Towards a post-German Europe
Beyond the exceptional circumstances of the crisis, Europe cannot continue to be run from a single power centre. Much of the point of European integration has always been about creating a balance between the member states – constrain the strongest and empower the weakest. Given its status as the largest advanced economy with a top credit rating, the crisis has naturally elevated Germany to the position of the dominant power in Europe. This has led to massive resistance, also beyond the troubled countries of the European South. The foreign minister of neighbouring Luxembourg has cried out that „Germany does not have the right to decide the economic model for other states“.
The essence of the way in which Germany flexes its muscles today lies in its belief that other Europeans can adopt the German culture of economic stability and fiscal prudence while undertaking structural reforms. The philosophy draws on Germany’s own experience in the last two decades with a post-reunification boom 1990 – 1995, followed by a tightening of monetary policy and painful structural reforms under the Agenda 2010 programme. Even when accepting the wisdom of Germany’s economic proposition for Europe, the question remains whether the transition mechanism of this policy can be made to work.
The challenge is a deep-rooted one. The single European currency has proved to be a political time-bomb, creating the illusion of equality and relevance among the member states, regardless of their economic fundamentals. What is worse, it has made countries dormant as they enjoyed emphemeral benefits of capital inflows, irrespective of the use to which they were put. Political systems became ossified as the fruits of growth were used to build extensive networks of privilege. The root causes of this situation still await to be addressed.
Germany in the meantime, has been through two decades of political and economic re-engineering. The culture of stability was sanctified through fiscal consolidation in the years 2003 – 2007, accompanied by labour market reforms. The annual fiscal tightening of 0.65 percent annually in Germany was nowhere near the Greek figure of 4.5 in the three years prior to 2012 as it was performed in a much more conducive economic context. The experience of reunification made fiscal transfers an unattractive political proposition. Finally, the European crisis provided a powerful political boost to the current government, creating a frame of reference which glorified the German model. As they look beyond the corner at the fortunes of other European nations, most Germans end up applauding Chancellor Merkel and her team.
The period of legitimacy by crisis which the government in Berlin has practiced since the peak of the Greek tensions in 2010 is nevertheless over as the slowdown comes to affect Germany itself. Chancellor Merkel might be comfortably re-elected in September but her legacy will rest not only on saving Europe from the abyss but on whether she will manage to put in place ingredients for a refashioned political system and sustainable economic model in Europe.
Germany claims to be a benevolent hegemon. Its plan is to enforce its economic culture across the continent based on wage moderation and fiscal responsiblity. In that, it is resigned to the fact that Europe’s renewal will take time. If the Schröder reforms required about six years to be implemented, at least as much is needed for the Southern European countries to stand on their feet.
The other Europeans are not unconvinced by the virtues of structural reform. Their concern is of more existential nature. They perceive reforms to be a luxury when what they have to do is to fight for economic survival and defend the basic legitimacy of their governments threatened by popular angst and rising extremism. The record of countries on which painful therapies have been imposed by means of the rescue programmes is in no way appealing. In such circumstances, a careful balancing act between a minimum of structural change and a desperate preservation of the remnants of socio-economic cohesion becomes by default the strategy of choice from Paris through Madrid onto Rome. The rhetorical battle around austerity is a way through which these tensions are expressed. The more it is absorbing, the more futile the debate becomes for working out an effective way out of the crisis. Not because it is unimportant but because it crowds out the political space for the most important compromise which Europe desperately needs – that between a long-term strategic perspective and painful economic reform.
As it prepares for this autumn’s parliamentary elections, Germany should for its own sake think intensively about a European arrangement in which it would no longer be a hegemonic power. A prolonged slump in the rest of Europe is beginning to weigh heavily on Germany’s growth. The country successfully replaced demand from Southern Europe with that coming from emerging powers, especially China, at an earlier stage of the crisis. However, with the Chinese growth faltering, the weakness of the European demand for German goods begins to hurt more than ever.
Among the possible scenarios, one stands out as offering the best chance for building a post-German Europe, that is a Europe in which Germany engages in a power-sharing exercise with other actors. This scenario starts with a Franco-German compromise about the economic strategy for the next five years – the worst of the crisis and beyond. Its relevance has less to do with the pivotal significance of the relationship between Berlin and Paris. The latter may well become a hindrance, leading Paris to overvalue the cards it holds in its hands. More important is the critical mass of both the economies and the role of France in the tipping of the scales of economic policy in Europe.
Core of the core
In this first scenario, Berlin comes to an understanding that the only qualitative difference to the current power arrangement can come from a Big Deal with France, the second largest eurozone economy and the tradional „mover and shaker“ of EU integration. All macroeconomic parameters indicate that France is almost exactly in-between Germany and Southern Europe. President Hollande has so far been a big disappointment for the French and the Germans alike but Berlin could be willing to give him the benefit of the doubt. Some German officials admit that turning towards Paris would reflect Berlin’s growing isolation and be a „strategy of last resort“. Germany has by now realised its lack of interlocutors in Europe can give it moral satisfaction but nothing else. „Where are our allies?“ – asks one German official. This nevertheless makes a compromise all the more likely. France would need to commit to genuinely introduce the German stability culture and structural reforms while Germany would have to flash a green light for a softer fiscal consolidation pattern, more investment and spending to come both through the European Investment Bank and some fiscal transfers, styled after the recent Youth Employment Initiative. Should Germany and France be able to agree a five-year economic strategy, this type of scenario would help bring about a breakthrough in the European crisis.
