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Political developments in Europe: Multiple challenges put EU’s future to the test

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To the Regional Outlook Europe overview page

  • The European Union faces a confluence of political challenges that threaten to seriously undermine the cohesion of the block
  • The persistent strength of various populist parties weighs on the implementation of necessary structural reforms at national and European levels
  • The ongoing refugee crisis and elevated terrorism risks threaten to undermine EU cohesion amid a general lack of consensus on how to tackle these challenges
  • The risk of a Brexit (UK exit from the EU) has increased, as the current state of the EU raises doubts about the net benefits of EU membership among British voters  
  • A de-escalation of tensions between the EU, Turkey and Russia remains unlikely and reciprocal sanctions will likely remain in place

Rising influence of populist parties weighs on the outlook for reform in Europe

The European Union, and in a wider sense the entire European continent, faces its most challenging years in decades. The region’s fragile economic recovery, its still unresolved refugee crisis and fears of terrorism continue to erode public support for established political parties and the idea of European unification. In various countries, populist anti-establishment Eurosceptic parties from both sides of the political divide continue to benefit from rising numbers of disenfranchised voters no longer feeling that they are represented by traditional parties. This increases the direct and indirect influence of the Eurosceptic parties on policymaking.

In the southern periphery of the euro area, austerity fatigue has helped mainly left-wing populist parties gain considerable representation in parliaments (Greece, Italy, Portugal, Spain), and has allowed them to form governments in Greece and Portugal that might opt to reverse the austerity and reform efforts of recent years. Meanwhile, in Spain, left-wing anti-austerity party Podemos’ refusal to join a three-party coalition government triggered early elections and continued political uncertainty. In large parts of Northern and Central Europe, mainly nationalist parties are benefiting from a gradual shift of public opinion to the political right. These nationalist-conservative movements are exploiting rising fears about migration and terrorism amid the ongoing refugee crisis that supplement lingering concerns about structural financial support for ailing euro area members. Although they are as yet not in government, nationalist right-wing parties are increasingly influencing policymaking, as established parties adopt some of their rhetoric and proposals in order to keep them at bay. Recent developments in Austria and France bear witness to this trend. Austria’s grand coalition government decided to assist Macedonia in closing its borders to refugees as nationalist parties are leading in opinion polls, while France remains opposed to large-scale reallocation of refugees across Europe given a strong Front National.

Consequently, the oftentimes statist economic policies and anti-European attitudes of both left-wing and right-wing populist parties are gaining increasing traction among mainstream political parties. The growing importance of populist parties meanwhile negatively affects the willingness and ability of established parties to embark on necessary structural reforms at national and European levels. At the same time, very loose ECB monetary policy and its stimulating effect on growth and depressing effect on government borrowing costs is temporarily reducing the need for the implementation of such reforms. Last year’s marked decline in structural reform momentum at national and EU levels bears witness to this development. The outlook for a reversal of this trend at EU level remains bleak, as the persistent strength of the German national-conservative Alternative für Deutschland (AfD) could cast a shadow over the country’s ability to act as a promoter of European integration. The same holds for the strong position of populist parties in France’s opposition and Poland’s government, traditionally key European allies of Germany, which will seriously undermine the country’s ability to garner sufficient support at European level for further European integration. Germany’s recent isolation amidst the height of the European refugee crisis does not help in this respect either. At the level of individual EU member states, the participation of populist parties in coalition governments brings with it risks of government instability. The same applies to disparate coalitions of various established parties formed with the main purpose of keeping populist parties out of power. The resulting deterioration in economic policymaking and political stability at national and European levels, as well as the increasing difficulty in reaching EU-wide consensus on necessary further deepening of European integration, is weighing on investors’ confidence in the strength of the European economic recovery.

