Time for a deal

The demise of the European constitutional treaty after the French and Dutch referendums in May and June has created a historic opportunity for British policy in Europe. Over much of the 15 years since German unification, the driving force behind EU politics has been an integrationist project of one kind or another—originally designed to contain the new Germany. This made it an uncomfortable period for Britain, which is congenitally sceptical about Brussels's power. But now, although there is still obvious scope for improvements in the union's institutional functioning, it seems that Europe's new priority will at last be to undertake the kind of economic and social reforms in which Britain is one of the "market leaders."

The current British presidency has already notched up a historic achievement—the opening of accession talks with Turkey. This would probably not have been possible without Jack Straw's strong lead from the chair, and British (and American) influence in Ankara. Now the British priority is to shape a favourable European context for the economic reforms which are needed at national level, especially in the core countries of "old Europe"—Germany, France, and Italy.

But what about the issue that in the summer looked set to wreck the British presidency—the reshaping of the EU budget? The failure to agree on this at Luxembourg in June led to angry recriminations against Tony Blair from Jacques Chirac and Gerhard Schröder, and even from some of Britain's allies in "new Europe." Will this disagreement come back to haunt us? Or is this another opportunity to shift Europe in the direction of British preferences?



For 40 years, the European budget and the common agricultural policy (CAP), which is at its heart, have been central to European politics. They have also been among the main reasons why Britain has been on the back foot in its dealings with Europe. The founding myth of the couple franco-allemand which has called the shots in Europe since the 1960s is that it was based on a "deal" between French agriculture and German industry—a deal which never included Britain. Indeed, De Gaulle imposed his two vetoes against Britain joining the EEC in 1963 and 1967 in part because he wanted to secure a European agricultural policy à l'image de la France.

The CAP created in the 1960s, with Britain excluded, was based on three pillars. First, "community preference"—levies on agricultural products imported from outside Europe (paid into Europe's central budget). Second, "market support"—intervention by community institutions to buy up surplus production in order to maintain a fixed price to farmers, and to subsidise food exports into world markets. Third, "own resources"—the financing of such intervention from a common community budget.

When Britain was finally admitted into the European community in 1973 it accepted this acquis communautaire. The government knew that there would be difficulties—Britain would have to make larger payments into the budget than other members because it imported more food from abroad, and it would get a smaller share of receipts, because its farm sector was smaller. But it hoped for communautaire solutions: Britain would be a net beneficiary from Europe's new regional fund, and restraint in the fixing of farm prices would minimise the costs of CAP.

These hopes were disappointed. The regional fund was stunted from birth, in part because the French refused to be net contributors to it. And year after year the powerful continental farm lobbies secured price increases which built up the costly CAP "mountains" and "lakes," and which sent Britain's net budget contribution soaring. As a young member of the European parliament in the early 1980s I remember watching with disbelief as Jacques Chirac—then also an MEP, and a former minister of agriculture—led the campaign for a wholly unjustified 12 per cent year on year increase in farm prices.

When Margaret Thatcher came to power in 1979, she demanded the special solution which Britain had been promised in 1973 if a serious problem were to emerge. It took four years to negotiate what the French promptly dubbed the chèque britannique. The outcome was a compromise: in its "rebate" Britain received back two thirds of the difference between what it pays into the EU budget and what it receives in allocated expenditure. Over the 30 years since Britain joined, despite the rebate, it has still paid into the European budget a net E64bn—over twice as much as France. And Britain has never had a favourable trade balance with the EU so, unlike Germany, it does not see its net contribution to the common budget as the price worth paying for larger trade advantages. Yet for decades it has been a common view on the continent that Europe pays for Britain, rather than the other way round.

The two main casualties of these excruciating negotiations were the spirit of genuine goodwill with which Britain joined Europe in 1973 under Edward Heath, and Germany—which had to foot much of the rebate bill. (There was rough justice in this, because Germany's farm lobby was one of the most vociferous in pushing up farm prices.) The main beneficiary was France, which preserved its advantages under the CAP, and continues to underpin its claim to leadership in Europe by presenting the British as selfish outsiders, obsessed with small change and lacking that spirit of solidarity and generosity which is the traditional hallmark of French policy.

Over the two decades since these controversies, a great deal has changed—indeed, Jacques Chirac is the only player from those times still on the political stage. The collapse of the Soviet Union after 1989 led to the enlargement of the EU in 2004, bringing in eight former communist countries together with Cyprus and Malta. In Britain, successful economic reforms in the 1980s and 1990s produced a surge in prosperity. Per capita income in Britain overtook both Germany and France.

Moreover, the CAP is no longer simply the EU's internal business. In the Uruguay round of world trade negotiations, concluded in 1994, agriculture was made subject to agreements at the global level of the WTO for the first time. Some of the most economically damaging features of European and US agricultural trade protectionism—notably export subsidies—have begun to be reduced. In the Doha round, which must be concluded by the end of 2006, agriculture is a central issue. Without further market-opening in farm trade, the movement towards freer global trade may come to a stop. India and Brazil have made a direct link between opening their markets and farm policy reforms in the rich world.