Alliances of faith
Should a new arrangement with France fail to work out, Germany will be left entertaining its small group of allies among the most credit-worthy countries which may no longer be as united as in the most difficult phase of the crisis. The dynamics of the Dutch political debate in particular unveils some genuine tensions when it comes to the pace and structure of fiscal consolidation. Berlin will then be left searching for allies elsewhere, including in the UK and Poland. Membership in the eurozone will become secondary to the faultlines of faith. This scenario offers no immediate prospect of providing a lasting solution to the eurozone problems. However, in the longer-term it can help the „hard way“ to tilt the balance in favour of the German stability culture. Its political and economic costs will be substantial and the results far from guaranteed.
The „more of the same“ scenario is the one in which deflation in the South of Europe is not overcome within the next 2-5 years while Germany itself loses its growth dynamics and becomes gradually embroiled in the blame-game unleashed by the discontent of its own population. Even Berlin’s own allies could turn against it. In this scenario, structural reforms in Southern European countries become hostages of the growing distrust of societies towards their political elites and the elites themselves towards Berlin and Brussels. German competitive advantages weaken as both the structural problems come to the fore with worsening demographics and lack of liberalisation of the services market while labour costs increase. In a glimpse of what is in stock, the head of Germany’s National Agency for Employment has warned recently that more immigrant workers will be needed to boost the economy and look after the ageing population.
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When Chancellor Merkel reacted angrily a couple of weeks ago that austerity is „not a German concept“, she was both right and wrong. She was right because German government consumption has expanded at an annual average rate of 2 percent in the period of the last five years. German wages are rising. The public sector trade union Ver.di negotiated a two-year wage deal with 2.65 percent wage rises in 2013 and 2.95 percent increases in 2014. However, the German government remains terrified about the prospect of the loss of its hard-won fiscal and financial discipline in Europe which ushered in the small stabilisation which Europe is now benefiting from. This is what the German Finance Minister Wolfgang Schäuble has in mind when he reacts with frustration at some capitals‘ attempts to bury „austerity“ once and for all.
On the basis of its economic experience in the last decade, Germany is entirely convinced that it has seen the light of the day and the others have to follow suit. Its labour market reforms, which began in 2004, created, through the rise in jobs and taxes, sufficient fiscal space for more government spending without endangering the balanced budget objective. Having learned from a real estate bubble in the aftermath of the country‘s reunification, Berlin has also worked hard to install a sense of prudence in the economy. At the same time, by far not all the Germans would agree that the labour market reforms have done miracles. Schemes which were meant to help companies move some of their labour force to temporary employment have been used with a vangeance, creating a huge pool of underutilised and underpaid workers. This would never be discussed, however, with Germany’s European partners.
Although politically committed to saving the euro, Germany fears that its unconditional support could prove counterproductive by animating what Berlin sees as the real beast of the European situation – moral hazard. But the argument has a double-edged sword. When Germany refrains from offering support, as it does now with the single resolution mechanism for the banking sector, a key component of the banking union, the others are not inclined to pursue deeper reforms fearing that at the end of the day, their businesses will still be less privileged through more expensive credit lines. There is nothing short of a grand deal that can put the European recovery plans on a firm footing.
How should such a deal be organised? It clearly needs to have two elements – one relating to policy and the other one to the institutions and procedures. Not everything will be cast in stone, however much the Germans would like to see that. The political room for manoeuvre needs to be preserved, as evidenced by the discussion over decelerating pace of fiscal consolidation in the eurozone. The trade-off is the same as always in the European project – between coordination which on the surface looks good but does not work in practice and integration which people fear could open a new „Pandora’s box“ and become impossible to achieve. Substance-wise, the space to be covered remains enormous. It is like being in an enormous castle with each chamber leading to another one and another. The discussion on the single resolution mechanism shows this well – how does one put in place a procedure to close a bank if the competence that has to do with credit, insolvency, reposession or tax for non-performing loans rests with the member states? By trial and error, coordination will be tested in Europe and integration will replace it when the latter would fail. This process is nowhere near its end.
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As the German federal elections come closer, the country‘s decision-makers need to realise that they themselves also have to move beyond the „business-as-usual“ scenario. The window of opportunity to relaunch Europe will be short, since electorates will be asked to the polling stations in June for elections to the European Parliament. Retaining its position of a hesitant hegemon, Berlin will itself start sliding towards political and economic insecurity. This will in no way help Europe, nor will it help Germany.
In Europe, it is no longer the question of being right or wrong about economic policy. The solution lies in a new contractual arrangement between those with the means to anchor Europe’s recovery and those which can only pay back with actions on the ground. To generate trust and confidence which is needed to make it work, both sides need to plead guilty.
The answer to Europe’s future is no longer only a question of new treaties. They will not replace the power of pursuasion and political statecraft which needs to be found in Berlin but also in Paris and other capitals. There is a limit to what federal designs can achieve. If their intention is to limit the space for political choice, they will end in failure. There are signs that this is better and better understood in Germany and across Europe.