Figure 1: Rising support for populist parties across Europe in recent opinion polls…
Figure 1: Rising support for populist parties across Europe in recent opinion polls…Sources: TNS Emnid, TNS NIPO, TNS Sofres, Gallup, Euromedia, GESOP, CBOS, Demoskop, YouGov
Figure 2: …amid a slow decline of still elevated unemployment
Figure 2: …amid a slow decline of still elevated unemploymentSource: Eurostat

European leaders struggle to uphold EU cohesion amid the migration crisis

Against the background of a lingering populist challenge across the continent, the escalation of the European migration crisis and a series of terrorist attacks within the EU could hardly have come at a worse moment. It has revealed major shortcomings in EU-wide crisis management and has sparked surging anti-immigrant sentiment. Refugee flows towards the EU mainly via Balkan countries surged in 2015, leading to more than 1.3 million asylum claims in the EU, up from 626,000 in 2014, amid escalating violence in Iraq, Libya, Syria and Afghanistan. The surging numbers of refugees confront transit and destination countries (mainly Austria, Germany and Sweden) with sizeable logistical challenges, while the slow response of EU policymakers amid a general lack of consensus is leading to unilateral actions by individual (groups of) countries. In particular, the re-imposition of border controls threatens to undermine the future viability of border-free travel in the Schengen area, damaging one of the cornerstones of European unification and bringing with it considerable economic costs. Along the so-called ‘Balkan route’, uncoordinated border closures and the construction of border fences threatens to reignite tensions between Balkan countries amid a general lack of international coordination.

Figure 3: Refugee arrivals in Greece, Italy and Spain in 2015
Figure 3: Refugee arrivals in Greece, Italy and Spain in 2015Source: UNHCR
Figure 4: Distribution of asylum seekers across EU countries in 2015
Figure 4: Distribution of asylum seekers across EU countries in 2015Source: BAMF, Eurostat

During the first months of this year, the number of refugee arrivals in the EU has declined considerably following the conclusion of the EU-Turkey readmission deal aimed at tackling illegal immigration. However, in the absence of a real restoration of stability in Afghanistan, Iraq and Syria, as well as in various African countries, refugee numbers will likely remain elevated and the pressure on the EU’s external borders will therefore continue. While refugee arrivals in the Western Mediterranean region will likely surge once the weather improves, rising numbers of refugees might once more opt for the ‘Balkan route’ should the EU-Turkey deal fail amid non-compliance with its conditions by both sides. Given the mutual distrust between the EU and Turkey, implementation of the agreement remains uncertain. Failure of the deal would leave the EU back at square one, with Germany’s isolation regarding the handling of the refugee crisis reducing the scope for a European solution. Rather, the EU-wide debate could shift to a strengthening of external border controls, improved possibilities for legal immigration as well as intensified policy efforts to stabilise the countries of origin of the refugees. However, should these debates fail to yield substantial results, the risk remains that individual countries will opt for unilateral solutions including the reinstatement of border controls. In any case, the topic will remain high on the EU’s agenda and thereby lead to the postponement of structural reforms needed to boost the resilience of the EU and euro area economy.

Meanwhile, in combination with rising anti-immigrant sentiment amid elevated risks of further terrorist attacks on EU territory, support for nationalist parties is unlikely to decline. As most refugees are heading for Germany, this could prove particularly problematic for Chancellor Merkel, given the current strength of the national-conservative AfD. The strength of right wing fringe parties will lead to ongoing pressure on EU governments for national rather than European solutions, bringing with it rising risks of a gradual disintegration of the EU and the Schengen area in particular. 

Another round of financial support for Greece

While EU leaders will likely remain preoccupied with the handling of the refugee crisis, the Greek sovereign debt crisis is still far from over, and the country will likely need additional EU financial support in the coming months. Failure to smoothly handle yet another Greek bailout might boost populist sentiment, particularly in northern EU countries, and strengthen British voters’ doubts about the economic advantages of the UK remaining in the EU. In Greece itself, social tensions could rise markedly as rising numbers of refugees get stuck in the country following the closure of the Greek-Macedonian border. Tough talks with euro area partners and the IMF are likely, as Greece will probably ask for considerable leniency while northern euro area governments will be wary of appearing too soft in the face of rising Euroscepticism at home.

