The document, a precursor to the manifesto for the European parliamentary elections on 9 June, insists that gradual moves towards integrated European Union armed forces should not commit UK troops to combat without the go- ahead of the British Government.
The U-turn on cuts will help to boost the party's chances of capturing up to five European seats in south-west England, which is heavily dependent on defence.
The paper, Making Europe Work For Us, reflects a 1991 warning from Menzies Campbell, Liberal Democrat defence spokesman, that the 'crude' 50 per cent reduction was not supportable in the light of post- Cold War European instability.
The party calls for a comprehensive review of UK defence policy 'set in the context of an evolving common European security policy and dictated by a rigorous analysis of defence needs. We anticipate that this will highlight the need substantially to reshape the UK's armed forces, which will have cost implications.' The moves are calculated to limit Tory accusations that Liberal Democrat policies would risk jobs and help to pave the way for the creation of a 'Euro-army'.
Elsewhere, the paper says that in a 'democratic, decentralised and diverse' European Union, legislative decisions of the Council of Ministers 'must, as a basic principle, be taken in the open and by majority voting' - a view strongly opposed by the Government and most Tory MPs. On defence, however, while integration might eventually lead to nations specialising in air defence or armour, 'UK forces would not be sent into combat without the consent of the British Government'.
Malcolm Rifkind, Secretary of State for Defence, said the policy was a mess. 'Do they want integrated armed forces, with no 'single-nation veto' or to keep national control? They cannot have both.'
The paper signals a retreat to a more pragmatic line on the central themes of the Maastricht treaty. It has not shifted from the 1992 election manifesto definition of 'federalism' as a decentralised Europe in which power is exercised at the lowest possible level.
But it says European institutions must find a new way of working that concentrates their efforts on the 'limited number of big issues that really matter and where only they can influence and act'.
Paddy Ashdown, the Liberal Democrat leader, said the party would exploit two images. 'The first is of the Channel Tunnel . . . connected on the French side with a high-speed modern rail link. On the British side, it is connected with a ramshackle under-invested system as far as London and will benefit nobody beyond that.
'The second image is of Sarajevo. If you will not have the kind of co- ordinated European foreign policy and defence that we want, and that seems a logical conclusion to the Maastricht process, then more and more the spectacle of Sarajevo will be one we will have to cope with.'
Economically, the paper endorses the 'eventual' aim of a single currency and the pledge to end Britain's opt-out from the social chapter, but the creation of 'worthwhile, productive jobs' for Europe's 19 million unemployed is listed as the first priority.
Tax increases are implicit in the paper's formula for greater prosperity through low interest rates and investment. 'This means reducing unsustainable budget deficits - but by raising revenue, targeting expenditure on job creation and eliminating waste, not by cutting back on essential public investment, as the Conservatives now plan.'
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