Currency and Financial Markets Europe Macroeconomics

Delusional Gemany

This article was first published on Project Syndicate on 14 November 2013.

In recent days, Germany’s representative on the European Central Bank’s governing council has expressed strong disagreement with the ECB’s decision on November 7 to cut its benchmark interest rate. Now the European Commission has opened an investigation into whether or not Germany’s huge current-account surplus is causing economic damage in the European Union and beyond. This investigation and criticism of Germany’s export-based growth model has incited outrage in Germany. Is Germany becoming a scapegoat for Europe’s problems, or is it really out of step with the EU and the world economy?

Germans have long been among the most europhile of peoples, but their mood has gradually been turning against Europe and its common currency, the euro. An openly anti-euro political party has emerged, and, though it did not make it into the Bundestag in September’s general election, it has fertile ground to grow. This is tragic, because Germany should be driving the development of a persuasive vision for Europe’s future.

Three illusions are responsible for the German public’s growing aversion to European integration – and for many Germans’ failure to understand that Germany has the most to lose from the euro’s collapse.

For starters, Germans are convinced that they have weathered the crisis extraordinarily well. Although GDP growth slowed sharply in 2009, it recovered quickly; Germany’s economy is now 8% larger than it was then. Likewise, the unemployment rate has fallen throughout the crisis, reaching 5.2%, the lowest level since reunification. And the German government’s commitment to fiscal consolidation enabled it to achieve a surplus last year; by 2018, the fiscal surplus is expected to amount to 1.5% of GDP.

Such figures have fueled the perception that Germany’s economy is booming, and that its future would be even brighter if the eurozone’s weaker economies were not dragging it down. But, viewed from a longer-term perspective, Germany’s economic performance is actually rather disappointing. A DIW Berlin study shows that, since the monetary union’s launch in 1999, Germany has recorded some of the eurozone’s lowest rates of GDP and productivity growth.

Moreover, real wages have barely risen; for more than 60% of German workers, they have actually fallen. Wages have risen substantially more elsewhere in Europe, despite the depth of the economic crisis. Given that Germany also has one of the eurozone’s lowest investment rates, its GDP growth is likely to be among Europe’s slowest in the coming years, making significant wage increases unlikely.

Of course, Germans are not entirely wrong; the crisis in Europe’s periphery is weakening Germany’s economic-growth prospects. But they should remember that, only a decade ago, Germany was the “sick man of Europe,” and that strong growth and dynamism elsewhere in Europe contributed substantially to its recovery. And they must recognize that Europeans are all in the same boat; what is good for Europe is good for Germany, and vice versa.

The second illusion that blinkers many Germans is that other European governments are after their money. As a result, Germany has been reluctant to engage fully in the debate about a European banking union, owing to the belief that it would expose German taxpayers to major risks and unknown costs through bank restructuring and deposit insurance. Similarly, Germans have been critical of the ECB’s monetary-policy instruments, especially its “outright monetary transactions” program, with opponents appealing to the German constitutional court to invalidate the OMT scheme’s conditional purchases of eurozone government debt.

Such opposition seems counter-intuitive, given that the ECB’s mere announcement of the OMT program calmed sovereign-debt markets and reduced borrowing costs in peripheral countries. Indeed, simply by providing a credible backstop against the risk of a eurozone collapse, the scheme has become one of the most successful measures introduced by any central bank in recent history. The most reasonable explanation for Germany’s response is that many Germans harbor a deep mistrust of other European governments, and thus believe that they cannot be counted on to avoid insolvency.

Germany’s third illusion is that the current crisis is ultimately a euro crisis. While it is tempting to scapegoat the common currency, the fact is that the euro has brought huge economic and financial benefits to Germany, owing to increased trade, greater price stability, more competition, and improved efficiency.

Furthermore, the eurozone crisis does not have the characteristics of a currency crisis. The euro is not overvalued or poorly managed, which would undermine competitiveness and erode confidence in the currency’s long-term stability. On the contrary, the remarkable resilience of the euro’s exchange rate vis-à-vis all other major currencies demonstrates enduring faith in the euro’s viability and stability. What financial markets no longer believe is that governments will do what it takes to rescue Europe from the crisis.

The argument that the crisis stems from the eurozone not being an optimal currency area is similarly flawed. No economy is an optimal currency area; there are substantial differences among US states and even across Germany’s Länder. The main challenge to the euro’s long-term viability is the lack of political will to implement complementary policies, such as a banking union and a credible fiscal union.

While the eurozone economy’s outlook has improved, it is not out of danger. A deep crisis in any member country is likely to become contagious. Given Germany’s trade and financial openness, as well as the leadership responsibility that accompanies its economic strength, it would face particularly high costs.

Against this background, Chancellor Angela Merkel’s third government, once it is formed, must rid the country of the illusions that are preventing it from playing a proactive and constructive role in ensuring that Europe functions as a union. Such an undertaking requires, above all, the restoration of trust among European countries. While that will undoubtedly be difficult to achieve, it is Germany’s only real option – and Europe’s real hope.

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