The German debt blindspot in the European crisis

The postwar German debt experience should inform a spirit of co-operation and goodwill today.

Never before has Europe confronted such a ‘Great Lockdown’, likely resulting in a recession far worse than the global financial crisis of 2008. Germany and the Netherlands refuse to support guaranteed European Union funds to assist the most stricken southern European countries coping with the human and economic consequences.

The French president, Emmanuel Macron, has warned that the EU could collapse if countries continue to block joint support with common guarantees. The populist anger in Italy, Spain and even France could well put such parties into power at the next elections.   

True, northern European countries have offered aid. But they have shown little joint financial solidarity with Italy and Spain, arguing that their taxpayers would thereby be rendered liable for other countries’ borrowing.

London agreement

It is ironic, at this moment of extensive human suffering across southern Europe, to remind Germany of the support it received in the 1953 London Agreement of German External Debts. Only eight years after the atrocities Germany had inflicted upon the whole European continent and beyond, many of today’s most afflicted countries—such as Spain, Italy, Greece and France—were among the 20 signatories to help restore West Germany’s debt sustainability and economic growth.

The agreement relieved the country of about 50 per cent of its total external debt (30 billion Deutschmarks, including debt from World War I). The debt relief represented roughly 10 per cent of West Germany’s gross domestic product in 1953, or 80 per cent of its export earnings that year. In combination with the Marshall plan, the debt forgiveness helped Germany regain access to capital markets and realise its subsequent Wirtschaftswunder. 

Encompassing the totality of external debt obligations and explicitly rejecting austerity, the agreement permitted West Germany a fresh start for the economy. Josef Abs, the head of the German delegation, who later became chair of Deutsche Bank, refused to accept austerity and structural reforms. Instead, the debts would be paid out of Germany’s current trade surplus, which was made possible by the undervaluation of Germany’s currency. 

Co-operation and goodwill

The mechanics of the London debt agreement are not an explicit model for the present discussion on the mutualisation of EU debts—it is the spirit of co-operation and goodwill to integrate Germany into the international community that counts. The agreement gave Germany the fiscal space for public investment and in addition lowered the cost of borrowing. What is missing today is the spirit that was the basis of success then. 

Germany and the Netherlands, the two EU countries carrying the largest surpluses on their current accounts, oppose ‘corona bonds’ as a joint instrument to finance the staggering health and economic costs of the pandemic. The most egregious denial of fiscal solidarity with southern-European countries came when the Dutch finance minister, Wopke Hoekstra, declared to reporters after the online Eurogroup meeting of euro-area finance ministers on April 9th: ‘Eurobonds is a thing I wasn’t okay with, I am not OK and I will never be OK with.’ In citing the danger of ‘moral hazard’, Hoekstra defended strict application of the no bail-out clause of the Maastricht treaty of 1992, which states that fiscal misconduct should not be rewarded by jointly assuming individual risks. 

In the German Große Koalition, the Christian-democrat chancellor, Angela Merkel, is fully in line with the liability argument rejecting ‘corona bonds’, backed by her Bavarian Christian Social Union sister party and the German business class. In her speech to the nation on March 18th on the pandemic—a rarity in her 15-year reign outside her New Year’s Day address—Merkel invoked history and solidarity. Missing, however, was any reference to ‘Europe’. 

Less strident

The German narrative is starting to become less strident, though. Olaf Scholz, the finance minister, initially arrogantly claimed that Germany’s frugal fiscal management had now made it possible to have more flexibility and provide the necessary ‘bazooka’ for the German economy. Yet Scholz did not back the Dutch position at the Eurogroup meeting. Instead, in tandem with the French finance minister, Bruno Le Maire, he mediated a compromise between the Dutch and Italian opposing positions. The difference on debt mutualisation however remains.    

Equally important was the media offensive by Scholz and Heiko Maas, Germany’s foreign minister, both members of the social-democratic SPD. They reached out to citizens in southern-European daily newspapers—in French, Spanish, Italian, Greek, Portuguese—to alleviate fears and guarantee German solidarity without austerity measures.   

Judging from many articles in the press internationally, German economists are not counted among the most progressive. True to this impression, in a special report in March the German Council of Economic Experts suggested many options for cushioning the economic impact of Covid-19 but did not recommend a mutualisation of debt.

Narrowing of positions

Yet a narrowing of positions between Michael Hüther of the neoclassical German Institute (IW) and Sebastian Dullien of the Keynesian Macroeconomic Policy Institute (IMK) had begun before the coronavirus crisis. Co-operating for the first time, in a March paper they called on the German government to increase badly-neglected public investment domestically by €450 billion over the next ten years. 

Building on such co-operation, at the end of last month seven leading German economists proposed ‘European crisis bonds’ amounting to €1 trillion. Under the heading of ‘To avoid economic disaster, Europe must demonstrate financial solidarity’, they cited the great danger of a demand and a supply shock.

Such bonds, with shared liability, should function as a one-off measure, they said, as with the Community Bond issued during the 1974 oil crisis. But the economists warned: ‘The longer the coronavirus crisis goes on and the greater the economic impact, the more obvious the existing differences in the fiscal capacity of countries will become. This would disunite Europe—at a time when it must stand together.’