Monday, September 1, 2014
5

Germany’s Neighborhood Watch

FRANKFURT – On a recent trip to Germany, I was struck by two distinct narratives. One narrative features a robust German economy with low unemployment, strong finances, and the right competitive position to exploit the most dynamic segments of global demand. The other narrative describes an economy that is encumbered by never-ending European debt crises whose perpetrators seek to shift their responsibility – and their financing needs – onto Germany’s pristine balance sheet.

Both narratives are understandable. But they cannot co-exist forever. After all, it is difficult to be a good house in a deteriorating neighborhood. Either the neighborhood improves, or the value of the house declines. And it matters a great deal which narrative prevails – for Germany, for Europe, and for the global economy.

Germany today is reaping the benefits of many years of responsible domestic economic management. In addition to maintaining sound public finances, German leaders implemented difficult structural reforms aimed at improving international competitiveness, including painful labor-market reforms. As a result, Germany is one of the few advanced economies today that has created many jobs and maintained financial stability. In other words, it is the AAA of AAAs.

Yet Germany is also part of a highly challenged neighborhood, if not its anchor. Its neighbors include countries – most notably on the eurozone’s periphery – that are struggling. They have high overall unemployment (and alarmingly high youth joblessness), and are unable to grow on their own power. In some cases, they also face solvency questions, and are far from achieving the socio-political consensus needed to get their economic houses in order.

To state the obvious, this contrast between Germany and its neighborhood is very awkward. It fuels endless internal and external tensions, encourages finger pointing, and promotes a loud and disruptive blame game. And all of this distracts attention from the need to compete in a rapidly changing global economy.

The longer all of this persists, the more it tears at the fabric of European unity. Accordingly, European officials need to continue to make steadfast progress in three major areas:

·         Improve individual countries’ domestic policy mix in a manner that targets debt sustainability through both growth promotion and deficit reduction, especially in the most vulnerable peripheral economies;

·         Enhance the eurozone’s internal financial circuit breakers to reduce the risk of disruptive financial feedback loops and destabilizing multiple equilibria; and

·         Strengthen the eurozone’s institutional underpinnings, as well as its mechanisms for policy coordination and peer review.

None of these steps is easy; and they are certainly not automatic. Moreover, to maximize their effectiveness, they must be implemented simultaneously; indeed, this is a situation in which one plus one plus one equals more than three. And this will not happen unless two other, even more controversial steps are taken.

First, Germany must play an even larger role in conducting and coordinating the eurozone’s policy responses. I know that many Germans are uncomfortable with this. But there is no workable alternative for Europe’s well-being – and, therefore, that of Germany.

The European Union’s institutions still lack the authority and credibility needed to take on this role. The European Central Bank does not possess the proper structural policy tools, and it has already been forced to bear burdens that, arguably, are beyond its strictly defined mandate. And there is no other economy that comes close to Germany in size, influence, and economic and financial health.

Second, the eurozone, led by a Germany that is working closely with France, needs to clarify decisively what it intends to look like in the medium term. There are two alternatives, both sensitive and controversial, and the choice is for Europeans alone to make and sustain; but they must make it if they are decisively to put behind them the risk of eurozone fragmentation.

On one hand, they can decide to let politics dominate economics. This is not easy for politicians to sell, especially in the core countries (particularly Germany, Finland, and the Netherlands), as it would involve large multi-year subsidies to the periphery – or the analytical equivalent of the difficult decision made over 20 years ago to reunify Germany at a currency parity. Here, however, there is the added difficulty of a potential conflict between regional politics and national democratic processes.

On the other hand, they can decide to allow economics to prevail. Here, eurozone members would collectively opt for a smaller and less imperfect union that includes countries with more similar initial conditions – economically, financially, politically, and socially. And, again, there is no easy way to do this, especially given that the eurozone was intentionally designed with no exit in mind.

Until these difficult and controversial decisions are made, periods of relative tranquility in Europe are likely to be interrupted by the recurrent eruption of financial instability and bouts of political bickering and dithering. And the longer this continues, the greater the risk that Germany’s neighborhood will erode the robustness of what the country has painstakingly built.

Ultimately, there can be no strong Germany without a stable eurozone; no stable eurozone without a strong Germany; and no global economic stability without both. It is time for Europeans to make the difficult longer-term choices that are critical to sustaining and enhancing their historical regional project.

Read more from our "The Euro at Bay" Focal Point.

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  1. CommentedPierre ratcliffe

    "Ultimately, there can be no strong Germany without a stable eurozone; no stable eurozone without a strong Germany; and no global economic stability without both. It is time for Europeans to make the difficult longer-term choices that are critical to sustaining and enhancing their historical regional project."

    Having revisited Keynes in general and his book of 1919 "the economic consequences of the peace" in particular,

    http://tinyurl.com/btg8dx9

    I find continuity in Europ's quagmire - with Germany again in the forefront, although in a different way. Today, how can a European market economy emerge with each member state clinging to its soverainty, governed by its own political, institutional and social system? Each country cannot produce the same goods and services in competition with each other. If Europ is to become some day, in the near or far future, a "nation", there has be specialisation and sharing. And as the world will continue to evolve, this requires that the more efficient and successful support those most affected by the changes.

  2. CommentedAndré Rebentisch

    You have to understand an ordoliberal mindset. The question is not if the house wins or loses. The question is if the situation is under control and the relations are reliable. In economics we could always twist the argument. The politically irresponsible reaction to austerity measures is blaming the creditors. Thus, the real crisis is responsible governance and reliability. We are already in a mode where the EU treaty is broken . Austerity is the appropriate control measure for a situation which was illegal under the treaties. In a state of exception Germans desire a swift return to order.

  3. CommentedKevin Lim

    All politics is local. The recent drubbing of Merkel's party in the polls virtually assures that there will be no change in Germany's insistence on austerity as the bitter antidote for Europe's ills (notwithstanding serious doubts as to the antidote's efficacy). The German public may be sympathetic to pro-growth policies but only in the domestic context. Otherwise, the reluctance to bail out feckless Greeks and Spaniards remains as strong as ever.

  4. CommentedEmre Konukoglu

    I think before assuming that Germany is going to take on this role we have to analyse the historical background to EU's formation. Given how Europe has dealt with inter-country conflicts in the past (i.e. world wars), I don't see how this assumption can have any viability....

  5. CommentedZsolt Hermann

    I think the last paragraph is the most important:
    "...Ultimately, there can be no strong Germany without a stable eurozone; no stable eurozone without a strong Germany; and no global economic stability without both. It is time for Europeans to make the difficult longer-term choices that are critical to sustaining and enhancing their historical regional project..."
    If we take seriously what we learn about our global system, that we are "all sitting on the same boat", we are interconnected and interdependent, than is there any possibility that there would eminent individuals, or nations that could pull away from the rest?
    Even the crisis we are in now is our common responsibility, Germany is just as responsible for the Greek and Spanish woes as the Greek and Spanish themselves.
    We all live in the same illusory system of constant growth and prosperity in a closed finite system.
    We all think that quantitative growth is the most important measure of our progress instead of a qualitative, mutual integration, providing each and everybody with necessities that are the basic conditions in our global, integral system, since I cannot prosper, progress unless the whole system is in balance and functions optimally.
    The first step in the recovery process is actually understanding the new system we exist in and our role in it.

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