THE FINANCIAL ELITE Bank of England governor Mervyn King, British Finance Minister Alistair Darling, German Chancellor Angela Merkel, British Prime Minister Gordon Brown and German Finance Minister Peer SteinbrückAffected by the economic recession the European Union is facing what could be the greatest crisis in its history. Economic woes have resulted in a growing number of disagreements among the member states. Many in Europe now feel that the rejection by the wealthy states to finance the economic recovery of the poorer nations, mostly in the east of Europe, could bring about the break up of the European Union into two blocs. The foundations of this dispute lie in the unhappiness of some countries with the way the Union is structured.

Because they make the greatest financial contributions to the Union, Germany and France feel that they deserve greater authorities in running it. On the other hand the smaller states are unwilling to give up their powers and expect the Union to help them fight the recession. In the future this situation could result in significant problems in the internal functioning and structure of the EU. This possibility is a great problem for Croatia, currently negotiating its accession to the European Union. In these negotiations Croatia will undertake numerous obligations, many of which will be to its detriment. However, if the relations within the Union and the system on the basis of which it functions change, all of the obligations Croatia undertakes in the negotiations could prove harmful in the long run. The problem is that Croatia today can hardly foresee the shape of the Union after 2012 when it is expected to join. That is why Croatian Government, in the event of further disruptions in the European Union, should seriously reconsider its long-term political goals. If the trend towards economic protectionism in the European Union, now very evident, continues, Croatia too should adapt its policies to the protection of the domestic economy. At this moment protectionism is seriously undermining the stability of the European Union.

The decision by Bank of England governor Mervyn King to start printing money in an attempt to alleviate the affects of the recession in Britain could further impair already tense relations among the European Union's member states. Printing money will result in inflation in Britain and a drop in the value of the British pound against the euro. That will mean that all British products and services will cost less on most of the foreign markets they are exported to, while products of the Eurozone countries will become less competitive on the British market. That is why many economists fear that this policy in Great Britain could further deepen the recession in the rest of the European Union.

And while it is a unilateral move, one Britain opted for without any consultation with the other member countries, there were few European politicians who criticised this behaviour on the part of the British. The reason is that over the past few months the governments of other large EU member states, such as Germany, France and Italy, have also begun leading very independent economic policies, avoiding an arrangement and joint anti-recession measures with all the countries that make up the Union.

The latest example of this kind of political doctrine was displayed at the European Union summit held at the beginning of this month in Brussels. And although one of the top items on the agenda was possible aid to the countries of Central and Eastern Europe who have been hardest hit by the recession, there was in the end no agreement on any such assistance package. The chief opponents of this kind of joint assistance plan were in fact Germany and France, the EU's most powerful members. And although the situation in the east of Europe is perilous to the economic stability of the entire Union, France and Germany are unwilling at this moment to bear the cost of financial aid to other countries, but rather consider fighting recession within their own borders a priority. That is why these two countries have already begun introducing various measures limiting access to their markets or, contrary to current EU rules, providing direct assistance to their companies.

This brand of economic protectionism could in the future result in significant political changes in the European Union. If the recession does last, it can be expected that a growing number of European states will begin to introduce these measures, and with that kind of policy it is hard to believe that the European Union, a community founded on the idea of a common free market and the equality of big and small countries and nations, can function. Jyoti Gupta, an Indian economist who has worked for years as a consultant for some of the best known global financial and political institutions such as the World Bank and the European Commission, is now a lecturer at the ESCP-EAP business school in London and Paris, and is a frequent guest lecturer in other countries, including Croatia, where he lectures at the Cotrugli Business Academy in Zagreb. Gupta feels that we can expect a significant rise in protectionism in Europe, one in which large European states will dominate.

