Undiplomatic Talk

Recently I was part of a international conference dedicated to ’50 Years of Israel-German Diplomatic Relations’, held at Hebrew University in Jerusalem. Rather the directly talking to the topic of the conference my task was to review Germany’s role in Europe by looking more closely on the Eurozone crisis. My talk was not very well received by some participants of the conference who are close to the Merkel government. For me this was another indication of German sensitivities when it comes to the Eurozone. It seems all about the written South and not at all about a functional analysis. Find my written text below.

Conference: “50 Years of German-Israeli Relations: Evaluating the Present, Envisioning the Future, Hebrew University, Jerusalem, March 8 -10, 2015

“Germany and the Future of the EU”

1. My talk will be about Germany and the EU. This may seem a bit besides the topic of our overall conference. And yet I hope that you accept my choice after my talk. The future of the EU is not only relevant for the member states but obviously also for a country like Israel. As we know in the meantime, Taken as an economic block, the EU is the largest trading partner of Israel. Germany then is the third largest trading partner of Israel after China and the US. Of all the EU members, Germany is the largest trading partner with a value of bilateral trade in goods and services of $ 6.5 billion in 2013. Israel holds rank 49 on the list of German trading partners. If we look at the trade balance surpluses of Germany, Israel ranks 27th. Israel and the EU have an association agreement that went into force in 2000. It seems to me that Israel can become an even more important partner for the EU in the future. However, this requires a strong and refocused EU that has the political and economic resources to get engaged in affairs beyond the Eurozone and other internal problems. My brief talk serves the purpose to analyze the situation of the Eurozone crisis, as I think the fate of the Eurozone tells a lot (but not all) about the future of European integration. Doing so, there is no way to avoid analyzing the key role of Germany in the crisis management of the Eurozone. It was late in 2011 when the pressure on the Eurozone was still increasing that Polish Foreign Minister Sikorski was stating that German inaction is more scarier then German action. This statement reflected very much the under-supply of leadership in the EU in a situation where the existing regime of economic governance was failing.

2. Today and after about two years of relative silence the Eurozone is – again – at a critical point in its brief history. The combination of low economic growth – deflation/disinflation and high unemployment across the Eurozone refers to deep-sitting endemic problems and at the same time constitutes a severe political problem. Five years of crisis management did not break the vicious circle, and it seems to me that it is legitimate to ask questions about the appropriateness of the type of crisis management that has been put in place. Even though we already had a longer lively and productive scholarly debate about the crisis management, it needed again Greece to move such a reflection on top of the EU agenda. The electoral victory of Syriza brought political dynamics back, and there is more then a slim chance that Grexit may happen when Greece runs into the next road block, and this may happen soon, as a matter of fact in the next few weeks or months.

3. It is well known that Germany is seen as the new dominator in Europe who uses the debt crisis to eventually achieve what was not successful a few decades ago, namely to create a German Europe. This perspective is widely spread across public opinions outside Germany and even in the world of scholars. Let me be clear about it, I think this is a ridiculous way to interpret Germany’s role in the Eurozone crisis. The various German governments since 2008 are not following a Master Plan to create a new German Empire. Rather then building a new Empire, so my argument, Germany tries to establish rules and norms to deal with the challenges. And yet, an argument can be made that Germany’s insistence of a particular crisis management reflects its deeply entrenched national policy preferences actually and at the same time risks to contribute to the economic woes of the Eurozone. This may be puzzling, and thus needs some explanation.

4. Let me start with the suggestion to differentiate between a dominant power and a hegemon. Germany often is described as the ‘reluctant’ hegemon, a notion that refers to the historically motivated reservations of Germany to act as a decisive leader in European affairs. If we accept the notion that a hegemon produces and maintained an international public good, is willing to carry its production costs, and designs the public good in a way that it includes interests of third parties, as was suggested by Charles Kindleberger in his analysis of the Great Depression of the 1930s, then Germany qualifies not as a hegemon. Rather, it acts on the base of national preferences as a dominant actor with veto power and the ability to shape the European agenda. It is unwilling (and not so much not reluctant) to produce the European public good, and thus to shoulder the costs of the production of this good. Let me support this statement with four arguments.

