Political Data

President of European Commission:	JACQUES SANTER
EU Presidency:	TONY BLAIR - UK Prime Minister
EU Trade Commissioner:	SIR LEON BRITTAN
Environment Commissioner:	RITT BJERREGAARD
President of EU Council:	ROBIN COOK - UK Foreign Minister
EU Employment Commissioner:	PADRAIG FLYNN
EU Foreign Affairs Commissioner:	HANS VAN DEN BROEK
EU Agricultural Commissioner:	FRANZ FISCHLER

Economic Situation

• The 11 Emu members are in healthy position. Industrial production is growing at an annual rate of 4%. Unemployment has been falling. Inflation is low; and the area as a whole has a current account surplus of 1.8% of GDP.
• Looking forward the outlook is good. The macroeconomic policy stance will support the recovery: fiscal policy is likely to ease somewhat following the achievement of the Maastricht criteria. Output growth in the euro area should reach nearly 3% both this year and next, according to OECD forecasts. Inflation should remain comfortably below 2%.

Areas of concern:

• Although the economic cycles of the euro area countries are roughly in sync, there remains some divergence between the core and periphery countries.
  1. The core: Germany, Austria, France, Luxembourg and Belgium. The core is finally recovering from several years of sluggish growth. Germany grew by 2.2% last year, while France achieved 2.4%. The economies in the core countries have plenty of slack, as prices are barely rising. Last year, these countries maintained tight monetary and fiscal policies. Short-term interest rates rose by about a quarter of a point. That tightening will restrict growth. Now, the core needs lower interest rates to make sure its recovery does not falter.
  2. The periphery: Spain, Portugal, Italy and Ireland. The periphery is growing so fast it is in danger of overheating. Spain's GDP increased by 3.4% last year and Ireland's by 7.5%. Italy's growth is accelerating rapidly: although its GDP rose only 1.5% in 1997. Growth in these countries seems likely to accelerate this year. The periphery needs higher interest rates soon to avoid an inflationary boom.

The 4% interest rate will imply higher rates for the core and lower rates for the periphery, exactly the opposite of what they need.

• Both labour and product markets remain too regulated. Unemployment may be falling but, according to the OECD, 11.5% of the labour force will still be out of work in 1999. Substantial structural reforms must also take place in order to give the euro economies the flexibility to respond to the obstacles to growth that will inevitably rise.
• Concern about excessive national debts from undermining the new edifice. It relates mainly to Italy, where government debt was more than 120% of GDP last year. That Italy and Belgium are likely to be admitted to the Emu next month is a testament to their heroic efforts to cut deficits. The severe logic of Emu says that a debt crisis similar to Asia could happen.

IMF Outlook:

• The broad consensus in favour of policies directed at price stability (i.e. low inflation) could be challenged if sufficient progress is not made in reducing structural unemployment. Fiscal and structural policy measures are needed for the monetary union to work. Monetary union removes country's ability to use interest and exchange rate policies (monetary policy) independently. As a result, underlying fiscal positions need to be strong to give room for manoeuvre on budgetary policy.

Summit Issues for European Union

1. Euro/Emu

   Eleven countries, including Italy, Germany and France, will adopt the euro come January. (Britain is opting out at this stage). The emu does not lack in political will. However, there is still a clear realization that Europe has to deal with some economic misalignments and weaknesses, which may threaten the success of monetary union. The May Summit which will decide on the first wave of entrants is expected to be anti-climactic. The press and the markets have been fully prepared for the results. Nevertheless, given that the initiation of monetary union is such a momentous occasion and that any negative signals from the EU could cause the market to lose confidence, the EU will likely press for a strong show of political will and support from its G8 partners in order to reinforce confidence and legitimise the EMU. The EU will want this support to be explicit in the Communiqué. Given the magnitude of this issue and the importance of maintaining economic stability in Europe, it is likely that the EU will push this issue successfully through the Summit process.