"Every European country has its own problems at this point in time, and based on that its own specific political plan. The governments of the big countries such as Germany, France and Britain have judged at this moment that, if they wish to stay in power, they must first address the problems in their own countries. The chief goal of every government is to try to save as many jobs as they can, and to do so governments are trying to use political measures to protect domestic companies and the domestic economy. I think that it is quite unrealistic at this point in time to expect European countries to act in concert on these issues, especially if it concerns assistance to sectors of the economy that employ many people and where there is a significant possibility of a massive rise in unemployment. The governments of these countries are very much aware that these measures are not in line with current rules, but it appears to me that they believe that at this point in time that they have no choice," said Gupta.

It is not difficult to understand why the heads of the large European countries wish at this point in time to protect domestic industry. France, Germany and Italy are now faced with the greatest economic duress in decades, and the situation could soon become much worse. Germany is the economically most powerful country in Europe, but the fact that this country generates as much as 50 percent of its GDP via exports now appears to be a problem. The recession has caused a drop in the purchasing power of most of the markets German companies exported to and that is currently Germany's biggest problem. As early as by the last quarter of 2008 industrial production in Germany had fallen by 6.8 percent, the greatest single quarterly drop since 1965. In this kind of situation the German government expects a negative economic growth of 3 percent, a drop in the GDP of 2.25 percent and at least 500 thousand job losses. Nevertheless, many economists say that these forecasts are overly optimistic and that the consequences of the recession in Germany will be much worse. Norbert Walter, the chief economist at Deutsche Bank, recently said that the drop in the German GDP in 2009 would be at least 5 percent, perhaps more. Angela Merkel's government has already approved two assistance packages to German companies and banks worth 62 billion euro, but as these funds have proven inadequate, that government is preparing a third assistance package worth as much as 100 billion euro, of which companies will be able to access 75 billion in the form of state guarantees, and the rest as direct loans. These huge aid packages are a massive strain on the state treasury. That is why it is no wonder that Angela Merkel is not now disposed to putting aside further tens of billions of euro to bail out Eastern European countries.

It is much the same in France. French President Nicolas Sarkozy, who claimed during his election campaign that he would eliminate the budget deficit by 2010, is now faced with a series of requests for help from big French firms. Sarkozy has introduced the issue of state guarantees for private company loans, and set up a 26 billion euro economic assistance fund. The effect of this is, however, a growth in the French budget deficit, which will amount in 2009 to as much as 109 billion euro, that is to say 5.6 percent of the GDP. No Eurozone member state is allowed to have a budget deficit in excess of 3 percent, but it is clear now that France will this year fail to meet this criteria. Nevertheless, in spite of Sarkozy's measures analysts forecast that France will see a drop in its GDP of 2.3 percent in 2009, and a significant drop in industrial production, as a result of which some 170 thousand French citizens could find themselves out of work in the coming six months. Considering that the automobile industry is a part of the economy with which tens of thousands of jobs are linked, it is no wonder that Sarkozy has paid out 5 billion euro in state aid to the French companies in the sector, under the condition that they keep their production in France, to the detriment of their factories in Slovakia and elsewhere.

Drago Jakovcevic, a professor at the Faculty of Economics in Zagreb, feels that the policies currently being led by France and Germany are proof of the failure of the economic model on which the European Union was based. "The crisis is hitting the very foundations of the European Union's economic system and it will have to be changed radically. This is the downfall of the neoliberal model, which paid no heed to basic economic values and has therefore collapsed. It was based on the expansion of multinational companies and the allocation of capital to countries in which labour and natural resources were cheap. This worked well, because it was in the interest of these countries to finance their development with the help of foreign capital. But this destroyed manufacturing in developed countries. Now this is a significant problem, and since the European Union never had a common fiscal policy, it is clear that countries now want to independently protect their economies and preserve manufacturing. Why should France give money to develop the automobile industry in Slovakia or the Czech Republic, only to then import automobiles from there and thereby worsen their own foreign trade balance. This growth of economic protectionism is sure to bring about serious debate on the future of the monetary union."