Under these pressures the framework of the CAP has already begun to shift. The main modifications have been to the CAP's second pillar—the market support system. Export subsidies have been significantly cut, and in the mid-term review of the CAP in 2003, what is described in Euro-jargon as "decoupling" was agreed. There will be a shift from indirect market support to income support—income aids paid directly to farmers, breaking the link to production. This has become the CAP's direction of travel, but the journey down this road continues to be painfully slow and the CAP remains very expensive. In 2004, agriculture still accounted for 45 per cent of the European budget, and it constitutes 44 per cent of the spending proposals for the period 2007-13. In London's view this continues to justify the British rebate.

Each laborious step towards CAP reform has met dogged French resistance. Paris has had to give ground in accepting decoupling, but it clings to its benefits from the existing levels of spending on agriculture. Here a key event was a European summit at the end of 2002, when Chirac persuaded Schröder to join him in one of those Franco-German démarches that are described—by those whose interests are served by them—as furnishing the motor of Europe. They agreed that EU farm spending at its level then should be rolled forward through to 2013.

History does not yet record why Schröder agreed to this renewal of the original De Gaulle-Adenauer farm policy compact of the 1960s, which has turned out to be so expensive for Germany. Perhaps he feared that Chirac might otherwise attempt to block the impending east European enlargement of the EU (a French referendum would have done the trick). Perhaps the split with the British over US policy towards Iraq was already casting its shadow. In any case, this joint position led to a blazing row between Blair and Chirac, who complained to the press that Blair was mal élevé, and that he had never before been spoken to in such terms.

The upshot was that although the European council agreed with the French and the Germans that the CAP's "financial envelope" would remain at the existing level until 2013, Blair won three key points. The EU's 2013 commitment was not to be a target for the CAP, but a ceiling; Chirac's attempt to close down the CAP "mid-term review," due in 2003, was refused (thus opening the way for agreement on decoupling); and enlargement would go ahead.

These skirmishes were the background to Chirac's attempt this summer to stage a re-run of the old Gaullist "hit" in which le vieux continent led by France does down perfidious Albion. In the constitutional referendum, he had argued for a "yes" to a Europe organised against les anglo-saxons and their dangerous free markets. Now he decided that the way to recover the political initiative at home after the referendum defeat was to reignite the campaign against Britain.

An opportunity was at hand in the shape of a long-continuing negotiation about the "financial perspective" for the EU budget over the period 2007-13. This does not need to be concluded until mid-2006, but, enlisting the support of Schröder and the Luxembourg presidency, Chirac pressed for an immediate settlement in June 2005, in which the British budget rebate would be capped—or, as he now suggested, eliminated. Chirac hoped that this tactic would again demonstrate French leadership in the EU. It would drive a useful wedge between Britain and the new east European member states, which will have to contribute to the British rebate. And it would be revenge on Blair for deciding to hold a British referendum on the EU constitution, precipitating his own catastrophic decision to follow suit.

Chirac was probably expecting a British veto, making Blair, rather than himself, the European mouton noir. But Blair signalled his willingness to negotiate on the rebate, thus sidestepping the punch. And he landed a shrewd blow by linking this to French agreement to further changes to the CAP—which, as he pointed out, is what had always generated the need for the chèque britannique. There is nervousness about these tactics in east European capitals, which are understandably anxious for a favourable budgetary settlement. But Blair's speech to the European parliament in June was widely applauded, especially when he called for the European budget to be refocused on 21st-century priorities and for that real solidarity which transfers money from the rich to the poor, rather than the reverse—which is what happens under the CAP. Even the French media were impressed, and the retiring head of the French employers' association said that what France needed was a leader of vision and courage like Tony Blair. Nicolas Sarkozy is manoeuvring in the wings of French politics to play this role after the next presidential election in 2007, and Jacques Chirac is beginning to look more and more like a lame duck.

How should Blair exploit the opportunity which this turn of events provides? In London, a tentative three-stage strategy is emerging. The first is an agreement over the next nine months on the EU budget "perspective"; the second is a successful conclusion to the Doha round in 2006; and the third is a major CAP reform arising from this, and from another budget and CAP mid-term review in 2007-08. Each stage will involve big debates in Europe and at home. They will test Blair's leadership—and provide an opportunity for Britain to recover the ground it lost in Europe during the 1950s and 1960s.

During the next few months Blair needs to achieve a link between these three stages, in which a British concession on the rebate is linked to bankable commitments to further major changes in the workings of the CAP. This cannot involve the abolition of the rebate—which would add several billion pounds a year to British public spending—but it could involve capping or freezing it. The problem is that such a British concession would be made up-front—and the payback would be deferred for several years. The tabloids and Tories would be united in opposition to concessions on "Margaret Thatcher's rebate." There would also be those in Whitehall who might be tempted to draw a parallel with Edward Heath's similar, unsuccessful, gamble on French goodwill 30 years ago.