Meanwhile, German leadership, which previously had convinced Greece to accept tough austerity measures, might remain weak as the ongoing refugee crisis ties up considerable diplomatic resources. Moreover, given lingering concerns about the sustainability of Greece’s sovereign debt, continued IMF involvement cannot be taken for granted. Even though a Greek sovereign default will likely be avoided once more, possibly messy negotiations threaten to further tarnish the EU’s image among an increasingly Eurosceptic electorate, while risks of a Greek exit from the euro area cannot be completely discounted.

Figure 5: Greece’s public finances
Figure 5: Greece’s public financesSource: EIU
Figure 6: Rising risks of a Brexit
Figure 6: Rising risks of a BrexitSource: Economist Intelligence Unit

The threat of Brexit

Given the rising doubts among British voters that the EU provides them with sufficient benefits in terms of economic prosperity, public safety and sovereignty in immigration matters in exchange for sizeable UK contributions to the EU budget, risks are increasing that UK voters may opt for the exit of their country from the EU at the upcoming referendum on 23 June. This could have serious economic and political consequences for the UK itself as well as the cohesion and policymaking of the then EU-27. According to polls conducted in April 2016, a slight majority supports leaving the EU, following a marked decline in support for continued EU membership as Prime Minister Cameron’s renegotiation of the UK’s relationship with the EU failed to convince voters. Even though the eventual outcome of the referendum remains too close to call, rising concerns about EU migration policies amid heightened terrorism risks have darkened the outlook for continued EU membership.

Should the UK vote to leave the EU, it could face dire economic consequences. First, it would enter a two-year transition period during which it would have to negotiate free-trade agreements with the then EU-27 as well as third parties. Given limited available resources, this could become a daunting task and bring with it considerable uncertainty for UK exporters, including financial services providers, whereas cooperation from former EU partners could not be taken for granted as their companies would stand to gain market share.

At the political level, given strong support for EU membership in Scotland, the UK’s exit from the EU will likely trigger another referendum on Scottish independence, which might create additional uncertainty about the country’s administrative and economic future. For the then EU-27, the UK’s departure would lead to a sizeable rebalancing of power in favour of France and Germany and to the detriment of proponents of relatively more liberal economic policies such as the Netherlands and the Czech Republic. Depending on the UK’s relative economic fate following its exit from the block, other EU members might consider following in its footsteps or at least pushing for a renegotiation of EU treaties, possibly at the demand of local populist parties. This could contribute to a further erosion of EU cohesion and the deepening of a two-speed Europe in which subgroups of countries might opt for varying degrees of cooperation.

Only limited room for significant policy changes regarding neighbouring countries and regions

As EU policy efforts are likely to focus mainly on keeping the union together, major foreign policy changes in the near future remain relatively unlikely. Even though tensions with Russia are gradually declining as the war between Ukraine and pro-Russian separatists turns into a ‘frozen conflict’, EU sanctions are unlikely to be lifted soon. While officially citing incomplete implementation of the Minsk II agreement, the EU will likely leave its sanctions on Russia in place in order not to risk Turkish support in handling the refugee crisis. Tensions between Russia and Turkey are unlikely to abate soon amid lingering Turkish concerns about Russian involvement in the conflict in Syria and possible support for Kurdish separatists.

Meanwhile, hoping for ongoing cooperation in handling the refugee crisis, the EU has scaled down its criticism regarding the ongoing deterioration of institutional quality, particularly the rule of law and press freedom, in Turkey as well as various other south-eastern European countries such as Bosnia-Herzegovina, Montenegro, Macedonia and Serbia. Yet, turning a blind eye to these developments while working on possible EU accession of these countries might cease swiftly should the EU-Turkey readmission deal collapse and refugee numbers surge again. This approach might contribute to a reduction of refugee numbers for the time being, but the apparent deviation from EU principles threatens to further alienate EU voters from established political parties.

To the Regional Outlook Europe overview page

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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
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