Most of the debate on the possible break-up of the monetary union has been centred in Italy. And while that country has been through four recessions in the past ten years, the current economic situation is the worst since 1975. Just in the last quarter of 2008 Italian production fell by 2.1 percent, with a negative economic growth of 1.8 percent. Nevertheless, in spite of these poor indicators the government led by Silvio Berlusconi only approved a relatively modest 2 billion euro for stimulation measures to get the economy going and to assist large companies. The problem is that Italy has for years led a very disorderly fiscal policy, which led to a strong growth of the public debt, which currently stands at 103 percent of the GDP. This is why the Italian government does not at this moment in time have at its disposal sufficient funds to help its economy.

An additional problem for Italy is that its large banking groups such as Unicredito and Banca Intesa have for years led a very expansive business policy. They undertook a vigorous expansion of their operations in Eastern European countries, and are now quite sensitive to the problems the recession has caused in these states. Italian economists fear a scenario in which the collapse of a daughter bank company abroad would bring about the instability of the Italian banking system. That is why the state should help the banks maintain their liquidity, but since they lack the money needed to do so, some radical Italian economists have begun to advocate the idea that Italy reject the euro and once again introduce their own national currency. If Italy were to have its own currency, like Britain does, it could print enough money to bail out its economy. It is, however, hard to believe at this juncture that Italy would actually leave the monetary union, but just the idea of publicly debating the possibility was once unthinkable.

This is yet another proof that in these conditions of recession the heads of European states are expressing more and more unhappiness with the way the European Union functions. Nouriel Roubini, a Turkish economist, is a professor at the University of New York's Stern business school. Roubini is now one of the most esteemed economists in the world, and has earned this status largely by being the first to foresee that the situation on the US real estate market would grow into a global financial crisis. Roubini feels that this recession is the first real test of the strength of the Eurozone. "I think that it is not at this moment certain that the Eurozone will fall apart, but the likelihood that this will come to pass is greater with each passing day. The situation in Europe is such that many countries have banking systems too large to fail, but to big to salvage. If the systems in Ireland and Greece collapse, it is likely that Germany or France will bail them out, because the opposite would mean the collapse of the Eurozone. But the problem is if along with them help is required for Austria and Italy, Spain and Portugal or Belgium and the Netherlands. I think that helping them all will not be possible," he said.

Still, in a situation when it will not be possible to provide assistance to everyone, many European economists feel that the key is in the stabilisation of the economic situations in the countries of Central and Eastern Europe. The countries in this region have for years based their development precisely on the foreign capital that has been invested into the region by large Western European banks.

The Austrian banks alone have invested about 224 billion euro there. This figure amounts to about 78 percent of the Austrian GDP and Austrians are now fearful that a recession could see many of these claims go into default. That would probably cause a collapse of the financial system in Austria. It is much the same in Italy, and there are significant outstanding debts in Eastern Europe held by banks from Germany, Belgium and France. The collection of these claims is currently most uncertain in Ukraine, Hungary, the Baltic states, Romania and Bulgaria. Most of these countries have already received help from the International Monetary Fund, but these funds were not enough to stabilise the situation and secure liquidity on the financial market.

<!-- @page { margin: 2cm } P { margin-bottom: 0.21cm } -->

That is why many feel that the European Union should secure an assistance fund for these countries of between 150 and 200 billion euro and thereby prevent the spread of the crisis to the countries of the Eurozone. The chef opponent of this idea is German Chancellor Angela Merkel, who is insisting that aid to each country be defined on an individual basis. US economist and Nobel Prize winner Paul Krugman feels that this approach could be very harmful. "The decision of European leaders to reject the idea of a joint plan to help the countries of Eastern Europe, and to instead to provide aid to each country individually will only result in the significant slowing of the distribution of the necessary funds. That will not succeed in stopping the negative recessionary trend," commented Krugman. Krugman's concern is understandable if one knows that the recession has yet to hit Poland, the Czech Republic and Slovakia, three important member states, on a large scale. So far they are resisting the crisis above all because they have built up significant industrial production over the past decade. The economies of the Czech Republic and of Slovakia are based on exports and it can be expected that a drop in purchasing power in the European Union could soon cause serious problems for them too, while Poland is in a somewhat better situation because, as a country of 40 million inhabitants, it is a self-sufficient market.

