Nightmare

CAMBRIDGE – Even before voters in the United Kingdom decided in June to “Brexit” the European Union, notes Anatole Kaletsky of Gavekal Dragonomics, German Chancellor Angela Merkel was widely credited with “finally answering Henry Kissinger’s famous question about the Western alliance: ‘What is the phone number for Europe?’”

Brexit merely confirmed the point: UK Prime Minister Theresa May’s first foreign trip after replacing David Cameron in July was to Berlin. If Merkel has the power to mold the relationship between the EU and the UK, as May appears to believe, she also has the power to shape the post-Brexit EU. 

The question is what type of Europe Germany wants. For Princeton University’s Harold James, “Brexit means Germany can no longer rely on its liberal, more market-oriented ally around the discussion table.” But Kaletsky wonders whether Germany wants to discuss much of anything at all. “If Europe’s phone number has a German dialing code,” he quips, “it goes through to an automated answer: ‘Nein zu Allem.’”

But Europe can no longer afford what Kaletsky describes as “the standard German response to all economic initiatives aimed at strengthening Europe.” As many Project Syndicate commentators point out, Europe’s global influence depends on further integration. And that is impossible without determined German leadership, which may now be hard to find. Indeed, with “public support for the government…” having “fallen below 50%,” Michael Bröning of the Friedrich-Ebert-Stiftung wonders if Merkel will even seek “reelection as her party’s candidate for another term.”

To understand what almost unchallenged German leadership in Europe could mean for the EU and the world requires a sober grasp of how Germans themselves view Europe and their role in it. And many Germans have come to consider the EU a burden, not a benefit; the other member states, they increasingly believe, want to squeeze ever more money out of them.

But the truth is that Germany has been one of the biggest winner over the past seven decades of European unification, both economically and politically. As Joschka Fischer, a former German foreign minister, put it in 2015, Germany restored its reputation after World War II by “embracing Western integration and Europeanization.” Because “Bismarck’s unification of Germany [occurred] in the nineteenth century,” he explains, “power became inextricably associated with nationalism and militarism.”

What Fischer calls “the foundation of the second, unified German nation-state in 1989” reflected and reinforced a very different mindset. For Anne-Marie Slaughter, President of New America and a former director of policy planning at the US State Department, today’s Germany accepts that increased power will require it to assume “greater responsibility to defend and extend” the international order from which it has benefited so greatly. She quotes German President Joachim Gauck: the post-World War II order gave rise to the “good Germany, the best we have ever known.” 

Yet Fischer fears that the lessons of European integration are being lost in the avalanche of crises that has hit the EU, with the Greek debt crisis catalyzing German disillusionment. In the fraught negotiations at the height of the crisis, he says, Germany “announced its desire to transform the eurozone from a European project into a kind of sphere of influence.” Germany no longer wanted “more Europe; it wanted less.”

Of course, the contrast between a “European Germany” and a “German Europe” is not new. In 2013, after Merkel was reelected, James noted that “independent German political units” have been disappearing ever since the 1648 Treaty of Westphalia. “If Germany’s new government leads the charge toward a stronger, more federal Europe,” he suggested, “a century from now, there may well be no sovereign German political unit at all. Germany and its lovers die in the end, only to live happily ever after.” 

Perhaps. In the meantime, Brexit, together with Merkel’s decision to admit more than a million migrants from Syria and elsewhere in the greater Middle East (partly to repair the reputational damage Germany suffered as a result of its stance toward Greece), has made Germany’s choice both clearer and more urgent. Germany can either regard Europe as a projection of German power politics, as it did in the first half of the twentieth century, or it can fulfill the post-1945 goal of self-dissolution into a truly European federal entity.

Immediate political factors aside, the question of Germany’s role in Europe stems from its economic dominance. During the eurozone crisis, many decried Germany’s current-account surplus, not Greek profligacy, as the true cause of the Union’s problems. But, as Harvard’s Kenneth Rogoff argues, “Germans view the maintenance of strong balance sheets as essential to their country’s stabilizing role in Europe.” Take one away, and you may be left without the other. 

