What does the German Grand Coalition have to offer Europe? Not much.
I have been carefully reading and weighing all the commentary regarding Germany’s Große Koalition (or GroKo) agreement, and it’s clear that the coalition agreement can be read as a testament to the current state of German political and economic philosophy. Having waited a year for the results of Germany’s federal election, now we know what that bipartisan philosophy has to say to Spain, Italy, Greece and the other struggling eurozone states: “Call us only in an emergency. And even then, we will do as little as necessary.”
While that “muddling through” approach got Europe through the worst of the eurozone crisis, it will not be successful in building a vibrant Europe for the 21st century. Germany is forfeiting its leadership and sowing the seeds of a eurozone split because it has complacently affixed the future to its very flawed economic vision.
Initially during the economic crisis that was unleashed in 2008, Germany provided badly needed leadership. I praised Chancellor Angela Merkel (including in an article on the Social Europe Journal website) for projecting confidence and reassuring financial markets and the broader public. During the early chaos of the Greek default crisis and a fear of spiraling debt levels in 2010, Germany’s brand of austerity economics had its place, with its emphasis on debt consolidation as a way of steadying the boat in rocky seas, particularly in places like Italy and Greece which had run up sizable public debt even before the economic or eurozone crises (unlike Spain and Ireland, which had low public debt before its bank bailouts). Chancellor Merkel had a point in 2009, when she lectured President Barack Obama and other world leaders about the perils of a global economy that is built on “debt and speculative bubbles.” Merkel sounded practically like a Social Democrat when she declared that the era of US-style, Wall Street casino capitalism must end.
But in the aftermath of September’s election, it is all-too-clear now that the German long- and medium-term vision for Europe is shortsighted, rigid, and not grounded in basic economics. The recent coalition agreement between the CDU and SPD has done little to pivot and rechart the present precarious course, which has resulted in damaging levels of unemployment and miniscule growth in far too many member states. Germany’s insistence on policies focused exclusively on competitiveness, debt levels and inflation – otherwise known as “austerity” — has only led to deflation and even higher debt levels for many states. Much of Europe is stuck or going backwards, and Chancellor Merkel seems unaware or unconcerned about her policies’ longer term consequences and the north-south divide they are cleaving.
North vs. South trade war?
Northern European nations rely on large trade surpluses with southern Europe and the rest of the world to stimulate their economies. Germany’s trade surplus has averaged almost a whopping 6% of GDP over the last decade, but it’s not alone: Sweden’s has averaged 7% during the same period. Germany says “do as we do” to its eurozone partners, yet basic economics shows that not all countries can run trade surpluses at the same time. The world’s overall current account balances must ultimately sum up to zero because one country’s exports is another country’s imports; you cannot have one without the other. In a world of 7 billion people, with China, India, Brazil and others wanting their seat at the table, the price for huge trade imbalances has grown, not only on a global basis but within Europe. Yet there is no agreed-upon mechanism to ensure trade equilibrium between nations in the global system, or even among member states in the eurozone.
Consequently, while Germany, Sweden and others enjoy surpluses and enviable economies, other member states are suffering through an affliction of what has been called the “denominator effect”: the contraction of the economy as a result of a triple jolt of tight fiscal policy and tight credit as a way of reducing government deficits, combined with a punishing euro exchange rate which has made it difficult to increase exports outside the eurozone. This has forced Italy, Spain and the others to service a rising debt burden on a shrinking economic base, leading to a classic debt-deflation trap. Whatever were the initial benefits of budget consolidation and austerity as a way to steady the rickety ship, at this point continued German-led austerity is threatening to sink Europe’s fragile recovery.
The demands of a currency union
Certainly Merkel has a point, that governments cannot simply run up unlimited debt, especially when they share a currency with others. But there’s a flipside to that coin. In a currency union, it is inevitable that some member states will have greater trade surpluses and better-off economies than others, unless specific policies are adopted to even out the imbalances. Those policies can be trade based, to provide incentives for surplus countries to increase their imports from the deficit countries; or they can be redistributional, like in the United States, in which a transfer union ensures that the better-off member states subsidize the poorer member states.
But Germany is insisting on a third way for the eurozone to work – for deficit states to engage in massive and long-term internal devaluation as a way of lowering wages, slashing government stimulus spending, and boosting competitiveness and exports. It’s never been done before, and for good reason: because it doesn’t work. As was predicted by many economists, this has proven to be disastrous and economically unsound, and will be even more so going forward.
For example, even though Greece and Spain’s painful internal devaluation has resulted in a competitiveness gain of approximately 5% vis a vis Germany, the euro has appreciated 5% against the dollar and other international currencies. So the euro’s appreciation has wiped out most of the gains that would have allowed Greece and Spain to increase their exports outside the eurozone. With Germany declining to substantially boost its own eurozone imports, or to participate in a transfer union or debt sharing, increasingly the eurozone is becoming a losing proposition for many member states.