<!-- @page { margin: 2cm } P { margin-bottom: 0.21cm } -->

Another advantage for Poland is that since acceding to the EU almost a million people have emigrated to other Union countries. This massive Diaspora has resulted in a constant flow of euro to Poland, which has had a positive effect on the Polish financial market. Nevertheless, it is presumed that a drop in economic activity in developed European countries will mean a large number of Polish immigrants will find themselves out of a job and will have to return to Poland. So although the economic situations in Poland, Slovakia and the Czech Republic are relatively stable, it can be expected that in the coming period these nations too will face significant difficulties. Many analysts feel that it would be fatal if the crisis in the financial systems of Eastern Europe were also to spill over into these countries, and that it is therefore crucial that the European Union acts as soon as possible. Nonetheless, even though this kind of negative scenario is very possible, the large member states of the European Union are at this moment not ready to finance assistance to Eastern Europe. That is why many feel that the economic recession could further deepen the differences and disagreements that exist between the members of the EU.

William Montgomery, a former US diplomat and ambassador to Croatia, is well acquainted with the political situation in Europe. He feels that the economic crisis only underscores the problems the European Union has been suffering from for years. "Even before the crisis started the European Union was faced with a number of challenges and open questions. The most important is the uncertainty concerning the future development of the Union, where some countries advocate a firm unitary community, while others seek a greater level of autonomy for the member states. Already then opinion polls have recorded a significant drop in the popularity of the Union among its inhabitants. If there was a greater level of agreement in the European Union on these key issues, the European countries would certainly get over the recession easier. But that is not the case, the problems existed before the recession – the large differences between the older, more developed, and the newer, less developed, member states were very evident and that is why it can be concluded that the crisis has hit the European Union at the worst possible moment. Today in the developed member states there truly is a growing resistance to the idea that they should finance the recovery of other countries; not just of the new members, but also of the older ones such as Greece. The deeper the recession goes and the longer it lasts, the greater the challenges the European Union will face."

It is quite evident that the economic woes have already begun to serve as triggers for political quarrels. French President Nicolas Sarkozy is the current frontrunner in these, who has over the past months on several occasions had sharp criticism for the Czech Republic, which at the beginning of the year took over the rotating presidency of the European Union. Sarkozy on several occasions stated that Europe should be much more engaged in conditions of global recession, and by doing so indirectly accused Czech politicians of being inactive. The Czechs responded in kind, accusing Sarkozy of promoting protectionism through his measures to help the French automobile industry, and by doing so undermining the Lisbon Agreement.

The culmination of the conflict took place at the EU summit in Brussels, where the Czech's accused DRAGO JAKOVCEVIC, a professor at Zagreb's Faculty of EconomicsSarkozy of presenting the summit as his own initiative in the public, even though it was initiated and organised by the Czech Republic. In the media this conflict has been interpreted for the most part through the prism of the personal antagonism between Sarkozy and the euro-sceptic Czech President Vaclav Klaus, but the more likely reason is the unhappiness of the French with the way the Union is now functioning. The French feel that the administration of the Union should be assumed by the large states in moments of crisis, which will also bear the greatest cost of financial recovery. This French position is tacitly supported by Germany, and by some other large Union member states. If these countries do in fact decide to seek changes in the internal structure of the Union, it can be assumed that they will find stiff resistance from a number of the smaller countries. Political analysts feel that the Union could in the future bring under consideration the fundamental system of decision-making in the European Union, which is based on a consensus.

William Montgomery feels that this system is unsustainable on the long term. "A decision-making system based on consensus is unsustainable on the long term, both in the European Union and in NATO. But I think that an even greater problem for the Union is that it lacks a mechanism to control the behaviour of its member states. Take, for example, what is currently happening to Croatia. Slovenia previously promised the European Union that it would not allow border issues to affect Croatian accession to the European Union. Today it is doing precisely that, and the Union has no way to make it respect what it previously promised. I think that is a big problem," he commented.