Ironically, as Daniel Gros, Director of the Brussels-based Centre for European Policy Studies, reminds us, at the start of the century, it was Germany that was the sick man of Europe. “Its economy was mired in recession, while the rest of Europe was recovering; its unemployment rate was higher than the eurozone average; it was violating the European budget rules by running excessive deficits; and its financial system was in crisis.” Through austerity and structural reforms, Germany transformed itself. 

Little wonder, then, that Germans counsel others to follow their example. But, as Gros points out, this story is only half right. After all, Germany has gained little in terms of productivity. Marcel Fratzscher, formerly of the European Central Bank, together with Jürgen Fitschen of Deutsche Bank and Reiner Hoffmann of the Confederation of German Trade Unions, assert that a “key reason for this lackluster performance is Germany’s notoriously paltry investment rate, which is among the lowest in the OECD.” They note that, “since 1999, the largest German multinationals have doubled their employee headcounts abroad, while cutting jobs at home.”

The euro’s introduction certainly helped Germany regain some competitiveness, but Gros points to an often-overlooked factor: “persistently high unemployment forced workers to accept lower wages and longer working hours, while wages continued to increase by 2-3% per year in the eurozone’s booming peripheral countries.” German gains in competitiveness, then, are relative, and subsequently Germany has obliged Spain and Greece – but not Italy – to undertake reforms much harsher than those it ever imposed on itself. 

Many economists now urge Germany to boost wages and demand to help exporters in Greece and other countries on the eurozone periphery. German firms might complain, but Dalia Marin, Chair of International Economics at the University of Munich, thinks that the “most important factor behind Germany’s success” is not price competitiveness, but quality. Because “German exporters are organized in a way that is less hierarchical and more decentralized than other European firms,” she argues, “employees at lower levels of the corporate hierarchy” can “devise and implement new ideas.” And, because “these employees are often closer to customers than those higher up, their collective knowledge about what the market is demanding is an important source of value.”

But it is unclear that periphery countries would benefit from higher German demand. As Gros argued in 2013, Germany is “just the tip of a Teutonic iceberg.” Beneath the surface, “the Netherlands, Switzerland, Sweden, and Norway are all running surpluses that are larger as a proportion of GDP.” Given that Germany imports relatively little from the eurozone periphery, higher German demand would mainly benefit countries that already have large external surpluses.

Does this mean that the German growth model should be ignored – in Europe and elsewhere? Harvard’s Dani Rodrik notes that countries such as India and Turkey (as well as many in Africa and in the former Soviet bloc) have proved that growth can also be debt-led. And, as Gros points out, the “Teutonic” surplus is currently balanced by “Anglo-Saxon” dissaving: “Together, the sum of the current-account deficits of the United States, the United Kingdom, and major Commonwealth countries amounts to more than $800 billion, or roughly 60% of the global total of all external deficits.” This helps to explain Merkel’s eagerness to maintain a close trading partnership with the UK. 

The University of California at Berkeley’s Barry Eichengreen traces Germany’s deep-seated “ideological aversion to budget deficits” to “the post-World War II doctrine of ‘ordoliberalism,’” championed most effectively by Ludwig Erhard as German finance minister in the 1950s and Chancellor in the mid-1960s. According to Eichengreen, ordoliberalism, which “counseled that government should enforce contracts and ensure adequate competition but otherwise avoid interfering in the economy,” succeeded in preventing “German policymakers from being tempted by excesses like those of Hitler and Stalin.” And yet its “emphasis on personal responsibility” ruled out “the idea that actions that are individually responsible do not automatically produce desirable aggregate outcomes.” 

As a result, “it rendered Germans allergic to macroeconomics.”

But, as James points out, ordoliberalism was a response to Germany’s need for “a complete change of its domestic regime to break out of its cycle of debt and default.” That experience, he argues, informs Germany’s approach to the eurozone in general, and to its highly indebted member countries in particular: “without a fundamental reorientation of a country’s politics, the thinking in Germany goes, debt forgiveness will always remain a futile exercise.”

