Judy Asks: Is Merkel’s Fight for Austerity Over?

Let’s hope so! Whereas austerity may be a personal virtue, it is a misplaced guide for public policy in times of economic duress. Explaining Chancellor Angela Merkel’s aversion to fiscal and monetary expansion is simple enough. After all, why should responsible Germans pay for the profligacy of others? The more interesting question, however, is why it took the rest of Europe so long to realize that austerity cannot bring recovery. Somehow the lessons of the 1930s seem to have been lost in a serious bout of collective amnesia.  Perhaps the answer is to be found in post-war developments within the academic study of economics, where the development of macroeconomic theory in pursuit of public policy goals has been neglected in favor of microeconomic models that focus on maximizing individual efficiency and profits? But the current crisis should remind us that seemingly straightforward policies quite often prove to be inappropriate responses for systemic crises.

It is not only Angela Merkel’s fight for austerity. Europe has accumulated too much debt. Growth based on new debt is unsustainable. Austerity is part of the solution to remedy that.

The advent of François Hollande on the European stage has ignited the clamors for growth policies. Where this is right is that one can belt-tighten so quickly and firmly that one suffocates. And secondly, European indebted countries need to continue investments in policies that secure competiveness and growth in the future. At the moment Spain is also slashing spending on research and development. That’s too much austerity since it also reduces future growth opportunities.

Yet where Hollande and France shouldn’t be an example is on debt and lack of reform. France has sponsored growth through debt for nearly forty years by running government deficits. That shouldn’t be Europe’s path. And France—apart from the timid reform on the retirement age under Sarkozy—has been loath to undertake deep reforms that enhance competiveness and unleash labor markets. That shouldn’t be the future of Europe.

In 2010, Europe had aimed for becoming the “the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion”. That failed. Now the target date is 2020. The right mix to arrive at that goal is cutting down on debt (read: austerity), structural reforms and putting priority on research and innovation and targeted growth measures so that future growth prospects aren’t derailed.

Angela Merkel is facing a bitter dilemma. Not only that, she is personally committed to her tough austerity measures. While pursuing them, she is also in full accord with the majority of the German public. However, what is her asset in domestic politics becomes more and more a handicap in the European arena. This is no unusual conflict even though it mostly comes the other way around: what sells well in Europe causes domestic trouble. Here what sells well in Germany does not find a good market in Europe.

Merkel has little room to maneuver. After the lost elections in North Rhine-Westphalia and the dismissal of her environment minister, Norbert Roettgen, she is under growing pressure. Her flagship Energiewende is not sinking but sailing through tough waters. As the defender of fiscal discipline—and German taxpayer’s money—she enjoys broad support from the German public. This is why she cannot give in without putting her power base at risk.

But the German public wants Merkel not only to be right, but also successful. For that she needs France. Many Germans hoped that François Hollande, after speaking lyrics in the election campaign, would switch to the prose of government. So far he has not met these expectations. Will he after the parliamentary elections? This is far from certain.

The good news is they need one another. Hollande may remind the Germans that France, even weakened, is an indispensable partner. He can have no interest in alienating France’s powerful neighbor. Anti-European resentments in Germany would have disastrous consequences. The current crisis is a defining moment. European nations will remember it for long time– those who are suffering like Greece and Spain but also those who are helping like Germany. The question is not whether Angela Merkel will cross the traditional German red lines in fiscal policy, but whether she will be able to move them without losing credibility and satisfy both her voters and French partner. Should she fail, not only austerity, but also Angela Merkel’s leadership may be in danger.

So far Frau Merkel has been waging a war of attrition, not movement. She has been hiding behind a trench of "No", waiting for the events to evolve. True, Germany eventually provided support to stop the crisis in Greece, but begrudgingly and with no coherent overall vision. Hollande’s victory in France, Monti’s steady mediation, Draghi’s prudent talk of growth, and Obama’s pressure nearing the November election, are forcing Merkel to act. She will continue to proceed with small steps, hoping this will be enough to check events in southern Europe and win elections in Germany in 2013. It sounds like a cautious, safe route, it is in fact very dangerous: for Merkel, her party, Germany, Europe, and the global economy.

No doubt, after the election of François Hollande and the defeat of her close ally Nicolas Sarkozy, Angela Merkel is facing a tough fight in Europe and German politics is also picking up on that. The Social Democrats—in the year before the 2013 general election and just after a major victory in Germany’s biggest state, North Rhine-Westphalia—are trying to find their own position on how to handle the euro crisis (until now they have supported each and every Euro bill Merkel has tried to pass through parliament). In addition, a growing number of prominent CDU members are distancing themselves from the way Angela Merkel has kicked her environmental minister out of office (he was responsible for the heavy electoral defeat in North Rhine-Westphalia).

She will only have a smooth ride in next year’s election if she stays on top of the euro crisis and comes across as someone who manages the issue well. At the moment, opinion polls show this to be the most pressing issue on people’s mind—if unemployment becomes the most important issue again (it has been the most important issue for the last 20 years!), it will be an uphill race because this is the home-turf of the SPD, and also the LINKE.

And this might be Hollande’s strategy. We will see.

Angela Merkel is likely to ease back on her austerity über alles approach in small ways but she cannot abandon it as the German voter will not allow any policies which will require further major transfers of German money to other Europeans. Despite the calls in Germany for more, rather than less Europe, when the choice is between more Europe or more German money, Europe will lose out. The European project has clearly reached its limits to the degree that it is identified with monetary union. Unifying Europe today resembles the choices West Germans faced in 1990 when they decided that their Germany worked and the other Germany did not and simply enlarged the West German political and economic system to the former East Germany. Today Germans still believe that their model works and given the enormous costs and transfers to eastern Germany, they are not about to dilute this for the chimera of European solidarity. The irony of today is that the Euro was the project of the pro-European Helmut Kohl, who thought a common currency would cement a unified Europe. Of course the Euro would be the Deutsche Mark writ large. Rather than resulting in a European Germany, a German Europe has emerged which is no longer sustainable within Germany, or outside it.

The fight for austerity is here to stay. What is over, for the time being, is the ordering of policy priorities, of which German Chancellor Angela Merkel was the principal spokeswoman, which saw austerity first, followed by structural reforms, which would then, automatically, lead the way to a glorious era of growth and employment. That ordering worked in the German context. But it has not and perhaps cannot be the one-size-fits-all solution for all countries at all times. It certainly cannot be the one and only recipe for Greece, Spain, and Italy at the current juncture. As highlighted by the presidential elections in France and dramatically revealed by the parliamentary elections in Greece, austerity first and only does not fly in democracies under duress. The political pendulum is thus swiftly turning towards growth. Yet the craftsmanship at play at the G8 is that of presenting austerity and growth not as opposite ends of the macroeconomic policy spectrum. The aim is that of simultaneously promoting growth while imposing budget austerity. What remains nebulous in the extreme is how to square the circle. Beyond supply side reforms, the question remains to what extent and how to reinterpret austerity by pursuing not only a completion of the single market and rising prices and consumption in creditor countries like Germany, but also allowing fiscal multiplier spending in debtor countries in deep economic crisis.