Cablegate: Economic Europe: A Year of Redefinition? Or A

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 FRANKFURT 008839

SIPDIS

STATE FOR EUR PDAS RIES, EB, EUR/AGS, AND EUR/ERA
STATE PASS FEDERAL RESERVE BOARD
STATE PASS NSC
TREASURY FOR DAS SOBEL
TREASURY ALSO FOR ICN COX, STUART
PARIS ALSO FOR OECD
TREASURY FOR OCC RUTLEDGE, MCMAHON

E.O. 12958: N/A
TAGS: ECON EFIN EUN
SUBJECT: Economic Europe: A Year of Redefinition? Or a
Dangerous Cocktail?

T-IA-F-03-0055

This cable is sensitive but unclassified. Not/not for
Internet distribution.

1. (SBU) Introduction and Summary: In his book "Struggle
for Europe," Yale University historian (and foreign service
brat) William Hitchcock describes not wars that have swept
through Europe but trials and tribulations of peacetime in
post WWII Europe. As the title suggests, peace does not
mean tranquility. One mechanism for securing cooperation
among European countries has been economic agreements: The
European Steel and Coal Agreement, Customs Union, Internal
Market, and, most recently, European Monetary Union. These
have been defining moments in the struggle for a cohesive
economic Europe.

2. (SBU) Among the economic developments discussed at the
EU economic officers conference this fall that we will be
tracking in 2004 are other potentially redefining events:
the accession of 10 new member states, signature of a
Constitutional Treaty for Europe, a new regulatory
infrastructure for financial services, structural reforms at
the national level, and negotiations on the EU budget.
Accentuating these developments will be changes in
leadership in the European Parliament and European
Commission in the fall of 2004 and the European Central Bank
(ECB) in 2003.

3. (SBU) It may not be too much of a stretch of the
imagination to think that 2003-2004 could be one of those
periods of struggle from which emerges a re-defined economic
Europe. Then again, it could be just another struggle, and
a nasty one at that. US interests are clearly at stake,
particularly as EU and US firms are more exposed than ever
before to each other's markets. A more dynamic, resilient
euro area economy could help create an alternative pillar
for global growth. That really would be a redefining
outcome. End Introduction and Summary.

Accession Countries

4. (SBU) Acceding countries are scheduled to join the EU in
May. Accounting for only around 6% of the euro area's GDP,
they are unlikely to add any noticeable bounce to the euro
area's overall economic performance in the short-term.
Nonetheless, they could change the quality of the EU debates
and exert indirect pressure for change. As transition
economies, these countries have moved from state-controlled
to market-oriented economic policies, generally appreciating
the benefits of the latter. Could this portend different
economic policy debates at the EU level? A German Finance
Ministry official unguardedly wondered whether "old Europe"
was ready for the ideas that young, well-educated economic
reformers would bring to the table.

5. (SBU) Attracting foreign direct investment has been a
boon to many acceding countries. Adopting policies that
continue to do so, such as low corporate and income taxes,
will apply indirect pressure on current member states to
improve their own competitive position. Standing still will
be a poor second best option.

Constitutional Treaty

6. (SBU) On the Constitutional Treaty, the Italian plan is
to have a signing ceremony in Rome in May. This would be
dubbed a "second Treaty of Rome," referring to the 1957
Treaty of Rome that gave birth to the European Economic
Community. Building upon existing agreements, the draft
Constitutional Treaty contains detailed provisions on the
operation of the ECB and economic and fiscal policy
coordination.

7. (SBU) As presently drafted, the Constitutional Treaty
suggests a slight shift in power sharing on economic issues.
The European Commission and Parliament would pick up new
competencies. In the area of financial services, the
Commission stands to have its powers to adopt detailed
implementing measures put on a firmer footing - provided
Parliament is satisfied that it has a right to "call back"
measures that they believe go beyond the Commission's
authority.

8. (SBU) The draft would formalize the Euro Group,
specifying areas where only members that have accepted the
euro can take decisions. It also would contain an enabling
clause for enhanced cooperation among willing member states.
These features are already present to some degree under
current arrangements. The Swedish "no" vote and the UK's
failure to measure up to its self-imposed standards for euro
adoption portends a higher likelihood of a multi-speed
economic EU. After all, member states that have adopted the
euro will be in the minority in the enlarged EU (12 of 25).
Perhaps the prospect of a multi-speed EU will provide
additional incentive for acceding countries to persevere in
their stated desire to adopt the euro as soon as possible
after accession.

Financial Services Regulatory Infrastructure

9. (SBU) Less obvious but potentially no less important
redefining developments are the regulatory and institutional
infrastructures being put into place in the area of
financial services at the EU level. New committees
composed of member state representatives are to give policy
advice to the Commission when it exercises its authority to
adopt implementing measures. Supporting those committees
are other committees of experts - supervisors and
technicians. This structure already exists in the
securities and financial conglomerates areas and should be
partially established by the beginning of next year in
banking and insurance.

10. (SBU) By assembling supervisors from all member states,
giving them defined projects that will result in EU-wide
binding legislation and a mandate to ensure consistent
interpretation and enforcement of that legislation across
the EU - well you can imagine what comes next - an EU
regulator or regulatory system. Not this year or next, but
the foundation is being laid. Indeed, a group of German
bankers have called for the creation of a EU supervisory
authority by 2013, and the French-based Eurofi has supported
a European Securities and Exchange Commission. There is a
movement to have an enabling clause in the constitution to
keep such an option open.

