135 billion rubles would reportedly come from unspent money from Russia’s 2015 budget. Nevertheless, this sum is quite modest, especially when compared with a plan Russia unveiled a year ago to spend $35 billion supporting businesses, banks and struggling regional governments. Falling energy prices have forced Russia to repeatedly amend its budget, with more cuts planned. Thus far, government assistance has helped safeguard the stability of Russia’s largest banks but has failed to stem the negative trajectory of Russia’s economy, which remains heavily dependent on the country’s energy exports.
There have been indications that the Kremlin is working to improve its relationships in the West during this time of economic troubles and a stalemate in Ukraine. Nineteenth century German statesman Otto van Bismarck once said that the secret of politics is to “make a good treaty with Russia.” With Europe preoccupied with its own economic and political challenges, Western European governments want to avoid any escalation in Ukraine and would generally prefer to improve ties with Moscow. French Economy Minister Emmanuel Macron said on Jan. 25 in a meeting with Russian businessmen that lifting sanctions by this summer is a “common goal.” This comment comes after U.S. Secretary of State John Kerry noted that sanctions could be lifted if progress is made on the issue of Ukraine. Washington would like to reach an accommodation with Moscow, but is still working to ensure that Ukraine remains pro-Western in the future because it is aware that Moscow will pose a threat to Ukraine and the Baltic states in the long run.
Germany has adopted an assertive stance following Russia’s moves in Crimea and eastern Ukraine, but ultimately tensions with Moscow are not in Berlin’s interest. Germany’s focus is maintaining a united European Union and eurozone. While Germany would like to see a pro-Western government in Kiev, instability in Ukraine, as well as sanctions against one of Germany’s major economic partners, Russia, distract Berlin from its main priorities in the European Union. German Finance Minister Wolfgang Schäuble wrote in an opinion piece published in Frankfurter Allgemeine Zeitung on Jan. 25 that Europe should work together with Russia when it comes to the Middle East, an outcome that the Kremlin had been hoping to produce as it became more involved in the Syrian conflict in late 2015. Russia’s limited involvement in the war in Syria was designed in part to enhance Moscow’s negotiating position with its Western counterparts. Nevertheless, Russia is facing a growing economic crisis that it cannot ignore. An increasingly weak Russia has limited options and is thus potentially more dangerous and unpredictable in its moves in Europe.
Three crises on the European continent are unfolding and interacting. Increasingly, the European Union is fragmenting. Russia is weakening but attempting to hide it. And Germany is looking for answers. As these problems intersect, the implications for the region will be far-reaching.