Jürgen Jeske, a former publisher of the newspaper Frankfurter Allgemeine Zeitung, questions the sincerity of that thinking. Germany’s “current economic dominance,” Jeske argues, “has been built on a policy framework that stands in direct opposition to” Erhard’s doctrine, which he adamantly defends. The truth, according to Jeske, is that Merkel’s government has abandoned ordoliberalism in favor of an economic strategy that “has been haphazard, driven more by political expediency than by any underlying philosophy.” As a result, “Germany’s policymakers seem to be stumbling from decision to decision” and “reacting with no clear sense of direction to the demands of the moment.”

Only non-Germans, it seems, need to stick to the rules.

Some fear that Germany’s foreign policy has become similarly two-faced. 

Slaughter is convinced that Germany remains a pillar of the West in terms of its allegiance to NATO and European unity. She cites a high-level report, “the product of several months of debate within the German foreign-policy and security community,” which “identifies Germany’s current values and interests as a commitment to ‘human dignity, freedom, democracy, the rule of law, and to an international order that is based on universal norms.’”

But Yuriko Koike, Tokyo’s newly elected Governor, is not so confident. She fears that the scale of Germany’s economic ties with Russia and China is injecting a form of “stealth neutralism” into the country’s diplomacy.

Indeed, Germany happily relied on the UK to take a tough stance against Russia after its annexation of Crimea and incursion into eastern Ukraine. Now, the UK’s departure may clear the way for a new Ostpolitik with Russia. As German Foreign Minister Frank-Walter Steinmeier suggested recently, “we should heed the lesson of détente: however deep the rifts, we must try to build bridges.” 

Nonetheless, Europe, Steinmeier wrote last year, “remains the foundation of Germany’s foreign policy,” and that “Germany is capable of acting effectively” to shape global developments “only within a solid European framework.” Likewise, Wolfgang Ischinger, a former German ambassador and current head of the Munich Security Conference, argued well before the Brexit vote that “Germany has an opportunity to provide a counterweight to long-standing British objections” against a more integrated European Foreign and Defense Policy. “By putting its considerable influence in the service of a cohesive, strategically focused foreign and security policy,” Ischinger argued, “Germany would simultaneously achieve two key objectives: a stronger and more capable EU and a more European Germany.”

Slaughter takes this view a step further. She calls for a “deepening” of the EU “through measures that would include democratizing EU financial decision-making by directly engaging national parliamentarians and exchanging tighter European fiscal constraints on member governments’ budgets for a European banking union, a eurozone budget, and Eurobonds.”

All of these ideas are of course currently anathema. But Volker Perthes, the chairman of Stiftung Wissenschaft und Politik (the German Institute for International and Security Affairs, which published the report cited by Slaughter), seems to understand that hostility to further European integration is incompatible with Germany’s own security. 

Germany’s willingness to play a greater role in a common foreign and defense policy reflects a fundamental truth: the “dividing lines between domestic and international affairs,” as Perthes puts it, “have become increasingly blurred.” Exhibit A is the refugee crisis, which “demands policy interventions in areas as diverse as defense, development aid, European integration, domestic security, and social-welfare policy.”

However Jacek Rostowski, a former finance minister and deputy prime minister of Poland, is unimpressed. He goes even further than Koike, arguing that Germany’s “misguided imposition of austerity on the eurozone has undermined European political cohesion, thereby opening the door for Russian revanchism and aggression.” 

In Rostowski’s view, US presidential candidate Donald Trump has a point in accusing European NATO members of free-riding on the US. Only four European NATO states meet the Alliance’s 2%-of-GDP target for defense spending. One of the four, ironically, is Greece. By contrast, Germany’s defense spending, at just 1.2% of GDP, falls far short of its obligation. Rostowski doesn’t mince words: “The US should tell Germany – in the same no-nonsense terms that Germany used with Greece – that it cannot defer to the US for its security while undermining Western unity to protect its taxpayers from possible intra-eurozone liabilities.” 