National Structural Reforms

11. (SBU) Another quiet, but potent re-defining development
is the structural reforms being undertaken in many member
states. Finally reality is catching up to the lip service
and good intentions - encapsulated in Lisbon agenda and
repeated annually in the Broad Economic Policy Guidelines.
The anvil of slow growth and the hammer of stronger euro
have forged the realization of the need for growth enhancing
reforms. Germany, France, and Italy, Portugal - embarked on
path others (Netherlands, Finland, Spain, Austria) have
traveled before.

12. (SBU) Such reforms are presented not as a question of
scrapping the social welfare state (or, heaven forbid,
becoming "more like us" American capitalists ). Rather, as
German Chancellor Schroeder shrewdly put it, "modernizing"
the welfare state. Economic growth, sometimes regarded as a
matter of life style (the right to more leisure and less
work), is no longer optional.

13. (SBU) An Independent High-Level Study Group's report to
the European Commission asserted that "Growth must become
Europe's number one economic priority" to help integration
of new members and for the sustainability of the "European
model which puts a high premium on cohesion." The Italian
Presidency has seized upon the issue by proposing a European
Action for Growth. With some tweaking by the UK, France and
Germany, Heads of State and Government should endorse the
initiative by year's end.
A Different EU?

14. (SBU) In addition to these major or minor potentially
defining developments will be other significant events in
2003-2004. The ECB will have a new President on November 1,
a new European Parliament will be elected in June 2004, and
in the fall of 2004 there will be new Commissioners and a
reshuffling of portfolios. Taken together, by the end of
2004, the EU could be rather different in economic policy
making and orientation.

Or A Dangerous Cocktail?

15. (SBU) Then again, 2003-2004 could be exhausted by
bitter, nasty struggles and thwarted by the powerful force
of bureaucratic inertia. The very ingredients that could re-
define economic Europe are also those of a "dangerous
cocktail," in the words of a senior Commission official.

16. (SBU) The Inter-Governmental Conference charged with
finalizing a Constitution for Europe will be composed of
acceding countries as well as member states. This would be,
in the view of one observer, the "first serious test" of the
enlarged EU's readiness to demonstrate the art of
negotiation and compromise, putting aside national interests
for European ones. The Italian Presidency, Germany and
France have cautioned against opening the draft text. This
smacks as a fait accompli. Voting rights, under terms of
the draft, would favor "charter" members, not Spain and
Poland.

17. (SBU) By flouting the Stability and Growth Pact rules
and the Treaty's requirements on budget deficits, France is
suggesting that acceding countries sign on to our rules
which apply to others, but not ourselves. Not very
community-like. Fudging the SGP rules could lead to the
same fuzzy math for the Maastricht criteria for acceding
countries' adoption of the euro. Not necessarily a
comfortable turn for the euro.

18. (SBU) Dissension over the draft Constitution and
Stability and Growth Pact disciplines could be exacerbated
by negotiations on the EU's budget perspectives for 2007-
2013. The Commission plans to have a "political framework"
agreed by the end of 2003. It faces serious headwinds.
Acceding countries are vying for shares of structural funds
while current members try to hold on to as much as possible,
either structural funds (like Portugal and Spain) or special
rebates (like the UK).

19. (SBU) Linkages between issues -- the constitution, the
SGP, budget, regulatory infrastructure, and policy measures,
are more than likely - if not direct then indirect. Losing
on one front could mean getting even on another. Taken
together, a pretty volatile mix. (Note: While this cable is
confined to economic issues, several commentators have
suggested that political issues being closely watched by
others will also determine whether the EU undergoes a
redefining moment or loses its way from imbibing the
dangerous cocktail.)

US Interests

19. (SBU) The United States continues to have a strong
interest in an economically strong, vibrant Europe. In his
"Drifting Apart or Growing Together? The Primacy of the
Transatlantic Economy, " Joseph Quinlan arrays data to
demonstrate that Europe and the US are more economically
interlinked than ever before. "The reality is that Europe,
on account of its deep investment roots in the U.S., is far
more exposed to U.S. economic conditions than any other
region of the world. A similar commitment of investment
goes in the other direction. 58% of corporate America's
foreign assets are in Europe with U.S. foreign affiliate
sales in Europe accounting for more than half of their sales
worldwide." He believes that the "common ground between the
U.S. and Europe is still fertile for further economic
integration."

20. (SBU) Areas in which Quinlan suggests integration could
be undertaken include corporate governance and financial
regulatory standards, the very areas in which EU regulatory
infrastructure is being created and on which the US and EU
have an informal dialogue. Structural reforms, fiscal
discipline, the Constitutional Treaty and entry of accession
countries could combine to affect US interests - for better
or for worse. A positive outcome for both the EU and the US
would be a more dynamic EU economy more resilient to
economic shocks, generating more domestic demand. This
would help create an alternative pillar for world economic
growth. Now that would be a re-defining outcome for Europe
from which the global economy could benefit.

21. (U) This cable coordinated with Embassies London,
Berlin, Rome, Paris and USEU.

22. (U) POC: James Wallar, Treasury Representative, e-mail
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)-
7535-2238.

BODDE

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