Issues in Brief

Political Risk Moves to the Forefront in the European Crisis

Senior Economist
November 6, 2012

The Eurozone crisis continues to ebb and flow, and it is buffeted by political swings that often emerge unexpectedly. This explains why markets and major partners of Europe, such as the United States, often find it perplexing to make sense of Eurozone policy initiatives. Amid the cacophony of statements, proposals, and ad hoc agreements coming out of Europe, it is not easy to decipher the political forces that shape them. The fact is that political risk remains potent and was underestimated in the period leading up to the crisis. This brief note sizes up the political landscape in major Eurozone nations.

The EU operates largely by consensus at the European Council level.[1] This means that a single country can block a major policy initiative or suddenly derail what appears to be a fait accompli. The key political risk thus resides at the national level. To simplify, I have broken political risk into five components: social discontent, weak coalition, populist politics, euro-skepticism, and regionalism (Table 1). The relevant time frame is the cycle of legislative elections.[2] The geographic frame comprises 14 Eurozone countries with significant impact on European politics.[3]

Unless governments collapse and snap elections are held, most regular polls lie relatively far in the future. The next big wave of national voting will not hit until 2015 or later, when 11 of these Eurozone countries will elect parliaments from which prime ministers are appointed and cabinets emerge. Three important countries hold ballots in 2013, however: Germany, Austria, and Italy. In the former two, euro-skepticism is on the rise, while populism increasingly creeps into early campaigning in Italy, a country led by a technocratic government supported by a weak coalition of four parties. These three elections could potentially introduce political risk earlier than the stylized calendar would suggest.

Six countries in the sample are led by relatively weak governments. Except for Greece (an unstable coalition) and the Netherlands (a coalition under construction), all others require at least four parties to form a parliamentary majority. The leader of Belgium’s federal government is from a party that came in second in recent elections. The Finnish coalition counts six parties that do not command a majority in parliament. Two of the three Greek coalition partners promised to refrain from active participation in government in order to avoid taking responsibility for its actions. The Italian prime minister is an independent who runs a technocratic government. In the Netherlands, two parties are still locked in negotiations to form a cabinet 1.5 months past the election. Lastly, Slovenia’s winning party in the 2011 election failed to make the coalition, which counts five groups with often divergent agendas.

These six governments are potential candidates for failure before their terms expire. If this happens, additional risks might include inability to form a new coalition, hung parliaments, and new constellations of political forces where euro-skepticism and regionalism are on the rise. In Belgium, Finland, Greece, and the Netherlands, euro-skepticism and/or regionalism are in the ascendancy.

Populist politics is difficult to quantify. I have categorized countries with populist politics as those in which extremist or demagogic programs have defined and/or propelled parties to national prominence. Eight out of 14 countries fall into this category.

In Austria, Belgium, and the Netherlands, two extremist parties control 30, 27, and 20 percent of parliamentary votes, respectively. In Finland, one extreme left-wing and one extreme right-wing party combine for 27 percent of seats. Two French parties—one extreme left and one extreme right—polled about 20 percent in the first round of the 2012 legislative election. In Greece, four extremist parties accounted for about 45 percent of a recent parliamentary vote. The three most populist parties in Italy currently score around 27 percent of popular vote ahead of next year’s polls. The inclusion of Slovakia in the populist category is based on Smer-Social Democracy’s dominance of parliament. In the past, this party was linked to nationalist and populist policies, though its stance has since moderated somewhat.

Two countries that were bailed out by the EU and IMF—Portugal and Greece—witnessed repeated social discontent. Strikes, mass demonstrations, and public protests vented through social media against the government have also hit Spain and France. By contrast, separatist movements are confined to only two states (Italian separatism, which in the past drove attempts by the north to separate from the south, appears to have lost some steam). Belgium continues to be ripe for a division, while selected Spanish provinces have recently renewed their quest for greater autonomy. Centrifugal political forces are bound to make it more difficult to arrive at crucial decisions at pan-European meetings where collegial consensus customarily drives agreement.

Mapping political risk is an inherently subjective enterprise. Yet even when accounting for the inevitable margins of error, the table below reveals high levels of potential risk in Europe. Only two Eurozone countries—Estonia and Ireland—escaped the label of “risky” in any of these five categories. I identify 37 percent of potential country–risk type pairs as "risky"—a relatively high percentage.

As the EU pushes toward closer integration by revamping its institutional fabric—including the fiscal, banking, and political union constructs—domestic political headwinds are becoming more nationalist and will drive back the integration efforts. Intracountry politics will eventually determine whether the euro currency union stays together. Political risk should be monitored as closely as sovereign debt financing issues.

 


Footnotes

[1] The European Council is the conclave of EU heads of state and government that defines the EU’s strategic vision. The Council’s decisions frame major executive and legislative initiatives that push the European integration forward.

[2] Most European polities elect heads of government through legislative polls. Heads of state rarely get involved in economic matters, with the exception of French leaders.

[3] To simplify, I omitted Cyprus, Luxembourg, and Malta from the analysis. All three are very small, and their politics are unlikely to weigh on pan-European initiatives.

 

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