In this situation it is to be expected that, if the crisis persists, the popularity of the Union will fall significantly among its inhabitants. There are already worrisome trends in public opinion. The extreme right-wing Dutch politician Gert Wilders recently said he would launch an initiative to chuck Bulgaria and Romania out of the Union, and opinion polls showed that Wilders' initiative is supported by 16 percent of the Dutch. On the other hand the opinion Bulgarians have of the European Union is not much better, and most of them feel that only politicians and criminals have benefited from accession to the EU.

This opinion of the EU, in Bulgaria, but also in the other new member states, is likely to get even worse if the Union continues to refuse them financial assistance in the crisis. Just in the second half of last year the Eurobarometer, the official statistics of the European Union, recorded a 3 percent drop in the popularity of the European Union. In 17 member states fewer than 50 percent of the population have a positive opinion of the European Union. It can be assumed that in the new statistical report, to be published in June, the popularity of the Union will be even lower. That is why many feel that the crisis could threaten the future of the community.

Nevertheless, Jyoti Gupta says that the European Union is sure to survive because it has no alternative. "In spite of the short term emergence of protectionism, I think that the large European countries have become aware that they have to help Eastern Europe, as the countries of the region are after all, on the long term, important markets for their companies. These countries still have a great deal of room for development, especially the development of infrastructure, and that is good for investment. That is why I feel that the European Union will survive in the long run. This crisis will result in a new world order in which some new economic powers will be affirmed, starting with China and India. On their own none of the large European countries will be an important global player on their own. I think that the leaders of the European countries are aware of that."

<!-- @page { margin: 2cm } H2 { margin-top: 0.49cm; margin-bottom: 0.49cm; page-break-after: auto } H2.western { font-family: "Times New Roman", serif; so-language: hr-HR } H2.cjk { font-family: "Lucida Sans Unicode" } H2.ctl { font-family: "Tahoma" } P { margin-bottom: 0.21cm } -->

And while it is certain that the European Union will survive this crisis, it is very possible that it will undergo significant changes to its structure and to the way it functions. This possibility is now a significant problem for Croatia. In its accession negotiations with the European Union, Croatia is implementing many reforms, many of which are very exacting. In the process Croatia is giving up some of its significant economic resources, even entire sectors of the economy such as shipbuilding. And while these reforms are now felt to be acceptable, because they will result in greater benefit after accession to the Union, changes within the EU could threaten this calculation.

Drago Jakovcevic feels that Croatia has to start implementing reforms for its own benefit, not the Union's. "Croatia has to start with rational reforms in which it will look only to its own interests. And these interests are a growth in production and expansion to new export markets. It is illusory to think that our salvation is in exporting to the markets of the European Union, and I feel that we should strengthen our exports to the East. Today we do not know what the European Union will look like when we accede to it, and we should behave accordingly. Those who advocate accession to the European Union immediately and at all costs yesterday claimed that we need to copy the policies of the Baltic states, which are now on the brink of collapse. We need, therefore to look to securing long term sustainability with or without the European Union," he said.

It is easy to understand Jakovcevic's position, because it is certain that Croatia will not accede to the European Union before 2012. But Croatia is negotiating on its accession now, and by the time it happens the Union may have changed significantly. Croatian negotiators will soon be negotiating on measures in agriculture. In that sector Croatia will probably have to make significant limitations in the production of some agricultural products. This paid off for the current members because they began receiving large agricultural subsidies after acceding to the Union, which helped them develop their agricultural sector. But what if these subsidies are reduced in the future.

Still, it is difficult to believe at this point in time that the Government will abandon the European reforms that have been started. Montgomery says that it is a very tough political decision. "Croatia is now very close to the European Union and that is why it is clear that any change of policy would be a very difficult decision for the government, but on the other hand, and considering the Slovenian blockade, it is my opinion that the Prime Minister, before he agrees to implement any reform that will result in a loss of jobs or any other unpopular measure, must demand that the EU gives a guarantee on the date of accession to the Union."