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WHO IS NEXT? Opinion

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DEMOCRACY WITHOUT SOLIDARITY

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Are the refugees disturbing the quest for the US of Europe?

Democracy without solidarity

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The Future of bank risk

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EDITORIAL EUROPEAN BUSINESS REVIEW

ARE THE REFUGEES DISTURBING THE QUEST FOR THE US OF EUROPE?

By N. Peter Kramer

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ince 1957 the phrase ‘ever closer union among the peoples of Europe’has survived every change to the EU treaties. Nearly 60 years ago it was inserted in the preamble of the Treaty of Rome, the EU founding document. For the classical Eurofederalists the ‘ever-closer union’ is the grim quest to the United States of Europe. Charles Michel, Prime-Minister of Belgium, chief of these Europhiles,feared during the last Summit that a British exemption to the ‘ever-closer union’ could create an opening for other also more-or-less sceptical national leaders.

Journalists were told that David Cameron and Charles Michel disagreed on whether closer-union was a good or a bad thing, but that they agreed that it mattered. Bundeskanzlerin Angela Merkel reacted on this discussion with a light-hearted remark that Michel would be better off pursuing an ‘ever-closer Belgium’. After that the struggle was quickly solved; leaving some European leaders confused behind.

The refugee crisis has tugged at the EU delicate unity like nothing before and has exposed the differences between EU member states that will linger long after the immediate danger has passed.

The bonds of trusts that hold together ‘Schengen’ have frayed. It is no longer a question of member states that disagree; now they stopped trying to understand each other’s problems. See, for instance, the Austrian minister blaming Greece not closing hermetically its border with Turkey. Probably he had the idea that this border had the same shape as the one between his country and Germany.

In the EU headquarters you can hear that ‘it has become impossible to work together with 28 members’. A big problem is the lack of a real EU Council leader. ‘Where is Tusk?’ is the question around Rond Point Schuman. The successor of Herman van Rompuy seems to be incapable to be impartial. He supported the initiative of the Visegrád-countries (including ‘his’ Poland) when they scapegoated Greece.

But optimists say that the European project advances only in times of crisis; probably too audacious this time. When the UK leaves, who will take over its annual contribution of €5 billion? Germany, paying already €15,5 billion, or a small country as The Netherlands (already nearly €5 billion)?

They don’t look in favour of that ‘honour’. So maybe crises present opportunities for Europhiles, but they are still huge crises.

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OPINION EUROPEAN BUSINESS REVIEW

DEMOCRACY WITHOUT SOLIDARITY

By Prof. Erik Jones* “There will never be a good a solid constitution unless the law reigns over the hearts of the citizens; as long as the power of legislation is insufficient to accomplish this, laws will always be evaded“ JeanJacques Rousseau (1772).

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ou can have the best political institutions in the world but if the people who live within them do not want to use them properly, then those institutions will not work. The challenge is to make people want to use common institutions properly and to agree on what constitutes proper use. This is the challenge that Jean-Jacques Rousseau tackled in his “considerations on the government of Poland and on its proposed reformation.” It is the same challenge advanced industrial democracies face today — at all levels of government. Moreover, better institutions or ‘structural reforms’ were not the answer for Rousseau and they are not the answer now: “Although it is easy, if you wish, to make better laws, it is impossible to make them such that the passions of men will not abuse them as they abused the laws that preceded them.”

When I listen to politicians like Wolfgang Schäuble or Jeroen Dijsselbloem talk about ‘moral hazard’ and the need for everyone to ‘follow the rules,’ I can see immediately that they have not understood the problem that people have to believe in the rules first.

And when I hear about politicians like the late Helmut Schmidt deriding the need for ‘vision’ saying things like

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“people who have visions should see a doctor,” then I know we are in trouble. People have to want to follow rules or they will find a way around them. People only want to follow rules if they believe those rules are fair and just; they also have to believe that following the rules is useful. Moreover, ‘following the rules’ restricts freedom and requires discipline. This means that people have to have some justification for collective action and common sacrifice.

When you add this all up – fairness, justice, effectiveness, purpose – you come up with a pretty complicated set of ideas that people need to receive and accept if they are to make institutions function. Maybe ‘vision’ is not the most appropriate metaphor to describe this requirement to explain why politics works the way it does, particularly in a democratic system. ‘Ideology’ is probably even more uncomfortable in the modern vernacular. But whatever we call it, we need to come up with some way to get people to believe they are all part of a bigger project. Democracy without solidarity does not work.

The examples of democracy suffering from a lack of solidarity are all around us. As someone who spent a long time studying Belgian politics, my first instinct is to point to the 550 days that the New Flemish Alliance complicated efforts by the country’s elites to form a government. That crisis only ended when the pressure in government bond markets was intense enough to focus attention on the very bad things that

EUROPEAN BUSINESS REVIEW OPINION

would happen if events spiralled out of control. The debate that took place in the United States Congress over the debt ceiling during the summer of 2011 is another illustration. But as we look more deeply into the functioning of the two Houses of Congress over the past few years, it is easy to see that the debt ceiling debate is just the tip of the iceberg. As Thomas Mann and Norman Orenstein describe it, the U.S. political system is “even worse than it looks.”

The Belgian and U.S. examples show two aspects of the pattern. One is the argument about legitimacy. This is where politicians or protestors claim that the current arrangement is unfair, unjust, ineffective, or headed in the wrong direction. Here you can think of just about any stump speech by Donald Trump, Marine Le Pen, Nigel Farage, or Beppe Grillo. Clearly these speeches resonate with some part of the electorate. Depending upon the country, you can usually mobilize between 15 and 25 percent of the vote around the general message of disenchantment; in some cases the appeal is even broader.

The second aspect is how the message translates into action. This is the part I try to capture with ‘solidarity’ (and its absence).

When solidarity weakens or diminishes, people start breaking rules or reinterpreting them in ways that exaggerate the worst features of any institutional arrangement. They begin using exclusive (or offensive) speech patterns which they justify as a break from the confines of ‘political correctness.’ They start dividing the world into ‘us’ and ‘them’. And they find ways to hold the functioning of institutions hostage until their specific concerns are addressed. Such actions are standard practice for Beppe Grillo’s ‘Five Star Movement’ but they are also what brought Ted Cruz such notoriety when he entered the U.S. Senate (following Nigel Farage’s playbook from the European Parliament).

Unfortunately, democratic institutions are not very good at channelling or constraining this kind of disruptive behaviour. On contrary, democracy thrives in a context where speech is free and institutions operate under ‘checks and balances’. This is the perfect environment for a loss of solidarity to spark a crisis of governance and yet we risk losing the essence of democracy whenever we try to use new rules to proscribe such unruly behaviour. It is a delicate and difficult balance — as you can see by looking at countries like Hungary, Poland and Turkey.

The balance is even harder to find when you look at federal countries or multinational arrangements. It is no accident that the two easiest examples of the problem we face (Belgium and the United States) are both federal countries. But the implications for the European Union are even more dramatic. In the

end, I do not see a scenario where the United States collapses into a collection of smaller political units.

Even Belgium is showing significant resilience and the New Flemish Alliance is participating in the federal government without demanding further devolution of power to Flanders (for now).

By contrast, the European Union is facing an existential crisis. The knee-jerk European response is always more rules, better enforcement, and structural reform. These are good responses in many situations. Unfortunately, this is not one of them. Too many Europeans do not believe that the rules are just or fair, they do not understand the need for collective sacrifice (or that the sacrifice is truly ‘collective’), and they do not think the solutions being offered are going to be effective. You can see this in debates about macroeconomic policy, financial regulation, migration, and the single market.

You can see this in the language that is being used to divide Europe into north and south, east and West, creditor and debtor. And you can see that both protest groups (including anti-European parties) and national governments are starting to use the institutions of Europe to jam up the process of governance until they get what they want for themselves.

Europe as a whole is not a democracy but it shares many democratic strengths and weaknesses. Free speech, freedom of assembly, and institutional checks and balances are at the top of both lists. The collapse of solidarity in Europe is threatening to break the union into pieces. If Europe’s politicians don’t start focusing their attention on coming up with an argument to explain how Europeans are all in this together, why they need to work with one-another, and where this great project is going, then they will have to live with the consequences of their inaction. This is what David Cameron promised when he raised the whole prospect of a national debate on Europe in his Bloomberg speech.

Unfortunately, that conversation has deteriorated into a debate about details rather than focusing on the big picture. National politicians need to tell the big story about Europe if they are to capture ‘the hearts of the citizens,’ in Rousseau’s turn of phrase. Whether we call that a ‘vision’, an ‘ideal’, or an ‘ideology’ is less important than winning the argument about Europe’s importance. The same is true for democracy itself. *Erik Jones is a Professor of European Studies and International Political Economy at the Johns Hopkins University School of Advanced International Studies (SAIS) and a Senior Research Fellow at Nuffield College, Oxford. **First published on February 13, 2016 at Prof. Erik Jones’ Personal Webpage.

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OPINION EUROPEAN BUSINESS REVIEW

THE EUROZONE NEEDS LESS HETEROGENEITY

By AndrĂŠ Sapir*

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isalignments of real exchange rates continue to be the most visible and painful symptom of asymmetric shocks within the Eurozone.

An important factor behind such misalignment is the difference in national wage formation and bargaining systems, especially between core and periphery members. This column argues that all members need to have institutions that ensure wage developments are in line with productivity developments. This would eliminate an important source of asymmetric behaviour and reduce resistance to EZ-wide fiscal mechanisms capable of absorbing asymmetric shock.

Before the creation of the euro, the prevailing view in European economic circles was that economic and monetary union would reduce the incidence of asymmetric shocks. Policy-induced asymmetric shocks would be largely eliminated by the adoption of a single monetary policy and of fiscal rules that would impose sound national fiscal policies. Exogenous asymmetric shocks associated with structural differences between Eurozone (EZ) countries were also considered less likely because EMU was supposed to produce structural convergence among these countries.

Misalignments of real exchange rates may not be the ultimate source of asymmetric shocks, but they

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are typically their most visible and painful symptom.

Whatever their fundamental cause, deviations of wage growth from labour productivity growth tend to create adjustment problems in a monetary union and should therefore be closely monitored and corrected before they become protracted and painful to adjust.