The history of monetary unions like the United States reveals that a successful eurozone will require an enhanced level of federalism and a merging of political and economic destinies to an extent that Germany and other northern European member states have sternly resisted. If Germany is to participate with others in a currency union, Germans must recognize that it will be a very long time – if ever – that member states like Greece, Portugal, Italy and Spain can be competitive with Germany. In the meantime, record unemployment and low growth are crippling them, and Germany’s “solutions” are making the problems worse.
At this point in the trajectory of the economic crisis, the alternatives to austerity are crystal clear. But what has been lacking is the political consensus and will to do what is necessary. Even the Social Democrats in Germany seem unwilling to take the next obvious steps. Thus, while all seems quiet at the moment, the eurozone in fact has reached a dangerous impasse in which some are doing OK while other states are suffering. As Germany celebrates a sense of having weathered the storm, for Spain, Portugal, Italy, Ireland and Greece – and now lately even the Netherlands — the crisis has never subsided.
Certainly some aspects of the coalition agreement, such as the introduction of the minimum wage and sectoral labor negotiations that could lead to higher wages, will allow a bit of reflation and a rise in German consumption that should boost imports a bit from the eurozone states. But the impact is likely to be insignificant. German economics professor Sebastian Dullien has estimated Germany’s domestic demand will receive an annual growth boost of a little more than 0.1 percentage points, which in turn will contribute to lowering Germany’s trade surplus by about 0.5% of GDP. “This might contribute to a rebalancing within the eurozone, but not by a decisive amount,” says Professor Dullien. “The German current account surplus will remain dangerously large.”
A Growth Bloc for Europe’s Future
For Spain, Italy, Portugal, Greece, Ireland, France, and now even the Netherlands, being locked into the “gold standard” of the euro along with a rigid and insular partner like Germany is increasingly a bad deal. Europe can’t afford to waste more time hoping Germany will change. A united bloc composed of France, Spain, Italy, Portugal, Greece, Ireland, Belgium and possibly the Netherlands needs to reject the current deflationary policies of Germany and band together to form a “Growth Bloc.” This bloc should announce a unilateral end to austerity and launch Japanese-style Abenomics for Europe. They should deploy their combined political power toward financing their fiscal deficits by using joint debt sharing and an expanded ECB mission, and by launching a full fiscal and monetary reflation strategy. This Growth Bloc would have over 220 million people – only four nations in the world would be more populous — and a near-majority of votes in the various European governing bodies, including the European Central Bank, the EU Council of Ministers, European Parliament and the European Investment Bank, which could be tapped for a Marshall Plan. The leadership for this effort must come from France, one of the two great engines of Europe. President Francois Hollande must confront Chancellor Merkel and give her an ultimatum: forge a grand reflation coalition to move Europe forward, or face the consequences.
Faced with a split of the eurozone, Germany would have little choice but to accept this strategy. Should the euro split apart, with one exchange rate in the north and one in the south, Germany’s exchange rate would double and its great export machine would suffer. German business leaders would pressure the government to make accommodations or face the prospect of this Growth Bloc exiting and redenominating, leaving Germany to carry on with the tatters of its failed policy. If it came to a split of the euro, that could be done while still maintaining the European Union, so it does not mean that Europe would shatter into pieces.
Europe is engaged in a high stakes poker game, yet so far only one side has been playing all the cards. A gap in the Franco-German alliance is growing. Already several French books have questioned Germany’s leadership, with finance professor Steve Ohana’s Désobéir pour sauver l’Europe calling on Germany to accept a change in the way monetary union is run, or to withdraw from EMU if it cannot accept the terms. Jacques Attali, previous head of the European Bank for Reconstruction and Development, has called Germany the real “sick man of Europe”, saying its low unemployment rate is a “joke” and a by-product of paying low-skilled workers such small wages, leading to the largest increase in inequality in Europe. Indeed, the proportion of the workforce earning less than 60% of the median wage is highest in Germany, as is the average pay gap between the highest and lowest paid (the coalition’s proposed minimum wage will narrow this, but by how much is uncertain).
Fellow Europeans have been patient with Germany, providing time for it to work through its various legal and political processes, including federal elections in September. But it’s clear now that will result in little change to the current predicament. Europe needs the right kind of leadership and, while there is much to admire about Germany, German leadership is the wrong kind for this important moment. Only a “Growth Bloc” kind of strategy, founded on reasonable degrees of sovereignty-sharing, will break the current impasse that is undermining Europe’s future.