If Germany and the eurozone countries are serious about resolving the euro crisis and halting the EU’s unraveling, a more federal institutional structure is needed, so that internal trade imbalances can be corrected through obligatory transfers of resources from one part of the currency union to another. Of course, Germany would have to contribute the most to stabilization efforts, which is why it has resisted such moves in the past.

Last year, however, Otmar Issing, a founding ECB board member and chief economist, wrote that “Europe’s current crisis has convinced many that existing institutional arrangements are unsustainable,” and suggested that the absence of “progress toward political unification” since the euro’s introduction “may be about to change.” Brexit has certainly confirmed Issing’s diagnosis, if not his forecast.

Issing himself is highly skeptical of prospects for political integration: “voters are far from enthusiastic about the prospect of ceding more authority to Europe.” And, in the absence of “true political unification,” any “transfer of fiscal competencies to the European level” would imply “serious risks.” As a result, for the time being, “political responsibility for higher transfer payments among countries must remain with the national governments, controlled by national parliaments and electorates.” 

Political unification, too, carries risks. “The danger”, argues Hans-Werner Sinn of Munich University and the Ifo Institute, is “that collective decision-making bodies not only provide services that are useful to everybody, but also may abuse their power to redistribute resources among the participating countries.”

For Sinn, this is not merely a matter of closing the EU’s infamous “democratic deficit” – the supposed lack of accountability that played a large part in the Brexit vote. (In fact, the most important decisions at the European level are made in the European Council, which comprises all of the – democratically elected – leaders of the member states.) Rather, the problem for Sinn is that “even democratic bodies are not immune” from temptation. “On the contrary, they make it possible for majorities to exploit minorities.” This is why such “bodies invariably need special rules to protect minorities, such as the requirement of qualified majority voting or unanimous decision-making.”

Sinn doesn’t say it, but his proposed constraints on political majorities are part and parcel of federalism. James agrees, arguing that Germany “is uniquely suited to act as a model for Europe, owing to its federal character, which is reflected in strong constitutional guarantees of states’ rights.” And, before the Brexit vote, Germany’s finance minister, Wolfgang Schäuble, had proposed a plan for limited political union. 

But Yanis Varoufakis, a former finance minister of Greece, finds fault with Schäuble’s proposal. “Schäuble,” he explains, “favors a formalized Eurogroup (composed of the eurozone’s finance ministers), presided over by a president who wields veto power – legitimized by a Euro Chamber comprising parliamentarians from the eurozone member states – over national budgets.” In exchange for giving up control over their national budgets, Schäuble promised countries such as France and Italy a common European budget that would partly fund unemployment and deposit-insurance schemes.

Varoufakis thinks that plan is too minimalist to work: “Nothing short of macroeconomically significant institutional reforms will stabilize Europe.” To get there, Varoufakis envisages a “pan-European democratic alliance of citizens” that can “generate the groundswell needed for such reforms to take root.”

A movement of that type would be welcome, but it needs a strong leader. Merkel, despite her current travails, can be that leader. Indeed, she appears to be the only possible choice on the horizon. 

If Europe found the will to push institutional reforms in the right direction, Merkel could become the EU’s first elected president. But to generate the will for the more integrated Europe that such a position would require, she must overrule Schäuble.

And she must do so soon. Another banking crisis is looming in Italy, where Prime Minister Matteo Renzi’s government may not survive a referendum in November on constitutional reform. As Renzi tries to stem growing support for the populist Five Start Movement, which favors withdrawal from the eurozone, he, like French President François Hollande, has held firm against austerity.

The emergence of an anti-austerity axis among Europe’s other large economies, together with the UK’s departure, means that Europe will not become more “German” anytime soon. The reality is that German-fostered austerity has failed – and now Europe needs growth. For that to happen, Germany must become more “European.” As George Soros has put it, the choice for Merkel, her government, and for Germany is straightforward: “lead or leave.”  Hugo Drochon