Unfortunately, the system of surveillance that operated in the EZ prior to the financial crisis was gravely deficient in this respect. In the days of the European Exchange Rate Mechanism, authorities monitored developments in real exchange rates (and competitiveness), and could use the nominal exchange rate to correct for losses in competitiveness. Prior to the crisis, however, national and European authorities seemed to have forgotten two elementary facts about a monetary union: First, that the loss of the nominal exchange rate instrument does not imply that real exchange rates cannot appreciate or depreciate; and, Second, that competitiveness adjustment risks being long and painful given the loss of the nominal exchange rate instrument.

As a result, real exchange rates in some EZ countries were allowed to become grossly over- or under-valued, creating difficult adjustment problems (see Levy 2012 for a related discussion).

EUROPEAN BUSINESS REVIEW OPINION

Reducing the occurrence of asymmetric shocks in EZ As Carlin (2013) emphasises, an important factor behind real exchange rate misalignment in the EZ, especially between the core and the periphery, is the difference in national wage formation and bargaining systems among its members. There is no easy solution to this problem.

One solution would be to harmonise wage-setting systems but this hardly sounds feasible given that national wage-setting systems have deep historical, political, and social roots. The alternative is to broadly maintain the existing systems but to constrain their functioning to ensure that they produce outcomes which are compatible with membership of a monetary union and the need to avoid persistent real exchange rate misalignment. This requires mechanisms to prevent and correct substantial misalignments of competitiveness between EZ countries.

The Macroeconomic Imbalance Procedure (MIP), established by the EU in 2011 in response to the economic and financial crisis, could be an important tool to monitor and correct macroeconomic imbalances in all EU countries. This is especially the case for countries belonging to the EZ for whom the MIP contains an enforcement mechanism, including the potential use of sanctions. The MIP’s monitoring mechanism uses a set of indicators to assess macroeconomic imbalances and divergences in competitiveness.

In recent research, my co-author and I propose to complement the MIP by national procedures to monitor and, if needed, correct competitiveness problems and increase ownership at the national level (Sapir and Wolff 2015). These procedures would be required by EU legislation and their performance monitored by the European Commission.

All EZ countries would put in place a competitivenessmonitoring framework involving regular assessments and the definition of instruments to prevent problems.

An interesting example is the Belgian legal framework, introduced in 1996 to preserve the country’s competitiveness in the EZ by keeping the evolution of wages in line with wage developments in its main trading partners. A national body regularly reports on the evolution of Belgian competitiveness. This assessment is used by social partners to fix a wage norm for the next round of wage negotiations. Although the norm amounts only to a non-binding guideline, it has generally been respected by the private sector (to which the system applies). In case social partners fail to agree on a wage norm compatible with the evolution of competitiveness, the government can step in and make the norm legally binding. The system has worked fairly well – it left the

wage formation and bargaining system that existed prior to the euro untouched, but made the behaviour of social partners compatible with membership of the euro. The result has been that unit labour costs in Belgium have evolved more-or-less in line with those in its main trading partners, thus avoiding significant competitiveness problems.

The Belgian system should not and cannot be exactly copied by other EZ countries, since they feature different wage-setting systems. What is important is that all EZ countries put in place a mechanism to ensure that, although operating within their own system, the behaviour of social partners and the outcome of their wage negotiations is compatible with membership of the euro, in terms of competitiveness and employment.

Improving adjustment to asymmetric shocks in EZ The proposal to monitor and, possibly, correct labour competitiveness problems fits well with the Maastricht logic. This (implicitly) makes national authorities responsible for ensuring that national labour markets are sufficiently flexible to deal with asymmetric shocks.

It also fits with the optimum currency area (OCA) literature which typically considers that the more a potential monetary union member risks being subject to asymmetric shocks, the more it needs labour market flexibility to compensate for the absence of the exchange rate instrument and adjust to such shocks (see, for instance, De Grauwe 2012).

However, the OCA literature never suggested that labour market flexibility, or even market flexibility in general, would be sufficient to deal with all asymmetric shocks.

Instead it considered EZ-wide mechanisms to also be crucial, especially for big shocks. Two potential EZ mechanisms suggested by the OCA literature could have been labour mobility (as originally envisaged by Mundell 1961) or fiscal transfers (as first suggested by Kenen 1967) between EZ countries, but neither was promoted or put in place.

The Maastricht construction lacked one of the two adjustment mechanisms emphasised by the OCA theory – fiscal integration. The other mechanism, labour mobility, was theoretically possible by virtue of the EU treaties that guarantee the right of free movement of labour within the EU, but remained limited in practice.

The sovereign debt crisis came as a surprise. No one had foreseen that a EZ government could face a liquidity or even a solvency problem. As a result, the EZ contained no mechanism to deal with this crisis when it occurred.

Several EZ countries found themselves suddenly unable to tap financial markets for their sovereign issuance

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THE WORLD EUROPEAN BUSINESS REVIEW

and had to turn to supra-national public lenders. One source was the IMF, but EZ countries needed their own rescue mechanism. They eventually created the European Financial Stability Facility (EFSF), a temporary mechanism later replaced by a permanent rescue mechanism, the European Stability Mechanism (ESM). EFSF/ESM loans come with conditionality that, so far, has always included making recipients’ labour markets more flexible. Hence, the new EZ regime set up in response to the financial and sovereign debt crisis includes an EZ risk-sharing mechanism in the form of fiscal assistance, along with structural reforms in product and labour markets.

Although this new regime is clearly better than the original EZ design it is still far from sufficient to provide the necessary adjustment within EZ. What is still missing in terms of adjustment mechanism? Many support the notion that what the EZ needs is not so much a fiscal union per se, but an efficient risk-sharing mechanism that ensures both sufficient adjustment to asymmetric shocks and as little moral hazard as possible.

An international comparison of existing federations by the IMF shows that the EZ lacks the degree of risk sharing seen in other jurisdictions with respect to three dimensions (IMF 2014). First, contrary to federations such as the US, Canada, or Germany, which manage to smooth about 80% of local shocks, the EZ only manages to insulate half of that amount. Second, fiscal insurance compensates 25% of local shocks in Canada, 15% in the US, and 10% in Germany. In the EZ, fiscal insurance was virtually nil before the creation of the EFSF/ESM and remains very small. Third, most of the risk sharing in federations happens through private channels, mainly capital markets and banks. The EZ is no exception, but the role of capital markets is much less than in other jurisdictions.

The previous discussion suggests that the distinction between fiscal insurance and private insurance through financial markets, and the fact that the latter typically plays the dominant role in smoothing local shocks in federations, is not an argument against the need for a EZ fiscal union. On the contrary, the fiscal union should not only provide direct fiscal insurance but also a fiscal backstop against financial risks to allow private insurance to fully operate.

Even if an efficient fiscal risk-sharing mechanism can be designed,1 there is little chance that it will be implemented as long as the fear of moral hazard and of the related ‘permanent fiscal transfers’ is present in the EZ. This fear largely reflects the heterogeneity that continues to prevail among EZ countries. In

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this respect, the Five Presidents’ Report was right to emphasise that “there is significant divergence” across the EZ and that “completion of a successful process of economic convergence … would pave the way for some degree of public risk sharing” (Juncker 2015). What the Report has in mind is structural convergence predicated upon structural reforms geared towards “more efficient labour and product markets and stronger public institutions.”

In political terms, this suggests that the acceptance by (some) EZ countries of steps towards a fiscal union will only be possible if (other) countries undertake major structural reforms. Whether structural reforms should be left entirely in the hands of national authorities, or if they would benefit from EZ coordination as suggested

by Draghi (2015), is an open question.

Let us be honest. The EZ cannot go forward with the degree of heterogeneity in national labour market institutions and outcomes that currently prevails.

All members of the monetary union need to have institutions that ensure that wage developments are in line with productivity developments. This would eliminate an important source of asymmetric behaviour among EZ countries that can lead to painful adjustments.

At the same time, the EZ needs to put in place risksharing mechanisms capable of absorbing asymmetric shocks. Improving the functioning of capital markets in Europe would certainly be an important contribution towards that objective but fiscal mechanisms will also have a role to play. Yet there is much resistance in some countries to create EZ-wide fiscal mechanisms because they fear that structural weaknesses in other countries, in particular in the functioning of labour markets, will lead to structural rather than temporary fiscal transfers.

Reducing heterogeneity in labour market institutions and outcomes is therefore crucial for the sustainability of EZ.

* Professor of Economics at UniversitéLibre de Bruxelles (ULB) and a former economic adviser to the president of the European Commission. In 2004, he published ‘An Agenda for a Growing Europe’, a report to the president of the Commission by a group of independent experts that is known as the Sapir report. ** This blog post was originally published on VOXEU.

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COVER STORY EUROPEAN BUSINESS REVIEW

NOV 8, 2016 HILLARY VERSUS DONALD? NOT SURE YET...

by N. Peter Kramer

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he results of the Super Tuesday primaries and caucuses gave Hillary Clinton full command of the Democratic presidential race as she rolled to major victories over her opponent Bernie Sanders in Texas, Virginia, Massachusetts, Florida and 5 more states. ‘What a Super Tuesday’, she said at a victory rally in Miami. Donald Trump rode the same day a powerful tide of voter fury to victories across the US, ending the campaign season’s most momentous day of balloting as the unrivaled favourite for the Republican presidential nomination. But opponent Ted Cruz still sees glimmers of hope after winning 3 states including

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the biggest, Texas. And not everybody in the Grand Old Party is happy with Trump’s triumphal march in the direction of the Republican Convention

Minority voters for Hillary The contests on Super Tuesday were well suited to Hillary Clinton’s strengths: her popularity with minority voters, her political kinship with Southern Democrats from her two decades with Bill in Arkansas and her success in delegate-rich Texas in 2008 when she beat opponent Obama. She won sizable victories in ‘her’

EUROPEAN BUSINESS REVIEW COVER

STORY

Arkansas as well as Alabama, Georgia and Tennessee, with especially big margins in counties with many blacks.