Today, however, the British negotiating position is much stronger. President Bush seems to be committed to a successful Doha agreement, which will require changes in both American and European farm policies. The new government that is likely to emerge in Germany under Christian Democrat leadership will want to mend fences with Washington and London—and also to find savings in public expenditure. In France, Jacques Chirac is on the way out, and there are many voices calling for a new approach—including a more constructive relationship with Britain. Meanwhile, it is obvious that the classic three-pillar CAP cannot be fully applied in eastern Europe without ruinous cost. More and more the question, "What is Europe for?" is forcing itself up the continental agenda—and the old formula, combining introverted and esoteric institutional obsessions with the hard-nosed defence of obsolescent vested interests, cannot provide the answer. So Blair will put the rebate on the table, and place his bets. And he will be right to do so.

There is, however, an unresolved debate in Britain itself about the third stage of this strategy—what fundamental changes in the CAP should Britain be seeking? Here the central concept is "co-financing," under which the financial liability for payments of decoupled income supports to farmers is shifted in part or in whole from the European budget to national budgets. With the shift from indirect market support to direct income aids, the original rationale for a single EU-level budget to finance intervention in a unified European agricultural marketplace is falling away. Provided that the decoupling of farm incomes from farm production is supervised by Brussels, there is no reason why such a system should disrupt the unity of the European single market for agricultural products. And of course, as the net beneficiaries from the CAP—notably France—increasingly pay for their own farmers, the size of the European farm budget should shrink, and with it the size of the British rebate.

But there is a problem for Tony Blair. Not only is the British farm lobby nervous about its fate under a system of Whitehall spending control, but some people in the treasury believe that Britain has a better deal under the rebate than it would get from co-financing. The calculation is a simple one. With the rebate, Britain gets back two thirds of what it contributes to the financing of the CAP. With co-payment, the treasury would have to pay in full its share of the cost of income supports for British farmers. On the other hand, the net gain to Britain from co-financing at 50 per cent would be between E700-900m a year (a figure that is difficult to estimate because the specific elements of the budget to be co-financed are as yet undecided)—and, perhaps more importantly, paying for the CAP from national budgets would end the "menu without prices" effect, and reinforce incentives for greater financial discipline.

So will Britain be able to table a convincing plan in what may be the decisive third round of this long-running match, in two years' time? After all, we cannot hope to persuade our partners to agree to co-financing if we ourselves do not want it.

Tony blair's instinctive view that Britain and Europe must be reconciled is surely correct. For reasons that have turned out to be good ones, he has had to give up his original hope to achieve this by joining the euro. The collapse of the European constitution in France and the Netherlands has spared him the risky task of putting the case for Britain in Europe in a referendum at home. This European budget-CAP negotiation will probably be his last chance to deliver on his vision of a Britain exercising its due influence in Europe—which also happens to be the best way of rallying British opinion in favour of the European project.

The fact is that the chèque britannique is increasingly difficult to defend, especially since the ten new member states will have to contribute to it. It should be replaced by a generalised "budgetary corrective mechanism," correcting all excessive net contributions including that of Germany. But equally indefensible is the old three-pillar CAP; 44 per cent of the European budget is spent supporting a sector that accounts for only 2 per cent of the EU's GDP. The treasury needs to reflect not only on the cost-benefit balance involved in shifting some of the cost of the CAP back to the national level, but also on the possible implications of such a shift for the system of "community preference," the biggest prize of all. EU duties on farm imports are currently at twice the level of their US equivalents. As well as being inequitable between (relatively rich) farmers and (relatively poor) consumers, this imposes a heavy cost-burden on the European economy as a whole. A more globally competitive Europe must, among other things, be a Europe with a lower food-cost structure.

For more than 40 years France has been able to secure its leadership in Europe by playing on German postwar inhibitions, and on British ambivalence about the whole project. The consequences for Britain have been disappointing and expensive—we have had to endure long lectures about the "European spirit" from the likes of Luxembourg, and at the same time pay heavily for the privilege (the Luxemburgers have never paid a net penny into Europe and yet 43 per cent of them still voted "no" in their referendum). But we are now within sight of the end of this dismal period in the generally successful history of Britain's relations with the European mainland.

The recent exposure of the underlying French ambivalence about Europe—always so much better concealed than that of the British—could put the perennial debate about the European institutional structure on to a more realistic footing. As France and Germany agonise about their economic and social models, Britain's recent successes give us the psychological advantage. In the new Europe of 25 we have solid allies for transatlanticism and open markets. Tony Blair has established a relationship with the Americans that could be critical for the success of the Doha round. This is the bigger picture in which we must view the long-running battles about the CAP, the European budget and the British rebate. The time has come to try for a deal.