«The good citizens of Germany might think it inconceivable that Germany might someday have to restructure its debt. But history suggests otherwise.»
If one has only one word with which to sum up the results of the recent German election, that word would be complacency. I was there earlier in the month, and the sense of complacency was palpable. The commentariat, like the voters, was more than happy with Mrs. Merkel’s stewardship of the economy. They were also tolerably satisfied with her handling of the euro crisis. The chancellor had delivered on her promise of doing «whatever it takes» to hold the euro together. Her reasonably tough line vis-à-vis Greece had prevented Germany from being taken as a pansy with an open pocket book.
Thus, German voters were more than ready to give Mrs. Merkel’s Christian Democrats enough seats in the Bundestag to guarantee more of the same. There may be much intrigue around the identity of her prospective coalition partners, the defeated Christian Democrats or the increasingly centrist-dominated Greens. But the answer will make little difference for economic policy. The Greens may pull the chancellor a little bit further in the direction of environmentalism and clean energy, but she has moved quite far in that direction already. The Social Democrats would like her to be even more supportive of the European project, but she is quite supportive of the EU already, and the Social Democrats have not been able to offer much in the way of an alternative. In any case, Mrs. Merkel has sufficient public support, in the wake of the election, to resist being pulled very far off her preferred course, whatever the direction.
In terms of the euro, this means that there will be no post-election «surprise» of the sort predicted by some champions of the single currency. 2013 has not exactly been a year of great progress in resolving the euro crisis, to put an understated gloss on the point. The return to growth in Southern Europe has been halting. Progress toward banking union has been hesitant. There has been no restructuring of Greece’s debt to its official creditors – the ECB and the IMF. Whether Portugal and Ireland will be able to return to the markets or, instead, require a second rescue package remains unclear. And the biggest problem is yet to come, namely an Italy that is unable to grow, incapable of reforming, and burdened with what increasingly looks like an unsustainable debt.
Angela Merkel will not pull a rabbit out of her hat
I can’t count the number of times over the summer I was told that the eerie silence of those putatively responsible for addressing these issues was due to the impending German elections. The radical reforms needed to decisively address these problems were toxic to German voters. The election had to take place before new policy initiatives could be rolled out.
This was always naïve. Mrs. Merkel is not about to pull a rabbit out of her hat. Rather, she was always going to stay the course. Her temperament is perfectly attuned to that of her public. She is content with the status quo, just as the German public is content. It is not her way to accept, much less offer, radical changes in policy strategy. The IMF has just told her that the growth of German GDP should accelerate further to 1.4% in 2014. Southern Europe may be suffering, but who is to say that a little suffering is bad for the soul?
A little suffering may not be bad for the soul, but it is bad for stability. There is still the possibility that high unemployment and continuing recession may result in a sudden vote of no confidence in the Greek or Italian government. Portugal and Ireland may fail in their efforts to regain bond market access. A big bank failure in Italy or Spain might alarm investors. Complacent Germans evidently believe that the status quo is tenable. In fact, any number of untoward events could upset the applecart. At that point, the crisis will be back with a vengeance.
Mrs. Merkel and other German leaders could in principle take steps to shatter the prevailing sense of complacency. They could drive home that the risks are very real. They could emphasize that just because the euro has survived a difficult five years is no guarantee that it will survive five more, absent fundamental policy reforms.
Specifically, they could argue that the risks can be adequately addressed only by creating an full-fledged banking union – not just a single supervisor empowered to require European banks to raise adequate capital, but also a common deposit insurance scheme and a jointly-funded resolution mechanism – along with a jointly-funded pan-European unemployment insurance fund. The banking union would break the «diabolic loop» between banking problems and sovereign debt problems. The jointly-funded unemployment insurance fund would provide for limited transfers from low to high unemployment regions, like those which operate in the United States.
The question is how to make the case. German leaders could start by observing that the common presumption that Germany will be a net contributor to these mechanisms is far from assured. Just because the German economy has been performing handsomely in the past is no guarantee that it will do so in the future. The country’s low investment rate and ageing infrastructure do not bode well for the future of productivity growth. The highest rated German university, according to the Shanghai Rankings, is the Technical University of Munich at number 50, which is not particularly impressive. The country’s sustainable energy policy is a logistical nightmare that, going forward, will weigh down German firms’ export competitiveness.
Above all, there are Germany’s dreadful demographics. Germany’s population is already shrinking. The fertility rate has dropped to fewer than 1.5 children per woman. The country is now taking steps to raise fertility rates, giving tax breaks for families with children and stay-at-home mothers. But whether encouraging mothers to stay at home rather than work is the best way of growing the labor force is dubious. And even the best-laid plans for raising fertility will impact the growth of the labor force only after 20 or more years.
One day, Germany might be at the receiving end
Germany’s demographic decline, in other words, is baked in. So too, therefore, is the decline of its economy. Together, these factors imply that the possibility that Germany will eventually number among Europe’s sick economies cannot be dismissed. Policies that transfer resources from booming to depressed regions might, in fact, benefit Germany. The country’s leaders need to make the case.
They also need to make the case that debt restructuring is not just for other countries. As George Soros has recently observed, Germany restructured its own debt three times in the 20th century: in 1924 as part of the Dawes Plan, in 1929 as part of the Young Plan, and after World War II as part of the Marshall Plan. The good citizens of Germany might think it inconceivable that Germany might someday have to restructure its debt. But history suggests otherwise.
This would not be a message of complacency. Sending it would be out of character for Mrs. Merkel. But when better to step out of character than immediately after a successful election run? Not doing so would only allow problems and risks to mount further, not just for the euro but for Germany itself.