While even the poorest showing would not stop Senator Sanders from the presidential race, Mrs Clinton was looking already past her party rival to the leading Republican candidate, Donald Trump. She said being ‘very disappointed’ that he initially refused to disavow support from the former Ku Klux Klan leader David Duke. ‘We can’t let organisations and individuals that hold deplorable views about what it means to be an American be given any credence at all’ she told reporters in Minnesota, ‘I am going to continue to speak out about bigotry wherever I see it or hear about it’.

Trump owns Super Tuesday, but Cruz sees glimmers of hope The billionaire’s Super Tuesday rout extended from New England to the Deep South, but he resoundingly lost the crown jewel Texas to Senator Ted Cruz who also defeated Trump in Oklahoma and Alaska.

Super Tuesday results exposed some vulnerabilities from Trump: he lost late-deciding voters in many states by wide margins to rival Marco Rubio, a sign that the Florida senator may have had some impact with his withering assault on Trump’s character. In Virginia, one of the biggest of the 11 states holding primaries or caucuses on Super Tuesday and a critical election battleground, Trump’s win was much narrower than the latest polls indicated.

Cruz’s three victories breathed new life into his beleaguered campaign after a string of defeats.

Meanwhile, Rubio won Minnesota’s caucuses, giving him his first victory. Delegates in Tuesday’s contests were awarded proportionally and by congressional district: now inner takes them all!

What’s next in the race For the Republicans Kansas, Kentucky, Louisiana and Maine are on in a few days, followed by Hawaii, Idaho, Michigan and Mississippi three days later. But the most consequential events will come on March 15. Voters will cast ballots that day in five large states: Florida, Illinois, Missouri, North Carolina and Ohio. Important is also that on March 15 Republican Party rules shift so that states awarding all of their delegates to the

winner. The end of that day it will be clear: is Donald Trump really on his way to the Republican nomination in Cleveland (18-21 July).

The Democrats have the same time important states as Michigan, Florida, Kansas and New York on the roll.

Clinton’s strategy is clear; her most urgent and trickiest task now will be not to tear down Mr Sanders but to show him respect so that his legions of young voters and lower- income white supporters will ultimately embrace her candidacy. But this goal will met with sustained criticism from the Sanders camp about Hillary’s heavy paid speeches in Wall Street.

Democrats falling in line; Republicans falling apart The steady and seemingly inexorable unification of the Democratic Party behind Hilary Clinton stands in striking contrast with the widening schisms within the Republican Party over the dominance of Donald Trump.

Mrs Clinton has won already most of the super delegates, the party- establishment; that could be a deciding factor in the Democratic Convention in Philadelphia (25-28 July). On the contrary the establishment of the GOP doesn’t show much happiness at the moment but has been blind too long for Trump’s success. The negative reactions now are not only late but also weak.

His serious opponents Cruz and Rubio stay in the race; so anti-Trump votes are divided, it will profit him. It looks that ‘The Donald’ is unstoppable; unless all of a sudden a new candidate will rise: Bloomberg maybe?

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EU AFFAIRS EUROPEAN BUSINESS REVIEW

THE CLASH OF NARRATIVES BETWEEN THE WEST AND RUSSIA

By Judy Dempsey* On January 14, Germany’s Foreign Minister Frank-Walter Steinmeier gave his inaugural speech to the Organization for Security and Cooperation in Europe (OSCE), which Berlin will chair during 2016.

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his offspring of the Cold War was established in 1975, when the two ideologically competing blocs—NATO and the Warsaw Pact—signed the Helsinki Final Act in an effort to improve relations. The OSCE’s emphasis on human rights provided dissident movements and individuals throughout Sovietdominated Eastern and Central Europe and in the Soviet Union itself with a legitimacy to oppose their governments.

Since the fall of the Berlin Wall in 1989 and the subsequent unification of Europe, the OSCE has gone through many crises, most of them related to Russia.

Divested of its empire, Russia has had successive

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leaders who have questioned the OSCE’s intentions, especially its emphasis on human rights and the status of the lands between the EU and Russia.

It is these lands—Georgia, Moldova, and Ukraine (and, to a lesser extent, Belarus)—that Russia does not want to be contaminated by the West. Russia’s blitzkrieg in Georgia in 2008, its annexation of Crimea in March 2014, and its subsequent invasion of eastern Ukraine confirmed Moscow’s unwillingness to let these countries choose their own political direction.

No wonder there is a deep crisis of trust and confidence in most European countries toward Russia. And

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because of this, Steinmeier argued that it was time to try to renew some dialogue and trust with Russia through the OSCE. On what basis? If he believes Germany can go back to the old days of Ostpolitik, through which engagement and cooperation with Russia would bring the country closer to Europe, this is a naive assumption.

Ostpolitik was a policy that ignored the aspirations of Germany’s Eastern neighbors. It was also a policy that weakened, not strengthened, the transatlantic relationship because of the way in which Germany wanted to forge a special economic and political bond with Russia. And it was a policy that ignored the security needs—if not the security vacuum—among Germany’s Eastern neighbors, as confirmed by Russia’s invasion of parts of Ukraine.

In his OSCE speech, Steinmeier referred to the Panel of Eminent Persons that was set up during 2015 to consider what could be done to strengthen European security and improve relations between the West and Russia.

The panel’s final report is revealing. Instead of woolly, diplomatic language, it spells out two competing narratives of what has taken place in the relationship between the West and Russia since the fall of the Berlin Wall in 1989. There is no meeting of minds.

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Moscow’s version of events is that “under the slogan of promoting democratic values eastwards the West continued to expand its institutions at the expense of Russian security interests.” And for Russia, the West pursued a policy of regime change in the Middle East, “ending in profound destabilization, civil war and refugee flow.”

The differences among the panel’s participants were so great and acrimonious that the Russian delegate, Sergey Karaganov, wrote a letter of disagreement that is included in the final report. “The paper is basically an old Western one in substance, in logic and in recommendations,” he wrote.

Actually, the paper is an unusually strong defense of the reunification of Europe after 1989 and the right of the lands between the EU and Russia to choose their own paths. That is what deeply unsettles Russia and undermines the security of these countries.

After the fall of Communism, the West, according to its narrative, “aimed to build a strategic partnership with Russia that would include close co-operation with, if not integration in, [the] Western institutions.” The view from the West is that NATO and EU enlargement did not follow a Western plan to encircle Russia. “It came about because large majorities in many of the newlyindependent states wanted to return to the democratic family.”

In Western eyes, Russia gave up on democracy and modernization and cooperation with the West. “It has also abandoned any pretense of playing by the rules, including respect for the political independence of sovereign states and the principle of not using force to change borders. As a result, Russia’s definition of its security today means insecurity for its neighbors.”

The Russian narrative rejects that view. “The West systematically took advantage of Russia’s weakness,” the report states. “The West talked of co-operation . . . but believed in Russia’s perennial aggressiveness or/ and weakness.”

*Judy Dempsey is non-Resident Senior Associate at Carnegie Europe – Editor in Chief of “Strategic Europe”

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FOUR PREDICTIONS ON THE FUTURE OF EUROPE

By Jan Techau*

At the end of all this madness, what is the EU going to look like? This is a question heard a lot these days, in one form or another.

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ost observers sense that these are extraordinary times for Europe, and that political realities might look very different rather soon. And while it is impossible to predict how the greatest political project in history will transform under existential pressures from both within and outside, all of these pressures point in a certain direction when it comes to Europe’s future.

Let’s start by saying that there will never be an end to all this madness. Human affairs never reach an end point, some sort of magic equilibrium of all driving forces at which those affairs can be frozen and preserved. In European integration parlance, this means that there is no such thing as finalitépolitique, that old canard. The EU serves a purpose, and its workings and its setup will be adapted as this purpose changes. Again and again.

So instead of looking at some imaginary final outcome that will be outdated the moment it is reached, let’s look at the forces that shape the union.

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Ultimately, it is the needs of Europeans that build the EU. Yes, political leadership and a good helping of civic boldness on behalf of the European citizenry are necessary as well, neither of which is in ample supply these days. But fundamentally, the EU either serves the needs of the day or it gets into crisis. Such a moment has been reached today. And the current crisis that Europeans are both observing and undergoing is nothing but the readjustment of a project that no longer serves the needs of the day properly, and therefore needs renovation.

What makes this moment different from earlier existential crises is that the direction of integration is more diffuse now than in the past. Some needs point toward more integration, but others perhaps point toward less. I am convinced that in the long term, the net result will be more integration. But it will not be wholesale “ever closer union,” the aim enshrined in the EU’s treaties. It will be something a little more diffuse.

The biggest overwhelming need is that Europeans will have to react to the harsh winds of political globalization in the future. Political globalization is more than just the economic globalization that has been talked about endlessly in the last decade. It is a quest for political order on a planet that has outgrown its merely regional

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structure. It will drag the Europeans out of their cozy, U.S.-subsidized corner of comfort, in which liberal order, pluralism, political stability, and the absence of major conflict were somehow taken for granted.

Europeans have a lot to lose in political globalization, because their lifestyles are so hard to maintain and defend. Others want to partake in it because they crave it. Yet others want to destroy it because they hate it.

And fundamentally, it relies on a global order that the Europeans are unable to guarantee.

All of this creates a need for a vessel that allows Europeans to compete in political globalization and contribute to global order. In political globalization, even big European countries such as Germany, Britain, and France are mere footnotes. Together, they might have the chance to make a difference. The EU will have to be that vessel, or it will crack.

So my first prediction is that in the medium to long term, there will be more integration of European foreign policy, and even of security and defense. Not before enormous pain, and much national resistance.

But if Europeans are not suicidal, and I don’t think they are (though I might be wrong here, given Europe’s poor track record on collective suicide), then this will come.

Hopefully, sooner than later.

My second prediction is that the euro will not be part of a future EU. The common currency is a need that does not exist. I am not saying that the euro was a bad idea.

I actually believe it was a very good idea, and I hope Europeans will manage to keep it alive by creating the political union needed to do so.

But strictly speaking, there is no compelling need for the euro. Political and economic globalization can be weathered without one. Contrary to what former German chancellor Helmut Kohl and former French president François Mitterrand thought when they paved the way for monetary union, a currency is not needed to forge deeper integration. Much bigger powers are at work. If they are not sufficient to bring Europeans closer together, the common currency will certainly not do the trick.