2. Asia Crisis and the IMF

   With regards to the Asia Crisis, the EU already participated in an Asia-EU Summit earlier this month. This Summit gave the EU a forum to voice its concerns to Asia and to pledge its support. At Birmingham, the EU will focus on the central role of the IMF and the need to reform its bail-out practices. The reasons for this focus are as follows:

   • In March, EU central bankers attacked the bail-out practices of the IMF and in April they put forth proposals for reform of these practices. These proposals included involving commercial banks at an earlier stage. There is concern in the EU about the IMF's handling of the Asia financial crisis. EU has called on the IMF to re-evaluate its policies and question itself on how far its policies generate moral hazard.
   • The EU also wants to raise its profile in international financial institutions as 11 European countries prepare to adopt a single currency next year in January.
   • The statement (or communiqué of sorts) that emerged from the Asia-Europe Summit in April stressed the central role of the IMF in dealing with international financial crises.

   Given that the Asia Crisis is so topical and central to the question of international economic stability, the issue of IMF reform will be discussed at the leaders' summit. The EU will likely stress involving commercial banks at an earlier stage, regular monitoring of private sector debt, and the need for transparency. It is likely that the EU will be a key player in these talks given the imminent realization of monetary union and its desire to raise its profile in the IFIs.

3. Russia

   Russia is important to the EU within the context of EU enlargement eastward. There is no question that the EU believes that expansion to the east is inevitable. The "Agenda 2000" and its CAP and regional aid reforms reflect this foreign policy priority. However, there are some implications that come with enlargement: 1) the inclusion of Estonia extends the EU into the former Soviet Union, reaching beyond NATO territory; 2) enlargement eastward puts a premium on the EU's relations with Belarus, Ukraine, and Russia. As a result, while the budgetary costs of enlargement to the East will probably not make it to the Summit agenda, the EU has a clear interest in making Russia feel as included and comfortable as possible so that it will not be hostile to EU expansion. Clearly, making Russia feel like an integral part of the team will be a priority for every leader at the Summit. As a result, any overtures of support and welcome to Russia in the Communiqué cannot be credited to EU interests exclusively. However, the motives of the EU are worth pointing out.

4. The Middle East

   Who said that the EU was destined to be a political dwarf? The EU is seeking to enhance its role in the Middle East process. Tony Blair (who presently holds the EU presidency), believes that the EU should be given a formal role in pushing forward stalled peace talks; but acknowledges that the US must still take the lead. On April 20th, Mr. Blair announced the establishment of a joint EU-Palestinian security committee at a meeting in Gaza with Yassir Arafat. The purpose of this committee is to break the deadlock between Israel and the Palestinians. The EU will likely try to use the Summit to give Europe a higher profile in the Middle East peace process and to spur Washington into renewing its own mediation efforts. The Middle East will likely appear in some way, shape or form in the final G8 Communiqué because it always has. However, a clear victory for the EU would be a signal that the US will begin mediation efforts, more specifically, that the US will initiate efforts to push Israel into honouring its peace commitments.

5. Cyprus

   The divided island of Cyprus is causing big trouble for the EU. Cyprus joined 10 eastern and central European nations for the March 31st launch meeting on EU accession. It is one of the six nations at the front of the queue to join the EU along with Poland, Hungary, the Czech Republic, Estonia and Slovenia. The possible accession of Cyprus has resulted in escalated tensions in the eastern Mediterranean, and increased tensions between the EU and Turkey. In order to proceed with enlargement, the EU must find a way to forge a healthier relationship with Turkey. It tried to do that in early March when it unveiled proposals for a broader EU-Turkey customs union and for deeper cooperation on agriculture, industry and services. However, while Turkey welcomed these proposals, it still refused to attend the pan-European conference in March, which was supposed to help defuse tensions between Greece and Turkey. In any event, the key to settling this issue so that EU can proceed with enlargement and with forging a common foreign and security policy, is to broker a settlement between the Greek and Turkish communities on the divided island of Cyprus. Given the strategic importance of attaining peace on this island, it is likely that EU will press of an intensification (or at the very least a maintenance) of US and UN involvement.

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Prepared by Cindy Blazevic, Aaron Chai, Christina Tahoces and Mary-Ellen Tompros, University of Toronto G8 Research Group, May 1998.

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