5. My first argument refers to the power of the economic narrative. The German narrative on the Eurozone crisis is that of an irresponsible spending spree of governments, and this narrative is very much fed by the case of Greece. As a matter of fact, of all the Eurozone economies who were running into sovereign debt crises it is only Greece that had a (too) high government debt in 2010. Spain and Ireland had public debt ratios much lower then Germany, and even Portugal had a not too high public debt ratio. The situation is different in Italy, but then again Italy anyway is a special case. Sovereign debt crises are not caused by irresponsible public debt build-ups but very much by private exuberance and the run off of financial systems. Those elements play an extremely small role in the German narrative, and this comes with the implication that the recipe has to deal with public austerity and supply side reforms. Chancellor Merkel and even more so Finance Minister Schaeuble turned to the ‘Schwaebische Hausfrau’ approach as the general remedy. Furthermore, rather then accepting that irresponsible private debt take up went obviously hand in hand with irresponsible credit hand-out of financial institutions, the strategy was to contain financial damages to the banks. This by the way explains why about three fourth of the public funds going to Greece immediately were used for debt service (interest and amortization). This strategy also downplayed the relatively high value of the public multiplier, i.e. each ‘austerity Euro’ came with a larger then one deletion of GDP.

6. My second argument states that Germany plays pre-dominantly to its national interests. This may be seen only as normal for a nation-state but actually can be counterproductive in a monetary union. The common currency created a common economic and overall monetary space where nation-states became sub-regions. In good times, the flaws of the governance regime were not posing a serious challenge. This changed when the Eurozone came into stormy weather. The attitude of ‘theirs’ and ‘ours’ had a strong revival, and again it was the Greek crisis where this attitude became a serious problem. Rather then dealing immediately with the liquidity crisis in 2010, German Chancellor Merkel – under the impression of an important regional election and with the headwinds of a s]at times hostile public – decided to procrastinate. As a matter of fact, the crisis management of the EU emerged extremely slowly – too less, too late – and took as guide to minimize costs for the creditors. There was never an attempt to produce a truly European public good.

7. My third argument deals with the German economic Angst. This is all about the fear that the ECB is overstepping its mandate, i.e. the mandate to identify and fight inflation. In contrast to other major central banks, the ECB was in all policy regards too late and too indecisive. This only changed in summer 2012 when Draghi made his ‘whatever it takes-‘ statement. German political representatives in the ECB made all efforts – until today – to hinder the ECB to act as a true lender of last resort. It is interesting that the resistance to a modified role of the ECB comes from many corners but that the government so far seems to accept the policies of the ECB. Actually, this should be an implicitness, given that the ECB is a politically independent institution. And yet, in the German debate the ECB became a highly politicized institution. Unlike in any other Eurozone member economy, in Germany the case of the mandate of the ECB was brought to the Supreme Court, and there is still the chance that the most recent QE may come under fire or even to a halt.

8. This leads me to my fourth argument. It is well known that financial crises and in particular balance sheet crises differ from regular business cycles downturns, and that they need much longer time periods until normalcy is re-achieved. The cases of the US and to some degree of the UK demonstrate that returning to a more promising growth path requires a fine-tuning of fiscal and monetary policies. Despite all austerity rhetoric even the British government was fiscally proactive. Fiscal policy and to some degree also monetary policy, as mentioned, differ in the Eurozone, and this goes back not least to the established crisis management put in place by the creditor camp and in particular by Germany. Germany insists on austerity, structural reforms and a turn towards export led-growth. At home, its main political agenda is the ‘black zero, and the coalition is not willing to make any use of the relative ample fiscal space that would allow Germany to act as a locomotive of the Eurozone.

9. What does this policy stance imply for the future? In regards to publicly hold debts, the EU under the leadership of Germany sticks to its strategy ‘EXTEND and PRETEND’. In its Fiscal Monitor from 2013 the IMF makes calculations about the primary surplus governments need to achieve if the target of a 60% debt share in 2030 should be achieved. Like all simulations this one relies too on projections and assumptions. Still, it is an interesting exercise that shows that the annual primary surplus is calculated for 5.6% for Ireland; 6.6 % for Italy; 5.9 % for Portugal; 4.0% for Spain, and 7.2% for Greece. Those are not figures for one year. Those are primary surpluses over a period of ten years, annually – 2020 – 2030. Eichengreen and Panizza analyzed a sample of 36 episodes with a primary surplus of 3.0% and more, and their results show that the probability of an annual primary surplus in the amount calculated by the IMF is extremely low. They can happen, though, but they rely on very specific conditions. My guess is that those requirements that were put into binding law cannot be fulfilled without serious political crises. In other words, we will see more of the same, in particular painful negotiations and fights about adjustments and policy changes.

10. The situation only can be improved if debtor economies are serious in their efforts to overcome the structural problems in their economies and simultaneously creditor countries are willing go the step of mutualization. This would require a fundamental change in the German crisis discourse, though.