Third, I foresee, after heavy pains, a more complete single market, and also a common EU approach to migration—though not to the integration of migrants, which will remain primarily a national matter. There is a huge need for more closely integrated markets in Europe. The high level of economic integration is what has given Europe its strength in economic globalization, and this integration will play a huge part in Europe’s survival in the age of political globalization.

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bananas, or cassis de Dijon—the subjects of key chapters in the EU’s development toward a single market. Closer integration will have to include services but also the huge market for training and skills. It will comprise an energy union, just as it will have to comprise a proper “market” for people. This market will include not just the now-endangered EU principle of free movement in the EU. It will also include its flip side, a properly regulated shared “market” for immigrants. What seems impossible today will have to come, no matter how much nationalist sentiments stand against it.

Finally, the EU will be a lot more realpolitik-driven.

This is where I predict I will be hammered by almost everyone. Realpolitik here means that the EU will be a union less of values and more of transactional politics.

It will be less idealistic and more functional. I am not saying that this will be a good thing. I am not advocating this! I wish it were different, and that Europeans could integrate at the highest possible level of shared morals and values. But this is unlikely to happen.

Europeans will find out that ironically, by toning down their values rhetoric among themselves and by accepting a larger variety of approaches within their integrated club, they will be more effective at preserving the core of their values in the age of political globalization. So I predict a Europe in which values will be handled closer to the lowest common denominator than to the great ideals that Europe wants to stand for. This will be a source of never-ending tension, but it will prove less costly than becoming divided over maximalist morals only to lose out in the harsh world of political globalization.

Taken together, this will be a very different Europe indeed. The peoples of Europe will no longer integrate because they feel love for the idea of an integrated Europe—if ever they did. Integration will come only when the pain is really massive. And it is massive only in some policy fields, not in all.

There is no real hope for EU federalists in this vision, even though they will get some of what they want.

Likewise, there is no reason for Euroskeptics to rejoice, as there will be much more integration than they deem desirable. But it might mean a Europe better equipped for our time. Until, of course, it changes all over again.

As it must. *Jan Techau is the director of Carnegie Europe, the European center of the Carnegie Endowment for International Peace. Techau works on EU integration and foreign policy, transatlantic affairs, and German foreign and security policy.

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AFTER TAIWAN ELECTIONS: A COLD WIND BLOWS OVER THE STRAIT AGAIN

by N. Peter Kramer Democratic Progressive Party (DPP) presidential candidate Ms Tsai Ing-wen secured a landslide victory on January 16, unseating the more China-friendly Chinese Nationalist Party (Kuomintang, KMT) with 56% of the vote.

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he becomes the second DPP President and the first female President in ROC’s (Taiwan). Four years ago, Ms Tsai lost the presidential elections to Ma Ying-jeou, then the incumbent President (Ma wasn’t re-electable this year; two terms are the constitutional maximum).

Tsai’s DPP also won an absolute majority in the simultaneous elections for the national parliament, the Legislative Yuan, 68 seats of the 113; the first time in Taiwan’s parliamentarian history that the DPP will have a majority. This DPP majority will make President Tai’s function easier. The constitutional rule is that the President’s party delivers the government (Executive Yuan), rather than the biggest party in the parliament.

This rule was a handicap for DPP President Chen Shuibian, 2000 – 2008, when the KMT kept the majority.

The picture is that the younger part of the electorate chose DPP. Reasons include the impact of the slower economic growth on employment (especially for younger people) and the fear of too close (economic) ties with Mainland China (Peoples Republic of China). The first ever meeting of the Presidents of both countries, in Singapore on November 7,2015, may have made a contribution to this fear; as did an incident a day before the elections, when a 16 year old Taiwanese singer waved the flag of her country on Korean television and she was heavily bullied by the Chinese authorities. ( Some researchers said that 12% of the voters were influenced by this incident). Also China’s reaction to recent protests in Hong Kong must have played a role in the mind of the DPP voters.

Taiwan’s economy In 2010 both sides signed the Cross- Strait Economic Cooperation Framework Agreement (ECFA) based on the ‘1992 Consensus’; a historical moment of official détente. In the meantime 20 practical agreements are signed. The negotiations on expanding the number of the trade and services agreements were still going on. Will they continue? The President- elect used vague phrases; understandable as many of her voters believe that ECFA has a negative effect on the Taiwanese economy and delivers only profit for big companies and corporations.

For the Taiwanese economy, ties with China are crucial.

Trade between the countries rose more than 50% over the last eight years. Mainland China is now Taiwan’s no.

1 trade partner. In the first 11 months of 2015 the trade volume (import+export) with the Mainland amounted to US$ 106.1 billion (22,5%); compared with US$ 55,6 billion (12%) with the US and US$ 53,3 billion (11,5%) with Japan. Trade with some EU countries was in total US$ 42,6 billion (9%). But also in 2014 Taiwan welcomed nearly 10 million foreign visitors; 40% from them came from Mainland.

President-elect Tsai has set expectations high: she wants to turn around Taiwan’s ailing economy and improve welfare in a society with an ageing population and

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stagnant university graduate salaries. She promised a ‘new era’ for Taiwan, reforming the overburdened pension system, upgrading struggling industries and delivering low-cost housing. This would mean a radical overhaul of the economy. During her election campaign Ms Tsai has hinted at stronger trade relations with the US and Europe as well as Southeast Asian countries; and also at participation more in international agreements.

China’s ‘de facto veto’ and an unwilling EU The ability to pursue the goal of international participation will be limited by ‘big power’ China that often has a de facto veto on Taiwan’s participation in international organisations (Taiwan has, as non-UN member), no chance to enter UN related organisations as WHO, ICAO etc) and agreements (as Trans-Pacific Partnership, the Regional Comprehensive Economic Partnership and ASEAN).

Taiwan has also been looking for many years for a trade agreement with the EU; however it looks as though the EU is stringing Taiwan along. Free trade agreements of the EU with Singapore, South Korea and Canada were worked out in the meantime, which means, for instance, that Korea-EU trade can take place under considerably better conditions than Taiwan’s trade with EU countries.

This EU restraint will certainly increase if the Cross Strait relations deteriorate.

The ‘1992 Consensus’, key to Cross-Strait negotiations The origin of the ‘1992 Consensus’ proposed by Taiwan and formally adopted by the Mainland is summarised in the wording “one China with respective interpretations”.

From 2000-2008 DPP President Chen Shui-bian did not acknowledge the ‘1992 Consensus’. As KMT President Ma Ying-jeou was elected in 2008, the Mainland leader Hu Jintao stated to US President George W. Bush that ‘the Chinese Mainland and Taiwan should restore consultation and talks on basis of the 1992 Consensus’.

This happened and trade negotiations between 2008 and 2016 were successful.

The questions now are: are both sides willing to continue these negotiations? Will the newly elected DPP President Tsai Ing-wen recognise the ‘1992 Consensus’: one China with respective interpretations? It will be tight rope walking for her. The Taiwan Affairs Office in Beijing repeated saying recently that Taiwan belongs to China and that it will oppose ‘secessionist activities’. On the other hand among Ms Tsai’s voters but also inside her parliamentary majority are many that expect her to raise the point of ‘independence’ for Taiwan. They don’t forget that this is the idea in which Ms Tsai started her political career!

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SPECIAL REPORT:

MOBILE IS EVERYTHING WMC 2016 BARCELONA The annual Mobile World Congress on Barcelona is the largest gathering of the mobile industry in the world. EBR’s editor-in-chief N. Peter Kramer was, as special guest of Huawei Technologies, among the 101.000 visitors from 208 countries.

In this EBR Special Report we publish Kramer’s articles (also online www.europeanbusinessreview.eu, click dossiers) about the digital transformation of our world; Zuckerberg’s warning not to ignore the unconnected; and the lagging behind by the EU.

N. Peter Kramer Editor-in-chief European Business Review

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THE DIGITAL TRANSFORMATION OF OUR WORLD

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The way we live, do things, study, earn a living, and run a business or organisation, has been transformed by digital technology

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owadays governments are under pressure to ride the digital transformation wave to accelerate social and economic development and improve competitiveness in their country.

Moving to a digital economy is a transformative process that happens over time as each participant or community embraces digital change. One of the key elements to this process is connectivity. Connectivity links the computing devices, sensors, and effectors at the edge to the compute and storage facilities housed in a datacenter. A connectivity system includes the edge devices, the network connectivity infrastructure, the datacenter core, and the transformation enablers represented by cloud services, Big Data analytics and the Internet of Things (IoT).

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Internet of Things The Internet of Things is one of the key disruptive forces in our economic lifetimes. By placing sensors into a product, it becomes a smart, connected product. Consequently the IoT will enable better manufacturing processes to be established with higher asset utilisation, better reliability, and new and rapidly deployed functionalities and capabilities. Marketing and after-sales services will be changed. But the biggest change IOT brings is the massive increase in contact with customers.

Looking at the future, it has been predicted that in 2025 about 55% of IoT use cases will come from the business-facing (smart manufacturing, smart city, smart utilities, etc) representing heavy investment to obtain productivity gains, asset management, and competitive advantage. Consumer-facing IoTs will be at 45% comprising smart homes, smart lifestyles, smart cars, etc. It will improve quality of life and sustainability.

‘People’s imagination is the real limitation’, I heard once… And may be that is true.

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ZUCKERBERG WARNS MOBILE INDUSTRY NOT TO IGNORE THE UNCONNECTED

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Nobody can ignore Mark Zuckerberg, chief executive of Facebook, at the Mobile World Congress 2016 in Barcelona. He stole the show to appear all through unannounced on stage during the presentation of the new Samsung smartphones

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Warning for the 5G industry Under questioning the Facebook CEO expressed ‘disappointment’ that the 5G industry focus was on connecting things (‘IoT’) rather than the unconnected, and there was a danger of just providing ‘faster connections’ for rich people. If that trend continued, argued Zuckerberg, there was a likelihood of making only a small dent in the unconnected number of people. ‘We need to finish the job of internet access for all’, he said.

There he predicted that virtual reality is the social networking in the future.

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e defended the Facebook initiative internet.org, launched three years ago, to connect the world’s population. He warned not to overlook the task of connecting some four billion people that still don’t have access to the web. Free Basics, as the internet.org service is called, offers users free access to a certain range of data services –including the social networkbut not the full internet. Much to delight of ardent net neutrality supporters who felt Free Basics and its use of zero rating unfairly manipulated internet usage.

However, significant progress has been made, insisted Zuckerberg, despite a major setback in India where Free Basics was banned by the national telecom regulator, because the free internet service is harming for local commercial initiatives. Zuckerberg doesn’t want to change the Free Basics model. ‘Every country is different’, pointing out that Free basics was still available in 38 countries and that it was responsible for attracting 19 million more people to the internet who didn’t have access before. The Facebook chief told the audience about realising internet access via solar-powered satellites, ‘the first satellite is in the sky above Africa’, he said.

It looked like the cynical question ’isn’t internet.org just a way to get more people on Facebook so Zuckerberg can earn more money on ads?’ hurt him. He repeated that he really wants that everyone on earth has access to internet. He told that aside from Free Basics there are more aspects of Internet.org. He would like to cooperate with operators and other ecosystem players to lower infrastructure costs for expanding internet access into difficult to reach places. This, he suggested, might feed into lower data prices for consumers.

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WHAT TO DO BEFORE 5G IS OPERATIONAL? ‘It is hard to believe that 2016 marks 25 years since the launch of the first 2G network and the first mobile phone call. Now it’s nearly impossible to imagine our lives without mobile’, Mats Granryd, Director General of GSMA, said in his introduction to the Mobile World Congress

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ooking around in this event in Barcelona you can read everywhere around you, on banners, publications, screens etcetera what he means: mobile is everything, the clear slogan of MWC 2016.

After 2g came 3G, and at the end of 2015 adoption of 4G technologies surpassed the milestone of one billion 4G connections in more than 150 countries with a 4G network. Now there is a huge excitement around 5G that will offer enormous potential for both consumers and industry. To being considerably faster than existing technologies, 5G holds the promise of applications with high social and economic value, leading to a ‘hyper connected society’. South Korea plans to showcase its 5G services at the Olympic Games in 2018. European Commissioner Oettinger, also present in Barcelona, suggested that Europe could make use of the European Football Championship in 2020 to showcase Europe’s 5G competence to its citizens.

Guo Ping, Deputy Chairman of the Board and Rotating CEO of Huawei Technologies stated however that not even the most innovative carriers won’t use 5G commercially before 2020 and large-scale 5G rollout will probably take even longer. ‘So before 5G arrives, what is necessary to do to capitalise on the opportunities emerging from the digital transformation of telecommunications and other industries?’, was his question.

Three things to do before 5G

‘Today, 99% of all equipment remains unconnected to the Internet. That will change and as it does; we must improve connectivity by increasing the number of connections that can be supported’, he stated.

‘The second thing we must do between now and 2020 is shift from supply-driven to being demanddriven so as to enable the digital transformation of vertical industries’; explaining this, Guo Ping said that ‘industries will demand more from networks: more capacity, more bandwidth, less latency’. He gave safe cities as an example. Before governments can build smart cities, they need to build safe cities. Municipalities must increase their ability to prevent crises, respond to emergencies and make decisions quickly.

The last and third thing Guo Ping mentioned was the must to redefine network capabilities. Carriers need to establish software-defined architecture, achieve agile operations, and develop big data operation capabilities.

4.5G booming in 2016 In October 2014 Huawei proposed 4.5G as an interim standard. This standard became a widely shared rallying point for operators moving beyond LTE. After a year of intensive research and collaboration, the 4.5G industry is now beginning to take shape. 2016 will be the first year in which large-scale commercial 4.5G networks are rolled out worldwide; after tests in 10 countries all over the world like Norway, China Germany, Spain, Japan and Canada.

4.5G is a stepping stone on the way to 5G. Using existing equipment, 4.5G enables faster connections and a better user experience. It also incorporates new technologies such as NB-IoT and broadband trunking, allowing operators to leverage their existing networks to better service the communication needs of industry markets.

Huawei’s Rotating CEO called for three actions before 5G arrives. The first thing to do is to increase connectivity.

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WMC 2016 BARCELONA: “MOBILE IS EVERYTHING”

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rom the moment you arrived at the World Mobile Congress 2016 in Barcelona you could read it everywhere: Mobile is everything. And maybe it is. It is now an intrinsic element in our everyday lives. Mobile networks keep us in touch with friends and family, stay on top of work, improve our fitness, monitor our health, manage our homes, conduct financial transactions, and much more. And what is to come next?

It is hard to believe that 2016 marks 25 years since the launch of the first 2G network and the first mobile phone call. Mobile has transformed the world since then. Mobile is about more than technology; it is about people, society, services and … connecting! Nowadays the mobile industry is a major contributor in driving growth and creating new economic opportunities. The industry generated $3.1 trillion in economic value in 2015; 4,2% of global GDP; and employed 31 million men and women, directly and indirectly.

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The progress made in the last 25 years is enormous, but there is still much to do. For instance improving the affordability of mobile services and extending network coverage to rural areas is a particular challenge, given the high level of poverty and the large proportion of the population living in rural and remote areas. Facebook’s Mark Zuckerberg pointed to this in Barcelona: ‘we need to finish the job of internet access’; he said and explained again the meaning of Internet.org, a Facebook initiative to connect the world population.

There is also a gender dimension to the connectivity gap, as it is estimated that 200 million fewer women than men own mobile phones in low- and middle income groups. Mobile has also a strong role to play in ad dressing the UN Sustainable Development Goals; an opportunity to shift the world onto the path of inclusive, sustainable and resilient development.

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What was new at the Mobile World Congress 2016?

A small selection of the plethora of launches and presentations in Barcelona.

SAMSUNG staked its claims on the smartphone crown, unveiling its flagship smartphones Galaxy S& and Galaxy S7 Edge. The new devices offer ‘refined design’ and ‘the first Dual Pixel camera on a smartphone’ delivering brighter and sharper images even in low light; a faster shutter speed and more accurate autofocus. The devices will be available from mid-March 2016.

Global operators GOOGLE and GSMA announced the launch of a new industry initiative designed to accelerate the availability of Rich Communications Services (RSC). The move will enable an open, consistent, and globally interoperable messaging service across Android services.

LG Electronics gave its flagship G5 smartphone a big push; a launch that the South Korean vendor hopes will put it back in the top bracket of smartphone vendors. A key feature is the device ’full-metal unibody,

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which co-exists with a removable battery. ‘This is the most exciting new phone that you will see at MWC’, exaggerated the LG Chief, given other prominent launches notably the Samsung Galaxy S7.

Huawei launched Mate-Book, a ‘two-in-one device’ that it said combines ‘the mobility of a smartphone with the power and productivity of a laptop and is targeted at enterprise rather than consumer buyers.

Huawei Consumer Business Group CEO Richard Yu said the device will ‘redefine the new style of business – connected computing across all devices in almost every scenario’. ‘The device seamlessly integrates mobility, high efficiency, work and entertainment’, the company said during a press conference.

Sony Mobile unveiled its latest additions to the Xperia smartphone line, called Xperia X, alongside a number of products designed to change the way users interact with technology. The company said the X line ‘embodies Sony Mobile’s new brand vison through adding new layers of intelligent technology across popular and acclaimed Xperia features: camera, battery and design’.

‘There is still more we can do’, Hiroki Totki, Sony Mobile Head, said. ‘But do you really need smartphones full of additional functions you never use?’.

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EU-COMMISSIONER OETTINGER (DIGITAL ECONOMY): “EUROPE IS LAGGING BEHIND”

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uring a WMC 16 roundtable with leaders from the telecom and automotive sector to discuss the future connectivity requirements for connected and autonomous driving, EU Commissioner Oettinger *(Digital Economy& Society) expressed concerns that Europe is lagging behind other regions in the world.

‘We Europeans have to do our job well’, he said, such as harmonising spectrum policy and modernising regulation. ‘We are lagging behind but we are coming back to the game’.

Oettinger promised another ‘white paper’ from the Commission and the 5G Industry Association, title 5G Empowering Vertical Industries. European automakers and telecom providers will work together to deliver connected and selfdriving cars across the EU’s 28 member states. Industry associations for these sectors will cooperate to ensure communications systems are upgraded to be fast and secure enough to support the technology for automated driving. A condition is that the technology across the EU has to be standardised.

The European Commission is forging ahead with a new plan to align the disparate and often contradictory digital interests in the 28 countries. The new European dream is the so-called digital-single market across the EU, a region with more than 60 languages and a population of more than 500 million. This digital single market involves a raft of new policies that would come into force by the end of the decade, if everything goes according to the plan. EU Commission’s Vice-President Ansip*, who is leading the digital campaign, said in Barcelona: ‘there are going to be no easy victories. It will be an uphill struggle’.

Mr Ansip, a former Estonian Prime Minister, is not exaggerating. He knows the obstacles given renewed anxiety about the global economy and the European problem of more than a million migrants from Syria, Afghanistan and Iraq. If the EU leaders, after deliberating a year long, can’t agree on who should be let across their national borders, some question how much time they will spend on ensuring, for instance, that Amazon purchases or iTunes subscriptions are delivered efficiently. eBay’s European head, Paul Todd, said: ,as soon as you go across a border it becomes complicated and costly’.

Another problem is that basic Internet skills along with other services like high-speed mobile networks vary drastically among European countries, as does understanding of e-commerce and general familiarity with the online world. In Sweden and Estonia for instance 85% of the population surfs the web each day; 75% bought goods online last year. Compare that with Bulgaria, Romania, Portugal, Spain and Italy, fast mobile connections don’t exist outside big cities; and high-speed broadband? Maybe they just started with rolling it out.

The European Commission says the EU needs a single digital market. The hope is that a unified digital marketplace would help to improve Europe’s moribund economy. The question is: how do you make that happen? *Yes, the European Commission has 2 members working on the digital future of the block. In Barcelona it turned out that they have each an own vision on the subject…

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MULTI-BILLION DOLLAR ONLINE GAMING INDUSTRY PRESENTS A TAXING PROBLEM FOR GOVERMENTS

by Martin Banks* Well away from the headline-grabbing diplomatic tensions over the Middle East, Nato and Ukraine, policy makers of the East and West share something even they may not be fully conscious of -- the challenge of taxing global business round the world, nations are struggling to determine how best to collect taxes from multinational giants like Amazon, Facebook and, notably, Google.

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to collect 25% of profits deemed to have been diverted through “contrived arrangements” -- regional sales offices in tax-free jurisdictions for instance.

With increasing amounts of commerce moving online and away from physical and easily taxable premises, who gets to collect the taxes and where? The struggle takes different forms in different jurisdictions, depending on the relative reliance on national vs local taxes, income vs sales taxes, and so forth.

Ironically, as outraged British taxpayers learned in recent days, the tax doesn’t actually apply to Google, which has agreed instead to pay L130 million in settlement for taxes owing over the past ten years. It has been calculated that this represents approximately 3% of Google’s revenues in the UK for that period.

Google is such a prized target that the UK even calls its newest tool, officially called a diverted profits tax, the Google Tax. Implemented in 2015, it is intended

In the US, the battle concerns the proposed Marketplace Fairness Act which is intended to let states collect sales taxes from online retailers even when they have

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no physical operations within the state. A version of the bill failed in the last Congress and is stalled in the current one.

In Russia, the struggle is over online gaming. This may seem idiosyncratic, but it makes sense. No industry has been more agile in avoiding national taxation than the multi-billion-dollar online gaming industry.

The biggest operators are all formally headquartered in low-tax and tax-free jurisdictions like Guernsey, Malta and Costa Rica.

Online gaming of any kind is a sensitive issue in Russia.

Last October, authorities began blocking dozens of unregistered domestic and international gaming sites.

And this week Liga Stavok, a major domestic betting firm, announced that it had become the first company to secure an official betting licence. At the same time, details of a new central payment processing system, called TSUPIS, have been announced. Expected to launch over the next few weeks, it is intended to record all payments into registered gaming sites so they can be taxed.

All indications are that legalization of online poker will be Russia’s next step. “It is necessary to create some comprehensive conditions which allow profitability and to get some taxes,” says Maxim Kats, a former professional poker player and current municipal deputy in Moscow.

The public debate in Russia has been over the morality and social value of gambling as a whole, and whether poker is gambling at all. A number influential figures argue forcefully that poker is a game predominantly of skill, not of chance. Even Kirsan Ilyumzhinov, the multi-millionaire Russian businessman who heads the World Chess Federation, has expressed this view.

“Concerning online poker and its legalisation in Russia - it should be legalised; too many people are involved

and are playing online,” he told an interviewer recently.”

But underlying the morality discussion, there is a serious tax debate too.

Vasily Anisimov, president of the State Lotteries Operators Association, says Russia is foregoing billions of rubles in potential taxes. Based on a proposed regime involving a 13% tax on players and 20% on poker operators, he believes Russia should be collecting 2-3 billion rubles annually.

Alexander Zakondyrin, a Moscow lawyer and politician, says this is money the nation badly needs. “Russians play poker, but their money goes abroad,” he says.

“In the current crisis situation, of low oil prices and sanctions against Russia, which excludes the use of foreign debt markets, Russia’s budget needs additional income.”

The Kremlin appears to agree. In 2014, Igor Shuvalov, Russia’s First Deputy Prime Minister, ordered the Ministry of Economic Development and the Ministry of Justice to put together a report on the legalization, regulation and taxation of online poker.

And last year, at a meeting bringing together government officials and the leaders of a number of public interest groups, Shuvalov declared his view that poker is not gambling, but is an intellectual game which should be legalized. He indicated that tax revenues derived from it should be allocated for the development of chess and other sports.

The consensus formed around the issue means that the changes will almost certainly happen this year, Zakondyrin says.

And if Russia is successful, how many other nations will start insisting that major global internet service providers -- not just poker specialists -- physically locate servers inside their borders, the better to enforce regulation and, of course, collect revenues?

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THE END OF CASH MONEY?

By Ben Antenore*

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wo nations, Norway and Sweden, are making serious moves toward the abolition of paperbased money.On January 22, Norway’s largest bank DNB called for an end to the usage of cash. In an interview with newspaper Verdens Gang, DNB executive TrondBentestuen spoke of the dangers and uncontrollable nature of paper currency: “Today, there is approximately 50 billion kroner in circulation and [central bank] Norges Bank can only account for 40 percent of its use. That means that 60 percent of money usage is outside of any control. We believe that is due to under-the-table money and laundering.” For Bentestuen and DNB then, the only solution to fighting money laundering and other illicit practices is a total

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phasing out of cash. He supported this conclusion with data, citing that only about 6 percent of Norwegians use cash daily and, of that small number, usage is skewed highly toward the elderly.

DNB isn’t alone in this dream for a paper-less kroner.

In 2013, the Norwegian Hospitality Association lobbied the Ministry of Finance to abolish the right of consumers to pay in cash at all shops and restaurants.

It explained that such an act would prevent “disreputable” business-owners from avoiding tax. Last year, following in the footsteps of its colleague DNB, Nordea, the second largest bank in Norway, announced it would stop handling cash at their branches. When

EUROPEAN BUSINESS REVIEW TRENDS

asked about that move, Åse Dahl, the bank manager at the Oslo Central Station Nordea branch, told the broadcaster NRK, “Society is getting steadily more digital, and customers want to do as much as possible online or on mobiles.”

Norway’s Scandinavian neighbor Sweden has also been moving towards a cash-less future, but at an even faster pace. Associate professor of industrial dynamics at the Royal Institute of Technology, NiklasArvidsson believes that four out of five purchases in Sweden are made electronically. At more than half of the branches of Sweden’s largest banks, no cash is kept on hand and cash deposits are refused. These banks believe that they have saved an incredible amount of money on security by removing the incentive for robberies. Instead of money, Swedes favor using cellphone applications and plastic cards. In 2015 alone, there were nearly 2.4 billion credit and debit transactions. In a slightly humorous turn, ABBA’s BjörnUlvaeus, the man who wrote “Money, Money, Money,” has become a disciple of Sweden’s cash-free movement.

Other Scandanavia countries are following in the footsteps of trailblazing Norway and Sweden. Last year, the Danish government stated that, as of 2016, retailers and restaurants should no longer be bound by law to accept cash payments. In Denmark, roughly a third of all citizens use the official Danske Bank phone application MobilePay, which links users’ phones together and allows for payment though swiping.

Finland also reports high use of electronic payment.

The European Central Bank recording that there were 213 card payments per inhabitant during 2012 in Finland. According to a study promoted by CNN and done by the Norwegian central bank, “Scandinavians rely on cash for less than 6% of all payments made. By contrast, around 47% of U.S. payments are still made with cash.”

In both Norway and Sweden, this ambitious transformation has encountered some resistance.

Norwegian Finance Ministry spokesman Tore Vamraak indicated less enthusiasm about cash-less currency when he spoke to VG about DNB’s announcement: “We have no plans to change the law in this area now […]

There are many, including the elderly, who still want to use cash and that must be allowed. Moreover, it isn’t unproblematic for privacy to make every transaction traceable.” In Sweden, there is similar concern about how its 1.8 million pensioners will adapt.

Johanna Hållén of the Swedish National Pensioners’ Organization expressed a desire for the Swedish government to consider its senior citizens and to take

things more slowly in the cash-less transition, “A lot of elderly people feel excluded when you need to use cash cards or your mobile phone to take a bus or use public toilets. Only 50% of our members use cash-cards everywhere and 7% never use cash-cards.”

Former director of the Swedish police force and former Interpol president Björn Eriksson has become the face of a protest against the cash-free movement. Eriksson believes that the transition is being championed by banks because it generates fee income and is a way for them, and credit card companies, to make a greater profit: “Something is being privatized without people knowing what the implications of that privatization are.” Eriksson also asserts that the total digitalization of currency will put rural citizens at a disadvantage, with cellular service coverage much less reliable once one leaves a city. For mobile card readers, which require a cellular connection, this presents an issue.

The promise of a cash-free currency has not rid Sweden of crime, however. In 2014, the number of electronic fraud cases in Sweden rocketed to 140,000, more than double what the amount had been in 2004. In 2012, Europe experienced a 15% jump in credit card fraud, hitting €1.3 billion in total.

For all of the hype surrounding a cash-free future, Scandinavians still feel a sentimentality for physical currency. In October of last year, Sweden’s banks rolled out a new series of bank notes depicting famed Swedes like Greta Garbo. *Ben Antenoreis European Affairs editorial assistant at “The European Institute”

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TRENDS EUROPEAN BUSINESS REVIEW

EUROPE NEEDS SMART POLICIES FOR SMART THINGS

By Paul MacDonnell*

T

he Internet revolution is not over, but it is changing. Its first wave brought billions of people online to connect and communicate through email, websites, social networks and other platforms that allow consumers to work, conduct commerce, learn and meet. The next wave will bring online billions of machines and devices that will make our lives easier, our commerce more efficient and our cities smarter.

But unless policymakers play their part, the benefits will come too slowly and at too high a price.

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EUROPEAN BUSINESS REVIEW TRENDS

Most of these connected devices – the new Internet of Things (IoT) – will be buried out of sight deep within factories, farms, warehouses, transport networks and utilities. Using sensors, warehouse shelves will know when they are nearly empty and send for more stock.

Bridges will know when they are developing structural problems and will call maintenance crews for repairs.

Waterways will warn environmental regulators about spikes of toxic algae. Cars will communicate with each other and the infrastructure, allowing traffic lights to be dynamic and warning people of impending collisions. Indeed, by 2020, there will be an estimated 26-50 billion connected devices worldwide. They will turbocharge the world’s productivity, adding up to $11 trillion in value per year by 2025.

The opportunities are particularly significant for Europe, where the public sector has already pioneered a number of initiatives for using the IoT that have become case studies for the rest of the world. The Spanish region of Asturias, for example, has launched a programme that will use unmanned aerial vehicles to detect floods, fires and other risks. When the drones detect rising water levels in waterways and reservoirs, they will automatically trigger an emergency alert to warn the public about the risk of flood. Paris has installed sensors on trees to detect damaging bacteria and on city streets to optimise maintenance. The cities of Cologne in Germany and Eindhoven in the Netherlands have launched traffic control initiatives using sensors on roads, railways and bridges to alert motorists of congestion or accidents. Europe’s proposed eCall initiative then promises to assist motorists involved in collisions anywhere in the European Union by using devices installed in vehicles to automatically contact the emergency services and send them crash details with GPS coordinates.

These examples hint at the enormous benefits that the IoT can offer. But to maximise these, Europe needs a comprehensive strategy encompassing not only investment within the public sector but also a wider programme to ensure there is no lag in the adoption of the technology by the private sector and consumers.

Europe should begin by building aggressively on its leadership in the public sector. Policymakers at every level from Brussels to city managers should seize flagship municipal initiatives as blueprints for more effective public services. The potential for the IoT is so closely tied to such areas as health, environment, transportation, defence and land and city management that the possibility of gaining significant benefits in the near future is actually stronger in public services than in the private sector.

European policymakers then need to take responsibility for removing barriers to the widespread adoption of the IoT. In particular, they should encourage the private sector to agree to common standards. The British government’s Technology Strategy Board, for example, provided £8m for an industry working group called HyperCat to develop an open standard for the IoT and reduce the need for additional software for facilitating data sharing with newly-connected devices. Likewise, it’s critical that the European Commission works to develop more continental radio spectrum markets and work to free up additional spectrum that the billions of wireless IoT devices will need.

Governmental R&D investment can play a role in speeding up the development of the IoT. It should not be forgotten that government-sponsored R&D helped smartphones, search engines, genomic sequencing and, of course, the Internet get off the ground. Government funding should of course not seek to crowd-out private investment; it should be complementary, seeking to advance research in areas that benefit the market as a whole.

Lastly, Europe needs a regulatory environment that does not unnecessarily limit IoT adoption.Anxiety that European companies will not play a major role in providing technology and services for the IoT, or unsubstantiated fears about security and privacy, should not guide regulation affecting the evolution of technology in Europe. Seeking to promote ‘national champions’ rather than the technology itself is likely to lead to inferior or overpriced technologies. And preemptively imposing strict privacy regulations on the IoT, like notice and opt-in requirements, will raise costs and slow down adoption.

Europe’s policymakers have already shown that they can think boldly and imaginatively about bringing citizens the benefits of the Internet of Things. They now need to consider what smart policies are needed to ensure they deliver on their promise.

*Head of European policy at the Center for Data Innovation in Brussels

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BANKING & FINANCE EUROPEAN BUSINESS REVIEW

BANKING CRISIS YET AGAIN AND HOW TO FIX IT

By Stefano Micossi*

Almost out of the blue, a combination of

diverse factors has elicited a run on bank stocks and junior and senior debt, raising the spectre of a renewed systemic bank crisis within the European Union.

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he policy response cannot come from the European Central Bank but, instead, must consist of regulatory responses capable of dispelling the uncertainty over future prudential capital requirements while also temporarily suspending the rules on state aid cum bail-in that had ignited the crisis.

Of course, financial instability has multiple roots, from the slowdown of the Chinese economy to the dire straits

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of the emerging countries, the fall in oil and commodity prices and its repercussions on the health of the financial system, and fresh fears (probably overplayed) of a new recession in advanced economies (Blanchard 2016). However, the banking system, notably in Europe, suffers from specific weaknesses that have played an important role in the investors’ rout and are in part policy-induced. Bank profitability has taken a hard and durable hit from higher capital requirements imposed in response to the 2008 financial crisis, and there is still considerable uncertainty as to the impact of the ongoing review of risk-weighting models by Basel supervisors on regulatory capital. Quantitative easing and negative deposit rates at the ECB are squeezing returns even further, leaving thinner margins for meeting internally rising capital requirements over

EUROPEAN BUSINESS REVIEW BANKING

the coming years, which promises more share issues in capital markets. The equity of some large banks appears barely able to satisfy current prudential requirements, thus leaving insufficient room to restructure the stockpile of non-performing loans (NPLs) – some €900 billion in total, of which about €350 billion are held by Italian banks – and potential losses from large levelthree (toxic) assets and derivative positions (especially in German and Swiss banks). This further feeds fears of bail-in of bank creditors in the event of large write-offs eventually requiring injections of state funds.

This is the environment in which the new EU regulations governing state aid to banks (as of summer 2013) and the resolution of banks in crisis (as of 1 January 2016) went into effect. These regulations require banks in need of state aid to first write down capital held by outstanding bondholders and other creditors for an amount up to 8% of the bank’s total liabilities (bail-in).

The new rules were to apply not only to newly issued bonds, but also to bonds already in circulation. For the latter, this entailed changing their risk profiles relative to what they had been when first sold to investors in the market. This is a highly questionable decision that has contributed importantly to recent turmoil.

The shock has been especially hard-felt in Italy. The Bank of Italy, as the national resolution authority, placed four small local banks in resolution last November. In total, they made up only 1% of bank deposits. The stock value and junior bonds for these banks were wiped out, inflicting significant losses on a plethora of small investors, many of whom had bought these securities at the issuing banks’ advice. The impact on bank stock and the bond market was magnified by spreading and unfounded fears that other banks might have to incur large losses due to their need to unwind large holdings of NPLs, possibly leading to more creditors’ bail in. It should be recalled, in this context, that, following the financial crisis, Italian banks issued around €67 billion of junior bonds, of which over half are held by retail investors. While these banks were, for the most part, solid, many savers grew anxious and started to offload their bonds. In some cases, depositors raced to withdraw deposits. A similar event happened in Portugal with the resolution of Banco Espirito Santo and the creation of Novo Banco, which also entailed a controversial decision to transfer senior Novo Bank bond issues to the bad bank, thus making them subject to bail in.

Slowly, in an atmosphere of growing international

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financial tensions, the shock has spread to other European markets, embroiling larger establishments such as Deutsche Bank, Commerzbank, Credit Suisse, Standard Chartered and Barclays.

There is little doubt, in my view, that we are facing a systemic shock, in which, as happened before with the sovereign bond crisis in the eurozone in 2010-12, a serious error in European policy has destabilised financial markets.[1] As was the case then, markets are unlikely to calm down on their own, meaning that there is a risk that this instability may spread, imperilling the banking system as a whole. In 2012, the problem was resolved when the European Central Bank stepped in with its Outright Monetary Transactions (OMT) programme, which stabilised the market for sovereign bonds. Today, an intervention cannot come from the ECB, which is already buying up €60 billion in public bonds per month, and whose interventions may indeed have the effect of aggravating the banks’ dismal profitability.

What is needed is a joint act by European governments to convince financial investors that bank liabilities are secure. As was done in 2008, the European governments must offer a public guarantee for bank liabilities, temporarily suspending European regulations governing state aid and, above all, the bailin provisions. As in 2008, banks should also be allowed to obtain a public backstop to cover the potential losses from securitising and restructuring their NPLs and level-three assets. The Treaty of Lisbon, which governs the workings of the EU, explicitly allows (in Article 107) the Commission to declare state aid “compatible” with the Treaty in the face of especially turbulent economic conditions.

It would also help if European regulators allowed banks presenting credible business plans to improve profitability, by rationalising their business models and cleansing their balance sheets, more time to meet final capital targets, as has been done in the US and the UK but not in continental Europe.

*Stefano Micossi is Director General of ASSONIME, a business association and think tank in Rome, Chairman of the LUISS School of European Political Economy (SEP)and a member of the CEPS Board of Directors. This commentary was originally published as a LUISS Policy Brief, 11 February 2016.

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BANKING & FINANCE EUROPEAN BUSINESS REVIEW

THE FUTURE OF BANK RISK MANAGEMENT

By Philipp Härle, Andras Havas, and Hamid Samandari*

Banks have made dramatic changes to risk management in the past decade -and the pace of change shows no signs of slowing. Here are five initiatives to help them stay ahead.

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isk management in banking has been transformed over the past decade, largely in response to regulations that emerged from the global financial crisis. But we believe it could be set to undergo even more sweeping change in the next decade.

Indeed, while risk-operational processes such as credit administration today account for some 50 percent of the function’s staff, and analytics just 15 percent, by 2025 those figures could be around 25 percent and 40 percent respectively.

The trends shaping the risk function come from all directions. While we cannot draw a blueprint of what a bank’s risk function will look like in 2025—no one can predict all the disruptions that might lie ahead— we can paint a picture of some important changes that are relatively certain. We see financial and nonfinancial regulation continuing to broaden and deepen as public sentiment becomes ever less tolerant of any appearance

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of preventable errors and inappropriate practices, or of bank failures. Simultaneously, customers’ expectations will rise in line with changing technology. In the battle for customer relationships, banks will need to offer real-time responses to customer requests to open an account or take out a loan, for example, which means the risk function will need to find ways to assess risks automatically, without human intervention.

Risk functions will also have to cope with additional, emerging risks—from cyberattacks to contagion in global markets and losses made due to the increasing use of models to make decisions (losses that are not uncommon but seldom reported).

At the same time, evolving technology and advanced analytics, such as machine learning, are enabling new risk-management techniques. Banks are experimenting with self-learning algorithms in credit underwriting, monitoring, and credit-card fraud detection, with

EUROPEAN BUSINESS REVIEW BANKING

encouraging results. Advances in behavioral economics will also help risk managers make better choices as they learn to recognize and eliminate common biases from their decisions. On the downside, with banking margins under pressure worldwide, the risk function will probably be expected to deliver these improvements with substantially reduced operating costs.

Five future-proof initiatives So how should risk managers respond to these changes?

Our belief is that there are some basic initiatives that banks can undertake today that will both deliver shortterm results and help them prepare for the future.

Here are five that not only have a strong short-term business case, but also will help build what we see as the essential components of a high-performing risk function in 2025.

Digitize core processes. By 2025, the risk function will have minimized manual interventions. Modeling, simplification, standardization, and automation will take their place, reducing nonfinancial risk and lowering operating expenses. To that end, the function should push to digitize core risk processes such as credit application and underwriting by approaching business lines with suggestions rather than waiting for the businesses to come to them. Increased efficiency, lower costs, and, often, a superior customer experience and improved sales will be the short-term gains.

Experiment with advanced analytics and machine learning. In the same vein, risk functions should experiment more with analytics, and particularly machine learning to enhance the accuracy of their predictive models. Some financial institutions have already achieved significant model improvements, leading to better credit-risk decisions.

Enhance risk reporting. Ever-broader regulation and the need to adjust to market developments require rapid, fact-based decision making, which means better risk reporting. While regulatory requirements have already done much to improve the quality of the data used in risk reports and their timeliness, less attention has been given to a report’s format or how it could be put to better use when making decisions. Replacing paper-based reports with an interactive tablet solution that offers information in real time and enables users to do root-cause analyses would enable banks to make better decisions, faster, and identify potential risks more quickly too.

Collaborate for balance-sheet optimization. Given the many different and new regulatory ratios (such as

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capital, funding, leverage, total loss-absorbing capacity, and bank levy, to name a few), the composition of the balance sheet is arguably more important than ever to support profitability. The risk function can help optimize the balance sheet by working with finance and strategy functions to consider various economic scenarios, strategic choices (how much a bank would be prepared to increase or shrink a loan portfolio, for example), and likely regulation. The process, performed with the support of analytical optimization tools, often suggests ways to improve return on equity by anywhere between 50 and 400 basis points while still fulfilling all regulatory requirements.

Put the enablers in place. It goes without saying that high-performing risk functions depend on a highperforming data infrastructure. What perhaps deserves more attention is the importance of starting to build the right mix of talent and embedding a risk culture.

Data scientists with advanced mathematical and statistical knowledge will increasingly need also to be able to work as “business translators,” collaborating across the bank to convert data insights into business actions. Indeed, risk managers will become trusted counselors to business areas (though fewer staff will be needed in traditional operational areas). Attracting talented employees will itself be a challenge, as many potential candidates could be lured to technology firms unless banks strengthen their value propositions. A strong risk culture—in which detection, assessment, and mitigation are part of the daily job of all bank employees—will be central to the success of the risk function. For despite the push toward automation and more sophisticated analytical and technical capabilities, only human intervention will ensure they are applied appropriately and ethically.

Fundamentally changing bank risk-management functions will take years. Now is the time to start the transformation. Our vision for a bank’s riskmanagement function in 2025 is one where the function is the architect of a seamless system that monitors risk throughout the organization and makes de-biased risk decisions, that has stronger, more collaborative relationships with other parts of the bank, and that is more engaged at a strategic level than it is today. The actions described here are some steps risk functions can take today to move toward this vision and to help the bank excel among its competitors. *Philipp Härle is a director in McKinsey’s London office, Andras Havas is an associate principal in the Budapest office, and Hamid Samandari is a director in the New York office.

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ENTREPRENEURSHIP EUROPEAN BUSINESS REVIEW

HOW SUCCESSFUL START-UP TEAMS ALLOCATE ROLES

By BalaVissa*

T

he financial success of a new venture depends heavily on who does what within the founding team. The most successful start-ups allocate positions based on prior work experience as well as how co-founders fit into the social context around them.

When co-founders get together to build a new venture one of the first and most important decisions they must make is who will do what in the new organisation.

When co-founders have highly complementary skills relevant to their venture, this division of task roles is straightforward. However, founding teams rarely come together because of complementary expertise.

In many cases individuals will meet at school or work and decide to plunge into a new venture together, thus co-founders often have overlapping skills making task division problematic.

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Some team-based start-ups deal with the issue of overlapping skill sets by creating idiosyncratic roles (think of the quirky Chief Happiness Officer or Chief Yahoo Officer!). However, in general start-ups are resource starved and need ”traditional” positions such as CEO, CFO or CMO in order to present themselves as a safer bet and an attractive, professional partner for investors and other influential resource holders.

Even when co-founders have equal equity stakes, someone has to take the title of CEO leaving the others to adopt positions considered lower in the executive food chain, titles such as CMO or COO. So what is the best way for co-founders to divvy up the positions to maximise their venture’s chances of success?

EUROPEAN BUSINESS REVIEW ENTREPRENEURSHIP

Take your marks…

In a recent paper, How do entrepreneurial founding teams allocate task positions?, HeeJung Jung of Imperial College London, Michael Pich of INSEAD and I, noted that founding teams typically leant towards two competence cues when deciding the division of labour within the team. One is prior experience - for example, a person with marketing experience makes a good fit for CMO. The second is a more general cue that depends on co-founders’ social status – for example, when all else is equal in an INSEAD founding team, a “dean’s lister” is perceived as being more competent than someone who isn’t and could therefore be seen as a better fit for a leadership role such as CEO. Depending on the particular context, individuals’ social attributes, such as gender, ethnicity, prestige of prior organisational affiliations and educational achievements, could become markers of general ability and thus influence the division of labour.

Across a set of three studies – one qualitative and two experimental - we found that founding teams allocated founders whose general competence cues suggested greater suitability to CEO positions, with fellow founders taking lower status roles on the executive. Interestingly, we found that ventures where founders were slotted in correctly based on their “status”, were significantly more successful. In other words, when occupants of positions were typical, their ventures did well.

The nerd and the dropout In the setting of our study, the general cues of competence were gender, ethnicity and occupational/academic achievement. Specifically, individuals who were male, white, worked in prominent firms like McKinsey or Goldman Sachs or were on the Dean’s list were seen within their teams as having greater general ability and hence more likely to emerge as CEOs of their ventures.

In contrast, individuals who were Asian females were typical occupants of lower status positions such as CMO or COO. When teams allocated founders to positions perceived as most suited to their characteristics – when a white male was made CEO and an Asian female CMO - the venture exeprienced much greater financial success. The reasoning is twofold. First, when position occupants are typical, there is much less conflict within the team and everyone focuses on the tasks at hand. Second, in these cases investors and other external stakeholders perceive the team as being more legitimate and in keeping with previous patterns of successful founding teams. Thus they were more likely to bestow resources on them.

Indeed such pattern matching is inevitable given the uncertainty around early stage investing. As legendary venture capitalist John Doerr said, “the success factor I’ve seen in the world’s greatest entrepreneurs…(is that)

they all seem to be white, male nerds who’ve dropped out of Harvard or Stanford and have absolutely no social life. So when I see that pattern coming in – which was true of Google – it was very easy to decide to invest.”

To be clear, we’re not advocating that the white, male dean’s lister always be the CEO. To ensure the success of any venture in its early stages, the position of CEO is best bestowed on someone who fits with the context of the broader institutional environment. For example, if three Chinese males started a venture in China, ethnicity and gender would be irrelevant predictors of team position or performance. Our model predicts that for such a founding team considerations such as who attended a prestigious Chinese university or had prior work experience in prominent firms in China would matter a great deal more in how division of labour is handled.

Aim for optimum If co-founders find themselves starting a business with others who have similar skillsets, then fitting people into roles based on both their specific markers of competence (such as their prior experience) as well as their general markers of competence (such as their perceived social status in their particular social context) is a good way to ensure a better chance of success.

Having said that, it is worth noting that having identical skillsets is never ideal, and founders should aim to have complementary competencies and experience. But this is a tall order for many new ventures whose founding teams come often together through friendship which creates the bonds of initial trust essential to taking the plunge together.

In the event that achievements and status are very similar, co-founders could overcome conflict by using more ambiguous titles, such as “co-founder and director” rather than pigeon-holing themselves into CEO, COO and CFO positions. Co-founders could also aim to revisit the allocation of positions regularly as shifting environments may require the different backgrounds of the founders to come to the fore at different times and for different reasons.

Our model is most applicable to teams that come together from the very beginning. Teams which have new founders joining in sequence are easier to structure given the high amount of risk the early founders take on, which positions them more strongly for the top jobs. *Ben Antenoreis European Affairs editorial assistant at “The European Institute”

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LAST PAGE EUROPEAN BUSINESS REVIEW

MOLDOVA: END OF THE POLITICAL RIDDLE?

By Radu Magdin*

M

oldova still suffers from a profound political crisis and the new Government still has some important steps to make to renew credibility at home and abroad: from stability to hope the road is a long one. Nowadays, Moldova‘s new executive still faces periodic protests, but not as powerful and well organised as it used to be. Medium term political stability is not only desirable but also possible.

The new Government, run by Pavel Filip, has begun a series of reforms in order to manage short and medium term plans for the country. This is why we can fairly state that the political riddle regarding Moldova’s future close to an end. Less guessing, less instability, more appetite for reforms and modernisation.

In terms of concrete steps, the prosecutor’s office reform has begun, corruption is Moldova‘s biggest plague and people expect justice after the billion dollars stolen from the country’s banks. General prosecutor Gurin resigned in a possible show of trust regarding the beginning of a new, reformed era. At the same time, it remains to be seen if what is agreed on paper will also transform into a concrete reality, this being valid also for the new judicial agency responsible for special cases.

Political turmoil is not yet over, a key test being the parliamentary election of a new President, somewhere between March and May this year. President Timofti is at the end of his 4 year mandate, and his replacement may face a delay also because people want a directly elected President.

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The country‘s finances are getting back on track as well, financial aid, while conditional, is on the way: Romania’s Government approved the 60 million euros loan, part of a larger 150 million loan, thus giving a positive endorsement regarding trust in Chisinau. The IMF and the European Commission are next in line.

A new political poll suggest that the pro-Russian parties lead the political scene in terms of favourability with 19.8% for Renato Usati and his party, followed by the socialists – Igor Dodon with 12.8%.

If elections would be organised next week in Moldova, the 6% limit to accede in Parliament would be met, on the pro-European side, by the DA civic platform (Dignity and Truth) and Maia Sandu’s party. Pro-European parties that currently compose the government – PD (the Democratic Party) and PL (the liberal party) would not manage to obtain the necessary votes: 4.3% for the democrats and 1.2% for the liberals. Leanca’s party, the PPE will snatch 3.7% (also insufficient); meanwhile, expremier Vlad Filat’s party is facing a dramatic drop in trust (over 14%) and has only 0.5% in vote intention.

So, the challenges for this Government are big and need to be met fast.

*Radu G. Magdin is Strategy Consultant and CEO of Smartlink Communications